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SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2004 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT
 For the transition period fromto Commission file number 0-22190   VERSO TECHNOLOGIES, INC.  MINNESOTA
(State or Other Jurisdiction
of Incorporation or Organization)
    
    41-1484525
(I.R.S. Employer Identification No.)
 400 Galleria Parkway, Suite 300, Atlanta, GA 30339
(Address of Principal Executive Offices) (678) 589-3500
(Registrants Telephone Number, Including Area Code)   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 o . Indicated by check mark whether registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act) Yes x No o . Shares of the registrants common stock, par value $.01 per share, outstanding
as of May 6, 2004: 132,910,005.




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VERSO TECHNOLOGIES, INC.
FORM 10-Q INDEX Page No.Part I. FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003
    
    
    2Condensed Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003
    
    
    3Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    29Item 4. Controls and Procedures
    
    
    29PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    30Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases Of Equity Securities
    
    
    30Item 6. Exhibits and Reports on Form 8-K
    
    
    30Signature Page
    
    
    32Exhibit Index
    
    
    33EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32.1 SECTION 906 CERTIFICATION OF THE CEOEX-32.2 SECTION 906 CERTIFICATION OF THE CFO
  1




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (in thousands, except share data)
 March 31,
    
    December 31,2004
    
    2003(Unaudited)ASSETS:Current assets:Cash and cash equivalents
    
    $
    24,552
    
    
    $
    7,654Restricted cash
    
    
    228
    
    
    
    2,290Accounts receivable, net of allowance for doubtful accounts of $1,979
and $1,995, respectively
    
    
    10,165
    
    
    
    13,620Inventories
    
    
    8,331
    
    
    
    8,727Other current assets
    
    
    1,149
    
    
    
    1,003Total current assets
    
    
    44,425
    
    
    
    33,294Property and equipment, net of accumulated depreciation and amortization
of $8,659 and $7,907, respectively
    
    
    5,353
    
    
    
    5,749Investment
    
    
    655
    
    
    
    673Other intangibles, net of accumulated amortization of $2,726 and $2,145,
respectively
    
    
    6,727
    
    
    
    7,308Goodwill
    
    
    16,228
    
    
    
    16,228Total assets
    
    $
    73,388
    
    
    $
    63,252LIABILITIES AND SHAREHOLDERS EQUITY:Current liabilities:Accounts payable
    
    $
    3,440
    
    
    $
    4,418Accrued compensation
    
    
    2,286
    
    
    
    1,564Accrued expenses
    
    
    3,083
    
    
    
    3,007Current portion of notes payable
    
    
    
    
    
    
    347Current portion of accrued costs of MCK acquisition
    
    
    1,581
    
    
    
    4,464Current portion of liabilities of discontinued operations
    
    
    1,021
    
    
    
    1,039Unearned revenue and customer deposits
    
    
    5,793
    
    
    
    5,718Total current liabilities
    
    
    17,204
    
    
    
    20,557Liabilities of discontinued operations, net of current portion
    
    
    793
    
    
    
    834Other long-term liabilities
    
    
    1,421
    
    
    
    1,637Notes payable, net of current portion
    
    
    2,666
    
    
    
    2,652Convertible subordinated debentures
    
    
    4,047
    
    
    
    3,979Total liabilities
    
    
    26,131
    
    
    
    29,659Shareholders equity:Preferred stock,no par value, 1,000,000 shares authorized;
780,000 shares issued and none outstanding
    
    
    
    
    
    
    Common stock, $.01 par value, 200,000,000 shares authorized;
132,904,255 and 122,781,117 shares issued and outstanding
    
    
    1,329
    
    
    
    1,228Additional paid-in capital
    
    
    323,017
    
    
    
    306,293Stock payable
    
    
    28
    
    
    
    130Accumulated deficit
    
    
    (276,880
    )
    
    
    (273,144
    )Deferred compensation
    
    
    (276
    )
    
    
    (1,012
    )Accumulated
other comprehensive income (loss) - foreign currency translation
    
    
    39
    
    
    
    98Total shareholders equity
    
    
    47,257
    
    
    
    33,593Total liabilities and shareholders equity
    
    $
    73,388
    
    
    $
    63,252
 The accompanying notes are an integral part of these condensed consolidated financial statements. 2




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VERSO TECHNOLOGIES, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands, except share data)
  For the three months ended March 31,2004
    
    2003(Unaudited)Revenue:Products
    
    $
    11,010
    
    
    $
    7,268Services
    
    
    5,551
    
    
    
    5,729Total revenue
    
    
    16,561
    
    
    
    12,997Cost of revenue:Products:Product costs
    
    
    4,441
    
    
    
    2,912Amortization of intangibles
    
    
    446
    
    
    
    152Total cost of product
    
    
    4,887
    
    
    
    3,064Services
    
    
    3,171
    
    
    
    2,513Total cost of revenue
    
    
    8,058
    
    
    
    5,577Gross profit:Products
    
    
    6,123
    
    
    
    4,204Services
    
    
    2,380
    
    
    
    3,216Total gross profit
    
    
    8,503
    
    
    
    7,420Operating expenses:General and administrative
    
    
    3,762
    
    
    
    3,321Sales and marketing
    
    
    3,170
    
    
    
    1,891Research and development
    
    
    2,811
    
    
    
    1,896Depreciation and Amortization of
property and equipment
    
    
    805
    
    
    
    653Amortization of intangibles
    
    
    135
    
    
    
    60Amortization
of deferred compensation, related to sales, general and administrative
    
    
    166
    
    
    
    199Reorganization costs
    
    
    584
    
    
    
    114Reorganization costs - stock related
    
    
    570
    
    
    
    80Total operating expenses
    
    
    12,003
    
    
    
    8,214Operating loss
    
    
    (3,500
    )
    
    
    (794
    )Other income (expense), net:Other income
    
    
    48
    
    
    
    9Equity in loss of investment
    
    
    (18
    )
    
    
    (33
    )Interest expense, net
    
    
    (266
    )
    
    
    (307
    )(236
    )
    
    
    (331
    )Loss before income taxes
    
    
    (3,736
    )
    
    
    (1,125
    )Income taxes
    
    
    
    
    
    
    Net loss
    
    $
    (3,736
    )
    
    $
    (1,125
    )Net loss per
common share - basic
and diluted
    
    $
    (0.03
    )
    
    $
    (0.01
    )Weighted
average shares outstanding - basic
and diluted
    
    
    126,783,895
    
    
    
    89,437,720
 The accompanying notes are
an integral part of these condensed consolidated financial statements. 3




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands, except share data)
 (Unaudited)
 For the three months ended March 31,2004
    
    2003Operating Activities:Continuing operations:Net loss from continuing operations
    
    $
    (3,736
    )
    
    $
    (1,125
    )Adjustments to reconcile net loss from continuing operations to net
cash provided by (used in) continuing operating activities:Equity in loss of investment
    
    
    18
    
    
    
    33Depreciation and amortization of property and equipment
    
    
    805
    
    
    
    653Amortization of intangibles
    
    
    581
    
    
    
    212Amortization of deferred compensation
    
    
    166
    
    
    
    199Provision for doubtful accounts
    
    
    420
    
    
    
    644Amortization of loan fees and discount on convertible subordinated debentures
    
    
    139
    
    
    
    92Reorganization costs-stock related
    
    
    570
    
    
    
    80Other
    
    
    (15
    )
    
    
    (68
    )Changes in current operating assets and liabilities, net of effects of acquisitions:Accounts receivable
    
    
    3,035
    
    
    
    (1,925
    )Inventories
    
    
    396
    
    
    
    652Other current assets
    
    
    (200
    )
    
    
    (375
    )Accounts payable
    
    
    (978
    )
    
    
    244Accrued compensation
    
    
    722
    
    
    
    3Accrued expenses
    
    
    (23
    )
    
    
    (909
    )Unearned revenue and customer deposits
    
    
    75
    
    
    
    86Net cash provided by (used in) continuing operating activities
    
    
    1,975
    
    
    
    (1,504
    )Discontinued operations:Payments of discontinued operations liabilities
    
    
    (59
    )
    
    
    (329
    )Net cash used in discontinued operating activities
    
    
    (59
    )
    
    
    (329
    )Net cash provided by (used in) operating activities
    
    
    1,916
    
    
    
    (1,833
    )Investing Activities:Purchases of property and equipment
    
    
    (425
    )
    
    
    (167
    )Purchased software development
    
    
    
    
    
    
    (160
    )Decrease in restricted cash
    
    
    2,062
    
    
    
    Payment of assumed liabilities and costs of acquisition of MCK Communications, Inc.
    
    
    (3,000
    )
    
    
    Acquisition of certain assets of Clarent Corporation, net of cash acquired
    
    
    
    
    
    
    (295
    )Net cash used in investing activities
    
    
    (1,363
    )
    
    
    (622
    )Financing Activities:Net borrowings (payments) on line of credit
    
    
    
    
    
    
    1,400Payments on long-term debt
    
    
    (350
    )
    
    
    Proceeds from private placement, net
    
    
    16,601
    
    
    
    Proceeds from issuances of common stock in connection with the
exercise of options, net
    
    
    91
    
    
    
    Net cash provided by financing activities
    
    
    16,342
    
    
    
    1,400Effect of exchange rate changes on cash
    
    
    3
    
    
    
    30Increase (decrease) in cash and cash equivalents
    
    
    16,898
    
    
    
    (1,025
    )Cash and cash equivalents at beginning of period
    
    
    7,654
    
    
    
    1,294Cash and cash equivalents at end of period
    
    $
    24,552
    
    
    $
    269Supplemental disclosure of cash flow information:Cash payments during the periods for:Interest
    
    $
    90
    
    
    $
    153Income taxes
    
    $
    (1
    )
    
    $
    10Non-cash investing and financing activitiesCompensatory options fully-vested and/or
extended in reorganization
    
    $
    570
    
    
    $
    80Issuance of common stock in litigation settlement
    
    
    
    
    
    
    264Issuance of warrants in exchange for services
    
    
    
    
    
    
    119Issuance of common stock in exchange for services
    
    
    133
    
    
    
    Assets
acquired and liabilities assumed in conjunction with business acquisitions:Fair value of assets acquired, excluding cash and restricted cash
    
    
    
    
    
    
    10,966Liabilities assumed
    
    
    
    
    
    
    986Notes payable for acquisition of certain assets of Clarent Corporation
    
    $
    
    
    
    $
    9,800The accompanying notes are an integral part of these condensed consolidated financial statements.
 4




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VERSO TECHNOLOGIES, INC AND SUBSIDIARIES. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS March 31, 2004 (Unaudited)  1.
    
    BASIS OF PRESENTATIONVerso Technologies, Inc. and subsidiaries (the Company), is a
communications technology and solutions provider for communications
service providers and enterprises seeking to implement application-based
telephony services, Internet usage management tools and outsourced
customer support services. The Companys operations include three
separate business segments, the Carrier Solutions Group, which includes
the Companys Clarent softswitching division and the Companys subsidiary
NACT Telecommunications, Inc. (NACT), the Enterprise Solutions Group,
which includes the Companys Clarent Netperformer division and the
Companys subsidiaries Telemate.Net Software, Inc. (Telemate.Net) and
MCK Communications, Inc. (MCK) and the Advanced Applications Services
Group, which includes the Companys technical applications support group
which was previously included as part of the Enterprise Solutions Group.
The Carrier Solutions Group includes domestic and international sales of
hardware and software, integration, applications and technical training
and support. The Enterprise Solutions Group offers hardware-based
solutions (which include software) for companies seeking to build private,
packet-based voice and data networks. Additionally, the Enterprise
Solutions Group offers software-based solutions for Internet access and
usage management that include call accounting and usage reporting for
Internet protocol network devices. The Advanced Applications Services
Group includes outsourced technical application services and application
installation and training services to outside customers, as well as customers of the Companys
Carrier Solution Group and Enterprise Solution Group segments. The
Company acquired MCK in September 2003 and substantially all the business
assets of Clarent Corporation (Clarent) in February 2003. These
acquisitions were all accounted for as purchases (see Note 2).The condensed consolidated financial statements include the accounts of
Verso Technologies, Inc. and its wholly-owned subsidiaries, including MCK,
Telemate.Net, NACT, and Clarent Canada Ltd.Certain prior year amounts in the consolidated financial statements have
been reclassified to conform with the current year presentation. These
reclassifications had no effect on previously reported net loss.The condensed consolidated quarterly financial statements are unaudited.
These statements include all adjustments, including recurring adjustments,
considered necessary by management to present a fair statement of the
results of the Companys operations, financial position and cash flows.
The results reported in these condensed consolidated financial statements
should not be regarded as necessarily indicative of results that may be
expected for the entire year.The year-end condensed consolidated balance sheet was derived from audited
consolidated financial statements. The accompanying condensed
consolidated unaudited quarterly financial statements are presented in
accordance with the rules and regulations of the Securities and Exchange
Commission (SEC) and do not include all disclosures normally required by
accounting principles generally accepted in the United States of America.
For further information, refer to the audited consolidated financial
statements and footnotes thereto included in the Companys Annual Report
on Form 10-K for the year ended December 31, 2003.2.
    
    MERGERS AND ACQUISITIONSMCK Communications, Inc.On September 26, 2003, to increase capital and to enhance the Companys
ability to provide technology that allows enterprises the ability to
migrate to next-generation environments, the Company acquired all of the
outstanding capital stock of MCK by means of a merger. The acquisition
cost was approximately $25.1 million, consisting of 18,278,423 shares of
the Companys common stock with a fair value of $24.1 million and
acquisition costs of approximately $1.0 million. 5




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  2.
    
    MERGERS AND ACQUISITIONS, ContinuedMCK Communications, Inc. - ContinuedThe acquisition was treated as a purchase for accounting purposes, and
accordingly, the assets and liabilities were recorded at their fair value
at the date of the acquisition.The Company prepared an allocation of the purchase price based on the
estimated fair values of acquired assets and liabilities. The Company
anticipates the fair value assessments and allocation of the purchase
price to be finalized in 2004. Intangible assets relating to channels of
distribution, strategic licenses and current technology total $3.6 million
and are being amortized over three years.In April 2003, the Company negotiated the original agreement to acquire
MCK in which the MCK stockholders would be entitled to receive
approximately 20.0 million shares of the Companys common stock which was
valued at $13.0 million, based on the volume weighted average closing
price per share of the Companys common stock as reported on the Nasdaq
Small Cap Market for the twenty trading day period beginning March 19,
2003 and ending April 15, 2003. As part of the original agreement, the
Company was to receive $7.5 million in cash. The terms of the agreement
were amended on June 13, 2003. Under the amended terms, MCK stockholders
were entitled to receive approximately 18.3 million shares of the
Companys common stock and the cash MCK was required to have at the
closing of the merger was reduced from $7.5 million to approximately $6.4
million. Although the number of shares of the Companys common stock to
be issued in the merger was reduced by the amendment, the amendment
changed the measurement date for valuing such shares. As a result of the
increase in the price of the Companys common stock prior to June 13,
2003, the revised valuation for the shares of the Companys common stock
to be issued in the merger increased to $24.1 million. As a result of
this increase in value, the goodwill recorded in the merger was impaired
upon closing the merger. The Company completed an impairment analysis in
accordance with Statement of Financial Accounting Standards (SFAS) No.
142, Goodwill and Other Intangible Assets (SFAS No. 142). Based upon
this analysis, the Company recorded a write-off of approximately $10.9
million during the quarter ended September 30, 2003.Clarent CorporationOn February 12, 2003, to enhance the Companys position in the
next-generation networking and technology market, the Company acquired
substantially all the business assets and certain related liabilities of
Clarent. The purchase consideration was approximately $10.8 million,
consisting of $9.3 million in discounted seller notes issued by the
Company and acquisition costs of approximately $1.5 million. At the
closing of the acquisition, the Company issued three promissory notes to
Clarent: a $5.0 million secured note due February 13, 2004, which bore
interest at 10% per annum and a $1.8 million non-interest bearing
unsecured note due February 13, 2004, discounted at 6.25% per annum, both
of which were paid in full at March 31, 2004; and a $3.0 million secured
note due February 12, 2008, which bears interest at 5% per annum,
discounted at 7.5% per annum. The unamortized discount totaled
approximately $334,000 at March 31, 2004. The assets the Company
purchased from Clarent secure the secured notes.The acquisition was treated as a purchase for accounting purposes, and
accordingly, the assets and liabilities were recorded at their fair value
at the date of the acquisition. Gross intangible assets acquired totaling
$821,000 primarily consist of current technology and are being amortized
over three years. 6




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  2.
    
    MERGERS AND ACQUISITIONS, ContinuedClarent Corporation - ContinuedThe preliminary allocations of the costs of acquisitions of MCK and the
net assets of Clarent, as adjusted, are as follows (in thousands): MCK
    
    ClarentCash
    
    $
    10,575
    
    
    $
    571Restricted cash
    
    
    2,015
    
    
    
    115Accounts receivable
    
    
    1,045
    
    
    
    2,717Inventories
    
    
    423
    
    
    
    5,465Other current assets
    
    
    453
    
    
    
    613Property and equipment
    
    
    365
    
    
    
    1,650Other intangibles
    
    
    3,600
    
    
    
    821Goodwill (1)
    
    
    14,473
    
    
    
    Accounts payable
    
    
    (508
    )
    
    
    (103
    )Accrued compensation
    
    
    (195
    )
    
    
    (198
    )Current portion of accrued costs of MCK purchase
    
    
    (5,810
    )
    
    
    Accrued expenses
    
    
    (782
    )
    
    
    (331
    )Deferred revenue
    
    
    (524
    )
    
    
    (480
    )Cost of acquisition
    
    $
    25,130
    
    
    $
    10,840
  (1)
    
    Prior to MCK goodwill write-down of $10.9 million  Pro Forma Effect of MCK and Clarent TransactionsThe results of MCK have been included in the consolidated results
beginning October 1, 2003 and the results of Clarent have been included in
the consolidated results subsequent to February 12, 2003. The
write-down of goodwill in 2003 for MCK of $10.9 million is
excluded from the amounts for the quarter ended March 31, 2003.
This write-down occurred simultaneous with, and is directly related
to the acquisition of MCK.  The following
unaudited pro forma information presents the results of continuing
operations of the Company for the three months ended March 31, 2003, as if
the acquisition of MCK and Clarent had taken place on January 1, 2003, (in
thousands, except per share amounts): Quarter endedMarch 31,2003Revenues
    
    $
    17,542Net loss
    
    $
    (7,125
    )Net loss per
common share - basic and diluted
    
    $
    (0.07
    )Weighted average shares outstanding
- basic and diluted
    
    
    107,716
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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  3.
    
    EQUITY INVESTMENTOn October 1, 2002, the Company acquired a 51% interest in Shanghai BeTrue
Infotech Co., Ltd. (BeTrue). The remaining 49% interest in BeTrue is
owned by Shanghai Tangsheng Investments & Development Co. Ltd (Shanghai
Tangsheng). The joint venture provides the Company with an immediate
distribution channel into the China and Asia-Pacific region for the
Companys application-based voice over Internet protocol (VoIP) gateway
solutions, billing systems, value-added applications and web filtering
solutions. Due to the shared decision making between the Company and its
equity partner, the results of BeTrue are treated as an equity investment
rather than being consolidated. The Company determined since BeTrue
was a business that BeTrue did
not fall under the scope of FASB Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN No. 46R) and there was no impact on the
Companys financial position or results of operations.The Company purchased the 51% interest in BeTrue for $100,000 from NeTrue
Communications, Inc., Shanghai Tangshengs former joint venture partner.
The Company also contributed to the joint venture certain next-generation
communication equipment and software valued at approximately $236,000 and
$100,000 cash.Summarized financial information reported by this affiliate for the three
months ended March 31, 2004 and 2003 (in thousands) are as follows: Three months endedMarch 31,2004
    
    2003Operating results:Revenues
    
    $
    403
    
    
    $
    78Operating loss
    
    $
    (35
    )
    
    $
    (77
    )Net loss
    
    $
    (35
    )
    
    $
    (65
    )
 8




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  4.
    
    DISCONTINUED OPERATIONSFollowing the acquisition of NACT in July 2001, the Company determined
that its value added reseller business and associated consulting practice
(legacy VAR business) was not strategic to the Companys ongoing
objectives and discontinued capital and human resource investment in its
legacy VAR business. Accordingly, the Company elected to report its legacy
VAR business as discontinued operations by early adoption of SFAS No. 144,
Accounting for the Impairment of Disposal of Long-Lived Assets (SFAS
No. 144). There were no results of discontinued operations for the
quarters ended March 31, 2004 and 2003, respectively.The liabilities of discontinued operations included in the accompanying
condensed consolidated balance sheet (in thousands) are as follows: March 31,
    
    December 31,2004
    
    2003Accrued restructuring costs
    
    $
    1,455
    
    
    $
    1,472Other current liabilities
    
    
    359
    
    
    
    401Liabilities of discontinued operations
    
    $
    1,814
    
    
    $
    1,873
  Accrued restructuring costs relate primarily to several leases for
buildings and equipment that are no longer being utilized in continuing
operations. The accrual is for all remaining payments due on these
leases, less estimated amounts to be paid by any sublessors. The accrual
for one of the leases with total payments remaining through January 31,
2010 of $2.3 million is offset by sublease receipts totaling $1.1 million
through the end of the Companys lease term and assumes an amount of
$240,000 for the extension of one of the subleases through the end of the
Companys lease term.  The activity in the restructuring accrual for discontinued operations was
as follows: Three months ended
March 31,2004
    
    2003Balance beginning of period
    
    $
    1,873
    
    
    $
    3,131Lease payments, net of sublease
receipts
    
    
    (17
    )
    
    
    (240
    )Other payments
    
    
    (42
    )
    
    
    (353
    )Balance end of period
    
    $
    1,814
    
    
    $
    2,538
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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  5.
    
    INVENTORIESInventories consist primarily of purchased electronic components, and are
stated at the lower of cost or market. Cost is determined by using the
first-in, first-out method.Inventories as of March 31, 2004 and December 31, 2003, are comprised of
the following (in thousands): March 31,
    
    December 31,2004
    
    2003Raw materials
    
    $
    5,592
    
    
    $
    5,610Work in process
    
    
    718
    
    
    
    1,028Finished goods
    
    
    2,021
    
    
    
    2,089Total inventories
    
    $
    8,331
    
    
    $
    8,727
  6.
    
    GOODWILL AND OTHER INTANGIBLESIntangible assets represent the excess of cost over the fair value of net
tangible assets acquired and identified other intangible assets, which
consist of purchased software development, channels of distribution,
strategic licenses, current technology and customer relationship.
Purchased software development is amortized on a straight-line basis over
an estimated useful life of three years once the projects are placed in
service. The channels of distribution, strategic licenses and current
technology are amortized on a straight-line basis over their estimated
useful life of three years. The customer relationship is amortized on a
straight-line basis over its estimated useful life of ten years. Goodwill
associated with acquisitions is not being amortized in accordance with
SFAS No. 142.Goodwill and other intangible assets consist of the following (in
thousands): Amortization
    
    March 31,
    
    December 31,Period in months
    
    2004
    
    2003Intangibles subject to amortization:Purchased software development
    
    36 months
    
    $
    2,629
    
    
    $
    2,629Channels of distribution
    
    36 months
    
    
    900
    
    
    
    900Strategic licenses
    
    36 months
    
    
    1,800
    
    
    
    1,800Current technology
    
    36 months
    
    
    1,721
    
    
    
    1,721Customer relationship
    
    120 months
    
    
    2,403
    
    
    
    2,403Weighted average months
    
    57 months
    
    
    9,453
    
    
    
    9,453Accumulated amortization:Purchased software development
    
    
    
    
    
    
    (1,591
    )
    
    
    (1,438
    )Channels of distribution
    
    
    
    
    
    
    (150
    )
    
    
    (75
    )Strategic licenses
    
    
    
    
    
    
    (300
    )
    
    
    (150
    )Current technology
    
    
    
    
    
    
    (385
    )
    
    
    (242
    )Customer relationship
    
    
    
    
    
    
    (300
    )
    
    
    (240
    )Net intangibles subject to amortization
    
    
    
    
    
    
    6,727
    
    
    
    7,308Goodwill
    
    
    
    
    
    
    16,228
    
    
    
    16,228Total goodwill and other intangibles
    
    
    
    
    
    $
    22,955
    
    
    $
    23,536
 10




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  7.
    
    LOAN FACILITY WITH SILICON VALLEY BANKIn February 2003, the Company amended its original credit agreement (the
Original Credit Agreement) with its primary lender, Silicon Valley Bank
(Silicon), to increase the Companys credit line with Silicon from $5.0
million to $10.0 million, subject to borrowing availability. The Company
also entered into certain additional arrangements with Silicon including
an export-import (EX-IM) facility that will provide for working capital
based on the Companys international accounts receivable and inventory
related to export sales. The Company and Silicon further amended the
credit facility in connection with the acquisition of MCK and the
acquisition of substantially all of the business assets along with certain
related liabilities of Clarent (as amended, the Amended Credit
Agreement). The Companys borrowings under the Amended Credit Agreement
are secured by substantially all of the assets of the Company. Interest
on borrowings under the Amended Credit Agreement is computed at 2.0% above
Silicons Base Rate, with a minimum Base Rate of 4.25% (6.25% at March 31,
2004). The Amended Credit Agreement provides for up to $2.5 million in
letters of credit. Advances are limited by a formula based on eligible
receivables, inventories, certain cash balances, outstanding letters of
credit and certain subjective limitations. Interest payments are due
monthly, and the Amended Credit Agreement expires in August 2004. The
Amended Credit Agreement includes a loan fee of $170,000 and .375% per
annum on unused available borrowings. In February 2004, the Company and
Silicon further amended the credit facility. Under the terms of the
Amended Credit Agreement, the Company must maintain a minimum tangible net
worth covenant, computed monthly, and may not declare dividends or incur
any additional indebtedness without the consent of Silicon, and must
comply with other financial covenants, as defined in the Amended Credit
Agreement. The Company was in compliance with these covenants as of March
31, 2004.Pursuant to the loan commitment letter with Silicon, on February 12, 2003,
the Company issued to Silicon a warrant to purchase 350,000 shares of the
Companys common stock at an exercise price of $0.44 per share. The fair
value of the warrant issued totaled approximately $119,000, using the
Black-Scholes option pricing method based on the following
weighted-average assumptions: expected volatility  104%; expected life 
five years; risk-free interest rate  3.0%; and expected dividend yield 
0%. The loan fees and fair value of the warrants issued are being
amortized to interest expense over the term of the Amended Credit
Agreement.The Company had no borrowings under the Amended Credit Agreement as of
March 31, 2004. The availability under the Amended Credit Agreement at
March 31, 2004 was $6.2 million. The Company has outstanding letters of
credit in the amount of $1.6 million at March 31, 2004, which reduces
borrowing capacity under the Amended Credit Agreement.8.
    
    OTHER COMPREHENSIVE LOSSComprehensive loss for the three months ended March 31, 2004 and 2003 is
shown in the following table (in thousands): Three months ended March 31,2004
    
    2003Net loss
    
    $
    (3,736
    )
    
    $
    (1,125
    )Other comprehensive (loss)
income:Foreign currency translation
    
    
    (59
    )
    
    
    51Comprehensive loss
    
    $
    (3,795
    )
    
    $
    (1,074
    )
 11




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  9.
    
    SEGMENT INFORMATIONThe Company reports information for three segments, the Carrier Solutions
Group, the Enterprise Solutions Group and the Advanced Applications
Services Group. Previously the Company reported two segments, the Carrier
Solutions Group and the Enterprise Solutions Group. In 2004, the Company
changed its internal reporting and decision-making for the Enterprise Solutions Group and
segregated the activity of the Advanced Applications Services Group.
Management evaluates the business segment performance based on
contributions before unallocated items. Inter-segment sales and transfers
are not significant. CarrierSolutionsGroup:
    
    The Companys Carrier Solutions Group consists of the operations of
the Companys Clarent softswitching division and the Companys
subsidiary, NACT. The Companys Carrier Solutions Group includes
hardware and software, integration, applications and technical
training and support.EnterpriseSolutionsGroup:
    
    The Companys Enterprise Solutions Group consists of the operations
of the Companys Clarent Netperformer division, the Companys
subsidiary Telemate.Net and the Companys subsidiary MCK. The
Enterprise Solutions Group offers hardware-based solutions (which
include software) for companies seeking to build private,
packet-based voice and data networks. Additionally, the Enterprise
Group offers software-based solutions for Internet access and usage
management that include call accounting and usage reporting for
Internet protocol network devices, as well as customer support.Advanced ApplicationsServicesGroup:
    
    The Companys Advanced Applications Services Group, consists of the
Companys technical applications support group which was previously
included as part of the Enterprise Solutions Group, and includes
outsourced technical application services and application
installation and training services to outside customers, as well as customers of the
Companys Carrier Solution Group and Enterprise Solution Group
segments.
 12




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  9.
    
    SEGMENT INFORMATION, Continued  Summarized financial information concerning the Companys reportable
segments is shown in the following table (in thousands): Carrier
    
    Enterprise
    
    ApplicationsSolutions
    
    Solutions
    
    ServicesGroup
    
    Group
    
    Group
    
    TotalFor the Three Months Ended March 31, 2004Revenue
    
    $
    8,449
    
    
    $
    4,967
    
    
    $
    3,145
    
    
    $
    16,561Contribution before unallocated items
    
    
    2,195
    
    
    
    858
    
    
    
    820
    
    
    
    3,873For the Three Months Ended March 31, 2003Revenue
    
    $
    6,722
    
    
    $
    3,169
    
    
    $
    3,106
    
    
    $
    12,997Contribution before unallocated items
    
    
    1,137
    
    
    
    1,438
    
    
    
    1,282
    
    
    
    3,857At March 31, 2004Goodwill
    
    $
    10,170
    
    
    $
    4,605
    
    
    $
    1,453
    
    
    $
    16,228Total Assets
    
    
    25,171
    
    
    
    15,221
    
    
    
    4,136
    
    
    
    44,528At December 31, 2003Goodwill
    
    $
    10,170
    
    
    $
    4,605
    
    
    $
    1,453
    
    
    $
    16,228Total Assets
    
    
    28,279
    
    
    
    16,545
    
    
    
    4,382
    
    
    
    49,206
  The following table reconciles the contribution before
unallocated items to the loss before income taxes (in thousands): Three Months Ended March 31,2004
    
    2003Contribution before unallocated items, per above
    
    $
    3,873
    
    
    $
    3,857General and administrative expenses
    
    
    (1,897
    )
    
    
    (1,654
    )Research and development
    
    
    (46
    )
    
    
    Sales and marketing
    
    
    (3,170
    )
    
    
    (1,891
    )Depreciation and amortization of property and equipment
    
    
    (805
    )
    
    
    (653
    )Amortization of intangibles
    
    
    (135
    )
    
    
    (60
    )Amortization of deferred compensation, related tosales, general and administrative
    
    
    (166
    )
    
    
    (199
    )Reorganization costs
    
    
    (584
    )
    
    
    (114
    )Reorganization costs-stock related
    
    
    (570
    )
    
    
    (80
    )Other
    
    
    (236
    )
    
    
    (331
    )Loss before income taxes
    
    $
    (3,736
    )
    
    $
    (1,125
    )
 13




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  9.
    
    SEGMENT INFORMATION, ContinuedThe following table reconciles the segment total assets to the Companys
total assets: March 31,
    
    December 31,2004
    
    2003Total assets before unallocated items, per above
    
    $
    44,528
    
    
    $
    49,206Corporate assets:Cash and cash equivalents
    
    
    24,470
    
    
    
    7,654Restricted cash
    
    
    228
    
    
    
    2,290Other current assets
    
    
    574
    
    
    
    144Property and equipment, net
    
    
    2,933
    
    
    
    3,285Investment
    
    
    655
    
    
    
    673$
    73,388
    
    
    $
    63,252
  The Company conducts research and development in Canada. International
sales of the Companys products and services originate only from the
United States. The geographic distribution of the Companys revenues and
contribution before unallocated items (in thousands) are as follows: Canada
    
    United States
    
    TotalFor the Three Months Ended March 31, 2004Revenue
    
    $
    
    
    
    $
    16,561
    
    
    $
    16,561Contribution before unallocated items
    
    
    (1,406
    )
    
    
    5,279
    
    
    
    3,873Total assets
    
    
    1,345
    
    
    
    72,043
    
    
    
    73,388For the Three Months Ended March 31, 2003Revenue
    
    $
    
    
    
    $
    12,997
    
    
    $
    12,997Contribution before unallocated items
    
    
    (484
    )
    
    
    4,341
    
    
    
    3,857At March 31, 2004Total assets
    
    $
    1,345
    
    
    $
    72,043
    
    
    $
    73,388At December 31, 2003Total assets
    
    $
    1,514
    
    
    $
    61,738
    
    
    $
    63,252
 14




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  10.
    
    REORGANIZATION COSTSIn the first quarter of 2004, the Company terminated a senior executive.
As a result of this action, the Company recorded reorganization costs of
$1.2 million during the three months ended March 31, 2004. The
reorganization costs consist of severance costs of $584,000 and non-cash
stock compensation of $570,000 related to the write-off of unamortized
deferred compensation.In the first quarter of 2003, the Company initiated a reorganization to
accommodate the acquisition of the assets of Clarent and eliminated 14
positions held by employees. As a result of these actions, the Company
recorded reorganization costs of $194,000 during the three months ended
March 31, 2003. The reorganization costs consist of severance costs of
$114,000 and non-cash stock compensation of $80,000.11.
    
    PRIVATE PLACEMENTOn February 24, 2004, the Company completed a private placement of
securities pursuant to which it issued 9.8 million shares of its common
stock and warrants to purchase 2.5 million shares of its common stock for
an aggregate purchase price of $17.7 million, or $1.80 per share. The
warrants issued in connection with the private placement are exercisable
for a period of seven years and at an exercise price of $2.30 per share.
The Company received approximately $16.6 million, net of expenses, from
the private placement of these securities.12.
    
    STOCK OPTIONS AND WARRANTSThe Company has a stock option plan for employees, board of directors,
consultants, and other individual contributors to the Company. In
addition, i
n connection with various financing and acquisition transactions, and for
services provided to the Company, the Company has issued warrants to
purchase the Companys common stock. A summary of stock options and
warrants outstanding at March 31, 2004, is as follows:  OPTIONS AND WARRANTS ISSUED TO EMPLOYEES Options and Warrants Outstanding
    
    Options and Warrants ExercisableRange of Exercise
    
    Outstanding at
    
    Weighted Average
    
    Exercisable at
    
    Weighted AveragePrices
    
    March 31, 2004
    
    Exercise Price
    
    March 31, 2004
    
    Exercise Price$0.19-$0.50
    
    
    3,484,893
    
    
    $
    0.43
    
    
    
    2,701,518
    
    
    $
    0.41$0.51-$1.19
    
    
    1,660,395
    
    
    $
    0.95
    
    
    
    767,277
    
    
    $
    0.87$1.20-$1.50
    
    
    458,000
    
    
    $
    1.44
    
    
    
    409,750
    
    
    $
    1.46$1.51-$2.13
    
    
    237,000
    
    
    $
    1.85
    
    
    
    9,000
    
    
    $
    1.60$2.14-$2.14
    
    
    4,573,619
    
    
    $
    2.14
    
    
    
    4,026,744
    
    
    $
    2.14$2.15-$3.05
    
    
    292,190
    
    
    $
    2.74
    
    
    
    282,226
    
    
    $
    2.75$3.06-$4.00
    
    
    1,778,234
    
    
    $
    3.49
    
    
    
    920,859
    
    
    $
    3.44$4.01-$5.00
    
    
    1,380,060
    
    
    $
    4.24
    
    
    
    1,156,935
    
    
    $
    4.25$5.01-$18.00
    
    
    683,075
    
    
    $
    6.77
    
    
    
    678,919
    
    
    $
    6.77Total
    
    
    14,547,466
    
    
    $
    2.16
    
    
    
    10,953,228
    
    
    $
    2.24
  Options and warrants issued to employees generally terminate ten years
from the date of grant. Termination dates on the options and warrants
listed above range from May 13, 2004 to March 22, 2014. 15




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  12.
    
    STOCK OPTIONS AND WARRANTS, ContinuedA summary of the status of stock options and warrants granted to employees
as of March 31, 2004, and the changes during the quarter ended is
presented below: Number of Shares of
    
    Weighted AverageUnderlying Options
    
    Exercise PricesOutstanding at
beginning of the period
    
    
    14,727,764
    
    
    $
    2.13Granted
    
    
    222,000
    
    
    
    1.88Exercised
    
    
    (243,098
    )
    
    
    0.56Forfeited
    
    
    (159,200
    )
    
    
    1.03Expired
    
    
    
    
    
    
    Outstanding at end of period
    
    
    14,547,466
    
    
    
    2.16Exercisable at end of period
    
    
    10,953,228
    
    
    
    2.24
  A summary of warrants issued primarily in connection with financing is as
follows: Number of
    
    Weighted AverageExercise Price
    
    Outstanding Warrants
    
    Exercise Price
    
    Expiration Date$0.01
    
    
    37,532
    
    
    $
    0.01
    
    
    September 2005-October 2006$1.50-$1.82
    
    
    1,244,106
    
    
    $
    1.63
    
    
    August 2005-January 2006$2.30-$3.09
    
    
    2,462,861
    
    
    $
    2.30
    
    
    February 2005-February 2011$3.80-$5.51
    
    
    2,122,469
    
    
    $
    4.98
    
    
    July 2005-October 2006$5.62-$5.65
    
    
    4,534,839
    
    
    $
    5.65
    
    
    February 2005-September 2006$6.00
    
    
    150,000
    
    
    $
    6.00
    
    
    October 2006Total
    
    
    10,551,807
    
    
    $
    4.25
  All warrants are vested.The exercise price and number of outstanding warrants for certain warrants
previously issued have been adjusted according to their antidilution
provisions. 16




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  12.
    
    STOCK OPTIONS AND WARRANTS, ContinuedA summary of the status of warrants issued primarily in connection with
financing as of March 31, 2004, and the changes during the quarter ended
is presented below: Number of Shares of
    
    Weighted AverageUnderlying Warrants
    
    Exercise PricesOutstanding at beginning of period
    
    
    8,010,196
    
    
    $
    4.90Granted
    
    
    2,457,525
    
    
    
    2.30Exercised
    
    
    
    
    
    
    Expired
    
    
    (25,000
    )
    
    
    5.00Effects of
anti-dilutive provisions
    
    
    109,086Outstanding and exercisable at end of period
    
    
    10,551,807
    
    
    
    4.25
  If the Company had used the fair value-based method of accounting for its
stock option and incentive plans and charged compensation cost against
income, over the vesting period, based on the fair value of options at the
date of grant, the pro-forma net loss and net loss per common share would
have been as follows (in thousands, except for per share amounts): Three months ended March 31,2004
    
    2003Net loss, as reported
    
    $
    (3,736
    )
    
    $
    (1,125
    )Add: Stock-based compensation
expense included in net loss
    
    
    166
    
    
    
    199Less: Total stock-based employee
compensation expense determined
under fair value based method
for all awards
    
    
    (653
    )
    
    
    (965
    )Pro forma net loss
    
    $
    (4,223
    )
    
    $
    (1,891
    )Net loss per common shareAs reported
    
    $
    (0.03
    )
    
    $
    (0.01
    )Pro forma
    
    
    (0.03
    )
    
    
    (0.02
    )
 17




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2004 (Unaudited)  13.
    
    NET LOSS PER SHAREBasic and diluted net loss per share are computed in accordance with SFAS
No. 128, Earnings Per Share, using the weighted average number of common
shares outstanding. The diluted net loss per share for the three months
ended March 31, 2004 does not include the effect of the common stock
equivalents, calculated by the treasury stock method, as their impact
would be antidilutive. Using the treasury stock method, common stock
equivalents are as follows: For the three months
ended March 31,2004
    
    2003Shares issuable under stock options
    
    
    3,944,394
    
    
    
    1,677,728Shares issuable pursuant to warrants
to purchase common stock
    
    
    271,363
    
    
    
    4,073,3084,215,757
    
    
    
    5,751,036
  14.
    
    LITIGATION Except for the pending matters described in Note 17 to the Companys
Consolidated Financial Statements included in the Companys Annual Report on
Form 10-K for the year ended December 31, 2003, the Company is not a party to
any material legal proceedings other than ordinary routine claims and
proceedings incidental to its business, and the Company does not expect these
ordinary routine claims and proceedings, either individually or in the
aggregate, to have a material adverse effect on the Company. There
have been no material developments during the quarter ended
March 31, 2004 regarding the pending matters described in
Note 17 to the Companys Consolidated Financial Statements
included in the Companys Annual Report on Form 10-K for the
year ended December 31, 2003. 18




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ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements in this Quarterly Report on Form 10-Q and in future
filings by the Company with the SEC and in the Companys written and oral
statements that are not statements of historical facts are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act
of 1995. The words believe, expect, anticipate, intend, will and
similar expressions are examples of words that identify forward-looking
statements. Forward-looking statements include, without limitation, statements
regarding our future financial position, business strategy and expected cost
savings. These forward-looking statements are based on our current beliefs, as
well as assumptions we have made based upon information currently available to
us. Each forward-looking statement reflects our current view of future events
and is subject to risks, uncertainties and other factors that could cause
actual results to differ materially from any results expressed or implied by
our forward-looking statements. Important factors that could cause actual
results to differ materially from the results expressed or implied by any
forward-looking statements include:  
    
    the volatility of the price of the Companys common stock;
    
    the Companys ability to fund future growth;
    
    the Companys ability to be profitable;
    
    the Companys ability to attract and retain qualified personnel;
    
    general economic conditions of the telecommunications market;
    
    market demand for and market acceptance of the Companys products;
    
    legal claims against the Company, including, but not limited to claims of
patent infringement;
    
    the Companys ability to protect the Companys intellectual property;
    
    defects in the Companys products;
    
    the Companys obligation to indemnify certain customers;
    
    the Companys exposure to risks inherent in international operations;
    
    the Companys dependence on contract manufacturers and suppliers;
    
    the Companys ability to integrate the operations of the businesses recently
acquired by the Company;
    
    the Companys dependence on a small number of customers for revenue with
respect to certain of the Companys products;
    
    the Companys ability to develop and maintain relationships with key
vendors;
    
    new regulation and legislation;
    
    general economic and business conditions;
    
    other risks and uncertainties disclosed in the Companys Annual Report on
Form 10-K for the year ended December 31, 2003 and in the Companys other
filings with the SEC. All subsequent forward-looking statements relating to the matters
described in this document and attributable to us or to persons acting on our
behalf are expressly qualified in their entirety by such factors. We have no
obligation to publicly update or revise these forward-looking statements to
reflect new information, future events, or otherwise, except as required by
applicable Federal securities laws, and we caution you not to place undue
reliance on these forward-looking statements. 19




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Overview Following the acquisition of NACT in 2001, the Company began selling
products to the carrier market and focusing its strategic direction on
developing and marketing next-generation communications products. The
Companys current business was built on acquisitions made by the Company by
leveraging the economic downturn in the telecommunications area. In the second
half of 2001, the Company acquired NACT and Telemate.Net; Telemate.Net products
are sold to enterprise customers. Both of these companies sold products almost
exclusively in domestic markets. In the first quarter of 2003, the Company
acquired substantially all of the operating assets of Clarent, which provided
the Company with patented VoIP technologies for both the carrier and enterprise
markets (primarily serving international markets) and significantly increased
the Companys market share in the worldwide softswitch market. At the end of
the third quarter of 2003, the Company acquired MCK and added MCKs integrated
access routers and distributed telephony devices products to the Companys
enterprise segment. For the three months ended March 31, 2004, 81% of the
Companys consolidated revenues are attributable to the business acquired in
these four acquisitions and 55% of the Companys consolidated revenues are
attributable to the businesses acquired by the Company in 2003. The Companys strategy through 2003 was to add next-generation
communications products to its suite of products through strategic acquisitions
and to leverage these operations through cost reductions to enhance cash flow.
With the acquisition of substantially all of the operating assets of Clarent,
the Company enhanced its strategy to move growth toward international markets.
International revenue increased to 35% of the Companys consolidated revenues
for 2003 versus 8% of the Companys consolidated revenues for 2002. As the
acquisition of substantially all of the operating assets of Clarent was funded
primarily by short-term seller financing, generating cash flow during 2003 was
extremely important to the Company. As such, the Company leveraged its
combined operations, reducing sales, general and administrative costs (as
compared to costs prior to the acquisition), while preserving the research and
development expenditures, which are necessary for the Companys long-term
growth and viability. Through 2003, the Companys focus had been on completing strategic
acquisitions, integrating these acquisitions and enhancing cash flow through
cost containment, especially in the sales and marketing area. In 2004, the
Company intends to significantly increase its expenditures for sales and
marketing and focus on growing revenues. In the first quarter of 2004, the
Company completed a private placement and raised approximately $16.6 million,
net of expenses, to fund the expanded sales and marketing programs. The
Company expects that these additional expenditures will significantly increase
the operating loss in 2004 as compared to 2003, excluding the write-down of
goodwill in 2003. General The Company is a communications technology and solutions provider for
communications service providers and enterprises seeking to implement
application-based telephony services, Internet usage management tools and
outsourced customer support services. The Companys continuing operations
include three separate business segments, the Carrier Solutions Group, which
includes the Companys Clarent softswitching division and the Companys
subsidiary NACT, the Enterprise Solutions Group, which includes the Companys
Clarent Netperformer division and the Companys subsidiaries Telemate.Net and
MCK, and the Advanced Applications Services Group, which includes the Companys
technical application support group which was previously included as part of
the Enterprise Solutions Group. The Carrier Solutions Group includes domestic
and international sales of hardware and software, integration, applications and
technical training and support. The Enterprise Solutions Group offers
hardware-based solutions (which include software) for companies seeking to
build private, packet-based voice and data networks. Additionally, the
Enterprise Solutions Group offers software-based solutions for Internet access
and usage management that include call accounting and usage reporting for
Internet protocol network devices. The Advanced Applications Services Group
includes customers of the Companys Carrier Solution Group and Enterprise
Solution Group segments, as well as outsourced technical application customers
and includes application installation and training services. The Company
acquired MCK in September 2003 and substantially all the business assets of
Clarent in February 2003. The consolidated financial statements include the accounts of Verso
Technologies, Inc. and its wholly-owned subsidiaries, including MCK,
Telemate.Net, NACT and Clarent Canada Ltd. The Company believes that the foregoing events significantly affect the
comparability of the Companys results of operations from year to year. You
should read the following discussion of the Companys results of operations and
financial condition in conjunction with the Companys consolidated financial
statements and related notes thereto included in Item 15 of the Companys
Annual Report on Form 10-K for the year ended December 31, 2003. 20




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Results of Operations Three Months Ended March 31, 2004, compared to Three Months Ended March 31, 2003 For the three months ended March 31, 2004, the Companys net loss totaled
$3.7 million, or $.03 per share, compared with a net loss of $1.1 million, or
$.01 per share, for the same period in 2003. The 2004 results included
$581,000 in amortization of intangibles, $584,000 of reorganization costs and
$570,000 of stock-related reorganization costs. The 2003 results included
$212,000 in amortization of intangibles, $114,000 of reorganization costs and
$80,000 of stock-related reorganization costs. Total revenue was $16.6 million in the three months ended March 31, 2004,
reflecting a 27% increase from the same period in 2003. Products revenue
increased from $7.3 million to $11.0 million, due to a $1.9 million net
increase from the Carrier Solutions Group attributable to a full quarter of
Clarent (softswitch) net of decline in NACT sales and a $1.8 million increase
from the Enterprise Solutions Group, primarily attributable to MCK and a full
quarter of Clarent (Netperformer) product sales. In 2003, the Company began
redirecting its focus for NACT products sales away from its historic market,
primarily emerging domestic carriers (which market was consolidating), towards
carriers in the international market. At the same time, the Company reduced
its sales and marketing expenditures for NACT, in a broad cost reduction
initiative required to enable the Clarent acquisition. These events negatively
impacted the revenue for NACT. Services revenue was $5.6 million for the
quarter ended March 31, 2004, reflecting a 3% decrease from the same period in
2003. Gross profit increased for the period ended March 31, 2004, and was 51%
of revenue in 2004, compared with 57% of revenue in 2003. The increase in
gross profit dollars resulted primarily from the increase in revenues. The
decrease in gross profit percentage is due to the increase in amortization of
intangibles and reduced margins on services revenues primarily in the Advanced
Applications Services Group. The decrease in the Advanced Applications
Services Group gross profit percentage is related to increased personnel and
related costs and decreased revenue due to lower utilization of certain
personnel due to a shift in some training and installation projects originally
planned in the first quarter of 2004. Total operating expenses incurred for the three months ended March 31,
2004, were $12.0 million, an increase of $3.8 million compared to the same
period of 2003. The increase is primarily attributable to the following items:
increases in general and administrative expenses of $441,000, sales and
marketing expenses of $1.3 million, research and development expenses of
$915,000, depreciation expenses of $152,000, amortization of intangibles of
$75,000 and reorganization costs of $960,000 and offset by decrease in
amortization of deferred compensation of $33,000. The increase in general and administrative, sales and marketing and
research and development expenses resulted from the addition of personnel and
related costs related to the acquisitions of MCK in September 2003 and
substantially all of the business assets of Clarent in February 2003. The increase in depreciation expense is primarily related to the fixed
assets recorded in connection with the acquisition of MCK and substantially all
the business assets of Clarent, as well as, the increases related to the
purchase of furniture and equipment of approximately $425,000 and $1.3 million
during the first three months of 2004 and the last nine months of 2003,
respectively, offset by decreases related to fully depreciated assets. Capital
expenditures are primarily depreciated on a straight-line basis over their
estimated useful lives of three years. The increase in intangible amortization is related to the amortization of
the channels of distribution related to the acquisition of MCK in September
2003. The $33,000 decrease in amortization of deferred compensation primarily
related to the termination of certain options and full vesting of other options
outstanding since the Companys acquisitions of Telemate.Net in November 2001
and Cereus Technology Partners, Inc. (Cereus) in September 2000. The
deferred compensation represents the intrinsic value of the Telemate.Net and
Cereus unvested options outstanding at the date of the acquisitions of
Telemate.Net and Cereus and is amortized over the remaining vesting period of
the options. The $470,000 increase in reorganization costs and $490,000 increase in
stock related reorganization costs is related to the termination of a senior
executive in the three months ended March 31, 2004. As a result of these
actions, the Company recorded total reorganization costs of $1.2 million during
the three months ended March 31, 2004. The Company initiated a reorganization
to accommodate the acquisition of the assets of Clarent in the three months
ended March 31, 2003 and eliminated 14 positions held by employees. As a
result of these actions, the Company recorded total reorganization costs of
$194,000 during the three months ended March 31, 2003. The reorganization
costs consist of severance costs and non-cash stock compensation. 21




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##### Table of Contents



As a percent of revenue, operating expenses were 72% during the three
months ended March 31, 2004 up from 63% for the same period in 2003. Other income was $48,000 during the three months ended March 31, 2004
compared with $9,000 for the same period in 2003. Equity in loss of investment was $18,000 during the three months ended
March 31, 2004, compared to $33,000 for the same period in 2003. This amount
represents the Companys portion of BeTrues income or losses. Due to the
shared decision making between the Company and its equity partner, the results
of BeTrue are treated as an equity investment rather than being consolidated. Net interest expense was $266,000 during the three months ended March 31,
2004, a decrease of $41,000 compared to the same period in 2003. The decrease
was attributable to payments made on the Companys notes payable for the
acquisition of assets from Clarent. Business Unit Performance Carrier
    
    Enterprise
    
    AdvancedSolutions
    
    Solutions
    
    ApplicationsDollars in thousands
    
    Group
    
    Group
    
    Services Group
    
    ConsolidatedFor the Three MonthsEnded March 31,
    
    2004
    
    2003
    
    2004
    
    2003
    
    2004
    
    2003
    
    2004
    
    2003Revenue
    
    $
    8,449
    
    
    $
    6,722
    
    
    $
    4,967
    
    
    $
    3,169
    
    
    $
    3,145
    
    
    $
    3,106
    
    
    $
    16,561
    
    
    $
    12,997Gross profit
    
    
    4,910
    
    
    
    3,806
    
    
    
    2,529
    
    
    
    2,145
    
    
    
    1,064
    
    
    
    1,469
    
    
    
    8,503
    
    
    
    7,420Gross margin
    
    
    58
    %
    
    
    57
    %
    
    
    51
    %
    
    
    68
    %
    
    
    34
    %
    
    
    47
    %
    
    
    51
    %
    
    
    57
    %General and administrative
    
    
    1,049
    
    
    
    1,207
    
    
    
    572
    
    
    
    273
    
    
    
    244
    
    
    
    187
    
    
    
    1,865
    
    
    
    1,667Research and development
    
    
    1,666
    
    
    
    1,462
    
    
    
    1,099
    
    
    
    434
    
    
    
    
    
    
    
    
    
    
    
    2,765
    
    
    
    1,896Contribution before
unallocated items
    
    $
    2,195
    
    
    $
    1,137
    
    
    $
    858
    
    
    $
    1,438
    
    
    $
    820
    
    
    $
    1,282
    
    
    $
    3,873
    
    
    $
    3,857Unallocated items:General and administrative
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,897
    
    
    
    1,654Sales and marketing
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    3,170
    
    
    
    1,891Research and development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    46
    
    
    
    Depreciation and amortization of
property and equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    805
    
    
    
    653Amortization of intangibles
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    135
    
    
    
    60Amortization of deferred compensation,
related to
sales, general and administrative
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    166
    
    
    
    199Reorganization costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    584
    
    
    
    114Stock related reorganization costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    570
    
    
    
    80Operating loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,500
    )
    
    
    (794
    )Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (236
    )
    
    
    (331
    )Loss before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (3,736
    )
    
    $
    (1,125
    )
 22




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##### Table of Contents



Carrier Solutions Group Total revenue from the Companys Carrier Solutions Group revenue was $8.4
million in the three months ended March 31, 2004, a 26% increase from the same
period in 2003. The net increase in revenue is attributable to an increase in,
and a full quarter of, Clarent product sales, offset by a decrease in NACT
product sales. In 2003, the Company began redirecting its focus for NACT
product sales away from its historic market, primarily emerging domestic
carriers (which market was consolidating) towards carriers in the international
market. At the same time, the Company reduced its sales and marketing
expenditures for NACT, in a broad cost reduction initiative required to enable
the Clarent acquisition. Gross profit increased by $1.1 million in the three months ended March 31,
2004, and was 58% percent of revenue, compared to 57% in the same period in
2003. The increase in gross profit dollars is attributable to the increase in
revenue. The increase in gross margin is due to higher margins this quarter
experienced by the Clarent softswitching division due to higher proportion of
software versus hardware product sales. Allocated operating expenses incurred in the Carrier Solutions Group for
the three months ended March 31, 2004, were $2.7 million, which were comparable
to the same period in 2003. The decrease in general and administrative
expenses is attributable to a reduction in bad debt expense at NACT partially
offset by a full quarter of operating expenses related to the Clarent
softswitching division. The increase in research and development expenses
reflects increases related to a full quarter of operations for the Clarent
softswitching division, net of reductions for NACT. As a percent of revenue,
operating expenses for the Carrier Solutions Group were 32% during the three
months ended March 31, 2004, down from 40% during the same period in 2003. Enterprise Solutions Group Total revenue for the Companys Enterprise Solutions Group was $5.0
million in the three months ended March 31, 2004, a 57% increase from the same
period in 2003. The increase in revenue is primarily related to the Companys
acquisition of MCK in September 2003. Gross profit increased by $384,000 in the three months ended March 31,
2004, and was 51% percent of revenue, compared with 68% of revenue in the same
period in 2003. The increase in gross profit dollars is attributable to the
increase in revenue. The decrease in gross margin is related to the increase
in amortization of intangibles related to MCK technology, inventory
obsolescence adjustments and increased product costs. Allocated operating expenses incurred in Enterprise Solutions Group for
the three months ended March 31, 2004, were $1.7 million, an increase of
$964,000 compared to the same period in 2003. The increases in general and
administrative expenses and research and development expenses relate to the
addition of MCK in September 2003 and Clarents Netperformer division in
February 2003. As a percent of revenue, allocated operating expenses for
Enterprise Solutions Group were 34% during the three months ended March 31,
2004 up from 22% during the same period in 2003. The increase is attributable
to the increase in research and development expenses as a percentage of revenue
related to the acquisition of MCK in September 2003 and a full quarter of
Clarents Netperformer division in February 2003. Advanced Applications Services Group Total revenue for the Companys Advanced Applications Services Group was
$3.1 million in the three months ended March 31, 2004, a 1% increase from the
same period in 2003. Gross profit decreased by $405,000 in the three months ended March 31,
2004, and was 34% of revenue, compared with 47% of revenue in the same period
in 2003. The decrease in gross profit dollars and gross margin is due to
increased personnel and related costs and decreased revenue due to lower
utilization rates of certain personnel due to a shift in some training and
installation projects originally planned in the first quarter of 2004. Allocated operating expenses incurred in Advanced Applications Services
Group for the three months ended March 31, 2004, were $244,000, an increase of
$57,000 compared to the same period in 2003. The increase in general and
administrative expenses primarily relate to an increase in personnel and
related costs. 23




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Critical Accounting Policies The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
of America requires management to make judgments, assumptions and estimates
that affect the amounts reported in the consolidated financial statements and
accompanying notes. Factors that could affect the Companys future operating
results and cause actual results to vary from expectations include, but are not
limited to, lower than anticipated growth from existing customers, an inability
to attract new customers, an inability to successfully integrate acquisitions
and technology changes, or a decline in the financial stability of the
Companys customers. Negative developments in these or other risk factors
could have a material adverse affect on the Companys financial position and
results of operations. A summary of the Companys critical accounting policies follows: Allowance for Doubtful Accounts The Company is required to estimate the collectibility of its trade
receivables. Considerable judgment is required in assessing the ultimate
realization of these receivables, including the creditworthiness of each
customer. The evaluation is based on credit information and collection history
concerning the customer up and through the determination date. The Company
determines the allowance for doubtful accounts based on a specific review of
outstanding customer balances and a general reserve based upon aging of
customer accounts and write-off history. Significant changes in required
reserves have been recorded in recent periods and may occur in the future due
to the current telecommunications and general economic environments and updates
to customer credit information and collection activity. Inventory Obsolescence The Company is required to state its inventories at the lower of cost or
market. In assessing the ultimate realization of inventories, the Company
makes judgments as to future demand requirements and compares that with the
current and committed inventory levels. The Company has recorded changes in
net realizable values in recent periods due to the impact of current and future
technology trends and changes in strategic direction, such as discontinuances
of product lines, as well as, changes in market conditions due to changes in
demand requirements. Estimates of the future demand for inventory are based on
sales projections for different products, as well as estimates of inventory
required to fulfill maintenance requirements for products previously sold. It
is possible that changes in the net realizable value of inventory may continue
to occur in the future due to the current market conditions. Restructuring Accruals Discontinued Operations: During 2001, the Company initiated certain restructuring plans. In
conjunction with these restructuring plans, the Company established a
restructuring reserve account for the estimated costs related to the plans.
These costs primarily related to facilities closings, severance costs and other
businesses exiting costs. For the facilities closings cost, a reserve was
established for all remaining lease payments due on buildings and equipment
that were no longer being utilized in continuing
operations, less assumptions for sub-leases. The accrual for one of the leases
with total payments remaining through January 31, 2010 of $2.3 million is
offset by sublease receipts totaling $1.1 million through the end of the lease
term and assumes an amount of $240,000 for the extension of one of the
subleases through the end of the lease term. As of March 31, 2004, the Company
had a remaining reserve balance of approximately $1.5 million, which is
included in liabilities of discontinued operations. The Company currently
believes that this remaining estimated balance is appropriate to cover future
obligations associated with the restructurings, however, changes in these
estimates could occur based on changes in the financial condition of the
sublesses. Deferred Tax Asset Valuation Allowance The Company currently has significant deferred tax assets, which are
subject to periodic recoverability assessment. Realization of the Companys
deferred tax assets is principally dependant upon achievement of projected
future taxable income. The Companys judgments regarding future profitability
may change due to market conditions, its ability to continue to successfully
execute its strategic plan and other factors. These changes, if any, may
require possible material adjustments to these deferred tax asset balances.
Due to the uncertainty of the Companys ability to recognize the entire tax
benefit, the Company established an offsetting provision for the tax assets. 24




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##### Table of Contents



Litigation and Related Contingencies The Company is subject to proceedings, lawsuits and other claims related
to labor, product and other matters. The Company is required to assess the
likelihood of any adverse judgments or outcomes to these matters, as well as,
potential ranges of probable losses. A determination of the amount of reserves
required, if any, for these contingencies is made by the Company with
assistance of its legal counsel after careful analysis of each individual issue
based upon the then-current facts and circumstances. The required reserves may
change in the future due to new developments in each matter or changes in
approach such as a change in settlement strategy in dealing with these matters. Goodwill, Intangible Assets and Long-Lived Assets Goodwill represents the excess of costs over the fair value of net assets
of businesses acquired. Goodwill and intangible assets acquired in a purchase
business combination and determined to have an indefinite useful life are not
amortized, but instead are tested for impairment at least annually in
accordance with provisions of SFAS No. 142. Significant estimates are made
with respect to the impairment testing. SFAS No. 142 also requires that
intangible assets with estimable useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144. In accordance with SFAS No. 144, long-lived assets, such as property,
plant and equipment and purchased assets subject to amortization, are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of the asset may not be recoverable. Recoverability of assets
to be held and used is measured by a comparison of the carrying amount of an
asset to estimated undiscounted future cash flows expected to be generated by
the asset. If the carrying amount of an asset exceeds its estimated future
cash flows, an impairment charge is recognized by the amount by which the
carrying amount of the asset exceeds the fair value of the asset. Significant
estimates are made with respect to recoverability and fair value assessments. 25




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##### Table of Contents



Liquidity and Capital Resources Summary Liquidity is the measurement of the Companys ability to have adequate
cash or access to cash at all times in order to meet financial obligations when
due, as well as to fund corporate expansion and other activities.
Historically, the Company has met its liquidity requirements through a
combination of cash provided by debt from third party lenders, issuances of
debt and equity securities, purchases of other businesses and the sale of
discontinued businesses. At March 31, 2004, the Company had a positive working capital position
(excess of current assets over current liabilities) of $27.2 million compared
to a positive working capital position of $12.7 million at December 31, 2003.
The Companys cash and cash equivalents totaled $24.6 million at March 31,
2004, and $7.7 million at December 31, 2003. Total long-term debt, net of
discount, was $6.7 million at March 31, 2004 and $6.6 million at December 31,
2003. At March 31, 2004 and December 31, 2003, the Company had no borrowings
under its $10.0 million Amended Credit Agreement with Silicon. The Companys
borrowing availability under the Amended Credit Agreement at March 31, 2004 was
$6.2 million. The Company has outstanding stand-by letters of credit in the
amount of $1.6 million at March 31, 2004, which reduce borrowing capacity under
the Amended Credit Agreement. On February 12, 2003, in connection with the Companys acquisition of the
assets of Clarent, the Company amended its existing Original Credit Agreement
with Silicon, and in connection therewith, the Company and Silicon entered into
certain amendments to the existing credit facility and certain additional
credit agreements. Such amendments and additional agreements increased the
Companys asset-based revolving credit line from $5.0 million to $10.0 million
and include an EX-IM facility that will provide for working capital based on
the Companys international accounts receivable and inventory related to export
sales primarily associated with Clarents assets. The amendments and
additional agreements also extended the term of the Original Credit Agreement
for 18 months (through August 13, 2004). On April 7, 2003, the Company and
Silicon further amended the credit facility to increase the EX-IM facility and
to modify certain financial covenants related to the timing of the closing of
the Clarent Asset Purchase. In February 2004, the Company and Silicon further
amended the credit facility. Under the terms of the Amended Credit Agreement,
the Company must maintain a minimum tangible net worth covenant, computed
monthly, and may not declare dividends or incur any additional indebtedness
without the consent of Silicon, and must comply with other financial covenants,
as defined in the Amended Credit Agreement. On February 12, 2003, the Company acquired substantially all the business
assets and assumed certain related liabilities of Clarent for $9.8 million in
notes. At the closing of the acquisition, the Company issued three promissory
notes to Clarent: a $5.0 million secured note due February 13, 2004, which
bore interest at 10% per annum and a $1.8 million non-interest bearing
unsecured note due February 13, 2004, both of which were paid in full as of
March 31, 2004; and a $3.0 million secured note due February 12, 2008, which
bears interest at 5% per annum. The assets the Company purchased from Clarent
secure the secured notes. Cash Flow Cash provided by the Companys continuing operations in the three months
ended March 31, 2004 totaled approximately $2.0 million compared with cash used
in continuing operations of $1.5 million in the same period in 2003. The
cash provided by continuing operations during the three months ended March 31,
2004 resulted primarily from changes in current operating assets and
liabilities of approximately $3.1 million and was offset by cash used by
continuing operations of $1.1 million (net loss from continuing operations of
$3.7 million reduced by non-cash charges totaling $2.6 million, including
depreciation and amortization of $805,000, stock-related reorganization costs
of $570,000, amortization of intangibles of $581,000 and provision for doubtful
accounts of $420,000). Cash used in the Companys discontinued operations in the three months
ended March 31, 2004 totaled $59,000 compared with cash used in discontinued
operations of $329,000 in the same period in 2003. The Company used cash in investing activities in the three months ended
March 31, 2004 of approximately $1.4 million, compared to $622,000 in the same
period of 2003. In the three months ended March 31, 2004, the Company used $3.0
million in cash related to the payment of accrued liabilities assumed in the
acquisition of MCK. During the three months ended March 31, 2004, restricted
cash decreased by $2.1 million. The Company spent $425,000 and $167,000 on
capital expenditures in the three months ended March 31, 2004 and 2003,
respectively. The Company also invested $160,000 on purchased software
development costs in the three months ended March 31, 2003. 26




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##### Table of Contents



Cash provided by financing activities totaled approximately $16.3 million
in the three months ended March 31, 2004 compared to $1.4 million in the same
period of 2003. For the three months ended March 31, 2004, the Company
received proceeds from a private placement, net of associated fees of $16.6
million, received proceeds from the issuance of the Companys common stock
related to the exercise of stock options of $91,000 and paid $350,000 on the
notes payable for the purchase of the assets of Clarent in 2003. The Company
borrowed $1.4 million on the Companys credit line in the three months ended
March 31, 2003, none of which remained outstanding as of March 31, 2004. Contractual Obligations and Commercial Commitments The following summarizes the Companys future contractual obligations at March
31, 2004 (in thousands): Less than
    
    
    
    
    
    
    
    
    
    AfterContractual Obligations
    
    Total
    
    1 year
    
    1-3 years
    
    4-5 years
    
    5 yearsLine of credit
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Additional payments for the acquisition of
Encore Group
    
    
    909
    
    
    
    489
    
    
    
    395
    
    
    
    25
    
    
    
    Notes payable for the purchase of Clarent
    
    
    3,000
    
    
    
    
    
    
    
    
    
    
    
    3,000
    
    
    
    Accrued costs of MCK acquisition
    
    
    4,042
    
    
    
    1,309
    
    
    
    2,623
    
    
    
    110
    
    
    
    Convertible subordinated debentures
    
    
    4,500
    
    
    
    
    
    
    
    4,500
    
    
    
    
    
    
    
    Operating leases:Continuing operations
    
    
    13,619
    
    
    
    2,959
    
    
    
    5,003
    
    
    
    4,142
    
    
    
    1,515Discontinued operations
    
    
    2,609
    
    
    
    809
    
    
    
    737
    
    
    
    768
    
    
    
    295Total contractual cash obligations
    
    $
    28,679
    
    
    $
    5,566
    
    
    $
    13,258
    
    
    $
    8,045
    
    
    $
    1,810
 Note, this table excludes interest expense and sublease rentals and
assumes that leases are not renewed. The Company has outstanding stand-by
letters of credit in the amount of $1.6 million at March 31, 2004. Sources of Cash For 2004, the Company expects that its primary sources of cash will be
from cash on hand and borrowings under its Amended Credit Agreement with
Silicon. The Company expects that its current operations will not generate
positive income from operations before interest, taxes, depreciation,
amortization of intangibles and amortization of deferred compensation for the
next year as the Company is investing in additional sales and marketing and
research and development costs. However, the Company believes that it will
have sufficient liquidity from its cash on hand and its unused credit facility
to meet its current financial obligations during the next twelve months. The Amended Credit Agreement with Silicon, however, is subject to certain
financial covenants (including a minimum tangible net worth covenant) and
limitations on the Companys ability to access funds under the Amended Credit
Agreement. If the Company is in violation of the Amended Credit Agreement, or
does not have sufficient eligible accounts receivable and inventories to
support the level of borrowings it may need, then the Company may be unable to
draw on the Amended Credit Agreement to the extent necessary. To the extent
the Company does not have borrowing availability under the Amended Credit
Agreement, the Company may be required to obtain additional sources of capital,
sell assets, obtain an amendment to the Amended Credit Agreement or otherwise
restructure its outstanding indebtedness. Additional borrowings other than
pursuant to the Amended Credit Agreement must be approved by Silicon and may
have to be approved by the holders of the Clarent secured note due in 2008. If
the Company is unable to obtain additional capital, sell assets, obtain an
amendment to the Amended Credit Agreement or otherwise restructure its
outstanding indebtedness, then the Company may not be able to meet its
obligations. The Amended Credit Agreement, if not extended or replaced,
expires August 12, 2004. The Companys short-term cash needs are for working capital, including
cash operating losses, capital expenditures, remaining unpaid transaction costs
and assumed liabilities related to the acquisition of MCK and payments related
to discontinued operations. At March 31, 2004, accrued costs of MCK
acquisition and other long-term liabilities include $1.6 million in lease
payments related to lease obligations for excess space at the date of
acquisition. The Company expects to pay out approximately $728,000 related to
these obligations in the next twelve months. At March 31, 2004, liabilities of
discontinued operations included $1.5 million in lease payments related to
discontinued operations. The Company expects to pay out approximately $297,000
related to discontinued operations in the next twelve months. 27




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The Companys long-term cash needs are related to the costs of growing its
current business as well as prospective businesses to be acquired, including
capital expenditures and working capital. The Company expects to meet these
cash needs through cash from operations, if any, cash on hand, borrowings under
the Amended Credit Agreement or other debt facilities, if available, as well as
through possible issuances of equity or debt securities. If sufficient
borrowing capacity under a working capital line of credit is unavailable (or if
the Company is unable to restructure its existing Amended Credit Agreement in
the event that the Company requires additional borrowing capacity), or if the
Company is otherwise unable to obtain additional capital or sell assets, then
the Company may not be able to meet its obligations and growth plans. 28




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ITEM 3: QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk The Company is exposed to various market risks, including changes in interest
rates and foreign currency exchange rates. Market risk is the potential loss
arising from adverse changes in market rates and prices, such as interest rates
and foreign currency exchange rates. The Company does not enter into
derivatives or other financial instruments for trading or speculative purposes.
The Company has also not entered into financial instruments to manage and
reduce the impact of changes in interest rates and foreign currency exchange
rates although the Company may enter into such transactions in the future. Interest Rate Risks The Companys notes payable and convertible subordinated debentures at March
31, 2004, carry interest rates, which are fixed. The Companys line of credit
with Silicon carries interest rates, which vary with the prime rate.
Accordingly, if the Company has any indebtedness outstanding under its line of
credit with Silicon, then any increases in Silicons prime rate will reduce the
Companys earnings. At March 31, 2004, the Company did not have any
indebtedness outstanding under its line of credit with Silicon. Foreign Currency Risks Products sold outside of the United States of America are transacted in U.S.
dollars and, therefore, the Company is not exposed to foreign currency exchange
risk. Transactions with Clarent Canada, MCKs subsidiary, MCK
Telecommunications, Inc. and NACTs subsidiary, NACT, Ltd. present foreign
currency exchange risk. The principal transactions are personnel and related
costs. The intercompany balance is denominated in U.S. dollars and changes in
foreign currency rates would result in foreign currency gains and losses.
Using the intercompany balance at March 31, 2004, a 10% strengthening of the
U.S. dollar against the Canadian dollar and the British pound would result in a
foreign currency transaction loss of approximately $29,000. To date, foreign
exchange gains and losses have not been significant. 
 ITEM 4: CONTROLS AND PROCEDURES The Companys Chief Executive Officer and Chief Financial Officer have
evaluated the effectiveness of the Companys disclosure controls and procedures
(as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the
period covered by this report, as required by paragraph (b) of Rules 13(a)-15
or 15(d)-15 of the Exchange Act. Based on such evaluation, such officers have
concluded that, as of the end of the period covered by this report, the
Companys disclosure controls and procedures are effective in alerting them on
a timely basis to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Companys periodic
filings under the Exchange Act. 29




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PART II - OTHER INFORMATION 
 Item 1. LEGAL PROCEEDINGS Except for the pending matters described in Note 17 to the Companys
Consolidated Financial Statements included in the Companys Annual Report on
Form 10-K for the year ended December 31, 2003, the Company is not a party to
any material legal proceedings other than ordinary routine claims and
proceedings incidental to its business, and the Company does not expect these
ordinary routine claims and proceedings, either individually or in the
aggregate, to have a material adverse effect on the Company. 
 Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES On February 24, 2004, the Company issued 9,830,102 shares of its common
stock and warrants to purchase 2,457,525 shares of its common stock to 18
investors in connection with the private placement of securities conducted by
the Company. The securities issued to the investors were issued without
registration under the Securities Act of 1933, as amended (the Securities
Act), in reliance upon the exemption from registration set forth in Regulation
D promulgated pursuant to Section 4(2) of the Securities Act (Regulation D).
The Company based such reliance upon factual representations made to the
Company by each investor as to such investors investment intent,
sophistication, and status as an accredited investor, as that term is defined
in Rule 501 of Regulation D, among other things. On January 21, 2004, the Company issued 24,016 shares of its common stock
to Clunet R. Lewis as compensation pursuant to that certain Consulting
Agreement between Mr. Lewis and the Company dated as of March 14, 2003. The
shares issued to the Mr. Lewis were issued without registration under the
Securities Act in reliance upon the exemption from registration set forth in
Regulation D. The Company based such reliance upon factual representations
made to the Company by Mr. Lewis as to such investors investment intent,
sophistication, and status as an accredited investor, among other things. On January 21, 2004, the Company issued 25,922 shares of its common stock
to William P. OReilly as compensation pursuant to that certain Consulting
Agreement between Mr. OReilly and the Company dated as of March 14, 2003. The
shares issued to the Mr. Lewis were issued without registration under the
Securities Act in reliance upon the exemption from registration set forth in
Regulation D. The Company based such reliance upon factual representations
made to the Company by Mr. Lewis as to such investors investment intent,
sophistication, and status as an accredited investor, among other things. 
 Item 6. EXHIBITS AND REPORTS ON FORM 8-K  (a)
    
    Exhibits  2.1
    
    Securities Purchase Agreement dated as of February
20, 2004, among the Company and each of the investors signatory
thereto. (The schedules to the Securities Purchase Agreement
have been omitted form this Report pursuant to Item 601(b)(2)
of Regulation S-K, and the Company agrees to furnish copies of
such omitted schedules supplementally to the SEC upon
request.)*4.1
    
    Form of warrant issued by the Company to each
investor in connection with the February 2004 private
placement. *4.2
    
    Form of Registration Rights Agreement among the
Company and the investors entered into in connections with the
February 2004 private placement. *31.1
    
    Rule 13a-14(a)/15d-14(a) Certification by the Companys Chief Executive Officer.31.2
    
    Rule 13a-14(a)/15d-14(a) Certification by the Companys Chief Financial Officer.32.1
    
    Section 1350 Certification by the Companys Chief Executive Officer.32.2
    
    Section 1350 Certification by the Companys Chief Financial Officer.*
    
    Incorporated by reference to the Companys Current
Report on Form 8-K filed on February 26, 2004. 30




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(b)
    
    Reports on Form 8-K.Reports on Form 8-K.During the quarter ended March 31, 2004, the Company filed with the
SEC the following Current Reports on Form 8-K:  (i)
    
    Current Report on Form 8-K filed on January 9,
2004, reporting under Item 12 of such report information
regarding the Companys estimated revenue for the fourth
quarter 2003;(ii)
    
    Current Report on Form 8-K filed on February 26,
2004, reporting under Item 5 of such report (a) certain
management changes, (b) the execution of a securities purchase
agreement pursuant to which the Company would issue 9,830,102
            shares of its common stock and warrants to purchase 2,457,525
            shares of its common stock in a private placement transaction
and (c) the subsequent completion of such private placement
transaction; and(iii)
    
    Current Report on Form 8-K filed on February
26, 2004, reporting under Item 12 of such report information
regarding the Companys results of operations and financial
condition for the fourth quarter of 2003. 31




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SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934 the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. VERSO TECHNOLOGIES, INC.Date:
May 10, 2004
    
    /s/ Juliet M. ReisingExecutive Vice President and Chief Financial Officer(duly authorized signatory andPrincipal Financial and Accounting Officer)
 32




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EXHIBIT INDEX  2.1
    
    Securities Purchase Agreement dated as of February 20, 2004, among the
Company and each of the investors signatory thereto. (The schedules to the
Securities Purchase Agreement have been omitted from this Report pursuant
to Item 601(b)(2) of Regulation S-K, and the Company agrees to furnish
copies of such omitted schedules supplementally to the SEC upon request.)
*4.1
    
    Form of Warrant issued by the Company to each investor in connection with
the February 2004 private placement. *4.2
    
    Form of Registration Rights Agreement among the Company and the investors
entered into in connection with the February 2004 private placement. *31.1
    
    Rule 13a-14(a)/15d-14(a) Certification by the Companys Chief Executive Officer.31.2
    
    Rule 13a-14(a)/15d-14(a) Certification by the Companys Chief Financial Officer.32.1
    
    Section 1350 Certification by the Companys Chief Executive Officer.32.2
    
    Section 1350 Certification by the Companys Chief Financial Officer. * Incorporated by reference to the Companys Current Report on Form 8-K filed
on February 26, 2004. 33