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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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, 2002
or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 0-24983
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)
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
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, 2002, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $47,409,057 (affiliates being, for these
purposes only, directors, executive officers and holders of more than 5% of
Registrant's Common Stock). On April 30, 2002, there were 12,043,462 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 2002 Annual Meeting of Stockholders to be
held on July 17, 2002, which will be filed with the Commission not later than
120 days subsequent to March 31, 2002, are incorporated by reference into Part
III of this report.
NETSOLVE, INCORPORATED
TABLE OF CONTENTS
Part I Page
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Item 1. Business 3
Item 2. Facilities 11
Item 3. Litigation 11
Item 4. Submission of Matters to a Vote of Security Holders 12
Executive Officers of the Registrant 13
Part II
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Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 14
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 32
Item 8. Financial Statements and Supplemental Data 33
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 51
Part III
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Item 10. Directors and Executive Officers of the Registrant 51
Item 11. Executive Compensation 51
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters 51
Item 13. Certain Relationships and Related Transactions 51
Part IV
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Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 52
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PART I
Item 1. BUSINESS
NetSolve offers a range of remote network infrastructure management
services that allow enterprises to out-task some or all of their network
management to increase network availability, performance and security while
reducing overall network operations cost, and simplifying timely migration to
new technologies. At our customers' election, our solutions can address all or
selected parts of lifecycle network operations, which consists of network
configuration and design, implementation, monitoring, fault diagnosis and
resolution, and performance management. We provide network management services
remotely 24 hours a day, 365 days a year from our Network Management Center
(NMC) in Austin, Texas. We develop and operate software tools that allow us to
manage these networks and allow our customers to access real-time network status
and reports via the Web. We have offered network management services since 1995
and currently have over 1,000 customers representing more than 40,000 managed
sites in 53 countries. Our solutions are scalable across multiple industries and
enterprises of all sizes. Our services are provided both directly to end users
as well as indirectly through resellers such as AT&T, IBM and NEC.
Our solutions
Our solutions allow enterprises to solve network problems and to transition
to new technologies. Enterprises benefit from NetSolve's expertise and breadth
of services without incurring the expense of acquiring internal tools and
resources to maintain their network. Our services can also be described as mass
customized, meaning we apply proven (i.e., learned and continually improved)
processes and tools to customers of all sizes to meet their individual
requirements. This mass customized approach permits the use of similar tools and
processes among customers allowing us to provide price and performance value to
our customers.
Full breadth of network management services. Our services are generally
marketed under the brand name ProWatch(R). Our ProWatch suite of services covers
issues encountered by customers in the LAN (local area network), IPT (IP
Telephony), WAN (wide area network), network security, server and desktop areas
of their business. With the exception of the new desktop and server services,
the ProWatch suite covers the entire lifecycle of an enterprise's network
requirements, including fault, configuration and performance management.
Reduced costs. Singularly focused on network management, NetSolve is able
to spread personnel-related costs, as well as costs of necessary network
infrastructure, software and tools, across hundreds of end users. As a result,
we are typically able to offer a more efficient network management solution at a
lower cost than if internally managed.
Increased business impact. Our end users no longer have to use their
internal resources to respond to the time-consuming and interrupt-driven
responsibilities of daily network operations. Hence, these organizations can
focus their resources on applying technology to improve their business.
Enhanced customer service. We own the network problems. NetSolve takes
ownership when a network issue arises and works on behalf of our customers
through resolution. We offer service guarantees that provide customers up to
100% of their management fee back each month.
Ease of network maintenance and technology upgrades. Our network management
professionals act as an extension of our customer's internal IT (information
technology) staff. We report to end users on a regular basis recommending
upgrades or changes when appropriate. We apply our technical skills and learning
across hundreds of networks and bring this breadth of experience to our
customer's unique issues. Additionally, we continually train our professionals
on emerging technologies that are impacting the network infrastructure, such as
IPT. As a result, we are able to assist enterprises as they migrate their
network to new technologies.
Enhanced network control. When NetSolve manages a network, our customers
continually have a window into their networks. We enable customers to maintain
ultimate control and visibility into critical network status and
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information. End users have access to ProWatch Exchange(R), NetSolve's network
management Web portal, providing customers with real-time network status of
every site we manage for them, as well as on-demand network performance reports.
Strategy
Our goal is to be the leading provider of remote network infrastructure
management services. The key elements of our strategy include the following:
Deliver targeted solutions and expand service offerings. We are focused on
solving network management needs for enterprises that are either assimilating
new technology or are attempting to solve complex IT issues. We believe that the
market to offer end-to-end network management services for enterprises is
largely untapped and that our solutions allow us to enter new and exciting
markets such as infrastructure security and IPT and to extend our services to
areas such as remote office management. We will seek to grow these solutions by
specifically targeting key industry verticals, such as mid-tier financial
institutions for our security offering. We intend to continue to grow our
expertise in WAN, LAN, IPT, network security and server devices in order to
provide specialized service solutions for managing IPT, host and network
security, remote office and VPNs (virtual private networks).
Support leading technologies. We support only the leading providers of
networking hardware and carrier services including AT&T, Qwest Communications,
Sprint, Worldcom, various regional bell operating companies and competitive
local exchange carriers (LECs), in the data transport arena, and Cisco and
Visual Networks in the market for customer premise equipment (CPE).
Add distribution partners. We will continue to market our services both directly
and by selecting strategic distribution partners who can bundle our services
with solutions, transport services, network equipment or consulting and
integration services. These partners will be focused on including network
management as a key component of their total services offering. We believe that
we can expand our current distribution relationships to further enhance this
significant competitive advantage.
License our technology. We will continue to license our technology and processes
to foreign companies and non-competing U.S. domestic companies that desire to
bring the NetSolve customer experience to their country or company. We entered
into a licensing agreement with NEC Corporation of Japan in fiscal 2001 under
which NEC Japan is authorized to utilize our internally developed network
management software tools as well as the service descriptions and processes that
we design and utilize to manage the customer.
Network management services
NetSolve's focus is on growing our recurring network management services
revenues. Our network management services are primarily comprised of recurring
revenue. NetSolve's service offerings combine core remote network management
capabilities such as remote router, switch and firewall management into
comprehensive solutions offerings that help our customers assimilate new
technologies or address complex IT management issues.
Core remote management services
Our core services include the remote management of routers, switches,
firewalls, network intrusion detection devices, host-based intrusion detection
software, servers and desktops. Historically, NetSolve has sold these core
services independently under its ProWatch brand such as ProWatch for WANs(R),
ProWatch for LANs(R) and ProWatch Secure(R). Recently we have focused on
combining these capabilities to provide three distinct remote management
solutions to our customers. These solutions are Infrastructure Security, IPT and
Remote Office Management. Each one of these service offerings combines elements
of our core services into a comprehensive solution for our customer.
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The WAN service includes management of the WAN-attached router; the
customer service unit, or CSU, connecting the router to the transport provider's
Frame Relay, ATM, or IP service; and the transport provider's network services.
The WAN 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 recurring network management services revenues are derived from ProWatch for
WANs and related WAN services.
In addition to the management of the WAN infrastructure between
headquarters sites and remote offices, we provide management of the LAN, server
management, desktop asset management, and VPN management services. With our LAN
management service we measure, monitor and manage the routers, switches and
intelligent hubs in remote office LANs. We also provide remote availability,
asset management, and performance monitoring for Windows 95/98/2000/NT and Sun
Solaris servers. For desktops, we provide asset management and tracking for our
customers enabled through our Web portal ProWatch Exchange, described below. The
VPN service is the same that is described in the Infrastructure Security
section.
Solutions
Infrastructure Security
-----------------------
NetSolve's infrastructure security offering addresses security needs of an
enterprise 24 hours a day, 365 days a year. These remote security
management capabilities include firewall management, intrusion detection
management, host-based intrusion detection management, and virtual private
network configuration and management. These security services are designed
to protect an enterprise's critical IT infrastructure with around-the-clock
monitoring and policy management services. The services described below may
be sold separately or be combined for a more complete offering.
NetSolve's security offering includes the following services:
Firewall Management. The firewall management service provides active
management of the firewall which is the electronic barrier between
network segments. Security engineers review firewall logs and event
streams to detect suspicious activity. ProWatch Secure Managed Firewall
Service supports Cisco's PIX Firewall series and Checkpoint firewalls.
Intrusion Detection Management. The intrusion detection management
service uses Cisco's IDS sensor to detect suspicious activity on
customer networks, repel attacks and bar the potential intruder from
accessing the end user's network.
Host-Based Intrusion Detection Management. The host intrusion detection
management service protects critical servers such as Web and mail
servers. This service can prevent and alarm on those types of network
attacks that cannot be fully prevented by a firewall or network
intrusion detection device. This service utilizes Entercept's Host IDS
technology.
Virtual Private Network Management. The virtual private network
configuration management service can be used by enterprises to
establish and maintain point-to-point VPNs between routers and
firewalls. NetSolve provides remote monitoring and management of this
secure connection.
IPT (IP Telephony)
-----------------
NetSolve combines remote router, switch, security and server management
capabilities to provide a remote management solution for IPT. NetSolve's IPT
service currently delivers remote operations support services for Cisco's
Architecture for Voice, Video and Integrated Data (AVVID). AVVID integrates
telephony functions onto IP-based LANs eliminating the need for PBX equipment
and enabling converged applications. The IPT service is intended for use in
conjunction with an AVVID IP Telephony Certified Cisco Partner that provides
Plan, Design,
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Implement (PDI) services. Operations managed by NetSolve consist of the ongoing
management and reporting services for an IP Network and its IP Telephony
functionality after the PDI activities are complete.
This service allows customers to migrate to an IPT implementation with
NetSolve assisting them with quality of service, reliability or availability
issues.
Remote Office Management
------------------------
NetSolve's remote office infrastructure management solution combines many
of NetSolve's historical services with new offerings aimed at providing
customers with solutions for the management of their remote office
infrastructure. These services include remote management of the WAN and LAN
infrastructure, management of security, and management of server and desktop
assets.
Web-enabled tools
NetSolve's Web-enabled network management tools provide end users with
access to up-to-date status information of their networks and is designed to
give end users increased understanding of their networks while they out-task the
network management to NetSolve. 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. An active network map displays the status of
all managed sites in an end user's network and online viewing access to the
monthly availability and on-demand performance reports included with the various
remote network management services.
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 its successors, Bay/Nortel, Cisco
and Nextira. We anticipate that sales of new maintenance contracts will decline
over time as current contracts expire and some are not renewed.
Customers
Historically, our solutions were primarily designed to address 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.
While we believe this is the key opportunity area for our solutions, we also
provide services to larger enterprises that can utilize our standard packaged
services without requiring significant customization. We currently have over
1,000 end users representing over 40,000 managed sites. Our end users consist of
our direct customers as well as customers of our resellers
Most of our resellers use our brand; however, AT&T and some others resell
our services under their trade and brand names. We receive our revenues directly
from the resellers. In some situations, the resellers include the cost
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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, IBM, Berbee, Garrison, Planetary Networks,
EIA, NEC Business Network Solutions, Solarcom, Inc., Broadwing and Spectria.
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.
Relationship with AT&T
We have two primary reseller agreements with AT&T, one for Managed Router
Service and one for Managed DSU Service. AT&T has sold these network management
services to their customers in conjunction with AT&T's overall network solution
offering using AT&T's trade and brand names. Our technicians have worked
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 71% of our total revenues in
fiscal year 2000, 69% of our total revenues in fiscal year 2001, and 61% of our
total revenues in fiscal year 2002. Our two primary agreements with AT&T
accounted for 55% of our total revenues in fiscal year 2002.
The Managed Router Service agreement with AT&T was renewed in January
2002 and the Managed DSU Service agreement with AT&T was renewed in April 2002.
These two agreements currently terminate on June 30, 2003 with respect to
placing new orders for service.
The agreement for Managed Router Service provides that AT&T may cancel
all of its orders for Managed Router Service by providing us with 180 days
advance written notice. At the end of the notice period, an eight-month
ramp-down period would begin, except that the ramp-down period may not begin
prior to July 1, 2003. Each month during the ramp-down period, AT&T may
transition no more than 12.5% of the existing sites away from NetSolve. After
the eight-month ramp-down, NetSolve may continue to provide Managed Router
Service only if mutually agreed between NetSolve and AT&T. In addition to the
cancellation by AT&T of all orders for Managed Router Service, AT&T may cancel
individual orders upon 30 days notice under certain circumstances.
The agreement for Managed DSU Service provides for NetSolve to deliver the
services for the original end-user service term of each order (subject to
certain exceptions specifically set forth in the agreement), up to a maximum
service term of 36 months, and further provides AT&T the option to continue the
services on a month-to-month basis following the expiration of the service term
for individual end users.
Sales and marketing
We market our services directly to end users as well as to resellers.
Services sold to carrier resellers are primarily for incorporation in services
the carriers sell directly to end users. Our strategy includes building our
reseller channels, and we expect that these channels will continue to represent
a large percentage of our network management revenues for the foreseeable
future. In an effort to create greater value in our partnerships, we are working
with our partners to move from strictly a reseller model to an ecosystem that
provides a comprehensive solution to customer problems. Our channel partners
fill important gaps in planning, design and implementation services in order to
more completely meet our customer needs. With this model, we can help our
customers assimilate new technologies, and implement and manage complex
technologies, and then assume responsibility for the ongoing operation of these
networks. Substantially all sales of our services to date have been made in the
U.S. However, we remotely manage locations in 53 countries around the world for
these U.S. based customers.
At March 31, 2002, we employed 28 people in the sales and sales support
area. Our sales organization helps resellers define services and familiarize the
resellers' sales forces with our services and networking options. Reseller
support by our sales organization also includes assistance with responses to
requests for proposals, network
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design and proposal generation, and participation in sales calls to
potential customers. Certain sales individuals are also responsible for direct
sales of our services to end users.
At March 31, 2002, we employed 7 people in marketing who are responsible
for marketing communications, public relations and product marketing. Primary
marketing communications include direct mail promotions, seminars, sales
collateral and support, and design and maintenance of our web site. Public
relations activities include obtaining media coverage and public recognition.
Product marketing activities include the creation of marketing, product, and
business plans as well as the delivery of tools for our sales force and our
channels including service definitions, pricing, competitive analysis, sales
presentation materials and industry-specific data sheets. The marketing group
also works with our larger reseller partners to define, develop and implement
their own services that embed a core NetSolve service.
Software and services development
Our software and services development groups consisted of 31 people as of
March 31, 2002. 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 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 new 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 212 individuals as of March 31,
2002, 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 backup when the primary
engineer is not available.
Other groups within our operations group support these customer engineer
teams. The first level of service delivery is our NMC, which is staffed 24 hours
a day, 365 days a year with network engineers and technicians who have a broad
range of technical expertise. Our NMC 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
15 minutes of a network failure. Upon isolation of the problem, the appropriate
service provider is dispatched (to the end user's premises if required) to
repair the outage. NMC 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, process managers,
installation engineers, and equipment staging and configuration personnel. The
Integrated Systems Support team handles all server, telephony and network
infrastructure for internal business users as well as maintaining all customer
connections. Finally, the process and tools automation team's primary focus is
to drive down the unit cost of our products while increasing quality of service
to our customers.
We deliver our services utilizing a workforce having 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
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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 mission critical systems disaster recovery. For disaster
avoidance for 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 and maintain on-site failover technologies for
critical server and database components. The customer network management
infrastructure and major critical server and database components are replicated
in a multi-site failover infrastructure in order to mitigate a complete loss of
our primary facility. Using NetSolve branded services as well as other products,
the infrastructure is monitored 24 hours a day, 365 days a year with certified
professionals on call to resolve issues with minimal impact.
We have implemented a range of security measures to prevent unauthorized
access to our networks and to our customers' networks. Customer networks are
connected to NetSolve's management infrastructure with separate connections
(Frame Relay PVC or VPN, for example) for each customer, which, by their nature,
restrict traffic flow to only the two endpoint networks. NetSolve also carefully
screens all employees before hiring. All prospective candidates undergo
behavioral as well as technical interviews. NetSolve employs a range of physical
site security measures to help prevent unauthorized access to NetSolve systems
and information. We continually evaluate our security posture to ensure that we
are providing a high level of protection to our own and our customers' networks.
NetSolve employs third-party network security engineers to periodically assess
the environment and controls for security weaknesses.
Competition
Currently, we compete primarily with the internal network administration
organizations of actual or potential end users of our services. 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. In order to compete effectively with internal organizations, NetSolve
is focusing on helping customers assimilate new technology where internal
resources are untrained and unproven, or helping customers manage complex
technologies where internal resources have ongoing problems. This focus on
specific solutions helps us move away from a simple cost comparison to internal
resources and move closer to a partnership with the customer as we address a key
problem. Other important factors in our success include quality of service,
price, functionality and features, product reputation and quality of support.
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. Some 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.
While much of the competition we face remains with the internal IT
departments, we also compete with other remote network management companies
including telecommunications providers such as AT&T, Sprint and WorldCom;
network equipment vendors such as Bay/Nortel and Lucent; and computer systems
vendors such as Hewlett Packard/Compaq and Unisys. With respect to our security
services, we compete with computer systems vendors such as IBM, network security
software and services vendors such as ISS, and security services vendors such as
Guardent, Riptech and Counterpane. We face potential competition from IT
consulting firms, systems
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integrators, VARs, and local and regional network services firms and other new
entrants into our markets, such as some of the members of the Management Service
Providers Association. Our competitors also include certain of our resellers,
including AT&T and IBM. Many of these current and potential competitor companies
have significantly greater financial, technical and marketing resources and
greater name recognition than we have and generate greater service revenue than
we do. 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.
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 two patents
and have applied for another patent 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, and the NetSolve name
together as one mark, and other marks, including ProWatch, ProWatch IV, ProWatch
for WANs, ProWatch for LANs, ProWatch Secure and ProWatch Exchange as separate
service marks in the U. S. We have also filed service mark and trademark
applications in Japan to seek protection for these marks in Japan. 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 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 retained 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 a product. 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.
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Employees
As of March 31, 2002, we had 306 full-time employees, including 35 in sales
and marketing, 31 in development, 212 in operations and 28 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
Currently our corporate headquarters are located in a leased facility in
Austin, Texas which covers approximately 70,000 square feet. In April 2001, we
commenced a previously executed lease of an additional facility in Austin, Texas
covering approximately 80,000 square feet. We plan to consolidate operations in
this new facility in the quarter ending June 2002. In March 2002, we recorded a
one-time charge of $2.7 million as a result of a decision to reduce excess
capacity in the Austin facilities. This charge primarily represents future
rentals for the lease of the 70,000-square-foot facility that expires in
November 2003. While the majority of operations will be consolidated, we will
retain approximately 6,400 square feet in the 70,000-square-foot facility for
disaster recovery purposes. Moving to our new facility and exiting our current
one will allow us to reduce excess capacity while retaining business continuity
and disaster recovery capability and will allow us to capitalize on the
operational efficiencies delivered over the past year. We maintain dual computer
rooms in these two geographically separate facilities and have redundant mission
critical equipment and customer connections in order to provide safeguards in
the event of a fire or similar emergency. All mission critical portions of the
70,000-square-foot facility and all portions of the new facility are covered by
uninterrupted power supply systems backed up by a power generator to guard
against system failures and to provide emergency power in the event of an
outage.
Item 3. LITIGATION
A consolidated putative class action complaint was filed on February 21,
2001 against the Company and certain of its officers in the United States
District Court for the Western District of Texas, Austin Division. In re
NetSolve Incorporated Securities Litigation, Civil Action No. A00-CA-591 SS.
Plaintiffs seek to represent a class comprised of purchasers of the Company's
common stock between April 18, 2000 and August 18, 2000 ("Class Period"). They
allege that the defendants engaged in a fraudulent scheme by issuing false and
materially misleading statements regarding the Company's business during Class
Period.
The Company moved to dismiss the complaint on March 8, 2001 for failing to
state a claim under which relief could be granted and for failing to comply with
the pleading requirements of the Private Securities Litigation Reform Act of
1995, 15 U.S.C. (S) 78u-4 et seq. On August 15, 2001, the District Court granted
this motion in part and denied it in part. The District Court dismissed claims
against one officer of the Company and dismissed certain of the theories under
which plaintiffs alleged liability against the Company. However, the District
Court let stand certain of the stated claims against the Company and certain of
its officers.
On December 17, 2001, the Company and individual defendants reached a
settlement of this action. The plaintiff class will receive $2,750,000 in
connection with the settlement, all of which will be funded by the Company's
insurance carrier. This settlement is subject to approval by the United States
District Court. A hearing on the settlement has been scheduled for September 13,
2002. Should this settlement not be approved by the District Court, it would not
then be feasible to predict or determine the final outcome in this proceeding,
and if the outcome were to be unfavorable, the Company's business, financial
condition, cash flows and results of operations could be materially adversely
affected.
-11-
On December 6, 2001, a second putative securities class action complaint
was filed against the Company, certain of its officers and the Company's
underwriters of its initial public offering in the United States District Court
for the Southern District of New York. Woodward v. NetSolve, Inc., 01 CV 11239.
Plaintiff seeks to represent a class comprised of purchasers of the Company's
common stock between September 29, 1999 and December 6, 2000. The plaintiffs
allege that the defendants failed to properly disclose certain commissions,
discounts and purported tie-in arrangements related to the Company's initial
public offering. The plaintiffs allege claims under Sections 11 and 15 of the
Securities Act against the Company, and the plaintiffs allege claims under
Section 11 and 12 of Securities Act, and Section 10 (b) of the Exchange Act,
against the Company's underwriters. This case has been coordinated for pretrial
purposes with over 300 other cases alleging similar claims against other
underwriters and companies. In re Initial Public Offering Securities Litigation,
21 MC 92 (SAS). It is not feasible to predict or determine the final outcome of
this proceeding, and if the outcome were to be unfavorable, the Company's
business, financial condition, cash flow and results of operations could be
materially adversely affected.
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, 2002.
-12-
EXECUTIVE OFFICERS OF THE REGISTRANT
The following information is provided with respect to each executive
officer of the registrant as of May 15, 2002, pursuant to General Instruction G
of Form 10-K:
Name Age Position(s)
---- --- -----------
Craig S. Tysdal ....... 55 Director; President and Chief Executive Officer
Kenneth C. Kieley ..... 51 Vice President--Finance, Chief Financial Officer
and Secretary
Honore LaBourdette .... 50 Vice President--Sales
Jerry W. Davis ........ 39 Vice President--Development
Robert C. Pojman ...... 38 Vice President--Business Development
Robert W. Kujawski .... 37 Vice President--Operations
H. Perry Barth ........ 36 Controller, Principal Accounting Officer
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 facilitates 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 Director for Nortel Networks from July 1998 until
January 2001 and as Regional Vice President from January 2001 until April 2001.
From June 1994 to July 1998, she was the Regional Director-Sales for Network
Equipment Technologies, Inc. and was focused on 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
Director of NetSolve's Network Management Center. From May of 1998 to May 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.
H. Perry Barth was named Principal Accounting Officer in April 2002. He has
served as our Controller since April 1999. Mr. Barth was employed as Controller
of Xetel Corporation, an electronics contract manufacturer, from May 1994 to
April 1999. Mr. Barth worked for PricewaterhouseCoopers LLP from 1988 to 1994.
-13-
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 eight quarters in the period ended March
31, 2002 as reported by the Nasdaq National Market System.
Price Per Share
---------------
Three Months Ended High Low
- ------------------ ---- ---
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
June 30, 2001 12.57 5.91
September 30, 2001 14.35 9.00
December 31, 2001 12.50 8.57
March 31, 2002 10.65 7.41
Holders of our common stock
At the close of business on May 20, 2002, there were approximately 119
holders of record of the common stock and approximately 2,840 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.
Securities authorized for issuance under equity compensation plans
See Item 12 of this report.
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 $21,059,000 have been used to repurchase 2,930,316
shares of the Company's common stock under its stock repurchase program. The
remainder of the proceeds of this offering 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 2000, 2001 and 2002 and as of March 31, 2001 and
2002 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
1998 and 1999 and as of March 31, 1998, 1999 and 2000 are derived from our
audited consolidated financial statements not included in this document.
-14-
Year Ended March 31,
--------------------------------------------------
1998 1999 2000 2001 2002
-------- -------- -------- -------- --------
(in thousands, except per share data)
Statement of operations data:
Revenues:
Network management services ................................................ $ 7,324 $ 12,777 $ 24,048 $ 33,032 $ 37,954
Equipment and other ........................................................ 7,199 13,939 14,613 13,420 10,411
-------- -------- -------- -------- --------
Total revenues ........................................................... 14,523 26,716 38,661 46,452 48,365
Cost of revenues:
Cost of network management services ........................................ 5,706 8,258 13,095 19,311 22,333
Cost of equipment and other ................................................ 5,425 10,665 11,202 9,536 7,133
-------- -------- -------- -------- --------
Total cost of revenues ................................................... 11,131 18,923 24,297 28,847 29,466
-------- -------- -------- -------- --------
Gross profit ................................................................. 3,392 7,793 14,364 17,605 18,899
Operating expenses:
Development ................................................................ 2,040 1,762 2,503 3,169 3,452
Sales and marketing ........................................................ 2,562 3,153 4,486 6,149 6,377
General and administrative ................................................. 2,159 2,098 3,095 3,559 5,238
Amortization of deferred compensation ...................................... -- -- 65 58 34
Reduction in facilities capacity ........................................... -- -- -- -- 2,650
-------- -------- -------- -------- --------
Total operating expenses ................................................. 6,761 7,013 10,149 12,935 17,751
-------- -------- -------- -------- --------
Operating income (loss) ...................................................... (3,369) 780 4,215 4,670 1,148
Other income, net ............................................................ 340 93 1,463 3,285 1,430
-------- -------- -------- -------- --------
Income (loss) from continuing operations before income taxes ................ (3,029) 873 5,678 7,955 2,578
Income tax expense (benefit) ................................................. (297) 19 (4,875) 2,944 913
-------- -------- -------- -------- --------
Net income (loss) from continuing operations ................................. (2,732) 854 10,553 5,011 1,665
Discontinued operations:
Income from discontinued operations, net of applicable income taxes ........ 165 -- -- -- --
Gain on sale of discontinued operations, net of applicable income taxes .... 341 98 -- -- --
-------- -------- -------- -------- --------
Net income (loss) ............................................................ $ (2,226) $ 952 $ 10,553 $ 5,011 $ 1,665
======== ======== ======== ======== ========
Basic income (loss) per share from(1):
Continuing operations ...................................................... $ (1.76) $ (0.51) $ 1.06 $ 0.37 $ 0.14
======== ======== ======== ======== ========
Net income (loss) .......................................................... $ (1.59) $ (0.48) $ 1.06 $ 0.37 $ 0.14
======== ======== ======== ======== ========
Weighted average shares used in basic per share calculations(1) .............. 2,995 3,297 8,800 13,502 12,101
======== ======== ======== ======== ========
Diluted income (loss) per share from(1):
Continuing operations ...................................................... $ (1.76) $ (0.51) $ 0.68 $ 0.34 $ 0.13
======== ======== ======== ======== ========
Net income (loss) .......................................................... $ (1.59) $ (0.48) $ 0.68 $ 0.34 $ 0.13
======== ======== ======== ======== ========
Weighted average shares used in diluted per share calculations(1) ............ 2,995 3,297 13,648 14,539 13,160
======== ======== ======== ======== ========
Pro forma basic income per share from(2):
Continuing operations ...................................................... $ 0.09 $ 0.88 $ 0.37 $ 0.14
======== ======== ======== ========
Net income ................................................................. $ 0.10 $ 0.88 $ 0.37 $ 0.14
======== ======== ======== ========
Pro forma weighted average shares used in basic per share calculations(2) .... 9,692 11,963 13,502 12,101
======== ======== ======== ========
Pro forma diluted income per share from(2):
Continuing operations ...................................................... $ 0.07 $ 0.77 $ 0.34 $ 0.13
======== ======== ======== ========
Net income ................................................................. $ 0.08 $ 0.77 $ 0.34 $ 0.13
======== ======== ======== ========
Pro forma weighted average shares used in diluted per share calculations(2) .. 11,341 13,648 14,539 13,160
======== ======== ======== ========
(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.
-15-
March 31,
-------------------------------------
1998 1999 2000 2001 2002
-------- -------- -------- -------- --------
(in thousands)
Balance sheet data:
Cash and cash equivalents ........................... $ 1,333 $ 2,764 $ 57,185 $ 45,411 $ 47,160
Working capital ..................................... 5,399 5,282 63,329 46,889 48,810
Total assets ....................................... 13,227 14,936 74,519 62,831 67,861
Capital lease obligations, net of current portion ... 1,146 1,027 324 -- --
Redeemable convertible preferred stock .............. 41,615 44,146 -- -- --
Total stockholders' equity (deficit) ................ (33,029) (34,529) 68,958 56,977 58,342
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; our ability to obtain any needed additional working
capital; the amount we use our facilities for anticipated growth in network
management service revenues; trends in sales of network management services,
sales of customer premise equipment, and sales which may be derived from our
work related to Cisco Systems, Inc.'s AVVID systems; the level of any stock
repurchase we may undertake; payments requested by customers regarding our WAN
guarantee; the amount of any added costs from anticipated new sales, marketing
and development resources we gain, our reliance on resellers, and the continued
development of competition; the outcome of pending litigation; revenues derived
from AT&T and other customers; our ability to attract and retain a qualified
workforce; our ability to protect our intellectual property rights; and the
impact of changes in accounting rules.
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 uptime, 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 during 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
-16-
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. On June 21,
2001, we announced that IBM Global Services will offer NetSolve's ProWatch suite
of managed network services worldwide. The acceptance of our first software
licensing agreement occurred in the quarter ended September 30, 2001. This
agreement allows another organization to utilize our technology to provide
remote network management services to its customers. Additionally, on October 1,
2001, we announced that we will offer remote network management for Cisco
Systems, Inc. Architecture for Voice, Video and Integrated Data (AVVID) Internet
Protocol IP Telephony (IPT).
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, software
licensing fees, software usage royalties and software maintenance fees.
Recurring network management services revenues are typically based on a
fixed monthly fee per customer site or device and are recognized in the
period in which the services are rendered. For fiscal year 2002,
approximately 82% of network management services revenues were from
recurring services.
. Nonrecurring network management services consist of data network design,
project implementation services, equipment installation services,
one-time project and development assignments that assist resellers in
defining and creating new network management services and software
professional fees. Nonrecurring network management services primarily
relate to services performed to assist customers in implementing new
networks. Nonrecurring network management revenues are also earned when
implementing network management services for existing networks; however,
the level of work and related fees are both lower. Nonrecurring 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 or per-device basis and we
recognize revenues associated with these services upon completion of the
network implementation for the location or device.
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. Network management services revenues also
include software licensing, usage royalties, maintenance fees and professional
fees. 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 2001 and 2002. 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 most
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 all or a portion of 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 revenues. However, in
the future,
-17-
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 certain of
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, Visual Networks and others. We recognize
equipment revenues in the period the CPE is shipped to the customer. However, if
the transaction is financed through our lease financing subsidiary, we recognize
the revenues upon sale of the underlying lease contract on a nonrecourse 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 continue to decline as we seek to manage our mix of revenues.
We currently have two primary reseller agreements with AT&T, one for
Managed Router Service and one for Managed DSU Service. AT&T accounted for 71%
of our total revenues in fiscal year 2000, 69% of our total revenues in fiscal
year 2001, and 61% of our total revenues in fiscal year 2002. We anticipate that
sales to AT&T will continue to comprise a substantial percentage of our revenues
in fiscal 2003, but believe the percentage will continue to decline. No other
customer accounted for more than 10% of our revenues in fiscal years 2000, 2001
or 2002.
In January 2002, we entered into a new amendment to our agreement with AT&T
relating to the Managed Router Services which accounted for 34% of our total
revenues, 26% of our total network management services revenues and 27% of our
recurring network management services revenues in fiscal year 2002. The pricing
terms of the new amendment include discounts on our services that we estimate
will reduce recurring management revenues by approximately $95,000 for the
quarter ending June 30, 2002, and an additional $370,000 for the quarter ending
September 30, 2002 with prices increasing slightly thereafter.
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.
Results of Operations
Fiscal year 2001 compared to fiscal year 2002
Revenues
Total revenues. Total revenues increased 4%, from $46.5 million in fiscal
year 2001 to $48.4 million in fiscal year 2002.
Network management services. Revenues from network management services
increased 15%, from $33.0 million in fiscal year 2001 to $38.0 million in fiscal
year 2002, representing 71% of total revenues in fiscal year 2001 and 78% of
total revenues in fiscal year 2002. The increase was due 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 22%, from
$13.4 million in fiscal year 2001 to $10.4 million in fiscal year 2002. Revenues
from equipment and other sales decreased primarily as a result of lower
equipment sales due to lower demand caused by a general slowdown of corporate
spending on network infrastructures.
-18-
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 16%, from
$19.3 million in fiscal year 2001 to $22.3 million in fiscal year 2002,
representing 58% of network management services revenues in fiscal year 2001 and
59% of such revenues in fiscal year 2002. 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 25%, from
$9.5 million in fiscal year 2001 to $7.1 million in fiscal year 2002,
representing 71% of equipment and other revenues in fiscal year 2001 and 69% of
equipment and other revenues in fiscal year 2002. The decrease in dollars was
primarily due to the decrease in equipment sales. The decrease in percentage was
due to an increase in CPE maintenance revenue as a percentage of equipment and
other 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 9%, from $3.2 million in fiscal year 2001 to $3.5 million in
fiscal year 2002, representing 7% of total revenues in both fiscal years 2001
and 2002. 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 and
increased use of software development consulting services. Development costs of
approximately $574,000 in fiscal year 2002 and $550,000 in fiscal year 2001 were
capitalized to match against software license fees under a licensing agreement
with a three-year term.
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 4%, from $6.1 million in
fiscal year 2001 to $6.4 million in fiscal year 2002, representing 13% of total
revenues in both fiscal years 2001 and 2002. The increase in dollars was due to
increased costs related to the addition of sales and marketing personnel. This
increase was partially offset by decreased spending for advertising during
fiscal year 2002 as compared to fiscal year 2001 as well as the one-time costs
incurred in fiscal year 2001 of $563,000 in connection with the acquisition of
certain of Comdisco's customers.
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 47%, from $3.6 million in fiscal year 2001 to $5.2 million in fiscal
year 2002, representing 8% of total revenues in fiscal year 2001 and 11% of
total revenues in fiscal year 2002. The increase was due primarily to
approximately $1.6 million of additional spending related to rent and operating
costs of a leased facility that we will occupy in the quarter ending June 30,
2002 as we consolidate substantially all of our operations into the new facility
as noted in Item 2. Facilities. We therefore anticipate that our quarterly costs
for facilities which are included in general and administrative costs will
decline by approximately $450,000 per quarter beginning with the quarter ending
September 2002.
-19-
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 decreased from $3.3 million in fiscal year 2001 to
$1.4 million in fiscal year 2002, representing 7% of total revenues in fiscal
year 2001 and 3% of total revenues in fiscal year 2002. The decrease was
primarily due to lower average interest rates earned on invested cash during
fiscal year 2002 compared to fiscal year 2001.
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
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 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 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. During fiscal year 2001,
approximately $550,000 of development costs were capitalized to match against
software license fees under a three-year agreement. No development costs were
capitalized in fiscal year 2000.
-20-
Selling and marketing. 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 of $563,000 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 increased
15%, from $3.1 million in fiscal year 2000 to $3.6 million 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 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.
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 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.
-21-
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, 2002. 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,
-------- --------- -------- -------- -------- --------- -------- --------
2000 2000 2000 2001 2001 2001 2001 2002
---- ---- ---- ---- ---- ---- ---- ----
(in thousands, except per share data)
Revenues:
Network management services ............. $ 8,358 $ 8,138 $ 8,215 $ 8,321 $ 8,636 $ 9,655 $ 9,931 $ 9,732
Equipment and other ..................... 3,212 3,128 3,618 3,462 2,614 2,630 2,437 2,730
-------- -------- -------- -------- -------- -------- -------- --------
Total revenues ...................... 11,570 11,266 11,833 11,783 11,250 12,285 12,368 12,462
Cost of revenues:
Cost of network management services ..... 4,286 4,620 5,179 5,226 5,233 5,537 5,800 5,763
Cost of equipment and other ............. 2,337 2,192 2,576 2,431 1,780 1,843 1,607 1,903
-------- -------- -------- -------- -------- -------- -------- --------
Total cost of revenues .............. 6,623 6,812 7,755 7,657 7,013 7,380 7,407 7,666
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit ................................ 4,947 4,454 4,078 4,126 4,237 4,905 4,961 4,796
Operating expenses:
Development ............................ 795 759 822 793 803 910 1,007 732
Sales and marketing .................... 1,468 1,408 1,423 1,850 1,399 1,563 1,688 1,727
General and administrative ............. 972 928 820 839 1,081 1,280 1,297 1,580
Amortization of deferred compensation .. 20 20 9 9 9 9 9 7
Reduction in facilities capacity ....... -- -- -- -- -- -- -- 2,650
-------- -------- -------- -------- -------- -------- -------- --------
Total operating expenses ............ 3,255 3,115 3,074 3,491 3,292 3,762 4,001 6,696
-------- -------- -------- -------- -------- -------- -------- --------
Operating income (loss) ..................... 1,692 1,339 1,004 635 945 1,143 960 (1,900)
Other income, net ........................... 859 955 828 643 544 407 267 212
-------- -------- -------- -------- -------- -------- -------- --------
Income before income taxes .................. 2,551 2,294 1,832 1,278 1,489 1,550 1,227 (1,688)
Income tax expense (benefit) ................ 944 848 678 474 520 541 454 (602)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) ........................... $ 1,607 $ 1,446 $ 1,154 $ 804 $ 969 $ 1,009 $ 773 $ (1,086)
======== ======== ======== ======== ======== ======== ======== ========
Basic net income (loss) per share ........... $ 0.11 $ 0.10 $ 0.09 $ 0.07 $ 0.08 $ 0.08 $ 0.06 $ (0.09)
======== ======== ======== ======== ======== ======== ======== ========
Weighted average shares used in basic per
share calculations ........................ 14,468 14,390 12,877 12,238 12,039 12,107 12,125 12,132
======== ======== ======== ======== ======== ======== ======== ========
Diluted net income (loss) per share ......... $ 0.10 $ 0.09 $ 0.09 $ 0.07 $ 0.08 $ 0.08 $ 0.06 $ (0.09)
======== ======== ======== ======== ======== ======== ======== ========
Weighted average shares used in diluted per
share calculations ........................ 16,235 15,507 12,910 12,263 12,065 13,378 13,274 12,132
======== ======== ======== ======== ======== ======== ======== ========
Network management revenue detail:
Recurring management revenue ............ $ 5,176 $ 5,643 $ 5,875 $ 6,054 $ 6,934 $ 7,789 $ 8,069 $ 8,313
Nonrecurring management revenue ......... 3,182 2,495 2,340 2,267 1,702 1,866 1,862 1,419
-------- -------- -------- -------- -------- -------- -------- --------
Total management revenue ............ $ 8,358 $ 8,138 $ 8,215 $ 8,321 $ 8,636 $ 9,655 $ 9,931 $ 9,732
-22-
Three Months Ended
---------------------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31,
-------- --------- -------- -------- -------- --------- -------- --------
2000 2000 2000 2001 2001 2001 2001 2002
---- ---- ---- ---- ---- ---- ---- ----
(As a percentage of total revenues)
Revenues:
Network management services ............. 72.2% 72.2% 69.4% 70.6% 76.8% 78.6% 80.3% 78.1%
Equipment and other revenues ............ 27.8 27.8 30.6 29.4 23.2 21.4 19.7 21.9
------ ------ ------ ------ ------ ------ ------ ------
Total revenues ..................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Total cost of revenues .................... 57.2 60.5 65.5 65.0 62.3 60.1 59.9 61.5
------ ------ ------ ------ ------ ------ ------ ------
Gross profit .............................. 42.8 39.5 34.5 35.0 37.7 39.9 40.1 38.5
Operating expenses:
Development ............................. 6.8 6.7 7.0 6.7 7.1 7.4 8.1 5.9
Sales and marketing ..................... 12.7 12.5 12.0 15.7 12.5 12.7 13.6 13.8
General and administrative .............. 8.4 8.2 6.9 7.1 9.6 10.4 10.5 12.7
Amortization of deferred compensation ... 0.2 0.2 0.1 0.1 0.1 0.1 0.1 0.1
Reduction in facilities capacity ........ -- -- -- -- -- -- -- 21.2
------ ------ ------ ------ ------ ------ ------ ------
Total operating expenses .............. 28.1 27.6 26.0 29.6 29.3 30.6 32.3 53.7
------ ------ ------ ------ ------ ------ ------ ------
Operating income (loss) ................... 14.7 11.9 8.5 5.4 8.4 9.3 7.8 (15.2)
Other income, net ......................... 7.4 8.5 7.0 5.5 4.8 3.3 2.1 1.7
------ ------ ------ ------ ------ ------ ------ ------
Income (loss) before income taxes ......... 22.1 20.4 15.5 10.9 13.2 12.6 9.9 (13.5)
Income tax expense (benefit) .............. 8.2 7.5 5.7 4.0 4.6 4.4 3.7 (4.8)
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss) ......................... 13.9% 12.9% 9.8% 6.9% 8.6% 8.2% 6.2% (8.7)%
====== ====== ====== ====== ====== ====== ====== ======
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:
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31,
-------- --------- -------- -------- -------- --------- -------- --------
2000 2000 2000 2001 2001 2001 2001 2002
---- ---- ---- ---- ---- ---- ---- ----
Cost of network
management services ........ 51.3% 56.8% 63.0% 62.8% 60.6% 57.3% 58.4% 59.2%
Cost of equipment and
Other ...................... 72.8 70.1 71.2 70.2 68.1 70.1 65.9 69.7
The following table sets forth operational metrics at the end of each of the
last eight quarters.
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31,
-------- --------- -------- -------- -------- --------- -------- --------
2000 2000 2000 2001 2001 2001 2001 2002
---- ---- ---- ---- ---- ---- ---- ----
Customers ..................... 1,142 1,197 1,271 1,281 1,354 1,366 1,352 1,288
Managed devices ............... 25,637 28,566 30,196 33,213 38,029 42,213 43,628 44,835
Average monthly recurring
revenue per customer ........... 1,643 1,589 1,539 1,650 1,868 1,951 1,905 2,077
-23-
Liquidity and capital resources
Net cash provided by operating activities was $5.8 million during fiscal
year 2000, $11.6 million during fiscal year 2001 and $8.1 million during fiscal
year 2002.
We used $880,000 during fiscal year 2002 to repurchase 135,000 shares of
our common stock. We have approval from our Board of Directors to purchase up to
four million shares, including those previously repurchased. Since the inception
of the stock repurchase program, the Company has repurchased 2.9 million shares
of its common stock at an aggregate cost of approximately $21.1 million. 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 $2.8 million during fiscal year 2000, $3.9 million during fiscal
year 2001 and $5.5 million during fiscal year 2002 to purchase capital assets
which includes leasehold improvements related to the addition of our new
facility, and to purchase capital assets used in the delivery of our network
management services. As discussed in Item 2. Facilities, the Company plans to
consolidate operations in its new facility in the quarter ending June 2002. This
lease commenced in April 2001 and will expire in April 2007 if the renewal
option is not exercised. We currently have no material commitments for capital
expenditures. We paid $975,000 during fiscal year 2000, $537,000 during fiscal
year 2001 and $324,000 during fiscal year 2002 toward our lease obligations for
capital equipment. We have no future commitments for capital leases.
As of March 31, 2002, we had $47.2 million in cash and cash equivalents,
$6.1 million in net accounts receivable and $49.9 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 and March 31, 2002, the Company had federal net
operating loss carryforwards of approximately $9 million and $4.2 million,
respectively, which will expire beginning in 2007, if not utilized. The Company
had alternative minimum tax credit carryforwards of approximately $298,000 and
$245,000 as of March 31, 2001 and March 31, 2002, respectively, which do not
expire. The Company also has foreign tax credits of $200,000 that expire
beginning in 2006 if not utilized. Utilization of these 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 the net operating losses
before utilization.
As of March 31, 2002, the Company has no debt or off-balance sheet debt. As
of March 31, 2002, the Company has noncancelable operating lease obligations of
approximately $8.2 million of which $2.6 million relates to the
70,000-square-foot facility that we will be exiting in the first quarter of
fiscal year 2003. At March 31, 2002, the Company did not have any relationships
with any unconsolidated entities or financial partnerships, such as entities
often referred to as structured finance or special purpose entities, which would
have been established for the purpose of facilitating off-balance sheet
arrangements or other contractually narrow or limited purposes. As such, the
Company is not exposed to any financing, liquidity, market or credit risk that
could arise if the Company were engaged in such relationships.
-24-
Related Party Transactions
The consolidated balance sheets as of March 31, 2001 and 2002 include in
accounts receivable a $100,000 loan to an officer of the Company. The loan is
represented by a full recourse note, is payable upon default, bears interest at
4.65% per annum and is secured by a security interest in all stock options
granted to the officer by the Company at any time prior to the satisfaction of
the loan and all shares of the Company's common stock issued upon the exercise
of any such options.
Critical Accounting Policies
General
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. We base our estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Estimates and assumptions are reviewed periodically. Actual results may differ
from these estimates under different assumptions or conditions.
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. These amounts are adjusted to the extent of any
reserves affecting the realization of these revenues as described below. 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 assignment or service, and recurring revenues are recognized on a monthly
basis as the services are performed. Revenue from software licensing
arrangements is deferred and amortized on a straight-line basis over the
licensing agreement's term. Revenue from software royalty fees are based on a
flat fee per device and are recognized monthly. 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 nonrecourse basis following installation of the equipment. Other
revenues, which consist primarily of equipment maintenance services, are
recognized in the period services are provided.
Receivables
We continuously monitor collections and payments from our customers and
maintain allowances for doubtful accounts based upon our historical experience
and any specific customer collection issues that we have identified. While
losses due to bad debt have historically been within our expectations, there can
be no assurance that we will continue to experience the same level of bad debt
losses that we have in the past. In addition, a significant amount of our
revenues and accounts receivable are concentrated in AT&T. A significant change
in the liquidity or financial position of AT&T could have a material adverse
impact on the collectability of our accounts receivable and our future operating
results, including a reduction in future revenues and additional allowances for
doubtful accounts.
-25-
Availability Reserve
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.
Recent Pronouncements
In July 2001, the Financial Accounting Standards Board issued Statement No.
141, Business Combinations ("Statement 141"). Statement 141 requires that all
business combinations be accounted for under the purchase method of accounting.
Additionally, certain intangible assets acquired as part of a business
combination must be recognized as separate assets, apart from goodwill.
Statement 141 is effective for all business combinations initiated subsequent to
June 30, 2001. The Company does not expect the adoption of Statement 141 will
have a significant impact on its financial statements.
Also in July 2001, the Financial Accounting Standards Board issued
Statement No. 142, Goodwill and Other Intangible Assets ("Statement 142").
Statement 142 requires that ratable amortization of goodwill be replaced with
periodic review and analysis of goodwill for possible impairment. Intangible
assets other than goodwill must be amortized over their estimated useful lives.
The provisions of Statement 142 will be effective for fiscal years beginning
after December 15, 2001. Beginning fiscal year 2003, the Company will adopt
Statement 142 and will review its intangible assets and goodwill for impairment
pursuant to this Statement. The Company does not expect the adoption of
Statement 142 will have a significant impact on its financial statements.
In September 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets ("Statement 144"). Statement 144
addresses the financial accounting and reporting for the impairment or disposal
of long-lived assets. Statement 144 is effective for financial statements issued
for fiscal years beginning after December 15, 2001. Management has not yet
determined what the effects of Statement 144 will be on the results of
operations and financial position of the Company.
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 history 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;
. renew our two primary agreements with AT&T beyond the ordering periods
that currently expire in June 2003;
. establish relationships with additional marketing partners for the
resale of our services;
-26-
. develop software to make our principal existing service, ProWatch for
WANs, as well as other services as they achieve larger volumes, 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
69% of our total revenues in fiscal year 2001 and 61% of our total revenues in
fiscal year 2002. We anticipate that sales to AT&T will continue to comprise a
substantial percentage of our revenues in fiscal year 2003, but we believe the
percentage will continue to decline. 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, significantly reduces its sales of our
services, or fails to renew our two primary agreements that have ordering
periods expiring in June 2003. We cannot be sure that we will be successful in
reducing our dependence on AT&T in the future, or that AT&T will continue to
renew its agreements with us.
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. We cannot assure
that AT&T will continue to sell our services to existing or additional AT&T
customers. A substantial reduction in our AT&T business from any cause,
including those described above, 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 continue encouraging end users to purchase equipment and
equipment maintenance services from other sources, and we therefore
anticipate that our revenues from equipment hardware and maintenance
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;
-27-
. 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 or an
unwillingness by our resellers to renew their agreements with us;
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. Quarterly
results of operations should not be relied upon 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 often 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 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 relatively 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 only
recently begun to develop these sales channels, and we have established
relationships with only a few resellers. While we have gained additional
experience in managing sales through resellers, we have not yet achieved
consistent results from such sales. 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.
-28-
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.
Our strategy of selling our services primarily through resellers may result
in us having 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
92% of our recurring network management services revenues in fiscal year 2002.
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 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 network security services and IP
Telephony, 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. We
cannot assure that future technological or industry
-29-
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 any member of our
management team without appropriate succession and transition arrangements.
Our ability to continue to build our business and meet our goals going
forward depends to a significant degree on the skills, experience and efforts of
our management team, including Craig S. Tysdal, our president and chief
executive officer. We do not have employment contracts requiring any of our
personnel, including the members of our management team, to continue their
employment for any period of time, and we do not maintain key man life insurance
on any of our personnel, including our executive officers. The loss of the
expertise of any member of our management team without appropriate succession
and transition arrangements could seriously damage our business.
In order to support our business, we must hire additional information technology
professionals, who are in 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 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.
-30-
If the market for outsourced 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 a
day, 365 days a year 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 currently have redundant systems at separate
geographic locations. However, in order to operate without undue risk of
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; and
. make it more difficult for us to attract new end users and resellers.
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.
-31-
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 enforcing our intellectual property against infringers or
defending 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 two patents. 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.
-32-
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
Index to Consolidated Financial Statements
Page
----
Report of Independent Auditors ........................................................................... 34
Consolidated Balance Sheets as of March 31, 2001 and 2002 ................................................ 35
Consolidated Statements of Operations for each of the three years in the period ended March 31, 2002 ..... 36
Consolidated Statements of Stockholders' Equity for each of the three years in the period ended
March 31, 2002 ........................................................................................ 37
Consolidated Statements of Cash Flows for each of the three years in the period ended March 31, 2002 ..... 38
Notes to Consolidated Financial Statements ............................................................... 39
-33-
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, 2001 and 2002, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended March 31, 2002. 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, 2001 and 2002, and the consolidated results
of their operations and their cash flows for each of the three years in the
period ended March 31, 2002, in conformity with accounting principles generally
accepted in the United States.
/S/ ERNST & YOUNG LLP
Austin, Texas
April 15, 2002
-34-
NETSOLVE, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31,
---------
2001 2002
---- ----
ASSETS
Current assets:
Cash and cash equivalents ....................................... $ 45,411 $ 47,160
Restricted cash ................................................. 306 349
Accounts receivable, net of allowance for doubtful accounts of
$207 at March 31, 2001 and $202 at March 31, 2002 ............. 4,013 6,061
Prepaid expenses and other assets ............................... 1,366 1,786
Deferred tax assets ............................................. 1,647 2,082
----------- ------------
Total current assets ................................................ 52,743 57,438
Property and equipment:
Computer equipment and software ................................. 9,277 10,337
Furniture, fixtures and leasehold improvements .................. 1,983 5,316
Equipment held under capital leases ............................. 1,343 --
Other equipment ................................................. 393 410
----------- ------------
12,996 16,063
Less accumulated depreciation and amortization .................. (7,163) (8,094)
----------- ------------
Net property and equipment .......................................... 5,833 7,969
Other assets ........................................................ 1,275 492
Deferred tax assets, net of current portion ......................... 2,980 1,962
----------- ------------
Total assets ........................................................ $ 62,831 $ 67,861
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................ $ 954 $ 825
Accrued liabilities ............................................. 3,468 3,975
Future rentals for idle facility ................................ -- 1,602
Deferred revenue ................................................ 1,108 1,178
Capital leases obligation ....................................... 324 --
----------- ------------
Total current liabilities ........................................... 5,854 7,580
Deferred revenue, net of current portion ............................ -- 891
Future rentals for idle facility, net of current portion ............ -- 1,048
Stockholders' equity:
Common stock, $.01 par value; 25,000,000 shares authorized;
14,866,318 issued and 12,071,002 outstanding
at March 31, 2001 and 15,063,591 issued and
12,133,275 outstanding at March 31, 2002 ....................... 148 150
Additional paid-in capital ..................................... 80,574 81,110
Treasury stock ................................................. (20,179) (21,059)
Deferred compensation .......................................... (69) (27)
Accumulated deficit ............................................ (3,497) (1,832)
----------- ------------
Total stockholders' equity .......................................... 56,977 58,342
----------- ------------
Total liabilities and stockholders' equity .......................... $ 62,831 $ 67,861
=========== ============
See accompanying notes.
-35-
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended March 31,
--------------------------------
2000 2001 2002
-------- -------- --------
Revenues:
Network management services ........................................... $ 24,048 $ 33,032 $ 37,954
Equipment and other ................................................... 14,613 13,420 10,411
-------- -------- --------
Total revenues ...................................................... 38,661 46,452 48,365
Costs of revenues:
Cost of network management services ................................... 13,095 19,311 22,333
Cost of equipment and other ........................................... 11,202 9,536 7,133
-------- -------- --------
Total cost of revenues .............................................. 24,297 28,847 29,466
-------- -------- --------
Gross profit ............................................................ 14,364 17,605 18,899
Operating expenses:
Development ........................................................... 2,503 3,169 3,452
Selling and marketing ................................................. 4,486 6,149 6,377
General and administrative ............................................ 3,095 3,559 5,238
Amortization of deferred compensation ................................. 65 58 34
Reduction in facilities capacity ...................................... -- -- 2,650
-------- -------- --------
Total operating expenses ............................................ 10,149 12,935 17,751
-------- -------- --------
Operating income ........................................................ 4,215 4,670 1,148
Other income (expense):
Interest income ....................................................... 1,592 3,319 1,405
Interest expense ...................................................... (117) (53) (10)
Other, net ............................................................ (12) 19 35
-------- -------- --------
1,463 3,285 1,430
-------- -------- --------
Income before income taxes .............................................. 5,678 7,955 2,578
Income tax expense (benefit) ............................................ (4,875) 2,944 913
-------- -------- --------
Net income .............................................................. $ 10,553 $ 5,011 $ 1,665
======== ======== ========
Dividends on redeemable convertible preferred stock ..................... $ (1,260) $ -- $ --
-------- -------- --------
Net income applicable to common stock ................................... $ 9,293 $ 5,011 $ 1,665
======== ======== ========
Basic net income per share .............................................. $ 1.06 $ 0.37 $ 0.14
Weighted average shares used in basic per share calculation ............. 8,800 13,502 12,101
Diluted net income per share ............................................ $ 0.68 $ 0.34 $ 0.13
Weighted average shares used in diluted per share calculation ........... 13,648 14,539 13,160
Pro forma basic net income per share .................................... $ 0.88 $ 0.37 $ 0.14
Pro forma weighted average shares used in basic per share calculation ... 11,963 13,502 12,101
Pro forma diluted net income per share .................................. $ 0.77 $ 0.34 $ 0.13
Pro forma weighted average shares used in diluted per share calculation.. 13,648 14,539 13,160
See accompanying notes.
-36-
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share data)
Common Stock Additional Total
-------------------- Paid-In Treasury Deferred Accumulated Stockholders'
Shares Amount Capital Stock Compensation Deficit Equity
------ ------ ------- ----- ------------ ------- ------
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
Exercise of common stock options and
warrants ............................... 197,273 2 364 -- -- -- 366
Deferred compensation .................... -- -- (8) -- 8 -- --
Tax benefit from exercise of stock
options ................................ -- -- 180 -- -- -- 180
Amortization of deferred
compensation ........................... -- -- -- -- 34 -- 34
Common stock repurchased ................. (135,000) (880) (880)
Net income ............................... -- -- -- -- -- 1,665 1,665
---------- -------- ---------- -------- ------------ ----------- -------------
Balance, March 31, 2002 ...................... 12,133,275 $ 150 $ 81,110 $(21,059) $ (27) $ (1,832) $ 58,342
========== ======== ========== ======== ============ =========== =============
See accompanying notes.
-37-
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended March 31,
----------------------------
2000 2001 2002
---- ---- ----
Cash flows from operating activities:
Net income .................................................... $ 10,553 $ 5,011 $ 1,665
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ............................... 1,733 2,342 3,346
Amortization of deferred compensation ....................... 65 58 34
Deferred tax assets ......................................... (4,987) 2,685 763
Loss on disposition of property and equipment ............... 1 4 2
Reduction in facilities capacity ............................ -- -- 2,650
Change in assets and liabilities:
Accounts receivable, net ................................... (2,291) 900 (2,048)
Prepaid expenses and other assets .......................... (415) (203) 363
Accounts payable ........................................... 605 (1,220) (129)
Accrued liabilities ........................................ 517 1,203 507
Deferred revenue ........................................... 95 847 961
-------- -------- --------
Net cash provided by operating activities ....................... 5,876 11,627 8,114
-------- -------- --------
Cash flows from investing activities:
Proceeds from sale of certificates of deposit ................. 2,000 -- --
Transfer of funds from (to) restricted cash ................... 1,579 395 (43)
Purchases of property and equipment ........................... (2,782) (3,884) (5,484)
Proceeds from sale of property and equipment .................. -- -- --
Proceeds from sale of discontinued operations ................. -- -- --
-------- -------- --------
Net cash provided by (used in) investing activities ............. 797 (3,489) (5,527)
-------- -------- --------
Cash flows from financing activities:
Repurchase of common stock .................................... -- (20,179) (880)
Net proceeds from sale of stock ............................... 48,084 -- --
Payments under capital lease obligations ...................... (975) (537) (324)
Proceeds from exercise of common stock options and warrants.... 639 804 366
-------- -------- --------
Net cash provided by (used in) financing activities ............. 47,748 (19,912) (838)
-------- -------- --------
Net change in cash and cash equivalents ......................... 54,421 (11,774) 1,749
Cash and cash equivalents, beginning of period .................. 2,764 57,185 45,411
-------- -------- --------
Cash and cash equivalents, end of period ........................ $ 57,185 $ 45,411 $ 47,160
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest ........................................ $ 117 $ 53 $ 10
======== ======== ========
Income taxes paid ............................................. $ 117 $ 278 $ 35
======== ======== ========
See accompanying notes.
-38-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2002
1. Organization and Description of the Company
NetSolve, Incorporated, a Delaware corporation, (the "Company") engages in
the business of providing remote network management services. These services
include network configuration and design, installation and implementation
coordination, fault diagnosis and resolution, and ongoing network management.
The Company also resells data network equipment manufactured by selected leading
suppliers of these products. The Company also licenses its software in other
countries. The Company's services are designed to allow its customers 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 accounting
principles generally accepted in the United States 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.
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.
-39-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
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 ("SFAS") No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets ("Statement 144"), warrant adjustments to such carrying
amounts. As of March 31, 2002, management has evaluated property and equipment
and believes there is no impairment of assets.
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.
-40-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
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,
-------------------- ---------------------
2000 2001 2002 2000 2001 2002
-------- -------- -------- -------- -------- --------
Numerator:
Net income from
continuing operations .................. $ 10,553 $ 5,011 $ 1,665 $ 10,553 $ 5,011 $ 1,665
Dividends on redeemable
convertible preferred stock ............ (1,260) -- -- -- -- --
-------- -------- -------- -------- -------- --------
Numerator for basic and
diluted net income
per share from continuing operations.. $ 9,293 $ 5,011 $ 1,665 $ 10,553 $ 5,011 $ 1,665
======== ======== ======== ======== ======== ========
Denominator:
Denominator for basic net
income per share from
continuing operations--
weighted average common
stock outstanding ...................... 8,800 13,502 12,101 11,963 13,502 12,101
Dilutive common stock
equivalents-common stock
options, warrants and
redeemable convertible
preferred stock ........................ 4,848 1,037 1,059 1,685 1,037 1,059
-------- -------- -------- -------- -------- --------
Denominator for diluted net
income per share
from continuing
operations--weighted
average common stock
outstanding and dilutive
common stock
equivalents ............................ 13,648 14,539 13,160 13,648 14,539 13,160
======== ======== ======== ======== ======== ========
-41-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
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. Revenue from software licensing
arrangements is deferred and amortized on a straight-line basis over the
licensing agreement's term because no vendor specific objective evidence has
been established for the license. Revenue from software royalty fees are based
on a flat fee per device and are recognized monthly. 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 nonrecourse 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 expenses
for the years ended March 31, 2000, 2001 and 2002 were approximately $839,000,
$1.1 million and $668,000, respectively.
Development
Expenditures for development are expensed as incurred.
Cash and Cash Equivalents
The Company considers all investments purchased with a maturity of three
months or less to be cash equivalents.
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 creditworthiness of the
customers. Accounts receivable from AT&T represented 53% and 60% of the
outstanding accounts receivable balance at March 31, 2001 and 2002,
respectively.
-42-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
The following table summarizes the changes in the allowance for doubtful
accounts for 2000, 2001 and 2002 (in thousands):
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
Additions charged to costs and expenses..................... 5
Write-off of uncollectible accounts ........................ (10)
-----
Balance at March 31, 2002 ..................................... $ 202
=====
Concentrations of Revenues
Revenues from AT&T amounted to 71%, 69% and 61% of the Company's net
revenues for the years ended March 31, 2000, 2001, and 2002, respectively. The
Company currently is providing multiple services to AT&T under two primary
reseller agreements.
Recent Pronouncements
In July 2001, the Financial Accounting Standards Board issued Statement No.
141, Business Combinations ("Statement 141"). Statement 141 requires that all
business combinations be accounted for under the purchase method of accounting.
Additionally, certain intangible assets acquired as part of a business
combination must be recognized as separate assets, apart from goodwill.
Statement 141 is effective for all business combinations initiated subsequent to
June 30, 2001. The Company does not expect the adoption of Statement 141 will
have a significant impact on its financial statements.
Also in July 2001, the Financial Accounting Standards Board issued
Statement No. 142, Goodwill and Other Intangible Assets ("Statement 142").
Statement 142 requires that ratable amortization of goodwill be replaced with
periodic review and analysis of goodwill for possible impairment. Intangible
assets other than goodwill must be amortized over their estimated useful lives.
The provisions of Statement 142 will be effective for fiscal years beginning
after December 15, 2001. Beginning fiscal year 2003, the Company will adopt
Statement 142 and will review its intangible assets and goodwill for impairment
pursuant to this Statement. The Company does not expect the adoption of
Statement 142 will have a significant impact on its financial statements.
In September 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets ("Statement 144"). Statement 144
addresses the financial accounting and reporting for the impairment or disposal
of long-lived assets. Statement 144 is effective for financial statements issued
for fiscal years beginning after December 15, 2001. Management has not yet
determined what the effects of Statement 144 will be on the results of
operations and financial position of the Company.
-43-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
Reclassifications
Certain reclassifications have been made to prior period balances to
conform to the current period presentation.
3. 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.
4. 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 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, 2002,
total outstanding options subject to repurchase rights were 1,575,016.
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 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 ISOs, 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).
At that time, the stockholders also
-44-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
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, 2002 the Company had reserved 4,976,159 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 and 2002, the Company reduced the
gross deferred compensation by $130,000 and $8,000, respectively. This amount
represents options that were cancelled as a result of employees leaving the
Company before the four year vesting was complete. Approximately $58,000 and
$34,000 was recorded as compensation expense in fiscal year 2001 and 2002,
respectively.
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 an option pricing model with
weighted-average risk free interest rates for 2000, 2001 and 2002 of 5.71%,
5.98% and 3.91%, respectively; no dividends; and a weighted-average expected
life of the option of five years for options granted before the Company's
initial public offering and four years for options granted subsequent to the
Company's initial public offering. The fair value for options granted subsequent
to the Company's 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 the initial
public offering. A volatility of 80% was used for options granted during fiscal
year 2002.
-45-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
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,
--------------------
2000 2001 2002
-------- -------- --------
Pro forma net income (loss) from continuing operations (in thousands) ... $ 9,485 $ 3,002 $ (1,002)
Pro forma basic net income (loss) per share ............................. $ 0.93 $ 0.22 $ (.08)
Pro forma diluted net income (loss) per share ........................... $ 0.60 $ 0.21 $ (.08)
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, 2000 March 31, 2001 March 31, 2002
---------------------- ----------------------- -----------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------- --------- --------- --------- --------- ---------
Outstanding--beginning of period ......... 2,438,939 $ 2.50 2,423,519 $ 6.78 2,833,260 $ 9.27
Granted ................................ 686,040 17.04 1,227,330 14.05 729,893 10.40
Exercised .............................. (605,465) 0.93 (373,034) 2.14 (169,944) 2.15
Canceled ............................... (95,995) 8.08 (444,555) 15.00 (175,713) 14.63
--------- --------- --------- --------- --------- ---------
Outstanding and exercisable--end of
period--total .......................... 2,423,519 $ 6.78 2,833,260 $ 9.27 3,217,496 $ 9.59
--------- --------- --------- --------- --------- ---------
Outstanding and exercisable--end of
period--vested ......................... 1,261,271 $ 1.76 1,254,481 $ 3.79 1,642,480 $ 3.73
--------- --------- --------- --------- --------- ---------
Weighted-average fair value of options
granted during the period .............. $ 9.13 $ 9.66 $ 6.33
-46-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
Exercise prices for options outstanding at March 31, 2002 are as follows:
Weighted-
Weighted- Average
Average Remaining
Exercise Exercise Contractual
Price Range Options Price Life
----------- ------- ----- ----
$ 0.20-$ 0.30 411,100 $ 0.20 1.3
$ 0.50-$ 0.50 1,250 0.50 3.3
$ 1.20-$ 1.20 76,000 1.20 3.5
$ 1.90-$ 2.80 281,863 2.22 4.7
$ 5.88-$ 8.50 1,254,960 6.86 8.0
$ 9.00-$12.85 658,370 10.83 8.9
$13.56-$19.13 125,551 18.20 7.9
$25.13-$33.25 408,402 29.45 8.1
---------
$ 0.20-$33.25 3,217,496 $ 9.59 6.9
------------- ========= ------ ---
5. 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,
2000 2001 2002
---- ---- ----
Deferred tax assets:
Tax carryforwards ............... $ 4,581 $ 3,370 $ 1,874
Depreciable assets .............. 52 107 202
Accruals, reserves and other .... 354 1,150 1,968
------- ------- -------
Gross deferred tax assets .......... 4,987 4,627 4,044
Valuation allowance ................ -- -- --
------- ------- -------
Net deferred taxes ................. $ 4,987 $ 4,627 $ 4,044
======= ======= =======
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 million).
As of March 31, 2001 and March 31, 2002, the Company had federal net
operating loss carryforwards of approximately $9 million and $4.2 million,
respectively, which will expire beginning in 2007, if not utilized. The Company
had alternative minimum tax credit carryforwards of $298,000 and $245,000 as of
March 31, 2001 and March 31, 2002, respectively, which do not expire. The
Company also has foreign tax credits of $200,000 that expire beginning in 2006
if not utilized. Utilization of these 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.
-47-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
Significant components of the expense (benefit) for income taxes attributable to
continuing operations are as follows (in thousands):
Year ended March 31,
-------------------------------
2000 2001 2002
---- ---- ----
Current ............................... $ 112 $ 197 $ 150
Deferred .............................. (4,987) 2,747 763
------- ------- ------
$(4,875) $ 2,944 $ 913
======= ======= ======
Income tax expense (benefit) is included in the financial statements as follows
(in thousands):
Year ended March 31,
-------------------------------
2000 2001 2002
---- ---- ----
Continuing operations ................. $(4,875) $ 2,944 $ 913
Stock option benefit credited to
equity .............................. -- (2,325) (180)
------- ------- ------
$(4,875) $ 619 $ 733
======= ======= ======
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,
-------------------------------
2000 2001 2002
---- ---- ----
Federal statutory rate ................ 34.0 % 34.0% 34.0%
Reduction in valuation allowance ...... (125.0) -- --
Permanent items and other ............. 5.2 3.0 1.4
------- ------- ------
Total expense ......................... (85.8)% 37.0% 35.4%
======= ======= ======
6. 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.
-48-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
7. Commitments and Contingencies
The Company leases equipment and office space under noncancelable operating
leases. Rent expenses for the years ended March 31, 2000, 2001 and 2002 were
approximately $1,603,000, $1,778,000 and $2,800,000, respectively. Future
minimum lease payments under these leases as of March 31, 2002 are as follows
(in thousands):
Year ended March 31,
- --------------------
2003 ......................................................... $ 2,644
2004 ......................................................... 2,132
2005 ......................................................... 1,102
2006 ......................................................... 1,112
2007 ......................................................... 1,151
Thereafter ................................................... 96
-------
Total minimum lease payments .................................... $ 8,237
=======
Of the $8.2 million of future minimum lease payments, $2.6 million relates
to the 70,000-square-foot facility; therefore, there will be no charge to
expense as this was recorded as a one-time charge as a result of a decision to
reduce excess capacity.
A consolidated putative class action complaint was filed on February 21,
2001 against the Company and certain of its officers in the United States
District Court for the Western District of Texas, Austin Division. In re
NetSolve Incorporated Securities Litigation, Civil Action No. A00-CA-591 SS.
Plaintiffs seek to represent a class comprised of purchasers of the Company's
common stock between April 18, 2000 and August 18, 2000 ("Class Period"). They
allege that the defendants engaged in a fraudulent scheme by issuing false and
materially misleading statements regarding the Company's business during the
Class Period.
The Company moved to dismiss the complaint on March 8, 2001 for failing to
state a claim under which relief could be granted and for failing to comply with
the pleading requirements of the Private Securities Litigation Reform Act of
1995, 15 U.S.C. (S) 78u-4 et seq. On August 15, 2001, the District Court granted
this motion in part and denied it in part. The District Court dismissed claims
against one officer of the Company and dismissed certain of the theories under
which plaintiffs alleged liability against the Company. However, the District
Court let stand certain of the stated claims against the Company and certain of
its officers.
On December 17, 2001, the Company and individual defendants reached a
settlement of this action. The plaintiff class will receive $2,750,000 in
connection with the settlement, all of which will be funded by the Company's
insurance carrier. This settlement is subject to approval by the United States
District Court. A hearing has been scheduled for September 13, 2002. Should this
settlement not be approved by the District Court, it would not then be feasible
to predict or determine the final outcome in this proceeding, and if the outcome
were to be unfavorable, the Company's business, financial condition, cash flows
and results of operations could be materially adversely affected.
On December 6, 2001, a second putative securities class action complaint
was filed against the Company, certain of its officers and the Company's
underwriters of its initial public offering in the United States District Court
for the Southern District of New York. Woodward v. NetSolve, Inc., 01 CV 11239.
Plaintiff seeks to represent a class comprised of purchasers of the Company's
common stock between September 29, 1999 and December 6, 2000.
-49-
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2002
The Plaintiffs allege that the defendants failed to properly disclose certain
commissions, discounts and purported tie-in arrangements related to the
Company's initial public offering. The Plaintiffs allege claims under Sections
11 and 15 of the Securities Act against the Company, and the Plaintiffs allege
claims under Section 11 and 12 of Securities Act, and Section 10(b) of the
Exchange Act, against the Company's underwriters. This case has been coordinated
for pretrial purposes with over 300 other cases alleging similar claims against
other underwriters and companies. In re Initial Public Offering Securities
Litigation, 21 MC 92 (SAS). It is not feasible to predict or determine the final
outcome of this proceeding, and if the outcome were to be unfavorable, the
Company's business, financial condition, cash flow and results of operations
could be materially adversely affected.
8. Restricted Cash
At March 31, 2002, the Company had outstanding irrevocable letters of
credit totaling $349,000 in favor of a lessor under a property lease. This
letter of credit is collateralized by a certificate of deposit.
9. Related Party Transactions
The consolidated balance sheets as of March 31, 2001 and 2002, include in
accounts receivable a $100,000 loan to an officer of the Company. The loan is
represented by a full recourse note, is payable upon default, bears interest at
4.65% per annum and is secured by a security interest in all stock options
granted to the officer by the Company at any time prior to the satisfaction of
the loan and all shares of the Company's common stock issued upon the exercise
of any such options.
10. Equity Compensation Plan Information
(As of March 31, 2002)
Number of
Number of securities
securities to be Weighted remaining available
issued upon average exercise for future issuance
Plan category exercise of price of under equity
------------- outstanding options outstanding options compensation plans*
------------------- ------------------- -------------------
(a) (b) (c)
Equity compensation plans approved by security
holders ............................................. 3,217,496 $ 9.59 1,758,663
Equity compensation plans not approved by security
holders ............................................. None None None
Total ............................................... 3,217,496 $ 9.59 1,758,663
*Does not include securities reflected in column (a)
-50-
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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 2002 Annual Meeting of Stockholders
to be held July 17, 2002, and to be filed not later than 120 days subsequent to
March 31, 2002, are incorporated herein by reference.
Pursuant to Item 401(b) of Regulation S-K, the 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 2002 Annual Meeting of Stockholders
to be held July 17, 2002, and to be filed not later than 120 days subsequent to
March 31, 2002, are incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The section entitled Security Ownership of Certain Beneficial Owners
and Management of our definitive Proxy Statement pursuant to Regulation 14A for
our 2002 Annual Meeting of Stockholders to be held July 17, 2002, and to be
filed not later than 120 days subsequent to March 31, 2002, is incorporated
herein by reference.
The following table contains information relating to NetSolve
compensation plans under which equity securities of NetSolve were authorized for
issuance during the last fiscal year. This information is as of March 31, 2002.
Number of
Number of securities
securities to be Weighted remaining available
issued upon average exercise for future issuance
Plan category exercise of price of under equity
------------- outstanding options outstanding options compensation plans*
------------------- ------------------- -------------------
(a) (b) (c)
Equity compensation plans approved by security
holders .......................................... 3,217,496 $ 9.59 1,758,663
Equity compensation plans not approved by security
holders .......................................... None None None
Total ............................................ 3,217,496 $ 9.59 1,758,663
*Does not include securities reflected in column (a)
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information under the caption Certain Relationships and Related
Transactions--Loan to Robert W. Kujawski contained in our definitive Proxy
Statement
-51-
pursuant to Regulation 14A for our 2002 Annual Meeting of Stockholders to be
held July 17, 2002, and to be filed not later than 120 days subsequent to March
31, 2002, is incorporated herein by reference.
Part IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
See Index to Consolidated Financial Statements on page 33.
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, 2002.
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 Bylaws of NetSolve.
4.1* Amdt. No. 1 4.1 Specimen Form of Common Stock Certificate of NetSolve.
to 333-65691
10.1* Amdt. No.1 to 10.1 Contract Services Agreement between AT&T Corp. and NetSolve, dated
333-65691 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* Amdt. No. 1 10.7 Form of Indemnification Agreement.
to 333-65691
10.4* 333-65691 10.8 1988 Stock Option Plan, as amended.
10.5* Amdt. No. 1 10.9 Amended and Restated Long-Term Incentive Compensation Plan.
to 333-65691
10.6* 333-65691 10.10 Form of Proprietary Information and Inventions Agreement entered
into between NetSolve and each officer.
10.7* 333-65691 10.11 Offer Letter from NetSolve to Craig S. Tysdal, dated August 12,
1993.
10.8* Amdt. No. 1 10.17 Form of Stock Option Agreement with Directors.
to 333-65691
10.9* Amdt. No. 1 10.18 Form of Shareholder Agreement with Directors.
to 333-65691
10.10* 0-24983 10.2 Office Lease Agreement between Austin Jack, LLC, as landlord and
Form 10-Q NetSolve, as Tenant, dated as of June 7, 2000, relating to Amber
(filed August Oaks.
14, 2000)
10.11* 0-24983 10.13 Offer letter from NetSolve to Honore LaBourdette dated April 4,
Form 10-Q 2001.
(filed May
30, 2001)
10.12* 0-24983 10.14 Exclusive Software License and Use Agreement entered into as of
-52-
Form 10-Q December 21, 2000 between NetSolve and NEC Corporation.+
(filed May
30, 2001)
10.13* 0-24983 10.15 Asset Purchase Agreement and Assignment of Contract Rights dated as
Form 10-Q of March 15, 2001 between Comdisco, Inc. and NetSolve.+
(filed May
30, 2001)
10.14* 0-24983 10.1 Management Services Purchase and Resale Agreement between NetSolve
Form 10-Q and International Business Machines Corporation dated March 9,
(filed Nov. 2001.+
14, 2001)
10.15 Amendment No. 16 dated as of January 1, 2002 to the Contract
Services Agreement between AT&T Corp. and NetSolve, dated December
21, 1995.+
10.16 Amendment No. 17 dated as of January 1, 2002 to the Contract
Services Agreement between AT&T Corp. and NetSolve, dated December
21, 1995.+
21.1* 333-65691 21.1 Subsidiaries of NetSolve.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
* Incorporated herein by reference. Amdt. No. 1 to 333-65691 references the
Company's Amendment No. 1, dated July 26, 1999, to its Registration
Statement on Form S-1, File No. 333-65691.
+ Portions of this exhibit have been omitted pursuant to a request for
confidential treatment.
-53-
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: June 7, 2002. By: /s/ Craig S. Tysdal
-------------------------
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 Officer and June 7, 2002
-------------------
(Craig S. Tysdal, President and Director
Chief Executive Officer)
/s/ Kenneth C. Kieley Principal Financial Officer June 7, 2002
---------------------
(Kenneth C. Kieley, Vice President-Finance,
Chief Financial Officer and Secretary)
/s/ H. Perry Barth Principal Accounting Officer June 7, 2002
------------------
(H. Perry Barth, Controller)
/s/ J. Michael Gullard Director June 7, 2002
----------------------
(J. Michael Gullard,
Chairman of the Board)
/s/ G. Joseph Lueckenhoff Director June 7, 2002
--------------------------
(G. Joseph Lueckenhoff)
/s/ John S. McCarthy Director June 7, 2002
--------------------
(John S. McCarthy)
/s/ Suzanne C. Narducci Director June 7, 2002
-----------------------
(Suzanne C. Narducci)
/s/ Howard D. Wolfe, Jr. Director June 7, 2002
------------------------
(Howard D. Wolfe, Jr.)
-54-