VERSO TECHNOLOGIES INC - 10-Q Quarterly Report

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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Quarter Ended June 30, 2002

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT

For the transition period from to _________

Commission file number 0-22190

---------------------------------------

VERSO TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)

MINNESOTA 41-1484525
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)

400 Galleria Parkway, Suite 300, Atlanta, GA 30339
(Address of principal executive offices)

(678) 589-3500
(Issuer's telephone number)

--------------------------------------

Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act of 1934 during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. Yes
[X] No[ ].

Shares of the Registrant's Common Stock, par value $.01 per share, outstanding
as of August 13, 2002: 79,005,006.

VERSO TECHNOLOGIES, INC.
FORM 10-Q

INDEX

Part I. FINANCIAL INFORMATION

Page No.
--------

Item 1.

Condensed Consolidated Balance Sheets as of June 30, 2002 and
December 31, 2001 ................................................. 2

Condensed Consolidated Statements of Operations for the three months
and the six months ended June 30, 2002 and 2001.................... 3

Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2002 and 2001....................................... 4

Notes to the Condensed Consolidated Financial Statements............ 6

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ....................................... 21

Item 3. Quantitative and Qualitative Disclosures about Market Risk.... 31

PART II. OTHER INFORMATION

Item 1. Legal Proceedings ............................................ 32

Item 2. Changes in Securities and Use of Proceeds .................... 32

Item 6. Exhibits and Reports on Form 8-K ............................. 33

Signature Page ........................................................ 35

Exhibit Index ......................................................... 36

PART I-ITEM 1: FINANCIAL STATEMENTS
VERSO TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(Unaudited)

JUNE 30, DECEMBER 31,
2002 2001
------------------------------

ASSETS:
Current assets:
Cash and cash equivalents $ 3,653 $ 7,745
Accounts receivable, net 11,924 9,047
Inventories, net 3,624 3,995
Other current assets 935 1,104
Assets of discontinued operations - 582

----------- -------------
Total current assets 20,136 22,473

Property and equipment, net 6,189 7,337
Intangibles, net 14,702 15,949
----------- -------------

Total assets $ 41,027 $ 45,759
=========== =============

LIABILITIES AND SHAREHOLDERS' EQUITY:
Current liabilities:
Note payable for the purchase of NACT $ 2,750 $ 5,340
Accounts payable 2,197 1,624
Accrued compensation 2,293 3,130
Accrued expenses 5,266 6,127
Unearned revenue and customer deposits 5,558 5,904
Current portion of liabilities of discontinued operations 2,773 3,128
----------- -------------

Total current liabilities 20,837 25,253

Liabilities of discontinued operations, net of current portion 1,503 1,772
Convertible subordinated debentures, net of discount 3,566 3,428
----------- -------------

Total liabilities 25,906 30,453
----------- -------------

Shareholders' equity:
Common stock, $.01 par value, 200,000,000 shares authorized;
78,906,406 and 77,619,654 shares issued and outstanding 789 776
Additional paid-in capital 272,269 271,462
Notes receivable from shareholders (1,632) (1,620)
Accumulated deficit (253,920) (252,131)
Deferred compensation (2,367) (3,166)
Accumulated other comprehensive loss - foreign currency translation (18) (15)
----------- -------------

Total shareholders' equity 15,121 15,306
----------- -------------
Total liabilities and shareholders' equity $ 41,027 $ 45,759
=========== =============

The accompanying notes are an integral part of these condensed consolidated
financial statements.

- 2-

VERSO TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except share data)

FOR THE THREE MONTHS ENDED JUNE 30, FOR THE SIX MONTHS ENDED JUNE 30,
2002 2001 2002 2001
-----------------------------------------------------------------------

Revenue:
Products $ 6,086 $ 2,088 $ 12,690 $ 2,827
Services 5,585 3,407 10,975 6,830
-------- -------- -------- ------
Total revenue 11,671 5,495 23,665 9,657

Cost of revenue:
Products 2,274 1,778 4,605 2,072
Services 2,519 2,098 5,137 4,357
-------- -------- -------- ------
Total cost of revenue 4,793 3,876 9,742 6,429
Gross profit:
Products 3,812 310 8,085 755
Services 3,066 1,309 5,838 2,473
-------- -------- -------- ------
Gross profit 6,878 1,619 13,923 3,228
Operating expenses:
General and administrative 2,996 2,275 6,108 4,847
Sales and marketing 1,866 352 3,631 833
Research and development 1,464 273 3,139 492
Depreciation 716 373 1,478 789
Amortization of intangibles 147 375 289 749
Amortization of deferred compensation 324 484 648 967
-------- -------- -------- ------
Total operating expenses 7,513 4,132 15,293 8,677
-------- -------- -------- ------

Operating loss from continuing operations (635) (2,513) (1,370) (5,449)

Other income 345 - 431 -

Interest expense, net, including $170, $116, $265 and
$353 of amortization of loan fees and discount on
convertible subordinated debentures in the three months and
the six months ended June 30, 2002 and 2001. (309) (164) (519) (406)
-------- -------- -------- ------

Loss from continuing operations before income taxes
and extraordinary item (599) (2,677) (1,458) (5,855)

Income taxes - - - -
-------- -------- -------- ------
Loss from continuing operations before extraordinary item (599) (2,677) (1,458) (5,855)

Loss from discontinued operations, net of income taxes - (103,024) (331) (116,214)
-------- -------- -------- ------

Loss before extraordinary item (599) (105,701) (1,789) (122,069)

Extraordinary item - loss from debt conversion - - - 1,640
-------- -------- -------- ------

Net loss $ (599) $ (105,701) $ (1,789) $ (123,709)
========== ========== ========== ==========

Net loss per common share - basic and diluted:
Loss before discontinued operations and extraordinary item $ (0.01) $ (0.05) $ (0.02) $ (0.12)
Loss from discontinued operations - (2.02) - (2.28)
-------- -------- -------- ------
Loss before extraordinary item (0.01) (2.07) (0.02) (2.40)
Extraordinary item - loss from debt conversion - - - (0.03)
-------- -------- -------- ------

Net loss per common share - basic and diluted $ (0.01) $ (2.07) $ (0.02) $ (2.43)
========== ========== ========== ==========

Weighted average shares outstanding - basic and diluted 78,254,493 51,120,684 78,069,301 50,829,910
========== ========== ========== ==========

The accompanying notes are an integral part of these condensed consolidated
financial statements.
3

VERSO TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)

FOR THE SIX MONTHS ENDED JUNE 30,
2002 2001
------------------------------------------

Operating Activities:
Continuing operations:
Net loss from continuing operations $ (1,458) $ (7,495)
Adjustments to reconcile net loss from continuing operations to net
cash used in continuing operating activities:
Extraordinary item - loss on debt conversion - 1,640
Amortization of intangibles 289 749
Depreciation 1,478 789
Amortization of deferred compensation 648 967
Provision for doubtful accounts 804 93
Inventory valuation reserve 171 -
Amortization of loan fees and discount on convertible subordinated debentures 265 353
Other 86 (1)
Changes in current operating items:
Accounts receivable, net (3,462) 14
Inventories, net 200 -
Other current assets 253 (739)
Accounts payable 573 720
Accrued compensation (837) (736)
Accrued expenses (498) (1,388)
Unearned revenue and customer deposits (346) (276)
-------- --------
Net cash used in continuing operating activities (1,834) (5,310)
-------- --------

Discontinued operations:
Loss from discontinued operations (331) (116,214)
Adjustment to reconcile loss from discontinued operations
to net cash (used in) provided by discontinued operating activities (127) 110,557
-------- --------
Net cash used in discontinued operating activities (458) (5,657)
-------- --------
Net cash used in operating activities (2,292) (10,967)
-------- --------

Investing Activities:

Continuing operations:
Purchased software development costs (161) -
Purchases of property and equipment, net (446) (947)
-------- --------
Net cash used in investing activities for continuing operations (607) (947)

Discontinued operations -
Net proceeds from sale of discontinued operations - 8,158
-------- --------
Net cash (used in) provided by investing activities (607) 7,211
-------- --------
Net cash used in operating and investing activities, carried forward (2,899) (3,756)
========= ========

4

VERSO TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(Unaudited)

FOR THE SIX MONTHS ENDED JUNE 30,
2002 2001
-------- -------

Net cash used in operating and investing activities, carried forward (2,899) (3,756)
-------- -------
Financing Activities:
Payments of note payable for the purchase of NACT (1,500) -
Payments on convertible subordinated debentures - (4,500)
Payments of notes receivable from shareholders 15 -
Proceeds from issuances of common stock, net 292 182
-------- -------
Net cash used in financing activities (1,193) (4,318)
-------- -------

Decrease in cash and cash equivalents (4,092) (8,074)
Cash and Cash Equivalents:
Beginning of period 7,745 11,155
-------- -------
End of period $ 3,653 $ 3,081
======== =======
Supplemental disclosure of cash flow information:
Cash payments during the period for:
Interest $ 147 $ 53
======== =======
Income taxes $ 38 $ 14
======== =======
Non-cash investing and financing activities

Common stock and compensatory
options issued in reorganization $ - $ 21
======== =======
Issuance of warrants in exchange for services $ 211 $ 92
======== =======
Issuance of common stock in exchange for services $ - $ 19
======== =======
Conversion of subordinated debentures to common stock - issuance of 1,496,598
shares of common stock and 945,378 common stock warrants $ - $ 2,877
======== =======
Issuance of common stock in arbitration settlement $ 403 $ -
======== =======

The accompanying notes are an integral part of these condensed consolidated
financial statements.

5

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002

1. BASIS OF PRESENTATION

Verso Technologies, Inc. and subsidiaries (the "Company"), is a
communications technology and solutions provider for communications
service providers and enterprises seeking to implement
application-based telephony services, Internet usage management tools
and outsourced customer support services. The Company's continuing
operations consist of two separate business segments, Gateway
Solutions, which includes the Company's subsidiary NACT
Telecommunications, Inc. ("NACT"), and Applications and Services, which
includes its customer response center operations and its subsidiary
Telemate.Net Software, Inc. ("Telemate.Net"). The Gateway Solutions
segment includes domestic and international sales of hardware and
software, integration, applications and technical training and support.
The Applications and Services segment offers primarily domestic network
management, support and maintenance, customer response center services
and application services. The Company acquired NACT in July 2001 and
Telemate.Net in November 2001. The Company's discontinued operations
include its value-added reseller ("VAR") business and associated
consulting practice ("legacy VAR business") and its hospitality
services group, which developed and marketed proprietary software and
related integration and maintenance services ("HSG").

The consolidated financial statements include the accounts of Verso
Technologies, Inc. and its wholly-owned subsidiaries, including
Telemate.Net which was acquired by the Company on November 16, 2001,
NACT which was acquired by the Company on July 27, 2001 and
MessageClick, Inc. ("MessageClick"), which was acquired by the Company
on November 22, 2000, each in transactions accounted for as purchases
(see Note 2).

Certain prior year amounts in the consolidated financial statements
have been reclassified to conform with the current year presentation.
These reclassifications had no effect on previously reported net loss.

The Company has adopted the consensus of Emerging Issues Task Force
Issue No. 01-14, "Income Statement Characterization of Reimbursements
Received for `Out-of-Pocket' Expenses Incurred."("EITF 01-14"). EITF
01-14 requires that reimbursements received for out-of-pocket expenses
be reflected as revenues and to reclassify prior period financial
statements to conform to the current period presentation. Prior to the
adoption of EITF 01-14, reimbursable out-of-pocket expenses were
reflected as a reduction to cost of revenue. Reimbursable out-of-pocket
expenses reclassified as service revenues for the three months and the
six months ended June 30, 2002 and 2001 were $179,000, $113,000,
$347,000 and $331,000, respectively.

The condensed consolidated quarterly financial statements are
unaudited. These statements include all adjustments (consisting of
normal recurring accruals) considered necessary by management to
present a fair statement of the results of operations, financial
position and cash flows. The results reported in these condensed
consolidated financial statements should not be regarded as necessarily
indicative of results that may be expected for the entire year.

The year-end condensed consolidated balance sheet was derived from
audited consolidated financial statements, but does not include all
disclosures required by generally accepted accounting principles. For
further information, refer to the audited consolidated financial
statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2001.

6

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

2. MERGERS AND ACQUISITIONS

Telemate.Net Software, Inc.

On November 16, 2001, to increase capital and add patented
communications billing and reporting for next-generation converged
Internet protocol and public switched telephone networks to the
Company's product offering, the Company acquired all of the outstanding
capital stock of Telemate.Net by means of a subsidiary merger. The
merger consideration was approximately $4.1 million, consisting of
24,758,070 shares of the Company's common stock with a fair value of
$16.6 million, based on a $0.67 average of the Company's common stock
price for the ten days prior to the date of acquisition, assumed
options to acquire 5,420,206 shares of the Company's common stock with
exercise prices ranging from $.20 to $5.42 per share (estimated fair
value of $1.8 million, using the Black-Scholes option pricing model
based on the following weighted-average assumptions: expected
volatility - 128%; expected life - one year; risk-free interest rate -
3.3%; and expected dividend yield - 0%), deferred compensation of
$131,000 and acquisition costs of approximately $2.0 million, reduced
by retirement of Series B redeemable preferred stock ("Series B
Preferred Stock") of $15.0 million and $438,000 of accrued interest
thereon and notes receivable from shareholders assumed of $947,000.

The acquisition was treated as a purchase for accounting purposes, and
accordingly, the assets and liabilities were recorded at their fair
value at the date of the acquisition. The excess of the purchase price
over the estimated fair value of net assets acquired totaled
approximately $1.3 million and was allocated to goodwill. In accordance
with Statement of Financial Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"), the Company is not
amortizing this goodwill.

The Company has prepared an initial allocation of the purchase price
based on the estimated fair values of certain intangible assets,
receivables and estimated liabilities. The Company is continuing to
obtain information as to ultimate valuation, recoverability and
realization with respect to the fair values of certain contingent
liabilities and anticipates the allocation of purchase price to be
finalized prior to the end of the fourth quarter of 2002.

NACT Telecommunications, Inc.

On July 27, 2001, the Company acquired all of the outstanding capital
stock of NACT to enter the next-generation networking and technology
market. The purchase consideration was approximately $20.6 million,
consisting of a cash payment of $14.2 million at closing funded
primarily by the Company's sale of $15 million of the Company's Series
B Preferred Stock to Telemate.Net, an additional amount payable on
March 31, 2002 of up to $5.3 million plus interest at prime, a grant to
NACT employees of in-the-money non-qualified options with a value of
$625,000 and acquisition costs of approximately $500,000.

On March 29, 2002, the Company entered into a Settlement Agreement and
General Release (the "WATP Settlement Agreement") with WA Telcom
Products Co., Inc. ("WATP") which provided for a restructuring of the
deferred payment due by the Company to WATP pursuant to that certain
Stock Purchase Agreement, dated as of June 4, 2001, as amended (the
"Purchase Agreement"), between the Company and WATP, whereby the
Company purchased from WATP all of the issued and outstanding capital
stock of NACT, and NACT became a wholly-owned subsidiary of the
Company. Pursuant to the WATP Settlement Agreement, the Company's
obligation to pay to WATP the deferred payment (the "Deferred Amount")
on the date the Company filed its Annual Report on Form 10-K for the
year ended December 31, 2001, was restructured pursuant to the terms
and conditions of a Convertible Secured Promissory Note dated April 25,
2002, made by the Company in favor of WATP, in the aggregate principal
amount of $4.25 million, together with interest accrued thereon (the
"Note"). Pursuant to the WATP Settlement Agreement, the Company paid to
WATP $1.5 million on April 1, 2002, which payment was applied to the
$1.5 million payment due on April 25, 2002, by the Company to WATP
pursuant to the Note. The remainder of the amount due under the Note is
payable by the Company to WATP as follows: (i) $500,000 on each of July
1, 2002; October 1, 2002; and January 1, 2003; and (ii) $1.25 million
plus all interest accrued under the Note since April 1, 2002, on April
1, 2003. The WATP Settlement Agreement has been approved by the United
States Bankruptcy Court for the Northern District of Illinois, Eastern
Division, which has jurisdiction over WATP's pending bankruptcy
proceeding.

7

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

2. MERGERS AND ACQUISITIONS, Continued

NACT Telecommunications, Inc., Continued

Furthermore, pursuant to the WATP Settlement Agreement, the Company and
WATP released each other from claims against each other arising out of
or related to the Purchase Agreement. Management's estimate of the
claims against WATP totaled approximately $1.3 million, which equaled
the reduction of the deferred payment and previously accrued interest
expense on the deferred payment.

At WATP's option, WATP may, at any time within the thirty-day period
before a payment under the Note is due, convert some or all of the
amount due on such payment date into shares of the Company's common
stock at a conversion price of $1.36 per share. The Company's
obligation to pay amounts due under the Note is (i) secured by all the
assets of the Company, NACT and Telemate.Net and a pledge by the
Company of all the issued and outstanding common stock of NACT and
Telemate.Net, and (ii) guaranteed by NACT and Telemate.Net. The Note
and security interests are subordinate to the rights of the Bank
arising under the Credit Agreement and other documents executed in
connection therewith.

According to the terms of the definitive stock purchase agreement with
Telemate.Net, on July 27, 2001, Telemate.Net purchased $15 million of
Series B Preferred Stock to fund the Company's acquisition of NACT.

The acquisition was treated as a purchase for accounting purposes, and
accordingly, the assets and liabilities were recorded at their fair
value at the date of acquisition. The excess of the purchase price over
the estimated fair value of net assets acquired (including identified
intangible assets of $1.7 million, which are being amortized over a
three year life) totaled approximately $10.5 million, as adjusted, and
was allocated to goodwill. In accordance with SFAS 142, the Company is
not amortizing this goodwill.

The Company has prepared an initial allocation of the purchase price
based on the estimated fair values of certain intangible assets,
receivables and estimated liabilities, including the deferred payment.
The Company is continuing to obtain information as to ultimate
valuation, recoverability and realization with respect to the fair
values of certain contingent liabilities and anticipates the allocation
of purchase price to be finalized in the third quarter of 2002.

Management has subsequently reviewed the liabilities assumed at the
time of the purchase of NACT and the liabilities assumed in the WATP
Settlement Agreement and adjusted its estimate of these liabilities.
Management reduced its estimate of liabilities by $900,000, which was
recorded as a reduction of goodwill in the previously allocated
purchase consideration.

The allocation of the purchase price for Telemate.Net and NACT, as
adjusted, are as follows:

Telemate.Net NACT
------------ --------

Cash $ 4,810 $ 2,538
Other current assets 1,361 10,547
Property and equipment 563 2,505
Intangibles 1,320 12,246
Current liabilities (4,079) (1,919)
Deferred payment on purchase of NACT -- (5,340)
Convertible subordinated debentures -- --
Deferred compensation 131 --
------- -------
Purchase consideration $ 4,106 $20,577
======= =======

8

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

2. MERGERS AND ACQUISITIONS, Continued

Prior to the purchase of NACT, the Company became an NACT reseller in
the first quarter of 2001. The Company resold NACT soft switching
systems with product revenues for the six months prior to acquisition
totaling $2.8 million and cost of product sales of $2.2 million.

Pro Forma Effect of Telemate.Net and NACT Transactions

The following unaudited pro forma information presents the results of
continuing operations of the Company for the six months ended June 30,
2001, as if the acquisitions of Telemate.Net and NACT had taken place
on January 1, 2001, (in thousands, except per share amounts):

JUNE 30,
2001
--------

Revenues $ 22,582
Loss from continuing operations $ (13,851)
Loss from continuing operations
per common share - basic and diluted $ (.18)
Loss before extraordinary item
per common share - basic and diluted $ (1.72)
Net loss per common share - basic and diluted $ (1.74)
Weighted average shares outstanding - basic and diluted 75,588

3. DISCONTINUED OPERATIONS

Following the acquisition of NACT in July 2001, the Company determined
that its legacy VAR business was not strategic to the Company's ongoing
objectives and discontinued capital and human resource investment in
this business. Accordingly, the Company elected to report its legacy
VAR business as discontinued operations by early adoption of SFAS No.
144, "Accounting for the Impairment of Disposal of Long-Lived Assets"
("SFAS 144") effective for the fourth quarter of 2001. These businesses
are included with HSG (which was reported as discontinued operations in
2001) for a combined presentation of discontinued operations. The
consolidated financial statements have been reclassified to segregate
the net assets and operating results of these combined discontinued
operations for all periods presented.

During 2000, the Company's board of directors decided to dispose of
HSG. In December 2000, the Company completed the sale of its domestic
lodging business and international hospitality business for aggregate
proceeds of $10.0 million. The Company sold its restaurant solutions
business for aggregate proceeds of $8.5 million in January 2001.

The loss on the sale of HSG totaled $11.5 million. A loss of $11.0
million was recorded in the third and fourth quarters of 2000 and an
additional $500,000 was recorded in the third quarter of 2001, the
latter related to winding up the Company's international hospitality
operations, the assets of which were sold in the fourth quarter of
2000.

9

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

3. DISCONTINUED OPERATIONS, Continued

Summary operating results of the discontinued operations for the three
months and six months ended June 30, 2002 and 2001 (in thousands) were
as follows:

The loss from discontinued operations in the three months ended June
30, 2001 includes depreciation of $273,000, amortization of intangibles
of $10.7 million, write-down of goodwill of $85.0 million,
reorganization costs of $2.8 million and amortization of deferred
compensation of $124,000. The loss from discontinued operations in the
six months ended June 30, 2001 includes depreciation of $546,000,
amortization of intangibles of $21.4 million, write-down of goodwill of
$85.0 million, reorganization costs of $2.8 million and amortization of
deferred compensation of $249,000.

Assets and liabilities of discontinued operations (in thousands) are as
follows:

JUNE 30, DECEMBER 31,
2002 2001
-------- ------------

Accounts receivable, net
$ -- $ 501
Other current assets -- 81
-------- --------
Assets of discontinued operations $ -- $ 582
======== ========

Accrued restructuring costs $ 2,603 $ 2,730
Accrued compensation 36 210
Other current liabilities 1,637 1,960
-------- --------
Liabilities of discontinued operations $ 4,276 $ 4,900
======== ========

The restructuring accrual relates to several leases for buildings and
equipment that are no longer being utilized in continuing operations.
The accrual is for all remaining payments due on these leases, less
amounts to be paid by any sublessors. The accrual for one lease with
total payments remaining of $2.8 million assumes that the building will
be sub-leased for 50% of the total lease liability over the term of the
lease.

10

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

3. DISCONTINUED OPERATIONS, Continued

Activity in the restructuring accruals was as follows:

Balance December 31, 2001 $2,730
Lease payments (434)
Additional restructuring accrual 307
------
Balance June 30, 2002 $2,603
======

4. INVENTORIES

Inventories consist primarily of purchased electronic components for
its Gateway Solutions segment, and are stated at the lower of cost or
market. Cost is determined by using the first-in, first-out method.

Inventories as of June 30, 2002 and December 31, 2001, are comprised of
the following (in thousands):

June 30, December 31,
2002 2001
-------- ------------
Raw materials $1,307 $1,677
Work in process 1,665 1,376
Finished goods 1,171 1,170
-------- ------------
Total inventories 4,143 4,223
Inventory reserve (519) (228)
-------- ------------
Inventories, net $3,624 $3,995
======== ============

5. INTANGIBLES

Intangible assets represent the excess of cost over the fair value of
net tangible assets acquired and identified other intangible assets.
These assets are amortized on a straight-line basis over estimated
useful lives of three years. Intangibles are evaluated for potential
impairment of value whenever events or changes in circumstances
indicate that full asset recoverability is questionable. Such
evaluations consider current as well as anticipated operating results
measured on the basis of undiscounted cash flows of the operation
relative to the asset. Goodwill associated with the acquisitions of
NACT and Telemate.Net (Note 2) is not being amortized in accordance
with SFAS 142.

11

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

5. INTANGIBLES, Continued

Intangible assets consist of the following (in thousands):

JUNE 30, DECEMBER 31,
2002 2001
-------- ------------
Intangibles subject to amortization
Purchased software development $ 1,909 $ 1,748
Accumulated amortization (525) (236)
------- -------
1,384 1,512

Intangibles not subject to amortization
Goodwill $13,318 $14,437
------- -------
Total intangibles $14,702 $15,949
======= =======

Estimated annual amortization expense is as follows (in thousands):

AMORTIZATION
------------
2002 $ 607
2003 636
2004 401
2005 29
-----
$1,673
======

The Company adopted SFAS 142 in the first quarter of 2002. Under the
provisions of SFAS 142, goodwill is no longer subject to amortization.
In the three and six months ended June 30, 2001, goodwill amortization
expense was $208,000 and $415,000, respectively. The impact of goodwill
amortization on basic and diluted loss per share is as follows (in
thousands, except per share amounts):

FOR THE THREE MONTHS ENDED JUNE 30, FOR THE SIX MONTHS ENDED JUNE 30,
2002 2001 2002 2001
------------------------------------ ---------------------------------

Reported net earnings $ (599) $ (105,701) $ (1,789) $ (123,709)
Add: Goodwill amortization -- 208 -- 415
----------- ---------- -------- ----------
Adjusted net earnings $ (599) $ (105,493) $ (1,789) $ (123,294)
=========== ========== ======== ==========

Basic and diluted earnings per share:
Reported net earnings $ (0.01) $ (2.07) $ (0.02) $ (2.43)
Goodwill amortization -- -- -- 0.01
----------- ---------- -------- ----------
Adjusted net earnings $ (0.01) $ (2.07) $ (0.02) $ (2.42)
=========== ========== ======== ==========

12

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

6. LOAN FACILITY WITH SILICON VALLEY BANK

In December 2001, the Company entered into a $5.0 million revolving
credit agreement (the "Credit Agreement") with Silicon Valley Bank (the
"Bank"). The Credit Agreement is secured by substantially all of the
assets of the Company. The interest rate (6.75% at June 30, 2002) is
computed at 2% above the Bank's Base Rate. The Credit Agreement
provides for up to $500,000 in letters of credit. Available borrowing
under the credit agreement is determined by a formula based on eligible
receivables, inventory, certain cash balances, outstanding letters of
credit and certain subjective limitations. Interest payments are due
monthly, and the Credit Agreement expires December 2002. The Credit
Agreement includes a loan fee of $50,000 and a fee of .25% on unused
available borrowings. The Company paid certain loan fees and attorney's
fees totaling approximately $106,000 in connection with the Credit
Agreement. Pursuant to the loan commitment letter with the Bank, the
Company agreed to issue to the Bank a warrant to purchase shares of the
Company's common stock if the Company did not raise additional equity
of $10.0 million by April 15, 2002. The Company did not raise such
additional equity and, as a result, on May 15, 2002, the Company issued
to the Bank a warrant to purchase 308,641 shares of the Company's
common stock at an exercise price of $.81 per share. The fair value of
the warrants issued, totaled approximately $211,000, using the
Black-Scholes option pricing method based on the following
weighted-average assumptions: expected volatility - 128%; expected life
- five years; risk-free interest rate - 3.3%; and expected dividend
yield - 0%. The loan fees, attorney's fees and fair value of the
warrants are being amortized to interest expense over the term of the
Credit Agreement.

The Company had no borrowings under the Credit Agreement as of June 30,
2002. The availability under the Credit Agreement at June 30, 2002 was
$4.6 million. Under the terms of the Credit Agreement, the Company is
required to maintain a minimum tangible net worth, computed quarterly,
and cannot declare dividends or incur any additional indebtedness
without the consent of the Bank, and must maintain other financial
covenants, as defined. The Company was in compliance with these
covenants as of June 30, 2002.

7. CONVERTIBLE SUBORDINATED DEBENTURES

In connection with the acquisition of MessageClick, certain investors
of MessageClick purchased $4.5 million of the Company's 7.5%
convertible subordinated debentures and warrants to purchase an
aggregate of 1,026,820 shares of the Company's common stock at an
exercise price of $7.30 per share. The debentures are convertible into
the Company's common stock at a conversion price of $4.41. The
convertible subordinated debentures are due November 22, 2005. The
debentures have been discounted to reflect the fair value of the
warrants issued, totaling approximately $1.4 million, using the
Black-Scholes option pricing method based on the following
weighted-average assumptions: expected volatility - 88%; expected life
- five years; risk-free interest rate - 5.5%; and expected dividend
yield - 0%. The unamortized discount totaled approximately $934,000 at
June 30, 2002. In addition, the Company paid certain private placement
fees and attorney's fees in connection with the sale of the debentures
totaling $50,000. The fees are being amortized to interest expense over
the term of the debentures.

The Company issued $7.0 million of its 5% convertible subordinated
debentures during the year ended December 31, 2000. The convertible
subordinated debentures were issued with warrants to purchase 368,322
shares of the Company's common stock at an exercise price of $4.98 per
share. The debentures were discounted to reflect the fair value of the
warrants issued, totaling approximately $1.0 million, using the
Black-Scholes option pricing method based on the following
weighted-average assumptions: expected volatility - 88%; expected life
- five years; risk-free interest rate - 5.5%; and expected dividend
yield - 0%. In addition, the Company paid certain private placement
fees (including 88,712 shares of the Company's common stock with a fair
value at the date of issuance totaling $350,000) and attorney's fees in
connection with the sale of the debentures totaling $454,000. The fees
were amortized to interest expense over the term of the debentures
until the debentures were retired or converted into the Company's
common stock.

13

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

7. CONVERTIBLE SUBORDINATED DEBENTURES, Continued

In January 2001, the Company modified the terms of its 5% convertible
subordinated debentures. According to the modified terms of the
agreement, the Company repurchased $4.5 million of the outstanding $7.0
million of its 5% convertible subordinated debentures. Of the remaining
$2.5 million in outstanding 5% convertible subordinated debentures,
$1.5 million were converted by the investors into the Company's common
stock at a price of $1.40 per share. The remaining $1.0 million of 5%
convertible subordinated debentures was converted at $1.19 per share.
In connection with this modification, the Company issued warrants to
purchase 954,455 shares of the Company's common stock at an exercise
price of $1.98 per share. The fair value of the warrants issued,
totaled approximately $977,000, using the Black-Scholes option pricing
method based on the following weighted-average assumptions: expected
volatility - 91%; expected life - five years; risk-free interest rate -
5.5%; and expected dividend yield - 0%. The cost of conversion,
including the warrants issued, totaled $1.6 million in the quarter
ended March 31, 2001.

The cost of conversion is reflected as an extraordinary item in the
statement of operations for the six months ended June 30, 2001 and
consisted of the following (in thousands):

Fair value of warrants issued $ 977
Write-off of related discount 365
Write-off of related loan fees 165
Beneficial conversion 107
Legal and other costs 26
------
$1,640
======

8. OTHER COMPREHENSIVE LOSS

The Company has adopted SFAS No. 130, "Reporting Comprehensive Income"
("SFAS 130"). SFAS 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the
adoption of this Statement had no impact on the Company's net income or
shareholders' equity. SFAS 130 requires that the Company's change in
foreign currency translation adjustments be included in other
comprehensive income. Comprehensive loss is shown in the following
table (in thousands):

THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2002 2001 2002 2001
----------------------------------- ------------------------------

Net loss $ (599) $ (105,701) $ (1,789) $ (123,709)
Other comprehensive loss:
Foreign currency translation -- -- (3) --
----------- ---------- -------- ----------
Comprehensive loss $ (599) $ (105,701) $ (1,792) $ (123,709)
=========== ========== ======== ==========

14

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

9. SEGMENT INFORMATION

As a result of the Company's acquisition of NACT, the Company is now
reporting information for two segments, Gateway Solutions and
Applications and Services (which the Company formerly referred to as
its Technology Services Group).

Gateway
Solutions: The Company's Gateway Solutions segment consists of
the operations of the Company's switching subsidiary,
NACT. The Company's Gateway Solutions segment
includes hardware and software, integration,
applications and technical training and support.
Prior to the Company's acquisition of NACT, the
Company became an NACT reseller in the first quarter
of 2001.

Applications
and Services: The Company's Applications and Services segment
consists of the operations of the Company's
customer response center services as well as the
operations of the Company's Telemate.Net subsidiary.
The Applications and Services segment offers network
management, support and maintenance, customer
response center services and application services.

Management evaluates the business segment performance based on
contributions before unallocated items. Inter-segment sales and
transfers are not significant.

Summarized financial information concerning the Company's reportable
segments is shown in the following table (in thousands):

GATEWAY APPLICATIONS
FOR THE THREE MONTHS ENDED JUNE 30, SOLUTIONS(a) AND SERVICES(a) TOTAL
- ----------------------------------- ------------- --------------- -----

2002
Revenue $ 7,080 $4,591 $11,671
Contribution before unallocated items 1,096 1,693 2,789
Goodwill and other intangibles 11,929 2,773 14,702
Total assets 28,422 3,846 32,268
Capital expenditures 222 -- 222

2001
Revenue $ 2,088 $3,407 $ 5,495
Contribution before unallocated items 310 459 769
Goodwill and other intangibles -- 1,978 1,978
Total assets -- 3,193 3,193
Capital expenditures -- -- --

(a) In 2002, Gateway Solutions includes costs associated with certain
corporate and administrative functions to support this business
unit, which functions are located in Utah. Prior to the
acquisition of NACT in July 2001, the Company became an NACT
reseller in the first quarter of 2001. The Company resold NACT
gateway solutions totaling $2.1 million with cost of product sales
of $1.8 million during the second quarter of 2001. Prior to the
acquisition of NACT, there were no identifiable assets or
operating expenses related to the Gateway Solutions segment.
Applications and Services includes no allocation of corporate
overhead costs, assets or capital expenditures. See also (b)
description.

15

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

9. SEGMENT INFORMATION, Continued

The following table reconciles the total contribution before
unallocated items to the loss from continuing operations before
extraordinary item (in thousands):

(b) All rent, utilities and other corporate office expenses, corporate
marketing expenses, corporate development costs and corporate
human resources, accounting and information technology functions
that support corporate, as well as, the Applications and Services
segment are reflected in unallocated corporate, sales, general and
administrative expenses. Office expenses, human resources,
accounting and information technology costs specifically related
to the Gateway Solutions segment are reflected in its contribution
before unallocated items.

Most warrants are vested when issued.

Options and warrants outstanding as of June 30, 2002 totaled
33,075,826.

The exercise price and number of outstanding warrants for certain
warrants previously issued have been adjusted according to their
antidilution provisions.

11. OTHER EVENTS

Settlement with RSL Communications, Ltd. and Affiliates

On or about July 6, 2000, RSL Communications, Ltd. (together with
certain of its affiliates (collectively, "RSL")) filed with the
American Arbitration Association a demand for arbitration against NACT,
which became a wholly-owned subsidiary of the Company on July 27, 2001.
In the arbitration, RSL claimed that, pursuant to a Sales Agreement
between RSL and NACT, NACT breached its obligation to indemnify and
defend RSL against patent infringement claims made against RSL by
Aerotel, Ltd. in an action pending in the United States District Court
for the Southern District of New York. RSL sought to recover from NACT
amounts paid by RSL to defend itself in such patent infringement
action, which RSL claimed was approximately $2.0 million, together with
other unspecified damages resulting from NACT's alleged breach. On
March 13, 2002, the Company entered into a Settlement Agreement and
General Release (the "RSL Settlement Agreement") with RSL, which
provided that the Company issue to RSL 523,430 shares of the Company's
common stock (the "Settlement Shares") and deposit $200,000 in escrow.
Pursuant to the terms of the RSL Settlement Agreement, the Company
filed with the Securities and Exchange Commission (the "SEC") a
Registration Statement on Form S-3 covering the resale of the
Settlement Shares. On June 17, 2002, the Company issued 523,430 shares
of the Company's common stock with a market value on the effective date
of the Form S-3 of approximately $403,000 and the $200,000 plus accrued
interest held in escrow was released to RSL at that time.

18

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

12. LITIGATION

Except as previously disclosed in the Company's Annual Report on Form
10-K for the year ended December 31, 2001 or as set forth below, the
Company is not a party to any material legal proceedings other than
ordinary routine claims and proceedings incidental to its business, and
the Company does not expect these claims and proceedings, either
individually or in the aggregate, to have a material adverse effect on
the Company.

As previously disclosed in the Company's Form 10-K for the year ended
December 31, 2001, on or about May 21, 2001, John M. Good, a former
employee of the Company, filed a lawsuit in the Court of Common Pleas,
Cuyahoga County, Ohio, against the Company claiming, among other
things, fraud, negligence, breach of fiduciary duty, breach of contract
and damages resulting from and related to the Company's alleged failure
to deliver 50,000 shares of the Company's common stock to Mr. Good upon
his exercise of an option to purchase such shares on or about January
3, 2000. Mr. Good seeks unspecified damages with respect to such
claims; however, based on the Company's further analysis of Mr. Good's
claims, in the opinion of the Company's management, the Company's
exposure to Mr. Good, were he to prevail in this matter, should not
exceed $550,000. The Company intends to defend such claims vigorously.
Trial for this case has been set for October 2002. Although no
assurances can be given as to the outcome of any lawsuit, in the
opinion of the Company's management, the final outcome in this matter
should not have a material adverse effect on the Company.

On or about February 8, 2002, William P. O'Reilly, a former executive
officer and director of the Company; Montana Corporation, Mr.
O'Reilly's consulting company; Clunet R. Lewis, a former officer of the
Company; and CLR Enterprises, Inc., Mr. Lewis' consulting company,
filed with the American Arbitration Association ("AAA") a demand for
arbitration against the Company. Messrs. O'Reilly and Lewis and their
respective consulting companies seek to have enforced the Consulting
Agreements dated April 1, 1999, as amended, to which they and the
Company are parties (the "Consulting Agreements"). Messrs. O'Reilly and
Lewis have claimed that the Company's attempt by written notice dated
June 1, 2001, to terminate the Consulting Agreements effective March
31, 2002, was ineffective and, as a result, such Consulting Agreements
have automatically renewed for additional two-year terms, which terms
expire on March 31, 2004. Under the terms of the Consulting Agreements,
Messrs. O'Reilly and Lewis are to receive, among other things,
consulting fees of $250,000 and $240,000 per year, respectively.
Messrs. O'Reilly and Lewis claim that such fees for the two-year
extension period shall become immediately due and payable in the event
Messrs. O'Reilly and Lewis prevail in the arbitration proceeding. The
Company intends to vigorously defend itself in this arbitration, and
although no assurances can be given as to the outcome of any
arbitration proceeding, in the opinion of the Company's management, the
final outcome in this matter should not have a material adverse effect
on the Company.

On or about April 29, 2002, Omni Systems of Georgia, Inc. ("Omni") and
Joseph T. Dyer ("Dyer") filed with the AAA a demand for arbitration
against the Company. Omni and Dyer claim that the Company breached the
Assignment dated as of August 31, 1998, by and among a subsidiary of
the Company, Dyer and Omni (the "Assignment") pursuant to which Omni
and Dyer assigned and transferred to a subsidiary of the Company all of
their right, title and interest in and to a certain computer software
property management system in exchange for a lump sum royalty payment
and certain monthly royalty payments equal to a percentage of the
maintenance and licensing net revenues received by the Company from
certain customers. Omni and Dyer claim that the Company has not paid to
them the monthly royalty payments owed to them pursuant to the
Assignment beginning in June 2002. Omni and Dyer further claim that,
due to the alleged breach of the Assignment, the Company is no longer
permitted to use the software. Omni and Dyer are seeking unspecified
monetary damages and to enjoin the Company's use of the software. The
Company believes that no amounts are owing under the Assignment and the
Company intends to vigorously defend itself in this arbitration, and
although no assurances can be given as to the outcome of any
arbitration proceeding, in the opinion of the Company's management, the
final outcome in this matter should not have a material adverse effect
on the Company.

19

VERSO TECHNOLOGIES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
June 30, 2002

13. RECENT ACCOUNTING PRONOUNCEMENTS

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections", which eliminates the requirement to report
gains and losses related to extinguishments of debt as extraordinary
items. The statement also included other amendments and technical
corrections which will not have a material impact on the Company. The
provisions of the statement related to the treatment of debt
extinguishments are required to be applied in fiscal years beginning
after May 15, 2002

In June 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." SFAS 146 requires that a liability for costs
associated with an exit or disposal activity be recognized when the
liability is incurred rather than when a company commits to such an
activity and also establishes fair value as the objective for initial
measurement of the liability. SFAS No. 146 will be adopted by the
Company for exit or disposal activities that are initiated after
December 31, 2002. Adoption will not have a material impact on the
consolidated financial statements of the Company.

20

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Certain statements in this Quarterly Report on Form 10-Q and in future filings
by the Company with the SEC and in the Company's written and oral statements
that are not statements of historical facts are "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. The
words "believe," "expect," "anticipate," "intend," "will" and similar
expressions are examples of words that identify forward-looking statements.
Forward-looking statements include, without limitation, statements regarding our
future financial position, business strategy and expected cost savings. These
forward-looking statements are based on our current beliefs, as well as
assumptions we have made based upon information currently available to us.

Each forward-looking statement reflects our current view of future events and is
subject to risks, uncertainties and other factors that could cause actual
results to differ materially from any results expressed or implied by our
forward-looking statements. Important factors that could cause actual results to
differ materially from the results expressed or implied by any forward-looking
statements include:

- - our ability to grow and manage the business and continue to have
positive operating cash flow and our ability to fund cash needed for
working capital including acquisition-related liabilities and capital
expenditures until the business is generating cash;

- - our ability to successfully access the capital markets to fund the
growth of our business and continuous development of our proprietary
products;

- - our ability to integrate our business with other entities we may
subsequently acquire;

- - trends for the continued growth of our business;

- - the effects of our accounting policies and general changes in generally
accepted accounting practices;

- - our ability to successfully market existing products and services,
which may be adversely impacted by competition and the general economy;

- - our ability to successfully develop and market new products and
services; and

- - other factors disclosed in our Form 10-K for the year ended December
31, 2001 and in our other filings with the SEC.

All subsequent forward-looking statements relating to the matters described in
this document and attributable to us or to persons acting on our behalf are
expressly qualified in their entirety by such factors. We have no obligation to
publicly update or revise these forward-looking statements to reflect new
information, future events, or otherwise, except as required by applicable
Federal securities laws, and we caution you not to place undue reliance on these
forward-looking statements.

21

GENERAL

The Company is a communications technology solutions provider for communications
service providers and enterprises seeking to implement application-based
telephony services, Internet usage management tools and outsourced customer
support services. The Company's continuing operations include two separate
business segments, Gateway Solutions, which includes the Company's subsidiary
NACT and Applications and Services, which includes its customer response center
operations and its subsidiary Telemate.Net. The Company acquired NACT in July
2001 and Telemate.Net in November 2001. The Company's discontinued operations
include its legacy VAR business and HSG.

The consolidated financial statements include the accounts of Verso
Technologies, Inc. and its wholly-owned subsidiaries, including Telemate.Net
which the Company acquired on November 17, 2001, NACT which the Company acquired
on July 27, 2001 and MessageClick, which the Company acquired on November 22,
2000, each in transactions accounted for as purchases.

The Company believes that the foregoing events significantly affect the
comparability of the Company's results of operations from year to year. You
should read the following discussion of the Company's results of operations and
financial condition in conjunction with the Company's consolidated financial
statements and related notes thereto included in Item 14 of the Company's Annual
Report on Form 10-K for the year ended December 31, 2001.

RESULTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2002, COMPARED TO THREE MONTHS ENDED JUNE 30, 2001

For the three months ended June 30, 2002, the Company's net loss totaled
$599,000, or $.01 per share, compared with net loss of $105.7 million, or $2.07
per share, for the same period in 2001. The 2001 results included a loss from
discontinued operations of $103.0 million.

Continuing Operations

For the three months ended June 30, 2002, the Company's net loss from continuing
operations totaled $599,000, or $.01 per share, compared with a net loss of $2.7
million, or $.05 per share, for the same period in 2001.

Total revenue was $11.7 million in the three months ended June 30, 2002,
reflecting a 112% increase from the same period in 2001. Products revenue was
$6.1 million in the three months ended June 30, 2002, and was primarily related
to the sale of NACT products. Services revenue was $5.6 million in the three
months ended June 30, 2002, reflecting a 64% increase from the same period in
2001. Gross profit increased by $5.3 million in the three months ended June 30,
2002, and was 59% of revenue in 2002, compared with 29% of revenue in the same
period of 2001. The increase in revenue, gross profit percentage and gross
profit dollars resulted primarily from the acquisition of NACT in July 2001.

Total operating expenses incurred in continuing operations for the three months
ended June 30, 2002, were $7.5 million, an increase of $3.4 million compared to
the same period of 2001. The increase is primarily attributable to the following
items: $721,000 increase in general and administrative expenses, $1.5 million
increase in sales and marketing expenses, $1.2 million increase in research and
development and $343,000 increase in depreciation expense offset by decreases in
intangible amortization of $228,000 and amortization of deferred compensation of
$160,000.

The increase in general and administrative expenses resulted from the addition
of personnel and related costs related to the acquisition of NACT offset by the
reduction of corporate general and administrative expenses. The decrease in
corporate general and administrative expenses resulted primarily from on-going
cost reduction initiatives resulting in reduced personnel, telecom and other
general and administrative expenses.

The increase in sales and marketing expenses resulted from the addition of
personnel and related costs related to the acquisitions of NACT and Telemate.Net
in July 2001 and November 2001, respectively.

The increase in research and development is primarily related to the acquisition
of NACT in July 2001.

The increase in depreciation expense is primarily related to the purchase of
furniture and equipment of approximately $400,000 and $500,000 during the first
six months of 2002 and for the last six months of 2001, respectively, as well as
the increased depreciation related to the assets acquired in the NACT and
Telemate.Net acquisitions. Capital expenditures are primarily depreciated on a
straight-line basis over their estimated useful lives of three years.

The $228,000 decrease in intangible amortization is primarily related to the
adoption of SFAS 142, which eliminated amortization of goodwill beginning
January 1, 2002.

22

The $160,000 decrease in amortization of deferred compensation primarily related
to the full vesting of certain options outstanding since the Company's
acquisition of Cereus Technology Partners, Inc. in September 2001. The deferred
compensation represents the intrinsic value of the Cereus unvested options
outstanding at the date of the acquisition of Cereus and is amortized over the
remaining vesting period of the options.

As a percent of revenue, operating expenses from continuing operations,
excluding the amortization of intangibles and deferred compensation, were 60%
during the three months ended June 30, 2002 and 2001.

Other income was $345,000 during the three months ended June 30, 2002 compared
with zero for the same period in 2001. Included in other income during the three
months ended June 30, 2002 was $254,000 of non-recurring transactions related to
insurance proceeds and the sale of non-operating assets.

Interest expense was $309,000 during the three months ended June 30, 2002, an
increase of $145,000 compared to the same period of 2001. The increase was
attributable to interest on the note payable for the purchase of NACT and the
amortization of the fair value of warrants issued to Silicon Valley Bank.

Business Unit Performance

(a) In 2002, Gateway Solutions includes costs associated with certain corporate
and administrative functions to support this business unit, which functions are
located in Utah. Prior to the acquisition of NACT in July 2001, the Company
became an NACT reseller in the first quarter of 2001. The Company resold NACT
gateway solutions totaling $2.1 million with cost of product sales of $1.8
million during the second quarter of 2001. Prior to the acquisition of NACT,
there were no identifiable assets or operating expenses related to the Gateway
Solutions segment. Applications and Services includes no allocation of corporate
overhead costs. See also (b) description

23

(b) All rent, utilities and other corporate office expenses, corporate marketing
expenses, corporate development costs and corporate human resources, accounting
and information technology functions that support corporate, as well as, the
Applications and Services segment are reflected in unallocated corporate, sales,
general and administrative expenses. Office expenses, human resources,
accounting and information technology costs specifically related to the Gateway
Solutions segment are reflected in its contribution before unallocated items.

GATEWAY SOLUTIONS

Gateway Solutions represents the sales of NACT products. Prior to the
acquisition of NACT in July 2001, the Company became an NACT reseller in the
first quarter of 2001. The Company resold NACT gateway solutions totaling $2.1
million with cost of product sales of $1.8 million during the second quarter of
2001. Prior to the acquisition of NACT, there were no identifiable assets or
operating expenses related to the Gateway Solutions segment.

APPLICATIONS AND SERVICES

Total applications and services revenue was $4.6 million in the three months
ended June 30, 2002, a 35% increase from the same period in 2001. The increase
in revenue is primarily related to the Company's acquisition of Telemate.Net in
November 2001.

Gross profit increased by $1.2 million in the three months ended June 30, 2002,
and was 55% percent of revenue, compared with 38% of revenue in the same period
in 2001. The improvement in gross profit dollars and margin was attributable to
the Company's customer response center operations and the addition of its
Telemate.Net operations.

Allocated operating expenses incurred in Applications and Services for the three
months ended June 30, 2002, were $839,000, a decrease of $11,000 compared to the
same period in 2001. The decrease in general and administrative expenses and
research and development expenses relates to the operations of MessageClick's
ASP operations, which were substantially eliminated in the second quarter of
2001. The increase in sales and marketing expenses relates to Telemate.Net,
which was acquired in November 2001. As a percent of revenue, operating expenses
for Applications and Services were 18% during the three months ended June 30,
2002 down from 25% during the same period in 2001.

Discontinued Operations

Following the acquisition of NACT in July of 2001, the Company determined that
its legacy VAR business was not strategic to the Company's ongoing objectives
and discontinued capital and human resource investment in these businesses.
Accordingly, the Company elected to report its legacy VAR business as
discontinued operations by early adoption of SFAS 144. These businesses were
added to HSG (which was reported as discontinued operations in 2000) for a
combined presentation of discontinued operations, and the condensed consolidated
financial statements have been reclassified to segregate the net assets and
operating results of these business segments.

There were no results of discontinued operations for the three months ended June
30, 2002. Summary operating results of the discontinued operations for the three
months ended June 30, 2001 (in thousands) were as follows:

Revenue $ 3,503
===============
Gross profit $ 104
===============
Operating loss $ (103,024)
===============
Loss from discontinued operations $ (103,024)
===============

The loss from discontinued operations in the three months ended June 30, 2001
includes depreciation of $273,000, amortization of intangibles of $10.7 million,
write-down of goodwill of $85.0 million, reorganization costs of $2.8 million
and amortization of deferred compensation of $124,000.

24

SIX MONTHS ENDED JUNE 30, 2002, COMPARED TO SIX MONTHS ENDED JUNE 30, 2001

For the six months ended June 30, 2002, the Company's net loss totaled $1.8
million, or $.02 per share, compared with net loss of $123.7 million, or $2.43
per share, for the same period in 2001. The 2002 results include a loss from
discontinued operations of $331,000. The 2001 results included a loss from
discontinued operations of $116.2 million and an extraordinary item - loss from
debt conversion totaling $1.6 million.

Continuing Operations

For the six months ended June 30, 2002, the Company's net loss from continuing
operations totaled $1.5 million, or $.02 per share, compared with a net loss of
$5.9 million, or $.12 per share, for the same period in 2001.

Total revenue was $23.7 million in the six months ended June 30, 2002,
reflecting a 145% increase from the same period in 2001. Products revenue was
$12.7 million in the six months ended June 30, 2002, and was primarily related
to the sale of NACT products. Services revenue was $11.0 million in the six
months ended June 30, 2002, reflecting a 61% increase from the same period in
2001. Gross profit increased by $10.7 million in the six months ended June 30,
2002, and was 59% of revenue in 2002, compared with 33% of revenue in the same
period of 2001. The increase in revenue, gross profit percentage and gross
profit dollars resulted primarily from the acquisition of NACT in July 2001.

Total operating expenses incurred in continuing operations for the six months
ended June 30, 2002, were $15.3 million, an increase of $6.6 million compared to
the same period of 2001. The increase is primarily attributable to the following
items: $1.3 million increase in general and administrative expenses, $2.8
million increase in sales and marketing expenses, $2.6 million increase in
research and development and $689,000 increase in depreciation expense offset by
decreases in intangible amortization of $460,000 and amortization of deferred
compensation of $319,000.

The increase in general and administrative expenses resulted from the addition
of personnel and related costs related to the acquisition of NACT offset by the
reduction of corporate general and administrative expenses. The decrease in
corporate general and administrative expenses resulted primarily from on-going
cost reduction initiatives resulting in reduced personnel, telecom and other
general and administrative expenses.

The increase in sales and marketing expenses resulted from the addition of
personnel and related costs related to the acquisitions of NACT and Telemate.Net
in July 2001 and November 2001, respectively.

The increase in research and development is primarily related to the acquisition
of NACT in July 2001.

The increase in depreciation expense is primarily related to the purchase of
furniture and equipment of approximately $400,000 and $500,000 during the first
six months of 2002 and for the last six months of 2001, respectively, as well as
the increased depreciation related to the assets acquired in the NACT and
Telemate.Net acquisitions. Capital expenditures are primarily depreciated on a
straight-line basis over their estimated useful lives of three years.

The $460,000 decrease in intangible amortization is primarily related to the
adoption of SFAS 142, which eliminated amortization of goodwill beginning
January 1, 2002.

The $319,000 decrease in amortization of deferred compensation primarily related
to the full vesting of certain options outstanding since the Company's
acquisition of Cereus Technology Partners, Inc. in September 2001. The deferred
compensation represents the intrinsic value of the Cereus unvested options
outstanding at the date of the acquisition of Cereus and is amortized over the
remaining vesting period of the options.

As a percent of revenue, operating expenses from continuing operations,
excluding the amortization of intangibles and deferred compensation, were 61%
during the six months ended June 30, 2002, down from 72% for the same period in
2001.

Other income was $431,000 during the six months ended June 30, 2002 compared
with zero for the same period in 2001. Included in other income during the six
months ended June 30, 2002 was $254,000 of non-recurring transactions related to
insurance proceeds and sale of non-operating assets.

Interest expense was $519,000 during the six months ended June 30, 2002, an
increase of $113,000 compared to the same period of 2001. The increase was
attributable to interest on the note payable for the purchase of NACT and the
amortization of the fair value of warrants issued to Silicon Valley Bank, offset
by the reduction of interest on the Company's 5% convertible subordinated
debentures, which were paid or converted to common stock in 2001.

25

BUSINESS UNIT PERFORMANCE

Dollars in thousands APPLICATIONS
GATEWAY SOLUTIONS AND SERVICES CONSOLIDATED
--------------------------------------------------------------
FOR THE SIX MONTHS ENDED
JUNE 30 2002 2001 2002 2001 2002 2001
- ------------------------------ -----------------------------------------------------------------

REVENUE $14,605 $ 2,827 $9,060 $6,830 $ 23,665 $ 9,657
======= ======= ====== ====== ======== =======
Gross profit 9,021 753 4,902 2,475 13,923 3,228

Gross margin 62% 27% 54% 36% 59% 33%
General and administrative 2,020 -- 344 870 2,364 870
Sales and marketing 1,816 -- 1,169 565 2,985 565
Research and development 2,915 -- 224 492 3,139 492
Other income (177) -- -- -- (177) --
------- ------- ------ ------ ------- -------
Contribution before unallocated items (a) $ 2,447 $ 753 $3,165 $ 548 5,612 1,301
======= ======= ====== ======

Unallocated items:
Corporate, sales, general and
administrative expenses(b) 4,390 4,245
Depreciation expense 1,478 789
Amortization expense 289 749
Amortization of deferred compensation 648 967
------- -------
Operating loss (1,193) (5,449)

Other income 254 --
Interest expense, net (519) (406)
------- -------
Loss from continuing operations
before extraordinary item $(1,458) $(5,855)
======= =======

(a) In 2002, Gateway Solutions includes costs associated with certain corporate
and administrative functions to support this business unit, which functions are
located in Utah. Prior to the acquisition of NACT in July 2001, the Company
became an NACT reseller in the first quarter of 2001. The Company resold NACT
gateway solutions totaling $2.8 million with cost of product sales of $2.1
million during the second quarter of 2001. Prior to the acquisition of NACT,
there were no identifiable assets or operating expenses related to the Gateway
Solutions segment. Applications and Services includes no allocation of corporate
overhead costs. See also (b) description.

(b) All rent, utilities and other corporate office expenses, corporate marketing
expenses, corporate development costs and corporate human resources, accounting
and information technology functions that support corporate, as well as, the
Applications and Services segment are reflected in unallocated corporate, sales,
general and administrative expenses. Office expenses, human resources,
accounting and information technology costs specifically related to the Gateway
Solutions segment are reflected in its contribution before unallocated items.

GATEWAY SOLUTIONS

Gateway Solutions represents the sales of NACT products. Prior to the
acquisition of NACT in July 2001, the Company became an NACT reseller in the
first quarter of 2001. The Company resold NACT gateway solutions totaling $2.8
million with cost of product sales of $2.1 million during the six months ended
June 30, 2001. Prior to the acquisition of NACT, there were no identifiable
assets or operating expenses related to the Gateway Solutions segment.

26

APPLICATIONS AND SERVICES

Total applications and services revenue was $9.1 million in the six months ended
June 30, 2002, a 33% increase from the same period in 2001. The increase in
revenue is primarily related to the Company's acquisition of Telemate.Net in
November 2001.

Gross profit increased by $2.4 million in the six months ended June 30, 2002,
and was 54% percent of revenue, compared with 36% of revenue in the same period
in 2001. The improvement in gross profit dollars and margin was attributable to
the Company's customer response center operations and the addition of its
Telemate.Net operations.

Allocated operating expenses incurred in Applications and Services for the six
months ended June 30, 2002, were $1.7 million, a decrease of $191,000 compared
to the same period in 2001. The decrease in general and administrative expenses
and research and development expenses relates to the operations of
MessageClick's ASP operations, which were substantially eliminated in the second
quarter of 2001. The increase in sales and marketing expenses relates to
Telemate.Net, which was acquired in November 2001. As a percent of revenue,
operating expenses for Applications and Services were 19% during the six months
ended June 30, 2002 down from 28% during the same period in 2001.

Discontinued Operations

Following the acquisition of NACT in July of 2001, the Company determined that
its legacy VAR business was not strategic to the Company's ongoing objectives
and discontinued capital and human resource investment in these businesses.
Accordingly, the Company elected to report its legacy VAR business as
discontinued operations by early adoption of SFAS 144. These businesses were
added to HSG (which was reported as discontinued operations in 2000) for a
combined presentation of discontinued operations, and the condensed consolidated
financial statements have been reclassified to segregate the net assets and
operating results of these business segments.

Summary operating results of the discontinued operations for the six months
ended June 30, 2002 and 2001 (in thousands) were as follows:

Six months ended June 30,
------------------------------------
2002 2001
--------------- -------------------

Revenue $ 223 $ 10,080
=============== ===================
Gross profit $ (331) $ 833
=============== ===================
Operating loss $ (331) $ (116,214)
=============== ===================
Loss from discontinued operations $ (331) $ (116,214)
=============== ===================

The loss from discontinued operations in the six months ended June 30, 2001
includes depreciation of $546,000, amortization of intangibles of $21.4 million,
write-down of goodwill of $85.0 million, reorganization costs of $2.8 million
and amortization of deferred compensation of $249,000.

Extraordinary Item

In January 2001, the Company modified the terms of the $7.0 million outstanding
balance of its 5% convertible subordinated debentures as follows: the Company
repurchased $4.5 million, converted $1.5 million into the Company's common stock
at a price of $1.40 per share, fixed the conversion rate at $1.19 per share for
the remaining $1.0 million and issued warrants to purchase 954,455 shares of the
Company's common stock at an exercise price of $1.98 per share. The cost of this
conversion and early retirement of debt totaled $1.6 million.

CRITICAL AND SIGNIFICANT ACCOUNTING POLICIES

The preparation of financial statements and related disclosures in conformity
with generally accepted accounting principles requires management to make
judgments, assumptions and estimates that affect the amounts reported in the
condensed consolidated financial statements and accompanying notes. Factors that
could affect the Company's future operating results and cause actual results to
vary from expectations include, but are not limited to, lower than anticipated
growth from existing customers, an inability to attract new customers, and
inability to successfully integrate acquisitions, technology changes, or a
decline in the financial stability of the Company's customers. Negative
developments in these or other risk factors could have a material adverse affect
on the Company's financial position and results of operations.

27

A summary of the Company's critical and significant accounting policies follows:

Allowance for Doubtful Accounts

The Company is required to estimate the collectibility of its trade receivables.
Considerable judgment is required in assessing the ultimate realization of these
receivables including the creditworthiness of each customer. Significant changes
in required reserves have been recorded in recent periods and may occur in the
future due to the current market environment.

Inventory Reserve

The Company is required to state its inventories at the lower of cost or market.
In assessing the ultimate realization of inventories, the Company is required to
make judgments as to future demand requirements and compare that with the
current or committed inventory levels. The Company has recorded changes in
required reserves in recent periods due to impact of current and future
technology trends and changes in strategic direction, such as discontinuances of
product lines, as well as, changes in market conditions due to changes in demand
requirements. It is possible that changes in required inventory reserves may
continue to occur in the future due to the current market conditions.

Restructuring Accruals

During the second and third quarters of 2001, the Company initiated certain
restructuring plans. In conjunction with these restructuring plans, the Company
established a restructuring reserve account for the estimated costs related to
the plans. These costs primarily related to facilities closings, severance costs
and MessageClick ASP service exiting costs. For the facilities closings cost, a
reserve was established for all remaining lease payments due on buildings and
equipment that were no longer being utilized in continuing operations, less
assumptions for sub-leases. The accrual for one lease with total payments
remaining of $2.8 million, assumes that the building will be sub-leased for 50%
of the total lease liability over the term of the lease. As of June 30, 2002,
the Company had a remaining reserve balance of approximately $2.6 million, which
is included in liabilities of discontinued operations. The Company currently
believes that this remaining estimated balance is appropriate to cover future
obligations associated with the restructurings. Activity in the restructuring
accruals was as follows:

Balance December 31, 2001 $ 2,730
Lease payments (434)
Additional restructuring accrual 307
--------
Balance June 30, 2002 $ 2,603
========
Fair Value of Assets and Liabilities Acquired

During 2001, the Company acquired NACT and Telemate.Net (see further discussion
in Note 2 to the consolidated financial statements). In conjunction with the
acquisitions, the Company was required to estimate the fair value of assets
(including goodwill and other intangibles) and liabilities acquired based on
industry conditions, historical experience and future operational cash flow
projections, option valuation models and evaluation of events subsequent to the
acquisitions. The Company believes that the estimated purchased balances
approximate fair market value.

Deferred Tax Asset Valuation Allowance

The Company currently has significant deferred tax assets, which are subject to
periodic recoverability assessment. Realization of the Company's deferred tax
assets is principally dependant upon achievement of projected future taxable
income. The Company's judgments regarding future profitability may change due to
market conditions, its ability to continue to successfully execute its strategic
plan and other factors. These changes, if any, may require possible material
adjustments to these deferred tax asset balances. Due to the uncertainty of the
Company's ability to recognize the entire tax benefit, the Company established
an offsetting provision for the tax benefit recorded.

28

Litigation and Related Contingencies

The Company is subject to proceedings, lawsuits and other claims related to
labor, product and other matters. The Company is required to assess the
likelihood of any adverse judgments or outcomes to these matters, as well as,
potential ranges of probable losses. A determination of the amount of reserves
required, if any, for these contingencies is made after careful analysis of each
individual issue based upon the then current facts and circumstances. The
required reserves may change in the future due to new developments in each
matter or changes in approach such as a change in settlement strategy in dealing
with these matters.

Intangible Assets

The Company has significant intangible assets related to goodwill and other
acquired intangibles. The determination of related estimated useful lives and
whether or not these assets are impaired involves significant judgments. Changes
in strategy and/or market conditions could significantly impact these judgments
and require adjustments to recorded asset balances. The Company assesses the
recoverability of its intangible assets by determining whether the value of
goodwill and other acquired intangible assets over their remaining life can be
recovered through undiscounted future operating cash flows of the acquired
operation. The amount of impairment, if any, is measured based on projected
discounted future operating cash flows using a discount rate reflecting the
Company's average cost of funds. Effective January 1, 2002, the Company adopted
SFAS 142, which stipulates an impairment test is to be performed at each
reporting date that requires a comparison of the fair value of an intangible
asset with its carrying amount. If the carrying amount of an intangible asset
exceeds its fair value, then an impairment loss shall be recognized in an amount
equal to that excess.

LIQUIDITY AND CAPITAL RESOURCES

Summary

Liquidity is the measurement of the Company's ability to have adequate cash or
access to cash at all times in order to meet financial obligations when due, as
well as to fund corporate expansion and other activities. Historically, the
Company has met its liquidity requirements through a combination of working
capital provided by debt from third party lenders, issuances of debt and equity
securities and sale of discontinued businesses.

At June 30, 2002, the Company had a negative working capital position (excess of
current liabilities over current assets) of $701,000 compared to a negative
working capital position of $2.8 million at December 31, 2001. The Company's
cash and cash equivalents totaled $3.7 million at June 30, 2002, and $7.7
million at December 31, 2001. Total long-term debt, including current portion,
net of discount, was $3.6 million at June 30, 2002 and $3.4 million at December
31, 2001. At June 30, 2002, the Company had no borrowings under its $5.0 million
Credit Agreement with the Bank. The Credit Agreement is secured by substantially
all of the assets of the Company. The availability under the Credit Agreement at
June 30, 2002 was $4.6 million.

Cash Flow

Cash used in the Company's continuing operations in the six months ended June
30, 2002 totaled approximately $1.8 million compared with cash used in
continuing operations of $5.3 million in the same period in 2001. The Company's
use of cash in continuing operations during the six months ended June 30, 2002
resulted primarily from cash used for changes in current operating items of
approximately $4.1 million and was offset by cash from continuing operations of
$2.3 million (net loss from continuing operations of $1.5 million reduced by
non-cash charges totaling $3.8 million, including depreciation and amortization
of $2.7 million, a provision for doubtful accounts of $804,000 and an inventory
valuation reserve of $171,000).

Cash used in the Company's discontinued operations in the six months ended June
30, 2002 totaled $458,000 compared with cash used in discontinued operations of
$5.6 million in the same period in 2001.

The Company used cash in investing activities for continuing operations in the
six months ended June 30, 2002 of approximately $607,000, compared to $947,000
in the same period of 2001. Of these amounts, the Company spent $446,000 and
$947,000 on capital expenditures in the six months ended June 30, 2002 and 2001,
respectively. The Company also invested $161,000 on purchased software
development costs in the six months ended June 30, 2002.

During the six months ended June 30, 2001, the Company received net proceeds
from sale of discontinued operations totaling $8.2 million for the sale of its
restaurant solutions business.

29

Cash used in financing activities from continuing operations totaled
approximately $1.2 million in the six months ended June 30, 2002, compared to
$4.3 million used in financing activities in the same period of 2001. Payments
of note payable for the purchase of NACT totaled $1.5 million and proceeds from
the issuance of the Company's common stock totaled $292,000 in the six months
ended June 30, 2002. Payments to repurchase convertible subordinated debentures
totaled $4.5 million and proceeds from the issuance of common stock totaled
$182,000 in the six months ended June 30, 2001.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

The following summarizes the Company's future contractual obligations at June
30, 2002 (in thousands):

Payments Due By Period
-------------------------------------------------------------
Less than After
Contractual Obligations Total 1 year 1-3 years 4-5 years 5 years
- ----------------------------------------------------------------------------------------------------------------------

Deferred payment due for the purchase of NACT $ 2,750 $2,750 $ -- $ -- $ --
Convertible subordinated debentures 4,500 -- -- 4,500 --
Operating leases:
Continuing operations 15,363 2,045 4,023 3,981 5,314
Discontinued operations 2,168 665 559 357 587
------- ------ ------ ------ ------
Total contractual cash obligations $24,781 $5,460 $4,582 $8,838 $5,901
======= ====== ====== ====== ======

SOURCES OF CASH

For 2002, the Company expects that its primary sources of cash will be from cash
on hand, working capital provided by operating activities, borrowings under the
Credit Agreement and other possible sources, including issuances of equity or
debt securities. The Company believes that, with its current operations, which
were cash flow positive for the last three quarters, it will have sufficient
liquidity from these sources to meet its current financial obligations through
2002. However, the Credit Agreement contains certain financial covenants and
limitations on the Company's ability to access funds under the Credit Agreement.
If the Company is in violation of the Credit Agreement, or does not have
sufficient eligible accounts receivable and inventory to support the level of
borrowings it may need, the Company may be unable to draw on the Credit
Agreement to the extent necessary. To the extent the Company does not have
borrowing availability under the Credit Agreement, the Company may be required
to obtain additional sources of capital, sell assets, obtain an amendment to the
Credit Agreement or otherwise restructure its outstanding indebtedness.

If the Company is unable to obtain additional capital, sell assets, obtain an
amendment to the Credit Agreement or otherwise restructure its outstanding
indebtedness, the Company may not be able to meet its obligations.

The Company's short-term cash needs are to cover working capital needs,
including cash operating losses, if any, capital expenditures, the restructured
payments during 2002 for the NACT acquisition and other acquisition-related
liabilities related to NACT, payments related to discontinued operations and,
assuming the Company's acquisition of 51% of Shanghai Betrue Infotech Co. Ltd.
closes before the end of the third quarter, $150,000 related to such
acquisition. At June 30, 2002, included in accrued compensation and current
portion of liabilities of discontinued operations is $130,000 for Telemate.Net
related severance costs and $2.8 million in payments related to discontinued
operations. The Company expects to pay out approximately $875,000 related to
Telemate.Net severance costs and discontinued operations for the remainder of
2002, and approximately $1.6 million related to the satisfaction of certain
liabilities relating to NACT for the remainder of 2002.

The Company's long-term cash needs are related to the costs of growing its
current business as well as prospective businesses to be acquired, including
capital expenditures and working capital, and funding the restructured payments
for the acquisition of NACT and other acquisition-related liabilities related to
NACT. The Company expects to meet these cash needs through cash from operations,
if any, cash on hand, borrowings under the Credit Agreement or other debt
facilities, if available, as well as through possible issuances of equity or
debt securities. If the Company is unable to secure a working capital line of
credit with sufficient borrowing availability (or restructure its existing line
of credit), obtain additional capital or sell assets, then the Company may not
be able to meet its obligations and growth plans.

30

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

The Company is exposed to various market risks, including changes in interest
rates. Market risk is the potential loss arising from adverse changes in market
rates and prices, such as interest rates. The Company does not enter into
derivatives or other financial instruments for trading or speculative purposes.
The Company has also not entered into financial instruments to manage and reduce
the impact of changes in interest rates. The Company may enter into such
transactions in the future.

Interest Rate Risks

The Company's debt at June 30, 2002, carries interest rates, which are fixed.

31

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Except as previously disclosed in the Company's Annual Report on Form
10-K for the year ended December 31, 2001 or as set forth below, the
Company is not a party to any material legal proceedings other than
ordinary routine claims and proceedings incidental to its business, and
the Company does not expect these claims and proceedings, either
individually or in the aggregate, to have a material adverse effect on
the Company.

As previously disclosed in the Company's Form 10-K for the year ended
December 31, 2001, on or about May 21, 2001, John M. Good, a former
employee of the Company, filed a lawsuit in the Court of Common Pleas,
Cuyahoga County, Ohio, against the Company claiming, among other
things, fraud, negligence, breach of fiduciary duty, breach of contract
and damages resulting from and related to the Company's alleged failure
to deliver 50,000 shares of the Company's common stock to Mr. Good upon
his exercise of an option to purchase such shares on or about January
3, 2000. Mr. Good seeks unspecified damages with respect to such
claims; however, based on the Company's further analysis of Mr. Good's
claims, in the opinion of the Company's management, the Company's
exposure to Mr. Good, were he to prevail in this matter, should not
exceed $550,000. The Company intends to defend such claims vigorously.
Trial for this case has been set for October 2002. Although no
assurances can be given as to the outcome of any lawsuit, in the
opinion of the Company's management, the final outcome in this matter
should not have a material adverse effect on the Company.

On or about February 8, 2002, William P. O'Reilly, a former executive
officer and director of the Company; Montana Corporation, Mr.
O'Reilly's consulting company; Clunet R. Lewis, a former officer of the
Company; and CLR Enterprises, Inc., Mr. Lewis' consulting company,
filed with the American Arbitration Association ("AAA") a demand for
arbitration against the Company. Messrs. O'Reilly and Lewis and their
respective consulting companies seek to have enforced the Consulting
Agreements dated April 1, 1999, as amended, to which they and the
Company are parties (the "Consulting Agreements"). Messrs. O'Reilly and
Lewis have claimed that the Company's attempt by written notice dated
June 1, 2001, to terminate the Consulting Agreements effective March
31, 2002, was ineffective and, as a result, such Consulting Agreements
have automatically renewed for additional two-year terms, which terms
expire on March 31, 2004. Under the terms of the Consulting Agreements,
Messrs. O'Reilly and Lewis are to receive, among other things,
consulting fees of $250,000 and $240,000 per year, respectively.
Messrs. O'Reilly and Lewis claim that such fees for the two-year
extension period shall become immediately due and payable in the event
Messrs. O'Reilly and Lewis prevail in the arbitration proceeding. The
Company intends to vigorously defend itself in this arbitration, and
although no assurances can be given as to the outcome of any
arbitration proceeding, in the opinion of the Company's management, the
final outcome in this matter should not have a material adverse effect
on the Company.

On or about April 29, 2002, Omni Systems of Georgia, Inc. ("Omni") and
Joseph T. Dyer ("Dyer") filed with the AAA a demand for arbitration
against the Company. Omni and Dyer claim that the Company breached the
Assignment dated as of August 31, 1998, by and among a subsidiary of
the Company, Dyer and Omni (the "Assignment") pursuant to which Omni
and Dyer assigned and transferred to a subsidiary of the Company all of
their right, title and interest in and to a certain computer software
property management system in exchange for a lump sum royalty payment
and certain monthly royalty payments equal to a percentage of the
maintenance and licensing net revenues received by the Company from
certain customers. Omni and Dyer claim that the Company has not paid to
them the monthly royalty payments owed to them pursuant to the
Assignment beginning in June 2002. Omni and Dyer further claim that,
due to the alleged breach of the Assignment, the Company is no longer
permitted to use the software. Omni and Dyer are seeking unspecified
monetary damages and to enjoin the Company's use of the software. The
Company believes that no amounts are owing under the Assignment and the
Company intends to vigorously defend itself in this arbitration, and
although no assurances can be given as to the outcome of any
arbitration proceeding, in the opinion of the Company's management, the
final outcome in this matter should not have a material adverse effect
on the Company.

Item 2. Changes in Securities

On June 17, 2002, the Company issued to RSL COM U.S.A., Inc. 523,430
shares of the Company's common stock. Pursuant to the RSL Settlement
Agreement, the Company paid a cash amount and issued such shares in
exchange for settlement of the claims made by RSL against NACT set
forth in that certain demand for arbitration filed by RSL with the
American Arbitration Association on July 6, 2000, which claims are
described in Note 10 of the Notes to the Condensed Consolidated
Financial Statements set forth in Item 1 of this Report. Such shares
were issued without registration under the Securities Act of 1933, as
amended (the "Securities Act"), in reliance upon the exemption in
Section 4(2) of the Securities Act and Rule 506 of Regulation D
promulgated thereunder ("Regulation D"). The Company based such
reliance on representations made by RSL as to its investment intent,
sophistication and status as an accredited investor, as defined in Rule
501 of Regulation D.

32

On April 25, 2002, the Company issued the Note to WATP pursuant to the
WATP Settlement Agreement, as more fully described in Note 2 of the
Notes to the Condensed Consolidated Financial Statements set forth in
Item 1 of this Report. At WATP's option, WATP may, at any time within
the thirty-day period before a payment under the Note is due, convert
some or all of the amount due on such payment date into shares of the
Company's common stock at a conversion price of $1.36 per share. The
Note is convertible into an aggregate of up to 2,367,774 shares of the
Company's common stock. The Note was issued without registration under
the Securities Act in reliance upon the exemption in Section 4(2) of
the Securities Act. The Company based such reliance on representations
made by WATP as to its investment intent and sophistication.

On August 2, 2002, the Company issued 65,000 shares of the Company's
common stock to SoftBrands, Inc. ("SoftBrands") pursuant to that
certain Stipulation for Settlement and Mutual Release dated as of May
30, 2002, by and among the Company, AremisSoft Corporation
("AremisSoft"), SoftBrands and certain other parties (the "Stipulation
for Settlement"). Pursuant to the Stipulation for Settlement, the
Company paid a cash amount and issued such shares in exchange for
settlement of certain claims made by AremisSoft and certain other
parties against the Company relating to the Company's sale of its
hospitality division in the fourth quarter of 2000. These shares were
issued without registration under the Securities Act in reliance upon
the exemption in Section 4(2) of the Securities Act and Regulation D.
The Company based such reliance on representations made by SoftBrands
as to its investment intent, sophistication and status as an accredited
investor, as defined in Rule 501 of Regulation D.

On May 15, 2002, the Company issued to the Bank a warrant to purchase
308,641 shares of the Company's common stock at an initial exercise
price of $0.81 per share. The warrant is exercisable until May 15,
2007. The warrant was issued without registration under the Securities
Act in reliance upon the exemption in Section 4(2) of the Securities
Act and Regulation D. The Company based such reliance on
representations made by the Bank as to its investment intent,
sophistication and status as an accredited investor, as defined in Rule
501 of Regulation D.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

4.1 Convertible Secured Promissory Note dated April 25,
2002, executed by the Company in favor of WATP in
connection with the WATP Settlement Agreement.
(Incorporated by reference to Exhibit 4.1 to the
Company's Current Report on Form 8-K filed on May 1,
2002.)

4.2 Warrant dated as of May 15, 2002, to purchase 308,641
shares of the Company's common stock granted to
Silicon Valley Bank.

4.3 Antidilution Agreement dated May 15, 2002, between
the Company and Silicon Valley Bank.

4.4 Registration Rights Agreement dated May 15, 2002,
between the Company and Silicon Valley Bank.

10.1 Settlement Agreement and General Release dated March
29, 2002, between WATP and the Company. (Incorporated
by reference to Exhibit 99.1 to the Company's Current
Report on Form 8-K filed on May 1, 2002.)

33

10.2 Security Agreement dated April 25, 2002, between the
Company and WATP entered into in connection with the
WATP Settlement Agreement. (Incorporated by reference
to Exhibit 99.2 to the Company's Current Report on
Form 8-K filed on May 1, 2002.)

10.3 Security Agreement dated April 25, 2002, among
Telemate.Net, NACT and WATP entered into in
connection with the WATP Settlement Agreement.
(Incorporated by reference to Exhibit 99.3 to the
Company's Current Report on Form 8-K filed on May 1,
2002.)

10.4 Pledge Agreement dated April 25, 2002, between the
Company and WATP entered into in connection with the
WATP Settlement Agreement. (Incorporated by reference
to Exhibit 99.4 to the Company's Current Report on
Form 8-K filed on May 1, 2002.)

10.5 Guaranty dated April 25, 2002, among Telemate.Net,
NACT and WATP entered into in connection with the
WATP Settlement Agreement. (Incorporated by reference
to Exhibit 99.5 to the Company's Current Report on
Form 8-K filed on May 1, 2002.)

10.6 Subordination Agreement dated April 25, 2002, among
the Company, NACT, Telemate.Net and Silicon Valley
Bank entered into in connection with the WATP
Settlement Agreement. (Incorporated by reference to
Exhibit 99.6 to the Company's Current Report on Form
8-K filed on May 1, 2002.)

10.7 Form of Deposit Account Control Agreement among
the Company, Silicon Valley Bank and WATP entered
into in connection with the WATP Settlement Agreement.
(Incorporated by reference to Exhibit 99.7 to the
Company's Current Report on Form 8-K filed on May
1, 2002.)

10.8 Stipulation for Settlement and Mutual Release dated
as of July 19, 2002, by and among the Company,
AremisSoft Corporation, SoftBrands, Inc. and others.

10.9 Interest Purchase Agreement dated as of June 4, 2002,
by and between the Company and NeTrue Communications,
Inc.

99.1 Certification of the Company's Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.

99.2 Certification of the Company's Chief Financial Office
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.

(b) Reports on Form 8-K.

On May 1, 2002, the Company filed a Current Report on Form 8-K
with the Securities and Exchange Commission which reported
under Item 5 of such report the Company's execution of the
WATP Settlement Agreement and the Note made in connection with
the WATP Settlement Agreement by the Company in favor of WATP
dated April 25, 2002, which restructures a deferred payment
due by the Company to WATP pursuant to a certain Stock
Purchase Agreement between the Company and WATP dated June 4,
2001. The Company did not file any other Current Report on
Form 8-K during the quarter ended June 30, 2002.

34

SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.

VERSO TECHNOLOGIES, INC.

Date: August 13, 2002

/s/ Juliet M. Reising
----------------------------------------------------

Executive Vice President and Chief Financial Officer
(duly authorized signatory and
Principal Financial and Accounting Officer)

35

EXHIBIT INDEX

4.1 Convertible Secured Promissory Note dated April 25, 2002,
executed by the Company in favor of WA Telcom Products Co.,
Inc. in connection with the WATP Settlement Agreement, as
defined below. (Incorporated by reference to Exhibit 4.1 to
the Company's Current Report on Form 8-K filed on May 1,
2002.)

4.2 Warrant dated as of May 15, 2002, to purchase 308,641 shares
of the Company's common stock granted to Silicon Valley Bank.

4.3 Antidilution Agreement dated May 15, 2002, between the Company
and Silicon Valley Bank.

4.4 Registration Rights Agreement dated May 15, 2002, between the
Company and Silicon Valley Bank.

10.1 Settlement Agreement and General Release dated March 29, 2002,
between WA Telcom Products Co., Inc. and the Company (the
"WATP Settlement Agreement"). (Incorporated by reference to
Exhibit 99.1 to the Company's Current Report on Form 8-K filed
on May 1, 2002.)

10.2 Security Agreement dated April 25, 2002, between the Company
and WA Telcom Products Co., Inc. entered into in connection
with the WATP Settlement Agreement. (Incorporated by reference
to Exhibit 99.2 to the Company's Current Report on Form 8-K
filed on May 1, 2002.)

10.3 Security Agreement dated April 25, 2002, among Telemate.Net
Software, Inc., NACT Telecommunications, Inc. and WA Telcom
Products Co., Inc. entered into in connection with the WATP
Settlement Agreement. (Incorporated by reference to Exhibit
99.3 to the Company's Current Report on Form 8-K filed on May
1, 2002.)

10.4 Pledge Agreement dated April 25, 2002, between the Company and
WA Telcom Products Co., Inc. entered into in connection with
the WATP Settlement Agreement. (Incorporated by reference to
Exhibit 99.4 to the Company's Current Report on Form 8-K filed
on May 1, 2002.)

10.5 Guaranty dated April 25, 2002, among Telemate.Net Software,
Inc., NACT Telecommunications, Inc. and WA Telcom Products
Co., Inc. entered into in connection with the WATP Settlement
Agreement. (Incorporated by reference to Exhibit 99.5 to the
Company's Current Report on Form 8-K filed on May 1, 2002.)

10.6 Subordination Agreement dated April 25, 2002, among the
Company, NACT, Telemate.Net Software, Inc. and Silicon Valley
Bank entered into in connection with the WATP Settlement
Agreement. (Incorporated by reference to Exhibit 99.6 to the
Company's Current Report on Form 8-K filed on May 1, 2002.)

10.7 Form of Deposit Account Control Agreement among the Company,
Silicon Valley Bank and WA Telcom Products Co., Inc. entered
into in connection with the WATP Settlement Agreement.
(Incorporated by reference to Exhibit 99.7 to the Company's
Current Report on Form 8-K filed on May 1, 2002.)

10.8 Stipulation for Settlement and Mutual Release dated as of July
19, 2002, by and among the Company, AremisSoft Corporation,
SoftBrands, Inc. and others.

10.9 Interest Purchase Agreement dated as of June 4, 2002, by and
between the Company and NeTrue Communications, Inc.

99.1 Certification of the Company's Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

99.2 Certification of the Company's Chief Financial Office pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.

36