Item 1. Business
Overview
Versata, Inc. (Nasdaq: VATA), (“Versata” or the “Company”) was incorporated in California on August 27, 1991, and was reincorporated in the State of Delaware on February 24, 2000. Versata provides a way for companies to define and manage the business logic in their software systems at the business level rather than the system code level. This currently includes support for a company’s process and transaction business logic. Over the coming year, Versata plans to introduce additional support for decision logic and data mapping logic. The result is expected to be an integrated solution for all the logic components driving a company’s business systems.
Versata’s products are currently optimized for the building, maintenance and ongoing evolution of large, complex, data-intensive enterprise applications. These applications typically access multiple data sources, incorporate multiple database tables and user interfaces, execute very complex business transactions and support thousands of users. The Versata solution replaces time-intensive hand-coding efforts with simple, intuitive business rules definition and graphical process flow specification. Over the coming year, the Company plans to enhance its products to also support the development of end-user oriented decision support applications.
While Versata is confident that there is a continuing opportunity for its technology in its core market of application development products, it also believes that there may be a valuable additional opportunity in the emerging and related area of master data management. Master data management concerns the management of highly valuable corporate data that is shared across multiple business systems and used in support of business processes and transactions throughout the enterprise. Examples of master data would include customer data, product data, pricing data and other data types that vary from one industry to the next. Management of such data requires the specification and enforcement of business rules and business logic that ensure complete, consistent and accurate shared corporate data across all business systems within the enterprise.
Versata markets its products primarily through a direct sales force in North America and in Europe. The Company’s internal team is supported by a network of consulting and systems integration partners, companies selling pre-packaged software applications, and companies selling software applications over the Internet on a subscription basis.
Versata also offers comprehensive professional services such as ROI analysis, training, staff augmentation and project management as well as complete turnkey solution services and comprehensive customer support.
Versata Solutions
Versata offers a new, better choice for IT organizations struggling to decide whether to build or buy the enterprise software applications needed to manage their business. The Company’s proven solutions use business rules to abstract the most difficult hand-coding required to create new software. This approach combines the time-to-market strengths of packaged enterprise applications and the competitive differentiation of custom software, all while eliminating the drawbacks of both approaches. Through this innovation, the Company’s technology helps customers in the financial services, insurance, telecom, manufacturing and other fast-paced industries continually adapt to remain competitive. Other specific benefits of the Versata solutions include:
Efficient Application Creation With Business Rules
Versata dramatically simplifies how corporations build and manage their software systems, and enables continuous adaptation of those systems through business rules. Versata business rules define the fundamental behavior required of a business system, otherwise known as business logic, in an easy-to-understand declarative language. This allows data-intensive enterprise systems to be created significantly faster and for far less cost than would otherwise be required when using experienced programmers to do the work by hand. Moreover, as
business conditions change, system modifications are no more difficult than changing the rules. In effect, the Company’s technology replaces time-intensive hand-coding by automatically compiling rules into reusable components that capture up to 95 percent of the business and process logic used in transactional systems.
Continuous Improvement Through Adaptive Enterprise Systems
Versata’s platform lets IT organizations create adaptive, real-time transaction processing, workflow and master data management systems. This allows organizations to respond immediately to sudden business process or policy changes. While other approaches could take days or weeks, Versata’s business-rules approach allows changes to be implemented in just hours. This technical breakthrough enables critical business systems to be continually adapted as market conditions change. As a result, Versata affords its customers the potential to be leaders in customer service within their respective industries in customer service, to achieve regulatory compliance and derive competitive differentiation.
New Master Data Management Capabilities
Versata business rules are ideal for unifying the inconsistent versions of common customer, product, pricing and security data that hinder the value of today’s integrated business applications. Versata master data management results in improved customer service and lower operational costs by eliminating the inefficiencies created by inconsistent records across different business applications. It also helps customers grow revenue through cross- and up-selling opportunities, and by rapidly achieving regulatory compliance. The Versata solution ensures master data consistency on a transaction-by-transaction basis, at the instant each piece of information is touched. And when new business processes or policies require complex modifications to the system, customers can implement them in hours through a single Versata business rules console, creating a key advantage over competitors who struggle for months to recode their own distributed applications. For example, within IBM there are a variety of customer information systems sharing master customer data. IBM has layered a master data management platform across these systems to manage and synchronize the information. This platform was built and is continuously adapted using current Versata tools. It affords IBM the ability to meet the rigorous demands of its business, as well as regulatory requirements. Two large banking institutions are also now working with Versata on a similar master data management solution.
Industrial Strength Transaction Processing
Versata business rules are designed for high performance and scalability, including a demonstrated 750,000 transactions and 2.25 million calls per day to the back-end IBM mainframe systems at British Telecom. This approach has also been adopted by many large and complex transactional applications, including those at CGI-AMS, Equifax, DaimlerChrysler, the U.S. Department of Labor, and Union Bank of California.
Business Strategy
The value of rapid development has been Versata’s primary message since inception. However, there have always been two key components to the Company’s product value proposition. The first is in application construction-specifically, faster and more cost-effective time to deployment for new applications created using Versata tools. The second component is in the area of application configuration and maintenance-specifically, the ability to quickly and easily configure applications at the time of deployment as well as to continuously adapt them at any point during the enterprise lifecycle.
Application Development
Versata believes that there is a strong ongoing opportunity for the Company in the application development market, particularly as it looks at introducing new platform capabilities like support for end-user configurable decision rules, support for declarative data model mapping, and support for rules auditing that would allow customers to easily create auditable applications supporting compliance requirements. However, Versata also
believes that there may be a significant business opportunity in delivering value-added solutions that are both easily configurable and can be continuously adapted to meet changing business conditions and regulatory pressures. A good example of this is in the area of master data management.
Master Data Management
Versata has a unique opportunity to provide a configurable and adaptable master data management platform. Using business rules and intelligent automation, this platform can be configured and continuously adapted to implement proprietary company policies, as well as regulatory and compliance requirements.
Based on existing customer experience, Versata believes that the development of enterprise master data management systems will likely follow the same development process as that used for traditional application development: business analysts define the business rules required to properly operate on and maintain the shared master data; rules are then used by programmers to draw models, sketch out pseudo-code, and write programs that are intended to meet the original specifications; programs are then integrated with the rest of the company’s infrastructure resources and deployed to a production environment. With Versata, the programming step is eliminated. Business analysts specify the business logic, which is then directly executed by the Versata runtime product, the Versata Logic Server. This simplification enables companies to react faster to business demands by developing applications and data management solutions more efficiently, with an enhanced ability to change these solutions as business needs change.
Versata believes that its rules technology coupled with its existing customer experience gives it a competitive advantage in the areas of application development and master data management. However, the Company expects to continue innovating. During 2005, Versata plans to introduce additional types of business rules technologies, including decision rules, data integration rules and data transformation rules. These capabilities are expected to enhance the ability of customers to solve increasingly complex application development challenges, and bring further productivity to master data management projects using Versata.
Products
To meet its goal of helping developers operate at the business level rather than the system code level, Versata sells and supports products that facilitate the creation and ongoing management of large-scale, data- and transaction-intensive applications using declarative business rules. These products include: the Versata Logic Server, the Versata Studio, the Versata Process Logic Engine, and the Versata Business Activity Monitoring Dashboard.
Current Products
Versata Logic Server™
The Versata Logic Server (“VLS”) is an application server extension that executes data processing operations defined by business rules, replacing hand-written procedural code. To make it easier to use application servers, the VLS also includes a framework that provides necessary, reusable services such as cross-object navigation, transaction sequencing, event-action synchronization and more. Developers using the VLS can focus on the business functionality of their applications rather than system-level code.
Versata Studio®
The Versata Studio houses what are known as development designers for the VLS. These visual interfaces allow developers to graphically create and implement business rules for Versata-powered systems. Business logic is defined using data models and a simple, declarative rules language. The Versata Studio also includes presentation designers for HTML and Java client interfaces. These designers create complete Java and HTML application clients that easily leverage the definition of VLS business components, though developers are also free to work with other presentation technologies, such as JavaServer Pages (“JSP”) and JSP Struts.
Versata Process Logic Engine™
The Versata Process Logic Engine (“PLE”) allows for the automation of rules related to business processes and workflows. As such, the PLE enacts business processes, routes work to participants, and provides integration points with external enterprise systems at application runtime.
The PLE also includes a graphical tool for configuring business process and workflow rules called the Versata Process Logic Designer.
Versata Business Activity Monitoring Dashboard™
A new product released in the first quarter of fiscal 2005, the Versata Business Activity Monitoring (“BAM”) Dashboard provides PLE customers with the means to visually track the performance of automated business processes governed by Versata-powered systems. The BAM Dashboard displays operational statistics using a common Web browser, though results can easily be exported to Excel or another spreadsheet for deeper analysis. Its at-a-glance design allows managers to quickly identify process bottlenecks and facilitate operational improvements.
2005 Planned Products
Versata 6™
Versata 6, a major upgrade of the Versata platform, is expected to be introduced in the first half of fiscal 2005. Planned features of Versata 6 include integrated support for data, transaction and process logic as well as features for enabling Web services and service-oriented architectures (“SOAs”) in Versata-powered applications. Support for rules monitoring and auditing is also expected to be included.
Expected to highlight the platform is the new Versata Workbench, which is being designed to leverage the open source Eclipse development environment. The Versata Workbench is planned to house the development designers needed to create business rules, object models and process models. Together, these enhancements are expected to help developers manage business processes using a simple, declarative language and by graphically mapping the impact of rules on Versata-powered systems.
Versata 6 is also expected to provide backward compatibility with the current VLS and Versata Studio.
Versata BAM Dashboard v2.0™
The next version of the Versata BAM Dashboard is intended to provide business activity monitoring for applications built using either the PLE or Versata 6. Additionally, BAM customers will be able to use business rules to customize and extend their BAM capabilities to not only monitor but also proactively manage the execution and performance of Versata-powered systems.
Although the Company intends to release Versata 6 and the Versata BAM Dashboard v2.0 with the functionalities described herein, there can be no assurance that these products will be released in a timely manner. Nor can it be guaranteed that each product will perform as described here.
Customers
During the fiscal year ended October 31, 2004, Versata licensed its products worldwide for use in a wide range of software applications in diverse markets such as financial services, health care, government, insurance, logistics, manufacturing, retail and telecommunications. New customers in 2004 included companies such as Cendant Corporation, Costaisa and GAD eG. In addition, several existing customers purchased additional software licenses, many because they moved their Versata-powered applications from development into production. Notable among the Company’s list of repeat customers during 2004 were British Telecom, CGI-AMS, Equifax, IBM, JPMorganChase, Merrill Lynch, the State of Utah and the U.S. Department of Labor.
The following are examples of the use of Versata’s products by selected new and repeat customers during the fiscal year ended October 31, 2004:
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British Telecom (“BT”), Britain’s largest telephone service provider, uses Versata to manage access to the system that governs BT’s wholesale leased line business. Sitting in front of BT’s mainframe, Versata acts as a traffic cop, ensuring consistency in managing data requests, and providing the mechanism by which BT is able to bill its customers per system transaction. More than 7.5 million service invocations are handled by the Versata system each month, resulting in more than 68 million transactions, yet the system performs at better than 99.99999 percent reliability.
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Cendant Corporation, a global conglomerate providing travel and real estate services, is replacing a legacy system for booking timeshare properties with a Java 2 Enterprise Edition (“J2EE”) application based on the Versata platform.
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Equifax, an information services provider, has used Versata as a component in the creation of an application framework that automates the process of extending credit and processing loans. Equifax customers in the financial services, telecommunications and retail sectors benefit from this application - a value-added service that has already been deployed by many businesses across key markets.
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GAD eG, one of two centralized IT-Service providers for a union of more than 500 German banks, uses Versata to meet regulatory requirements within the Basel II rule set for streamlined credit processes. Versata technology is used as an embedded component for their new core banking system BANK21, which is being migrated from COBOL to J2EE.
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Merrill Lynch, one of the largest financial services firms in the world, has been the beacon master data management customer for Versata. Merrill Lynch has used Versata to develop a master data management application that created a clearinghouse for requests for changes or additions to its master data records. In this way, Versata helped them establish consistency in the way client, product, security, and pricing data is accessed and manipulated.
For the 2004 fiscal year, GAD eG accounted for approximately 14% of total Versata revenues. For the 2003 fiscal year, Fidelity (formerly FNIS) accounted for approximately 19% of total Versata revenues and CGI-AMS accounted for approximately 14% of total revenues. Fidelity accounted for approximately 14% of total revenues for the 2002 fiscal year.
Alliances
JBoss
JBoss, an open source software provider, and Versata entered into an agreement in May 2004 to provide full support for the JBoss Application Server in current and future versions of Versata products. In July 2004, Versata began shipping products for use with the JBoss Application Server.
IBM
In August 2004, Versata joined IBM’s ISV Advantage initiative, which provides technical and marketing support to the Company to help meet the specific needs of small and medium-sized IBM business customers. In addition, IBM has named Versata a premier business partner, which gives the Company the authority to use the “IBM Premier Business Partner” designation and logo in all sales and marketing outreach.
Oracle
Oracle, the leader in database technology, provides database and other infrastructure technology that is utilized by Versata and Versata’s customers. In order to support the development, maintenance and sale of Versata products to Oracle customers, Versata joined the Oracle Partner Network. As a member of the Partner Network, Versata receives access to Oracle products for development and testing as well as other marketing benefits such as the use of Oracle Partner logos. A large number of the Company’s customers use Versata tools to build applications for Oracle databases.
BEA Systems
BEA Systems, one of the world’s leading e-business infrastructure software companies, has had an alliance partnership with Versata since 2000. Many of BEA’s largest customers are running Versata applications on BEA technology, including British Telecom and Merrill Lynch. As a Star Alliance Partner, Versata has access to BEA software, support and marketing resources to ensure that Versata and BEA products work together to address customer needs.
Competition
Application Development Market
The application development market is intensely competitive, subject to technological changes and affected by new product introductions and other marketing activities engaged in by industry participants. Versata expects the competition in this industry to persist and intensify as the market continues consolidating. Versata’s primary competition comes from companies developing their software applications internally using traditional programming approaches. However, the Company also competes with a number of other entities:
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Vendors of application server development products such as IBM, BEA Systems, Oracle and Borland Software;
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Vendors of Web services development environments such as IBM and Borland Software;
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Vendors of business rules engines for creating decision support applications such as ILOG, Fair Isaac, Computer Associates, Pegasystems and Haley Enterprises; and
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Companies that market business application software such as Oracle and SAP.
Versata has identified the principal competitive factors in the application development market as:
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Product functionality and features customized for developing and maintaining complex, data-intensive applications;
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Ease of application implementation;
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Performance, scalability and availability;
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Use of standards-based technology; and
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Ease of integration with customers’ existing legacy data, software applications and middleware computing infrastructure.
Master Data Management Market
In contrast, Versata believes that the master data management arena is an emerging opportunity area with few competitors. However, industry analysts such as Meta Group, Tower Group and Gartner predict that known industry leaders and several smaller software companies will begin to innovate and deliver master data management offerings. Some of the potential competitors in this market segment will likely include Chordiant, DWL, SAP, Siebel and Soliton.
General competitive issues
In addition, the following factors affect Versata’s competitiveness in all markets in which it participates:
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Quality of professional services offerings;
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Quality of customer support services;
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Pricing; and
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Company reputation.
Services
An important component of Versata’s overall solution is its ability to provide customers with comprehensive professional services-from training, advice and mentoring, customer support, staff augmentation and rapid requirements development to complete turnkey development and deployment services. Through this comprehensive suite of offerings, Versata helps its customers rapidly respond to changing market conditions without facing internal staffing constraints. Versata’s services organization consists of staff consultants and technical support personnel. The Company can also engage a variety of system integration partners and independent contractors to augment its service offerings.
Consulting Services
Versata consulting services offer insight into the realities of complex transaction and process-based business application development. The Company’s services include system architecture, data modeling, system design, software application development, testing, configuration, installation, quality assurance, risk assessment and performance tuning. Versata also provides project management services to assist customers in developing and deploying large enterprise applications with multiple data sources, multiple database tables, and multiple user interfaces. The Company also offers complete turnkey services whereby Versata professionals and consulting partners deliver complete customized solutions. These services can be provided on-site or via remote electronic connection, offering a balance between personal interaction and speed of responsiveness. Many Versata customers have sought the expertise of Versata consultants during 2004.
Advisory Services
The Versata advisory services program is a rapid-response mechanism for customers with challenging development tasks and who would prefer hands-on help. Advisory services are provided by highly experienced application design and development professionals, any of whom can be obtained on an hourly or per-task basis. Customers can turn to advisory services when they have a specific “how to” question related to their application development or deployment projects.
Training Services
Versata offers its customers introductory and advanced training in the use of its products. These training services are offered in several geographic locations, either as standard public training classes located throughout the U.S. and Europe or on-site private training classes. Versata prices these services per course or on a per-day basis.
Customer Support
Versata believes that a high level of customer service and support is essential to its success. The Company offers a range of customer support services including (i) daily Web, telephone, and e-mail support from its United States, Canada, Australia, Germany and United Kingdom facilities during business hours, (ii) 24-hour-a-day/seven-day-a-week production system support, (iii) 24-hour-a-day/seven-day-a-week self-service support through the Company’s online case tracking system, developer knowledge base and discussion groups, and electronic software delivery system, (iv) “how-to” support through the advisory services group and (v) on-site support upon request. The Company’s customers typically purchase annual maintenance and support contracts at prices dependent upon their desired level of service.
Services Partners
In addition to Versata’s internal services organization, the Company has relationships with resellers, professional service organizations and global system integrators that offer consulting, training and customer support services. These partners include IBM Global Services, Online Business Systems, and Capgemini. Versata’s service partners are encouraged to attend and complete a series of Versata training courses.
Sales and Marketing
Sales
Versata markets its products primarily through a direct sales force in North America and in Europe. As of December 31, 2004, Versata’s direct sales organization consisted of 12 professionals throughout North America and Europe.
Versata utilizes teams consisting of both sales and technical professionals to create organization- and need-specific proposals, presentations and demonstrations for each prospect. When competitively pitching for new business, the Company often delivers a proof of concept and/or an ROI analysis. In many of these engagements, the tangible results of Versata’s proof of concept and/or ROI analysis substantiate the ease-of-use and time-to-market advantages of the Versata platform.
Versata complements its direct sales force with channel sales through various types of relationships that either sell, or help sell, products and services. These relationships include:
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System Integration Partners. Versata’s system integration partners include companies that custom develop and integrate software applications, including global system integrators as well as regional consulting partners. These partners refer Versata’s products to new and existing customers and then typically provide consulting and system integration services. Some of the Company’s systems integration partners include Advanced Logics, Capgemini, eCorridor, IBM Global Services, Lockheed Martin Services and Online Business Systems.
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Independent Software Vendors (“ISVs”). ISV’s use Versata’s technology to create and resell their pre-packaged software applications to end-users. Versata typically receives a royalty from these partners for every sell-through application that integrates the Versata products. Some of these partners include Active-Logistics, Ametras, CGI-AMS, JPMorganChase, Tradepoint Systems and Utility Solutions.
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International Distributors. Versata’s international distributors resell software products to companies in Europe and the Middle East.
Marketing
Versata supports its sales efforts through a variety of marketing initiatives implemented by both its corporate headquarters and its regional offices. The Company’s marketing organization focuses on creating market awareness for Versata’s solutions, generating sales leads, forming relationships with leading technology
companies and educating industry analysts about its solutions. Versata conducts a variety of marketing initiatives worldwide to educate its target market. The Company has engaged in marketing activities such as business seminars, trade shows, press relations, industry analyst programs, ongoing public relations, direct mailings and telemarketing, managing and maintaining its corporate Website, and producing and distributing sales support materials. Versata’s marketing organization also participates in acquiring, organizing and prioritizing customer and industry feedback in order to help provide product direction to its development organizations. Versata formalized this customer-driven approach by establishing customer summit meetings to provide forums for discussing customer needs and requirements. Customer summit meetings provide a useful forum in which to share information, test product concepts and collect data on customer and industry needs.
Product Development
Most of Versata’s software products are developed internally by the Company’s own engineering team. This includes everything from core product definition to design, implementation and documentation. To maximize the ability of its engineering organization to rapidly respond to customer needs and market fluctuations, the Company has established a tightly integrated process whereby marketing, sales, services and product support personnel provide Versata’s engineering team with continuous feedback from the Company’s customers, partners and competitors. Versata believes this approach helps the Company innovate to produce products that directly address customer challenges as they emerge. Taking these important steps forward has required Versata to substantially improve its engineering resources and processes during 2004. Among the improvements is a new engineering team at Halifax, Nova Scotia. The team boasts decades of software architecture, design, development and delivery experience, which the Company believes creates a competitive advantage in an industry where continuous innovation is a must.
The net result of these engineering improvements is that Versata is now able to continuously integrate changes and consistently improve its software. In fiscal 2005, the Company intends to seek and invest in improvements in product design, development, testing, and quality assurance to further its goal of rapid responsiveness to customer and market feedback.
Intellectual Property and Licensing
Intellectual Property
Versata relies on a combination of intellectual property rights to establish and protect its intellectual property. These legal protections afford only limited protection for the Company’s technology, and it cannot provide any assurance that other companies will not develop technologies that are similar or superior to its technology. If the Company fails to protect its proprietary technology, the business could be seriously harmed.
While various proprietary intellectual property rights are important to Versata’s success, the Company believes that its business as a whole is not materially dependent on obtaining any particular patent. The Company currently has a U.S. patent relating to its automated development tool that uses a drag-and-drop metaphor. This patent is scheduled to expire on April 9, 2016. It is possible that other companies could successfully challenge the validity or scope of the patent and that the patent may not provide a competitive advantage. Versata enforces its copyright, trademark, service mark and trade name rights. Furthermore, as part of the Company’s proprietary protection procedures, it enters into non-disclosure agreements with its employees, consultants, customers, distributors and business partners and into license agreements with respect to its software, documentation and other proprietary information. The Company further seeks to avoid disclosure of its intellectual property by restricting access to its source code. Despite these precautions, third parties could copy or otherwise obtain and use the Company’s products or technology without authorization, or develop similar technology independently. In addition, the laws of many countries do not protect the Company’s proprietary rights to as great an extent as do the laws of the U.S.
Currently, Versata is not aware of any pending claims that its products, trademarks or other proprietary rights infringe upon the proprietary rights of third parties. While the Company relies on patent, copyright,
trademark, trade secret laws and contractual restrictions to protect its technology, the Company believes that factors such as the creativity and technological skills of its personnel, new product developments, frequent product enhancements and reliable customer service and product maintenance are more essential to establishing and maintaining a technology leadership position. See the “Risk Factors” section under Item 1 for a discussion of the risks associated with proprietary rights.
Third Party Licensing
Versata integrates third-party software into its products. While the Company believes that alternative sources of such third-party software are available, and based upon past experience and standard industry practice such licenses generally could be obtained on commercially reasonable terms, any significant interruption in the supply of such products could adversely impact the Company’s sales of its products unless and until the Company could secure another supplier.
International Operations
We currently have international subsidiaries located in Australia, Canada, Germany, and the United Kingdom. In March 2004, we sold certain intangible assets of our French subsidiary to our German subsidiary. We no longer maintain a staff or offices in France.
Employees
As of December 31, 2004, we had 73 active employees and 11 contractors. Of these individuals, 17 employees and contractors were in sales and marketing, 24 employees and contractors were in product development, 15 employees were in professional services, 12 employees were in customer support, and 16 employees and contractors were in finance and administration. Our employees are not represented by any collective bargaining unit, and we believe our relations with employees are satisfactory.
Risk Factors That May Affect Future Results
We operate in a rapidly changing environment that involves numerous risks and uncertainties. The following section lists some, but not all, of these risks and uncertainties, which may have a material adverse effect on our business, financial condition or results of operations. Investors should carefully consider the following risk factors in evaluating an investment in our common stock.
Risks Related to Our Business
We Have Limited Working Capital and May Experience Difficulty in Obtaining Needed Funding, Which May Limit Our Ability to Effectively Pursue Our Business Strategies.
As of October 31, 2004, we had $9.8 million in cash and short-term investments, and working capital of approximately $5.1 million. To date, we have not achieved profitability or positive cash flow on a sustained basis. Although we believe that our current cash, cash equivalents, and any net cash provided by operations will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next twelve months, it is possible that events may occur that could render our current working capital reserves insufficient. Because our revenue is unpredictable and a significant portion of our expenses are fixed, a reduction in projected revenue or unanticipated requirements for cash outlays could deplete our limited financial resources, potentially to a serious degree. We may find it necessary to obtain additional equity or debt financing in fiscal 2005 or beyond. If we require additional external funding, there can be no assurance that we will be able to obtain it on a timely basis if at all, or, if available, on terms acceptable to us. Moreover, additional financing will cause dilution to existing stockholders. If we cannot secure adequate financing sources on a timely basis, then we would be required, at a minimum, to reduce our operating expenses, which would restrict our ability to pursue our business objectives and could adversely impact our ability to maintain our revenue levels.
We Have Incurred Operating Losses Since Our Inception and May Incur Net Losses and Negative Cash Flows for the Foreseeable Future.
We have experienced operating losses in each quarterly and annual period since inception, and we expect to incur losses in the near future. Although we hope to achieve positive cash flow and GAAP profitability by the end of fiscal 2005, if our revenue grows less than we anticipate or if our operating expenses increase more than expected, we may never achieve profitability. As of October 31, 2004, we had an accumulated deficit of $210.9 million.
Our Quarterly Revenues and Operating Results May Fluctuate in Future Periods.
Our operating results have varied and may continue to vary substantially from period to period. The timing and amount of our license fees are subject to a number of factors that make estimating revenues and operating results prior to the end of a quarter uncertain. While we receive certain recurring revenues on royalty-based license agreements and also from deferred maintenance and support fees, a significant amount of license fees in any quarter is dependent on the execution of new license sales in a particular quarter. Our professional services revenue in any quarter is substantially dependent on our license revenue. Services are normally purchased in conjunction with software, although it is not a requirement. Should our license revenues decrease, there will be a reduced market for our services. Any revenue shortfall in services could have an immediate and significant adverse effect on our results of operations. Operating expenses for any year are normally based on the attainment of planned revenue levels for that year and are generally incurred ratably throughout the year. As a result, if revenues were less than planned in any period while expense levels remain relatively fixed; our operating results would be adversely affected for that period. In addition, unplanned expenses such as increases in salaries, third party software licensing fees, and cost of software development, could adversely affect operating results for the period in which such expenses were incurred.
Our Failure to Accurately Forecast Sales May Lead to a Disappointment of Market Expectations.
Our Company uses a “pipeline” system, a common industry practice, to forecast sales and trends in our business. Our sales personnel monitor the status of all proposals, such as the date when they estimate that a customer will make a purchase decision and the potential dollar amount of the sale. We aggregate these estimates periodically in order to generate a sales pipeline. We compare the pipeline at various points in time to look for trends in our business. While this pipeline analysis may provide us with some guidance in business planning and budgeting, these pipeline estimates are necessarily speculative and may not consistently correlate to revenues in a particular quarter or over a longer period of time. A variation in the conversion of the pipeline into contracts or in the pipeline itself such as occurred in the past could cause our Company to improperly plan or budget and thereby adversely affect our business or results of operations. In particular, the current slowdown in the economy is causing purchasing decisions to be delayed, reduced in amount or cancelled which will therefore reduce the overall license pipeline conversion rates in a particular period of time.
If We Do Not Develop and Enhance New and Existing Products to Keep Pace With Technological, Market and Industry Changes, Our Revenues May Decline.
The markets for our products are characterized by rapid technological advances in software development, evolving standards in software technology and frequent new product introductions and enhancements. Product introductions and short product life cycles necessitate high levels of expenditures for research and development. To maintain our competitive position, we must:
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Enhance and improve existing products and continue to introduce new products that keep pace with technological developments, such as the new master data management products;
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Satisfy increasingly sophisticated customer requirements; and
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Achieve market acceptance.
The success of new products is dependent on several factors including proper new product definition, product cost, timely completion and introduction of new products, differentiation of new products from those of our competitors, and market acceptance of these products. Although the Company intends to release Versata 6 and the Versata BAM Dashboard v2.0 with the functionalities described herein during fiscal 2005, there can be no assurance that these products will be released in a timely manner, include the described functionalities, or achieve broad market acceptance. Our inability to run on new or increasingly popular operating systems, and/or our failure to successfully enhance and improve our products in a timely manner could have a material adverse effect on our business, results of operations, financial condition or cash flows. In addition, Versata may in the future discover errors in new releases or new products after the commencement of commercial shipments. Since many customers are using Versata products for mission-critical business operations, any of these occurrences could seriously harm the Company’s business and generate negative publicity.
If the Versata Products and Related Services Do Not Achieve Widespread Market Acceptance, the Source of Substantially All of Our Revenue Will be At Risk.
We cannot predict the level of market acceptance that will be achieved or maintained by our products and services. If either the Internet infrastructure software market in general, or the market for our software or related services in particular, fails to grow or grows more slowly than we anticipate, or if either market fails to accept our products and related services, the source of substantially all of our revenue will be at risk. We expect to continue to derive substantially all our revenue from and be dependent upon the Versata products and related services in the future. The market for the Versata products and related services is new, rapidly evolving and highly competitive, and we cannot be certain that a viable market for our products will ever develop or be sustained. Our future financial performance will depend in large part on the successful development, introduction and customer acceptance of our new products, product enhancements and related services in a timely and cost effective manner. We expect to continue to commit significant resources to market and further develop our products and related services and to enhance the brand awareness of our software and services.
New Versions and Releases of Our Products May Contain Errors or Defects and Result in Loss of Revenue.
The software products we offer are complex and, despite extensive testing and quality control, may have had, and in the future could have errors or defects, especially when we first introduce them. Typically we need to issue corrective releases of our software products to fix any defects or errors. Defects or errors could also cause damage to our reputation, loss of revenues, product returns or order cancellations, lack of market acceptance of our products, and expose us to litigation. Accordingly, defects or errors particularly if they are more numerous than expected could have a material and adverse effect on our business, results of operations and financial condition.
We Depend on Technology Licensed from Third-party Software Developers and our Ability to Develop and Sell our Products and Services Could be Delayed or Impaired if We Fail to Maintain These License Arrangements.
We incorporate into our products third-party software that enables, enhances or compliments aspects of our products’ functionality. This third-party software may not continue to be available on commercially reasonable terms or with acceptable levels of support, or at all. Our inability to maintain these software licenses on current terms could delay or impair the sale of our products and services until equivalent software, if available, is identified, licensed or developed, and integrated. This could adversely affect our business and impair our future growth.
Versata had an OEM agreement with WebGain for TopLink, a Java object-to-relational persistence architecture, as a part of the Versata 5 platform. The TopLink architecture bridges the gap between object-oriented Java systems such as Versata and relational database systems such as Oracle. The original OEM agreement with WebGain expired in 2004. Oracle acquired the assets and intellectual property for the TopLink
product from WebGain. Versata is working to put in place a new agreement with Oracle. There can be no assurance that Versata can finalize this agreement in a timely manner or with favorable terms. If Versata is not able to enter into a new agreement with Oracle, Versata could lose the right to use and distribute TopLink and remedies could include damages or injunctive relief.
We May Have to Delay Recognizing License or Service Related Revenue for a Significant Period, Which Could Negatively Impact Our Results of Operations.
Although we typically enter into standard license agreements and time-and-materials services agreements, we may occasionally have to delay recognizing license or service revenue for a significant period of time for a variety of types of transactions, including:
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Transactions which require specified future deliverables not covered by maintenance and support arrangements;
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Transactions that involved significant production, modification or customization;
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Transactions that contain customer acceptance clauses, cancellation/exchange rights, or refund rights;
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Transactions that involve certain customer financing arrangements;
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Transactions that involve new products;
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Transactions that involve extended payment terms or payments based on milestones;
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Transactions that do not support current established pricing of training, professional services, maintenance and support, or other typical undelivered elements in an arrangement;
These factors and other specific accounting requirements for software revenue recognition, require that we have very precise terms in our license agreements to allow us to recognize revenue when we initially deliver software or perform services. Although we have a standard form of license agreement that meets the criteria for current revenue recognition on delivered elements, we negotiate and revise these terms and conditions in some transactions. Sometimes we are unable to negotiate terms and conditions that permit revenue recognition at the time of delivery or even as work on the project is completed.
If Accounting Interpretations Relating to Revenue Recognition Change, Our Reported Revenues Could Decline, or We Could be Forced to Make Changes in Our Business Practices.
Over the past several years, the American Institute of Certified Public Accountants has issued Statement of Position No. 97-2, Software Revenue Recognition (“SOP 97-2”), and Statement of Position No. 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions (“SOP 98-9”). In addition, in December 2003, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (“SAB 104”), which explains how the SEC staff believes existing revenue recognition rules should be applied to or interpreted for transactions not specifically addressed by existing rules. These standards address software revenue recognition matters primarily from a conceptual level and do not include specific implementation guidance. We believe that our revenue has been recognized in compliance with SOP 97-2, SOP 98-9 and SAB 104. However, the accounting profession and regulatory agencies continue to discuss various provisions of these pronouncements with the objective of providing additional guidance on their application. These discussions and the issuance of new interpretations, once finalized, could lead to unanticipated reductions in recognized revenue. They could also drive significant adjustments to our business practices, which could result in increased administrative costs, lengthened sales cycles and other changes which could adversely affect our results of operations.
Issuance of New Laws or Accounting Regulations, or Re-interpretation of Existing Laws or Regulations, Could Materially Impact our Business or Stated Results.
From time to time, the government, courts and financial accounting boards issue new laws or accounting regulations, or modify or re-interpret existing ones. There may be future changes in laws, interpretations or
regulations that would affect our financial results or the way in which we present them. Additionally, changes in the laws or regulations could have adverse effects on hiring and many other aspects of our business that would affect our ability to compete, both nationally and internationally. For example, recently issued accounting regulations requiring the company to account for employee stock option grants as an expense could have the result of our not using options as widely for our employees which could impact our ability to hire and retain key employees.
We Will Incur Increased Costs as a Result of Recently Enacted and Proposed Changes in Laws and Regulations Relating to Corporate Governance Matters and Public Disclosure.
Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, rules adopted or proposed by the SEC and by the NASDAQ National Market and new accounting pronouncements will result in increased costs to us as we evaluate the implications of these laws, regulations and standards and respond to their requirements. To maintain high standards of corporate governance and public disclosure, we intend to invest substantial resources to comply with evolving standards. This investment will result in increased general and administrative expenses and a diversion of management time and attention from strategic revenue generating and cost management activities. In addition, these new laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on our board committees or as executive officers. We are taking steps to comply with the recently enacted laws and regulations in accordance with the deadlines by which compliance is required, but cannot predict or estimate the amount or timing of additional costs that we may incur to respond to their requirements.
If Java Technology Does Not Continue to be Widely Adopted for E-business Application Development, Our Business Will Suffer.
Our products are based on Java technology, an object-oriented software programming language and distributed computing platform developed by Sun Microsystems. Java was developed primarily for the Internet and corporate intranet applications. It is still too early to determine whether Java will achieve greater acceptance as a programming language and platform for enterprise applications. Alternatives to Java include Microsoft’s C# language and .Net computing platform. Should Java not continue to be widely adopted, our business will suffer. Alternatively, if Sun Microsystems makes significant changes to the Java language or its proprietary technology, or fails to correct defects and limitations in these products, our ability to continue improving and shipping our products could be impaired. In the future, our customers also may require the ability to deploy our products on platforms for which technically acceptable Java implementations either do not exist or are not available on commercially reasonable terms.
If We Infringe the Patents or Proprietary Rights of Others Our Business, Financial Condition and Operating Results Would Be Harmed.
We do not believe our products infringe the proprietary rights of third parties, but third parties may nevertheless assert infringement claims against us in the future. Regardless of whether these claims have merit, they can be time consuming and expensive to defend or settle, and can harm our business and reputation. Furthermore, we may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Litigation, whether resolved in our favor or not, could be time-consuming to defend, result in increased costs, divert management’s attention and resources, cause product shipment delays or require us to enter into unfavorable royalty or licensing agreements.
Some of our products, incorporate intellectual property licensed from third parties or open source software. If we fail to successfully exclude such technology from our indemnification obligations, claims that such open source or third party technology infringes the intellectual property rights of a third party could materially and adversely affect our business and financial condition.
We May Incur Substantial Expenses If We are Sued for Product Liability.
Our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions contained in our license agreements may not be effective as a result of existing or future federal, state or local laws or ordinances or unfavorable judicial decisions. Although we have not experienced any product liability claims to date, sale and support of our products entails the risk of such claims, which could be substantial in light of customers’ use of such products in mission-critical applications. If a claimant brings a product liability claim against us, it could have a material adverse effect on our business, results of operations and financial condition. Our products interoperate with many parts of complicated computer systems, such as mainframes, servers, personal computers, application software, databases, operating systems and data transformation software. Failure of any one of these parts could cause all or large parts of computer systems to fail. In such circumstances, it may be difficult to determine which part failed, and it is likely that customers will bring a lawsuit against several suppliers. Even if our software was not at fault, we could suffer material expense and material diversion of management time in defending any such lawsuits.
We Depend on Increased Business from Our Current and New Customers and if We Fail to Generate Repeat and Expanded Business or Grow Our Customer Base, Our Products and Services Revenues Will Likely Decline.
In order to be successful, we need to broaden our business by selling product licenses and services to current and new customers. Many of our customers initially make a limited purchase of our products and services for pilot programs. These customers may not choose to purchase additional licenses to expand their use of our products. These and other potential customers also may not yet have developed or deployed initial software applications based on our products. If these customers do not successfully develop and deploy these initial software applications, they may choose not to purchase deployment licenses or additional development licenses. In addition, as we introduce new versions of our products, or new products, our current customers may not require the functionality of our new products and may not license these products.
If we fail to add new customers who license our products, our revenue will also likely decline. The total amount of professional services and customer support fees we receive in any period depends in large part on the size and number of software licenses that we have previously sold as well as our customers electing to renew their customer support agreements. In the event of a further downturn in our software license revenue or a decline in the percentage of customers who renew their annual support agreements, our professional services and fees for customer support revenue could become flat or further decline.
Our Failure to Maintain Ongoing Sales Through Distribution Channels Will Result in Lower Revenues.
To date, we have sold our products principally through our direct sales force, as well as through indirect sales channels, such as Independent Software Vendors (“ISVs”), systems integrators, independent consultants, application service providers (“ASPs”) and resellers. Our ability to achieve revenue growth in the future will depend in part on our success in making our direct sales force more efficient and in further establishing and expanding relationships with distributors, ASPs, ISVs, Original Equipment Manufacturers (“OEMs”) and systems integrators. We intend to seek distribution arrangements with additional ISVs to embed our solutions in their products. It is possible that we will not be able to increase the efficiency of our direct sales force or other distribution channels, or secure license agreements with additional ISVs on commercially reasonable terms. Moreover, even if we succeed in these endeavors, it still may not increase our revenues. If we invest resources in these types of expansion and our revenues do not correspondingly increase, our business, results of operations and financial condition will be materially and adversely affected.
We rely on informal relationships with a number of consulting and systems integration firms to enhance our sales, support, service and marketing efforts, particularly with respect to implementation and support of our products as well as lead generation and assistance in the sales process. We will need to expand our relationships
with third parties in order to support license revenue growth. Many such firms have similar, and often more established, relationships with our principal competitors. In addition, our ability to attract such third parties is dependent on our ability to timely develop and enhance new and existing products to support the necessary marketplace and technology standards. It is possible that these and other third parties will not provide the level and quality of service required to meet the needs of our customers, that we will not be able to maintain an effective, long term relationship with these third parties, and that these third parties will not successfully meet the needs of our customers.
Our Business is Subject to Risks from International Operations.
We conduct business internationally. Accordingly, a portion of our revenues is derived from international sales and is therefore subject to the related risks including the general economic conditions in each country, the overlap of different tax structures, the difficulty of managing an organization spread over various countries, changes in regulatory requirements, compliance with a variety of foreign laws and regulations, longer payment cycles and volatilities of exchange rates in certain countries. There can be no assurances that we will be able to successfully address each of these challenges. Other risks associated with international operations include import and export licensing requirements, trade restrictions and changes in tariff rates.
A portion of our business is conducted in currencies other than the U.S. dollar. Changes in the value of major foreign currencies relative to the value of the U.S. dollar may adversely affect revenues and operating results.
If We Lose Key Employees or Cannot Hire Key Qualified Employees, It May Adversely Affect Our Ability to Manage Our Business, Develop Our Products and Increase Our Revenues.
We believe our continued growth and success depends to a large extent on the continued service of our senior management and other key employees and the hiring of key qualified employees. In the software industry, there is substantial and continuous competition for highly skilled business, product development, technical and other personnel. We may experience increased compensation costs that are not offset by either improved productivity or higher prices. We may not be successful in recruiting new personnel and in retaining and motivating existing personnel. Members of our senior management team have left Versata over the years for a variety of reasons and we cannot assure you that there will not be additional departures. Any changes in management can be disruptive to our operations. In general, we do not have long-term employment or non-competition agreements with our employees. Part of our total compensation program includes stock options. The volatility or lack of positive performance of our stock price may from time to time adversely affect our ability to retain or attract key employees.
Risks Related to Our Industry
Weakening of World Wide Economic Conditions Realized in the Internet Infrastructure Software Market May Result in Decreased Revenues or Lower Revenue Growth Rates.
The revenue growth of our business depends on the overall demand for computer software, particularly in the product segments in which we compete. Any further slowdown of the worldwide economy affects the buying decision of corporate customers, such as it has in the recent years. Because our sales are primarily to Global 2000 customers, our business also depends on general economic and business conditions. A reduction in demand for computer software, caused by a weakening of the economy, such as occurred in fiscal 2001, 2002 and 2003, or otherwise, may result in continued decreased revenues or lower revenue growth rates.
Entering Into New or Developing Markets May Also Result in Decreased Revenues or Lower Revenue Growth Rates
As we focus on the new market opportunity in master data management and the Business Rules Engine industry, we may be competing with large, established suppliers and/or systems integrators as well as start-up companies. Some of our current and potential competitors may have greater resources, including technical and
engineering resources, than we do. Since the master data management market is relatively new, we believe that success in developing and selling master data management products will require us to devote appropriate efforts to develop the strong sales, marketing and development skills required to address new target markets. These efforts may increase our operating costs and, if we fail to generate timely revenue from the master data management business, our working capital and operating results could be adversely affected. There can be no assurance that our efforts to pursue the master data management business or entering the Business Rules engine industry will be successful or will not adversely affect our financial condition or results of operations, particularly in the near term.
If We Do Not Effectively Compete With New and Existing Competitors, Our Revenues and Operating Margins Will Decline.
The software development market in general, and the market for our software and related services in particular, are new, rapidly evolving and highly competitive. We expect the competition in this industry to persist and intensify as the market continues to consolidate. Many of our competitors, including but not limited to IBM, BEA Systems, Oracle, Borland Software, ILOG, Fair Isaac, Pegasystems, Haley Enterprises, SAP and Computer Associates have longer operating histories and significantly greater financial, technical, marketing and other resources than we do. As a result, they may be able to respond more quickly to new or changing opportunities, technologies and customer requirements. Many of our competitors, such as the ones mentioned herein; also have more extensive customer bases, broader customer relationships and broader industry alliances that they could leverage, thereby establishing relationships with many of our current and potential customers. These companies also have significantly more established customer support and professional service organizations. In addition, these companies may adopt aggressive pricing policies or offer more attractive terms to customers, may bundle their competitive products with broader product offerings or may introduce new products and enhancements. Furthermore, current and potential competitors may establish cooperative relationships among themselves or with third parties to enhance their products. As a result, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. If we fail to compete successfully with our competitors, the demand for our products would decrease. Any reduction in demand could lead to loss of market share, a decrease in the price of our products, fewer customer orders, reduced revenues, reduced margins, and increased operating losses. These competitive pressures could seriously harm our business and operating results.
Risks Related to Our Stock
The Price of Our Common Stock is Volatile, and It May Fluctuate Significantly.
The market price of our common stock has fluctuated significantly and has declined sharply since our initial public offering in March 2000. Our Company’s stock price is affected by a number of factors, some of which are beyond our control, including:
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Quarterly variations in results, announcements that our revenue or income are below analysts’ expectations;
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The competitive landscape;
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Technological innovations by us or our competitors;
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Changes in earnings estimates or recommendations by analysts;
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Sales of large blocks of our common stock, sales or the intention to sell stock by our executives and directors;
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General economic and market conditions;
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Additions or departures of key personnel;
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Estimates and projections by the investment community; and
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Fluctuations in our stock trading volume, which is particularly common among highly volatile securities of software companies.
As a result, our stock price is subject to significant volatility. In the past, following periods of volatility or decline in the market price of a company’s securities, securities class action litigation has at times been instituted against that company. This could cause us to incur substantial costs and experience a diversion of management’s attention and resources.
Any Potential Delisting of Versata’s Common Stock from the NASDAQ Small Cap Market Could Harm Our Business.
Versata’s common stock currently trades on the NASDAQ Small Cap Market, which has certain quantitative continued listing requirements. In March 2004 we transferred the listing of our common stock from the NASDAQ National Market to the NASDAQ Small Cap Market because we no longer met the NASDAQ National Market’s minimum stockholder’s equity requirements. If we are unable to maintain compliance with the Small Cap Market’s continued listing requirements, our common stock could be de-listed from the Small Cap Market, with future sales conducted only in the over the counter market. A transfer to the over the counter market could have a negative impact on the price and liquidity of our common stock.
We May Engage in Future Acquisitions that Dilute Our Stockholders and Cause Us To Incur Debt or Assume Contingent Liabilities.
As part of our strategy, we expect to review opportunities to buy other businesses or technologies that would complement our current products, expand the breadth of our markets or enhance technical capabilities, or that may otherwise offer growth opportunities. In the event of any future acquisitions, we could:
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pay amounts of cash to acquire assets or businesses;
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issue stock that would dilute current stockholders’ percentage ownership;
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incur debt; or
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assume liabilities.
These purchases also involve numerous risks, including:
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problems combining the purchased operations, technologies or products or integration of new personnel;
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unanticipated costs;
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diversion of management’s attention from our core business;
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adverse effects on existing business relationships with suppliers and customers;
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risks associated with entering markets in which we have no or limited prior experience; and
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potential loss of key employees of purchased organizations.
We cannot assure you that we will be able to successfully integrate any businesses, products, technologies or personnel that we might purchase in the future.
Our Charter Documents, Delaware Law and our Stockholder Rights Plan Contain Provisions That May Inhibit Potential Acquisition Bids, Which May Adversely Affect The Market Price of Our Common Stock, Discourage Merger Offers or Prevent Changes in Our Management.
Our board of directors has the authority to issue up to 833,333 shares of preferred stock and to determine the rights, preferences, privileges and restrictions, including voting rights, of the shares without any further vote or action by our stockholders. If we issue any of these shares of preferred stock in the future, the rights of holders of our common stock may be negatively affected. If we issue preferred stock, a change of control of our company could be delayed, deferred or prevented. We have no current plans to issue shares of preferred stock.
Section 203 of the Delaware General Corporation Law restricts certain business combinations with any interested stockholder as defined by that statute. In addition, our certificate of incorporation and bylaws contain
certain other provisions that may have the effect of delaying, deferring or preventing a change of control. These provisions include:
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the elimination of actions by written consent of stockholders; and
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the establishment of an advance notice procedure for stockholder proposals and director nominations to be acted upon at annual meetings of the stockholders.
In April 2004, our board of directors adopted a stockholder rights plan. Under this plan, we issued a dividend of one right for each share of our common stock. Each right initially entitles stockholders to purchase a fractional share of our preferred stock for $13.00. However, the rights are not immediately exercisable. If a person or group acquires, or announces a tender or exchange offer that would result in the acquisition of, a certain percentage of our common stock, unless the rights are redeemed by us for $0.001 per right, the rights will become exercisable by all rights holders, except the acquiring person or group, for shares of our preferred stock or the stock of the third party acquirer having a value of twice the right’s then-current exercise price.
These provisions are designed to encourage potential acquirers to negotiate with our board of directors and give our board of directors an opportunity to consider various alternatives to increase stockholder value. These provisions are also intended to discourage certain tactics that may be used in proxy contests. However, the potential issuance of preferred stock, our charter and bylaw provisions, the restrictions in Section 203 of the Delaware General Corporation Law and our stockholder rights plan could discourage potential acquisition proposals and could delay or prevent a change in control, which may adversely affect the market price of our stock. These provisions and plans may also have the effect of preventing changes in our management.
Item 2.
Item 2. Properties
Our principal executive and administrative offices are located in approximately 25,000 square feet of office space in Oakland, California, and we have subleased approximately 13,000 square feet of this space. Our lease expires in August 2010 and our sublease expires in October 2005. Our monthly net lease payments on the Oakland facility are approximately $30,000. We also maintain leased offices or “executive suites” in Redwood City, Hamburg, Neuss (Germany), London, Bedford (Canada) and Melbourne.
Item 3.
Item 3. Legal Proceedings
Securities Class Action and State Derivative Actions
On February 14, 2003, the United States District Court for the Northern District of California issued Orders of Final Approval of the Settlements of the consolidated securities class action and the consolidated derivative action that were all initially filed in 2001. Pursuant to the terms of the settlement, Versata’s directors and officers insurers paid $9.75 million, Versata issued 200,000 shares of common stock and implemented certain corporate therapeutics. The shares of common stock have a $3.50 per share put option exercisable for 20 trading days commencing one year after distribution; however, the put shall expire should our stock trade above $3.50 per share for 15 trading days during the one year period following the distribution. Distribution of the settlement shares occurred on January 28, 2004. As of October 31, 2004 and 2003, we had accrued $660,000 and $700,000, respectively, for this liability in “accrued restructuring and other” in the accompanying financial statements.
Litigation and Other Claims
From time to time, we become subject to legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, we do not believe that the outcome of any of these legal matters will have a material adverse effect on our consolidated results of operations, financial position or cash flows.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a) Price Range of Common Stock
Our common stock is listed on the NASDAQ Small Cap Market under the symbol “VATA.” Public trading of our common stock commenced on March 3, 2000. Prior to that date, there was no public market for our common stock. The following table sets forth, for the periods indicated, the high and low sale price per share of our common stock. We implemented a one-for-six reverse stock split on May 24, 2002. All prices below have been adjusted for the reverse split.
We believe that a number of factors may cause the market price of our common stock to fluctuate. See “Item 1. Business-Risk Factors That May Affect Future Results”. As of January 10, 2005, there were 1,750 holders of record of our common stock.
We have never paid or declared any cash dividends on our common stock or other securities and do not anticipate paying cash dividends in the foreseeable future. We currently intend to retain all future earnings, if any, for use in the operations of our business.
(b) Use of Proceeds from Sales of Registered Securities
On March 2, 2000 the Securities and Exchange Commission declared effective our Registration Statement on Form S-1 (File No. 333-92451) relating to our initial public offering of our common stock. The 737,917 shares offered by us under the Registration Statement were sold at a price of $144.00 per share. The aggregate proceeds to the Company from the offering were $97.1 million after deducting the underwriting discounts and commissions of $7.4 million and expenses incurred in connection with the offering of approximately $1.7 million. The Company closed its initial public offering on March 8, 2000.
Versata invested the net proceeds from its initial public offering in interest-bearing investment-grade instruments. The net proceeds generated from the offering have been used primarily to fund the Company’s working capital, capital expenditures and general corporate needs. In addition, the Company paid approximately $1.2 million in connection with the acquisition of Verve, Inc.
(c) Securities authorized for issuance under equity compensation plans.
(d) Recent Sales of Unregistered Securities
None.
Item 6.
Item 6. Selected Financial Data
(a) In December 2001, we changed our fiscal year-end from December 31 to October 31.
(b) Revenue decreased in fiscal years 2002 and 2003 due to decreased IT spending, overall economic and market conditions as well as our focus on expense management.
(c) Loss from operations for fiscal years 2004, 2003 and 2002 includes restructuring and other related expenses of $1.6 million, $3.7 million and $1.9 million, respectively.
(d) Loss from operations for the ten months ended October 31, 2001 reflects restructuring and other expenses of $19.7 million and an intangible and goodwill impairment charge of $4.1 million.
(e) Working capital and total long-term liabilities as of October 31, 2001 reflect $2.4 million of deferred revenue reclassified from current liabilities to long-term liabilities.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Overview
From our incorporation in August 1991 through December 1994, we were a professional services company and generated revenue from technical consulting projects. In January 1995, we commenced development efforts on our initial software products, which we generated revenue from in late 1995 through early 1998. In September 1996, we began development of our first Web-based software product, which we began shipping commercially in September 1997. In September 1998, we introduced the first generation of what is now our suite of software products.
On December 31, 2001, Versata announced a change in its fiscal year end from December 31 to October 31. The change was effective for the ten-month period ended October 31, 2001.
In July 2004, Versata decided to expand its research and development resources in Halifax, Nova Scotia and to end its relationship with Virtusa. The Company retained Virtusa, which has advanced technology centers in India and Sri Lanka, in 2003 to provide engineering services including platform port development, quality assurance, and maintenance. One reason the Company decided on this course of action was to take advantage of several tax incentives offered by the Canadian government. These incentives make this approach economically competitive to alternative offshore options.
We derive our revenue from the sale of software product licenses and from related services. Our software is generally priced on a per central processing unit (“CPU”) basis. Sales of software licenses typically include revenue associated with product maintenance which provides the customer with unspecified software upgrades over a specified term, typically one year. Maintenance and support revenue consists of fees relating to the provision of customer support as well as product updates and upgrades. Professional services revenue includes technical consulting, training, mentoring, staff augmentation and project management or rapid requirements development to complete turnkey solution services. Customers typically purchase professional services from us for specialized training and mentoring activities directed at optimizing the customer’s use of our software products. Professional services are generally sold on a time-and-materials basis. Maintenance and customer support is priced based on the particular level of support chosen by the customer and the number of CPU’s in operation.
Versata markets its products primarily through a direct sales force in North America and in Europe. The Company’s internal team is supported by a network of consulting and systems integration partners, companies selling pre-packaged software applications, and companies selling software applications over the Internet on a subscription basis.
Our revenues to date have been derived predominantly from customers in North America. Net revenues from international sales represented 41%, 27%, and 23%, of our total revenue for the years ended October 31, 2004, 2003, and 2002.
Our cost of software license revenue consists of royalty payments to third parties for technology incorporated into our products and electronic delivery costs. Our cost of maintenance and support revenue consists of salaries, other employee related costs and general office costs incurred in providing customer maintenance and support. Our cost of professional services revenue consists of salaries and other employee related costs, travel, and payments to third party consultants incurred in providing training, and consulting services. Cost of professional services revenue as a percentage of professional services revenue is likely to vary significantly from period to period depending on overall utilization rates, the mix of services we provide and whether these services are provided by us or by third-party contractors.
Since our inception, we have incurred substantial costs to develop and support our technology and products, to recruit and train personnel for our product development, sales and marketing and professional services departments, and to establish our administrative infrastructure. To date, all software development costs have been expensed in the period incurred as such costs have not met the criteria for capitalization under Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed (“SFAS 86”). Historically, our operating expenses have exceeded the revenue generated by our products and services. As a result, we have incurred net losses in each quarter since inception and had an accumulated deficit of $210.9 million as of October 31, 2004 and $206.1 million as of October 31, 2003.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following are critical accounting policies and estimates used in the preparation of our consolidated financial statements:
Revenue Recognition
We derive revenue from three sources as follows: (i) sale of software licenses to end users, value added resellers (“VAR’s”), distributors, system integrators and independent software vendors (“ISV’s”); (ii) maintenance and support which consist of post-contract customer support (“PCS”); and (iii) professional services which include consulting and training. We recognize revenue in accordance with the American Institute of Certified Public Accountants (“AICPA”) Statement of Position 97-2, Software Revenue Recognition (“SOP 97-2”), as amended. Under SOP 97-2, we record revenue from licensing of software products to end-users and system integrators, who use our software to build systems for their customers, when both parties sign a license agreement, the fee is fixed or determinable, collection is reasonably assured and delivery of the product has occurred. For VAR’s and distributors, we recognize revenue upon notification of sell-through, provided all other revenue recognition criteria are met. For sales to certain ISV’s, where we receive non-refundable royalty payments, we defer the fair value of PCS related to the arrangement and recognize the remainder as license revenue, when paid, provided all other revenue recognition criteria are met. Generally, we provide payment terms that range from thirty to ninety days from the invoice date. Accordingly, payment terms that exceed ninety days are not considered fixed or determinable and revenue is recognized as payments become due. When contracts contain multiple elements, and for which vendor specific objective evidence (“VSOE”) of fair value exists for the undelivered elements, we recognize revenue for the delivered elements based upon the residual method. VSOE is generally the price for products sold separately or the renewal rate in the agreement for PCS. Undelivered elements consist primarily of PCS and other services such as consulting, mentoring and training. Services are generally not considered essential to the functionality of the software. We recognize revenue allocated to PCS ratably over the period of the contracts, which is generally twelve months. For revenue related to consulting services, we recognize revenue as the related services are performed. In instances where services are deemed essential to the software, both the software license fee and consulting fees are recognized using the percentage-of-completion method of contract accounting. The portion of fees related to either products delivered or services rendered which are not due under our Company’s standard payment terms are reflected in deferred revenue and in unbilled receivables.
Significant management judgments and estimates must be made in connection with determination of the revenue to be recognized in any accounting period. If we made different judgments or utilized different estimates for any period, material differences in the amount and timing of revenue recognized could result.
Determining Functional Currencies for the Purpose of Consolidation
We have several foreign subsidiaries, which together account for approximately 41% of our net revenues for the year ended October 31, 2004, and 11% of our assets and 38% of our total liabilities as of October 31, 2004.
In preparing our consolidated financial statements, we are required to translate the financial statements of the foreign subsidiaries from the currency in which they keep their accounting records, generally the local currency, into United States dollars. This process results in exchange gains and losses which, under the relevant accounting guidance, are either included within the statement of operations or as a separate part of our stockholders’ equity under the caption “cumulative translation adjustment.”
If any subsidiary’s functional currency is deemed to be the local currency, then any gain or loss associated with the translation of that subsidiary’s financial statements is included in cumulative translation adjustments. If we dispose of any of our subsidiaries, any cumulative translation gains or losses would be realized in our statement of operations. If we determine that there has been a change in the functional currency of a subsidiary to the United States dollar, any translation gains or losses arising after the date of change would be included within our statement of operations.
The magnitude of these gains or losses is dependent upon movements in the exchange rates of the foreign currencies in which we transact business against the United States dollar. These currencies include the United Kingdom Pound Sterling, the Euro, the Indian Rupee, and Australian and Canadian dollars. Any future translation gains or losses could be significantly higher than those noted in each of these periods. In addition, if we determine that a change in the functional currency of one of our subsidiaries has occurred at any point in time, we would be required to include any translation gains or losses from the date of change in our statement of operations.
Allowance for Doubtful Accounts
We make judgments as to our ability to collect outstanding receivables and provide allowances for the portion of receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding invoices. For those invoices not specifically reviewed, provisions are provided at differing rates, based upon the age of the receivable. In determining these percentages, we analyze our historical collection experience and current economic trends. If the historical data we use to calculate the allowance provided for doubtful accounts does not reflect the future ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed and the future results of operations could be materially affected.
Stock-based Compensation
Versata currently accounts for stock-based employee compensation arrangements using the intrinsic value method in accordance with provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and Financial Accounting Standards Board Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans (“FIN 28”), and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). Under APB 25, compensation expense is based on the difference, if any, on the date of grant, between the fair value of our Company’s common stock and the exercise price. SFAS 123 defines a “fair value” based method of accounting for an employee stock option or similar equity investment. Our Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS 123 and Financial Accounting Standards Board Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services (“EITF 96-18”).
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, Share-based Payment (“SFAS 123R”). SFAS 123R revises SFAS 123 and supersedes APB 25. SFAS 123R applies to transactions in which an entity exchanges its equity instruments for goods or services and also applies to liabilities an entity may incur for goods or services that are based on the fair value of those equity instruments. Under SFAS 123R, the Company will be required to follow a fair value approach using an option-pricing model, such as the Black-Scholes option valuation model, at the date of a stock option grant. The deferred compensation calculated under the fair value method would then be amortized over the respective vesting period of the stock option. We will adopt the provisions of SFAS 123R during our 2005
fiscal year. The adoption of SFAS 123R is expected to have a material impact on our results of operations. Information concerning the impact on our operating results of using SFAS 123R is included in Note 3 of the “Notes to Consolidated Financial Statements”.
Results of Operations
The following table sets forth, for the periods indicated, certain items from the consolidated statements of operations of Versata expressed as a percentage of total revenues:
Year Ended October 31, 2004 Compared to Year Ended October 31, 2003
Revenue
Total Revenue. Total revenue consists of software license revenue, maintenance and support, and professional services revenue. Total revenue in 2004 increased marginally from 2003, by $66,000, to $15.3 million with only minor changes in the revenue components between both fiscal years. Total revenue in Europe increased by 52% in 2004 while total revenue in North America decreased by 19%.
Software License Revenue. Software license revenue in 2004 increased slightly from 2003 by $6,000 to $5.9 million. License revenue in 2004 was $2.9 million in both Europe and North America. In comparison, for 2003, North America accounted for 84% of license revenue while Europe accounted for 16% of license revenue. The increase in European license revenue for 2004 was driven by a large contract with a new customer in Germany. License revenue accounted for 38% of total revenues in both 2004 and 2003.
Maintenance and Support Revenue. Maintenance and support revenue consists of revenue associated with providing customer support and product upgrades and updates. These revenues are derived from new
maintenance and support contracts and the renewal of existing maintenance and support contracts. Such revenue is recognized ratably, usually over one-year time periods. Maintenance and support revenue increased by $111,000, or 2%, from $5.8 million in 2003 to $5.9 million in 2004. Maintenance and support revenue in 2004, as compared to 2003, decreased by 6% in North America and increased by 19% in Europe. The increased maintenance and support revenue in Europe reflects the increased license revenue sales for that region in 2004. Maintenance and support revenue accounted for 39% of total revenues in 2004 and 38% in 2003.
Professional Services Revenue. Professional services revenue consists of revenue associated with providing technical consulting and training services as well as reimbursable expenses. Professional services revenue decreased by $51,000 or 1% from $3.6 million in 2003 to $3.5 million in 2004. Professional services revenue in 2004 as compared to 2003 increased by 6% in North America and decreased by 14% in Europe. The increase in North America was driven by a large consulting assignment with a state governmental entity. Professional services revenue accounted for 23% of total revenues in 2004 and 24% in 2003.
Geographic information
Following is a summary of revenue by major geographic region (in thousands):
Cost of Revenue
Total Cost of Revenue. Total cost of revenue consists of cost of software license revenue, cost of maintenance and support revenue and cost of professional services revenue. Total cost of revenue decreased by $163,000 or 3% from $5.2 million in 2003 to $5.1 million in 2004. The decrease in total cost of revenue primarily reflects a reduction in the cost of software license revenue in 2004, as compared to 2003.
Cost of Software License Revenue. Cost of software license revenue consists of royalty payments to third parties for technologies incorporated into our products, as well as electronic distribution costs. Cost of software license revenue decreased by $113,000 or 52% from $218,000 in 2003 to $105,000 in 2004. Third party royalties decreased by $174,000 or 81% in 2004. This was principally related a change in the estimate for accrued royalties from a prior year.
Cost of Maintenance and Support Revenue. Cost of maintenance and support revenue consists of salaries, other employee related costs and general office costs incurred in providing customer maintenance and support.
Cost of maintenance and support revenue was $1.6 million in both 2004 and 2003. For 2004, as compared to 2003, the Company experienced a decrease in employee related costs offset by an increase in travel expense. The number of employees decreased from 13 at the beginning of fiscal 2004 to 10 at the end of fiscal 2004.
Cost of Professional Services Revenue. Cost of professional services revenue consists of salaries and other employee related costs, travel, and payments to third party consultants incurred in providing consulting and training services. Cost of professional services revenue was constant at $3.4 million in both 2004 and 2003. For 2004, as compared to 2003, the Company experienced an increase in personnel related costs offset by decreases in training costs and reimbursable expenses. The number of employees decreased from 19 at the beginning of fiscal 2004 to 14 at the end of fiscal 2004.
Gross Profit and Gross Margin
Gross Profit. Gross profit increased by $229,000 or 2% from $10.0 million in 2003 to $10.3 million in 2004. This increase was principally related to lower cost of software license revenue as well as a slight increase in total revenue. Maintenance and support and software license revenues experienced a gross profit increase of approximately $179,000 and $119,000, respectively for the year ended October 31, 2004, as compared to the year ended October 31, 2003.
Gross Margin.
Following is a summary of gross margins by revenue type:
Gross margin increased slightly to 67% for the year ended October 31, 2004 from 66% for the year ended October 31, 2003. The total gross margin increase was related to higher revenue and lower costs for both software license and maintenance and support for the year ended October 31, 2004, as compared to the year ended October 31, 2003. These increases were offset by slightly lower revenue and higher costs within professional services for the year ended October 31, 2004, as compared to the year ended October 31, 2003.
Operating Expenses
Following is a summary of operating expenses (in thousands):
(1) Excluding stock-based compensation. See Note 9 of the Notes to Consolidated Financial Statements for additional information.
Operating Expenses. Operating expenses decreased by $5.8 million or 28% from $20.9 million in 2003 to $15.0 million in 2004. The majority of the expense reductions in 2004 related to restructuring, product development, and stock-based compensation. As a percentage of revenue, operating costs decreased to 98% in 2004, compared to 137% in 2003.
Sales and Marketing. Sales and marketing expenses consist of salaries, commissions, travel and entertainment expense and marketing programs. Sales and marketing expenses increased by $155,000 or 3% from $5.6 million in 2003 to $5.7 million in 2004. This increase was primarily attributable to higher commissions and marketing program costs offset by lower personnel related costs and partner commissions. The number of employees decreased from 27 at the beginning of fiscal 2004 to 17 at the end of fiscal 2004.
Product Development. Product development expenses include costs associated with the development of new products, enhancements to existing products, quality assurance and technical publication activities. These costs consist primarily of employee salaries and the cost of consulting resources that supplement our product development teams. Product development expense decreased by $1.2 million or 23% from $5.3 million in 2003 to $4.1 million in 2004. This decrease was principally related to lower personnel related costs offset by an increase in consulting costs. This decrease reflects the cost savings achieved from our consulting relationship with Virtusa in 2004. The number of employees decreased from 34 at the beginning of fiscal 2004 to 15 at the end of fiscal 2004.
General and Administrative. General and administrative expenses consist of salaries for executive, finance and administrative personnel, information systems costs and allowance for doubtful accounts. General and administrative expenses decreased by $119,000 or 3% from $3.4 million in 2003 to $3.3 million in 2004. This decrease was primarily attributable to reductions in personnel related expenses and allocated IT costs, offset by increases in consulting expense and bad debt provisions. We expect general and administrative expense to increase in fiscal 2005 as we incur additional costs relating to compliance with Sarbanes Oxley Act of 2002. The number of employees decreased from 16 at the beginning of fiscal 2004 to 15 at the end of fiscal 2004.
Stock-Based Compensation. Stock-based compensation expense includes the amortization of earned and unearned employee stock-based compensation and expenses for stock granted to consultants in exchange for services. Unearned employee stock-based compensation expenses are amortized on an accelerated basis over the vesting period of the related options, generally 50 months. Earned employee stock-based compensation is expensed at the time the stock is issued. We incurred a non-cash charge for stock-based compensation of $372,000 in 2004, compared to $856,000 in 2003. This decrease relates to the cancellation of unvested options for terminated employees as well as generally lower employee headcount in 2004. Stock-based compensation expense paid to employees decreased by $275,000 or 48% from $571,000 in 2003 to $296,000 in 2004. This decrease reflects our lower staff levels and the commensurate reduction in both common stock and stock option awards. As of October 31, 2004 the Company had no unamortized stock-based compensation on its balance sheet.
Amortization of Intangibles. We incurred non-cash charges of $2,000 in 2004 for the amortization of intangibles, as compared to $2.0 million incurred in 2003. As of October 31, 2004 the Company had no unamortized intangibles on its balance sheet.
Restructuring and Other Expenses. Restructuring and other expenses consist primarily of expenses relating to excess office facilities, and reductions in personnel. We incurred restructuring and other expenses of $1.6 million in 2004 and $3.7 million in 2003, a decrease of 58%. This decrease related principally to the reversal of reserves recorded in 2003 pertaining to excess office space within our Oakland, California headquarters. The decrease was offset by accelerated depreciation charges and other expenses incurred in the renegotiation of the lease agreement for our Oakland headquarters. In March, 2004 we sold certain intangible assets of our French subsidiary to our German subsidiary for approximately $170,000. We recorded restructuring expenses of approximately $463,000 related to statutory severance payments, legal fees and other charges relating to the sale of the French subsidiary.
Interest Income, net. Interest income, net is primarily comprised of interest income from our cash balances and investments, offset by interest paid on our capital lease obligations. We had interest income, net of $156,000 in 2004, compared to $233,000 in 2003. This decrease was principally related to lower cash and investment balances.
Year Ended October 31, 2003 Compared to Year Ended October 31, 2002
Revenue
Total Revenue. Total revenue consists of software license revenue, maintenance and support, and professional services revenue. Total revenue decreased by $4.9 million or 24% from $20.2 million in 2002 to $15.3 million in 2003. This decrease was attributable to the continued decline in spending on new information technology (IT) infrastructure projects, general competitive pressures, and overall market and economic conditions. In addition, during fiscal 2003 management attention was largely focused on sales to existing customers and expense reductions, not on generating sales to new customers.
Software License Revenue. Software license revenue decreased by $800,000 or 12% from $6.6 million in 2002 to $5.8 million in 2003. Domestic operations accounted for 84% of license revenues in 2003 compared to 82% in 2002. As a percentage of total revenue, license revenues accounted for 38% of total revenues in 2003 compared to 33% in 2002. License sales slowed in fiscal 2003 as management worked on expense management and improving satisfaction within our existing customer base. In addition, license sales suffered from a general decline in spending on large-scale IT infrastructure projects and general competitive pressures.
Maintenance and Support Revenue. Maintenance and support revenue consists of revenue associated with providing customer support and product upgrades and updates. Maintenance and support revenue was $5.8 million for both 2002 and 2003. These revenues are derived from new maintenance and support contracts and the renewal of existing maintenance and support contracts. Such revenue is recognized ratably over time periods of at least one year and therefore tends to result in more stable revenue amounts from year-to-year. Maintenance and support revenue was essentially the same for both our domestic and international operations in 2002 and 2003. Maintenance and support revenue accounted for 38% of total revenues in 2003 and 29% in 2002.
Professional Services Revenue. Professional services revenue consists of revenue associated with providing technical consulting and training services. Professional services revenue decreased by $4.2 million or 54% from $7.8 million in 2002 to $3.6 million in 2003. Professional services revenue accounted for 24% of total revenues in 2003 and 39% in 2002. This decrease was related to our customers increasing use of in-house project management, our focus on sales to existing customers, and general competitive pressures.
Geographic information
Following is a summary of revenue by major geographic region (in thousands):
Cost of Revenue
Total Cost of Revenue. Total cost of revenue consists of cost of software license revenue, cost of maintenance and support revenue and cost of professional service revenue. Total cost of revenue decreased by $2.7 million or 34% from $7.9 million in 2002 to $5.2 million in 2003. This decrease in cost of revenue primarily reflects the reduction in cost of professional services revenue in 2003 as compared to 2002.
Cost of Software License Revenue. Cost of software license revenue consists of royalty payments to third parties for technology incorporated into our product, as well as electronic distribution costs. Cost of software license revenue remained constant at approximately $200,000 in 2002 and 2003. Third party royalties increased slightly in 2003 offsetting a marginal decrease in costs of packaging and distribution.
Cost of Maintenance and Support Revenue. Cost of maintenance and support revenue consists of salaries, other employee related costs and general office costs incurred in providing customer maintenance. Cost of maintenance and support revenue increased by $183,000 or 13% from $1.5 million in 2002 to $1.6 million in 2003. This increase was principally related to increased salaries and other employee related expenses.
Cost of Professional Services Revenue. Cost of professional services revenue consists of salaries and other employee related costs, travel, and payments to third party consultants incurred in providing training, and consulting services. Cost of professional services revenue decreased by $2.9 million or 46% from $6.3 million in 2002 to $3.4 million in 2003. This decrease was principally related to decreased salaries and other employee related expenses as well as third-party professional consulting fees. The number of employees decreased by 26 from 45 at the beginning of 2002 to 19 at the end of 2003.
Gross Profit and Gross Margin
Gross Profit. Gross profit decreased by $2.2 million or 18% from $12.2 million in 2002 to $10.0 million in 2003. This decrease was driven by lower revenues for both software license and professional services as well as significantly lower cost of revenue within professional services.
Gross Margin.
Following is a summary of gross margins by revenue type:
Gross margin increased to 66% for the year ended October 31, 2003 from 61% for the year ended October 31, 2002. The total gross margin increase reflected a 24% decrease in total revenue offset by a 34% decrease in total cost of revenue for the year ended October 31, 2003, as compared to the year ended October 31, 2002. The most significant revenue and cost of revenue movements between the years ended October 31, 2004 and 2003 related to professional services where revenue and cost of revenue were reduced by 54% and 46%, respectively.
Operating Expenses
Following is a summary of operating expenses (in thousands):
(1) Excluding stock-based compensation. See Note 9 of the Notes to Consolidated Financial Statements for additional information.
Operating Expenses. Operating expenses decreased by $2.8 million or 12% from $23.7 million in 2002 to $20.9 million in 2003. The majority of expense reductions related to sales and marketing and general and administrative costs, offset by increased restructuring costs. As a percentage of revenue, operating costs increased to 137% in 2003 compared to 118% in 2002, reflecting the lower revenues in 2003.
Sales and Marketing. Sales and marketing expenses consist of salaries, commissions, sales offices, travel and entertainment expense and marketing programs. Sales and marketing expenses decreased by $3.1 million or 36% from $8.7 million in 2002 to $5.6 million in 2003. This decrease was primarily attributable to reductions in personnel and related expenses, marketing program costs, commissions and travel and entertainment expenses. The number of employees decreased by 24 from 51 at the beginning of 2002 to 27 at the end of 2003.
Product Development. Product development expenses include costs associated with the development of new products, enhancements to existing products, quality assurance and technical publication activities. These costs consist primarily of employee salaries and the cost of consulting resources that supplement our product development teams. Product development expense decreased by $200,000 or 4% from $5.5 million in 2002 to $5.3 million in 2003. Employee costs were similar in both years reflecting the reductions in staff made in the first two quarters for fiscal 2002. The number of employees decreased by 18 from 52 at the beginning of 2002 to 34 at the end of 2003.
General and Administrative. General and administrative expenses consist of salaries for executive, finance and administrative personnel, information systems costs and allowance for doubtful accounts. General and administrative expenses decreased by $1.2 million or 26% from $4.6 million in 2002 to $3.4 million in 2003. This decrease was primarily attributable to reductions in accounting and legal expenses, bad debt provisions, and reduction in personnel and related expenses. The number of employees decreased by 12 from 28 at the beginning of 2002 to 16 at the end of 2003.
Stock-Based Compensation. Stock-based compensation expense includes the amortization of earned and unearned employee stock-based compensation and expenses for stock granted to consultants in exchange for services. Unearned employee stock-based compensation expenses are amortized on an accelerated basis over the vesting period of the related options, generally 50 months. Earned employee stock-based compensation is expensed at the time the stock is issued. We incurred a non-cash charge of $856,000 in 2003 as compared to $1.0 million in 2002. The decrease relates primarily to the cancellation of unvested options for terminated employees, offset by earned stock-based compensation expense of $571,000 in 2003. As of October 31, 2003 unamortized stock-based compensation totaled $45,000. This expense will be incurred in the year ending October 31, 2004 subject to any unvested option cancellations for future employee terminations.
Amortization of Intangibles. We incurred non-cash charges of $2.0 million in 2003 and 2002 for the amortization of intangibles. As of October 31, 2003 the unamortized balance of intangibles totaled $2,000. This balance will be amortized in the year ending October 31, 2004.
Restructuring and Other Expenses. Restructuring and other expenses consist primarily of expenses relating to excess office facilities, and reductions in personnel. We incurred restructuring and other expenses of $3.7 million in 2003 and $1.9 million in 2002. This increase related principally to the provision of reserves on our leased premises in Oakland, California.
Interest Income, net. Interest income, net is primarily comprised of interest income from our cash balances and investments, offset by interest paid on equipment loan and capital lease obligations. We had interest income, net of $233,000 in 2003, compared to interest income, net of $420,000 in 2002. This decrease was principally related to lower cash and investment balances and a general reduction in interest rates.
Liquidity and Capital Resources
Since inception, we have funded our operations primarily through the private sale of our equity securities, and our initial public offering, resulting in the aggregate, net proceeds of approximately $167.2 million. We have also funded our operations through equipment financing. As of October 31, 2004, we had $9.8 million in cash and cash equivalents and short-term investments, $5.1 million in working capital and no loan balances outstanding. Of the $9.8 million in cash and cash equivalents and short-term investments, approximately $586,000 was located within accounts maintained by our international subsidiary companies.
Net cash used in operating activities was $7.5 million, $2.8 million, and $9.2 million for the years ended October 31, 2004, 2003, and 2002, respectively. Net cash used in operating activities in each period reflects net losses, offset by changes in working capital and non-cash expenses including depreciation and amortization, stock-based compensation and restructuring accruals. For the year ended October 31, 2004, operating cash flows related to accrued restructuring and other included the payment of $4.2 million in restricted cash to the landlord of our Oakland, California headquarters as part of an office lease amendment executed on March 10, 2004. Depreciation and amortization charges declined to $1.4 million in 2004, from $3.8 million in 2003 and $4.3 million in 2002. This decline principally reflects lower expenditures on fixed assets and intangibles in these periods and the write-off of fixed assets no longer in service.
Net cash provided by investing activities was $4.8 million for the year ended October 31, 2004. Net cash used in investing activities was $942,000 for the year ended, October 31, 2003, and $1.2 million for the year ended October 31, 2002. Cash provided by investing activities during the year ended October 31, 2004 primarily reflects the release of $4.2 million in restricted cash as part of an office lease amendment for our Oakland, California headquarters, as well as the net proceeds from the sale of short-term investments offset by purchases of property and equipment. Net cash used in investing activities during the years ended October 31, 2003 and October 31, 2002 primarily reflects the purchase of short-term investments offset by the proceeds from the sale of short-term investments and a decrease in restricted cash balances.
Net cash used in financing activities was zero for the year ended October 31, 2004 as the net proceeds from the exercise of stock options were offset by the principal payments on capital lease obligations. Net cash used in financing activities was $102,000 for the year ended October 31, 2003. This primarily reflects principal payments made on capital leases, offset by the proceeds of option and warrant exercises. Net cash provided by financing activities was $749,000 for the year ended October 31, 2002 and included $977,000 of proceeds from the sale of common stock to former officers, offset by principal payments made on capital leases.
We believe our cash, cash equivalents and short-term investments as of October 31, 2004 will be sufficient to meet our general expenses, working capital and capital expenditure requirements for at least the next year. To further ensure we have sufficient working capital resources, we executed a loan agreement with Venture Banking Group on December 20, 2004 whereby the Company may borrow up to $1.0 million under a revolving credit
facility. We also entered into several capital equipment leases in the year ended October 31, 2004 with terms
ranging from 12 to 36 months. The total value of the equipment leased was $151,000 and the amount owed under the leasing arrangements was $123,000, as of October 31, 2004.
Our Company has entered into leases for certain office space with original terms ranging from 6 months to the year 2010. The lease for office space at our principal executive and administrative offices in Oakland, California, includes scheduled base rent increases over the term of the lease. In addition, this lease contains an escalation clause to recover increases in future operating costs and real estate taxes over the base year. We also entered into a sub-lease agreement for certain office space located within our Oakland, California headquarters. This sub-lease was recently extended to October 31, 2005. The future minimum lease payments shown below include both gross and net lease commitments, inclusive of escalations.
Future minimum lease payments under all non-cancelable operating leases at October 31, 2004 are as follows (in thousands):
The company has no off-balance sheet arrangements and has not utilized any variable interest entities for the years ended October 31, 2004, 2003 and 2002.
Contingencies
The Company accounts for contingencies in accordance with Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (“SFAS 5”). SFAS 5 requires that the Company record an estimated loss from a loss contingency when information available prior to issuance of the Company’s financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated. Accounting for contingencies such as legal matters requires significant judgment. Many of these legal matters can take years to resolve. Generally, as the time period increases over which the uncertainties are resolved, the likelihood of changes to the estimate of the ultimate outcome increases. Management believes that the accruals for loss contingencies are adequate.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to a variety of risks including changes in foreign currency fluctuations and interest rates. In the normal course of business, we establish policies and procedures to manage our exposure to fluctuations in interest rates.
Foreign Currency Risks. As of October 31, 2004, Versata had operating subsidiaries located in the United Kingdom, Germany, Canada, and Australia. Our revenue outside North America was 41% for the year ended October 31, 2004. International sales were made from the Company’s foreign sales subsidiaries and were denominated in the local currency of each country. Our subsidiaries incur their expenses in the local currency. Accordingly, foreign subsidiaries use the local currency as their functional currency.
The Company’s international business is subject to risks typical of an international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange volatility. Accordingly, the Company’s future results could be materially adversely impacted by changes in these or other factors.
The Company is also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall financial results. Due to the materiality and nature of our international operations we do not currently enter into foreign currency hedge transactions. A uniform 10% change in foreign exchange rates for the year ended October 31, 2004 would have changed the Company’s net loss by approximately $84,000.
Interest Rate Risks. We invest our cash in a variety of financial instruments, consisting principally of investments in commercial paper, interest-bearing demand deposit accounts with financial institutions, money market funds and highly liquid debt securities of corporations, municipalities and the U.S. Government. These investments are denominated in U.S. dollars. Cash balances in foreign currencies overseas are operating balances and are invested in short-term time deposits of the local operating bank.
All of the cash equivalents, short-term and long-term investments are treated as “available-for-sale.” Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have seen a decline in market value due to changes in interest rates. However, the Company reduces its interest rate risk by investing its cash in instruments with short maturities.
The table below presents the principal amount and related weighted average interest rates for our investment portfolio. Short-term investments are all in fixed rate instruments.
Table of investment securities at October 31, 2004 (in thousands):
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, Share-based Payment (“SFAS 123R”). SFAS 123R revises SFAS 123 and supersedes APB 25. SFAS 123R applies to transactions in which an entity exchanges its equity instruments for goods or services and also applies to liabilities an entity may incur for goods or services that are based on the fair value of those equity instruments. Under SFAS 123R, the Company will be required to follow a fair value approach using an option-pricing model, such as the Black-Scholes option valuation model, at the date of a stock option grant. The deferred compensation calculated under the fair value method would then be amortized over the respective vesting period of the stock option. We will adopt the provisions of SFAS 123R during our 2005 fiscal year. The adoption of SFAS 123R is expected to have a material impact on our results of operations. Information concerning the impact on our operating results of using SFAS 123R is included in Note 3 of the “Notes to Consolidated Financial Statements”.
Item 8.
Item 8. Financial Statements and Supplementary Data
Our consolidated financial statements are located on the pages below.
Page
Report of Independent Registered Public Accounting Firm-Grant Thornton, LLP
Report of Independent Registered Public Accounting Firm-PricewaterhouseCoopers LLP
Consolidated Balance Sheets
Consolidated Statements of Operations and Comprehensive Loss
Consolidated Statement of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Schedule II-Valuation and Qualifying Accounts
SCH-I
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Effective February 11, 2003, we elected to change our certifying accountant as follows:
(i) We dismissed PricewaterhouseCoopers LLP as our independent registered public accounting firm.
(ii) The report of PricewaterhouseCoopers LLP on our consolidated financial statements for the fiscal year ended October 31, 2002 did not contain an adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope, or accounting principles.
(iii) The decision to dismiss PricewaterhouseCoopers LLP as our independent registered public accounting firm was approved by the audit committee of our board of directors.
(iv) In connection with the audit of our financial statements for the fiscal year ended October 31, 2002 and the subsequent interim periods, preceding the dismissal, we had no disagreements with PricewaterhouseCoopers LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of PricewaterhouseCoopers LLP, would have caused them to make reference to the subject mater of the disagreements in connection with its report. We requested PricewaterhouseCoopers LLP to furnish a letter addressed to the Securities and Exchange Commission as to whether it agrees with the above statements. A copy of that letter, dated February 13, 2003, is filed as Exhibit 16 to our report on Form 8-K filed with the Securities and Exchange Commission on February 18, 2003.
Effective February 11, 2003, we engaged Grant Thornton, LLP as our new independent auditors. The decision to engage Grant Thornton, LLP was approved by our audit committee.
There were no disagreements with our Independent Accountants during the last two fiscal years.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of disclosure controls and procedures. Based on the evaluation of our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15 (e) and 15d-15 (3) required by Securities Exchange Act Rules 13a-15 (b) or 15-d-15 (b), the Company’s Chief Executive Officer and Chief Financial Officer have concluded that as of the end of the period covered by this report the Company’s disclosure controls and procedures were effective.
Changes in internal controls. There were no changes in the Company’s internal controls over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Certain information required by Part III is omitted from this Form 10-K because the Company will file a definitive Proxy Statement pursuant to Regulation 14A (the “Proxy Statement”) not later than 120 days after the end of the fiscal year covered by this Form 10-K, and certain information to be included therein is incorporated herein by reference.
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information required by this Item is incorporated by reference from the Proxy Statement under the section captioned “Election of Directors.”
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated by reference from the Proxy Statement under the section captioned “Executive Compensation.”
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is incorporated by reference from the Proxy Statement under the section captioned “Security Ownership of Certain Beneficial Owners and Management.”
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by this Item is incorporated by reference from the Proxy Statement under the section captioned “Certain Relationships and Related Transactions.”
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated by reference from the Proxy Statement under the section captioned “Principal Accountant Fees and Services.”
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following documents are filed as a part of this Annual Report on Form 10-K:
1. Financial Statements.
The consolidated financial statements contained herein are as listed on the “Index” on page.
2. Financial Statement Schedule.
Reference is made to Schedule II.
3. Exhibits.
Reference is made to Item 15(b) of this Annual Report on Form 10-K.
(b) Exhibits.
Exhibits submitted with the Annual Report on Form 10-K as filed with the Securities and Exchange Commission and those incorporated by reference to other filings are listed on the Exhibit Index.
EXHIBIT INDEX
+ Specified portions of this agreement have been omitted and have been filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.
* Management contract or compensatory plan or arrangement.
** Previously filed.
(1) Incorporated by reference from the Company’s Form 8-K dated December 1, 2000.
(2) Incorporated by reference from the Company’s Registration Statement on Form S-1 (File No. 333-92451).
(3) Incorporated by reference from the Company’s Form 10-Q dated August 14, 2000.
(4) Incorporated by reference from the Company’s Form 10-Q dated September 24, 2000.
(5) Incorporated by reference from the Company’s Form 8-K dated April 9, 2004.
(6) Incorporated by reference from the Company’s Form 8-K dated December 22, 2004.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Versata, Inc. duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: January 28, 2005
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Alan Baratz and William Frederick, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitutes, may lawfully do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Page
Report of Independent Registered Public Accounting Firm-Grant Thornton, LLP
Report of Independent Registered Public Accounting Firm-PricewaterhouseCoopers LLP
Consolidated Balance Sheets
Consolidated Statements of Operations and Comprehensive Loss
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Schedule II-Valuation and Qualifying Accounts
SCH-I
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Versata, Inc.
We have audited the accompanying consolidated balance sheets of Versata, Inc. and subsidiaries (the “Company”) as of October 31, 2004 and 2003 and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Versata, Inc. and subsidiaries as of October 31, 2004 and 2003, and the consolidated results of their operations and their consolidated cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
We have also audited Schedule II for the years ended October 31, 2004 and 2003. In our opinion, this schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ GRANT THORNTON, LLP
Grant Thornton, LLP
San Jose, California
January 4, 2005 (except for Note 12, for which the date is January 19, 2005)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Versata, Inc.:
In our opinion, the consolidated statements of operations and comprehensive loss, of stockholders’ equity and of cash flows present fairly, in all material respects, the results of operations and cash flows of Versata, Inc and its subsidiaries for the year ended October 31, 2002, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for the year ended October 31, 2002 listed in the index appearing under Item 15(a) 2 on page 40 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. We conducted our audit of these statements in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
/s/ PRICEWATERHOUSECOOPERS LLP
San Jose, California
December 11, 2002
VERSATA, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
VERSATA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except per share data)
(1) Excludes stock-based compensation. See note 9 for additional information.
The accompanying notes are an integral part of these consolidated financial statements.
VERSATA, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
VERSATA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company
Versata, Inc. (Nasdaq: VATA), (“Versata” or the “Company”) was incorporated in California on August 27, 1991, and was reincorporated in the State of Delaware on February 24, 2000. Versata provides a way for companies to define and manage the business logic in their software systems at the business level rather than the system code level. This currently includes support for a company’s process and transaction business logic.
On May 17, 2002, Versata stockholders approved a reverse split of Versata’s common stock, and on May 24, 2002 the Company implemented a one for six reverse stock split. All shares and per share amounts in these consolidated financial statements have been restated to give effect to this reverse stock split. The number of common shares authorized decreased commensurately from 150.0 million to 25.0 million.
2. Basis of Presentation
The consolidated financial statements include the accounts of Versata and its subsidiaries, all of which are wholly owned and located in North America, Europe and Australia. All inter-company accounts and transactions have been eliminated in consolidation.
We have an accumulated deficit of $210.9 million as of October 31, 2004 and we have generated losses and negative cash flows from operating activities in current and prior periods. We may incur additional operating losses and negative cash flows in the future. Failure to generate sufficient revenue or reduce certain discretionary spending could have a material adverse affect on our ability to achieve our intended business objectives.
3. Summary of Significant Accounting Policies
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Estimates include, but are not limited to, the establishment of reserves for accounts receivable and restructuring, revenue recognition, the useful lives for property, equipment, and intangible assets, and stock-based compensation. Actual results could differ from those estimates.
Revenue recognition
We derive revenue from three sources as follows: (i) sale of software licenses to end users, value added resellers (“VAR’s”), distributors, system integrators and independent software vendors (“ISV’s”); (ii) maintenance and support which consist of post-contract customer support (“PCS”); and (iii) professional services which include consulting and training. We recognize revenue in accordance with the American Institute of Certified Public Accountants (“AICPA”) Statement of Position 97-2, Software Revenue Recognition (“SOP 97-2”), as amended. Under SOP 97-2, we record revenue from licensing of software products to end-users and system integrators, who use our software to build systems for their customers, when both parties sign a license agreement, the fee is fixed or determinable, collection is reasonably assured and delivery of the product has occurred. For VAR’s and distributors, we recognize revenue upon notification of sell-through, provided all other revenue recognition criteria are met. For sales to certain ISV’s, where we receive non-refundable royalty payments, we defer the fair value of PCS related to the arrangement and recognize the remainder as license revenue, when paid, provided all other revenue recognition criteria are met. Generally, we provide payment terms that range from thirty to ninety days from the invoice date. Accordingly, payment terms that exceed ninety days are not considered fixed or determinable and revenue is recognized as payments become
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
due. When contracts contain multiple elements, and for which vendor specific objective evidence (“VSOE”) of fair value exists for the undelivered elements, we recognize revenue for the delivered elements based upon the residual method. VSOE is generally the price for products sold separately or the renewal rate in the agreement for PCS. Undelivered elements consist primarily of PCS and other services such as consulting, mentoring and training. Services are generally not considered essential to the functionality of the software. We recognize revenue allocated to PCS ratably over the period of the contracts, which is generally twelve months. For revenue related to consulting services, we recognize revenue as the related services are performed. In instances where services are deemed essential to the software, both the software license fee and consulting fees are recognized using the percentage-of-completion method of contract accounting. The portion of fees related to either products delivered or services rendered which are not due under our Company’s standard payment terms are reflected in deferred revenue and in unbilled receivables.
Significant management judgments and estimates must be made in connection with determination of the revenue to be recognized in any accounting period. If we made different judgments or utilized different estimates for any period, material differences in the amount and timing of revenue recognized could result.
Cash and cash equivalents and short-term investments
We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Our short-term investments consist of debt securities with maturities greater than three months at the date of purchase and are carried at fair value as of the balance sheet date. Unrealized gains and losses are reported without adjustment for taxes as a component of stockholders’ equity. The cost of securities sold is based upon the specific identification method. At each period end presented, amortized cost approximated fair value and unrealized gross gains or losses were insignificant, and during each of the periods presented, realized gains were insignificant.
The portfolio of cash, cash equivalents and short-term investments consisted of the following (in thousands):
Fair value of financial instruments
The reported amounts of certain of our Company’s financial instruments including cash and cash equivalents and short-term investments, receivables, and accounts payable approximate fair value due to their short maturities.
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Concentration of credit risk
Financial instruments, which potentially subject our Company to concentrations of credit risk, consist primarily of cash, investments, certificates of deposit, money market accounts, and accounts receivable. Our Company places its cash investments with three major financial institutions. At October 31, 2004 and October 31, 2003 our Company had deposits in excess of federally insured limits of $100,000 totaling $9.5 million and $13.5 million, respectively.
The Company performs ongoing customer credit evaluations within the context of the industry in which it operates, does not require collateral, and maintains allowances for potential credit losses on customer accounts when deemed necessary. A specific bad debt reserve of up to 100% of the invoice value is provided for certain problematic customer balances. A general reserve is established for all other accounts based on the age of the invoices. Delinquent account balances are written-off after management has determined that the likelihood of collection is not probable.
One customer accounted for 14% of the total revenue generated for the year ended October 31, 2004. Two customers comprised 19% and 14%, respectively, of the total revenue generated for the year ended October 31, 2003.
Three customers accounted for approximately 59% of our net accounts receivable as of October 31, 2004 and two customers accounted for approximately 32% of our net accounts receivable as of October 31, 2003.
Property and equipment
Property and equipment is stated at cost and is depreciated using the straight-line method over the estimated useful lives of the related assets, which range from two to five years. Leasehold improvements are amortized on a straight-line basis over the life of the lease or the estimated useful life of the asset, whichever is shorter. Equipment under capital lease is amortized using the straight-line method over the lesser of the lease term or their estimated useful lives.
Major additions and improvements are capitalized, while replacements, maintenance, and repairs that do not improve or extend the life of the assets are charged to expense. In the period assets are retired or otherwise disposed of, the cost and related accumulated depreciation and amortization are removed from the accounts, and any gain or loss on disposal is included in results of operations.
Unbilled receivables
Fees from arrangements that provide for extended payment terms, and for which our Company does not have a sufficient history of collection are recognized as revenue when payments become due. The portion of fees related to either products delivered or services rendered which are not due under our Company’s standard payment terms are reflected in deferred revenue and in unbilled receivables until payments become due.
Stock-based Compensation
Versata currently accounts for stock-based employee compensation arrangements using the intrinsic value method in accordance with provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and Financial Accounting Standards Board Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans (“FIN 28”), and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). Under APB 25, compensation expense is based on the difference, if any, on the date of grant, between the fair value of our Company’s common stock and the exercise price. SFAS 123 defines a
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
“fair value” based method of accounting for an employee stock option or similar equity investment. Our Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS 123 and Financial Accounting Standards Board Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services (“EITF 96-18”).
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, Share-based Payment (“SFAS 123R”). SFAS 123R revises SFAS 123 and supersedes APB 25. SFAS 123R applies to transactions in which an entity exchanges its equity instruments for goods or services and also applies to liabilities an entity may incur for goods or services that are based on the fair value of those equity instruments. Under SFAS 123R, the Company will be required to follow a fair value approach using an option-pricing model, such as the Black-Scholes option valuation model, at the date of a stock option grant. The deferred compensation calculated under the fair value method would then be amortized over the respective vesting period of the stock option. We will adopt the provisions of SFAS 123R during our 2005 fiscal year. The adoption of SFAS 123R is expected to have a material impact on our results of operations. Information concerning the impact on our operating results of using SFAS 123R is included below.
Summarized below are the pro forma effects on net loss and net loss per share data, if the Company had elected to use the fair value approach prescribed by SFAS 123 to account for its employee stock-based compensation plans (in thousands, except per share data):
Software development costs
Software development costs are included in product development and are expensed as incurred. After technological feasibility is established, material software development costs are capitalized. The capitalized cost is then amortized on a straight-line basis over the estimated product life, or in the ratio of current revenues to total projected product revenues, whichever is greater. The Company has defined technological feasibility as the establishment of a working model, and typically occurs when the beta testing commences. To date, the period between achieving technological feasibility and the general availability of such software has been short and software development costs qualifying for capitalization have been insignificant. Accordingly, the Company has not capitalized any software development costs.
Foreign currency translation
Assets and liabilities of foreign operations where the functional currency is the local currency, are translated into U.S. dollars at the balance sheet date exchange rate. Revenues and expenses are translated at the average rate
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
prevailing during the period. The related gains and losses from translation are recorded as a translation adjustment in a separate component of stockholders’ equity. Foreign currency transaction gains and losses have been immaterial to date.
Comprehensive loss
Comprehensive loss consists of net loss, the net changes in foreign currency translation adjustment and the net unrealized gains and losses on available-for-sale securities.
Income taxes
Our Company has accounted for income taxes using an asset and liability approach which requires the recognition of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our Company’s financial statements or tax returns. The measurement of current and deferred tax liabilities and assets are based on provisions of the enacted tax law. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized.
Net loss per share
Basic and diluted net loss per share is computed by dividing the net loss available to holders of common stock for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net loss per share excludes potential common stock if their effect is antidilutive. Potential common stock consists of unvested restricted common stock, and incremental common or preferred shares issuable upon the exercise of stock options or warrants.
The following table sets forth the computation of basic and diluted net loss per share on post-split basis (in thousands, except per share data):
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table sets forth potential shares of common stock that are not included in the diluted net loss per share calculation above because to do so would be anti-dilutive for the periods (in thousands).
Segment information
We identify our operating segments based on business activities, management responsibility and geographical location. For all periods presented, we operated in a single business segment, primarily in North America. Revenue for geographic regions reported below is based upon either the customer’s location or the subsidiary performing the services. Following is a summary of the geographic information related to revenues (in thousands):
Long-lived assets, predominantly property and equipment, are based at various domestic and international locations. As of October 31, 2004, long-lived assets costing approximately $3.5 million were located in North America, $803,000 in Europe, and $141,000 were located elsewhere. As of October 31, 2003, approximately $7.2 million were located in North America, $909,000 in Europe, and $188,000 were located elsewhere.
Certain risks and uncertainties
The Company’s products are concentrated in the industry segment for internet infrastructure software that is characterized by rapid technological advances, changes in customer requirements and evolving regulatory
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
requirements and industry standards. These products depend in part on third-party technology that the Company licenses from a limited number of suppliers. Also, the Company has depended on a limited number of products for substantially all of its revenue to date. Failure by the Company to anticipate or to respond adequately to technological developments in its industry, changes in customer or supplier requirements or changes in regulatory requirements or industry standards, or any significant delays in the development or introduction of products or services, could have a material adverse effect on the Company’s business, cash flows and operations.
The Company generally grants its customer a warranty, which guarantees that the Company’s products will substantially conform to the Company’s current specifications as well as indemnification for customers from third party claims. Costs related to these guarantees and indemnifications have not been significant and the Company cannot reasonably estimate the potential impact of these guarantees and indemnifications on future results of operations.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, Share-based Payment (“SFAS 123R”). SFAS 123R revises SFAS 123 and supersedes APB 25. SFAS 123R applies to transactions in which an entity exchanges its equity instruments for goods or services and also applies to liabilities an entity may incur for goods or services that are based on the fair value of those equity instruments. Under SFAS 123R, the Company will be required to follow a fair value approach using an option-pricing model, such as the Black-Scholes option valuation model, at the date of a stock option grant. The deferred compensation calculated under the fair value method would then be amortized over the respective vesting period of the stock option. We will adopt the provisions of SFAS 123R during our 2005 fiscal year. The adoption of SFAS 123R is expected to have a material impact on our results of operations. Information concerning the impact on our operating results of using SFAS 123R is included above in this Note 3 of the “Notes to Consolidated Financial Statements”.
4. Balance Sheet Components (in thousands):
Accounts receivable, net
Property and equipment, net
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
During the fiscal years ended October 31, 2004, 2003 and 2002, certain property, leasehold improvements and equipment relating to subleased offices were disposed of as part of our restructuring efforts.
Intangibles, net
Intangible assets were amortized on a straight-line basis over the expected life of 3 years.
Accrued current liabilities
5. Restructuring and Other
During fiscal 2002, we eliminated 70 positions and expensed $1.9 million to restructuring and other as a result of the Company’s overall restructuring efforts.
In 2003 we provided for office closures and anticipated losses on subleases of approximately $3.7 million. In addition, we reduced 10 positions within the Company.
In 2004 we incurred restructuring expense of approximately $1.6 million. This expense was principally related to severance payments and associated costs of approximately $920,000, for both domestic and international personnel, and fixed asset write-offs, moving and other expenses of approximately $570,000 related to the relocation of our office headquarters in Oakland, California.
On March 10, 2004 the Company and its landlord executed an amendment to the lease agreement for the Company’s headquarter office space located in Oakland, California. This amendment reduced the Company’s future rent expense as well as reducing our physical space obligations from approximately 75,000 square feet to approximately 25,000 square feet. In addition, we agreed to extend the lease term by two additional years to August 31, 2010. As partial consideration for the amendment, Versata released to the landlord the sum of $4.2 million of the existing letter of credit which appeared as restricted cash on the Company’s balance sheet in the sum of $4.8 million, as of January 31, 2004. The payment of the amendment consideration was accomplished by the landlord’s draw of the entire amount of the letter of credit and the remainder, $608,000, was credited by
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
the landlord towards our rent obligations through October 31, 2004. In addition, Versata issued to the landlord warrants for 50,000 shares of common stock with a fair market value of $54,000, based upon the Black-Scholes option-pricing model.
In March, 2004 we sold certain intangible assets of our French subsidiary to our German subsidiary for approximately $170,000. We recorded restructuring expenses of approximately $463,000 related to statutory severance payments, legal fees and other charges relating to the sale of the French subsidiary.
On May 13, 2004 the Company entered into an extension of an existing sublease within its Oakland, California headquarters. Pursuant to the terms and conditions of the master lease amendment, and triggered by the sublease extension, the Company relocated to the space it is partially subleasing within the building. The leasehold improvements made by the Company, along with certain furniture and fixtures contained within its prior premises, were abandoned when the Company relocated. Under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”), the Company was required to depreciate these assets over the remainder of the period the Company remained within its prior premises.
Other costs accrued at October 31, 2004 primarily reflect $660,000 for the anticipated costs of the settlement agreement for the Securities Class Action and State Derivative Actions described in Note 11.
The following table summarizes the restructuring and other activity during the years ended October 31, 2004 and 2003 (in thousands):
6. Related Party Transactions
In November 1999, our former Chief Financial Officer, Kevin Ferrell, delivered a full-recourse promissory note to us in payment for 100,000 shares of Series F preferred stock. The principal amount secured under the note was $556,000. The note bore interest at the rate of 7.00% per annum, compounded annually, and was secured by the purchased shares. The principal balance would become due and payable in one lump sum on the third anniversary of the signing of the note (November 2002). In 2000, Mr. Ferrell paid down approximately $103,000 in principal and $35,000 in interest towards this note. In December 1999, Mr. Ferrell delivered a full-recourse promissory note to us in payment of the exercise price of 400,000 outstanding stock options under our 1997 stock option plan. The principal amount secured under the note was $1.2 million. In 2000, Mr. Ferrell paid down approximately $84,000 in interest towards this note. Mr. Ferrell resigned in February 2001. In February 2001, we
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
exercised our right to repurchase 240,000 unvested shares of Mr. Ferrell’s 400,000 option shares. We paid par value to repurchase the shares, which reduced the principal amount of the note by $720,000. The offset to the reduction in the note was recorded as a reduction in paid in capital. In October 2001, we wrote down $632,000 in principal in connection with both of Mr. Ferrell’s notes. In April 2002, we cancelled both promissory notes and related accrued interest of $301,000 in exchange for a pledge of 260,000 shares of our Company’s common stock owned by Mr. Ferrell. On that date, the fair market value of the 260,000 shares was $109,000 and was recorded as treasury stock. We recorded $192,000 in restructuring and other expenses as a result of this transaction.
In January 2000, Mr. Hewitt delivered a full recourse promissory note to us in payment of the exercise price of stock options issued pursuant to our 1997 Stock Option Plan. The principal amount secured under the note was $1 million. The note had a term of three years and bore interest at the rate of 7.00% per annum, compounded annually. The note was secured by the purchased shares and additional collateral. The entire unpaid balance of the note was due and payable upon termination of employment, failure to pay any installment of principal or interest when due, or insolvency or bankruptcy, or in the event we are acquired. None of the shares serving as security for the note could have been sold unless the principal portion of the note attributable to those shares and the accrued interest on that principal portion was paid to us. In December 2000, Mr. Hewitt delivered to us another full recourse promissory note in the amount of $375,000. The note was secured by shares of our common stock held by us for the previous loan. The note was due and payable on January 31, 2002, and bore interest at the prime rate as reported in The Wall Street Journal from time to time and compounded annually. Accrued interest was due on each anniversary of the signing of the note. Mr. Hewitt resigned in March 2001. In June 2001, in connection with Mr. Hewitt’s termination of employment, we cancelled both promissory notes and related accrued interest totaling $1.5 million in exchange for a pledge of 770,000 shares of our Company’s common stock owned by the officer. On that date, the fair market value of the 770,000 shares was $919,000 and was recorded as treasury stock and $598,000 was included in restructuring and other expenses. In the first quarter of fiscal 2002 the Company received $978,000 in cash from the sale of Mr. Hewitt’s shares held in escrow.
In November 2003, we entered into an engineering services agreement with Virtusa Corporation, a US and Indian based premier software engineering services firm which provides engineering support to software product developers and enterprise customers. Our former board member, Robert Davoli, was also a board member of Virtusa Corporation. A major shareholder, Sigma Partners, is also a venture capital investor in Virtusa Corporation. Our former board member Robert Davoli and board member Wade Woodson serve as managing directors of Sigma Partners. The Company paid Virtusa approximately $626,000 in the year ended October 31, 2004. No amounts were paid to Virtusa in the year ended October 31, 2003. As of October 31, 2004, we owed Vistusa approximately $324,000 for services provided in the year ended October 31, 2004.
In July 2004, Versata decided to expand its research and development resources in Halifax, Nova Scotia and to end its relationship with Virtusa. One reason the Company decided on this course of action was to take advantage of several tax incentives offered by the Canadian government. These incentives make this approach economically competitive to alternative offshore options.
7. Income Taxes
The Company accounts for income taxes under the provision of FASB Statement No. 109, Accounting for Income Taxes (“SFAS 109”). Under SFAS 109, deferred tax assets and liabilities are determined based on the difference between the financial statements and the tax bases of those assets and liabilities. Deferred income taxes reflect the net tax effects of net operating losses and tax credit carryovers and temporary timing differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The primary components of the net deferred tax asset are as follows (in thousands):
Due to uncertainty surrounding the realization of the favorable tax attributes in future tax returns, the Company has recorded a valuation allowance against its net deferred tax asset.
At October 31, 2004 the Company has the following approximate net operating loss carryforwards and research and experimentation credit carryforwards available to reduce future taxable income, if any (in thousands):
The Company’s net operating loss and research and experimentation credit carryforwards expire through 2024 (through 2014 for state net operating loss carryforwards) if not used beforehand to offset taxable income or tax liabilities. For federal and state tax purposes, our Company’s net operating loss and research and experimentation credit carryforwards may be subject to certain limitations on annual utilization in the event of changes in ownership, as defined by federal and state tax laws.
8. Common Stock
Our Company’s Certificate of Incorporation, as amended, authorizes our Company to issue 25,000,000 shares of common stock, and 833,333 shares of preferred stock.
During fiscal 2000, certain common stock option holders exercised unvested options subject to a repurchase right held by our Company in the event of voluntary or involuntary termination of employment of the stockholder. On April 6, 2001, the Company issued 384,166 shares of restricted common stock to certain executive officers of the company. The purchase price per share was at par value. The shares are subject to a repurchase right held by our Company. As of October 31, 2004 and October 31 2003, 17,045 and 45,164 shares of restricted common stock, respectively, were subject to repurchase by our Company.
During fiscal 2004, the Company issued 161,070 shares of common stock to certain employees resulting in a stock-based compensation charge of $296,000.
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
9. Stock Options and Purchase Plan
In November 1999, the Board of Directors of our Company approved the 2000 Stock Option Plan (“the 2000 Plan”), which became effective on March 3, 2000 in connection with the initial public offering of the common stock. The 2000 Plan serves as the successor to the Corporation’s 1994, 1996, and 1997 Stock Option Plans (the “Predecessor Plans”). All options outstanding under the Predecessor Plans have been incorporated into the 2000 Plan, and no further option grants or stock issuances will be made under the Predecessor Plans. Each option so incorporated will continue to be governed by the terms of the agreement evidencing that option, and no provision of the 2000 Plan will adversely affect or otherwise modify the rights of the holders of such incorporated options with respect to their acquisition of shares of common stock thereunder.
The 2000 Plan is comprised of five separate equity incentive programs: (i) the Discretionary Option Grant Program under which options may be granted to individuals in the Corporation’s service which will provide them with the right to purchase shares of common stock at a fixed price per share equal to the fair market value of the common stock on the grant date; (ii) the Stock Issuance Program under which such individuals may be issued shares of common stock directly, either through the purchase of those shares at fair market value or as a bonus for services rendered to the Corporation; (iii) the Salary Investment Option Grant Program under which the Corporation’s officers and other highly-compensated executives may elect to invest a portion of their base salary each year in special option grants with a below-market exercise price; (iv) the Automatic Option Grant Program under which non-employee Board members will automatically receive special option grants at designated intervals over their period of Board service; and (v) the Director Fee Option Grant Program under which non-employee Board members may elect to have all or any portion of their annual cash retainer fee applied to special stock option grants with a below-market exercise price.
The Company established the 2003 Employment Inducement Award Plan (“2003 Stock Plan”) to provide a material inducement for the best available employees to join the Company and to promote the success of the Company’s business. The 2003 Stock Plan permits the grant of non-statutory stock options, restricted stock and stock appreciation rights to employees as a material inducement to entering into their initial employment with the Company; provided, however, that a former employee who is returning to the employ of the Company following a bona-fide period of non-employment by the Company may also receive an Award hereunder. The maximum aggregate number of shares which may be issued under the 2003 Stock Plan is 800,000 shares; provided, however, that commencing October 1, 2004, on the first day of each fiscal year of the Company during the term of the 2003 Stock Plan, an additional 400,000 shares shall automatically be added to the Plan; provided, further, that in no event shall more than 50% of the Shares issuable under the 2003 Stock Plan be granted pursuant to awards with an exercise price or purchase price that is less than 100% of fair market value on the date of grant. The shares may be authorized, but un-issued, or reacquired common stock.
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table summarizes activity under our Company’s stock option plans:
The following table summarizes information concerning outstanding and exercisable options as of October 31, 2004:
Fair value disclosures
Pro forma information regarding net loss and net loss per share is required by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), which also requires that the information be determined as if our Company has accounted for its employee stock options granted
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
under the fair value method. The fair value for these options was estimated using the minimum value method to the date of our initial public offering and the Black-Scholes option-pricing model thereafter.
Our Company calculated the minimum fair value of each option grant on the date of grant using the Black-Scholes option-pricing method as prescribed by SFAS 123 using the following assumptions:
The weighted average fair value of the options granted in the years ended October 31, 2004, 2003, and 2002, was $1.85, $1.78, and $2.20, respectively.
Stock-based compensation
In connection with certain stock option grants, the Company recognized $76,000 of unearned compensation that is being amortized over the vesting periods of the related options, usually 50 months, on an appropriate accelerated basis, in accordance with FIN 28. In addition, the Company recognized $296,000 of stock-based compensation through the issuance of our common stock to certain employees in the year ended October 31, 2004. Stock-based compensation expense recognized during the years ended October 31, 2004, 2003 and 2002, was $372,000, $856,000, and $1.0 million, respectively.
Amortization of stock-based compensation expense is as follows (in thousands):
Employee stock purchase plan
Versata’s Employee Stock Purchase Plan (the “Purchase Plan”) was adopted by our Board of Directors in November 1999 and was approved by the stockholders in February 2000. A total of 83,000 shares of common stock have been reserved for issuance under the Purchase Plan. The reserve will automatically increase on the first trading day of the second fiscal quarter each year, by an amount equal to one percent (1%) of the total number of shares of our common stock outstanding on the last trading day of the immediately preceding first fiscal quarter. In no event will any annual reserve increase exceed 1,000,000 shares.
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Purchase Plan enables eligible employees to designate up to 15% of their compensation for the purchase of stock. The purchase price is 85% of the lower of the fair market value of Versata’s common stock on the first day or the last day of each six-month purchase period. No compensation expense is recorded in connection with the plan. In August 2001, the Company suspended employee participation in the Purchase Plan. We did not issue shares under the Purchase Plan during the years ended October 31, 2004 and October 31, 2003.
10. Employee Benefit Plans
In May 1995, our Company established a 401(k) Profit Sharing Plan (the “Plan”) which covers substantially all employees. Under the Plan, employees are permitted to contribute up to 25% of gross compensation not to exceed the annual 402(g) limitation for any Plan year. Discretionary contributions may be made by our Company. Our Company made no contributions during the fiscal years ended October 31, 2004, October 31, 2003, or October 31, 2002.
11. Commitments and Contingencies
Our Company has entered into leases for certain office space with terms ranging from 6 months to the year 2010. The lease for the office space at our principal executive and administrative offices in Oakland, California includes scheduled base rent increases over the term of the lease. In addition, this lease contains an escalation clause to recover increases in future operating costs and real estate taxes over the base year. We also entered into a sub-lease agreement for certain office space located within our Oakland, California headquarters. This sub-lease was recently extended to October 31, 2005. The future minimum lease payments shown below are inclusive of such escalation.
On March 10, 2004 the Company and its landlord executed an amendment to the lease agreement for the Company’s headquarter office space located in Oakland, California. This amendment reduced the Company’s future rent expense as well as reducing our physical space obligations from approximately 75,000 square feet to approximately 25,000 square feet. In addition, we agreed to extend the lease term by two additional years to August 31, 2010.
On May 13, 2004 the Company entered into an extension of an existing sublease within its Oakland, California headquarters. Pursuant to the terms and conditions of the master lease amendment, and triggered by the sublease extension, the Company has relocated to the space it is partially subleasing within the building.
Future minimum lease payments under all non-cancelable leases at October 31, 2004 are as follows (in thousands):
VERSATA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Rent expense for the years ended October 31, 2004, 2003 and 2002 was approximately $1.1 million, $1.6 million, and $1.6 million, respectively.
Securities Class Action and State Derivative Actions
On February 14, 2003, the United States District Court for the Northern District of California issued Orders of Final Approval of the Settlements of the consolidated securities class action and the consolidated derivative action that were all initially filed in 2001. Pursuant to the terms of the settlement, Versata’s directors and officers insurers paid $9.75 million, Versata issued 200,000 shares of common stock and implemented certain corporate therapeutics. The shares of common stock have a $3.50 per share put option exercisable for 20 trading days commencing one year after distribution; however, the put shall expire should our stock trade above $3.50 per share for 15 trading days during the one year period following the distribution. Distribution of the settlement shares occurred on January 28, 2004. As of October 31, 2004 and 2003, we had accrued $660,000 and $700,000, respectively, for this liability in “accrued restructuring and other” in the accompanying financial statements.
12. Subsequent Events
On December 20, 2004, Versata, Inc. (the “Company”) entered into a one year Loan and Security Agreement (the “Loan Agreement”) with Venture Banking Group (“VBG”) for the purpose of establishing a revolving line of credit. The Loan Agreement provides for borrowings by the Company of up to $1.0 million in the aggregate at anytime outstanding. The Loan Agreement requires the Company to maintain its primary depository and operating accounts with VBG and to maintain a minimum unrestricted cash balance of $4.0 million with VBG. Interest on borrowings under the Agreement is payable monthly and accrues at one-half of one percentage point above the prime rate. Unpaid principal, together with accrued and unpaid interest is due on the maturity date. Borrowings under the facility are collateralized by substantially all of the Company’s assets excluding its intellectual property.
The Loan Agreement contains affirmative and negative covenants with which the Company must comply, including reporting requirements, maintenance of insurance and restrictions on incurring indebtedness, granting liens, and paying dividends on its capital stock. The events of default under the loan agreement include payment defaults, cross defaults with certain other indebtedness, breaches of covenants, and insolvency events.
On November 5, 2004 the Company executed a letter of intent to expand its office facilities in Halifax, Nova Scotia. The lease has a five-year term and provides office space of approximately 4,940 sq ft. A definitive lease agreement is currently being negotiated by the Company and the lessor.
On January 4, 2005 the Company entered into an agreement to extend its sublease with Nuestar until October 31, 2005.
On January 19, 2005 the Board of Directors appointed George Paolini, 49, to Versata’s Board to fill the vacancy created by Robert Davoli’s resignation. Mr. Paolini will serve as a Class III director with a term expiring at the upcoming annual meeting. Mr. Paolini will serve on the Company’s Audit and Nominating Committees. Mr. Robert Davoli resigned as a board member of the Company effective January 19, 2005. Mr. Davoli did not serve on any committees.
VERSATA, INC.
UNAUDITED QUARTERLY INFORMATION
The following table sets forth our historical unaudited quarterly information for our most recent eight quarters, both in absolute dollars and as a percentage of total revenue for each quarter. We believe this quarterly information has been prepared on a basis consistent with our audited financial statements and includes all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the information shown. Our quarterly operating results have fluctuated and may continue to fluctuate significantly as a result of a variety of factors and operating results for any quarter are not necessarily indicative of results for a full fiscal year.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
SCH-I