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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 1999
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)
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<S> <C>
DELAWARE 77-0182779
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
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, were 14,963,000 as of September 15, 1999.
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VERITY, INC.
FORM 10-Q
TABLE OF CONTENTS
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PAGE
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PART I: FINANCIAL INFORMATION
Item 1: Financial Statements........................................ 1
Condensed Consolidated Balance Sheets as of May 31, 1999 and
August 31, 1999........................................... 1
Condensed Consolidated Statements of Operations for the
Three Months Ended August 31, 1998 and 1999............... 2
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended August 31, 1998 and 1999............... 3
Notes to Condensed Consolidated Financial Statements........ 4
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 6
Item 3: Quantitative and Qualitative Disclosures About Market
Risk...................................................... 22
PART II: OTHER INFORMATION
Item 1: Legal Proceedings........................................... 23
Item 2: Changes in Securities and Use of Proceeds................... 23
Item 3: Defaults upon Senior Securities............................. 23
Item 4: Submission of Matters to a Vote of Security Holders......... 23
Item 5: Other Information........................................... 24
Item 6: Exhibits and Reports on Form 8-K............................ 24
Signatures............................................................. 25
</TABLE>
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PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERITY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
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<CAPTION>
MAY 31, AUGUST 31,
1999 1999
-------- -----------
(UNAUDITED)
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Current assets:
Cash and cash equivalents................................. $ 7,907 $ 8,275
Short-term investments.................................... 28,327 98,488
Trade accounts receivable, net............................ 17,174 17,545
Prepaid and other......................................... 1,481 2,037
-------- --------
Total current assets.............................. 54,889 126,345
Property and equipment, net................................. 5,693 5,554
Long-term investments....................................... 4,132 9,023
Other assets................................................ 312 272
-------- --------
Total assets...................................... $ 65,026 $141,194
======== ========
LIABILITIES
Current liabilities:
Accounts payable.......................................... $ 3,786 $ 3,789
Accrued compensation...................................... 6,665 6,523
Other accrued liabilities................................. 1,989 1,809
Deferred revenue.......................................... 9,167 8,193
-------- --------
Total current liabilities......................... 21,607 20,314
-------- --------
STOCKHOLDERS' EQUITY
Common stock, $0.001 par value:
Authorized: 30,000,000 shares in 1999 and 2000;
Issued and outstanding: 12,806,000 shares in 1999 and
14,957,000 shares in 2000.............................. 13 15
Additional paid-in capital.................................. 99,425 171,886
Unrealized gain (loss) on investments....................... 27 (86)
Accumulated deficit......................................... (56,046) (50,935)
-------- --------
Total stockholders' equity........................ 43,419 120,880
-------- --------
Total liabilities and stockholders' equity........ $ 65,026 $141,194
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
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VERITY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
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<CAPTION>
THREE MONTHS ENDED
AUGUST 31,
------------------
1998 1999
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(UNAUDITED)
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Revenues:
Software products......................................... $ 9,889 $14,474
Service and other......................................... 3,331 5,291
------- -------
Total revenues.................................... 13,220 19,765
------- -------
Costs of revenues:
Software products......................................... 437 144
Service and other......................................... 1,082 1,620
------- -------
Total costs of revenues........................... 1,519 1,764
------- -------
Gross profit................................................ 11,701 18,001
------- -------
Operating expenses:
Research and development.................................. 3,275 3,726
Marketing and sales....................................... 5,952 8,064
General and administrative................................ 1,381 1,580
------- -------
Total operating expenses.......................... 10,608 13,370
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Income from operations...................................... 1,093 4,631
Other income, net........................................... 287 629
------- -------
Net income before provision for income taxes................ 1,380 5,260
Provision for income taxes.................................. 150 150
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Net income.................................................. $ 1,230 $ 5,110
======= =======
Net income per share -- basic............................... $ 0.11 $ 0.38
======= =======
Net income per share -- diluted............................. $ 0.10 $ 0.32
======= =======
Number of shares -- basic................................... 11,627 13,486
======= =======
Number of shares -- diluted................................. 12,882 15,806
======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
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VERITY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
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<CAPTION>
THREE MONTHS ENDED
AUGUST 31,
---------------------
1998 1999
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(UNAUDITED)
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Cash flows from operating activities:
Net income................................................ $ 1,230 $ 5,110
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 874 777
Provision for doubtful accounts........................ 363 (48)
Amortization of discount on securities................. (134) (287)
Other.................................................. (25) (193)
Changes in operating assets and liabilities:
Trade accounts receivable............................ 5,081 (223)
Prepaid and other current assets..................... (171) (553)
Accounts payable..................................... (229) --
Accrued compensation and other accrued liabilities... (635) (251)
Deferred revenue..................................... (1,198) (978)
-------- ---------
Net cash provided by operating activities......... 5,156 3,354
-------- ---------
Cash flows from investing activities:
Acquisition of property and equipment..................... (184) (600)
Purchases of marketable securities........................ (19,552) (150,275)
Maturity of marketable securities......................... 5,000 59,183
Proceeds from sale of marketable securities............... 8,652 16,214
-------- ---------
Net cash used in investing activities............. (6,084) (75,478)
-------- ---------
Cash flows from financing activities:
Proceeds from the sale of common stock.................... 758 72,464
Principal payments on notes payable and capital lease
obligations............................................ (109) --
-------- ---------
Net cash provided by financing activities......... 649 72,464
-------- ---------
Effect of exchange rate changes on cash..................... 17 28
-------- ---------
Net increase (decrease) in cash and cash
equivalents..................................... (262) 368
Cash and cash equivalents, beginning of period.............. 5,505 7,907
-------- ---------
Cash and cash equivalents, end of period.................... $ 5,243 $ 8,275
======== =========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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VERITY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF AUGUST 31, 1999 AND FOR THE QUARTERS ENDED
AUGUST 31, 1998 AND 1999 AND THEREAFTER IS UNAUDITED)
1. INTERIM FINANCIAL DATA (UNAUDITED)
The unaudited financial statements for the quarters ended August 31, 1998
and 1999 have been prepared on the same basis as the audited financial
statements and, in the opinion of management, include all material 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. The accompanying financial statements should be read in conjunction
with the Company's annual financial statements on Form 10-K for the year ended
May 31, 1999.
The Company's balance sheet as of May 31, 1999 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 PER SHARE
Basic earnings per share are computed using the weighted average number of
common shares outstanding during the period. Diluted earnings per share are
computed using the weighted average number of common and common equivalent
shares outstanding during the period. Dilutive common equivalent shares consist
of stock options.
3. COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive
Income." This statement establishes requirements for disclosure of comprehensive
income and becomes effective for the Company for its fiscal year 1999, with
reclassification of earlier financial statements for comparative purposes.
Comprehensive income generally represents all changes in stockholders' equity
except those resulting from investments or contributions by stockholders. SFAS
130 requires unrealized gains or losses on the Company's available-for-sale
securities, which prior to adoption were reported separately in stockholders'
equity, to be included in other comprehensive income. The Company has adopted
SFAS 130; however, the effects of the adoption were immaterial to all periods
presented.
4. RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Public Accountants issued
Statement of Position No. 98-1 (SOP 98-1), "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." This standard requires
companies to capitalize qualifying computer software costs, which are incurred
during the application development stage and amortize them over the software's
estimated useful life. SOP 98-1 is effective for fiscal years beginning after
December 15, 1998. The Company has evaluated the requirements of SOP 98-1 and
its current policy is in compliance with this pronouncement.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities." This Statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires an entity to recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. This Statement is
effective for all quarters of fiscal years beginning after June 15, 1999. The
Company has not determined its strategy for the adoption of SFAS 133 or its
effect on the financial statements.
4
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VERITY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF AUGUST 31, 1999 AND FOR THE QUARTERS ENDED
AUGUST 31, 1998 AND 1999 AND THEREAFTER IS UNAUDITED)
During October 1997, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
No. 97-2 (SOP 97-2), "Software Revenue Recognition." This statement delineates
the accounting for software product and maintenance revenues. It supersedes
Statement of Position No. 91-1, "Software Revenue Recognition," and is effective
for transactions entered into in fiscal years beginning after December 15, 1997.
The Company has evaluated the requirements of SOP 97-2 and its current revenue
recognition policy is in compliance with this pronouncement. In December 1998,
AcSEC released Statement of Position No. 98-9 (SOP 98-9), modification of SOP
97-2, "Software Revenue Recognition," with respect to certain transactions. SOP
98-9 amends SOP 97-2 to require that an entity recognize revenue for multiple
element arrangements by means of the "residual method" when (1) there is
vendor-specific objective evidence ("VSOE") of the fair values of all the
undelivered elements that are not accounted for by means of long-term contract
accounting, (2) VSOE of fair value does not exist for one or more of the
delivered elements and (3) all revenue recognition criteria of SOP 97-2 (other
than the requirement for VSOE of the fair value of each delivered element) are
satisfied. The provisions of SOP 98-9 that extend the deferral of certain
paragraphs of SOP 97-2 became effective December 15, 1998. These paragraphs of
SOP 97-2 and SOP 98-9 will be effective for transactions that are entered into
in fiscal years beginning after March 15, 1999. Retroactive application is
prohibited. The Company has evaluated the requirements of SOP 98-9 and its
current revenue recognition policy is in compliance with this pronouncement.
5. BANK LINE OF CREDIT
The commitments made under this agreement expire on September 30, 1999. The
line of credit is collateralized by all corporate assets, excluding leased
equipment. Borrowings under the line of credit bear interest at the lender's
prime rate (8.25% at August 31, 1999). 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
August 31, 1999, no borrowings were outstanding under the line of credit.
6. COMPUTATION OF EARNINGS PER SHARE
Basic and diluted net income per share are calculated as follows for the
three months ended August 31, 1998 and 1999 (in thousands, except per share
data):
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THREE MONTHS ENDED
AUGUST 31,
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1998 1999
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Basic:
Weighted-average shares................................... 11,627 13,486
======= =======
Net income................................................ $ 1,230 $ 5,110
======= =======
Net income per share...................................... $ 0.11 $ 0.38
======= =======
Diluted:
Weighted-average shares................................... 11,627 13,486
Common equivalent shares from stock options............... 1,255 2,320
------- -------
Shares used in per share calculation...................... 12,882 15,806
------- -------
Net income................................................ $ 1,230 $ 5,110
======= =======
Net income per share...................................... $ 0.10 $ 0.32
======= =======
</TABLE>
7. COMMON SHARE REGISTRATION
In August 1999, an additional public offering of common stock was closed,
which generated net proceeds of $71.0 million.
5
<PAGE> 8
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and related notes, which appear for the fiscal
year ended May 31, 1999. The following discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those discussed below and elsewhere in this
Quarterly Report on Form 10-Q, particularly under the heading "-- Risk Factors."
OVERVIEW
From 1988 to 1994, we derived substantially all of our revenues from the
license of custom search and retrieval applications and consulting and other
services related to such applications. Recently, we have refined and enhanced
our core technology to add functionality and facilitate incorporation of our
technology in a variety of applications addressing the enterprise, Internet,
online, and original equipment manufacturer, or OEM, markets. We expect that for
the foreseeable future we will continue to derive the largest portion of our
revenues from licensing our technology for enterprise applications.
During fiscal 1997 and early fiscal 1998, we incurred substantial net
losses and our quarterly revenues fluctuated significantly. In particular, we
incurred reduced revenues on a quarter-to-quarter basis in the first quarter of
fiscal 1997, the third quarter of fiscal 1997 and the first quarter of fiscal
1998. In this period, we experienced significant turnover in our workforce,
including turnover of several members of senior management. Also, we experienced
difficulties in integrating or leveraging our acquisitions of Cognisoft
Corporation and 64K Incorporated in fiscal 1997. Under these circumstances, on
July 31, 1997 we retained Mr. Gary J. Sbona as our president and chief executive
officer, and we entered into an agreement with Regent Pacific Management
Corporation, a management firm of which Mr. Sbona is the chief executive
officer. Pursuant to this agreement, Regent Pacific has provided management
services for Verity, including the services of Mr. Sbona as chief executive
officer and president and at least four other Regent Pacific personnel as part
of our management team.
Starting in fiscal 1998, the new management team implemented changes
designed to refocus our business on our core products and markets and to
streamline operations. In connection with the changes, we incurred a $3.0
million restructuring charge in the quarter ended November 30, 1997. Our
restructuring and renewed focus contributed to significantly improved results
during the second half of fiscal 1998 and during fiscal 1999. During the
quarterly periods ended August 31, 1997 to May 31, 1999, we experienced
increased revenues on a quarterly basis. In addition, during the quarterly
periods ended May 31, 1998 to August 31, 1999, we experienced six straight
quarters of record revenues and profitability. We incurred a net loss of $16.5
million in fiscal 1998, which included the $3.0 million restructuring charge. In
fiscal 1999, we achieved net income of $12.1 million. While our goal is to
increase revenue and generate net income in future periods, we cannot assure you
that our strategy will be successful, that we will experience the rate of
revenue growth we experienced in the last nine quarters in future periods, or
that we will continue to maintain positive cash flow or profitability.
Our revenues are derived from license fees for our software products and
fees for services complementary to our products, including software maintenance,
consulting and training. Fees for services generally are charged separately from
the license fees for our software products. Effective for contracts entered into
starting June 1, 1998, we recognize revenues in accordance with the provisions
of American Institute of Certified Public Accountants Statement of Position No.
97-2, "Software Revenue Recognition." We recognize maintenance revenues from
ongoing customer support and product upgrades ratably over the term of the
applicable maintenance agreement, which is typically 12 months. Generally, we
receive payments for maintenance fees in advance and they are nonrefundable. We
recognize revenues for consulting and training generally when the services are
performed. Statement of Position No. 97-2 supersedes Statement of Position No.
91-1, "Software Revenue Recognition," and was effective for transactions we
entered into in fiscal years beginning after December 15, 1997.
6
<PAGE> 9
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues represented
by certain items in the Company's Condensed Consolidated Statements of
Operations for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
AUGUST 31,
--------------
1998 1999
----- -----
<S> <C> <C>
Revenues:
Software products......................................... 74.8% 73.2%
Service and other......................................... 25.2 26.8
----- -----
Total revenues.................................... 100.0 100.0
----- -----
Costs of revenues:
Software products......................................... 3.3 0.7
Service and other......................................... 8.2 8.2
----- -----
Total costs of revenues........................... 11.5 8.9
----- -----
Gross profit................................................ 88.5 91.1
----- -----
Operating expenses:
Research and development.................................. 24.8 18.9
Marketing and sales....................................... 45.0 40.8
General and administrative................................ 10.4 8.0
----- -----
Total operating expenses.......................... 80.2 67.7
----- -----
Income from operations...................................... 8.3 23.4
Interest and other expenses................................. 2.1 3.2
----- -----
Income before provision for income taxes.................... 10.4 26.6
Provision for income taxes.................................. 1.1 0.7
----- -----
Net income.................................................. 9.3% 25.9%
===== =====
</TABLE>
Revenues
Our total revenues increased 49.5% from $13.2 million for the three months
ended August 31, 1998 to $19.8 million for the three months ended August 31,
1999. Our total revenues as compared to the three-month period ended August 31,
1998 increased primarily due to increased revenues from licensing of Topic tools
and enterprise products. Software product revenues decreased as a percentage of
total revenues from 74.8% for the three months ended August 31, 1998 to 73.2%
for the three months ended August 31, 1999. Service and other revenues increased
as a percentage of total revenues from 25.2% for the three months ended August
31, 1998 to 26.8% for the comparable period in fiscal 2000.
Software product revenues. Software product revenues increased 46.4% from
$9.9 million for the three months ended August 31, 1998 to $14.5 million for the
three months ended August 31, 1999. The increase was due principally to
increased revenues from licensing of Topic tools and enterprise products.
Service and other revenues. Our service and other revenues consist
primarily of fees for software maintenance, consulting and training. Service and
other revenues increased 58.8% from $3.3 million for the three months ended
August 31, 1998 to $5.3 million for the three months ended August 31, 1999.
Maintenance and consulting revenues increased significantly between the
comparable periods due to a growth in customer base.
Service and other revenues from foreign operations accounted for 5.5% and
6.2% of total revenues, respectively, for the three months ended August 31, 1998
and 1999. Our export sales consist primarily of products licensed for delivery
outside of the United States. For the three months ended August 31, 1998 and
1999, export sales accounted for 22.4% and 14.5% of total revenues,
respectively. We expect that revenues derived from foreign operations and export
sales will continue to vary in future periods as a percentage of total revenues.
7
<PAGE> 10
Revenues from Lotus Development Corporation accounted for 12.0% of our
revenues for the three months ended August 31, 1999. Revenues derived from sales
to the federal government and its agencies were 3.8% and 13.8% of our revenues
for the three months ended August 31, 1998 and 1999, respectively. We expect
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. The cost of our software products consist
primarily of product media, duplication, manuals, packaging materials, shipping
expenses and royalties, and in certain instances, licensing of third-party
software incorporated in our products. Costs of software products decreased
67.0% from $437,000 for the three months ended August 31, 1998 to $144,000 for
the three months ended August 31, 1999, representing 4.4% and 1.0%,
respectively, of the software product revenues. The decrease in absolute dollars
during the three-month period ended August 31, 1999, was primarily due to
decreasing costs of third party software components in fiscal 2000. The decrease
in costs as a percentage of software product revenues was primarily related to
the increased software product revenues for the three months ended August 31,
1999.
Costs of service and other. Our costs of service and other consists of
costs incurred in providing consulting services, customer training, telephone
support and product upgrades to customers. Costs of service and other revenues
increased 49.7% from $1.1 million for the three months ended August 31, 1998 to
$1.6 million for the three months ended August 31, 1999, representing 32.5% and
30.6%, respectively, of service and other revenues. The increase in absolute
dollars during the three-month period ended August 31, 1999, was due principally
to an increase in the staffing of our professional services organization. The
decrease in costs as a percentage of service and other revenues was primarily
related to an increase in consulting and maintenance revenues for the three
months ended August 31, 1999.
Operating Expenses
Research and development. Research and development expenses increased 13.8%
from $3.3 million for the three months ended August 31, 1998 to $3.7 million for
the three months ended August 31, 1999, representing 24.8% and 18.9%,
respectively, of total revenues. The increase in absolute dollars for the three
months ended August 31, 1999 was primarily due to an increase in research and
development personnel. The decrease in costs as a percentage of total revenues
was primarily related to the increased revenues for the three months ended
August 31, 1999. We believe that research and development expenses may increase
in the future primarily due to the introduction of new products to our product
line and other anticipated product development efforts. Future research and
development expenses may continue to vary as a percentage of total revenues.
Marketing and sales. Marketing and sales expenses increased 35.5% from $6.0
million for the three months ended August 31, 1998 to $8.1 million for the three
months ended August 31, 1999, representing 45.0% and 40.8%, respectively, of
total revenues. The increase in absolute costs for the three months ended August
31, 1999 was primarily related to the continuous expansion of our marketing and
sales organization in the United States and Europe. The decrease in costs as a
percentage of total revenues was primarily related to the increased revenues for
the three months ended August 31, 1999. We anticipate we will continue to make
significant investments in marketing and sales.
General and administrative. General and administrative expenses increased
14.4% from $1.4 million in the three months ended August 31, 1998 to $1.6
million for the three months ended August 31, 1999, representing 10.4% and 8.0%,
respectively, of total revenues. The increase in absolute costs for the three
months ended August 31, 1999 was primarily related to increases in professional
service fees required to support our operations. The decrease in costs as a
percentage of total revenues was primarily related to the increased revenues for
the three months ended August 31, 1999.
8
<PAGE> 11
Income Taxes
We have established a valuation allowance against our deferred tax assets
due to the uncertainty surrounding the realization of such assets. Management
evaluates on a regular 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.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed our operations primarily through
proceeds of approximately $23.6 million from private sales of preferred stock,
proceeds from our initial public offering and secondary public offerings of
common stock and, to a lesser extent, bank credit lines and capital operating
leases. We completed our initial public offering of common stock in October 1995
and realized net proceeds of $32.5 million. In January 1996, we completed our
second public offering of common stock, which generated net proceeds of $16.5
million. In August 1999, we completed another public offering of common stock,
which generated net proceeds of $71.0 million. We intend to use the net proceeds
from the sale of the common stock for general corporate purposes, including
working capital, content development and licensing, advertising and brand
promotion, and potentially for the acquisition of or investment in companies,
technologies or assets that complement our business. As of August 31, 1999, we
had $115.8 million in cash and cash equivalents and available-for-sale
securities.
Our operating activities provided cash of $5.2 million and $3.4 million for
the three months ended August 31, 1998 and 1999, respectively. Cash provided by
operating activities, in the three months ended August 31, 1998, as compared to
$40.4 million at May 31, 1999 was primarily due to our net income, a decrease in
accounts receivable, and depreciation and amortization expense offset in part by
deferred revenue. Cash provided in connection with operating activities for the
three months ended August 31, 1999, was primarily due to our net income and
depreciation and amortization expense offset in part by deferred revenue.
Our investing activities used cash of $6.1 million and $75.5 million for
the three months ended August 31, 1998 and 1999, respectively. For the three
months ended August 31, 1998 and 1999, cash used by investing activities
consisted primarily of purchases of marketable securities partially offset by
proceeds from the sale and maturity of marketable securities.
Cash provided by financing activities was $649,000 and $72.5 million for
the three months ended August 31, 1998 and 1999, respectively. In the three
months ended August 31, 1998, financing activities consisted primarily of
proceeds from the sale of common stock as a result of option exercises. In the
three months ended August 31, 1999, financing activities consisted primarily of
proceeds from the sale of common stock in conjunction with our public offering.
At August 31, 1999, the Company's principal sources of liquidity were its
cash, cash equivalents, and short-term investments of $106.8 million. In March
1998, the Company negotiated a $5,000,000 line of credit under an agreement with
a bank, which expired on September 30, 1998. On September 22, 1998, the Company
extended the term on its bank line of credit for an additional two months until
November 30, 1998. On November 15, 1998, the Company renegotiated the agreement.
The commitments made under this agreement expire on September 30, 1999. The line
of credit is collateralized by all corporate assets, excluding leased equipment.
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 August 31, 1999, no borrowings were
outstanding under the line of credit.
Capital expenditures, including capital leases, were approximately $184,000
and $600,000 for the three months ended August 31, 1998 and 1999, respectively.
For the three months ended August 31, 1998 and 1999, these expenditures
consisted principally of purchases of property and equipment, primarily for
computer hardware and software.
We believe that our current cash and cash equivalents and our funds
generated from operations, if any, will provide adequate liquidity to meet our
capital and operating requirements through at least fiscal 2001.
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Thereafter, or if our spending plans change, we may find it necessary to seek to
obtain additional sources of financing to support our capital needs, but we
cannot assure you that such financing will be available on commercially
reasonable terms, or at all.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Public Accountants issued
Statement of Position No. 98-1 (SOP 98-1), Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. This standard requires
companies to capitalize qualifying computer software costs, which are incurred
during the application development stage and amortize them over the software's
estimated useful life. SOP 98-1 is effective for fiscal years beginning after
December 15, 1998. We have evaluated the requirements of SOP 98-1 and our
current policy is in compliance with this pronouncement.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS No. 133), Accounting for Derivative
Instruments and Hedging Activities. This Statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires an entity to recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. This Statement is
effective for all quarters of fiscal years beginning after June 15, 1999. We
have not determined our strategy for the adoption of SFAS 133 or its effect on
the financial statements.
During October 1997, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
No. 97-2 (SOP 97-2), Software Revenue Recognition. This statement delineates the
accounting for software product and maintenance revenues. It supersedes
Statement of Position No. 91-1, "Software Revenue Recognition," and is effective
for transactions entered into in fiscal years beginning after December 15, 1997.
We have evaluated the requirements of SOP 97-2 and our current revenue
recognition policy is in compliance with this pronouncement. In December 1998,
AcSEC released Statement of Position No. 98-9 (SOP 98-9), modification of SOP
97-2, Software Revenue Recognition, with respect to certain transactions. SOP
98-9 amends SOP 97-2 to require that an entity recognize revenue for multiple
element arrangements by means of the "residual method" when (1) there is
vendor-specific objective evidence ("VSOE") of the fair values of all the
undelivered elements that are not accounted for by means of long-term contract
accounting, (2) VSOE of fair value does not exist for one or more of the
delivered elements and (3) all revenue recognition criteria of SOP 97-2 (other
than the requirement for VSOE of the fair value of each delivered element) are
satisfied. The provisions of SOP 98-9 that extend the deferral of certain
paragraphs of SOP 97-2 and SOP 98-9 will be effective for transactions that are
entered into in fiscal years beginning after March 15, 1999. Retroactive
application is prohibited. We have evaluated the requirements of SOP 98-9 and
our current revenue recognition policy is in compliance with this pronouncement.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. Beginning in the year
2000, these code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. This change is referred to as "year
2000 compliant." In a few months, computer systems and/or software products used
by many companies may need to be upgraded to be year 2000 compliant.
We have developed a phased year 2000 readiness plan for the current
versions of our products. The plan includes:
- development of corporate awareness;
- assessment;
- implementation including remediation, upgrading and replacement of
certain product version;
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- validation testing; and
- contingency planning.
We also will continue to respond to customer concerns about prior versions
of our products on a case-by-case basis.
The current versions of our products are "year 2000 compliant" when
configured and used in accordance with the related documentation, and provided
that the underlying operating system of the host machine and any other software
used with or in the host machine or our products are also year 2000 compliant.
We have not tested our products on all platforms or all versions of operating
systems that we currently support and have advised our customers to verify that
their platforms and operating systems support the transition to the year 2000.
We face additional risk that suppliers of products, services and systems
that we purchase and others with whom we transact business or from whom we
license technology are not year 2000 compliant. We have not specifically tested
software obtained from third parties that is incorporated into our products,
such as licensed software, shareware, and freeware, but we are seeking
assurances from our vendors that licensed software is year 2000 compliant.
Despite testing by Verity and current and potential customers, and assurances
from developers of products incorporated into our products, our products may
contain undetected errors or defects associated with year 2000 date functions.
Known or unknown errors or defects in our products could result in the following
adverse effects to our operations:
- delay or loss of revenue;
- diversion of development resources;
- damage to our reputation; or
- increased service or warranty costs.
If third parties can not provide us with products, services or systems that
are year 2000 compliant on a timely basis, our business, results of operations
and financial condition could be materially and adversely affected. We plan to
evaluate various contingency plans in case third-party vendors' systems are not
year 2000 compliant by November 30, 1999.
Finally, as is the case with other similarly situated software companies,
if our current or future customers fail to achieve year 2000 compliance, or if
they divert technology expenditures, especially technology expenditures that
were reserved for enterprise software, to address year 2000 compliance problems,
our business, results of operations, or financial condition could be materially
and adversely affected.
We have funded our year 2000 plan from operating cash flows and have not
separately accounted for these costs in the past. To date, we have not incurred
any material costs related to year 2000 compliance activities. We may continue
to incur additional amounts related to the year 2000 for administrative
personnel to manage the project, outside contractor assistance, technical
support for our products, product engineering and customer satisfaction. The
costs of these year 2000 compliance activities are currently being reviewed and
analyzed by management to determine the potential exposure, which could
adversely affect our business, results of operations, and financial condition.
These estimates will be derived utilizing numerous assumptions of future events
including the continued availability of certain resources, third party
modification plans and other factors. However, we cannot assure you that these
estimates will be achieved and actual results could differ significantly from
those plans. We may experience material problems and costs with year 2000
compliance. We cannot assure you that we will identify and remedy all
significant year 2000 problems in a timely fashion, that remedial efforts in
this regard will not involve significant time and expense, or that these
problems will not have a material adverse effect on our business, results of
operations and financial condition. We have not yet fully developed a
comprehensive contingency plan to address situations that may result if we are
unable to achieve year 2000 readiness of our critical operations. The cost of
developing and implementing such a plan may itself be material. We are also
subject to external forces that might generally affect industry
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and commerce, such as utility or transportation company year 2000 compliance
failures and related service interruptions.
We have not been a party to any litigation or any proceedings to date
involving our products or services related to year 2000 compliance issues;
however, we cannot assure you that we will not in the future be required to
defend our products or services in proceedings, or to negotiate the resolution
of claims based on year 2000 issues. Some commentators have predicted
significant litigation regarding year 2000 compliance issues, and we are aware
of such lawsuits against other software vendors. Because of the unprecedented
nature of such litigation, it is uncertain whether or to what extent we may be
affected by it. The costs of defending and resolving year 2000-related disputes,
and any liability of Verity for year 2000-related damages, including
consequential damages, could have a material adverse effect on our business,
results of operations and financial condition.
IMPACT OF EUROPEAN MONETARY CONVERSION
We are aware of the issues associated with the changes in Europe resulting
from the formation of a European economic and monetary union. One change
resulting from this union required EMU member states to irrevocably fix their
respective currencies to a new currency, the euro, as of January 1, 1999, at
which date the euro became a functional legal currency of these countries.
During the next three years, business in the EMU member states will be conducted
in both the existing national currency, such as the French franc or the Deutsche
mark, and the euro. As a result, companies operating or conducting business in
EMU member states will need to ensure that their financial and other software
systems are capable of processing transactions and properly handing these
currencies, including the euro. We are still assessing the impact that the
conversion to the euro will have on our internal systems, the sale of our
products, and the European and global economies. We will take appropriate
corrective actions based on the results of such assessment. We have not yet
determined the cost related to addressing this issue.
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RISK FACTORS
The risks and uncertainties described below are not the only risks and
uncertainties we face. Additional risks and uncertainties not presently known to
us or that we currently deem immaterial also may impair our business operations.
If any of the following risks actually occur, our business, results of
operations and financial condition would suffer. In that event, the trading
price of our common stock could decline, and our stockholders may lose all or
part of their investment in our common stock. The risks discussed below also
include forward-looking statements and our actual results may differ
substantially from those discussed in these forward-looking statements.
RISKS RELATED TO OUR BUSINESS
OUR GROWTH RATE MAY SLOW AND WE MAY NOT BE ABLE TO MAINTAIN PROFITABILITY
Despite our recent financial performance, we have in the past incurred
significant losses and substantial negative cash flow. In the future, our
revenues may grow at a rate slower than was experienced in previous periods and,
on a quarter-to-quarter basis, our growth in net sales may be significantly
lower than our historical quarterly growth rate, particularly over the last six
quarters. To achieve revenue growth, we must:
- increase market acceptance of our products;
- respond effectively to competitive developments;
- attract, retain and motivate qualified personnel; and
- upgrade our technologies and commercialize our products and services
incorporating such technologies.
We cannot assure you that we will be successful in achieving any of these
goals or that we will experience increased revenues, positive cash flows, or
maintain profitability.
OUR REVENUES AND OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS, WHICH COULD
ADVERSELY AFFECT OUR STOCK PRICE
The results of operations for any quarter are not necessarily indicative of
results to be expected in future periods. We expect our stock price to vary with
our operating results and, consequently, any adverse fluctuations in our
operating results could have an adverse effect on our stock price. Our operating
results have in the past been, and will continue to be, subject to quarterly
fluctuations as a result of a number of factors. These factors include:
- the size and timing of orders;
- changes in the budget or purchasing patterns of corporations and
government agencies, foreign country exchange rates, or pricing pressures
from competitors;
- increased competition in the software and Internet industries;
- the introduction and market acceptance of new technologies and standards
in search and retrieval, Internet, document management, database,
networking, and communications technology;
- variations in sales channels, product costs, the mix of products sold, or
the success of quality control measures;
- the integration of people, operations, and products from acquired
businesses and technologies;
- changes in operating expenses and personnel;
- the overall trend toward industry consolidation; and
- changes in general economic conditions and specific economic conditions
in the computer and software industries.
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Any of the factors, some of which are discussed in more detail below, could
have a material adverse impact on our operations and financial results, and
consequently our stock price.
THE SIZE AND TIMING OF LARGE ORDERS MAY MATERIALLY AFFECT OUR QUARTERLY
OPERATING RESULTS
The size and timing of individual orders may cause our operating results to
fluctuate. The dollar amounts of large orders for our products have been
increasing, and therefore the operating results for a quarter could be
materially adversely affected if one or more large orders are either not
received or are delayed or deferred by customers. A significant portion of our
revenues in recent quarters has been derived from these relatively large sales
to a limited number of customers, and we currently anticipate that future
quarters will continue to reflect this trend. Sales cycles for these customers
can be up to six months or longer. In addition, customer order deferrals in
anticipation of new products may cause our operating results to fluctuate. Like
many software companies, we have generally recognized a substantial portion of
our 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 our products could have a material adverse
effect on our business, results of operations and financial condition in any
particular quarter. In addition, to the extent that significant sales occur
earlier than expected, operating results for subsequent quarters may fail to
keep pace or even decline.
OUR EXPENDITURES ARE TIED TO ANTICIPATED REVENUES, AND THEREFORE IMPRECISE
FORECASTS MAY RESULT IN POOR OPERATING RESULTS
Revenues are difficult to forecast because the market for search and
retrieval software is uncertain and evolving. Because we generally ship software
products within a short period after receipt of an order, we typically do 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 our revenues is derived from royalties based upon sales by third-party
vendors of products incorporating our technology. These revenues may be subject
to extreme fluctuation and are difficult for us to predict. Our expense levels
are based, in part, on our expectations as to future revenues and are to a large
extent fixed. Therefore, we 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 our expectations or any material delay of customer orders
would have an almost immediate adverse affect on our operating results and on
our ability to achieve profitability.
WE MUST SUCCESSFULLY INTRODUCE NEW PRODUCTS OR OUR CUSTOMERS WILL PURCHASE OUR
COMPETITORS PRODUCTS AND OUR BUSINESS WILL BE ADVERSELY AFFECTED
During the past few years, management and other personnel have focused on
modifying and enhancing our core technology to support a broader set of search
and retrieval solutions for use on enterprise-wide systems, over online
services, the Internet and on CD-ROM. In order for our strategy to succeed and
to remain competitive, we must leverage our core technology to develop new
product offerings by us and by our original equipment manufacturer, or OEM,
customers that address the needs of these new markets. These development efforts
are expensive. If these products do not generate substantial revenues, our
business and results of operations will be adversely affected. We cannot assure
you that such products will be successfully completed on a timely basis or at
all, will achieve market acceptance or will generate significant revenues.
Our development efforts are focused on expanding our suite of products,
designing enhancements to our core technology and addressing additional
technical challenges inherent in integrating our products with those of our
strategic partners and developing new applications for enterprise, e-commerce,
OEM and sophisticated CD-ROM publishing markets. We plan to undertake
development of further enhancements of the search performance, scalability,
functionality and deployability of our products. We cannot assure you that these
products will be developed and released on a timely basis, or that these
products will achieve market acceptance.
Our future operating results will depend upon our ability to increase the
installed base of our information retrieval technology and to generate
significant product revenues from our core products. Our future operating
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results will also depend upon our ability to successfully market our technology
to online and Internet publishers who use this technology to index their
published information in our format. To the extent that customers do not adopt
our technology for indexing their published information, users will be unable to
search such information using our search and retrieval products, which in turn
will limit the demand for our products.
WE FACE INTENSE COMPETITION FROM COMPANIES WITH SIGNIFICANTLY GREATER FINANCIAL,
TECHNICAL, AND MARKETING RESOURCES, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO
MAINTAIN OR INCREASE SALES OF OUR PRODUCTS
The information retrieval software market is intensely competitive and we
cannot assure you that we will maintain our current position of market share. A
number of companies offer competitive products addressing the enterprise and
Internet markets. We compete with Dataware, Excalibur, Hummingbird/PC Docs/
Fulcrum, Infoseek, Inktomi, Lotus and Microsoft among others. We also compete
indirectly with database vendors, such as Oracle, that offer information search
and retrieval capabilities with their core database products and web platform
companies, such as Netscape.
In the future, we may encounter competition from a number of companies.
Many of our existing competitors, particularly Microsoft, as well as a number of
other potential new competitors, have significantly greater financial, technical
and marketing resources than we do. Because the success of our strategy is
dependent in part on the success of our strategic partners, competition between
our strategic partners and the strategic partners of our competitors, or failure
of our strategic partners to achieve or maintain market acceptance could have a
material adverse effect on our competitive position. Although we believe that
our products and technologies compete favorably with competitive products, we
cannot assure you that we will be able to compete successfully against our
current or future competitors or that competition will not have a material
adverse effect on our results of operations and financial condition.
WE RELY ON REGENT PACIFIC MANAGEMENT CORPORATION FOR THE MANAGEMENT OF VERITY,
AND THE LOSS OF THESE SERVICES COULD ADVERSELY AFFECT OUR BUSINESS
Regent Pacific Management Corporation, a management firm of which Gary J.
Sbona is chief executive officer, provides management services for our company.
The management services provided under our agreement with Regent Pacific include
the services of Mr. Sbona as chairman of the board, chief executive officer and
president of Verity, and at least four other Regent Pacific personnel as part of
Verity's management team. This agreement is due to expire on August 31, 2000 and
may be extended until February 2001 at the option of the board. This agreement
may be canceled at the option of the board after February 2000. If the agreement
with Regent Pacific were canceled or not renewed, the loss of the Regent Pacific
personnel could have a material adverse effect on our operations, especially
during the transition phase to new management. Similarly, if any adverse change
in Verity's relationship with Regent Pacific occurs, it could hinder
management's ability to direct our business and materially and adversely affect
our results of operations and financial condition.
OUR BUSINESS MAY SUFFER DUE TO RISKS ASSOCIATED WITH INTERNATIONAL SALES
Historically, our foreign operations and export sales account for a
significant portion of our annual revenues. Our international business
activities are subject to a number of risks, each of which could impose
unexpected costs on us that would have an adverse effect on our operating
results. These risks include:
- difficulties in complying with regulatory requirements and standards;
- tariffs and other trade barriers;
- costs and risks of localizing products for foreign countries;
- reliance on third parties to distribute our products;
- longer accounts receivable payment cycles;
- potentially adverse tax consequences;
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- limits on repatriation of earnings; and
- burdens of complying with a wide variety of foreign laws.
We currently engage in only limited 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, these 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 our results of operations. The
financial stability of foreign markets could also affect our international
sales. In addition, revenues earned in various countries where we do business
may be subject to taxation by more than one jurisdiction, thereby adversely
affecting our earnings. We cannot assure you that such factors will not have an
adverse effect on the revenues from our future international sales and,
consequently, our results of operations.
Service and other revenues derived from foreign operations accounted for
6.1%, 6.4% and 6.2% of total revenues, respectively, in fiscal 1998, fiscal 1999
and the three months ended August 31, 1999. Our export sales consist primarily
of products licensed for delivery outside of the United States. In fiscal years
1998 and 1999 and the three months ended August 31, 1999, export sales accounted
for 26.6%, 27.1% and 14.5% of total revenues. We expect that revenues derived
from foreign operations and export sales will continue to account for a
significant percentage of our revenues for the foreseeable future. These
revenues may fluctuate significantly as a percentage of revenues from period to
period. In addition, a portion of these revenues was derived from sales to
foreign government agencies, which may be subject to risks similar to those
described immediately below.
A SIGNIFICANT PORTION OF OUR REVENUES IS DERIVED FROM SALES TO THE FEDERAL
GOVERNMENT WHICH ARE SUBJECT TO BUDGET CUTS AND, CONSEQUENTLY, THE POTENTIAL
LOSS OF REVENUES UPON WHICH WE HAVE HISTORICALLY RELIED
Revenues derived from sales to the federal government and its agencies were
9.0%, 8.1% and 13.8% of total revenues in fiscal years 1998 and 1999 and the
three months ended August 31, 1999, respectively. Future reductions in United
States spending on information technologies could have a material adverse effect
on our operating results. 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 our products to re-evaluate their needs.
These budget reductions are expected to continue over at least the next several
years.
Almost all of our government contracts contain termination clauses, which
permit contract termination upon our default or at the option of the other
contracting party. We cannot assure you such a cancellation will not occur in
the future, and any termination would adversely affect our operating results.
IF WE ARE UNABLE TO ENHANCE OUR EXISTING PRODUCTS AND DEVELOP NEW PRODUCTS TO
RESPOND TO OUR RAPIDLY CHANGING MARKETS, OUR PRODUCTS MAY BECOME OBSOLETE
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, our position in our existing markets or other markets that we may enter
could be eroded rapidly by product advancements by competitors. If we are unable
to develop and introduce products in a timely manner in response to changing
market conditions or customer requirements, our financial condition and results
of operations would be materially and adversely affected.
The life cycles of our products are difficult to estimate. Our future
success will depend upon our ability to enhance existing products and to develop
new products on a timely basis. In addition, our 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
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Language, or HTML, and Extensible Markup Language, or XML, and address
increasingly sophisticated customer needs. We cannot assure you that we 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.
We strive to achieve compatibility between our products and the text
publication formats we believe are or will become popular and widely adopted. We
invest substantial resources in development efforts aimed at achieving such
compatibility. Any failure by us to anticipate or respond adequately to
technology or market developments could result in a loss of competitiveness or
revenue. For instance, to date we have focused our efforts on integration with
the Adobe PDF 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, our business could be materially and adversely affected.
We embed our basic search engine in key OEM application products and,
therefore, our sales of information retrieval products depend on our ability to
maintain compatibility with these OEM applications. We cannot assure you that we
will be able to maintain compatibility with these vendors' products or continue
to be the search technology of choice for OEMs. The failure to maintain
compatibility with or be selected by OEMs would materially and adversely affect
our sales. Further, the failure of the products of our key OEM partners to
achieve market acceptance could have a material adverse effect on our results of
operations.
OUR SOFTWARE PRODUCTS ARE COMPLEX AND MAY CONTAIN ERRORS THAT COULD DAMAGE OUR
REPUTATION AND DECREASE SALES
Our complex software products may contain errors that may be detected at
any point in the products' life cycles. We have in the past discovered software
errors in some of our products and have experienced delays in shipment of
products during the period required to correct these errors. We cannot assure
you that, despite our testing and quality assurance efforts and similar efforts
by current and potential customers, errors will not be found. The discovery of
an error may result in loss of or delay in market acceptance and sales,
diversion of development resources, injury to our reputation, or increased
service and warranty costs, any of which could have a material adverse effect on
our business, results of operations and financial condition. Although we
generally attempt by contract to limit our exposure to incidental and
consequential damages, and to cap our liabilities to our proceeds under the
contract, if a court fails to enforce the liability limiting provisions of our
contracts for any reason, or if liabilities arise which are not effectively
limited, our operating results could be materially and adversely affected.
IF WE LOSE KEY PERSONNEL, OR ARE UNABLE TO ATTRACT ADDITIONAL QUALIFIED
PERSONNEL, OUR ABILITY TO CONDUCT AND GROW OUR BUSINESS WILL BE IMPAIRED
We believe that hiring and retaining qualified individuals at all levels is
essential to our success, and we cannot assure you that we will be successful in
attracting and retaining the necessary personnel. In addition, we are highly
dependent on our direct sales force for sales of our products as we have limited
distribution channels. Continuity of technical personnel is an important factor
in the successful completion of development projects, and any turnover of our
research and development personnel could materially and adversely impact our
development and marketing efforts.
Our future success also depends on our continuing ability to identify,
hire, train and retain other highly qualified sales, technical and managerial
personnel. Competition for this type of personnel is intense, and we cannot
assure you that we will be able to attract, assimilate or retain other highly
qualified technical and managerial personnel in the future. The inability to
attract, hire or retain the necessary sales, technical and managerial personnel
could have a material adverse effect upon our business, operating results and
financial condition.
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OUR ABILITY TO COMPETE SUCCESSFULLY WILL DEPEND, IN PART, ON OUR ABILITY TO
PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH WE MAY NOT BE ABLE TO PROTECT
We rely on a combination of patent, trade secrets, copyright and trademark
laws, nondisclosure agreements and other contractual provisions and technical
measures to protect our intellectual property rights. The source code for our
proprietary software is protected both as a trade secret and as a copyrighted
work. Policing unauthorized use of our products, however, is difficult.
Litigation may be necessary in the future to enforce our intellectual property
rights, to protect our trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Litigation could result in substantial costs and diversion of
resources and could have a material adverse effect on our business, operating
results and financial condition regardless of the outcome of the litigation.
Effective copyright and trade secret protection may be unavailable or
limited in some foreign countries. To license our products, we frequently rely
on "shrink wrap" licenses that are not signed by the end user and, therefore,
may be unenforceable under the laws of several jurisdictions. In addition,
employees, consultants and others who participate in the development of our
products may breach their agreements with us regarding our intellectual
property, and we may not have adequate remedies for any such breach. We also
realize that our trade secrets may become known through other means not
currently foreseen by us. Notwithstanding our efforts to protect our
intellectual property, our competitors may be able to develop products that are
equal or superior to our products without infringing on any of our intellectual
property rights.
OUR PRODUCTS EMPLOY TECHNOLOGY THAT MAY INFRINGE ON THE PROPRIETARY RIGHTS OF
THIRD PARTIES, WHICH MAY EXPOSE US TO LITIGATION
Third parties may assert that our products infringe their proprietary
rights, or may assert claims for indemnification resulting from infringement
claims against us. Any such claims may cause us to delay or cancel shipment of
our products which could materially adversely affect our business, financial
condition and results of operations. In addition, irrespective of the validity
or the successful assertion of such claims, we could incur significant costs in
defending against such claims.
WE ARE DEPENDENT ON PROPRIETARY TECHNOLOGY LICENSED FROM THIRD PARTIES, THE LOSS
OF WHICH COULD DELAY SHIPMENTS OF PRODUCTS INCORPORATING THIS TECHNOLOGY AND
COULD BE COSTLY
Some of the technology used by our products is licensed from third parties,
generally on a nonexclusive basis. We believe that there are alternative sources
for each of the material components of technology we license from third parties.
However, the termination of any of these licenses, or the failure of the
third-party licensors to adequately maintain or update their products, could
result in delay in our ability to ship these products while we seek to implement
technology offered by alternative sources. Any required replacement licenses
could prove costly. Also, any delay, to the extent it becomes extended or occurs
at or near the end of a fiscal quarter, could result in a material adverse
effect on our quarterly results of operations. While it may be necessary or
desirable in the future to obtain other licenses relating to one or more of our
products or relating to current or future technologies, we cannot assure you
that we will be able to do so on commercially reasonable terms or at all.
POTENTIAL ACQUISITIONS MAY HAVE UNEXPECTED CONSEQUENCES OR IMPOSE ADDITIONAL
COSTS ON US
Our business is highly competitive and our growth is dependent upon market
growth and our ability to enhance our existing products and introduce new
products on a timely basis. One of the ways we will address the need to develop
new products is through acquisitions of complementary businesses and
technologies. From time to time, we have considered and evaluated potential
business combinations both involving our acquisition of another company and
transactions involving the sale of Verity through, among other things, a
possible
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merger or consolidation of our business into that of another entity. We may
engage in discussions relating to these types of transactions in the future.
Acquisitions involve numerous risks, including the following:
- difficulties in integration of the operations, technologies, and products
of the acquired companies;
- the risk of diverting management's attention from normal daily operations
of the business;
- accounting consequences, including changes in purchased research and
development expenses, resulting in variability in our quarterly earnings;
- potential difficulties in completing projects associated with purchased
in process research and development;
- risks of entering markets in which we have no or limited direct prior
experience and where competitors in such markets have stronger market
positions;
- the potential loss of key employees of the acquired company; and
- the assumption of unforeseen liabilities of the acquired company.
We cannot assure you that our previous or future acquisitions will be
successful and will not adversely affect our financial condition or results of
operations. In fiscal 1997, we experienced difficulties in integrating and
leveraging our acquisitions of Cognisoft Corporation and 64K Incorporated. We
must also maintain our ability to manage any such growth effectively. Failure to
manage growth effectively and successfully integrate acquisitions we make could
harm our business and operating results.
WE ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION DUE TO OUR EXPECTED STOCK
PRICE VOLATILITY
In the past, securities class action litigation has often been brought
against a company following a decline in the market price of its securities.
Because we expect our stock price to fluctuate significantly, we may be the
target of similar litigation in the future. Securities litigation could result
in substantial costs and divert management's attention and resources, and could
seriously harm our business.
RISKS RELATED TO OUR INDUSTRY
WE DEPEND ON INCREASING USE OF THE INTERNET, INTRANETS, EXTRANETS AND ON THE
GROWTH OF ELECTRONIC COMMERCE. IF THE USE OF THE INTERNET, INTRANETS, EXTRANETS
AND ELECTRONIC COMMERCE DO NOT GROW AS ANTICIPATED, OUR BUSINESS WILL BE
SERIOUSLY HARMED
The products of most of our customers depend on the increased acceptance
and use of the Internet as a medium of commerce and on the development of
corporate intranets and extranets. As a result, acceptance and use may not
continue to develop at historical rates and a sufficiently broad base of
business customers may not adopt or continue to use the Internet as a medium of
commerce. The lack of such development would impair demand for our products and
would adversely affect our ability to sell our products. Demand and market
acceptance for recently introduced services and products over the Internet and
the development of corporate intranets and extranets are subject to a high level
of uncertainty, and there exist few proven services and products.
The business of most of our customers would be seriously harmed if:
- use of the Internet, the Web and other online services does not continue
to increase or increases more slowly than expected;
- the infrastructure for the Internet, the Web and other online services
does not effectively support expansion that may occur; or
- the Internet, the Web and other online services do not create a viable
commercial marketplace, inhibiting the development of electronic commerce
and reducing the need for our products and services.
19
<PAGE> 22
CAPACITY CONSTRAINTS MAY RESTRICT THE USE OF THE INTERNET AS A COMMERCIAL
MARKETPLACE, WHICH WOULD RESTRICT OUR GROWTH
The Internet may not be accepted as a viable long-term commercial
marketplace for a number of reasons. These include:
- potentially inadequate development of the necessary communication and
network infrastructure, particularly if rapid growth of the Internet
continues;
- delayed development of enabling technologies and performance
improvements;
- delays in the development or adoption of new standards and protocols; and
- increased governmental regulation.
Our ability to grow our business is dependent on the growth of the Internet
and, consequently, any such adverse events would impair our ability to grow our
business.
SECURITY RISKS AND CONCERNS MAY DETER THE USE OF THE INTERNET FOR CONDUCTING
ELECTRONIC COMMERCE, WHICH WOULD ADVERSELY AFFECT THE DEMAND FOR OUR PRODUCTS
A significant barrier to electronic commerce and communications is the
secure transmission of confidential information over public networks. Advances
in computer capabilities, new discoveries in the field of cryptography or other
events or developments could result in compromises or breaches of our security
systems or those of other web sites to protect proprietary information. If any
well-publicized compromises of security were to occur, it could have the effect
of substantially reducing the use of the Internet for commerce and
communications, resulting in reduced demand for our products, thus adversely
affecting our revenues.
SECURITY RISKS EXPOSE US TO ADDITIONAL COSTS AND TO LITIGATION
Anyone who circumvents our security measures could misappropriate
proprietary information or cause interruptions in our services or operations.
The Internet is a public network, and data is sent over this network from many
sources. In the past, computer viruses, software programs that disable or impair
computers, have been distributed and have rapidly spread over the Internet. We
may be required to expend significant capital and other resources to protect
against the threat of security breaches or to alleviate problems caused by
breaches. To the extent that our activities may involve the storage and
transmission of proprietary information, such as credit card numbers, security
breaches could expose us to a risk of loss or litigation and possible liability.
Our security measures may be inadequate to prevent security breaches, and our
business would be harmed if we do not prevent them.
OUR OR THIRD PARTIES' COMPUTER SYSTEMS MAY FAIL IN THE YEAR 2000, WHICH WOULD
DELAY OUR PRODUCT DEVELOPMENT AND THE SALE OF OUR PRODUCTS
Failure of our computer systems could adversely affect our product
development processes and/or our ability to cost-effectively manage Verity
during the time required to fix such problems. In addition, computer failures
could cause our customers to postpone or cancel orders for our products. We are
currently assessing the readiness of our computer systems and those of our major
customers to handle dates beyond the year 1999. Unforeseen problems in our own
computers and embedded systems and from customers, suppliers and other
organizations with which we conduct transactions worldwide may arise. These
statements constitute year 2000 disclosures under federal law.
20
<PAGE> 23
RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK
THE MARKET PRICE OF OUR COMMON STOCK WILL FLUCTUATE AND YOU MAY LOSE ALL OR PART
OF YOUR INVESTMENT
Our common stock is quoted for trading on the Nasdaq National Market. The
market price for our common stock may continue to be highly volatile for a
number of reasons including:
- future announcements concerning Verity or its competitors;
- quarterly variations in operating results;
- announcements of technological innovations;
- the introduction of new products or changes in product pricing policies
by us or competitors;
- proprietary rights or other litigation; and
- changes in earnings estimates by analysts or other factors.
In addition, stock prices for many technology companies fluctuate widely
for reasons, which may be unrelated to operating results. These fluctuations, as
well as general economic, market and political conditions such as recessions or
military conflicts may materially and adversely affect the market price of our
common stock.
WE HAVE IMPLEMENTED CERTAIN ANTI-TAKEOVER PROVISIONS THAT MAY PREVENT OR DELAY
AN ACQUISITION OF VERITY THAT MIGHT BE BENEFICIAL TO OUR STOCKHOLDERS
Provisions of our certificate of incorporation and bylaws, as well as
provisions of Delaware law, could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders. These
provisions include:
- establishment of a classified board of directors such that not all
members of the board may be elected at one time;
- the ability of the board of directors to issue without stockholder
approval up to 1,999,995 shares of preferred stock to increase the number
of outstanding shares and thwart a takeover attempt;
- no provision for cumulative voting in the election of directors, which
would otherwise allow less than a majority of stockholders to elect
director candidates;
- limitations on who may call special meetings of stockholders;
- prohibiting stockholder action by written consent, thereby requiring all
stockholder actions to be taken at a meeting of our stockholders; and
- establishing advance notice requirements for nominations for election to
the board of directors or for proposing matters that can be acted upon by
stockholders at stockholder meetings.
In September 1996, our Board of Directors adopted a Share Purchase Rights
Plan, commonly referred to as a "poison pill." In addition, the anti-takeover
provisions of Section 203 of the Delaware General Corporations Law and the terms
of our stock option plan may discourage, delay or prevent a change in control of
Verity. On July 28, 1999, our Board of Directors approved an amendment of our
Stockholders Rights Plan. This amendment is intended as a means to guard against
abusive takeover tactics and is not in response to any particular proposal. The
amendment is aimed to discourage acquisitions of more than 15 percent of the
Verity's common stock without negotiations with the Board of Directors. In
addition, in July and September 1999, our Board of Directors and shareholders,
respectively, approved an amendment to our certificate of incorporation
increasing the number of shares of authorized common stock from 30,000,000
shares to 100,000,000 shares. The Board of Directors could sell these shares
strategically to approve a hostile takeover, for example by selling them in a
private transaction to investors who would oppose a takeover or favor the
current Directors, or could be issued in connection with our "poison pill."
21
<PAGE> 24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. The primary objective of our investment activities is
to preserve the principal while at the same time maximizing yields without
significantly increasing risk. To achieve this objective, we maintain our
portfolio of cash equivalents and investments in a variety of securities,
including both government and corporate obligations and money market funds. As
of August 31, 1999, approximately 90% of our total portfolio matures in one year
or less, with the remainder maturing in less than two years. We do not use
derivative financial instruments in our investment portfolio. We place our
investments with high credit quality issuers and, by policy, limit the amount of
credit exposure to any one issuer.
The following table presents the amounts of our cash equivalents and
investments that are subject to interest rate risk by year of expected maturity
and average interest rates as of August 31, 1999:
<TABLE>
<CAPTION>
FY2000 FY2001 TOTAL FAIR VALUE
------- ------ ------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Cash equivalents............................ $ 8,275 -- $ 8,275 $ 8,275
Average interest rate....................... 2.5%
Short-term investments...................... $98,488 -- $98,488 $98,488
Average interest rate....................... 5.4%
Long-term investments....................... -- $9,023 $ 9,023 $ 9,023
Average interest rates...................... -- 5.7%
</TABLE>
Foreign Currency Risk. We transact business in various foreign currencies,
including the British pound, the German mark, the Dutch guilder and the French
Franc. We have established a foreign currency hedging program utilizing foreign
currency forward exchange contracts to hedge certain sales contracts denominated
in foreign currency. Under this program, fluctuations in foreign currencies
during the period from the signing of the contract until payment are partially
offset by realized gains and losses on the hedging instruments. The goal of this
hedging program is to lock in exchange rates on our sales contracts denominated
in foreign currencies. The notional amount of hedged contracts and the estimated
fair value are not material.
22
<PAGE> 25
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On July 21, 1999, Phoenix Leasing Incorporated exercised a warrant to
purchase an aggregate of 493 shares of Verity common stock. The transaction is
considered a net exercise and is exempt from regulations pursuant to Section
3(a)(9) of the Securities Act of 1933, as amended.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on September 21,
1999, which was continued to September 27, 1999. Proxies for the meeting were
solicited pursuant to Regulation 14A. At the meeting, management's nominees for
directors and six proposals were submitted to the stockholders of the Company.
Management's nominees for directors were elected by the following vote:
<TABLE>
<CAPTION>
SHARES
------------------------
VOTING FOR WITHHELD
NOMINEE ---------- ----------
<S> <C> <C>
Steven M. Krausz............................................ 11,463,152 562,078
Charles P. Waite............................................ 11,459,253 565,977
</TABLE>
Gary J. Sbona, Steven M. Krausz, Charles P. Waite, Jr. and Stephen A.
MacDonald continued to serve as directors of the Company after the annual
meeting. Mr. Sbona will continue to serve as the Chairman of the Board until the
Annual Meeting of Stockholders to be held in 2001. Mr. MacDonald will continue
to serve until the Annual Meeting of Stockholders to be held in 2000, and Mr.
Krausz and Mr. Waite will continue to serve until the Annual Meeting of
Stockholders to be held in 2002.
A second proposal to approve an amendment to the Company's Certificate of
Incorporation to increase the authorized number of shares of common stock from
30,000,000 to 100,000,000 shares was submitted to a vote of the stockholders of
the Company. The proposal was approved by the following vote:
<TABLE>
<CAPTION>
FOR THE PROPOSAL AGAINST THE PROPOSAL ABSTENTIONS BROKER NON-VOTES
- ---------------- -------------------- ----------- ----------------
<S> <C> <C> <C>
6,821,195 5,150,310 53,725 N/A
</TABLE>
A third proposal to approve the Company's 1995 Employee Stock Purchase
Plan, as amended, to increase the aggregate number of shares of common stock
authorized for issuance under such plan from 1,300,000 to 2,000,000 shares was
submitted to a vote of the stockholders of the Company. The proposal was
approved by the following vote:
<TABLE>
<CAPTION>
FOR THE PROPOSAL AGAINST THE PROPOSAL ABSTENTIONS BROKER NON-VOTES
- ---------------- -------------------- ----------- ----------------
<S> <C> <C> <C>
9,501,070 747,475 39,375 1,737,310
</TABLE>
A fourth proposal to approve the Company's 1995 Stock Option Plan, as
amended, to increase the aggregate number of shares of common stock authorized
for issuance under such plan from 4,060,836 to 5,060,836 shares was submitted to
a vote of the stockholders of the Company. The proposal was approved by the
following vote:
<TABLE>
<CAPTION>
FOR THE PROPOSAL AGAINST THE PROPOSAL ABSTENTIONS BROKER NON-VOTES
- ---------------- -------------------- ----------- ----------------
<S> <C> <C> <C>
5,426,423 5,046,743 70,054 1,482,010
</TABLE>
A fifth proposal to approve the Company's 1995 Outside Directors Stock
Option Plan, as amended, to increase the aggregate number of shares of common
stock authorized for issuance under such plan from
23
<PAGE> 26
200,000 to 500,000 shares, and to increase the annual grant size from 5,000
shares to 20,000 shares was submitted to a vote of the stockholders of the
Company. The proposal was approved by the following vote:
<TABLE>
<CAPTION>
AGAINST THE BROKER NON-
FOR THE PROPOSAL PROPOSAL ABSTENTIONS VOTES
- ---------------- -------------------- ----------- ----------------
<S> <C> <C> <C>
5,591,743 4,660,057 64,677 1,708,753
</TABLE>
A final proposal to ratify the selection of PricewaterhouseCoopers LLP as
independent accountants of the Company for its fiscal year ending May 31, 2000
was also submitted to a vote of the stockholders of the Company. The proposal
was approved by the following vote:
<TABLE>
<CAPTION>
FOR THE PROPOSAL AGAINST THE PROPOSAL ABSTENTIONS BROKER NON-VOTES
- ---------------- -------------------- ----------- ----------------
<S> <C> <C> <C>
11,971,949 11,887 41,394 N/A
</TABLE>
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
A. Exhibits -- SEE EXHIBIT INDEX
B. Reports on Form 8-K
None.
24
<PAGE> 27
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/ TODD K. YAMAMI
------------------------------------
Todd K. Yamami
Corporate Controller
(Principal Accounting Officer)
Dated: October 7, 1999
25
<PAGE> 28
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- -----------------------
<C> <S>
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. Reference is
made to Section 2 of Exhibit 2.1.
3.2 By-Laws.(1)
3.3 Certificate of Retirement of Series of Preferred Stock.(2)
3.4 Certificate of Designation, Preferences and Rights of Series
A Preferred Stock.(2)
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.(3)
27.1 Financial Data Schedule
</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 Form 10-Q for the quarter ended August 31, 1996.
(3) Incorporated by reference from Exhibit No. 1 to the Company's Form 8-K as
filed with the Securities and Exchange Commission on October 10, 1996.
26
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINING SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEET AT AUGUST 31, 1999 (UNAUDITED) AND THE
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED AUGUST 31, 1999
(UNAUDITED) IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAY-31-2000
<PERIOD-START> JUN-01-1999
<PERIOD-END> AUG-31-1999
<CASH> 8,275
<SECURITIES> 98,492
<RECEIVABLES> 18,395
<ALLOWANCES> 850
<INVENTORY> 0
<CURRENT-ASSETS> 126,345
<PP&E> 18,810
<DEPRECIATION> 13,256
<TOTAL-ASSETS> 141,194
<CURRENT-LIABILITIES> 20,314
<BONDS> 0
0
0
<COMMON> 15
<OTHER-SE> 120,865
<TOTAL-LIABILITY-AND-EQUITY> 141,194
<SALES> 14,474
<TOTAL-REVENUES> 19,765
<CGS> 144
<TOTAL-COSTS> 1,764
<OTHER-EXPENSES> 13,370
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 10
<INCOME-PRETAX> 5,260
<INCOME-TAX> 150
<INCOME-CONTINUING> 5,110
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,110
<EPS-BASIC> 0.38
<EPS-DILUTED> 0.32
</TABLE>
