UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K/A
AMENDMENT NO. 1 TO FORM 10K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended April 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from ____________________ to ____________________
Commission File Number: 0-21793
VERSATILITY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-1214354
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
11781 Lee Jackson Memorial Highway
Seventh Floor
Fairfax, Virginia 22033
(703) 591-2900
(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing sale price of the Common Stock on July 14,
1997, as reported on the Nasdaq National Market was approximately $30,842,559.
Shares of Common Stock held by each executive officer and director and by each
person who is known to own 5% or more of the outstanding Common Stock have been
excluded from this computation in that such persons may be deemed to be
affiliates. This determination of affiliate status is not a conclusive
determination for other purposes. As of July 14, 1997 the Registrant had
7,355,753 shares of Common Stock outstanding, par value $.01 per share.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement dated July 28, 1997
delivered to the Stockholders in connection with the Annual Meeting of
Stockholders to be held on August 26, 1997 are incorporated by reference in Part
III hereof.
TABLE OF CONTENTS
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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
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THE UNDERSIGNED REGISTRANT HEREBY AMENDS THE FOLLOWING ITEMS, FINANCIAL
STATEMENTS, EXHIBITS OR OTHER PORTIONS OF ITS ANNUAL REPORT ON FORM 10-K AS SET
FORTH HEREIN. THIS ANNUAL REPORT ON FORM 10K/A IS FILED IN CONNECTION WITH THE
COMPANY'S RESTATEMENT OF ITS CONSOLIDATED FINANCIAL STATEMENTS FOR THE FISCAL
YEAR ENDED APRIL 30, 1997. EXCEPT AS OTHERWISE NOTED, INFORMATION CONTAINED IN
THIS REPORT IS AS OF APRIL 30, 1997.
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PART I
THIS DOCUMENT CONTAINS VARIOUS FORWARD-LOOKING STATEMENTS AND
INFORMATION THAT ARE BASED ON MANAGEMENT'S BELIEFS AS WELL AS ASSUMPTIONS MADE
BY AND INFORMATION CURRENTLY AVAILABLE TO MANAGEMENT. SUCH STATEMENTS ARE
SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES WHICH COULD CAUSE ACTUAL RESULTS TO
VARY MATERIALLY FROM THOSE CONTAINED IN SUCH FORWARD LOOKING STATEMENTS. SHOULD
ONE OR MORE OF THESE RISKS OR UNCERTAINTIES MATERIALIZE, OR SHOULD UNDERLYING
ASSUMPTIONS PROVE INCORRECT, ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE
ANTICIPATED, ESTIMATED, EXPECTED OR PROJECTED. CERTAIN OF THESE RISKS AND
UNCERTAINTIES AS WELL AS OTHER RISKS AND UNCERTAINTIES ARE DESCRIBED IN FACTORS
WHICH MAY EFFECT FUTURE OPERATING RESULTS HEREIN AND IN THE COMPANY'S
REGISTRATION STATEMENT ON FORM S-1 FILED UNDER THE SECURITIES ACT OF 1933, AS
AMENDED, AND DECLARED EFFECTIVE ON DECEMBER 12, 1996.
ITEM 1. BUSINESS
OVERVIEW
Versatility is a leading provider of client/server customer interaction
software that enables businesses to automate and enhance their telemarketing and
teleselling capabilities. The Company's software products are designed to
increase the productivity and revenue-generating capabilities of organizations
operating call centers to interact with existing and potential customers. The
Company's products include desktop software applications, development and
customization tools and optional server-based software services, and support a
wide variety of leading computing platforms, allowing users to implement a
scalable, flexible and interoperable software solution that can be used
independently or as part of an integrated enterprise-wide customer interaction
implementation. Versatility also offers fee-based professional, consulting and
maintenance services to provide implementation, integration and ongoing support
of the Company's software products.
The Company's products are used by customers operating large and
mid-sized call centers for activities including telebanking, claims servicing,
customer service, consumer product telesales and other applications. Since
introducing the VERSATILITY SERIES in May 1995, the Company has licensed
VERSATILITY SERIES applications for use on over 12,000 agent desktops. The
Company's customers include Avantel, S.A., British Telecommunications, Plc,
Chase Card 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.
In August 1996, the Company released the VERSATILITY CALLCENTER
client/server packaged software application which provides the basic features
and functions of the Versatility Series desktop applications to smaller formal
or informal call centers, typically found in mid-sized companies or departments
of larger organizations. Customers using the VERSATILITY CALLCENTER product can
expand to the more scalable VERSATILITY SERIES.
PRODUCTS
The Company's products include the VERSATILITY SERIES, a suite of
modular applications that includes optional software-based marketing and
telephony services. The VERSATILITY SERIES can be modified with available
customization tools and is designed to support customers with large user
populations. For smaller installations, the Company offers VERSATILITY
CALLCENTER (see subsequent developments) which includes key elements of the
VERSATILITY SERIES applications, scaled to support 50 users or less.
VERSATILITY SERIES. The VERSATILITY SERIES is generally marketed to
large organizations operating formal call centers. At the core of the
VERSATILITY SERIES are the VERSATILITY CALL CENTER APPLICATIONS, which allow
call center agents to effectively conduct telemarketing, telesales and customer
services activities. VERSATILITY SERIES customers purchase one of the
VERSATILITY CALL CENTER APPLICATIONS and usually purchase one or more optional
services from either the VERSATILITY MARKETING MANAGEMENT SERVICES or the
VERSATILITY OPEN TELEPHONY SERVICES.
The VERSATILITY SERIES includes applications to address telemarketing,
telesales and customer services activities with VERSATILITY
TELESALES/TELESERVICE. The Company was also developing two additional
applications, VERSATILITY FINANCIAL SERVICES and VERSATILITY TELECOM, which will
include the same architecture and core functionality as the Company's current
application, with additional features specifically designed to address the
financial and telecommunications industries. The VERSATILITY SERIES supplies a
call center agent with customer information as an outbound telephone call is
made or as an inbound call is routed to that agent. Once customer contact is
made, an agent can access product information, such as features, benefits and
commonly asked questions, in order to effectively and accurately market and sell
that product. An agent can then click to descriptions of other products to
cross-sell or up-sell. To close a sale, an agent can access on-line order taking
and fulfillment capabilities. Building on these core functions, the VERSATILITY
SERIES provides additional capabilities to generate on-line quotes, readily
access information regarding discounts and schedule automatic customer
call-backs.
All VERSATILITY CALL CENTER APPLICATIONS are Windows-based and are
integrated with the VERSATILITY POWERGUIDE facility, a presentation support tool
providing call guides and scripting capabilities. VERSATILITY POWERGUIDE enables
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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.
In addition to VERSATILITY CALL CENTER APPLICATIONS, the VERSATILITY SERIES
provide network server services, called the VERSATILITY MARKETING MANAGEMENT
SERVICES, which provide the call center network and its managers with a number
of capabilities, including list, database and campaign management, adaptive
marketing, statistical tracking, data warehousing, decision support, document
production, integration with document management systems and centralized call
center operations management. Additionally, the VERSATILITY SERIES CTI services,
called VERSATILITY OPEN TELEPHONY SERVICES, 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.
VERSATILITY CALLCENTER. In August 1996, the Company released VERSATILITY
CALLCENTER, a CD-ROM-based call center software application designed to support
formal or informal call centers of 50 agents or less. VERSATILITY CALLCENTER
includes many of the features of the VERSATILITY CALL CENTER APPLICATIONS,
including customer profiles, product information, product features and benefits,
question and objection handling, quotation preparation and order taking and
servicing, literature fulfillment, activity tracking with call back calendars
and reminders, scripting and call guides. In addition, the product supports list
management and call recycling for outbound campaigns and CTI for screen-based
dialing and incoming call management, including screen pops of customer profile
information. VERSATILITY CALLCENTER also incorporates several network-based
server facilities that include elements of the VERSATILITY MARKETING MANAGEMENT
and VERSATILITY OPEN TELEPHONY services, redesigned to meet the needs of this
smaller customer. VERSATILITY CALLCENTER is also licensed based on the number of
concurrent users and has a U.S. list price of $1,695 per user.
Federal, state and foreign law, including the Telephone Consumer Protection
Act of 1991 and the Federal Fair Debt Collection Practices Act, regulate certain
uses of outbound call processing systems. Although compliance with these laws
may limit the potential uses of the Company's products in some respects, the
Company's products can be programmed to operate automatically in full compliance
with these laws through the use of appropriate calling lists and calling
campaign time parameters. There can be no assurance, however, that future
legislation further restricting telephone solicitation practices, if enacted,
would not adversely affect the Company.
SUBSEQUENT DEVELOPMENTS
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In October 1997 the Company ceased actively marketing the VERSATILITY
CALLCENTER CD-Rom based product, and notified its customers it would no longer
provide support for the application. The Versatility CallCenter was a
client/server packaged software application in which provides the basic features
and functions of the Versatility series desktop applications to smaller formal
or informal call centers typically found in mid-sized companies or departments
of larger organizations.
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, 1997, the
Company employed 31 employees providing professional services, maintenance and
training.
PROFESSIONAL SERVICES. The Company's consultants work closely with customers
to provide assistance with application implementation and customization,
interface development, communications and information systems integration,
planning and project management. Fees for professional services are charged
separately from the Company's software product licenses and are charged on a
time-and-materials basis or 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.
CUSTOMERS
Since introducing the VERSATILITY SERIES in May 1995, the Company has
licensed VERSATILITY SERIES applications for use on over 12,000 agent desktops.
For the fiscal year ended April 30, 1997, the Company's two largest customers
accounted for 45.0% of the Company's total revenue, of which one customer,
British Telecommunications, Plc ("BT"), accounted for 34.6%. Although the
particular customers may change from period to period, the Company expects that
large sales to a limited number of customers will continue to account for a
significant percentage of its total revenue in any particular period. Revenue
from customers outside the United States accounted for 16.3%, 40.8% and 54.6% of
the Company's total revenue for fiscal 1995, 1996 and 1997, respectively. See
further discussion regarding the business segment and geographic area
information in Note 11 of Notes to the Consolidated Financial Statements.
TECHNOLOGY AND PRODUCT DEVELOPMENT
The Company's core technology was designed to facilitate the development and
customization of enterprise-wide customer interaction applications which are
interoperable with a number of other applications and can be used by a wide
variety of customers. The Company's applications are built upon a common core
architecture that is designed to leverage efficiently the performance and
scalability of client/server computing and object-oriented development
methodologies. Versatility believes that its product architecture allows it to
craft tailored solutions for its customers and to simplify and facilitate new
product development.
The VERSATILITY SERIES AND VERSATILITY CALLCENTER products are built using a
highly scalable and flexible three-tier client/server model which takes
advantage of the difference in computing power between the desktop client and
the server to free-up limited desktop computing power and memory. The Company's
products support a number of client computing platforms, such as Microsoft
Windows 95 and Microsoft Windows NT; leading relational databases from
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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 Foundation Classes and Centura
Team Developer.
Versatility began the development of products based on a client/server
architecture in November 1993. The Company made substantial investments in new
product development in 1994 and introduced the Versatility Series in May 1995.
In August 1996, the Company released VERSATILITY CALLCENTER. The Company
continues to make substantial investments in product development to improve and
enhance the functionality of its existing products. The Company also intends to
expand its existing product offerings and to introduce new products for the
client/server applications market. Although the Company expects that certain of
its new products will be developed internally, the Company may, based on timing
and cost considerations, acquire technology and products from third parties.
The Company's current development efforts include the completion of the
first two industry specific versions of the VERSATILITY SERIES - VERSATILITY
TELECOM and VERSATILITY FINANCIAL SERVICES. These vertical versions are due to
ship in the fall and are designed to significantly lower the customization
efforts and costs by pre-building many of the vertical components typically
requiring customization during deployment of the customer interaction
application. By working with its existing customers and prospects in these
particular verticals, as well as industry analysts, Versatility has been able to
identify and develop these vertical requirements.
In June 1997, Versatility announced the industry's first components-based
application architecture and delivered the initial products - VERSATILITY
TELESALES/TELESERVICE V 3.0 and VERSATILITY POWERGUIDE V 2.0 of this component
based framework. The company will be working aggressively over the rest of the
fiscal year to deliver the other components of this Application Framework.
In addition, Versatility continues to significantly expand the CTI
middleware options supported by VERSATILITY OPENTEL. VERSATILITY OPENTEL is the
window on telephony for the desktop and provides the desktop application with
access to various PBX, ACD, and IVRs. In the past, VERSATILITY OPENTEL primarily
supported the Dialogic CT-Connect CTI product that was resold by Versatility.
Now, VERSATILITY OPENTEL either supports or will support within the next three
months Genesys' T-Server product, Nabnasset's VESP product, and the Microsoft
TAPI 2.1 standard in addition to CT-Connect.
Lastly, Versatility continues to do integration work with Nortel's new
Symposium platform. In May, 1997, the two companies announced the selection of
Versatility as a Nortel Symposium Partner which provides for the reselling of
the Versatility products by the various Nortel distributors and resellers in the
U.S.
As of April 30, 1997, the Company's research and development and quality
assurance staff consisted of 35 employees. The Company's total expenses for
research and development for fiscal years 1995, 1996 and 1997 were $711,000,
$2.1 million and $2.9 million, respectively. The Company anticipates that it
will continue to commit substantial resources to research and development in the
future.
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
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commencement of commercial shipments, resulting in loss of or delay in market
acceptance, which could have a material adverse effect upon the Company's
business, financial condition and results of operations.
SALES AND MARKETING
SALES. The Company believes that the coordinated use of multiple selling
channels is required to reach the diverse and growing base of prospective
customers. Based on their telemarketing strategies and buying patterns, these
prospective customers can be divided into three groups: (i) customers with
large-scale installations which are best served through direct sales teams, (ii)
customers with large-scale installations who require turnkey system solutions
from third party systems integrators, and (iii) customers with mid-sized
installations who need basic solutions that can be purchased relatively
inexpensively and can be quickly implemented. To address these groups, in
November 1995, the Company established four strategic selling units to focus
attention and specific solutions to targeted selling channels and markets. These
four selling units were Enterprise Solutions, Alliances, Channels and
International. Enterprise Solutions consists of two selling groups, which sell
directly to specific vertical markets, financial institutions and communications
services companies. In February 1997, Alliances and Channels were combined,
becoming Commercial Markets, which focuses on other opportunities in other
commercial markets, most of which are sold through third party resellers. The
International selling unit markets through third party resellers to customers in
Europe, the Middle East, South Africa and the Pacific Rim.
ENTERPRISE SOLUTIONS. Enterprise Solutions consists of two selling
groups, Financial Services and Telecommunications. These direct sales units
focus on the financial services and communications industries throughout
North America. They market the VERSATILITY SERIES to large organizations
which require a customized and integrated call center application. These
selling units include 40 employees divided into sales and sales support
teams for each target market, a professional services organization that
performs implementation, project management and customization activities and
a customer services group responsible for post-implementation support. In
addition, the Company has begun enlisting the support of a specific group of
professional services organizations which will engage in the practice of
implementing and customizing the Company's software products. Referred to as
"Practice Partners," these organizations do not resell or otherwise market
the Company's products. Instead, the Company intends to support the Practice
Partners' efforts to learn to install, customize and support the Company's
products.
COMMERCIAL MARKETS. The Commercial Markets selling unit markets the
VERSATILITY SERIES to prospects in other markets, primarily through third
party systems integrators and distributors who provide comprehensive
solutions to large-scale enterprise-wide environments and who want to
provide their customers with an integrated call center solution. This
selling unit consists of sales and sales personnel supporting third party
systems integrators and distributors and a services department that handles
certain support activities for the distributors or for their customers. The
Company currently has active relationships with several third party systems
integrators including Electronic Data Systems Corporation, Norstan Inc. and
Cincom Systems, Inc. The unit also targets mid-sized companies that operate
formal and informal call centers of 10 to 50 agents with a product called
VERSATILITY CALLCENTER. This product is sold through Versatility Integration
Professional ("VIP") resellers or is sold directly to an end user customer
if there is not a trained VIP reseller in place to support the sale. This
selling unit was formed to develop regional-based sales and support teams to
evaluate, recruit and train VIP resellers. As of April 30, 1997, this
selling unit consisted of 25 employees and had arrangements with 36 VIP
resellers.
INTERNATIONAL. The International selling unit markets the VERSATILITY
SERIES and VERSATILITY CALLCENTER products to third party systems
integrators, distributors and resellers outside of North America. This
selling unit has regional sales and support teams covering Western
Europe, the Middle East and certain African countries and expects to
begin selling in the Pacific Rim and Latin American regions. The
International selling unit is headquartered in Aldermaston, U.K., with
support personnel located in the Netherlands and Sweden and, as of April
30, 1997, consisted of 10 employees.
MARKETING. The Company's marketing efforts support each of the
strategic selling units. The Company's marketing programs include product
management, product marketing, maintenance and enhancement of the Company's
Web site, direct marketing, including the operation of the Company's
in-house direct mail and telemarketing operation, public relations and press
and analyst communications and event support. The Company's marketing
department also maintains marketing relationships with a variety of third
party vendors, such as telephone
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switch manufacturers, computer manufacturers, database providers and others.
As of April 30, 1997, the Company's marketing department consisted of 23
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 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. 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. 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
9
<PAGE>
obtaining and using the Company's products or technology. There also can be no
assurance that others will not independently develop similar technologies or
duplicate any technology developed by the Company. Any such events could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company has entered into agreements with a small number of its customers
requiring the Company to place its source code in escrow. These escrow
agreements typically provide that these customers have a limited, non-exclusive
right to use such code in the event that there is a bankruptcy proceeding by or
against the Company, if the Company ceases to do business or if the Company
fails to meet its support obligations. Entering into such agreements may
increase the likelihood of misappropriation by third parties.
As the number of customer interaction software applications in the industry
increases and the functionality of these products further overlaps, software
development companies like the Company may increasingly become subject to claims
of infringement or misappropriation of the intellectual property rights of
others. There can be no assurance that third parties will not assert
infringement or misappropriation claims against the Company in the future with
respect to current or future products. Any claims or litigation, with or without
merit, could be time-consuming, result in costly litigation, cause product
shipment delays or require the Company to enter into royalty or licensing
arrangements. Such royalty or licensing arrangements, if required, may not be
available on terms acceptable to the Company, if at all, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. Adverse determinations in such claims or litigation could
also have a material adverse effect on the Company's business, financial
condition and results of operations.
REGULATORY ENVIRONMENT
Federal, state and foreign 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, 1997, the Company had 186 full-time employees, of which 165
were based in the United States and 21 were based internationally. None of the
employees of the Company are covered by a collective bargaining agreement. As of
April 30, 1997 the Company did not have long-term employment agreements with any
of its employees. The Company considers its relations with its employees to be
good.
The Company believes its future success will depend in large part on the
Company's ability to recruit and retain qualified employees, especially
experienced software engineering and sales personnel. The competition for such
personnel is intense. There can be no assurance that the Company will be
successful in retaining or recruiting key personnel.
RECENT DEVELOPMENTS
10
<PAGE>
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 10Q 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. This report of Form 10K/A includes restated financial
statements for the fiscal year ended April 30, 1997. The uncertainties resulting
from this announcement have had a material adverse affect on the Company's
business and financial condition. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation."
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,
and instituted proceedings to remove the Company's common stock from listing on
the National Market. The NASD has indicated that trading may resume after
publication of the Company's restated financial statements; however, a hearing
on delisting is scheduled for April 30, 1998. There can be no assurance that the
Company's common stock will resume trading on the NASDAQ National Market or
that, once trading resumes, the common stock will continue to be listed on the
National Market or any other listing or exchange.
Since April 30, 1997, 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.
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 operating losses. At April 25, 1998 the
Company employed 131 people in the US and 43 in its international unit.
ITEM 2. PROPERTIES
The Company's principal administrative, sales, marketing, support, and
research and development facility is located in 41,940 square feet of modern
office space in Fairfax, Virginia. This facility is leased to the Company
through 2004. In addition, the Company has entered into a lease for an
additional 9,033 square feet of office space located in a building in Fairfax,
Virginia near its existing offices. The Company also leases 2,463 square feet in
Irvine, California and 6,600 square feet in Aldermaston, U.K. Management
believes its current facilities are adequate. The Company is currently in the
process of either subleasing or looking at alternatives to subleasing any excess
space they have as a result of the downsizing of employees.
ITEM 3. LEGAL PROCEEDINGS
One of the Company's former VARs has filed a claim for arbitration
(non-binding) against the Company asserting, among other things, that the
Company misrepresented the functionality of its products and wrongfully
terminated the VAR's reseller agreement, and claiming not less than $1.0 million
in damages. The Company defended this action in arbitration proceedings. 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.
Recent Developments
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"). In addition, the Company's
11
<PAGE>
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 assert 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 alleges 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 assert, 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.
Although the Company intends to vigorously defend against all claims
brought against it, the ultimate outcome, including amount of possible loss of
litigation cannot be determined at this time. It is expected that the cost to
defend these lawsuits will be substantial and will have a material adverse
effect on the Company's business and results of operation.
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.
A former employee has sued the Company for approximately $1,200,000 for
breach of contract amongst other claims. The outcome of this matter cannot be
ascertained at this time.
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 quarter ended
April 30, 1997.
12
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol "VERS." Following the Company's initial public offering on December 13,
1996, Nasdaq reported the following high and low sales prices in each quarter:
<TABLE>
<CAPTION>
Low High
--- ----
<S><C>
Quarter ended January 31, 1997 (subsequent to December 13, 1996) $ 13.13 $ 18.25
Quarter ended April 30, 1997 8.00 13.63
</TABLE>
As of July 14, 1997, the Company had approximately 30 holders of record of
its Common Stock. The Company has never declared or paid cash dividends on its
Common Stock. The Company currently intends to retain any earnings for use in
its business and does not anticipate paying any cash dividends on its capital
stock in the foreseeable future. In addition, the Company's loan agreement with
its commercial bank prohibits the payment of cash dividends.
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, and instituted proceedings to remove the Company's common stock from
listing on the National Market. The NASD has indicated that trading may resume
after publication of the Company's restated financial statements; however, a
hearing on delisting is scheduled for April 30, 1998, and there can be no
assurance that the Company's common stock will continue to be listed on the
National Market.
13
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended April 30,
-----------------------------------------------------------------
1993 1994 1995 1996 1997 (As Restated) (2)
-------- --------- --------- --------- ----------------------
(In thousands, except per share data)
<S><C>
Consolidated Statement of Operations Data:
Revenue:
License revenue..................... $5,510 $5,393 $ 8,045 $ 10,345 $ 10,255
Service and maintenance revenue..... 2,411 2,987 3,440 6,190 8,054
------ ------ -------- -------- --------
Total revenue................... 7,921 8,380 11,485 16,535 18,309
------ ------ -------- -------- --------
Cost of revenue:
License revenue..................... 1,890 1,924 1,493 573 1,098
Service and maintenance revenue..... 1,745 2,056 2,385 4,267 5,868
------ ------ -------- -------- --------
Total cost of revenue........... 3,635 3,980 3,878 4,840 6,966
------ ------ -------- -------- --------
Gross margin.......................... 4,286 4,400 7,607 11,695 11,343
------ ------ -------- -------- --------
Operating expenses:
Selling, general and administrative. 4,048 3,717 4,550 7,770 16,751
Research and development............ 183 389 711 2,074 2,892
Depreciation and amortization....... 438 133 365 161 281
Write-off of capitalized software... -- -- -- 829 --
------ ------ -------- -------- --------
Total operating expenses........ 4,669 4,239 5,626 10,834 19,924
------ ------ -------- -------- --------
Income (loss) from operations......... (383) 161 1,981 861 (8,581)
Interest income (expense), net........ (7) (20) (9) 3 404
------ ------ -------- -------- --------
Income (loss) before provision
(benefit) for (390) 141 1,972 864 (8,177)
income taxes........................
Provision (benefit) for income taxes.. (18) 31 715 207 (323)
------ ------ -------- -------- ---------
Net income (loss)..................... $ (372) $ 110 $ 1,257 $ 657 $ (7,854)
====== ====== ======== ======== =========
Net income (loss) per share (1)....... $ 0.12 $ (1.26)
======== =========
Average common and common equivalent
shares outstanding (1)................ 5,603 6,241
======== ========
<CAPTION>
April 30,
----------------------------------------------------------------
1993 1994 1995 1996 1997 (As Restated) (2)
-------- -------- -------- -------- ----------------------
Consolidated Balance Sheet Data:
Cash and cash equivalents............. $ 108 $ 192 $ 1,414 $ 2,280 $18,826
Working capital (deficiency).......... (318) (573) 446 5,028 25,355
Total assets.......................... 2,832 2,060 4,288 9,631 37,090
Long-term debt, less current portion.. 101 114 51 70 287
Redeemable convertible preferred stock -- -- -- 3,561 --
Stockholders' equity (deficit)........ (35) 75 1,331 1,834 28,168
</TABLE>
- ----------
(1) Calculated on the basis described in Note 1 of Notes to Consolidated
Financial Statements.
(2) See Note 13 of Notes to Consolidated Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Subsequent to the issuance of the Company's consolidated financial statements
for the year ended April 30, 1997, the Company's management determined that
certain revenue had been inappropriately recognized, the related receivables had
been improperly recorded, and certain costs had not been accrued or were
improperly recorded during the fiscal year ended April 30, 1997. The discussion
and analysis that follows has been revised to reflect the restatement for fiscal
year 1997.
OVERVIEW
Versatility is a leading provider of client/server customer interaction
software that enables businesses to automate their telemarketing and teleselling
capabilities. Founded in 1981 as an information management consulting firm,
Versatility introduced its first commercial product in 1985, a telemarketing
application product based on the Digital Equipment Corporation ("DEC") VAX/VMS
System. The Company operated as a DEC value-added reseller, supplying turnkey
call center solutions to large and mid-sized companies in a variety of
industries, until the end of fiscal 1994. In November 1993, the Company began
developing applications based on the client/server architecture
14
<PAGE>
which culminated with the release of the VERSATILITY SERIES in May 1995. In
fiscal 1996, substantially all of the Company's revenue was derived from sales
or services related to the VERSATILITY SERIES. In August 1996, the Company
released VERSATILITY CALLCENTER, a CD-ROM-based call center software application
that supports call centers of 50 agents or less. The VERSATILITY CALL CENTER
CD-ROM product was discontinued in October 1997.
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. While Hardware sales relating to implementation of
the Company's VAX/VMS application was $1.4 million and represented 12.1% of the
Company's revenue in fiscal 1995. The Company had $1.0 million and $767,364 of
hardware revenue in fiscal years 1996 and 1997, respectively. Since the
introduction of its client/server products beginning in fiscal 1996 hardware
sales have become a less significant percentage of total revenues. 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, 1997, the Company's two largest
customers accounted for 45.0% of the Company's total revenue, of which one
customer, BT, accounted for 34.6%. Although the particular customers may change
from period to period, the Company expects that large sales to a limited number
of customers will continue to account for a significant percentage of its total
revenue in any particular period. Given the customer concentration and the
duration of the sales and implementation cycle, the loss of a major customer or
any reduction or delay in sales to or implementation by these or other customers
could have a material adverse effect on the Company's operating results in any
particular period.
Revenue from customers outside the United States accounted for 16.3%, 40.8%
and 54.6% of the Company's total revenue for fiscal 1995, 1996 and 1997,
respectively. While the Company's expenses incurred in foreign countries are
typically denominated in the local currencies, revenue generated by the
Company's international sales typically is paid in U.S. dollars or British
pounds. Although exposure to currency fluctuations to date has been
insignificant, there can be no assurance that fluctuations in currency exchange
rates in the future will not have a material adverse impact on the Company's
international operations. The Company currently does not engage in hedging
activities.
During the course of the development of the client/server software
applications, the Company capitalized costs associated with the VERSATILITY
SERIES in compliance with Statement of Financial Accounting Standards No. 86
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed" ("SFAS 86"). The amount of software capitalized totaled $995,000 and,
beginning in November 1994, was amortized over three years on a straight-line
basis. In connection with two major implementations of the VERSATILITY SERIES
product in July 1995, the Company decided to add features and functions which
were substantially different than those included in the software as originally
capitalized. Management determined that these features and functions
substantially altered the content of the product, effectively eliminating any
remaining useful life of the capitalized asset. Accordingly, the Company wrote
off the remaining asset of $829,000 in the first quarter of fiscal 1996. The
Company anticipates that for the foreseeable future, no software development
costs will meet the requirements for capitalization under SFAS 86.
15
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods
indicated as a percentage of total revenue:
<TABLE>
<CAPTION>
Percentage of Total Revenue
--------------------------------------------
Year Ended April 30,
--------------------------------------------
1995 1996 1997 (As Restated) (1)
---------- ---------- ----------------------
<S><C>
Revenue:
License revenue......................... 70.0% 62.6% 56.0%
Service and maintenance revenue......... 30.0 37.4 44.0
-------- -------- --------
Total revenue...................... 100.0 100.0 100.0
-------- -------- --------
Cost of revenue:
License revenue......................... 13.0 3.5 6.0
Service and maintenance revenue......... 20.8 25.8 32.1
-------- -------- --------
Total cost of revenue.............. 33.8 29.3 38.1
-------- -------- --------
Gross margin................................. 66.2 70.7 61.9
-------- -------- --------
Operating expenses:
Selling, general and administrative..... 39.6 47.0 91.5
Research and development................ 6.2 12.5 15.8
Depreciation and amortization........... 3.2 1.0 1.5
Write-off of capitalized software....... -- 5.0 --
------- -------- --------
Total operating expenses........... 49.0 65.5 108.8
-------- -------- --------
Income from operations....................... 17.2 5.2 (46.9)
Interest income (expense), net............... (0.1) (0.0) 2.2
-------- -------- --------
Income (loss) before provision (benefit) 17.1 5.2 (44.7)
for income taxes
Provision (benefit) for income taxes......... 6.2 1.2 (1.8)
-------- -------- --------
Net income (loss)............................ 10.9% 4.0% (42.9)%
======== ======== ========
</TABLE>
(1) See Note 13 of the Notes to the Consolidated Financial Statements.
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:
<TABLE>
<CAPTION>
Year Ended April 30,
------------------------------------------
1995 1996 1997 (As Restated) (1)
------ ------ -----------------------
<S><C>
Cost of license revenue..................... 18.6% 5.5% 10.7%
Cost of service and maintenance revenue..... 69.3% 68.9% 72.9%
</TABLE>
(1) See Note 13 of the Notes to the Consolidated Financial Statements.
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
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
16
<PAGE>
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.
FISCAL 1996 COMPARED TO FISCAL 1995
REVENUE. Total revenue increased 44.0% from $11.5 million in fiscal 1995 to
$16.5 million in fiscal 1996. Revenue from license fees increased 28.6% from
$8.0 million in fiscal 1995, or 70.0% of total revenue, to $10.3 million in
fiscal 1996, or 62.6% of total revenue. Service and maintenance revenue
increased 79.9% from $3.4 million in fiscal 1995, or 30.0% of total revenue, to
$6.2 million in fiscal 1996, or 37.4% of total revenue. The increase in total
revenue was significantly influenced by the roll-out of the VERSATILITY SERIES
at BT, which contributed $3.0 million in license revenue and $1.2 million in
service and maintenance revenue. Revenue from hardware sales decreased from $1.4
million in fiscal 1995 to $139,000 in fiscal 1996, as the Company completed its
transition to licensing products based on a client/server architecture. Hardware
revenue in fiscal 1995 was derived primarily from sales of DEC VAX/VMS hardware,
while such revenue for fiscal 1996 consisted of incidental sales of hardware
related to the VERSATILITY SERIES product. The Company does not expect
significant hardware sales to occur in the future.
COST OF REVENUE. Total cost of revenue increased from $3.9 million in fiscal
1995, or 33.8% of total revenue, to $4.8 million in fiscal 1996, or 29.3% of
total revenue. Cost of license revenue decreased from $1.5 million in fiscal
1995, or 18.6% of license revenue, to $573,000 in fiscal 1996, or 5.5% of
license revenue. This decrease resulted from the Company's shift away from
providing complete hardware and software configurations for its customers using
DEC hardware and software. The cost of service and maintenance revenue increased
from $2.4 million in fiscal 1995, or 69.3% of service and maintenance revenue,
to $4.3 million in fiscal 1996, or 68.9% of service and maintenance revenue. The
increase represents the addition of consulting and other staff to support
additional revenue as well as the costs relating to the installation of the
Company's products at BT.
SELLING, GENERAL AND ADMINISTRATIVE. The Company's selling, general and
administrative expenses increased from $4.6 million in fiscal 1995, or 39.6% of
total revenue, to $7.8 million in fiscal 1996, or 47.0% of total revenue.
17
<PAGE>
The increase was primarily attributable to additions to the Company's sales and
marketing staff. During fiscal 1996, the number of the Company's employees grew
from 67 to 135. Of the increase, 45 new hires joined the sales and marketing
departments, with the remainder accepting management or administrative
positions.
RESEARCH AND DEVELOPMENT. Research and development expenses increased from
$711,000 in fiscal 1995, or 6.2% of total revenue, to $2.1 million in fiscal
1996, or 12.5% of total revenue. In addition, $743,000 of research and
development expenditures were capitalized in fiscal 1995, while no such costs
were capitalized in fiscal 1996. If these capitalized software development
expenditures were added, research and development expenses for fiscal 1995,
would have been $1.5 million. This increase in research and development
expenditures resulted from the addition of software developers needed to support
the Company's new product development, as well as costs relating to enhancements
to the VERSATILITY SERIES AND VERSATILITY CALLCENTER products.
DEPRECIATION AND AMORTIZATION AND WRITE-OFF OF CAPITALIZED SOFTWARE.
Depreciation and amortization expenses decreased from $365,000 in fiscal 1995 to
$161,000 in fiscal 1996. Certain assets had been fully amortized in fiscal 1995
and the Company entered into leasing arrangements for capital equipment acquired
in fiscal 1996. Depreciation and amortization expenses in fiscal 1995 included
$166,000 of amortization of capitalized software. The unamortized portion of
this asset, amounting to $829,000, was written off in fiscal 1996 as management
determined that no net realizable value in the asset remained. No such write-off
was recorded in fiscal 1995.
INTEREST INCOME (EXPENSE), NET. Interest income (expense), net was ($9,000)
in fiscal 1995 and $3,000 in fiscal 1996. The difference resulted from higher
available cash balances in fiscal 1996, primarily due to the cash raised in a
private placement in January 1996, which was partially offset by increased
interest expense due to borrowings under the Company's line of credit.
PROVISION FOR INCOME TAXES. The Company's provision for income taxes was
$715,000 in fiscal 1995 compared to $207,000 in fiscal 1996. The effective rate
in fiscal 1995 was 36.3%, while the effective rate in fiscal 1996 was 24.0%. The
Company incurred a lower effective rate in fiscal 1996 due to tax benefits
derived from sales made through the Company's Foreign Sales Corporation and due
to a previously unrecognized tax benefit derived from the write-off in a
previous period of an investment in a discontinued subsidiary.
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 April 30, 1997, the Company's existing
$2.5 million line of credit had an outstanding balance of $2.3 million and
$404,678 was outstanding under its $1.0 million equipment line of credit.
Advances under the working capital line bore interest at a variable annual rate
equal to the prime rate of the bank plus 0.5%, and advances under the equipment
line bore interest at a variable annual rate equal to the prime rate of the bank
plus 1.0%. Both lines expired on August 5, 1997.
On October 29, 1997, the Company entered into a new 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 which will be effective April 30, 1998, in which the bank
will waive all prior non-compliance and which provides 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; upon the effective
date the Company will permanently pay 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. The agreement provides that the Company must maintain certain
financial covenants, including a minimum tangible net worth and a minimum cash
balance.
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At April 30, 1997, the Company had $18.8 million in cash and cash
equivalents and $6.0 million in short term investments. For the year ended April
30, 1997, net cash used in operating activities totaled $6.6 million. In
addition, the Company used $8.9 million for investing activities, which included
$812,000 for capital expenditures, $516,000 loaned to Serenity Real Properties
Limited Partnership and $7.5 million to purchase investments in corporate and
municipal bonds. These uses of cash were offset by the net proceeds of $30.6
million from the Company's initial public offering and net borrowings of $1.5
million under the Company's working capital line of credit, resulting in a net
cash increase of $16.5 million.
The Company invested $156,000, $235,000 and $812,000 in capital expenditures
in fiscal 1995, 1996 and 1997, respectively. Capital expenditures include
purchases of computer hardware used primarily in product development, product
demonstrations, training and support. Over the course of fiscal 1996, the
Company had financed a portion of its capital equipment needs through operating
leases. During fiscal 1997, the Company financed $437,000 of the capital assets
acquired through a capital lease under its $1.0 million equipment line of credit
with the remainder through operating leases.
At April 27, 1998, the Company had $5.2 million in cash and cash equivalents
and $8.1 million in accounts receivable. Subsequent to the date of the financial
statements contained herein, the Company has incurred substantial operating
losses and anticipates a significant loss in the fourth quarter of fiscal 1998.
Additionally, the Company expects to incur significant amounts to defend the
lawsuits described below in "Litigation Risks." While significant cost cutting
measures have been initiated and completed in some circumstances, 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. If the Company is unable to obtain additional
financing sufficient to meet its operating needs, the Company may be required to
significantly reduce the scope of its operations, which would have a material
adverse effect on the Company's business, results of operations and its ability
to compete. Such reduced operations and levels of cash may also cause the
Company to default under its credit facility.
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 April 27, 1998, the Company had
$5.2 million in cash and cash equivalents and $8.1 million in accounts
receivable. 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 defend the lawsuits 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. If the Company is unable
to obtain additional financing sufficient to meet its operating needs, the
Company may be required to significantly reduce the scope of its operations,
which would have a material adverse effect on the Company's business, results of
operations and its ability to compete. Such reduced operations and levels of
cash may also cause the Company to be in default under its credit facility. 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 have had a material adverse
affect on the Company's business and financial condition. In addition to its
proceedings with the NASD (described in "Proceedings with the NASD" above), the
filing of the lawsuits against the Company (described in "Litigation Risks"
below) such announcement 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
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the Company's products and services until the Company's restated financial
results are released. There is no assurance that once such results are released,
such customers will purchase the Company's products and services. Second, there
can be no assurance that, once such financial results are released and trading
in the Company's Common Stock resumes, that the trading price per share of the
Company's Common Stock will further decline due to reactions by analysts or
otherwise.
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.
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
assert 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 alleges 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 assert, 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. Although the Company intends to vigorously defend
against all claims brought against it, the ultimate outcome, including the
amount of possible loss, of litigation cannot be determined at this time. It is
expected that the cost to defend these lawsuits will be substantial and will
have a material adverse effect on the Company's business and results of
operations. An unfavorable outcome in the litigation could have a material
adverse effect on the Company's financial condition and results of operations.
A former employee has sued the Company for approximately $1,200,00 for
alleged breaches of contract amongst other claims. The outcome of this matter
cannot be ascertained at this time.
A former customer is seeking damages in excess of $1,000,000 for
alleged breaches of contract and warranties, as well as alleged
mispresentations. 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.
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, and instituted proceedings to remove the Company's common stock from
listing on the National Market. The NASD has indicated that trading may resume
after publication of the Company's restated financial statements; however, a
hearing on delisting is scheduled for April 30, 1998. In addition, the NASD is
continuing to investigate the circumstances surrounding the Company's
restatements. There can be no assurance that the Company's common stock will
continue to be listed on the National Market.
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,
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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 1997, the Company's two largest
customers accounted for 45.0% of the Company's total revenue, of which, BT
accounted for 34.6%. Although the particular customers may change from period to
period, the Company expects that large sales to a limited number of customers
will continue to account for a significant percentage of its revenue in any
particular period for the foreseeable future. Therefore, the loss, deferral or
cancellation of an order could have a significant impact on the Company's
operating results in a particular quarter. The Company has no long-term
contracts with its customers and there can be no assurance that its current
customers will place additional orders, or that the Company will obtain orders
of similar magnitude from other customers. The loss of any major customer or any
reduction, delay in or cancellation of orders by any such customer, or the
failure of the Company to market successfully to new customers could have a
materially adverse effect on the Company's business, financial condition and
results of operations.
QUARTERLY FLUCTUATIONS IN REVENUE AND OPERATING RESULTS. The Company's
revenue and operating results could fluctuate significantly from quarter to
quarter due to a combination of factors, including variations in the demand for
the Company's products, the level of product and price competition, the length
of the Company's sales process, the size and timing of individual transactions,
the mix of products and services sold, the mix of sales through direct and
indirect channels, any delay in or cancellation of customer implementations, the
Company's success in expanding its customer support organization, direct sales
force and indirect distribution channels, the timing of new product
introductions and enhancements by the Company or its competitors, the ratio of
international to domestic sales, commercial strategies adopted by competitors,
changes in foreign currency exchange rates, customers' budgets constraints, and
the Company's ability to control costs. In addition, a limited number of
relatively large customer orders has accounted for and is likely to continue to
account for a substantial portion of the Company's total revenue in any
particular quarter. The timing of such orders can be difficult to predict given
the average size of the Company's orders and the length of its sales process.
The Company has in the past recognized a substantial portion of its revenue in
the last month of a quarter. Therefore, the loss, deferral or cancellation of an
order could have a significant adverse impact on the Company's revenue and
operating results in a particular quarter. Because the Company's operating
expense levels are relatively fixed and tied to anticipated levels of revenue,
any delay in the recognition of revenue from a limited number of license
transactions could cause significant variations in operating results from
quarter to quarter. Based upon all of the foregoing, the Company believes that
quarter-to-quarter comparisons of its results of operations are not necessarily
meaningful and such comparisons should not be relied upon as indications of
future performance. It is also likely that the Company's future quarterly
operating results in any given period will not meet the expectations of market
analysts or investors, which could have an adverse effect on the price of the
Company's Common Stock.
LENGTH OF SALES AND IMPLEMENTATION PROCESSES. Selling the Company's products
generally requires the Company to provide a significant level of education to
prospective customers regarding the use and benefits of the Company's products.
In addition, implementation of the Company's products involves a significant
commitment of resources by prospective customers and is commonly associated with
substantial integration efforts which may be performed by the Company, by the
customer, or by a third party systems integrator. For these and other reasons,
the length of time between the date of initial contact with the potential
customer and the implementation of the Company's products is often lengthy,
typically ranging from two to nine months or more, and is subject to delays over
which the Company has little or no control. The Company's implementation cycle
could be lengthened by increases in the size and complexity of its
implementations and by delays in its customers' adoption of client/server
computing environments.
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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.
The Company's fiscal 1997 strategy of marketing its products directly to
end-users and indirectly through VARs and third party systems integrators may
result in distribution channel conflicts. The Company's direct sales efforts may
compete with those of its indirect channels and, to the extent different
resellers target the same customers, resellers may also come into conflict with
each other. Although the Company has attempted to manage its distribution
channels in a manner to avoid potential conflicts, there can be no assurance
that channel conflicts will not materially adversely affect its relationships
with existing third party systems integrators or VARs or adversely affect its
ability to attract new third party systems integrators and VARs.
DEPENDENCE ON PRACTICE PARTNERS. The Company is currently enlisting the
support of a specific group of professional services organizations which will
engage in the practice of implementing and customizing the Company's software
products. Referred to as "Practice Partners," these organizations do not resell
or otherwise market the Company's products. Instead, the Company intends to
support the Practice Partners' efforts to learn to install, customize and
support the Company's products. The Company's future revenues may depend on the
ability of the Practice Partners to achieve this goal. Further, the costs
required to enlist, train and assist the Practice Partners could have a
materially adverse affect on the Company's business, financial condition and
results of operations. Subsequent to Fiscal 1997, the Company reduced its
reliance on Practice Partners.
INTERNATIONAL OPERATIONS. Revenue from sales outside the United States in
fiscal 1995, 1996 and 1997 accounted for approximately 16.3%, 40.8% and 54.6%,
respectively, of the Company's total revenue. International operations are
subject to inherent risks, including the impact of possible recessionary
environments in economies outside the
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United States, changes in demand for the Company's products resulting from
fluctuations in exchange rates, unexpected changes in legal and regulatory
requirements including those relating to telemarketing activities, changes in
tariffs, seasonality of sales, costs of localizing products for foreign markets,
longer accounts receivable collection periods and greater difficulty in accounts
receivable collection, difficulties and costs of staffing and managing foreign
operations, reduced protection for intellectual property rights in some
countries, potentially adverse tax consequences and political and economic
instability. There can be no assurance that the Company will be able to sustain
or increase international revenue, or that the factors listed above will not
have a material adverse impact on the Company's international operations. While
the Company's expenses incurred in foreign countries are typically denominated
in the local currencies, revenue generated by the Company's international sales
typically is paid in U.S. dollars or British pounds. Although exposure to
currency fluctuations to date has been insignificant, there can be no assurance
that fluctuations in currency exchange rates in the future will not have a
material adverse impact on the Company's international operations. The Company
currently does not engage in hedging activities.
A significant element of the Company's strategy in fiscal 1997 was to
continue the expansion of its operations in international markets. This
expansion has required and will continue to require significant management
attention and financial resources to develop international sales channels.
Because of the difficulty in penetrating new markets, along with the Company's
size and geographic location, there can be no assurance that the Company will be
able to maintain or increase international revenue. To the extent that the
Company is unable to do so, the Company's financial condition and results of
operations could be materially adversely affected. A substantial portion of the
Company's international sales are expected to be made using indirect selling
channels, such as third party systems integrators and VARs. A reduction in sales
by all or some of these distributors or a termination of their relationships
with the Company could have a material adverse effect on the Company's business,
financial condition and results of operations.
COMPETITION. The market for the Company's products is intensely competitive,
highly fragmented and subject to rapid change. Because the Company offers
multiple applications which can be purchased separately or integrated as part of
the VERSATILITY SERIES, the Company competes with a variety of companies
depending on the target market for their applications software products. The
Company's principal competitors in the customer interaction software market are
Information Management Associates, Inc., Scopus Technology, Inc. and The Vantive
Corporation. For installations where telephony functions are of prime
importance, competitors include Davox Corporation, Early Cloud and Company (a
division of IBM) and EIS International, Inc. The Company also competes with
third party professional service organizations that develop custom software and
with the information technology departments of potential customers, which
develop applications internally. Among the Company's potential competitors are
also a number of large hardware and software companies that may develop or
acquire products that compete with the Company's products. Increased competition
is likely to result in price reductions, reduced operating margins and loss of
market share, any of which could materially adversely affect the Company's
business, financial condition and results of operations. Many of the Company's
current and potential competitors have significantly greater financial,
technical, marketing and other resources than the Company. As a result, they may
be able to respond more quickly to new or emerging technologies and changes in
customer requirements, or to devote greater resources to the development,
promotion and sale of products than can the Company. There can be no assurance
that the Company will be able to compete successfully against current and future
competitors or that competitive pressures faced by the Company will not
materially adversely affect its business, financial condition and results of
operations.
MANAGEMENT OF GROWTH. The Company expected significant growth in revenue,
and therefore staffed up operations and personnel. Continued growth will
challenge the Company's management systems and resources and require the Company
to improve and upgrade its management information systems. In addition, the
Company will need to hire more technical, sales and marketing, support and
administrative personnel to adequately service and support its growing customer
base. There can be no assurance that the Company will be able to successfully
upgrade its systems or to attract, retain and successfully train the necessary
personnel to accomplish its growth strategies or that it will not experience
constraints that will adversely affect its ability to satisfy customer demand in
a timely fashion or to satisfactorily support its customers. Any of these events
could injure the Company's reputation or lead to loss of customers. If the
Company is unable to manage growth effectively, the Company's business,
financial condition and results of operations could be adversely affected.
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DEPENDENCE ON GROWTH OF CLIENT/SERVER COMPUTING ENVIRONMENT. The
client/server software environment is relatively new. The Company markets its
products solely to customers that have committed or are committing their call
center systems to client/server environments, or are converting legacy systems,
in part or in whole, to a client/server environment. The Company's success will
depend on further development of and growth in the number of organizations
adopting client/server computing environments. There can be no assurance,
however, that the client/server market will maintain its current rate of growth.
There also can be no assurance that the client/server computing trends
anticipated by the Company will occur or that the Company will be able to
respond effectively to the evolving requirements of this market. If the
client/server market fails to grow, or grows at a rate slower than experienced
in the past, the Company's business, financial condition and results of
operations could be materially adversely affected.
RAPID TECHNOLOGICAL CHANGE AND PRODUCT DEVELOPMENT RISKS. The customer
interaction software market is subject to rapid technological change, changing
customer needs, frequent new product introductions and evolving industry
standards that may render existing products and services obsolete. As a result,
the Company's position in this market could be eroded rapidly by unforeseen
changes in application features and functions. The life cycles of the Company's
products are difficult to estimate. The Company's growth and future operating
results will depend in part upon its ability to enhance existing applications
and develop and introduce new applications that meet or exceed technological
advances in the marketplace, that meet changing customer requirements, that
respond to competitive products and that achieve market acceptance. The
Company's product development and testing efforts are expected to require
substantial investments by the Company. There can be no assurance that the
Company will possess sufficient resources to make these necessary investments.
The Company has in the past experienced delays both in developing new products
and in customizing existing products, and there can be no assurance that the
Company will not experience difficulties that could cause delays in the future.
In addition, there can be no assurance that such products will meet the
requirements of the marketplace and achieve market acceptance, or that the
Company's current or future products will conform to industry standards. If the
Company is unable, for technological or other reasons, to develop and introduce
new and enhanced products in a timely manner, the Company's business, financial
condition and results of operations could be materially adversely affected.
Software products as complex as those offered by the Company may contain
errors that may be detected at any point in the products' life cycles. The
Company has, in the past, discovered software errors in certain of its products
and has experienced delays in shipment of products during the period required to
correct these errors. In particular, the computing environment is characterized
by a wide variety of standard and non-standard configurations that make
pre-release testing for programming or compatibility errors very difficult and
time consuming. There can be no assurance that, despite extensive testing by the
Company and by current and potential customers, errors will not be found,
resulting in loss of, or delay in, market acceptance and sales, diversion of
development resources, injury to the Company's reputation, or increased service
and warranty costs, any of which could have a material adverse effect on the
Company's business, financial condition and results of operations.
DIFFICULTY IN PROTECTING PROPRIETARY TECHNOLOGY; RISK OF INFRINGEMENT. The
Company relies on a combination of copyright, trade secret and trademark laws,
confidentiality procedures and contractual provisions to protect its proprietary
rights in its products and technology. The Company does not rely upon patent
protection and does not currently expect to seek patents on any aspects of its
technology. There can be no assurance that the confidentiality agreements and
other methods on which the Company relies to protect its trade secrets and
proprietary technology will be adequate. Further, the Company may be subject to
additional risks as it enters into transactions in countries where intellectual
property laws are not well developed or are poorly enforced. Legal protections
of the Company's rights may be ineffective in such countries. Litigation to
defend and enforce the Company's 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.
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The Company has entered into agreements with a small number of its customers
requiring the Company to place its source code in escrow. These escrow
agreements typically provide that these customers have a limited, non-exclusive
right to use such code in the event that there is a bankruptcy proceeding by or
against the Company, if the Company ceases to do business or if the Company
fails to meet its support obligations. Entering into such agreements may
increase the likelihood of misappropriation by third parties.
As the number of customer interaction software applications in the industry
increases and the functionality of these products further overlaps, software
development companies like the Company may increasingly become subject to claims
of infringement or misappropriation of the intellectual property rights of
others. There can be no assurance that third parties will not assert
infringement or misappropriation claims against the Company in the future with
respect to current or future products. Any claims or litigation, with or without
merit, could be time-consuming, result in costly litigation, cause product
shipment delays or require the Company to enter into royalty or licensing
arrangements. Such royalty or licensing arrangements, if required, may not be
available on terms acceptable to the Company, if at all, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. Adverse determinations in such claims or litigation could
also have a material adverse effect on the Company's business, financial
condition and results of operations.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a significant
extent upon the continued service of its executive officers and other key
management and technical personnel, and on its ability to continue to attract,
retain and motivate qualified personnel, such as experienced software developers
and sales personnel. Competition for such employees is very intense. The Company
has no long-term employment contracts with any of its employees. The loss of the
services of one or more of the Company's executive officers, software developers
or other key personnel or the Company's inability to recruit replacements for
such personnel could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company maintains $1.0
million of key-man life insurance on Ronald R. Charnock, the Company's President
and Chief Executive Officer at April 30, 1997.
Since April 30, 1997, 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.
OTHER LEGAL PROCEEDINGS. 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.
A former employee has sued the Company for approximately $1,200,000 for
alleged breaches of contract amongst other claims. The outcome of this matter
cannot be ascertained at this time.
A former customer is seeking damages in excess of $1,000,000 for
alleged breaches of contract and warranties, as well as alleged
mispresentations. 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.
25
<PAGE>
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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
26
<PAGE>
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, the Company's
independent accountants, are set forth on the pages indicated in Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
27
<PAGE>
PART III
Certain information required by Part III is omitted from this Annual Report
on Form 10-K since the Company will file its definitive Proxy Statement for its
Annual Meeting of Stockholders to be held on August 26, 1997, pursuant to
Regulation 14A of the Securities Exchange Act of 1934, as amended (the "Proxy
Statement"), not later than 120 days after the end of the fiscal year covered by
this Report, and certain information included in the Proxy Statement is
incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Executive Officers
The information required by this Item is incorporated by reference to
the information set forth under the caption "Occupation of Directors and
Executive Officers" on pages 3 and 4 of the Proxy Statement.
(b) Directors
The information required by this Item is incorporated by reference to
the information set forth under the caption "Occupation of Directors and
Executive Officers" on pages 3 and 4 of the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
information set forth under the caption "Compensation and Other Information
Concerning Directors and Officers" on pages 5 and 6 of the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
information set forth under the caption "Management and Principal Holders of
Voting Securities" on pages 1 and 2 of the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
information set forth under the caption "Certain Relationships and Related
Transactions" on page 10 of the Proxy Statement.
28
<PAGE>
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
<TABLE>
<CAPTION>
Page
----
<S><C>
Independent Auditors' Report............................................................ F-2
Consolidated Balance Sheets............................................................. F-3
Consolidated Statements of Operations................................................... F-5
Consolidated Statements of Cash Flows................................................... F-6
Consolidated Statements of Changes in Stockholders' Equity.............................. F-7
Notes to Consolidated Financial Statements.............................................. F-8
</TABLE>
2. Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts for the years ended
April 30, 1995, 1996 and 1997 F-9
3. Exhibits
Exhibit Number Description of Exhibit
-------------- ----------------------
23 Consent of Deloitte & Touche LLP
(b) Reports on Form 8-K:
None
(c) Exhibits
See (a) above
(d) Financial Statement Schedules
See (a) above
29
<PAGE>
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: April 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:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<S><C>
/s/ Paul J. Zoukis President and Chief Operating Officer April 28, 1998
__________________
Paul J. Zoukis
/s/ Kenneth T. Nelson Chief Financial Officer (Principal Financial April 28, 1998
_____________________ Accounting Officer)
Kenneth T. Nelson
/s/ Thomas A. Smith Director April 28, 1998
___________________
Thomas A. Smith
/s/ Charles A. Johnson Director April 28, 1998
______________________
Charles A. Johnson
/s/ Paul J. Palmer Director April 28, 1998
__________________
Paul J. Palmer
</TABLE>
30
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
VERSATILITY INC.
<TABLE>
<CAPTION>
Page
----
<S><C>
Independent Auditors' Report......................................................................................... F-2
Consolidated Balance Sheets at April 30, 1996 and 1997............................................................... F-3
Consolidated Statements of Operations for the years ended April 30, 1995, 1996 and 1997.............................. F-5
Consolidated Statements of Cash Flows for the years ended April 30, 1995, 1996 and 1997.............................. F-6
Consolidated Statements of Changes in Stockholders' Equity for the years ended April 30, 1995, 1996 and 1997......... F-7
Notes to Consolidated Financial Statements........................................................................... F-8
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors of Versatility Inc.:
We have audited the accompanying consolidated balance sheets of Versatility
Inc. and its subsidiaries (the "Company") as of April 30, 1996 and 1997, and the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for each of the three years in the period ended April 30, 1997.
We have also audited the financial statement schedule listed in Item 14(a)2 of
this Form 10-K/A. These consolidated financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Versatility Inc. and its
subsidiaries at April 30, 1996 and 1997, and the results of their operations and
their cash flows for each of the three years in the period ended April 30, 1997
in conformity with generally accepted accounting principles. In addition, in our
opinion, the financial statement schedule referred to above, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
We have not audited any financial statements of the Company for any period
subsequent to April 30, 1997. However, 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 in the fiscal year
ended April 30, 1997 and the first three quarters of fiscal 1998. In addition,
the Company expects to incur significant expenses in connection with defending
certain lawsuits filed against the Company subsequent to April 30, 1997, and
certain customers of the Company have stated that they will postpone purchases
of the Company's products and services at least until the Company's restated
financial results are released. These matters raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to 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.
As discussed in Note 13, the accompanying consolidated financial statements
as of April 30, 1997 and for the year then ended and the financial statement
schedule for the year ended April 30, 1997 listed in Item 14(a)2, of this Form
10-K/A have been restated.
DELOITTE & TOUCHE LLP
Washington, DC
April 28, 1998
F-2
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
April 30, April 30,
1996 1997
---- ----
(As Restated,
-------------
see Note 13)
-------------
<S><C>
ASSETS
Current assets:
Cash and cash equivalents....... $ 2,280,273 $18,825,764
Short-term investments.......... -- 6,039,255
Accounts receivable, net of
allowance for doubtful accounts
of $157,874 and $909,501...... 5,670,503 5,844,987
Prepaid expenses................ 642,045 575,144
Inventory....................... -- 18,880
Related party receivables....... 117,221 153,381
Note receivable-related party... -- 519,305
Deferred income taxes........... 130,238 --
----------- -----------
Total current assets....... 8,840,280 31,976,716
----------- -----------
Other assets:
Deposits........................ 157,835 187,650
Prepaid Expenses -- 259,755
Related party investment........ 3,137 --
Investments..................... -- 1,433,464
Income taxes receivable......... -- 1,530,000
Assets held for sale............ 76,004 508,210
Purchased software, net of
accumulated amortization of
$11,500 and $42,098........... 103,500 177,136
----------- -----------
Total other assets......... 340,476 4,096,215
----------- -----------
Property and equipment:
Computers....................... 893,674 1,168,246
Office furniture and equipment.. 637,559 665,597
Leasehold improvements.......... 181,485 206,402
Capital leases.................. 160,822 652,533
----------- -----------
1,873,540 2,692,778
Less: accumulated depreciation
and amortization............. (1,423,234) (1,675,749)
----------- -----------
Net property and equipment. 450,306 1,017,029
----------- -----------
Total................................ $ 9,631,062 $37,089,960
=========== ===========
</TABLE>
See notes to the consolidated financial statements.
F-3
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
April 30, April 30,
1996 1997
---- ----
(As Restated,
-------------
see Note 13)
-------------
<S><C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................... $ 824,745 $ 1,590,962
Accrued liabilities.................... 1,393,653 2,337,034
Related party payables................. 3,443 28,030
Income taxes payable................... 356,503 104,777
Capital lease payable.................. 30,848 38,900
Line of credit
- Operating 800,772 2,288,319
- Equipment -- 404,678
Deferred revenue....................... 284,700 1,788,037
---------- -----------
Total current liabilities......... 3,694,664 8,580,737
---------- -----------
Long-term liabilities:
Capital lease payable, less current 69,983 24,611
maturities
Deferred rent.......................... 221,899 316,360
Deferred income taxes.................. 249,401 --
---------- -----------
Total other liabilities........... 541,283 340,971
---------- -----------
Commitments and Contingencies (Notes 1 and 6)
Series A redeemable convertible preferred
stock, par value $.01 -- 992,061 shares
authorized, issued and outstanding,
liquidation preference -- $3.52784 per
share at April 30, 1996; no shares
authorized, issued or outstanding at
April 30, 1997............................ 3,561,293 --
Stockholders' equity:
Preferred stock, $.01 par value, no
shares authorized, issued or
outstanding at April 30, 1996;
2,000,000 shares authorized, no
shares issued or outstanding at
April 30, 1997....................... -- --
Common stock, par value $.01 --
20,000,000 shares authorized,
4,000,000 shares issued and
outstanding at April 30, 1996;
7,297,365 shares issued and
outstanding at April 30, 1997........ 40,000 72,974
Additional paid-in capital............. -- 34,349,298
Foreign currency translation adjustments (66,311) (83,880)
Retained earnings (deficit)............ 1,860,133 (6,170,140)
---------- -----------
Stockholders' equity.............. 1,833,822 28,168,252
---------- -----------
Total....................................... $9,631,062 $37,089,960
========== ===========
</TABLE>
See notes to the consolidated financial statements.
F-4
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended April 30,
--------------------------------------------
1995 1996 1997
------------ ------------ -------------
(As Restated,
-------------
see Note 13)
-------------
<S><C>
Revenue:
License revenue......................... $ 8,045,345 $10,345,323 $ 10,254,344
Service and maintenance revenue......... 3,439,806 6,189,949 8,054,268
----------- ----------- ------------
Total revenue...................... 11,485,151 16,535,272 18,308,612
----------- ----------- ------------
Cost of revenue:
License revenue......................... 1,493,194 573,329 1,098,434
Service and maintenance revenue......... 2,384,946 4,266,984 5,867,917
----------- ----------- ------------
Total cost of revenue.............. 3,878,140 4,840,313 6,966,351
----------- ----------- ------------
Gross margin................................ 7,607,011 11,694,959 11,342,261
----------- ----------- ------------
Operating expenses:
Selling, general and administrative..... 4,550,182 7,769,751 16,750,776
Research and development................ 710,828 2,073,797 2,891,889
Depreciation and amortization........... 365,490 161,346 280,682
Write off of capitalized software....... -- 829,026 --
----------- ----------- ------------
Total operating expenses........... 5,626,500 10,833,920 19,923,347
----------- ----------- ------------
Income (loss) from operations............... 1,980,511 861,039 (8,581,086)
Interest income (expense), net.............. (8,977) 3,140 403,989
----------- ----------- ------------
Income (loss) before provision for income
taxes....................................... 1,971,534 864,179 (8,177,097)
Provision (benefit) for income taxes........ 714,947 207,309 (322,824)
----------- ----------- ------------
Net income (loss)........................... $ 1,256,587 $ 656,870 $ (7,854,273)
=========== =========== ============
Net income (loss) per share................. $ 0.12 $ (1.26)
=========== ============
Weighted average common and common
equivalent shares outstanding............. 5,603,205 6,240,566
=========== ============
</TABLE>
See notes to the consolidated financial statements.
F-5
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended April 30,
-------------------------------------------
1995 1996 1997
------------ ------------ --------------
(As Restated,
--------------
see Note 13)
--------------
<S><C>
Cash flows from operating activities:
Net income (loss).................................. $1,256,587 $ 656,870 $ (7,854,273)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation................................... 199,685 149,846 250,084
Amortization................................... 165,805 11,500 30,598
Loss (gain) on equity investment............... (122) 989 6
Deferred income taxes.......................... 288,719 (208,291) (119,163)
Write-off of capitalized software.............. -- 829,026 --
Changes in assets and liabilities:
Accounts receivable........................ (414,912) (4,284,630) (174,484)
Prepaid expenses........................... (8,156) (617,089) (192,854)
Inventory.................................. -- 7,356 (18,880)
Related party receivables.................. 3,143 34,016 (36,160)
Deposits................................... (52,184) (80,304) (29,815)
Accounts payable........................... 170,482 (65,710) 766,217
Accrued liabilities........................ 319,481 641,578 943,381
Related party payables..................... 4,460 (82,775) 24,587
Income taxes payable/receivable............ 308,580 (92,264) (1,781,726)
Deferred rent.............................. 20,938 67,893 94,461
Deferred revenue........................... (53,740) 96,594 1,503,337
---------- ----------- -----------
Net cash (used in) provided by
operating activities................. 2,208,766 (2,935,395) (6,594,684)
---------- ----------- -----------
Cash flows from investing activities:
Purchase of investments............................ -- -- (7,472,719)
Purchase of property and equipment and assets held
for sale......................................... (155,734) (235,310) (1,249,013)
Software development costs......................... (743,396) -- --
Purchased software................................. -- (115,000) (104,234)
Related party note receivable...................... -- -- (516,174)
---------- ----------- -----------
Net cash used in investing activities.. (899,130) (350,310) (9,342,140)
---------- ----------- -----------
Cash flows from financing activities:
Borrowings under line of credit.................... -- 800,772 4,807,215
Payments under line of credit...................... -- -- (2,914,990)
Proceeds from sale of preferred stock, net......... -- 3,473,293 --
Proceeds from sale of common stock, net............ -- -- 30,644,979
Principal payments under note payable.............. (65,453) (35,250) --
Principal payments under capital leases............ (22,432) (20,731) (37,320)
---------- ----------- -----------
Net cash provided by (used in)
financing activities.................. (87,885) 4,218,084 32,499,884
---------- ----------- -----------
Effect of exchange rate changes on cash................ -- (66,311) (17,569)
---------- ----------- -----------
Net increase in cash and cash equivalents.............. 1,221,751 866,068 16,545,491
Cash and cash equivalents, beginning of period......... 192,454 1,414,205 2,280,273
---------- ----------- -----------
Cash and cash equivalents, end of period............... $1,414,205 $ 2,280,273 $18,825,764
========== =========== ===========
Supplemental disclosures of cash flow information:
Interest paid...................................... $ 18,691 $ 27,732 $ 160,061
========== =========== ===========
Income taxes paid.................................. $ 114,309 $ 506,490 $ 1,262,161
========== =========== ===========
</TABLE>
See notes to the consolidated financial statements.
F-6
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Number of Foreign
Shares of Additional Currency Retained
Common Common Paid-in Translation Earnings
Stock Stock Capital Adjustment (Deficit) Total
--------- ------ ---------- ----------- --------- -----
<S><C>
Balance, May 1, 1994.................. 4,000,000 $ 40,000 $ -- $ -- $ 34,676 $ 74,676
Net income........................ 1,256,587 1,256,587
--------- -------- ----------- -------- ----------- -----------
Balance, April 30, 1995............... 4,000,000 40,000 -- -- 1,291,263 1,331,263
Foreign currency translation
adjustments..................... -- -- -- (66,311) -- (66,311)
Accretion of dividends on redeemable
preferred stock................. -- -- -- -- (88,000) (88,000)
Net income........................ -- -- -- -- 656,870 656,870
--------- -------- ----------- -------- ----------- -----------
Balance, April 30, 1996............... 4,000,000 40,000 -- (66,311) 1,860,133 1,833,822
Conversion of redeemable
preferred stock................. 992,061 9,921 3,727,372 -- -- 3,737,293
Issuance of common stock related to
public offering................. 2,275,364 22,754 30,598,273 -- -- 30,621,027
Issuance of common stock related to
exercise of stock options....... 29,940 299 23,653 -- -- 23,952
Foreign currency translation
adjustments..................... -- -- -- (17,569) -- (17,569)
Accretion of dividends on redeemable
preferred stock................. -- -- -- (176,000) (176,000)
Net loss (As Restated, see
Note 13)........................ -- -- -- -- (7,854,273) (7,854,273)
--------- -------- ----------- -------- ----------- -----------
Balance, April 30, 1997 (As Restated, see
Note 13)............................ 7,297,365 $ 72,974 $34,349,298 $(83,880) $(6,170,140) $28,168,252
========= ======== =========== ======== =========== ===========
</TABLE>
See notes to the consolidated financial statements.
F-7
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Years Ended April 30, 1995, 1996 and 1997
Versatility Inc. (the "Company") was incorporated as National Political
Resources, Inc, in the District of Columbia in 1981 and merged into NPRI, Inc.,
a Virginia corporation, in July 1991. In January 1996, NPRI, Inc.
reincorporated in Delaware. The Company changed its name to Versatility Inc. in
June 1996.
The Company is a provider of client/server customer interaction software
that enables businesses to automate and enhance their telemarketing and
teleselling capabilities. The Company's products include software applications,
development and customization tools and optional software services. The Company
also offers fee-based professional, consulting and maintenance services.
In December 1996, Versatility Inc. (the "Company"), completed an initial
public offering of 2.2 million shares of common stock at $15.00 per share. In
addition, in January 1997, the underwriters in such public offering exercised
their option to purchase 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.
RESTATEMENT OF FINANCIAL STATEMENTS -- The accompanying consolidated
financial statements as of April 30, 1997 and for the year then ended have been
restated. See Note 13 for additional information.
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.
During the year ended April 30, 1997, the Company incurred a net loss
of $7.9 million and used cash in operating activities of $6.6 million. During
fiscal 1998 the Company continued to incur significant losses and use
significant cash in its operating activities. For the nine months ended January
31, 1998, the Company incurred a net loss of $18.1 million (unaudited) and used
cash in operating activities of $18.3 million (unaudited). 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 first two quarters of fiscal 1998 as a
result of concerns over the accounting treatment of certain transactions, which
the Company was examining. The uncertainties resulting from this announcement
have had an adverse effect on the Company's business and financial condition.
Subsequent to such announcement certain customers of the Company have stated
that they will postpone purchases of the Company's products and services at
least until the Company's restated financial results are released, 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 instituted proceedings to remove
the Company's common stock from listing on the National Market (see Note 6).
There is no assurance that once such results are released, such customers will
purchase the Company's products and services. Additionally, the Company expects
to incur significant amounts to defend the lawsuits filed against the Company.
In addition, as discussed in Note 5, the Company was not in compliance with
certain covenants in its line of credit based on the restated financial
statements. 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 general sufficient cash flow to meet
its obligations on a timely basis, to comply with the terms and covenants of its
F-8
<PAGE>
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 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. The Company is also reviewing its strategic alternatives, which
include additional capital raising activities and evaluating potential corporate
partners. If the Company is unable to obtain additional financing sufficient to
meet its operating needs, the Company may be required to significantly reduce
the scope of its operations, which would have a material adverse effect on the
Company's business, results of operations and its ability to compete. Such
reduced operations and levels of cash may also cause the Company to default
under its credit facility.
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
held-to-maturity since the Company has the positive intent and ability to hold
the securities to maturity. Remaining maturities on the Company's investments at
the time of purchase are generally less than one year. Fair value, which is
based on quoted market prices, approximates carrying value. At April 30, 1996,
the Company had no investments.
As of April 30, 1997, the Company's investments consisted of the following:
<TABLE>
<CAPTION>
Maturity of Securities
----------------------------------------
Amortized Within One One to Five Five to Ten
Cost Basis Year Years Years
---------- ---------- ----------- -----------
<S><C>
Treasury notes........ $ 803,044 $ 803,044 $ -- $ --
Municipal bonds....... 1,737,175 303,711 1,160,809 272,655
Corporate bonds....... 4,932,500 4,932,500 -- --
---------- ---------- ---------- --------
$7,472,719 $6,039,255 $1,160,809 $272,655
========== ========== ========== ========
</TABLE>
During fiscal 1998 the Company changed the classification of its
remaining investments to available for sale.
INVENTORY -- Inventory consists of miscellaneous marketing collateral and is
stated at the lower of cost or market, on a first-in, first-out basis.
CAPITALIZED SOFTWARE -- During the course of the development of the
VERSATILITY SERIES software, the Company capitalized its development costs in
compliance with Statement of Financial Accounting Standards No. 86, "ACCOUNTING
FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED OR OTHERWISE MARKETED."
The amount of
F-9
<PAGE>
software capitalized totaled $995,000 and, beginning in November 1994, was
amortized over three years on a straight-line basis. In connection with two
major implementations of the VERSATILITY SERIES product in July 1995, the
Company decided to add features and functions to the product that were
substantially different than those included in the software as originally
capitalized. Management determined that these features and functions
substantially altered the content of the product, effectively eliminating any
remaining useful life of the capitalized asset. Accordingly, the Company wrote
off the remaining asset of $829,000 in the first quarter of fiscal 1996.
PURCHASED SOFTWARE -- Purchased software is amortized on a straight-line
basis over the shorter of five years or the useful life of the asset.
PROPERTY AND EQUIPMENT -- Property and equipment are stated at cost.
Depreciation on property and equipment, including amortization on capital
leases, is computed on a straight-line basis over the estimated useful lives of
the assets, ranging from three to ten years. The leasehold improvements are
depreciated over the shorter of the useful life of the assets or the term of the
related lease. Repairs and maintenance are charged to operations as incurred.
Major improvements and betterments are capitalized.
DEFERRED RENT -- Deferred rent represents the effects of certain rent
concessions that are amortized over the life of the lease on a straight-line
basis.
RECAPITALIZATION -- In conjunction with the issuance of the Series A
redeemable convertible preferred stock (the "Series A Preferred Stock") (See
Note 7), the Company declared, on January 24, 1996, a 4,000 for 1 stock split on
its common stock, and changed the par value from $1.00 to $.01. The shares
outstanding have been restated to give effect to the stock split.
REDEEMABLE PREFERRED STOCK -- The Company accreted the increase in the
redemption value of its Series A Preferred Stock through a charge to retained
earnings through December 13, 1996 when the Series A Preferred Stock was
converted to common stock (See Note 7).
CURRENCY TRANSLATION -- Assets and liabilities of the Company's foreign
operations are translated into U.S. dollars at the exchange rate in effect at
the balance sheet date and revenues and expenses are translated at average rates
in effect during the period. The unrealized currency translation adjustment is
reflected as a separate component of stockholders' equity on the balance sheet.
REVENUE RECOGNITION -- The Company's revenue is derived principally from two
sources: (i) product license fees for the use of the Company's software products
and (ii) service fees for implementation, maintenance, consulting and training
related to the Company's software products. The Company's contracts with its
customers often involve significant customization and installation obligations.
In these situations, license revenue is recognized based on the percentage of
completion method, which is based on 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. 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
$1.4 million, $1.0 million and $767,364 for the years ended April 30, 1995, 1996
and 1997, respectively. Since the introduction of the client/server products
beginning in fiscal 1996, hardware sales have become a less significant
percentage of total revenue. Revenue from the sale of hardware is recorded based
on shipping to the customer.
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.
F-10
<PAGE>
NET INCOME (LOSS) PER SHARE -- Net income (loss) per share is computed using
the weighted average number of common and common equivalent shares outstanding
during the period. Common equivalent shares consist of redeemable convertible
preferred stock (using the as if converted method) and stock options (using the
treasury stock method). Common equivalent shares are excluded from the
computation if their effect is antidilutive except that pursuant to the
Securities and Exchange Commission Staff Accounting Bulletins and staff policy,
such computations include all common and common equivalent shares issued within
the 12 months preceding the effective date of the initial public offering as if
they were outstanding for all periods presented (using the treasury stock
method). Historical earnings per share prior to fiscal 1996 have not been
presented since such amounts are not deemed meaningful due to the significant
change in the Company's capital structure that occurred in connection with the
public offering.
In February 1997, Statement of Financial Accounting Standards No. 128,
"EARNINGS PER SHARE" (SFAS 128), was issued and will become effective during the
Company's fiscal year ending April 30, 1998. The Company expects that the
implementation of SFAS 128 should not have a material effect on the earnings per
share calculation.
NON-CASH TRANSACTIONS -- The Company acquired $47,544 of equipment through
capital leases during fiscal 1996.
CONCENTRATION OF CREDIT RISK -- Financial instruments which potentially
subject the Company to a concentration of credit risk principally consist of
accounts receivable. In fiscal 1996, two customers accounted for 25.7% and 22.2%
of the Company's total revenue, respectively; and in fiscal 1997, two customers
accounted for 34.6% and 10.4% of the Company's total revenue, respectively. As
of April 30, 1997 60.7% of accounts receivable was concentrated with three
customers. The Company generally does not require collateral on accounts
receivable as the majority of the Company's customers are large, well
established companies. The Company provides reserves for 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 1997 as if the
fair-value-based method defined in SFAS 123 had been applied (see Note 9).
RECLASSIFICATIONS -- Certain amounts previously reported have been
reclassified to conform with current year presentation.
RECENT PRONOUNCEMENTS -- In June 1997, Statement of Financial Accounting
Standards No. 130, "REPORTING COMPREHENSIVE INCOME," and Statement of Financial
Accounting Standards No. 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND
RELATED INFORMATION," were issued, which are effective for fiscal years
beginning after December 15, 1997. The Company will comply with all requirements
no later than fiscal 1999.
2. BUSINESS ACQUISITION
Versatility (UK) Limited was acquired by the Company during December 1995.
The stockholders of the Company were the same stockholders of Versatility (UK)
Limited, with proportionate ownership in both companies being the same. The
acquisition was completed by exchanging 2,000,000 shares of common stock of the
Company
F-11
<PAGE>
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.
The following is a reconciliation of revenue and earnings previously
reported by the Company for the year ended April 30, 1995 with the combined
amounts currently presented in the financial statements for that year:
<TABLE>
<CAPTION>
Versatility Intercompany Consolidated
Company (UK) Limited Royalties Amounts
------- ------------ ------------ ------------
<S><C>
Net sales................... $ 10,516,837 $1,801,964 ($833,650) $11,485,151
Income from operations...... 951,896 1,028,615 -- 1,980,511
</TABLE>
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:
<TABLE>
<CAPTION>
Versatility Intercompany Consolidated
Company (UK) Limited Royalties Amounts
------- ------------ ------------ ------------
<S><C>
Net sales................. $6,688,983 $2,530,343 ($571,361) $8,647,965
Income from operations.... 191,137 344,775 -- 535,912
</TABLE>
3. RELATED PARTY TRANSACTIONS
RELATED PARTY RECEIVABLES -- The Company has the following current
receivables from related parties or affiliated entities at April 30, 1996 and
1997 as follows:
<TABLE>
<CAPTION>
April 30,
------------------------
1996 1997
---------- ----------
<S><C>
Stockholder/Officer loan............ $102,765 $117,755
Other............................... 14,456 35,626
-------- --------
$117,221 $153,381
======== ========
</TABLE>
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 1996
and 1997 is $37,221 and $4,740, 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 1995, 1996 and 1997 was
$120,000, $120,000 and $50,000, respectively.
SALE OF PARTNERSHIP INTEREST AND TERMINATION OF LEASE
Prior to October 31, 1996, the Company was the 1% general partner of the
Partnership of which Mr. Ronald R. Charnock, the Company's 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,
F-12
<PAGE>
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.
4. ACCRUED LIABILITIES
Accrued liabilities consisted of the following as of April 30, 1996 and
1997:
<TABLE>
<CAPTION>
April 30,
---------------------------
1996 1997
------------ ------------
<S><C>
Accrued commissions and salaries............... $ 335,395 $ 511,676
Accrued bonuses................................ 461,586 362,467
Accrued payroll taxes and withholdings......... 341,397 195,001
Accrued vacation............................... 203,219 289,034
Sales, use and other taxes payable (credit).... (44,529) 654,788
Other.......................................... 96,585 324,068
------------- -----------
$ 1,393,653 $ 2,337,034
============ ===========
</TABLE>
5. LINE OF CREDIT
In June 1995, the Company obtained a $1.0 million line of credit from a bank
for financing accounts receivable and working capital. The line of credit was
collateralized with a first priority security interest in all accounts
receivable. The line expired on August 31, 1996.
On August 28, 1996, the Company obtained a new $2.5 million operating line
of credit from a bank for financing accounts receivable and working capital and
a new $1.0 million equipment line of credit from the same bank to finance
acquisition of property and equipment. These lines of credit expired on August
5, 1997. The operating and equipment lines of credit bear interest at the prime
rate plus 0.5% and 1.0%, respectively. The weighted average interest rate for
fiscal 1996 and 1997 was 9.1% and 9.0%, respectively. The lines of credit are
collateralized with a first priority security interest in all assets. The lines
of credit have various covenants, including limitations on disposition of
assets. The Company also must maintain certain financial ratios and is
prohibited from paying cash dividends. At April 30, 1997 the Company was not in
compliance with various covenants in the line of credit based on the restated
financial statements (See Note 13). Additionally, 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, 1997 was $2.3
million. The amount borrowed under the equipment line was $437,384 through April
30, 1997. The amount outstanding under this equipment line was $404,678 as of
April 30, 1997. Under the terms of the equipment line, this amount was to have
been converted to a capital lease. However, due to the instances of non
compliance as discussed below, the borrowings under the equipment line have been
reclassified as a current liability.
On October 29, 1997, the Company entered into a new line of credit
arrangement providing a $5.0 million operating line of credit and a new $2.0
million equipment line of credit from the same bank. On April 28, 1998, the
Company entered into an amendment of the line of credit described above (to be
effective April 30, 1998), which will waive all instances of non compliance
which had occurred as a result of the restated financials and provides for the
following terms: the $2.0 million equipment line will be canceled and the
outstanding balance of $256,703 will
F-13
<PAGE>
be transferred to the operating line of credit. The Company will permanently pay
down the operating line by $1.5 million to $3.8 million on April 30, 1998 and
agrees not to borrow any additional amounts under the line. The Company also
will issue 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 has 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 $1.7
million. The line matures on November 5, 1998. The interest rate was increased
to prime plus 3.0% on the amendment date.
6. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES -- The Company leases office space, equipment and
automobiles under noncancelable operating leases expiring through 2004. The
leases for office space have abatements that range from two to six months and
scheduled annual rent escalations of approximately 3%. None of the equipment or
automobile agreements contain unusual renewal or purchase options. Total rent
expense for the years ended April 30, 1995, 1996 and 1997 was $514,963, $876,093
and $1.4 million, respectively.
As of April 30, 1997, future minimum lease payments for the operating leases
are as follows:
<TABLE>
<CAPTION>
Years Ending April 30,
----------------------
<S><C>
1998.......................................... $ 1,373,342
1999.......................................... 1,314,992
2000.......................................... 1,210,442
2001.......................................... 1,014,924
2002.......................................... 761,819
Thereafter.................................... 2,015,145
-----------
Total......................................... $ 7,690,664
===========
</TABLE>
CAPITAL LEASES -- The Company is obligated under capital leases for various
office equipment. As of April 30, 1997, future minimum lease payments for the
capital leases are as follows:
<TABLE>
<CAPTION>
Years Ending April 30,
----------------------
<S><C>
1998........................................................ $ 45,284
1999........................................................ 14,564
2000........................................................ 9,504
2001........................................................ 7,920
----------
Total....................................................... 77,272
Less: Imputed interest at 10%............................... (13,761)
----------
Present value of future minimum lease payments.............. $ 63,511
==========
</TABLE>
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 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
F-14
<PAGE>
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
assert 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 alleges 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 assert, 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. The Company intends to vigorously defend this
action. The ultimate outcome including the amount of the possible loss cannot be
determined at this time. It is expected that the cost to defend this lawsuit
will be substantial and will have a material adverse effect on the Company's
business and results of operations. An unfavorable outcome in the litigation
could have a material adverse effect on the Company's financial condition and
results of operations.
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:
o A former employee has sued the Company for approximately
$1,200,000 for alleged breaches of contract amongst other claims.
o 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.
o 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.
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, and instituted proceedings to remove the Company's common stock from
listing on the National Market. The NASD has indicated that trading may resume
after publication of the Company's restated financial statements; however, a
hearing on delisting is scheduled for April 30, 1998. In addition, the NASD is
continuing to investigate the circumstances surrounding the Company's
restatements. There can be no assurance that the Company's common stock will
continue to be listed on the National Market.
F-15
<PAGE>
7. REDEEMABLE CONVERTIBLE PREFERRED STOCK
On January 24, 1996, the Company issued 992,061 shares of the Company's
Series A Preferred Stock. Shares of Series A Preferred Stock have the same
voting rights as common stock. On December 13, 1996 each share of Series A
Preferred Stock converted into one share of common stock as part of the public
offering. Subsequent to the public offering, the Second Amended and Restated
Certificate of Incorporation was filed, which deleted all references to the
formerly designated Series A Preferred Stock. In addition, 2,000,000 shares of
preferred stock were authorized. The Board of Directors has the authority to
issue the preferred stock in one or more series and to fix the rights,
preferences, privileges and restrictions thereof.
8. STOCKHOLDERS' EQUITY
As of April 30, 1995, the Company had 5,000 shares of common stock
authorized, 1,000 shares issued and outstanding, and no preferred stock
authorized, issued or outstanding. In January 1996, a recapitalization of the
Company was effected. A new corporation was formed, whereby 4,000 shares of
Versatility Inc. common stock were issued for every one share previously
outstanding. The total of authorized shares of common stock was increased to
20,000,000 and 992,061 shares of Series A Preferred Stock were authorized.
Subsequently, the Series A Preferred Stock was canceled and 2,000,000 shares of
preferred stock was authorized (see Note 7).
9. BENEFIT PLANS
401(K) PLAN. The Company has a savings and investment plan (the "Plan")
which covers employees of the Company and that qualifies under section 401(k) of
the Internal Revenue Code. All full-time employees who are at least 21 years old
and have completed at least six months of service are eligible to participate.
Under the terms of the Plan, employees may defer a portion of their salaries as
employee contributions. A discretionary corporate contribution is determined
annually. The Company made a contribution of $44,191 in fiscal 1997. No
contributions were made in fiscal 1995 and 1996. Employee contributions are
vested immediately; however, discretionary company contributions are 100% vested
upon three years of service. The Company is not obligated under any other post
retirement benefit plans.
STOCK OPTION PLANS. The 1996 Stock Option Plan (the "1996 Plan") provides
for the granting of incentive and nonqualified stock options to purchase up to
750,000 shares of common stock. The option price must be equal to or greater
than the fair market value at the date of grant. Options are granted for terms
of up to ten years and most are exercisable in cumulative annual 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.
F-16
<PAGE>
Information regarding the Company's stock option plans is summarized below:
<TABLE>
<CAPTION>
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
----------- ----- ----------- ----- ----------- -----
<S><C>
May 1, 1995 options outstanding....... -- $ -- -- $ -- -- $ --
Granted............................. 228,758 0.80 62,569 0.80 -- --
Exercised........................... -- -- -- -- -- --
Cancelled........................... -- -- -- -- -- --
------- ------- ------ ------- ------- -------
April 30, 1996 options outstanding.... 228,758 0.80 62,569 0.80 -- --
Granted............................. -- -- -- -- 139,000 10.50
Exercised........................... (29,194) 0.80 (746) 0.80 -- --
Cancelled........................... -- -- -- -- -- --
------- ------- ------ ------- ------- -------
April 30, 1997 options outstanding.... 199,564 $ 0.80 61,823 $ 0.80 139,000 $ 10.50
======= ======= ====== ======= ======= =======
Exercisable as of April 30, 1996...... 228,758 $ 0.80 12,514 $ 0.80 -- $ --
======= ======= ====== ======= ======= =======
Exercisable as of April 30, 1997...... 199,564 $ 0.80 24,282 $ 0.80 32,300 $ 10.50
======= ======= ====== ======= ======= =======
Available for future grant............ -- -- 611,000
======= ====== =======
</TABLE>
Options to purchase 320,000 shares of Common Stock were granted to an
officer on January 17, 1996. These options are not part of the above plans.
These stock options vested immediately with an exercise price of $.80 per share,
which was determined by the Board of Directors of the Company to be the fair
market value. None of these options were exercised or cancelled as of April 30,
1997.
1996 EMPLOYEE STOCK PURCHASE PLAN. On September 30, 1996, the Board of
Directors adopted the 1996 Employee Stock Purchase Plan (the "1996 Purchase
Plan"). The 1996 Purchase Plan took effect on May 1, 1997 and provides for the
issuance of a maximum of 100,000 shares of common stock. The 1996 Purchase Plan
will enable eligible employees to purchase common stock at 85% of the lower of
the fair market value of the Company's common stock on the first day or the last
day of each six-month purchase period. No shares have been purchased under the
1996 Purchase Plan as of April 30, 1997.
The Company has computed the pro forma disclosures required under SFAS 123
for all stock options granted as of April 30, 1997 using the Black-Scholes
option pricing model prescribed by SFAS 123. The weighted average fair value at
date of grant for options granted during fiscal 1996 and 1997 was $0.45 and
$5.96, respectively.
The assumptions used and the weighted average information for the years
ended April 30, 1996 and 1997 are as follows:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S><C>
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%
</TABLE>
F-17
<PAGE>
Stock options outstanding and exercisable at April 30, 1997 follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average
----------------
Remaining Weighted
Exercise Contractual Average
Price Number Life in Exercise Number Exercise
Range Outstanding Years Price Exercisable Price
----- ----------- ----- ----- ----------- -----
<S><C>
$ 0.80 582,133 3.78 $ 0.80 543,846 $ 0.80
$10.50 139,000 9.58 $ 10.50 32,300 $ 10.50
</TABLE>
The effect of applying SFAS 123 would be as follows:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S><C>
Pro forma net income (loss)..................... $459,933 $(8,263,561)
Pro forma net income (loss) per share........... $ 0.08 $ (1.32)
</TABLE>
10. INCOME TAXES
The provision for income taxes is computed based on pretax accounting income
for April 30, 1995, 1996 and 1997. Deferred income taxes include the tax effects
of temporary differences between pretax accounting income and taxable income.
For April 30, 1997 the Company incurred losses in accounting and taxable income,
giving rise to a taxable net operating loss of approximately $7,570,000. The
Company will have federal net operating loss carryforwards from the April 30,
1997 year of approximately $5,319,000 after relevant loss carryback claims.
These losses will expire in 2012. In addition, the Company will have State
operating loss carryforwards of approximately $4 million which will expire
beginning in 2002.
The provision for income taxes at April 30, 1995, 1996 and 1997 consists of
the following:
<TABLE>
<CAPTION>
1995 1996 1997
--------- ---------- ------------
<S><C>
Current provision (benefit):
Federal.................................... $ 335,267 $ 284,641 $ (330,285)
Foreign.................................... 51,518 78,520 104,777
State...................................... 39,443 51,229 (97,316)
--------- --------- ----------
Total current provision (benefit)..... 426,228 414,390 (322,824)
--------- --------- ----------
Deferred provision:
Federal.................................... 258,328 (175,496) --
Foreign.................................... -- -- --
State...................................... 30,391 (31,585) --
--------- --------- ----------
Total deferred provision (benefit).... 288,719 (207,081) --
--------- --------- ----------
Total provision (benefit) for income taxes...... $ 714,947 $ 207,309 $ (322,824)
========= ========= ==========
</TABLE>
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:
<TABLE>
<CAPTION>
1995 1996 1997
---------- --------- ----------
<S><C>
Deferred tax assets:
Vacation expense.......................... $ 19,125 $ 70,309 $ 89,858
Accrued bonus expenses.................... 78,703 -- --
Bad debt reserve.......................... 26,735 59,929 290,907
Rent expense.............................. -- 84,233 129,712
Deferred revenue.......................... -- -- 305,315
Net operating loss carryforward- federal
& state................................... -- -- 1,762,946
Foreign tax credit carryforward........... -- -- 35,708
General business credit carryforward...... -- -- 215,279
AMT tax credit carryforward............... -- -- 45,023
</TABLE>
F-18
<PAGE>
<TABLE>
<CAPTION>
1995 1996 1997
---------- --------- ----------
<S><C>
Other..................................... 2,202 -- 15
---------- --------- ----------
Total deferred tax assets................. 126,765 214,471 2,874,763
---------- --------- ----------
Deferred tax liabilities:
Software costs............................ 315,030 -- --
Accelerated depreciation and other........ 12,424 333,634 (37,241)
---------- --------- ----------
Total deferred tax liabilities............ 327,454 333,634 (37,241)
---------- --------- ----------
Valuation allowance....................... (126,765) -- (2,837,522)
---------- --------- ----------
Net deferred tax liabilities.............. $ (327,454) $(119,163) $ --
========== ========= ==========
</TABLE>
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:
<TABLE>
<CAPTION>
1995 1996 1997
-------- -------- ------
<S><C>
U.S. Federal statutory rate............................. 34.0% 34.0% (34.0)%
State income taxes, net of Federal income tax benefit... 4.0 4.0 (0.76)
Impact of foreign earnings and taxes.................... (1.0) (1.7) 1.2
General business credits................................ (3.1) -- --
Benefit from foreign sales corporation.................. -- (13.4) (1.97)
Valuation Allowance..................................... 6.4 -- 34.73
Other................................................... (4.0) 1.0 (3.1)
---- ----- -----
Effective tax rate...................................... 36.3% 23.9% (3.9)%
==== ===== =====
</TABLE>
11. BUSINESS SEGMENT AND GEOGRAPHIC AREA INFORMATION
GEOGRAPHIC AREA INFORMATION -- The Company operates in one industry segment,
the development and marketing of computer software programs and related
services. The Company markets its products worldwide and operations can be
grouped into two main geographic areas. Pertinent financial data by major
geographic area is summarized below.
<TABLE>
<CAPTION>
Eliminations
and Other
United United Corporate
States Kingdom Expenses Consolidated
------ ------- -------- ------------
<S><C>
Years ending April 30, 1995:
Revenue........................ $10,516,837 $1,801,964 $ (833,650) $11,485,151
Income from operations......... 2,969,058 1,028,615 (2,017,162) 1,980,511
Identifiable assets............ 3,834,339 453,273 -- 4,287,612
1996:
Revenue........................ $14,241,435 $2,991,493 $ (697,656) $16,535,272
Income from operations......... 5,250,464 1,060,603 (5,450,028) 861,039
Identifiable assets............ 9,518,498 112,564 -- 9,631,062
1997:
Revenue........................ $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
</TABLE>
The Company charges a royalty to Versatility (UK) Limited for software sales
of the Company's products sold by Versatility (UK) Limited. The royalty is
intended to cover primarily software development expense and marketing expense.
Versatility (UK) Limited reflects the royalty as a cost of revenue. For fiscal
1995, 1996 and 1997 the royalty was $833,650, $697,656 and $256,454,
respectively. These amounts were eliminated in consolidation and are not
reflected in the revenue and income from operations amounts above.
Included in United States revenue is $68,654, $3.8 million and $6.4 million
of export revenue for fiscal 1995, 1996 and 1997, 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 $617,544, $527,681 and $1.3 million of export revenue
F-19
<PAGE>
for fiscal 1995, 1996 and 1997, respectively, which was mainly generated in
Western Europe, exclusive of the United Kingdom.
SIGNIFICANT CUSTOMERS -- The Company had the following customers with
revenue in excess of 10%:
1995 1996 1997
-------- -------- --------
Customer A........ -- 25.7% 34.6%
Customer B........ -- 22.2% 10.4%
Customer C........ 17.7% -- --
12. INTEREST INCOME (EXPENSE), NET
Interest income (expense), net includes interest income of $9,369, $66,643
and $544,096 in fiscal 1995, 1996 and 1997, respectively, and interest expense
of $18,346, $63,503, and $140,107 in fiscal 1995, 1996 and 1997, respectively.
13. RESTATEMENT OF FINANCIAL STATEMENTS
Subsequent to the issuance of the Company's consolidated financial
statements for the year ended April 30, 1997, the Company's management
determined that certain revenue had been inappropriately recognized, the related
receivables had been improperly recorded, and certain costs had not been accrued
or were improperly recorded. As a result, the accompanying consolidated
financial statements as of April 30, 1997 and for the year then ended have been
restated.
A summary of the significant effects of the restatements is as follows:
As of April 30, 1997 As Previously Reported As Restated
-------------------- ---------------------- -----------
Accounts receivable $15,971,315 $5,844,987
Prepaid expenses - current 1,181,865 575,144
Deferred income taxes 230,729 --
Prepaid expenses - non current -- 259,755
Income taxes receivable -- 1,530,000
Assets held for sale 648,314 508,210
Accounts payable 2,107,630 1,590,962
Accrued liabilities 2,016,656 2,337,034
Income taxes payable 662,042 104,777
Capital lease payable 181,069 38,900
Lines of credit:
- - Equipment -- 404,678
Deferred Revenue 978,008 1,788,037
Capital lease payable, 287,120 24,611
less current maturities
Retained earnings (deficit) 3,629,393 (6,170,140)
F-20
<PAGE>
For the Year ended, As Previously Reported As Restated
April 30, 1997: ---------------------- -----------
- ---------------
Total revenue $27,351,895 $18,308,612
Total cost of revenue 6,433,494 6,966,351
Selling, general and 15,252,104 16,750,776
administrative
Income (loss) before 2,909,662 (8,177,097)
provision for income taxes
Provision (benefit) for 964,402 (322,824)
income taxes
Net income (loss) 1,945,260 (7,854,273)
Net income (loss) per share 0.30 (1.26)
Weighted average common 6,456,851 6,240,566
and common equivalent
shares outstanding
F-21
<PAGE>
Versatility Inc.
Schedule II-Valuation and Qualifying Accounts and Reserves
<TABLE>
<CAPTION>
Additions
------------------------
Charged to Charged to
Balance at Costs and Other Balance at
Description May 1, Expenses Accounts Deductions April 30
----------- ------ -------- -------- ---------- --------
<S><C>
For the year ended April 30, 1995
- ---------------------------------
Allowance for doubtful accounts $ 70,354 $102,241 -- $102,241 $ 70,354
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)
- -------------------------------------
(As Restated)
- -------------------------------------
Allowance for doubtful accounts 157,874 997,046 -- 245,419 909,501
</TABLE>
(1) See Note 13 of the Notes to the Consolidated Financial Statements.
F-22
<PAGE>
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 Lease Agreement between the State of California Public
Employees' Retirement System and the Company dated July 10,
1994, as amended (1)
10.6 Loan and Security Agreement between the Company and Silicon
Valley Bank dated as of August 28, 1996 (1)
10.7 Deed of Trust Note dated as of October 31, 1996 issued by
Serenity Real Properties Limited Partnership to the Company
(1)
10.8 * Lease Agreement between the Commonwealth Atlantic Land II
Inc. and the Company dated June 5, 1997
11.1 * Computation of Earnings Per Share
21.1 * Subsidiaries
23.1 * Independent Auditor's Consent
27.1 * Financial Data Schedule
* Filed herewith.
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (File No. 333-13771), as amended.
F-23
Exhibit 11.1
Computation of Historical Net Income (loss) Per Common Share
<TABLE>
<CAPTION>
Year Ended April 30,
1995 1996 1997
---- ---- ----
<S><C>
Net income $ 1,256,587 $ 656,870 $ (7,854,273)
=========== =========== ============
Weighted average number of shares
outstanding 4,000,000 5,858,601
Add:
Shares issuable upon conversion of
Series A Redeemable Convertible
Preferred Stock 992,061
Shares issuable from the assumed
exercise of options as determined by the
application of the treasury stock method 611,144 381,965(1)
----------- ------------
5,603,205 6,240,566
=========== ============
Net income (loss) per common share $ 0.12 $ (1.26)
=========== ============
</TABLE>
The above computations include all common equivalent shares issued within the 12
months preceding the filing date as if they were outstanding for all periods
presented (using the treasury stock method) and the as if converted method with
regards to the Series A redeemable convertible preferred stock. Earnings per
share for fiscal 1995 has not been presented since such amounts are not deemed
meaningful due to the significant change in the Company's capital structure that
occurred in connection with the public offering.
(1) See Note 1 to the consolidated financial statements. Pursuant to the
Securities and Exchange Commission Staff Accounting Bulletins all common
and common equivalent shares issued within the 12 months preceding the
effective date of the initial public offering are treated as if they were
outstanding for all periods presented (using the treasury stock method)
even if the effect is antidilutive.
Exhibit 21.1
SUBSIDIARIES OF THE REGISTRANT
Versatility (UK) Limited
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-24071 of Versatility Inc. on Form S-8 of our report dated April 28, 1998
(which expresses an unqualified opinion and includes explanatory paragraphs
relating to the going concern uncertainty described in Note 1 and to the
restatement described in Note 13) appearing in the Annual Report on Form 10-K/A
of Versatility Inc. for the year ended April 30, 1997.
DELOITTE & TOUCHE LLP
Washington, DC
April 28, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ACCOMPANYING CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> APR-30-1997
<PERIOD-START> MAY-01-1996
<PERIOD-END> APR-30-1997
<CASH> 18,825,764
<SECURITIES> 6,039,255
<RECEIVABLES> 5,844,987
<ALLOWANCES> 909,501
<INVENTORY> 18,880
<CURRENT-ASSETS> 31,976,716
<PP&E> 2,692,778
<DEPRECIATION> 1,675,749
<TOTAL-ASSETS> 37,089,960
<CURRENT-LIABILITIES> 8,580,737
<BONDS> 24,611
0
0
<COMMON> 72,974
<OTHER-SE> 28,095,278
<TOTAL-LIABILITY-AND-EQUITY> 37,089,960
<SALES> 10,254,344
<TOTAL-REVENUES> 18,308,612
<CGS> 1,098,434
<TOTAL-COSTS> 6,966,351
<OTHER-EXPENSES> 19,923,347
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 403,989
<INCOME-PRETAX> (8,581,086)
<INCOME-TAX> (322,824)
<INCOME-CONTINUING> (7,854,273)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,854,273)
<EPS-PRIMARY> (1.26)
<EPS-DILUTED> (1.26)
</TABLE>
