**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-K**

 
| **ý** | ** ** | **Annual  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  for the fiscal year ended October 31, 2004.**                                                                                                                                                                                                     |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                 |
| **or**     |
|       |       |                                                                                                                                                                                                                                                                                                                                       |
| **o**      | ** ** | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  for the transition period from                 to                    .** |

 

**Commission file number: 0-28540**

 

**VERSANTCORPORATION**

(Exact name ofregistrant as specified in its charter)

 
| **California**                                                                               | ** ** | **94-3079392**                        |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction  of incorporation or organization)                             |       | (I.R.S. Employer  Identification No.) |
|                                                                                         |       |                                  |
| **6539  Dumbarton Circle, Fremont, California 94555**                                        |
| (Address of  principal executive offices) (Zip code)                                         |
|                                                                                         |       |                                  |
| **(510)  789-1500**                                                                          |
| (Registrant’s  telephone number, including area code)                                   |
|                                                                                         |       |                                  |
| Securities  registered pursuant to Section 12(b) of the Act: **None**                        |
|                                                                                         |       |                                  |
| Securities  registered pursuant to Section 12(g) of the Act: **Common  Stock, no par value** |

 

Indicate by check markwhether the Registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes ý   o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or an amendment to Form 10-K. o

 

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Exchange Act Rule12b-2).  Yes oNo ý

 

The aggregate marketvalue of the outstanding common stock held by non-affiliates of the Registrantas of April 30, 2004, the last business day of the registrant’s most recentlycompleted second fiscal quarter, based on the closing price of $2.08 per shareon the Nasdaq Smallcap Market on April 30, 2004, was approximately$62,138,003.20.  This amount excludes631,764 shares of common stock held by directors, officers and certainshareholders of the Registrant as of April 30, 2004.  Exclusion of shares held by any person shouldnot be construed to indicate that that person possesses power, direct orindirect, to direct or cause the direction of the management or policies of theRegistrant, or that such person is controlled by or is under common controlwith the Registrant.

 

As of February 11, 2005,there were outstanding 34,823,361 shares of the Registrant’s common stock, nopar value.

 

 

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DOCUMENTS INCORPORATED BY REFERENCE 

 

Portions of the Registrant’sdefinitive proxy statement relating to its 2005 Annual Meeting of Shareholdersare incorporated by reference in Part III of this Annual Report on Form 10-Kwhere indicated.  Alternatively, theRegistrant may file an amendment to this Form 10-K to provide such informationwithin 120 days following the end of Registrant’s fiscal year endedOctober 31, 2004.

 

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**VERSANT CORPORATION**

**ANNUAL REPORT ON FORM 10-K**

**For the Fiscal Year Ended October31, 2004**

 

**TABLE OF CONTENTS**

 
| **Item No.**   | ** ** | **Name of Item**                                                                                                       | ** ** | **Page**   |
|----------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|------------|
|           |       |                                                                                                                   |       |       |
| **PART I**     |
|           |       |                                                                                                                   |       |       |
| Item 1.        |       | Business.                                                                                                              |       | 5          |
|           |       |                                                                                                                   |       |       |
| Item 2.        |       | Properties.                                                                                                            |       | 13         |
|           |       |                                                                                                                   |       |       |
| Item 3.        |       | Legal Proceedings.                                                                                                     |       | 13         |
|           |       |                                                                                                                   |       |       |
| Item 4.        |       | Submission of Matters to a Vote of Security  Holders.                                                                  |       | 13         |
|           |       |                                                                                                                   |       |       |
| Item 4A.       |       | Executive Officers of the Registrant.                                                                                  |       | 13         |
|           |       |                                                                                                                   |       |       |
| **PART II**    |
|           |       |                                                                                                                   |       |       |
| Item 5.        |       | Market for Registrant’s Common Equity and  Related Stockholder Matters And Issuer Purchases of Equity Securities. |       | 14         |
|           |       |                                                                                                                   |       |       |
| Item 6.        |       | Selected Financial Data.                                                                                               |       | 16         |
|           |       |                                                                                                                   |       |       |
| Item 7.        |       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations.                           |       | 17         |
|           |       |                                                                                                                   |       |       |
| Item 7A.       |       | Quantitative  and Qualitative Disclosures About Market Risk.                                                           |       | 48         |
|           |       |                                                                                                                   |       |       |
| Item 8.        |       | Financial  Statements and Supplementary Data.                                                                          |       | 48         |
|           |       |                                                                                                                   |       |       |
| Item 9.        |       | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure.                                 |       | 80         |
|           |       |                                                                                                                   |       |       |
| Item 9A        |       | Controls  and Procedures                                                                                               |       | 81         |
|           |       |                                                                                                                   |       |       |
| Item 9B.       |       | Other  Information.                                                                                                    |       | 84         |
|           |       |                                                                                                                   |       |       |
| **PART  III**  |
| ** **     | ** ** | ** **                                                                                                             | ** ** | ** ** |
| Item 10.       |       | Directors  and Executive Officers of the Registrant.                                                                   |       | 84         |
|           |       |                                                                                                                   |       |       |
| Item 11.       |       | Executive  Compensation.                                                                                               |       | 84         |
|           |       |                                                                                                                   |       |       |
| Item 12.       |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters.                      |       | 84         |
|           |       |                                                                                                                   |       |       |
| Item 13.       |       | Certain  Relationships and Related Transactions.                                                                       |       | 84         |
|           |       |                                                                                                                   |       |       |
| Item 14.       |       | Principal  Accountant Fees and Services                                                                                |       | 85         |
|           |       |                                                                                                                   |       |       |
| **PART IV**    |
|           |       |                                                                                                                   |       |       |
| Item 15.       |       | Exhibits  and Financial Statement Schedules                                                                            |       | 85         |
|           |       |                                                                                                                   |       |       |
| Signatures     |       | 86                                                                                                                     |
|           |       |                                                                                                                   |       |       |
| Certifications |       |                                                                                                                   |

 

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VDS, VersantâenJinâ, Versant JDO, Versant Open Access and VRTFare trademarks of Versant in the UnitedStates and/or other countries.   Allother corporate or trade names or service marks referred to in this report arethe names or marks of their respective owners in the United States and/or othercountries.

 

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**CAUTIONREGARDING FORWARD-LOOKING STATEMENTS**

 

*This Form10-K contains forward-looking statements within the meaning of Section 21E ofthe Securities Exchange Act of 1934 and Section 27A of the Securities Act of1933.  These forward-looking statementsare based on our current expectations about our business and industry andreflect our beliefs and assumptions based upon information that is reasonablyavailable to us at the date of this report. In many cases you may identify these forward-looking statements by wordssuch as “will,” “should,” “may,” “might, “believes,” “anticipates,” “expects,” “intends,”“estimates” and similar expressions. These forward-looking statements may include, among other things,projections of our future financial performance and trends anticipated for ourbusiness.*

 

*Wecaution investors that forward-looking statements are only predictions,forecasts or estimates based upon our current expectations about futureevents.  The forward-looking statementsare not guarantees of our future performance and are subject to significantrisks and uncertainties that are difficult to predict.  Our actual results and performance may differmaterially from the results and performance anticipated by any forward-lookingstatements due to these risks and uncertainties. Some of the important risksand factors that could cause our results and performance to differ from resultsor performance anticipated by this report are discussed in Item 7 of thisreport, “Management’s Discussion and Analysis of Financial Condition andResults of Operation - Risk Factors,” which you should read carefully.    We undertake no obligation to revise orupdate any forward-looking statements in order to reflect events or circumstancesthat may arise or occur after the date of this report or for any otherreason.  Readers are urged to carefullyreview and consider the various disclosures made by us in this report and inour other reports filed with the Securities and Exchange Commission thatattempt to advise interested parties of the risks and factors that may affectour business.*

 

**PART I**

 

**Item 1****.  Business.**

 

**Overview**

 

We are a leading providerof object-oriented data management and data integration software that forms acritical component of the infrastructure of enterprise computing.   Companies use our solutions to solve complexdata management and data integration problems. To address these problems, we design, develop, market and supportdatabase management systems, data access and data integration products. We alsoprovide related product support, training and consulting services to assistusers in developing and deploying software applications based on our products.We operate our business within a single operating segment that we refer to asData Management. We were incorporated in California in August 1988 under thename Object Sciences Corporation and completed the initial public offering ofour common stock in July 1996. In March 2004, through a merger, we acquiredPoet Holdings, Inc., or Poet, a European-based provider of object-oriented datamanagement software whose stock was publicly traded prior to the merger.  Our principal executive offices are locatedat 6539 Dumbarton Circle, Fremont, California 94555 and our telephone number is(510) 789-1500.  Our website can be foundat www.versant.com.

 

***Overviewof our Products and Services***

*** ***

We provide sophisticateddata management, data access and data integration software solutions designedto address the complex data management needs of enterprises and providers ofproducts requiring data management functions. Our products are typically deployed to manage data for business systemsto enable these systems to access and integrate data necessary for their datamanagement applications. Our Versant Developer Suite, or VDS and Versant OpenAccess product offerings are used primarily by larger enterprises, such astechnology providers, telecommunications carriers, government defense agenciesand defense contractors, healthcare companies and companies in the financialservices and transportation industries, each of which have significantlarge-scale data management requirements.  With the incorporation of Poet’s FastObjects solution into our productline following our March 2004 merger with Poet, we have expanded the scope ofour solutions to also address data management needs of smaller businesssystems. Our customers’ data management needs can involve many businessfunctions, ranging from management of the use and sharing of a company’sinternal enterprise data to the processing of externally originated informationsuch as customer enrollment, billing and payment transaction data.  Our solutions have also been used to solvecomplex data management issues such as fraud detection risk analysis and yieldmanagement.   Our data access productsdeliver enterprise class data access to a variety of data management systems,including our own. 

 

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In addition to ourproduct offerings, to assist users in developing and deploying applicationsbased on VDS, FastObjects, and Versant Open Access, we offer a variety ofservices, including consulting, training and technical support services.  We also offer a dedicated consulting practicefor IBM WebSphere customers.  Under anagreement signed in late 2000 and renewed most recently in August 2004, weallocate certain of our consultants to IBM and both IBM and Versant salesrepresentatives sell these consultants’ services.

 

***Benefitsof our Solutions***

*** ***

Our VDS, FastObjects andVersant Open Access products provide customers the following benefits forspecialized data management:

 

•      *High Performance*.  Ourobject-based architecture provides direct access or navigation to storedobjects.  The balanced client-server architectureof our products enhances performance by efficiently distributing processingburdens between clients and servers to leverage the processing power ofnetworked computers.

 

•      *Highly Scalable Support for Distributed Computing*.  Through object-level operations,compatibility with Web browsers and other design features, our products can bescaled to work in various environments ranging from small workgroup operationsto operations involving thousands of users over wide area networks or theInternet.

 

•      *Reliability, Availability and Serviceability*.  Our VDS product offers a number of featuresdesigned to permit continuous operation, including features providing onlinebackup and recovery and online modification of the database system, as well assystem utilities that can operate while the system is running.  These features, together with replication anddisk mirroring provided by our Fault Tolerant Server, support operations 24hours per day, 365 days per year.

 

•      *Language-Independent Support for Object-Oriented Programming*.  Our products provide native support for theleading object-oriented software development languages - C++ and Java.  This quality of our products facilitatesrapid and flexible application development by our customers and the maintenanceand evolution of complex, dynamic applications that closely model real-worldsystems and processes.

 

•      *Support for Component Architectures*.  Versant Open Access integrates with leadingJ2EE application servers, including the IBM WebSphere and BEA Weblogicapplication servers. These application servers enable users to build and deployJ2EE-based applications that will work compatibly and directly with VersantOpen Access in order to gain the inherent productivity and performanceadvantages of the underlying object or relational databases.

 

•      *Integration with Users’ Existing Information Systems*.  Versant products operate on a wide range ofserver platforms including: UNIX platforms from Sun Microsystems,Hewlett-Packard, IBM, Compaq and Silicon Graphics; Linux platforms from RedHat; and Microsoft Windows and NT platforms. In addition, our customers’applications, which are based on our product, can interoperate with informationstored in relational database management systems, enabling these applications tocomplement the structured applications strengths of relational databasemanagement systems.

 

# Fiscal 2004 Overview, Developments and Strategy 

#  

In fiscal 2004 we soughtto expand our product line, working capital and global reach by acquiring PoetHoldings, Inc., or Poet, through a merger we consummated in March of 2004.  Poet was the developer of our FastObjectsproduct and was a publicly held company prior to the merger.  Based in Germany, Poet was acquired in partto expand our European sales and operations. Later in the year we also acquired FastObjects, Inc., the exclusiveNorth American distributor of Poet’s FastObjects product and purchased certaintechnology from JDO Genie (PTY) LTD. that now forms the core of our VersantOpen Access product.  During fiscal 2004,we focused our sales and marketing efforts on seeking revenue from our datamanagement products, VDS and FastObjects, our data access product, Versant OpenAccess, and from our consulting services. VDS and, to a lesser extent FastObjects, were the major drivers of ourlicense revenues in fiscal 2004 and a key focus of our marketing efforts.

 

We derived approximately58% of our revenue from our services programs in fiscal 2004.  Our services programs include paidmaintenance and paid support of our data management and data access products,and our WebSphere Professional

 

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Services practice, which is intended to produce incremental revenue, aswell as to serve as an additional channel for generating new product licenseand maintenance revenue. 

 

In fiscal 2004, thetechnology industry sector was the largest source of our revenue. Theincorporation of Versant products into the offerings of independent softwarevendors (ISVs) such as PeopleSoft and Borland and increasing sales of the ISV’sproducts have increased license revenue in this sector. Examples of thesetechnology applications are demand consensus forecasts, collaborative planning,and requirements management. In addition, the growth of the Versant WebSphereProfessional Services practice since its inception in year 2000 has increasedthe amount of our business in the technology sector because of increasingadoption of WebSphere by technology companies.

 

In fiscal 2004, thetelecommunications industry also continued to be a very significant verticalmarket sector for us.  Customers in thetelecommunications industry have used our products in such strategicdistributed applications as network modeling and management, fault diagnosis,fraud prevention, service activation and assurance, and customer billing.  We have also attained customer acceptance inother vertical markets, including defense, financial services, transportation,and health care.  

 

**Products and Services**

** **

***VersantDeveloper Suite (VDS)***

*** ***

VDS, a sixth generationobject database management system, is designed to support multi-user,commercial applications in distributed environments.  VDS enables uses to store, manage anddistribute information that we believe often cannot be administered effectivelyby traditional database technologies, including information of the followingtypes:

 

•      real-time data,such as graphics, images, video, audio and unstructured text;

•      dynamic,graph-oriented data, such as network management data and advanced financialinstruments; and

•      meta-data, dataaiding integration of diverse systems, and workflow information, which takentogether enable the construction of systems that integrate diverse systems andadd new functionality, often making this functionality available over theInternet.

 

The object-oriented,balanced client-server architecture of VDS provides the basis forhigh-performance, scalable distributed applications.  We believe that VDS offers performancesuperior to that of relational database management systems, particularly forcomplex data applications, for which VDS has the capability of processing awide variety of abstract data types in a highly concurrent, high performancemanner.  

 

VDS is designed tointegrate up to 65,000 databases connected over a like number of locations on avariety of hardware and software platforms. Each database has a theoretical storage capacity of 4.6 millionterabytes, an amount far beyond the actual capacity of most existing operatingsystems.  VDS implements a variety ofdatabase features, including a two-phase commitment for distributed transactionintegrity and database triggers to monitor changing events and data and tonotify users and applications when specified events occur.  In addition, on-line management utilitiesenable routine maintenance to be performed while the database is running.  These include utilities to perform backupoperations, manage log files, dynamically evolve database schema, add, deleteand compress volumes on disk storage and related functions.  These utilities provide multiple levels ofadministrative access and application security. We also believe that use of VDS allows our customers to reduce the time neededto develop applications for their data management systems and improve systemperformance.

 

With version 6.0 of VDS,we bundle several components, including the core object database managementsystem, C++ and Java language interfaces, XML for import and export of datainto the database and asynchronous replication services to provide updatesamong distributed Versant databases.  Webelieve that by bundling these components with VDS we enhance our solution andmake it easier for our customers to deploy these components.

 

As part of the VDS familywe also offer Fault Tolerant Server and High Availability Backup Solution,options that are used in situations that require advanced capabilities.

 

Versant Fault TolerantServer******provides******forhighly reliable operations in mission-critical environments. This productprovides transparent failure recovery by connecting database clients tosynchronized copies of the database stored on physically separatecomputers.  If one of the databases failsdue to operating system failure, hardware breakdown or other interruption, theother database continues operation without application interruption.  When the failed database is restored, the twodatabases automatically resynchronize and resume operations without applicationinterruption. 

 

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Our High AvailabilityBackup Solution enables VDS to use the mirroring and backup features of otherenterprise storage systems to take an online backup of very large data volumeswithin seconds, without impacting transaction response times.

 

Versant enJin has beenreplaced by VDS using VDS’s Java Data Objects (JDO) language interface. enJinprovided the benefits of an object-oriented database expressed in a Javastandard interface, but used a proprietary Versant interface internally. JDO isa Java standard, and with VDS, provides the functionality of enJin buteliminates the need for a proprietary interface. 

 

***FastObjects***

 

FastObjects is an objectdatabase management system designed to provide zero-administration and worknatively with the customer’s product. The primary target for FastObjectsproduct line is for use as an embedded data management system to be integratedin a customer’s products. FastObjects is used in a vast range of applications,including medical devices, vending machines, telecom equipment and defensesystems.

 

***VersantOpen Access***

*** ***

Versant Open Access is asoftware product family that provides business application developers with apowerful object storage tool. Versant Open Access reduces the cost of objectstorage, makes it available to the entire development team and simplifies thedevelopment process. In addition, Versant Open Access provideshigh-productivity visual development tools so the learning curve is quick andeasy, and the product is productive for programmers with a wide range of skilllevels. Versant Open Access is designed to provide high-performance, achallenge for many other competitive products in this space. This was recentlyvalidated by Versant Open Access earning top honors in the TORPEDO benchmark byThe Middleware Company. Versant Open Access is offered in versions forapplications written in Java and Microsoft .NET environments. Versant JDO, aproduct we announced last year, and technology we acquired from JDO Genie (PTY)LTD. in June 2004, have both been absorbed into the Versant Open Access family.

 

***Other***

*** ***

As previously disclosedin a Form 8-K filed on August 25, 2004, we recorded a non-cash charge in ourstatement of operations for the three months ended July 31, 2004 whichrepresented the net book value of all assets associated with our Versant RealTime Framework product  (“VRTF”).  VRTF was launched in fiscal 2003 and wasbased on technology we acquired through our November 2002 acquisition of MokumeSoftware, Inc. While Versant believes that the need still exists in the marketplacefor a product such as VRTF, our primary operational focus since merging withPoet in March 2004 has been on integrating the two companies and leveragingtheir respective object database and data access product suites, with the goalof increasing Versant’s accessible market. We have determined that thisobjective requires priority and a greater dedication of resources within ourorganization such that we cannot distract or dilute our efforts in this regardby continuing with the more early stage real time initiative addressed by VRTF.

 

***Licensingand Pricing of Products***

 

We categorize ourcustomers into two broad groups, End Users and Value Added Resellers (“VARs”).Our End User customers are companies who use our products internally and do notredistribute our product outside of their corporate organizations. Our VARcustomers include traditional Value Added Resellers, Systems Integrators, OEMsand other vendors who redistribute our products to external third partycustomers, either individually or as part of an integrated product.  We license our data management productsthrough two types of perpetual licenses—development licenses and deploymentlicenses. Development licenses are typically sold on a per seat basis andauthorize a customer to develop an application program that uses our softwareproduct.

 

Before an End Usercustomer may deploy an application that it has developed under our developmentlicense, it must purchase deployment licenses based on the number of computersconnected to the server that will run the application using our databasemanagement system.  For certain applications, we offer deployment licensespriced on a per user basis.  Pricing of VDS and FastObjects variesaccording to several factors, including the number of computer servers on whichthe application will run and the number of users that will be able to accessthe server at any one time.  Customers may elect to simultaneouslypurchase development and deployment licenses for an entire project.

 

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VARs and distributors,purchase development licenses from us on a per seat basis, on terms similar tothose of development licenses sold directly to End-Users.  VARs areauthorized to sublicense deployment copies of our data management products thatare either bundled or embedded in the resellers’ applications and sold directlyto end-users.  VARs are required to report their distribution of oursoftware and are charged a royalty that is based either on the number of copiesof application software distributed or computed as a percentage of the sellingprice charged by the VAR to its end-user customers and these royalties may beprepaid in full or paid upon deployment. Provided that all other conditions forrevenue recognition have been met, revenue is recognized as follows: (i) as toprepaid license arrangements, revenue is recognized when the prepaid licensesare sold to the VAR, and (ii) as to other license arrangements, revenue isrecognized at the time the VAR provides a royalty report to us for sales madeduring a given period.

 

Revenue from our resaleof third-party products is recorded at total contract value with thecorresponding cost included in cost of sales when we act as a principal inthese transactions and we assume the risks and rewards of ownership, includingthe risk of loss for collection, delivery or returns. When we do not assume therisks and rewards of ownership, revenue from our resale of third-party productsor services is recorded at contract value net of the cost of sales.

 

**Services**

** **

In addition to ourproduct offerings, we offer customers training, consulting and maintenance andtechnical support services.  We provide avariety of training and consulting services to assist customers in the design,development, education and management of applications they build on the base ofour core products as well as IBM’s WebSphere application server.  Training services are offered for a varietyof Versant-specific and object-related technologies and range from beginning toadvanced levels.  Consulting services areavailable for analysis and design assistance, mentoring and technical transfer,application coding, design reviews and performance analysis.  In addition, we provide custom developmentservices to customers that request unique or proprietary productextensions.  Depending on the nature andcomplexity of the custom development services requested, these services may beperformed by our consulting employees or by third-party integrators that havejoined our IGNITE! Partner Program and have received training from us.   Our IBM WebSphere consulting services areprovided under an agreement signed in late 2000 and renewed in August 2004,pursuant to which we allocate certain of our consultants to IBM for WebSphereconsulting and both IBM and Versant sales representatives sell theseconsultants’ services.

 

Our maintenance andtechnical support services are generally available at an annual fee that variesdepending on the type of support the customer requires.  Maintenance and support contracts, whichtypically have twelve-month terms, are offered concurrently with the initiallicense of our product and entitle the customer to telephone support and toproduct and documentation updates.  Foradditional fees, customers may purchase a special support package that providesa designated support engineer, and may obtain telephone support available 24hours per day.  Maintenance contracts aretypically renewable annually and typically paid for in advance for all productsexcept deployments of FastObjects, which are typically paid in arrears.

 

**Customers and Applications**

 

VDS, FastObjects andVersant Open Access are licensed for development and/or deployment in a widerange of applications.  A substantialamount of our sales are for applications in the technology, telecommunications,defense, healthcare and financial services sectors.  Many of our customers have licensed multiplecopies for use in different applications.

 

In our fiscal years ended October 31, 2004, 2003 and2002, IBM represented 17%, 19%, and 14% of our total revenues,respectively.  Versant’s agreement withIBM is comprised of a Customer Solutions Agreement dated as of June 16,2000  as supplemented by a Statement ofWork that was issued under that agreement in October 2000, and amendmentsthereto, pursuant to which Versant performs certain consulting services for IBMcustomers as described below.  However,nothing in our agreement with IBM commits IBM to use Versant’s services at anyparticular level, or to use Versant’s services at all.  Therefore we have no assurances that it willreceive revenue from our relationship with IBM. We are however required to maintain a certain number of consultingpersonnel with certain skill levels to service this business.  Consequently, we believe that the quality andpricing of our services to IBM (rather than the terms of our agreement withIBM) are the primary factors in determining the ongoing viability and durationof our relationship with IBM.    

 

Our future performance will depend in significant parton the growth of the use of VDS, FastObjects and Versant Open Access intechnology, telecommunications, defense, healthcare and financial marketapplications and the continued acceptance of our products within theseindustries.  Consequently, the failure ofour products to perform favorably in and

 

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become an accepted component of applications for these industries, or aslower than expected increase or a decrease in the volume of sales of ourproducts and services to technology-based, telecommunications, defense,healthcare or financial services companies, could have a material adverseeffect on our business.

 

**Sales and Marketing**

 

We market and sell ourproducts principally through our direct sales force and through value-addedresellers, systems integrators and distributors.

 

*DirectSales.*Our direct sales organization is based at ourcorporate headquarters in Fremont, California and at our other regional officesaround the world.  The direct salesorganization includes our field sales personnel, who are responsible foraccount management, and systems engineers, who answer technical questions andassist customers in running benchmarks against competitive products anddeveloping prototype applications.

 

*IndirectSales.*  An importantpart of our future sales strategy will be the development of indirectdistribution channels, such as value-added resellers, systems integrators andforeign distributors.  We expect tocontinue our focus on indirect sales channels in fiscal 2005.  Systems integrators may include our productswith those of other vendors, to provide a complete solution to theircustomers.  Value-added resellers andsystems integrators are typically not subject to any minimum purchase or resalerequirements and can cease marketing our products at any time.  Certain value-added resellers, distributorsand systems integrators offer products they produce or that are produced bythird parties that compete with our products.

 

*Marketing. *Our marketing programs areaimed at audiences with the goal of building visibility and generating leadsfor our business. Our marketing programs include our efforts at cultivatingmedia and analyst relations, fostering valuable investor communications, speakers’programs, online marketing, partner marketing programs and participation inconferences and tradeshows.

 

*SalesProcess*.  The cycle forcomplete a sale of our products to new, large enterprise customers can exceedsix months and may extend to a year or more. For existing customers with successfully deployed applications, salescycles for new applications of our core products are generally muchshorter.  During the sales cycle,meetings involving both technical and management staff are conducted frequentlyat the prospective customer’s site and at our headquarters.  As part of their product selection process,our prospective customers typically perform a detailed technical evaluation orbenchmark of our object-based technologies, often directly comparing them tocompetitive products.  Upon completion ofthe evaluation, a customer who chooses our solution may purchase one or moredevelopment licenses depending upon the number of programmers that will developand build the customer’s application. Additionally, a customer may purchase technical support, trainingcourses and consulting services.  Ourcustomers may purchase deployment licenses at the same time as they purchasedevelopment licenses, or may defer their purchase of deployment licenses andrelated maintenance until they complete the application development (a processthat typically takes at least six months and can exceed one year). Once anapplication is ready for deployment, a customer may purchase deploymentlicenses from us.  

 

*Shippingand Backlog*.** **All our software is shipped fromour Fremont facility and is delivered to the customer upon receipt of anapproved order and a signed license agreement. We typically do not have a material backlog of unfilled license ordersat any given time, and we do not consider backlog to be a meaningful indicatorof our future performance.

 

*InternationalSales and Marketing*. Our foreign sales are recorded by subsidiaries located in Germany andthe United Kingdom who also sell our products through distributors and valueadded resellers, as well as directly to end-users.  Our revenues from international sales were$8.4 million in the year ended October 31, 2004, $5.4 million in the year endedOctober 31, 2003 and $6.4 million in the year ended October 31, 2002.  Our international revenues increased infiscal 2004, in part as a result of our acquisition of Poet, whose revenues arelargely from European customers.  Forinformation regarding the risks attendant to our foreign operations, please seeItem 7. – “Management’s Discussion and Analysis of Financial Condition andResults of Operations—Risk Factors—Risks Related to Our Business—Weincreasingly depend on our international operations”.  

 

The table below presentsthe Company’s revenue by region (in thousands):

 

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| ** **                                   | ** ** | ** **                          | ** ** | ** **         | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|----------------------------------------------|------------|-------------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                                   | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from**      | ** ** | **2003 from** | ** ** |
| ** **                                   | ** ** | **2004**                            | ** ** | **2003**           | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                                   | ** ** | ** **                          | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| **Total  revenues by geographic area:**      |       |                                |       |               |       |          |       |                              |       |   |   |
| North America                                |       | $                                   | 14,457     |               | $          | 16,622        |       | $                                 | 13,510     |   | -13 | % | 23 | % |
| Europe                                       |       | 7,689                               |       | 4,690              |       | 5,360         |       | 64                                | %          | -13 | % |
| Asia Pacific                                 |       | 729                                 |       | 747                |       | 1,086         |       | -2                                | %          | -31 | % |
| Total                                        |       | $                                   | 22,875     |               | $          | 22,059        |       | $                                 | 19,956     |   | 4 | % | 11 | % |
|                                         |       |                                |       |               |       |          |       |                              |       |   |   |
| **Percent  of revenues by geographic area:** |       |                                |       |               |       |          |       |                              |       |   |   |
| North America                                |       | 63                                  | %          | 76                 | %          | 68            | %          |                              |       |   |   |
| Europe                                       |       | 34                                  | %          | 21                 | %          | 27            | %          |                              |       |   |   |
| Asia Pacific                                 |       | 3                                   | %          | 3                  | %          | 5             | %          |                              |       |   |   |
| Total                                        |       | 100                                 | %          | 100                | %          | 100           | %          |                              |       |   |   |

 

**Research and Development**

 

We have committed, andexpect to continue to commit, substantial resources to our research anddevelopment efforts.  Our currentdevelopment efforts are focused on:

 

•      ongoing effortsto improve the performance and scalability of our core products;

 

•      supporting newindustry standards for our Versant Open Access product;

 

•      improving theintegration of our products with leading third party technology providers; and

 

•      providingsupport and/or integration with existing and emerging computing standards.

 

Our research anddevelopment expenses were approximately $5.1 million in the year ended October31, 2004, $4.3 million in the year ended October 31, 2003 and $5.8 million inthe year ended October 31, 2002. To date, all research and developmentexpenditures have been expensed as incurred.

 

To date, our productshave been developed almost entirely internally by our own research anddevelopment personnel, with the principal exceptions of FastObjects, which weacquired in connection with our acquisition of Poet and Versant Open Access,which is based on the core technology we purchased form JDO Genie (PTY) LTD. Weselectively supplement our internal staff with outside consultants havingexpertise in specific areas.  Ourresearch and development team consists mainly of software engineers with significantexperience and expertise in technologies such as:

 

• object-orientedsoftware development, including Java;

 

• relationaldatabase technology;

 

• platformengineering;

 

• designand integration;

 

• large-scalerun-time environments;  and

 

• middlewaretechnologies.

 

We perform some of ourporting and enhancement engineering work in our development office in India.Versant India, our wholly owned subsidiary, had 26 employees as of October 31,2004 and occupies an approximately 6,500 square foot facility leased in Pune,India.

 

11

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Pursuant to a consultingagreement, we have contracted to have some research and development work forour Versant Open Access product performed for certain periods by JDO Genie(PTY) LTD, a South African company from which we acquired core technology usedin Versant Open Access

 

We believe that ourfuture results will depend on our ability to improve our current technologiesand to develop new products and product enhancements on a timely basis.  The market for our products and services ischaracterized by changing customer demands, rapid technological change andfrequent introductions of new products and product enhancements.  Customer requirements for products can changerapidly as a result of innovations or changes within the computer hardware andsoftware industries, the introduction of new products and technologies(including new hardware platforms and programming languages) and the emergence,evolution or widespread adoption of industry standards.  The actual or anticipated introduction of newproducts, technologies and industry standards can render existing productsobsolete or unmarketable or result in delays in the purchase of theseproducts.  As a result, the life cycles ofour products are difficult to estimate. We have in the past experienced delays in the introduction of newproducts and features, and may experience similar delays in the future.  If we are unable, for technological or otherreasons, to develop new products or enhancements of existing products in atimely manner in response to changing market conditions or customerrequirements, our business, operating results and financial condition will bematerially adversely affected.

 

**Intellectual Property and OtherProprietary Rights**

 

We rely primarily on acombination of copyright and trademark laws, trade secrets, confidentialityprocedures and contractual provisions to protect our proprietarytechnology.  For example, we license oursoftware pursuant to signed license agreements and, to a lesser extent, “shrink-wrap”licenses displayed in evaluation downloads and in software installationscreens, which impose certain restrictions on the licensee’s ability to utilizeour software.  In addition, we take stepsto avoid disclosure of our trade secrets, such as requiring persons with accessto our proprietary information to execute non-disclosure agreements with us,and we restrict access to our software source code.  We seek to protect our software,documentation and other written materials under trade secret and copyrightlaws, which afford only limited protection. We were also awarded a UnitedStates patent (No. 5,822,759) for our proprietary cache system used within ourproduct suites, which expires in 2015.

 

**Competition**

 

For our VDS andFastObjects products, we compete with companies offering object and relationaldatabase management systems, many of which are large and very well establishedcorporations with broader product lines and stronger sales and distributionchannels. For our Versant Open Access product, our competitors consist of bothrelational database management companies, many of whom have incorporated, orare expected to incorporate in their systems object-oriented interfaces andother functionality more directly competitive with our technologies, as well ascompanies who already have substantial experience in object-oriented softwaredevelopment and provide components similar to those included in Versant OpenAccess. 

 

Many of our competitors,especially Oracle and Computer Associates, have longer operating histories,significantly greater financial, technical, marketing, service and otherresources, significantly greater name recognition, broader product offeringsand a larger installed base of customers.  In addition, many of our competitors have well-established relationshipswith our current and potential customers. We may not be able to competesuccessfully against current or future competitors, and competitive pressurescould have a material adverse effect on our business, pricing, operatingresults and financial condition.

 

For a more detaileddiscussion of the competition we face in our business, see Item 7. — *“Management’s Discussion and Analysis of Financial Condition andResults of Operations—Risk Factors—Risks Related to Our Industry—Our productsface significant competition.”*

 

**Employees**

 

As of October 31, 2004,we and our subsidiaries had a total of 126 employees, of whom 50 were based inthe United States, 50 in Europe, and 26 in India. ** **Of the total, 47 employees wereengaged in engineering and technical services, 27 were engaged in sales andmarketing, 27 were engaged in the services organization and 25 were engaged ingeneral administration and finance. To our knowledge, none of our employees isrepresented by a labor union with respect to employment with Versant.  We have experienced no organized workstoppage to date and believe that our relationship with our employees is good.

 

12

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Our future performancedepends in significant part upon the continued service of our key technical,sales and senior management personnel. The loss of the services of one or more of our key employees could havea material adverse effect on our business, operating results and financialcondition.

 

**Item 2****.  Properties.**

** **

Our principal administrative, sales, marketing andresearch and development operations are located in Fremont, California.  Our current lease, which expires in June2007, is for a building of approximately 54,000 square feet.  However, we only occupy approximately 21,000square feet of this space, and in the fourth quarter of fiscal year 2004 werecorded a restructuring charge to reflect this reduced space usage in futureperiods.

 

Additionally, we lease asales office in Plano, Texas and our international subsidiaries lease space,generally under multi-year operating lease agreements, in Pune, India, and inboth Munich and Hamburg, Germany.  Inconnection with the restructuring event previously mentioned, we closed thesales office that we formerly leased in Basingstoke, England. We believe thatour current facilities will be adequate for our requirements for the nextseveral years.

 

**Item 3****.  Legal Proceedings.**

** **

Wemay from time to time be subject to various legal proceedings in the ordinarycourse of business.  Currently we are notsubject to any material legal proceedings required to be disclosed under thisItem 3.

 

**Item 4****.  Submission of Matters to a Vote of SecurityHolders.**

 

We held our 2004 AnnualMeeting of Shareholders on August 17, 2004.  Set forth below aredescriptions of the matters voted on at the meeting and the results of thevotes taken at the meeting:

 
| ** ** | ** **                                                                                                                                                                                    | ** ** | **Votes  For** | ** ** | **Votes  Against** | ** ** | **Votes  Abstained** | ** ** | **Votes  Withheld** | ** ** | **Broker  Non-Votes** | ** ** |
|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------|------------|--------------------|------------|----------------------|------------|---------------------|------------|-----------------------|------------|
| 1.         | Election of  Directors:                                                                                                                                                                       |       |           |       |               |       |                 |       |                |       |                  |       |
|       | Uday Bellary                                                                                                                                                                                  |       | 21,868,032     |       |               |       |                 |       | 2,323,828           |       |                  |       |
|       | William Henry  Delevati                                                                                                                                                                       |       | 21,867,932     |       |               |       |                 |       | 2,323,928           |       |                  |       |
|       | Herbert May                                                                                                                                                                                   |       | 22,443,411     |       |               |       |                 |       | 1,748,449           |       |                  |       |
|       | Nick Ordon                                                                                                                                                                                    |       | 22,411,741     |       |               |       |                 |       | 1,780,119           |       |                  |       |
|       | Jochen Witte                                                                                                                                                                                  |       | 22,454,610     |       |               |       |                 |       | 1,737,250           |       |                  |       |
|       |                                                                                                                                                                                          |       |           |       |               |       |                 |       |                |       |                  |       |
| 2.         | Amendment to the  Company’s 1996 Employee Stock Purchase Plan to increase the number of shares  of Common Stock reserved for issuance under the plan from 1,250,000 to  1,800,000 shares |       | 12,033,206     |       | 442,635            |       | 873,610              |       |                |       | 10,842,409            |       |
|       |                                                                                                                                                                                          |       |           |       |               |       |                 |       |                |       |                  |       |
| 3.         | Ratify the  appointment of Grant Thornton LLP as the Company’s independent accountants  for Fiscal Year 2004                                                                             |       | 23,894,485     |       | 101,369            |       | 196,006              |       |                |       |                  |       |

 

**4A****. ExecutiveOfficers of the Registrant.**

** **

Set forth below is informationregarding our executive officers as of February 14, 2005: 

 

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| **Name of Executive Officer** | ** ** | **Age** | ** ** | **Position with the Company**                                                      | ** ** |
|-------------------------------|------------|---------|------------|------------------------------------------------------------------------------------|------------|
|                          |       |    |       |                                                                               |       |
| Nick Ordon                    |       | 57      |       | President and Chief Executive Officer and Director                                 |       |
|                          |       |    |       |                                                                               |       |
| Lee McGrath                   |       | 43      |       | Vice President, Finance and Administration, Chief  Financial Officer and Secretary |       |
|                          |       |    |       |                                                                               |       |
| Jochen Witte                  |       | 44      |       | President, European Operations and Director                                        |       |

 

**NickOrdon**has served as President, Chief Executive Officer and adirector of the Company since he joined Versant in January 1998. From July 1996to December 1997, Mr. Ordon was Vice President and General Manager ofMessaging at Lotus Development Corporation, a software development company andwholly-owned subsidiary of International Business Machines Corporation. FromAugust 1994 to July 1996, he was Vice President and General Manager of theCommercial Business Unit of Lockheed Martin Corporation, an aerospace productscompany. From January 1993 to August 1994, Mr. Ordon served as General Manager,NetWare Operations with Hewlett-Packard Company. Prior to entering industry,Mr. Ordon was a pilot in the United States Air Force.  Mr. Ordon received both a Bachelor andMasters of Science degree in Aerospace Engineering from the University of Coloradoand a Masters of Business Administration degree in Finance and Operations fromSyracuse University. 

** **

**LeeMcGrath**has served as Versant’s Vice President, Finance andAdministration, Chief Financial Officer and Secretary since joining Versant inJuly 2000. From June 1999 to July 2000, he served as Director of FinancialPlanning and Analysis, Flat Panel Systems, for Philips Components, a divisionof Philips Electronics. From June 1997 to May 1999, Mr. McGrath served asController for Digital Link Corporation, a networking equipment company. FromDecember 1982 to June 1997, he was with Measurex, a manufacturer of electroniccontrol systems, where he served in a variety of financial management andcontroller positions, in both the company’s U.S. and overseas offices.Mr. McGrath is a Chartered Certified Accountant and received a Masters ofBusiness Administration degree from Pepperdine University. 

 

****Jochen Witte********has served as President, European Operations****since joining Versant in March 2004 following Versant’s merger with PoetHoldings, Inc.  Mr. Witte is a member ofVersant’s Board of Directors as well as being responsible for Versant’sEuropean operations.  Most recently, Mr.Witte was the CEO of Poet Holdings Inc., which he co-founded in 1993. Heinitially worked as the Managing Director of Germany and became Poet’s ChiefFinancial Officer in 1999 when Poet went public. Prior to working with Poet,Mr. Witte was with BKS Software, where he rose to Managing Director afterbeginning with responsibility for sales and training.  Mr. Witte received a degree in BusinessAdministration from the Berlin Technical University and also attended theUniversity of Wales as an exchange student.

 

There is no arrangementor understanding between any of our executive officers and any other personpursuant to which any executive officer was or is to be selected as an officer,except that Mr. Witte was appointed to his current office in connection withour merger with Poet.  There is no familyrelationship between any of the foregoing executive officers or between any ofsuch executive officers and any of the members of our Board of Directors. Ourexecutive officers serve at the discretion of the Board.

 

**PART II**

 

**Item 5****.  Market for Registrant’s CommonEquity and Related Stockholder Matters.**

 

***PriceRange of Common Stock***

* *

Our common stock isquoted on the Nasdaq SmallCap Market under the symbol “VSNT.”  Our common stock commenced trading on theNasdaq National Market on July 18, 1996. From July 19, 1999 until March 7, 2000 our common stock was traded onthe Nasdaq SmallCap Market.  From March8, 2000 to September 30, 2002, our common stock was traded on the NasdaqNational Market.   Since October 1, 2002our common stock has been quoted on the Nasdaq SmallCap Market.  We requested that listing of our common stockbe transferred to the Nasdaq Smallcap Market as of October 1, 2002 due to thefact that it then seemed unlikely that, in the near term, we would continue tobe able to satisfy the listing criteria of the Nasdaq National MarketSystem.  The following table lists thehigh and low intra-day prices of our common stock reported on the Nasdaq StockMarket for the periods indicated during the last two fiscal years

 

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| **Year Ended October 31, 2004** | ** ** | **High**   | ** ** | **Low**    | ** ** |
|---------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fourth Quarter                  |       | 1.09       |       | 0.60       |       |
| Third Quarter                   |       | 2.13       |       | 0.98       |       |
| Second Quarter                  |       | 3.05       |       | 1.39       |       |
| First Quarter                   |       | 2.60       |       | 1.50       |       |

 
| **Year Ended October 31, 2003** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------|------------|------------|------------|
|                            |       |       |       |       |       |
| Fourth Quarter                  |       | 2.68       |       | 0.52       |       |
| Third Quarter                   |       | 0.96       |       | 0.48       |       |
| Second Quarter                  |       | 1.10       |       | 0.62       |       |
| First Quarter                   |       | 1.29       |       | 0.41       |       |

 

On January 24, 2005 theclosing price of our common stock was $0.77 on the Nasdaq Stock Market. We donot currently meet the listing requirements necessary for our common stock tobe listed on the Nasdaq Smallcap Market due to the fact that our common stockhas traded at a price below $1.00 per share for sustained period.  To regain compliance with this listingrequirement our common stock must trade at or above this price and we have beenafforded a grace period to regain compliance with this requirement.  However, there remains a risk that we may beunable to regain compliance within the permitted grace period and that ourshares could be delisted from the Nasdaq Smallcap Market see Item 7 — *“Management’s Discussion and Analysis of Financial Condition andResults of Operations—Risk Factors—Risks Related to Our Stock— In order for ourcommon stock to continue to be listed on The Nasdaq SmallCap Market, we mustsatisfy the Nasdaq SmallCap listing requirements, and there can be no assurancethat we will be able to do so*.”

 

***Shareholders***

* *

There were approximately155 holders of record of our common stock as of January 4, 2005.  We believe that a significant number ofbeneficial owners of our common stock hold their shares in street name.  Based on information available to us, webelieve we have at least 400 beneficial shareholders of our common stock.

 

***Dividend Policy***

*** ***

We have neither declarednor paid cash dividends on our common stock in the past.  We intend to retain future earnings, if any,to fund development and growth of our business and, therefore, do notanticipate that we will declare or pay cash dividends on our common stock inthe foreseeable future

 

In connection with ourmerger with Poet, the holders of our then outstanding shares of Series APreferred Stock had their outstanding shares of Series A Preferred Stockconverted into shares of our common stock at an increased conversion rate ofthree shares (rather than two shares) of common stock per each share of SeriesA Preferred Stock.  In addition, theexercise price of certain common stock purchase warrants held by such preferredshareholders was reduced from $2.13 to $1.66 per share and the term of suchwarrants was extended by one year.  As aresult of these actions a deemed dividend in the amount of approximately $2.4million was recorded during the three months ended April 30, 2004.  Please see Item 7. — “*Management’sDiscussion and Analysis of Financial Condition and Results of Operations -DeemedDividend to the Preferred Shareholders*”.

* *

***RecentSales of Unregistered Securities***

*** ***

On June 27, 2004, Versantentered into an Asset Purchase Agreement with JDO Genie (PTY) Ltd., a privatelyheld South African corporation.  Pursuantto this agreement, Versant purchased from JDO Genie a software product, relatedtechnology and customer agreements.   Asa portion of the purchase price of these assets, Versant agreed to issue to JDOGenie 230,150 shares of Versant’s common stock in a private transaction exemptfrom registration under the Securities Act, subject to approval of suchissuance by the South African Reserve Bank under South Africa’s exchangecontrol regulations within a certain time period, which Versant and JDO Genieextended by mutual agreement.  Theissuance of Versant common shares to JDO Genie was approved by the SouthAfrican Reserve Bank on January 14, 2005 and Versant will issue these shares inreliance upon the exemption(s) from registration provided by Section 4(2),and/or Regulation S under the Securities Act

 

15

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and/or Rules 505 or 506 of Regulation D promulgated under theSecurities Act.  In relying upon theseexemptions Versant considered the fact the issuance of the shares is being madeto a single foreign corporate purchaser who has been provided publiclyavailable information about Versant and who was advised by legal counsel inconnection with the transaction.  Versantalso considered that JDO Genie has made appropriate investment agreements andrepresentations to Versant regarding its sophistication, knowledge, investmentintent and compliance with resale restrictions applicable to restrictedsecurities under the Securities Act. Versant has not agreed to register the shares issued to JDO Genie underthe Securities Act. 

 

***IssuerPurchases of Equity Securities***

 

No purchases of Versantsecurities were made by or on behalf of Versant in the fourth quarter of ourfiscal year ended October 31, 2004. 

 

**Item 6****.  Selected Financial Data**

 

The following selectedconsolidated financial data has been derived from our audited consolidatedfinancial statements.  The informationset forth below is not necessarily indicative of results of our future operations,and should be read in conjunction with “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and the consolidated financialstatements and notes in this Form 10-K in order to fully understand factorsthat may affect the comparability of the information presented below andfactors that might cause the following selected financial data not to beindicative of our future financial condition and results of operation.   In particular, it should be noted thatbecause we changed our fiscal year end from December 31 to October 31 in 2001,our transition period in 2001 was only a 10-month period, which impacts thecomparability of the following financial data.  In addition, in our fiscal year ended October 31, 2004 we completed ourmerger with Poet, which increased our revenues and operating expenses for partof fiscal 2004 and substantially increased the number of our outstanding sharesat fiscal year-end for purposes of computing net loss per share in fiscal2004.  In fiscal 2004 we also incurred arestructuring charge of approximately $3.2 million as well as a charge ofapproximately $1.0 million related to the impairment of intangible assets.  Each of these items in fiscal 2004 alsoaffects the comparability of the following selected financial data:

 
| ** **                                                        | ** ** | **Year  Ended  10/31/2004**               | ** ** | **Year  Ended  10/31/2003** | ** ** | **Year  Ended  10/31/2002** | ** ** | **Ten Months  Ended  10/31/2001** | ** ** | **Year  Ended  12/31/2000** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------------|------------|-----------------------------|------------|
| ** **                                                        | ** ** | **(in thousands, except per share data)** | ** ** |
| Consolidated  Statement of Operations Data:                       |       |                                      |       |                        |       |                        |       |                              |       |                        |       |
| Total revenue                                                     |       | $                                         | 22,875     |                        | $          | 22,059                      |       | $                                 | 19,956     |                        | $          | 23,909 |   | $ | 28,445 |   |
| Income (loss)  from operations                                    |       | (7,651                                    | )          | (2,712                      | )          | (3,609                      | )          | (7,012                            | )          | 2,152                       |       |
| Net income  (loss)                                                |       | (11,997                                   | )          | (2,389                      | )          | (3,390                      | )          | (7,158                            | )          | 1,856                       |       |
| Net income  (loss) per share attributable to common shareholders: |       |                                      |       |                        |       |                        |       |                              |       |                        |       |
| Basic                                                             |       | $                                         | (0.38      | )                           | $          | (0.17                       | )          | $                                 | (0.28      | )                           | $          | (0.59 | ) | $ | 0.16 |   |
| Diluted                                                           |       | $                                         | (0.38      | )                           | $          | (0.17                       | )          | $                                 | (0.28      | )                           | $          | (0.59 | ) | $ | 0.12 |   |

 
| ** **                        | ** ** | **As of**          | ** ** | **As of**      | ** ** | **As of**      | ** ** | **As of**      | ** ** | **As of**      | ** ** |
|-----------------------------------|------------|--------------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|
| ** **                        | ** ** | **10/31/2004**     | ** ** | **10/31/2003** | ** ** | **10/31/2002** | ** ** | **10/31/2001** | ** ** | **12/31/2000** | ** ** |
| ** **                        | ** ** | **(in thousands)** | ** ** |
| Consolidated  Balance Sheet Data: |       |               |       |           |       |           |       |           |       |           |       |
| Total assets                      |       | $                  | 32,545     |           | $          | 11,069         |       | $              | 11,921     |           | $          | 15,370 |   | $ | 22,502 |   |
| Working capital                   |       | 1,311              |       | 602            |       | 2,326          |       | 3,664          |       | 7,863          |       |
| Long-term debt                    |       | —             |       | —         |       | —         |       | 3              |       | 40             |       |
|                                   |            |                    |            |                |            |                |            |                |            |                |            |  |  |  |  |  |

 

16

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**Item 7****.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

*Asindicated in the paragraph above Item 1 in this report, this Form 10-K(including this Item 7) contains certain forward-looking statements within themeaning of the Securities Exchange Act and the Securities Act.  In many cases you may identify theseforward-looking statements by words such as “will,” “should,” “may,” “might,” “believes,”“anticipates,” “expects,” “intends,” “estimates” and similar expressions. Theseforward-looking statements include, among other things, projections of ourfuture financial performance and trends anticipated for our business.  We caution investors that forward-lookingstatements are only predictions or estimates based upon our current expectationsabout future events.  The forward-lookingstatements are not guarantees of future performance and are subject tosignificant risks and uncertainties that are difficult to predict.  Our actual results and performance may differmaterially from the results and performance anticipated by any forward-lookingstatements due to these risks and uncertainties, some of which are discussedbelow in this Item 7 under the heading  “RiskFactors.” Readers are urged to carefully review and consider the various disclosuresmade by us in this report and in our other reports filed with the Securitiesand Exchange Commission that attempt to advise interested parties of the risksand factors that may affect our business.*

 

**CertainIndustry Terms**

 

Listedbelow, for reference are certain technical terms that are well known and oftenused in our industry.  We have definedthese terms here to assist readers in better understanding the informationprovided in this report:

 

•      Relational Database - Data management softwarethat stores data as tables and columns and can be accessed using an industrystandard language called SQL.

•      Application Server Software - Deployment softwarethat is used to build and deploy Internet applications including commercialwebsites and company internal websites.

•      Cache - Performance enhancing software that workswith servers to improve their response times and throughput.

•      Integration Framework - Bridging software thatcan connect two disparate pieces of software together.

•      XML - A standard format used to exchange data(information) between multiple software systems.

•      Object-Oriented - object oriented refers tosoftware that uses smaller building blocks called objects to create largersoftware systems.

•      DataIntegration - Data integration is a broad term for a variety of techniques thatenable the data from one software system to be used in other software systems.

•      Replication - arange of technical approaches that enable multiple databases to beapproximately synchronized, or to contain the same data.

•      Disk mirroring- uses specialized software, and often specialized hardware, to get the samedata on two storage disks for the purpose of increasing the reliability ormaking a quick snapshot (duplicate backup) of a database.

•      Fault tolerantserver- a server that offers higher reliability by the use of duplicatedhardware and specialized software. In the case of a failure of one database,the surviving database can continue offering normal service.

•      J2EE-based- Anapplication or software component that is deployed in a Java 2 EnterpriseEdition (J2EE) software environment.

•      Zero-administration- An application that has been constructed so that no intervention from aDatabase Administrator is required.

•      Native-Applicationsare constructed from a large number of individual software pieces. Theconstruction is usually easier and resulting application more reliable when thesoftware pieces are built using the same software language, with compatibleinteraction methods, and running on the same operating system. Theseinteractions would be called “native”. In the less-desirable case, there willthe need for conversions and adaptations, and the interactions could be called “non-native”

 

**Overview**

 

We are a Californiacorporation and were incorporated in August 1988. We design, develop,market and support high performance object database management, data access anddata integration software systems and provide related services, and theseproducts and services collectively comprise our single operating segment, DataManagement.  

 

Our data managementproduct and services offer customers the ability to manage real-time, XML andother types of hierarchical and navigational data. Our combined suite ofproducts and services cater to a wide range of customers with a wide variety ofneeds ranging from solutions for small devices, like remote controls, up tofull-scale enterprise solutions, which manage hundreds of gigabytes ofstreaming data. We believe that by using our data management solutions,customers

 

17

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cut hardware costs, accelerate and simplify development, significantlyreduce administration costs and deliver products with a significant competitiveedge.

 

On March 18, 2004 wefinalized a merger in which we acquired Poet Holdings, Inc., or Poet.  Poet brought two distinct lines of businessto Versant.  The first was Poet’s DataManagement line of business, comprised of its FastObjects database productline.  The second was Poet’s CatalogSolutions business, comprised of the X-Solutions and eSupplier Solutionsproducts which we disclosed as a separate “Catalog” operating segment in ourForms 10-Q for the three months ended April 30, 2004 and July 31, 2004. Whilewe intend to continue integrating Poet’s database product line into ourexisting product line to provide a broader suite of data management products,in September 2004 we concluded the sale of the Catalog Solutions line ofbusiness, thereby returning our business back to the single operating segment,Data Management, that existed prior to our merger with Poet.

 

On July 6, 2004 weacquired FastObjects Inc., the exclusive distributor of Poet’s database productline in North America, and on June 30, 2004 we acquired data access technologyfrom JDO Genie (PTY) LTD, a privately held South African company.

 

Our Data Managementbusiness is currently comprised of the following products:

•      *Versant Developer Suite*, or VDS, a sixth generation objectdatabase management system that is used in high-performance large-scalereal-time applications. Versant enJin has been replaced by VDS using VDS’s JavaData Objects (JDO) language interface. 

•      *FastObjects*, an object-oriented database management systemthat can be embedded as a high performance component into customers’ applicationsand systems, and

•      *Versant Open Access*, a software product that providesbusiness application developers a powerful object storage tool. Versant OpenAccess is offered in versions for applications written in Java and Microsoft..NET environments. Versant JDO, a product we announced last year, and thetechnology we acquired in June 2004 from JDO Genie, have both been absorbedinto the Versant Open Access family.

 

As previously disclosedin a Form 8-K filed on August 25, 2004, we recorded a non-cash charge in ourstatement of operations for the three months ended July 31, 2004 whichrepresented the net book value of all assets associated with our Versant RealTime Framework product or “VRTF”.   VRTFwas launched in fiscal 2003, and was based on technology we acquired throughour November 2002 acquisition of Mokume Software, Inc. While Versant believesthat the need exists in the marketplace for a product such as VRTF, our primaryoperational focus since merging with Poet in March 2004 has been on integratingthe two companies and leveraging their respective object database and dataaccess product suites, with the goal of increasing Versant’s accessible market.We have determined that this objective requires priority and a greaterdedication of resources within our organization such that we cannot distract ordilute our efforts in this regard by continuing with the more early stage realtime initiative addressed by VRTF.

 

We license our productsand sell associated maintenance, training and consulting services to end-usersthrough our direct sales force and through value-added resellers, systemsintegrators and distributors. Services are an important aspect of our business,and in the fiscal years ended October 31, 2004, and October 31, 2003, amajority of our revenues were derived from services. In addition to theseproducts and services, we resell related software developed by third parties.To date, substantially all of our revenue has been derived from the followingdata management products and services:

 

•      sales oflicenses for VDS, FastObjects and to a much lesser extent, Versant Open Access;

•      maintenance andtechnical support services for our products;

•      consultingservices (Versant and Poet consulting practice and dedicated IBM WebSphereconsulting practice) and training services;

•      nonrecurringengineering fees received in connection with providing services associated withVDS;

•      the resale oflicenses, and maintenance, training and consulting services for third-partyproducts that complement VDS; and

•      reimbursementsreceived for out-of-pocket expenses we incurred that are booked as revenue inour statement of operations.

 

During fiscal 2004, ourprimary focus was on:

 

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•      Concluding ouracquisitions of Poet Holdings, Inc. FastObjects, Inc. and the data accesstechnology from JDO Genie (PTY) LTD (which is a component of our Versant OpenAccess product line). 

 

•      Integrationactivities surrounding these mergers, including the restructuring plan we announcedduring October 2004 aimed at streamlining our operations and minimizingredundancies in light of the above acquisitions. 

 

•      Concluding thesale of our catalog business

 

However, we also maintained focus on: (i) sales andproduct development activities designed to obtain revenue growth from andenhance database our management products, and (ii) obtaining growth in ourconsulting service programs.

 

Although we showedoverall revenue growth in 2004 compared with 2003, mainly due to our mergerwith Poet, our net loss for 2004 was $12 million comprised of the following:

 

•      The cost of ourrestructuring in 2004 was approximately $3.3 million. We expect this to yieldfuture cost reduction benefits.

 

•      The conversionof Series A Preferred stock and the modification of the outstanding warrantsheld by our former Series A Preferred shareholders in conjunction with the Poetmerger resulted in an inducement to these preferred shareholders, which wasrecorded as a deemed dividend in the amount of approximately $2.4 million inthe three months ended April 30, 2004. This was a non-cash expense.

 

•      A non-cashcharge in our statement of operations for the three months ended July 31,2004 of approximately $1 million representing the net book value of all assetsassociated with our Versant Real Time Framework product or “VRTF”. 

 

•      The catalogbusiness incurred significant operating losses from the date of acquisitionthrough to the date of sale. These operating losses together with the loss onthe sale of this business accounted for approximately $2 million of our netloss in 2004 and 

 

•      Approximately$3.3 million of the total net loss was due to the excess of other operatingexpenses and costs of revenue not mentioned above exceeding revenues as weproceeded through the integration activities surrounding our acquisitions.

 

For 2005 we expect thatour principal sources of revenue will be licenses of VDS and FastObjects, aswell as maintenance, support, training and consulting services and to a lesserextent license and service revenues from our Versant Open Access product. Weexpect the relative mix of our revenues between license, maintenance andprofessional services to be substantially the same in 2005 compared with 2004.We continue to experience significant quarterly fluctuations in total revenueand believe this trend will continue in 2004 and is similar to many companiesin our industry.

 

Like many enterprise software companies, we do notoperate with a significant backlog of orders. Our license revenue, in particular,is difficult to forecast and it is not atypical for a significant proportion oforders for a given quarter to be closed during the last month of thatquarter.  Information technology spendingin general has been considerably depressed over the recent years and customers’purchasing behavior has become more conservative. We expect lengthy sales cycles and customers’ preference forlicensing our software on an “as needed” basis (versus the customer behavior wehad seen in the late 1990’s of prepaying license fees in advance of usage) tocontinue to be factors impacting our license revenues in 2005. The inherentlyunpredictable business cycle of an enterprise software company, together withthe cautious macro-economic environment, makes discernment of meaningfulbusiness trends difficult.  However inspite of this inherent uncertainty we expect overall revenues to grow in 2005compared with 2004.  We expect modestimprovements in the North America region compared with our fiscal 2004, in partdue to our July 2004 acquisition of FastObjects, Inc.  We also expect that Europe will continue tocontribute in excess of 30% of our total revenues in fiscal 2005 due to theacquisition of Poet, a company with primarily European business to date. Wealso expect some traction in the marketplace with our Versant Open Accessproduct, although we expect revenues to be skewed more towards the second halfof fiscal 2005. Consistent with the past three years, we expect technology,telecommunications and defense to be our largest vertical market sectors in2005. 

 

Our agreement withIBM (originally executed in year 2000), through which we are subcontracted towork on WebSphere consulting engagements, was amended in August 2003 to extendits term to September 1, 2004, and was again

 

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amended in August 2004 to extend its term to September 1, 2005. Weexpect that this agreement will again be renewed in August or September of2005; although such renewal will not by itself guarantee that we will beengaged by IBM to perform any particular level of services and thus will notassure us of any ongoing level of revenue from IBM (nor have there been anyguarantees of this nature in the past). However, we expect utilization of ourWebsphere consulting practice to improve over 2004 (primarily due to lower thannormal utilization rates in our quarter ended July 31, 2004) and be more inline with utilization levels in 2003. We also expect increased professionalservices engagements in relation to our FastObjects product line. 

 

We expect gross margin percentages to improve slightlyover 2004 with expected revenue growth offset to an extent by increasedamortization of purchased intangibles compared with 2004.

 

Overall, we expect operating expenses in 2005 to decrease compared with2004. We expect marketing and sales expense and research and developmentexpense in 2005 to return to similar levels to those in 2003, largely due tothe restructuring plan we committed to in October 2004. Overall average engineeringheadcount levels in 2004 were consistent with 2003 though the geographicdistribution was adjusted in light of the direct engineering staff we now havein Hamburg, Germany as result of the merger with Poet. This gives us theadvantage of a skilled regional engineering element closer to the Europeanmarket and customers, and is additionally a more cost-effective model. Weexpect to increase staffing in our Indian operation over the course of 2005. Weexpect general and administrative expense to increase in 2005, primarilydue to the estimated cost of implementation and compliance with Sarbanes Oxley404 requirements. We need to comply with this legislation for our year endedOctober 31, 2005, and we expect to incur significant third party consultingcosts in assisting us to become compliant and increased audit fees related tothe year-end attestation our auditors will have to perform on the effectivenessof our internal controls.   

 

**CriticalAccounting Policies**

 

The preparation of ourconsolidated financial statements requires us to make estimates and judgmentsthat affect the reported amount of our assets and liabilities at the date ofthe financial statements and of our revenues and expenses during the reportingperiod.  We base these estimates and judgments on information reasonablyavailable to us, such as our historical experience and trends and industry,economic and seasonal fluctuations, and on our own internal projections that wederive from that information.   Although we believe our estimates arereasonable under the circumstances, there can be no assurances that ourestimates will be accurate given that the application of these accountingpolicies necessarily involves the exercise of subjective judgment and themaking of assumptions regarding future uncertainties.  We consider “critical”those accounting policies that require our most difficult, subjective orcomplex judgments, and that are the most important to the portrayal of ourfinancial condition and results of operations.  These critical accountingpolicies relate to revenue recognition, goodwill and acquired intangibleassets, impairment of long-lived assets, the determination of our reserve fordoubtful accounts and stock-based compensation.

 

***Revenue Recognition***

 

We recognize revenue inaccordance with the provisions of Statement of Position (SOP) 97-2, *Software Revenue Recognition,* and SOP 98-9, Modification ofSOP 97-2*, Software Revenue Recognition with Respect toCertain Transactions*.   Revenue consists mainly of revenueearned under software license agreements, maintenance support agreements(otherwise known as post-contract customer support or “PCS”), and agreementsfor consulting and training activities.

 

We use the residualmethod to recognize revenue when a license agreement includes one or moreelements to be delivered at a future date.   If there is anundelivered element under the license arrangement, we defer revenue based onvendor-specific objective evidence, or VSOE, of the fair value of theundelivered element, as determined by the price charged when the element issold separately. If VSOE of fair value does not exist for all undeliveredelements, we defer all revenue until sufficient evidence exists or all elementshave been delivered. Under the residual method, discounts are allocated only tothe delivered elements in a multiple element arrangement, with any undeliveredelements being deferred based on the vendor-specific-objective-evidence thevalue of such undelivered elements. We typically do not offer discounts on futureundeveloped products.

 

Revenue from softwarelicense arrangements, including prepaid license fees, is recognized when all ofthe following criteria are met:

 

•      Persuasiveevidence of an arrangement exists.

 

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•      Delivery hasoccurred and there are no future deliverables except PCS.

•      Fee is fixedand determinable. If we cannot conclude that a fee is fixed and determinable,then assuming all other criteria have been met, revenue is recognized aspayments become due in accordance with paragraph 29 of SOP 97-2; and

•      Collection isprobable. Probability of collection is assessed using the following customerinformation: credit service reports, bank and trade references, public filings,and/or current financial statements.  Prior payment experience is reviewedon all existing customers.  Payment terms in excess of our standardpayment terms of 30-90 days net, are granted on an exception basis, typicallyin situations where customers elect to purchase development and deploymentlicenses simultaneously for an entire project and are attempting to align theirpayments with deployment schedules.  Extended payment terms are onlygranted to customers with a proven ability to pay at the time the order isreceived, and with prior approval of our senior management. In accordance withparagraph 27 of SOP 97-2, we have an established history of collection, withoutconcessions, on longer-term receivables. In addition, the volume of extended payment term arrangements has dramaticallyreduced since fiscal 2000 consistent with customers adopting a moreconservative approach to software purchases and their reluctance to prepay forlicenses prior to usage. We typically do not grant extended payment termsbeyond one year.

 

If an acceptance periodor other contingency exists, revenue is not recognized until satisfaction ofthe contingency, customer acceptance or expiration of the acceptance period, asapplicable. Our license fees are non-cancelable and non-refundable and we do notmake concessions or grant a refund for any unused amount. Also, our customeragreements for prepaid deployment licenses do not make payment of our licensefees contingent upon the actual deployment of our software.   Therefore a customer’s delay or accelerationin his deployment schedule does not impact our revenue recognition. Revenuefrom related PCS for all product lines (with the exception of deployments ofFastObjects products) is billed in advance of the service being provided and isdeferred and recognized on a straight-line basis over the term of the PCS,which is generally twelve months. PCS revenue from deployments of theFastObjects product line is paid in arrears of the service being provided andis recognized as revenue at the time the customer provides a report to us fordeployments made during a given period. Training and consulting revenue isrecognized when a purchase order is received, the services have been performedand collection is deemed probable.  Consulting services are billed on an hourly,daily or monthly rate.  Training classes are billed based on group orindividual attendance.

 

We categorize ourcustomers into two broad groups, End Users and Value Added Resellers (“VARs”).Our End User customers are companies who use our products internally and do notredistribute the product outside of their corporate organizations. Our VARcustomers include traditional Value Added Resellers, Systems Integrators, OEMsand other vendors who redistribute our products to external third party customers,either individually or as part of an integrated product. We license our datamanagement products through two types of perpetual licenses—developmentlicenses and deployment licenses. 

 

Development licenses aretypically sold on a per seat basis and authorize a customer to develop anapplication program that uses our software product.

 

Before an End Usercustomer may deploy an application that it has developed under our developmentlicense, it must purchase deployment licenses based on the number of computersconnected to the server that will run the application using our databasemanagement system.  For certain applications, we offer deployment licensespriced on a per user basis.  Pricing of VDS and FastObjects variesaccording to several factors, including the number of computer servers on whichthe application will run and the number of users that will be able to accessthe server at any one time.  Customers may elect to simultaneouslypurchase development and deployment licenses for an entire project. Thesedevelopment and deployment licenses may also provide for prepayment of anonrefundable amount for future deployment*.*

 

VARs and distributorspurchase development licenses from us on a per seat basis on terms similar tothose of development licenses sold directly to End-Users.  VARs areauthorized to sublicense deployment copies of our data management products thatare either bundled or embedded in the VAR’s applications and sold directly toend-users.  VARs are required to report their distribution of our softwareand are charged a royalty that is based either on the number of copies ofapplication software distributed or computed as a percentage of the sellingprice charged by the VARs to their end-user customers. These royalties fromVARs may be prepaid in full or paid upon deployment. Provided that all otherconditions for revenue recognition have been met, revenue is recognized, (i) asto prepaid license arrangements, when the prepaid licenses are sold to theVARs, and (ii) as to other license arrangements, at the time the VAR provides aroyalty report to us for sales made by the VAR during a given period.

 

Revenue from our resaleof third-party products is recorded at total contract value with thecorresponding cost included in cost of sales when we act as a principal inthese transactions and we assume the risks and rewards of ownership (including

 

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the risk of loss for collection, delivery or returns). When we do notassume the risks and rewards of ownership, revenue from our resale ofthird-party products or services is recorded at contract value net of the costof sales.

 

In the rare case that acustomer requests engineering work for porting our product to an unsupportedplatform or customization of our software for specific functionality, or anyother non-routine technical work, we recognize revenue in accordance with SOP81-1 and use either the percentage of completion or completed contract methodsfor recognizing revenue.  We use thepercentage of completion method if we can make reasonable and dependableestimates of labor costs and hours required to complete the work inquestion.  We periodically review theseestimates in connection with work performed and rates actually charged andrecognize any losses when identified. Progress to completion is determined using the cost-to-cost method,whereby cost incurred to date as a percentage of total estimated costdetermines the percentage completed and revenue recognized.  When using the percentage of completionmethod, the following conditions must exist:

 

•      An agreementmust include provisions that clearly specify the rights regarding goods orservices to be provided and received by both parties, the consideration to beexchanged and the manner and terms of settlement.

•      The buyer canbe expected to satisfy his obligations under the contract.

•      Versant can beexpected to satisfy its obligations under the contract.

 

The completed contractmethod is used when reasonable or dependable estimates cannot be made. As aresult, in such situations we defer all revenue until such time as the work hasbeen completed.

 

***Goodwill and AcquiredIntangible Assets***

 

We account for purchasesof acquired companies in accordance with Statement of Financial AccountingStandards No. 141 *Business Combinations* (SFAS 141)and account for the related acquired intangible assets in accordance with SFASNo. 142 *Goodwill and Other Intangible Assets*(SFAS 142).  In accordance with SFAS 141, we allocate the cost of theacquired companies to the identifiable tangible and intangible assets acquiredaccording to their respect fair values as of the date of completion of theacquisition, with the remaining amount being classified as goodwill. Certain intangible assets, such as “acquired technology,” are amortized toexpense over time, while in-process research and development costs (“IPR&D”),if any, are charged to operations at the acquisition date.

 

For the purpose oftesting for goodwill impairment in our single Data Management operating segmentwe have aggregated the goodwill for the following acquisitions:

 

•      Versant Europe,acquired in 1997;

•      Poet, acquiredon March 18, 2004;

•      Technology of JDOGenie, acquired on June 30, 2004; and

•      FastObjects,Inc., acquired on July 6, 2004.

 

We filed a Form 8-K onAugust 25, 2004 reporting our assessment that the carrying value of intangibleassets and goodwill acquired through our acquisition of Mokume Software Inc.,in November 2002 had been fully impaired. Consequently, for the quarter ended July 31, 2004 we recorded a chargeof approximately $1.0 million related to the write-off of remaining Mokumeintangible assets and goodwill.

 

We test goodwill forimpairment in accordance with SFAS 142, which requires that goodwill be testedfor impairment at the reporting unit level (which in our case is at theconsolidated company level) at least annually and more frequently upon theoccurrence of certain events, as provided in SFAS 142. We use the marketapproach to assess the fair value of our assets and this value is compared withthe carrying value of those assets to test for impairment. The total fair valueof our assets is estimated by summing the fair value of our equity (asindicated by our publicly traded share price and shares outstanding plus a controlpremium), debt and current liabilities. Under this approach, if the estimatedfair value of our assets is greater than the carrying value of these assets,then there is no goodwill impairment. If the estimated fair value of our assetsis less than the carrying value of these assets then a memo allocation of thereporting unit’s estimated fair value to its assets and liabilities as thoughthe reporting unit had just been acquired in a business combination isrequired. The impairment loss is the amount, if any, by which the implied fairvalue of goodwill is less than that reporting unit’s goodwill carrying amountand would be recorded in earnings during the period of such impairment. 

 

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Asrequired by SFAS 142, we ceased amortizing goodwilleffective November 1, 2002.  Prior to November 1, 2002, weamortized goodwill over five years using the straight-line method. Identifiable intangibles are currently amortized over five years in relation tothe JDO Genie PTY LTD acquisition, six years inrelation to the FastObjects, Inc. acquisition andseven years in relation to the merger with Poet, using the straight-line methodin each of these cases.

 

***Impairmentof Long-Lived Assets***

 

Weevaluate long-lived assets, including intangible assets other than goodwill,for impairment in accordance with the provisions of SFASNo. 144 *Accounting for the Impairment or Disposal ofLong-Lived Assets* (SFAS 144).  SFAS 144 requires that long-lived assets and intangibleassets other than goodwill be evaluated for impairment whenever events orchanges in circumstances indicate that the carrying value of an asset may notbe recoverable.  The recoverability test compares the carrying amount ofthe asset or asset group to the expected undiscounted net cash flows to begenerated by these assets. If the carrying amount of the asset or asset groupis less than the expected undiscounted net cash flows to be generated by theseassets, an impairment loss is recorded in earnings during the period of suchimpairment and is calculated as the excess of the carrying amount of the assetor asset group over its estimated fair value. 

 

***Reservefor Doubtful Accounts***

 

Weinitially record our provision for doubtful accounts based on historicalexperience and then adjust this provision at the end of each reporting periodbased on a detailed assessment of our accounts receivable and allowance fordoubtful accounts.  In estimating the provision for doubtful accounts, weconsider, among other factors: (i) the aging of theaccounts receivable; (ii) trends within and ratios involving the age of theaccounts receivable; (iii) the customer mix in each of the aging categories andthe nature of the receivable (i.e. license, consulting, maintenance, etc.);(iv) our historical provision for doubtful accounts; (v) the credit-worthinessof each customer; (vi) the economic conditions of the customer’s industry; and(vii) general economic conditions.

 

Shouldany of these factors change, the estimates made by management will also change,which could impact the level of our future provision for doubtfulaccounts.  Specifically, if the financialcondition of our customers were to deteriorate, affecting their ability to makepayments, an additional provision for doubtful accounts may be required. Anumber of our customers are in the telecommunications industry and, as part ofour evaluation of the provision for doubtful accounts, we have considered notonly the economic conditions in that industry but also the financial conditionof our customers in that industry in determining the provision for doubtfulaccounts.  If conditions deterioratefurther in that industry, or any other industry, then an additional provisionfor doubtful accounts may be required.

 

***Non-CashStock Expense***

 

We have elected to continue toaccount for employee stock-based compensation plans using the intrinsic valuemethod, as prescribed by APB No. 25 *Accounting for StockIssued to Employees* and interpretations thereof (collectively “APB25”) rather than the fair value method prescribed by SFASNo. 123 *Accounting for Stock-Based Compensation*(SFAS 123), as amended by SFAS148.  Accordingly, deferred compensation is only recorded if the currentprice of the underlying stock exceeds the exercise price on the date ofgrant.  We record and measure deferred compensation for stock optionsgranted to non-employees at their fair value.  Deferred compensation isexpensed over the vesting period of the related stock option, which isgenerally up to four years.

 

In December 2004,the FASB issued SFAS No.123R, “Share-Based Payment,” a revision of SFAS No.123, “Accounting for Stock-Based Compensation” and superseding APB Opinion No.25, “Accounting for Stock Issued to Employees.” SFASNo. 123R requires the Company to expense grants made under the Company’s stockoption program. That cost will be recognized over the vesting period of theplans. SFAS No. 123R is effective for interim periodsbeginning after June 15, 2005. Upon adoption of SFASNo. 123R, amounts previously disclosed under SFAS No.123 will be recorded in the Company’s statement of operations. The Company isevaluating the alternatives allowed under the standard, which the Company isrequired to adopt effective for its fourth quarter of fiscal 2005.

 

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**Results of Operations**

 

Ourfiscal 2004 acquisitions of Poet, the JDO Genieassets and FastObjects, Inc. became effective on March 18,2004, June 30, 2004 and July 6, 2004, respectively. Our consolidatedstatement of operations for our 2004 fiscal year incorporates the results fromthe effective dates of the respective acquisitions.  References in this section to any year(such as “2003” or “2004”) refer to our fiscal year ended on October 31 ofthat year.

 
| ** **                                                    | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                                                    | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from**      | ** ** | **2003 from** | ** ** |
| ** **                                                    | ** ** | **2004**                                 | ** ** | **2003**           | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                                                    | ** ** | ** **                               | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Total revenue                                                 |       | $                                        | 22,875     |               | $          | 22,059        |       | $                                 | 19,956     |   | 4 | % | 11 | % |
|                                                          |       |                                     |       |               |       |          |       |                              |       |   |   |
| Net loss from continuing operations before deemed  dividend   |       | (7,620                                   | )          | (2,389             | )          | (3,390        | )          | 219                               | %          | -30 | % |
|                                                          |       |                                     |       |               |       |          |       |                              |       |   |   |
| Deemed dividend to preferred shareholders                     |       | (2,422                                   | )          |               |       |          |       |                              |       |   |   |
|                                                          |       |                                     |       |               |       |          |       |                              |       |   |   |
| Loss from discontinued operations, net of income tax          |       | (1,646                                   | )          |               |       |          |       |                              |       |   |   |
| Loss from sale of discontinued operations, net of  income tax |       | (309                                     | )          |               |       |          |       |                              |       |   |   |
| Net Loss                                                      |       | $                                        | (11,997    | )                  | $          | (2,389        | )          | $                                 | (3,390     | ) | 402 | % | -30 | % |

 

There are three major components in our income statementfor the twelve months ended October 31, 2004, namely:

 

1.     Results from ***continuing operations***;this is comprised of revenues and expenses in our on-going data managementoperating segment and specifically excludes all results of the discontinuedCatalog business.  

 

***2.******     Deemed dividend to preferred shareholders;*** The conversionof Series A Preferred stock and the modification of the outstanding commonstock warrants held by our former series A preferred shareholders in connectionwith our merger with Poet resulted in an inducement to the preferred shareholderswhich was reflected as a deemed dividend in our income statement for 2004.Please see the paragraph entitled “*Deemed Dividend to thePreferred Shareholders*” below for more detail.

 

***3.******    ***Results from ***discontinued operations;***thisis comprised of Catalog business revenues and expenses and the loss on sale ofour Catalog business (sold in September 2004). Please see theparagraph entitled “Discontinued Operations” below for more detail.

 

***All subsequent discussion of our revenues, cost of revenues andoperating expense line items in this Item 7 refer only to continuingoperations, all of which are in our data management segment*. **

 

***Revenue***

 

Ourrevenue consists of license fees, maintenance fees (which includes technicaland phone support), and fees for professional services (which includes Versantconsulting, our IBM WebSphere practice, training andrelated billable travel expense).******

 

Our international sales are made at the foreigncurrency equivalent of a U. S. dollar based price.  An increase or decrease in the value of theUnited States dollar relative to foreign currencies could make our productsmore or less expensive, respectively, and, therefore impact our competitivenessin foreign markets. We intend to maintain our sales and marketing

 

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activities outside the United States, which includesupporting our subsidiaries, distributors and resellers in Europe, Japan andother Asia/Pacific countries.  This willrequire significant management attention and financial resources, and mayincrease costs and impact margins unless and until corresponding revenue isachieved.

 
| ** **                                  | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|---------------------------------------------|------------|------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                                  | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from**      | ** ** | **2003 from** | ** ** |
| ** **                                  | ** ** | **2004**                                 | ** ** | **2003**           | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                                  | ** ** | ** **                               | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| **Total revenues by geographic area**       |       |                                     |       |               |       |          |       |                              |       |   |   |
| North America                               |       | $                                        | 14,457     |               | $          | 16,622        |       | $                                 | 13,510     |   | -13 | % | 23 | % |
| Europe                                      |       | 7,689                                    |       | 4,690              |       | 5,360         |       | 64                                | %          | -13 | % |
| Asia Pacific                                |       | 729                                      |       | 747                |       | 1,086         |       | -2                                | %          | -31 | % |
|                                        |       | $                                        | 22,875     |               | $          | 22,059        |       | $                                 | 19,956     |   | 4 | % | 11 | % |
|                                        |       |                                     |       |               |       |          |       |                              |       |   |   |
| **Percent of revenues by geographic area:** |       |                                     |       |               |       |          |       |                              |       |   |   |
| North America                               |       | 63                                       | %          | 76                 | %          | 68            | %          |                              |       |   |   |
| Europe                                      |       | 34                                       | %          | 21                 | %          | 27            | %          |                              |       |   |   |
| Asia Pacific                                |       | 3                                        | %          | 3                  | %          | 5             | %          |                              |       |   |   |
|                                        |       | 100                                      | %          | 100                | %          | 100           | %          |                              |       |   |   |

 
| ** **                           | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|--------------------------------------|------------|------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                           | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from**      | ** ** | **2003 from** | ** ** |
| ** **                           | ** ** | **2004**                                 | ** ** | **2003**           | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                           | ** ** | **10/31/04**                             | ** ** | **10/31/03**       | ** ** | **10/31/02**  | ** ** | **10/31/03**                      | ** ** | **10/31/02** | ** ** |
| ** **                           | ** ** | ** **                               | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| **Total revenues by category:**      |       |                                     |       |               |       |          |       |                              |       |   |   |
| License revenue                      |       | $                                        | 9,686      |               | $          | 9,082         |       | $                                 | 10,106     |   | 7 | % | -10 | % |
| Maintenance revenue                  |       | 6,783                                    |       | 6,076              |       | 5,300         |       | 12                                | %          | 15 | % |
| Professional services revenue        |       | 6,406                                    |       | 6,901              |       | 4,550         |       | -7                                | %          | 52 | % |
|                                 |       | $                                        | 22,875     |               | $          | 22,059        |       | $                                 | 19,956     |   | 4 | % | 11 | % |
|                                 |       |                                     |       |               |       |          |       |                              |       |   |   |
| **Percent of revenues by category:** |       |                                     |       |               |       |          |       |                              |       |   |   |
| License revenue                      |       | 42                                       | %          | 41                 | %          | 51            | %          |                              |       |   |   |
| Maintenance revenue                  |       | 30                                       | %          | 28                 | %          | 27            | %          |                              |       |   |   |
| Professional services revenue        |       | 28                                       | %          | 31                 | %          | 23            | %          |                              |       |   |   |
|                                 |       | 100                                      | %          | 100                | %          | 100           | %          |                              |       |   |   |

 
|                               |   | **Twelve months ended October 31,** |       |     |       |     |   |
|------------------------------------|--------|------------------------------------------|------------|----------|------------|----------|--------|
|                               |   | **2004**                                 | ** ** | **2003** | ** ** | **2002** |   |   |   |   |   |
| **Percent of revenues by sector:** |   | 14                                       | %          | 16       | %          | 19       | %      |   |   |   |   |
| Defense (Inc. Gov’t)          |   | 38                                       | %          | 33       | %          | 20       | %      |   |   |   |   |
| Technology                         |   | 20                                       | %          | 26       | %          | 38       | %      |   |   |   |   |
| Telecommunications                 |   | 28                                       | %          | 25       | %          | 23       | %      |   |   |   |   |
| Other                              |   | 100                                      | %          | 100      | %          | 100      | %      |   |   |   |   |

 

Fiscal 2004 Compared to Fiscal 2003

 

Therelative mix of our revenues between license, maintenance and professionalservices revenue in 2004 was substantially the same year over year.Geographically, our North American revenues declined and under-performedcompared with expectations, especially for the two consecutive quarters, ended April 30,and July 31, 2004. We attribute this outcome more to cautious purchasingbehavior in the region rather than a discernable trend away from using Versant’stechnology. European revenues grew significantly, primarily due to our mergerwith Poet, although revenues from Versant’s core data management products alsogrew in this region. 

 

25

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For the last two years, the technology sector has beenour largest revenue source. The incorporation of Versant products into theapplication offerings of independent software vendors (ISVs) such as PeopleSoftand Borland and increasing sales of the ISV’s products have increased licenserevenue in this sector.  Examples ofthese applications are demand consensus forecasts, collaborative planning, andrequirements management. In addition, the growth of the Versant WebSphere Professional Services practice since itsinception in year 2000 has increased the amount of our business in thetechnology sector because of increasing adoption of WebSphereby technology companies.

 

The telecommunications industry continues to be a verysignificant vertical market sector for us. Our products are used in the telecommunications industry in suchstrategic distributed applications as network modeling and management, faultdiagnosis, fraud prevention, service activation and assurance, and customerbilling. Defense sector revenue was down in 2004, but we attribute this more tothe erratic purchasing behavior and lengthy sales cycles of our defensecustomers and sub contractors rather than an indication of a meaningful revenuetrend.   

 

Fiscal 2003 Compared to Fiscal 2002

 

The relative mix of our revenues between license,maintenance and professional services in 2003 was more heavily weighted towardprofessional services revenue and less towards license revenue than in 2002 dueto the growth in our WebSphere consulting practice in2003 and the lower license transaction volume in 2003 compared with 2002.Geographically, both our European and Asian revenues declined in absolute andrelative terms.  We believe that thesedeclines resulted from the economic downturn during this period, which has hada more marked effect on international sales than on domestic sales,particularly in Europe, and especially as it applied to the telecommunicationsindustry.

 

The technology sector was the biggest contributor tothe increase in 2003 revenues, largely attributable to the growth in our WebSphere consulting practice revenues. Telecommunicationscustomers represented 26% of total revenues in 2003 and continue to be asignificant vertical market for Versant, although this sector was down comparedwith 2002 and with historical norms for Versant, reflecting the ongoingeconomic challenges in that industry. Defense sector revenue was consistentwith 2002 in both absolute and percentage terms.

 

**License Revenue**

 

Licenserevenue represents perpetual license fees received from our end user and valueadded reseller customers and recognized in our statement of operations inaccordance with SOP 97-2.  Cost oflicense revenue consists primarily of product royalty obligations incurred byus when we sublicense tools provided by third parties and costs of resellingthird party products and secondarily of costs of user manuals, product media,production labor costs, freight and packaging. 

 
| ** **  | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|-------------|------------|------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|
| ** **  | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from**      | ** ** | **2003 from** | ** ** |
| ** **  | ** ** | **2004**                                 | ** ** | **2003**           | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **  | ** ** | ** **                               | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| **License** | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Revenue     |       | $                                        | 9,686      |               | $          | 9,082         |       | $                                 | 10,106     |   | 7 | % | -10 | % |
| Cost        |       | 457                                      |       | 843                |       | 902           |       | -46                               | %          | -7 | % |
| Margin      |       | $                                        | 9,229      |               | $          | 8,239         |       | $                                 | 9,204      |   | 12 | % | -10 | % |
| Margin %    |       | 95                                       | %          | 91                 | %          | 91            | %          |                              |       |   |   |

 

Fiscal 2004 Compared to Fiscal2003

 

The net increase in license revenue of approximately$600,000 in 2004 over 2003 was comprised of an approximate $1.9 million licenserevenue contribution from Poet products, which was primarily generated inEurope, offset by an approximate $1.3 million decrease in Versant’s core datamanagement license sales. Much of this shortfall was attributable to weaknessin the US / APAC Value Added Reseller (“VAR”)channels in the second and third quarters of 2004. Resale of third partyproducts was 1% of total license revenue in 2004 down considerably from the 8%we experienced in 2003. 

 

26

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Cost of license revenue decreased by approximately$400,000 primarily due to approximately $500,000 lower cost of resold licensescompared with 2003 and offset by approximately $100,000 in higher product royaltypayments compared to last year.

 

License margins improved by 4% in 2004, due to the factthat our revenue mix included fewer revenues from lower margin resales of third party products.

 

Fiscal 2003 Compared to Fiscal 2002

 

Licenserevenue in 2003 decreased 10% to $9.1 million from $10.1 million in 2002,primarily due to lower transaction volume rather than price pressure.  Lengthy sales cycles and customers’preference for licensing our software on an “as needed” basis versus thehistorical practice of prepaying license fees in advance of usage were factorsadversely affecting our license revenues, as was the macroeconomic environment,especially as it pertained to the telecommunications industry. Resale of thirdparty products was 8% of total license revenue in 2003 with the remainder beingprimarily sales of Versant’s core database product, VDS.

 

Costof license revenue decreased 7% in 2003 to approximately $800,000 compared toapproximately $900,000 in 2002.  This netyear over year decline of approximately $100,000 was primarily due to decreasedlicense sales volume. 

 

Licensemargins remained constant at 91%.

 

**Maintenance and technical support**

 

Maintenanceand technical support revenue includes revenue derived from maintenanceagreements under which we provide customers with internet and telephone accessto support personnel and software upgrades, dedicated technical assistance andemergency response support options.  Italso includes maintenance revenue on the resale of third party products.  Cost of maintenance and technical supportrevenue consists principally of personnel costs associated with providingtechnical support

 
| ** **      | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|-----------------|------------|------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|
| ** **      | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from**      | ** ** | **2003 from** | ** ** |
| ** **      | ** ** | **2004**                                 | ** ** | **2003**           | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **      | ** ** | ** **                               | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| **Maintenance** | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Revenue         |       | $                                        | 6,783      |               | $          | 6,076         |       | $                                 | 5,300      |   | 12 | % | 15 | % |
| Cost            |       | 1,516                                    |       | 1,312              |       | 1,291         |       | 16                                | %          | 2 | % |
| Margin          |       | $                                        | 5,267      |               | $          | 4,764         |       | $                                 | 4,009      |   | 11 | % | 19 | % |
| Margin%         |       | 78                                       | %          | 78                 | %          | 76            | %          |                              |       |   |   |

 

Fiscal 2004 Compared to Fiscal 2003

 

The increase in revenue of approximately $700,000 in2004 compared with 2003 was comprised principally of the addition of Poet’smaintenance and support contracts that were primarily executed in Europe whilemaintenance revenue from Versant’s VDS customers in2004 remained at levels similar to those of 2003. 

 

Costof maintenance and technical support revenue increased, primarily as a result of the addition of Poet’s customer supportorganization in Europe.

 

Maintenanceand technical support margins remainedunchanged with 2003.

 

We exited the year with 8 maintenance and technicalsupport employees worldwide (5 in North America and 3 in Europe).

 

Fiscal 2003 Compared to Fiscal 2002

 

Maintenanceand technical support revenues increased 15% to $6.1 million in 2003 from $5.3million in 2002. This increase was primarily due to an increase in maintenancepricing on new license deals, which mitigated the impact of reduced licensesales, and also our continued efforts to bring the installed customer base currenton their maintenance contracts for customers that were running older versionsof our software.  

 

27

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Costof maintenance and technical support revenue increased slightly due to salarycost, though total headcount levels did not change year over year.   

 

Maintenanceand technical support margins improved slightly, with revenue increasesexceeding the nominal increase in expense.

 

**Professional Services**

 

Professional services revenue consists of revenue fromconsulting, training and technical support as well as billable travel expensesincurred by our service organization. Cost of professional services revenueconsists principally of personnel costs (both employee and sub-contractor)associated with providing consulting and training. Cost of revenues fromprofessional services may vary depending on whether such services are providedby Versant personnel or by typically more expensive sub-contracted third partyconsultants.

 
| ** **                | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|---------------------------|------------|------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from**      | ** ** | **2003 from** | ** ** |
| ** **                | ** ** | **2004**                                 | ** ** | **2003**           | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                | ** ** | ** **                               | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| **Professional services** | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Revenue                   |       | $                                        | 6,406      |               | $          | 6,901         |       | $                                 | 4,550      |   | -7 | % | 52 | % |
| Cost                      |       | 5,858                                    |       | 6,011              |       | 4,041         |       | -3                                | %          | 49 | % |
| Margin                    |       | $                                        | 548        |               | $          | 890           |       | $                                 | 509        |   | -38 | % | 75 | % |
| Margin%                   |       | 9                                        | %          | 13                 | %          | 11            | %          |                              |       |   |   |

 

Fiscal 2004 Compared to Fiscal2003

 

The decrease in revenues ofapproximately $500,000 in professional services revenue in 2004 compared with2003 was comprised primarily of a decrease in Versant’s WebSphereconsulting revenue. This decrease was due to lower utilization rates in thispractice, especially in our quarter ended July 31, 2004, as some long-termengagements concluded and our consultants transitioned onto new engagements. WebSphere consulting represented 60% of total professionalservices revenue for 2004 compared with 62% for 2003. 

 

Costof professional services revenue decreased in 2004 by approximately $200,000due to lower headcount and related costs of approximately $300,000, offset byapproximately $100,000 of increased subcontracted consulting costs as some ofour employees transitioned to subcontractor status.  

 

Professionalservices margins decreased 4% in 2004, with revenue reductions outpacing costdecreases.

 

We exited the year with 19 professional servicesemployees worldwide, comprised of 13 in North America and 6 in Europe.

 

Fiscal 2003 Compared to Fiscal 2002  

 

Professional services revenue increased 52% to $6.9million in 2003 from $4.6 million in 2002, with approximately $1.6 million ofthe total increase coming from the growth in our Webspherepractice with the remaining $700,000 due to the growth in Versant’s consultingpractice.  WebSphere consulting represented 62% of total professional services in 2003compared with 60% of the total in 2002.

 

Costof professional services revenue increased 49% to $6.0 million in 2003 from$4.0 million in 2002 mainly due to the increased volume of subcontractedconsulting resources required to support the increased sale volume. 

 

Professionalservices margins improved by 2% in 2003 despite increased usage ofsubcontracted labor due to higher utilization rates for our professionalservices.

 

***GrossProfit Margins***

 

Thekey factors that cause variations in our gross profit are:

 

•      Salesvolume

 

28

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•      Themix of our product sales, as this directly impacts our total costs of revenue.In general, a higher proportion of license revenue will result in lowerrelative total costs of revenue and thus higher gross profit margins.  Our maintenance revenues have the next lowestassociated costs, with consulting revenues attracting the highest costs.

•      Amortizationof intangible assets associated with our acquisitions please see the paragraphentitled “Amortization of Purchased Intangibles” below. 

 
| ** **                  | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|-----------------------------|------------|------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                  | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from**      | ** ** | **2003 from** | ** ** |
| ** **                  | ** ** | **2004**                                 | ** ** | **2003**           | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                  | ** ** | ** **                               | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Total revenue               |       | $                                        | 22,875     |               | $          | 22,059        |       | $                                 | 19,956     |   | 4 | % | 11 | % |
|                        |       |                                     |       |               |       |          |       |                              |       |   |   |
| Cost of license revenue     |       | 457                                      |       | 843                |       | 902           |       |                              |       |   |   |
| Cost of maintenance revenue |       | 1,516                                    |       | 1,312              |       | 1,291         |       |                              |       |   |   |
| Cost of services revenue    |       | 5,858                                    |       | 6,011              |       | 4,041         |       |                              |       |   |   |
| Amortization of intangibles |       | 698                                      |       | 91                 |       | —        |       |                              |       |   |   |
| Total cost of revenue       |       | 8,529                                    |       | 8,257              |       | 6,234         |       | 3                                 | %          | 32 | % |
|                        |       |                                     |       |               |       |          |       |                              |       |   |   |
| Gross Profit                |       | $                                        | 14,346     |               | $          | 13,802        |       | $                                 | 13,722     |   | 4 | % | 1 | % |
| Gross Profit %              |       | 63                                       | %          | 63                 | %          | 69            | %          |                              |       |   |   |

 

Fiscal 2004 Compared to Fiscal 2003

 

Our gross profit improved by 4% in absolute terms in2004 compared with 2003, consistent with the increased sales volume in 2004.

 

Amortizationof purchased intangibles, a non-cash expense that is related to theacquisitions we consummated in 2004, had a significant impact on our grossprofit for 2004 (particularly due to the merger with Poet) and will continue tohave this impact in 2005.  Amortizationof purchased intangibles was approximately 3% of total revenue in 2004 comparedwith less than 1% of revenue in 2003.

 

Fiscal 2003 Compared to Fiscal 2002

 

Ourgross profit increased in absolute terms primarily due the increasedprofessional services revenue described above, but declined in percentage termsdue to higher margin license revenues being a smaller percentage of the overallproduct mix in 2003 compared with 2002, with the increase in the mix taken upby lower margin professional services.  

 

Amortizationof Purchased Intangibles

 

Inaccordance with SFAS 141, we allocate the cost ofcompanies and technology we acquire to the identifiable tangible and intangibleassets acquired according to their respective fair values as of the date ofcompletion of the acquisition, with the remaining amount being classified asgoodwill.  Certain intangible assets, such as “acquired technology” and “customerrelationships” are amortized to expense over time. Our 2004 statement ofoperations has been charged with the amortization of the customer relationshipassets acquired in the Poet and FastObjects Inc.transactions and the developed technology assets acquired in the Poet, JDO Genie (PTY) LTD. and Mokumetransactions as follows:      

 
| ** **                                    | ** ** | ** **                               | ** ** | ** **         | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|-----------------------------------------------|------------|------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                                    | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from**      | ** ** | **2003 from** | ** ** |
| ** **                                    | ** ** | **2004**                                 | ** ** | **2003**           | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                                    | ** ** | ** **                               | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Mokume  Software, Inc. (Amortized over 5 yrs) |       | $                                        | 72         |               | $          | 91            |       | —                            |       | -21 | % | n/a |   |
| Poet Holdings, Inc. (Amortized over 7 yrs)    |       | 571                                      |       |               |       | —        |       | n/a                               |       | n/a |   |
| JDO  Genie (PTY), LTD (Amortized over 5 yrs)  |       | 35                                       |       |               |       | —        |       | n/a                               |       | n/a |   |
| FastObjects,  Inc. (Amortized over 6 yrs)     |       | 20                                       |       | —             |       | —        |       | n/a                               |       | n/a |   |
| Total amortization of purchased intangibles   |       | $                                        | 698        |               | $          | 91            |       | —                            |       | 667 | % | n/a |   |

 

The following table showshow our existing intangible assets as of October 31, 2004 will beamortized to our consolidated statements of operations in future years,assuming no impairment of these intangible assets: 

 

29

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| ** **                                                   | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **Intangible** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                                   | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **Asset**      | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **Balance**    | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **Twelve months ended October 31,** | ** ** | ** ** | ** ** | **As of**  | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **2005**                                 | ** ** | **2006**   | ** ** | **2007**   | ** ** | **2008**   | ** ** | **2009**   | ** ** | **Thereafter** | ** ** | **10/31/2004** | ** ** | **Note**   | ** ** |
| ** **                                                   | ** ** | **(in thousands)**                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Mokume  Software, Inc. (Amortized over 5 yrs)                | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **     | ** ** | **(1)**    | ** ** |
| Poet Holdings, Inc. (Amortized over 7 yrs)                   |       | $                                        | 613        |       | $          | 613        |       | $          | 613        |       | $          | 613            |       | $              | 613        |       | $          | 855 |   | $ | 3,920 | ** ** | **(2)** | ** ** |
| JDO  Genie (PTY), LTD (Amortized over 5 yrs)                 |       | $                                        | 105        |       | $          | 105        |       | $          | 105        |       | $          | 105            |       | $              | 71         |       |       |   | $ |  491 |   |   |   |
| FastObjects,  Inc. (Amortized over 6 yrs)                    |       | $                                        | 63         |       | $          | 63         |       | $          | 63         |       | $          | 63             |       | $              | 63         |       | $          | 44 |   | $ | 359 |   |   |   |
| ***Total estimated amortization of  purchased intangibles*** |       | $                                        | 781        |       | $          | 781        |       | $          | 781        |       | $          | 781            |       | $              | 747        |       | $          | 899 |   | $ | 4,770 |   |   |   |

 

----

Note(1): As reported in our Form 8-K filing on August 25, 2004 we wrote offthe entire carrying value of all intangible assets and goodwill in relation toour acquisition of Mokume Software, Inc. in ourconsolidated statement of operations for the three months ended July 31,2004, due to our assessment of impairment. 

 

Note(2): As reported in our Form 8-K filing on August 25, 2004, we reduced thecarrying value of identifiable intangible assets attributable to the catalogsolutions business by approximately $1.4 million on our balance sheet as of July 31,2004, which reduced the carrying value of these assets to approximately $1.5million. Then on September 13, 2004, we filed a Form 8-K reporting thatPoet, a wholly owned subsidiary of Versant, had executed a definitive agreementwith ems  ePublishing AG (“EMS”),a privately held company based in Karlsruhe, Germany,for the sale of the catalog solutions business. This sale was effected through a sale of all Poet GmbH’sshare capital to EMS.  Pursuant to thissale, EMS assumed all assets (tangible and intangible) and all liabilities ofPoet GmbH. Consequently, the remaining balance of approximately $1.5 millionattributable to the identifiable intangible assets of the catalog solutionsbusiness was written off entirely in our consolidated statement of operationsfor the three months ended October 31, 2004 and reported as part of lossfrom sale of discontinued operations (please see the paragraph entitled “DiscontinuedOperations” below for more detail). For fiscal 2005 onwards the amortization ofintangible assets acquired in the merger with Poet Holdings will relate only tothe data management assets we acquired from Poet. 

 

***Marketing and Sales Expenses***

 

Marketingand sales expenses consist primarily of marketing and sales labor costs, salescommissions, and expenses from recruiting, business development, travel,advertising, public relations, seminars, trade shows, lead generation,marketing and sales literature, product management, and facilities relatedexpenses. 

 
| ** **          | ** ** | ** **                               | ** ** | ** **    | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|---------------------|------------|------------------------------------------|------------|---------------|------------|---------------|------------|-----------------------------------|------------|
| ** **          | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from** | ** ** | **2003 from** | ** ** |
| ** **          | ** ** | **2004**                                 | ** ** | **2003**      | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **          | ** ** | **(in thousands)**                       | ** ** | ** **    | ** ** | ** **    | ** ** |
| Marketing and sales |       | $                                        | 8,026      |          | $          | 7,698         |       | $                                 | 7,854      |   | 4 | % | -2 | % |
|                     |            |                                          |            |               |            |               |            |                                   |            |  |  |  |  |  |

 

Fiscal 2004 Compared to Fiscal 2003

 

The 2004 increase in marketing and sales expense ofapproximately $300,000 is comprised of approximately $800,000 attributable tothe addition from Poet’s marketing and sales organization in Europe, offset byan approximately $500,000 reduction in Versant’s pre-existing marketing andsales organization. In 2004 we carried out marketing and sales headcountreductions in both North America and Europe and reduced commission expense inNorth America due to lower revenue levels in Versant’s core data managementproducts in that region. Average headcount during 2004 was in line with 2003 ona worldwide basis but with European headcount slightly up and North Americanheadcount slightly down compared with 2003. We exited the year with 27marketing and sales employees worldwide consisting of 13 in North America and14 in Europe.

 

30

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Fiscal 2003 Compared to Fiscal 2002

 

Marketingand sales expense decreased 2% in 2003 to $7.7 million from $7.9 million in2002. This decrease was the result of lower commission expense correspondingwith the lower license revenue in 2003.

 

***Researchand Development Expenses***

 

Researchand development expenses consist primarily of salaries, recruiting and otheremployee-related expenses, depreciation, and expenses associated withdevelopment tools, equipment, supplies and travel. We believe that asignificant level of research and development expenditures is required toremain competitive and to timely complete products under development.  Accordingly, we anticipate that we willcontinue to devote substantial resources to research and development to design,produce and increase the quality, competitiveness and acceptance of ourproducts. However, if we continue our research and development efforts withoutcorresponding increases in revenue, our results of operations would beadversely affected.  To date, allresearch and development expenditures have been expensed as incurred.

 
| ** **               | ** ** | ** **                               | ** ** | ** **    | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|--------------------------|------------|------------------------------------------|------------|---------------|------------|---------------|------------|-----------------------------------|------------|
| ** **               | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from** | ** ** | **2003 from** | ** ** |
| ** **               | ** ** | **2004**                                 | ** ** | **2003**      | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **               | ** ** | **(in thousands)**                       | ** ** | ** **    | ** ** | ** **    | ** ** |
| Research and development |       | $                                        | 5,112      |          | $          | 4,340         |       | $                                 | 5,835      |   | 18 | % | -26 | % |
|                          |            |                                          |            |               |            |               |            |                                   |            |  |  |  |  |  |

 

Fiscal 2004 Compared to Fiscal 2003

 

Theincrease of approximately $800,000 in research and development expense in 2004was due primarily to the addition of Poet’s research and developmentorganization in Europe (approximately $700,000 of the increase) and secondarilydue to engineering work contracted to a third party in China (approximately$100,000 of the increase). Averageheadcount in our research and development organization during 2004 was downslightly compared with 2003 on a worldwide basis, however the geographic mix ofemployees in this organization was different. We reduced headcount slightly inNorth America in efforts to control costs and we experienced turnover andinflationary pressures on salaries in our Indian organization in a similarfashion to many “high tech” employers in that region.  We exited the year with 47 research anddevelopment employees worldwide comprised of 9 in North America, 12 in Europeand 26 in India.

 

Fiscal 2003 Compared to Fiscal 2002

 

Researchand development expenses decreased 26% in 2003 to $4.3 million from $5.8million for 2002, primarily due to reduction of headcount made in conjunctionwith cost reduction efforts.

 

***Generaland Administrative Expenses***

 

Generaland administrative expenses consist primarily of salaries, benefits and otheremployee related costs for our finance, human resources, legal and executivemanagement functions.   In addition,general and administrative expenses include outside legal, audit and publicreporting costs, allocated facilities costs and reserves for estimated baddebts.

 
| ** **                 | ** ** | ** **                               | ** ** | ** **    | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|----------------------------|------------|------------------------------------------|------------|---------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                 | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from** | ** ** | **2003 from** | ** ** |
| ** **                 | ** ** | **2004**                                 | ** ** | **2003**      | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                 | ** ** | **(in thousands)**                       | ** ** | ** **    | ** ** | ** **    | ** ** |
| General and administrative |       | $                                        | 4,478      |          | $          | 3,267         |       | $                                 | 3,440      |   | 37 | % | -5 | % |
|                            |            |                                          |            |               |            |               |            |                                   |            |  |  |  |  |  |

 

Fiscal 2004 Compared to Fiscal 2003

 

The increase of $1.2 million is comprised ofapproximately $800,000 attributable to the addition of Poet’s general andadministrative organization in Europe, approximately $300,000 of higher legal,accounting and consulting costs resulting primarily from our merger and acquisitionactivities and approximately $100,000 for executive bonuses. Our average total worldwide headcount during 2004 washigher compared with 2003 due primarily to the accounting and informationtechnology staff we assumed in the Poet merger. We closed 2004 with 25 generaland administrative employees worldwide. Some of these employees were employedon a part-time basis yielding the equivalent of 21 full-time employeesworldwide comprised of 10 in North America and 11 in Europe.

 

31

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Fiscal 2003 Compared to Fiscal 2002

 

Generaland administrative expenses decreased 5% to $3.3 million in 2003 from $3.4million in 2002 primarily due to reduced bad debt expense, a major component ofwhich was the collection of a previously reserved European receivable.

 

***RestructuringCosts***

 

Duringthe second quarter of fiscal 2004, we implemented a restructuring plan aimed atoptimizing performance in our catalog business that was acquired as part of themerger with Poet.   The primary goal wasto reduce operating expenses to more appropriately align them with sustainablerevenue levels.   As a result, weincurred costs related to employee severance payments, related benefit andoutplacement expenses totaling approximately $400,000 that were recorded asrestructuring costs in operating expenses during the second and third quartersof fiscal 2004. Given that our catalog business was acquired in September 2004by EMS and EMS assumed all assets, liabilities and employees of the catalogbusiness, all obligations under this restructuring plan have been fulfilled asof October 31, 2004.

 

DuringOctober 2004 we committed to an additional restructuring plan to take thefollowing actions in an effort to reduce operating expenses in our datamanagement business:

 
| **Restructuring Action**                                                                                                               | ** ** | **Restructuring Expense  recorded in Quarter  ending October 31, 2004** | ** ** | ** ** | ** **                                        | ** ** | ** **                                    |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|------------|---------------------------------------------------|------------|-----------------------------------------------|
| **Cash Impact**                                                                                                                        |
| **Amount**                                                                                                                             | ** ** | **Estimated Timing**                                                    |
| ** **                                                                                                                             | ** ** | **(in thousands)**                                                      | ** ** | ** ** | ** **                                        |
| 15% workforce  reduction and separation costs                                                                                          |       | $                                                                       | 550        |       | $                                                 | 550        |                                          | Paid in October 2004 through  February 2005 |   |
|                                                                                                                                   |       |                                                                    |       |       |                                              |       |                                          |
| Closure of  certain European offices and reduction in utilization of leased space for  California  headquarters, by approximately  50% |       | $                                                                       | 2,107      |       | No cash impact  above original  lease  commitment |       | Paid in monthly installments through May 2007 |   |
| Write-off of  leasehold  improvements relating to the  unutilized portion of the office  space mentioned above                         |       | $                                                                       | 200        |       | No Cash  impact                                   |       | N/A                                           |   |
| **Total**                                                                                                                              | ** ** | **$**                                                                   | **2,857**  | ** ** | **$**                                             | **550**    | ** **                                    | ** ** | ** ** |
|                                                                                                                                        |            |                                                                         |            |            |                                                   |            |                                               |  |  |  |

 

The Company took these actions in order to streamline itsoperations and minimize redundancies in light of its acquisitions of PoetHoldings, Inc., FastObjects, Inc. and the assets of JDO Genie (PTY) LTD during 2004 and in general to reduceongoing operating expenses in an effort to improve operating results andconserve working capital.   The Company completed these actions by October 31,2004 and no additional charges related to these actions are anticipated infiscal 2005.

 

***Impairmentof Intangibles***

 
| ** **                 | ** ** | ** **                               | ** ** | ** **    | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|----------------------------|------------|------------------------------------------|------------|---------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                 | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from** | ** ** | **2003 from** | ** ** |
| ** **                 | ** ** | **2004**                                 | ** ** | **2003**      | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                 | ** ** | **(in thousands)**                       | ** ** | ** **    | ** ** | ** **    | ** ** |
| Impariment  of intangibles |       | 1,024                                    |       | —        |       | —        |       | n/a                               |       | n/a |   |

 

Asdisclosed in a Form 8-K we filed on August 25, 2004, our evaluation of ourintangible assets carried out in the course of preparing our balance sheet asof July 31, 2004 (the close of our third fiscal quarter), indicatedimpairment in the carrying value of the goodwill and intangible assets relatedto our acquisition of Mokume Software, Inc., in November 2002.Consequently, in the three months ended July 31, 2004, we recorded anon-cash charge of approximately $1.0 million comprised of approximately$300,000 in unamortized intangible assets and approximately $700,000 ofgoodwill that represents the net book value of all recorded Mokumeintangible assets as of July 31, 2004.

 

32

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***Non-CashStock Expense***

 
| ** **                                          | ** ** | ** **                               | ** ** | ** **    | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------|------------|---------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                                          | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from** | ** ** | **2003 from** | ** ** |
| ** **                                          | ** ** | **2004**                                 | ** ** | **2003**      | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                                          | ** ** | **(in thousands)**                       | ** ** | ** **    | ** ** | ** **    | ** ** |
| Unvested Poet options                               |       | $                                        | 86         |          | $          | —        |       | $                                 | —     |   |   |   |   |   |
|                                                |       |                                     |       |          |       |          |       |                              |       |   |   |
| Stock option grants to non employees                |       | —                                   |       | 88            |       |          |       |                              |       |   |   |
|                                                |       |                                     |       |          |       |          |       |                              |       |   |   |
| Accelerated vesting in the Mokume  Merger Agreement |       | —                                   |       | 1,121         |       |          |       |                              |       |   |   |
|                                                |       |                                     |       |          |       |          |       |                              |       |   |   |
| Total non cash stock expense                        |       | $                                        | 86         |          | $          | 1,209         |       | —                            |       | -93 | % | n/a |   |
|                                                     |            |                                          |            |               |            |               |            |                                   |            |  |  |  |  |  |

 

In December 2004,the FASB issued SFAS No.123R, “Share-Based Payment,” a revision of SFAS No.123, “Accounting for Stock-Based Compensation” and superseding APB Opinion No.25, “Accounting for Stock Issued to Employees.” SFASNo. 123R requires the Company to expense grants made under the Company’s stockoption program. That cost will be recognized over the vesting period of theplans. SFAS No. 123R is effective for interim periodsbeginning after June 15, 2005. Upon adoption of SFASNo. 123R, amounts previously disclosed under SFAS No.123 will be recorded in the Company’s statement of operations. The Company isevaluating the alternatives allowed under the standard, which the Company isrequired to adopt effective for its fourth quarter of fiscal 2005.

 

Fiscal 2004

 

Infiscal 2004, non-cash stock expense represents the amortization of the deferredcompensation related to options assumed in the Poet merger. 

 

Fiscal2003

 

Infiscal 2003, non-cash stock expense consisted of the following:

 

•              approximately$100,000 of stock based expenserelated to stock options granted to non-employee contractors.

 

•              approximately$1.1 million of non-cash stock expense related to the acceleration of thevesting of employee owned shares, pursuant to an Amendment Agreement dated September 26,2003, entered into with certain of the former stockholders of Mokume Software, Inc. (the “former Mokumestockholders”).  The Amendment Agreementamended the Agreement and Plan of Reorganization dated as of November 19,2002 pursuant to which Versant acquired Mokume (the “Mokume Merger Agreement”). 

 

Pursuant to the Mokume MergerAgreement, Versant originally issued 2,424,000 shares of its common stock (the “Mokume Shares”) to the former Mokumestockholders.  Under the terms of the Merger Agreement, Versant wasentitled to repurchase from the former Mokumestockholders a total of 1,212,000 of the MokumeShares (the “Contingent Shares”) at the price of $0.01 per share if certaincontingencies related to the Mokume acquisition didnot occur within a defined time period (the “Contingency”).  TheContingent Shares held by certain of the former Mokumestockholders were also subject to monthly vesting conditions based on theircontinued employment with Versant over a two-year period beginning on November 19,2002.  In addition, all the shares issued to the former Mokume stockholders under the MokumeMerger Agreement were subject to potential forfeiture to Versant to satisfyclaims for indemnification that might be asserted by Versant for breaches of Mokume’s representations and warranties under the MergerAgreement, subject to certain release conditions. The principal modificationsto the Mokume Merger Agreement effected by theAmendment Agreement are summarized below.

 

•      Atotal of 363,600 of the Contingent Shares were forfeited by the former Mokume stockholders and cancelled without consideration.The remaining 848,400 Contingent Shares are no longer subject to forfeiture orrepurchase by Versant and were released from the Contingency and any vestingrestrictions now applicable to them.

 

33

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•      Subjectto certain conditions, the 2,060,400 remaining MokumeShares were to be released from the risk of forfeiture to satisfy claims forindemnification made by Versant under the Merger Agreement in installments overtime as follows:  (a) 606,400 shares werereleased from potential forfeiture under indemnification claims on September 26,2003.and (b)  the balance of 1,454,000 shares were to be released invarious increments at various times during the one-year period beginning on November 19,2003 and ending November 19, 2004, when all shares not previouslyforfeited would be released from indemnification claims.  Under this formula, 1,370,400 shares havebeen released from potential forfeiture under indemnification claims in variousincrements at various times through the period ending May 19, 2004; and

 

•      TheAmendment Agreement also provides former Mokumestockholders certain rights to satisfy Versant indemnification claims in cashin lieu of forfeiting Mokume Shares.

 

•      Allof the remaining 690,000 Mokume Shares are currentlybeing held by Versant to potentially satisfy indemnity claims by Versant thatarose from a lawsuit filed against Versant on October 29, 2004 by SystemsAmerica, Inc. and Mokume, Inc. (a different companythan that acquired by Versant) Any indemnity shares not forfeited to satisfythe indemnity claim will be disbursed to the former Mokumestockholders. The suit, which seeks unspecified damages and injunctive relief,alleges that former employees of Systems America, Inc. left Systems America toform a company named Mokume Software, Inc., and inthe process misappropriated Systems America’s trade secrets and confidentialinformation, unfairly competed with Systems America vis-à-vis its customerrelationships, and infringed Systems America’s trademarks and trade names. Thesuit further alleges that when Versant acquired MokumeSoftware Inc. in November of 2002, Versant acquired the benefit of themisappropriated trade secrets, confidential information, customerrelationships, and trademarks and trade names. Versant denies the allegationsin the litigation and intends to vigorously defend against the Complaint.

 

***OtherIncome (Expense), Net***

 

Other income (expense),net primarily represents the foreign currency gain or loss as a result ofsettling transactions denominated in currencies other than our functional currencyand the re-measurement of non-functional currency monetary assets andliabilities.  Secondarily, it representsthe interest expense associated with our financing activities offset by incomeearned on our cash and cash equivalents.

 
| ** **                                                 | ** ** | ** **                               | ** ** | ** **    | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------|------------|---------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                                                 | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from** | ** ** | **2003 from** | ** ** |
| ** **                                                 | ** ** | **2004**                                 | ** ** | **2003**      | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                                                 | ** ** | **(in thousands)**                       | ** ** | ** **    | ** ** | ** **    | ** ** |
| Foreign exchange gain/(loss)                               |       | $                                        | (47        | )             | $          | 343           |       | $                                 | (49        | ) | -114 | % | -800 | % |
| Interest expense                                           |       | (3                                       | )          | (2            | )          | (2            | )          | 50                                | %          | 0 | % |
| Interest Income                                            |       | 77                                       |       | 41            |       | 49            |       | 88                                | %          | -16 | % |
| Other Income/(expense)                                     |       | 57                                       |       | 15            |       | 289           | (1)        | 280                               | %          | -95 | % |
| Change to equity method of accounting of FastObjects, Inc. |       | 35                                       | (2)        |          |       |          |       | n/a                               |       | n/a |   |
| Other income (expense), net                                |       | $                                        | 119        |          | $          | 397           |       | $                                 | 287        |   | -70 | % | 38 | % |

 

----

(1)   thisincludes a $200,000 refund of an insurance deductible.

(2)   in 2004 weincreased our ownership position in FastObjects, Inc.from an approximate 19% to 100%. This adjustment reflects the retroactivechange to the equity method of accounting.

 

***Provisionfor Income Taxes***

 

Weaccount for income taxes in accordance with Statement of Financial AccountingStandards No. 109, “Accounting for Income Taxes”.

 

34

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| ** **                 | ** ** | ** **                               | ** ** | ** **    | ** ** | ** **    | ** ** | **Percent change in fiscal year** | ** ** |
|----------------------------|------------|------------------------------------------|------------|---------------|------------|---------------|------------|-----------------------------------|------------|
| ** **                 | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from** | ** ** | **2003 from** | ** ** |
| ** **                 | ** ** | **2004**                                 | ** ** | **2003**      | ** ** | **2002**      | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| ** **                 | ** ** | **(in thousands)**                       | ** ** | ** **    | ** ** | ** **    | ** ** |
| Provision for income taxes |       | $                                        | 88         |          | $          | 74            |       | $                                 | 68         |   | 19 | % | 9 | % |
|                            |            |                                          |            |               |            |               |            |                                   |            |  |  |  |  |  |

 

Weincurred net operating losses in 2004, 2003 and, 2002. We also incurred foreignwithholding taxes of $88,000, $74,000 and $68,000 in 2004, 2003, and 2002,respectively, which are included within the income tax provision.  

 

At October 31,2004, the Company had federal and state net operating loss carryforwardsof $48.6 million and $13.0 million, respectively and federal and state taxcredit carryforwards of $2.2 million and $1.1million, respectively.  The federal andstate net operating loss carryforwards and federaltax credit carryforwards expire on various datesthrough 2024, if not utilized.  The statetax credit carryforwards can be carried forwardindefinitely. Due to the Company’s history of operating losses, the Companybelieves that there is sufficient uncertainty regarding the realizabilityof these carryforwards and, therefore, a valuationallowance of approximately $22.3 million has been recorded against the Company’snet deferred tax assets of approximately $22.3 million.  Approximately $1.6 million of the valuationallowance for deferred tax assets is attributable to employee stock option deductions,the benefit from which will be allocated to additional paid-in capital when andif subsequently realized.  The Companywill continue to assess the realizability of the taxbenefit available based on actual and forecasted operating results.

 

Due tothe “change in ownership” provisions of the Internal Revenue Code of 1986, theavailability of net operating loss and tax credit carryforwardsto offset federal taxable income in future periods is subject to an annuallimitation due to changes in ownership for income tax purposes.

 

***Amortization and Write-down of Goodwill***

 

Inaccordance with SFAS No. 142, goodwill is no longersubject to amortization.  Instead thisgoodwill amount is subject to periodic evaluation for impairment and is reducedto the extent of any such impairment.

 

**GOODWILLBALANCES as of October 31, 2004**

 

| **Acquisition** | ** ** | **Balance**    | ** ** |
|-----------------|------------|----------------|------------|
| Versant Europe  |       | 219,440        |       |
| Poet            |       | 16,051,747     |       |
| FastObjects     |       | 602,473        |       |
| Versant India   |       | 21,000         |       |
| **Total**       | ** ** | **16,894,660** | ** ** |

 

Asdisclosed in a Form 8-K on August 25, 2004, our evaluation of ourintangible assets carried out in the course of preparing our balance sheet asof July 31, 2004 (the close of our third fiscal quarter), indicatedimpairment in the carrying value of the goodwill and intangible assets relatedto our acquisition of Mokume Software, Inc. In thethree months ended July 31, 2004, we recorded a non-cash charge ofapproximately $1.0 million comprised of approximately $300,000 in unamortizedintangible assets and approximately $700,000 of goodwill.  As a result, we are carrying no goodwill for Mokume as of October 31, 2004.

 

***Deemed Dividend to the PreferredShareholders***

 

As aresult of our merger with Poet, the former holders of our then outstandingSeries A Preferred Stock agreed to take certain actions to cause their1,313,743 outstanding shares of Versant Series A Preferred Stock to beconverted into 3,941,229 shares of Versant common stock effective uponconsummation of the Poet merger. In exchange for this agreement, the number ofshares of common stock issuable upon the conversionof each share of Series A Preferred Stock was increased from two to threecommon shares and, effective upon such conversion, warrants to purchase a totalof 1,313,743 shares of Versant common stock held by the holders of the Series APreferred Stock were amended to reduce the exercise price of such

 

35

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warrants from $2.13 to$1.66 per share of common stock and to extend the term of such warrants by oneyear. The conversion of Series A Preferred stock and the modification of theoutstanding warrants held by these preferred shareholders resulted in aninducement to those shareholders that was accounted for as a deemed dividend inthe amount of approximately $2.4 million recorded during the three months endedApril 30, 2004.

 

***DiscontinuedOperations***

 

On September 16,2004, Versant we completed our sale to ems  ePublishing AG, a privately held German company based in Karlsruhe, Germany (“EMS”), of all the stock of Poet GmbH,an indirect Versant subsidiary that owned the assets and employed the personnelof Versant’s Catalog Solutions Business (the “Catalog Business”). The sale wasconsummated pursuant to a Share Purchase and Transfer Agreement dated September 13,2004 (the “Sale Agreement”) between EMS and Poet Software GmbH, anothersubsidiary of Versant (“Poet Software”) that owned all the shares of PoetGmbH.  Pursuant to the Sale Agreement,EMS agreed to assume the operations of the Catalog Business.

 

TheCatalog Business was originated by Poet and acquired by Versant in connectionwith its March 2004 merger with Poet. This business involves the development and sale of software productlines that enable companies to create, manage, customize and distributeelectronic sales catalogs to conduct business-to-business e-commercetransactions.  The principal assetsdisposed of in the sale of the Catalog Business to EMS include the X-Solutionsand eSupplier Solutions product lines, including thePoet X-Buy, Poet X-Market, Poet X-Sell, Poet eSupplier Port, Poet eSupplier Web and Poet eSupplierLink products, related rights to those products and customer agreements of theCatalog Business as well as the transfer of Catalog Business personnel.  Pursuant to the Sale Agreement, it was alsoagreed that Poet GmbH (now owned by EMS) may use the “Poet” trade name and markin connection with data processing and software businesses and that Versant,its subsidiary Poet Holdings, Inc. and their affiliates agreed to cease theiruse of the “Poet” trade name or mark effective as of January 1, 2005. Inaddition, pursuant to the Sale Agreement Poet Software granted Poet GmbHcertain non-exclusive rights to certain Poet database software for use withcertain existing Poet GmbH customer contracts.

 

Inexchange for the shares of Poet GmbH, EMS has paid Poet Software a closing cashpayment of 1,000,000 euros and agreed to pay a further 172,000 euros for atotal of 1,172,000 euros cash consideration (or approximately $1.4 million USD). In addition, EMS has agreed to pay a royalty onfuture revenues of Poet GmbH’s Catalog Business overthe ten-month period following the signing of the Sale Agreement in an amountequal to 30% of all Poet GmbH’s catalog solutionsbusiness revenues which: (a) exceed 800,000 euros (or approximately $1,048,000 USD based on current exchange rates) during the period fromSeptember 1, 2004 to December 31, 2004; (b) exceed 600,000 euros (orapproximately $786,000 USD based on current exchangerates) during the period from January 1, 2005 to March 31, 2005; and(c) exceed 600,000 euros (or approximately $786,000 USDbased on current exchange rates) during the period from April 1, 2005 to June 30,2005.

 

Thefollowing tables show the results of the Company’s discontinued catalogsolutions business from March 18, 2004 (the effective date of the Poetmerger) through the date of disposition and summarize the components on theCompany’s loss from the sale of the catalog solutions business. The book valueof Poet GmbH’s net assets at the date of sale were comprisedof approximately $405,000 trade receivables, approximately $65,000 of net fixedassets and approximately $47,000 other assets offset by approximately $12,000accounts payable and approximately $225,000 other liabilities.

 

Loss from discontinuedoperations, net of income tax

 
| ** **                 | ** ** | **Twelve months ended** | ** ** |
|----------------------------|------------|-------------------------|------------|
| ** **                 | ** ** | **October 31,**    | ** ** |
| ** **                 | ** ** | **2004**                | ** ** | **2003** | ** ** |
| ** **                 | ** ** | **(in thousands)**      | ** ** |
| Total revenue              |       | $                       | 1,165      |   | — |   |
| Total cost of revenue      |       | 758                     |       | — |   |
| Gross Profit               |       | 407                     |       | — |   |
|                       |       |                    |       |   |   |
| Operating Expenses         |       | 2,053                   |       | — |   |
| Loss From Operations       |       | (1,646                  | )          | — |   |
| Other Income, Net          |       | —                  |       | — |   |
| Loss before Taxes          |       | (1,646                  | )          | — |   |
| Provision for income taxes |       | —                  |       | — |   |
| Net Loss                   |       | $                       | (1,646     | ) | $ | — |   |
|                            |            |                         |            |  |  |  |  |

 

Lossfrom the sale of discontinued operations, net of income tax

 
| ** **                                                 | ** ** | **Twelve months ended** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                 | ** ** | **October 31,**    | ** ** |
| ** **                                                 | ** ** | **2004**                | ** ** |
| ** **                                                 | ** ** | **(in thousands)**      | ** ** |
| Cash payments received or receivable from EMS              |       | $                       | 1,442      |   |
|                                                       |       |                    |       |
| Book value of Poet GmbH’s  net assets at date of sale |       | (280                    | )          |
|                                                       |       |                    |       |
| Write-off of catalog business intangible assets            |       | (1,471                  | )          |
|                                                       |       |                    |       |
| Loss on sale                                               |       | $                       | (309       | ) |

 

36

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**Liquidityand Capital Resources**

 
| ** **                                                    | ** ** | **Twelve months ended  October 31, 2004** | ** ** | **Percent  change in  fiscal year  2004 from  2003** | ** ** | **Twelve months ended  October 31, 2003** | ** ** | **Percent  change in  fiscal year  2003 from  2002** | ** ** | **Twelve months ended  October 31, 2002** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------|------------|
|                                                          |       |                                           |       |                                                 |       |                                           |       |                                                 |       |                                           |       |
| Net cash provided by (used in) operating activities           |       | (6,523                                         | )          | 498                                                  | %          | (1,091                                         | )          | -314                                                 | %          | 509                                            |       |
|                                                          |       |                                           |       |                                                 |       |                                           |       |                                                 |       |                                           |       |
| Net cash provided by (used in) investing activities           |       | 6,391                                          |       | -1313                                                | %          | (527                                           | )          | -2495                                                | %          | 22                                             |       |
|                                                          |       |                                           |       |                                                 |       |                                           |       |                                                 |       |                                           |       |
| Net cash provided by (used in) financing activities           |       | (32                                            | )          | -105                                                 | %          | 673                                            |       | -340                                                 | %          | (281                                           | )          |
|                                                          |       |                                           |       |                                                 |       |                                           |       |                                                 |       |                                           |       |
| Period-end cash, cash equivalents and short-term  investments |       | 3,633                                          |       | 10                                                   | %          | 3,311                                          |       | -25                                                  | %          | 4,427                                          |       |
|                                                          |       |                                           |       |                                                 |       |                                           |       |                                                 |       |                                           |       |
| Period-end working capital                                    |       | 1,311                                          |       | 118                                                  | %          | 602                                            |       | -74                                                  | %          | 2,326                                          |       |

 

On October 31, 2004we had approximately $3.6 million in cash and cash equivalents.  Of this amount, approximately $1.9 millionwas held in US bank accounts and approximately $1.7 million was held in foreign accounts, principally in Europe. 

 

Inrelation to our cash balances held overseas, there are no European Unionforeign exchange restrictions on repatriating our overseas-held cash to theUnited States.  However, we may besubject to income tax withholding in the source countries and to U.S. Federaland State income taxes if the cash payment or transfer from our subsidiaries tothe U.S. parent were to be classified as a dividend.  Other payments made by our European overseassubsidiaries in the ordinary course of business (e.g. payment of royalties orinterest from the subsidiaries to the U.S. parent) are generally not subject toincome tax withholding due to tax treaties. We do not currently have plans to repatriate the cash held in ourforeign subsidiaries to the United States.

 

**Commitmentsand Contingencies**

 

In November 1996,we entered into a ten-year operating lease agreement for our corporateheadquarters in Fremont, California that commenced on June 1, 1997 andexpires on May 31, 2007.  The terms ofthe lease provide for certain increases in rental payments during the leaseterm.  Rental expense under thisagreement, including contractual rent increases, is recognized on astraight-line basis.  We also lease fieldoffice space in Europe and India, generally under multi-year operating leaseagreements.  Consolidated rent expensefor the year ended October 31, 2004, the year ended October 31, 2003and year ended October 31, 2002, was approximately $1,674,000, $1,425,000,and $1,545,000, respectively.

 

Pursuant to a consulting agreement, we have contractedto have some research and development work for a portion of our Versant OpenAccess product performed for certain periods by JDOGenie (PTY) LTD, a South African company from which we acquired core technologyused in our Versant Open Access product. This contract was executed inconjunction with our June 30, 2004 acquisition of the JDOGenie technology and expires on the anniversary of the acquisition unless bothparties to the contract mutually agree to extend the term of the arrangement.The contract includes a fixed monthly retainer, milestone payments, objectivebased bonus payments and a provision for the reimbursement of travel expensesall payable by Versant

 

TheCompany’s future annual minimum commitments at October 31, 2004 undernon-cancelable operating leases and the JDO Genieconsulting contract are listed in the table below.  The Company has approximately $2.3 million ofthese commitments recorded in the October 31, 2004 Balance Sheet. 

 

37

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| **(in thousands)**               | ** ** | **Operating** | ** ** | **Consulting** | ** ** | ** ** | ** ** |
|----------------------------------|------------|---------------|------------|----------------|------------|------------|------------|
| **Year Ending October 31,** | ** ** | **Leases**    | ** ** | **Contract**   | ** ** | **Total**  | ** ** |
| 2005                             |       | $             | 2,024      |           | $          | 475        |       | $ | 2,499 |   |
| 2006                             |       | 1,705         |       |           |       | 1,705      |       |
| 2007                             |       | 994           |       |           |       | 994        |       |
| 2008                             |       | 22            |       |           |       | 22         |       |
| Total Commitments                |       | $             | 4,745      |           | $          | 475        |       | $ | 5,220 |   |

 

**Cash Flow from Operating Activities**

 

Ourlargest source of operating cash flows is cash collections from our customersfollowing the purchase of our products and services. Our primary uses of cashin operating activities are for personnel related expenditures and facilitiescosts. 

 

Withour October 2004 restructuring action and the disposition of the catalogbusiness we’re forecasting our cash expenses in our income statement for 2005(i.e. excluding depreciation and amortization of intangible assets) to beconsistent with levels we operated at prior to the merger with Poet. We doexpect some revenue growth in 2005 and believe that, together with ourprojected expense reductions, this gives us a realistic opportunity ofoperating at a cash flow breakeven position or better for 2005. 

 

In2004 the approximate $6.6 million use of cash in operating activities wascomprised of:

 

•      Anapproximate $4.9 million net outflow of cash in our data management businessmade up of:

 

•      Approximately$24.3 million of cash expense, mainly employee related, an increase of $1.9million over cash expenses paid in operating activities in 2003, primarily dueto the addition of Poet’s employee base from March 18, 2004, plus

 

•      Approximately$700,000 of restructuring expense paid in 2004, offset by

 

•      Approximately$20.1 million in collections from our customers which was down from 2003despite higher revenue levels for the following reasons:

 

•      Ourcollections performance in 2004 was not as good as in 2003 mainly due to thehigher proportion of European receivables in 2004 versus 2003 attributable tohigher revenue levels in Europe and which typically take longer to collect thandomestic receivables and, secondarily, the effect of IBM changing its paymentterms to all its vendors from 45 days to 60 days impacted us more in 2004 thanin 2003.

 

•      Adecrease in deferred revenue in Versant’s core business due to reduced demandfor premium support services (e.g. 24x7 support) and certain of our enterprisecustomers moving to a time and material model for support, both factors, webelieve, being a function of product stability on deployed customerapplications rather than an indicator of customer defection to competitivetechnologies.  Another factor in thedeferred revenue decrease is the weak license revenue performance in the NorthAmerican geography in the three months ended April 30, 2004 and July 31,2004. Versant’s deferred revenue balance in total declined by $0.9 million yearover year however the deferred revenue brought to the company by the Poet and FastObjects Inc. acquisitions has partially offset thedecline in our deferred revenues attributable to our core business, a trend wesee continuing next year and to a larger extent. Given that maintenance supportservices are paid in arrears for FastObjects productdeployments compared with in advance for all other Versant products we expectnear term cash flows will continue to be impacted until we fully transition tothis new model.

 

•      Anapproximate $1.7 million net outflow of cash from operations in our catalogbusiness (incurred from March 18, 2004 through to the sale of thisbusiness in September 2004).

 

In2003 the $1.1 million use of cash in operating activities was comprised of:

 

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•      Approximately$22.4 million of cash expense, mainly employee related and

 

•      Approximately$400,000 legal and investment banking fees attributable to our merger withPoet, offset by

 

•      Approximately$21.7 million in collections from our customers

 

**Cash Flow From Investing Activities**

 

In the past, our primary uses of cash ininvesting activities are typically for purchases of property and equipment(typically IT related equipment). To a much smaller extent, our sources of cashfrom investing activities are proceeds from the sale of property and equipment.However, over the past two years (2003 and 2004) we have made a number ofacquisitions (Mokume, Poet, FastObjects,Inc. and the JDO Genie technology) and have incurredsignificant costs in effecting these acquisitions as well as acquiring the cashbalances of the acquired companies in the case of Poet Holdings and FastObjects Inc., all of which are reflected in this section ofthe cash flow statement. Additionally, in 2004, we also sold our catalogbusiness for cash, the proceeds from which are reflected in investingactivities.  We’re forecasting moderatelevels of capital expenditure in 2005, mainly in the IT/systems arena. Weexpect that some infrastructure may need to be added/improved as a result ofSOX 404 implementation.

 

In2004 net cash provided by investing activities was approximately $6.4 million,comprised of:

 

•      Approximately$7.2 million of cash inflows from the acquisition of Poet (net of transactioncosts) and the sale of our catalog business, offset by

 

•      Approximately$500,0000 of investing outflows representing the net acquisition costs of FastObjects Inc. and the JDOGenie technology in 2004 and approximately $300,00 of purchases of property andequipment 

 

In2003 net cash used in investing activities was approximately $500,000 comprisedof:

 

•      Approximately$200,000 of acquisition costs for Mokume Software,Inc., and 

 

•      Approximately$300,000 of purchases of property and equipment 

 

**Cash Flows From Financing Activities**

 

Our existing asset basedcredit line for $5 million with Pacific Business Funding expired on September 3,2004 and we elected not to renew the facility at that time due to our very lowhistoric usage of this credit line.  Weintend evaluating similar facilities, possibly with other banks, during 2005.The last time we borrowed under our line with Pacific Business Funding was in October 2003in the amount of $500,000 and this amount was repaid within a month. 

 

Our primary uses of cash in financing activitieswere typically for repayments under our receivables line that, as we mentionedabove, expired in September 2004. Our usual sources of cash from financingactivities are proceeds from the sale of common stock under our employee stockoption and stock purchase plans and, in the periods that we had a receivableline in place, periodic draw-downs on the credit line that were typicallyrepaid within a month. 

 

Our publicly traded stockis an important potential source of financing for us as follows:

 

•      Employeestock option and stock purchase plans: We’ve taken a conservative approach inour forecast regarding financing inflows from exercises of employee stockoptions or share purchases under our Employee Stock Purchase Plan (“ESPP”) as our stock has been trading under $1.00 per sharefor the past few months and many of our employee options now have exerciseprices significantly in excess of the current bid price of our stock. However,should our stock price rise above current levels, employees will be likely to exercisemore options than in the recent past and enrollment in the ESPPmay increase, thereby potentially generating extra cash flow for thecompany.  

 

•      Acquisitionsor long term financing opportunities: In the case of acquisitions we have usedour stock as “currency” in effecting purchases of other companies ortechnologies, Poet being the most significant example as this acquisitionbrought significant cash resources to the company (reported under investingactivities). Another source of longer term financing could be a privateoffering of stock or other equity securities of Versant, although we are notactively working on anything in this realm. For the avenue of eitheracquisition or long term financing to be viable it is important that our stockremains traded on NASDAQ. We have received notification from NASDAQ that ourbid price has traded below the minimum $1.00 per share bid price level for sometime and have been given a grace period to rectify this or

 

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potentiallyhave our common stock delisted off the NASDAQ SmallCap Market. Please see “*Risk Factors– Risks Related to Our Stock —In order for our common stock to continue to belisted on The Nasdaq  SmallCapMarket, we must satisfy the Nasdaq  SmallCap listing requirements, and there can be noassurance that we will be able to do so”* below. However we believethat there is a good chance that we will be able to again come into compliancewith the NASDAQ listing requirements through operational means, although ifthis is not the case we would likely need to consider effecting a reverse splitof our common stock to achieve compliance with this listing requirement.

 

In2004, uses of cash in financing activities were almost completely matched bycash provided by financing activities as follows:

 

•      $500,000in outflows due to repayment of the amount drawn-down on the receivables linein October 2003, offset by

 

•      Approximately$500,000 in inflows consisting of proceeds from the sale of common stock underour employee stock option and stock purchase plans.

 

In2003, approximately $700,000 of cash was provided by financing activities asfollows:

 

•      $500,000in inflows due to a draw-down on our receivables line of credit in October 2003,and

 

•      Approximately$200,000 in inflows consisting of proceeds from the sale of common stock underour employee stock option and stock purchase plans.

 

Althoughwe expect to effectively manage our cash resources, there can be no assurancethat our cash resources will be adequate, if our financial results fall shortof our goals, as our operating results are very difficult to predict and we aredependent upon future events, including our ability to successfully negotiate anew revolving credit line or obtain additional debt or equity financing.  Additional debt or equity financing may berequired or desirable, although it is not currently anticipated, and may not beavailable to us on commercially reasonable terms, or at all.  The prices at which new investors would bewilling to purchase our securities may be lower than the market value ortrading price of our common stock, which has recently decreased. The sale ofadditional equity or convertible debt securities could result in dilution toour shareholders, which could be substantial and may involve the issuance ofpreferred securities that would have liquidation preferences that entitleholders of the preferred securities to receive certain amounts before holdersof common stock in connection with an acquisition or business combinationinvolving Versant or a liquidation of Versant. New investors may also seekagreements giving them additional voting control or seats on our board ofdirectors.  Even if we were able toobtain additional debt or equity financing, the terms of this financing mightsignificantly restrict our business activities and in some circumstances, mightrequire us to obtain the approval of our shareholders, which could delay orprevent consummation of the financing transaction.  Cash may also be needed to acquire or investin complementary businesses or products or to obtain the right to usecomplementary technologies and we expect that, in the event of such anacquisition or investment, if significant, it will be necessary for us to seekadditional debt or equity financing.

 

**RiskFactors**

 

*This annual report on Form 10-K containsforward-looking statements regarding the Company that involve risks anduncertainties, including, but not limited to, those set forth below, that couldcause our actual results of operations to differ materially from thosecontemplated in the forward-looking statements. The matters set forth below should be carefully considered whenevaluating our business and prospects.*

 

***Risks Related to Our Business***

 

***Weare dependent on a limited number of products***.  Nearly all of our license revenue to date hasbeen derived from VDS.  Consequently, if our ability to generaterevenue from VDS were negatively impacted, ourbusiness, cash flows and results of operations would be materially adverselyaffected.  Many factors could negativelyimpact our ability to generate revenue from VDS,including without limitation slowness in the general economy or in keyindustries we serve, such as the telecommunications and financial servicesindustries, the success of competitive products of other vendors, reduction inthe prices we can obtain for our products due to competitive factors, theadoption of new technologies or standards that make either producttechnologically obsolete or customer reluctance to invest in object-orientedtechnologies.  Although we have takensteps to diversify our product line through our acquisition of Poet and its FastObjects data management product our recent introductionof our Open Access JDO product, we still expect thatsales of VDS will continue to be critical to our

 

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revenuesfor the foreseeable future.  Accordingly,any significant reduction in revenue levels from our VDSproducts can be expected to have a strong negative impact on our business andresults of operation.

 

***Our revenue levels are not predictable. ***Our revenue has fluctuated dramatically on aquarterly basis, and we expect this trend to continue.  For example, in fiscal 2004 our quarterlyrevenue fluctuated from a high of $6.4 million in the first quarter of fiscal2004 to a low of $5.0 million in the second quarter of fiscal 2004.  These quarterly fluctuations result from anumber of factors, including:

 

**•**      delaysby our customers (including customers who are resellers) in signingrevenue-bearing contracts that were expected to be entered into in a particularfiscal quarter;

**•**      generalmacroeconomic factors that impact information technology, or “IT”, capitalpurchasing decisions;

**•**      thelengthy sales cycle associated with our products;

•      customerand market perceptions of the value and currency of object-oriented softwaretechnology;

**•**      uncertaintyregarding the timing and scope of customer deployment schedules of applicationsbased on VDS where revenue is contingent upon thecustomer’s deployment of our product;

**•**      failureto timely develop and launch successful new products;

**•**      fluctuationsin domestic and foreign demand for our products and services, particularly inthe telecommunications, technology, and defense markets  

**•**      theimpact of new product introductions, both by us and by our competitors;

**•**      ourunwillingness to lower prices significantly to meet prices set by ourcompetitors or reductions of our prices to meet competition;

**•**      theeffect of publications of opinions about us and our competitors and theirproducts;

•      customerdeferrals of orders in anticipation of product enhancements or new productofferings by us or our competitors; and

•      potentialcustomers’ unwillingness to invest in our products given our perceived financialinstability.

 

***We may not be able to manage costs effectively given theunpredictability of our revenue.*** We expect to continue to maintain a relativelyhigh level of fixed expenses, including expenses related to Poet’s operations.If planned revenue growth, including revenue from Poet’s products, does notmaterialize, then our business, financial condition and results of operationswill be materially harmed.

 

***Our customer concentration increases the potential volatility of ouroperating results.*** A significant portion of our total revenue has been, and we believe willcontinue to be, derived from a limited number of orders placed by largeorganizations.  For example, onecustomer, IBM (who subcontracts for us on WebSphereconsulting engagements), represented 17% of our total revenue in fiscal 2004and 19% in fiscal 2003. The timing of large orders and of their fulfillment hascaused, and in the future is likely to cause, material fluctuations in ouroperating results, particularly on a quarterly basis. In addition, our majorcustomers tend to change from year to year. The loss of any one or more of our major customers, or our inability toreplace a customer making declining purchases with a new customer of comparablesignificance, could each have a material adverse effect on our business.

 

***We have limited working capital and may experience difficulty inobtaining needed funding, which may limit our ability to effectively pursue ourbusiness strategies.*** At October 31, 2004, we had approximately$3.6 million in cash and cash equivalents and working capital of approximately$1.3 million.  We have experiencedsignificant declines in our cash and working capital in fiscal 2004. To date,we have not achieved profitability or positive cash flow on a sustainedbasis.  In response to this situation, inthe fourth quarter of fiscal 2004 we restructured our business operations toreduce our operating expenses.  Althoughwith this restructuring we believe that our current cash, cash equivalents, andany net cash provided by operations will be sufficient to meet our anticipatedcash needs for working capital and capital expenditures for the next twelvemonths, it is possible that events may occur that could render our currentworking capital reserves insufficient.  Because our revenue is unpredictable and asignificant portion of our expenses are fixed, a reduction in our projectedrevenue or unanticipated requirements for cash outlays could deplete ourlimited financial resources.  Forexample, our acquisition of Poet and its operations may increase certain of ouroperating expenses even after our fiscal 2004 restructuring, and if revenuesfrom Poet’s product line don’t materialize when anticipated our working capitalcould be adversely impacted.  Impairmentof our working capital would require us to make expense reductions and/or toraise funds through borrowing or debt or equity financing.  Our bank line of credit expired in September 2004and there can be no assurance that we will secure a new bank line of credit.Likewise, there can be no assurance that any equity or debt funding will beavailable to us on favorable terms, if at all. If we cannot secure adequate financing sources, then we would berequired to further reduce our operating expenses, which would restrict ourability to pursue our business objectives.

 

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***Reduceddemand for our products and services may prevent us from achieving targetedrevenue and profitability. ***Ourrevenue and our ability to achieve and sustain profitability depend on theoverall demand for the software products and services we offer.  Reduced demand for our product line mayresult from competition offered by alternative technologies or negativecustomer perception of our object-oriented technology.  General economic conditions can also have asignificant adverse effect on our revenues and results of operations.  The slowdown in the world economy that began inthe early 2000s caused many of our customer or potential customer to experiencedeclines in their revenues and results of operations.  This in turn caused potential or existingcustomers to defer purchases of capital equipment, particularly for critical ITinfrastructure, which is the market sector we serve  The current war in Iraq and generallyuncertain world conditions and concerns about terrorism also have increased thecurrent uncertainty in the economic environment, and we cannot predict theimpact of these or similar events in the future, or of any related or unrelatedmilitary action, on our customers or our business.  We believe that, in light of these concerns,some businesses may continue to curtail or eliminate capital spending oninformation technology.  In addition, wehave experienced continued hesitancy on the part of our existing and potentialcustomers to commit to new products or services from us. Further, prior to ourmerger with Poet in March of 2004, Poet’s ability to forecast the timingand amount of its sales had been substantially reduced by the economic slowdown,and Poet had experienced lengthened sales cycles, lower average selling pricesand reduced bookings and revenues.  IfU.S. or global economic conditions worsen, this revenue impact may worsen aswell and have a material adverse impact on our business, operating results andfinancial condition.

 

***We rely for revenue on the technology, telecommunications and defensewhich are characterized by complexity and intense competition.***  Historically, we have been highly dependentupon the telecommunications industry and, more recently, we are becomingincreasingly dependent upon the technology and defense industries for sales of VDS.  Our success inthese areas is dependent, to a large extent, on general economic conditions,our ability to compete with alternative technology providers our ability todevelop products that can successfully operate in different computingenvironments and whether our customers and potential customers believe we havethe expertise and financial stability necessary to provide effective solutionsin these markets on an ongoing basis.  Ifthese conditions, among others, are not satisfied, we may not be successful ingenerating additional opportunities in these markets.  Currently, companies in these markets arescaling back their technology expenditures and the telecommunications industryhas in particular experienced significant economic difficulties andconsolidation trends which could jeopardize our ability to continue to deriverevenue from customers in that industry. In addition, the types of applications and commercial products for thetechnology, telecommunications and defense markets are continuing to developand are rapidly changing, and these markets are characterized by an increasingnumber of new entrants whose products may compete with ours.  As a result, we cannot predict the futuregrowth of (or whether there will be future growth in) these markets, and demandfor object-oriented databases applications in these markets may not develop orbe sustainable.  We also may not be successfulin attaining a significant share of these markets due to competition and otherfactors, such as our limited working capital. Moreover, potential customers in these markets generally developsophisticated and complex applications that require substantial consultingexpertise to implement and optimize. This requires that we maintain a highlyskilled consulting practice with specific expertise in these markets. There canbe no assurance that we can hire and retain adequate personnel for this practice.

 

***Weincreasingly depend on our international operations.***  A large and increasing portion of our revenueis derived from customers located outside North America.  For the fiscal year ended October 31, 2004,international revenue made up approximately 37% of our total revenue, while forthe year ended October 31, 2003, approximately 24% of our total revenue wasderived from customers outside the United States and Canada.  Following our acquisition of Poet, we expectthat international revenue will represent a larger percentage of our totalrevenue than it has historically. Consequently we must conduct our operations internationally and maintaina significant presence in international markets.  As a result of our acquisition of Poet we nowhave approximately 50 employees based in Europe.  In addition, we also perform a significantamount of engineering work in India through our wholly owned subsidiary locatedin Pune, India. In fiscal 2002, we transitioned someof our international sales efforts to a business model that employs localdistributors. While use of local distributors reduces certain sales andoperating expenses, it also makes our business more dependent on the skills andefforts of third parties and can decrease our profit margins.

 

Ourinternational operations are subject to a number of risks in addition to therisks faced by our domestic operations. These risks include, but are not limited to:

 

•      longerreceivable collection periods;

 

•      adversechanges in regulatory requirements;

 

•      dependenceon independent resellers;

 

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•      fluctuationsin foreign exchange rates;

 

•      compliancewith multiple and conflicting regulations and technology standards in differentjurisdictions;

 

•      importand export restrictions, tariffs and other regulatory restrictions;

 

•      difficultiesin, and increased costs of, staffing and managing foreign operations;

 

•      potentiallyadverse tax consequences arising from international operations andinter-company transactions;

 

•      theburdens of complying with a variety of foreign laws;

 

•      theimpact of business cycles, economic and political instability and potentialhostilities outside the United States; and

 

•      limitedability to enforce agreements, intellectual property rights and other rights insome foreign countries.

 

In addition, in light of increasing global securityand terrorism, there may be additional risks of disruption to our internationalsales activities.  Any prolongeddisruption in markets in which we derive significant revenue may potentiallyhave a material adverse impact on our revenues and results of operations.

 

***Ourpersonnel, management team and operations are located in different countriesand as a result,  we may experiencedifficulty in coordinating our activities and successfully implementing Companygoals.***  Followingour 2004 merger with Poet, we acquired significant operations and personnel inEurope, whose activities must be well coordinated with those of our U.S.workforce and other employees. Following the Poet merger, our management teamresides in both our U.S. headquarters in Fremont, California and our offices inHamburg, Germany.  The fairly largegeographic dispersion of our management team and our workforce may make it moredifficult for us to successfully manage longer term objectives, coordinateactivity across the company and integrate our operations and business plans. 

 

***Ourproducts have a lengthy sales cycle.***  The sales cycle for our VDSand FastObjects products varies substantially fromcustomer to customer, and often exceeds nine months and can sometimes extend toa year or more, especially for sales to defense sector customers.  Sales to our Versant Open Access customersare often concluded in shorter time intervals. Due in part to the strategic nature of our products and associatedexpenditures, potential customers are typically cautious in making productacquisition decisions. Influencing our customers’ decision to license ourproducts generally requires that we provide a significant level of education toprospective customers regarding the uses and benefits of our products, and thatwe frequently commit, without any charge or reimbursement, pre-sales supportresources, such as assistance in performing benchmarking and applicationprototype development.  Because of thelengthy sales cycle for our products and the relatively large average dollarsize of individual licenses, a lost or delayed sale could have a significantimpact on our operating results for a particular fiscal period.

 

***Weare subject to litigation and the risk of future litigation.***We and certain of our present and former officers and directors were named asdefendants in four class action lawsuits filed in the United States DistrictCourt for the Northern District of California in 1998.  The complaint alleged violations of Sections10(b) and 20(a) of the Securities Exchange Act of 1934, or Exchange Act, andSecurities and Exchange Commission Rule 10b-5 promulgated under the ExchangeAct, in connection with public statements about Versant and its financialperformance. Although this case has been dismissed as of this date, there canbe no assurance that we will not be subject to similar litigation in thefuture.  In addition, in the last quarterof fiscal 2004 we were served with a complaint filed by Systems America, Inc.,a privately held company, which alleges that, prior to our acquisition of Mokume Software, Inc. in November 2002, persons associatedwith Mokume misappropriated Systems America’s tradesecrets and confidential information, unfairly competed with Systems Americawith respect to its customer relationships, and infringed Systems America’strademarks and trade names. The Complaint seeks unspecified damages andinjunctive relief against the Company and Mokume’sformer personnel. We do not believe this complaint has merit or that thislitigation is material.  We deny theallegations in the complaint and intend to vigorously defend against thecomplaint.  However, even if we prevail,litigation can be expensive to defend, can consume significant amounts ofmanagement time and could result in an adverse judgment or settlement thatcould have adverse effects on our results of operations and financialcondition.  

 

***Inorder to be successful, Versant must attract, retain and motivate key employeesand failure to do so could seriously harm the company.***  In order to be successful, Versant mustattract, retain and motivate its executives and other key

 

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employees, including those in managerial, sales and technical positionsand those who became our employees as a result of our merger with PoetHoldings. In recent months our stock price has declined and we reduced ourworkforce in connection with a restructuring of our operations in the fourthquarter of fiscal 2004. These and other circumstances may adversely affectVersant’s ability to attract and retain key management, sales and technicalpersonnel who are critical to the success of our operations. Versant mustcontinue to motivate employees and keep them focused on the achievement of ourstrategies and goals. In addition, as a result of our merger with Poet in Marchof 2004, Versant now employs a sizable German workforce subject to German law,which generally provides greater financial protection to terminated employeesthan does United States law. Consequently, failure to retain our Germanemployees may cause us to incur significant severance costs, which couldadversely affect our operating results and financial condition.

 

***We will incur increased costs as a result of recently enacted laws andregulations relating to corporate governance matters and public disclosure.***Recentlyenacted and proposed changes in the laws and regulations affecting publiccompanies, including the provisions of the Sarbanes-Oxley Act of 2002, rulesadopted or proposed by the SEC and by the NASDAQ National Market and newaccounting pronouncements will result in increased costs to us as we evaluatethe implications of these laws, regulations and standards and respond to theirrequirements. To maintain high standards of corporate governance and publicdisclosure, we intend to invest substantial resources to comply with evolvingstandards. This investment will result in increased general and administrativeexpenses within Fiscal year 2005 and a diversion of management time andattention from strategic revenue generating and cost management activities. Inaddition, these new laws and regulations could make it more difficult or morecostly for us to obtain certain types of insurance, including director andofficer liability insurance, and we may be forced to accept reduced policylimits and coverage or incur substantially higher costs to obtain the same orsimilar coverage. The impact of these events could also make it more difficultfor us to attract and retain qualified persons to serve on our board ofdirectors, on our board committees or as executive officers. We are takingsteps to comply with the recently enacted laws and regulations in accordancewith the deadlines, by which compliance is required, but we cannot predict orestimate the amount or timing of additional costs that we may incur to respondto their requirement and cannot be certain that we will be able to fully complywith the provisions of Section 404 of the Sarbanes-Oxley Act regardingcompliance with certain assessments and auditor attestations regarding internalcontrol structure reporting.

 

***Althoughwe expect that our merger with Poet will ultimately result in benefits to us,we may not realize those benefits because of integration difficulties and otherchallenges. ***

 

Following our merger with Poet Holdings in March of2004 we have been continually engaged in ongoing efforts to successfullyintegrate the operations of the two companies. However, much integration workstill remains to be done and any failure to meet the challenges involved insuccessfully integrating the operations of Versant and Poet or to realize anyof the anticipated benefits or synergies of the merger could seriously harm ourresults. Integration efforts absorb significant amounts of senior management’stime.  Realizing the benefits of themerger will depend in part on the ability of the combined company to continueto overcome significant challenges, such as timely, efficient and successfulexecution of post-merger strategies, including:

 

•      combiningthe day-to-day operations of the two companies;

•      makingsuccessful strategic decisions with respect to Versant’s and Poet’s productlines;

•      integratingand managing the operations of the combined company across multiple distantgeographic locations, including updating and extending management controls,reporting systems and procedures on a timely basis;

•      retainingand assimilating the key personnel of each company;

•      integratingthe technology and products of the two companies and their marketingstrategies;

•      retainingexisting customers and strategic partners of both companies and attracting newcustomers and strategic partners; and

•      successfullyexploiting potential synergies of the two companies.

 

The risks related to the execution of thesepost-merger strategies include:

 

•       potentialdisruption of the combined company’s ongoing business;

•       distractionof senior management resulting from the efforts to combine and integrate Versant’sand Poet’s operations;

•       difficultyin successfully coordinating the management of the combined company, includingdifficulties arising from the fact that the combined company’s management teamis dispersed between offices in Fremont, California and Hamburg, Germany;

•       difficultiesinherent in creating successful strategies for coordinating sales and marketingplans for the combined company’s products and services;

 

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•    changesin strategic directions that may adversely affect near-term and long-termrevenues;

•    therisk that synergies anticipated for the combined company’s products will not beachieved or may not be realized within the time frame currently anticipated;

•    thepossibility that efforts to achieve operating expense reductions may beunsuccessful or give rise to unexpected liabilities;

•    thepotential need to demonstrate to customers that the merger will not result inadverse changes in customer service standards or business;

•    impairmentof relationships with employees, suppliers and customers as a result of theintegration of new management personnel; and

•    failureto retain key employees, including members of the management team, of thecombined company.

 

***UntilMarch 18, 2005, Versant cannot take certain actions without the approval of atleast 80% of Versant’s directors then in office***.  Upon consummation of our merger with Poet,Versant’s articles of incorporation were amended to provide that, for a periodof 12 months immediately after the effective time of the merger, certainactions, including any proposed acquisition of Versant, any sale of any productline, any material change in operation of Versant’s business or any change inthe authorized number of Versant’s directors, will require the approval of atleast 80% of the members of Versant’s board of directors then in office. SinceVersant’s board is now comprised of three directors who were members of Versant’sboard immediately prior to the merger and two directors who were members of Poet’sboard immediately prior to the merger, approval of these transactions willeffectively require the unanimous vote of all directors. The board members mayhave different views on which transactions are beneficial to Versant and itsshareholders. Failure to obtain this required approval may cause Versant tolose opportunities that could be favorable to it and its shareholders.

 

***Chargesto earnings resulting from the application of the purchase method of accountingfor the merger with Poet may adversely affect the market value of Versant’scommon stock.*** In accordance with United States generallyaccepted accounting principles, Versant accounts for the merger with Poet usingthe purchase method of accounting, which results in charges to earnings thatcould have a material adverse effect on the market value of Versant commonstock. Under the purchase method of accounting, Versant has allocated the totalestimated purchase price to of Poet to net tangible assets and amortizableintangible assets based on their fair values as of the date of the closing ofthe merger, and recorded the excess of the purchase price over those fairvalues as goodwill. Versant will incur additional depreciation and amortizationexpense over the useful lives of certain of the net tangible and intangibleassets acquired in connection with the merger. which will extend into futurefiscal years. In addition, to the extent the value of goodwill or intangibleassets becomes impaired, Versant may be required to incur material charges relatingto the impairment of those assets. These depreciation, amortization, andpotential impairment charges could have a material impact on Versant’s resultsof operations.

 

***Risks Related to Our Industry***

 

***Our products face significant competition.* **For our VDS and FastObjects products, we compete with companies offeringother database management systems. We face competition from traditionalrelational database management companies who are substantial competitorsincluding Oracle, Computer Associates, Sybase, IBM and Microsoft.  We also face competition from object databasecompanies including Object Design (which was acquired by Progress SoftwareCorporation in 2002) and Objectivity, Inc. Additionally, some prospective customersattempt to build specialized data storage capability themselves using their owninternal engineering resources, sometimes starting with low level operatingsystem functionality, and other times utilizing lower level data storageroutines that are commercially available, such as Berkeley DB, asimplified database without query processing capability. 

 

For Versant Open Access, competitors include otherobject-relational mapping products such as Hibernate, TopLink,other suppliers of products using the JDO standard,such as SolarMetric, and a variety of small vendorsoffering a variety of technical approaches. 

 

Many of our competitors, and especially Oracle andComputer Associates, have longer operating histories, significantly greaterfinancial, technical, marketing, service and other resources, significantlygreater name recognition, broader suites of product offerings, stronger salesand distribution channels and a much larger installed base of customers thanours.  In addition, many of our competitorshave well-established relationships with our current and potential customers.Our competitors may be able to devote greater resources to the development,promotion and sale of their products and also may have more direct access tocorporate decision-makers of key customers based on previous relationships Ourcompetitors may also be able to respond more quickly to new or emergingtechnologies and changes in customer requirements and may be able

 

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to obtain sales ofproducts competitive to ours through package sales of a suite of products we donot offer or compete with.  We may not beable to compete successfully against current or future competitors, andcompetitive pressures could have a material adverse effect on our business,operating results and financial condition.

 

***Wedepend on successful technology development.***  We believe that significant research anddevelopment expenditures will continue to be necessary for us to remaincompetitive.  While we believe ourresearch and development expenditures will improve our product lines, becauseof the uncertainty of software development projects, these expenditures willnot necessarily result in successful product introductions.  Uncertainties affecting the success ofsoftware development project introductions include technical difficulties,delays in introductions of new products, market conditions, competitiveproducts and consumer acceptance of new products and operating systems.

 

Wealso face certain challenges in integrating third-party technology with ourproducts.  These challenges include thetechnological challenges of integration, which may result in developmentdelays, and uncertainty regarding the economic terms of our relationship withthe third-party technology providers, which may result in delays of thecommercial release of new products.

 

We expect that evolving industry standards will affectour business. For example, the EJB 3.0 standard (JSR 220) for data storage in the Java 2 Enterprise Editionwill offer risks and opportunities for Versant. The principal risk is that thistechnology may stimulate the creation of a broader range of competitors, some ofwhom will offer applications bundled with application servers. The opportunityis that we expect a very large number of applications to be built withprogramming interfaces that can readily use Versant products to gainperformance and other advantages. In the .NET market, Microsoft hasexperimented with an object-relational tool, code-named ObjectSpaces,but has withdrawn the tool saying any offering would be beyond the release oftheir product, code-named “Longhorn”.

 

***Wemust protect our intellectual property.*** Despite our efforts to protect our proprietaryrights, unauthorized parties may attempt to copy aspects of our products, obtainor use information that we regard as proprietary or use or make copies of ourproducts in violation of license agreements. Policing unauthorized use of our products is difficult and potentiallyexpensive.  In addition, the laws of manyjurisdictions do not protect our proprietary rights to as great an extent as dothe laws of the United States. Shrink-wrap licenses may be wholly or partially unenforceable under thelaws of certain jurisdictions, and copyright and trade secret protection forsoftware may be unavailable in certain foreign countries.  Our means of protecting our proprietaryrights may not be adequate, and our competitors may independently developsimilar technology.

 

***Wemay be subject to claims of intellectual property infringement.***We expect that developers of object-oriented technology will increasingly besubject to infringement claims as the number of products, competitors andpatents in our industry sector grows. For example, in the last quarter of fiscal 2004 we were served with a complaintfiled by Systems America, Inc. alleging that we received misappropriatedintellectual property from Mokume Software, Inc. whenwe acquired Mokume in November 2002 and that Mokume had interfered with certain business relationship ofSystems America.  We believe these claimslack merit and intend to defend them vigorously if they are pursued.  However, any claim of this type, whethermeritorious or not, could be time-consuming, result in costly litigation, causeproduct shipment delays and require us to enter into royalty or licensingagreements.  If any of our products ortechnologies were found to infringe third-party rights, royalty or licensingagreements to use such third-party rights might not be available on termsacceptable to us, or at all, which could have a material adverse effect uponour business, operating results and financial condition.

 

***Wedepend on our personnel, for whom competition is intense.***  Our future performance depends in significantpart upon the continued service of our key technical, sales and seniormanagement personnel.  The loss of theservices of one or more of our key employees could have a material adverseeffect on our business.  Our future successalso depends on our continuing ability to attract, train and motivate highlyqualified technical, sales and managerial personnel. Our current financialposition and recent declines in our stock price may make it more difficult toattract and retain highly talented individuals due to constraints on ourability to offer compensation at levels that may be offered by largercompetitors.

 

***RisksRelated to our Stock***

 

***Ourcommon stock is listed on the Nasdaq  SmallCap Market. ***Wedo not currently meet the listing requirements necessary for our common stockto be listed on the Nasdaq National Market System (“NMS”).  Effective October 1,2002, we transferred the listing of our common stock from the NMS to the Nasdaq  SmallCap Market.  Thelisting of our common stock on The Nasdaq  SmallCap Market may be perceived as a negative by investorsand may adversely affect the liquidity and trading price of our common stock.We may be unable to re-list our common stock on the NMS.

 

46

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***Inorder for our common stock to continue to be listed on The Nasdaq SmallCapMarket, we must satisfy the Nasdaq SmallCap listing requirements, and there canbe no assurance that we will be able to do so***.  Although the continued listing requirementsof the Nasdaq SmallCap Market are not as demanding as those of the NMS, theydo, among other things, require that our stock have a minimum bid price of$1.00 per share, which we sometimes refer to below as the $1.00 minimum pricerequirement, and that either (i) we have shareholders’ equity of $2,500,000, or(ii) we have $500,000 in net income or (iii) the market value of our publicly held shares be $35 million or more. Asreported in our September 17, 2004 report on Form 8-K, on September 15, 2004,we received notification from the Nasdaq Stock Market that, because our commonstock had traded at a price below $1.00 per share for thirty consecutivetrading days, we must regain compliance with the $1.00 minimum pricerequirement to avoid delisting of our common stock from the Nasdaq SmallCapMarket.   To regain compliance with thiscontinued listing requirement, our common stock must have a $1.00 or greaterminimum bid price for a minimum of least ten consecutive trading days, orpossibly longer as may be required by Nasdaq pursuant to its MarketplaceRules.  Under Nasdaq’s currentMarketplace Rules, we have been provided a grace period until March 14, 2005 toachieve compliance with the $1.00 minimum price requirement.  If we have not regained compliance with thisrequirement by March 14, 2005, then we will potentially be eligible for furthergrace periods which could extend beyond six months depending upon our abilityto meet Nasdaq SmallCap Market initial listing requirement, an importantelement of which is meeting a minimum net shareholders’ equity requirement of$5 million. Our net shareholders’ equity at October 31, 2004 was approximately$22.9 million. If we experience difficulty in regaining compliance with the$1.00 minimum price requirement, we may need to consider adoption of a reversestock split to obtain compliance.  Due tothese circumstances, there exists a significant risk that our common stockcould cease to qualify for listing on the Nasdaq SmallCap Market. If our commonstock is delisted from trading on the Nasdaq SmallCap Market, then the tradingmarket for our common stock, and the ability of our shareholders to trade ourshares and obtain liquidity and fair market prices for their Versant shares arelikely to be significantly impaired and the market price of Versant’s commonstock may decline significantly.  

 

***We may engage in future acquisitions that dilute our shareholders andcause us to incur debt or assume contingent liabilities. ***As part of ourstrategy, we expect to review opportunities to buy other businesses ortechnologies that would complement our current products, expand the breadth ofour markets or enhance technical capabilities, or that may otherwise offergrowth opportunities.  In the event ofany future acquisitions, we could:

 

•      payamounts of cash to acquire assets or businesses;

•      issuestock that would dilute current shareholders’ percentage ownership;

•      incurdebt; or

•      assumeliabilities.

 

Suchacquisitions also involve numerous risks, including:

 

•      problemscombining the acquired operations, technologies or products or integration ofnew personnel;

•      theincurrence of unanticipated costs in completing such acquisitions or ininheriting unforeseen liabilities and expenses of acquired businesses;

•      diversionof management’s attention from our core business;

•      adverseeffects on existing business relationships with suppliers and customers;

•      risksassociated with entering markets in which we have no or limited priorexperience; and

•      potentialloss of key employees of purchased organizations.

 

Therecan be no assurance that we will be able to successfully integrate any acquiredbusinesses, products or technologies that we might purchase in the future.

 

***Ourstock price is volatile.*** Our revenue, operating results and stock price have been and maycontinue to be subject to significant volatility, particularly on a quarterlybasis.  We have previously experiencedrevenue and earnings results that were significantly below levels expected bysecurities analysts and investors, which have had an immediate and significantadverse effect on the trading price of our common stock.  This may occur again in the future.  Additionally, as a significant portion of ourrevenue often occurs late in the quarter, we may not learn of revenueshortfalls until late in the quarter, which, when announced, could result in aneven more immediate and adverse effect on the trading price of our commonstock.

 

***Wemay desire or need to raise additional funds through debt or equity financings,which would dilute the ownership of our existing shareholders and possiblysubordinate certain of their rights to rights of new investors***.  We may choose to raise additional funds indebt or equity financings if they are available to us on terms we believereasonable to increase our working capital, strengthen our financial positionor to make acquisitions. Any sales of additional equity or convertible debtsecurities would result in dilution of the equity interests of our existingshareholders, which could be substantial.

 

47

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Additionally, if we issue shares of preferred stock or convertible debtto raise funds, the holders of those securities might be entitled to variouspreferential rights over the holders of our common stock, including repaymentof their investment, and possibly additional amounts, before any payments couldbe made to holders of our common stock in connection with an acquisition of thecompany.  Such preferred shares, ifauthorized, might be granted rights and preferences that would be senior to, orotherwise adversely affect, the rights and the value of Versant’s commonstock.  Also, new investors may requirethat we enter into voting arrangements that give them additional voting controlor representation on our board of directors. 

 

**Item 7A****:Quantitative and Qualitative Disclosures About Market Risk**

 

***Foreigncurrency hedging instruments. ***Wetransact business in various foreign currencies and, accordingly, we aresubject to exposure from adverse movements in foreign currency exchangerates.  To date, the effect of changes inforeign currency exchange rates on revenue and operating expenses has not beenmaterial.  Operating expenses incurred byour foreign subsidiaries are denominated primarily in local currencies.  We currently do not use financial instrumentsto hedge these operating expenses.  Weintend to assess the need to utilize financial instruments to hedge currencyexposures on an ongoing basis. In addition, a substantial portion of our cashbalances is held in foreign financial institutions and is subject to exposurefrom adverse movements in foreign currency exchange rates.

 

We do not use derivativefinancial instruments for speculative trading purposes.

 

***Interestrate risk.* **Ourcash equivalents primarily consist of money market accounts, accordingly, ourinterest rate risk is de minimus.

 

**Item 8****.  Financial Statements and Supplementary Data.**

 

48

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

To the Board of Directorsand Shareholders

Versant Corporation

 

We have audited theaccompanying consolidated balance sheets of Versant Corporation andsubsidiaries (the “Company”) as of October 31, 2004 and 2003 and the relatedconsolidated statements of operations and comprehensive income, shareholders’equity, and cash flows for each of the two years in the period ended October31, 2004.  These financial statements arethe responsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.  

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Versant Corporationand subsidiaries as of October 31, 2004 and 2003, and the consolidated resultsof their operations and their consolidated cash flows for each of the two yearsin the period ended October 31, 2004, in conformity with accounting principlesgenerally accepted in the United States of America.

 

We have also auditedSchedule II for the years ended October 31, 2004 and 2003. In ouropinion, this schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly, in all material respects, theinformation set forth therein.

 

The accompanyingconsolidated financial statements as of October 31, 2003 have been restated toreflect the accounting change discussed in Note 2.

 

 
| /s/ Grant Thornton LLP     |   |
|----------------------------|--------|
| December 14, 2004          |
| San Francisco,  California |

 

49

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REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders

Versant Corporation:

 

We have audited the accompanying consolidatedstatements of operations, shareholders’ equity and cash flows of VersantCorporation and subsidiaries for the year ended October 31, 2002.  In connection with our audit of theconsolidated financial statements, we also have audited the related financialstatement schedule listed in Item 15(a)2. These consolidated financial statements and the related financial statementschedule are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements and the related financial statementschedule based on our audit.  

 

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.  We believe that our audit provides areasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the results ofoperations, cash flows and changes in shareholders’ equity of VersantCorporation and subsidiaries for the year ended October 31, 2002, in conformitywith accounting principles generally accepted in the United States ofAmerica.  Also, in our opinion, therelated financial statement schedule, when considered in relation to the basicconsolidated financial statements taken as whole, presents fairly, in allmaterial respects, the information set forth therein.

 

As discussed in Note 2 to the consolidated financialstatements, the Company has restated its consolidated financial statements forthe year ended October 31, 2002.

 

 
| /s/ KPMG LLP                            |   |
|-----------------------------------------|--------|
|                                    |
| Mountain View, California               |
| November 26, 2002 (except as to Note 2, |
| which is as of February 14, 2005)       |

 

50

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**VERSANT CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(In thousands)**

 
| ** **                                                                                                                                  | ** ** | **October 31, 2004** | ** ** | **October 31, 2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                                                                                  | ** ** | ** **           | ** ** | **As restated**      | ** ** |
| ASSETS                                                                                                                                      | ** ** | ** **           | ** ** | ** **           | ** ** |
| Current assets:                                                                                                                             |       |                 |       |                 |       |
| Cash and cash  equivalents                                                                                                                  |       | $                    | 3,313      |                 | $          | 2,991 |   |
| Restricted cash                                                                                                                             |       | 320                  |       | 320                  |       |
|                                                                                                                                        |       |                 |       |                 |       |
| Accounts  receivable, net of allowance for doubtful accounts of $368 and $258 at  October 31, 2004 and 2003, respectively                   |       | 5,121                |       | 4,023                |       |
| Other current  assets                                                                                                                       |       | 823                  |       | 623                  |       |
| Total current  assets                                                                                                                       |       | 9,577                |       | 7,957                |       |
|                                                                                                                                        |       |                 |       |                 |       |
| Property and  equipment, net                                                                                                                |       | 742                  |       | 1,232                |       |
| Other assets                                                                                                                                |       | 561                  |       | 543                  |       |
| Intangibles, net  of accumulated amortization of $414 and $91 at October 31, 2004 and 2003,  respectively                                   |       | 4,770                |       | 389                  |       |
| Goodwill, net                                                                                                                               |       | 16,895               |       | 948                  |       |
|                                                                                                                                        |       | $                    | 32,545     |                 | $          | 11,069 |   |
|                                                                                                                                        |       |                 |       |                 |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                  |       |                 |       |                 |       |
|                                                                                                                                        |       |                 |       |                 |       |
| Current  liabilities:                                                                                                                       |       |                 |       |                 |       |
| Line of credit                                                                                                                              |       | $                    | —     |                 | $          | 500 |   |
| Accounts payable                                                                                                                            |       | 839                  |       | 739                  |       |
| Accrued  liabilities                                                                                                                        |       | 4,307                |       | 2,148                |       |
| Current portion  of deferred revenue                                                                                                        |       | 3,027                |       | 3,905                |       |
| Current portion  of deferred rent                                                                                                           |       | 93                   |       | 63                   |       |
| Total current  liabilities                                                                                                                  |       | 8,266                |       | 7,355                |       |
|                                                                                                                                        |       |                 |       |                 |       |
| Long-term  liabilities, net of current portion:                                                                                             |       |                 |       |                 |       |
|                                                                                                                                        |       |                 |       |                 |       |
| Long-term  portion of deferred revenue                                                                                                      |       | 43                   |       | 83                   |       |
| Long-term  restructuring liabilities                                                                                                        |       | 1,120                |       | —               |       |
| Long-term  portion of deferred rent                                                                                                         |       | 237                  |       | 309                  |       |
| Total long-term  liabilities                                                                                                                |       | 1,400                |       | 392                  |       |
|                                                                                                                                        |       |                 |       |                 |       |
| Commitment and  Contingencies (Note 5)                                                                                                      |       |                 |       |                 |       |
|                                                                                                                                        |       |                 |       |                 |       |
| Shareholders’  equity:                                                                                                                 |       |                 |       |                 |       |
| Convertible  preferred stock, Authorized 3,000 shares, issued and outstanding 0 and 1,314  in 2004 and 2003, respectively                   |       | —               |       | 7,772                |       |
|                                                                                                                                        |       |                 |       |                 |       |
| Common stock,  Authorized 75,000 shares, issued and outstanding 34,698 and 14,648 at October  31, 2004 and 2003, respectively, no par value |       | 94,021               |       | 55,096               |       |
| Deferred  Compensation                                                                                                                      |       | (146                 | )          | —               |       |
| Accumulated  deficit                                                                                                                        |       | (71,565              | )          | (59,568              | )          |
| Accumulated  other comprehensive income                                                                                                     |       | 569                  |       | 22                   |       |
| Total  shareholders’ equity                                                                                                            |       | 22,879               |       | 3,322                |       |
|                                                                                                                                        |       | $                    | 32,545     |                 | $          | 11,069 |   |

 

See accompanying notes to consolidated financial statements

 

51

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**VERSANT CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(In thousands, except per share amounts)

 
| ** **                                                                | ** ** | ** **           | ** ** | **Year Ended**       | ** ** | ** **           | ** ** |
|---------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                | ** ** | **October 31, 2004** | ** ** | **October 31, 2003** | ** ** | **October 31, 2002** | ** ** |
|                                                                      |       |                 |       |                 |       |                 |       |
| Revenue:                                                                  |       |                 |       |                 |       |                 |       |
| License                                                                   |       | $                    | 9,686      |                 | $          | 9,082                |       | $ | 10,106 |   |
| Maintenance                                                               |       | 6,783                |       | 6,076                |       | 5,300                |       |
| Professional  services                                                    |       | 6,406                |       | 6,901                |       | 4,550                |       |
| Total revenue                                                             |       | 22,875               |       | 22,059               |       | 19,956               |       |
|                                                                      |       |                 |       |                 |       |                 |       |
| Cost of revenue:                                                          |       |                 |       |                 |       |                 |       |
| License                                                                   |       | 457                  |       | 843                  |       | 902                  |       |
| Maintenance                                                               |       | 1,516                |       | 1,312                |       | 1,291                |       |
| Professional  services                                                    |       | 5,858                |       | 6,011                |       | 4,041                |       |
| Amortization of  intangibles                                              |       | 698                  |       | 91                   |       | —               |       |
| Total cost of  revenue                                                    |       | 8,529                |       | 8,257                |       | 6,234                |       |
|                                                                      |       |                 |       |                 |       |                 |       |
| Gross profit                                                              |       | 14,346               |       | 13,802               |       | 13,722               |       |
|                                                                      |       |                 |       |                 |       |                 |       |
| Operating  expenses:                                                      |       |                 |       |                 |       |                 |       |
| Marketing and  sales                                                      |       | 8,026                |       | 7,698                |       | 7,854                |       |
| Research and  development                                                 |       | 5,112                |       | 4,340                |       | 5,835                |       |
| General and  administrative                                               |       | 4,478                |       | 3,267                |       | 3,440                |       |
| Restructuring  costs                                                      |       | 3,271                |       | —               |       | —               |       |
| Impairment of  Intangibles                                                |       | 1,024                |       | —               |       | —               |       |
| Non cash stock  expense  (1)                                         |       | 86                   |       | 1,209                |       | —               |       |
| Amortization of  goodwill                                                 |       | —               |       | —               |       | 202                  |       |
| Total operating  expenses                                                 |       | 21,997               |       | 16,514               |       | 17,331               |       |
|                                                                      |       |                 |       |                 |       |                 |       |
| Loss from  operations                                                     |       | (7,651               | )          | (2,712               | )          | (3,609               | )          |
|                                                                      |       |                 |       |                 |       |                 |       |
| Other income,  net :                                                      |       | 119                  |       | 397                  |       | 287                  |       |
| Loss from  continuing operations before taxes and deemed dividend         |       | (7,532               | )          | (2,315               | )          | (3,322               | )          |
| Provision for  income taxes                                               |       | 88                   |       | 74                   |       | 68                   |       |
| Net loss from  continuing operations before deemed dividend               |       | (7,620               | )          | (2,389               | )          | (3,390               | )          |
| Deemed dividend  to preferred shareholders                                |       | (2,422               | )          | —               |       | —               |       |
| Net loss from  continuing operations attributable to common shareholders  |       | (10,042              | )          | (2,389               | )          | (3,390               | )          |
| Loss from  discontinued operations, net of income tax                     |       | (1,646               | )          | —               |       | —               |       |
| Loss from sale  of discontinued operations, net of income tax             |       | (309                 | )          | —               |       | —               |       |
| Net loss                                                                  |       | $                    | (11,997    | )                    | $          | (2,389               | )          | $ | (3,390 | ) |
|                                                                      |       |                 |       |                 |       |                 |       |
| Basic and  diluted loss per share:                                        |       |                 |       |                 |       |                 |       |
| Net loss from  continuing operations attributable to common shareholders  |       | $                    | (0.32      | )                    | $          | (0.17                | )          | $ | (0.28 | ) |
| Loss from  discontinued operations, net of income tax                     |       | $                    | (0.05      | )                    | $          | —               |       | $ | — |   |
| Loss from sale  of discontinued operations, net of income tax             |       | $                    | (0.01      | )                    | $          | —               |       | $ | — |   |
|                                                                      |       |                 |       |                 |       |                 |       |
| Net loss  attributable to common shareholders                             |       | $                    | (0.38      | )                    | $          | (0.17                | )          | $ | (0.28 | ) |
|                                                                      |       |                 |       |                 |       |                 |       |
| Basic and  diluted weighted average shares used in per share calculations |       | 31,173               |       | 13,682               |       | 12,267               |       |

 

See accompanying notes to consolidated financial statements.

 

52

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----

(1) Non-cash stockexpense is allocated among the expense classifications as follows:

 
| ** **                          | ** ** | **Twelve months ended  October 31** | ** ** |
|-------------------------------------|------------|-------------------------------------|------------|
| ** **                          | ** ** | **2004**                            | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                          | ** ** | **(In thousands)**                  | ** ** |
| Research and  development expense   |       | $                                   | 25         |   | $ | — |   | $ | — |   |
| Marketing and  sales expense        |       | 25                                  |       | 5 |   | — |   |
| General and  administrative expense |       | 36                                  |       | 1,204 |   | — |   |
| Total non-cash stock expense        |       | $                                   | 86         |   | $ | 1,209 |   | $ | — |   |

 

53

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**VERSANT CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY**

(In thousands, except share amounts)

 
| ** **                                                                                                    | ** ** | ** **                 | ** ** | ** ** | ** ** | ** **   | ** ** | ** **      | ** ** | ** **    | ** ** | ** **             | ** ** | **Accumulated**  | ** ** | ** ** | ** ** | ** **         | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------|------------|------------------------|------------|------------------|------------|------------|------------|--------------------|------------|
| ** **                                                                                                    | ** ** | ** **                 | ** ** | ** ** | ** ** | ** **   | ** ** | ** **      | ** ** | ** **    | ** ** | ** **             | ** ** | **Other  Comp-** | ** ** | **Total**  | ** ** | **Total  Comp-**   | ** ** |
| ** **                                                                                                    | ** ** | **Convertible  Preferred** | ** ** | **Common** | ** ** | **Deferred** | ** ** | **Accumulated** | ** ** | **rehensive** | ** ** | **Shareholders’** | ** ** | **rehensive**    | ** ** |
| ** **                                                                                                    | ** ** | **Shares**                 | ** ** | **Amount** | ** ** | **Shares**   | ** ** | **Amount**      | ** ** | **Comp**      | ** ** | **Deficit**            | ** ** | **Income**       | ** ** | **Equity** | ** ** | **Income  (loss)** | ** ** |
|                                                                                                          |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       |               |       |
| **Balance  at October 31, 2001, as restated**                                                                 |       | 1,313,743                  |       | $          | 7,772      |         | 12,130,803 |            | $          | 52,465        |       | $                      | —     |             | $          | (53,789    | )          | $                  | 117        |   | $ | 6,565 |   |   |   |
|                                                                                                          |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       |               |       |
| ESPP and  exercises of stock options                                                                          |       | —                     |       | —     |       | 245,512      |       | 325             |       |          |       | —                 |       |             |       | $          | 325        |               |       |   |
| Stock based  compensation cost associated with the issuance of common shares for consulting  services         |       | —                     |       | —     |       | —       |       |            |       |          |       | —                 |       |             |       |       |       |               |       |
| Repurchase of  common shares                                                                                  |       | —                     |       | —     |       |         |       |            |       |          |       | —                 |       |             |       |       |       |               |       |
| Net loss                                                                                                      |       | —                     |       | —     |       |         |       | —          |       |          |       | (3,390                 | )          |             |       | $          | (3,390     | )             | $          | (3,390 | ) |
| Other  comprehensive income, net of tax:                                                                      |       |                       |       | —     |       |         |       |            |       |          |       |                   |       |             |       |       |       |               |       |
| Foreign currency  translation adjustments                                                                     |       | —                     |       | —     |       | —       |       | —          |       |          |       | —                 |       | 76               |       | 76         |       | $                  | 76         |   |
| Total  comprehensive loss                                                                                     |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       | $                  | (3,314     | ) |
|                                                                                                          |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       |               |       |   |
| **Balance  at October 31, 2002, as restated**                                                                 |       | 1,313,743                  |       | $          | 7,772      |         | 12,376,315 |            | $          | 52,790        |       | —                 |       | $                | (57,179    | )          | $          | 193                |       | $ | 3,576 |   |   |   |
|                                                                                                          |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       |               |       |
| ESPP and  exercises of stock options                                                                          |       | —                     |       | —     |       | 97,696       |       | 72              |       |          |       | —                 |       |             |       | $          | 72         |               |       |   |
| Exercise of stock  options                                                                                    |       |                       |       |       |       | 113,229      |       | 105             |       |          |       |                   |       |             |       | $          | 105        |               |       |   |
| Stock based  compensation                                                                                     |       |                       |       |       |       | 674,800      |       | 1,209           |       |          |       |                   |       |             |       | $          | 1,209      |               |       |   |
| Issuance of  common stock in Mokume acquisition                                                               |       |                       |       |       |       | 1,385,600    |       | 920             |       |          |       |                   |       |             |       | $          | 920        |               |       |   |
| Net loss                                                                                                      |       | —                     |       | —     |       | —       |       | —          |       |          |       | (2,389                 | )          |             |       | $          | (2,389     | )                  | $          | (2,389 | ) |
|                                                                                                          |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       |               |       |
| Other  comprehensive income, net of tax:                                                                      |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       |               |       |
| Foreign currency  translation adjustments                                                                     |       | —                     |       | —     |       | —       |       | —          |       |          |       |                   |       | (171             | )          | $          | (171       | )                  | $          | (171 | ) |
| Total  comprehensive loss                                                                                     |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       | $                  | (2,560     | ) |
| ** **                                                                                                    |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       |               |       |   |   |   |   |   |   |
| **Balance  at October 31, 2003, as restated**                                                                 |       | 1,313,743                  |       | $          | 7,772      |         | 14,647,640 |            | $          | 55,096        |       | $                      | —     |             | $          | (59,568    | )          | $                  | 22         |   | $ | 3,322 |   |   |   |
|                                                                                                          |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       |               |       |
| ESPP                                                                                                          |       | —                     |       | —     |       | 299,274      |       | 198             |       |          |       |                   |       |             |       | $          | 198        |               |       |   |
| Exercise of stock  options                                                                                    |       |                       |       |       |       | 283,938      |       | 270             |       |          |       |                   |       |             |       | $          | 270        |               |       |   |
| Conversion of  preferred stock to common                                                                      |       | (1,313,743                 | )          | (7,772     | )          | 3,941,229    |       | 7,772           |       |          |       |                   |       |             |       | $          | —     |               |       |   |
| Inducement to  preferred stockholders relating to conversion of preferred stock and  modification of warrants |       |                       |       |       |       |         |       | 2,422           |       |          |       | (2,422                 | )          |             |       | $          | —     |               | $          | (2,422 | ) |
| Issance of common  stock and options in connection with Poet acquisition                                      |       |                       |       |       |       | 15,525,342   |       | 28,330          |       | (299          | )          |                   |       |             |       | $          | 28,031     |               |       |   |
| Amoritzation of  unearned stock based compensation                                                            |       |                       |       |       |       |         |       |            |       | 86            |       |                   |       |             |       | $          | 86         |               |       |   |
| Cancellation of  unvested Poet stock options                                                                  |       |                       |       |       |       |         |       | (67             | )          | 67            |       |                   |       |             |       | $          | —     |               |       |   |
| Net loss before  deemed dividend                                                                              |       | —                     |       | —     |       |         |       |            |       |          |       | (9,575                 | )          |             |       | $          | (9,575     | )                  | $          | (9,575 | ) |
| Foreign currency  translation adjustments                                                                     |       | —                     |       | —     |       | —       |       | —          |       |          |       |                   |       | 547              |       | $          | 547        |               | $          | 547 |   |
| Total  comprehensive loss                                                                                     |       |                       |       |       |       |         |       |            |       |          |       |                   |       |             |       |       |       | $                  | (11,450    | ) |
| **Balance  at October 31, 2004**                                                                              |       | —                     |       | $          | —     |         | 34,697,423 |            | $          | 94,021        |       | $                      | (146       | )                | $          | (71,565    | )          | $                  | 569        |   | $ | 22,879 |   |   |   |

 

See accompanyingnotes to consolidated financial statements.

 

54

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**VERSANT CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In thousands)

 
| ** **                                                                                       | ** ** | **Year Ended**  | ** ** | **Year Ended**  | ** ** | **Year Ended**  | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| ** **                                                                                       | ** ** | **October 31,** | ** ** | **October 31,** | ** ** | **October 31,** | ** ** |
| ** **                                                                                       | ** ** | **2004**        | ** ** | **2003**        | ** ** | **2002**        | ** ** |
|                                                                                             |       |            |       |            |       |            |       |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                           |       |            |       |            |       |            |       |
| Net loss                                                                                         |       | $               | (11,997    | )               | $          | (2,389          | )          | $ | (3,390 | ) |
| Deemed dividend                                                                                  |       | 2,422           |       | —          |       | —          |       |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities:       |       |            |       |            |       |            |       |
| Write off of  leasehold improvements in conjuction with restructuring                            |       | $               | 200        |            | $          | —          |       | $ | — |   |
| Depreciation and  amortization                                                                   |       | 1,557           |       | 987             |       | 1,333           |       |
| Write-down of  goodwill                                                                          |       | 707             |       | —          |       | —          |       |
| Write -down of  intangibles                                                                      |       | 317             |       | —          |       | —          |       |
| Stock based  compensation                                                                        |       | 86              |       | 1,209           |       | —          |       |
| Write off of  equipment                                                                          |       | 65              |       | 22              |       | 50              |       |
| Loss on sale of  Catalog business                                                                |       | 309             |       | —          |       | —          |       |
| Provision for  doubtful accounts receivable                                                      |       | 87              |       | (132            | )          | 296             |       |
| Changes in  current assets and liabilities, net of acquisitions:                                 |       |            |       |            |       |            |       |
| Accounts  receivable                                                                             |       | (93             | )          | 106             |       | 2,185           |       |
| Other current  assets and inventory                                                              |       | 237             |       | 723             |       | (90             | )          |
| Other assets                                                                                     |       | —          |       | (522            | )          | (21             | )          |
| Accounts payable                                                                                 |       | (305            | )          | (553            | )          | 53              |       |
| Accrued  liabilities                                                                             |       | 1,707           |       | (916            | )          | 490             |       |
| Deferred revenue                                                                                 |       | (1,780          | )          | 405             |       | 2               |       |
| Deferred rent                                                                                    |       | (42             | )          | (31             | )          | (399            | )          |
| Net cash  provided by (used in) operating activities                                             |       | (6,523          | )          | (1,091          | )          | 509             |       |
|                                                                                             |       |            |       |            |       |            |       |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                           |       |            |       |            |       |            |       |
| Mokume  acquisition costs                                                                        |       | $               | —     |            | $          | (260            | )          | $ | — |   |
| Cash acquired in  Poet Holdings acquistion net of acquistion costs                               |       | 5,931           |       | —          |       | —          |       |
| Proceeds from  sale of catalog solutions business                                                |       | 1,223           |       | —          |       | —          |       |
| Purchase of  FastObjects, Inc., net of cash received                                             |       | (301            | )          | —          |       | —          |       |
| Purchase of JDO  Genie technology                                                                |       | (200            | )          | —          |       | —          |       |
| Purchase of  property and equipment                                                              |       | (262            | )          | (267            | )          | (3              | )          |
| Proceeds from  sale of property and equipment                                                    |       |            |       | —          |       | 25              |       |
| Net cash  provided by (used in) investing activities                                             |       | 6,391           |       | (527            | )          | 22              |       |
|                                                                                             |       |            |       |            |       |            |       |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                           |       |            |       |            |       |            |       |
| Proceeds from  sale of common stock, net                                                         |       | $               | 468        |            | $          | 177             |       | $ | 325 |   |
| Net borrowings  (payments) under short-term note and bank loan                                   |       | (500            | )          | 500             |       | (550            | )          |
| Principal  payments under capital lease obligations                                              |       | —          |       | (4              | )          | (56             | )          |
| Net cash  provided by (used in) financing activities                                             |       | (32             | )          | 673             |       | (281            | )          |
|                                                                                             |       |            |       |            |       |            |       |
| EFFECTS OF  EXCHANGE RATE CHANGES                                                                |       | 486             |       | (171            | )          | 76              |       |
|                                                                                             |       |            |       |            |       |            |       |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                            |       | 322             |       | (1,116          | )          | 326             |       |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF PERIOD                                                |       | 3,311           |       | 4,427           |       | 4,101           |       |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                                      |       | $               | 3,633      |            | $          | 3,311           |       | $ | 4,427 |   |
|                                                                                             |       |            |       |            |       |            |       |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION                                               |       |            |       |            |       |            |       |
| Cash paid for:                                                                                   |       |            |       |            |       |            |       |
| Interest                                                                                         |       | $               | 3          |            | $          | 2               |       | $ | 1 |   |
| Foreign  withholding and state income taxes                                                      |       | 89              |       | 74              |       | 62              |       |
|                                                                                             |       |            |       |            |       |            |       |
| SUPPLEMENTAL  SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES                             |       |            |       |            |       |            |       |
| Conversion of  Preferred Shares                                                                  |       | $               | 7,772      |            | $          | —          |       | $ | — |   |
| Deemed dividend  to preferred shareholders                                                       |       | 2,422           |       | —          |       | —          |       |
| Common stock  issued in conjunction with Poet acquisition                                        |       | 25,928          |       | —          |       | —          |       |
| Options issued  in conjuction with Poet acquisition, net of intrinsic value of unvested  options |       | 2,103           |       |            |       |            |       |
| Mokume  acquisition for common stock                                                             |       | —          |       | 920             |       | —          |       |
| Non cash stock  compensation                                                                     |       | 86              |       | 1,209           |       | —          |       |

 

See accompanyingnotes to consolidated financial statements.

 

55

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**VERSANTCORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**October31, 2004**

 

**1.****         Organization,Operations and Liquidity**

 

Versant Corporation wasincorporated in California in August 1988. References to the “Company” in these Notes to Consolidated FinancialStatements refer to Versant Corporation and its subsidiaries.  The Company is involved in the design,development, marketing and support of high performance object databasemanagement, data access and data integration software systems.

 

The Company is subject tothe risks associated with similar companies in a comparable stage ofdevelopment. These risks include, but are not limited to, fluctuations inoperating results, seasonality, a lengthy sales cycle, dependence on thecontinued acceptance of object database technology, competition, a limitedcustomer base, dependence on key individuals, dependence on internationaloperations, foreign currency exchange rate fluctuations, product concentration,and the ability to adequately finance its ongoing operations.

 

As of October 31, 2004,the Company had not achieved business volume sufficient to restoreprofitability and positive cash flow consistently, on an annual basis.  The Company operated at a net loss of $12million in 2004, $2.4 million in 2003 and $3.4 million in 2002. Managementanticipates funding future operations from current cash resources and futurecash flows from operations.  If financialresults fall short of projections, additional debt or equity may be requiredand the Company may need to implement further cost controls.  No assurances can be given that these effortswill be successful, if required.

 

**2.****         Restatementof Consolidated Financial Statements**

 

TheCompany is restating its consolidated financial statements for the fiscal years1999 through 2003. As disclosed in the Company’s Amendment to Form 10-Q filedSeptember 14, 2004 with respect to the Company’s fiscal quarter ended April 30,2004, the Company discovered the restatement as a result of a review of the1999 accounting for the initial issuance of Series A preferred stock. Thisreview was triggered in connection with the conversion of the outstandingSeries A preferred stock into common stock during the quarter endedApril 30, 2004. 

 

Thisrestatement of the consolidated financial statements corrects the applicationof EITF 98-5. “Accounting for Convertible Securities with Beneficial ConversionFeatures or Contingently Adjustable Conversion Ratios”. The outcome of theCompany’s review resulted in an increase in both preferred stock andaccumulated deficit of $2,859,650, which is attributable to the initialissuance of the Series A preferred stock in 1999. The initial issuance of theSeries A preferred stock gave rise to a beneficial conversion discount in theamount of $2,859,650 for the three and nine months ended September 30,1999, because the preferred stock was immediately convertible at its issuancedate at a conversion price below the then market price of the Company’s commonstock. The discount assigned to the beneficial conversion feature should haveresulted in an increase to preferred stock and accumulated deficit on ourbalance sheet in the amount of $2,859,650 in July 1999.  Thisincrease was not recorded in 1999 and we have restated the accompanyingconsolidated balance sheets accordingly. This adjustment did not impact the previously reported shareholders’equity in total.  The following tablesummarizes the impact of the adjustment described above on the Company’sstatement of shareholders’ equity for the three years ended October 31, 2003and the Company’s balance sheet as of October 31, 2003: 

 

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| ** **                    | ** ** | **As Previously  Reported** | ** ** | **Adjustment  amount** | ** ** | **As  Restated** | ** ** |
|-------------------------------|------------|-----------------------------|------------|------------------------|------------|------------------|------------|
| ** **                    | ** ** | ** **                  | ** ** | **(in thousands)**     | ** ** | ** **       | ** ** |
| Balance at  October 31, 2001: |       |                        |       |                   |       |             |       |
| Preferred Stock               |       | $                           | 4,912      |                   | $          | 2,860            |       | $ | 7,772 |   |
| Accumulated  Deficit          |       | $                           | (50,929    | )                      | $          | (2,860           | )          | $ | (53,789 | ) |
|                          |       |                        |       |                   |       |             |       |
| Balance at  October 31, 2002: |       |                        |       |                   |       |             |       |
| Preferred Stock               |       | $                           | 4,912      |                   | $          | 2,860            |       | $ | 7,772 |   |
| Accumulated  Deficit          |       | $                           | (54,319    | )                      | $          | (2,860           | )          | $ | (57,179 | ) |
|                          |       |                        |       |                   |       |             |       |
| Balance at  October 31, 2003: |       |                        |       |                   |       |             |       |
| Preferred Stock               |       | $                           | 4,912      |                   | $          | 2,860            |       | $ | 7,772 |   |
| Accumulated  Deficit          |       | $                           | (56,708    | )                      | $          | (2,860           | )          | $ | (59,568 | ) |

 

**3.****         Summaryof Significant Accounting Policies**

 

Principles ofConsolidation

 

The consolidatedfinancial statements include the accounts of the Company and its subsidiarieslocated in the United Kingdom, France, Germany, and India.  All significant inter-company balances andtransactions are eliminated in consolidation.

 

Use of Estimates

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amount of assets and liabilities andthe disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period.  Actual resultscould differ from those estimates.

 

Fair Value of FinancialInstruments

 

At October 31, 2004 andOctober 31, 2003, the carrying values of cash, accounts receivable, accountspayable and accrued liabilities approximated their fair values since they wereshort-term in nature. As of October 31, 2003, debt approximated fair value asit was short-term in nature and had stated interest rates based on currentmarket rates.

 

Cash and Cash Equivalents

 

Cash and cash equivalentsconsist of checking and money market accounts, of which $320,000 is restrictedcash due to the Company’s payroll processing arrangement. As of October 31,2004 and 2003 cash balances held in foreign financial institutions were $1.7and $1.2 million, respectively. 

 

Property and Equipment

 

Property and equipment,at cost, consisted of the following:

 

57

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| ** **                                           | ** ** | **10/31/04**       | ** ** | **10/31/03** | ** ** |
|------------------------------------------------------|------------|--------------------|------------|--------------|------------|
| ** **                                           | ** ** | **(in thousands)** | ** ** |
| Computer  equipment                                  |       | $                  | 4,845      |         | $          | 3,965 |   |
| Furniture and  fixtures                              |       | 2,167              |       | 1,967        |       |
| Software                                             |       | 1428               |       | 686          |       |
| Leasehold  improvements                              |       | 1,178              |       | 1,178        |       |
|                                                 |       | 9,618              |       | 7,796        |       |
| Less—accumulated  depreciation and amortization |       | (8,876             | )          | (6,564       | )          |
|                                                 |       | $                  | 742        |         | $          | 1,232 |   |

 

Property and equipmentare depreciated on a straight-line basis over the estimated useful lives of theassets ranging from two to seven years. Leased assets and leaseholdimprovements are amortized over the shorter of the estimated useful lives orthe term of the lease.

 

Reserve for Doubtful Accounts

 

The Company initiallyrecords our provision for doubtful accounts based on historical experience andthen adjusts this provision at the end of each reporting period based on adetailed assessment of the Company’s accounts receivable and allowance fordoubtful accounts.  In estimating the provision for doubtful accounts, theCompany considers, among other factors: (i) the aging of the accountsreceivable; (ii) trends within and ratios involving the age of the accounts receivable;(iii) the customer mix in each of the aging categories and the nature of thereceivable (i.e. license, consulting, maintenance, etc.); (iv) the Company’shistorical provision for doubtful accounts; (v) the credit-worthiness of eachcustomer; (vi) the economic conditions of the customer’s industry; and (vii)general economic conditions.

 

Should any of thesefactors change, the estimates made by management will also change, which couldimpact the level of our future provision for doubtful accounts.  Specifically, if the financial condition ofour customers were to deteriorate, affecting their ability to make payments, anadditional provision for doubtful accounts may be required. A number of ourcustomers are in the telecommunications industry and, as part of our evaluationof the provision for doubtful accounts, we have considered not only theeconomic conditions in that industry but also the financial condition of ourcustomers in that industry in determining the provision for doubtful accounts.  If conditions deteriorate further in thatindustry, or any other industry, then an additional provision for doubtfulaccounts may be required.

 

Goodwill

 

The Company accounts forpurchases of acquired companies in accordance with Statement of Financial AccountingStandards No. 141 *Business Combinations* (SFAS 141)and account for the related acquired intangible assets in accordance with SFASNo. 142 *Goodwill and Other Intangible Assets*(SFAS 142).  In accordance with SFAS 141, we allocate the cost of theacquired companies to the identifiable tangible and intangible assets acquiredaccording to their respect fair values as of the date of completion of theacquisition, with the remaining amount being classified as goodwill. Certain intangible assets, such as “acquired technology,” are amortized toexpense over time, while in-process research and development costs (“IPR&D”),if any are charged to operations at the acquisition date.

 

For the purpose oftesting for goodwill impairment in our single Data Management operating segmentwe have aggregated the goodwill for the following acquisitions:

 

•      Versant Europe,acquired in 1997

•      Poet, acquiredon March 18, 2004

•      Technology of JDOGenie, acquired on June 30, 2004

•      FastObjects,Inc. the former exclusive distributor of Poet’s database product line in NorthAmerica, acquired on July 6, 2004

 

In July 2004, Versantassessed that the carrying value of intangible assets and goodwill acquiredthrough our acquisition of Mokume Software, Inc., in November 2002 had been fullyimpaired.  While Versant believes thatthe need exists in the marketplace for a product such as VRTF, our primaryoperational focus since merging with Poet, in March 2004, has been onintegrating the two companies and leveraging their respective object databaseand data access product suites, with the goal of increasing Versant’saccessible market.  Versant hasdetermined that this objective requires priority and a greater dedication ofresources within its organization such that we cannot distract or dilute ourefforts in this regard by continuing with the more

 

58

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early stage real time initiative addressed by VRTF.  Consequently Versant recorded approximately$1.0 million related to the write-off of remaining Mokume intangible assets andgoodwill.

 

The Company testsgoodwill for impairment in accordance with SFAS 142, which requires thatgoodwill be tested for impairment at the reporting unit level (which in ourcase is at the consolidated company level) at least annually and morefrequently upon the occurrence of certain events, as provided in SFAS 142. TheCompany uses the market approach to assess the fair value of our assets andthis value is compared with the carrying value of those assets to test for impairment.The total fair value of the Company’s assets is estimated by summing the fairvalue of its equity (as indicated by our publicly traded share price and sharesoutstanding plus a control premium), debt and current liabilities. Under thisapproach, if the estimated fair value of its assets is greater than thecarrying value of these assets then there is no goodwill impairment. If theestimated fair value of our assets is less than the carrying value of theseassets then a memo allocation of the reporting unit’s estimated fair value toits assets and liabilities as though the reporting unit had just been acquiredin a business combination is required. The impairment loss is the amount, ifany, by which the implied fair value of goodwill is less than that reportingunit’s goodwill carrying amount and would be recorded in earnings during theperiod of such impairment. 

 

As required by SFAS 142,we ceased amortizing goodwill effective November 1, 2002.  Prior toNovember 1, 2002, we amortized goodwill over five years using thestraight-line method.  Identifiable intangibles are currently amortizedover five years in relation to the JDO Genie PTY LTD acquisition, six years inrelation to the FastObjects, Inc. acquisition and seven years in relation tothe merger with Poet Holdings Inc. using the straight-line method in all threesituations.

 

Had SFAS 142 beeneffective in fiscal 2002, reported net income and earnings per share would havebeen adjusted as follows:

 
| ** **                         | ** ** | **For the Year Ended October 31,**            | ** ** |
|------------------------------------|------------|-----------------------------------------------|------------|
| ** **                         | ** ** | **2004**                                      | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                         | ** ** | **(in thousdands, except per share amounts)** | ** ** |
| Reported net  loss                 |       | $                                             | (11,997    | ) | $ | (2,389 | ) | $ | (3,390 | ) |
| Add back:  Goodwill amortization   |       |                                          |       |   |   | 202 |   |
| Adjusted net  loss                 |       | $                                             | (11,997    | ) | $ | (2,389 | ) | $ | (3,188 | ) |
|                               |       |                                          |       |   |   |   |   |
| Basic and  diluted loss per share: |       |                                          |       |   |   |   |   |
| Reported net  loss                 |       | $                                             | (0.38      | ) | $ | (0.17 | ) | $ | (0.28 | ) |
| Goodwill  amortization             |       |                                          |       |   |   | $ |  0.02 |   |
| Adjusted net  loss                 |       | $                                             | (0.38      | ) | $ | (0.17 | ) | $ | (0.26 | ) |

 

Impairment of Long-Lived Assets

 

We evaluate long-livedassets, including intangible assets other than goodwill, for impairment inaccordance with the provisions of SFAS No. 144 *Accountingfor the Impairment or Disposal of Long-Lived Assets* (SFAS144).  SFAS 144 requires that long-lived assets and intangible assetsother than goodwill be evaluated for impairment whenever events or changes incircumstances indicate that the carrying value of an asset may not berecoverable.  The recoverability test compares the carrying amount of theasset or asset group to the expected undiscounted net cash flows to be generatedby these assets. If the carrying amount of the asset or asset group is lessthan the expected undiscounted net cash flows to be generated by these assets,an impairment loss in recorded in earnings during the period of such impairmentand is calculated as the excess of the carrying amount of the asset or assetgroup over its estimated fair value. 

 

Research and Development

 

Costs incurred in theresearch and development of software products are expensed as incurred untiltechnological feasibility has been established. Once technological feasibility is established, these costs arecapitalized under SFAS No. 86, “Accounting for the Costs of Computer Softwareto be Sold, Leased or Otherwise Marketed”. The establishment of technological feasibility and the ongoingassessment of the recoverability of these costs requires considerable judgmentby management with respect to certain external factors, including, but notlimited to, anticipated future gross product revenues, estimated economic lifeand changes in software and hardware technologies.  Amounts that could have been capitalized wereinsignificant and, therefore, no costs have been capitalized to date.

 

59

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Accrued Liabilities

 

Short-term and long-term accruedliabilities consisted of the following:

 

| ** **                     | ** ** | **10/31/04**       | ** ** | **10/31/03** | ** ** |
|--------------------------------|------------|--------------------|------------|--------------|------------|
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Payroll and  related           |       | $                  | 1,093      |         | $          | 934 |   |
| Customer  deposits             |       | 457                |       | 72           |       |
| Taxes payable                  |       | 81                 |       | 14           |       |
| Restructuring  accrual **(1)** | ** ** | 2,611              |       |         |       |
| Other                          |       | 1,185              |       | 1,128        |       |
| Total                          |       | $                  | 5,427      |         | $          | 2,148 |   |

 

----

| (1) See note # 5 |   |   |   |   |   |
|------------------|--------|--------|--------|--------|--------|

 

Deferred Revenue

 

Deferred revenuerepresents amounts received from customers under license and maintenanceagreements that the Company is not yet entitled to recognize as revenue becausethe earnings process has not been completed.

 

Deferred revenueconsisted of the following:

 

| ** **               | ** ** | **10/31/04**       | ** ** | **10/31/03** | ** ** |
|--------------------------|------------|--------------------|------------|--------------|------------|
| ** **               | ** ** | **(in thousands)** | ** ** |
| Maintenance              |       | $                  | 3,018      |         | $          | 3,655 |   |
| Training and  consulting |       | 49                 |       | 31           |       |
| License                  |       | 3                  |       | 302          |       |
| Total                    |       | $                  | 3,070      |         | $          | 3,988 |   |

 

Foreign Currency Translation

 

The functional currencyof the Company’s subsidiaries is the local currency.  Accordingly, all assets and liabilities aretranslated into U.S. dollars at the current exchange rate as of the applicablebalance sheet date.  Revenues andexpenses are translated at the average exchange rate prevailing during theperiod.  Gains and losses resulting fromthe translation of the financial statements are included in accumulated othercomprehensive income (loss) in the accompanying consolidated statements of shareholders’equity.  Currently, the Company does notemploy a foreign currency hedge program utilizing foreign currency exchangecontracts as the foreign currency transactions, and risks to date have not beensignificant. Foreign currency transaction gains and losses are reported inresults of operations in the period in which they occur.

 

Guarantees 

 

Our software licenseagreements generally include certain provisions for indemnifying customersagainst liabilities if our software products infringe a third party’sintellectual property rights. To date, we have not incurred any material costsas a result of such indemnifications and have not accrued any liabilitiesrelated to such obligations in our consolidated financial statements. 

 

Our software licenseagreements also generally include a warranty that our software products willsubstantially operate as described in the applicable program documentation. Wealso warrant that services we perform will be provided in a manner consistentwith industry standards.  To date, wehave not incurred any material costs associated with these warranties. 

 

Revenue Recognition

 

We recognize revenue inaccordance with the provisions of Statement of Position (SOP) 97-2, *Software Revenue Recognition,* and SOP 98-9, Modification ofSOP 97-2*, Software Revenue Recognition with Respect toCertain Transactions*.   Revenue consists mainly of revenueearned under software license agreements, maintenance support agreements(otherwise known as post-contract customer support or “PCS”), and agreementsfor consulting and training activities.

 

We use the residualmethod to recognize revenue when a license agreement includes one or moreelements to be delivered at a future date.   If there is anundelivered element under the license arrangement, we defer revenue based onvendor-specific objective evidence, or VSOE, of the fair value of theundelivered element, as determined by the price charged

 

60

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when the element is sold separately. If VSOE of fair value does notexist for all undelivered elements, we defer all revenue until sufficientevidence exists or all elements have been delivered. Under the residual method,discounts are allocated only to the delivered elements in a multiple element arrangement,with any undelivered elements being deferred based on thevendor-specific-objective-evidence the value of such undelivered elements. Wetypically do not offer discounts on future undeveloped products.

 

Revenue from softwarelicense arrangements, including prepaid license fees, is recognized when all ofthe following criteria are met:

 

•      Persuasiveevidence of an arrangement exists.

•      Delivery hasoccurred and there are no future deliverables except PCS.

•      Fee is fixedand determinable. If we cannot conclude that a fee is fixed and determinable,then assuming all other criteria have been met, revenue is recognized aspayments become due in accordance with paragraph 29 of SOP 97-2; and

•      Collection isprobable. Probability of collection is assessed using the following customerinformation: credit service reports, bank and trade references, public filings,and/or current financial statements.  Prior payment experience is reviewedon all existing customers.  Payment terms in excess of our standard paymentterms of 30-90 days net, are granted on an exception basis, typically insituations where customers elect to purchase development and deploymentlicenses simultaneously for an entire project and are attempting to align theirpayments with deployment schedules.  Extended payment terms are onlygranted to customers with a proven ability to pay at the time the order isreceived, and with prior approval of our senior management. In accordance withparagraph 27 of SOP 97-2, we have an established history of collection, withoutconcessions, on longer-term receivables. In addition, the volume of extended payment term arrangements hasdramatically reduced since fiscal 2000 consistent with customers adopting amore conservative approach to software purchases and their reluctance to prepayfor licenses prior to usage. We have not granted extended payment terms beyondone year.

 

If an acceptance periodor other contingency exists, revenue is not recognized until satisfaction ofthe contingency, customer acceptance or expiration of the acceptance period, asapplicable. Our license fees are non-cancelable and non-refundable and we donot make concessions or grant a refund for any unused amount. Also, ourcustomer agreements for prepaid deployment licenses do not make payment of ourlicense fees contingent upon the actual deployment of our software.  Therefore a customer’s delay or accelerationin his deployment schedule does not impact our revenue recognition. Revenuefrom related PCS for all product lines (with the exception of deployments ofFastObjects products) is billed in advance of the service being provided and isdeferred and recognized on a straight-line basis over the term of the PCS,which is generally twelve months. PCS revenue from deployments of the FastObjectsproduct line is paid in arrears of the service being provided and is recognizedas revenue at the time the customer provides a report to us for deploymentsmade during a given period. Training and consulting revenue is recognized whena purchase order is received, the services have been performed and collectionis deemed probable.  Consulting services are billed on an hourly, daily ormonthly rate.  Training classes are billed based on group or individualattendance.

 

We categorize ourcustomers into two broad groups, End Users and Value Added Resellers (“VARs”).Our End User customers are companies who use our products internally and do notredistribute the product outside of their corporate organizations. Our VARcustomers include traditional Value Added Resellers, Systems Integrators, OEMsand other vendors who redistribute our products to external third partycustomers, either individually or as part of an integrated product. We licenseour data management products through two types of perpetual licenses—developmentlicenses and deployment licenses. 

 

Development licenses aretypically sold on a per seat basis and authorize a customer to develop anapplication program that uses our software product.

 

Before an End Usercustomer may deploy an application that it has developed under our developmentlicense, it must purchase deployment licenses based on the number of computersconnected to the server that will run the application using our databasemanagement system.  For certain applications, we offer deployment licensespriced on a per user basis.  Pricing of VDS and FastObjects variesaccording to several factors, including the number of computer servers on whichthe application will run and the number of users that will be able to accessthe server at any one time.  Customers may elect to simultaneouslypurchase development and deployment licenses for an entire project. Thesedevelopment and deployment licenses may also provide for prepayment of anonrefundable amount for future deployment*.*

 

VARs and distributorspurchase development licenses from us on a per seat basis on terms similar tothose of development licenses sold directly to End-Users.  VARs areauthorized to sublicense deployment copies of our data management products thatare either bundled or embedded in the VAR’s applications and sold directly toend-users.  VARs

 

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are required to report their distribution of our software and arecharged a royalty that is based either on the number of copies of applicationsoftware distributed or computed as a percentage of the selling price chargedby the VARs to their end-user customers. These royalties from VARs may beprepaid in full or paid upon deployment. Provided that all other conditions forrevenue recognition have been met, revenue is recognized, (i) as to prepaidlicense arrangements, when the prepaid licenses are sold to the VARs, and (ii)as to other license arrangements, at the time the VAR provides a royalty reportto us for sales made by the VAR during a given period.

 

Revenue from our resaleof third-party products is recorded at total contract value with thecorresponding cost included in cost of sales when we act as a principal inthese transactions and we assume the risks and rewards of ownership (includingthe risk of loss for collection, delivery or returns). When we do not assumethe risks and rewards of ownership, revenue from our resale of third-partyproducts or services is recorded at contract value net of the cost of sales.

 

In the rare case that acustomer requests engineering work for porting our product to an unsupportedplatform or customization of our software for specific functionality, or anyother non-routine technical work, we recognize revenue in accordance with SOP81-1 and use either the percentage of completion or completed contract methodsfor recognizing revenue.  We use thepercentage of completion method if we can make reasonable and dependableestimates of labor costs and hours required to complete the work in question.  We periodically review these estimates inconnection with work performed and rates actually charged and recognize anylosses when identified.  Progress tocompletion is determined using the cost-to-cost method, whereby cost incurredto date as a percentage of total estimated cost determines the percentagecompleted and revenue recognized.  Whenusing the percentage of completion method, the following conditions must exist:

 

•      An agreementmust include provisions that clearly specify the rights regarding goods orservices to be provided and received by both parties, the consideration to beexchanged and the manner and terms of settlement.

•      The buyer canbe expected to satisfy his obligations under the contract.

•      Versant can beexpected to satisfy its obligations under the contract.

 

The completed contractmethod is used when reasonable or dependable estimates cannot be made. As aresult, in such situations we defer all revenue until such time as the work hasbeen completed.

 

Discontinued Operations

 

The results of operationsfor lines of business sold or held for sale and the related gains or lossesfrom sale are reported as discontinued operations I they meet certain criteriaoutlined in SFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets.”

 

Comprehensive loss

 

Accumulated and othercomprehensive income (loss) presented in the accompanying consolidated balancesheets consists of cumulative foreign currency translation adjustments. The taxeffects of the components of the comprehensive loss are insignificant.

 
| ** **                               | ** ** | **Fiscal Year Ended** | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                               | ** ** | **10/31/2004**        | ** ** | **10/31/2003**         | ** ** |
| ** **                               | ** ** | **(in thousands)**    | ** ** |
| Net loss                                 |       | $                     | (11,997    | )                      | $          | (2,389 | ) |
| Foreign currency  translation adjustment |       | $                     | 547        |                   | $          | (171 | ) |
| Comprehensive  loss                      |       | $                     | (11,450    | )                      | $          | (2,560 | ) |

 

Net Loss Per Share

 

Basic net loss per shareis computed by dividing net loss by the weighted average number of sharesoutstanding.  Diluted net loss per shareis computed by dividing net loss by the sum of the weighted average number ofshares outstanding plus the dilutive potential common shares.  The dilutive effect of stock options iscomputed using the treasury stock method, and the dilutive effect ofconvertible preferred stock is computed using the if converted method.  Dilutive securities are excluded from thediluted net loss per share computation if their effect is anti-dilutive.

 

62

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The reconciliation of thenumerators and denominators of the basic and diluted net loss per sharecomputations is as follows (in thousands, except per share amounts):

 
| ** **                                | ** ** | **Income (Loss)**                           | ** ** | **Shares**        | ** ** | **Per Share** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|-------------------|------------|---------------|------------|
| ** **                                | ** ** | **(Numerator)**                             | ** ** | **(Denominator)** | ** ** | **Amount**    | ** ** |
| ** **                                | ** ** | **(in thousands, except per share amount)** | ** ** |
| **FOR THE  YEAR ENDED OCTOBER 31, 2004:** |       |                                        |       |              |       |          |       |
| Basic and  diluted net loss per share     |       | $                                           | (11,997    | )                 | 31,173     |          | $          | (0.38 | ) |
| **FOR THE  YEAR ENDED OCTOBER 31, 2003:** |       |                                        |       |              |       |          |       |
| Basic and  diluted net loss per share     |       | $                                           | (2,389     | )                 | 13,682     |          | $          | (0.17 | ) |
| **FOR THE  YEAR ENDED OCTOBER 31, 2002:** |       |                                        |       |              |       |          |       |
| Basic and  diluted net loss per share     |       | $                                           | (3,390     | )                 | 12,267     |          | $          | (0.28 | ) |

 

The following potentialshares of common stock have been excluded from the computation of diluted netloss per share because the effect would have been anti-dilutive (in thousands):

 
| ** **                                                     | ** ** | **Year Ended** | ** ** | **Year Ended**     | ** ** | **Year Ended** | ** ** |
|----------------------------------------------------------------|------------|----------------|------------|--------------------|------------|----------------|------------|
| ** **                                                     | ** ** | **10/31/04**   | ** ** | **10/31/03**       | ** ** | **10/31/02**   | ** ** |
| ** **                                                     | ** ** | ** **     | ** ** | **(in thousands)** | ** ** | ** **     | ** ** |
| Shares issuable  under stock options                           |       | 4,598          |       | 3,918              |       | 3,947          |       |
| Shares issuable  pursuant to warrants to purchase common stock |       | 1,312          |       | 1,333              |       | 1,333          |       |
| Shares issuable  upon conversion of preferred stock            |       | —         |       | 2,627              |       | 2,627          |       |
|                                                           |       | 5,910          |       | 7,878              |       | 7,907          |       |

 

The weighted averageexercise price of stock options outstanding was $3.12, $2.66, and $3.35 as ofOctober 31 2004, October 31, 2003, and October 31, 2002, respectively. Theweighted average exercise price of warrants was $1.84 for Fiscal year endOctober 31, 2004 and $2.13 for fiscal year end October 31, 2003 and October 31,2002.

 

Stock-based Compensation

 

We have elected to continue to account for employeestock-based compensation plans using the intrinsic value method, as prescribedby APB No. 25 *Accounting for Stock Issued to Employees*and interpretations thereof (collectively “APB 25”) rather than the fair valuemethod prescribed by SFAS No. 123 *Accounting for Stock-BasedCompensation* (SFAS 123), as amended by SFAS 148.  Accordingly,deferred compensation is only recorded if the current price of the underlyingstock exceeds the exercise price on the date of grant.  We record andmeasure deferred compensation for stock options granted to non-employees attheir fair value.  Deferred compensation is expensed over the vestingperiod of the related stock option, which is generally up to four years. Hadcompensation cost for the Company’s stock plans and employee stock purchaseplan been determined based on the fair value at the grant dates for the awardscalculated in accordance with SFAS No.123, the Company’s net loss and net lossper share would have increased to the pro forma amounts indicated below (inthousands except for per share amounts):

 
| ** **                                       | ** ** | ** **  | ** ** | **Year Ended  10/31/2004**                  | ** ** | **Year Ended  10/31/2003** | ** ** | **Year Ended  10/31/2002** | ** ** |
|--------------------------------------------------|------------|-------------|------------|---------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                       | ** ** | ** **  | ** ** | **(in thousands, except per share amount)** | ** ** |
| Net loss                                         |       | As reported |       | $                                           | (11,997    | )                          | $          | (2,389                     | )          | $ | (3,390 | ) |
| Stock  compensation recognized under APB 25      |       |        |       | 86                                          |       | 1,209                      |       | —                     |       |
| Compensation  expense under SFAS 123 related to: |       |        |       |                                        |       |                       |       |                       |       |
| Stock based  compensation                        |       |        |       | (813                                        | )          | (2,570                     | )          | (2,057                     | )          |
| Employee stock  purchase plans                   |       |        |       | (157                                        | )          | (109                       | )          | (138                       | )          |
|                                             |       | Pro forma   |       | $                                           | (12,881    | )                          | $          | (3,859                     | )          | $ | (5,585 | ) |
|                                             |       |        |       |                                        |       |                       |       |                       |       |
| Basic net loss  per share                        |       | As reported |       | $                                           | (0.38      | )                          | $          | (0.17                      | )          | $ | (0.28 | ) |
|                                             |       | Pro forma   |       | $                                           | (0.41      | )                          | $          | (0.28                      | )          | $ | (0.46 | ) |
|                                             |       |        |       |                                        |       |                       |       |                       |       |
| Diluted net loss  per share                      |       | As reported |       | $                                           | (0.38      | )                          | $          | (0.17                      | )          | $ | (0.28 | ) |
|                                             |       | Pro forma   |       | $                                           | (0.41      | )                          | $          | (0.28                      | )          | $ | (0.46 | ) |

 

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The fair value ofeach option grant is estimated on the date of grant using the Black-Scholesoption-pricing model with the following assumptions:

 

| ** **               | ** ** | **Year Ended** | ** ** | **Year Ended** | ** ** | **Year Ended** | ** ** |
|--------------------------|------------|----------------|------------|----------------|------------|----------------|------------|
| ** **               | ** ** | **10/31/2004** | ** ** | **10/31/2003** | ** ** | **10/31/2002** | ** ** |
| Risk free  interest rate |       | 2.78           | %          | 2.25           | %          | 3.50           | %          |
| Dividend yield           |       | 0              | %          | 0              | %          | 0              | %          |
| Volatility               |       | 129            | %          | 113            | %          | 107            | %          |
| Expected life            |       | 3 years        |       | 3 years        |       | 3 years        |       |

 

The fair value ofemployee stock purchase rights granted under the 1996 Employee Stock PurchasePlan was estimated on the date of grant using the Black-Scholes option-pricingmodel with the following assumptions:

 

| ** **               | ** ** | **Year Ended**  | ** ** | **Year Ended**  | ** ** | **Year Ended**  | ** ** |
|--------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| ** **               | ** ** | **October 31,** | ** ** | **October 31,** | ** ** | **October 31,** | ** ** |
| ** **               | ** ** | **10/31/2004**  | ** ** | **10/31/2003**  | ** ** | **10/31/2002**  | ** ** |
| Risk free  interest rate |       | 1.97            | %          | 1.81            | %          | 2.39            | %          |
| Dividend yield           |       | 0               | %          | 0               | %          | 0               | %          |
| Volatility               |       | 145             | %          | 107             | %          | 107             | %          |
| Expected life            |       | 0.5-2 years     |       | 0.5-2 years     |       | 0.5-2 years     |       |

 

Segment and GeographicInformation

 

Statement of FinancialAccounting Standards (“SFAS”) No. 131, *Disclosures about Segmentsof an Enterprise and Related Information* establishes standards forthe manner in which public companies report information about operatingsegments in annual and interim financial statements. It also establishesstandards for related disclosures about products and services, geographicareas, and major customers. The method for determining what information toreport is based on the way management organizes the operating segments withinthe Company for making operating decisions and assessing financial performance.The Company’s chief operating decision-maker is considered to be the Company’schief executive officer (“CEO”). The CEO reviews financial informationpresented on an entity level basis accompanied by disaggregated informationabout revenues by product type and certain information about geographic regionsfor purposes of making operating decisions and assessing financial performance.The entity level financial information is identical to the informationpresented in the accompanying statements of operations. Therefore, the Companyhas determined that it operates in a single operating segment, Data Management.

 

The Company operates inNorth America, Europe and Asia Pacific. In general, revenues are attributed tothe country in which the contract originates. 

 
| ** **                     | ** ** | **Twelve  Months  Ended  10/31/04** | ** ** | **Twelve  Months  Ended  10/31/03** | ** ** | **Twelve  Months  Ended  10/31/02** | ** ** |
|--------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| ** **                     | ** ** | **(in thousands)**                  | ** ** |
| **Total  Revenues by Region:** |       |                                |       |                                |       |                                |       |
| North America                  |       | $                                   | 14,457     |                                | $          | 16,622                              |       | $ | 13,510 |   |
| Europe                         |       | 7,689                               |       | 4,690                               |       | 5,360                               |       |
| Asia Pacific                   |       | 729                                 |       | 747                                 |       | 1,086                               |       |
|                           |       | $                                   | 22,875     |                                | $          | 22,059                              |       | $ | 19,956 |   |

 

Long-lived assets byregion are as follows: 

 
| ** **                              | ** ** | **Twelve  Months  Ended  10/31/04** | ** ** | **Twelve  Months  Ended  10/31/03** | ** ** | **Twelve  Months  Ended  10/31/02** | ** ** |
|-----------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| ** **                              | ** ** | **(in thousands)**                  | ** ** |
| **Total  Long-lived assets by Region:** |       |                                |       |                                |       |                                |       |
| North America                           |       | $                                   | 579        |                                | $          | 1,290                               |       | $ | 1,965 |   |
| Europe                                  |       | 605                                 |       | 148                                 |       | 120                                 |       |
| Asia Pacific                            |       | 119                                 |       | 151                                 |       | 110                                 |       |
|                                    |       | $                                   | 1,303      |                                | $          | 1,589                               |       | $ | 2,195 |   |

 

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Concentration of CreditRisk

 

Financial instrumentsthat potentially subject the Company to a concentration of credit riskprincipally consist of accounts receivable. The Company performs periodiccredit evaluation of its customers’ financial condition. The Company generallydoes not require collateral on accounts receivable because the majority of theCompany’s customers are large, well established companies.  The Company provides reserves for estimatedcredit losses in accordance with management’s ongoing evaluation.

 

In the years endedOctober 31, 2004, 2003 and 2002, IBM represented 17%, 19%, and 14% of total revenues,respectively. In the fiscal year ended October 31, 2004 and 2003 IBMrepresented 14%, and 13% of the outstanding accounts receivable balance,respectively.  Additionally, we had twoother customers in Fiscal year 2003 that each represented 15% of the accountsreceivable balance. One customer represented 15% of accounts receivable atOctober 31, 2002.

 

**4.Discontinued operations**

** **

On September 16, 2004,the Company completed its sale to ems ePublishing AG, a privately held Germancompany based in Karlsruhe, Germany (“EMS”), of all the stock of Poet GmbH, anindirect Versant subsidiary that owns the assets and employs the personnel ofVersant’s Catalog Solutions Business (the “Catalog Business”). The sale wasconsummated pursuant to a Share Purchase and Transfer Agreement dated September13, 2004 (the “Sale Agreement”) between EMS and Poet Software GmbH, anothersubsidiary of Versant (“Poet Software”) that owned all the shares of PoetGmbH.  Pursuant to the Sale Agreement,EMS agreed to assume the operations of the Catalog Business.

 

The Catalog Business wasoriginated by Poet and acquired by Versant in connection with its March 2004merger with Poet.  This business involvesthe development and sale of software product lines that enable companies to create,manage, customize and distribute electronic sales catalogs to conductbusiness-to-business e-commerce transactions. The principal assets disposed of in the sale of the Catalog Business toEMS include the X-Solutions and eSupplier Solutions product lines, includingthe Poet X-Buy, Poet X-Market, Poet X-Sell, Poet eSupplier Port, Poet eSupplierWeb and Poet eSupplier Link products, related rights to those products andcustomer agreements of the Catalog Business as well as the transfer of CatalogBusiness personnel.  Pursuant to the SaleAgreement, it was also agreed that Poet GmbH (now owned by EMS) may use the “Poet”trade name and mark in connection with data processing and software businessesand that Versant, its subsidiary Poet Holdings, Inc. and their affiliatesagreed to cease their use of the “Poet” trade name or mark effective as ofJanuary 1, 2005. In addition, pursuant to the Sale Agreement Poet Softwaregranted Poet GmbH certain non-exclusive rights to certain Poet databasesoftware for use with certain existing Poet GmbH customer contracts.

 

In exchange for theshares of Poet GmbH, EMS has paid Poet Software a closing cash payment of1,000,000 euros and agreed to pay a further 172,000 euros for a total of1,172,000 euros cash consideration (or approximately $1.4 million USD). Inaddition EMS has agreed to pay a royalty on future revenues of Poet GmbH’sCatalog Business over the ten-month period following the signing of the SaleAgreement in an amount equal to 30% of all Poet GmbH’s catalog solutionsbusiness revenues which:  (a) exceed800,000 euros (or approximately $1,048,000 USD based on current exchange rates)during the period from September 1, 2004 to December 31, 2004;  (b) exceed 600,000 euros (or approximately$786,000 USD based on current exchange rates) during the period from January 1,2005 to March 31, 2005; and (c) exceed 600,000 euros (or approximately $786,000USD based on current exchange rates) during the period from April 1, 2005 toJune 30, 2005.

 

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The following tables showthe results of the Company’s discontinued catalog solutions business from March18, 2004 (the effective date of the Poet merger) through the date ofdisposition and summarize the components on the Company’s loss from the sale ofthe catalog solutions business.  The bookvalue of Poet GmbH’s net assets at the date of sale were comprised ofapproximately $405,000 trade receivables, approximately $65,000 of net fixedassets and approximately $47,000 other assets offset by approximately $12,000accounts payable and approximately $225,000 other liabilities.

 

Lossfrom discontinued operations, net of income tax

 
| ** **                  | ** ** | **Twelve months ended  October 31,** | ** ** |
|-----------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                  | ** ** | **(in thousands)**                   | ** ** |
| Total revenue               |       | $                                    | 1,165      |   | — |   |
| Total cost of  revenue      |       | 758                                  |       | — |   |
| Gross Profit                |       | 407                                  |       | — |   |
|                        |       |                                 |       |   |   |
| Operating  Expenses         |       | 2,053                                |       | — |   |
| Loss From  Operations       |       | (1,646                               | )          | — |   |
| Other Income,  Net          |       | —                               |       | — |   |
| Loss before  Taxes          |       | (1,646                               | )          | — |   |
| Provision for  income taxes |       | —                               |       | — |   |
| Net Loss                    |       | $                                    | (1,646     | ) | $ | — |   |
|                             |            |                                      |            |  |  |  |  |

 

Lossfrom the sale of discontinued operations, net of income tax

 
| ** **                                                 | ** ** | **Twelve months ended** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                 | ** ** | **October 31,**         | ** ** |
| ** **                                                 | ** ** | **2004**                | ** ** |
| ** **                                                 | ** ** | **(in thousands)**      | ** ** |
| Cash payments  received or receivable from EMS             |       | $                       | 1,442      |   |
|                                                       |       |                    |       |
| Book value of  Poet GmbH’s net assets at date of sale |       | (280                    | )          |
|                                                       |       |                    |       |
| Write-off of  catalog business intangible assets           |       | (1,471                  | )          |
|                                                       |       |                    |       |
| Loss on sale                                               |       | $                       | (309       | ) |

 

**5.Restructuring Costs**

** **

During the second quarterof fiscal 2004, we implemented a restructuring plan aimed at optimizingperformance in our catalog business that was acquired as part of the mergerwith Poet.   The primary goal was toreduce operating expenses to more appropriately align them with sustainablerevenue levels.   As a result, weincurred costs related to employee severance payments, related benefit andoutplacement expenses totaling approximately $400,000 that were recorded asrestructuring costs in operating expenses during the second and third quartersof fiscal 2004. Given that our catalog business was acquired in September 2004by EMS and EMS assumed all assets, liabilities and employees of the catalogbusiness, all obligations under this restructuring plan have been fulfilled asof October 31, 2004.

 

During October 2004 wecommitted to an additional restructuring plan to take the following actions inan effort to reduce operating expenses in our data management business:

 
| **Restructuring Action**                                                                                                               | ** ** | **Restructuring Expense  recorded in Quarter  ending October 31, 2004** | ** ** | ** ** | ** **                                        | ** ** | ** **                                    |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|------------|---------------------------------------------------|------------|-----------------------------------------------|
| **Cash Impact**                                                                                                                        |
| **Amount**                                                                                                                             | ** ** | **Estimated Timing**                                                    |
| ** **                                                                                                                             | ** ** | **(in thousands)**                                                      | ** ** | ** ** | ** **                                        |
| 15% workforce  reduction and separation costs                                                                                          |       | $                                                                       | 550        |       | $                                                 | 550        |                                          | Paid in October 2004 through  February 2005 |   |
|                                                                                                                                   |       |                                                                    |       |       |                                              |       |                                          |
| Closure of  certain European offices and reduction in utilization of leased space for  California  headquarters, by approximately  50% |       | $                                                                       | 2,107      |       | No cash impact  above original  lease  commitment |       | Paid in monthly installments through May 2007 |   |
| Write-off of  leasehold  improvements relating to the  unutilized portion of the office  space mentioned above                         |       | $                                                                       | 200        |       | No Cash  impact                                   |       | N/A                                           |   |
| **Total**                                                                                                                              | ** ** | **$**                                                                   | **2,857**  | ** ** | **$**                                             | **550**    | ** **                                    | ** ** | ** ** |

 

TheCompany took these actions in order to streamline its operations and minimizeredundancies in light of its acquisitions of Poet Holdings Inc., FastObjects,Inc. and the assets of JDO Genie (PTY) Ltd. during 2004 and in general toreduce ongoing operating expenses in an effort to improve operating results andconserve working capital.   The Company completed these actions byOctober 31, 2004, and no additional charges related to these actions areanticipated in fiscal 2005.

 

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As a result of these actions,the Company currently expects to realize annual savings in operating expensesas follows:

 
| ** **                                     | ** ** | **Twelve months ended 10/31** | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|-------------------------------|------------|------------|------------|
| ** **                                     | ** ** | **2005**                      | ** ** | **2006**   | ** ** | **2007** | ** ** | **Total** | ** ** |
| ** **                                     | ** ** | **(in thousands)**            | ** ** | ** ** | ** ** |
| **Expected  benefits of plan**                 |       |                          |       |       |       |   |   |   |   |
| Cost of  professional services and maintenance |       | $                             | 464        |       | $          | 464 |   | $ | 416 |   | $ | 1,344 |   |
| Marketing &  sales expense                 |       | 452                           |       | 452        |       | 429 |   | 1,333 |   |
| Research &  development expense            |       | 1,432                         |       | 1,432      |       | 1,297 |   | 4,161 |   |
| General &  administrative expense          |       | 440                           |       | 440        |       | 394 |   | 1,274 |   |
|                                           |       | $                             | 2,788      |       | $          | 2,788 |   | $ | 2,536 |   | $ | 8,112 |   |
|                                           |       |                          |       |       |       |   |   |   |   |
| Total cost of restructuring                    |       |                          |       |       |       |   |   | 2,857 |   |
| Net total benefit of plan                      |       |                          |       |       |       |   |   | $ | 5,255 |   |

 

The following table summarizesthe Company’s restructuring activity through October 31, 2004:

 
| ** **                                    | ** ** | **Consolidated**       | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **Employee Severance** | ** ** | **Fixed Assets** | ** ** | **Lease Terminations** | ** ** | **Total** | ** ** |
| ** **                                    | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Opening Balance  at October 31, 2003          |       | $                      | —     |   | $ | — |   | $ | — |   | $ | - |   |
| Additions  charged to Statement of operations |       | 964                    |       | 200 |   | 2,107 |   | 3,271 |   |
| Additions charged  to Goodwill                |       | 192                    |       | — |   | — |   | 192 |   |
| Cash Paid                                     |       | (652                   | )          | — |   | — |   | (652 | ) |
| Non Cash                                      |       | —                 |       | (200 | ) | — |   | (200 | ) |
| Acrrual Balance  @ October 31, 2004           |       | $                      | 504        |   | $ | — |   | $ |  2,107 |   | $ |  2,611 |   |
|                                               |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |

 

**6. Acquisitions**

** **

Poet Holdings, Inc.

 

On March 17, 2004,shareholders approved the merger with Poet Holdings Inc (Poet).  As a result, Poet became a wholly ownedsubsidiary of Versant Corporation.  Themerger with Poet was done to create a broader object database product suite andthereby increase the size and variety of Versant’s customer base, as well ascapitalize on Poet’s strong European presence and to bring Poet’s cash assetsinto the merged company.  The results ofoperations of Poet Holdings are included in Versant’s income statement fromMarch 18, 2004 onwards.

 

The total purchase pricewas $29,967,916, and consisted of the following:

a)     Atotal of 11,089,542 shares of Poet commons stock exchanged for 15,525,342shares of Versant stock, valued at $25,927,321, using a fair value per share of$1.67 per share.  The fair value pershare of $1.67 was computed using Versant’s average stock price five daysbefore and five days after the acquisition, eliminating the high and the lowprices in that date range;

b)    Atotal of 1,274,834 options to purchase shares of Poet common stock exchangedfor 1,784,780 equivalent options to purchase shares of Versant common stock,valued at $2,402,825 (reduced by the intrinsic value of unvested options in theamount of $299,546);

c)     Directtransaction costs of $1,937,316.

 

The fair value of the optionsassumed in the transaction was determined using the Black-Scholesoption-pricing model and the following weighted average assumptions: expectedlife of 5 years, risk-free interest rate of 2.91%, expected volatility of 130%and no expected dividend yield.  Thisacquisition was accounted for as a purchase and the purchase price issummarized as follows:

 
| Value  of Versant Stock issued       |   | $         | 25,927,321 |   |
|--------------------------------------|--------|-----------|------------|--------|
| Value  of options issued             |   | 2,402,825 |       |
| Intrinsic  value of unvested options |   | (299,546  | )          |
| Direct  transaction costs            |   | 1,704,651 |       |
| Additional  Direct transaction costs |   | 232,665   |       |
| Total  purchase price                |   | $         | 29,967,916 |   |

 

Under the purchase methodof accounting, the total purchase price was allocated to Poet’s net tangibleand identifiable intangible assets based upon their fair value as of the dateof completion of the merger, with the excess of the purchase price resulting inthe establishment of goodwill, which is amortizable over 15 years, for taxationpurposes. 

 

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Standard valuation procedures and techniques wereutilized in determining the fair value. Each intangible asset was valued based upon the estimated impact on ourexpected future after-tax cash flows. The net changes in our expected futureafter-tax cash flows generated by the respective developed technology and tradenames/trademarks were then discounted to present value. The discount was basedon an analysis of the weighted-average cost of capital for the industry.

 

In conjunction with the purchase, $299,546 of deferredcompensation cost was recorded representing the intrinsic value of unvestedoptions issued to former Poet employees. This amount is being amortized tocompensation expense in accordance with the vesting terms of the relatedoptions. As a result of restructuring discussed above, certain former Poetemployees were terminated in the fourth quarter of fiscal 2004 and $67,000 ofunearned compensation relating to unvested options of these employees werereversed through equity.  For the Fiscalyear ended October 31, 2004, $86,275 was recognized as compensation expense.

 

Based upon the preliminary evaluation,  the allocation of the purchase price andmanagement’s estimate of fair value based upon the preliminary valuation, thepurchase price allocation, was as follows:

 
| Tangible assets  acquired |   | $          | 10,072,330 |   |
|---------------------------|--------|------------|------------|--------|
| Intangible  assets        |   | 5,963,000  |       |
| Goodwill                  |   | 15,819,082 |       |
| Additional  Goodwill      |   | 232,665    |       |
| Total assets  acquired    |   | 32,087,077 |       |
| Liabilities  assumed      |   | (1,819,615 | )          |
| Deferred  Compensation    |   | (299,546   | )          |
| Net assets  acquired      |   | $          | 29,967,916 |   |

 

Upon the consummation of the Poet transaction, weallocated $1,100,000 to customer relationships and $6,300,000 to developedtechnology for a total of $7,400,000  of amortizableintangible assets with estimated useful lives of 7 years, which represented ourbest estimates of expected customer attrition and the expected economic life ofthe acquired technology.  Poet’s databasebusiness represented $4,300,000 of this amount. Based on our best estimates asof March 18, 2004 (the date we consummated our merger with Poet), in ouraccounting for the merger with Poet we allocated $3,100,000 of the purchaseprice to developed technology and customer relationships attributable to Poet’scatalog solutions business.

 

Subsequent to consummation of the merger with Poet wecontinued efforts begun by Poet prior to the merger to structure the investmentin the catalog solutions business to better correspond with our assessment ofits near term business outlook. We continued to operate the catalog solutionsbusiness as a going concern due to existing customer contracts and to maintainthe business value.  In tandem with theseefforts, we began investigating the possibility of identifying a strategicpartner or acquirer for this non-core element of Versant’s business and hadbeen in contact with third parties for whom the catalog solutions business ismore strategically aligned. As a result of these investigations and discussionswith third parties, we reduced the carrying value of identifiable intangibleassets attributable to the catalog solutions business by approximately$1,437,000 on our balance sheet as of July 31, 2004, to bring the carryingvalue of these assets down to approximately $1,500,000.  In September 2004, the Company completed thesale of the Catalog Solutions business to EMS (please see Note 4 – DiscontinuedOperations)

 

During the twelve-month periods ended October 31,2004, we also recorded $570,902 in cost of revenue related to the amortizationof acquired intangibles.  Amortizationcharged to income for the subsequent seven years is estimated, based on theOctober 31, 2004 intangible asset value, to be $613,351 for fiscal years 2005through 2010, and $240,230 for fiscal year 2011.

 

The merger with Poet also required certain changes inVersant’s existing corporate structure, which have been implemented.  First, it called for Versant to reduce thesize of its Board of Directors from eight to five directors, with Versant’sboard of directors to be composed of two directors from Poet, Jochen Witte andHerbert May, and three directors from Versant, who are Nick Ordon, Versant’sChief Executive Officer, Uday Bellary and William Henry Delevati, who wereincumbent Versant directors prior to the Poet merger.  In addition, Versant’s articles ofincorporation were amended to: (i) increase the authorized number ofVersant’s common shares from 45,000,000 to 75,000,000 shares;(ii) increase the number of shares of Versant common stock issuable uponthe conversion of each share of Versant’s Series A preferred stock fromtwo to three common shares; (iii) cause each outstanding share of Versant’sSeries A preferred stock to be automatically converted into shares ofVersant common stock immediately after effectiveness of the merger at theincreased conversion rate described in (ii) above; (iv) provide thatthe merger will not trigger the liquidation preference rights of Versant’sSeries A preferred stock; (v) require that at least 80% of Versant’sdirectors then in office approve certain corporate transactions or any

 

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change in the authorized number of Versant’s directors; and(vi) provide that the amendment described in clause (v) cannot bechanged for 12 months after consummation of the merger without theapproval of at least 80% of Versant’s directors then in office.

 

In connection with the merger, Versant and VertexTechnology Fund, Ltd., Vertex Technology Fund (II), Ltd. and the Joseph M.Cohen Family Limited Partnership (collectively, the “Preferred Shareholders”)entered into a Preferred Stock Conversion Agreement (the “Conversion Agreement”)pursuant to which the Preferred Shareholders agreed to take certain actions tocause their 1,313,743 outstanding shares of Versant Series A Preferred Stock tobe converted into 3,941,229 shares of Versant common stock effective uponconsummation of the Poet merger. In exchange for this agreement, the number ofshares of common stock issuable upon conversion of a share of Series Apreferred stock was increased from two to three shares and, effective upon suchconversion, warrants to purchase a total of 1,313,743 shares of Versant commonstock held by the Preferred Shareholders were amended to reduce the exerciseprice of such warrants from $2.13 to $1.66 per share of common stock and toextend the term of such warrants by one year. The conversion of Series APreferred stock and the modification of the outstanding warrants held byPreferred Shareholders resulted in an inducement to the Preferred Shareholdersof $2,422,000, which represents the excess of the fair value of theconsideration transferred to the holders of the preferred stock over the fairvalue of the preferred stock under the original terms and the excess of thefair value of the modified warrants over the fair value of such warrants undertheir original terms.

 

Fast Objects, Inc.

 

On June 25, 2004 theCompany signed an agreement to acquire FastObjects, Inc., a US and Canadiandistributor for the FastObjects database management products.  Completion of the acquisition was subject tothe approval of certain closing conditions, which were met as of theacquisition date of July 6, 2004. Prior to the acquisition, the Poet subsidiaryowned preferred shares representing approximately 19% of FastObjectsstock.  The acquisition of FastObjects ispart of the post-merger process of integrating Versant and Poet’sbusinesses.  In 2002, prior to its mergerwith Versant in March 2004, Poet, had spun off its North American fieldoperation for its FastObjects product to FastObjects, Inc.  This acquisition allows Versant to bringFastObjects, Inc. product back into its regional distribution network in NorthAmerica. The results of operations of FastObjects, Inc. were included inVersant’s income statement from July 6, 2004 onwards.

 

The total amount allocated to tangible and intangibleassets and liabilities acquired was $636,249 and consisted of the following:

 

a)     Pre-existinginvestment of 19% ownership in FastObjects, Inc. of $300,000;

b)    Increasein investment of $35,020, based on conversion from cost to equity method ofaccounting;

c)     Netcash of $277,730, which includes a payment of $540,974 to the shareholders ofFast Objects, Inc, less cash of $263,244 received from Fast Objects;

c)     Directtransaction costs of $23,499.

 

This acquisition wasaccounted for as a purchase and the basis for allocation is summarized asfollows:

 

| Existing  Investment      |   | $       | 300,000 |   |
|---------------------------|--------|---------|---------|--------|
| *Increase in  investment  |   | 35,020  |    |
| Net Cash to Fast  Objects |   | 277,730 |    |
| Direct  transaction costs |   | 23,499  |    |
| Total purchase  price     |   | $       | 636,249 |   |

 

----

*The acquisition ofFastObjects, Inc. increased our ownership stake in this company to 100%compared with the approximate 19% ownership position we enjoyed prior to thetransaction. As a result of this increased ownership position our investment inthis subsidiary was converted from the cost method of accounting to the equitymethod of accounting, resulting in a $35,020 increase to investment income withapproximately $17,000 recorded in the three months ended April 30,2004 and thebalance recorded in the three months ended July 31, 2004.

 

Under the purchase methodof accounting, the total purchase price was allocated to FastObjects’ nettangible and identifiable intangible assets based upon their fair value as ofthe date of completion of the merger, with the excess of the purchase priceresulting in the establishment of goodwill, which is amortizable over 15 years,for taxation purposes. Standard

 

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valuation procedures andtechniques were utilized in determining the fair value.  Each intangible asset is valued based uponthe estimated impact on our expected future after-tax cash flows. The netchanges in the Company’s expected future after-tax cash flows generated by thecustomer relationships were then discounted to present value. The discount wasbased on an analysis of the weighted-average cost of capital for theindustry.  Based upon the allocation ofthe purchase price and management’s estimate of fair value based upon thevaluation of identifiable tangible and intangible assets, the purchase priceallocation was as follows:

 

| Tangible assets  acquired      |   | $         | 144,253 |   |
|--------------------------------|--------|-----------|---------|--------|
| Amortizable  intangible assets |   | 380,000   |    |
| Goodwill                       |   | 602,473   |    |
| Total assets  acquired         |   | 1,126,726 |    |
| Liabilities  assumed           |   | (490,477  | )       |
| Net assets  acquired           |   | $         | 636,249 |   |

 

An amount of $380,000 has been allocated toamortizable intangible assets, which represents the Company’s valuation of thecustomer relationships we acquired in the acquisition.  The Company estimate useful life of thesecustomer relationships to be 6 years given the turnover rate associated withtraditional distributorships. During fiscal year ended October 31, 2004, theCompnay recorded $20,090 in cost of revenue related to the amortization ofacquired intangibles. Amortization charged to income for the subsequent sixyears is $63,333 for fiscal years 2005 through 2009 and $43,244 for fiscal year2010.

 

JDO Genie.

 

On June 27, 2004, Versant signed an asset purchase agreement to acquirethe JDO Genie product line and its customers from JDO Genie (PTY) Ltd. (JDOGenie), a privately held South African company.   The transaction was consummated on June 30,2004.  The acquisition of JDO Genieproduct allows Versant to provide a solution that can serve as the foundationfor multiple data access products connecting applications to both object andrelational databases. This arrangement also includes a one-year consultingcontract with the JDO Genie development team, which includes objective-basedbonus payments totaling $250,000.  Theseamounts are expensed as incurred and not included as part of the purchaseprice.

 

Our operations from June 30, 2004 reflect revenues andcosts associated with our operation of the business of developing and marketingJDO Genie. The results of operations of JDO Genie were included in Versant’sincome statement from June 30, 2004 onwards.

 

The total purchase price was $525,000, and consistedof the following:

 

a)     Cashpayment of $200,000 made in July of 2004; and

b)    Deferred portionof purchase price of $325,000*

 

This acquisition was accounted for as a purchase andthe price is summarized as follows:

 

| Cash Payment          |   | $       | 200,000 |   |
|-----------------------|--------|---------|---------|--------|
| *Deferred  Payment    |   | 325,000 |    |
| Total purchase  price |   | $       | 525,000 |   |

 

----

*Under the terms of the agreement entered into on June27, 2004 with JDO Genie (PTY) LTD, pursuant to which we purchased the JDO Genieproduct, the deferred portion of the purchase price payable to JDO Genie (PTY)LTD was to be either:

 

a.  230,150 restricted shares of Versant commonstock, if JDO Genie (PTY) LTD receives formal written approval to receive suchshares from the South African Reserve Bank on or before September 27, 2004 (90days after the closing of Versant’s purchase the JDO Genie product).  The approval period was subsequently extendedby seven months, by mutual agreement amongst Versant and JDO Genie (PTY)LTD.  This number of shares representsthe equivalent of $400,000 of such stock, based on the price of $1.73 pershare, which price was contractually determined by using the average price ofVersant common stock for the five days

 

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prior to executing thepurchase agreement for the JDO Genie product. These shares would be issued as restricted securities subject to theresale restrictions of Rule 144 under the Securities Act of 1933, as amended;or

 

b.  Had theSouth African Reserve Bank not provided such formal approval of JDO Genie (PTY)LTD’s receipt of the shares of Versant common stock described above, within 90days of the inception (which was subsequently extended as described above) ofthe agreement, then in lieu of the shares, Versant was to pay JDO Genie (PTY)LTD $325,000 on June 30, 2005.  However,the issuance of Versant common shares to JDO Genie was approved by the SouthAfrican Reserve Bank on January 14, 2005 and, consequently, Versant will issuethe 230,150 common shares to JDO Genie in the near future (see discussionbelow).

 

Under the purchase method of accounting, the totalpurchase price was allocated to JDO Genie’s net intangible assets based upontheir fair value as of the date of completion of the asset purchase. Based uponthe preliminary allocation of the purchase price and management’s estimate offair value based upon our valuation, the purchase price allocation, is asfollows

 

| Amortizable  intangible assets |   | 525,000 |    |
|--------------------------------|--------|---------|---------|
| Net assets  acquired           |   | $       | 525,000 |   |
|                                |        |         |         |  |

 

An amount of $525,000 has been allocated to amortizable intangible assets, whichrepresents our valuation of the JDO Genie technology. We have estimated thatthe JDO Genie technology has a useful live of 5 years, which represents ourbest estimate of the expected economic life of the acquired technology. Duringfiscal year ended October 31, 2004, we recorded $35,000 in cost of revenue relatedto the amortization of acquired intangibles. Amortization charged to income forthe subsequent five years is estimated, based on the October 31, 2004intangible asset value, to be  $105,000for fiscal years 2005 through 2008 and approximately $71,000 for fiscal year2009.

 

We performed a valuationof the purchased assets to determine the fair value of each identifiabletangible and intangible asset and in assist in allocating the purchase priceamong the acquired assets. Standard valuation procedures and techniques wereutilized in determining the fair value. Each intangible asset is valued based upon the estimated impact on ourexpected future after-tax cash flows. The net changes in our expected futureafter-tax cash flows generated), developed technology was then discounted topresent value. The discount was based on an analysis of the weighted-averagecost of capital for the industry.

 

As discussed above, the issuance of Versant commonshares to JDO Genie was approved by the South African Reserve Bank on January14, 2005 and, consequently, Versant will issue the 230,150 common shares to JDOGenie in the near future.  The adjustmentof purchase price will be recorded during the quarter ending January 31, 2005,and we result in an increase in purchase price of $75,000 ($25,000 of whichwill be allocated to acquired technology, and the remaining $50,000 of whichwill be recorded as goodwill).  Versantwill issue these shares in reliance upon the exemption(s) from registrationprovided by Section 4(2), and/or Regulation S under the Securities Act and/orRules 505 or 506 of Regulation D promulgated under the Securities Act.  In relying upon these exemptions Versantconsiders the fact the issuance of the shares is being made to a single foreigncorporate purchaser who is provided publicly available information aboutVersant and who was advised by legal counsel in connection with thetransaction.  Versant also considers thatJDO Genie has made appropriate investment agreements and representations toVersant regarding its sophistication, knowledge, investment intent andcompliance with resale restrictions applicable to restricted securities underthe Securities Act.  Versant has notagreed to register the shares issued to JDO Genie under the Securities Act.

 

Pro forma results of operations

 

The Pro forma condensedconsolidated statements of operations are presented below as if the merger withPoet and the acquisition of FastObjects, Inc. had occurred on November 1, 2003and November 1, 2002.  These pro forma figuresdo not include amounts for JDO Genie, as they are unavailable (in thousandsexcept per share data).

 

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| ** **                 | ** ** | **Twelve months ended  October, 31** | ** ** |
|----------------------------|------------|--------------------------------------|------------|
| ** **                 | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| Revenue                    |       | $                                    | 25,935     |   | $ | 28,044 |   |
| Net Income (loss)          |       | $                                    | (8,587     | ) | $ | (1,073 | ) |
| Earnings (loss)  per share |       | $                                    | (0.28      | ) | $ | (0.08 | ) |

 

Mokume Software, Inc.

 

On November 19, 2002, the Company acquired 100% of theoutstanding common stock of Mokume Software, Inc. (“Mokume”).   Mokume developed, real-time computingsoftware solutions and related services for customers in the manufacturingindustry to improve their business processes and logistics.  At the time of acquisition, the Companyexpected that its object database technology would be an integral part of the Company’sreal-time solution offerings.

 

We incurred approximately $1.1 million of non-cashstock expense related to the acceleration of the vesting of employee ownedshares, pursuant to an Amendment Agreement dated September 26, 2003, enteredinto with certain of the former stockholders of Mokume Software, Inc. (the “formerMokume stockholders”).  The AmendmentAgreement amended the Agreement and Plan of Reorganization dated as of November19, 2002 pursuant to which Versant acquired Mokume (the “Mokume MergerAgreement”).

 

Pursuant to the Mokume Merger Agreement, Versantoriginally issued 2,424,000 shares of its common stock (the “Mokume Shares”) tothe former Mokume stockholders.  Under the terms of the Merger Agreement,Versant was entitled to repurchase from the former Mokume stockholders a totalof 1,212,000 of the Mokume Shares (the “Contingent Shares”) at the price of$0.01 per share if certain contingencies related to the Mokume acquisition didnot occur within a defined time period (the “Contingency”).  TheContingent Shares held by certain of the former Mokume stockholders were alsosubject to monthly vesting conditions based on their continued employment withVersant over a two-year period beginning on November 19, 2002.  Inaddition, all the shares issued to the former Mokume stockholders under theMokume Merger Agreement were subject to potential forfeiture to Versant tosatisfy claims for indemnification that might be asserted by Versant forbreaches of Mokume’s representations and warranties under the Merger Agreement,subject to certain release conditions. The principal modifications to theMokume Merger Agreement effected by the Amendment Agreement are summarizedbelow.

 

•      Atotal of 363,600 of the Contingent Shares were forfeited by the former Mokumestockholders and cancelled without consideration and the remaining 848,400Contingent Shares are no longer subject to forfeiture or repurchase by Versantand have been released from the Contingency and any vesting restrictions nowapplicable to them.

 

•      Subjectto certain conditions, the 2,060,400 remaining Mokume Shares were to bereleased from the risk of forfeiture to satisfy claims for indemnification madeby Versant under the Merger Agreement in installments over time as follows:  (a) 606,400 shares were released frompotential forfeiture under indemnification claims on September 26, 2003.and(b)  the balance of 1,454,000 shares were to be released in variousincrements at various times during the one-year period beginning on November19, 2003 and ending November 19, 2004, when all shares not previously forfeitedwould be released from indemnification claims. Under this formula, 1,370,400 shares have been released from potentialforfeiture under indemnification claims in various increments at various timesthrough the period ending May 19, 2004; and

 

•      TheAmendment Agreement also provides former Mokume stockholders certain rights tosatisfy Versant indemnification claims in cash in lieu of Mokume Shares.

 

•      Allof the remaining 690,000 Mokume Shares are currently being held as indemnityshares of which all or a portion may be used to satisfy an indemnity claim byVersant that arose from a Complaint filed against Versant on October 29, 2004by Systems America, Inc.and Mokume, Inc. (a different company than thatacquired by Versant) Any indemnity shares not forfeited to satisfy theindemnity claim will be disbursed to the former Mokume stockholders. TheComplaint, which seeks unspecified damages and injunctive relief, alleges thatformer employees of Systems America, Inc. left Systems America to form acompany named Mokume Software, Inc., and, in the process, misappropriatedSystems America’s trade secrets and confidential information, unfairly competedwith Systems America vis-à-vis its customer relationships, and infringedSystems America’s

 

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trademarks and trade names. The Complaint furtheralleges that when the Versant acquired Mokume Software Inc. in November of2002, Versant acquired the benefit of the misappropriated trade secrets,confidential information, customer relationships, and trademarks and tradenames. Versant denies the allegations in the litigation and intends tovigorously defend against the Complaint.

 

Our evaluation of our intangible assets carried out inthe course of preparing our balance sheet as of July 31, 2004 (the close of ourthird fiscal quarter), indicated impairment in the carrying value of thegoodwill and intangible assets related to our acquisition of Mokume Software, Inc.in November 2002. Consequently, in the three months ended July 31, 2004, werecorded a non-cash charge of approximately $1.0 million comprised ofapproximately $300,000 in unamortized intangible assets and approximately$700,000 of goodwill that represents the net book value of all recorded Mokumeintangible assets as of July 31, 2004.

 

The following table shows how our intangible assets asof October 31, 2004 will be amortized to our consolidated statements ofoperations in future years, assuming no impairment of these intangible assets:

 
| ** **                                                   | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | **Intangible  Asset  Balance  As of  10/31/2004** | ** ** | **Note** | ** ** |
|--------------------------------------------------------------|------------|--------------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|---------------------------------------------------|------------|----------|------------|
| ** **                                                   | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     |
| ** **                                                   | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     |
| **Twelve months ended October 31,**                          | ** ** | ** **         |
| **2005**                                                     | ** ** | **2006**           | ** ** | **2007**   | ** ** | **2008**   | ** ** | **2009**   | ** ** | **Thereafter** |
| ** **                                                   | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Mokume Software,  Inc. (Amortized over 5 yrs)                | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** **                                        | ** ** | **(1)**  | ** ** |
| Poet Holdings,  Inc. (Amortized over 7 yrs)                  |       | $                  | 613        |       | $          | 613        |       | $          | 613        |           | $          | 613        |       | $                                                 | 613        |     | $          | 855 |   | $ | 3,920 | ** ** | **(2)** | ** ** |
| JDO Genie (PTY),  LTD (Amortized over 5 yrs)                 |       | $                  | 105        |       | $          | 105        |       | $          | 105        |           | $          | 105        |       | $                                                 | 71         |     |       |   | $ | 491 |   |   |   |
| FastObjects,  Inc. (Amortized over 6 yrs)                    |       | $                  | 63         |       | $          | 63         |       | $          | 63         |           | $          | 63         |       | $                                                 | 63         |     | $          | 44 |   | $ | 359 |   |   |   |
| ***Total  estimated amortization of purchased intangibles*** |       | $                  | 781        |       | $          | 781        |       | $          | 781        |           | $          | 781        |       | $                                                 | 747        |     | $          | 899 |   | $ | 4,770 |   |   |   |

 

**7. Recently Issued Accounting Pronouncements**

 

In December 2004, the FASB issued SFAS No. 123R, “Share-BasedPayment,” a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”and superseding APB Opinion No. 25, “Accounting for Stock Issued to Employees.”SFAS No. 123R requires the Company to expense grants made under the Company’sstock option program. That cost will be recognized over the vesting period ofthe plans. SFAS No. 123R is effective for interim periods beginning after June15, 2005. Upon adoption of SFAS No. 123R, amounts previously disclosed underSFAS No. 123 will be recorded in the Company’s statement of operations. TheCompany is evaluating the alternatives allowed under the standard, which theCompany is required to adopt effective for its fourth quarter of fiscal 2005.

 

**8.****        LeaseObligations and other Purchase Commitments**

 

In November 1996, the Company entered into anagreement to lease its corporate headquarters facility under a ten-yearoperating lease agreement commencing on June 1, 1997 and expiring on May 31,2007.  The terms of the lease provide forcertain increases in rental payments during the lease term.  Rental expense under this agreement,including contractual payment increases is recognized on a straight-line basis.The Company also leases field office space in Europe and India, generally undermulti-year operating lease agreements. Consolidated rent expense for the year ended October 31, 2004, the yearended October 31, 2003 and year ended October 31, 2002, was approximately$1,674,000, $1,425,000, and $1,545,000, respectively.

 

Pursuant to a consulting agreement, we have contractedto have some research and development work for a portion of our Versant OpenAccess product performed for certain periods by JDO Genie PTY LTD, a SouthAfrican company from which we acquired core technology used in Versant OpenAccess. This contract was executed in conjunction with the June 30, 2004

 

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acquisition of the JDO Genie technology and expires on the anniversaryof the acquisition unless both parties to the contract mutually agree toextend. The contract includes a fixed monthly retainer, milestone payments,objective based bonus payments and a provision for the reimbursement of travelexpenses.

 

The Company’s future annual minimum commitments atOctober 31, 2004 under non-cancelable operating leases and the JDO Genieconsulting contract are listed in the table below.  The Company has recorded approximately $2.3million of the commitments on the October 31, 2004 Balance Sheet:

 

| **(in thousands)  Year Ending October 31,** | ** ** | **Operating  Leases** | ** ** | **Consulting  Contract** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|--------------------------|------------|-----------|------------|
| 2005                                        |       | $                     | 2,024      |                     | $          | 475       |       | $ | 2,499 |   |
| 2006                                        |       | 1,705                 |       |                     |       | 1,705     |       |
| 2007                                        |       | 994                   |       |                     |       | 994       |       |
| 2008                                        |       | 22                    |       |                     |       | 22        |       |
| Total  Commitments                          |       | $                     | 4,745      |                     | $          | 475       |       | $ | 5,220 |   |

 

**9.****        Lineof Credit**

 

Our asset based credit line for $5 million with Pacific BusinessFunding expired on September 3, 2004 and we elected not to renew the facilityat that time due to a very low usage of the instrument.  We intend evaluating similar facilities,possibly with other banks, during 2005. The last time we borrowed under ourline with Pacific Business Funding was in October 2003 in the amount of$500,000 (which was repaid in November 2003).

 

**10.****      Shareholders’Equity**

 

Versant has the following option plans in place:

 

•              1996Equity Incentive Plan

 

Under Versant’s 1996 Equity Incentive Plan, optionsare generally granted to its employees with a three-year vesting schedule inwhich 25% of the option vests and becomes exercisable nine months from grantdate and the remaining 75% vests ratably, on a monthly-basis thereafter overthe remaining 27 months of the vesting schedule.  Versant’s Compensation Committee has fromtime to time approved non-standard stock option vesting schedules for thepurposes of employee retention or bonus grants, such as a three-year grant,with 25% vesting in three months and the remaining vesting ratably on amonthly-basis thereafter or an option grant with 100% of the option grantvesting three months after the grant date. All options granted to employees under the Company’s 1996 EquityIncentive Plan expire ten years after the grant date.  Grant holders have three months after leavingthe Company to exercise their vested options.

 

•              1996 Directors StockOption Plan

 

Under Versant’s 1996 Directors Stock Option Plan,Versant grants 40,000 options as an initial grant to new directors of the Boardand 20,000 as an annual succeeding grant thereafter.  Both grants vest 50% on the first and secondanniversaries of the option grant.  Theoptions granted under the 1996 Directors Stock Option Plan expire ten yearsafter the grant date.  Directors haveseven months after leaving their directorships to exercise their vestedoptions.

 

Versant acquired all of Poet’s stock option plans inconnection with our March 2004 acquisition of Poet.  Prior to the acquisition Poet had thefollowing plans in place:

 

•              1995 Stock OptionPlan

 

74

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Under Poet’s 1995 Stock Option Plan, options weregenerally granted with a four-year vesting schedule of which 25% are vestedtwelve months after the date of grant with the remaining options vestingratably on a monthly-basis over the remaining 36-month vesting period. Poet hasapproved non-standard stock option vesting schedules for the purposes ofemployee retention or bonus grants, including an option grant with 100% of theoption grant vested at 6 months.

 

•              2001 Non-statutoryPlan.

 

Standard vesting under this plan is a three-yearvesting schedule with 33% of the options vesting one year after the date ofgrant, and the remaining options vesting ratably on a monthly-basis over theremaining 24-month vesting period.

 

•              Director Plan

 

Under Poet’s 1999 Director’s Plan, options weregenerally granted to its directors with a three-year vesting schedule, with 33%vesting twelve months from the option grant date with remaining vesting ratablyon a monthly-basis over the remaining 24-month vesting period. Poet has grantedoptions, as approved by their Board of Directors, with non-standard optionvesting, including an option grant vesting 100% on the fourth anniversary ofthe grant date; and a four-year grant with 25% vesting on each subsequentanniversary of the grant date.

 

No further options will be granted under any of Poet’soption plans.

 

Shares Reserved for Future Issuance

 

As of October 31, 2004, the Company had reservedshares of common stock for the following purposes:

 
| Employee stock  purchase plan      |   | 57,280    |   |
|------------------------------------|--------|-----------|--------|
| Stock options  available for grant |   | 2,140,677 |   |
| Exercise of  warrants outstanding  |   | 1,313,743 |   |
| Unexercised  stock options         |   | 4,598,929 |   |
|                               |   | 8,110,629 |   |

 

Stock Options

 

Option activity under all of the Company’s optionplans is as follows:

 
| ** **                       | ** ** | **Options  Available for  grant** | ** ** | **Number of  Options  outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|----------------------------------|------------|-----------------------------------|------------|-------------------------------------|------------|----------------------------------------|------------|
| **Balance  at October 31, 2001** | ** ** | **1,151,400**                     | ** ** | **3,243,392**                       | ** ** | **$**                                  | **3.89**   | ** ** |
| Authorized                       |       | 850,000                           |       | —                              |       | —                                 |       |
| Granted                          |       | (973,800                          | )          | 973,800                             |       | 1.52                                   |       |
| Exercised                        |       | —                            |       | (13,420                             | )          | 1.30                                   |       |
| Canceled                         |       | 444,499                           |       | (444,499                            | )          | 3.34                                   |       |
| **Balance  at October 31, 2002** | ** ** | **1,472,099**                     | ** ** | **3,759,273**                       | ** ** | **$**                                  | **3.35**   | ** ** |
| Authorized                       |       | 250,000                           |       | —                              |       | —                                 |       |
| Granted                          |       | (1,429,695                        | )          | 1,429,695                           |       | 0.91                                   |       |
| Exercised                        |       | —                            |       | (113,229                            | )          | 0.93                                   |       |
| Canceled                         |       | 1,344,981                         |       | (1,344,981                          | )          | 2.87                                   |       |
| **Balance  at October 31, 2003** | ** ** | **1,637,385**                     | ** ** | **3,730,758**                       | ** ** | **$**                                  | **2.66**   | ** ** |
| Authorized                       |       | 1,784,780                         |       |                                |       |                                   |       |
| Granted                          |       | (1,926,930                        | )          | 130,200                             |       | 1.54                                   |       |
| Assumed                          |       |                              |       | 1,784,780                           |       | 3.49                                   |       |
| Exercised                        |       | (127,713                          | )          | (283,938                            | )          | 0.95                                   |       |
| Canceled                         |       | 773,155                           |       | (762,871                            | )          | 2.33                                   |       |
| **Balance  at October 31, 2004** | ** ** | **2,140,677**                     | ** ** | **4,598,929**                       | ** ** | **$**                                  | **3.12**   | ** ** |

 

75

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Thefollowing table summarizes information concerning outstanding and exercisableoptions at October 31, 2004.

 
| ** **                                   | ** ** | **Options Outstanding**                       | ** ** | ** **                                         | ** ** | **Options Exercisable**                | ** ** |
|----------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------|------------|
| **Exercise Prices**                          | ** ** | **Number  Outstanding  at October 31,  2004** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable at  October 31,  2004** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| From $ 0.35  to  $ 0.61  |       | 963,353                                       |       | 8                                                  |       | $                                      | 0.47       |   | 879,371 |   | $ | 0.46 |   |
| From $ 0.67  to  $ 0.92  |       | 773,869                                       |       | 8                                                  |       | 0.86                                   |       | 569,453 |   | 0.85 |   |
| From $ 1.02  to  $ 1.48  |       | 382,609                                       |       | 7                                                  |       | 1.15                                   |       | 323,075 |   | 1.16 |   |
| From $ 1.55  to  $ 2.22  |       | 669,354                                       |       | 7                                                  |       | 1.69                                   |       | 587,758 |   | 1.69 |   |
| From $ 2.38  to  $ 3.38  |       | 652,551                                       |       | 6                                                  |       | 2.66                                   |       | 652,273 |   | 2.66 |   |
| From $ 3.57  to  $ 5.69  |       | 406,215                                       |       | 5                                                  |       | 4.64                                   |       | 406,215 |   | 4.64 |   |
| From $ 6.31  to $ 8.21        |       | 433,985                                       |       | 4                                                  |       | 7.36                                   |       | 433,984 |   | 7.36 |   |
| From $ 8.57  to  $ 13.37 |       | 290,892                                       |       | 5                                                  |       | 9.89                                   |       | 283,892 |   | 9.83 |   |
| From $ 18.00 to  $128.70                |       | 26,101                                        |       | 5                                                  |       | 75.37                                  |       | 26,101 |   | 75.37 |   |
|                                         |       | 4,598,929                                     |       | 7                                                  |       | $                                      | 3.12       |   | 4,162,122 |   | $ | 3.32 |   |

 

In May 1996, the Board adopted the 1996 Employee StockPurchase Plan (the “Purchase Plan”). The Company’s shareholders approved thePurchase Plan in June 1996.  At thattime, the Company reserved 650,000 shares of common stock for issuance underthe Purchase Plan.  In August 2004, theCompany’s shareholders approved an amendment to the Purchase Plan to increasethe number of shares reserved for issuance under the Purchase Plan from1,250,000 to 1,800,000 shares. The Purchase Plan enables eligibleemployees to purchase common stock at 85% of the lower of the fair market valueof the Company’s common stock on the first business day of each offeringperiod, which is 24 months in length, or the last day of each purchase period,which is 6 months in length. For the year ended October 31, 2004, employeespurchased 299,274 shares of common stock at an average price of $0.69 pershare. For the year ended October 31, 2003, employees purchased 97,696 sharesof common stock at an average price of $0.74 per share.

 

Non Cash Stock Expense

 
| ** **                                          | ** ** | ** **                          | ** ** | ** **          | ** ** | ** **          | ** ** | **Percent change in fiscal year** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------|------------|---------------------|------------|---------------------|------------|-----------------------------------|------------|
| ** **                                          | ** ** | **Twelve months ended October 31,** | ** ** | **2004 from  2003** | ** ** | **2003 from  2002** | ** ** |
| **2004**                                            | ** ** | **2003**                            | ** ** | **2002**            |
| ** **                                          | ** ** | **(in thousands)**                  | ** ** | ** **          | ** ** | ** **          | ** ** |
| Unvested Poet  options                              |       | $                                   | 86         |                |       |                |       |                              |       |   |   |   |
|                                                |       |                                |       |                |       |                |       |                              |       |   |   |
| Stock option  grants to non employees               |       |                                |       | 88                  |       |                |       |                              |       |   |   |
|                                                |       |                                |       |                |       |                |       |                              |       |   |   |
| Accelerated  vesting in the Mokume Merger Agreement |       |                                |       | 1,121               |       |                |       |                              |       |   |   |
|                                                |       |                                |       |                |       |                |       |                              |       |   |   |
| Total non cash  stock expense                       |       | $                                   | 86         |                | $          | 1,209               |       | —                            |       | -93 | % | n/a |   |
|                                                     |            |                                     |            |                     |            |                     |            |                                   |            |  |  |  |  |

 

In fiscal 2004, stockbased compensation expense represents the amortization of the deferredcompensation related to options assumed in the Poet merger.

 

In fiscal 2003, the $1.2 million in stock basedcompensation consisted of the following:

 

•      Approximately$100,000 of stock based compensationexpense related to stock options granted to non-employee contractors.

 

76

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•      InOctober of 2003, the Company also recorded approximately $1.1 million of stockbased compensation expense related to the acceleration of the vesting ofemployee owned shares, pursuant to an Amendment Agreement dated September 26,2003, entered into with certain of the former stockholders of Mokume Software,Inc. (the “former Mokume stockholders”), which amended the Agreement and Planof Reorganization dated as of November 19, 2002 pursuant to which Versantacquired Mokume (the “Mokume Merger Agreement”).

 

Pursuant to the Mokume Merger Agreement, Versantoriginally issued 2,424,000 shares of its common stock (the “Mokume Shares”) tothe former Mokume stockholders.  Under the terms of the Merger Agreement,Versant was entitled to repurchase from the former Mokume stockholders a totalof 1,212,000 of the Mokume Shares (the “Contingent Shares”) at the price of$0.01 per share if certain contingencies related to the Mokume acquisition didnot occur within a defined time period (the “Contingency”).  TheContingent Shares held by certain of the former Mokume stockholders were alsosubject to monthly vesting conditions based on their continued employment withVersant over a two-year period beginning on November 19, 2002.  Inaddition, all the shares issued to the former Mokume stockholders under theMokume Merger Agreement were subject to potential forfeiture to Versant tosatisfy claims for indemnification that might be asserted by Versant forbreaches of Mokume’s representations and warranties under the Merger Agreement,subject to certain release conditions. The principal modifications to theMokume Merger Agreement effected by the Amendment Agreement are summarizedbelow.

 

•      Atotal of 363,600 of the Contingent Shares were forfeited by the former Mokumestockholders and cancelled without consideration and the remaining 848,400Contingent Shares are no longer subject to forfeiture or repurchase by Versantand have been released from the Contingency and any vesting restrictions nowapplicable to them.

 

•      Subjectto certain conditions, the 2,060,400 remaining Mokume Shares were to bereleased from the risk of forfeiture to satisfy claims for indemnification madeby Versant under the Merger Agreement in installments over time asfollows:  (a) 606,400 shares werereleased from potential forfeiture under indemnification claims on September26, 2003.and (b)  the balance of 1,454,000 shares were to be releasedin various increments at various times during the one-year period beginning onNovember 19, 2003 and ending November 19, 2004, when all shares not previouslyforfeited would be released from indemnification claims.  Under this formula, 1,370,400 shares havebeen released from potential forfeiture under indemnification claims in variousincrements at various times through the period ending May 19, 2004; and

 

•      TheAmendment Agreement also provides former Mokume stockholders certain rights to satisfyVersant indemnification claims in cash in lieu of Mokume Shares.

 

•      Allof the remaining 690,000 Mokume Shares are currently being held as indemnityshares of which all or a portion may be used to satisfy an indemnity claim byVersant that arose from a Complaint filed against Versant on October 29, 2004by Systems America, Inc.and Mokume, Inc. (a different company than thatacquired by Versant) Any indemnity shares not forfeited to satisfy theindemnity claim will be disbursed to the former Mokume stockholders. TheComplaint, which seeks unspecified damages and injunctive relief, alleges thatformer employees of Systems America, Inc. left Systems America to form acompany named Mokume Software, Inc., and, in the process, misappropriatedSystems America’s trade secrets and confidential information, unfairly competedwith Systems America vis-à-vis its customer relationships, and infringedSystems America’s trademarks and trade names. The Complaint further allegesthat when the Versant acquired Mokume Software Inc. in November of 2002,Versant acquired the benefit of the misappropriated trade secrets, confidentialinformation, customer relationships, and trademarks and trade names. Versantdenies the allegations in the litigation and intends to vigorously defendagainst the Complaint.

 

**11.****      Income Taxes**

 

The Company accounts for income taxes pursuant to the provisions ofSFAS No. 109, “Accounting for Income Taxes,” which requires an asset andliability approach to accounting for income taxes. Deferred tax liabilities andassets are determined based on the difference between the financial statementcarrying amounts and the tax basis of assets and liabilities and are measuredusing the enacted statutory tax rates in effect at the balance sheet date. TheCompany records a valuation allowance to reduce its deferred tax assets whenuncertainty regarding that realizability exists.

 

77

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Income (loss) before provision for income taxes consisted of (inthousands):

 
| ** **    | ** ** | **Year Ended  10/31/2004** | ** ** | **Year Ended  10/31/2003** | ** ** | **Year Ended  10/31/2002** | ** ** |
|---------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| United States |       | $                          | (10,282    | )                          | $          | (3,800                     | )          | $ | (4,266 | ) |
| International |       | (1,627                     | )          | 1,485                      |       | 944                        |       |
|          |       | $                          | (11,909    | )                          | $          | (2,315                     | )          | $ | (3,322 | ) |

 

The provision for income taxes consisted of the following (in thousands):

 
| ** **                        | ** ** | **Year Ended  10/31/2004** | ** ** | **Year Ended  10/31/2003** | ** ** | **Year Ended  10/31/2002** | ** ** |
|-----------------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| Current:                          |       |                       |       |                       |       |                       |       |
| Federal                           |       | $                          | —     |                       | $          | —                     |       | $ | — |   |
| State                             |       | —                     |       | —                     |       | —                     |       |
| Foreign  withholding              |       | 88                         |       | 74                         |       | 68                         |       |
| Total current                     |       | 88                         |       | 74                         |       | 68                         |       |
| Deferred:                         |       |                       |       |                       |       |                       |       |
| Federal                           |       | —                     |       | —                     |       | —                     |       |
| State                             |       | —                     |       | —                     |       | —                     |       |
| Total deferred                    |       | —                     |       | —                     |       | —                     |       |
| Total provision  for income taxes |       | $                          | 88         |                       | $          | 74                         |       | $ | 68 |   |

 

The provision for income taxes differs from the amount estimated byapplying the statutory federal income tax rate to income (loss) before taxes asfollows (in thousands):

 
| ** **                                                     | ** ** | **Year Ended  10/31/2004** | ** ** | **Year Ended  10/31/2003** | ** ** | **Year Ended  10/31/2002** | ** ** |
|----------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                                     | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| Federal tax  (benefit) at statutory rate                       |       | $                          | (4,168     | )                          | $          | (810                       | )          | $ | (1,162 | ) |
| State tax  (benefit) at statutory rate, net of federal benefit |       | (101                       | )          | (142                       | )          | (115                       | )          |
| Change in  valuation allowance                                 |       | 1,761                      |       | 790                        |       | 1,000                      |       |
| Foreign tax  differential                                      |       | 488                        |       | 17                         |       | 268                        |       |
| Book intangible  assets amortization not deductible for tax    |       | 1,073                      |       | —                     |       | —                     |       |
| Deemed dividend  not deductible for tax                        |       | 848                        |       | —                     |       | —                     |       |
| Other                                                          |       | 187                        |       | 219                        |       | 77                         |       |
| Provision for  income taxes                                    |       | $                          | 88         |                       | $          | 74                         |       | $ | 68 |   |
|                                                                |            |                            |            |                            |            |                            |            |  |  |  |  |

 

The components of the net deferred tax asset were as follows (inthousands):

 
| ** **                        | ** ** | **10/31/2004** | ** ** | **10/31/2003** | ** ** | **10/31/2002** | ** ** |
|-----------------------------------|------------|----------------|------------|----------------|------------|----------------|------------|
| Deferred tax  asset:              |       |           |       |           |       |           |       |
| Net operating  loss carryforwards |       | $              | 17,755     |           | $          | 16,582         |       | $ | 15,808 |   |
| Tax credit  carryforwards         |       | 3,292          |       | 3,302          |       | 3,071          |       |
| Other                             |       | 1,215          |       | 617            |       | 832            |       |
|                              |       | 22,262         |       | 20,501         |       | 19,711         |       |
| Valuation  allowance              |       | (22,262        | )          | (20,501        | )          | (19,711        | )          |
| Net deferred tax  asset           |       | $              | —     |           | $          | —         |       | $ | — |   |

 

78

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At October 31, 2004, the Company had federal and statenet operating loss carryforwards of $48.6 million and $13.0 million,respectively and federal and state tax credit carryforwards of $2.2 million and$1.1 million, respectively.  The federaland state net operating loss carryforwards and federal tax credit carryforwardsexpire on various dates through 2024, if not utilized.  The state tax credit carryforwards can becarried forward indefinitely. Due to the Company’s history of operating losses,the Company believes that there is sufficient uncertainty regarding therealizability of these carryforwards and, therefore, a valuation allowance ofapproximately $22.3 million has been recorded against the Company’s netdeferred tax assets of approximately $22.3 million.  Approximately $1.6 million of the valuationallowance for deferred tax assets is attributable to employee stock optiondeductions, the benefit from which will be allocated to additional paid-incapital when and if subsequently realized. The Company will continue to assess the realizability of the tax benefitavailable based on actual and forecasted operating results.

 

Due to “change in ownership” provisions of theInternal Revenue Code of 1986, the availability of net operating loss and taxcarryforwards to offset federal taxable income in future periods is subject toan annual limitation.

 

**12.****          Warrants**

 

In connection with the issuance of Series A Convertible Preferred Stockin fiscal 1999, the Company issued warrants to purchase 1,489,799 shares of theCompany’s common stock for cash consideration of $73,357. In September 2000warrants to purchase 158,450 shares of common stock were exercised for a totalof $338,000.  Under their original terms,the warrants had an exercise price of $2.13 per share, were immediatelyexercisable and expired upon the earlier of:

 

(1)   July11, 2004;

(2)   Anacquisition of the Company (whether by merger, consolidation, tender offer orotherwise) in which the Company’s shareholders prior to the acquisition ownless than a majority of the surviving corporation, or the sale of all orsubstantially all of the Company’s assets; or

(3)   15business days after the Company gives notice to the holder that the Company’sstock price has closed above $12.00 for 45 consecutive business days.

 

In connection with the Poet merger, warrants topurchase a total of 1,313,743 shares of Versant common stock held by thePreferred Shareholders were amended to reduce the exercise price of suchwarrants from $2.13 to $1.66 per share of common stock and to extend the termof such warrants by one year (see Note 10 for further discussion).

 

At October 31, 2004, warrants to purchase 1,313,743 shares of commonstock remain outstanding.

 

**13.****          Related PartyTransactions**

 

We entered into an agreement with PMI in October 2002for the resale of third-party products, for which we recognized revenue inDecember 2002.  We received a payment of $1,011,790.91 in October of 2002from PMI in connection with this transaction. During this time, Mr. DanielRoberts was the Executive Vice President of Business Operations and ChiefInformation Officer of the PMI Group Inc. (PMI) and also served as a directorof Versant from July 2001 through March 2004.

 

**14.****          Quarterly Information (unaudited)**

 

Summarized quarterly supplemental consolidated financial informationfor 2004 and 2003, net of discontinued operations:

 

79

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| ** **                                                    | ** ** | **Fiscal 2004 Quarters Ended**            | ** ** | **Fiscal 2003 Quarters Ended** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------|------------|--------------------------------|------------|
| ** **                                                    | ** ** | **Oct 31,**                               | ** ** | **Jul 31,**                    | ** ** | **Apr 30,** | ** ** | **Jan 31,** | ** ** | **Oct 31,** | ** ** | **Jul 31,** | ** ** | **Apr 30,** | ** ** | **Jan 31,** | ** ** |
| ** **                                                    | ** ** | **(in thousands, except per share data)** | ** ** |
|                                                          |       |                                      |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                       |       | $                                         | 6,230      |                           | $          | 5,252 |   | $ | 5,027 |   | $ | 6,366 |   | $ | 5,757 |   | $ | 5,429 |   | $ | 5,024 |   | $ | 5,849 |   |
|                                                          |       |                                      |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross profit                                                  |       | $                                         | 4,145      |                           | $          | 2,819 |   | $ | 2,902 |   | $ | 4,480 |   | $ | 4,070 |   | $ | 3,375 |   | $ | 3,074 |   | $ | 3,283 |   |
|                                                          |       |                                      |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating Income  (loss)                                      |       | $                                         | (3,351     | )                              | $          | (3,167 | ) | $ | (1,681 | ) | $ | 548 |   | $ | (1,049 | ) | $ | (142 | ) | $ | (802 | ) | $ | (720 | ) |
|                                                          |       |                                      |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from  discontinued operations net of income tax          |       | $                                         | (181       | )                              | $          | (760 | ) | $ | (705 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                          |       |                                      |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from sale  of discontinued operations, net of income tax |       | $                                         | (309       | )                              |       |   |   |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                          |       |                                      |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income  (loss) applicable to common shareholders          |       | $                                         | (4,022     | )*                             | $          | (3,827 | )* | $ | (4,753 | ) | $ | 605 |   | $ | (801 | ) | $ | (153 | ) | $ | (771 | ) | $ | (664 | ) |
|                                                          |       |                                      |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic net income  (loss) per share                            |       | $                                         | (0.12      | )                              | $          | (0.11 | ) | $ | (0.20 | ) | $ | 0.04 |   | $ | (0.06 | ) | $ | (0.01 | ) | $ | (0.06 | ) | $ | (0.05 | ) |
|                                                          |       |                                      |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Diluted net  income (loss) per share                          |       | $                                         | (0.12      | )                              | $          | (0.11 | ) | $ | (0.20 | ) | $ | 0.03 |   | $ | (0.06 | ) | $ | (0.01 | ) | $ | (0.06 | ) | $ | (0.05 | ) |

 

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*The acquisition ofFastObjects, Inc. increased our ownership stake in this company to 100%compared with the approximate 19% ownership position we enjoyed prior to thetransaction. As a result of this increased ownership position our investment inthis subsidiary was converted from the cost method of accounting to the equitymethod of accounting, resulting in a $35,020 increase to investment income withapproximately $17,000 recorded in the three months ended April 30,2004 and thebalance recorded in the three months ended July 31, 2004.  Previously we had reported the entire $35,020as a cumulative effect of accounting changing in the three months ended July31, 2004.

 

**Item 9****.  Changes in and Disagreementswith Accountants on Accounting and Financial Disclosure.**

 

Effective June 23, 2003, we elected to change our certifying accountantas follows:

 

(i)            Wedismissed KPMG LLP as our independent accountants.

 

(ii)           Thereport of KPMG LLP on our consolidated financial statements for the fiscal yearended October 31, 2002 did not contain an adverse opinion or disclaimer ofopinion and was not qualified or modified as to uncertainty, audit scope, oraccounting principles.  KPMG LLP has onlyreported on the corporation’s consolidated financial statements for the fiscalyear ended October 31, 2002.

 

(iii)          Thedecision to dismiss KPMG as our independent accountants was approved by theaudit committee of our board of directors on June 23, 2003.

 

(iv)          Inconnection with the audit of our financial statements for the fiscal year endedOctober 31, 2002 and the subsequent interim periods, preceding the dismissal,we had no disagreements with KPMG on any matter of accounting principles orpractices, financial statement disclosure, or auditing scope or procedure,which disagreements, if not resolved to the satisfaction of KPMG, would havecaused them to make reference to the subject matter of the disagreements inconnection with its report.  We requestedKPMG to furnish a letter addressed to the Securities and Exchange Commission asto whether it agrees with the above statements. A copy of that letter, dated June 24, 2003, is filed as Exhibit 16 toour report on Form 8-K filed with the Securities and Exchange Commission onJune 25, 2003.

 

Effective June 24, 2003,we engaged Grant Thornton LLP as our new independent auditors. The decision toengage Grant Thornton LLP was approved by our Audit Committee on June 23, 2003.

 

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**SCHEDULE II - VALUATION ANDQUALIFYING ACCOUNTS AND RESERVES**

 
| ** **                            | ** ** | **Balance at  Beginning of Period** | ** ** | **Additions  Charged to  Income** | ** ** | **Deductions** | ** ** | **Balance at  End of Period** | ** ** |
|---------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|----------------|------------|-------------------------------|------------|
| ** **                            | ** ** | **(in thousands)**                  | ** ** |
| **Allowance  for doubtful accounts:** |       |                                |       |                              |       |           |       |                          |       |
| Year ended  October 31, 2004          |       | $                                   | 258        |                              | 111        |           | 1          |                          | $          | 368 |   |
| Year ended  October 31, 2003          |       | $                                   | 687        |                              | 139        |           | 568        |                          | $          | 258 |   |
| Year ended  October 31, 2002          |       | $                                   | 482        |                              | 296        |           | 91         |                          | $          | 687 |   |

 

**Item 9A****.  Controls and Procedures*.***

 

(a)   Evaluationof Disclosure Controls and Procedures. Securities and Exchange Commission, or SEC, rules define the term “disclosurecontrols and procedures” to mean a company’s controls and other procedures thatare designed to ensure that information required to be disclosed in the reportsthat it files or submits under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported, within the time periods specified in theSEC’s rules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in its reports filed under the SecuritiesExchange Act of 1934 is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,or persons performing similar functions, as appropriate to allow timelydecisions regarding required disclosure. Based on the evaluation of the effectiveness of our disclosurecontrols and procedures by our management and the advice of our independentauditors, with the participation of our Chief Executive Officer and our ChiefFinancial Officer, our Chief Executive Officer and our Chief Financial Officerhave, for the reasons noted below, concluded that, as of the end of the periodcovered by this report, our disclosure controls and procedures were not fullyeffective to ensure that information required to be disclosed in the reportsthat the Company files or submits under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported, within the time periods specifiedin the Commission’s rules and forms.

 

In the course of conducting its audit of our financialstatements for our fiscal year ended October 31, 2004, in late November 2004our registered independent public accounting firm, Grant Thornton LLP,determined that there were certain material weaknesses and significantdeficiencies in our internal controls. Promptly following this determination, Grant Thornton advised ourmanagement and, on December 13, 2004, the audit committee of our board ofdirectors, of the following matters that Grant Thornton considered to be****material weaknesses****in ourinternal controls:

 

(i)            GrantThornton concluded that the number of year end audit adjustments and a prioramendment to the Company’s reported financial statements relating to anacquisition matter were indicative of a material weakness in controls overclosing procedures and the accounting for non-routine transactions.  Our auditors determined that the Companylacked certain procedures, staffing, and required expertise needed to properlyaccount for non-routine transactions (such as acquisitions of other businesses)and prepare certain of its required financial statement disclosures (primarilywith respect to non-routine transactions). Additionally, in connection with its fiscal 2004 year-end audit, GrantThornton discovered several cut-off errors in our financial statements(primarily with respect to period-end accruals) that should have beenidentified by the Company prior to the audit (in aggregate these adjustmentsrepresented approximately 1% of our net loss for fiscal 2004).

 

(ii)           Our auditors also identified a material weakness in ourconsolidation controls.  During GrantThornton’s audit, errors were noted in the Company’s consolidation,specifically with respect to eliminating entries.  Such errors are due to the complexity of theconsolidation, in addition to a lack of certain formal procedures and expertisenecessary to ensure an accurate consolidation. Primarily due to the Company’s acquisition of Poet Holdings, Inc., whichsignificantly increased the number of our corporate subsidiaries and thequantity of inter-company transactions, the Company’s consolidation ofaccounting information has become a complex and time-consuming process(especially as it relates to inter-company eliminations).  The current consolidation process is botherror-prone and inefficient.

 

At the time it advised our audit committee of its aboveconclusions, Grant Thornton also advised the audit committee of the followingsignificant deficiencies in our internal controls:

 

•      Monitoring controls over the recording and analysis of revenuetransactions (particularly multiple element transactions) are in need ofimprovement. There are currently no established or documented policies andprocedures that require review of revenue entries and related analysisperformed by accounting personnel.  Theneed for additional training of personnel dealing with the recording and reviewof revenue transactions was also identified as an area for improvement.

 

•      Inadequate segregation of duties was noted with respect to therevenue, expenditure and payroll processes as numerous incompatible tasks areperformed by the same accounting personnel. The 

 

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Company needs to review current policies and procedures toensure that incompatible duties are not performed by one individual or thatthere are specific compensating controls if incompatible duties cannot be avoided.

 

The material weaknessesand significant deficiencies in internal controls described above still exist;howeverin the quarter ended October 31, 2004 we took certain actions to improve ourdisclosure controls and procedures and our internal control over financialreporting that are described below in subparagraph (i) of part (b) of this Item9A (see “Changes in Internal Control Over Financial Reporting”).  In addition, following the close ofour fiscal year on October 31, 2004, we have taken several other affirmativesteps to begin the process of remediating these weaknesses in controls asdescribed more fully in subparagraph (ii) of part (b) of this Item 9A.  We expect the significant remaining actionsnecessary to address our existing weaknesses will be addressed as part of ourSarbanes-Oxley 404 compliance program, which we have recently begun and withwhich we must be in compliance by October 31, 2005.  These significant remaining actions include:

 

•      Creationof a standard reporting package for all our consolidated entities to ensurethat the information necessary for a complete and accurate consolidation isprepared at the individual entity level, and the creation of procedures tofacilitate consistent and complete inter-company eliminations.

 

•      Development of formal policies andprocedures, including enhanced closing procedures, procedures for the proactivereview of revenue transactions and procedures for identifying, addressing andresolving the accounting and related disclosure for significant and complextransactions.

 

•      Enhancement of our closing procedures to provide for morerigorous review of all account reconciliations; and enhanced procedures forensuring proper expense cut-off.

 

•      Review of our current policies and procedures to develop processesso that incompatible duties are not performed by one individual or that thereare specific compensating controls if incompatible duties cannot be avoided.

 

When in certain of theCompany’s prior filings under the Securities Exchange Act officers of Versantprovided conclusions regarding the effectiveness of our disclosure controls andprocedures, they believed that their conclusions were accurate and that certainamendments made to our Exchange Act filings during the fiscal year endedOctober 31, 2004 to address certain accounting matters were not indicative ofmaterial weakness in our disclosure controls and procedures.  However, after receiving and assessing theformal advice regarding our controls that our independent auditors provided inthe course of the audit of our financial statements for the year ended October31, 2004, our Chief Executive Officer and Chief Financial Officer have reachedthe conclusions set forth above in the first paragraph of part (a) of this Item9A.  As noted above, we have been andcontinue to be engaged in efforts to improve our disclosure controls andprocedures, and we expect that these efforts will, over time, positivelyaddress the weaknesses noted by our independent auditors.

 

We believe that thematerial weaknesses and significant deficiencies in our internal controlsidentified by our independent auditors and described above do not materiallyaffect the fairness or accuracy of the presentation of our financial conditionand results of operation in our historical financial statements as set forth inour reports previously filed with the SEC under the Securities Exchange Act of1934.

 

(b)           Changes in Internal Control OverFinancial Reporting.  SEC rulesdefine the term “internal control over financial reporting” as a processdesigned by, or under the supervision of, the Company’s principal executive andprincipal financial officers, or persons performing similar functions, andeffected by the Company’s board of directors, management and other personnel,to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles and includes thosepolicies and procedures that:

 

•      Pertain to the maintenance of records that in reasonable detailaccurately and fairly reflect the transactions and dispositions of the assetsof the Company;

 

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•      Provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures ofthe Company are being made only in accordance with authorizations of managementand directors of the Company; and

 

•      Provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use or disposition of the Company’sassets that could have a material effect on the financial statements.

 

(i)            Duringthe fiscal quarter ended October 31, 2004, we made the following changes in theCompany’s internal control over financial reporting that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting:

 

•      We simplified our subsidiary structure in Europe and reducedthe number of subsidiaries we will need to consolidate in fiscal 2005.

 

•      We made changes in our accounting personnel and launched asearch for a new Director of Finance / Corporate Controller.

 

•      We re-organized responsibilities within our accountingorganization to provide a stronger focus on our SEC reporting and to increasethe total internal person-hours dedicated to the SEC reporting process.

 

•      We increased employee training on SEC reporting requirementsand subscribed to an accounting research service in an effort to keep morecurrent with accounting pronouncements and financial reporting matters.

 

(ii)           Subsequentto the period ended October 31, 2004, we have also taken the following actionsthat have materially affected, or are reasonably likely to materially affect,the Company’s internal control over financial reporting:

 

•      We recently hired a new corporate controller to enhance ourinternal accounting expertise.

 

•      We established a formal disclosure committee comprised of oneaudit committee member and senior management to assist the Company withquestions involving internal control over financial reporting or otherdisclosure controls.

 

•      We retained an independent consulting firm with expertise in SECreporting to assist us with our future SEC filings.

 

•      We are in the process of engaging a firm with therequisite experience and expertise to assist us in our Sarbanes-Oxley 404implementation and compliance within the timeframe required by law.

 

The certifications ofVersant’s chief executive officer and chief financial officer attached asExhibits 31.1 and 31.2 to this Annual Report on Form 10-K include, in paragraph4 of such certifications, information concerning Versant’s disclosure controlsand procedures and internal control over financial reporting. Suchcertifications should be read in conjunction with the information contained inthis Item 9A for a more complete understanding of the matters covered by suchcertifications.

 

83

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**Item 9B****.  Other Information.**

 

None

 

**PART III**

 

**Item 10****. Directors and Executive Officers of the Registrant**

 

The information about directors required for this Itemis incorporated by reference from our Proxy Statement to be filed in connectionwith our 2004 Annual Meeting of Shareholders. Information about executive officers that is required for this Item canbe found in Item 4A of this report.

 

The Board has adopted a Code of Conduct and Ethicsthat applies to Versant’s principal executive officer, principal financialofficer and all other employees of the Company. This Code of Conduct and Ethics is posted on our website athttp://www.versant.com.  We intend tosatisfy the disclosure requirement under Item 10 of Form 8-Kregarding any amendment to, or waiver from, a provision of this Code of Conductand Ethics by posting such information on our website at http://www.versant.comon the investors’ relations page.

 

**Item 11****.  Executive Compensation**

 

The information required for this Item is incorporatedby reference from our Proxy Statement to be filed in connection with our 2005Annual Meeting of Shareholders.

 

**Item 12****.  Security Ownership of CertainBeneficial Owners and Management and Related Shareholder Matters**

 

The information required for this Item is incorporated by referencefrom our Proxy Statement to be filed in connection with our 2005 Annual Meetingof Shareholders.

 

**Item 13****.  Certain Relationships andRelated Transactions.**

 

The information required for this Item is incorporated by referencefrom our Proxy Statement to be filed in connection with our 2005 Annual Meetingof Shareholders.

 

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**Item 14****.  Principal Accountant Fees andServices**

 

The information required for this Item is incorporatedby reference from our Proxy Statement to be filed in connection with our 2005Annual Meeting of Shareholders.

 

**Item 15****.  Exhibits and FinancialStatement Schedules.**

 
| (a)    |   | 1.     |   | The following financial statements are filed in Item  8 of this report on Form 10-K:                                                             |
|--------|--------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                             |
|   |   |   |   | Reports of Independent Registered Public Accounting  Firm                                                                                        |
|   |   |   |   | Consolidated Balance Sheets                                                                                                                      |
|   |   |   |   | Consolidated Statements of Operations                                                                                                            |
|   |   |   |   | Consolidated Statements of Shareholders’ Equity                                                                                             |
|   |   |   |   | Consolidated Statements of Cash Flows                                                                                                            |
|   |   |   |   | Notes to Consolidated Financial Statements                                                                                                       |
|   |   |   |   |                                                                                                                                             |
|   |   | 2.     |   | The following financial statement schedule is filed  at the end of Item 8 of this report on Form 10-K:                                           |
|   |   |   |   |                                                                                                                                             |
|   |   |   |   | Schedule II - Valuation and Qualifying Accounts and  Reserves                                                                                    |
|   |   |   |   |                                                                                                                                             |
|   |   | 3.     |   | The exhibit list in the “Exhibit Index” is  incorporated herein by reference as the list of exhibits required as part of  this report. |

 

85

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
|   | VERSANT  CORPORATION                         |            |
|--------|----------------------------------------------|-----------------|
|   |                                         |            |
|   |                                         |            |
|   | By:                                          | /s/ Lee McGrath |   |   |
|   | Lee McGrath                                  |            |
|   | Vice President,  Finance and Administration, |            |
|   | And Chief  Financial Officer                 |            |
|   | Date: February  14, 2005                     |            |
|        |                                              |                 |  |  |

 

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**POWER OF ATTORNEY**

 

By signing this Form 10-K below, I hereby appoint eachof Nick Ordon and Lee McGrath as my attorneys-in-fact to sign all amendments tothis Form 10-K on my behalf, and to file this Form 10-K (including all exhibitsand other documents related to the Form 10-K) with the Securities and ExchangeCommission.  I authorize each of myattorneys-in-fact to (1) appoint a substitute attorney-in-fact for himself and(2) perform any actions that he believes are necessary or appropriate to carryout the intention and purpose of this Power of Attorney.  I ratify and confirm all lawful actionstaken, directly or indirectly, by my attorneys-in-fact and by any properlyappointed substitute attorneys-in-fact.

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the Registrant and in the capacities and on the datesindicated.

 
| **Name**                                                      | ** ** | **Title**  | ** **                                  | **Date**   |
|---------------------------------------------------------------|------------|------------|---------------------------------------------|------------|
| ** **                                                    | ** ** | ** ** | ** **                                  | ** ** |
| PRINCIPAL EXECUTIVE OFFICER:                                  |       |       |                                        |       |
|                                                          |       |       |                                        |       |
| /s/ Nick Ordon                                                |       |       | President, Chief                            |       | February 10, 2005 |
| Nick Ordon                                                    |       |       | Executive Officer and                       |       |   |
|                                                          |       |       | Director                                    |       |   |
|                                                          |       |       |                                        |       |   |
|                                                          |       |       |                                        |       |   |
| /s/ Jochen Witte                                              |       |       | ****President, European Operations****  and |       | February 10, 2005 |
| Jochen Witte                                                  |       |       | Director                                    |       |   |
|                                                          |       |       |                                        |       |   |
|                                                          |       |       |                                        |       |   |
| PRINCIPAL FINANCIAL OFFICER AND  PRINCIPAL ACCOUNTING OFFICER |       |       |                                        |       |
|                                                          |       |       |                                        |       |   |
| /s/ Lee McGrath                                               |       |       | Vice President-Finance                      |       | February 10, 2005 |
| Lee McGrath                                                   |       |       | and Administration, and Chief               |       |   |
|                                                          |       |       | Financial Officer                           |       |   |
|                                                          |       |       |                                        |       |   |
|                                                          |       |       |                                        |       |   |
| ADDITIONAL DIRECTORS:                                         |       |       |                                        |       |   |
|                                                          |       |       |                                        |       |   |
| /s/ Uday Bellary                                              |       |       | Director                                    |       | February 10, 2005 |
| Uday Bellary                                                  |       |       |                                        |       |   |
|                                                          |       |       |                                        |       |   |
| /s/ William Henry Delevati                                    |       |       | Director                                    |       | February 10, 2005 |
| William Henry Delevati                                        |       |       |                                        |       |   |
|                                                          |       |       |                                        |       |   |
| /s/ Herbert May                                               |       |       | Director                                    |       | February 10, 2005 |
| Herbert May                                                   |       |       |                                        |       |   |

 

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**EXHIBIT INDEX**

 

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                        | ** ** | **Incorporated  by Reference** | ** ** | **Filed**  |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|------------|
| **Number**  | ** ** | **Exhibit  Description**                                                                                                                                                                                                          | ** ** | **Form**                       | ** ** | **Date**   | ** ** | **Number** | ** ** | **Herewith** |
| 2.01        |       | Agreement and Plan of Reorganization dated as of  November 19, 2002 by and among the Registrant, VM Merger Corp., Mokume  Software, Inc. and the stockholders of Mokume Software, Inc. †                                     |       | 8-K                            |       | 11/27/02   |   | 2.01 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 2.02        |       | Amendment Agreement dated September 26, 2003 by and  among the Registrant and former stockholders of Mokume Software, Inc.                                                                                                        |       | 8-K                            |       | 10/03/03   |   | 99.01 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 2.03        |       | Agreement and Plan of Merger with Poet Holdings,  Inc. dated September 27, 2003 by and among the Registrant, Puma  Acquisition Inc. and Poet Holdings Inc. †                                                            |       | 8-K                            |       | 09/29/03   |   | 99.01 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 2.04        |       | Amendment to Agreement and Plan of Merger, dated as  of January 20, 2004, by and among the Registrant, Poet Holdings, Inc.  and Puma Acquisition, Inc.                                                                       |       | S-4/A                          |       | 2/2/04     |   | 2.2 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 2.05        |       | Share Purchase and Transfer Agreement dated as of  September 13, 2004 between Poet Software GmbH and ems ePublishing AG and  attached list of annexes thereto (translated to English from the original  German text). † |       | 8-K                            |       | 9/17/03    |   | 2.1 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 3.01        |       | Registrant’s Amended and Restated Articles of  Incorporation of the Company, filed with the California Secretary of State on  March 18, 2004                                                                                 |       | S-8                            |       | 03/24/2004 |   | 4.01 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 3.02        |       | Registrant’s Amended and Restated Bylaws                                                                                                                                                                                     |       |                           |       |       |   |   |   | ý |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 10.01       |       | Registrant’s 1996 Directors Stock Option Plan, as  amended as of July 30, 2003, and related documents**                                                                                                                 |       | S-8                            |       | 08/14/03   |   | 4.06 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 10.02       |       | Registrant’s 1996 Employee Stock Purchase Plan, as  amended as of August 17, 2004 and related documents**                                                                                                                    |       |                           |       |       |   |   |   | ý |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 10.03       |       | Registrant’s 1996 Equity Incentive Plan, as amended  as of April 18, 2002, and related documents**                                                                                                                           |       | S-8                            |       | 05/09/02   |   | 4.05 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 10.04       |       | Poet Holdings, Inc. Amended and Restated 1995 Stock  Plan and Forms of Stock Option Agreement and Exercise Notice thereunder.**                                                                                                   |       | S-8                            |       | 3/24/04    |   | 4.5 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 10.05       |       | Poet Holdings, Inc. 1999 Director Option Plan and  Forms of Director Option Agreement and Director Option Exercise Notice  thereunder.**                                                                                          |       | S-8                            |       | 3/24/04    |   | 4.6 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 10.06       |       | Poet Holdings, Inc. 2001 Non Statutory Stock Option  Plan and Forms of Stock Option Agreement and Exercise Notice thereunder.**                                                                                                   |       | S-8                            |       | 3/24/04    |   | 4.7 |   |   |
|        |       |                                                                                                                                                                                                                              |       |                           |       |       |   |   |   |   |
| 10.07       |       | Form of Letter from Registrant to option holders of  Poet Holdings, Inc., regarding assumption of options by Registrant.                                                                                                     |       | S-8                            |       | 3/24/04    |   | 99.01 |   |   |

 

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| 10.09  |   | Form of Indemnity Agreement entered into by  Registrant with each of its directors and executive officers                                                                                                                                                 |       |       |   |     |   |   |   | ý |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|--------|----------|--------|--------|--------|--------|
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 10.10  |   | Form of Amendment to Versant Corporation Stock  Option Agreement**                                                                                                                                                                                        |       | SB-2       |   | 7/16/96  |   |   |   |   |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 10.11  |   | Lease Agreement dated November 25, 1996 between John  Arrillaga, Trustee et al. and Registrant                                                                                                                                                            |       | 10-KSB     |   | 04/03/98 |   | 10.15  |   |   |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 10.12  |   | Letter Agreement dated November 26, 1997 between  Registrant and Nick Ordon**                                                                                                                                                                             |       | 10-KSB     |   | 03/31/97 |   | 10.18  |   |   |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 10.13  |   | Offer letter dated June 26, 2000 between Registrant  and Lee McGrath**                                                                                                                                                                                    | ** ** |       |   |     |   |   |   | ý |
|   |   |                                                                                                                                                                                                                                                      | ** ** | ** ** |   |     |   |   |   |   |
| 10.14  |   | Managing Director Service Contract between Poet  Software GmbH, a wholly owned subsidiary of Registrant, and Jochen Witte**                                                                                                                               | ** ** |       |   |     |   |   |   | ý |
|   |   |                                                                                                                                                                                                                                                      | ** ** | ** ** |   |     |   |   |   |   |
| 10.15  |   | Registration Rights Agreement dated October 16, 1998  between the Registrant and Vertex Technology Fund Pte. Ltd.                                                                                                                                         |       | 10-KSB     |   | 03/31/99 |   | 10.31  |   |   |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 10.18  |   | Registration Rights Agreement dated December 28,  1998 between the Registrant and the parties listed on the Schedule of  Investors attached thereto                                                                                                       |       | 10-KSB     |   | 03/31/99 |   | 10.35  |   |   |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 10.20  |   | Form of Registrant’s Common Stock Purchase Warrant  in connection with that certain Preferred Stock and Warrant Purchase  Agreement dated June 28, 1999 between the Registrant and the parties listed  on the Schedule of Investors attached thereto |       | 8-K        |   | 07/13/99 |   | 10.02  |   |   |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 10.21  |   | Supplement dated June 28, 1999 to Registration  Rights Agreement among the Registrant and the parties listed on the Schedule  of Investors attached thereto                                                                                               |       | 8-K        |   | 07/13/99 |   | 10.02  |   |   |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 10.22  |   | Preferred Stock Conversion Agreement dated as of  September 26, 2003 by and amount the Registrant, Vertex Technology Fund,  Ltd., Vertex Technology Fund (II), Ltd. and the Joseph M. Cohen Family  Limited Partnership                                   |       | 8-K        |   | 09/29/03 |   | 99.02  |   |   |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 16.01  |   | Letter dated June 24, 2003 from KPMG LLP regarding  change in Registrant’s certifying accountant                                                                                                                                                     |       | 8-K        |   | 6/25/03  |   | 16     |   |   |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 21.01  |   | Subsidiaries of the Registrant                                                                                                                                                                                                                            |       |       |   |     |   |   |   | ý |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 23.01  |   | Consent of Grant Thornton LLP                                                                                                                                                                                                                             |       |       |   |     |   |   |   | ý |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 23.02  |   | Consent of KPMG LLP                                                                                                                                                                                                                                       |       |       |   |     |   |   |   | ý |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 31.01  |   | Rule 13a-14(a)  Certification of Principal Executive Officer                                                                                                                                                                                              |       |       |   |     |   |   |   | ý |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 31.02  |   | Rule 13a-14(a)  Certification of Principal Financial Officer.                                                                                                                                                                                             |       |       |   |     |   |   |   | ý |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 32.01  |   | Section 1350  Certification of Principal Executive Officer                                                                                                                                                                                                |       |       |   |     |   |   |   | ý |
|   |   |                                                                                                                                                                                                                                                      |       |       |   |     |   |   |   |   |
| 32.02  |   | Section 1350  Certification of Principal Financial Officer                                                                                                                                                                                                |       |       |   |     |   |   |   | ý |

 

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†              Pursuant to Item601(b)(2) of Regulations of S-K, certain annexes, exhibits and schedules tothis Exhibit have been omitted but will be furnished supplementally to theCommission upon request.

 

89

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**           Management contract orcompensatory plan.

 

90

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