-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QslR1m/ynDq+1ruuVgaEMWTCk7B7ScPQvvFjn9EPVewkB/LeP9BwoJ1A574hepgK U8VbaKAteZoqVBjy/Tkz5Q== 0000950144-99-003586.txt : 19990331 0000950144-99-003586.hdr.sgml : 19990331 ACCESSION NUMBER: 0000950144-99-003586 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MELITA INTERNATIONAL CORP CENTRAL INDEX KEY: 0001034956 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 581378534 STATE OF INCORPORATION: GA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-22317 FILM NUMBER: 99579216 BUSINESS ADDRESS: STREET 1: 5051 PEACHTREE CORNERS CIRCLE CITY: NORCROSS STATE: GA ZIP: 30092-2500 BUSINESS PHONE: 7702394000 MAIL ADDRESS: STREET 1: 5051 PEACHTREE CORNERS CIRCLE CITY: NORCROSS STATE: GA ZIP: 30092-2500 10-K405 1 MELITA INTERNATIONAL CORPORATION 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 --------------------- FORM 10-K FOR ANNUAL AND TRANSITIONAL REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (MARK ONE) (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________
Commission File Number: 0-22317 MELITA INTERNATIONAL CORPORATION (Exact Name of Registrant Specified in Its Charter) GEORGIA 58-1378534 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5051 PEACHTREE CORNERS CIRCLE 30092 NORCROSS, GEORGIA (Zip Code) (Address of principal executive offices)
Registrant's telephone number, including area code: (770) 239-4000 Securities registered pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED - ----------------------------------------------------- ----------------------------------------------------- None N/A
Securities registered pursuant to Section 12(g) of the Act: TITLE OF EACH CLASS ------------------- Common Stock, no par value per share Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing price for the Common Stock on February 12, 1999 as reported by the Nasdaq Stock Market, was $79,537,243. The shares of Common Stock held by each officer and director and by each person known to the company who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of February 12, 1998, Registrant had outstanding 15,581,527 shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE The Registrant's definitive Proxy Statement for the 1999 Annual Meeting of Shareholders, currently expected to be held on or about May 26, 1999, is incorporated by reference in Part III of this Form 10-K to the extent stated herein. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I ITEM 1. BUSINESS OVERVIEW We are a leading provider of automated customer relationship management systems that enable businesses to integrate their telephony-based customer contact strategies with their front office and back office operations. Organizations use our principal product, PhoneFrame Explorer, to implement strategies for customer interaction that increase agent productivity and effectiveness, reduce the costs of call center operations and enhance revenue generation for a broad range of activities, including collections, telemarketing and customer service. Our PhoneFrame Explorer product provides comprehensive call center solutions based on a distributed, object-oriented software architecture that integrates with commonly installed computing, telephony and Internet infrastructures using industry standards for component interoperation. Our customers include leading organizations worldwide in industries such as banking, financial services, communications, service agencies and retail in which businesses are engaged in frequent and production-oriented contact with customers or prospects. INDUSTRY BACKGROUND Long-term customer relationships are critical to the success of businesses operating in an increasingly competitive global marketplace. As customers become more sophisticated and demanding in the level of service they require, businesses are striving to develop and improve customer relationships as a means to distinguish themselves, their products and their services. This effort requires businesses to use every opportunity to strengthen their relationships with customers, from marketing and sales activities to post-sales service, support and collections. Effective customer interaction can build customer loyalty, which in turn can reduce customer retention costs and increase revenue. Organizations are increasingly using information systems to improve the quality of their interaction with customers across the enterprise. In recent years, organizations have recognized that telephone communications, the Internet and other electronic means of interaction have become an increasingly effective way to manage customer relationships. This trend has been facilitated as telecommunications costs have decreased and new enabling technologies, such as computer/telephony integration, or CTI, and Internet-based applications have emerged to help automate the customer relationship management process. CTI automates the generation and management of telephony-based customer contacts and provides real-time access to computer-based information resources. This automation is provided within call centers through the use of specialized software and hardware that integrate telephony platforms, computer systems and business applications. According to an industry source, our primary target markets, CTI and outbound and blended call management, were approximately $1.2 billion worldwide in 1998 and are together expected to grow at a compound annual growth rate of 25.2% to $2.4 billion by 2001. Call centers enable agents to process a steady flow of outbound or inbound telephone contacts relating to products and services. Call centers generally consist of supervisor and agent workstations linked to a central telephone switch and computer system. Call centers historically have focused either on conducting outbound calls, for functions such as collections and product sales, or managing inbound calls, for functions such as product support, order processing and customer service. Inbound call centers utilize an interactive voice response, or IVR, unit and an ACD system that together screen and route incoming calls through the call center. Outbound call centers incorporate predictive dialing software to automate outbound dialing. Common examples of outbound call center applications include collections, telemarketing, teleservice and customer support. Increasingly, call center applications feature dynamic inbound/outbound or call blending functionality, which permits agents to be switched automatically between inbound and outbound calls as inbound call volume fluctuates. A key objective of an organization's outbound call center is maximizing the time spent by agents on the telephone with customers or potential customers while minimizing the "nuisance call" rate. A nuisance call is 3 a live contact that the call management system must either put on hold or disconnect because no agent is available. High nuisance call rates caused by overdialing increase telecommunications costs and damage customer relations. Call center systems that utilize sophisticated predictive dialing software can minimize the nuisance call rate while maintaining high agent productivity. We believe that this capability is essential to organizations operating call centers. Call center systems were originally developed as centralized, mainframe-based information systems, which were expensive, provided limited functionality and productivity and were generally closed and proprietary. Distributed, standards-based computing environments have allowed call center systems to be developed that utilize CTI, other standard application programming interfaces, or APIs, and the flexibility and openness of distributed, object-oriented software architectures. The result is that call center systems can now incorporate leading hardware and software products from multiple vendors, are significantly less expensive to implement and can demonstrate increased system functionality and flexibility. The increasing usage of the Internet and the proliferation of related technologies are having a growing impact on the way businesses manage customer relationships. In particular, Internet usage is generating greater inbound customer contact traffic, placing new demands on traditional inbound customer contact systems. At the same time, the Internet is changing how outbound systems are used to manage customer relationships. Businesses are seeking to take advantage of these changes by integrating all forms of customer communication channels, including telephone, e-mail, fax and the Internet and by linking these integrated channels with existing and new business applications. Call center operations have become a core competency for many businesses engaged in frequent contact with customers or prospects. In order to maximize the return on their call center investment, businesses seek call center solutions that are adaptable to emerging technologies, flexible, scaleable, intuitive to use, allow transparent data access, integrate existing IT, telephony and Internet systems and can be deployed in a distributed manner across the enterprise. THE MELITA SOLUTION We provide integrated customer relationship management solutions that automate outbound or blended call centers, enabling our customers to enhance telephony-based customer interaction. Our principal product, PhoneFrame Explorer, is a scaleable, integrated solution based on a distributed, object-oriented architecture. The PhoneFrame Explorer product provides comprehensive functionality and a user-friendly application development environment enabling organizations to implement effective customer contact strategies for a broad range of activities, including collections, telemarketing and customer service. Our solution provides: - High agent productivity, low nuisance call rates, and low operating costs through patented predictive dialing and inbound/outbound call management functionality; - Enhanced agent interaction with customers through front-end software applications that allow agents to access information throughout the enterprise on a real-time basis and that guide agents through each step of the customer interaction process; - Dynamic campaign development, deployment and modification through powerful, easy-to-use script generation and application development software and services; and - The ability to leverage existing investments in call center systems and adapt to emerging technologies through standards-based, open, scaleable, distributed, object-oriented software architecture. A critical element of the comprehensive solutions we provide is our underlying philosophy of Customer Care. Our products represent a critical link between the business enterprise and its customers, providing the business with a solution that allows it to provide the best customer care. Our Customer Care philosophy focuses on enhancing the quality of People to People Communication and is reflected in all facets of our operations and products. We have incorporated applications into our existing products that reflect this philosophy, including our patented predictive dialing algorithms, Cancel Dial functionality, dynamic in- 2 4 bound/outbound call blending and Single System Image View, our solution for presenting customer data integrated from multiple sources on an agent's screen. STRATEGY Our primary objective is to be the leading provider of automated customer relationship management systems that enable businesses to integrate their customer contact strategies with their front office and back office operations. Our strategy to achieve this objective includes the following key elements: Leverage Installed Base of Customers: We will continue to focus sales and marketing efforts on our installed base of customers. In 1998, 68.6% of our product revenues were from sales to existing customers. We also intend to continue to leverage our penetration of currently targeted vertical markets by using our existing customers as a reference base to gain new customers. We work actively with existing customers to help define emerging applications and pursue joint development activities. Leverage Technology Leadership and Software Focus: We believe we are a global technology leader in the field of call center automation software and CTI, having pioneered many of the industry's fundamental call center technologies. We hold a comprehensive U.S. and foreign-based patent portfolio covering numerous processes and technologies utilized in call management systems. We have based our products on our MPower software architecture, which is a distributed, object-oriented, standards-based architecture. Our software focused solution is compatible with standard telephony and computing infrastructure from a variety of major OEMs, allowing businesses to leverage existing telephony and computing technology. We are leveraging our technological expertise in call center systems and seek to develop solutions to incorporate multi-channel customer contact across the enterprise, including inbound and outbound calling, the Internet, fax and e-mail. Continue to Focus on Providing Comprehensive Customer Relationship Management Solutions: We provide system design, application configuration, integration and training services in conjunction with the installation of our products. We believe our ability to integrate customer relationship management solutions with existing systems and applications is an important factor in the purchasing decisions of customers, and we intend to continue our emphasis on providing these design and integration services. Continue to Expand Sales and Marketing: We intend to pursue an increased share of the market for call management systems by hiring additional sales and marketing personnel. We are expanding our global and national accounts program. This program focuses on sales and marketing efforts to large, multinational corporations. In 1998, we opened offices in both Irvine, California and Chicago, Illinois that include sales, marketing and support personnel. Our sales and marketing personnel grew from 99 at the end of 1997 to 142 at the end of 1998. Increase Penetration of International Markets: We currently have relationships with VARs in Europe, Latin America and the Pacific Rim. We intend to commit additional resources to these relationships in selected international markets. In 1998, we established VAR agreements with Lucent Technologies covering four countries in South America, we continued our expansion of our Mexico City office and we opened a new office in Paris. We also intend to expand our international operations through hiring additional personnel and forming additional relationships with VARs and distributors in Europe, Latin America and the Pacific Rim. Continue to Develop Domestic Distribution Channels: We have historically relied on our direct sales channel domestically. In 1998, we established joint distribution relationships with Aspect Telecommunications Corporation and Williams Communications, LLC for North America. We intend to increase support of distribution channels in North America with additional channel programs and personnel. We also plan to strengthen existing joint marketing and distribution relationships. PRODUCTS Our principal product, PhoneFrame Explorer, is an integrated suite of distributed, object-oriented software applications and standards-based hardware that provides outbound and blended call management solutions. PhoneFrame Explorer software components are based on open standards, thereby allowing integration with varied and complex user environments and eliminating the need for proprietary hardware. 3 5 PhoneFrame Explorer products are sold to organizations that operate outbound and blended call centers. These call centers require solutions that integrate with existing communication and information systems including mainframe-based information systems, local area networks, relational database management systems, agent workstations, PBX/ACDs, IVRs and the Internet. Utilizing customer records residing in an organization's existing databases, PhoneFrame Explorer products automate customer relationship management and guide agents through the customer interaction process. (System Architecture Graphic) 4 6 Components of the PhoneFrame Explorer product include the Universal Server; the Command Post; our desktop solutions, Magellan and Melita OpenClient Access; and the Universal Telephony Platform, or UTP.
PHONEFRAME EXPLORER PRODUCT COMPONENT DESCRIPTION Universal Server Server software that controls and coordinates system operation. Used to manage calling list data, replies to Internet contacts, call attempt and contact history, agent profiles, time zone and area code data, call processing, agent and supervisor activity. Platform: IBM RISC/6000, AIX operating system, Sybase database Command Post Suite of software applications used by system managers to configure, operate, monitor and report on agent and system activities utilizing an interactive GUI. Platform: Pentium PC, Windows NT Desktop Solutions Client-based software which runs on the agent workstation and manages the client session with the Universal Server for each contact routed to the agent workstation. We provide two alternative desktop solutions: Magellan Software that controls Windows GUI screen presentation on the agent workstation. Provides read/write access to data in customer's existing systems. Additionally, Magellan Builder facilitates development of customer interaction and call flow applications featuring an interactive GUI. Melita Software development kit that provides OpenClient industry-standard components, such as JavaBean or Access ActiveX, that allow the existing enterprise or third-party desktop solutions to be integrated with the PhoneFrame Explorer solution. Platform: PC, Windows 3.1, 95 and NT Universal Telephony Platform Call processing and media management software capable of using either CTI links to leading PBX/ACDs or telephony links through industry standard call processing hardware to perform call processing across multiple countries.
The Universal Server is the server component of the PhoneFrame Explorer solution that controls and coordinates the overall system operations. It runs on an IBM RISC/6000 with the AIX operating system and utilizes Sybase for storing and managing customer contacts, call flow applications, contact history and agent profiles. TCP/IP is used for all communication with other system components allowing the PhoneFrame Explorer system to be configured in a user's local or wide-area network. Universal Server software also supports Simple Network Management Protocol, or SNMP, for remote management and diagnostics. Command Post provides a suite of software that allows call center managers or system administrators to configure, manage, monitor and report on call center activity across an enterprise. Our Command Post software includes applications such as Production Monitoring, which provides a floor-plan view of call center 5 7 operations with real-time information display for each agent position. Based on Windows NT, the Command Post user interface provides a user-friendly environment for managing and reporting on all aspects of system operation. Our desktop solutions include Magellan and Melita OpenClient Access. Magellan provides an application development environment for call center managers to create call flow applications without having to write software. Magellan applications provide user-defined, graphical user interfaces to guide agents through customer interactions. Magellan supports real-time access to enterprise-wide customer and product information residing anywhere within the computing and telephony infrastructures by utilizing industry standards for data access. Melita OpenClient Access is a software development kit providing industry-standard components that allow customers to integrate their own or third-party desktop software into the PhoneFrame Explorer solution. Customers can choose between an ActiveX or JavaBean component to integrate with their custom applications into any Windows-based or browser-based environment. The UTP provides state-of-the-art telephony and CTI functionality including call processing and media management. It is based on our MPower architecture and employs industry-standard telephony components and the Windows NT operating system. The UTP offers an international set of digital interfaces, including T1, E1 and ISDN. This open, NT server-based communications platform incorporates numerous standards, including SCSA, CORBA and TCP/IP. UTP's enhanced CTI capabilities enable call blending and "single-switch" software only solutions. SNMP is fully supported for remote monitoring and diagnostics. SERVICES We provide multiple forms of service and support for our customers, including maintenance, installation, integration, training, consulting and custom application development. Customers that receive maintenance services are entitled to customer and technical support 24 hours a day, seven days a week. Maintenance customers also receive ongoing system support and baseline software upgrades. Installation and integration services consist of custom application design, configuration and documentation, along with the physical installation and integration of the system. Introductory training classes are provided as part of each initial system purchase, and advanced classes are provided for additional fees. Our consulting services provide our customers with expertise and assistance in planning, designing and implementing our solutions. We also offer other special customer services such as custom application development, scripting and call center consulting to our customers. Our customer service group is composed of a Professional Services group, which provides services for a fee when contracted for by a customer, and a Global Support Services group, which manages inventory, purchasing, testing and ongoing relations with customers. Services personnel are located throughout the United States and in the United Kingdom, France, Mexico and Canada. Additional services are provided by the company's VARs and distribution partners. We contract with third parties to provide local hardware support. As of December 31, 1998, we employed 178 people in our Professional Services and Global Support Services groups. SALES AND MARKETING We sell our products primarily through a direct sales channel and, to a lesser extent, indirectly through distributors and VARs. We conduct sales in the United States, Mexico, Canada, France and the United Kingdom primarily through direct channels. We sell our products and services in other countries through indirect channels. Our VARs and distributors are independent organizations that perform some or all of the following functions for our products: sales and marketing, systems implementation and integration, and ongoing consulting and technical support. We believe that our VARs and distributors have a significant influence over product choices made by our customers and that our VAR and distributor relationships are an important element in our marketing, sales and implementation efforts. 6 8 Our marketing activities include product management, product marketing, direct marketing, public relations, press and analyst communications, event support and management of our website. Our Business Development Group is responsible for creating distribution relationships, strategic alliances, joint marketing agreements and co-development relationships with call center industry providers. Our customers independently operate domestic and international user groups. Each group conducts annual as well as regional user group meetings typically focused on common applications and call center opportunities. We participate as invited in the user group conferences generally by conducting seminars, product demonstrations and educational sessions. As of December 31, 1998, we employed 142 people in our sales and marketing group. CUSTOMERS Our call management solutions are used by organizations in a broad range of industries. In 1998, the top five industry groups by revenue were banking, financial services, service agencies, communications and retail. Revenues from the top five customers were 24.5% of total revenues in 1996, 27.9% of total revenues in 1997 and 23.2% of total revenues in 1998. In 1996, no single customer accounted for more than 10% of total revenues. In 1997, BancOne Services Corp. (now First USA) accounted for 11.8% of total revenues, and in 1998, CitiGroup accounted for 13.1% of total revenues. Although specific customers may change from period to period, we expect that large sales to a limited number of customers will continue to account for a significant percentage of our revenues in any particular period for the foreseeable future. The following table sets forth certain of our current customers that have purchased $200,000 or more in products and services from us during the two year period ended December 31, 1998: BANKING Banco Rio de la Plata Banco Santander Bancomer, S.A. Bank of Montreal Chevy Chase Bank, FSB CitiGroup Credicard SA First Union Mortgage Corporation First USA Green Tree Financial Corporation HSBC Huntington National Bank Lloyds Bank PNC Bank Royal Bank of Canada Sovereign Bank FSB Texas Commerce Bank Toronto Dominion Bank Union Bank FINANCIAL SERVICES Advanta Mortgage Group Countrywide Home Loans, Inc. Dun & Bradstreet, Inc. Empire Funding Corporation Fidelity Funding Financial Group Fiscalex, LTDA Mortgage Lenders Network Navy Federal Credit Union Norwich Union One Hour Acceptance Primus Automotive Financial Services, Inc. COMMUNICATIONS America Online, Inc. Bell Atlantic Mobility Cox Enterprises, Inc. MCI Wireless MediaOne Group Swisscom AG SERVICE AGENCIES Allied Interstate, Inc. Ameridial, Inc. Credit Bureau Services, Inc. Equant Marketing Group Franklin Acceptance Corporation National Asset Recovery Sitel Corporation Snyder Communications, Inc. Specialized Card Services, Inc. Tecmarketing, S.A. de C.V. RETAILERS AND OTHER Atlanta Journal and Constitution Automobile Club of Southern California Franklin Mint J.C. Penney Company, Inc. Johns Hopkins Health Systems Pennsylvania American Water Co. Saks Incorporated 7 9 TECHNOLOGY AND PRODUCT DEVELOPMENT We intend to continue investment in research and development to maintain our position as a leader in call center technology. Our MPower architecture is a distributed, object-oriented, component-based software architecture that facilitates the development, test, configuration, deployment and interoperability of our call center solutions. The system provides three core sets of services: - user interface presentation, navigation and reporting; - server-based system management services; and - telephony-based, CTI and multi-media contact services, including our patented predictive dialing and dynamic call blending applications. Our products are based on an open architecture utilizing industry standards and provide seamless integration with third-party systems or customers' existing technology infrastructure. We will seek to continue to develop products that adhere to existing and emerging standards. The presentation and navigation components of the software have been implemented using Windows Graphical User Interface guidelines. We have engaged usability labs and focus groups to define interface requirements and verify usability. TCP/IP is used as the transport layer for all component communication. Standard data access protocols such as EHLLAPI, DDE and ODBC, and software development tools such as ActiveX and JavaBean, facilitate integration with third-party desktop applications and protocol stacks. Our UTP software has been designed using industry standards and we intend to continue this approach. Our systems use standard off-the-shelf analog and digital communications components. CTI links to the various PBX/ACD systems used by our customers are typically proprietary and necessitate the use of CTI middleware. We have standardized CT-Connect Server from Dialogic Corporation to facilitate integration with various PBX/ACD switching platforms. We are finalizing plans to release Melita Enterprise Explorer, the next major release of software in the Explorer product line. We announced Enterprise Explorer in the fall of 1998, are currently in the beta-testing phase and expect Enterprise Explorer to be in general release in the second half of 1999. Enterprise Explorer software will extend our MPower software architecture to include enterprise resource sharing and mixed media services. This will allow customers to deploy a single system across multiple sites for different types of communication between a business and its customers. Enterprise Explorer will permit both agent and telephony resources to be managed from a central location and shared among multiple sites using Asynchronous Transfer Mode (ATM) or Voice over Internet Protocol technology. This will enhance the ability of businesses to implement enterprise-wide contact strategies and eliminate the issues created by multiple, isolated "islands" of technology. In connection with the implementation of a distributed architecture, the pacing algorithm of the Universal Server will be enhanced to minimize the nuisance call rate. New Command Post software will allow system managers to define "virtual agent groups" consisting of agents across multiple sites and will allow managers to monitor these agents in real time. Enterprise Explorer will include NT server-based Mixed Media Servers that will provide all communication services for the system, including the ability to process faxes, e-mail and Internet communication. COMPETITION The market for our products is intensely competitive, fragmented and subject to rapid change. Because our principal products are call management systems, which include both software applications and hardware, we compete with a variety of companies that provide these components independently or as an integrated system. Our primary competitors in the field of integrated inbound/outbound call management systems are Davox, EIS and Mosaix. We compete primarily against Davox and Mosaix in the collections segment of the outbound call management systems market, and against EIS in the telemarketing and telesales segments of the inbound/outbound call management systems market. We also compete in the CTI segment of the market, where principal competitors include Genesys Telecommunications Laboratories, Inc., GeoTel Communications Corporation, Information Management Associates, Inc., and Quintus Corporation, among others. Some 8 10 of our competitors may align themselves with PBX/ACD vendors, other communications equipment providers or other vendors in an effort to increase sales potential for their products. We may face additional direct competition from PBX/ACD vendors, other communications equipment providers, communications service providers, computer hardware and software vendors and others. We may also face competition from non-traditional competitors in the emerging computer telephony market. These competitors may include Interactive Intelligence Inc., Oracle Corporation, IBM and others. We generally face competition from at least one of our principal competitors on major sales and believe that price is a major factor considered by our prospective customers. Increased competition has contributed significantly to price reductions, and we expect these price reductions to continue. In addition, increased competition may result in reduced operating margins and loss of market share. Many of our current and potential competitors have 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 emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products than we could. We believe that the primary competitive factors affecting our markets include product features such as flexibility, scaleability, interoperability, functionality and ease of use, as well as reputation, quality, performance, price and customer service and support. REGULATORY ENVIRONMENT Certain uses of outbound call management systems are regulated by federal, state and foreign law. The Federal Telephone Consumer Protection Act, or TCPA, prohibits the use of automatic dialing equipment to call emergency telephone lines, health care and similar facility patient telephone lines, and telephone lines where the called party is charged for incoming calls, such as those used by pager and cellular phone services. The TCPA prohibits use of such equipment to engage two or more lines of a multi-line business simultaneously, and restricts the use of artificial or prerecorded voice messages in calls to residential lines. Among other things, the TCPA required the Federal Communications Commission, or FCC, to create regulations protecting residential telephone subscribers from unwanted telephone solicitations. In addition, the Telemarketing and Consumer Fraud and Abuse Prevention Act authorized the Federal Trade Commission, or FTC, to prohibit a variety of deceptive and/or abusive telemarketing practices, including, among other things, repetitive or harassing calls and requests by telemarketers for payments before certain types of services are provided. The rules adopted by the FCC and FTC prohibit calls to persons who have indicated that they do not wish to be contacted, and the FCC specifically requires telemarketers to maintain a company-specific "do-not-call list" that contains the names and numbers of residential subscribers who do not want to receive calls. The rules also require that telemarketers may call consumers only after 8:00 a.m. and before 9:00 p.m., local time. The FCC rules do not restrict calls made to parties that have an "established business relationship" with the caller or calls placed by tax-exempt nonprofit organizations. The Telemarketing Fraud Prevention Act, or TFPA, adopted in June 1998, imposes severe criminal penalties, including forfeiture of property, for fraud committed through telemarketing calls. Certain states have enacted similar laws limiting access to telephone subscribers who object to receiving solicitations. The Fair Debt Collection Practices Act, or FDCPA, limits communication by certain debt collectors with consumers only after 8:00 a.m. and before 9:00 p.m., local time, and not at the consumer's place of business. Many of our customers are exempt from the FDCPA. In addition, certain states have enacted laws regarding debt collection practices, which in some cases may impose restrictions on telephonic collection activities in addition to those of the FDCPA. Although compliance with these laws may limit the potential use of our products in some respects, we believe our systems can be programmed to operate automatically in full compliance with these laws through the use of appropriate calling lists and calling campaign time parameters. PROPRIETARY RIGHTS We rely on a combination of patent, copyright, trade secret and trademark laws, confidentiality procedures and contractual provisions to protect our proprietary rights in our products and technology. We hold numerous U.S. and foreign patents covering various processes and technologies utilized in call management systems. These patents cover our proprietary implementations of applications such as inbound/outbound call blending, call progress analysis, screen pops of the called person's account information, Cancel 9 11 Dial and Single System Image View. We also have a number of pending patent applications on customer interaction management innovations for which patents have not yet issued. In many cases, we have also received or applied for patents in other countries covering the innovations covered by existing U.S. patents or patent applications. EMPLOYEES As of December 31, 1998, we had 448 full-time employees, (178 in customer service and operations, 142 in sales and marketing, 77 in research and development and 51 in administration), of whom 398 were based in the United States and 50 were based in other countries. With the exception of eight employees of our Mexico City subsidiary, none of our employees are covered by a collective bargaining agreement. We consider our employee relations to be good. We believe our future success will depend in large part on our ability to recruit and retain qualified employees, especially experienced software engineering personnel. The competition for such personnel is intense, and we cannot assure that we will be successful in retaining or recruiting key personnel. EXECUTIVE OFFICERS AND DIRECTORS Our executive officers and directors, and their ages as of January 31, 1999, are as follows:
NAME AGE POSITION ---- --- -------- Aleksander Szlam......................... 47 Chairman of the Board and Chief Executive Officer Dan K. Lowring........................... 38 Vice President, Administration and Chief Financial Officer, Secretary and Treasurer William K. Dumont........................ 49 Senior Vice President, Worldwide Sales John A. Lamb............................. 46 Senior Vice President, Strategic Product Marketing Donald L. House(1)....................... 57 Director Don W. Hubble(1)......................... 59 Director
- --------------- (1) Member of the Audit Committee and the Compensation Committee. ALEKSANDER SZLAM founded Melita in 1979 and has served as Chairman of the Board and Chief Executive Officer of Melita since its inception. Prior to founding Melita, Mr. Szlam worked as a design engineer and scientist at Lockheed Corporation, NCR and Solid State Systems. DAN K. LOWRING has served as Vice President, Administration and Chief Financial Officer of Melita since August 1998, and has served as Secretary since March 1997 and Treasurer since January 1997. Mr. Lowring also served as Vice President, Corporate and Strategic Planning of Melita from December 1997 to August 1998. From July 1993 to December 1996 he served as Director of Finance, from March 1993 to July 1993 he served as Controller, and from October 1990 to March 1993 he served as Manager of Finance of Melita. Prior to joining Melita, Mr. Lowring served in various capacities with a division of Raymond James Financial, Inc. and with R.H. Macy & Co. WILLIAM K. DUMONT has served as Senior Vice President, Worldwide Sales of Melita since August 1998. Mr. Dumont also served as Vice President, Sales of Melita from December 1996 until August 1998. Prior to joining Melita, Mr. Dumont served as Regional Manager for Octel Communications Corporation from 1994 to 1996, and from 1990 to 1994 he served as Regional Vice President of VMX, Inc., both of which are voice processing companies. JOHN A. LAMB has served as Senior Vice President, Strategic Product Marketing of Melita since August 1998. Mr. Lamb also served as Vice President, New Business Development of Melita from September 1996 to August 1998, and was Director of Special Projects of Melita from February 1996 to September 1996. Mr. Lamb served as Vice President, Research and Development of Microhelp, Inc., a software development 10 12 company, from January 1995 to November 1995. From 1990 to 1995, he held various positions in the sales and engineering departments of Melita. DONALD L. HOUSE has served as a Director of Melita since June 1997. A private investor and business advisor to technology companies since 1988, Mr. House served as Chairman of the Board of Directors of Clarus Corporation (formerly known as SQL Financials, Inc.), a developer of electronic commerce, financial and human resources application software, from January 1993 through December 1997. He continues to serve on the Board of Clarus Corporation. In addition, Mr. House serves on the Board of Carreker-Antinori, Inc., a provider of software and consulting services to the financial industry, where he is a member of the Audit Committee. He also serves as a director of a number of private high technology firms. From September 1991 until December 1992, Mr. House served as President of Prentice Hall Professional Software, a subsidiary of Simon and Schuster, Inc. From 1968 through 1987, Mr. House served in a number of senior executive positions with Management Science America, Inc., a provider of enterprise application software. DON W. HUBBLE has served as a Director of Melita since June 1997. Mr. Hubble has served as the Chairman, President and Chief Executive Officer of Angelica Corporation, a health-care, textile rental and apparel company, since January 1998 and served as an independent consultant from October 1996 to December 1997. Mr. Hubble served with National Service Industries, Inc., or NSI, from 1980 until October 1996, most recently serving as President and Chief Operating Officer. Mr. Hubble also served in various capacities with a number of divisions of NSI, including National Linen Service, Block Industries and Certified Leasing Company. There are no family relationships between any of our directors or executive officers. CERTAIN FORWARD LOOKING STATEMENTS In this report (including the documents incorporated herein by reference), we have made certain forward-looking statements that are based on our current beliefs and the information currently available to us, as well as estimates and assumptions we have made. Words such as "anticipate," "believe," "estimate," "expect," "future," "intend," "plan" and similar expressions, as they relate to us or our management, identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions relating to our operations and results of operations, competitive factors and pricing pressures, shifts in market demand, the performance and needs of the industries we serve, the costs of product development and other risks and uncertainties, including the risk and uncertainties identified above under "Risk Factors." Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results or outcomes may vary significantly from those anticipated, believed, estimated, expected, intended or planned. Please see Exhibit 99.1 "Safe Harbor Compliance Statement for Forward Looking Statements", the terms of which are incorporated herein, for additional factors to be considered by shareholders and prospective shareholders. ITEM 2. PROPERTIES Our principal administrative, sales, marketing, support, and research and development facility is located in approximately 100,000 square feet of modern office space in Norcross, Georgia. This facility is leased to us through 2005. The facility is owned by a partnership controlled by our Chairman of the Board, Chief Executive Officer and principal shareholder. We also lease space for several sales and support centers located in the United States and in London, Mexico City, Paris and Toronto. We believe we will require significant additional office space within the next 12 months and that suitable space will be available to accommodate expansion of our operations on commercially reasonable terms. We anticipate leasing approximately 75,000 additional square feet of general office space at market rates near our current headquarters, in Norcross, Georgia, from a partnership controlled by our Chairman of the Board, Chief Executive Officer and principal shareholder, within the next 12-24 months. We also anticipate leasing approximately 10,000 feet of general office space at market rates in London within the next 12 months upon the termination of our current lease in London. 11 13 ITEM 3. LEGAL PROCEEDINGS We are not currently a party to any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year ended 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS Our common stock is listed on the Nasdaq National Market, or Nasdaq, under the symbol "MELI." The following table sets forth the range of high and low sale prices for our common stock on Nasdaq during the periods indicated commencing June 4, 1997, the date of our initial public offering.
HIGH LOW ---- --- 1997: Second Quarter (from June 4, 1997)........................ $13 $10 Third Quarter............................................. 12 7/8 7 5/8 Fourth Quarter............................................ 12 1/4 7 3/4 1998: First Quarter............................................. 19 1/8 8 1/2 Second Quarter............................................ 19 1/8 11 3/4 Third Quarter............................................. 17 3/8 8 Fourth Quarter............................................ 21 1/4 7 1/4 1999: First Quarter (through February 12, 1999)................. 25 1/8 16 3/8
On February 12, 1999, the last sale price of the common stock on Nasdaq was $17 15/16 per share. As of January 31, 1999, there were 53 holders of record of our common stock. We have never declared or paid any cash dividends on our common stock. We currently anticipate that we will retain all future earnings for use in our business and do not anticipate paying cash dividends in the foreseeable future. 12 14 ITEM 6. SELECTED FINANCIAL DATA You should read the following selected consolidated financial data in conjunction with our consolidated financial statements and the related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this report. We have derived the statement of operations data for the years ended December 31, 1996, 1997 and 1998 and the balance sheet data as of December 31, 1997 and 1998 from our financial statements audited by Arthur Andersen LLP and included elsewhere in this report. We have derived the statement of operations data for the years ended December 31, 1994 and 1995 and the balance sheet data as of December 31, 1994, 1995 and 1996 from our audited financial statements not included in this report.
YEAR ENDED DECEMBER 31, ----------------------------------------------- 1994 1995 1996 1997 1998 ------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Net revenues: Product.................................................. $18,186 $24,620 $32,077 $46,065 $67,943 Service.................................................. 8,970 10,662 15,463 19,725 25,467 ------- ------- ------- ------- ------- Total revenues.................................... 27,156 35,282 47,540 65,790 93,410 Cost of revenues: Product.................................................. 6,310 8,730 11,494 15,531 21,336 Service.................................................. 3,254 5,282 6,863 9,642 13,346 ------- ------- ------- ------- ------- Total cost of revenues............................ 9,564 14,012 18,357 25,173 34,682 ------- ------- ------- ------- ------- Gross margin............................................... 17,592 21,270 29,183 40,617 58,728 Operating expenses: Engineering, research and development.................... 3,660 4,050 5,070 6,880 10,410 Selling, general and administrative...................... 11,332 12,559 16,765 22,320 31,253 ------- ------- ------- ------- ------- Total operating expenses.......................... 14,992 16,609 21,835 29,200 41,663 ------- ------- ------- ------- ------- Income from operations..................................... 2,600 4,661 7,348 11,417 17,065 Other income, net.......................................... 46 88 261 662 1,193 ------- ------- ------- ------- ------- Income before income taxes................................. 2,646 4,749 7,609 12,079 18,258 Income tax provision (benefit): Tax provision............................................ (26) -- -- 3,023 6,573 Deferred tax adjustment.................................. -- -- -- (1,473) -- ------- ------- ------- ------- ------- Net income................................................. $ 2,672 $ 4,749 $ 7,609 $10,529 $11,685 ======= ======= ======= ======= ======= Income before pro forma income taxes....................... $ 2,672 $ 4,749 $ 7,609 $12,079 Pro forma income taxes..................................... 1,164 1,794 2,827 4,469 ------- ------- ------- ------- Pro forma net income....................................... $ 1,508 $ 2,955 $ 4,782 $ 7,610 ======= ======= ======= ======= Earnings per share: Diluted earnings per share............................... $ 0.24 $ 0.38 $ 0.62 $ 0.73 $ 0.74 Pro forma diluted earnings per share..................... $ 0.14 $ 0.24 $ 0.39 $ 0.53 Weighted average shares outstanding: Diluted.................................................. 11,143 12,338 12,363 14,386 15,815
DECEMBER 31, ----------------------------------------------- 1994 1995 1996 1997 1998 ------- ------- ------- ------- ------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash, cash equivalents and marketable securities........... $ 5,406 $ 5,959 $ 9,489 $30,814 $30,440 Working capital............................................ 8,594 6,904 8,124 32,251 42,882 Total assets............................................... 17,635 20,928 27,069 56,395 75,308 Long-term debt, net of current portion..................... 3,068 2,644 -- -- -- Total shareholders' equity................................. 7,103 6,657 10,872 37,289 50,069
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We are a leading provider of automated customer relationship management systems that enable businesses to integrate their telephony-based customer contact strategies with their front office and back office 13 15 operations. Organizations use our principal product, PhoneFrame Explorer, to implement strategies for customer interaction that increase agent productivity and effectiveness, reduce the costs of call center operations, improve customer relationships and enhance revenue generation for a broad range of activities, including collections, telemarketing and customer service. We offer ongoing maintenance support of our products. We also offer fee-based installation, education, custom application development and consulting services. Historically, we have internally generated the funds necessary for our growth through profits and cash provided by operating activities. Our revenues are derived primarily from two sources: (i) product license fees for the use of our software products and revenues from sales of related computer and telephony hardware that utilizes the software and (ii) service fees for ongoing system support, maintenance, installation, education and consulting services. We recognize product revenue upon shipment of the product if there are no significant post-delivery obligations, if collection is probable and if the agreement requires payment within one year. Revenues from post-contract maintenance support are recognized ratably over the term of the support period. Post-contract maintenance support revenues accounted for 17.6% of total revenues in 1998. Revenues from consulting, installation and education services are recognized as the services are performed. In any given period, a significant portion of our revenues may be derived from large sales to a limited number of customers. During 1996, no customer accounted for more than 10% of our total revenues. During 1997, BancOne Services Corp. (now First USA) accounted for 11.8% of our total revenues. During 1998, CitiGroup accounted for 13.1% of our total revenues. Revenues from our five largest customers represented 24.5%, 27.9% and 23.2% of our total revenues for 1996, 1997 and 1998, respectively. Revenues from sales to customers outside the United States accounted for 21.0%, 18.4% and 24.8% of our total revenues for 1996, 1997 and 1998, respectively. We rely on VARs and distributors to sell, install and support our products in countries outside of the United States, Canada, Mexico and the United Kingdom. We believe that our continued growth and profitability will require further expansion of our international operations. To successfully expand international sales, we must establish additional foreign operations, hire additional personnel and recruit additional VARs and distributors. To the extent that we are unable to do so on a timely basis, our revenue growth, if any, may be slowed, and profitability may be adversely affected as significant costs may be incurred in advance of the international revenues. Our international revenues are denominated primarily in U.S. dollars or British pounds. Our expenses incurred in foreign countries are typically denominated in local currencies. We have recognized pre-tax foreign exchange gains (losses) of approximately $162,000, ($20,000) and $(23,000) in 1996, 1997 and 1998, respectively. There can be no assurance that future fluctuations in currency exchange rates will not have a material adverse impact on our future international operations. RESULTS OF OPERATIONS The following table sets forth items shown in our statement of operations as a percentage of total revenues for the periods indicated. The table should be read in conjunction with our financial statements and notes thereto contained elsewhere in this report.
YEAR ENDED DECEMBER 31, ----------------------- 1996 1997 1998 ----- ----- ----- Net revenues: Product................................................... 67.5% 70.0% 72.7% Service................................................... 32.5 30.0 27.3 ----- ----- ----- Total revenues.................................... 100.0 100.0 100.0 Cost of revenues: Product................................................... 24.2 23.6 22.8 Service................................................... 14.4 14.7 14.3 ----- ----- ----- Total cost of revenues............................ 38.6 38.3 37.1 ----- ----- ----- Gross margin................................................ 61.4 61.7 62.9
14 16
YEAR ENDED DECEMBER 31, ----------------------- 1996 1997 1998 ----- ----- ----- Operating expenses: Engineering, research and development..................... 10.7 10.5 11.1 Selling, general and administrative....................... 35.2 33.8 33.5 ----- ----- ----- Total operating expenses.......................... 45.9 44.3 44.6 ----- ----- ----- Income from operations...................................... 15.5 17.4 18.3 Other income, net........................................... 0.5 1.0 1.2 ----- ----- ----- Income before income taxes.................................. 16.0 18.4 19.5 Income tax provision (benefit): Tax provision............................................. -- 4.6 7.0 Deferred tax adjustment................................... -- (2.2) -- ----- ----- ----- Net income.................................................. 16.0% 16.0% 12.5% ===== ===== ===== Income before pro forma income taxes........................ 16.0% 18.4% Pro forma income taxes...................................... 6.0 6.8 ----- ----- Pro forma net income........................................ 10.0% 11.6% ===== =====
The following table sets forth, for each component of net revenues, the cost of such revenues as a percentage of such revenues for the periods indicated:
YEAR ENDED DECEMBER 31, ----------------------- 1996 1997 1998 ----- ---- ---- Cost of product revenues.................................... 35.8% 33.7% 31.4% Cost of service revenues.................................... 44.4% 48.9% 52.4%
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Revenues Product. We increased our product revenues by 47.5% from $46.1 million in 1997 to $67.9 million in 1998. The increase in product revenues was due to continued strong demand for our products, increased marketing and sales efforts, increased international sales through the direct channel and increased sales through distribution channels. Over this period, we expanded our call center solutions with the introduction of PhoneFrame Explorer in the fourth quarter of 1997. Service. We increased our service revenues by 29.1% from $19.7 million in 1997 to $25.5 million in 1998. Service revenues increased primarily due to an increase in the number of maintenance and support agreements and, to a lesser degree, from revenues generated by installation of new systems, upgrades to existing systems and consulting services. We introduced consulting services in the fourth quarter of 1997. Cost of Revenues Product. The cost of product revenues includes the cost of material, the cost of sublicensing third-party software, personnel-related costs for internal product assembly and fees paid to third parties for outsourced product assembly. Cost of product revenues increased from $15.5 million, or 33.7% of related product revenues, in 1997, to $21.3 million, or 31.4% of related product revenues in 1998. The increase in absolute dollars in the cost of product revenues was due to the increase in the volume of shipments of our products. The product cost decrease, as a percentage of product revenues, was primarily due to product design improvements, reduced material purchase costs, and lower hardware content of the systems. Service. The cost of service revenues primarily consists of employee-related costs for customer support, consulting and field service personnel and fees paid to third parties for installation services and post- installation hardware maintenance services. Cost of service revenues increased from $9.6 million, or 48.9% of related service revenues, in 1997, to $13.3 million, or 52.4% of related services revenues, in 1998. The increase 15 17 in absolute dollars in the cost of service revenues was primarily due to the increase in service personnel to support the larger installed customer base and higher volume of installations. The increase as a percentage of service revenues, was primarily due to increased infrastructure spending for international operations and to support expansion of domestic indirect distribution channels. Operating Expenses Engineering, research and development. Engineering, research and development expenses primarily consist of employee-related costs for engineering personnel involved with software, voice processing and CTI technology development. Also included are outside contractor costs for development projects and expendable equipment purchases. Engineering, research and development costs increased from $6.9 million, or 10.5% of total revenues, in 1997, to $10.4 million, or 11.1% of total revenues, in 1998. The increase in absolute dollars resulted primarily from the addition of developers and outside contractors to support our new product development efforts, which were focused on continued enhancements to PhoneFrame Explorer and ongoing development of future products, including Enterprise Explorer. We intend to continue to invest heavily in product development activities. As a result, we expect that engineering, research and development costs will increase in absolute dollars and may increase as a percentage of revenues in the future. Selling, general and administrative. Selling, general and administrative expenses consist primarily of employee-related costs for sales, marketing, administrative, finance and human resources personnel. Also included are marketing expenditures for trade shows, advertising and other promotional expenditures. Selling, general and administrative costs increased from $22.3 million, or 33.8% of total revenues, in 1997, to $31.3 million, or 33.5% of total revenues, in 1998. This increase in absolute dollars was primarily related to the expansion of our sales and marketing resources, increased commission expenses due to higher sales, and increased levels of marketing activities. The decrease as a percentage of total revenues was primarily a result of leveraging the infrastructure and improvements to operating efficiencies. We intend to continue to expand our sales, marketing and sales support operations in 1999. As a result, we expect selling, general and administrative costs will increase in absolute dollars and may increase as a percentage of revenue in the future. Other Income (Expense), Net Other income (expense), net increased from $662,000 in 1997 to $1.2 million in 1998. The increase was primarily due to interest income earned on our investments in marketable securities and the elimination of interest expense attributable to the receipt of proceeds from our initial public offering in June 1997. Income Tax Provision (Benefit) In connection with the initial public offering on June 4, 1997, we converted our U.S. taxable status from an S corporation to a C corporation and, accordingly, we are subject to federal and state income taxes. We recorded tax provisions at the effective tax rate of 36.0% in 1998, as compared to 37.0% in 1997. The reduction in our effective tax rate was the result of certain tax planning initiatives. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 Revenues Product. We increased our product revenues by 43.6% from $32.1 million in 1996 to $46.1 million in 1997. The increase in product revenues was due to continued strong demand for our products, new product offerings and increased sales and marketing efforts. Over this period, we expanded our call center solutions by introducing Magellan in the fourth quarter of 1996. Service. We increased our service revenues by 27.6% from $15.5 million in 1996 to $19.7 million in 1997. Service revenues increased primarily due to an increase in the number of post-contract maintenance support agreements and, to a lesser degree, from revenues generated by installation of new systems and upgrades to existing systems. 16 18 Cost of Revenues Product. Cost of product revenues increased from $11.5 million, or 35.8% of related product revenues, in 1996, to $15.5 million, or 33.7% of related product revenues, in 1997. The increase in absolute dollars in the cost of product revenues was due to the increase in the volume of shipments of our products. The decrease as a percentage of product revenues was primarily due to product design improvements and reduced material purchase costs. Service. Cost of service revenues increased from $6.9 million, or 44.4% of related service revenues, in 1996, to $9.6 million, or 48.9% of related service revenues, in 1997. The increase in absolute dollars in the cost of service revenues was primarily due to the increase in service personnel to support the larger installed customer base and higher volume of installations. The increase as a percentage of service revenues was primarily due to increased infrastructure spending for international operations. Operating Expenses Engineering, research and development. Engineering, research and development costs increased from $5.1 million, or 10.7% of total revenues, in 1996, to $6.9 million, or 10.5% of total revenues, in 1997. The increase in absolute dollars resulted primarily from the addition of developers and outside contractors to support our new product development efforts, which resulted in the release of PhoneFrame Explorer in 1997. Selling, general and administrative. Selling, general and administrative costs increased from $16.8 million, or 35.2% of total revenues, in 1996, to $22.3 million, or 33.8% of total revenues, in 1997. This increase in absolute dollars was primarily related to the expansion of our sales and marketing resources, increased commission expenses due to higher sales, and increased levels of marketing activities. The decrease as a percentage of total revenues was primarily a result of leveraging the infrastructure and improving operating efficiency. Other Income (Expense), Net Other income (expense), net increased from $261,000 in 1996 to $662,000 in 1997. The increase was primarily due to interest income earned on our investments in marketable securities, which increased substantially due to the net proceeds of the June 1997 initial public offering of our stock and the $11.2 million of positive cash flow from operations recorded during 1997. Income Tax Provision (Benefit) Upon the conversion from an S corporation to a C corporation in June 1997, we recognized a one-time benefit by recording deferred tax assets of $1.5 million. Subsequent to our conversion, we also recorded tax provisions at the effective tax rate of 37.0% in 1997. FINANCIAL CONDITION Total assets as of December 31, 1998, were $75.3 million, an increase of $18.9 million from December 31, 1997. The increase was primarily due to increases in accounts receivable and net property and equipment. Cash, cash equivalents and marketable securities decreased by $374,000. Accounts receivable increased $16.5 million primarily due to increased sales levels. Net property and equipment increased by $2.1 million primarily due to purchases of equipment and software to support the increased number of employees and purchases of equipment used for development purposes. Current liabilities as of December 31, 1998 were $25.2 million, an increase of $6.1 million from December 31, 1997. The increase was primarily due to an increase in accounts payable and accrued liabilities. 17 19 LIQUIDITY AND CAPITAL RESOURCES We have funded our operations to date primarily through internally generated cash flow. Our operating activities generated cash of $9.3 million in 1996, $11.2 million in 1997 and $2.8 million in 1998. In 1998, our cash was generated by net income, an increase in accounts payable and accrued liabilities and deferred revenue, primarily offset by an increase in accounts receivable. In 1997, our cash was generated by net income, an increase in accounts payable and accrued liabilities, partially offset by an increase in accounts receivable and a decrease in customer deposits. Our investing activities used cash of $1.5 million in 1996, $27.5 million in 1997 and $3.0 million in 1998. Our use of cash was primarily for the purchase of capital equipment and software to support our growth and for investments in marketable securities. The increase from 1996 to 1997 of funds available for investing was principally due to the proceeds from our initial public offering in 1997. Our financing activities used cash of $3.8 million in 1996 and generated $13.2 million in 1997 and $1.0 million in 1998. During 1997, we received $36.0 million of cash from the initial public offering of our stock. As of December 31, 1998, we had working capital of $42.9 million. Cash, cash equivalents and marketable securities were $30.4 million. We estimate that we will incur capital expenditures of approximately $5 million in 1999, related to anticipated increased capital needs of technology and facility upgrades, and support of increased staffing. We believe that existing cash, cash equivalents and marketable securities and potential cash flow from operations will be sufficient to meet our cash requirements for at least the next twelve months. YEAR 2000 READINESS Introduction Many currently installed computer systems and software products are coded to accept only two digit entries in date code fields. Beginning in the year 2000, many of these systems will need to be modified to accept four digit entries or otherwise distinguish twenty-first century dates from twentieth century dates. As a result, over the next year, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. The Company's State of Readiness Our management has chartered a Year 2000 Committee and charged it with the task of evaluating our Year 2000 readiness and recommending action that we should take to minimize disruption from the Year 2000 issue. The Year 2000 Committee has developed a comprehensive checklist, or Year 2000 Plan, to address our Year 2000 readiness with respect to both IT and non-IT systems. The Year 2000 Plan covers all major and minor IT and non-IT systems potentially impacted by the Year 2000. Beginning in the second quarter of 1998, we initiated a quarterly review of the status of resolution of any items in the Year 2000 Plan. The latest versions of our products are designed to be Year 2000 compliant. We are in the process of determining the extent to which our earlier software products as implemented in our installed customer base are Year 2000 compliant, as well as the impact of any non-compliance on us and our customers. To operate our business, we rely upon relationships with third parties over which we can assert little control. The Year 2000 Committee is in the process of assessing the risks associated with the failure of such third parties to adequately address the Year 2000 issue. The Year 2000 Committee is also assessing the risks associated with non-IT systems on which our operations rely that may contain microcontrollers or embedded systems technologies that are not Year 2000 compliant. The Costs to Address Our Year 2000 Issues We estimate that the cost to address our Year 2000 issues will not have a material impact on operations. 18 20 The Risks of Our Year 2000 Issues We do not currently believe that the effects of any Year 2000 non-compliance in our installed base of software adversely affect our business, financial condition and results of operations. However, our investigation is in its preliminary stages, and no assurance can be given that we will not be exposed to potential claims resulting from system problems associated with the century change. There can also be no assurance that our software products that are designed to be Year 2000 compliant contain all necessary date code changes. In addition, Year 2000 non-compliance in our internal IT systems and certain non-IT systems on which our operations rely or non-compliance by our business partners could adversely affect our business, financial condition and results of operations. We believe that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues in a variety of ways. Many companies are expending significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase software products such as those offered by us. Potential customers may also choose to defer purchasing Year 2000 compliant products until they believe it is absolutely necessary, thus potentially resulting in stalled market sales within the industry. Conversely, Year 2000 issues may cause other companies to accelerate purchases, thereby causing an increase in short-term demand and a consequent decrease in long-term demand for software products. Additionally, Year 2000 issues could cause a significant number of companies, including our current customers, to reevaluate their current software needs and as a result switch to other systems or suppliers. Any of the foregoing could adversely affect our business, financial condition and results of operations. Our Contingency Plans We are prepared to develop contingency plans for business functions that are susceptible to a substantive risk of disruption resulting from a Year 2000 related event. However, we have not yet identified any business function that is materially at risk of Year 2000 related disruption, and thus have not yet developed detailed contingency plans specific to Year 2000 events for any business function. We are prepared for the possibility, however, that certain business functions may be hereafter identified as at risk. We will develop contingency plans for such business functions as and if such determinations are made. NEW ACCOUNTING PRONOUNCEMENT In 1998, the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 will be effective for our fiscal year ending December 31, 2000. We do not believe that the adoption of this pronouncement will have a material impact on our financial position or results of operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to a number of market risks in the ordinary course of our business, such as foreign currency exchange risk resulting from our international operations. These risks arise in the normal course of business rather than from trading. In addition, some of our traded assets are exposed to market risks such as interest rate fluctuations. Primarily securities owned by us through Melita Finance Corporation, our wholly-owned investment subsidiary, are sensitive to changes in interest rates. Our management has examined our exposures to all of these risks and has concluded that none of our exposures in these areas is material to fair values, cash flows or earnings. 19 21 The following table provides information about securities owned by us through Melita Finance Corporation that are sensitive to markets risks:
SECURITIES SENSITIVE TO MARKET RISK BY MATURITY AS OF DECEMBER 31, 1998 (IN THOUSANDS) 2004 AND 1999 2000 2001 2002 2003 AFTER TOTAL ------ ------ ---- ---- ---- -------- ------- Fixed Rate ($US) $5,242 $4,131 -- -- -- $12,956 $22,329 Average Interest Rate 6.35% 6.55% -- -- -- 6.74% 6.56%
20 22 ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998 AND 1997 TOGETHER WITH AUDITORS' REPORT INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of Independent Public Accountants.................... 21 Consolidated Balance Sheets as of December 31, 1997 and 1998...................................................... 22 Consolidated Statements of Operations for the three years in the period ended December 31, 1998........................ 23 Consolidated Statements of Shareholders' Equity for the three years in the period ended December 31, 1998......... 24 Consolidated Statements of Comprehensive Income for the three years in the period ended December 31, 1998......... 25 Consolidated Statements of Cash Flows for the three years in the period ended December 31, 1998........................ 26 Notes to Consolidated Financial Statements.................. 27
21 23 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Melita International Corporation: We have audited the accompanying consolidated balance sheets of Melita International Corporation (a Georgia corporation) and subsidiaries as of December 31, 1997 and 1998 and the related consolidated statements of operations, shareholders' equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 financial statements referred to above present fairly, in all material respects, the financial position of Melita International Corporation and subsidiaries as of December 31, 1997 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Atlanta, Georgia January 30, 1999 22 24 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1998 (IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, ------------------ 1997 1998 ------- ------- ASSETS Current assets: Cash and cash equivalents................................. $ 6,845 $ 7,684 Marketable securities..................................... 23,969 22,756 Accounts receivable, net of allowance for doubtful accounts of $876 and $2,450 at December 31, 1997 and 1998, respectively..................................... 15,796 32,287 Inventories............................................... 2,461 1,260 Deferred taxes............................................ 2,035 3,731 Prepaid expenses and other................................ 251 403 ------- ------- Total current assets.............................. 51,357 68,121 ------- ------- Property and equipment, at cost: Furniture and fixtures.................................... 1,648 2,241 Equipment................................................. 8,195 11,618 Leasehold improvements.................................... 831 1,095 ------- ------- Total property and equipment...................... 10,674 14,954 Less accumulated depreciation............................. 5,735 7,946 ------- ------- Net property and equipment........................ 4,939 7,008 Other assets................................................ 99 179 ------- ------- $56,395 $75,308 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 5,326 $ 6,624 Accrued liabilities....................................... 7,763 11,835 Deferred revenue.......................................... 4,029 5,965 Customer deposits......................................... 1,988 815 ------- ------- Total current liabilities......................... 19,106 25,239 ------- ------- Commitments and contingencies (Note 5) Shareholders' equity: Preferred stock, no par value; 20,000,000 shares authorized, no shares issued and outstanding at December 31, 1997 and 1998............................. -- -- Common stock, no par value; 100,000,000 shares authorized; 15,168,395 shares issued and outstanding at December 31, 1997, and 15,270,738 shares issued and outstanding at December 31, 1998................................... 69 69 Additional paid-in capital................................ 36,046 37,075 Accumulated other comprehensive income.................... 30 96 Retained earnings......................................... 1,144 12,829 ------- ------- Total shareholders' equity........................ 37,289 50,069 ------- ------- $56,395 $75,308 ======= =======
The accompanying notes are an integral part of these consolidated balance sheets. 23 25 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, --------------------------------- 1996 1997 1998 --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net revenues: Product................................................... $32,077 $46,065 $67,943 Service................................................... 15,463 19,725 25,467 ------- ------- ------- Total revenues.................................... 47,540 65,790 93,410 ------- ------- ------- Cost of revenues: Product................................................... 11,494 15,531 21,336 Service................................................... 6,863 9,642 13,346 ------- ------- ------- Total cost of revenues............................ 18,357 25,173 34,682 ------- ------- ------- Gross margin................................................ 29,183 40,617 58,728 ------- ------- ------- Operating expenses: Engineering, research and development..................... 5,070 6,880 10,410 Selling, general and administrative....................... 16,765 22,320 31,253 ------- ------- ------- Total operating expenses.......................... 21,835 29,200 41,663 ------- ------- ------- Income from operations...................................... 7,348 11,417 17,065 Other income, net........................................... 261 662 1,193 ------- ------- ------- Income before income taxes.................................. 7,609 12,079 18,258 Income tax provision (benefit): Tax provision as C corporation............................ -- 3,023 6,573 Deferred tax adjustment................................... -- (1,473) -- ------- ------- ------- Net income.................................................. $ 7,609 $10,529 $11,685 ======= ======= ======= Pro forma net income: Income before income taxes................................ $ 7,609 $12,079 Pro forma income taxes.................................... 2,827 4,469 ------- ------- Pro forma net income.............................. $ 4,782 $ 7,610 ======= ======= Earnings per share: Basic earnings per share.................................. $ 0.63 $ 0.76 $ 0.77 Diluted earnings per share................................ $ 0.62 $ 0.73 $ 0.74 Pro forma basic earnings per share........................ $ 0.40 $ 0.55 Pro forma diluted earnings per share...................... $ 0.39 $ 0.53 Weighted average shares outstanding: Basic..................................................... 12,088 13,832 15,193 Diluted................................................... 12,363 14,386 15,815
The accompanying notes are an integral part of these consolidated statements. 24 26 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ---------------------------------------------------------- MELITA INTERNATIONAL MELITA EUROPE CORPORATION LIMITED INVENTIONS, INC. ADDITIONAL ------------------- ---------------- ----------------- PAID-IN SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL ---------- ------ ------- ------ ------- ------- ---------- (IN THOUSANDS, EXCEPT SHARE DATA) Balance, December 31, 1995................... 8,000,000 $ 2 31,328 $46 100 $1 $ 20 Net income before pro forma income taxes..... -- -- -- -- -- -- -- Distributions to shareholders........... -- -- -- -- -- -- -- Foreign currency translation adjustment............. -- -- -- -- -- -- -- ---------- --- ------- --- ---- -- ------- Balance, December 31, 1996................... 8,000,000 2 31,328 46 100 1 20 Net income before pro forma income taxes..... -- -- -- -- -- -- -- Proceeds from the issuance of common stock.................. 4,025,000 -- -- -- -- -- 36,046 Combination transaction (Note 1)............... 3,143,395 67 (31,328) (46) (100) (1) (20) Note and cash distributions to shareholders........... -- -- -- -- -- -- -- Unrealized gain on marketable securities............. -- -- -- -- -- -- -- Foreign currency translation adjustment............. -- -- -- -- -- -- -- ---------- --- ------- --- ---- -- ------- Balance, December 31, 1997................... 15,168,395 69 -- -- -- -- 36,046 Net income............... -- -- -- -- -- -- -- Proceeds from the issuance of common stock.................. 102,343 -- -- -- -- -- 1,029 Unrealized gain on marketable securities............. -- -- -- -- -- -- -- Foreign currency translation adjustment............. -- -- -- -- -- -- -- ---------- --- ------- --- ---- -- ------- Balance, December 31, 1998................... 15,270,738 $69 -- $-- -- $-- $37,075 ========== === ======= === ==== == ======= OTHER COMPREHENSIVE RETAINED INCOME EARNINGS TOTAL ------------- -------- -------- (IN THOUSANDS, EXCEPT SHARE DATA) Balance, December 31, 1995................... $ 5 $ 6,583 $ 6,657 Net income before pro forma income taxes..... -- 7,609 7,609 Distributions to shareholders........... -- (3,424) (3,424) Foreign currency translation adjustment............. 30 -- 30 --- -------- -------- Balance, December 31, 1996................... 35 10,768 10,872 Net income before pro forma income taxes..... -- 10,529 10,529 Proceeds from the issuance of common stock.................. -- -- 36,046 Combination transaction (Note 1)............... -- -- -- Note and cash distributions to shareholders........... -- (20,153) (20,153) Unrealized gain on marketable securities............. 15 -- 15 Foreign currency translation adjustment............. (20) -- (20) --- -------- -------- Balance, December 31, 1997................... 30 1,144 37,289 Net income............... -- 11,685 11,685 Proceeds from the issuance of common stock.................. -- -- 1,029 Unrealized gain on marketable securities............. 89 -- 89 Foreign currency translation adjustment............. (23) -- (23) --- -------- -------- Balance, December 31, 1998................... $96 $ 12,829 $ 50,069 === ======== ========
The accompanying notes are an integral part of these consolidated statements. 25 27 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEAR ENDED DECEMBER 31, -------------------------- 1996 1997 1998 ------ ------- ------- (IN THOUSANDS) Net income.................................................. $7,609 $10,529 $11,685 Other comprehensive income, net of tax: Foreign currency translation adjustment................... 30 (20) (23) Unrealized gain on marketable securities.................. -- 15 89 ------ ------- ------- Other comprehensive income............................. 30 (5) 66 ------ ------- ------- Comprehensive income........................................ $7,639 $10,524 $11,751 ====== ======= =======
The accompanying notes are an integral part of these consolidated statements. 26 28 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, --------------------------- 1996 1997 1998 ------ -------- ------- (IN THOUSANDS) Cash flows from operating activities: Net income or pro forma net income........................ $4,782 $ 7,610 $11,685 Adjustments to reconcile net income or pro forma net income to net cash provided by operating activities: Pro forma income taxes................................. 2,827 1,446 -- Deferred taxes......................................... -- (562) (1,695) Depreciation and amortization.......................... 1,141 1,279 2,212 Loss on sale of property and equipment................. 6 -- -- Changes in assets and liabilities: Accounts receivable.................................. (2,657) (3,935) (16,492) Inventories.......................................... 585 (19) 1,201 Prepaid expenses and other assets.................... 172 (81) (152) Accounts payable..................................... (334) 2,897 1,298 Accrued liabilities.................................. 794 3,552 4,071 Deferred revenue..................................... 472 964 1,936 Customer deposits.................................... 1,417 (1,861) (1,173) Other, net........................................... 63 (95) (103) ------ -------- ------- Total adjustments................................. 4,486 3,585 (8,897) ------ -------- ------- Net cash provided by operating activities......... 9,268 11,195 2,788 ------ -------- ------- Cash flows from investing activities: Purchases of property and equipment....................... (1,531) (3,494) (4,280) Purchases of marketable securities........................ -- (23,954) 1,302 ------ -------- ------- Net cash used in investing activities............. (1,531) (27,448) (2,978) ------ -------- ------- Cash flows from financing activities: Repayment of capital lease obligations.................... (48) (19) -- Net proceeds from issuance of common stock................ -- 36,046 1,029 Repayment of notes payable to stockholder................. -- (2,625) -- Repayment of notes payable to stockholder representing distributions.......................................... (375) (12,900) -- Distributions to stockholder.............................. (3,424) (7,253) -- ------ -------- ------- Net cash provided by (used in) financing activities...................................... (3,847) 13,249 1,029 ------ -------- ------- Net change in cash and cash equivalents..................... 3,890 (3,004) 839 Cash and cash equivalents, beginning of year................ 5,959 9,849 6,845 ------ -------- ------- Cash and cash equivalents, end of year...................... $9,849 $ 6,845 $ 7,684 ====== ======== ======= Marketable securities....................................... $ -- $ 23,969 $22,756 ====== ======== ======= Cash, cash equivalents and marketable securities............ $9,849 $ 30,814 $30,440 ====== ======== ======= Supplemental cash flow information: Cash paid for interest during the year...................... $ 279 $ 335 -- ====== ======== ======= Income taxes paid........................................... $ -- $ 3,198 $ 6,392 ====== ======== =======
The accompanying notes are an integral part of these consolidated statements. 27 29 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Melita International Corporation ("Melita" or the "Company") provides customer contact and customer relationship management systems that enable its customers to operate efficient call centers. The Company's principal product is an integrated system comprised of both hardware and software. Melita offers ongoing maintenance support for its products, as well as fee-based installation, education and consulting services. The Company markets its products worldwide through direct sales forces and through distributors in Europe, Latin America and Asia (Note 7). COMPLETION OF INITIAL PUBLIC OFFERING On June 4, 1997, the Company completed an initial public offering (the "Offering") of 4,025,000 shares of common stock at $10 per share resulting in net proceeds of $36,046,000. BASIS OF COMBINATION Prior to June 4, 1997, the financial statements are presented on a combined basis and include the accounts of Melita, Melita Europe Limited ("Melita Europe") and Inventions, Inc. ("Inventions"), since all were under common control. All significant intercompany accounts and transactions have been eliminated in combination. Concurrent with the Offering, the shareholders of Melita Europe and Inventions contributed their respective shares in exchange for 3,143,395 shares of Melita. The combination was treated similar to a pooling of interests and no step-up basis was recorded as the entities involved were under common control. PRINCIPLES OF CONSOLIDATION The accompanying financial statements since June 4, 1997 include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances have been eliminated in consolidation. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash or cash equivalents. MARKETABLE SECURITIES The Company's marketable securities are categorized as available-for-sale securities, as defined by the Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Unrealized holding gains and losses are reflected as a net amount in a separate component of shareholders' equity until realized. For the purpose of computing realized gains and losses, cost is identified on a specific identification basis. 28 30 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) INVENTORIES Inventories are stated at the lower of cost (first-in, first-out method) or market. Cost includes raw materials, labor, and overhead. Market is defined as replacement cost for work in progress and raw materials and net realizable value for finished goods. Inventories consist of the following at December 31, 1997 and 1998 (in thousands):
1997 1998 ------ ------ Raw materials............................................... $1,251 $ 143 Work in process............................................. 457 37 Finished goods.............................................. 753 1,080 ------ ------ Total inventories................................. $2,461 $1,260 ====== ======
PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. The straight-line method of depreciation was adopted for property placed in service after September 30, 1997. Prior to September 30, 1997, an accelerated method was used. The difference between the accelerated method and the straight-line method was immaterial. The estimated useful lives are as follows: Furniture and fixtures............. Five to seven years Equipment.......................... Three to seven years Leasehold improvements............. Remaining life of lease
INCOME TAXES Prior to June 4, 1997, Melita and Inventions were organized as S corporations under the Internal Revenue Code and, therefore, were not subject to federal income taxes. The income or loss of Melita and Inventions was included in the shareholders' individual federal and state tax returns, and as such, no provision for income taxes was recorded in the accompanying combined statements of operations. The Company historically made distributions to cover the shareholders' anticipated tax liability. In connection with the Offering, the Company converted its U.S. taxable status from an S corporation to a C corporation and, accordingly, became subject to federal and state income taxes. Upon the conversion, the Company recognized a one-time benefit by recording deferred tax assets of $1,473,000. The accompanying financial statements prior to June 4, 1997 reflect a provision for income taxes on a pro forma basis as if the Company were liable for federal and state income taxes as a taxable corporate entity throughout the years presented. The pro forma income tax provision has been computed by applying the Company's anticipated statutory tax rate to pretax income, adjusted for permanent tax differences (Note 3). FOREIGN CURRENCY TRANSLATION The financial statements of Melita Europe are translated into U.S. dollars in accordance with SFAS No. 52, "Foreign Currency Translation." Net assets of Melita Europe are translated at the current rates of exchange at December 31. Income and expense items are translated at the average exchange rate for the year. The resulting translation adjustments are recorded in shareholders' equity. The Company has recognized foreign exchange gains (losses) of approximately $162,000, ($20,000) and ($23,000) in 1996, 1997 and 1998, respectively. 29 31 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) REVENUE RECOGNITION The Company generates product revenues primarily from its principal product, an integrated system comprised of both hardware and software. The Company's service revenues are generated from maintenance contracts which include support, parts and labor, and software update rights. Service revenues also include fee-based installation, training, and consulting services. The Company recognizes product revenues when a contract has been executed, the product has been shipped and the Company has no significant obligations yet to be satisfied. The Company's sales contracts provide for certain payment terms normally based upon signing the contract, customer receipt of the product, and commencement of operation of the customer's system. Revenues from maintenance contracts are recognized ratably over the term of the contractual support period which ranges up to 5 years. If maintenance is included in the original integrated product contract, such amounts are unbundled from the license fee based on the value established by independent sale of such maintenance to customers. Consulting revenues are primarily related to implementation services performed under separate service arrangements related to the installation of the Company's hardware and software products. Revenues from consulting, installation, and training services are recognized as the services are performed. Deferred revenues primarily relate to products that have not yet been delivered and maintenance services which have been paid by the customers prior to the performance of those services. Deferred revenue amounted to $4,029,000 and $5,965,000 at December 31, 1997 and 1998, respectively. CAPITALIZED SOFTWARE DEVELOPMENT COSTS Research and development expenditures are charged to expense as incurred. Software development costs are charged to research and development expense until technological feasibility is established, after which remaining software production costs are capitalized in accordance with SFAS No. 86, "Accounting for Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed." The Company has defined technological feasibility of its products as the point in time at which the Company has a working model of the related product, which is when the product has achieved "beta" status. Historically, the development costs incurred during the period between the achievement of beta status by a product and the point at which the product is available for general release to customers have not been material. Accordingly, the Company has concluded that the amount of development costs capitalizable under the provisions of SFAS No. 86 was not material to the financial statements for the years ended December 31, 1996, 1997 and 1998. Therefore, the Company has charged all software development costs to expense as incurred for the years ended December 31, 1996, 1997 and 1998. WARRANTY COSTS The Company generally warranties its products for 90 days and provides for estimated warranty costs upon shipment of such products. Warranty costs have not been and are not anticipated to be significant. CONCENTRATIONS OF CREDIT RISK Concentrations of credit risk with respect to accounts receivable are limited due to the wide variety of customers and markets for which the Company's services are provided as well as their dispersion across many different geographic areas. As a result, as of December 31, 1997 and 1998, the Company did not consider itself to have any significant concentrations of credit risk. During 1997, only BankOne Services Corporation (now First USA Bank), at 11.8%, accounted for greater than 10% of total revenues. During 1998, only CitiGroup, at 13.1%, accounted for greater than 10% of total revenues. In 1996, 1997 and 1998, the Company's five largest customers accounted for approximately 24.5%, 27.9% and 23.2%, respectively, of total revenues. These sales 30 32 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) were predominantly to customers in the financial services industry. Although the particular customers may change from period to period, the Company expects that large sales to a limited number of customers will continue to account for a significant percentage of its revenues in any particular period for the foreseeable future. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. BASIC AND DILUTED NET EARNINGS PER SHARE Basic earnings per share and pro forma basic earnings per share are computed using net income or pro forma net income divided by the sum of (i) the weighted average number of shares of common stock outstanding ("Weighted Shares") for the period presented including the number of shares issued in the combination of Melita, Melita Europe and Inventions discussed in Note 1 and (ii) for periods prior to the Offering, the number of shares pursuant to Staff Accounting Bulletin 1B.3 that at the assumed public offering price would yield proceeds in the amount necessary to pay the distribution to the majority stockholder as a result of the Offering that are not covered by the earnings for the year ("Distribution Shares"). The only difference between basic and diluted net earnings per share is the result of the treasury stock method effect of common equivalent shares ("CESs"). Diluted earnings per share and pro forma diluted earnings per share is computed using net income or pro forma net income divided by the sum of (i) Weighted Shares, (ii) the Distribution Shares and (iii) the treasury stock method effect of CESs outstanding of 275,000, 554,000 and 622,000 for the years ended December 31, 1996, 1997 and 1998, respectively. FAIR VALUE OF FINANCIAL INSTRUMENTS The book values of accounts receivable, accounts payable, and other financial instruments approximate their fair values at December 31, 1997 and 1998 principally because of the short-term maturities of these instruments. ACCRUED LIABILITIES Accrued liabilities at December 31, 1997 and 1998 include the following (in thousands):
1997 1998 ------ ------- Accrued salaries and wages.................................. $3,279 $ 4,935 Other current liabilities................................... 4,169 6,608 Accrued rent................................................ 315 292 ------ ------- Total accrued liabilities......................... $7,763 $11,835 ====== =======
NEW ACCOUNTING PRONOUNCEMENTS In 1998, the Financial Accounting Standards Board issued Statement No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 is effective for the year ending December 31, 2000. The adoption of this statement is not expected to have a significant impact on the Company's financial statements. 31 33 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) RECLASSIFICATIONS Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. 2. NOTES PAYABLE TO SHAREHOLDER In 1997, the Company issued to the shareholder of the Company notes payable in the amount of $12,900,000 representing undistributed earnings through December 31, 1996. Additionally, the Company accumulated earnings of $7,253,000 through the closing date of the Offering. With the proceeds from the Offering, the Company paid an original note of $2,625,000 and the $12,900,000 notes payable and the $7,253,000 of additional accumulated earnings through the closing date of the Offering. Interest paid to shareholder was $271,000, $335,000, and $0 for the years ended December 31, 1996, 1997 and 1998, respectively. 3. INCOME TAXES In connection with the Offering, the Company converted from an S corporation to a C corporation and, accordingly, became subject to federal and state income taxes. The components of the total deferred tax assets as of December 31, 1997 and 1998 are as follows (in thousands):
1997 1998 ------ ------ Deferred tax assets and liabilities: Deferred revenue.......................................... $1,207 $1,866 Accrued liabilities....................................... 230 623 Allowance for doubtful accounts........................... 263 784 Depreciation.............................................. (70) 64 Inventory................................................. 405 394 ------ ------ Total net deferred tax assets..................... $2,035 $3,731 ====== ======
The following summarizes the components of the income tax provision for the years ended December 31, 1996, 1997 and 1998 (in thousands):
PRO FORMA ACTUAL --------------- ------- 1996 1997 1998 ------ ------ ------- Current domestic taxes: Federal................................................... $2,775 $4,405 $ 6,546 State..................................................... 326 517 580 Foreign taxes............................................... (75) 109 1,143 Deferred taxes.............................................. (199) (562) (1,696) ------ ------ ------- Tax provision..................................... $2,827 $4,469 $ 6,573 ====== ====== =======
32 34 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A reconciliation from the federal statutory rate to the tax provision for the years ended December 31, 1996, 1997 and 1998 is as follows:
PRO FORMA ACTUAL ----------- ------ 1996 1997 1998 ---- ---- ------ Statutory federal tax rate.................................. 34.0% 34.0% 35.0% State income taxes, net of federal tax benefit.............. 4.0 4.0 2.4 Foreign operations.......................................... (1.3) (1.2) (0.8) Other....................................................... 0.5 0.2 (0.6) ---- ---- ---- Effective tax rate.......................................... 37.2% 37.0% 36.0% ==== ==== ====
4. BENEFIT PLAN Melita has a defined contribution profit-sharing plan (the "Plan") for substantially all Melita employees meeting the eligibility requirements as defined in the plan agreement. The Plan provides for annual contributions by Melita at the discretion of the board of directors. The Plan also contains a 401(k) feature which allows participants to contribute up to 15% of their eligible compensation, as defined, and provides for discretionary employer matching contributions. Total contributions by Melita to the Plan were $119,000, $429,000 and $391,000 for the years ended December 31, 1996, 1997 and 1998, respectively. 5. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS At December 31, 1998, the future minimum operating lease payments (including leases with related parties) under noncancelable operating leases were as follows (in thousands): 1999........................................................ $ 810 2000........................................................ 723 2001........................................................ 668 2002........................................................ 607 Thereafter.................................................. 1,768 ------ Total future minimum lease payments............... $4,576 ======
The Company's leases are primarily for equipment and facilities. Total rental expense for operating leases was $751,000, $714,000 and $866,000 in 1996, 1997 and 1998, respectively. In August 1994, the Company entered into a lease agreement with an unrelated party to lease land and buildings commencing April 1995. The agreement provides for annual rentals of approximately $542,000 to $636,000 per year over a ten-year term. In November 1995, the Company's majority shareholder purchased the land and buildings and now rents them to the Company under the terms of the original lease. Rent expense paid to the shareholder was $543,000, $544,000 and $555,000 in 1996, 1997 and 1998, respectively. LEGAL MATTERS Many of the Company's installations involve products that are critical to the operations of its clients' businesses. Any failure in a Company product could result in a claim for substantial damages against the Company, regardless of the Company's responsibility for such failure. Although the Company attempts to limit contractually its liability for damages arising from product failures or negligent acts or omissions, there can be no assurance the limitations of liability set forth in its contracts will be enforceable in all instances. 33 35 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company is subject to legal proceedings and claims which have arisen in the ordinary course of business. In the opinion of management, the amount of potential liability with respect to these actions will not materially affect the financial position or results of operations of the Company. 6. STOCK OPTION PLANS During 1992, the Company approved a stock option plan (the "1992 Plan") for key employees for which 640,000 shares of common stock were authorized for use in the plan. During 1995, the number of authorized shares was increased to 1,000,000 shares of common stock. Options are granted at the fair market value and are exercisable based on the specific terms of the grant up to ten years from the grant date. Options granted primarily vest ratably over a four- or five-year employment period. The Company reserved the right to purchase vested options at the then-estimated fair market value prior to the date of an IPO. During 1996, the Company purchased 30,250 vested but unexercisable options held by terminated employees for $39,774. No options were purchased during 1997 or 1998. Cash paid to repurchase options is expensed as incurred. On February 6, 1997, the Company approved the 1997 Stock Option Plan (the "1997 Plan") for which 1,350,000 shares of common stock were authorized for issuance, less any options issued under the 1992 Plan. In October of 1997, the Company increased the number of shares available under the 1997 Plan to 1,850,000. On May 11, 1998, the shareholders approved an amendment to the 1997 Plan whereby the number of shares of common stock available for issuance under the 1997 Plan will automatically be adjusted on the first day of each fiscal year, beginning with 1998, by a number of shares such that the total number of shares reserved for issuance under the 1997 Plan equals the sum of (i) the aggregate number of shares previously issued under the 1997 Plan and the 1992 Plan; (ii) the aggregate number of shares subject to then outstanding options granted under the 1997 Plan and the 1992 Plan; and (iii) 5% of the number of shares of common stock outstanding on the last day of the preceding fiscal year. Options are granted at the fair market value and are exercisable based on the specific terms of the grant up to ten years from the grant date. The options vest primarily over a four-year period subject to acceleration upon the achievement of certain performance measures. 34 36 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Activity for the 1992 Plan and 1997 Plan is as follows:
OPTION OPTIONS PRICE --------- ----------- Outstanding at December 31, 1995............................ 861,450 $2.75-$3.00 Granted................................................... 133,785 4.07 Exercised................................................. -- Forfeited/repurchased..................................... (57,463) 2.75- 4.07 --------- Outstanding at December 31, 1996............................ 937,772 2.75- 4.07 Granted................................................... 457,325 5.50-10.00 Exercised................................................. -- Forfeited/repurchased..................................... (120,309) 2.91-10.00 --------- Outstanding at December 31, 1997............................ 1,274,788 2.75-10.00 Granted................................................... 1,072,125 5.50-10.00 Exercised................................................. (80,245) Forfeited/repurchased..................................... (498,487) 2.75-14.50 --------- Outstanding at December 31, 1998............................ 1,768,181 2.75-14.50 =========
At December 31, 1998, options to purchase 747,559 shares were available for future grant and options were exercisable to purchase 698,999 shares, as discussed in the following table:
NUMBER OF SHARES NUMBER WEIGHTED OUTSTANDING AT WEIGHTED EXERCISABLE AT AVERAGE EXERCISE DECEMBER 31, AVERAGE DECEMBER 31, EXERCISE PRICES 1998 EXERCISE PRICE 1998 PRICE -------- -------------- -------------- -------------- -------- $ 2.75-$ 3.00 621,054 $ 2.89 529,273 $ 2.88 4.07- 7.94 215,242 5.30 98,926 4.71 8.38- 10.00 552,400 9.11 64,000 9.30 10.25- 14.50 379,485 11.31 6,800 10.25 --------- ------- $ 2.75-$14.50 1,768,181 $ 6.93 698,999 $ 3.80 ========= =======
During 1995, the Financial Accounting Standards Board issued SFAS No. 123, which defines a fair value-based method of accounting for an employee stock option plan or similar equity instrument. However, it also allows an entity to continue to measure compensation cost for those plans using the method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." Entities electing to remain with the accounting in APB No. 25 must make pro forma disclosures of net income and, if presented, earnings per share, as if the fair value-based method of accounting defined in the statement had been applied. The Company has elected to account for its stock-based compensation plan under APB No. 25; however, the Company has computed for pro forma disclosure purposes the value of all options granted during 1996 and 1997 using the Black-Scholes option pricing model as prescribed by SFAS No. 123 using the following weighted average assumptions used for grants in 1996, 1997 and 1998:
1996 1997 1998 --------- --------- --------- Risk-free interest rate...................... 5.4%-6.5% 5.7%-6.5% 4.0%-5.5% Expected dividend yield...................... -- -- -- Expected lives............................... 5 years 5 years 5 years Expected volatility.......................... 65% 65% 65%
35 37 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The total value of the options granted during the years ended December 31, 1996, 1997 and 1998 were computed as approximately $264,000, $1,716,000 and $6,613,000, respectively, which would be amortized over the vesting period of the options. If the Company had accounted for these plans in accordance with SFAS No. 123, the Company's reported earnings and pro forma earnings and net income per share and pro forma net income per share for the years ended December 31, 1996, 1997 and 1998 would have decreased to the following amounts (in thousands, except per share amounts):
PRO FORMA ACTUAL --------------- ------- 1996 1997 1998 ------ ------ ------- Net income or pro forma net income: As reported in the financial statements................... $4,782 $7,610 $11,685 Pro forma in accordance with SFAS No. 123................. 4,581 7,288 10,861 Basic earnings per share: As reported in the financial statements................... $ 0.40 $ 0.55 $ 0.77 Pro forma in accordance with SFAS No. 123................. 0.38 0.53 0.71 Diluted earnings per share: As reported in the financial statements................... $ 0.39 $ 0.53 $ 0.74 Pro forma in accordance with SFAS No. 123................. 0.37 0.51 0.69
7. GEOGRAPHIC INFORMATION Melita is a multinational corporation operating in a single segment as defined by statement of Financial Accounting Standards No. 131 "Disclosures about Segments of an Enterprise and Related Information." The following represents total revenues, net income and total assets of the following geographic segments representing over 10% of the combined totals for the years ended December 31, 1996, 1997 and 1998 (in thousands):
1996 1997 1998 ------- ------- ------- United States: Total revenues.......................................... $37,568 $53,694 $70,289 Net income.............................................. 6,217 8,682 9,569 Total assets............................................ 23,799 51,612 66,812 Europe: Total revenues.......................................... $ 4,292 $ 7,347 $ 9,939 Net income.............................................. 452 1,680 1,733 Total assets............................................ 3,270 4,594 6,830 Other: Total revenues.......................................... $ 5,680 $ 4,749 $13,182 Net income.............................................. 940 167 383 Total assets............................................ -- 189 1,666
8. STOCK RECAPITALIZATION On February 7, 1997, the Company and Inventions recapitalized their authorized, issued, and outstanding common stock by declaring a stock dividend of 99 shares of nonvoting common stock with respect to each outstanding share of voting common stock. In connection with the stock dividend, the Company amended its articles of incorporation to increase its authorized capital stock to 2,000,000,000 shares, consisting of 20,000,000 shares of voting common stock and 1,980,000,000 shares of nonvoting common stock and Inventions amended its articles of incorporation to increase its authorized capital stock to 10,000 shares, consisting of 100 shares of voting common stock and 9,900 shares of nonvoting common stock. Concurrently on the effective date of the Offering, the Company effected a 100 to 1 reverse stock split to return the number 36 38 MELITA INTERNATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) of authorized shares to 20,000,000 shares and issued and outstanding shares to 8,000,000 shares. Accordingly, the financial statements reflect the capitalization of the Company as if the stock dividend and the reverse stock split occurred at the beginning of each period presented. Additionally, following completion of the Offering, the Company's authorized capital stock consists of 100,000,000 shares of common stock, no par value per share, and 20,000,000 shares of preferred stock, no par value per share. 9. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Following is a summary of the quarterly results of operations for the years ended December 31, 1996, 1997 and 1998 (in thousands except per share amounts):
FIRST SECOND THIRD FOURTH TOTAL ------- ------- ------- ------- ------- 1996 Total revenues........................... $11,021 $11,886 $11,589 $13,044 $47,540 Gross margin............................. 7,133 7,163 7,027 7,860 29,183 Pro forma net income..................... 1,278 1,299 909 1,296 4,782 Pro forma diluted earnings per share..... 0.10 0.11 0.07 0.10 0.39 1997 Total revenues........................... $14,669 $15,530 $16,928 $18,663 $65,790 Gross margin............................. 8,902 9,532 10,488 11,695 40,617 Pro forma net income..................... 1,425 1,665 2,083 2,437 7,610 Pro forma diluted earnings per share..... 0.11 0.13 0.13 0.15 0.53 1998 Total revenues........................... $20,372 $22,204 $24,252 $26,582 $93,410 Gross margin............................. 12,825 13,915 15,235 16,753 58,728 Net income............................... 2,548 2,733 3,071 3,333 11,685 Diluted earnings per share............... 0.16 0.17 0.19 0.21 0.74
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information concerning the directors of the Company required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's 1998 fiscal year ended December 31, 1998 under the heading "Election of Directors". Certain information regarding directors and executive officers of the Company is included in Part I, Item 1 of this report on Form 10-K. ITEM 11. EXECUTIVE COMPENSATION The information concerning the directors of the Company required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's 1998 fiscal year ended December 31, 1998 under the heading "Compensation and Other Information Concerning Directors and Officers." 37 39 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information concerning the directors of the Company required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's 1998 fiscal year ended December 31, 1998 under the heading "Security Ownership of Certain Beneficial Owners and Management." ITEM 13. CERTAIN RELATIONSHIPS AND TRANSACTIONS The information concerning the directors of the Company required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's 1998 fiscal year ended December 31, 1998 under the heading "Certain Transactions." PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: 1. Financial Statements See the index to Consolidated Financial Statements on page 20 for a list of the financial statements and supplementary data filed herewith. 2. Financial Statement Schedule (i) The following Financial Statement Schedule of Melita International Corporation for the Years Ended December 31, 1998, 1997 and 1996 is filed as a part of this Report on Form 10-K and should be read in conjunction with the Financial Statements, and related notes thereto, of Melita International Corporation. MELITA INTERNATIONAL CORPORATION SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO BALANCE AT BEGINNING OF COSTS AND END OF YEAR EXPENSES DEDUCTIONS YEAR ------------ -------------- ---------- ---------- 1996: Allowance for doubtful accounts............... $331,000 $ 260,000 $ 104,000 $ 487,000 Allowance for inventory obsolescence.......... $146,000 $ 831,000 $ 492,000 $ 485,000 1997: Allowance for doubtful accounts............... $487,000 $1,140,000 $ 751,000 $ 876,000 Allowance for inventory obsolescence.......... $485,000 $ 986,000 $ 596,000 $ 875,000 1998: Allowance for doubtful accounts............... $876,000 $1,691,000 $ 117,000 $2,450,000 Allowance for inventory obsolescence.......... $875,000 $ 922,000 $ 840,000 $ 957,000
(ii) Report of Independent Public Accountants on Financial Statement Schedule. 38 40 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To Melita International Corporation: We have audited in accordance with generally accepted auditing standards, the financial statements of Melita International Corporation and subsidiaries included in this Form 10-K and have issued our report thereon dated January 30, 1999. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The foregoing schedule is the responsibility of the company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Atlanta, Georgia January 30, 1999 39 41 (b) Reports on Form 8-K Filed During the Fourth Quarter of 1998. (i) Reports on Form 8-K with respect to the appointment of Carl James Schaper as our President and Chief Operating Officer effective September 23, 1998, as filed October 2, 1998. (c) Exhibits. The following exhibits are filed as part of, or are incorporated by reference into, this report on Form 10-K:
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 3.1 -- Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.3 to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 333-22855) filed March 28, 1997). 3.2 -- Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.4 to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 333-22855) filed March 28, 1997). 4.1 -- See Exhibits 3.1 and 3.2 for provisions of the Amended and Restated Articles of Incorporation and Amended and Restated Bylaws of the Company defining rights of the holders of Common Stock of the Company. 4.2 -- Specimen Stock Certificate (incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-1 (File No. 333-22855) filed March 6, 1997). 10.1 -- Lease Agreement between the Company and 5051 Peachtree Corners Circle, L.L.C. (incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-1 (File No. 333-22855) filed on March 6, 1997). 10.2 -- 1992 Stock Option Plan effective June 4, 1992, as amended March 1, 1997 (incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-1 (File No. 333-22855) filed on March 6, 1997). 10.3 -- 1997 Stock Option Plan effective February 6, 1997, as amended October 21, 1997 (incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K (File No. 0-22317) filed on March 31, 1998). 10.4 -- Employee Stock Purchase Plan adopted March 1, 1997 (incorporated by reference to Exhibit 10.4 to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 333-22855) filed March 28, 1997). 10.5 -- 401(k) Profit Sharing Plan as amended effective January 1, 1993 (incorporated by reference to Exhibit 10.5 filed to the Company's Registration Statement on Form S-1 (File 333-22855) filed March 6, 1997). 10.6 -- Employment Agreement between the Company and Aleksander Szlam dated March 5, 1997 (incorporated by reference to Exhibit 10.6 to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File 333-22855) filed March 28, 1997). 10.7 -- Form of Tax Indemnification Agreement between the Company and certain shareholders of the Company (incorporated by reference to Exhibit 10.8 to the Company's Registration Statement on Form S-1 (File 333-22855) filed March 6, 1997). 10.8 -- Form of Tax Indemnification Agreement between Inventions, Inc. and certain shareholders of Inventions, Inc. (incorporated by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-1 (File 333-22855) filed March 6, 1997). 21.1 -- List of Subsidiaries of the Company. 23.1 -- Consent of Arthur Andersen LLP. 27.1 -- Financial Data Schedule (SEC use only). 99.1 -- Private Securities Litigation Reform Act of 1995 Safe Harbor Compliance Statement for Forward-Looking Statements
40 42 SIGNATURES Pursuant to the requirements of Section 12 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MELITA INTERNATIONAL CORPORATION By: /s/ ALEKSANDER SZLAM ------------------------------------ Aleksander Szlam Chairman of the Board and Chief Executive Officer March 30, 1999 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 in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ ALEKSANDER SZLAM Chairman of the Board and March 30, 1999 - -------------------------------------------------------- Chief Executive Officer Aleksander Szlam (Principal Executive Officer) /s/ DAN K. LOWRING Vice President, March 30, 1999 - -------------------------------------------------------- Administration and Chief Dan K. Lowring Financial Officer (Principal Financial and Accounting Officer) /s/ DON W. HUBBLE Director March 30, 1999 - -------------------------------------------------------- Don W. Hubble /s/ DONALD L. HOUSE Director March 30, 1999 - -------------------------------------------------------- Donald L. House
41 EX-21.1 2 LIST OF SUBSIDIARIES OF THE COMPANY 1 EXHIBIT 21.1 LIST OF SUBSIDIARIES Melita Intellectual Property, Inc. Melita Europe Limited Melita International SARL Melita International FSC, Ltd. Support Groups, SRL de C.V. Melita Finance Corporation Melita de Mexico, SRL de C.V. Inventions, Inc. EX-23.1 3 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into Melita International Corporation's previously filed Registration Statement File No. 333-56299 and Registration Statement File No. 333-41503. ARTHUR ANDERSEN LLP Atlanta, Georgia March 23, 1999 EX-27.1 4 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF MELITA INTERNATIONAL CORP. FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 7,684 22,756 34,737 2,450 1,260 68,121 14,954 7,946 75,308 25,239 0 0 0 69 50,000 75,308 93,410 93,410 34,682 34,682 39,972 1,691 0 18,258 6,573 11,685 0 0 0 11,685 0.77 0.74
EX-99.1 5 SAFE HARBOR COMPLIANCE STATEMENT 1 EXHIBIT 99.1 SAFE HARBOR COMPLIANCE STATEMENT FOR FORWARD LOOKING STATEMENTS You should consider carefully the following factors in evaluating us and our business. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us, which we currently deem immaterial or that are similar to those faced by other companies in our industry or business in general, may also impair our business operations. If any of the following risks actually occurs, our business, financial condition or results of future operations could be materially and adversely affected. In such case, the trading price of our common stock could decline, and you could lose all or part of your investment. OUR OPERATING RESULTS COULD FLUCTUATE, CAUSING OUR STOCK PRICE TO FALL Our revenues and operating results could vary substantially from quarter to quarter. If our quarterly revenues or operating results fall below the expectations of investors or public market analysts, the price of our common stock could fall substantially. Our quarterly revenues and operating results may vary as a result of a number of factors, including: - changes in the demand for our products; - the level of product and price competition; - the length of our sales and implementation process; - our ability to control costs; - the size and timing of individual transactions; - the mix of products and services sold; - software defects and other product quality problems; - any delay in or cancellation of customer installations; - our success in expanding our direct sales force and indirect distribution channels; - the timing of new product introductions and enhancements by us or our competitors; - customer order deferrals in anticipation of enhancements or new products offered by us or our competitors; - changes in foreign currency exchange rates; - customers' fiscal constraints; and - general economic conditions. In addition, a limited number of relatively large customer orders has accounted for and is likely to continue to account for a substantial portion of our total revenues in any particular quarter. Any delay or deferral of customer orders may cause significant variations in our operating results from quarter to quarter. A high percentage of our costs are for staffing and operating expenses and are fixed in the short term based on anticipated revenue levels. Therefore, variations between anticipated order dates and actual order dates, as well as non-recurring or unanticipated large orders, can cause significant variations in our operating results from quarter to quarter. Please see Item 7: "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations." OUR LENGTHY SALES AND IMPLEMENTATION CYCLE COULD ADVERSELY AFFECT US If we experience delays in, or cancellation of, sales or implementations of our products and services, our business and financial results could be hurt. To sell our products, we generally must provide a significant level 2 of education to prospective customers regarding the use and benefits of our products. In addition, prospective customers must make a significant commitment of resources in connection with the implementation of our products, which typically requires substantial integration efforts by us or our customer. For these and other reasons, the length of time between the date of initial contact with the potential customer and the installation and use of our products is typically six months or more, and may be subject to delays over which we have little or no control. Our implementation cycle could be lengthened in the future by increases in the size and complexity of our installations and in the number of third-party systems with which our products must integrate. In addition, any unexpected delays in individual implementations could expose us to liability claims from our customers. OUR OPERATING RESULTS ARE SUBSTANTIALLY DEPENDENT ON ONE PRODUCT LINE AND THE MARKET FOR CALL CENTER SOLUTIONS We currently derive substantially all of our revenues from sales of our PhoneFrame Explorer and upgrades of our older PhoneFrame CS products and related services. We introduced PhoneFrame CS in early 1995 and PhoneFrame Explorer in late 1997. We are currently beta testing our new Enterprise Explorer line of blended call center products and expect to begin commercial shipment later this year. We anticipate that a significant portion of our future revenue may be attributable to our Enterprise Explorer product line. Although we intend to enhance these products and develop related products, we expect to continue to focus on providing call center solutions as our primary line of business. As a result, any factor adversely affecting the market for call center solutions in general, or the PhoneFrame products in particular, could hurt our business and financial results. We may face potential charges resulting from the impact of having to write down inventory of outdated products that cannot be sold. The market for call center systems is intensely competitive, highly fragmented and subject to rapid change. Our future success will depend on continued growth in the market for call center systems. If this market fails to grow or grows more slowly than we currently anticipate, our business and financial results would be hurt. WE RELY ON A FEW CUSTOMERS FOR A SIGNIFICANT PORTION OF OUR REVENUES We have derived and believe that we will continue to derive a significant portion of our revenues in any period from a limited number of large corporate clients. In 1998, our five largest customers accounted for 23.2% of our total revenues. During 1997, our five largest customers accounted for 27.9% of our total revenues. Although the specific customers may change from period to period, we expect that large sales to a limited number of customers will continue to account for a significant percentage of our revenues in any particular period for the foreseeable future. Therefore, the loss, deferral or cancellation of an order could have a significant impact on our operating results in a particular quarter. Our current customers may not place additional orders and we may not obtain orders of similar magnitude from other customers. If we lose any major customer, suffer any reduction, delay in or cancellation of orders by any such customer or fail to market successfully to new customers, our business and financial results could be hurt. THERE ARE MANY RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS Our sales outside the United States accounted for 21.0%, 18.4% and 24.8% of our total revenues in 1996, 1997 and 1998, respectively. A significant element of our business strategy is to continue expansion of our operations in international markets. This expansion will continue to require significant management attention and financial resources to develop international sales channels. Because of the difficulty in penetrating new markets, we may not be able to maintain or increase international revenues. Our international operations are subject to inherent risks, including: - the impact of possible recessionary environments in economies outside the United States; - changes in legal and regulatory requirements, including those relating to telemarketing activities; - changes in tariffs; - seasonality of sales; 2 3 - the costs of localizing products for foreign markets and integrating products with foreign system components; - longer accounts receivable collection periods and greater difficulty in accounts receivable collection; - difficulties and costs of staffing and managing foreign operations; - reduced protection for intellectual property rights in some countries; - potentially adverse tax consequences; - political and economic instability; and - the higher cost of foreign service delivery. While our expenses incurred in foreign countries typically are denominated in the local currencies, revenues generated by our international sales typically are paid in U.S. dollars or British pounds. Accordingly, while our exposure to currency fluctuations to date has been insignificant, we could experience fluctuations in currency exchange rates in the future that would have a material adverse impact on our international operations. We currently do not engage in currency hedging activities. OUR GROWTH IS DEPENDENT UPON THE SUCCESSFUL DEVELOPMENT OF OUR DIRECT AND INDIRECT SALES CHANNELS We currently sell our products domestically primarily through our direct sales force and internationally through both direct and indirect sales channels. We support our customers with our internal technical and customer support staff. Our ability to achieve significant revenue growth in the future will greatly depend on our ability to recruit and train sufficient technical, customer support and direct sales personnel. We have in the past and may in the future experience difficulty in recruiting qualified sales, technical and support personnel. If we are unable to rapidly and effectively expand our direct sales force and our technical and support staff, our business and financial results could be hurt. We believe that our future growth also will depend on developing and maintaining successful indirect sales channels, including value added resellers, or VARs, and distributors. Our strategy is to continue to increase the proportion of customers served through these indirect channels. We are currently investing, and plan to continue to invest, significant resources to develop these indirect channels. This could adversely affect our operating results if these efforts do not generate revenues necessary to offset this investment. Also, our inability to recruit and retain qualified VARs and distributors could adversely affect our results of operations. Because lower unit prices are typically charged on sales made through indirect channels, increased indirect sales could adversely affect our average selling prices and result in lower gross margins. In addition, sales of our products through indirect channels will reduce our gross profits from our services as the VARs and distributors provide these services. As indirect sales increase, our direct contact with our customer base will decrease, and we may have more difficulty accurately forecasting sales, evaluating customer satisfaction and recognizing emerging customer requirements. In addition, our VARs and distributors may develop, acquire or market products competitive with our products. Our strategy of marketing our products directly to customers and indirectly through VARs and distributors may result in distribution channel conflicts. Our direct sales efforts may compete with those of our indirect channels and, to the extent different VARs and distributors target the same customers, VARs and distributors may also come into conflict with each other. Any channel conflicts which develop may have a material adverse effect on our relationships with VARs and distributors or hurt our ability to attract new VARs and distributors. Please see Item 1: "Business -- Strategy" and "-- Sales and Marketing." THERE ARE SEVERAL RISKS ASSOCIATED WITH OUR ACQUISITION STRATEGY We may in the future engage in selective acquisitions of businesses that are complementary to ours, including other providers of contact management or CTI solutions or technology. While we have from time to time in the past considered acquisition opportunities, we have never acquired a significant business and have no existing agreements or commitments to effect any acquisition. Accordingly, we may not be able to identify 3 4 suitable acquisition candidates available for sale at reasonable prices, consummate any acquisition or successfully integrate any acquired business into our operations. Further, acquisitions may involve a number of additional risks, including diversion of management's attention, failure to retain key acquired personnel, unanticipated events or circumstances and legal liabilities, some or all of which could hurt our business and financial results. Problems with an acquired business could have a material adverse impact on our performance as a whole. If we engage in acquisitions in the future, we might finance such acquisitions with the proceeds from public offerings as well as with possible debt financing, the issuance of additional equity securities (common or preferred stock) or a combination of the foregoing. We may not be able to arrange adequate financing on acceptable terms. If we were to proceed with one or more significant future acquisitions in which the consideration consisted of cash, a substantial portion of our available cash could be used to consummate the acquisitions. If we were to consummate one or more significant acquisitions in which the consideration consisted of stock, our shareholders could suffer significant dilution of their interests in us. Many business acquisitions must be accounted for using purchase accounting. Most of the businesses that might become attractive acquisition candidates for us are likely to have significant intangible assets. If we acquire these businesses and are required to account for them as a purchase, we would typically be required to recognize substantial goodwill amortization charges, reducing future earnings. In addition, such acquisitions could involve non-recurring acquisition-related charges, such as the write-off or write-down of software development costs or other intangible items. WE MAY BE CONFRONTED WITH DEFECTS IN OUR SOFTWARE OR THE INABILITY TO ACQUIRE THIRD-PARTY SOFTWARE OR HARDWARE THAT IS ERROR-FREE Software products as complex as those we offer may contain errors that could be detected at any point in the products' life cycles. We have, in the past, discovered software errors in certain of our products and have experienced delays in shipment or implementation of products during the period required to correct these errors. Despite extensive testing by us and by current and potential customers, errors may still be found. This could result in a loss of, or delay in, market acceptance and sales, diversion of development resources, injury to our reputation or increased service and warranty cost. In particular, the call center environment is characterized by a wide variety of standard and non-standard configurations that make pre-release testing for programming or compatibility errors very difficult and time consuming and limit our ability to uncover all defects prior to shipment and installation at a customer's location. Certain software used in our products is licensed by us from third parties, and our products are designed to operate on certain hardware platforms manufactured by third parties. Such third-party software or hardware may contain errors that we are dependent upon the third-party to correct. WE MAY FACE LIABILITY TO CLIENTS IF OUR SYSTEMS FAIL Our products are often critical to the operations of our clients' businesses and provide benefits that may be difficult to quantify. If our product or a client's system fails, the client could make a claim for substantial damages against us, regardless of our responsibility for such failure. Although we attempt to limit contractually our liability for damages arising from product failures or negligent acts or omissions, the limitations of liability set forth in our contracts may not be enforceable in all instances and may not otherwise protect us from liability for damages. Although we maintain general liability insurance coverage, including coverage for product liability and errors or omissions, this coverage may not continue to be available on reasonable terms or in sufficient amounts to cover one or more large claims. In addition, the insurer might disclaim coverage as to any future claim. If we experience one or more large claims against us that exceed available insurance coverage or changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, our business and financial results could be hurt. 4 5 WE MUST CONTINUE TO ADVANCE OUR TECHNOLOGY AND COMPLY WITH INDUSTRY REQUIREMENTS TO REMAIN COMPETITIVE The market for call center systems is subject to rapid technological change, changing customer needs, frequent new product introductions and evolving industry standards that may render our existing products and services obsolete. As a result, unforeseen changes in customer and technological requirements for application features, functions and technologies could rapidly erode our position in this market. If we are unable, for technological or other reasons, to develop and introduce new and enhanced products in a timely manner, our business and financial results could be hurt. Our growth and future operating results will depend in part upon our ability to enhance existing applications and develop and introduce new applications that anticipate, meet or exceed technological advances in the marketplace, that meet changing customer requirements, that respond to competitive products and that achieve market acceptance. Our product development and testing efforts have required, and are expected to continue to require, substantial investments. We may not possess sufficient resources to make these necessary investments. In addition, we cannot assure that these products will meet the requirements of the marketplace and achieve market acceptance, or that our current or future products will conform to industry standards. WE MAY EXPERIENCE DELAYS IN DEVELOPMENT OF NEW PRODUCTS We have in the past experienced delays both in developing new products and customizing existing products. We could experience similar delays in the future. Delays could occur for a variety of reasons, including: - the complex nature of our products; - difficulties in getting newly developed software code to function properly with existing code; - difficulty in recruiting sufficient numbers of programmers with the proper technical skills and capabilities; - loss of programmers with existing technical knowledge of our products; - changing standards or protocols within the computer and telephony equipment with which our products integrate; - inherent limitations in, difficulties in integrating with, and unforeseen problems with using other company or industry products and software; - changes in design specifications once technical problems are uncovered; and - unforeseen problems with the implementation of a distributed, object-oriented architecture and processing. THE INABILITY TO ATTRACT AND RETAIN MANAGEMENT AND OTHER PERSONNEL MAY ADVERSELY AFFECT US The future success of our growth strategy will depend to a significant extent on our ability to attract, train, motivate and retain highly skilled professionals, particularly software developers, sales and marketing personnel and other senior technical personnel. Highly skilled employees with the education and training we require are in high demand. If we are unable to hire and retain such qualified personnel, our ability to adequately manage and complete our existing sales and to bid for, obtain and implement new sales would be impaired. Further, we must train and manage our growing employee base, requiring an increase in the level of responsibility for both existing and new management personnel. WE MUST SUCCESSFULLY MANAGE GROWTH OF OPERATIONS We have recently experienced significant growth in revenue, operations and personnel. Continued growth will place significant demands on our management and other resources. Our inability to manage our growth effectively could have a material adverse effect on the quality of our services and projects, our ability to attract and retain key personnel, our business prospects and our financial results. In particular, we will have to continue to increase the number of our personnel, particularly skilled technical, marketing and management 5 6 personnel, and continue to develop and improve our operational, financial, communications and other internal systems. We recently implemented a new help-desk information system to upgrade our automated customer support capability and we are in the process of replacing our financial reporting systems. We have recently implemented a plan to outsource a significant portion of the production and integration of the PhoneFrame Explorer systems to a non-affiliated third party. We cannot assure that this third party will be able to meet the required demand for production and integration of our products without interruption. In addition, due to the highly complex nature of our products, we cannot assure that the products produced and integrated by this third party will provide operation as reliable as those produced and integrated by our employees. Any disruptions resulting from the implementation of the help-desk information system, the new financial reporting system or the outsourcing plan, or the failure to implement these changes in a timely manner could hurt our business and financial results. YEAR 2000 RISKS MAY RESULT IN MATERIAL ADVERSE EFFECTS ON OUR BUSINESS Many companies need to upgrade their computer systems and software products in order to ensure that these systems and software are able to distinguish 21st century dates from 20th century dates. While our current products are designed to comply with these "Year 2000" requirements, we may still face claims resulting from system problems associated with the century change. Our software products that are designed to be Year 2000 compliant may not contain all necessary date code changes. Customers using earlier versions of our products that were not Year 2000 compliant may have to install a later version of the software that is Year 2000 compliant or implement a modification to correct that version. Because our software system is often integrated with hardware and operating or interface software over which we exert little control, the failure of the manufacturers of those systems to ensure that they are Year 2000 compliant may cause the integrated system to fail. Any Year 2000 problems with our products and implementations that are not satisfactorily corrected could hurt our business and financial results. We believe that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues in a variety of ways. Expenditures by many companies to address Year 2000 issues may result in reduced funds available to purchase software products such as those that we offer. Potential customers may also choose to defer purchasing Year 2000 compliant products until they believe it is absolutely necessary, thus potentially resulting in stalled market sales within the industry. Conversely, Year 2000 issues may cause companies to accelerate purchases, thereby causing an increase in short-term demand and a consequent decrease in long-term demand for software products. Additionally, Year 2000 issues could cause a significant number of companies, including our customers, to reevaluate their current software needs and as a result switch to other systems or suppliers. Any of the foregoing could hurt our business and financial results. Please see Item 7: "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Year 2000 Readiness." In addition, Year 2000 non-compliance in our internal information technology, or IT, systems and non-IT systems on which our operations rely could hurt our business and financial results. In spite of our best efforts to upgrade our systems, we may still face Year 2000 compliance issues. OUR PRINCIPAL SHAREHOLDER CONTINUES TO CONTROL OUR AFFAIRS Aleksander Szlam, our Chairman of the Board, Chief Executive Officer and principal shareholder, is the beneficial owner of approximately 73.5% of the outstanding shares of our common stock. Accordingly, Mr. Szlam is in a position to control our affairs through his ability to control any election of members of our Board of Directors, as well as any decision whether to merge or sell our assets, to amend our charter and bylaws, or to take other actions requiring the vote or consent of our shareholders. This concentration of ownership could also discourage bids for the shares of common stock at a premium to, or create a depressive effect on, the market price of the common stock. 6 7 WE MAY NOT BE ABLE TO CONTINUE TO COMPETE SUCCESSFULLY WITH OTHER COMPANIES The market for our products is intensely competitive, fragmented and subject to rapid change. Because our principal products are call management systems, which include both software applications and hardware, we compete with a variety of companies that provide these components independently or as an integrated system. We may not be able to compete successfully against current and future competitors and competitive pressures faced by us could hurt our business and financial results. Our primary competitors in the field of integrated inbound/outbound call management systems are Davox Corporation, or Davox; EIS International, Inc., or EIS; and Mosaix International, Inc., or Mosaix. We compete primarily against Davox and Mosaix in the collections segment of the outbound call management systems market, and against EIS in the telemarketing and telesales segments of the inbound/outbound call management systems market. We also compete in the CTI segment of the market, where principal competitors include Firstwave Technologies, Inc., Genesys Telecommunications Laboratories, Inc., GeoTel Communications Corporation, Information Management Associates, Inc., and Quintus Corporation, among others. Some of our competitors may align themselves with telecommunications equipment providers, such as providers of private branch exchange, or PBX, and automatic call distribution, or ACD, equipment, other telecommunications equipment providers or other vendors in an effort to increase sales potential for their products. We may also face additional direct competition from PBX/ACD vendors, other telecommunications equipment providers, telecommunications service providers, computer hardware and software vendors and others. We may also face competition from non-traditional competitors in the emerging computer telephony market. These competitors may include Interactive Intelligence Inc., Oracle Corporation, IBM and others. We generally face competition from one or more of our principal competitors on major installations and believe that price is a major factor considered by our prospective customers. Increased competition has contributed significantly to price reductions, and we expect these price reductions to continue. In addition, increased competition may result in reduced operating margins and loss of market share. Many of our current and potential competitors have 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 emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products than we could. WE MAY BE SUBJECT TO CHANGING GOVERNMENTAL REGULATIONS Certain uses of outbound call processing systems are regulated by federal, state and foreign laws and regulations. Compliance with these laws and regulations by our customers may limit the usefulness of our products and these laws and regulations could therefore adversely affect demand for our products. In addition, future legislation or regulatory activity could further restrict telephone practices and could adversely affect us. Please see Item 1: "Business -- Regulatory Environment." OUR FAILURE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS MAY ADVERSELY AFFECT US We rely on a combination of patent, copyright, trade secret and trademark laws, confidentiality procedures and contractual provisions to protect our proprietary rights in our products and technology. These measures may not be adequate to protect our trade secrets and proprietary technology. Further, we may be subject to additional risks as we enter into transactions in countries where intellectual property laws are not well developed or are poorly enforced. Legal protections of our rights may be ineffective in such countries. If we must engage in litigation to defend and enforce our intellectual property rights, either domestically or in other countries, we could face substantial costs and diversion of resources, regardless of the final outcome of such litigation. Despite our efforts to safeguard and maintain our proprietary rights both in the United States and abroad, we may not be successful in doing so and the steps we take in this regard may not be adequate to deter misappropriation or independent third-party development of our technology or to prevent an unauthorized third party from copying or otherwise obtaining and using our products or technology. Others may independently develop similar technologies or duplicate any technology developed by us. With certain exceptions, we historically have not actively pursued infringements of our patents, and any future attempt by us to enforce our patents might not be successful or result in royalties that exceed the cost of such enforcement efforts. We may not be able to detect all instances of infringement. 7 8 We have entered into agreements with certain of our distributors giving them a limited, non-exclusive right to use portions of our source code to create foreign language versions of our products for distribution in foreign markets. In addition, we have entered into agreements with a number of our customers requiring us to place our source code in escrow. These escrow arrangements typically provide that these customers have a limited, non-exclusive right to use this code in the event that there is a bankruptcy proceeding by or against us, if we cease to do business or if we fail to meet our support obligations. These arrangements may increase the likelihood of misappropriation by third parties. As the number of call management software applications in the industry increases and the functionality of these products further overlaps, software development companies like us may increasingly become subject to claims of infringement or misappropriation of the intellectual property rights of others. Although we believe that our software components and other intellectual property do not infringe on the intellectual property rights of others, we still face the risk that such a claim will be asserted against us in the future, that assertion of such claims will result in litigation and that we might not prevail in such litigation or be able to obtain a license for the use of any infringed intellectual property from a third party on commercially reasonable terms. Furthermore, litigation, regardless of its outcome, could result in substantial cost to us, divert management's attention from our operations and delay customer purchasing decisions. OUR SUCCESS DEPENDS ON OUR KEY EXECUTIVES Our success will depend in large part upon the continued availability of the services of our senior executives, including Aleksander Szlam, our Chairman and Chief Executive Officer. Although we have an employment agreement with Mr. Szlam, the agreement does not obligate him to continue his employment with us. We might not be able to retain the services of Mr. Szlam. We do not maintain key man life insurance on Mr. Szlam. OUR CHARTER AND BYLAWS AND GEORGIA LAW MAY INHIBIT A TAKEOVER OF MELITA The Board of Directors has authority to issue up to 20,000,000 shares of preferred stock and to fix the rights, preferences, privileges and restrictions, including voting rights, of the preferred stock without further vote or action by our shareholders. The rights of the holders of our common stock will be subject to, and may be adversely affected by, the rights of the holders of preferred stock that may be issued in the future. While we have no present intention to issue shares of preferred stock, such issuance could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. In addition, our charter and bylaws contain provisions that may discourage proposals or bids to acquire us. These provisions could have the effect of making it more difficult for a third party to acquire control of us and adversely affect prevailing market prices for our common stock. OUR STOCK PRICE HAS BEEN VOLATILE The market price of our common stock could be subject to significant fluctuations in response to variations in quarterly operating results and other factors. In addition, the securities markets have experienced significant price and volume fluctuations from time to time that have often been unrelated or disproportionate to the operating performance of particular companies. Any announcement with respect to any adverse variance in revenue or earnings from levels generally expected by securities analysts or investors for a given period would have an immediate and significant adverse effect on the trading price of the common stock. In addition, factors such as announcements of technological innovations or new products by us, our competitors or third parties, rumors of such innovations or new products, changing conditions in the market for call center systems, changes in estimates by securities analysts, announcements of extraordinary events, such as acquisitions or litigation, or general economic conditions may have a significant adverse impact on the market price of the common stock. 8 -----END PRIVACY-ENHANCED MESSAGE-----