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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
[X]Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended March 31, 2001
or
[_]Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 0-24983
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NETSOLVE, INCORPORATED
(Exact Name of Registrant as Specified in its Charter)
Delaware 75-2094811-2
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
12331 Riata Trace Parkway
Austin, Texas 78727
(Address of principal executive offices, including zip code)
(512) 340-3000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
Par Value Per Share
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K, or any
amendment to this Form 10-K [_] .
On April 30, 2001, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $43,882,226 (affiliates being, for these
purposes only, directors, executive officers and holders of more than 5% of
Registrant's Common Stock). On April 30, 2001, there were
12,021,002 outstanding shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement pursuant to
Regulation 14A for the registrant's 2001 Annual Meeting of Stockholders to be
held on July 18, 2001, which will be filed with the Commission on or about May
30, 2001, are incorporated by reference into Part III of this report.
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NETSOLVE, INCORPORATED
INDEX
Page
Part I ----
Item 1. Business...................................................... 3
Item 2. Facilities.................................................... 13
Item 3. Litigation.................................................... 13
Item 4. Submission of Matters to a Vote of Security Stockholders...... 14
Executive Officers of the Registrant.......................... 15
Part II
Market for the Registrant's Common Equity and Related
Item 5. Stockholder Matters........................................... 16
Item 6. Selected Financial Data....................................... 16
Management's Discussion and Analysis of Financial Condition
Item 7. and Results of Operations..................................... 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.... 31
Item 8. Financial Statements and Supplemental Data.................... 32
Changes in and Disagreements with Accountants on Accounting
Item 9. and Financial Disclosure...................................... 48
Part III
Item 10. Directors and Executive Officers of the Registrant............ 49
Item 11. Executive Compensation........................................ 49
Security Ownership of Certain Beneficial Owners and
Item 12. Management.................................................... 49
Item 13. Certain Relationships and Related Transactions................ 49
Part IV
Exhibits, Financial Statement Schedules, and Reports on Form
Item 14. 8-K........................................................... 50
2
PART I
Item 1. BUSINESS
We offer a range of network management and security services that allow
companies to outsource some or all network activities in order to increase
network reliability and up-time, reduce overall network costs, and simplify
timely migration to new technologies. Our management services are intended to
address all or selected parts of the full life cycle of network management,
which consists of network design, configuration, implementation, monitoring,
fault diagnosis, fault resolution, reporting, upgrading and documentation. We
furnish our network management services remotely 24 hours per day, seven days
per week from our network management center in Austin, Texas, and we operate
software tools that allow companies to access up-to-date network status
reports through standard web browsers. We also offer around-the-clock remote
security protection services for the Internet and intranet perimeter points of
our customers' networks. Our security offerings currently include a managed
firewall service and a remote intrusion detection and response service. We
have offered network management services since 1995 and currently have over
1,200 end users representing over 30,000 managed sites. We have primarily
targeted middle market enterprises, and provide services both directly to end
users as well as indirectly through resellers such as AT&T and NEC.
Industry background
Businesses increasingly depend on the ability to access and share
electronic information reliably. To enable effective internal communication,
more and more companies are relying on client/server-based databases and
applications, e-mail, remote access by mobile workers and various forms of
online information. The proliferation of the use of the Internet and the
emergence of e-commerce are driving the need for businesses to exchange
electronic information externally with customers, business partners and
vendors. In response to the growing need to share information internally and
externally, companies' operations increasingly depend on data networks,
including both wide area networks, or WANs, which allow companies to
communicate with a large number of computers over a broad geographic area, and
local area networks, or LANs, which are generally more limited in the number
of computers in the network and the geographic area covered. This
proliferation of networks has resulted in a dramatic increase in network
traffic as well as heightened requirements for network performance. It has
also increased the magnitude of sensitive corporate information shared over
networks, causing network security to become a high priority for many
businesses. As a result of these trends, a growing number of businesses view
responsive, reliable and secure networks as mission-critical to their
operations.
As networks have become a more integral part of day-to-day operations, many
companies are seeking to control network costs and improve operating
efficiencies. Economic and performance issues are especially important for
organizations operating WANs to connect geographically dispersed sites.
Providers of WAN equipment and services have responded to customer demand by
providing switched data technologies which allow any user to be connected to
any other user in a more efficient manner than previous network architectures.
Examples of these switched data technologies include Frame Relay, Asynchronous
Transfer Mode, or ATM, and Internet Protocol, or IP. These switched data
technologies are able to share and allocate bandwidth, the electronic
frequencies used to transmit data over computer networks, based on actual
network use, while older network architectures use fixed bandwidth and
dedicated circuits regardless of network use. The shared bandwidth of switched
data technologies has typically resulted in WANs that are more reliable and
less expensive than the technologies they replaced. Switched data services
have grown rapidly since WAN service providers initially introduced Frame
Relay services as a solution; however, that growth has begun to slow as the
providers of those solutions have achieved high rates of penetration over the
last several years. ATM services, a switched data technology characterized by
higher capacities and higher speeds, are less widely offered today but are
expected to compete with Frame Relay and experience rapid growth in the next
several years. Likewise, services based on IP, including Virtual Private
Networks or VPNs which utilize the Internet to replace Frame Relay and ATM in
some applications, are becoming an important option to the traditional
dedicated circuit WAN infrastructure.
The growth of the switched data market has been enabled by the rapid
development of sophisticated networking hardware such as routers, inverse
multiplexers and switches. At the same time, software companies
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have introduced network management and security software designed to work with
and optimize the new hardware. Implementation and management of new hardware
and software technologies typically require significant expertise in order to
maintain reliability, performance and security, especially since networks have
grown more complex and heterogeneous as new technologies have been integrated
with legacy networks. Further, the tools available to manage today's networks
are complex and often require incremental investments in hardware, software,
personnel and training. The proliferation of services available from WAN
service providers, such as the major telecommunications carriers, further
complicates network management and security.
In today's environment, companies have often encountered difficulty
implementing and managing networks internally because of the significant
shortage of qualified networking and information technology, or IT,
professionals coupled with the increased complexity in today's networks. Based
on information published by the Gartner Group in 2000, we believe that for
every 10 IT jobs available in 2000, there were only 7.5 people available to
fill those positions. Maintaining internal IT staffs is costly since network
management skills must be constantly upgraded to respond to the rapid changes
in networking and security technologies. This situation is even more acute in
the area of network security, an area that is increasing in importance due to
threats of security attacks via the Internet as well as rapidly changing
security technology. The resource scarcity and high cost of internal IT staffs
represent significant challenges for businesses, especially mid-sized
companies that are large enough to require sophisticated networks, but too
small to gain efficiencies of scale achievable by a large enterprise that can
amortize the costs of an in-house IT network management group across a large
organization.
Many companies are beginning to turn to third-party service providers for
network management and security, particularly when those skills are not core
business competencies. While some companies out-source their entire computing
environment, a growing number of companies are managing their computing
environments more actively and affordably by out-tasking a particular set of
activities. Businesses seeking to out-task network management services
typically need to migrate quickly to newer technologies as they become
available, increase the reliability of their networks and reduce the overall
cost of managing their networks. Further, these businesses' networks must be
available to internal and external users 24 hours per day, seven days per
week. Even if network management activities are out-tasked, internal
IT managers need access to network information and performance reporting at
all times. In addition, network security must be assured, with access to the
networks limited to authorized users, and then only to those applications and
data for which the users have been authorized. All of this network management
must be done in an environment of constant and rapid change in networking and
security technology where the time to implement new technologies can affect
the time to market of new products and services.
Our solution
We offer network management services that allow customers to out-task
network-specific activities in order to increase network reliability and up-
time, reduce overall network costs and migrate to new technologies and
services on a timely basis. We also offer security protection for network
perimeter points such as an enterprise's Internet or intranet connections. Our
solutions are designed to address the needs of middle market enterprises,
however we also currently provide services to several larger organizations
that can utilize our standard packaged services without requiring significant
customization. We currently have over 1,200 end users representing over
30,000 managed sites. We believe our solution offers the following key
benefits:
Full breadth of network management services. Each of our network management
services cover the entire life cycle of an enterprise's network requirements
for that service, including network design, configuration, implementation,
monitoring, fault diagnosis, fault resolution, reporting, upgrading and
documentation. See Business--Network management services for a description of
the network elements currently covered by our services. In some cases, our
reseller partners provide the network design, configuration and implementation
services, and we anticipate that these service components will decline as a
percentage of our total revenues. End users have the ability to outsource all
of their network requirements to us, or they can retain control over certain
aspects of their network and out-task only selected network management tasks.
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Reduced costs. Substantial costs are incurred in retaining and maintaining
an internal IT staff that is qualified to manage a complex, multi-site
network. We are able to amortize these personnel-related costs, as well as
costs of necessary network infrastructure, software and tools, over hundreds
of end users. As a result, we believe we are able to offer a better network
solution at a lower cost than if an end user attempted to manage its network
in-house. Furthermore, we evaluate, purchase, develop and integrate
application-specific software and tools that allow us to deliver reliable
solutions at low costs. We support only the relatively small number of
providers of networking hardware and carrier services that we believe
collectively dominate the market. By focusing on the leading equipment
manufacturers and carriers, we are able to leverage economies of scale in
managing multiple end-user networks.
Increased network reliability, security and up-time. As enterprises
continue to increase their use of networks for internal and external
communication and for conducting e-commerce, the need for reliable and secure
networks becomes more critical. We provide our remote network management and
security services to end-user locations worldwide 24 hours per day, seven days
per week. Our remote network management services for WANs generally include a
guarantee to provide end-to-end network availability for at least 99.5% of the
time in any given month.
Ease of network maintenance and technology upgrades. Our network management
professionals act as an extension of the customer's IT staff. By relying on
our expertise, infrastructure and tools, end users are able to meet the
challenges posed by rapidly evolving technologies and move quickly and
affordably to more advanced network solutions as needed. We report to end
users on an ongoing basis and recommend upgrades or changes when appropriate.
Web-enabled network monitoring and reporting. End users can out-task to us
the complex, frustrating and expensive responsibilities of dealing with day-
to-day network management and security issues, yet still be able to understand
and see their networks in operation. End users can access our web-enabled
network management and monitoring tools and view on their computer screens a
network map that gives a current status of every site on their networks. We
also provide end users with reports of network activity on demand.
Strategy
Our goal is to be a leading provider of remote network management services.
The key elements of our strategy include the following:
Target primarily middle market enterprises. We believe that a significant
market opportunity exists for our services among enterprises that are large
enough to employ WANs across multiple sites, but too small to amortize the
costs of an in-house IT network management staff across a large organization.
These middle market companies, which typically have between 100 and
1,000 employees and annual revenues between $25 million and $500 million, are
facing a growing need for network expertise and technology. At the same time,
they are encountering increased difficulties in attracting qualified and
affordable networking professionals. We believe that our network management
and security services offer an attractive solution for many middle market
companies and we intend to target these companies as we market our existing
services and develop new services. We also believe that larger entities face
some of these same challenges and may in some instances be able to benefit
from our network management and security services and we will selectively
target some of these entities as we market our services.
Support leading technologies. We have been able to provide cost-effective
solutions to our customers by supporting only the leading providers of
networking hardware and carrier services. The suppliers that we support
include AT&T, MCI/WorldCom, Qwest Communications, Sprint, various regional
bell operating companies and competitive local exchange carriers in the data
transport arena, and Bay/Nortel, Cisco and Visual Networks in the market for
customer premise equipment, or CPE. We believe these suppliers are the
predominant providers of networking hardware and carrier services to our
target market. By designing our services to support this select group of
leading service and equipment vendors, we seek to leverage our expertise,
technologies and processes,
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while still providing support for the needs of most middle market companies as
well as some larger entities. We intend to continue to develop our processes
and tools to support new hardware and services introduced by leading vendors.
This ongoing support may require us to modify existing services and, in some
cases, develop new services. For example, we recently completed a pilot
program to manage voice-over-IP technology with a Fortune 200 company.
Expand service offerings. We seek to expand our service offerings by
leveraging our existing expertise, technologies and processes in the network
management arena. In August 1996, we introduced a security service that
provides remote intrusion detection. These offerings use our network
management center and tools infrastructure and are supplemented by additional
proprietary and third-party tools. In addition, the security service is
enhanced by engineers with specific network security expertise. In September
2000, we began offering virtual private network (VPN) management services. We
continue to expand our WAN and LAN offerings and continue to look into
services that will move us into managing enterprises' network infrastructure
towards the desktop.
Add distribution partners. We believe that we can market our services most
effectively by partnering with resellers that bundle our services with
transport services, network equipment or consulting and integration services.
We believe that we can expand our current distribution relationships, or
establish referral or joint sales opportunities, to include equipment
manufacturers, high-end tool providers, e-commerce service providers such as
Application Service Providers, or ASP's, and systems integrators/outsourcers.
We believe that these relationships will provide us with a significant
competitive advantage.
License our technology. We entered into a licensing agreement with NEC
Corporation of Japan under which NEC Japan will be authorized to utilize our
proprietary network management software tools as well as the service
descriptions and processes that we design and utilize to manage networks. This
license is for use only with respect to services sold by NEC to entities with
headquarters locations in Japan. The license agreement provides for an up-
front software license fee, annual software license maintenance fees, and
ongoing royalties based on the number of devices managed using our software
tools. We believe we can enter into similar relationships to license our
technology in other countries.
Network management services
Our network management services include one-time services such as design
and implementation of new networks, as well as ongoing, or recurring,
management and security services. We also entered into a licensing agreement
in fiscal year 2001 that will allow a third party to provide our services
utilizing our processes and software tools to companies with headquarters
locations in Japan. Our current service offerings are grouped under three
general categories: remote network management services, Internet and intranet
security services, and web-enabled network management tools.
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Remote network management services
Our services include the remote management of router-based WANs and LANs,
LAN switches and intelligent hubs. These services are intended to address the
full life cycle of network management, which includes the activities depicted
in the following table. Customers may elect to purchase full life cycle
management services or may, in some cases, purchase only recurring ongoing life
cycle activities, defined as those after the Implement activity in the table
below. Pricing for recurring services is generally established as a monthly fee
on a per-managed-device basis. The following highlights services performed by
us for each life cycle activity:
Life cycle activity Our services
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Design Design network to meet specific end-user requirements
Offer CPE and maintenance pricing information
Configure Configure CPE to enhance initial and ongoing network
performance
Determine addressing, packet filtering and routing
protocol
Update CPE configurations as required to meet ongoing
customer business requirements
Implement Provide project management
Stage, configure and install equipment
Verify operational readiness
Monitor Proactively monitor network 24 hours per day, 7 days per
week from our network management center
Diagnose Proactively diagnose faults
Notify end user of status
Resolve Proactively identify and resolve faults
Notify end user of status
Report Offer network performance, transport provider
performance, cost analysis reports and transport
utilization statistics
Offer asset management information
Upgrade Upgrade or change components in the network as
requirements or configurations change
Review software releases
Install and configure new software and equipment as
appropriate
Document Download and archive on our management platform
information related to CPE configurations, carrier and
CPE service provider data and other network
connectivity information
We have two branded network management service offerings: ProWatch for WANs
and ProWatch for LANs.
ProWatch for WANs. We introduced our first WAN remote management service in
January 1994 to enable remote management of router-based Frame Relay and ATM
networks. This service is marketed by us and certain of our resellers as
ProWatch for WANs. It is also marketed by other resellers, sometimes in
modified versions, under the various brands of those resellers. The managed
elements in this service include the WAN-attached router; the customer service
unit, or CSU, connecting the router to the transport provider's Frame Relay or
ATM service; and the transport provider's network services. Approximately
23% of our recurring management revenues are currently derived from our managed
CSU business that is a subset of the ProWatch for WANs service that does not
include management of the router. Features offered in different options of
ProWatch for WANs include:
. performance engineering and fault management;
. proactive monitoring; and
. performance reporting.
The ProWatch for WANs service generally includes a guarantee to provide the
customer end-to-end network availability for at least 99.5% of the time in any
given month, with the customer generally receiving a refund of the management
fee in any month the guaranteed availability rate is not achieved.
Substantially all of our
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recurring network management services revenues are derived from ProWatch for
WANs and related WAN services.
ProWatch for LANs. We introduced our LAN remote management service in May
1997 to measure, monitor and manage the routers, switches and intelligent hubs
in corporate LANs. This service can also monitor the availability of servers
manageable by the Simple Network Management Protocol, or SNMP. Our LAN
management services are marketed by us and certain of our resellers as
ProWatch for LANs and are also marketed by other resellers under the various
brands of those resellers. In developing the ProWatch for LANs service, we
leveraged the expertise, technologies and processes we developed in providing
ProWatch for WANs. The primary differences between ProWatch for LANs and
ProWatch for WANs are the exclusion of the transport provider's network
services and the inclusion of additional performance reporting capabilities.
We recently completed a pilot program designed to test the feasibility of
adding voice-over-IP application support to our ProWatch for LANs service and
are in the process of adding this capability to our standard services.
Internet and intranet security services--ProWatch Secure
Our network security services, marketed under the brand name ProWatch
Secure, provide protection 24 hours per day, seven days per week for networks'
Internet and intranet perimeter points. These security services include the
following elements of remote network security management: security assessment
and recommendations; implementation; ongoing security management; assurance;
security reports and consultation; configuration management; and virtual
private network, or VPN, configuration management. The pricing for these
security services is generally established as a monthly fee on a per-managed-
device basis. We offer two different security services:
ProWatch Secure Managed Firewall Service. This service provides active
management of the firewall, the electronic barrier between network segments.
Our security engineers regularly review firewall logs and alarms to detect
suspicious activity. Through this monitoring we can consult with the end user
regarding potential changes in the firewall configuration. ProWatch Secure
Managed Firewall Service is supported on Cisco's PIX Firewall series. The
Cisco PIX Firewall is configured by our security engineers to enforce the
security policy that best meets the end user's requirements to control access
by specified applications and source addresses. The ProWatch Secure Managed
Firewall Service was introduced in September 1998 as a more basic security
service than our Remote Intrusion Detection and Response Service.
ProWatch Secure Remote Intrusion Detection and Response Service. For more
demanding security environments, such as those engaged in e-commerce,
customers can implement intrusion detection monitoring as a second layer of
network security. This service provides additional perimeter security beyond
that offered by the access protection of ProWatch Secure Managed Firewall
Service. ProWatch Secure Remote Intrusion Detection and Response Service uses
Cisco's NetRanger intrusion detection system to detect suspicious activity on
customer networks, repel attack attempts and bar the potential intruder from
accessing the end user's network. We introduced our ProWatch Secure Remote
Intrusion Detection and Response Service in August 1996.
End users may purchase these services individually, together or as part of
a combined network management service offering.
Web-enabled tools
Our web-enabled network management tools provide end users with access to
up-to-date status information of their networks, giving end users greater
control and understanding of their networks while out-tasking day-to-day
management to us. Access to this information is included as a component of our
standard network management services and is provided to end users at no
additional charge. End users access these tools through a standard web browser
using our ProWatch Exchange application. ProWatch Exchange provides trouble
ticket status and history, plus network installation project status. An active
network map displays the status of all managed sites in an end user's network.
ProWatch Exchange also provides on-line viewing access to the monthly
availability and on-demand performance reports included with the various
remote network management services.
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Equipment and other services
We resell customer premise equipment from leading network equipment
manufacturers or their resellers. This equipment typically includes routers,
CSUs and LAN switches and is obtained from Cisco and, to a lesser extent, from
Bay/Nortel, Paradyne and others. Sales of this equipment are made only to our
network management services customers in conjunction with the sale of our
services. This equipment constitutes the primary components of the end-user
networks we manage. Customers who purchase this equipment from us rather than
from other sources typically do so for the convenience of a single supplier
solution. We anticipate sales of equipment to continue to decline and at some
point to possibly be eliminated from our offerings.
We also resell on-site maintenance services, primarily to customers who
have purchased the associated equipment from us. These services address issues
associated with hardware failures and software bugs, as well as software
upgrades provided for under the equipment provider's maintenance contract.
These maintenance services are provided by 3Com or successors, Bay/Nortel,
Cisco and Milgo Solutions. We anticipate sales of new maintenance contracts to
decline and that these revenues will decline over time as current contracts
expire with at least some not being renewed.
Customers
Our solutions are designed to address primarily the needs of middle market
enterprises, roughly defined as companies that have between 100 and
1,000 employees and annual revenues between $25 million and $500 million. In
addition, we also currently provide services to several larger organizations
that can utilize our standard packaged services without requiring significant
customization. We currently have over 1,200 end users representing over
30,000 managed sites. Our end users consist of our direct customers as well as
customers of our resellers
When sold to end users by resellers, such as AT&T, our services are
typically sold under the reseller's trade or brand name. In some instances,
however, the reseller utilizes our brand names. In all cases, we receive our
revenues directly from the resellers. In some situations, the resellers
include the cost of our services in the pricing they establish for their
related services while in other cases the services and CPE we provide are
billed separately by the reseller. Our resellers include AT&T, Kent Datacomm,
NEC Business Network Solutions and Solarcom, Inc..
We have derived a significant portion of our revenue from one reseller,
AT&T. No other customer accounted for more than 10% of our revenues in any of
the last three fiscal years. AT&T accounted for 59% of our total revenues in
fiscal year 1999, 71% of our total revenues in fiscal year 2000, and 69% of
our total revenues in fiscal year 2001.
In March 2001, we entered into an agreement to provide remote network
management services to customers of Comdisco that agreed to an assignment to
us of their contract with Comdisco. Under that agreement, we will provide our
services to approximately fifteen customers having approximately 3,000 devices
under management.
Relationship with AT&T
We have entered into reseller agreements with two separate organizations
within AT&T: AT&T Solutions and AT&T Data and Internet Services. Both of these
organizations market and resell our network management services to AT&T
customers in conjunction with AT&T's overall network solution offering using
AT&T's trade name. Our technicians work directly with AT&T's sales and
marketing personnel and the end users to design, implement and manage the end
users' networks. As with our other reseller arrangements, we receive our
revenues for the resale of our services to AT&T customers directly from AT&T.
AT&T accounted for 59% of our total revenues in fiscal year 1999, 71% of our
total revenues in fiscal year 2000, and 69% of our total revenues in fiscal
year 2001.
The reseller agreements with AT&T have separate terms for each of the two
organizations. The arrangements with AT&T Solutions currently terminate on
December 31, 2001 with respect to placing new orders
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for service. Individual orders received prior to July 1, 1999 may be canceled
at AT&T's option at a rate not to exceed 150 devices per month beginning in
July 2001. This rate represents approximately 4% per month of the orders
eligible for this option as of June 30, 1999. For orders placed after June 30,
1999, the agreement provides for us to continue providing services until the
earlier of the expiration of the end-user customer service term or
December 31, 2004. However, individual orders placed after June 30, 1999 may
be canceled at any time at AT&T's option on thirty days' notice by paying a
cancellation charge. These cancellations are limited to 10% of the beginning
backlog of all orders in any twelve month period. In addition, all orders may
be cancelled at any time after July 1, 2001, upon 12 months' written notice.
In the event of a cancellation, the number of devices that may be cancelled by
AT&T each month may not exceed 8% of the number of devices billed in the last
full month prior to cancellation.
Our reseller agreements with AT&T Data and Internet Services relate
primarily to AT&T's Frame Relay Plus Services. Our arrangements relating to
Frame Relay Plus Services will terminate December 31, 2001, except that,
following the termination date, we will continue to provide services until the
earlier of the expiration of the end user customer service term or
December 31, 2004.
Sales and marketing
We market our services directly to end users as well as to resellers.
Services sold to carrier resellers support the carriers' network operations or
are incorporated in services the carriers sell directly to end users. In
fiscal year 2001, 20% of network management service revenues was derived from
direct customers. Our strategy is to build our reseller channels and we expect
that these channels will represent an increasing percentage of our network
management revenues for the foreseeable future. Our resellers include AT&T,
Kent Datacomm, NEC Business Network Solutions and Solarcom, Inc. All sales of
our services to date have been made in the U.S. However, we remotely manage
locations in 42 countries around the world for these U.S.-based customers. We
have also entered into an agreement with NEC Japan under which we will license
our service descriptions, software tools and processes.
At March 31, 2001, we employed 18 people in sales and sales support. Each
sales person is assigned one or more reseller channels to support. Certain
sales individuals are also responsible for direct sales to end users of our
services. Reseller support by our sales organization includes assistance with
responses to requests for proposals, network design and proposal generation,
and participation in sales calls to potential customers. Our sales
organization also helps resellers define services and familiarize the
reseller's sales forces with our services and networking options.
Substantially all of our sales and marketing employees are based at our
headquarters in Austin.
At March 31, 2001, we employed 11 people in marketing who are responsible
for marketing communications, public relations and new service introductions.
Primary marketing communications include direct mail promotions, seminars,
sales collateral and support and our web site. Public relations activities
include obtaining media coverage and public recognition. Marketing activities
related to new service introductions include service definition, pricing,
competitive analysis, service beta test and general availability launches,
identification of potential reseller partners and service creation program
management. The marketing group also works closely with our larger reseller
partners to define, develop and implement embedded services.
Software and services development
Our software and services development groups consisted of 25 people as of
March 31, 2001. One objective of our software development group is to develop
or integrate the tools we utilize to manage networks and to develop software
applications, such as ProWatch Exchange, which become components of our
services. While certain of our applications and tools are proprietary, all are
built using industry-standard protocols, tools and development environments,
including HyperText Markup Language, or HTML, Java, Java Script, Microsoft
Access, Oracle 8.x relational database software and development tools, Remote
Monitoring, or RMON, SNMP and Visual Basic. Another objective of our software
development group is to create versions of our tools that
10
can be utilized under license by third party providers of remote network
management services such as is being done for NEC Japan. The objective of our
services development group is to research new technologies and develop service
offerings, including early operations processes, that address the needs of our
target customers with respect to these technologies.
Operations
Our operations organization, comprised of 199 individuals as of March 31,
2001, is responsible for delivery of our services to end users. By defining
network management tasks into sets of tightly defined services, we are able to
deliver functionality to our end users at cost effective prices. Our services
generally are provided using a team approach where each customer is assigned
to a team of customer engineers, with one member of the team being assigned
primary customer responsibility and each member providing back-up when the
primary engineer is not available.
These customer engineer teams are supported by other groups within our
operations group. The first level of service delivery is our network
management center, which is staffed 24 hours per day, seven days per week with
network engineers and technicians who have a broad range of technical
expertise. Our network management center continuously monitors responses to
polls to managed devices and opens trouble tickets in response to network
outages. The goal of this group is to provide the end user with notice and a
diagnosis within fifteen minutes of a network failure. Upon isolation of the
problem, the appropriate service provider is dispatched to the end user's
premises as required to repair the outage. Network management center employees
can electronically enter trouble tickets into selected transport provider's
systems to enable faster resolution of carrier network issues.
Other groups within operations include project managers, installation
engineers, equipment staging and configuration personnel, and a network and
tools infrastructure group. By using specialized teams for defined processes,
we can utilize network engineers with a broad range of skills and experience.
We deliver our services utilizing a workforce with a wide range of skills,
from entry-level to highly trained networking professionals. We use a strict
operational methodology combined with proprietary software tools to leverage
our workforce. We believe that we can meet our resource requirements by hiring
experienced networking professionals and by recruiting and training recent
college graduates. Nonetheless, qualified IT professionals are in short supply
and we face significant competition for these professionals.
Our approach to loss of the critical systems and management network
infrastructure utilized to manage customer networks is one of disaster-
avoidance backed up by selected disaster recovery. The network management
infrastructure is primarily Frame Relay-based which provides the high
availability inherent in that technology. To minimize the potential loss of
access to local telecommunications infrastructure, we employ a SONET ring
which is served from two separate local exchange carrier serving offices. Our
facility contains two separate rooms with some redundant computing and
networking equipment, each of which is monitored 24 hours per day, seven days
per week. We currently plan to begin operation of a second management facility
in the latter half of 2001.
Competition
Currently, we compete primarily with the internal network administration
organizations of actual or potential end users of our services although
competition from other service providers is beginning to increase. Many of
these end users have internal network support capabilities and could choose to
satisfy their needs through internal resources rather than through outside
service providers. We believe that the principal factors involved in competing
effectively with internal solutions include quality of service, price,
functionality and features, product reputation and quality of support. We
believe our services compete favorably with companies' internal solutions on
the basis of quality of service and support, price and features. Furthermore,
in competing with companies' internal resources, we have the advantage of
leveraging the knowledge we have gained from working with many different
customer networks.
11
The remote network management services market is new, highly fragmented,
rapidly evolving and largely undefined. There are few substantial barriers to
entry, and we expect that we will face additional competition from existing
competitors and new market entrants in the future. These competitors may have
significantly greater financial, technical and marketing resources and greater
name recognition than we have. We believe that the principal competitive
factors in this market include networking and security engineering expertise,
scalable management tools, reliability and quality of service, large scale,
the ability to maintain and expand distribution channels, price, the timing of
introductions of new services, and conformity with industry standards. While
we believe that we currently are able to provide end users with reliable
network management and security services at prices that allow us to compete
favorably with respect to other service providers, there can be no assurance
that we will have the resources or expertise to compete successfully in the
future.
We currently face competition from other remote network management
companies such as Nuvo Network Management; telecommunications providers such
as AT&T, Sprint, and MCI/WorldCom; network equipment vendors such as
Bay/Nortel and Lucent; and computer systems vendors such as Hewlett Packard
and Unisys. With respect to our security services, we currently face
competition from computer systems vendors such as IBM and network security
software and services vendors such as Counterpane and ISS. We also face
potential competition from IT consulting firms, systems integrators, VARs, and
local and regional network services firms and other new entrants into our
markets, such as some of the members of the recently formed Management Service
Providers Association of which we are a member. Many of these current and
potential competitor companies have significantly greater financial, technical
and marketing resources and greater name recognition and generate greater
service revenue than we have. There can be no assurance that we will be able
to compete successfully against current or potential competitors. Our failure
to successfully compete would significantly damage our business.
We also face potential competition from resellers with which we currently
partner, such as AT&T, or could partner, to market and sell our services.
These resellers generally have substantially greater resources than we have
and could directly compete, rather than partner, with us. Such a decision by
our resellers would significantly damage our business.
With respect to the sale of equipment and on-site equipment maintenance
services, we compete primarily with the equipment manufacturers and their
resellers.
Intellectual property rights
We rely on a combination of patent, trademark, service mark and trade
secret laws and contractual restrictions to establish and protect certain
proprietary rights in technology underlying our services. We have one patent
and have applied for other patents with the United States Patent Office. These
patents relate to software technology which allows us to poll, or communicate
with, large numbers of routers or other SNMP devices over multiple WANs. We
intend to continue to evaluate the appropriateness of these protections and to
seek additional patent protection for our inventions when appropriate. There
can be no assurance that additional patents will be issued from our currently
pending or any future applications, or that any patents that may be issued
will be sufficient in scope or strength to provide meaningful protection or
any commercial advantage to us. We have registered our logo, which includes
the NetSolve name, and other marks, including ProWatch, ProWatch IV, ProWatch
for WANs, ProWatch for LANs, ProWatch Secure and ProWatch Exchange as separate
service marks in the United States and various state trademark offices. We are
in the process of filing service marks and trademarks in Japan, which we
expect to be completed by the end of May 2001. We have not made any other
foreign patent or trademark filings. We have entered into proprietary rights
and confidentiality agreements with our employees, and generally enter into
nondisclosure agreements with our suppliers, distributors and appropriate
customers in order to limit access to and disclosure of our proprietary
information.
There can be no assurance that these contractual arrangements or the other
steps taken by us to protect our intellectual property will prove sufficient
to prevent infringement or misappropriation of our technology or to deter
independent third-party development of similar technologies. Any infringement
or misappropriation, should
12
it occur, could significantly damage our business. Furthermore, litigation may
be necessary to enforce our intellectual property rights, to protect our trade
secrets, to determine the validity and scope of the proprietary rights of
others, or to defend against claims of infringement or invalidity. Litigation
could result in substantial costs and diversion of resources. We may be unable
to protect our intellectual property, and we could incur substantial costs
defending our intellectual property from infringement or claims of
infringement.
In June 1996, in connection with our federal registration of a service mark
that includes the NetSolve name, GRC International, Inc. claimed that our use
of the name NetSolve infringed GRC's common law intellectual property rights.
This claim was settled by an agreement with GRC and GRC withdrew its
opposition and consented to our service mark registration. GRC retains the
right to use the name NetSolve to describe a particular software product, and
we retain the full right to our corporate name. We also agreed with GRC to
refrain from using NetSolve as a brand name to describe products and services.
We believe that the limited joint use of the name NetSolve by GRC will not
have a material adverse effect on us. With the exception of GRC, we have not,
to date, been notified that our services infringe the proprietary rights of
third parties; however, there can be no assurance that third parties will not
claim infringement or indemnification by us with respect to current or future
services or products. We expect that participants in our markets will be
increasingly subject to infringement claims as the number of services and
competitors in our industry segment grows. Any of these claims, whether
meritorious or not, could be time-consuming, result in costly litigation,
cause delays in product and service installation and implementation, prevent
us from using important technologies or methods, subject us to substantial
damages, or require us to enter into royalty or licensing agreements. These
royalty or licensing agreements might not be available on terms acceptable to
us or at all. As a result, any of these claims could materially harm our
business.
Employees
As of March 31, 2001, we had 277 full-time employees, including 29 in sales
and marketing, 25 in development, 199 in operations and 24 in finance,
administration and corporate services. Our success depends to a significant
degree upon the continued contributions of our executive management, network
management and engineering teams. Our future success will depend in large part
upon our continued ability to attract and retain highly skilled and qualified
personnel.
None of our employees is represented by a collective bargaining agreement.
We believe relations with our employees are good.
Item 2. FACILITIES
Our corporate headquarters are located in a leased facility in Austin,
Texas which covers approximately 70,000 square feet. A portion of this
facility is covered by an uninterrupted power supply system backed up by a
power generator to guard against system failure and to provide emergency power
in the event of an outage. We also maintain dual computer rooms in this
facility with some redundant equipment in order to provide safeguards in the
event of a fire or similar emergency. The lease for this facility expires in
November 2008, including a five-year option to renew.
We have leased an additional facility in Austin, Texas covering
approximately 80,000 square feet. This lease commenced in April 2001 and
expires in April 2012, including a five-year option to renew. We believe these
facilities will be adequate to meet our foreseeable requirements or that
suitable additional or substitute space will be available on commercially
reasonable terms.
Item 3. LITIGATION
A series of complaints were filed in the United States District Court for
the Western District of Texas, Austin Division against the Company and certain
of its officers in September and October 2000. Plaintiffs in each of these
cases sought to represent a class comprised of purchasers of the Company's
common stock between
13
April 18, 2000 and August 18, 2000 ("Class Period"). Those complaints alleged
that the defendants engaged in a fraudulent scheme by issuing false and
materially misleading statements regarding the Company's business during the
Class Period. Those cases were consolidated into one action, In re NetSolve
Incorporated Securities Litigation, Civil Action No. A00-CA-591 SS, before
Judge Samuel Sparks of the United States District Court for the Western
District of Texas. Judge Sparks also appointed HLM Management Company and
Donald Douglas Sr. Lead Plaintiffs on December 21, 2000.
Lead Plaintiffs filed their Amended and Consolidated Complaint on February
21, 2001. The Company moved to dismiss the complaint on March 8, 2001 for
having failed to state a claim under which relief can be granted and for
having failed to comply with the pleading requirements of the Private
Securities Litigation Reform Act of 1995, 15 U.S.C. (S) 78u-4 et seq. Lead
Plaintiffs opposed the Company's motion on March 30, 2001. The Company replied
to Lead Plaintiffs' opposition papers on April 11, 2001.
The Company and each individual defendant believe that this lawsuit is
meritless and the Company and its officers intend to vigorously defend
themselves in this action.
Item 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the three
months ended March 31, 2001.
14
EXECUTIVE OFFICERS OF THE REGISTRANT
The following information is provided with respect to each executive
officer of the registrant as of May 15, 2001, pursuant to General Instruction
G of Form 10-K:
Name Age Position(s)
---- --- ----------
Craig S. Tysdal......... 54 Director; president and chief executive officer
Kenneth C. Kieley....... 50 Vice president--finance, chief financial officer and secretary
Honore Labourdette...... 49 Vice president--sales
Jerry W. Davis.......... 38 Vice president--development
Robert C. Pojman........ 37 Vice president--business development
Robert W. Kujawski...... 36 Vice president--operations
Craig S. Tysdal became our president and chief executive officer and a
member of our board of directors in September 1993. From May 1990 to March
1993, Mr. Tysdal was employed as senior vice president--worldwide sales at
Network Equipment Technologies, Inc., a worldwide supplier of WAN equipment.
He was also employed at Network Equipment Technologies, Inc. as its vice
president--product marketing from July 1989 to April 1990 and as its vice
president--sales from October 1986 to June 1989.
Kenneth C. Kieley joined us in September 1989 as our vice president--
finance, chief financial officer and secretary. From July 1985 to September
1989, Mr. Kieley served as vice president--finance of VMX, Inc., a
manufacturer of voice messaging systems. Mr. Kieley worked for Ernst & Young
LLP from 1975 to 1985.
Robert C. Pojman was appointed to vice president--business development in
April 2001. Prior to that he served as our vice president--Operations since
February 1997. Mr. Pojman was employed as first vice president--data centers
at Deluxe Data Systems, a software and services company which facilitiates the
processing and clearing of payments. He also worked at Deluxe Data Systems as
director, technical services from June 1993 to April 1995 as well as director
of operations services from July 1992 to June 1993.
Jerry W. Davis became our vice president--development in April 2000. From
April 1998 to April 2000, and prior to that for the period of September 1994
to July 1996, Mr. Davis held key roles with NetSolve in the areas of product
and planning management. From 1996 to 1998, Mr. Davis was employed as a major
account systems consultant for 3Com Corporation. He was also employed as an
independent consultant from 1992 to 1994 and as a plant project engineer for
Dresser Industries from 1987 until 1992.
Honore LaBourdette was named vice president--sales in May 2001. Ms.
LaBourdette served as regional vice president--sales for Nortel Networks from
July 1998 until April 2001. From June 1994 to July 1998, she was the regional
director--sales for Network Equipment Technologies, Inc. and was focused on a
direct sales efforts in the western region of the United States.
Robert W. Kujawski was named vice president--operations in April 2001.
Prior to his appointment of vice president of Operations, Mr. Kujawski served
as manager of NetSolve's Network Management Center. From May of 1998 to June
of 2000, Mr. Kujawski served as group area development manager and director of
Production Services for Norwest Mortgage Inc. Mr. Kujawski served in various
positions at Deluxe Data Systems, Incorporated including manager, Data Center
Operations, Data Center Help Desk manager, Data Center Shift supervisor and
Software Certification Analyst/Team Leader from October 1987 to May 1998.
15
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market information
Our common stock trades on the Nasdaq National Market under the symbol
"NTSL." The following table sets forth the high and low per share sales prices
of our common stock for each of the last seven quarters in the period ended
March 31, 2001, as reported by the Nasdaq National Market System.
Price Per
Share
-------------
Three Months Ended High Low
------------------ ------ ------
September 30, 1999............................................. $37.00 $17.19
December 31, 1999.............................................. 35.88 16.25
March 31, 2000................................................. 61.50 27.81
June 30, 2000.................................................. 33.63 20.50
September 30, 2000............................................. 29.50 6.38
December 31, 2000.............................................. 9.08 5.00
March 31, 2001................................................. 8.50 5.75
Prior to September 29, 1999, a public market did not exist for our common
stock. Therefore, market information does not exist for the three months ended
June 30, 1999 and the information provided for the three months ended
September 30, 1999 reflects the high and the low prices per share over the two
days of trading during that period.
Holders of our common stock
At the close of business on May 21, 2001, there were approximately 136
holders of record of the common stock and approximately 3,369 shareholders of
beneficial interest.
Dividends
We have not paid any dividends on our common stock and do not intend to pay
any dividends in the foreseeable future.
Use of Proceeds
The Company's registration statement on Form S-1 (File No. 333-65691) was
declared effective on September 28, 1999. Gross proceeds from the offering
were used to pay offering costs through December 31, 1999. Net proceeds from
the offering in the amount of $20,179,000 have been used to repurchase an
aggregate of 2,795,316 shares of the Company's common stock since August 2000.
The remainder of the proceeds of this offering, $27,921,000, is temporarily
invested in short-term, investment-grade, interest-bearing securities pending
their use for other purposes.
Item 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read together
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the consolidated financial statements and related notes
appearing elsewhere in this document. The following selected consolidated
financial data for fiscal years 1999, 2000 and 2001 and as of March 31, 2000
and 2001 are derived from our consolidated financial statements included
elsewhere in this document, which have been audited by Ernst & Young LLP,
independent auditors. The following selected consolidated financial data for
fiscal years 1997 and 1998 and as of March 31, 1997, 1998 and 1999 are derived
from our audited consolidated financial statements not included in this
document.
16
March 31,
-------------------------------------------
1997 1998 1999 2000 2001
------- ------- ------- ------- -------
(in thousands, except per share data)
Statement of operations data:
Revenues:
Network management services...... $ 2,830 $ 7,324 $12,777 $24,048 $33,032
Equipment and other.............. 3,486 7,199 13,939 14,613 13,420
------- ------- ------- ------- -------
Total revenues................. 6,316 14,523 26,716 38,661 46,452
Cost of revenues:
Cost of network management
services........................ 2,434 5,706 8,258 13,095 19,311
Cost of equipment and other...... 2,638 5,425 10,665 11,202 9,536
------- ------- ------- ------- -------
Total cost of revenues......... 5,072 11,131 18,923 24,297 28,847
------- ------- ------- ------- -------
Gross Profit...................... 1,244 3,392 7,793 14,364 17,605
Operating expenses:
Development...................... 1,262 2,040 1,762 2,503 3,169
Sales and marketing.............. 2,246 2,562 3,153 4,486 6,149
General and administrative....... 1,489 2,159 2,098 3,095 3,559
Amortization of deferred
compensation.................... -- -- -- 65 58
------- ------- ------- ------- -------
Total operating expenses....... 4,997 6,761 7,013 10,149 12,935
------- ------- ------- ------- -------
Operating income (loss)........... (3,753) (3,369) 780 4,215 4,670
Other income, net................. 34 340 93 1,463 3,285
------- ------- ------- ------- -------
Income (loss) from continuing
operations before income taxes... (3,719) (3,029) 873 5,678 7,955
Income tax expense (benefit)...... (1,257) (297) 19 (4,875) 2,944
------- ------- ------- ------- -------
Net income (loss) from continuing
operations....................... (2,462) (2,732) 854 10,553 5,011
Discontinued operations:
Income from discontinued
operations, net of applicable
income taxes.................... 2,142 165 -- -- --
Gain on sale of discontinued
operations, net of applicable
income taxes.................... 10,615 341 98 -- --
------- ------- ------- ------- -------
Net income (loss)................. $10,295 $(2,226) $ 952 $10,553 $ 5,011
======= ======= ======= ======= =======
Basic income (loss) per share
from(1):
Continuing operations............ $ (1.75) $ (1.76) $ (0.51) $ 1.06 $ 0.37
======= ======= ======= ======= =======
Net income (loss)................ $ 2.72 $ (1.59) $ (0.48) $ 1.06 $ 0.37
======= ======= ======= ======= =======
Weighted average shares used in
basic per share calculations(1).. 2,851 2,995 3,297 8,800 13,502
======= ======= ======= ======= =======
Diluted income (loss) per share
from(1):
Continuing operations............ $ (1.75) $ (1.76) $ (0.51) $ 0.68 $ 0.34
======= ======= ======= ======= =======
Net income (loss)................ $ 2.72 $ (1.59) $ (0.48) $ 0.68 $ 0.34
======= ======= ======= ======= =======
Weighted average shares used in
diluted per share
calculations(1).................. 2,851 2,995 3,297 13,648 14,539
======= ======= ======= ======= =======
Pro forma basic income per share
from(2):
Continuing operations............ $ 0.09 $ 0.88 $ 0.37
======= ======= =======
Net income....................... $ 0.10 $ 0.88 $ 0.37
======= ======= =======
Pro forma weighted average shares
used in basic per share
calculations(2).................. 9,692 11,963 13,502
======= ======= =======
Pro forma diluted income per share
from(2):
Continuing operations............ $ 0.07 $ 0.77 $ 0.34
======= ======= =======
Net income....................... $ 0.08 $ 0.77 $ 0.34
======= ======= =======
Pro forma weighted average shares
used in diluted per share
calculations(2).................. 11,341 13,648 14,539
======= ======= =======
- --------
(1) Calculated as described in note 2 of notes to consolidated financial
statements. Additional per share information is disclosed on the
consolidated statements of operations in the consolidated financial
statements included elsewhere in this document.
(2) Reflects the conversion of our redeemable convertible preferred stock into
common stock. See note 4 of notes to consolidated financial statements.
17
March 31,
---------------------------------------------
1997 1998 1999 2000 2001
-------- -------- -------- ------- -------
(in thousands)
Balance sheet data:
Cash and cash equivalents....... $ 8,128 $ 1,333 $ 2,764 $57,185 $45,411
Working capital................. 9,464 5,399 5,282 63,329 46,889
Total assets.................... 16,068 13,227 14,936 74,519 62,831
Capital lease obligations, net
of current portion............. 175 1,146 1,027 324 --
Redeemable convertible preferred
stock.......................... 39,085 41,615 44,146 -- --
Total stockholders' equity
(deficit)...................... (28,313) (33,029) (34,529) 68,958 56,977
18
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-looking Statements
This report and other presentations made by us contain "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act
of 1934, as amended. We sometimes identify forward-looking statements with
such words as "expects", "anticipates", "intends", "believes" or similar words
concerning future events. They include, among others, statements relating to
trends in revenue, company growth, sales, margin and expenses, and the drivers
behind those trends; trends in sales of network management services, sales of
customer premise equipment, and sales to AT&T. These statements involve known
and unknown risks, uncertainties and other factors that could cause our actual
results to differ materially from the results expressed or implied by such
statements, including general economic and business conditions, conditions
affecting the industries served by us, conditions affecting our customers and
suppliers, competition, the overall market acceptance of the Company's
services, and other factors disclosed in Item 3 "Quantitative and Qualitative
Disclosures About Market Risk" and this Report. Accordingly, although we
believe that the expectations reflected in our forward-looking statements are
reasonable, there can be no assurance that they will prove to be correct.
Any forward-looking statement speaks only as of the date on which such
statement was made, and we do not undertake any obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement was made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time and it is not possible for us to
predict all of such factors, nor can we assess the impact of each such factor
or the extent to which any factor, or combination of factors, may cause
results to differ materially from those contained in any forward-looking
statement.
Overview
We provide network management services that allow enterprises and carriers
to outsource some or all network-specific activities in order to increase
network reliability and up-time, reduce overall network costs, and simplify
timely migration to new technologies. We were incorporated in September 1985
in the State of Delaware and began operating in the second half of 1987. Until
December 1996, substantially all of our services revenues were derived from
the sale of data transport services. To provide these transport services, we
leased network transmission facilities from major carriers, and we also resold
AT&T's transport services. We began developing our first remote network
management service offering for WANs in early 1993 and began offering that
service, together with AT&T's transport services, in the quarter ended March
31, 1994. We began selling network management services separately from our
data transport services in the quarter ended March 31, 1995. We introduced our
first security service in the quarter ended September 30, 1996. We
discontinued our data transport business in the quarter ended December 31,
1996. We began offering network management services for LANs in the quarter
ended June 30, 1997. We began offering virtual private network (VPN)
management services during the quarter ended September 30, 2000.
Revenues
Our revenues consist of network management services revenues as well as
equipment resales and other revenues. Our network management services include
both recurring and nonrecurring revenues:
. Revenues from recurring services represent monthly fees charged to
resellers or end users for our network management services. Recurring
network management services revenues are typically based on the number
of devices under management and are recognized in the period in which
the services are rendered. For fiscal year 2001, approximately 69% of
network management services revenues were from recurring services.
. Non-recurring network management services consist of data network
design, project implementation services and equipment installation
services, as well as one-time project and development assignments
19
that assist resellers in defining and creating new network management
services. Non-recurring network management services revenues are
generally recognized upon completion of the assignment or service. For
example, we charge fees for project implementation services on a per-
location basis and we recognize revenues associated with these services
upon completion of the network implementation for a location.
Our network management services revenues are derived from contracts with
telecommunications carriers, value-added resellers of networking equipment and
services, and enterprises sold to by our direct sales force. Our services
include both initial implementation and project management services for a one-
time fee per location as well as ongoing management services for a fixed
monthly fee per managed device. Our contracts with end users are generally for
terms of 24 to 36 months, although customers may cancel services prior to the
end of the service terms. Cancellations due to reasons other than closings of
managed locations, which to date have not been material, are generally subject
to cancellation fees ranging from 20% to 80% of the recurring charges payable
for the remainder of the service term. Cancellation fees as a percentage of
network management services revenues were less than 1% in each of fiscal years
1999, 2000 and 2001. We recognize revenues from cancellation fees on a cash
basis unless collection is assured. Our contracts with resellers typically
extend from 12 to 36 months and, in some cases, require that we continue
providing services throughout the term of the reseller's contract with the end
user. In these cases, we continue to recognize revenues upon performance of
the services, even if performance occurs after the term of the contract with
the reseller.
Our network management services for WANs typically include a guarantee
providing end-to-end network availability for at least 99.5% of the time in
any given month. In the event the guaranteed availability is not achieved, we
generally are obligated to refund our WAN management fees for that month. This
guarantee covers some components of the end user's WAN, such as the transport
services provided by the end user's carrier, that are not directly under our
control. As a result, we may, in some instances, refund amounts to customers
for circumstances beyond our control. We establish a reserve against
guarantees we offer. Historically, guarantee payments have not been material
in relation to network management services. However, in the future, refunds
made under our guarantees or otherwise could have a material adverse impact on
the results of our operations.
We derive equipment and other revenues from the resale of customer premise
equipment, or CPE, and from the sale of CPE maintenance contracts to our
network management services customers. CPE is networking equipment which
usually resides at the customer's location and includes routers, customer
service units or CSUs, and LAN switches. We utilize CPE produced by Cisco and,
to a lesser extent, by Bay/Nortel, Paradyne and others. We recognize revenues
from the sale of CPE upon shipment to the end user. However, if the
transaction is financed through our lease financing subsidiary, we recognize
the revenues upon sale of the underlying lease contract on a non-recourse
basis. We recognize revenues from CPE maintenance contracts on a monthly basis
as the services are provided. We only resell CPE to our network management
services customers. Although we believe some of our customers will continue to
purchase CPE from us, our strategy is to focus on our network management
services which generate higher margins. We therefore anticipate that revenues
from CPE sales will decline as we seek to manage our mix of revenues.
We currently have a network management services contract with two business
units within AT&T: AT&T Solutions and AT&T Data and Internet Services. AT&T
accounted for 59% of our total revenues in fiscal year 1999, 71% of our total
revenues in fiscal year 2000, and 69% of our total revenues in fiscal year
2001. We anticipate that sales to AT&T will continue to comprise a substantial
percentage of our revenues in fiscal 2002, but believe the percentage will
begin to decline beginning in the June 2001 quarter. No other customer
accounted for more than 10% of our revenues in fiscal years 1999, 2000 or
2001.
Historically, we have generated substantially all of our revenues from
sales to customers in the United States, although we manage devices in several
locations around the world for these U.S.-based customers.
20
Results of Operations
Fiscal year 2000 compared to fiscal year 2001
Revenues
Total revenues. Total revenues increased 20%, from $38.7 million in fiscal
year 2000 to $46.5 million in fiscal year 2001.
Network management services. Revenues from network management services
increased 37%, from $24.0 million in fiscal year 2000 to $33.0 million in
fiscal year 2001, representing 62% of total revenues in fiscal year 2000 and
71% of total revenues in fiscal year 2001. The increase was due almost
entirely to increased recurring revenues resulting from a growth in the number
of managed devices under contract.
Equipment and other. Revenues from equipment and other decreased 8%, from
$14.6 million in fiscal year 2000 to $13.4 million in fiscal year 2001,
primarily as a result of amendments we have made to some of our reseller
agreements whereby we receive management fees for ordering CPE and managing
CPE inventories for these resellers as well as fewer installations of new
networks which drive CPE sales. The decrease was partially offset by increased
CPE maintenance revenue due to an increase in the number of equipment
maintenance contracts in place.
Costs of revenues
Cost of network management services. Cost of network management services
includes salary and other costs of personnel, depreciation of equipment
utilized to manage customer networks, the network management infrastructure
utilized to provide remote network management services, and the costs of
third-party providers of CPE installation services. Cost of network management
services is expensed as incurred. Cost of network management services
increased 47%, from $13.1 million in fiscal year 2000 to $19.3 million in
fiscal year 2001, representing 54% of network management services revenues in
fiscal year 2000 and 58% of such revenues in fiscal year 2001. The dollar and
percentage increase was due primarily to the addition of personnel and network
management infrastructure enhancements that should allow us to scale
efficiently going forward in anticipation of continued growth.
Cost of equipment and other. Cost of equipment and other includes the
purchase of CPE from manufacturers and distributors and maintenance contracts
purchased for resale to end users. These costs are expensed in the period the
related revenues are recognized. Cost of equipment and other decreased 15%,
from $11.2 million in fiscal year 2000 to $9.5 million in fiscal year 2001,
representing 77% of equipment and other revenues in fiscal year 2000 and 71%
of equipment and other revenues in fiscal year 2001. The decrease in dollars
was due to reduced costs of resold equipment resulting from the decrease in
equipment resales. The decrease in costs of resold equipment was partially
offset by an increase in maintenance costs which occurred as a result of an
increase in the number of maintenance contracts in place. The percentage
decrease was due to increased CPE maintenance revenue which generally has
higher gross margins than equipment sales.
Operating expenses
Development. Development expenses consist primarily of salaries and related
costs of development personnel, including contract programming services.
Development employees are responsible for developing internal software
systems, selecting and integrating purchased software applications, developing
software tools for our network management services, developing our web-enabled
software applications that give customers access to network management
information, and defining and developing operating processes for new services.
Development expenses increased 27%, from $2.5 million in fiscal year 2000 to
$3.2 million in fiscal year 2001, representing 6% of total revenues in fiscal
year 2000 and 7% of total revenues in fiscal year 2001. The increase in
dollars was due to an increase in the number of software and service
development personnel devoted to the development and enhancement of network
management tools and our network management services.
21
Selling and marketing. Sales and marketing expenses consist primarily of
salaries, commissions, travel and costs associated with creating awareness of
our services. Sales and marketing expenses increased 37%, from $4.5 million in
fiscal year 2000 to $6.1 million in fiscal year 2001, representing 12% of
total revenues in fiscal year 2000 and 13% of total revenues in fiscal year
2001. The increase in dollars and as a percentage of total revenues was due to
costs incurred in the fourth quarter of fiscal year 2001 in connection with
the acquisition of customers from Comdisco, increased spending for advertising
as well as costs related to the addition of sales and marketing personnel.
General and administrative. General and administrative expenses consist
primarily of expenses related to our human resources, finance and executive
departments. Included in human resources spending is a majority of costs of
recruiting and relocating new employees. General and administrative expenses
increased 15%, from $3.1 million in fiscal year 2000 to $3.6 in fiscal year
2001, representing 8% of total revenues in both fiscal years 2000 and 2001.
The dollar increase was due primarily to legal fees related to the pending
class action securities lawsuit, additional spending related to recruiting and
relocating new employees and to being a public company.
Other income, net
Other income, net consists primarily of interest income earned on our cash
balances, slightly offset by interest expense from our leases for capital
equipment. Other income, net increased from $1.5 million in fiscal year 2000
to $3.3 million in fiscal year 2001, representing 4% of total revenues in
fiscal year 2000 and 7% of total revenues in fiscal year 2001. The increase
was due primarily to interest income earned on the net proceeds received from
the Company's initial public offering.
Income tax expense (benefit)
The income tax benefit recorded for fiscal year 2000 was $4.9 million,
compared to an expense of $2.9 million for fiscal year 2001. The benefit in
fiscal year 2000 is attributable to a reduction in the deferred tax asset
valuation allowance. Since the valuation allowance against deferred tax assets
was completely eliminated as of March 31, 2000 (resulting in the recording of
income tax benefits), income tax provisions for periods subsequent to March
31, 2000 are no longer offset by similar benefits.
Fiscal year 1999 compared to fiscal year 2000
Revenues
Total revenues. Total revenues increased 45%, from $26.7 million in fiscal
year 1999 to $38.7 million in fiscal year 2000.
Network management services. Revenues from network management services
increased 88%, from $12.8 million in fiscal year 1999 to $24.0 million in
fiscal year 2000, representing 48% of total revenues in fiscal year 1999 and
62% of total revenues in fiscal year 2000. Approximately one half of the
dollar increase was due to increased recurring revenues resulting from a
growth in the number of managed devices under contract. The remainder of the
increase was due to increased implementation revenues resulting from higher
volumes of newly installed sites, increased management fees for ordering and
managing CPE for selected resellers, and increased equipment installation
revenue.
Equipment and other. Revenues from equipment and other increased 5%, from
$13.9 million in fiscal year 1999 to $14.6 million in fiscal year 2000,
primarily as a result of increased CPE maintenance revenue due to an increase
in the number of equipment maintenance contracts in place offset by a decrease
in CPE revenue. Revenues from CPE sales decreased as a result of amendments we
have made to some of our reseller agreements whereby we receive management
fees for ordering CPE and managing CPE inventories for these resellers. In
addition, we expect to limit discounts on CPE and encourage end users to
purchase equipment from other sources.
22
Costs of revenues
Cost of network management services. Cost of network management services
increased 59%, from $8.3 million in fiscal year 1999 to $13.1 million in
fiscal year 2000, representing 65% of network management services revenues in
fiscal year 1999 and 54% of such revenues in fiscal year 2000. The dollar
increase was due primarily to the addition of personnel to accommodate growth,
upgrades to the network management infrastructure and, to a lesser extent,
increased subcontractor costs related to installation of CPE. The percentage
decrease was due primarily to improvements in processes and tools which
resulted in a higher number of managed devices per operations employee.
Cost of equipment and other. Cost of equipment and other increased 5%, from
$10.7 million in fiscal year 1999 to $11.2 million in fiscal year 2000,
representing 77% of equipment and other revenues in both fiscal years 1999 and
2000. The increase in dollars was due to an increased number of maintenance
contracts in place during fiscal year 2000 partially offset by lower costs of
CPE sales due to lower CPE sales.
Operating expenses
Development. Development expenses increased 42%, from $1.8 million in
fiscal year 1999 to $2.5 million in fiscal year 2000, representing 7% of total
revenues in fiscal year 1999 and 6% of total revenues in fiscal year 2000. The
increase in dollars was due to an increase in the number of software and
service development personnel devoted to the development and enhancement of
network management tools and our network management services.
Selling and marketing. Sales and marketing expenses increased 42%, from
$3.2 million in fiscal year 1999 to $4.5 million in fiscal year 2000,
representing 12% of total revenues in both fiscal years 1999 and 2000. The
increase in dollars was due to increased spending for advertising and customer
relations as well as costs related to the addition of sales and marketing
personnel.
General and administrative. General and administrative expenses increased
48%, from $2.1 million in fiscal year 1999 to $3.1 million in fiscal year
2000, representing 8% of total revenues in both fiscal years 1999 and 2000.
The dollar increase was due primarily to additional spending related to
recruiting of new employees and to being a public company.
Other income, net
Other income, net consists primarily of interest income earned on our cash
balances, partially offset by interest expense from our leases for capital
equipment. Other income, net increased from $93,000 in fiscal year 1999 to
$1.5 million in fiscal year 2000, representing less than 1% of total revenues
in fiscal year 1999 and 4% of total revenues in fiscal year 2000. The increase
was due primarily to interest income earned on the net proceeds received from
the Company's initial public offering.
Income tax expense (benefit)
The income tax provision recorded for fiscal year 1999 was $19,000,
compared to a benefit of $4.9 million for fiscal year 2000. The benefit in
fiscal year 2000 is attributable to a reduction in the deferred tax asset
valuation allowance. In August 1999, we determined that a portion of the
deferred tax asset, which had been fully reserved at March 31, 1999, would
more likely than not be utilized. As of March 31, 2000, we concluded that all
of the remaining deferred tax asset would more likely than not be utilized. As
a result, the valuation allowance was eliminated during fiscal year 2000.
Quarterly results of operations
Results of operations have varied from quarter to quarter. Accordingly, we
believe that period-to-period comparisons of results of operations are not
necessarily meaningful and should not be relied upon as indications
of future performance. Our operating results may fluctuate as a result of many
factors, including our ability to renew or retain existing end-user and
reseller relationships, the cost of introducing new service offerings and the
profitability of such offerings, and the level and nature of competition.
Further, we may be unable to adjust
23
spending rapidly enough to compensate for any significant fluctuations in the
number of new managed devices implemented in a given period. Any significant
shortfall in the number of new managed devices could therefore seriously
damage our business. Finally, there can be no assurance that we will continue
to be profitable in the future or, if we are profitable, that our levels of
profitability will not vary significantly between quarters.
The following tables set forth quarterly consolidated statements of
operations data in dollars and, except as noted below, as a percentage of
total revenues for each of the eight quarters in the period ended March 31,
2001. The information should be read together with the consolidated financial
statements and related notes appearing elsewhere in this document. Additional
per share information is disclosed on the consolidated statements of
operations in the consolidated financial statements included elsewhere in this
document. Operating results for any quarter are not necessarily indicative of
results for any future period.
Three Months Ended
----------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31,
1999 1999 1999 2000 2000 2000 2000 2001
-------- --------- -------- -------- -------- --------- -------- --------
(in thousands, except per share data)
Revenues:
Network management
services............. $ 4,584 $ 5,502 $ 6,300 $ 7,663 $ 8,358 $ 8,138 $ 8,215 $ 8,322
Equipment and other... 4,492 3,790 2,795 3,536 3,212 3,128 3,618 3,462
------- ------- ------- ------- ------- ------- ------- -------
Total revenues....... 9,076 9,292 9,095 11,199 11,570 11,266 11,833 11,784
Cost of revenues:
Cost of network
management services.. 2,672 3,132 3,296 3,993 4,286 4,620 5,179 5,226
Cost of equipment and
other................ 3,536 2,973 2,047 2,647 2,337 2,192 2,576 2,432
------- ------- ------- ------- ------- ------- ------- -------
Total cost of
revenues............ 6,208 6,105 5,343 6,640 6,623 6,812 7,755 7,658
------- ------- ------- ------- ------- ------- ------- -------
Gross profit............ 2,868 3,187 3,752 4,559 4,947 4,454 4,078 4,126
Operating expenses:
Development........... 579 591 611 723 795 759 822 792
Sales and marketing... 943 1,025 1,129 1,389 1,468 1,408 1,423 1,850
General and
administrative....... 622 663 888 922 972 928 820 839
Amortization of
deferred
compensation......... 5 20 20 20 20 20 9 9
------- ------- ------- ------- ------- ------- ------- -------
Total operating
expenses............ 2,149 2,299 2,648 3,054 3,255 3,115 3,074 3,490
------- ------- ------- ------- ------- ------- ------- -------
Operating income........ 719 888 1,104 1,505 1,692 1,339 1,004 636
Other income, net....... 46 31 669 716 859 955 828 643
------- ------- ------- ------- ------- ------- ------- -------
Income before income
taxes.................. 765 919 1,773 2,221 2,551 2,294 1,832 1,279
Income tax expense
(benefit).............. (1,136) (1,070) (351) (2,318) 944 848 678 473
------- ------- ------- ------- ------- ------- ------- -------
Net income.............. $ 1,901 $ 1,989 $ 2,124 $ 4,539 $ 1,607 $ 1,446 $ 1,154 $ 806
======= ======= ======= ======= ======= ======= ======= =======
Basic net income per
share.................. $ 0.38 $ 0.37 $ 0.15 $ 0.32 $ 0.11 $ 0.10 $ 0.09 $ 0.07
======= ======= ======= ======= ======= ======= ======= =======
Weighted average shares
used in basic per share
calculations........... 3,361 3,713 13,873 14,269 14,468 14,390 12,877 12,238
======= ======= ======= ======= ======= ======= ======= =======
Diluted net income per
share.................. $ 0.25 $ 0.11 $ 0.13 $ 0.28 $ 0.10 $ 0.09 $ 0.09 $ 0.07
======= ======= ======= ======= ======= ======= ======= =======
Weighted average shares
used in diluted per
share calculations..... 5,055 11,877 16,104 16,296 16,235 15,507 12,910 12,263
======= ======= ======= ======= ======= ======= ======= =======
Pro forma basic net
income per share....... $ 0.05 $ 0.06 $ 0.08 $ 0.10 $ 0.11 $ 0.10 $ 0.09 $ 0.07
======= ======= ======= ======= ======= ======= ======= =======
Pro forma weighted
average shares used in
basic per
share calculations..... 9,756 9,969 13,873 14,269 14,468 14,390 12,877 12,238
======= ======= ======= ======= ======= ======= ======= =======
Pro forma diluted net
income per share....... $ 0.04 $ 0.05 $ 0.07 $ 0.09 $ 0.10 $ 0.09 $ 0.09 $ 0.07
======= ======= ======= ======= ======= ======= ======= =======
Pro forma weighted
average shares used in
diluted per
share calculations..... 11,450 11,877 16,104 16,296 16,235 15,507 12,910 12,263
======= ======= ======= ======= ======= ======= ======= =======
24
Three Months Ended
-------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31,
1999 1999 1999 2000 2000 2000 2000 2001
-------- --------- -------- -------- -------- --------- -------- --------
(As a percentage of total revenues)
Revenues:
Network management
services............. 50.5% 59.2% 69.3% 68.4% 72.2% 72.2% 69.4% 70.6%
Equipment and other
revenues............. 49.5 40.8 30.7 31.6 27.8 27.8 30.6 29.4
----- ----- ----- ----- ----- ----- ----- -----
Total revenues....... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Total cost of
revenues............ 68.4 65.7 58.7 59.3 57.2 60.5 65.5 65.0
----- ----- ----- ----- ----- ----- ----- -----
Gross profit............ 31.6 34.3 41.3 40.7 42.8 39.5 34.5 35.0
Operating expenses:
Development........... 6.4 6.4 6.7 6.5 6.8 6.7 7.0 6.7
Sales and marketing... 10.3 11.0 12.4 12.4 12.7 12.5 12.0 15.7
General and
administrative....... 6.9 7.1 9.8 8.2 8.4 8.2 6.9 7.1
Amortization of
deferred
Compensation......... 0.1 0.2 0.2 0.2 0.2 0.2 0.1 0.1
----- ----- ----- ----- ----- ----- ----- -----
Total operating
expenses............ 23.7 24.7 29.1 27.3 28.1 27.6 26.0 29.6
----- ----- ----- ----- ----- ----- ----- -----
Operating income........ 7.9 9.6 12.2 13.4 14.7 11.9 8.5 5.4
Other income, net....... 0.5 0.3 7.4 6.4 7.4 8.5 7.0 5.5
----- ----- ----- ----- ----- ----- ----- -----
Income before income
taxes.................. 8.4 9.9 19.6 19.8 22.1 20.4 15.5 10.9
Income tax expense
(benefit).............. (12.5) (11.5) (3.9) (20.7) 8.2 7.5 5.7 4.0
----- ----- ----- ----- ----- ----- ----- -----
Net income.............. 20.9% 21.4% 23.5% 40.5% 13.9% 12.9% 9.8% 6.9%
===== ===== ===== ===== ===== ===== ===== =====
Cost of network management services, expressed as a percentage of network
management services revenues, and the cost of equipment and other, expressed
as a percentage of equipment and other revenues, were as follows:
Three Months Ended
-------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31,
1999 1999 1999 2000 2000 2000 2000 2001
-------- --------- -------- -------- -------- --------- -------- --------
Cost of network
management services.... 58.3% 56.9% 52.3% 52.1% 51.3% 56.8% 63.0% 62.8%
Cost of equipment and
other.................. 78.7 78.4 73.2 74.9 72.8 70.1 71.2 70.2
Liquidity and capital resources
Net cash provided by operating activities was $892,000 during fiscal year
1999, $5.8 million during fiscal year 2000 and $11.6 million during fiscal
year 2001.
We used $20.2 million during fiscal year 2001 to repurchase
2,795,316 million shares of our common stock. We have approval from our Board
of Directors to purchase up to four million shares, including those previously
repurchased. The extent and timing of any repurchases will depend on market
conditions and other business considerations. Repurchased shares may be held
in treasury for general corporate purposes, including for use in connection
with the Company's stock option plans, or may be retired.
We used $1.6 million during fiscal year 1999, $2.8 million during fiscal
year 2000 and $3.9 million during fiscal year 2001 to purchase capital assets
primarily used in the delivery of our network management services. We
currently have no material commitments for capital expenditures. Proceeds from
leases of capital equipment were $831,000 during fiscal year 1999 and
$0 during fiscal years 2000 and 2001. We paid $732,000 during fiscal year
1999, $975,000 during fiscal year 2000 and $537,000 during fiscal year 2001
toward our lease obligations for capital equipment. We intend to continue to
add sales, marketing and development resources over the next 12 months and we
anticipate that costs associated with sales, marketing and development
initiatives may increase as a percentage of revenues but will not result in
significant uses of working capital. As discussed in Item 2. Facilities, we
have leased an additional facility in Austin, Texas covering approximately
80,000 square feet. This lease commenced in April 2001 and will expire in
April 2007 if the renewal option is not exercised.
25
As of March 31, 2001, we had $45.4 million in cash and cash equivalents,
$4.0 million in net accounts receivable and $46.9 million in working capital.
We believe that our current cash balances together with cash generated from
operations, will be sufficient to fund our anticipated working capital needs
and capital expenditures, including capital expenditures related to our newly
leased facility, and any potential future acquisitions for at least 12 months.
Our current cash balances are kept in short-term, investment-grade, interest-
bearing securities pending their use. In the event our plans or assumptions
change or prove to be inaccurate, or if we consummate any unplanned
acquisitions of businesses or assets, we may be required to seek additional
sources of capital. Sources of additional capital may include public and
private equity and debt financings, sales of nonstrategic assets and other
financing arrangements.
As of March 31, 2001, we had net operating loss carryforwards of
approximately $9.0 million available to offset future net income for
U.S. federal income tax purposes. These net operating loss carryforwards will
expire beginning in 2007 if not utilized. We have alternative minimum tax
credit carryforwards of approximately $298,000 which do not expire. Our
utilization of these net operating loss and tax credit carryforwards may be
subject to a substantial annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code. The annual limitation may result in
the expiration of the net operating losses before utilization. During the year
ended March 31, 2000 we determined that it was more likely than not that these
tax assets would be utilized. Accordingly, the previously recorded valuation
allowance was eliminated. This conclusion was based on factors such as the
recent consecutive quarters of income, future profitability expectations, and
the nature of the deferred tax assets.
Risk Factors
We may be unable to operate profitably in the future.
We may not operate profitably. Although we began operating in 1987, we did
not introduce our first network management service until the quarter ended
March 31, 1994. Our track record of operating profitably in the network
management services business is short, and it is difficult to predict our
future revenues and operating results. We have previously incurred substantial
net losses. Our ability to operate profitably in the future depends on
increasing sales of our services while maintaining sufficient gross profit
margins. We must, among other things:
. maintain satisfactory relationships with resellers such as AT&T, our
largest customer, and network equipment manufacturers such as Cisco;
. establish relationships with additional marketing partners for the
resale of our services;
. develop software to make our principal existing service, ProWatch for
WANs, more efficient and economical;
. develop and sell other network management services; and
. maintain reliable, uninterrupted service from our network management
center 24 hours per day, seven days per week.
Our revenues will decline significantly and our business will be adversely
affected if AT&T discontinues, or materially reduces, sales of our services.
Sales to AT&T, which resells our services to its customers, accounted for
71% of our total revenues in fiscal year 2000 and 69% of our total revenues in
fiscal year 2001. We anticipate that sales to AT&T will continue to comprise a
substantial percentage of our revenues in fiscal 2002, but believe the
percentage will begin to decline beginning in the June 2001 quarter. To the
extent we continue to depend on AT&T for a large portion of our sales, our
total revenues will decline materially if AT&T discontinues selling our
services or significantly reduces its sales of our services. We cannot be sure
that we will be successful in reducing our dependence on AT&T in the future.
26
Our existing agreements with AT&T expire in December 2001. In addition, a
number of the orders for services that we provide to AT&T's customers under
one of these agreements can be cancelled at anytime upon ninety days notice
and all new orders placed after June 30, 1999 under that agreement can be
cancelled upon twelve months notice. Our agreements with AT&T are not
exclusive arrangements. We will need to maintain a good working relationship
with different business units of AT&T in order to maintain the business we
currently provide to AT&T's customers and to encourage AT&T to sell our
services to additional customers. Problems in our relationship with AT&T would
seriously damage our business. We cannot assure you that AT&T will continue to
sell our services to existing or additional AT&T customers. A substantial
reduction in our AT&T business would result in diminished revenues for an
extended period of time as we attempted to replace that business.
Our quarterly results may fluctuate and cause the price of our common stock to
fall.
Our revenues and results of operations are difficult to predict and may
fluctuate significantly from quarter to quarter. If either our revenues or
results of operations fall below the expectations of investors or public
market analysts, the price of our common stock could fall dramatically.
Our revenues are difficult to forecast and may fluctuate for a number of
reasons:
. the market for network management services is relatively new, and we
have no reliable means to assess overall customer demand;
. we derive a majority of our revenues from AT&T and other resellers, and
our revenues therefore depend significantly on the willingness and
ability of AT&T and those other resellers to sell our services to their
customers;
. we may not be able to attract additional resellers to market our
services as expected;
. we expect to encourage end users to purchase equipment from other
sources, and we therefore anticipate that our revenues from equipment
resales will continue to decline as we seek to manage our mix of
revenues;
. we may not add new end users as rapidly as we expect;
. we may lose existing end users as the result of competition, problems
with our services or, in the case of end users who are customers of our
resellers, problems with the reseller's services; and
. we may not be able to develop new or improved services as rapidly as
they are needed.
Most of our expenses, particularly employee compensation and rent, are
relatively fixed. As a result, variations in the timing of revenues could
significantly affect our results of operations from quarter to quarter and
could result in quarterly losses.
Our future operating results may vary by season, which will make it difficult
to predict our future performance.
As a result of seasonal factors, we believe that quarter-to-quarter
comparisons of our results of operations are not necessarily meaningful. These
factors may adversely affect our operating results or cause our operating
results to fluctuate, resulting in a decrease in our stock price. You should
not rely on our quarterly results of operations to predict our future
performance.
Our bookings may be slower during the months of July and August due to the
vacation schedules of our resellers' sales and marketing employees. This
situation may lead to lower levels of revenues earned during the following
fiscal quarter, which ends December 31.
Our revenues during our third and fourth fiscal quarters may be more
volatile and difficult to predict due to the budgeting and purchasing cycles
of our end users. End users typically purchase our services at the same time
they purchase new network equipment such as routers. As a result, the timing
of their large capital expenditures
27
could affect the timing of their purchases of our services. Some end users may
not be able to purchase network equipment and our services near the end of a
calendar year due to depleted budgets. Other end users may accelerate
purchases in order to use an unspent portion of their budget.
The market for our services is new and evolving rapidly, and our business will
be seriously damaged if the market does not develop as we expect.
Our long-term viability depends significantly upon the acceptance and use
of remote network management services. The market for remote network
management services is new and rapidly evolving. This market environment makes
it more difficult to determine the size and growth of the market and to
predict how this market will develop. Changes in technology, the availability
of qualified information technology professionals and other factors that make
internal network management more cost effective than remote network management
would adversely affect the market for our services. Our business may be
seriously damaged if this market fails to grow, grows more slowly than we
expect or develops in some way that is different from our expectations.
We must establish relationships with additional resellers in order to increase
our revenues and become consistently profitable.
We expect to rely increasingly on resellers such as telecommunications
carriers, internet service providers and data networking value-added resellers
to market our services. We must establish these alternative sales channels in
order to increase our revenues and become consistently profitable. We have
limited experience in managing sales through resellers. We have only recently
begun to develop these sales channels, and we have established relationships
with only a few resellers. Except for AT&T, these resellers have not generated
significant sales of our services to date and may not succeed in marketing our
services in the future.
Our agreements with resellers, including AT&T, generally do not require
that the resellers sell any minimum level of our services and generally do not
restrict the resellers' development or sale of competitive services. We cannot
be sure that these resellers will dedicate resources or give priority to
selling our services. In addition, resellers may seek to make us reduce the
prices for our services in order to lower the total price of their equipment,
software or service offerings.
Reseller relationships may adversely affect our business by weakening our
relationships with end users, decreasing the strength of our brand name and
limiting our ability to sell services directly to resellers' customers.
If we succeed in increasing our sales through resellers, we may have weaker
relationships with the end users of our services. This may inhibit our ability
to gather customer feedback that helps us improve our services, develop new
services and monitor customer satisfaction. We may also lose brand
identification and brand loyalty, since our services may be identified by
private label names or may be marketed differently by our resellers. A failure
by any of our resellers to provide their customers with satisfactory products,
services or customer support could injure our reputation and seriously damage
our business. Our agreements with these resellers may limit our ability to
sell our services directly to the resellers' customers in the future.
Any material decrease in sales of our WAN management services will
significantly reduce our total revenues and adversely affect our business.
Competitive pressures, general declines in the levels of new wide area
network, or WAN, installations or other factors that adversely affect sales of
our WAN management services or that cause significant decreases in the prices
of our WAN management services could significantly limit or reduce our
revenues. Sales of our ProWatch for WANs and similar WAN management services
accounted for 96% of our recurring network management services revenues in
fiscal year 2001. Likewise, a substantial portion of our nonrecurring network
management services and equipment resale revenues depend on the successful
sale of these WAN management services. We expect that these WAN management
services will continue to generate substantially all of our
28
revenues for the foreseeable future. Our financial performance therefore
depends directly on continued market acceptance of our WAN management
services, as well as our ability to introduce enhanced versions of these
services that make these services more efficient and economical.
Our failure to develop and sell additional services could impair our financial
results and adversely affect our business.
Our future financial performance will depend in part on our ability to
develop, introduce and sell new and enhanced network management services other
than WAN management services, including services that:
. address the increasingly sophisticated needs of current and prospective
end users; and
. respond on a timely and cost-effective basis to technological advances
and emerging industry standards and protocols.
Although we have developed new services, such as network management
services for local area networks, or LANs, and network security services, we
have not derived significant revenues from these services to date. We cannot
be sure that we will be successful selling these services or developing
additional services on time or on budget. The development of new services is a
complex and uncertain process. The newness of the market for remote network
management services makes it difficult to determine whether a market will
develop for any particular network management service. If we succeed in
increasing the percentage of our revenues that is derived from resellers, we
may have weaker relationships with the end users of our services, making it
even more difficult for us to identify services acceptable to our target
market of mid-sized companies. We cannot assure you that future technological
or industry developments will be compatible with our business strategy or that
we will be successful in responding to these changes in a timely or cost-
effective manner. Our failure to develop and sell services other than WAN
management services could seriously damage our business.
Our business may be harmed if we lose the services of our chief executive
officer.
Our ability to build our business and compete effectively depends to a
significant degree on the skills, experience and efforts of our executive
officers, particularly Craig S. Tysdal, our president and chief executive
officer. Mr. Tysdal has led us during our transition from our data transport
business to the network management services field. He is our key
representative in our relationship with AT&T. We do not have employment
contracts requiring Mr. Tysdal or any of our other personnel to continue their
employment for any period of time, and we do not maintain key man life
insurance on Mr. Tysdal or any of our other personnel. The loss of the
services of Mr. Tysdal could seriously damage our business.
In order to support our business, we must hire additional information
technology professionals, who are in extremely short supply.
We derive all of our revenues from network management services and related
resales of equipment. These services can be extremely complex, and in general
only highly qualified, highly trained information technology, or IT,
professionals have the skills necessary to develop and provide these services.
In order to continue to support our current and future business, we need to
attract, motivate and retain a significant number of qualified IT
professionals. Qualified IT professionals are in short supply, and we face
significant competition for these professionals, from not only our competitors
but also our end users, marketing partners and other companies throughout the
network services industry. Other employers may offer IT professionals
significantly greater compensation and benefits or more attractive career
paths or geographic locations than we are able to offer. Any failure on our
part to hire, train and retain a sufficient number of qualified IT
professionals would seriously damage our business.
We could incur significant costs if we are unable to retain our information
technology professionals.
Because of the limited availability of IT professionals, we seek to hire
persons who have obtained college bachelor's degrees and then train those
persons to provide our services. As a result, we invest a significant
29
amount of time and money in training these new employees before they begin to
support our business. We do not enter into employment agreements requiring
these employees to continue in our employment for any period of time.
Departures of trained employees could limit our ability to generate revenues
and would require us to incur additional costs in training new employees.
We currently compete most directly with our customers' internal solutions, and
we expect increasing competition from other network services companies.
To compete successfully, we must respond promptly and effectively to the
challenges of technological change, evolving standards and our competitors'
innovations by continuing to enhance our services, as well as our sales
programs and channels. Any pricing pressures, reduced margins or loss of
market share resulting from increased competition, or our failure to compete
effectively, could seriously damage our business.
We face competition from different sources. Currently, a major source of
competition is the internal network administration organizations of our end
users and resellers. These organizations may have developed tools and
methodologies to manage their network processes and may be reluctant to adopt
applications offered by third parties like us.
If the market for out-sourced network management services grows as we
expect, we believe this market will become highly competitive. Competition is
likely to increase significantly as new network management services companies
enter the market and current competitors expand their service and product
lines. Many of these potential competitors are likely to enjoy substantial
competitive advantages, including:
. larger technical staffs;
. more established sales channels;
. more software development experience;
. greater name recognition; and
. substantially greater financial, marketing, technical and other
resources.
If our operations are interrupted, we may lose customers and revenues.
We must be able to operate our network management infrastructure 24 hours
per day, seven days per week without interruption. If our operations are
interrupted, we may lose customers and revenues. All of our network management
services are provided remotely from our network management center, which is
located at a single site in Austin, Texas. We do not have any redundant
systems or facilities at a separate geographic location. In order to operate
without interruption, we must guard against:
. power outages, fires, tornadoes and other natural disasters at our
network management center;
. telecommunications failures;
. equipment failures or "crashes;"
. security breaches; and
. other potential interruptions.
Any interruptions could:
. require us to make payments on the contractual performance guarantees we
offer our customers;
. cause end users to seek damages for losses incurred;
. require us to spend more money replacing existing equipment or adding
redundant facilities;
. damage our reputation for reliable service;
. cause existing end users and resellers to cancel our contracts; or
. make it more difficult for us to attract new end users and resellers.
30
Our revenues would decline and our business would be adversely affected if the
networking equipment and carrier services we support become obsolete or are
otherwise not used by a large part of our target market.
As part of our strategy, we have elected to support only selected providers
of networking equipment and carrier services. For example, we support routers
manufactured by 3Com, Bay/Nortel and Cisco, but not by other equipment
providers. Our services cannot be used by companies with networking equipment
and carrier services that we do not support. Our business would be seriously
damaged if, in the future, the networking equipment manufacturers and carrier
services that we support were not the predominant providers to our target
market or if their equipment or services became unavailable or significantly
more expensive. Technological advances that make obsolete any of the
networking equipment and carrier services that we support, or that offer
significant economic or functional advantages over the equipment and services,
also could limit or reduce our revenues or could force us to incur significant
costs attempting to support other networking equipment and carrier services.
We may be unable to protect our intellectual property, and we could incur
substantial costs defending our intellectual property from infringement or
claims of infringement made by others.
Our business and financial performance depends to a significant degree upon
our software and other proprietary technology. The software industry has
experienced widespread unauthorized reproduction of software products. We have
only one patent. The steps we have taken may not be adequate to deter
competitors from misappropriating our proprietary information, and we may not
be able to detect unauthorized use and take appropriate steps to enforce our
intellectual property rights.
We could be the subject of claims alleging infringement of third-party
intellectual property rights. In addition, we may be required to indemnify our
distribution partners and end users for similar claims made against them. Any
infringement claim could require us to spend significant time and money in
litigation, pay damages, develop non-infringing intellectual property or
acquire licenses to intellectual property that is the subject of the
infringement claims. As a result, any infringement claim could seriously
damage our business.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company invests its cash in money market funds or instruments which
meet high credit quality standards specified by the Company's investment
policy. The Company does not use financial instruments for trading or other
speculative purposes.
31
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
Page
----
Report of Independent Auditors............................................ 33
Consolidated Balance Sheets as of March 31, 2000 and 2001................. 34
Consolidated Statements of Operations for each of the three years in the
period ended March 31, 2001.............................................. 35
Consolidated Statements of Stockholders' Equity (Deficit) for each of the
three years in the period ended March 31, 2001........................... 36
Consolidated Statements of Cash Flows for each of the three years in the
period ended March 31, 2001.............................................. 37
Notes to Consolidated Financial Statements................................ 38
32
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
NetSolve, Incorporated
We have audited the accompanying consolidated balance sheets of NetSolve,
Incorporated as of March 31, 2000 and 2001, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for
each of the three years in the period ended March 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of NetSolve, Incorporated, at March 31, 2000 and 2001, and the consolidated
results of their operations and their cash flows for each of the three years
in the period ended March 31, 2001, in conformity with accounting principles
generally accepted in the United States.
/s/ Ernst & Young LLP
Austin, Texas
April 19, 2001
33
NETSOLVE, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
Year Ended March 31,
----------------------
2000 2001
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents............................. $ 57,185 $ 45,411
Restricted cash....................................... 395 306
Accounts receivable, net of allowance for doubtful
accounts of $219 at
March 31, 2000 and $207 at March 31, 2001............ 4,913 4,013
Inventory............................................. 252 52
Prepaid expenses and other assets..................... 2,139 1,314
Deferred tax assets................................... 3,682 1,647
---------- ----------
Total current assets................................... 68,566 52,743
Restricted cash........................................ 306 --
Property and equipment:
Computer equipment and software....................... 5,696 9,277
Furniture, fixtures and leasehold improvements........ 1,765 1,983
Equipment held under capital leases................... 1,701 1,343
Other equipment....................................... 363 393
---------- ----------
9,525 12,996
Less accumulated depreciation and amortization........ (5,230) (7,163)
---------- ----------
Net property and equipment............................. 4,295 5,833
Other assets........................................... 47 1,275
Deferred tax assets, net of current portion............ 1,305 2,980
---------- ----------
Total assets........................................... $ 74,519 $ 62,831
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................... $ 2,174 $ 954
Accrued liabilities................................... 2,265 3,468
Deferred revenue...................................... 261 1,108
Capital leases obligation............................. 537 324
---------- ----------
Total current liabilities.............................. 5,237 5,854
Capital leases obligation, net of current portion...... 324 --
Stockholders' equity:
Common stock, $.01 par value; 25,000,000 shares
authorized; 14,485,586 issued
and outstanding at March 31, 2000 and
14,866,318 issued and 12,071,002
outstanding at March 31, 2001......................... 145 148
Additional paid-in capital............................ 77,578 80,574
Treasury Stock........................................ -- (20,179)
Deferred compensation................................. (257) (69)
Accumulated deficit................................... (8,508) (3,497)
---------- ----------
Total stockholders' equity............................. 68,958 56,977
---------- ----------
Total liabilities and stockholders' equity............. $ 74,519 $ 62,831
========== ==========
See accompanying notes.
34
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended March 31,
-------------------------
1999 2000 2001
------- ------- -------
Revenues:
Network management services....................... $12,777 $24,048 $33,032
Equipment and other............................... 13,939 14,613 13,420
------- ------- -------
Total revenues.................................... 26,716 38,661 46,452
Costs of revenues:
Cost of network management services............... 8,258 13,095 19,311
Cost of equipment and other....................... 10,665 11,202 9,536
------- ------- -------
Total cost of revenues............................ 18,923 24,297 28,847
------- ------- -------
Gross profit....................................... 7,793 14,364 17,605
Operating expenses:
Development....................................... 1,762 2,503 3,169
Selling and marketing............................. 3,153 4,486 6,149
General and administrative........................ 2,098 3,095 3,559
Amortization of deferred compensation............. -- 65 58
------- ------- -------
Total operating expenses.......................... 7,013 10,149 12,935
------- ------- -------
Operating income................................... 780 4,215 4,670
Other income (expense):
Interest income................................... 441 1,592 3,319
Interest expense.................................. (254) (117) (53)
Other, net........................................ (94) (12) 19
------- ------- -------
93 1,463 3,285
------- ------- -------
Income from continuing operations before income
taxes............................................. 873 5,678 7,955
Income tax expense (benefit)....................... 19 (4,875) 2,944
------- ------- -------
Net income from continuing operations.............. 854 10,553 5,011
Gain on sale of discontinued operations, net of
applicable income taxes........................... 98 -- --
------- ------- -------
Net income......................................... $ 952 $10,553 $ 5,011
======= ======= =======
Dividends on redeemable convertible preferred
stock............................................. $(2,531) $(1,260) $ --
======= ======= =======
Net income (loss) applicable to common stock....... $(1,579) $ 9,293 $ 5,011
======= ======= =======
Basic net income (loss) per share from:
Continuing operations............................. $ (0.51) $ 1.06 $ 0.37
Discontinued operations........................... 0.03 -- --
------- ------- -------
Net income (loss)................................. $ (0.48) $ 1.06 $ 0.37
Weighted average shares used in basic per share
calculation....................................... 3,297 8,800 13,502
Diluted net income (loss) per share from:
Continuing operations............................. $ (0.51) $ 0.68 $ 0.34
Discontinued operations........................... 0.03 -- --
------- ------- -------
Net income (loss)................................. $ (0.48) $ 0.68 $ 0.34
Weighted average shares used in diluted per share
calculation....................................... 3,297 13,648 14,539
Pro forma basic net income per share from:
Continuing operations............................. $ 0.09 $ 0.88 $ 0.37
Discontinued operations........................... 0.01 -- --
------- ------- -------
Net income........................................ $ 0.10 $ 0.88 $ 0.37
Pro forma weighted average shares used in basic per
share calculation................................. 9,692 11,963 13,502
Pro forma diluted net income per share from:
Continuing operations............................. $ 0.07 $ 0.77 $ 0.34
Discontinued operations........................... 0.01 -- --
------- ------- -------
Net income........................................ $ 0.08 $ 0.77 $ 0.34
Pro forma weighted average shares used in diluted
per share calculation............................. 11,341 13,648 14,539
See accompanying notes.
35
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share data)
Total
Common Stock Additional Stockholders'
------------------ Paid-In Treasury Deferred Accumulated Equity
Shares Amount Capital Stock Compensation Deficit (Deficit)
---------- ------ ---------- -------- ------------ ----------- -------------
Balance, March 31,
1998................... 3,265,094 $ 33 -- -- -- $(33,062) $(33,029)
Exercise of common
stock options and
warrants.............. 71,352 -- 79 -- -- -- 79
Dividends on redeemable
convertible preferred
stock................. -- -- (79) -- -- (2,452) (2,531)
Net income............. -- -- -- -- -- 952 952
---------- ---- ------- -------- ---- -------- --------
Balance, March 31,
1999................... 3,336,446 33 -- -- -- (34,562) (34,529)
Exercise of common
stock options and
warrants.............. 669,413 7 632 -- -- -- 639
Dividends on redeemable
convertible preferred
stock................. -- -- (954) -- -- (306) (1,260)
Deferred compensation.. -- -- 322 -- (322) --
Issuance of common
stock from Initial
Public Offering, net
of offering costs..... 4,085,000 41 48,043 -- -- -- 48,084
Conversion of preferred
stock to common
stock................. 6,394,727 64 29,535 -- -- 15,807 45,406
Amortization of
deferred
compensation.......... -- -- -- -- 65 -- 65
Net income............. -- -- -- -- -- 10,553 10,553
---------- ---- ------- -------- ---- -------- --------
Balance, March 31,
2000................... 14,485,586 145 77,578 -- (257) (8,508) 68,958
Exercise of common
stock options and
warrants.............. 380,732 3 801 -- -- -- 804
Deferred compensation.. -- -- (130) -- 130 --
Tax benefit from
exercise of stock
options............... -- -- 2,325 -- -- -- 2,325
Amortization of
deferred
compensation.......... -- -- -- -- 58 -- 58
Common stock
repurchased........... (2,795,316) -- -- (20,179) -- -- (20,179)
Net income............. -- -- -- -- -- 5,011 5,011
---------- ---- ------- -------- ---- -------- --------
Balance, March 31,
2001................... 12,071,002 $148 $80,574 $(20,179) $(69) $ (3,497) $ 56,977
========== ==== ======= ======== ==== ======== ========
See accompanying notes.
36
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended March 31,
--------------------------
1999 2000 2001
------- ------- --------
Cash flows from operating activities:
Net income........................................ $ 952 $10,553 $ 5,011
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization................... 1,234 1,733 2,342
Amortization of deferred compensation........... -- 65 58
Deferred tax assets............................. -- (4,987) 2,685
(Gain) loss on disposition of property and
equipment...................................... (4) 1 4
Gain on sale of discontinued operations......... (98) -- --
Change in assets and liabilities:
Accounts receivable, net....................... (1,020) (2,291) 900
Inventory and prepaid expenses and other
assets........................................ (751) (415) (203)
Accounts payable............................... 208 605 (1,220)
Accrued liabilities............................ 287 517 1,203
Deferred revenue............................... 84 95 847
------- ------- --------
Net cash provided by operating activities.......... 892 5,876 11,627
------- ------- --------
Cash flows from investing activities:
Proceeds from sale of certificates of deposit... 2,532 2,000 --
Transfer of funds from (to) restricted cash..... (634) 1,579 395
Purchases of property and equipment............. (1,639) (2,782) (3,884)
Proceeds from sale of property and equipment.... 4 -- --
Proceeds from sale of discontinued operations... 98 -- --
------- ------- --------
Net cash provided by (used in) investing
activities........................................ 361 797 (3,489)
------- ------- --------
Cash flows from financing activities:
Repurchase of common stock...................... -- -- (20,179)
Net proceeds from sale of stock................. -- 48,084 --
Proceeds from capital lease financing........... 831 -- --
Payments under capital lease obligations........ (732) (975) (537)
Proceeds from exercise of common stock options
and warrants................................... 79 639 804
------- ------- --------
Net cash provided by (used in) financing
activities........................................ 178 47,748 (19,912)
------- ------- --------
Net change in cash and cash equivalents............ 1,431 54,421 (11,774)
Cash and cash equivalents, beginning of period..... 1,333 2,764 57,185
------- ------- --------
Cash and cash equivalents, end of period........... $ 2,764 $57,185 $ 45,411
======= ======= ========
Supplemental disclosure of cash flow information:
Cash paid for interest.......................... $ 242 $ 117 $ 53
======= ======= ========
Income taxes paid............................... $ 24 $ 117 $ 278
======= ======= ========
See accompanying notes.
37
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2001
1. Organization and Description of the Company
NetSolve, Incorporated, a Delaware corporation, (the "Company") engages in
the business of providing enterprise data networking management services
within the U.S. These services include network design, installation and
implementation coordination, and ongoing network management. The Company also
resells data networking equipment manufactured by selected leading suppliers
of these products. The Company's services are designed to allow its clients to
selectively outsource, or "out-task" network specific tasks in order to
migrate to new technology, increase network reliability, and reduce overall
network costs.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of NetSolve,
Incorporated and its wholly-owned subsidiaries, Specialized Network Services,
Inc. and SNS Credit Corporation. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Inventory
Inventory consists of purchased finished goods held for sale to customers.
Inventory is stated at the lower of cost or market with cost determined on a
specific identification basis. Inventory reserves were $98,000 at March 31,
2000 and $59,000 at March 31, 2001.
Property and Equipment
Property and equipment are recorded at historical cost. Maintenance and
repairs are charged to expense as incurred and betterments which increase the
value or extend the useful life of the equipment are capitalized.
Depreciation is provided using the straight-line method over the estimated
useful lives of the related assets. The Company's assets are currently
depreciated over periods ranging from three to seven years. Leasehold
improvements are amortized over the life of the related lease or assets,
whichever is shorter. Amortization of assets recorded under capital leases is
included in depreciation expense.
The Company periodically reviews the carrying amounts of property and
equipment, identifiable intangible assets and excess of cost over fair value
of net assets acquired or liabilities assumed, both purchased in the normal
course of business and acquired through business combinations, to determine
whether current events or circumstances, as defined in Statement of Financial
Accounting Standards No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of ("Statement 121"), warrant
adjustments to such carrying amounts. In reviewing the carrying values of
property and equipment and identifiable intangible assets, the Company
considers, among other things, the future cash inflows expected to result from
the use of the asset and its eventual disposition less the future cash
outflows expected to be necessary to obtain those inflows. At this time,
future cash inflows exceed future cash outflows; thus, no material impairment
loss has been recognized.
38
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2001
Income Taxes
The Company accounts for income taxes in accordance with SFAS 109,
Accounting for Income Taxes. This statement prescribes the use of the
liability method whereby deferred tax asset and liability account balances are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed in Note 5, the alternative fair value accounting provided for under
SFAS 123, Accounting for Stock-Based Compensation, requires use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, compensation cost is recognized over the vesting period
based on the difference, if any, on the date of grant between the fair value
of the Company's stock and the price the employee must pay to acquire the
stock.
Earnings Per Share
The Company's earnings per share data are presented in accordance with SFAS
128, Earnings Per Share. Basic income (loss) per share is computed using the
weighted average number of common shares outstanding. Diluted income (loss)
per share is computed using the weighted average number of common shares
outstanding adjusted for the incremental shares attributed to outstanding
securities with the ability to purchase or convert into common stock. The
treasury stock method, using the average price of the Company's common stock
for the period, is applied to determine dilution from options and warrants.
The if-converted method is used for convertible securities. Potentially
dilutive common stock options and warrants that were excluded from the
calculation of diluted income (loss) per share because their effect is
antidilutive totaled 1,648,841 in 1999. For 1999, 6,394,727 shares of
convertible preferred stock were excluded from the calculation of diluted
income (loss) per share as their effect is also antidilutive.
A reconciliation of the numerators and denominators used in computing per
share net income (loss) from continuing operations is as follows:
Proforma
Year ended March 31, Year ended March 31,
-------------------------- -----------------------
1999 2000 2001 1999 2000 2001
-------- ------- ------- ------ -------- -------
Numerator:
Net income from continuing
operations............... $ 854 $10,553 $ 5,011 $ 854 $ 10,553 $ 5,011
Dividends on redeemable
convertible preferred
stock.................... (2,531) (1,260) -- -- -- --
-------- ------- ------- ------ -------- -------
Numerator for basic and
diluted net income (loss)
per share from continuing
operations............... $ (1,677) $ 9,293 $ 5,011 $ 854 $ 10,553 $ 5,011
======== ======= ======= ====== ======== =======
Denominator:
Denominator for basic net
income (loss) per share
from continuing
operations--weighted
average common stock
outstanding.............. 3,297 8,800 13,502 9,692 11,963 13,502
Dilutive common stock
equivalents-common stock
options, warrants and
redeemable convertible
preferred stock.......... -- 4,848 1,037 1,649 1,685 1,037
-------- ------- ------- ------ -------- -------
Denominator for diluted
net income (loss) per
share from continuing
operations--weighted
average common stock
outstanding and dilutive
common stock
equivalents.............. 3,297 13,648 14,539 11,341 13,648 14,539
======== ======= ======= ====== ======== =======
39
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2001
Revenue Recognition
Network management services revenues are recognized in the period services
are provided by NetSolve, whether sold directly or through resellers, based
upon rates established by contract net of any availability credits. The
typical contract terms are from 24 to 36 months and provide for one-time
services, consisting primarily of project implementation services at a fixed
fee per customer site or device, as well as recurring services which are
provided at a fixed monthly fee per customer site or device over the life of
the contract. Revenues for project implementation services are recognized upon
completion of the implementation of the site, and recurring revenues are
recognized on a monthly basis as the services are performed. Equipment
revenues are recognized in the period the equipment is shipped to the
customer. Equipment revenues from assets leased by the Company's lease
financing subsidiary are recognized upon the sale of the equipment and the
related lease to a third party lessor on a non-recourse basis following
installation of the equipment. Other revenues, which consist primarily of
equipment maintenance services, are recognized in the period services are
provided. The Company's remote network management services for WANs typically
include a guarantee providing end-to-end network availability for at least
99.5% of the time in any given month. In the event the guaranteed availability
is not achieved, the Company generally is obligated to refund its WAN
management fees for that month. The Company provides a reserve based on the
estimated costs of these refunds. Historically, guarantee payments have not
been significant.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense for
the years ended March 31, 1999, 2000 and 2001 was approximately $419,000,
$839,000 and $1.1 million, respectively.
Research and Development
Expenditures for research and development are expensed as incurred.
Cash, Cash Equivalents and Certificates of Deposit
The Company considers all investments purchased with a maturity of three
months or less to be cash equivalents. Certificates of deposit consist of
investments that mature within one year.
Concentrations of Credit Risk
Financial instruments which potentially expose the Company to
concentrations of credit risk as defined by SFAS 105, Disclosure of
Information about Financial Instruments with Off-Balance-Sheet Risk and
Financial Instruments with Concentrations of Credit Risk, consist primarily of
cash and cash equivalents (including restricted cash), investments and
accounts receivable. The Company places its temporary cash investments with
FDIC-insured financial institutions in accounts which, at times, may exceed
federally insured limits. The Company has not experienced any losses in such
accounts. The Company believes it is not exposed to any significant credit
risk on cash and cash equivalents. The Company performs credit evaluations of
its customers' financial condition when management deems it appropriate and
generally requires no collateral from its customers. Concentrations of credit
risk with respect to accounts receivable are generally limited due to the
credit-worthiness of the customers. Accounts receivable from AT&T represented
56% and 53% of the outstanding accounts receivable balance at March 31, 2000
and 2001, respectively.
40
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2001
The following table summarizes the changes in the allowance for doubtful
accounts for 1999, 2000 and 2001 (in thousands):
Balance at March 31, 1998.............................................. $209
Additions charged to costs and expenses.............................. 59
Write-off of uncollectible accounts.................................. (41)
----
Balance at March 31, 1999.............................................. 227
Additions charged to costs and expenses.............................. 16
Write-off of uncollectible accounts.................................. (24)
----
Balance at March 31, 2000.............................................. 219
Additions charged to costs and expenses.............................. 11
Write-off of uncollectible accounts.................................. (23)
----
Balance at March 31, 2001.............................................. $207
====
Concentrations of Revenues
Revenues from AT&T amounted to 59%, 71%, and 69% of the Company's net
revenues for the years ended March 31, 1999, 2000, and 2001 respectively. The
Company currently is providing multiple services to AT&T under a single
agreement with separate amendments for each service. Negotiations to renew the
contract and the related amendments, which expire in December 2001, have not
yet commenced and there can be no assurance these agreements will be renewed.
No other customer accounted for greater than 10% of revenue in fiscal years
1999, 2000, or 2001.
Recent Pronouncements
In June 1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 137, Accounting for Derivative Instruments
and Hedging Activities, Deferral of Effective Date of FASB Statement No. 133,
in which Statement 133 is now required to be adopted in the Company's fiscal
year 2001. The Company does not anticipate that the adoption of the new
Statement will have a material impact on the results of operations or the
financial position of the Company, as the Company has no derivatives.
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, Revenue Recognition (SAB 101), which
provides guidance on the recognition, presentation and disclosure of revenue
in financial statements. The Company adopted the provisions of SAB 101 for all
transactions during the year ending March 31, 2001. The application of SAB 101
did not have a material impact on the results of operations or the financial
position of the Company.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation -- an interpretation of APB
Opinion 25," ("Interpretation No. 44") which is generally effective July 1,
2000. Interpretation No. 44 clarifies the application of APB Opinion 25 for
certain matters, specifically (a) the definition of an employee for purposes
of applying APB Opinion 25, (b) the criteria for determining whether a plan
qualifies as a non-compensatory plan, (c) the accounting consequence of
various modifications to the terms of a previously fixed stock option or
award, and (d) the accounting for an exchange of stock compensation awards in
a business combination. The adoption of Interpretation No. 44 did not have a
material impact on the financial position or the results of operations.
41
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2001
Reclassifications
Certain reclassifications have been made to prior period balances to
conform to the current period presentation.
3. Sale of Transport Business Segment
In December 1996, the Company made a decision to discontinue its data
transport services business segment and closed a transaction with Intermedia
Communications Inc. of Florida ("Intermedia") for the sale of a portion of
that segment. The sale to Intermedia was closed on December 30, 1996 at a
price of $12,280,000 of which $2,000,000 was placed in an escrow account. The
escrowed funds were released to the Company in November 1997.
As a part of this transaction, all customer and supplier contracts related
to a portion of the business segment were assigned to Intermedia, and the
capital equipment related to this portion of the business segment was sold to
Intermedia. The agreement for this sale contains a non-compete provision which
prohibits the Company from competing in the data transport business for five
years.
In connection with this sale, the Company agreed to provide management
services to assist Intermedia in supporting the acquired customer base for a
period of 12 months. These services were provided through October 1997. The
Company recorded revenue of $715,000 in fiscal year 1998 with respect to these
services.
To complete the discontinuance of this business segment, the Company
assigned its rights and obligations to customer contracts for other transport
services resold by the Company, and its obligations under a supplier contract,
effective October 1, 1997 to NetPlus, Inc. The purchase price, which was
initially established at 25% of NetPlus' gross profit from these services (as
defined in the purchase agreement) for a period of three years beginning April
1, 1998 up to a maximum of $600,000, was renegotiated to $100,000 which was
received in fiscal year 1999. Revenues in fiscal year 1998, prior to the
assignment to NetPlus in October 1997, totaled approximately $1,072,000, and
related costs of providing such services approximated $826,000. Revenues from
this business segment were $1,072,000 for fiscal year 1998.
During fiscal year 1998, upon conclusion of all remaining activities of
this business segment, the Company reversed unused accruals totaling
approximately $557,000 (including $250,000 which was provided to absorb
potential reductions in the purchase price if billings to the sold customer
base fell below levels set forth in the agreement with Intermedia).
4. Redeemable Convertible Preferred Stock
The Company had issued and outstanding 3,944,184 shares of Series A
redeemable convertible preferred stock and 2,450,543 shares of Series B
redeemable convertible preferred stock on March 31, 1999. Each share of
preferred stock outstanding as of September 29, 1999 was automatically
converted into one share of the Company's common stock and retired upon the
closing of the Company's initial public offering on October 4, 1999.
5. Stockholders' Equity
Stockholder Repurchase Rights
The Company has entered into stockholder agreements with all employees and
consultants who have received grants of options pursuant to the Company's
stock option plans. These agreements generally grant the Company certain
repurchase rights with respect to common stock purchased by the stockholders.
The percentage
42
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2001
of shares subject to repurchase generally decreases by 25% on the first
anniversary of the granting of a stock option and quarterly (at 6.25% per
quarter) thereafter. The Company's repurchase rights are exercisable upon
termination of employment of the employee or consultant. At March 31, 2001,
total outstanding options subject to repurchase rights were 1,578,779.
Stock Option Plans
In November 1988, the Company adopted a stock option plan providing for the
granting of options to purchase shares of the Company's common stock to key
employees, directors, officers and consultants as designated by the Company's
Board of Directors. The plan expired with respect to the granting of new
options in October 1998. The Plan provided for the issuance of both Incentive
Stock Options ("ISOs") as well as options not qualifying as ISOs within the
meaning of the Internal Revenue Code of 1986, as amended. Under the terms of
the Plan, the option price per share of ISOs must not have been be less than
100% of the fair market value of the Company's common stock per share at date
of grant. Options were granted with a term of 10 years and were immediately
exercisable. Shares acquired pursuant to the exercise of options are subject
to certain vesting and repurchase requirements as set forth above.
In July 1997, the Company adopted a long-term incentive compensation plan.
This plan is a comprehensive, stock-based incentive compensation plan,
providing for discretionary awards of incentive stock options within the
meaning of the Internal Revenue Code of 1986, as amended, nonqualified stock
options, stock appreciation rights, restricted stock, restricted stock units,
performance shares, performance units, bonus stock and other stock-based
awards. All awards are made in, or based on the value of, the Company's common
stock. The plan is administered by the Compensation Committee of the Company's
Board of Directors, which consists entirely of outside directors. Regular,
full-time employees of the Company, as well as directors of, and consultants
to, the Company are eligible to participate in, and receive awards under the
plan. Originally, the maximum number of shares of common stock for which
awards could be granted under the plan was 1,350,000. On July 11, 2000, the
stockholders approved an amendment to the plan to increase the total number of
shares of common stock authorized for issuance thereunder from 1,350,000 to
4,350,000 (an increase of 3,000,000). The stockholders also reapproved the
plan as required under Section 162 (m) of the Internal Revenue Code. The price
payable upon exercise of an option which is intended to constitute an
incentive stock option may not be less than 100% of the fair market value of
the common stock at the time of grant.
At March 31, 2001 the Company had reserved 5,166,333 shares of common stock
for issuance upon exercise of all options.
Deferred Compensation
The Company recorded gross deferred compensation of approximately $322,000
in fiscal year 2000. The amount recorded represents the difference between the
grant price and the deemed fair market value of the Company's common stock for
shares subject to options granted in fiscal year 2000. In fiscal year 2000,
321,960 shares were granted below fair market value and the exercise price and
deemed fair values were $9.00 and $10.00, respectively. The deferred
compensation is amortized over the vesting period of each respective option,
generally four years. In fiscal year 2001, the company reduced the gross
deferred compensation by $130,000. This amount represents options that were
cancelled as a result of employees leaving the Company before the four year
vesting was complete. Approximately $65,000 and $58,000 was recorded as
compensation expense in fiscal year 2000 and 2001, respectively.
43
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2001
Statement of Financial Accounting Standards No. 123
Pro forma information regarding net income (loss) is required by SFAS 123,
and has been determined as if the Company had accounted for its stock options
under the fair value method of that Statement. The fair value for options
granted prior to the Company's initial filing on Form S-1 dated October 15,
1998 was estimated as of the date of grant using a minimum value option
pricing model with weighted-average risk free interest rates for 1999, 2000
and 2001 of 5.56%, 5.71% and 5.98%, respectively; no dividends; and a
weighted-average expected life of the option of five years for options granted
before our initial public offering and four years for options granted
subsequent to our initial public offering. The fair value for options granted
subsequent to our initial filing date was established as of the date of grant
using the Black-Scholes pricing model with a volatility of 40% for options
granted subsequent to the initial filing date but prior to our initial public
offering and a volatility of 85% for options granted subsequent to our initial
public offering. A volatility of 92.5% was used for options granted during
fiscal year 2001.
The minimum value option valuation model with a near zero volatility
results in an option value similar to the option value that would result from
using the Black-Scholes option valuation model with a near zero volatility.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and which
are fully transferable. In addition, option valuation models in general
require the input of highly subjective assumptions, including the expected
stock price volatility. Because the Company's stock options have
characteristics significantly different than those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion the existing models do not
necessarily provide a reliable single measure of the fair value of its stock
options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The impact
on the pro forma results which follow may not be representative of
compensation expense in future periods when the effect of the amortization of
multiple awards may be reflected in the amounts. The Company's pro forma net
loss from continuing operations (net of income taxes) and pro forma basic and
diluted net loss per share follows:
Year ended March 31,
---------------------
1999 2000 2001
------ ------ ------
Pro forma net income from continuing operations (in
thousands)............................................. $ 679 $9,485 $3,002
Pro forma basic net income (loss) per share............. $(0.56) $ 0.93 $ 0.22
Pro forma diluted net income (loss) per share........... $(0.56) $ 0.60 $ 0.21
44
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2001
A summary of the Company's stock option activity under the Plan(s) and
related information follows (since options under the Plan(s) are immediately
exercisable, outstanding exercisable options at the end of the period are
shown both in total and for vested amounts which would not be subject to
repurchase if exercised):
March 31, 1999 March 31, 2000 March 31, 2001
-------------------- -------------------- --------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------- --------- --------- --------- --------- ---------
Outstanding--beginning
of period.............. 2,007,647 $ 3.03 2,438,939 $ 2.50 2,423,519 $ 6.78
Granted............... 618,176 $ 7.23 686,040 $17.04 1,227,330 $14.05
Exercised............. (70,102) $ 1.10 (605,465) $ 0.93 (373,034) $ 2.14
Canceled.............. (116,782) $ 3.11 (95,995) $ 8.08 (444,555) $15.00
--------- ------ --------- ------ --------- ------
Outstanding and
exercisable--end of
period--total.......... 2,438,939 $ 2.50 2,423,519 $ 6.78 2,833,260 $ 9.27
========= ====== ========= ====== ========= ======
Outstanding and
exercisable--end of
period--vested......... 1,498,301 $ 0.63 1,261,271 $ 1.76 1,254,481 $ 3.79
========= ====== ========= ====== ========= ======
Weighted-average fair
value of
Options granted during
the
period................. $ 2.02 $ 9.13 $ 9.66
Exercise prices for options outstanding at March 31, 2001 are as follows:
Weighted-
Weighted- Average
Average Remaining
Exercise Exercise Contractual
Price Range Options Price Life
----------- ------- --------- -----------
$0.20-$0.30 416,100 $ 0.20 2.3
$0.40-$0.50 50,750 $ 0.40 0.3
$1.20-$1.20 76,000 $ 1.20 4.5
$1.90-$2.80 411,821 $ 2.39 6.1
$5.75-$8.50 1,128,325 $ 6.75 8.8
$9.00-$12.00 149,668 $ 9.34 8.1
$17.50-$25.13 158,738 $19.17 8.6
$27.88-$33.25 441,858 $29.48 9.1
--------- ------ ---
$0.20-$33.25 2,833,260 $ 9.27 7.2
============= ========= ====== ===
Warrants
The Company issued warrants at various dates between 1991 and 1993 to
purchase up to 88,750 shares of Series A and Series B redeemable convertible
preferred stock in connection with certain equipment financing leases. These
warrants were exercisable at a price of $4.00 per share and all have expired
as of December 31, 1999 with the exception of 10,000 which expire in 2001. In
1993, additional warrants to purchase up to 28,750 shares of common stock at
an exercise price of $.01 per share were issued under the anti-dilution
provisions of the warrants for Series A and B redeemable convertible preferred
stock and expire in 2001. In 1993, the Company issued a warrant to a bank to
purchase up to 25,000 shares of Series B redeemable convertible preferred
stock at an exercise price of $4.00 per share and a warrant to purchase up to
25,000 shares of common
45
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2001
stock at an exercise price of $.01 per share. The warrants were exercised by
the bank in December 1999 and are no longer outstanding. These warrants were
accounted for at the fair value of the warrants on the date of issuance.
6. Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred taxes are as follows (in thousands):
March 31, March 31, March 31,
1999 2000 2001
--------- --------- ---------
Deferred tax assets:
Tax carryforwards............................ $ 6,544 $4,581 $3,370
Depreciable assets........................... 130 52 107
Accruals, reserves and other................. 421 354 1,150
------- ------ ------
Gross deferred tax assets...................... 7,095 4,987 4,627
Valuation allowance............................ (7,095) -- --
------- ------ ------
Net deferred taxes............................. $ -- $4,987 $4,627
======= ====== ======
The valuation allowance decreased by approximately $7,095,000 during fiscal
year 2000. The reduction was due to the utilization of net operating losses
which were not previously benefited ($2.1 million) and management's
determination that the remaining deferred tax items would more likely than not
be realized ($5.0 million).
As of March 31, 2000 and March 31, 2001, the Company had federal net
operating loss carryforwards of approximately $11,671,000 and $9,034,000,
respectively which will expire beginning in 2007, if not utilized. The Company
had alternative minimum tax credit carryforwards of $291,000 and $298,000 as
of March 31, 2000 and March 31, 2001, respectively, which do not expire.
Utilization of the net operating losses and credit carryforwards may be
subject to a substantial annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code of 1986. The annual limitation may
result in the expiration of net operating losses before utilization.
Significant components of the expense (benefit) for income taxes
attributable to continuing operations are as follows (in thousands):
Year ended March 31,
---------------------
1999 2000 2001
---- ------- -------
Current............................................ $19 $ 112 $ 197
Deferred........................................... -- (4,987) 2,747
--- ------- -------
$19 $(4,875) $ 2,944
=== ======= =======
Income tax expense (benefit) is included in the financial statements as
follows (in thousands):
Year ended March 31,
---------------------
1999 2000 2001
---- ------- -------
Continuing operations.............................. $19 $(4,875) $ 2,944
Income from discontinued Operations................ 2 -- --
Stock option benefit credited to Equity............ -- -- (2,325)
--- ------- -------
$21 $(4,875) $ 619
=== ======= =======
46
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2001
The Company's expense (benefit) for income taxes attributable to continuing
operations differs from the expected tax benefit amount computed by applying
the statutory federal income tax rate of 34% to income before income taxes as
a result of the following:
Year ended March
31,
----------------------
1999 2000 2001
------ ------ ----
Federal statutory rate.. 34.0 % 34.0 % 34.0 %
Reduction in valuation
allowance.............. (36.7) (125.0) --
Permanent items and
other.................. 4.9 5.2 3.0
------ ------ ----
Total expense
(benefit).............. 2.2 % 85.8 % 37.0 %
====== ====== ====
7. Defined Contribution Plan
The Company has a 401(k) plan for all full-time employees who have reached
age 18 and completed certain service requirements. Employer contributions may
be made by the Company at the discretion of the Board of Directors. No such
employer contributions have been made to date.
9. Commitments and Contingencies
The Company leases equipment and office space under noncancelable operating
leases. Rent expense for the years ended March 31, 1999, 2000 and 2001 was
approximately $1,352,000, $1,603,000 and $1,778,000, respectively. Future
minimum lease payments under these leases as of March 31, 2001, are as follows
(in thousands):
Year ended March 31,
--------------------
2002........................................................... $ 2,230
2003........................................................... 2,619
2004........................................................... 2,132
2005........................................................... 1,102
2006........................................................... 1,112
Thereafter..................................................... 1,151
-------
Total minimum lease payments..................................... $10,346
=======
A series of complaints were filed in the United States District Court for
the Western District of Texas, Austin Division against the Company and certain
of its officers in September and October 2000. Plaintiffs in each of these
cases sought to represent a class comprised of purchasers of the Company's
common stock between April 18, 2000 and August 18, 2000 ("Class Period").
Those complaints alleged that the defendants engaged in a fraudulent scheme by
issuing false and materially misleading statements regarding the Company's
business during the Class Period.
10. Capital Leases
The Company leases various computer, networking and other equipment under
capital lease arrangements. The following is a schedule by years of future
minimum lease payments under these capital leases together with the present
value of the net minimum lease payments as of March 31, 2001 (in thousands).
Year ended March 31,
--------------------
2002.............................................................. $337
2003.............................................................. --
----
Total minimum lease payments........................................ 337
Less amount representing interest................................... (13)
----
Present value of net minimum lease payments......................... $324
====
47
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2001
11. Restricted Cash
At March 31, 2001, the Company had outstanding irrevocable letters of
credit totaling $306,000 in favor of a lessor under a capital lease for
equipment. These letters of credit are collateralized by certificates of
deposit. All capital leases will mature during fiscal year 2002; therefore,
these letters of credit will no longer exist on March 31, 2002.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
48
Part III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The section entitled "Election of Directors" and the subsection entitled
"Section 16(a) Beneficial Ownership Reporting Compliance" of our definitive
Proxy Statement pursuant to Regulation 14A for our 2001 Annual Meeting of
Stockholders to be held July 18, 2001, and to be filed on or about May 30,
2001, is incorporated herein by reference.
Additional information with respect to our executive officers is found at
the end of Part I of this report under the heading "Executive Officers of the
Registrant."
Item 11. EXECUTIVE COMPENSATION
The subsection entitled "The Board of Directors--Director Compensation" and
the section entitled "Executive Compensation" of our definitive Proxy
Statement pursuant to Regulation 14A for our 2001 Annual Meeting of
Stockholders to be held July 18, 2001, and to be filed on or about May 30,
2001, are incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Security Ownership of Certain Beneficial Owners and
Management" of our definitive Proxy Statement pursuant to Regulation 14A for
our 2001 Annual Meeting of Stockholders to be held July 18, 2001, and to be
filed on or about May 30, 2001, are incorporated herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The subsection entitled "Loan to Craig S. Tysdal" of our definitive Proxy
Statement pursuant to Regulation 14A for our 2001 Annual Meeting of
Stockholders to be held July 18, 2001, and to be filed on or about May 30,
2001, are incorporated herein by reference.
49
Part IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
Financial Statements (included in Item 8 of this report) Page No.
-------------------------------------------------------- --------
Report of Independent Auditors..................................... 33
Consolidated Balance Sheets as of March 31, 2000 and 2001.......... 34
Consolidated Statements of Operations for each of the three years
in the period ended March 31, 2001................................ 35
Consolidated Statements of Stockholders Equity (Deficit) for each
of the three years in the period ended March 31, 2001............. 36
Consolidated Statements of Cash Flows for each of the three years
in the period ended March 31, 2001................................ 37
Notes to Consolidated Financial Statements......................... 38
50
The consolidated financial statement schedules are omitted because they are
not applicable or because the required information is included in the
consolidated financial statements or notes thereto.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the three months ended March 31,
2001.
Previously Filed*
-----------------------
With File
Exhibits Number As Exhibit Description
-------- ------------ ---------- -----------
3.1 333-65691 3.3 Restated Certificate of Incorporation of
NetSolve, as filed.
3.2 333-65691 3.4 By-laws of NetSolve.
4.1 Amdt. No. 1 4.1 Specimen Form of Common Stock Certificate of
to 333-65691 NetSolve.
10.1 Amdt. No.1 10.1 Contract Services Agreement between AT&T
to 333-65691 Corp. and NetSolve, dated December 21, 1995,
together with amendments relating thereto.+
10.2 333-65691 10.2 Lease between CarrAmerica Realty, L.P., t/a
Riata Corporate Park, as Landlord, and
NetSolve, as Tenant, dated as of September
30, 1997, relating to Riata Corporate Park.
10.3 333-65691 10.4 Master Lease Agreement between Trimarc
Financial, as Leasor, and NetSolve, as
Lessee, dated as of January 30, 1998,
relating to certain items of equipment.
10.4 333-65691 10.5 Asset Acquisition Agreement between
Intermedia Communications Inc. and NetSolve,
dated as of December 30, 1996.
10.5 Amdt. No. 1 10.7 Form of Indemnification Agreement.
to 333-65691
10.6** 333-65691 10.8 1988 Stock Option Plan, as amended.
10.7** Amdt. No. 1 10.9 Amended and Restated Long-Term Incentive
to 333-65691 Compensation Plan.
10.8 333-65691 10.10 Form of Proprietary Information and
Inventions Agreement entered into between
NetSolve and each officer.
10.9** 333-65691 10.11 Offer Letter from NetSolve to Craig S.
Tysdal, dated August 12, 1993.
10.10** Amdt. No. 1 10.17 Form of Stock Option Agreement with
to 333-65691 Directors.
10.11** Amdt. No. 1 10.18 Form of Shareholder Agreement with Directors.
to 333-65691
10.12 0-24983 10.2 Office Lease Agreement between Austin Jack,
Form 10-Q L.L.C., as landlord and NetSolve, as Tenant,
dated as of June 7, 2000, relating to Amber
Oaks
10.13** Offer letter from NetSolve to Honore
LaBourdette dated April 4, 2001
10.14 Exclusive Software License and Use Agreement
entered into as of December 21, 2000 between
NetSolve and NEC Corporation.+
10.15 Asset Purchase Agreement and Assignment of
Contract Rights dated as of March 15, 2001
between Comdisco, Inc. and NetSolve.+
21.1 333-65691 22.1 Subsidiaries of NetSolve.
23.1 Consent of Ernst & Young LLP, Independent
Auditors.
51
- --------
* Incorporated herein by reference. Abbreviations used are (i) Amdt. No. 1 to
333-65691 to reference the Registrant's Amendment No. 1, dated July 26,
1999, to its Registration Statement on Form S-1, File No. 333-65691, and
(ii) Form 10-Q to reference the Company's Quarterly Report on Form 10-Q for
the period ended June 30, 2000.
** Management contract or compensation plan or arrangement required to be
filed as an exhibit hereto pursuant to Item 14(c).
+ Portions of this exhibit have been omitted pursuant to a request for
confidential treatment.
52
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, NetSolve, Incorporated, has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
NetSolve, Incorporated
Date: May 30, 2001.
/s/ Craig S. Tysdal
By: _________________________________
Craig S. Tysdal,
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of NetSolve,
Incorporated and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Craig S. Tysdal Principal Executive May 30, 2001
______________________________________ Officer and Director
(Craig S. Tysdal, President and
Chief Executive Officer)
/s/ Kenneth C. Kieley Principal Financial May 30, 2001
______________________________________ Officer and Principal
(Kenneth C. Kieley, Vice President- Accounting Officer
Finance
Chief Financial Officer and Secretary)
/s/ J. Michael Gullard Director May 30, 2001
______________________________________
(J. Michael Gullard, Chairman of the
Board)
/s/ G. Jospeh Lueckenhoff Director May 30, 2001
______________________________________
(G. Joseph Lueckenhoff)
/s/ John S. McCarthy Director May 30, 2001
______________________________________
(John S. McCarthy)
/s/ Suzanne C. Narducci Director May 30, 2001
______________________________________
(Suzanne C. Narducci)
/s/ Howard D. Wolfe, Jr. Director May 30, 2001
______________________________________
(Howard D. Wolfe, Jr.)
53