<PAGE> 1
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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 FEBRUARY 28, 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: 0-26880
VERITY, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0182779
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
894 ROSS DRIVE
SUNNYVALE, CALIFORNIA 94089
(408) 541-1500
(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
The number of shares outstanding of the Registrant's Common Stock,
$0.001 par value, was 10,855,000 as of February 28, 1997.
This report consists of 21 pages. The Exhibit Index to this report is
located on page 19.
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VERITY, INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements............................................................ 1
Condensed Consolidated Balance Sheets as of May 31, 1996 and February 28, 1997.. 1
Condensed Consolidated Statements of Operations for the Quarters Ended February
29, 1996 and February 28, 1997 and the Nine Months Ended February 29, 1996 and
February 28, 1997.............................................................. 2
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
February 29, 1996 and February 28, 1997......................................... 3
Notes to Condensed Consolidated Financial Statements............................ 4
Item 2: Management's Discussion and Analysis of Financial Condition and Results of
Operations...................................................................... 6
PART II: OTHER INFORMATION
Item 1: Legal Proceedings............................................................... 17
Item 2: Changes in Securities........................................................... 17
Item 3: Defaults upon Senior Securities................................................. 17
Item 4: Submissions of Matters to a Vote of Security Holders............................ 17
Item 5: Other Information............................................................... 17
Item 6: Exhibits and Reports on Form 8-K................................................ 17
Signatures............................................................................... 18
</TABLE>
<PAGE> 3
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
VERITY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
MAY 31, FEBRUARY 28,
1996 1997
-------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................................. $ 2,482 $ 1,745
Short-term investments ................................................ 40,899 21,175
Trade accounts receivable, less allowance for doubtful accounts
of $389 in 1996 and $525 in 1997 ................................... 8,822 8,554
Prepaid and other current assets ...................................... 1,161 1,769
-------- --------
Total current assets .......................................... 53,364 33,243
Property and equipment, at cost, net of accumulated depreciation
and amortization ...................................................... 4,744 9,182
Long-term investments ................................................... 4,592 10,188
Other assets ............................................................ 24 870
-------- --------
Total assets .................................................. $ 62,724 $ 53,483
======== ========
LIABILITIES
Current liabilities:
Current portion of long-term debt and capital lease obligations ....... $ 426 $ 648
Accounts payable ...................................................... 3,368 3,507
Accrued compensation .................................................. 1,565 1,963
Other accrued liabilities ............................................. 779 1,225
Deferred revenue ...................................................... 3,139 3,568
-------- --------
Total current liabilities ..................................... 9,277 10,911
Long-term debt and capital lease obligations, net of current portion .... 639 291
-------- --------
Total liabilities ............................................. 9,916 11,202
-------- --------
STOCKHOLDERS' EQUITY
Common stock, $.001 par value:
Authorized: 30,000,000 shares in 1996 and 1997;
Issued and outstanding 10,735,000 shares in 1996 and 10,855,000 shares 11 11
in 1997
Additional paid-in capital .............................................. 87,882 88,975
Notes receivable from stockholders ...................................... (1,225) (1,089)
Unrealized gain (loss) on investments ................................... (125) 5
Accumulated deficit ..................................................... (33,735) (45,621)
-------- --------
Total stockholders' equity .................................... 52,808 42,281
-------- --------
Total liabilities and stockholders' equity .................... $ 62,724 $ 53,483
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
1
<PAGE> 4
VERITY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
FEB. 29 FEB. 28 FEB. 29 FEB. 28
1996 1997 1996 1997
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Software products ................................ $ 6,444 $ 9,181 $ 16,158 $ 26,136
Service and other ................................ 1,557 1,942 4,542 5,395
-------- -------- -------- --------
Total revenues ........................... 8,001 11,123 20,700 31,531
-------- -------- -------- --------
Costs of revenues:
Software products ................................ 718 585 1,370 2,204
Service and other ................................ 679 918 2,014 2,771
-------- -------- -------- --------
Total costs of revenues .................. 1,397 1,503 3,384 4,975
-------- -------- -------- --------
Gross profit ....................................... 6,604 9,620 17,316 26,556
-------- -------- -------- --------
Operating expenses:
Research and development ......................... 2,163 4,050 5,957 10,839
Acquisition of in-process research and development -- 10,029 -- 10,029
Marketing and sales .............................. 3,880 5,466 9,951 15,454
General and administrative ....................... 881 1,196 2,505 3,548
-------- -------- -------- --------
Total operating expenses ................. 6,924 20,741 18,413 39,870
-------- -------- -------- --------
Loss from operations ............................... (320) (11,121) (1,097) (13,314)
Other income, net .................................. 432 296 435 1,428
-------- -------- -------- --------
Net income (loss) .................................. $ 112 $(10,825) $ (662) $(11,886)
======== ======== ======== ========
Net income (loss) .................................. $ 112 $(10,825) $ (662) $(11,886)
Accretion to redemption value of mandatorily
redeemable convertible preferred stock ........... -- -- (611) --
-------- -------- -------- --------
Net income (loss) applicable to common stockholders $ 112 $(10,825) $ (1,273) $(11,886)
======== ======== ======== ========
Net income (loss) per share ........................ $ 0.01 $ (1.00) $ (0.18) $ (1.10)
======== ======== ======== ========
Number of shares used in per share calculation ..... 11,105 10,841 6,884 10,800
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
2
<PAGE> 5
VERITY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
FEB. 29 FEB. 28
------- -------
1996 1997
---- ----
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss ............................................................. $ (662) $(11,886)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization ..................................... 1,055 2,732
Provision for doubtful accounts .................................. 229 150
Amortization of discount on securities ............................ (159) (517)
Common stock issued for services .................................. 60 --
Exchange loss ..................................................... -- 12
Changes in operating assets and liabilities:
Trade accounts receivable ....................................... (2,990) 120
Prepaid and other current assets ................................ (929) (719)
Accounts payable ................................................ (896) 139
Accrued compensation and other accrued liabilities .............. 3,523 895
Deferred revenue ................................................ 841 433
Write-off of in-process research and development ................ -- 10,029
-------- --------
Net cash provided by operating activities .................... 72 1,388
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment ................................ (1,431) (6,923)
Purchases of marketable securities ................................... (44,951) (49,272)
Maturity of marketable securities .................................... -- 33,800
Proceeds from sale of marketable securities .......................... -- 30,462
Investment in preferred stock ........................................ -- (167)
Acquisition of Cognisoft Corporation ................................. -- (10,000)
Capitalization of software ........................................... -- (1,035)
Increase in other assets ............................................. (44) (28)
-------- --------
Net cash used in investing activities ........................ (46,426) (3,163)
-------- --------
Cash flows from financing activities:
Borrowings under line of credit ...................................... 750 1,500
Payments on line of credit ........................................... (1,645) (1,500)
Proceeds from the sale of mandatorily redeemable convertible preferred
stock, net of issuance costs ...................................... 3,242 --
Proceeds from stockholders on notes receivable ....................... -- 135
Proceeds from the sale of common stock ............................... 49,666 1,093
Proceeds from issuance of notes payable .............................. 150 --
Proceeds from sales and lease backs of property and equipment ........ 147 --
Principal payments on notes payable and capital lease obligations .... (882) (125)
-------- --------
Net cash provided by financing activities .................... 51,428 1,103
-------- --------
Effect of exchange rate changes on cash ................................ 13 (65)
-------- --------
Net increase (decrease) in cash and cash equivalents ......... 5,087 (737)
Cash and cash equivalents, beginning of period ......................... 324 2,482
-------- --------
Cash and cash equivalents, end of period ............................... $ 5,411 $ 1,745
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest ............................. $ 219 $ 153
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Accretion to redemption value of mandatorily redeemable convertible
preferred stock ................................................... $ 611 --
Issuance of common stock for notes receivable ........................ $ 365 --
Conversion of mandatorily redeemable convertible preferred stock to
common stock ...................................................... $ 35,922 --
Common stock issue costs included in other accrued liabilities ....... $ 179 --
Assets acquired in Cognisoft acquisition ............................. -- $ 548
Liabilities assumed in Cognisoft acquisition ......................... -- $ 500
Cognisoft acquisition consideration included in accrued liabilities .. -- $ 77
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
<PAGE> 6
VERITY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF FEBRUARY 28, 1997 AND FOR THE QUARTERS ENDED
FEBRUARY 29, 1996 AND FEBRUARY 28, 1997 AND THEREAFTER IS UNAUDITED)
1. INTERIM FINANCIAL DATA (UNAUDITED):
The unaudited financial statements for the quarters ended February 29, 1996
and February 28, 1997 have been prepared on the same basis as the audited
financial statements and, in the opinion of management, include all adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation of
the financial position and results of operations in accordance with generally
accepted accounting principles. Although certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to the
rules and regulations of the Securities and Exchange Commission, the Company
believes the disclosures made are adequate to make the information presented not
misleading. It is suggested that the accompanying financial statements be read
in conjunction with the Company's annual financial statements on Form 10-K for
the year ended May 31, 1996.
The Company's balance sheet as of May 31, 1996 was derived from the
Company's audited financial statements but does not include all disclosures
necessary for the presentation to be in accordance with generally accepted
accounting principles.
2. COMPUTATION OF NET INCOME AND LOSS PER SHARE
Net income and loss per share is computed using the weighted average number
of shares of common stock outstanding. Common equivalent shares from stock
options, warrants and preferred stock are included in the computation when their
effect is dilutive and excluded from the computation when their effect is
antidilutive, except that, pursuant to the Securities and Exchange Commission
Staff Accounting Bulletins, common and common equivalent shares and mandatorily
redeemable convertible preferred stock, issued at prices below the initial
public offering price during the twelve months immediately preceding the initial
filing date of the Company's initial public offering have been included in the
calculation as if they were outstanding for all periods ending prior to the
effectiveness of the Company's initial public offering using the treasury stock
method and the initial public offering price.
3. RECENT ACCOUNTING PRONOUNCEMENTS
During October 1995, the Financial Accounting Standards Board issued
Statement No. 123, "Accounting for Stock-based Compensation", (SFAS 123) which
establishes a fair value based method of accounting for stock based compensation
plans. While the Company is studying the impact of the pronouncement, it
continues to account for employee stock options under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." SFAS 123 will be effective for the
Company's fiscal year ended May 31, 1997.
During February 1997, the Financial Accounting Standards Board issued
Statement No. 128, "Earnings per Share", (SFAS 128) which specifies the
computation, presentation and disclosure requirements for reporting earnings per
share information. SFAS 128 becomes effective for all periods, including interim
periods, ending on or after December 15, 1997. The impact of adopting SFAS 128
on the Company's financial statements has not yet been determined.
4
<PAGE> 7
4. BANK LINE OF CREDIT
The Company has available an unsecured $7,500,000 line of credit under an
agreement with a bank which expires on September 30, 1997. Borrowings under the
line of credit bear interest at the lender's prime rate. The agreement requires
the Company to comply with certain financial covenants and prohibits the
assumption of any major debt, except for equipment leases, without the bank's
approval. As of February 28, 1997, no borrowings were outstanding under the line
of credit.
5. CAPITALIZED SOFTWARE
During the three months and nine months ended February 28, 1997, the
Company capitalized approximately $230,000 and $1.0 million, respectively, and
amortized approximately $190,000 and $240,000, respectively, of software
development costs, as required under generally accepted accounting principles,
in connection with the development of a number of products included in the
Company's new SEARCH'97 product line.
6. COGNISOFT MERGER
On January 10, 1997, the Company entered into an Agreement and Plan of
Reorganization and Merger with Cognisoft Corporation (Cognisoft) providing for
the Company's purchase of Cognisoft for $10 million in cash. Cognisoft, a
startup company located in Bellevue, Washington, is currently developing an
Intranet application that enables corporations to "push" information to users
from multiple data sources. The Company accounted for the merger using the
purchase method of accounting and the results of operations of Cognisoft have
been included with those of the Company since January 13, 1997, the date the
acquisition was consummated. Approximately $10 million of the purchase price was
allocated to purchased research and development related to products for which
technological feasibility had not been established and for which there was no
alternative future use.
Summarized below are the unaudited pro forma results of operations of the
Company as though Cognisoft had been acquired at the beginning of fiscal 1996.
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
May 31, 1996 February 28, 1997
------------ -----------------
(in thousands, except per share amounts)
<S> <C> <C>
Revenue $ 30,718 $ 31,531
Net loss $ (383) $(12,597)
Net loss per share $ (0.13) $ (1.17)
</TABLE>
The above amounts are based upon certain assumptions and estimates which
the Company believes are reasonable and do not reflect any benefit from
economies which might be achieved from combined operations. The pro forma
financial information presented above is not necessarily indicative of either
the results of operations that would have occurred had the acquisition taken
place at the beginning of fiscal 1996 or of future results of operations of the
combined companies.
7. SUBSEQUENT EVENT
On March 17, 1997, the Company's Board of Directors approved a plan whereby
each employee holding options to purchase the Company's common stock were given
a choice to either retain his or her current options or to cancel and exchange
such options for new options to purchase four (4) shares of Common Stock for
each five (5) shares subject to the cancelled options. The exercise price per
share for the new options was set equal to the fair market price on March 17,
1997.
5
<PAGE> 8
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Verity develops, markets and supports software tools and applications that
enable individuals, enterprises and publishers to intelligently search, filter
and disseminate textual information residing on enterprise networks, online
services, the Internet, CD-ROM and other electronic media. The Company was
founded in 1988, and, historically, derived the substantial majority of its
revenue from the licensing of high-priced, custom search and retrieval
applications for use almost entirely by large organizations and government
agencies. During these years, the Company also generated a substantial portion
of its revenues by providing the consulting services required to support these
products.
In early fiscal 1994, Verity retained a new Chief Executive Officer and
replaced several members of its senior management team. Shortly thereafter, the
Company shifted its strategy from the sale of high-priced products requiring
significant customization to leveraging the Company's Topic technology to
develop a number of new, lower-priced products that address the needs of broader
markets. During this period, the Company also focused on building strategic
alliances for the primary purpose of expanding the user base of the Company's
technology rather than generating significant revenues. The objectives of the
Company's strategy are to establish its software as a de facto standard and to
offset lower unit prices for its products with higher sales volumes.
The Company's ongoing implementation of this strategy has involved several
significant actions. During recent years, the Company has reduced significantly
its average unit license fees. Also, during this period, the Company has devoted
significant resources to modify and enhance its core technology to support a
broader set of search and retrieval solutions for use on desktop and
enterprise-wide systems, and over the Internet. Key engineering efforts in this
regard have included the continued enhancement of the functionality of the
Company's Topic search engine and the modification of the Topic software to
facilitate its incorporation in third parties' information management,
publishing and groupware software applications. More recently, the Company's
engineering efforts have focused on the development of new applications of Topic
software for use with CD-ROM, online services and the Internet, together with
the Company's new SEARCH'97 product line. The Company's technology is deployed
within the Company's own suite of applications, and also as an embedded feature
within broadly distributed third-party software applications, such as Lotus
Notes, Adobe Acrobat, Frame FrameViewer and Documentum Server and WorkSpace. The
Company has also licensed its technology to prominent providers of Internet
products and online services, including Netscape Communications, NetManage,
Quarterdeck, AT&T WorldNet Services, and MCI's Delphi Internet, together with
Internet publishers, including Cisco Systems, Tandem Computer, Compaq Computer
and the Financial Times.
In connection with its new strategy, the Company has also replaced the
majority of its work force and substantially reorganized all of the departments
within the Company. While experiencing significant turnover, the Company
increased the number of research and development personnel from 29 at the
beginning of fiscal 1994 to 89 at February 28, 1997. Given its reduced focus on
offering custom solutions, the Company was able to decrease the number of
personnel involved in its relatively low-margin consulting business from 29 at
the beginning of fiscal 1994 to 17 at February 28, 1997.
Since inception, the Company has incurred significant losses and
substantial negative cash flow. Due in part to the transition, the Company
experienced declining revenues and increased net losses in fiscal years 1993
through 1995. At February 28, 1997, the Company had cumulative operating losses
of $35.8 million, with net losses of $5.8 million, $313,000 and $11.9 million
for fiscal 1995, fiscal 1996 and the nine months ended February 28, 1997,
respectively. For the three months ended February 28, 1997, total revenues
increased 39% over the corresponding fiscal 1996 period, primarily as a result
of a 42% increase in software product revenues. Operating expenses for the three
months ended February 28, 1997 increased
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<PAGE> 9
over the prior three months as a percentage of revenues, due primarily to the
in-process research and development expenses incurred as a result of the
acquisition of Cognisoft Corporation and, with respect to research and
development expense, less capitalization of software development costs. Research
and development expenses were $4.1 million, or 36% of revenues, compared with
$2.2 million, or 27% of revenues, for the same period last year. For the
Company's previous quarter ended November 30, 1996, research and development
expenses were $3.3 million or 28% of revenues. While it is the Company's goal to
increase revenues and generate net income in future periods, no assurance can be
given that the Company's revenues will increase from quarter to quarter in
future periods, or that the Company will achieve positive cash flow or
profitability.
In January 1997, the Company acquired Cognisoft Corporation, a startup
company located in Bellevue, Washington, which is currently developing an
Intranet application that enables corporations to "push" information to users
from multiple data sources. As a result of the acquisition, the Company incurred
a one-time charge against earnings of approximately $10 million during the
quarter ended February 28, 1997, which related to the amount of the purchase
price that was allocated to research and development on products that had not
reached technological feasibility and for which there was no alternative future
use. These costs represented 90.2% and 31.8% of total revenues for the three
months and nine months ended February 28, 1997, respectively.
The ongoing implementation of the Company's new strategy has placed, and
may continue to place, a significant strain on the Company's resources,
including its personnel. The Company believes that hiring and retaining
qualified individuals at all levels in the Company is essential to its success,
and there can be no assurance that the Company will be successful in attracting
and retaining the necessary personnel. If Company management is unable to
effectively manage its planned transition, identify opportunities in a timely
fashion, and evaluate and manage the Company's business and competitive
position, the Company's results of operations and financial condition will be
materially and adversely affected. Furthermore, there can be no assurance that
the Company will introduce all of its SEARCH'97 products or other new products
on a timely basis, or that the SEARCH'97 products or other new or recently
introduced products will achieve market acceptance.
The Company's revenues are derived from licenses fees for its software
products and fees for services complementary to its products, including software
maintenance, consulting and training. Fees for services generally are charged
separately from the license fees for the Company's software products. The
Company recognizes revenues in accordance with the provisions of American
Institute of Certified Public Accountants Statement of Position No. 91-1,
Software Revenue Recognition. Accordingly, maintenance revenues from ongoing
customer support and product upgrades are recognized ratably over the term of
the applicable maintenance agreement, which is typically 12 months. Payments for
maintenance fees generally are received in advance and are nonrefundable.
Revenues for consulting and training generally are recognized when the services
are performed.
7
<PAGE> 10
RESULTS OF OPERATIONS
The following table sets forth the percentage of revenues represented by
certain items in the Company's Condensed Consolidated Statements of Operations
for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
FEB. 29 FEB. 28 FEB. 29 FEB. 28
1996 1997 1996 1997
<S> <C> <C> <C> <C>
Revenues:
Software products ................. 80.5% 82.5% 78.1% 82.9%
Service and other ................. 19.5 17.5 21.9 17.1
----- ------ ----- -----
Total revenues ............ 100.0 100.0 100.0 100.0
----- ------ ----- -----
Costs of revenues:
Software products ................. 9.0 5.3 6.6 7.0
Service and other ................. 8.5 8.3 9.7 8.8
----- ------ ----- -----
Total costs of revenues ... 17.5 13.5 16.3 15.8
----- ------ ----- -----
Gross profit
Operating expenses: ................. 82.5 86.5 83.7 84.2
----- ------ ----- -----
Research and development .......... 27.0 36.4 28.8 34.4
In-process research and development -- 90.2 -- 31.8
Marketing and sales ............... 48.5 49.1 48.1 49.0
General and administrative ........ 11.0 10.8 12.1 11.3
----- ------ ----- -----
Total operating expenses .. 86.5 186.5 89.0 126.4
----- ------ ----- -----
Loss from operations .............. (4.0) (100.0) (5.3) (42.2)
Interest and other expenses ....... 5.4 2.7 2.1 4.5
----- ------ ----- -----
Net income (loss) ................. 1.4% (97.3)% (3.2)% (37.7)%
===== ====== ===== =====
</TABLE>
REVENUES
Total revenues increased 52.3% from $20.7 million for the nine months ended
February 29, 1996 to $31.5 million for the nine months ended February 28, 1997.
Total revenues increased 39% from $8.0 million for the three months ended
February 29, 1996 to $11.1 million for the three months ended February 28, 1997.
Total revenues for the comparable nine months period increased primarily due to
increased revenues from licensing of Internet/publishing products and tools.
Software product revenues increased as a percentage of total revenues from 78.1%
and 80.5% for the nine months and three months ended February 29, 1996
respectively, to 82.9% and 82.5%, respectively, for the comparable periods in
fiscal 1997. Conversely, service and other revenues declined as a percentage of
total revenues from 21.9% and 19.5% for the nine months and three months ended
February 29, 1996, respectively, to 17.1% and 17.5%, respectively, for the
comparable periods in fiscal 1997.
Software product revenues. Software product revenues increased 61.8% from
$16.2 million for the nine months ended February 29, 1996 to $26.1 million for
the nine months ended February 28, 1997. The increase for the nine months ended
February 28, 1997 over the nine months ended February 29, 1996 was due
principally to increased revenues from licensing of Internet/publishing products
and tools. Software product revenues increased 42.5% from $6.4 million for the
three months ended February 29, 1996 to $9.2 million for the three months ended
February 28, 1997. The increase for the three months ended February 28, 1997
over the three months ended February 28, 1996 was due principally to increased
revenues from licensing of enterprise products and, to a lesser extent,
Internet/publishing products and tools.
Service and other revenues. Service and other revenues increased 18.8% from
$4.5 million for the nine months ended February 29, 1996 to $5.4 million for the
nine months ended February 28, 1997. Service and other revenues increased 24.7%
from $1.6 million for the three months ended February 29, 1996 to $1.9 million
for the three months ended February 28, 1997. Maintenance revenues increased
significantly between the comparable periods, but these increases were partially
offset by reduced training revenues.
Revenues from foreign operations accounted for 7.8% and 4.3% of total
revenues, respectively, for the nine months ended February 29, 1996 and February
28, 1997, with European operations alone accounting for 6.6% and 4.3% of total
revenues for those periods. For the nine months ended February 29, 1996 and
February 28, 1997, export sales accounted for 21.6% and 22.2% of total revenues,
respectively. Revenue
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<PAGE> 11
from foreign operations accounted for 6.1% and 4.4%, respectively, for the three
months ended February 29, 1996 and February 28, 1997, with European operations
alone accounting for 5.5% and 4.4% of total revenues for those periods. For the
three months ended February 29, 1996 and February 28, 1997, export sales
accounted for 22.8% and 21.9% of total revenues, respectively. The decreases in
revenues from foreign operations as a percentage of revenues resulted primarily
from decreased rest of world revenues and increased domestic revenues. The
Company expects that revenues derived from foreign operations and export sales
will continue to vary in future periods as a percentage of total revenues.
No single customer accounted for more than 10% of the Company's revenues
for the nine months and three months ended February 29, 1996. For the nine
months ended February 28, 1997, licensing and maintenance of software products
to Cisco Systems, Inc. accounted for approximately 12.6% of the Company's
revenues. For the three months ended February 28, 1997, licensing and
maintenance of software products to Southwestern Bell Telephone accounted for
approximately 13.4% of the Company's revenues. Revenues derived from sales to
the federal government and its agencies were 11.8% and 7.1% of the Company's
revenues for the nine months ended February 29, 1996 and February 28, 1997,
respectively and 8.5% and 6.3% of the Company's revenues for the three months
ended February 29, 1996 and February 28, 1997, respectively. The Company expects
that revenues from such government sales will continue to vary in future periods
as a percentage of revenues.
COSTS OF REVENUES
Costs of software products. Costs of software products increased 60.9% from
$1.4 million for the nine months ended February 29, 1996 to $2.2 million for the
nine months ended February 28, 1997 representing 8.5% and 8.4%, respectively, of
software product revenues. The increase in absolute dollars was principally
related to the higher level of software product sales compared to the prior
year's period. Costs of software products decreased 18.5% from $718,000 for the
three months ended February 29, 1996 to $585,000 for the three months ended
February 28, 1997 representing 11.1% and 6.4%, respectively, of the software
product revenues. The decrease in absolute dollars and in costs as a percentage
of software product sales was primarily related to decreased sales of licensed
software relating to third party software components included in certain
products during the period ended February 28, 1997.
Costs of service and other. Costs of service and other revenues increased
37.6% from $2.0 million for the nine months ended February 29, 1996 to $2.8
million for the nine months ended February 28, 1997, representing 44.3% and
51.4%, respectively, of service and other revenues. Costs of service and other
revenues increased 35.2% from $679,000 for the three months ended February 29,
1996 to $918,000 for the three months ended February 28, 1997, representing
43.6% and 47.3%, respectively, of service and other revenues. The increase in
absolute dollars was primarily related to the higher level of service revenues
compared to the prior year's period. The increase in costs as a percentage of
service and other revenues was due principally to increases in technical support
and consulting personnel.
OPERATING EXPENSES
Research and development. Research and development expenses increased 82.0%
from $6.0 million for the nine months ended February 29, 1996 to $10.8 million
for the nine months ended February 28, 1997, representing 28.8% and 34.4%,
respectively, of total revenues. Research and development expenses increased
87.2% from $2.2 million for the three months ended February 29, 1996 to $4.1
million for the three months ended February 28, 1997, representing 27.0% and
36.4%, respectively, of total revenues. The increase in these costs was
primarily due to a significant increase in headcount of research and development
personnel focused on development of products addressing online,
Internet/publishing, CD-ROM, and groupware applications. In particular, in the
nine months ended February 28, 1997, the Company incurred increased staffing
expense relating principally to product development in connection with the
introduction of its new SEARCH'97 product line. The Company believes that
research and development expenses will increase in the future primarily due to
the expansion of the Company's product line as a result of the acquisition of
Cognisoft and other anticipated product development efforts. Future research and
development expenses may vary as a percentage of total revenues.
9
<PAGE> 12
In-process research and development. In January 1997, the Company acquired
Cognisoft Corporation, a startup company located in Bellevue, Washington, which
is currently developing an Intranet application that enables corporations to
"push" information to users from multiple data sources. As a result of the
acquisition, the Company incurred a one-time charge against earnings of
approximately $10 million during the quarter ended February 28, 1997, which
related to the amount of the purchase price that was allocated to research and
development on products that had not reached technological feasibility and for
which there was no alternative future use. These costs represented 90.2% and
31.8% of total revenues for the three months and nine months ended February 28,
1997, respectively.
Marketing and sales. Marketing and sales expenses increased 55.3% from
$10.0 million for the nine months ended February 29, 1996 to $15.5 million for
the nine months ended February 28, 1997, representing 48.1% and 49.0%,
respectively, of total revenues. Marketing and sales expenses increased 40.9%
from $3.9 million in the three months ended February 29, 1996 to $ 5.5 million
for the three months ended February 28, 1997, representing 48.5% and 49.1%,
respectively, of total revenues. The increase in these costs was primarily
related to the Company's expansion of its marketing and sales organization in
the United States and Europe and promotional costs associated with the launch of
the SEARCH'97 product line. The Company anticipates it will continue to make
significant investments in marketing and sales.
General and administrative. General and administrative expenses increased
41.6% from $2.5 million in the nine months ended February 29, 1996 to $3.5
million for the nine months ended February 28, 1997, representing 12.1% and
11.3%, respectively, of total revenues. General and administrative expenses
increased 35.8% from $881,000 in the three months ended February 29, 1996 to
$1.2 million for the three months ended February 28, 1997, representing 11.0%
and 10.8%, respectively, of total revenues. The increase in these costs was
primarily due to increases in personnel and professional service fees required
to support the Company's expanded operations relative to the prior year's
periods.
The Company intends to continue to make significant investments in
marketing and sales and in research and development throughout fiscal 1997,
which could cause operating expenses to increase faster than revenues.
INCOME TAXES
The Company has established a valuation allowance against its deferred tax
assets due to the uncertainty surrounding the realization of such assets.
Management evaluates on a quarterly basis the recoverability of the deferred tax
assets and the level of the valuation allowance. At such time as it is
determined that it is more likely than not that deferred tax assets are
realizable, the valuation allowance will be appropriately reduced.
10
<PAGE> 13
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations primarily
through proceeds of approximately $23.6 million from private sales of Preferred
Stock, proceeds from its initial public offering and secondary public offering
of Common Stock and, to a lesser extent, bank credit lines and capital operating
leases. The Company completed its initial public offering of Common Stock in
October 1995 and realized net proceeds of $32.5 million. In January 1996, the
Company completed its secondary public offering of Common Stock, which generated
net proceeds of $16.5 million. The Company has used a portion of those proceeds
to repay borrowings under its line of credit in the amount of $1.6 million. As
of February 28, 1997, the Company had $33.1 million in cash and cash equivalents
and available-for-sale securities.
The Company's operating activities generated cash of $72,000 and $1.4
million for the nine months ended February 29, 1996 and February 28, 1997. In
the nine months ended February 29, 1996, increases in accounts receivable were
offset by an increase in accrued compensation and other accrued liabilities. For
the nine months ended February 28, 1997, cash generated in operations consisted
primarily of the write-off of in-process research and development and
depreciation and amortization expense. These activities were largely offset by
the Company's net loss for the period.
The Company's investing activities used cash of $46.4 million and $3.2
million for the nine months ended February 29, 1996 and February 28, 1997,
respectively. For the nine months ended February 29, 1996, cash used in
investing activities consisted primarily of purchases of marketable securities
with its proceeds from the sale of Common Stock. For the nine months ended
February 28, 1997, cash used in investing activities consisted primarily of
proceeds from the sale and maturity of marketable securities and the acquisition
of Cognisoft Corporation less purchases of marketable securities and property
and equipment.
Cash provided by financing activities was $51.4 million and $1.1 million
for the nine months ended February 29, 1996 and February 28, 1997, respectively.
In the nine months ended February 29, 1996, financing activities consisted
primarily of proceeds from the Company's initial public offering and secondary
offering of Common Stock, and, to a lesser extent, the sale of Preferred Stock.
In the nine months ended February 28, 1997, financing activities consisted
primarily of the sale of Common Stock in connection with the Company's Employee
Stock Purchase Plan .
At February 28, 1997, the Company's principal sources of liquidity were its
cash, cash equivalents, and short-term investments of $22.9 million. The Company
has available an unsecured $7,500,000 line of credit under an agreement with a
bank which expires on September 30, 1997. Borrowings under the line of credit
bear interest at the lender's prime rate. The agreement requires the Company to
comply with certain financial covenants and prohibits the assumption of any
major debt, except for equipment leases, without the bank's approval. At
February 28, 1997, the Company had no outstanding borrowings under the line of
credit.
Capital expenditures, including capital leases, were approximately $1.4
million and $6.9 million for the nine months ended February 29, 1996 and
February 28, 1997, respectively. For the nine months ended February 29, 1996,
these expenditures consisted principally of purchases of property and equipment,
primarily for computer hardware and software. In the nine months ended February
28, 1997, these expenditures consisted primarily of leasehold improvements and
capital equipment related to the Company's relocation to a new facility.
The Company believes that its current cash and cash equivalents, its bank
line of credit, its capital leases and funds generated from operations, if any,
will provide adequate liquidity to meet the Company's capital and operating
requirements through at least calendar 1997. Thereafter, or if the Company's
spending plans change, the Company may find it necessary to seek to obtain
additional sources of financing to support its capital needs, but there is no
assurance that such financing will be available on commercially reasonable
terms, or at all.
11
<PAGE> 14
RISK FACTORS
The following risk factors should be considered carefully in connection
with the Company's business.
History of Losses; Strategic Realignment. Since inception, the Company has
incurred significant losses and substantial negative cash flow. In the nine
months ended February 28, 1997, the Company had a net loss of approximately
$11.9 million, and an operating loss of approximately $13.3 million. The Company
was founded in 1988, and historically derived the substantial majority of its
revenues from the licensing of high-priced, custom search and retrieval
applications for use almost entirely by large organizations and government
agencies. During these years, the Company also generated a substantial portion
of its revenues by providing the consulting services required to support these
products. In early fiscal 1994, the Company shifted its strategy to focus
increasingly on more versatile, lower-priced software applications which require
less specialized consulting. To achieve revenue growth, the Company must, among
other things, increase market acceptance of the Company's technology, achieve
significantly increased sales levels, respond effectively to competitive
developments, continue to attract, retain and motivate qualified persons, and
continue to upgrade its technologies and commercialize products and services
incorporating such technologies. There can be no assurance that the Company's
strategy will be successful or that the Company will experience increased
revenues or become profitable or cash flow positive at any time in the future.
Management of Transition. The Company is experiencing a period of
transition and new product introductions that have placed, and will continue to
place, a significant strain on its resources, including personnel. During the
past few years, management and other personnel have focused on modifying and
enhancing the Company's core technology to support a broader set of search and
retrieval solutions for use on desktop and enterprise-wide systems, and over
online services, the Internet and on CD-ROM. In order for the Company's strategy
to succeed, the Company must, among other things, leverage its core technology
to develop new product offerings by the Company and by its original equipment
manufacturer ("OEM") customers that address the needs of these new markets. Many
of the Company's products are still being developed or have only recently been
introduced, and there is no assurance that such products will be successfully
completed on a timely basis, will achieve market acceptance or will generate
significant revenues. Projects relating to these efforts, including the
development and commercial deployment of the Company's next generation SEARCH'97
suite of products, its Agent Server products and its groupware products for
Microsoft Exchange, continued enhancement of the functionality of the Company's
search engine, and technical integration of the Company's products with the
products of the Company's strategic partners, when added to the day-to-day
activities of the Company, will continue to strain the Company's resources and
personnel.
In connection with its strategy, the Company has also replaced the majority
of its work force and substantially reorganized all of the departments within
the Company. While experiencing substantial turnover, the Company increased the
number of research and development personnel from 29 at the beginning of fiscal
1994 to 89 at February 28, 1997. During the same period, the Company decreased
the number of consulting personnel from 29 at the beginning of fiscal 1994 to 17
at February 28, 1997. Continuity of personnel can be an important factor in the
successful completion of the Company's development projects, and ongoing
turnover in the Company's research and development personnel could materially
and adversely impact the Company's development and marketing efforts. The
Company believes that hiring and retaining qualified individuals at all levels
in the Company is essential to its success, and there can be no assurance that
the Company will be successful in attracting and retaining the necessary
personnel. If Company management is unable to effectively manage its planned
transition or any subsequent growth, identify opportunities in a timely fashion,
and evaluate and manage the Company's business and competitive position, then
its results of operations and financial condition will be materially and
adversely affected.
Fluctuations in Operating Results. The Company's quarterly operating
results have varied and are expected to vary significantly in the future. These
fluctuations may be caused by many factors, including, among others, the size
and timing of individual orders; customer order deferrals in anticipation of new
products; changes in the budgets or purchasing patterns of government agencies;
timing of introduction or
12
<PAGE> 15
enhancement of products by the Company or its competitors; market acceptance of
new products; technological changes in search and retrieval, database,
networking, or communications technology; competitive pricing pressures; changes
in the Company's operating expenses; personnel changes; foreign currency
exchange rates; mix of products sold; quality control of products sold; and
general economic conditions.
A significant portion of the Company's revenues in recent quarters has been
derived from relatively large sales to a limited number of customers, and the
Company currently anticipates that future quarters will continue to reflect this
trend. Sales cycles for these customers can be up to six months or longer. In
addition, like many software companies, the Company has generally recognized a
substantial portion of its revenues in the last month of each quarter, with
these revenues concentrated in the last weeks of the quarter. Accordingly, the
cancellation or deferral of even a small number of purchases of the Company's
products could have a material adverse effect on the Company's business, results
of operations and financial condition in any particular quarter. To the extent
that significant sales occur earlier than expected, operating results for
subsequent quarters may fail to keep pace or even decline.
Product revenues are also difficult to forecast because the market for
search and retrieval software is uncertain and evolving. Because the Company
generally ships software products within a short period after receipt of an
order, the Company typically does not have a material backlog of unfilled
orders, and revenues in any quarter are substantially dependent on orders booked
in that quarter. In addition, a portion of the Company's revenues are derived
from royalties based upon sales by third-party vendors of products incorporating
the Company's technology. These revenues may be subject to extreme fluctuation
and are difficult for the Company to predict. The Company's expense levels are
based, in part, on its expectations as to future revenues and to a large extent
are fixed. Therefore, the Company may be unable to adjust spending in a timely
manner to compensate for any unexpected revenue shortfall. Any significant
shortfall of demand in relation to the Company's expectations or any material
delay of customer orders would have an almost immediate adverse affect on the
Company's operating results and on the Company's ability to achieve
profitability.
The Company's revenues, and particularly its software products revenues,
increased significantly in fiscal 1997 over fiscal 1996. Due to the evolving
nature of the markets for the Company's products and other factors, however,
there can be no assurance that the Company's revenues will continue to increase
significantly or at all in future periods.
As a result of the foregoing and other factors, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
Fluctuations in operating results may also result in volatility in the price of
the shares of the Company's Common Stock.
Developing Market; Unproven Acceptance of the Company's Products. The
Company has recently introduced or announced several products addressing a
market which has only recently begun to develop, is rapidly evolving and is
characterized by an increasing number of market entrants who have introduced or
developed products and services addressing search and retrieval requirements
over private and public networks, CD-ROM, online services and the Internet.
While the Company has commenced commercial shipment of several of its SEARCH'97
products, there is no assurance that such products will achieve market
acceptance or that future products will be developed and released on a timely
basis.
As is typical in the case of a new and evolving industry, demand and market
acceptance for recently introduced products and services are subject to a high
level of uncertainty. The software industry addressing the information
management requirements of networked systems, CD-ROM, online services and the
Internet is young and has few proven products. Moreover, critical issues
concerning the commercial use of online services and the Internet (including
security, reliability, cost, ease of use and access, and quality of service)
remain unresolved and may impact the growth of the Internet and online markets,
together with the software standards and electronic media employed in such
markets.
13
<PAGE> 16
The Company's future operating results will depend in substantial part upon
its ability to increase the installed base of its intelligent search and
filtering technology and to begin to generate significant product revenues from
its products, its SEARCH'97 products and other products addressing the
information retrieval requirements of individuals and corporations from data
sources within an enterprise and on CD-ROM, online services and the Internet.
The Company's future operating results will also depend upon its ability to
successfully market its technology to online and Internet publishers who use
such technology to index their published information in the format used by
Verity. To the extent that such publishers do not adopt the Company's technology
for indexing their published information, users will be unable to search such
information using the Company's search and retrieval products, which in turn
will limit the demand for the Company's products.
Because the market for certain of the Company's products and services is
new and evolving, it is difficult to assess or predict with any assurance the
growth rate, if any, and size of this market. There can be no assurance that the
market for the Company's products and services will develop, or that the
Company's products or services will achieve market acceptance. If the market
fails to develop, develops more slowly than expected or becomes saturated with
competitors, or if the Company's products do not achieve significant market
acceptance, the Company's business, operating results and financial condition
will be materially adversely affected.
A significant element of the Company's strategy is to embed its technology
in products offered by the Company's OEM customers. Many of the markets for such
products are also new and evolving and, therefore, subject to the same risks
faced by the Company in the markets for its own products. In addition,
consolidation in the industries served by the Company could, and acquisition or
development by any of the Company's significant customers of technology
competitive with the Company's would, materially and adversely affect the
Company's business and prospects.
Dependence on International Operations. In fiscal 1995, fiscal 1996 and the
nine months ended February 28, 1997, revenues derived from foreign operations
accounted for approximately 14.3%, 6.6% and 4.3% of the Company's total
revenues, respectively, with European operations alone accounting for 11.9%,
5.6% and 4.3% of revenues for these periods. The Company's export sales
accounted for 24.1%, 19.1% and 22.2% of revenues in fiscal 1995, fiscal 1996,
and the nine months ended February 28, 1997, respectively. Accordingly, on a
combined basis, foreign operations and export sales accounted for approximately
38.4%, 25.7% and 26.5% of revenues in fiscal 1995, fiscal 1996 and the nine
months ended February 28, 1997, respectively. The Company expects that revenues
derived from foreign operations and export sales will continue to account for a
significant percentage of the Company's revenues for the foreseeable future;
however, these revenues may fluctuate significantly as a percentage of revenues
from period to period. Certain of these revenues have been derived from sales to
foreign government agencies which may be subject to risks similar to those
described below.
There are a number of risks inherent in the Company's international
business activities, including unexpected changes in regulatory requirements,
tariffs and other trade barriers, costs and risks of localizing products for
foreign countries, longer accounts receivable payment cycles, potentially
adverse tax consequences, limits on repatriation of earnings and the burdens of
complying with a wide variety of foreign laws. Additionally, the Company does
not engage in hedging activities to protect against the risk of currency
fluctuations. Fluctuations in currency exchange rates could cause sales
denominated in U.S. dollars to become relatively more expensive to customers in
a particular country, leading to a reduction in sales or profitability in that
country. Also, such fluctuations could cause sales denominated in foreign
currencies to affect a reduction in the current U.S. dollar revenues derived
from sales in a particular country. Furthermore, future international activity
may result in increased foreign currency denominated sales and, in such event,
gains and losses on the conversion to U.S. dollars of accounts receivable and
accounts payable arising from international operations may contribute
significantly to fluctuations in the Company's results of operations. The
financial stability of foreign markets could also affect the Company's
international sales. In addition, revenues of the Company earned in various
countries where the Company does business may be subject to taxation by more
than one jurisdiction, thereby adversely affecting the Company's earnings. There
can be no assurance that such factors will not have an adverse effect on the
14
<PAGE> 17
revenues from the Company's future international sales and, consequently, the
Company's results of operations.
Dependence on United States Government and the Risk of Contract
Termination. Agencies of the United States government have accounted for a
significant portion of the Company's revenues. Specifically, these agencies
accounted for approximately 25.5%, 10.5% and 7.1% of revenues in fiscal 1995,
fiscal 1996 and the nine months ended February 28, 1997, respectively. Sales to
government agencies declined as a percentage of revenues during these periods,
and may decline in the future. In recent years, budgets of many government
agencies have been reduced, causing certain customers and potential customers of
the Company's products to re-evaluate their needs. Such budget reductions are
expected to continue over at least the next several years. Future reductions in
United States spending on information technologies could have a material adverse
effect on the Company's operating results.
Almost all of the Company's government contracts contain termination
clauses which permit contract termination upon the Company's default or for
convenience of the other contracting party. There can be no assurance such
cancellations will not occur in the future, and any such termination could
adversely affect the Company's operating results.
Technological Change; Market Acceptance of Evolving Standards.
Historically, the Company has derived substantially all of its revenues from the
license of custom search and retrieval applications and consulting and other
services related to such applications. Recently, the Company has refined and
enhanced its core technology to add functionality and facilitate incorporation
of the Company's technology in a variety of applications addressing the desktop,
CD-ROM, enterprise, online and Internet markets. Nevertheless, the Company
expects that for the foreseeable future it will continue to derive the largest
portion of its revenues from licensing its technology for enterprise
applications.
The computer software industry is subject to rapid technological change,
changing customer requirements, frequent new product introductions and evolving
industry standards that may render existing products and services obsolete. As a
result, the Company's position in its existing markets or other markets that it
may enter could be eroded rapidly by product advancements by competitors. The
life cycles of the Company's products are difficult to estimate. The Company's
future success will depend, in part, upon its ability to enhance existing
products and to develop new products on a timely basis. In addition, its
products must keep pace with technological developments, conform to evolving
industry standards, particularly client/server and Internet communication and
security protocols, as well as publishing formats such as Hypertext Markup
Language ("HTML"), and address increasingly sophisticated customer needs. There
can be no assurance that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of new
products, or that new products and product enhancements will meet the
requirements of the marketplace and achieve market acceptance. If the Company is
unable to develop and introduce products in a timely manner in response to
changing market conditions or customer requirements, the Company's financial
condition and results of operations would be materially and adversely affected.
In addition, a significant strategy of the Company is to achieve
compatibility between the Company's products and the text publication formats
the Company believes are or will become popular and widely adopted. The Company
invests substantial resources in development efforts aimed at achieving such
compatibility. Any failure by the Company to anticipate or respond adequately to
technology or market developments could result in a loss of competitiveness or
revenue. For instance, to date the Company has focused its efforts on
integration with the Adobe PDF, Netscape and Lotus Notes environments and, more
recently, the Microsoft Exchange environment. Should any of these products or
technologies lose or fail to achieve acceptance in the marketplace or be
replaced by other products or technologies, the Company's business could be
materially adversely affected.
Because one of the Company's strategies is to embed its basic search engine
in key OEM application products, the Company's sales of its intelligent search
and filtering products depend in part on its ability to maintain compatibility
with these OEM applications. There is no assurance that the Company will be able
to maintain compatibility with these vendors' products or continue to be the
search technology of choice for
15
<PAGE> 18
such OEMs, and the failure to maintain compatibility with or be selected by such
OEMs would materially adversely affect the Company's sales. Further, the failure
of the products of the Company's key OEM partners to achieve market acceptance
could have a material adverse effect on the Company's results of operations.
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. There can be no assurance that, despite testing and
quality assurance efforts 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, results of operations and financial
condition. Although the Company generally attempts to limit by contract its
exposure to incidental and consequential damages, and to cap the Company's
liabilities under the contract, if a court failed to enforce the liability
limiting provisions of the Company's contracts for any reason, or if liabilities
arose which were not effectively limited, the Company's operating results could
be materially and adversely affected.
16
<PAGE> 19
PART II: OTHER INFORMATION
Item 1: Legal Proceedings:
Not Applicable.
Item 2: Changes in Securities:
Not Applicable.
Item 3: Defaults upon Senior Securities:
Not Applicable.
Item 4: Submission of Matters to a Vote of Security Holders:
Not Applicable.
On January 27, 1997, the Company filed a Form 8-K with the Securities
and Exchange Commission relating to the Company's acquisition of Cognisoft
Corporation. See Note 6 to Notes to Condensed Consolidated Financial Statements.
Item 5: Other Information:
Not Applicable.
Item 6: Exhibits and Reports on Form 8-K:
A. Exhibits - - See Exhibit Index
B. Form 8-K
17
<PAGE> 20
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.
VERITY, INC.
By: /s/ DONALD C. MCCAULEY
----------------------------------------
Donald C. McCauley
Chief Financial Officer
(Principal Financial and Accounting
Officer)
Dated: April 14, 1997
18
<PAGE> 21
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIAL
NUMBER DESCRIPTION OF DOCUMENT PAGE NO.
------- ----------------------- ----------
<S> <C> <C>
2.1 Form of Agreement and Plan of Merger between Verity, Inc., a California corporation, and Verity
Delaware Corporation, a Delaware corporation, filed September 22, 1995.(1)
3.1 Certificate of Incorporation of the Company. (1)
3.2 By-Laws. (1)
3.3 Certificate of Retirement of Series of Preferred Stock.(7)
3.4 Certificate of Designation, Preferences and Rights of Series A Preferred Stock.(7)
4.1 Amended and Restated Rights Agreement dated August 1, 1995, as amended. (1)
4.2 Form of Rights Agreement between Verity, Inc. and First National Bank of Boston dated
September 18, 1996.(6)
10.1 Form of Indemnification Agreement for directors and officers. (1)
10.2 Amended and Restated 1995 Stock Option Plan and forms of agreements thereunder.(7)
10.3 1995 Employee Stock Purchase Plan.(1),(4)
10.4 1995 Outside Directors Stock Option Plan and forms of agreement thereunder. (1),(4)
10.5 Employment Agreement between Philippe F. Courtot and the Company dated July 15, 1993,
together with related Amended and Restated Stock Purchase Agreement dated as of June 1, 1995.
(1),(4)
10.6 Security and Loan Agreement between Imperial Bank and the Company dated April 7, 1994, as amended.(2)
10.7 Series G Preferred Stock Purchase Agreement dated August 29, 1994. (2)
10.8 Series H Preferred Stock Purchase Agreement dated August 1, 1995. (2)
10.9 Sublease Agreement between Booz-Allen & Hamilton, Inc. and the Company dated April 1,
1988, as amended. (1)
10.10 Lease Agreement between The Trustees of the Roman Catholic Church of the Archdiocese of
Canberra and Goulburn and the Company dated July 1, 1993 (Australia). (1)
10.11 Lease Agreement between Peel Investments (North) Limited and the Company dated 1994 (England). (1)
10.12 Lease Agreement between Le Centre D'Affaires Perinord and the Company dated November 26,
1992 (France). (1)
10.13 Lease Agreement between Oskam Vastgoed De Meern B.V. and the Company dated September 1,
1990 (The Netherlands). (1)
10.14 OEM Software Development and Run Time License Agreement between Adobe Systems, Inc. and the
Company dated July 29, 1994, as amended.(1),(5)
10.15 License Agreement between Frame Technology Corporation and the Company dated May 29, 1992. (1),(5)
10.16 OEM Development and License Agreement between the Company and Delphi Internet Services
Corporation dated as of August 23, 1995. (1),(5)
10.18 Lease Agreement between Ross Drive Investors and the Company dated January 22, 1996.(3)
11.1 Statement of computation of net income and loss per share. 20
27.1 Financial Data Schedule 21
</TABLE>
- ----------
(1) Incorporated by reference from the exhibits with corresponding numbers
from the Company's Registration Statement (No. 33-96228), declared
effective on October 5, 1995.
(2) Incorporated by reference from the exhibits with corresponding numbers
from the Company's Registration Statement (No. 33-80567), declared
effective on January 17, 1996.
(3) Incorporated by reference from the exhibits with corresponding numbers
from the Company's Form 10-Q for the quarter ended February 29, 1996.
(4) Management contract or compensatory plan covering executive officers
and directors of the Company.
(5) Confidential Treatment has been granted for portions of these exhibits.
(6) Incorporated by reference from exhibit no. 1 from the Company's Form
8-K as filed with the Securities and Exchange Commission on October 10,
1996.
(7) Incorporated by reference from the exhibits with corresponding numbers
from the company's Form 10-Q for the quarter ended August 31, 1996.
19
<PAGE> 1
EXHIBIT 11.1
VERITY, INC.
STATEMENT OF COMPUTATION OF NET INCOME AND LOSS PER SHARE
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
Feb. 29 Feb. 28 Feb. 29 Feb. 28
1996 1997 1996 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Primary and Fully Diluted:
Weighted average common shares outstanding for the period 10,279 10,841 5,766 10,800
Common equivalent shares pursuant to Staff Accounting
Bulletin No. 83 ....................................... -- -- 1,118 --
Common equivalent shares from dilutive stock options .... 826 -- -- --
------- -------- ------- --------
Shares used in per share calculation ...................... 11,105 10,841 6,884 10,800
======= ======== ======= ========
Net income (loss) before accretion ........................ $ 112 $(10,825) $ (662) $(11,886)
Accretion to redemption value of mandatorily redeemable
preferred stock ......................................... -- -- (611) --
------- -------- ------- --------
Net income (loss) applicable to common stockholders ....... $ 112 $(10,825) $(1,273) $(11,886)
======= ======== ======= ========
Net income (loss) per share ............................... $ 0.01 $ (1.00) $ (0.18) $ (1.10)
======= ======== ======= ========
</TABLE>
20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule containing summary financial information extracted from the
condensed consolidated balance sheet at February 28, 1997 (unaudited) and the
consolidated statement of operations for the nine months ended February 28, 1997
(unaudited) is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAY-31-1997
<PERIOD-START> JUN-01-1997
<PERIOD-END> FEB-28-1997
<EXCHANGE-RATE> 1
<CASH> 1,745
<SECURITIES> 21,175
<RECEIVABLES> 9,079
<ALLOWANCES> 525
<INVENTORY> 0
<CURRENT-ASSETS> 33,243
<PP&E> 15,345
<DEPRECIATION> 6,163
<TOTAL-ASSETS> 53,483
<CURRENT-LIABILITIES> 10,911
<BONDS> 291
0
0
<COMMON> 11
<OTHER-SE> 42,281
<TOTAL-LIABILITY-AND-EQUITY> 53,483
<SALES> 26,136
<TOTAL-REVENUES> 31,531
<CGS> 2,204
<TOTAL-COSTS> 4,975
<OTHER-EXPENSES> 39,870
<LOSS-PROVISION> 150
<INTEREST-EXPENSE> 153
<INCOME-PRETAX> (11,886)
<INCOME-TAX> 0
<INCOME-CONTINUING> (11,886)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,886)
<EPS-PRIMARY> (1.10)
<EPS-DILUTED> (1.10)
</TABLE>
