UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended January 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Transition Period from ____________________ to ____________________
Commission File Number: 0-21793
VERSATILITY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-1214354
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11781 Lee Jackson Memorial Highway
Seventh Floor
Fairfax, Virginia 22033
(703) 591-2900
(Address and telephone number of principal executive offices)
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 [ ] NO [X]
As of April 7, 1998, there were 7,562,467 shares of common stock outstanding,
par value $.01 per share.
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VERSATILITY INC.
Form 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
--------
<S><C>
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of April 30, 1997 and January 31, 1998 3
Condensed Consolidated Statements of Operations for the Three Months Ended January 31, 1997 and
1998 and the Nine Months Ended January 31, 1997 and 1998 5
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended January 31, 1997 and 1998 6
Condensed Consolidated Statements of Changes in Stockholders' Equity for the Nine Months Ended
January 31, 1998 7
Notes to Condensed Consolidated Financial Statements 8
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 10
PART II: OTHER INFORMATION
Item 1: Legal Proceedings 19
Item 2: Changes in Securities 19
Item 3: Defaults upon Securities 19
Item 4: Submission of Matters to a Vote of Security Holders 20
Item 5: Other Information 20
Item 6: Exhibits and Reports on Form 8-K 20
Signatures 21
</TABLE>
2
<PAGE>
Part I: Financial Information
Item 1: Financial Statements
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
April 30, 1997 January 31, 1998
-------------- ----------------
(As Restated,
-------------
See Note 4)
-------------
<S><C>
ASSETS
Current assets:
Cash and cash equivalents........................ $18,825,764 $ 4,352,410
Short-term investments........................... 6,039,255 4,504,565
Accounts receivable, net of allowance for
doubtful accounts of $909,501 and $826,687..... 5,844,987 4,982,267
Prepaid expenses................................. 575,144 746,336
Inventory........................................ 18,880 --
Note receivable-trade............................ -- 300,000
Note receivable-related party.................... 519,305 --
Income taxes receivable.......................... -- 2,083,000
Related party receivables........................ 153,381 107,842
----------- -----------
Total current assets........................ 31,976,716 17,076,420
----------- -----------
Other assets:
Deposits......................................... 187,650 430,908
Prepaid expenses................................. 259,755 92,769
Investments...................................... 1,433,464 1,430,983
Income taxes receivable.......................... 1,530,000 --
Assets held for sale............................. 508,210 --
Purchased software, net of accumulated
amortization of $42,098 and $76,511........... 177,136 181,609
----------- -----------
Total other assets.......................... 4,096,215 2,136,269
----------- -----------
Property and equipment
Computers........................................ 1,168,246 2,295,852
Office furniture and equipment................... 665,597 820,535
Leasehold improvements........................... 206,402 294,217
Capital leases................................... 652,533 744,883
----------- -----------
2,692,778 4,155,487
Less: Accumulated depreciation and
amortization.................................. (1,675,749) (2,014,972)
----------- -----------
Net property and equipment.................. 1,017,029 2,140,515
----------- -----------
Total assets.......................................... $37,089,960 $21,353,204
=========== ===========
</TABLE>
See Notes to condensed consolidated financial statements.
3
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
April 30, January 31,
1997 (As 1998
----------- -----------
Restated,
-----------
See Note 4)
-----------
<S><C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................. $ 1,590,962 $ 514,392
Accrued liabilities.............................. 2,337,034 2,393,246
Related party payables........................... 28,030 12,385
Income taxes payable............................. 104,777 14,777
Capital lease payable............................ 38,900 47,613
Line of credit...................................
- Operating 2,288,319 5,036,083
- Equipment 404,678 293,697
Deferred revenue................................. 1,788,037 2,247,575
----------- ------------
Total current liabilities................... 8,580,737 10,559,768
----------- ------------
Other liabilities:
Capital lease payable, less current
maturities..................................... 24,611 50,169
Deferred rent.................................... 316,360 368,035
----------- ------------
Total other liabilities..................... 340,971 418,204
----------- ------------
Commitments and Contingencies
Stockholders' equity:
Preferred stock, $.01 par value,
2,000,000 shares authorized, no shares
issued or outstanding......................... -- --
Common stock, par value $.01-- 20,000,000
shares authorized, 7,297,365 shares issued and
outstanding at April 30, 1997; 7,556,119 shares
issued and outstanding at January 31, 1998.... 72,974 75,561
Additional paid-in capital....................... 34,349,298 34,727,236
Foreign currency translation adjustments......... (83,880) (118,002)
Retained deficit................................. (6,170,140) (24,309,563)
----------- ------------
Total stockholders' equity.................. 28,168,252 10,375,232
----------- ------------
Total liabilities and stockholders' equity............ $37,089,960 $ 21,353,204
=========== ============
</TABLE>
See Notes to condensed consolidated financial statements
4
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
January 31, January 31,
1997 (As 1998 1997 (As 1998
-------- ---- -------- ----
Restated, See Restated, See
------------- -------------
Note 4) Note 4)
------- -------
<S><C>
Revenue:
License revenue................................... $ 1,651,485 $ 885,686 $ 7,458,540 $ 6,340,058
Service and maintenance revenue................... 1,920,153 2,431,131 5,704,072 8,660,943
----------- ----------- ----------- ------------
Total revenue................................ 3,571,638 3,316,817 13,162,612 15,001,001
----------- ----------- ----------- ------------
Cost of revenue:
License revenue................................... 347,295 953,476 756,771 2,533,628
Service and maintenance revenue................... 1,389,144 3,755,129 3,875,698 10,088,218
----------- ----------- ----------- ------------
Total cost of revenue........................ 1,736,439 4,708,605 4,632,469 12,621,846
----------- ----------- ----------- ------------
Gross margin.......................................... 1,835,199 (1,391,788) 8,530,143 2,379,155
----------- ----------- ----------- ------------
Operating expenses:
Selling, general and administrative............... 3,957,842 6,955,886 10,534,545 16,616,234
Research and development.......................... 648,388 1,065,353 1,928,353 3,528,157
Litigation settlement and related costs........... -- -- -- 500,000
Depreciation and amortization..................... 80,835 167,022 187,918 369,638
----------- ----------- ----------- ------------
Total operating expenses..................... 4,687,065 8,188,261 12,650,816 21,014,029
----------- ----------- ----------- ------------
Loss from operations.................................. (2,851,866) (9,580,049) (4,120,673) (18,634,874)
Interest income (expense), net........................ 122,337 69,205 109,786 495,451
----------- ----------- ----------- ------------
Loss before provision (benefit) for income
taxes............................................... (2,729,529) (9,510,844) (4,010,887) (18,139,423)
Provision (benefit) for income taxes.................. 113,176 -- (322,824) --
----------- ----------- ----------- ------------
Net loss.............................................. (2,842,705) (9,510,844) (3,688,063) (18,139,423)
=========== =========== =========== ============
Net loss per share.................................... $ (0.44) $ (1.26) $ (0.62) $ (2.44)
=========== =========== =========== ============
Weighted average common and common
equivalent shares outstanding....................... 6,530,422 7,542,950 5,909,289 7,424,972
=========== =========== =========== ============
</TABLE>
See Notes to condensed consolidated financial statements
5
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
January 31,
1997(As 1998
------- ----
restated, See
-------------
Note 4)
-------
<S><C>
Cash flows from operating activities:
Net loss........................................... $ (3,688,063) $(18,139,423)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation................................... 168,249 335,225
Amortization................................... 19,669 34,413
Loss on equity investment...................... 6 --
Changes in assets and liabilities:
Accounts receivable........................ 112,583 862,720
Prepaid expenses........................... (183,486) (4,206)
Inventory.................................. (28,643) 18,880
Related party receivables.................. (26,498) 45,539
Deposits................................... 19,453 (243,258)
Accounts payable........................... 298,640 (1,076,570)
Accrued liabilities........................ 537,437 56,212
Related party payables..................... 55,056 (15,645)
Income taxes payable/receivable............ (1,203,810) (643,000)
Deferred rent.............................. 77,787 51,675
Deferred revenue........................... 967,522 459,538
----------- ------------
Net cash used in operating activities.. (2,874,098) (18,257,900)
----------- ------------
Cash flows from investing activities:
Purchase of investments............................ -- 1,537,171
Purchase of property and equipment and assets
held for sale.................................... (530,923) (989,387)
Purchased software................................. (81,783) --
Notes receivable................................... -- (300,000)
Related party note receivable...................... (516,174) 519,305
----------- ------------
Net cash used in investing activities.. (1,128,880) 767,089
----------- ------------
Cash flows from financing activities:
Borrowings under line of credit.................... 2,791,821 2,747,764
Payments under line of credit...................... (2,859,910) (110,981)
Proceeds from sale of common stock, net............ 30,643,746 380,525
Principal payments under capital leases............ (41,250) 34,271
----------- ------------
Net cash provided by financing
activities........................... 30,534,407 3,051,579
----------- ------------
Effect of exchange rate changes on cash................ (17,569) (34,122)
----------- ------------
Net decrease in cash and cash equivalents.............. 26,513,860 (14,473,354)
Cash and cash equivalents, beginning of period......... 2,280,273 18,825,764
----------- ------------
Cash and cash equivalents, end of period............... $28,794,133 $ 4,352,410
=========== ============
Supplemental disclosures of cash flow information:
Interest paid...................................... $ 125,807 $ 241,859
=========== ============
Income taxes paid.................................. $ 885,461 $ 669,000
=========== ============
</TABLE>
See Notes to condensed consolidated financial statements
6
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
<TABLE>
<CAPTION>
Number
of Shares Foreign
of Additional Currency
Common Common Paid-In Translation Retained
Stock Stock Capital Adjustments Deficit Total
--------- ------ ---------- ----------- -------- -----
<S><C>
Balance, April 30, 1997(As Restated, See
Note 4)....................................7,297,365 $72,974 $34,349,298 $ (83,880) $ (6,170,140) $ 28,168,252
Issuance of common stock related to
exercise of stock options.............. 258,754 2,587 377,938 380,525
Foreign currency translation
adjustments............................ (34,122) (34,122)
Net loss................................. (18,139,423) (18,139,423)
--------- ------- ----------- --------- ------------ ------------
Balance, January 31, 1998....................7,556,119 $75,561 $34,727,236 $(118,002) $(24,309,563) $ 10,375,232
========= ======= =========== ========= ============ ============
</TABLE>
See Notes to condensed consolidated financial statements.
7
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared on the same basis as the audited consolidated financial
statements and, in the opinion of management, include all adjustments
(consisting of only normal recurring adjustments) necessary to present fairly
the financial information set forth therein, in accordance with generally
accepted accounting principles. The results of operations for the interim
periods are not necessarily indicative of the results to be expected for any
future period. Certain information and footnote disclosures normally contained
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. These condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto, together with management's
discussion and analysis of financial condition and results of operations,
contained in Versatility Inc.'s Annual Report on Form 10-K/A for the fiscal year
ended April 30, 1997.
2. 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 action 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 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 and 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 to the above claim, 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. 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.
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 30, 1997 and October 30, 1997, and that its Form 10-Q
for the quarter ended January 31, 1998 of this 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
8
<PAGE>
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.
3. LINE OF CREDIT
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 on April 28, 1998, the Company entered
into an amendment to the credit facility effective April 30, 1998, in which the
bank will waive all prior defaults, and which provides for the following terms:
the $2.0 million equipment line will be cancelled and the outstanding balance of
$256,703 will be transferred to the operating line of credit. On 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 and 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. The line of credit matures on November 5, 1998.
4. RESTATEMENT OF FINANICAL 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 January 31, 1998 and 1997 and for the three months
and nine months then ended, respectively, have been restated.
<TABLE>
<CAPTION>
As of April 30, 1997: As Previously Reported As Restated
- --------------------- ---------------------- -----------
<S><C>
Current Assets $42,940,494 $31,976,716
Current Liabilities 8,261,754 8,580,737
Retained Earnings 3,629,393 (6,170,140)
<CAPTION>
For the Quarter Ended As Previously Reported As Restated
--------------------- ---------------------- -----------
January 31, 1997:
-----------------
<S><C>
Total Revenue $ 6,997,710 $ 3,571,638
Total Operating Expenses 4,534,293 4,687,065
Net Income (loss) 583,932 (2,842,705)
Net Income (loss) per share $ .09 $ (.44)
Weighted average common and common
equivalent shares outstanding $ 6,851,944 $ 6,530,422
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
For the Nine Months Ended As Previously Reported As Restated
------------------------- ---------------------- -----------
January 31, 1997:
-----------------
<S><C>
Total Revenue $18,649,214 $13,162,612
Total Operations Expenses 12,513,586 12,650,816
Net Income (loss) 1,002,103 (3,688,063)
Net Income (loss) per share $ .17 $ (.62)
Weighted average common and common
equivalent shares outstanding 6,027,096 5,909,289
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
THIS DOCUMENT CONTAINS FORWARD-LOOKING STATEMENTS AND INFORMATION THAT ARE
BASED ON MANAGEMENT'S BELIEFS AS WELL AS ASSUMPTIONS MADE BY 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 WITH THE SECURITIES AND
EXCHANGE COMMISSION, AND DECLARED EFFECTIVE ON DECEMBER 12, 1996 AND THE
COMPANY'S ANNUAL REPORT ON FORM 10-K/A FOR THE FISCAL YEAR ENDED APRIL 30, 1997.
OVERVIEW
Versatility is a leading provider of client/server customer interaction
software that enables businesses to automate their telemarketing and teleselling
capabilities. Founded in 1981 as an information management consulting firm,
Versatility introduced its first commercial product in 1985, a telemarketing
application product based on the Digital Equipment Corporation ("DEC") VAX/VMS
System. The Company operated as a DEC value-added reseller, supplying turnkey
call center solutions to large and mid-sized companies in a variety of
industries, until the end of fiscal 1994. In November 1993, the Company began
developing applications based on the client/server architecture which culminated
with the release of the VERSATILITY SERIES in May 1995.
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 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 accounts.
Revenue from customers outside the United States accounted for 63.8% and
28.6% of the Company's total revenue for the first nine months of fiscal 1997
and 1998, respectively. While the Company's expenses incurred in foreign
countries are typically denominated in the local currencies, revenue generated
by the Company's international sales typically is paid in U.S. dollars or
British pounds. Although exposure to currency fluctuations to date has been
insignificant, there can be no assurance that 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.
10
<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
Three Months Ended Nine Months Ended
January 31, January 31,
1997(1) 1998 1997(1) 1998
------- ---- ------- ----
<S><C>
Revenue:
License revenue......................... 46.2% 26.7% 56.7% 42.3%
Service and maintenance revenue......... 53.8 73.3 43.3 57.7
----- ------ ----- ------
Total revenue...................... 100.0 100.0 100.0 100.0
----- ------ ----- ------
Cost of revenue:
License revenue......................... 9.7 28.8 5.8 16.9
Service and maintenance revenue......... 38.9 113.2 29.4 67.3
----- ------ ----- ------
Total cost of revenue.............. 48.6 142.0 35.2 84.1
----- ------ ----- ------
Gross margin................................. 51.4 (42.0) 64.8 15.9
----- ------ ----- ------
Operating expenses:
Selling, general and administrative..... 110.8 209.7 80.0 110.8
Research and development................ 18.2 32.1 14.7 23.5
Litigation settlement and related costs. -- -- -- 3.3
Depreciation and amortization........... 2.3 (.5) 1.4 2.5
----- ------ ----- ------
Total operating expenses........... 131.2 246.9 96.1 140.1
----- ------ ----- ------
Loss from operations......................... (79.8) (288.9) (31.3) (124.2)
Interest income (expense), net............... 3.4 2.2 .8 3.3
----- ------ ----- ------
Loss before benefit for
income taxes............................... (76.4) (286.7) (30.5) (120.9)
Benefit for income taxes..................... 3.2 -- (2.5) --
----- ------ ----- ------
Net loss..................................... (79.6)% (286.7)% (28.0)% (120.9)%
===== ====== ===== ======
</TABLE>
(1) As Restated, see Note 4 of the Notes to the condensed 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>
Three Months Ended Nine Months Ended
January 31, January 31,
1997(1) 1998 1997(1) 1998
------- ---- ------- ----
<S><C>
Cost of license revenue..................... 21.0% 107.7% 10.1% 40.0%
Cost of service and maintenance revenue..... 72.3% 154.5% 67.9% 116.5%
</TABLE>
(1) As Restated, see Note 4 of the Notes to the condensed consolidated
financial statements.
REVENUE. Total revenue decreased 7.1% from $3.6 million in the three months
ended January 31, 1997 to $3.3 million in the three months ended January 31,
1998, and increased 14.0% from $13.2 million in the first nine months of fiscal
1997 to $15.0 million in the first nine months of fiscal 1998. Revenue from
license fees decreased 46.3% from $1.6 million in the three months ended January
31, 1997, or 46.2% of total revenue, to $.9 million in the three months ended
January 31, 1998, or 26.7% of total revenue. Revenue from license fees decreased
15.0% from $7.5 million in the nine months ended January 31, 1997, or 56.7% of
total revenue, to $6.3 million in the nine months ended January 31, 1998, or
42.3% of total revenue. The decrease in license fees was primarily related to
indirect sales not materializing, while the Company was de-emphasizing its
direct sales activities. Service revenue increased 26.6% from $1.9 million in
the three months ended January 31, 1997 to $2.4 million in the three months
ended January 31, 1998, and 51.8% from $5.7 million in the first nine months of
fiscal 1997 to $8.7 million in the first nine months of fiscal 1998. This
increase was due to greater demand for the Company's implementation and project
management services. The mix of revenue changed from approximately 57% licenses
revenue and 43% service revenue in the
11
<PAGE>
prior year to approximately 42% licenses revenue and 58% services revenue in the
current year, due to the increase in service revenue for the first nine months
of fiscal 1998. In addition, the shift in revenue mix is also attributed to (i)
the impact of the de-emphasis on direct sales efforts for fiscal 1998, and (ii)
the Company's decision to allocate more of its resources towards performing
services for existing customers.
COST OF REVENUE. Cost of license revenue is comprised of the costs of media,
packaging, documentation and incidental hardware costs. Cost of service and
maintenance revenue consists of salaries, wages, benefits and other direct costs
related to installing, customizing and supporting customer implementations.
These costs also include telephone support and training.
Total cost of revenue increased from $1.7 million in the three months ended
January 31, 1997, or 48.6% of total revenue, to $4.7 million in the three months
ended January 31, 1998, or 142.0% of total revenue, and from $4.6 million for
the first nine months of fiscal 1997, or 35.2% of total revenue, to $12.6
million for the first nine months of fiscal 1998, or 84.1% of total revenue.
Cost of license revenue increased from $347,000 in the three months ended
January 31, 1997, or 21.0% of license revenue to $953,000 in the three months
ended January 31, 1998, or 107.7% of license revenue, and from $757,000 in the
first nine months of fiscal 1997, or 10.1% of license revenue, to $2.5 million
in the first nine months of fiscal 1998, or 40.0% of license revenue. Cost of
service and maintenance revenue increased from $1.4 million in the three months
ended January 31, 1997, or 72.3% of service and maintenance revenue, to $3.8
million in the three months ended January 31, 1998, or 154.5% of service and
maintenance revenue. Cost of service and maintenance revenue increased from $3.9
million in the first nine months of fiscal 1997, or 67.9% of service and
maintenance revenue, to $10.1 million in the first nine months of fiscal 1998,
or 116.5% of service and maintenance revenue. The increase was the result of
additions to the Company's consulting, customization and implementation staff to
support the Company's projects. Total cost of revenue was adversely affected in
the current year compared to the same period in the prior year due to the change
in revenue mix between licenses and services and the use of third party
consultants, which increased significantly the costs of providing services.
SELLING, GENERAL AND ADMINISTRATIVE. Selling expenses consist of personnel
costs, including compensation and benefits and costs of travel, advertising,
public relations, seminars and trade shows. General and administrative expenses
represent the costs of executive, finance and support personnel and unallocated
corporate expenses such as rent, utilities, legal and auditing. Selling, general
and administrative expenses increased from $4.0 million for the three months
ended January 31, 1997, or 110.8% of total revenue, to $7.0 million for the
three months ended January 31, 1998, or 209.7% of total revenue, and from $10.5
million for the first nine months of fiscal 1997, or 80.0% of total revenue, to
$16.6 million for the first nine months of fiscal 1998, or 110.8% of total
revenue. This increase was attributable to additions to the Company's headcount,
primarily sales and marketing staff.
RESEARCH AND DEVELOPMENT. Research and development expenses consist of
personnel costs and direct overhead costs incurred in developing software
features and functionality. Research and development expenses increased from
$648,000 for the three months ended January 31, 1997, or 18.2% of total revenue,
to $1.1 million for the three months ended January 31, 1998, or 32.1% of total
revenue, and from $1.9 million for the first nine months of fiscal 1997, or
14.7% of total revenue, to $3.5 million for the first nine months of fiscal
1998, or 23.5% of total revenue. The increase was due to the hiring of
additional software engineers to support increased development activities. In
addition the Company used outside consultants to assist with quality assurance
testing.
LITIGATION SETTLEMENT AND RELATED COSTS. One of the Company's former VARs
filed a claim for arbitration against the Company in connection with the
termination of the VAR's reseller agreement with the Company, claiming not less
than $1.0 million in damages. The Company defended this action in arbitration
proceedings. 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 has recorded a one-time charge in the quarter
ending July 31, 1997 related to this litigation for $500,00, which includes the
settlement charge and other costs and expenses associated with defending the
litigation.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses were
$81,000 in the three months ended January 31, 1997, and $167,000 in the three
months ended January 31, 1998, and $188,000 for the first nine months of fiscal
1997 and $370,000 for the first nine months of fiscal 1998. The increase in
fiscal year 1998 was due to the additional equipment the Company purchased in
fiscal 1998.
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INTEREST INCOME (EXPENSE), NET. Interest income (expense), net consists of
interest earned on cash and cash equivalents, offset by interest expense on debt
and equipment financing. Net interest income (expense) was $122,000 and $69,000
for the three months ended January 31, 1997 and 1998, respectively, and $110,000
and $495,000 for the first nine months of fiscal 1997 and fiscal 1998,
respectively. The difference results from interest income attributable to the
cash raised through the initial public offering in the third quarter of fiscal
1997, partially offset by interest expense related to borrowings on the line of
credit.
PROVISION (BENEFIT) FOR INCOME TAXES. The Company accounts for income taxes
under Statement of Financial Accounting Standards No. 109 "ACCOUNTING FOR INCOME
TAXES" ("SFAS 109"). The provision (benefit) for income taxes is computed based
on pretax income, with deferred income taxes recorded for the differences
between pretax accounting and pretax taxable income (loss). The Company's
provision (benefit) for income taxes was $113,000 for the three months ended
January 31, 1997. The Company did not record a benefit in fiscal 1998. The
Company's provision (benefit) for income taxes was ($323,000) in the first nine
months of fiscal 1997.
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LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date through cash generated from
operations, through the private sale of preferred stock in January 1996 totaling
$3.5 million, from funds obtained from revolving credit facilities with
commercial banks and the Company's initial public offering in December 1996 that
raised $30.6 million in net proceeds.
On October 29, 1997, the Company entered into a 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.
At January 31, 1998, the Company had $8.9 million in cash, cash
equivalents and short-term investments and $1.4 million in investments. For the
nine months ended January 31, 1998, net cash used in operations totaled $18.3
million. In addition, the Company generated $.9 million from investing
activities. Among others items, the Company also had borrowings of $1.5 million
under the Company's working capital line of credit and generated $380,000
related to employees exercising stock options, resulting in a net cash decrease
of $14.5 million.
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 and
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. The line of credit matures on November 5,
1998.
At April 27, 1998, the Company had $5.2 million in cash and cash equivalents
and $8.1 in accounts receivable. Subsequent to the date of the financial
statements contained herein, the Company has incurred substantial and
anticipates a significant loss in the fourth quarter of fiscal 1998.
Additionally, the Company expects to incur significant expenses 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 Company's Annual Report on Form 10-K/A 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 for the year ended
April 30, 1997.
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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 30, 1997, and that its Form 10-Q for the quarter ended January 31, 1998
would not be filed on time, all as a result of concerns over the accounting
treatment of certain transactions which the Company was examining. The
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" below), the
filing of the lawsuits against the Company (described in "Litigation Risks"
below) such announcement has and will continue to have additional adverse
effects on the Company. First, due to the Company's financial uncertainty,
certain customers of the Company have stated that they will postpone purchases
of the Company's products and services until the Company'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 not decline further 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
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 operations. An unfavorable outcome in the
litigation could have a material adverse effect on the Company's financial
condition and results of operations.
PROCEEDINGS WITH THE NASD. As a result of concerns over the matters
disclosed in the Company's March 12, 1998 press release, the 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
Nasdaq 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 Nasdaq
National Market or any other listing or exchange.
DEPENDENCE ON NEW PRODUCTS; RISK ASSOCIATED WITH SERVICING THE CUSTOMER
INTERACTION SOFTWARE MARKET. The Company currently derives substantially all of
its revenue from sales of its VERSATILITY SERIES software and related services.
The VERSATILITY SERIES was introduced in May 1995, and the Company expects that
this product and related services will continue to account for a all of the
Company's revenue for the foreseeable future. However, the Company has little
operating history with the VERSATILITY SERIES products. The Company's financial
results for periods prior to fiscal 1996 reflect sales of the Company's previous
generation of products, which the Company no longer actively markets. The
lifecycle of the Company's current products is difficult to estimate as a result
of many factors, including the unknown future demand for customer interaction
software and the effects of competition in this market. Moreover, although the
Company intends to enhance these products and develop related products, the
Company's strategy is to continue to focus on providing customer interaction
software applications as its sole line of business. As a result, any factor
adversely affecting the market for customer interaction software applications in
general, or the VERSATILITY SERIES products in particular, could adversely
affect the Company's business, financial condition and results of operations.
The market for customer interaction software products is intensely competitive,
highly fragmented and subject to
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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. 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. 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.
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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 strategy of marketing its products directly to end-users and
indirectly through VARs and third party systems integrators may result in
distribution channel conflicts. The Company's direct sales efforts may compete
with those of its indirect channels and, to the extent different resellers
target the same customers, resellers may also come into conflict with each
other. Although the Company has attempted to manage its distribution channels in
a manner to avoid potential conflicts, there can be no assurance that channel
conflicts will not materially adversely affect its relationships with existing
third party systems integrators or VARs or adversely affect its ability to
attract new third party systems integrators and VARs.
DEPENDENCE ON PRACTICE PARTNERS. The Company is currently enlisting the
support of a specific group of professional services organizations which will
engage in the practice of implementing and customizing the Company's software
products. Referred to as "Practice Partners," these organizations do not resell
or otherwise market the Company's products. Instead, the Company intends to
support the Practice Partners' efforts to learn to install, customize and
support the Company's products. The Company's future revenues may depend on the
ability of the Practice Partners to achieve this goal. Further, the costs
required to enlist, train and assist the Practice Partners could have a
materially adverse affect on the Company's business, financial condition and
results of operations.
INTERNATIONAL OPERATIONS. International operations are subject to inherent
risks, including the impact of possible recessionary environments in economies
outside the United States, changes in demand for the Company's products
resulting from fluctuations in exchange rates, unexpected changes in legal and
regulatory requirements including those relating to telemarketing activities,
changes in tariffs, seasonality of sales, costs of localizing products for
foreign markets, longer accounts receivable collection periods and greater
difficulty in accounts receivable collection, difficulties and costs of staffing
and managing foreign operations, reduced protection for intellectual property
rights in some countries, potentially adverse tax consequences and political and
economic instability. There can be no assurance that the Company will be able to
sustain or increase international revenue, or that the factors listed above will
not have a material adverse impact on the Company's international operations.
While the Company's expenses incurred in foreign countries are typically
denominated in the local currencies, revenue generated by the Company's
international sales typically is paid in U.S. dollars or British pounds.
Although exposure to currency fluctuations to date has been insignificant, there
can be no assurance that fluctuations in currency exchange rates in the future
will not have a material adverse impact on the Company's international
operations. The Company currently does not engage in hedging activities.
A significant element of the Company's strategy 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.
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COMPETITION. The market for the Company's products is intensely competitive,
highly fragmented and subject to rapid change. Because the Company offers
multiple applications which can be purchased separately or integrated as part of
the VERSATILITY SERIES, the Company competes with a variety of companies
depending on the target market for their applications software products. The
Company's principal competitors in the customer interaction software market are
Brock International, Inc., Digital Systems International, Inc., Information
Management Associates, Inc., Scopus Technology, Inc. and The Vantive
Corporation. For installations where telephony functions are of prime
importance, competitors include Davox Corporation, Early Cloud and Company (a
division of IBM) and EIS International, Inc. The Company also competes with
third party professional service organizations that develop custom software and
with the information technology departments of potential customers, which
develop applications internally. Among the Company's potential competitors are
also a number of large hardware and software companies that may develop or
acquire products that compete with the Company's products. Increased competition
is likely to result in price reductions, reduced operating margins and loss of
market share, any of which could materially adversely affect the Company's
business, financial condition and results of operations. Many of the Company's
current and potential competitors have significantly greater financial,
technical, marketing and other resources than the Company. As a result, they may
be able to respond more quickly to new or emerging technologies and changes in
customer requirements, or to devote greater resources to the development,
promotion and sale of products than can the Company. There can be no assurance
that the Company will be able to compete successfully against current and future
competitors or that competitive pressures faced by the Company will not
materially adversely affect its business, financial condition and results of
operations.
MANAGEMENT OF GROWTH. 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 strategies or that it will not
experience constraints that will adversely affect its ability to satisfy
customer demand in a timely fashion or to satisfactorily support its customers.
Any of these events could injure the Company's reputation or lead to loss of
customers. If the Company is unable to manage growth effectively, the Company's
business, financial condition and results of operations could be adversely
affected.
DEPENDENCE ON GROWTH OF CLIENT/SERVER COMPUTING ENVIRONMENT. The
client/server software environment is relatively new. The Company markets its
products solely to customers that have committed or are committing their call
center systems to client/server environments, or are converting legacy systems,
in part or in whole, to a client/server environment. The Company's success will
depend on further development of and growth in the number of organizations
adopting client/server computing environments. There can be no assurance,
however, that the client/server market will maintain its current rate of growth.
There also can be no assurance that the client/server computing trends
anticipated by the Company will occur or that the Company will be able to
respond effectively to the evolving requirements of this market. If the
client/server market fails to grow, or grows at a rate slower than experienced
in the past, the Company's business, financial condition and results of
operations could be materially adversely affected.
RAPID TECHNOLOGICAL CHANGE AND PRODUCT DEVELOPMENT RISKS. The customer
interaction software market is subject to rapid technological change, changing
customer needs, frequent new product introductions and evolving industry
standards that may render existing products and services obsolete. As a result,
the Company's position in this market could be eroded rapidly by unforeseen
changes in application features and functions. The life cycles of the Company's
products are difficult to estimate. The Company's growth and future operating
results will depend in part upon its ability to enhance existing applications
and develop and introduce new applications that meet or exceed technological
advances in the marketplace, that meet changing customer requirements, that
respond to competitive products and that achieve market acceptance. The
Company's product development and testing efforts are expected to require
substantial investments by the Company. There can be no assurance that the
Company will possess sufficient resources to make these necessary investments.
The Company has in the past experienced delays both in developing new products
and in customizing existing products, and there can be no assurance that the
Company will not experience difficulties that could cause delays in the future.
In addition, there can be no assurance that such products will meet the
requirements of the marketplace and achieve market acceptance, or that the
Company's current or future products will conform to industry standards. If the
Company is unable, for technological or other reasons, to develop and introduce
new and enhanced products in a timely manner, the Company's business, financial
condition and results of operations could be materially adversely affected.
Software products as complex as those offered by the Company may contain
errors that may be detected at any point in the products' life cycles. The
Company has, in the past, discovered software errors in certain of its products
and has experienced delays in shipment of products during the period required to
correct these errors. In particular, the computing environment is characterized
by a wide variety of standard and non-standard configurations that make
pre-release testing for programming or
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compatibility errors very difficult and time consuming. There can be no
assurance that, despite extensive testing by the Company and by current and
potential customers, errors will not be found, resulting in loss of, or delay
in, market acceptance and sales, diversion of development resources, injury to
the Company's reputation, or increased service and warranty costs, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
DIFFICULTY IN PROTECTING PROPRIETARY TECHNOLOGY; RISK OF INFRINGEMENT. The
Company relies on a combination of copyright, trade secret and trademark laws,
confidentiality procedures and contractual provisions to protect its proprietary
rights in its products and technology. The Company does not rely upon patent
protection and does not currently expect to seek patents on any aspects of its
technology. There can be no assurance that the confidentiality agreements and
other methods on which the Company relies to protect its trade secrets and
proprietary technology will be adequate. Further, the Company may be subject to
additional risks as it enters into transactions in countries where intellectual
property laws are not well developed or are poorly enforced. Legal protections
of the Company's rights may be ineffective in such countries. Litigation to
defend and enforce the Company's intellectual property rights could result in
substantial costs and diversion of resources and could have a materially adverse
effect on the Company's business, financial condition and results of operations,
regardless of the final outcome of such litigation. Despite the Company's
efforts to safeguard and maintain its proprietary rights both in the United
States and abroad, there can be no assurance that the Company will be successful
in doing so or that the steps taken by the Company in this regard will be
adequate to deter misappropriation or independent third-party development of the
Company's technology or to prevent an unauthorized third party from copying or
otherwise obtaining and using the Company's products or technology. There also
can be no assurance that others will not independently develop similar
technologies or duplicate any technology developed by the Company. Any such
events could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company has entered into agreements with a small number of its customers
requiring the Company to place its source code in escrow. These escrow
agreements typically provide that these customers have a limited, non-exclusive
right to use such code in the event that there is a bankruptcy proceeding by or
against the Company, if the Company ceases to do business or if the Company
fails to meet its support obligations. Entering into such agreements may
increase the likelihood of misappropriation by third parties.
As the number of customer interaction software applications in the industry
increases and the functionality of these products further overlaps, software
development companies like the Company may increasingly become subject to claims
of infringement or misappropriation of the intellectual property rights of
others. There can be no assurance that third parties will not assert
infringement or misappropriation claims against the Company in the future with
respect to current or future products. Any claims or litigation, with or without
merit, could be time-consuming, result in costly litigation, cause product
shipment delays or require the Company to enter into royalty or licensing
arrangements. Such royalty or licensing arrangements, if required, may not be
available on terms acceptable to the Company, if at all, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. Adverse determinations in such claims or litigation could
also have a material adverse effect on the Company's business, financial
condition and results of operations.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a significant
extent upon the continued service of its executive officers and other key
management and technical personnel, and on its ability to continue to attract,
retain and motivate qualified personnel, such as experienced software developers
and sales personnel. Competition for such employees is very intense. The 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 Charnock, then the
Company's President and Chief Financial Officer at January 31, 1998. Since April
30, 1997, the Company has replaced substantially all of its senior management.
The Company's current President and Chief Operating 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 laws 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
19
<PAGE>
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 ones are listed below). Taken together or individually, an
adverse outcome on the results of these suits may have a materially adverse
impact on the Company. The outcome of these matters cannot be ascertained at
this time:
A former employee has sued the Company for approximately $1.2 million
for breach of contract amongst other claims;
A former customer is seeking damages in excess of $1 million for
alleged breach 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;
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.
20
<PAGE>
Part II: Other Information
Item 1: Legal Proceedings:
One of the Company's former VARs filed a claim for arbitration against
the Company in connection with the termination of the VAR's reseller agreement
with the Company, claiming not less than $1.0 million in damages. 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 decision was appealed.
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 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 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. An unfavorable outcome in the litigation could have a material adverse
effect on the Company's financial condition and results of operations.
In addition to the above claim, 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 ones are listed 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.
A former employee has sued the Company for approximately $1.2 million
for breach of contract amongst other claims;
A former customer is seeking damages in excess of $1 million for
alleged breach 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;
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.
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 30, 1997 and October 30, 1997, and that its Form 10-Q for
the quarter ended January 31, 1998 would not be filed on time, all as of result
of concerns over the accounting treatment of certain transactions. As a result
of this press release 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.
21
<PAGE>
Item 2: Changes in Securities and Use of Proceeds:
Not Applicable.
Item 3: Defaults Upon Senior Securities:
Not Applicable.
Item 4: Submission of Matters to a Vote of Security Holders:
None.
Item 5: Other Information:
Not Applicable.
Item 6: Exhibits and Reports on Form 8-K:
Not Applicable
22
<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/ Kenneth T. Nelson
_____________________
Kenneth T. Nelson
Senior Vice President, Finance
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
23
<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> 9-MOS
<FISCAL-YEAR-END> APR-30-1998
<PERIOD-START> MAY-01-1997
<PERIOD-END> JAN-31-1998
<CASH> 4,352,410
<SECURITIES> 4,504,565
<RECEIVABLES> 4,982,267
<ALLOWANCES> 826,687
<INVENTORY> 0
<CURRENT-ASSETS> 17,076,420
<PP&E> 4,155,487
<DEPRECIATION> (2,014,972)
<TOTAL-ASSETS> 21,353,204
<CURRENT-LIABILITIES> 10,559,768
<BONDS> 50,169
0
0
<COMMON> 75,561
<OTHER-SE> 10,299,671
<TOTAL-LIABILITY-AND-EQUITY> 21,353,204
<SALES> 6,340,058
<TOTAL-REVENUES> 15,001,001
<CGS> 2,533,628
<TOTAL-COSTS> 12,621,846
<OTHER-EXPENSES> 21,014,029
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (18,634,874)
<INCOME-TAX> 0
<INCOME-CONTINUING> (18,139,423)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (18,139,423)
<EPS-PRIMARY> (2.44)
<EPS-DILUTED> (2.44)
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