UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q/A
AMENDMENT NO. 1 TO 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 October 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Transition Period from ________________ to ________________
Commission File Number: 0-21793
VERSATILITY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-1214354
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11781 Lee Jackson Memorial Highway
Seventh Floor
Fairfax, Virginia 22033
(703) 591-2900
(Address and telephone number of principal executive offices)
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
As of December 2, 1997 there were 7,542,902 shares of common stock outstanding,
par value $.01 per share.
<PAGE>
VERSATILITY INC.
Form 10-Q/A
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 October 31, 1997 3
Condensed Consolidated Statements of Operations for the Three Months Ended October 31, 1996 and
1997 and the Six Months Ended October 31, 1996 and 1997 5
Condensed Consolidated Statements of Cash Flows for the Six Months Ended October 31, 1996 and 1997 6
Condensed Consolidated Statements of Changes in Stockholders' Equity for the Six Months Ended
October 31, 1997 7
Notes to Condensed Consolidated Financial Statements 8
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 12
PART II: OTHER INFORMATION
Item 1: Legal Proceedings 22
Item 2: Changes in Securities 23
Item 3: Defaults upon Securities 23
Item 4: Submission of Matters to a Vote of Security Holders 23
Item 5: Other Information 23
Item 6: Exhibits and Reports on Form 8-K 24
Signatures 25
</TABLE>
2
<PAGE>
THE UNDERSIGNED REGISTRANT HEREBY AMENDS THE FOLLOWING ITEMS, FINANCIAL
STATEMENTS, EXHIBITS OR OTHER PORTIONS OF ITS QUARTERLY REPORT ON FORM
10-Q AS SET FORTH HEREIN. THIS QUARTERLY REPORT ON FORM 10Q/A IS FILED
IN CONNECTION WITH THE COMPANY'S RESTATEMENT OF FINANCIAL STATEMENTS
FOR THE FISCAL YEAR ENDED APRIL 30, 1997 AND FOR THE FISCAL QUARTERS
ENDIING JULY 31, 1998 AND OCTOBER 31, 1998. EXCEPT AS OTHERWISE NOTED,
INFORMATION CONTAINED IN THIS REPORT IS AS OF OCTOBER 31, 1997.
Part I: Financial Information
Item 1: Financial Statements
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
April 30, 1997 October 31, 1997
-------------- ----------------
(As Restated, (As Restated,
------------- -------------
See Note 4) See Note 4)
----------- -----------
<S><C>
ASSETS
Current assets:
Cash and cash equivalents....................... $18,825,764 $10,997,266
Short-term investments.......................... 6,039,255 5,239,625
Accounts receivable, net of allowance for
doubtful accounts of $909,501 and $692,028.... 5,844,987 4,768,432
Prepaid expenses................................ 575,144 1,004,970
Inventory....................................... 18,880 105,683
Note receivable-trade........................... -- 400,000
Note receivable-related party................... 519,305 --
Income taxes receivable......................... -- 2,083,000
Related party receivables....................... 153,381 185,928
----------- -----------
Total current assets....................... 31,976,716 24,784,904
----------- -----------
Other assets:
Deposits........................................ 187,650 275,808
Prepaid expenses................................ 259,755 148,431
Investments..................................... 1,433,464 1,426,499
Income Taxes Receivable 1,530,000 --
Assets held for sale............................ 508,210 543,107
Purchased software, net of accumulated
amortization of $42,098 and $64,021.......... 177,136 159,849
----------- -----------
Total other assets......................... 4,096,215 2,553,694
----------- -----------
Property and equipment
Computers....................................... 1,168,246 1,371,783
Office furniture and equipment.................. 665,597 764,823
Leasehold improvements.......................... 206,402 222,556
Capital leases.................................. 652,533 652,533
----------- -----------
2,692,778 3,011,695
Less: Accumulated depreciation and
amortization................................. (1,675,749) (1,860,440)
----------- -----------
Net property and equipment................. 1,017,029 1,151,255
----------- -----------
Total assets......................................... $37,089,960 $28,489,853
=========== ===========
See Notes to the condensed consolidated financial statements.
3
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
</TABLE>
<TABLE>
<CAPTION>
April 30, 1997 October 31, 1997
-------------- ----------------
(As Restated, (As restated,
------------- -------------
See Note 4) See Note 4)
----------- -----------
<S><C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................... $ 1,590,962 $ 921,379
Accrued liabilities............................ 2,337,034 2,464,141
Related party payables......................... 28,030 9,307
Income taxes payable........................... 104,777 14,777
Capital lease payable.......................... 38,900 18,769
Line of credit.................................
- Operating 2,288,319 2,519,892
- Equipment 404,678 330,690
Deferred revenue............................... 1,788,037 1,979,767
----------- -----------
Total current liabilities................. 8,580,737 8,258,722
----------- -----------
Other liabilities:
Capital lease payable, less current
maturities................................... 24,611 --
Deferred rent.................................. 316,360 350,432
----------- -----------
Total other liabilities................... 340,971 350,432
----------- -----------
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; 7,534,554 shares
issued and outstanding at October 31, 1997.... 72,974 75,346
Additional paid-in capital..................... 34,349,298 34,710,200
Foreign currency translation adjustments....... (83,880) (106,128)
Retained deficit............................... (6,170,140) (14,798,719)
----------- -----------
Total stockholders' equity................ 28,168,252 19,880,699
----------- -----------
Total liabilities and stockholders' equity.......... $37,089,960 $28,489,853
============ ===========
</TABLE>
See Notes to the condensed consolidated financial statements.
4
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
October 31,(As Restated, See October 31,(As Restated, See
Note 4) Note 4)
1996 1997 1996 1997
---- ---- ---- ----
<S><C>
Revenue:
License revenue............................... $2,767,994 $ 3,409,799 $ 5,807,055 $ 5,454,372
Service and maintenance revenue............... 2,152,051 2,342,989 3,783,919 6,229,812
---------- ----------- ----------- -----------
Total revenue............................ 4,920,045 5,752,788 9,590,974 11,684,184
---------- ----------- ----------- -----------
Cost of revenue:
License revenue............................... 204,252 915,870 409,476 1,580,152
Service and maintenance revenue............... 1,246,893 3,057,502 2,486,554 6,333,089
---------- ----------- ----------- -----------
Total cost of revenue.................... 1,451,145 3,973,372 2,896,030 7,913,241
---------- ----------- ----------- -----------
Gross margin...................................... 3,468,900 1,779,416 6,694,944 3,770,943
---------- ----------- ----------- -----------
Operating expenses:
Selling, general and administrative........... 3,547,896 5,327,453 6,576,703 9,660,348
Research and development...................... 661,399 1,501,002 1,279,965 2,462,804
Litigation settlement and related costs....... -- -- -- 500,000
Depreciation and amortization................. 57,267 104,056 107,083 202,616
---------- ----------- ----------- -----------
Total operating expenses................. 4,266,562 6,932,511 7,963,751 12,825,768
---------- ----------- ----------- -----------
Loss from operations.............................. (797,662) (5,153,095) (1,268,807) (9,054,825)
Interest income (expense), net.................... (6,939) 177,543 (12,551) 426,246
---------- ----------- ----------- -----------
Loss before provision (benefit) for income
taxes........................................... (804,601) (4,975,552) (1,281,358) (8,628,579)
Benefit for income taxes.......................... (274,000) -- (436,000) --
---------- ----------- ----------- -----------
Net loss.......................................... (530,601) (4,975,552) (845,358) (8,628,579)
========== =========== =========== ===========
Net loss per share................................ $ (0.09) $ (0.67) $ (0.15) $ (1.17)
========== =========== =========== ===========
Weighted average common and common
equivalent shares outstanding................... 5,603,205 7,412,089 5,603,205 7,365,984
========== =========== =========== ==========
</TABLE>
See Notes to the condensed consolidated financial statements.
5
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
October 31,(As Restated, See
NOTE 4)
1996 1997
---- ----
<S><C>
Cash flows from operating activities:
Net loss........................................... $ (845,358) $(8,628,579)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation................................... 95,583 180,693
Amortization................................... 11,500 21,923
Loss on equity investment...................... 6 --
Changes in assets and liabilities:
Accounts receivable........................ (1,370,546) 1,076,555
Prepaid expenses........................... (458,603) (318,502)
Inventory.................................. (15,997) (86,803)
Related party receivables.................. (10,160) (32,547)
Deposits................................... (512) (88,158)
Accounts payable........................... 338,340 (669,583)
Accrued liabilities........................ 845,548 127,107
Related party payables..................... 74,636 (18,723)
Income taxes payable/receivable............ (735,625) (643,000)
Deferred rent.............................. 61,113 34,072
Deferred revenue........................... 1,312,430 191,730
----------- -----------
Net cash used in operating activities.. (697,645) (8,853,815)
Cash flows from investing activities:
Purchase of investments............................ -- 806,595
Purchase of property and equipment and assets
held for sale.................................... (239,778) (354,452)
Notes receivable................................... -- (400,000)
Related party note receivable...................... (516,174) 519,305
------------ -----------
Net cash provided by (used) in investing
activities....................................... (755,952) 571,448
Cash flows from financing activities: ----------- -----------
Borrowings under line of credit.................... 2,490,214 231,573
Payments under line of credit...................... (1,318,250) (73,988)
Proceeds from sale of common stock, net............ -- 363,274
Principal payments under capital leases............ (19,264) (44,742)
----------- -----------
Net cash provided by financing
activities........................... 1,152,700 476,117
----------- -----------
Effect of exchange rate changes on cash................ 3,650 (22,248)
----------- -----------
Net decrease in cash and cash equivalents.............. (297,247) (7,828,498)
Cash and cash equivalents, beginning of period......... 2,280,273 18,825,764
----------- ------------
Cash and cash equivalents, end of period............... $ 1,983,026 $10,997,266
=========== ===========
Supplemental disclosures of cash flow information:
Interest paid...................................... $ 66,195 $ 136,257
=========== ===========
Income taxes paid.................................. $ 303,635 $ 669,000
=========== ===========
</TABLE>
See Notes to the condensed consolidated financial statements.
6
<PAGE>
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
<TABLE>
<CAPTION>
Number of Foreign
Shares of Additional Currency
Common Common Paid-In Translation Retained
Stock Stock Capital Adjustments Deficit Total
--------- ------- ----------- --------- ------------ -----------
<S><C>
Balance, April 30, 1997(As Restated, 7,297,365 $72,974 $34,349,298 $ (83,880) $ (6,170,140) $28,168,252
See Note 4)................................
Issuance of common stock related to
exercise of stock options............ 237,189 2,372 360,902 363,274
Foreign currency translation
adjustments.......................... (22,248) (22,248)
Net loss............................... (8,628,579) (8,628,579)
--------- ------- ----------- --------- ------------ -----------
Balance, October 31, 1997(As Restated,
see Note 4)................................ 7,534,554 $75,346 $34,710,200 $(106,128) $(14,798,719) $19,880,699
========= ======= =========== ========= ============ ===========
</TABLE>
See Notes to the 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
One of the Company's former Value added Resellers (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 proceeding. 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 $500,000, which includes the settlement charge and other
costs and expenses associated with defending 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 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 cannot be
ascertained at this time, the Company has not recorded any significant accruals
related to these matters
8
<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 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, 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.
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 in subsequent quarters, on April 28, 1998, the Company
entered into an amendment to the credit facility effective April 30, 1998, in
which the bank 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.
9
<PAGE>
4. 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 October 31, 1997 and 1996 and for the three and six
months then ended, respectively, 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
--------------------- ---------------------- -----------
Current Assets $42,940,494 $31,976,716
Current Liabilities 8,261,754 8,580,737
Retained Earnings (deficit) 3,629,393 (6,170,140)
For the Quarter ended
---------------------
October 31, 1996: As Previously Reported As Restated
----------------- ---------------------- -----------
Total Revenue $ 6,051,472 $4,920,045
Total Operating Expenses 4,274,125 4,266,562
Net Income (loss) 215,825 (530,601)
Net Income (loss) per share $ .04 ($ .09)
Weighted average common
and common equivalent
share outstanding 5,603,205 5,603,205
As of October 31, 1997: As Previously Reported As Restated
------------------------ ---------------------- -----------
Curent Assets $38,469,984 $24,784,904
Current Liabilities 6,479,258 8,258,722
Retained Earnings (deficit) 1,044,452 (14,798,719)
For the Quarter ended As Previously Reported As Restated
---------------------- ---------------------- -----------
October 31, 1997
----------------
Total Revenue $ 7,597,664 $ 5,752,788
Total Operating Expenses 8,272,874 6,932,511
Net Income (loss) (2,631,382) (4,975,552)
Net Income (loss) per share ($ .36) ($ .67)
Weighted average common 7,412,089 7,412,089
and common equivalent shares
10
<PAGE>
For the Six Months ended As Previously Reported As Restated
------------------------ ---------------------- -----------
October 31, 1996:
-----------------
Total Revenue $ 11,471,504 $ 9,590,974
Total Operating Expenses 7,979,293 7,963,751
Net Income (loss) 418,171 (845,358)
Net Income (loss) per share $ .07 ($ .15)
Weighted average common
and common equivalent
shares outstanding 5,603,205 5,603,205
For the Six Months ended As Previously Reported As Restated
------------------------ ---------------------- -----------
October 31, 1997:
-----------------
Total Revenue $ 16,608,827 $ 11,684,184
Total Operating Expenses 14,680,383 12,825,768
Net Income (loss) (2,584,941) (8,628,579)
Net Income (loss) per share ($ .35) ($ 1.17)
Weighted average common
and common equivalent
shares outstanding 7,365,984 7,365,984
11
<PAGE>
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. 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.
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 generally recognized upon shipment as long as cash collection
is probable. Service revenue for implementation, consulting services and
training is 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.
For the first six months of fiscal 1997, British Telecommunications Plc
("BT") and Avantel, S.A. accounted for 24.6% and 22.4%, respectively, of the
Company's total revenue. Although the particular customers may change from
period to period, the Company expects that large sales to a limited number of
customers will continue to account for a significant percentage of its total
revenue in any particular period. Given the customer concentration and the
duration of the sales and implementation cycle, the loss of a major customer or
any reduction or delay in sales to or implementation by these or other customers
could have a material adverse effect on the Company's operating results in any
particular period.
Revenue from customers outside the United States accounted for 61.5% and
32.3% of the Company's total revenue for the first six 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.
12
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 Six Months Ended
October 31, October 31,
1996(1) 1997(1) 1996(1) 1997(1)
------- ------- ------- -------
<S><C>
Revenue:
License revenue......................... 56.3% 59.3% 60.5% 46.7%
Service and maintenance revenue......... 43.7 40.7 39.5 53.3
----- ----- ----- -----
Total revenue...................... 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of revenue:
License revenue......................... 4.2 15.9 4.3 13.5
Service and maintenance revenue......... 25.3 53.1 25.9 54.2
----- ----- ----- -----
Total cost of revenue.............. 29.3 69.0 30.2 67.7
----- ----- ----- -----
Gross margin................................. 70.5 31.0 69.8 32.3
----- ----- ----- -----
Operating expenses:
Selling, general and administrative..... 72.1 92.6 68.6 82.7
Research and development................ 13.4 26.1 13.3 21.1
Litigation settlement and related costs. -- -- 4.3
Depreciation and amortization........... 1.2 1.8 1.1 1.7
----- ----- ----- -----
Total operating expenses........... 86.7 120.5 83.0 109.8
----- ----- ----- -----
Loss from operations......................... (16.2) (89.5) (13.2) (77.5)
Interest income (expense), net............... (0.1) 3.1 (0.1) 3.6
----- ----- ----- -----
Loss before benefit for
income taxes............................... (16.4) (86.4) (13.4) (73.9)
Benefit for income taxes..................... (5.6) -- (4.5) --
----- ----- ----- -----
Net loss..................................... (10.8)% (86.4)% (8.8)% (73.9)%
===== ===== ====== =====
</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 Six Months Ended
October 31, October 31,
1996(1) 1997(1) 1996(1) 1997(1)
------- ------- ------- -------
<S><C>
Cost of license revenue..................... 7.4% 26.9% 7.1% 29.0%
Cost of service and maintenance revenue..... 57.9% 130.5% 65.7% 101.7%
</TABLE>
(1) As Restated. See Note 4 of the Notes to the condensed consolidated
financial statements.
REVENUE. Total revenue increased 16.9% from $4.9 million in the three months
ended October 31, 1996 to $5.8 million in the three months ended October 31,
1997, and 21.8% from $9.6 million in the first six months of fiscal 1997 to
$11.7 million in the first six months of fiscal 1998. Revenue from license fees
increased 23.2% from $2.8 million in the three months ended October 31, 1996, or
56.3% of total revenue, to $3.4 million in the three months ended October 31,
1997, or 59.3% of total revenue. Revenue from license fees decreased 6.0% from
$5.8 million in the six months ended October 31, 1996, or 60.5% of total
revenue, to $5.5 million in the six months ended October 31, 1997, or 46.7% of
total revenue. The decrease in license fees was primarily related to indirect
sales channels sales not materializing, while the Company was de-emphasizing its
direct sales activities. Service revenue increased 8.9% from $2.2 million in the
three months ended October 31, 1996 to $2.3 million in the three months ended
October 31, 1997, and 64.6% from $3.8 million in the first six months of fiscal
1997 to $6.2 million in the first six 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 60% licenses revenue and
40% service revenue in the prior year to approximately 47% licenses revenue and
53% services revenue in the current year, due to the increase in service
13
<PAGE>
revenue for the first six 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 $1.5 million in the three months ended
October 31, 1996, or 29.3% of total revenue, to $4.0 million in the three months
ended October 31, 1997, or 69% of total revenue, and from $2.9 million for the
first six months of fiscal 1997, or 30.2% of total revenue, to $7.9 million for
the first six months of fiscal 1998, or 67.7% of total revenue. Cost of license
revenue increased from $204,000 in the three months ended October 31, 1996, or
4.2% of license revenue to $916,000 in the three months ended October 31, 1997,
or 15.9% of license revenue, and from $409,000 in the first six months of fiscal
1997, or 4.3% of license revenue, to $1,580,000 in the first six months of
fiscal 1998, or 13.5% of license revenue. Cost of service and maintenance
revenue increased from $1.2 million in the three months ended October 31, 1996,
or 57.9% of service and maintenance revenue, to $3.1 million in the three months
ended October 31, 1997, or 130.5% of service and maintenance revenue. Cost of
service and maintenance revenue increased from $2.5 million in the first six
months of fiscal 1997, or 65.7% of service and maintenance revenue, to $6.3
million in the first six months of fiscal 1998, or 101.7% 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 service.
SELLING, GENERAL AND ADMINISTRATIVE. Selling expenses consist of personnel
costs, including compensation and benefits and costs of travel, advertising,
public relations, seminars and trade shows. General and administrative expenses
represent the costs of executive, finance and support personnel and unallocated
corporate expenses such as rent, utilities, legal and auditing. Selling, general
and administrative expenses increased from $3.5 million for the three months
ended October 31, 1996, or 72.1% of total revenue, to $5.3 million for the three
months ended October 31, 1997, or 92.6% of total revenue, and from $6.6 million
for the first six months of fiscal 1997, or 68.6% of total revenue, to $9.7
million for the first six months of fiscal 1998, or 82.7% of total revenue. This
increase was attributable to additions to the Company's headcount, primarily
sales and marketing staff. At October 31, 1996, sales, marketing and
administrative had 88 employees versus 132 employees at October 31, 1997.
RESEARCH AND DEVELOPMENT. Research and development expenses consist of
personnel costs and direct overhead costs incurred in developing software
features and functionality. Research and development expenses increased from
$661,000 for the three months ended October 31, 1996, or 13.4% of total revenue,
to $1.5 million for the three months ended October 31, 1997, or 26.1% of total
revenue, and from $1.3 million for the first six months of fiscal 1997, or 13.3%
of total revenue, to $2.5 million for the first six months of fiscal 1998, or
21.1% of total revenue. The increase was due to the hiring of additional
software engineers to support increased development activities. At October 31,
1996, research and development had 28 employees versus 45 employees at October
31, 1997. In addition, in the second quarter, 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 $500,000, which includes the
settlement charge and other costs and expenses associated with defending the
litigation.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses were
$57,000 in the three months ended October 31, 1996, and $104,000 in the three
months ended October 31, 1997, and $107,000 for the first six months of fiscal
1997 and $203,000 for the first six months of fiscal 1998.
14
<PAGE>
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 $(7,000) and $178,000
for the three months ended October 31, 1996 and 1997, respectively, and
$(13,000) and $426,000 for the first six 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 $274,000 for the three months ended
October 31, 1997. The Company recorded no benefit for the three months ended
October 31, 1996. The Company's benefit for income taxes was $436,000 in the
first six months of fiscal 1997. No benefit was recorded for the first six
months of fiscal 1998.
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 October 31, 1997, the Company had $16.2 million in cash, cash
equivalents and short-term investments and $4.8 million in accounts receivable.
For the six months ended October 31, 1997, net cash used in operations totaled
$8.9 million. In addition, the Company generated $571,000 from investing
activities, partially offset by borrowings of $232,000 under the Company's
working capital line of credit and $519,000 related to employees exercising
stock options, resulting in a net cash decrease of $7.8 million.
Recent Developments
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 million in accounts receivable. Subsequent to the date of
the financial statements contained herein, the Company has incurred substantial
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 and 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.
15
<PAGE>
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.
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" 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.
An unfavorable outcome in the litigation could have a material adverse effect on
the Company's financial condition and results of operations.
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.
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
16
<PAGE>
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 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,
17
<PAGE>
implementation of the Company's products involves a significant commitment of
resources by prospective customers and is commonly associated with substantial
integration efforts which may be performed by the Company, by the customer, or
by a third party systems integrator. For these and other reasons, the length of
time between the date of initial contact with the potential customer and the
implementation of the Company's products is often lengthy, typically ranging
from two to nine months or more, and is subject to delays over which the Company
has little or no control. The Company's implementation cycle could be lengthened
by increases in the size and complexity of its implementations and by delays in
its customers' adoption of client/server computing environments. Delay in or
cancellation of the sale or implementation of applications could have a
materially adverse effect on the Company's business, financial condition and
results of operations and cause the Company's operating results to vary
significantly from quarter to quarter.
EXPANSION OF SALES FORCE AND CHANNELS OF DISTRIBUTION. Historically, the
Company has distributed its products primarily through its direct sales force.
An integral part of the Company's strategy was to expand its direct sales force
while developing additional marketing, sales and implementation relationships
with third party systems integrators and VARs. The Company's ability to achieve
revenue growth in the future will depend on its ability to attract, train and
retain additional qualified direct sales personnel. In addition, the Company was
investing significant resources to develop its relationships with third party
systems integrators and VARs, especially in international markets. The Company
has only limited experience distributing its products through indirect channels.
If the Company is unable to develop its relationships with third party systems
integrators and VARs, or if the third party systems integrators and VARs with
which the Company develops relationships are unable to effectively market, sell
and implement the Company's software applications, the Company's business,
financial condition and results of operations could be materially adversely
affected.
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,
18
<PAGE>
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.
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. 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
19
<PAGE>
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.
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
20
<PAGE>
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 R. Charnock, then the
Company's President and Chief Executive Officer at October 31, 1997. Since April
30, 1997 the Company has replaced all of its senior management. The Company's
current President and Chief Operating Officer joined the Company in February
1988, 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 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: Because the outcome cannot be ascertained at this time, the
Company has not recorded any significant accruals related to these matters:
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.
21
<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'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 $500,000, which includes the settlement charge and other costs and expenses
associated with defending 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 action filed in the United States District
Court for the Sourthern 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 Bopwen 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 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
22
<PAGE>
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.
Item 2: Changes in Securities and Use of Proceeds
On December 12, 1996, the Company's Registration Statement on Form S-1
(File No. 333-13771) became effective. The Company has filed Form SR
disclosing the sale of securities and the use of proceeds through March
12, 1997. The net proceeds from the offering were $30,625,564. No
information has changed, except for the use of proceeds. The Company
used all of the proceeds form such offering during the period from the
effective date (December 12, 1996) through October 31, 1997, as
follows:
Purchase and installation of machinery and $ 1,656,436
equipment
Repayment of indebtedness 1,526,195
Working capital 27,442,933
-----------
Total $30,625,564
===========
None of these payments were made to directors, officers, general
partners of the Company or their associates, or to persons owning ten
percent or more of any class of equity securities of the Company, and
to the affiliates of the Company.
Item 3: Defaults Upon Senior Securities:
Not Applicable.
Item 4: Submission of Matters to a Vote of Security Holders:
The Annual Meeting of Stockholders (the "Annual Meeting") was held on
August 26, 1997 at the Holiday Inn Fair Oaks. In connection with the
Annual Meeting, proxies representing 6,628,636 shares or 90.5% of the
total outstanding shares were present and voted in the following
manner:
<TABLE>
<CAPTION>
Number of Votes Cast
--------------------
Description of Matter For Withheld Instructed
--------------------- --- -------- ----------
<S><C>
1 To elect two Class I directors to serve on the
Board of Directors for a three-year term or
until their successors are elected and qualified.
Marcus W. Heth 6,621,521 7,115 1,550
Charles A. Johnson 6,623,071 5,656 1,550
</TABLE>
<TABLE>
<CAPTION> Broker
For Against Abstain Non-Vote
--- ------- ------- --------
<S><C>
2 To ratify the selection of the firm of Deloitte &
Touche LLP as independent auditors for the fiscal
year ending April 30, 1998. 6,624,576 2,500 1,560 0
</TABLE>
Item 5: Other Information:
Not Applicable.
23
<PAGE>
Item 6: Exhibits and Reports on Form 8-K:
A. Exhibits
Exhibit No. Exhibits
- ----------- --------
10.10 Loan and Security Agreement between the Company and Silicon
Valley Bank, dated as of October 29, 1997
11.1 Statement Regarding Computation of Net Income (Loss) Per Share
27.1 Financial Data Schedule
B. Reports on Form 8-K:
There were no reports on Form 8-K filed during the quarter
ended October 31, 1997.
24
<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)
25
<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> 6-MOS
<FISCAL-YEAR-END> APR-30-1998
<PERIOD-START> MAY-01-1997
<PERIOD-END> OCT-31-1997
<CASH> 10,997,266
<SECURITIES> 5,239,625
<RECEIVABLES> 4,768,432
<ALLOWANCES> 692,028
<INVENTORY> 105,683
<CURRENT-ASSETS> 24,784,904
<PP&E> 3,011,695
<DEPRECIATION> (1,860,440)
<TOTAL-ASSETS> 28,489,853
<CURRENT-LIABILITIES> 8,258,722
<BONDS> 0
0
0
<COMMON> 75,346
<OTHER-SE> 19,805,353
<TOTAL-LIABILITY-AND-EQUITY> 28,489,853
<SALES> 5,454,372
<TOTAL-REVENUES> 11,684,184
<CGS> 1,580,152
<TOTAL-COSTS> 7,913,241
<OTHER-EXPENSES> 12,825,768
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (9,054,825)
<INCOME-TAX> 0
<INCOME-CONTINUING> (8,628,579)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,628,579)
<EPS-PRIMARY> (1.17)
<EPS-DILUTED> (1.17)
</TABLE>
