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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
Commission File Number: 000-23699
VISUAL NETWORKS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 52-1837515
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification
No.)
2092 Gaither Road, Rockville, 20850
Maryland
(Address of Principal Executive (Zip Code)
Office)
Registrant's telephone number, including area code: (301) 296-2300
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 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 [ ]
Documents incorporated by reference: Specified portions of the Definitive
Proxy Statement to be filed with the Commission pursuant to Regulation 14A in
connection with the 2002 Annual Meeting are incorporated herein by reference
into Part III of this Report. Such proxy statement will be filed with the
Securities and Exchange Commission not later than 120 days after the
Registrant's fiscal year ended December 31, 2001.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will 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. [X]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of March 28, 2002 was approximately $90,576,000. The
number of outstanding shares of the Registrant's common stock as of March 28,
2002 was 31,967,492 shares.
TABLE OF CONTENTS
PART I
Item 1. Business
Overview
Industry Background
Problems Managing Networks Based on IP and the Internet
The Visual Networks Solution
The Visual Networks Strategy
Products
The Visual Networks Selling Strategy
Product Development
Customers
Strategic Partnership
Competition
Manufacturing
Patents and Other Intellectual Property Rights
Employees
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for Our Common Stock and Related Stockholder
Matters
Item 6. Selected Consolidated Financial Data
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosure about Market
Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
PART III
Item 10. Our Directors and Executive Officers
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and
Management
Item13. Certain Relationships and Related Transactions
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K
Signatures
FORWARD LOOKING STATEMENTS
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT ON FORM 10-K
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY. FACTORS THAT MIGHT CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
IN THE SECTION ENTITLED "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS." READERS SHOULD CAREFULLY REVIEW THE RISKS
DESCRIBED IN OTHER DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE
SECURITIES AND EXCHANGE COMMISSION, INCLUDING THE QUARTERLY REPORTS ON FORM 10-Q
TO BE FILED BY THE COMPANY IN 2002. READERS ARE CAUTIONED NOT TO PLACE UNDUE
RELIANCE ON THE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF
THIS ANNUAL REPORT ON FORM 10-K. THE COMPANY UNDERTAKES NO OBLIGATION TO
PUBLICLY RELEASE ANY REVISIONS TO THE FORWARD-LOOKING STATEMENTS OR REFLECT
EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS DOCUMENT.
PART I
Item 1. Business.
Overview
We design, manufacture, sell and support comprehensive service management
systems for providers and users of new world connectivity services. Our systems
combine software components, or agents, installed at key places in a network
with centralized software applications designed for performance monitoring,
real-time troubleshooting and network capacity planning. We manufacture and sell
hardware devices that embody these software agents as well as perform other
network infrastructure functions. Our products, Visual UpTime, Visual IP InSight
and Cell Tracer, provide network performance measurement and analysis that allow
network service providers to achieve the service levels required by their
subscriber customers and to lower operating costs associated with new world
networks. The availability of performance monitoring and troubleshooting
software agents also allows customers to verify service levels supplied by their
service providers and monitor traffic traversing their networks, a requirement
for many enterprises wishing to use public telecommunications services to carry
mission-critical data. These applications are essential to both service provider
and enterprise customers in generating revenue, attracting and retaining
customers, and maintaining a competitive position. We believe that our systems
are deployed in configurations managing up to 4,500 transport circuits and
Internet access for up to 1.5 million desktop computers.
We believe that we are a worldwide leader in providing service management
systems, having shipped systems for deployment on an aggregate of over 155,000
transport circuits and over 40 million desktops. We have developed relationships
with major service providers including AT&T, BellSouth, Earthlink, Equant,
Prodigy, SBC, Sprint, Verizon and WorldCom. These service providers either
resell our systems to their subscribers or integrate our systems into their
network infrastructure to enable them to offer enhanced network services. For
the year ended December 31, 2001, we had consolidated revenue of approximately
$74.2 million, of which 77% was attributable to service providers.
Vertical Systems Group, a leading industry analyst, estimates that
approximately 791,000 frame relay circuits and 51,000 ATM circuits will be
installed worldwide from 2002 through 2004. International Data Corporation, or
IDC, a leading industry analyst, estimates that the number of Internet capable
devices in the United States will grow from 306 million in 2002 to more than 786
million by 2006. The Yankee Group, another leading industry analyst, estimates
that the annual market for e-commerce and Web site implementation and management
services will grow from $370 million in 2000 to $850 million in 2003. Vertical
Systems estimates that worldwide frame relay and ATM service revenue will grow
from $12.3 billion in 2000 to $26.8 billion in 2004. To support these
applications and services, networks are growing in size and complexity. We plan
to apply our comprehensive product portfolio for service level performance
monitoring and troubleshooting to improve the quality and performance of these
networks so that they are suitable for mission critical applications. To take
advantage of the projected growth in these markets, we plan to continue to
expand our relationships with our service provider customers which together
account for the majority of Internet Protocol, or IP, network traffic worldwide.
Our company was incorporated in Maryland in August 1993 under the name
Avail Networks, Inc. and reincorporated in Delaware in December 1994 as Visual
Networks, Inc. Our principal executive offices are located at 2092 Gaither Road,
Rockville, Maryland 20850. Our telephone number is (301) 296-2300.
Industry Background
Wide Area Network Services Market
The Wide Area Network, or WAN, services market has grown rapidly with the
increase in computing and the associated data traffic volumes carried over WANs.
WAN services are used to interconnect the computing facilities of geographically
dispersed sites within an enterprise, to connect the computing facilities of one
enterprise to another and to allow remote users to utilize the enterprise
computing facilities. Businesses and other organizations are becoming ever more
dependent on data communications and the myriad of computers and devices that
facilitate data communications. We believe that WAN data traffic volumes will
continue to expand rapidly due to four key trends driving telecommunications
markets worldwide:
- proliferation of distributed computing applications such as electronic
mail, electronic transaction processing, enterprise resource planning and
inter-enterprise information transfer based on Web technologies;
- deregulation of the telecommunications services industry, which has
intensified competition and resulted in decreasing prices of WAN services;
- availability of high capacity fiber-optic networks and the emergence of
high bandwidth network access technologies that increase the ability to transfer
large volumes of electronic information; and
- rapid growth of remote applications that access enterprise resources such
as telecommuting and e-commerce, and the availability of broadband access
technologies that enable them.
Today's networks are deployed using a supply chain of various wholesale and
retail network service providers for network access, backbone transport and
hosting, including traditional telephone companies and new world broadband
network providers. These service providers may either be competing or
cooperating with one another to provide the complete connectivity service
solution to the ultimate customer, the enterprise. In this environment, a high
premium has been placed on network performance and availability. This results in
the need for tools that offer a consistent, reliable way to measure service
quality, end-to-end, across many ownership boundaries, vendors and types of
access media.
WAN Service Management Market Dynamics
Frame relay and ATM are the generally accepted technologies for corporate
backbone WANs. However, the use of IP technologies and networks to support
mission-critical applications is increasing. Telecommuters and field sales and
support people are dependent on remote access Virtual Private Networks, or VPNs,
to perform their jobs. In addition, mission-critical corporate applications and
e-commerce are being provided over corporate intranets and Internet
technologies.
The rapid proliferation of new technologies to deliver IP services adds to
the complexity of these services. For example, the Vertical Systems Group
predicts that the worldwide number of business and residential Digital
Subscriber Line, or DSL, subscribers will grow from 8.4 million in 2001 to 26.7
million in 2004. The combination of mission-criticality and the increased
complexity of managing multiple technologies causes difficulties for network
providers and their subscribers alike. The scarcity of skilled labor strains
enterprise information technology, or IT, staffs, causing the need for solutions
that can help to manage the complexity.
As a result, enterprises are delegating more responsibility to their
service providers. Both the service providers and their enterprise IT customers
need solutions to manage their out-sourced relationships. Service providers need
service management solutions for the myriad of new technologies that they are
deploying. IDC predicts that between 2001 and 2003 products explicitly focused
on managing IP services will experience an increase in popularity as service
providers seek to get the most out of their IP equipment investments.
The simultaneous increase in complexity and mission-criticality and the
dependence on service providers lead to opportunities for creating new
value-added services. Service providers, in a constant quest to protect margins
and retain customers, are aggressively competing on quality and other high-value
services such as bundled hosting services. Service providers must now provide
comprehensive service offerings across all of the pertinent technologies. This
convergence requires service management solutions that can manage across a wide
spectrum of services.
At the same time, economic conditions and fierce service price competition
have forced service providers to become intensely focused on improving their
margins through operational cost savings. As a result, service providers are
deploying systems and technologies that speed the resolution of customer trouble
tickets or prevent them altogether.
WAN Network Deployment
A typical WAN deployment supporting mission-critical applications includes
various types of customer premises equipment, or CPE, owned by the subscriber,
deployed at the subscriber's site and interconnected by the WAN service. It may
also include Web servers and applications that may be hosted at the customer
site or in a service provider's Web data center. The point at which the
subscriber CPE connects to the WAN service is known as the service demarcation
(the "demarc"), or the point where the service provider hands off the service to
the subscriber, and ultimately, is the point where the services are defined. The
subscriber is generally responsible for network performance on its side of the
demarc while the service provider is responsible for network performance on its
side of the demarc.
The equipment used for frame relay, ATM, IP and Internet services includes
both the access equipment located at the subscriber premises and the switches
located at the service provider's central office. Vertical Systems projects that
the market for this equipment will grow from approximately $10.3 billion in 2000
to approximately $14.2 billion in 2004. The equipment used for hosted services
includes firewalls, routers, content caches, servers and databases. IDC's
current forecast shows annual market revenue increasing from $4.8 billion at the
end of 2001 to nearly $20.8 billion by the end of 2006.
WAN Network Architectures
WAN services are provided through two network architectures, time division
multiplexing, or TDM, and statistical multiplexing. TDM services, such as
leased-line and integrated services digital network, or ISDN, rely on
architectures which provide dedicated circuits between computing facilities and
provide fixed bandwidth regardless of traffic flow. Unless information is
continuously transmitted, the dedicated bandwidth is often idle resulting in the
inefficient use of expensive bandwidth. The use of dedicated bandwidth does,
however, provide guaranteed throughput and fixed delay, ensuring high quality of
service for all network traffic. TDM services are suitable for the large
installed base of mainframe computing environments running mission-critical,
host-centric applications where the variability in traffic volume is low and the
traffic volume is relatively predictable. Statistical multiplexing technologies
and their derivative services are based on the concept of logical connectivity
and shared bandwidth which is dynamically allocated in real time according to
prevailing traffic patterns. As a result of this shared bandwidth, WANs based on
these statistical multiplexing services over private networks can be up to 50%
less expensive than WANs based on TDM services for distributed computing
applications. Because bandwidth in the WAN is shared among multiple subscribers,
however, these services are generally characterized by "best effort" throughput
and variable delay. WANs based on statistical multiplexing over the public
Internet using technologies such as VPNs can be quite inexpensive, but have the
least reliable performance. The challenge in each of these cases is to achieve
the cost savings and yet still provide network performance and availability
suitable for mission-critical applications.
Logical connectivity is provided via frame relay, ATM and public IP VPN, or
private IP VPN running over frame relay and ATM. Frame relay and ATM are the
predominant technologies used today for mission-critical applications. Private
IP VPN is rapidly emerging to broaden the scope of coverage. Vertical Systems
estimates that worldwide revenue for frame relay service, the most widely used
service, will grow at a compound annual growth rate of 19% from 2000 through
2004. The worldwide number of installed frame relay ports is projected to grow
from approximately 1.5 million in 2000 to more than 2.6 million in 2004. The
worldwide number of installed ATM ports is projected by Vertical Systems to grow
from approximately 26,400 in 2000 to approximately 87,700 in 2004.
There are many established and emerging technologies for accessing the
service provider's logical network. The predominant access technologies
facilitate dedicated service as well as traditional dial-up access over
traditional telephone networks. More recently, broadband access technologies
such as DSL, cable and fixed wireless are gaining momentum for branch and small
office/home office connectivity. At high capacity data centers, the use of
optical access to achieve extremely high transmission speeds is gaining
momentum.
The growth of logical connectivity services has resulted in increased focus
by subscribers on WAN service levels defined by parameters such as service
availability, throughput and delay. Because of the importance of
mission-critical applications such as enterprise resource planning, transaction
processing, work group collaboration, remote telecommuting, sales force
automation and electronic order entry, subscribers are demanding that their
service providers offer, guarantee and achieve higher service levels.
The proliferation of logical connectivity services has also resulted in
increased administrative costs for subscribers as network managers are
responsible for multiple networks consisting of older leased-line services as
well as multiple access and logical connectivity options. The high cost of
administering multiple networks coupled with the attractive pricing of logical
connectivity services is driving the need for subscribers to outsource some of
the service management to their service provider, without forfeiting control or
visibility of performance. Subscriber demand for multiple, guaranteed and
verified WAN service levels presents challenges to service providers that must
be able to offer these service levels while maintaining profitability.
When the complexity of the network supply chain is added to the complexity
of multiple technologies and derived service offerings, the result is the new
world of wide area networking, and it is often characterized by confusion and
chaos. The goal of new world service management solutions is to bring order to
the chaos while meeting the requirements of both the service providers and their
enterprise customers.
Where Service Provider and Enterprise Requirements Meet
Service providers want solutions that will enable the delivery of higher
performing services to the enterprise customers. Service providers want to
differentiate themselves by the quality and breadth of their service offerings.
They want to rapidly provision network services and troubleshoot network
problems without the costly effort of dispatching technicians. In this highly
competitive industry, service providers must be able to get services up and
running quickly. By being alerted to degradations of services before their
customers are affected, service providers ensure customer satisfaction with the
services, thereby reducing customer turnover. Subscribers demand high network
performance and want the appropriate tools to hold their respective service
providers accountable.
Both parties want returns on their network investments. Service providers
want to charge more for enhanced services and save on operations costs.
Enterprises want to optimize the performance of their network and minimize their
IT expenses. By optimizing network resources, service providers and enterprises
will be able to reduce the cost of downtime.
The requirements of the service provider and the enterprise meet at the
point of service delivery, the service demarc. Service Level Agreements, or
SLAs, are defined in terms of performance attributes such as average and peak
throughput, availability and delay. Service management solutions must provide a
representation of the service performance against their defining SLAs. In cases
where a service is not performing as defined, service level management becomes
the tool set for rapidly isolating problem conditions and enabling the
restoration of service performance to required levels. It is important to
understand that service-affecting conditions can arise in either the service
provider's or the subscriber's infrastructure. Effective service level
management software must be able to distinguish between the two and monitor the
performance of the network at the point of service delivery.
Problems Managing Networks Based on IP and the Internet
In leased-line environments, the performance, quality and maintainability
of the service are independent of the volume and type of traffic running over
the service. The diagnostic and measurement capabilities required to
sufficiently maintain these services are fairly simple and are focused largely
on physical transmission characteristics such as bit error rates or line coding
violations. These capabilities are widely available within the service
providers' facilities and work in conjunction with simplistic devices deployed
by the subscribers. By contrast, the performance, quality and maintainability of
logical connectivity services are highly dependent on the volume and type of
traffic running over the service. This extensive interplay between the
subscriber's data traffic and the service provider service requires
sophisticated diagnostic and measurement capabilities that not only analyze
physical transmission characteristics but the traffic itself. Historically, this
level of measurement and analysis capability has generally required the use of
expensive portable protocol analyzers, which are typically not deployed on a
continuous basis at the demarc. This inability to measure service performance
and quality has created the following difficulties for both subscribers and
service providers:
Suspect service levels inhibit subscriber acceptance of services.
Subscribers want to be continuously assured that logical connectivity services
are performing sufficiently to support mission-critical applications. As the
demand for higher service levels and multiple service levels has increased,
subscribers and their service providers need a mechanism to measure, verify and
improve service levels.
Operational cost models are not scaleable. The inability to
cost-effectively measure performance at the demarc, and thereby demonstrate to
subscribers the WAN service level being provided, results in service providers
requiring many highly skilled personnel to provision and operate logical
connectivity services. This cost is exacerbated by the gap between the high
demand for and limited supply of trained personnel. The implication of this
model is that operating costs are driven up and service providers' WAN service
businesses are not scaleable to the levels required to generate the necessary
economies of scale. The specific areas of concern are:
-Inefficient service provisioning. The service provider has difficulty
determining whether the WAN service is properly deployed until the subscriber's
network has been connected to the service and the subscriber's applications are
operational. This often results in multiple dispatches of personnel to the
subscriber site and extensive interaction with the subscriber for its equipment
and applications to be configured properly. The service provider is typically
restricted from billing the subscriber for the service until the subscriber's
applications are working properly over the service.
-Extensive troubleshooting and high maintenance. When subscribers
experience degraded network performance, they generally assume there is a
problem with the service supplied by their service provider. It can often take
days, weeks or even months to diagnose the causes of degraded performance
requiring highly skilled personnel with sophisticated instrumentation and
diagnostic tools. Although these degraded performance conditions are frequently
caused by faulty or misconfigured subscriber equipment or applications, the
service provider is forced to expend significant time and effort without
reimbursement to help diagnose the problem.
-Inaccurate network engineering and planning. The shared bandwidth nature
of WAN services coupled with subscriber demand for many class of service levels
increases the importance of accurate network planning and design to ensure that
the network architecture is optimized for performance and cost. If the network
is engineered with excess capacity, it may improve the performance of subscriber
applications, but it will tend to negate the inherent bandwidth efficiencies of
logical connectivity technologies. By contrast, if the network is designed with
inadequate capacity, performance will suffer. Successful network engineering and
planning is dependent on accurate historical usage information which, because of
the inability of traditional equipment to measure traffic at the demarc, is
difficult to ascertain for these services.
We believe that an essential element of logical connectivity services being
demanded by subscribers is the ability to manage and verify service levels. We
believe that service providers will experience difficulty meeting the increasing
demand for logical connectivity services without having systems for managing
service levels. The labor-intensity of provisioning and maintaining the service
inhibits the service providers' ability to scale the WAN services profitably
without service level management capability. As the service providers' focus
shifts to profitability, the growth in frame relay, ATM, IP and Internet
services will depend, in part, on the ability of service providers to implement
systems that can manage service levels, lower operational costs and increase
scalability.
The Visual Networks Solution
We offer a market-leading family of WAN service level management systems
that combine WAN access functionality with planning, monitoring and
troubleshooting capabilities that enable customers to implement required service
levels while simultaneously decreasing the costs and complexity of achieving the
levels. Our systems measure and analyze network performance at the demarc
through innovative software applications that address the historical problems of
managing service levels. Our service management systems apply to services that
account for 90% of wide area connectivity. Our systems also provide service
management for hosted application services. We believe that our systems offer
customers the following benefits:
Increased confidence in service levels. Our systems enable service
providers and their subscribers to accurately measure, report on and improve
service levels. These abilities serve to clarify the relationship between
subscriber and service provider, resulting in increased subscriber confidence in
running mission-critical computing applications on these services.
Increased scalability and lower costs of service providers' and
subscribers' operational models. Our systems can reduce the labor-intensive
nature of deploying logical connectivity services, thereby decreasing both
service providers' and subscribers' costs and increasing their ability to
generate revenue, by enabling:
-Rapid and cost-effective service provisioning. Our systems allow the
service provider to verify that its service is properly provisioned without
waiting for the subscriber network or applications to be connected and
configured. This tends to reduce customer support costs during initiation of
service and allows the service provider to begin billing for the service earlier
than was previously possible.
-Reduced need for reactive troubleshooting. Our systems reduce the need
for service providers to perform troubleshooting after the fact, by continuously
monitoring network performance at the demarc and proactively alerting the
service provider and subscriber to anomalous performance characteristics. These
early warnings allow the network operator to take corrective action before the
performance of any application on the network is impaired. Because many of the
anomalous characteristics are subscriber-related, the subscriber is more likely
to take corrective action without involving the service provider. The net result
is that fewer maintenance personnel are required to solve fewer problems,
thereby increasing service provider efficiency and subscriber satisfaction.
-More rapid and less costly troubleshooting. Because our systems provide
information that enables isolation of problems between the service provider
network and subscriber equipment and applications, the service provider can more
quickly diagnose the cause of faulty or degraded performance. Many problems that
would otherwise last for days and require on-site visits of highly skilled
personnel can be diagnosed remotely within minutes by our systems. Because our
systems are designed to allow both the service provider and the subscriber to
access the same reports and analyses simultaneously, more problem conditions can
be resolved collaboratively.
-Reduced impact of problem conditions. Our systems automatically identify
applications and users that are effected by problem conditions. This enables
maintenance personnel to attack those problems that have the largest business
impact first, thus reducing the overall business impact of faults.
-More accurate network engineering and planning. Our systems continuously
provide an accurate and detailed view of historical WAN service usage patterns
along with automated guidance regarding the need to change circuit capacities.
This allows subscribers and service providers to implement a network design
optimized for cost and performance.
The Visual Networks Strategy
Our overall strategy is to maintain and build upon our market leadership in
the deployment of WAN service level management systems for networks based on IP
and the Internet. Key elements of our strategy include:
Capitalizing on our strong incumbency position with major service
providers. We have an outstanding customer list of top-tier service providers,
including AT&T, BellSouth, Earthlink, Equant, Prodigy, SBC, Sprint, Verizon and
WorldCom. These service providers have standardized many of their offerings
around our service management solutions. The Visual Networks brand is well
recognized and highly respected in this community. As the financial condition of
many of the emerging carriers has weakened, we have seen a flight to quality and
stability in the communications services market that will benefit our
traditional customer base. Because of the requirement to provide complete
services solutions regardless of the underlying technology, we believe that
these well-capitalized service providers are in the best position for long-term
success and will be the driving force behind converged service offerings. We
intend to capitalize on these relationships to expand market coverage and
introduce new features and functions.
Deploying our systems as part of service provider networks. We believe that
service providers will become the predominant means for the deployment of
service management systems. Although these systems can be deployed by either
service providers or subscribers, we believe that maximum benefit is usually
achieved when the systems are deployed by the service providers supplying
subscribers with access to performance data. In this deployment model, service
providers can employ collaborative fault and performance management techniques
that lead to greater network quality. More important, we believe the benefits of
lower provisioning and maintenance costs are generally most effectively captured
if the system is deployed by the service provider.
Embedding agent technology in the equipment of other manufacturers. In
order to fully instrument the network and achieve the highest possible port
penetrations of our management capabilities on both new and previously deployed
services, we are partnering with leading manufacturers of access equipment to
embed our agent technology into their systems. To this end, we have entered into
strategic partnerships with Cisco Systems and Kentrox. Cisco Systems has
embedded our agent technology into the operating system software (IOS) of its
router products and made other system software improvements to support tight
interoperability with the Visual UpTime back office system. Likewise, Kentrox
has embedded our agent technology into its ATM access concentrator product line.
Visual Networks will receive license revenue from the end customers that use
Visual UpTime to manage these agents.
Extending our technology leadership. We believe a combination of
technological competencies have been crucial to our success. These competencies
include network analysis technology and its application to the effective
operation of WANs, the integration of network analysis with WAN access
technology and collaborative subscriber/service provider system architectures.
We continue to invest in our core competencies by focusing on feature
development, architectural enhancements and cost reductions. We intend to
continue to invest in the development of our systems, with particular emphasis
on features and architectural improvements designed to accommodate large-scale
deployment by service providers. This includes leveraging our current remote
access, frame relay, ATM, IP and Internet technologies to provide customers with
a single vender solution for end-to-end service level management as well as to
address emerging opportunities such as VPNs.
Deploying our systems to support e-commerce and application hosting. We
believe that our systems for e-commerce and Web-hosting applications will be
deployed predominantly for performance management of Intranet and Web-based
services. Used in conjunction with other types of management systems, our
systems can significantly improve network availability for key business users
and applications.
Expanding our business globally. Many of our largest service provider and
subscriber customers are multinational corporations. We intend to develop a
presence outside of the U.S. with particular focus on the service providers that
have the largest share of the worldwide markets for remote access, frame relay,
ATM, IP and Internet services.
Products
Visual UpTime
Visual UpTime is the de facto standard for service management of frame
relay and ATM networks. This complete service management system helps users
optimize network performance and reduce overall costs of network ownership.
Visual UpTime won Network World's Best of Test award for the best WAN
management product of 2000. The award was based on customer reviews conducted
throughout the year. Also, Visual UpTime 7.0, our latest release, was selected
as a Finalist for the ComNet New Product Achievement Award in January 2002.
Visual UpTime is a service level management system consisting of analysis
service elements, or ASEs, performance archive managers, or PAMs, and platform
applicable clients, or PACs, that perform data collection, data interpretation
and presentation. By intelligently monitoring network-wide performance, Visual
UpTime enables users to track and solve service level problems either on the
subscriber or service provider side of the demarc.
ASE. The ASE is a combination of embedded proprietary software and hardware
that performs detailed analysis of network performance at the demarc. Most
versions of the ASE provide the functionality of WAN access equipment, such as a
DSU/CSU. Visual UpTime ASEs use sophisticated proprietary software in
conjunction with networking-specific microprocessors and integrated circuits to
perform detailed analysis of every bit, frame and packet traversing the demarc.
The ASEs generally store the analysis results locally in memory and wait for the
PAM to request the results. When the ASE detects an anomalous condition, it
sends an unsolicited alert to the PAM so that network operators can take prompt
action. Depending on customer requirements, our core ASE technology can be
deployed in a number of configurations based on physical circuit speed, number
of virtual circuits supported, type of access functionality and the local area
network environment.
PAM. The PAM is the system database and request broker between the PACs and
either the database or ASEs. Unlike traditional data transfer management
architectures which depend on continuous polling between the manager (PAM) and
agents (ASEs), a bandwidth consuming process, Visual UpTime distributes most of
the processing burden to the ASE, allowing the PAM-ASE data sharing to take
place less frequently, typically once a day. This feature is critical in WAN
environments where costly bandwidth makes continuous management polling
impractical.
PAC. The PAC is Visual UpTime's client software for packaging and
presenting information stored in the PAM and ASE. Multiple PACs may access a
single PAM or ASE. The PAC includes three integrated toolsets:
-Performance monitoring. This toolset is an early warning system, alerting
network operators to impending service degradation that allows corrective action
to be taken before the subscriber's application performance degrades. This
toolset displays network performance related events and alarms. The performance
monitoring toolset is tightly linked to the troubleshooting toolset, allowing an
operator to evaluate quickly and precisely the conditions that caused the event
or alarm.
-Troubleshooting. This toolset enables an operator to rapidly perform
detailed diagnostics to identify the cause of service level problems. This
toolset displays real-time and historical network performance statistics. The
troubleshooting toolset includes a protocol capture and analysis capability used
by network operators to isolate problems arising from the interplay between a
subscriber's CPE or applications and the WAN service.
-Planning and reporting. This toolset is a report generation tool that
creates a wide variety of reports from the network performance data stored in
the PAM. This toolset is used primarily for capacity planning and network
engineering, management of service level agreements between service provider and
subscriber and executive reporting from the network operations staff to senior
management personnel. The planning and reporting toolset is accessible through a
PAC or a Web-browser.
The Visual UpTime components are sold as a complete system which requires
at least one PAC/PAM per deployment along with one ASE deployed at the demarc of
each circuit on which service level management is required. We believe the
system is currently deployed in configurations managing up to 4,500 transport
circuits. System pricing varies by size of deployment and relative mix between
circuit speeds.
Visual IP InSight
Visual IP InSight is a WAN service management system for remote access
network technologies utilizing IP and the Internet. It helps both service
providers and enterprises provide the highest quality IP services to their
customers. Visual IP InSight helps operations managers, network managers and
customer care (help desk) personnel proactively manage the complete service
experience whether it is for a service subscriber or an internal enterprise
user. Visual IP InSight has also become a cornerstone for credible SLA offerings
of Internet service providers. Visual IP InSight won Internet Telephony
magazine's Product of the Year Award for 2001 in the category of Performance
Monitoring, Network Management and Quality of Service from a field of over 150
entrants.
The product includes three software applications:
-IP InSight Service Operations. This function provides information
regarding problems in real-time and monitors performance of IP applications,
such as e-mail and domain name system using metrics such as availability,
throughput, latency and packet loss.
-IP InSight Customer Care. This feature allows customer care personnel to
call up a customer's history of network connections and PC configurations.
-IP InSight Service Level Manager. This function makes it easy to define,
monitor and administer SLAs. Its unique tools also map users to their specific
services, service providers and SLAs.
System components for Visual IP InSight include agents, data collectors and
a data repository. These components communicate with each other over an IP
network providing a steady stream of real-time information. Visual IP InSight's
architecture is distributed and fault-tolerant, and it scales to carrier class
networks.
The system's agents are the origin of quality-of-service and test data.
There are two types of agents: dedicated agents and client agents. Dedicated
agents are software that is embedded in hardware devices called IP Service
Elements, or ISEs, that are connected to the network at suitable monitoring
points. ISEs perform active tests on command as configured by the network
manager. Client agents are software that is installed on the PCs of service
subscribers. It runs transparently until end-user help is required.
Context-sensitive online help suggests solutions to more than 150 dial-access
problems and keeps a descriptive error log that customer care personnel can use
to solve problems that end users cannot resolve on their own. In parallel, the
client agent can passively monitor user activity on the network or perform
active tests when requested by the network manager. The client agent can be
deployed in any remote access environment: dial modem, cable modem, Digital
Subscriber Line, ISDN or wireless service. All varieties of dedicated agents and
client agents can be used together in the same network with the same IP InSight
systems.
Visual IP InSight Collectors collect data from the various agents and send
it to the back-end database. A collector can be deployed either behind a
firewall or in key points in the public IP network, and a single collector can
handle hundreds of thousands of active agents.
Visual IP InSight Aggregators are servers positioned at key locations in
the network or data center. Collectors pass the client agent and service agent
data they have collected to one or more aggregators for data validation and
loading into various data repositories. All of the performance data gathered is
stored in a high performance relational database. Data is presented using a
secure web interface, allowing detailed information on the performance of the
network and applications to be quickly distributed throughout an organization or
between customers and partners.
Cell Tracer
Our network analyzer product, Cell Tracer, is a combination of embedded
proprietary software and hardware and Microsoft Windows presentation software
that performs detailed analysis of network performance on ATM circuits. The
Windows software, running on a Pentium-based computer, connects either locally
or remotely to the hardware to perform detailed analysis of every bit, cell and
packet traversing the ATM circuit. Cell Tracer is designed to meet both the
network monitoring and troubleshooting needs of field support personnel and the
centralized operational needs for supporting remote ATM circuits. Depending on
customer requirements, Cell Tracer can be utilized in a number of configurations
based on physical circuit speed, access line type and monitoring applications.
The Visual Networks Selling Strategy
We implement a push - pull sales strategy where market demand is generated
by marketing programs, cultivated by the direct sales force and fulfilled by
channel partners. The channel partners are traditional service providers, such
as AT&T, Equant, Sprint and WorldCom and the traditional local telephone
companies; emerging service providers, including ISPs and competitive
telecommunications providers; value added resellers, or VARs; and system
integrators.
In our sales model, marketing activities generate subscriber demand through
a variety of focused marketing programs. The result of this demand generation
activity is a set of qualified leads that are cultivated by our direct field
sales force or our inside sales force depending on the size and complexity of
the opportunity. Direct sales drives the opportunity towards closure by applying
Visual systems to the prospective customer's network environment and describing
the associated value proposition, typically a lengthy process. Upon completion
of these steps, direct sales will determine the prospect's preferred fulfillment
channel and steer the opportunity through that channel. Direct sales will remain
engaged until the demand is satisfied.
We have several fulfillment channels. Customer requirements may be met
through the subscription to a service provider's managed service that embeds our
technology, or by the acquisition of our products from a service provider or
VAR. Demand could also be fulfilled by a system integrator or service provider
partner who provides out-sourced, or hosted, management services using
our technology.
The development of a service provider service based on our technology is a
complex sale to multiple departments within a service provider's organization.
We work with the service provider to develop a service definition and business
plan for the integration of Visual products into the service provider's existing
service.
We provide pre-sale technical support to each of our channels. The time
required to develop a relationship with a channel partner can take from two to
12 months for VARs and system integrators, and from 12 to 24 months for service
providers. The sales cycle for subscriber deployment through an established
channel is typically four to six months long.
We have sales and technical support teams assigned to each major service
provider account. In addition, our senior management team devotes significant
time furthering the business relationships with these service providers and we
invest significant marketing resources to stimulate sales with these service
providers.
As of December 31, 2001, we employed 87 people in sales and marketing. Our
expenditures for sales and marketing activities were approximately $24.4 million
in 1999, $41.9 million in 2000 and $33.5 million in 2001.
Product Development
We have developed core competencies in network analysis technology and its
application to the effective operation of WANs, the integration of network
analysis with WAN access technology and collaborative subscriber/service
provider system architectures.
We have made significant investments in system architecture and feature
development. Through the acquisitions of Net2Net Corporation, Inverse Network
Technology and Avesta Technologies, Inc., we accelerated the pace of product
development in order to provide customers with a single vendor solution for
end-to-end service encompassing frame relay, ATM, IP and the Internet. We will
continue to expand Visual UpTime for managing frame relay, ATM or IP
connectivity over broadband access services. We will continue to expand Visual
IP InSight for broadband access technologies as well. We are focused on the
further enhancement and refinement of our systems, including the development of
the architectural scalability that will be required for wide-scale
implementation through the service provider deployment model. Additionally, we
expect to invest in system refinements that will increase the economic benefit
of deployments outside North America.
As of December 31, 2001, there were 59 persons working in our research and
development area. Our research and development expenditures were approximately
$16.7 million in 1999, $27.3 million in 2000 and $19.3 million in 2001.
Customers
Since mid-1996, we have developed business relationships, currently at
different levels of maturity, with a number of service providers, including
AT&T, BellSouth, Earthlink, Equant, Prodigy, SBC, Sprint, Verizon and WorldCom.
Sales of products or services to AT&T, Sprint and WorldCom accounted for 29%,
14% and 10%, respectively, of consolidated revenue for 2001.
AT&T Relationship. In December 1997, we entered into a non-exclusive
procurement agreement with AT&T. The agreement had an initial term of three
years and has automatically renewed with the right by either party to terminate
the agreement upon 30 days' notice. Prices and discounts for all equipment
purchased by AT&T are fixed, except in certain limited circumstances. The
equipment carries a five-year warranty. If we offer more favorable prices and
terms to any other customer for the same quantity of products during the term of
the agreement, we are obligated to amend the agreement to provide AT&T with the
same or comparable overall terms. The agreement does not obligate AT&T to make
any minimum purchases from us. We also provide certain support services to AT&T.
WorldCom Relationship. In August 1997, we entered into a non-exclusive
three-year reseller agreement with WorldCom, which has automatically renewed for
a second one-year term. Prices and discounts for all equipment purchased by
WorldCom are fixed. The equipment carries a five-year warranty. If we offer more
favorable prices to any other customer for the same quantity of products
purchased over a similar period of time, we are obligated to adjust the pricing
to WorldCom to the more favorable price. The reseller agreement does not
obligate WorldCom to make any minimum purchases from us.
Sprint Relationship. In May 2000, we entered into a new non-exclusive
three-year reseller agreement with Sprint, in effect extending the basic terms
of our earlier agreement with Sprint made in August 1996. Prices for all
equipment purchased by Sprint are fixed for the term. The equipment carries a
five-year warranty. If we offer more favorable prices and terms to any other
customer during the term of the agreement, such terms and prices will be
applicable to Sprint's orders. The reseller agreement does not obligate Sprint
to make any minimum purchases from us. We also provide certain support services
to Sprint.
Equant Relationship. In June 2001, we entered into a non-exclusive one-year
reseller agreement with Equant. Prices and discounts for all equipment purchased
by Equant are fixed, except in certain limited circumstances. The equipment
carries a five-year warranty. If we offer more favorable prices to any other
customer purchasing in the same or lesser volumes and upon the same terms during
the term of the agreement, such prices will be applicable to Equant's orders.
The agreement does not obligate Equant to make any minimum purchases from us. We
also provide certain support services to Equant.
Strategic Partnerships
An increasingly important means for us to achieve our goals is through
strategic partnerships. Our agent software technologies need to reside on
hardware devices that are attached to the network in locations that are
interesting to monitor and analyze, such as the demarcation point. While we have
developed and sold various devices for this purpose and will continue to do so,
fully meeting our customer's requirements for broad and cost effective support
of myriad access technologies requires that we also expand our agent deployment
through devices produced by other vendors. These partnerships will generally
involve transfer of our proprietary technology under license, significant
development activities on the part of one or both partners, as well as joint
sales, marketing and support activities.
Cisco Systems Relationship. In December 2000, we entered into an
interoperability and marketing agreement with Cisco Systems, Inc. to provide
Cisco customers with integrated access solutions.
Kentrox Relationship. In October 2000, we entered into a development and
licensing agreement with ADC Telecommunications, Inc. to deliver a comprehensive
ATM managed service solution to Kentrox customers.
Competition
The markets for telecommunications equipment and software are intensely
competitive. Our products integrate key functionality traditionally found in
five distinct market segments: the WAN access equipment market; the bandwidth
management equipment market; the network test and analysis market; the market
for operational support systems, or OSSs; and the market for client-based
network management and Internet infrastructure testbeds. We believe that our
products are the only systems that integrate functional attributes from all
these market segments to cost-effectively provide WAN service level management.
Because of the size and growth opportunity associated with the WAN service level
management market, we expect to encounter increased competition from current and
potential participants in each of these segments. Increased competition may
result in price reductions, reduced profitability and loss of market share, any
of which would have a material adverse effect on our business, financial
condition and results of operations.
WAN access equipment. The WAN access equipment market is highly fragmented.
Leading vendors in this segment include Kentrox, Paradyne and Adtran. These
companies may partner with companies offering network test and analysis products
in order to compete in the WAN service level management market. We are aware of
such an arrangement between Paradyne and NetScout Systems. Internetworking
providers may integrate WAN access functionality with routers, which may
adversely affect Visual UpTime's cost justification. We are working to mitigate
this risk and turn it to our advantage through a partnership with Cisco Systems
whereby our product's agent capabilities have been integrated into such products
and the cost justification is actually improved.
Bandwidth management equipment. There exists a class of devices whose
primary purpose is to adjust the flows of customer traffic into the network to
improve the perceived performance of the networking services. To understand and
manage the traffic flows, these devices must provide a certain degree of
functionality which is also found in performance management systems. The major
supplier in this market segment is Packeteer.
Network test and analysis. An essential element of a WAN service level
management system is technology and expertise associated with network test and
analysis. Products in this market include portable and distributed protocol
analyzers and transmission test instruments. The major suppliers in this market
segment are Network Associates, Agilent Technologies, Acterna, Fluke, Spirent
and NetScout.
Telecommunications operational support systems. OSSs encompass all of the
systems related to service deployment including provisioning systems, billing
systems, trouble-ticketing systems, and fault and performance management
systems. Historically, OSSs have been developed by the in-house staffs of the
service providers and have sometimes been a source of competitive advantage to
service providers. A number of vendors also produce suites of OSS components for
the service provider market. Major vendors in the OSS components market include
Telcordia, Agilent, Amdocs and Narus. Visual UpTime provides a significant
portion of the functionality that might otherwise be found in a fault and
performance management system for statistically multiplexed WAN services.
However, in some cases, a service provider may consider in-house development as
an alternative to deployment of Visual UpTime.
Client-based network management and Internet infrastructure test-beds. An
emerging trend in network management is increased emphasis on visibility of
actual user experience. Installing clients on end user desktops is a
particularly effective way to gather this type of data. This technology can be
deployed either as a service offering using simulated desktops or sold as
standalone software.
Major suppliers of standalone software include Lucent Technologies, NetIQ,
Concord, Jyra Research and NetScout Systems. Major suppliers of service-based
solutions include Keynote Software and Northgate Information Solutions.
We intend to compete by offering superior features, performance,
reliability and flexibility at competitive prices. We also intend to compete on
the strength of our relationships with service providers. As competition in the
WAN service level management market intensifies, we believe that the industry
may be characterized by price competition similar to that present in the broader
networking market. In response to competitive trends, we expect to continue to
reduce the cost of our systems in order to avoid a deterioration of gross
margins.
Manufacturing
We have moved to a predominately out-sourced manufacturing model in order
to achieve significant scalability. We are ISO 9001 certified for design,
development and manufacturing of WAN Service Management Systems (hardware and
software) in our Rockville, Maryland facility. We have not experienced any
significant delays or material unanticipated costs resulting from the use of
subcontractors; however, such a strategy involves certain risks, including the
potential absence of adequate capacity and reduced control over delivery
schedules, manufacturing yields, quality and costs. Although we attempt to
maintain appropriate back-up suppliers, in the event that any significant
subcontractor was to become unable or unwilling to continue to manufacture
and/or test our products in required volumes, we would have to identify and
qualify acceptable replacements. This qualification process could be lengthy and
no assurance could be given that any additional sources would become available
to us on a timely basis. A delay or reduction in component shipments, or a delay
or increase in costs in the assembly and testing of products by third party
subcontractors, could materially and adversely affect our business, financial
condition and results of operations.
Although we generally use standard parts and components for our products,
several key components are currently purchased only from sole, single or limited
sources. Any interruption in the supply of these components or the inability to
procure these components from alternate sources at acceptable prices and within
a reasonable time could have a material adverse effect upon our business,
financial condition and results of operations.
Patents and Other Intellectual Property Rights
We presently have four patents issued in the United States: (i) a "Method
and Apparatus for Non-Intrusive Measurement of Round Trip Delay in
Communications Networks", which expires in May 2015; (ii) a "Method and
Apparatus for Measurement of Peak Throughput in Packetized Data Networks", which
expires in November 2016; (iii) a "Method and Apparatus for Performing Service
Level Analysis of Communications Network Performance Metrics", which expires in
November 2018; and (iv) a "Method and Apparatus for Performing In-Service
Quality of Service Testing", which expires in December 2017. Additionally, we
have been notified by the United States Patent and Trademark Office that our
application for a patent on a 'Method and Application for Dynamic Modeling of
Complex Networks and Prediction of Impacts of Faults Therein' has been allowed
and should be issued shortly. We also have a number of patent applications
pending in the United States and our key foreign markets. No assurance can be
given that competitors will not successfully challenge the validity or scope of
our patents or that such patents will provide a competitive advantage to us.
We expect that software and communications product developers will
increasingly be subject to claims of infringement of patents as the number of
products and competitors in our industry segment grows and the functionality of
products in the industry segment overlaps. We are not aware that any of our
products infringe the property rights of third parties.
In October 1997, a lawsuit was filed against Avesta and one of its
employees alleging infringement of two patents, unfair competition, breach of
contract and interference with contractual relations resulting in unjust
enrichment. See Item 3 for additional disclosure.
As part of our confidentiality procedures, we generally enter into
non-disclosure agreements with our employees, business partners and customers
with respect to our software, documentation and other proprietary information.
Despite these precautions, it may be possible for a third party to copy or
otherwise obtain and use our products or technology without authorization, or to
develop similar technology independently. Policing unauthorized use of our
products is difficult. Effective protection of intellectual property rights is
unavailable or limited in certain foreign countries. There can be no assurance
that protection of our proprietary rights will be adequate or that our
competitors will not independently develop similar technology, duplicate our
products or design around any of our patents or other intellectual rights.
Employees
As of December 31, 2001, we had 210 full-time employees, including 59 in
product development, 78 in sales, 9 in marketing, 12 in manufacturing, 9 in
customer service and 43 in finance, centralized services and administration.
Our future success will depend in significant part on the continued service
of our key technical, sales and senior management personnel. Competition for
such personnel is intense and there can be no assurance that we can retain our
key managerial, sales and technical employees, or that we can attract,
assimilate or retain other highly qualified technical, sales and managerial
personnel in the future. None of our employees are represented by a labor union.
We have not experienced any work stoppages and consider our relations with our
employees to be good.
Item 2. Properties.
Our principal administrative, sales and marketing, research and development
and customer support facilities are located in approximately 75,000 square feet
of office space in Rockville, Maryland, that we occupy under leases that expire
in December 2006. A third party currently occupies approximately 10,000 square
feet of this space under a sublease that expires in October 2002.
Item 3. Legal Proceedings.
In July, August and September 2000, several purported class action
complaints were filed against us and certain of the our former executives, these
complaints have since been combined into a single consolidated amended complaint
(the "complaint"). The complaint alleges that between February 7, 2000 and
August 23, 2000, the defendants made false and misleading statements which had
the effect of inflating the market price of our stock, in violation of Sections
10(b) and 20 (a) of the Securities Exchange Act of 1934. The complaint does not
specify the amount of damages sought. We believe that the plaintiffs' claims are
without merit and intend to defend against these allegations vigorously. We have
filed a motion to dismiss the complaint, which is now pending before the court.
We anticipate that a substantial portion of the legal costs that we might incur
related to this matter will be paid by our directors' and officers' insurance
policy. We cannot presently determine the ultimate outcome of this action. A
negative outcome could have a material adverse effect on our financial position
or results of operations. Failure to prevail in the litigation could result in,
among other things, the payment of substantial monetary or punitive damages.
In October 1997, a lawsuit was filed against Avesta and one of its
employees alleging infringement of two patents, unfair competition, breach of
contract and interference with contractual relations resulting in unjust
enrichment. Avesta answered the complaint, denying all allegations, and also
asserted counterclaims against the plaintiff for patent misuse, unfair
competition and interference with business and patent invalidity. Pursuant to an
agreement between the parties, on June 13, 2001, the court dismissed the action
without prejudice, preserving to the parties the right to refile the action
pending future developments of the Visual Trinity product.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5. Market for Our Common Stock and Related Stockholder Matters.
Our common stock is traded on the Nasdaq National Market under the symbol
"VNWK." The following table sets forth, for the indicated periods, the range of
high and low closing per share sales prices for the common stock as reported on
the Nasdaq National Market.
High Low
---- ---
2000
----
First Quarter ............................ $ 83.50 $ 50.31
Second Quarter ........................... 60.50 24.31
Third Quarter ............................ 26.75 5.88
Fourth Quarter ........................... 6.94 2.03
2001
----
First Quarter .............................. $ 6.53 $ 2.50
Second Quarter ............................. 8.75 3.03
Third Quarter .............................. 8.61 2.12
Fourth Quarter ............................. 4.62 1.77
2002
----
First Quarter (from January 1, 2002 through
March 28, 2002) ......................... $ 4.94 $ 2.94
On March 28, 2002, the last reported sale price of our common stock was
$2.94 per share. As of March 28, 2002, we had approximately 538 stockholders of
record.
We have never paid or declared any cash dividends on our common stock. It
is our present policy to retain earnings, if any, to finance the growth and
development of the business and, therefore, we do not anticipate declaring or
paying cash dividends on our common stock in the foreseeable future.
Item 6. Selected Consolidated Financial Data.
The selected consolidated financial data below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements, notes
thereto and other financial information included elsewhere in this Form 10-K.
The selected consolidated financial data as of and for the years ended December
31, 1999, 2000 and 2001, are derived from our consolidated financial statements
which have been audited by Arthur Andersen LLP, independent public accountants.
The selected consolidated financial data for the years ended December 31, 1997
and 1998 is derived from audited consolidated financial statements not included
in this Form 10-K.
Years Ended December 31,
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
(in thousands, except per share data)
Consolidated Statement of Operations Data:
Revenue................................... $ 29,300 $ 56,088 $ 91,719 $ 89,041 $ 74,248
Cost of revenue........................... 11,179 20,829 30,888 32,515 29,431
------ ------ ------ ------ ------
Gross profit.......................... 18,121 35,259 60,831 56,526 44,817
Operating expenses:
Research and development.............. 9,148 13,771 16,677 27,277 19,320
Write-off of in process research and
development(1)...................... - - - 39,000 -
Sales and marketing................... 14,555 19,759 24,447 41,907 33,484
General and administrative............ 3,798 5,528 7,928 11,247 8,895
Merger-related costs(2)............... - 4,318 6,776 - -
Restructuring and impairment charges(3) (4) - 751 - 335,810 9,328
Amortization of acquired intangibles(1) - - - 53,426 805
------- ------- -------- ------ --------
Total operating expenses......... 27,501 44,127 55,828 508,667 71,832
Income (loss) from operations............. (9,380) (8,868) 5,003 (452,141) (27,015)
Interest income, net...................... 165 2,413 2,270 2,598 325
--- ----- ----- ----- ---------
Income (loss) before income taxes......... (9,215) (6,455) 7,273 (449,543) (26,690)
Benefit (provision) for income taxes...... - - (3,722) 34,058 (272)
------- ------- ------ ------ ---------
Net income (loss)......................... (9,215) (6,455) 3,551 (415,485) (26,962)
====== ====== ===== ======== =======
Dividends and accretion on preferred stock (1,457) (171) - - -
Net income (loss) attributable to common
stockholders............................ (10,672) (6,626) 3,551 (415,485) (26,962)
Basic earnings (loss) per share........... (1.44) (0.30) 0.14 (14.46) (0.85)
Diluted earnings (loss) per share......... (1.44) (0.30) 0.13 (14.46) (0.85)
Basic weighted-average shares(5).......... 7,431 21,946 24,583 28,733 31,585
Diluted weighted-average shares(5)........ 7,431 21,946 26,547 28,733 31,585
Consolidated Balance Sheet Data:
Cash and cash equivalents................. 9,601 51,655 54,629 17,369 5,921
Working capital........................... (782) 43,146 50,353 (2,482) (6,576)
Total assets.............................. 21,036 71,780 83,154 74,057 28,902
Long-term debt, net of current portion.... 138 1,011 782 243 -
Redeemable convertible preferred stock.... 14,855 - - - -
Stockholders' equity (deficit)............ (13,251) 48,322 58,252 26,085 (515)
(1) In 2000, we acquired Avesta in a purchase business combination. The
purchase price allocation included $39.0 million of in-process technology which
was expensed as of the acquisition date. The amortization of acquired
intangibles in 2000 and 2001 relates to goodwill and other intangible assets
recorded in connection with the Avesta acquisition. See Notes 1 and 5 of Notes
to Consolidated Financial Statements.
(2) During 1998, we incurred certain merger-related costs in connection
with our acquisition of Net2Net Corporation. During 1999, we incurred certain
merger-related costs in connection with our acquisition of Inverse Network
Technology. See Note 1 of Notes to Consolidated Financial Statements.
(3) In 1998, we recorded a restructuring charge related to the
consolidation of certain functions and the discontinuation of certain product
development efforts related to the acquisition of Net2Net. In 2000, we recorded
a restructuring charge of $7.0 million that consisted primarily of severance and
other termination benefits related to a workforce reduction and lease costs and
associated leasehold improvement write-offs related to the closure of certain
facilities. In the second quarter of 2001, we reversed $723,000 of the
restructuring charge recorded in the fourth quarter of 2000 resulting primarily
from lower than estimated lease costs. In the second quarter of 2001, we also
recorded a restructuring charge of $3.9 million that consisted primarily of
employee termination costs including severance and other benefits, lease costs
and associated leasehold improvement write-offs related to the closure of
certain facilities resulting from the discontinuation of the Visual Trinity
product, other contractual obligations and the write-off of an investment.
During the fourth quarter of 2001, we reversed $1.2 million of the restructuring
charge recorded in the second quarter of 2001 due to lower than estimated,
facility closure costs and other contractual obligations. During the fourth
quarter of 2001, we also recorded a restructuring charge of $385,000 that
consisted of severance and other termination benefits related to a workforce
reduction. See Notes 1 and 6 of Notes to Consolidated Financial Statements.
(4) In 2000, we recorded an impairment charge of $328.8 million for the
write-off of goodwill and other intangibles related to the acquisition of
Avesta. In 2001, we recorded an impairment charge of $7.1 million related to all
of the remaining intangible assets from the Avesta acquisition based on the
discontinuation of the Visual Trintiy product and plans for the Visual eWatcher
product. The impairment charge also included the write-off of an investment of
$3.7 million. See Notes 1, 5 and 6 of Notes to Consolidated Financial
Statements.
(5) For an explanation of the determination of the weighted-average number
of shares used in computing earnings (loss) per share amounts, See Note 1 of
Notes to Consolidated Financial Statements.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following discussion of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements, the related notes thereto, and other financial information included
elsewhere in this Form 10-K. References to "we", "us" or "our" refer to Visual
Networks, Inc. on a consolidated basis.
Overview
From our incorporation in August 1993 through December 1996, our principal
objective was to secure sufficient equity financing to enable us to accelerate
product development efforts of Visual UpTime for frame relay deployment and
create the infrastructure necessary to support these efforts. We first shipped
Visual UpTime in mid-1995 and began generating significant revenue during 1996.
Since our inception, we have focused on establishing relationships with service
providers with the goal of having these service providers include our products
into their infrastructure or in their service offerings to their subscribers.
Consistent with this goal, we have established agreements with AT&T, Equant,
Sprint and WorldCom. During 1998, 1999 and 2000, we continued to focus on
selling Visual UpTime and added to our product portfolio as a result of a series
of acquisitions - the Net2Net product, Cell Tracer, in 1998; the Inverse
products, Visual IP InSight and Visual Internet Benchmark, in 1999; and the
Avesta products, Visual Trinity and Visual eWatcher, in 2000. During 2001, we
discontinued development and sales efforts of Visual Trinity and sold the Visual
Internet Benchmark product. During 2001, we also made a decision to combine
certain functionality of the web performance management technology of the Visual
eWatcher product with the Visual IP InSight product. Development efforts
relating to incorporating this functionality are expected to begin in 2002 and
be included in a future release of the Visual IP InSight product in 2003. We
continue to focus on sales of Visual UpTime, Visual IP InSight and Cell Tracer.
We prepare our financial statements in conformity with generally accepted
accounting principles in the United States. As such, we are required to make
certain estimates, judgments and assumptions that we believe are reasonable
based upon the information available. These estimates and assumptions affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the periods
presented. Actual results could differ from those estimates. The estimates
included in the preparation of our financial statements relate to accounts
receivable allowances, inventory reserves, estimates of expense accruals and the
cash flow estimates used in evaluating impairment of long-lived assets under
Statement of Financial Accounting Standards No. 121. Our significant accounting
policies are described fully in Note 2 of Notes to Consolidated Financial
Statements. We believe that our accounting policies related to revenue
recognition and the impairment of long-lived assets are the most critical to aid
in fully understanding and evaluating our reported financial results.
We recognize revenue from our service management products and services
including hardware, software, benchmark services, professional services and
technical support. We generally recognize revenue from the sale or license of
our products upon delivery and passage of title to the customer. Where
agreements provide for evaluation or customer acceptance, we recognize revenue
upon the completion of the evaluation process and acceptance of the product by
the customer. Revenue from multiple-element software arrangements is recognized
using the residual method whereby the fair value of any undelivered elements,
such as customer support and services, is deferred and any residual value is
allocated to the software and recognized as revenue upon delivery and passage of
title. The fair values of professional services, technical support and training
have been determined based on our specific objective evidence of fair value. Our
maintenance contracts require us to provide technical support and software
updates to customers. We recognize technical support revenue, including
maintenance revenue that is bundled with product sales, ratably over the term of
the contract period, which generally ranges from one to five years. We recognize
revenue from services when the services are performed. Subscription fees for our
benchmark reports are recognized upon delivery of the reports.
While substantially all of our product sales to date have been made to
customers in the United States, we plan to sell our products to foreign
customers at prices denominated in U.S. dollars. However, if we commence selling
material volumes of product to such customers at prices not denominated in U.S.
dollars, we intend to adopt a strategy to hedge against fluctuations in foreign
currency.
With the acquisition of Avesta in May 2000, we allowed our business
strategy to become less focused, which increased the complexity of our business
and adversely affected our results of operations. Our revenue decreased from
$91.7 million in 1999 to $89.0 million in 2000 while our operating expenses
increased resulting in significant losses from operations. Our historical trend
of increasing revenue each quarter began to reverse in the second quarter of
2000. These revenue decreases were due to lower than expected revenue related to
the Visual Trinity and Visual eWatcher products (the products added through the
Avesta acquisition) as well as decreases in the revenue provided by our other
products. Despite these revenue decreases, our operating expenses increased
significantly in the corresponding periods due, in large part, to the addition
of the Avesta operations. In an attempt to refocus our efforts, we announced a
plan in the fourth quarter of 2000 to realign our product portfolio, streamline
our operations and devote resources to the markets and products that offer us
the greatest growth opportunities. In connection with this plan, we recorded a
restructuring charge of $7.0 million in the fourth quarter of 2000. In the
second quarter of 2001, we discontinued development and sales efforts on the
Visual Trinity product and sold the Visual Internet Benchmark product in an
effort to further focus our product portfolio and streamline our operations and
resources. In the fourth quarter of 2001, we completed a workforce reduction to
continue focusing on reducing our operating expenses. In connection with these
efforts, we recorded restructuring charges of $3.9 million in the second quarter
of 2001 and $385,000 in the fourth quarter of 2001.
In determining the carrying amount of our long-lived assets, we review our
long-lived assets, including property and equipment, identifiable intangibles
and goodwill whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be fully recoverable. To determine
recoverability of our long-lived assets, we evaluate the probability that future
estimated undiscounted net cash flows will be less than the carrying amount of
the assets. If future estimated undiscounted net cash flows are more likely than
not to be less than the carrying amount of the long-lived assets, then such
assets are written down to their fair value.
Due to the significance of the developments in 2000, we performed an
evaluation of the recoverability of our long-lived assets in accordance with
Statement of Financial Accounting Standards No. 121, including those assets
related to the Avesta acquisition. Based upon this evaluation, we concluded that
the remaining values of the goodwill and other intangible assets related to the
Avesta acquisition were impaired. This conclusion was based upon our revised
estimate of the undiscounted cash flows expected to be provided by the Avesta
operations. The estimate of such cash flows was substantially less than the
carrying values of the related long-lived assets. As a result, we recorded an
impairment charge of $328.8 million in the fourth quarter of 2000. This charge
included $203.2 million related to goodwill, which represented the entire
remaining unamortized balance, and $125.6 million related to the other acquired
intangibles including the completed technology, the assembled workforce and the
trademarks and tradenames. In the second quarter of 2001, we announced a
decision to discontinue development and sales efforts on the Visual Trinity
product. In the fourth quarter of 2001, we also made a decision to combine
certain functionality of the web performance management technology of the Visual
eWatcher product with the Visual IP InSight product. As a result of these
decisions, we performed an evaluation of the recoverability of our long-lived
assets, including those related to the Avesta acquisition and concluded that the
remaining intangibles were impaired as the Visual Trinity product and the Visual
eWatcher product were the only products acquired with Avesta. We recorded
impairment charges of $3.1 million in the second quarter of 2001 and $197,000 in
the fourth quarter of 2001 related to the remaining intangibles from the Avesta
acquisition.
During 2001, our revenue decreased from $89.0 million in 2000 to $74.2
million in 2001. This revenue decrease during 2001 was due, in part, to the
discontinuation of the Visual Trinity product and the sale of the Visual
Internet Benchmark product as well as decreases in all of our other product
lines. In response to these revenue decreases, we focused on implementing our
comprehensive plan to strengthen our business by:
|X| Strengthening our product portfolio: We released Visual UpTime 6.0 and
Visual IP Insight 5.5 and eliminated Visual Trinity and Visual Internet
Benchmark;
|X| Strengthening our senior management team: During 2001, Elton King was
hired as President and Chief Executive Officer and in January 2002, John
Saunders became our Chief Financial Officer;
|X| Concentrating our sales, marketing, research and product development
initiatives around service providers and their end user customers: We
established a new service provider relationship with Equant for IP VPN services
worldwide and increased our total revenue from service providers, as a
percentage of total revenue, from 70% in 2000 to 77% in 2001; and
|X| Reducing our operating expenses: We reduced our workforce by
approximately 230 people since October 2000, closed our facilities in Ottawa,
Canada; Sunnyvale, California; and New York, New York, and reduced our
facilities in Rockville, MD, resulting in a 23% reduction in operating expenses
(excluding charges related to acquisitions and restructuring and impairment),
from $80.4 million in 2000 to $61.7 million in 2001.
Results of Operations
The following table presents certain consolidated statement of operations
data as a percentage of our revenue:
Years Ended December 31,
1999 2000 2001
---- ---- ----
Revenue............................................. 100.0% 100.0% 100.0%
Cost of revenue..................................... 33.7 36.5 39.6
---- ---- ----
Gross profit...................................... 66.3 63.5 60.4
Operating expenses:
Research and development.......................... 18.2 30.6 26.0
Write-off of purchased research and development... - 43.8 -
Sales and marketing............................... 26.7 47.1 45.0
General and administrative........................ 8.6 12.6 12.0
Merger-related costs.............................. 7.3 - -
Restructuring and impairment charges.............. - 377.2 12.6
Amortization of goodwill and other intangibles.... - 60.0 1.1
------ ---- -------
Total operating expenses................. 60.8 571.3 96.7
Income (loss) from operations....................... 5.5 (507.8) (36.3)
Interest income, net................................ 2.4 2.9 0.4
----- -------- --------
Net income (loss) before income taxes............... 7.9 (504.9) (35.9)
Benefit (provision) for income taxes................ (4.0) 38.3 (0.4)
-------- --------- --------
Net income (loss)................................... 3.9% (466.6)% (36.3)%
====== ======== ========
The following table presents the revenue by product (in thousands):
Years Ended December 31,
1999 2000 2001
---- ---- ----
Visual UpTime........................ $ 78,490 $ 59,754 $ 55,557
Visual Cell Tracer................... 6,056 7,946 2,980
Visual IP InSight.................... 4,557 9,466 8,095
Continuing product revenue..... 89,103 77,166 66,632
Visual Internet Benchmark............ 2,616 4,607 4,025
Visual Trinity and eWatcher.......... - 7,268 3,591
Discontinued product revenue... 2,616 11,875 7,616
Total revenue.............. $ 91,719 $ 89,041 $ 74,248
======== ======== ========
2001 Compared with 2000
Revenue. Revenue was $89.0 million in 2000 compared to $74.2 million in
2001, a decrease of $14.8 million. The overall decrease in revenue of 16.6% was
primarily due to a decrease in Visual Cell Tracer revenue of $5.0 million, from
one customer, a decrease in Visual UpTime revenue of $4.2 million, primarily
from value added resellers and service providers, a decrease in Visual IP
Insight revenue of $1.4 million and a decrease in Visual Trinity revenue of $3.7
million as a result of the discontinuation of the product. The decrease in Cell
Tracer revenue was attributable to reduced demand from our sole customer for the
product. The decrease in sales of Visual UpTime was primarily attributable to a
decrease in purchases from one of our major service provider customers. Sales to
all service providers increased from approximately 70% of revenue for 2000 to
77% for 2001.
As a result of the discontinuation of the Visual Trinity product, we
anticipate that future revenue for the product will consist primarily of
technical support revenue, all of which is currently included in deferred
revenue. We plan to provide technical support for the Visual Trinity product
through September 2002.
We will continue to recognize revenue from the Visual Internet Benchmark
product that we sold during 2001, for existing contracts, under which we are
still required to perform services. We receive royalty payments from the
purchaser on new contracts.
Gross profit. Cost of revenue consists of subcontracting costs, component
parts, direct compensation costs, communication costs, warranty and other
contractual obligations, royalties, license fees and other overhead expenses
related to manufacturing operations and support of our software products and
benchmark services. Gross profit was $56.5 million for 2000 compared to $44.8
million for 2001, a decrease of $11.7 million. Gross margin was 63.5% of revenue
for 2000 as compared to 60.4% of revenue for 2001. The decrease in gross margin
percentage was due primarily to significant fixed manufacturing and other costs
supporting a lower revenue base, fewer high margin software sales primarily due
to the discontinuation of the Visual Trinity product and higher fixed costs to
support the Visual Benchmark service for existing contracts. Our future gross
margins may be affected by a number of factors, including product mix, the
proportion of sales to service providers, competitive pricing, manufacturing
volumes and an increase in the cost of component parts.
Research and development expense. Research and development expense consists
of compensation for research and development staff, depreciation of test and
development equipment, certain software development costs and costs of prototype
materials. Research and development expense was $27.3 million for 2000 compared
to $19.3 million in 2001, a decrease of $8.0 million. The decrease in research
and development expense was due primarily to workforce reductions and facility
closures during 2000 and 2001. Research and development expense was 30.6% and
26.0% of revenue for 2000 and 2001, respectively. We intend to incur research
and development expenses at a level consistent with the fourth quarter of 2001
or decrease them in absolute dollars during 2002 as a result of our continued
focus on the reduction of operating expenses.
Write-off of purchased research and development. A write-off of purchased
research and development costs of $39.0 million was recorded in 2000 in
connection with the acquisition of Avesta, Avesta had in-process technology
which represented research and development projects of Avesta that had not
reached technological feasibility and that had no alternative future use in
research and development activities or otherwise. We must charge to expenses as
of the date of the acquisition date amounts assigned to in-process research and
development ("IPR&D") meeting the foregoing.
The evaluated projects were future releases of the Trinity, eWatcher and
other products. The products in process included both upgrades to existing
products as well as major modifications for future releases. Additional products
that had been started but not yet assigned a numerical designation and were
considered to be only 1% complete were excluded from the evaluation. The Trinity
related projects represented the majority of the value assigned to the IPR&D
projects. We valued the acquired IPR&D based upon an independent appraisal. The
values of the IPR&D projects were determined by estimating the future cash flows
from the projects, once commercially feasible, discounting the net cash flows
back to their present values and then applying a percentage of completion to the
calculated values to reflect the uncertainty of technical success of the
projects. The rates used to discount the net cash flows to their present values
were based on Avesta's weighted average cost of capital. The percentage of
completion was based on management's estimates of the amount of resources spent
to date and on the expected use of future resources.
As of the valuation date, Avesta was offering version 1.3 of the Trinity
product. Versions 2.0, 2.1 and 3.0 were considered IPR&D projects and were
estimated to be 95%, 15% and 5% complete, respectively. The eWatcher product had
been acquired by Avesta in 1998 and versions 2.0 and 2.5 were considered IPR&D
projects and were estimated to be 25% and 4% complete, respectively. Certain
risks and uncertainties are associated with the completion of the development of
these products within a reasonable projected period of time. Each of the
acquired IPR&D projects had not demonstrated technological feasibility as of the
acquisition date.
Sales and marketing expense. Sales and marketing expense consists of
compensation for the sales and marketing staff, commissions, pre-sales support,
travel and entertainment expense, trade shows and other marketing programs.
Sales and marketing expense was $41.9 million for 2000 compared to $33.5 million
for 2001, a decrease of $8.4 million. The decrease in sales and marketing
expense was due primarily to workforce reductions during 2000 and 2001. Sales
and marketing expense was 47.1% and 45.1% of revenue for 2000 and 2001,
respectively. We intend to incur sales and marketing expenses at a level
consistent with the fourth quarter of 2001 or decrease them in absolute dollars
during 2002 as a result of our continued focus on the reduction of operating
expenses.
General and administrative expense. General and administrative expense
consists of the costs of executive management, finance, administration, and
other activities. General and administrative expense was $11.2 million for 2000
compared with $8.9 million for 2001, a decrease of $2.3 million. The decrease in
general and administrative expense was due primarily to workforce reductions and
facility closures during 2000 and 2001. General and administrative expense was
12.6% and 12.0% of revenue for 2000 and 2001, respectively. We intend to incur
general and administrative expenses at a level consistent with the fourth
quarter of 2001 or decrease them in absolute dollars during 2002 as a result of
our continued focus on the reduction of operating expenses.
Restructuring and impairment charges. We recorded a restructuring charge of
$7.0 million in the fourth quarter of 2000 that consisted primarily of severance
and other termination benefits related to a workforce reduction of approximately
140 employees and lease costs and leasehold improvement write-offs related to
the closure of facilities in Ottawa, Canada and Sunnyvale, California and the
reduction in size of our facilities in Rockville, Maryland and New York, New
York. During the second quarter of 2001, we reversed $723,000 of the
restructuring charge recorded in the fourth quarter of 2000 due primarily to
lower than estimated costs related to facility closure costs. We recorded a
restructuring charge of $3.9 million in the second quarter of 2001 that
consisted primarily of severance and other termination benefits related to a
workforce reduction of approximately 50 employees and lease costs and leasehold
improvement write-offs related to the closure of our New York, New York facility
following our announcement to discontinue the Visual Trinity product. During the
fourth quarter of 2001, we reversed $1.2 million of the restructuring charge
recorded in the second quarter of 2001 due to lower than estimated costs related
to facility closures and other contractual obligations. We recorded another
restructuring charge of $385,000 in the fourth quarter of 2001 that consisted of
severance and other termination benefits related to a workforce reduction of
approximately 40 people resulting from our continued focus on the reduction of
our operating expenses.
We recorded an impairment charge of $328.8 million in the fourth quarter of
2000 for the write-off of goodwill and other intangibles related to the Avesta
acquisition. We recorded an additional impairment charge of $3.1 million in the
second quarter of 2001 as a result of our discontinuation of the Visual Trinity
product. We also recorded an impairment charge of $3.9 million in the fourth
quarter of 2001 related to the impairment of an investment acquired with the
Avesta acquisition and the write-off of the remaining intangible assets related
to the Avesta acquisition as a result of our plans for the eWatcher product
(see Note 6 of Notes to Consolidated Financial Statements).
Amortization of acquired intangibles. We recorded $53.4 million in
amortization of goodwill and other intangibles in 2000 related to the Avesta
acquisition compared with $805,000 in 2001. The decrease was the result of
decreased goodwill and intangibles resulting from the impairment charges
recorded in 2000 and 2001.
Interest income, net. Interest income, net, was $2.6 million for 2000
compared to $325,000 for 2001. The decrease of $2.3 million was primarily due to
decreased cash balances.
Income taxes. The provision for income taxes for 2001 was $272,000 and
related primarily to state income taxes and other non-recoverable income tax
payments.
Net loss. Net loss for 2000 was $415.5 million as compared to $27.0 million
for 2001, a decrease of $388.5 million. The decrease was due primarily to a
decrease in restructuring and impairment charges, amortization of intangibles
and operating expenses, offset in part by decreases in revenue, gross profit,
interest income and income tax benefits.
2000 Compared with 1999
Revenue. We recognized $91.7 million in revenue for 1999 compared to $89.0
million in revenue for 2000, a 2.9% decrease. The decline was due primarily to a
decrease in Visual UpTime revenue of $18.7 million, primarily from service
providers, offset by increases in revenue related to Visual Cell Tracer, Visual
IP InSight and Visual Internet Benchmark and the effect of the acquisition of
the Avesta Trinity and eWatcher products. The decrease in sales of Visual UpTime
was primarily attributable to a change in purchasing behavior of two major
service providers. Sales to all service providers accounted for approximately
72% of revenue for 1999 as compared to 70% for 2000.
Gross profit. Gross profit was $60.8 million for 1999 compared to $56.5
million for 2000, a decrease of $4.3 million. Gross margin was 66.3% of revenue
for 1999 compared to 63.5% of revenue for 2000. The decrease in gross margin
percentage was due primarily to higher fixed costs supporting a lower revenue
base and approximately $1.9 million in inventory write-downs offset, in part, by
the addition of higher-margin software sales of Visual Trinity and Visual
eWatcher.
Research and development expense. Research and development expense was
$16.7 million for 1999 as compared to $27.3 million for 2000, an increase of
$10.6 million. The increase in research and development expense was due
primarily to the costs of the Avesta research and development staff subsequent
to the date of acquisition, increased staffing levels and related support costs,
and purchases of materials and services used in the development of new or
enhanced products. Research and development expense was 18.2% and 30.6% of
revenue for 1999 and 2000, respectively.
Write-off of purchased research and development. A write-off of purchased
research and development costs of $39.0 million was recorded in 2000 in
connection with the acquisition of Avesta, as described above.
Sales and marketing expense. Sales and marketing expense was $24.4 million
for 1999 compared to $41.9 million for 2000 an increase of $17.5 million. The
increase in sales and marketing expense was due primarily to the costs of Avesta
sales and marketing staff and programs subsequent to the date of acquisition and
continued growth in staffing, commissions and marketing programs. Sales and
marketing expense was 26.7% and 47.1% of revenue for 1999 and 2000,
respectively.
General and administrative expense. General and administrative expense was
$7.9 million for 1999 compared to $11.2 million for 2000, an increase of $3.3
million. The increase in general and administrative expense was due primarily to
the additional costs of the Avesta staff and professional services incurred
subsequent to the date of acquisition and increased staffing, professional
services and corporate facilities and network infrastructure costs. General and
administrative expense was 8.6% and 12.6% revenue for 1999 and 2000,
respectively.
Restructuring and impairment charges. We recorded a restructuring charge of
$7.0 million in the fourth quarter of 2000 that consisted primarily of severance
and other termination benefits related to a workforce reduction of approximately
140 employees and lease costs and leasehold improvement write-offs related to
the closure of facilities in Ottawa, Canada and Sunnyvale, California and the
reduction in size of our facilities in Rockville, Maryland and New York, New
York. We also recorded an impairment charge of $328.8 million for the write-off
of goodwill and other intangibles related to the Avesta acquisition (see Note 6
of Notes to Consolidated Financial Statements).
Amortization of acquired intangibles. We recorded $53.4 million in
amortization of goodwill and other intangibles related to the Avesta acquisition
in 2000.
Interest income, net. Interest income, net, for 1999 was approximately $2.3
million as compared to $2.6 million for 2000. The increase of $0.3 million was
primarily due to decreased interest expense related to capital leases and other
borrowings.
Income taxes. The benefit for income taxes for 2000 was $34.1 million. The
effective tax rate of 8% differed from the statutory rates primarily due to the
income tax effect of the Avesta acquisition and increases in the valuation
allowance.
Net income (loss). Net loss for 1999 was $3.6 million for 1999 as compared
to $415.5 million for 2000, an increase of $419.1 million. The decrease was due
primarily to decreases in revenue and gross profit, increased operating
expenses, the write-off of purchased research and development, the amortization
of goodwill and other intangible assets and the restructuring and impairment
charges.
Liquidity and Capital Resources
At December 31, 2001, our unrestricted cash balance was $5.9 million
compared to $17.4 million as of December 31, 2000, a decrease $11.5 million.
This decrease is primarily attributable to cash used in operations, due to
operating losses as well as the payment of certain restructuring charges
recorded in 2000. Net cash used in operating activities in 2001 was $19.7
million. During the year, we also used cash of $692,000 to purchase equipment
and other fixed assets, and we made principal payments on capital lease
obligations of $564,000. Cash provided by the maturities of short-term
investments was $6.2 million, the sale of common stock pursuant to the exercise
of employee stock options and our employee stock purchase plan was $1.3 million,
and net borrowings from our bank were $2.0 million.
We require substantial working capital to fund our business, particularly
to finance inventories, accounts receivable, research and development activities
and capital expenditures as well as to fund our operating losses. To date, we
have financed our operations and capital expenditures primarily with the
proceeds from our initial public offering completed in February 1998 and from
our operating income generated through the first quarter of 2000. In 2001, as
indicated above, we became dependent on cash that was provided by our bank under
a credit facility. In addition, from time to time, we have obtained advance
payments in connection with certain customer purchase orders. In the fourth
quarter of 2001, we received an advance payment of approximately $3.6 million
that was classified as a customer deposit in the accompanying consolidated
balance sheet as of December 31, 2001; the related customer orders were
fulfilled in February 2002. We do not anticipate receiving customer advance
payments in the future. Our future capital requirements will depend on many
factors, including the rate of revenue growth, if any, as well as our gross
margin and our levels of operating expenses, including product research and
development, sales and marketing and general and administrative expenses.
In response to the trends of decreasing revenue and increasing operating
expenses, we initiated a restructuring plan in the fourth quarter of 2000 to
realign our product portfolio, streamline our operations and devote resources to
the markets and products that we believe have the greatest opportunity for
growth. In the second quarter of 2001, we announced a plan to discontinue
development and sales efforts on the Visual Trinity product and eliminate the
related costs. In the fourth quarter of 2001, we made additional reductions in
workforce and other operating costs. As a result of these actions, operating
expenses, excluding charges related to acquisitions and restructuring and
impairment charges, have been reduced from a level of $24.0 million in the
fourth quarter of 2000 to $11.9 million in the fourth quarter of 2001.
Although our revenue for the fourth quarter of 2001 was $17.3 million
compared to revenue of $15.3 million in the comparable period of last year, our
fourth quarter 2001 revenue decreased from $19.2 million and $20.3 million for
the quarters ended September 30, 2001 and June 30, 2001, respectively. Revenue
decreased from $89.0 million for the year ended December 31, 2000 to $74.2
million for the year ended December 31, 2001. Our ability to generate operating
income in the future is dependent upon not only our continued success in
reducing operating expenses, but also our ability to sustain revenue. General
market conditions, competitive pressures and other factors beyond our control
may adversely affect our ability to generate sufficient revenue to enable us to
become profitable. There can be no assurances that we will be able to sustain
revenue or become profitable. In the event that the anticipated cost reductions
are not realized or we do not meet our revenue goals, we may be required to
further reduce our cost structure.
The significant operating losses incurred by us since the third quarter of
2000 have resulted in a significant reduction in our cash. Our balance of cash
and cash equivalents has decreased from $54.6 million at December 31, 1999 to
$5.9 million at December 31, 2001. Accounts payable and accrued liabilities
totaled $11.7 million at December 31, 2001, and current liabilities exceeded
current assets by approximately $6.64 million.
In order to strengthen our financial position and provide cash for working
capital purposes, in March 2002, we issued senior secured convertible debentures
in the aggregate amount of $10.5 million in a private placement offering. The
debentures are due March 25, 2006, payable in common stock or cash at our option
provided certain conditions are satisfied, bear interest at an annual rate of 5%
payable quarterly, and are secured by a first priority lien on substantially all
of our assets. The debentures may be converted into our common stock at the
option of the holders at a price of $3.5163 per share, subject to certain
adjustments. The debentures are convertible into a number of shares of common
stock equal to the principal amount of the debentures divided by the conversion
price, or 2,986,093 shares on the date of issuance. We are required to adjust
the conversion price if we issue certain additional shares of our common stock
or instruments convertible into common stock at a price that is less than the
conversion price of the debentures. We have the right to require the holders to
convert their debentures into common stock if the closing price of our common
stock exceeds 175% of the conversion price for 20 consecutive days after
September 26, 2003.
The debentures include certain financial covenants related to earnings
before interest, taxes, depreciation and amortization for 2002 and 2003. If the
financial covenants are not met, the holders may cause us to redeem the
debentures at a price equal to the principal amount of the debentures plus
accrued interest. The redemption may be made in cash or common stock at our
option subject to certain conditions. Redemption of the debentures also may be
required upon a specified change of control or upon the occurrence of any one of
the other triggering events including, but not limited to, our default on other
indebtedness, our failure to register the shares of common stock that may be
issued to the debenture holders and our failure to maintain our common stock
listing on an eligible market.
We also issued warrants to purchase 828,861 shares of our common stock at
an initial exercise price of $4.2755 per share. The exercise price may be
adjusted if we issue certain additional shares of our common stock or
instruments convertible into common stock at a lower price than the initial
exercise price. The warrants expire on March 25, 2007. The debentures also give
the holders the right to purchase 575 shares of to-be-created Series A preferred
stock for $5.8 million prior to May 6, 2002. The Series A preferred stock will
accrue dividends at an annual rate of 5% that are payable quarterly beginning on
June 30, 2002. We will have the right to cause the redemption of the Series A
preferred stock on the fourth anniversary of the issuance of such stock based on
similar terms to the debentures. We have also granted to the debenture holders
the right to purchase $4.75 million of additional shares of to-be-created
preferred stock at any time after the six-month anniversary but before the
fifteen-month anniversary of the issuance of the debentures. The debenture
holders were also granted certain equity participation and registration rights.
In connection with the issuance of the debentures, the outstanding amounts
borrowed from the bank under our accounts receivable-based and our equipment
financing arrangements were repaid, and the related loan agreements were
terminated. The standby letter of credit, as amended, issued by the bank in
December 2000 in the amount of $2.5 million with an expiration date of September
30, 2002 remains outstanding and secured with our pledge of a certificate of
deposit in the amount of $2.5 million that matures on October 31, 2001.
The future success of our company will be dependent upon, among other
factors, our ability to generate adequate cash for operating and capital needs.
We are relying on our existing balance of cash and cash equivalents and the net
proceeds from the issuance of the convertible debentures discussed above
together with future sales and the collection of the related accounts receivable
to meet our future cash requirements. If cash provided by these sources is not
sufficient, we will be required to further reduce our expenditures for
operations or to seek additional capital through other means that may include
the sale of assets, the sale of equity securities or additional borrowings.
There can be no assurance that additional capital will be available, or
available on terms that are reasonable or acceptable to us. If we are unable to
generate additional cash, our business and financial condition may be materially
and adversely affected such that we may need to consider other alternatives for
our future.
Additional Risk Factors
In addition to the other information provided or incorporated by reference
in this document, stockholders should also consider the following factors
carefully in evaluating whether to make an investment decision. Stockholders
should also refer to the section entitled "Forward Looking Statements".
We have a history of losses and an accumulated deficit and we may not be
profitable in the future.
Our limited history, operating losses and accumulated deficit make
predicting our future operating results difficult. Our company was organized in
1993 and we introduced Visual UpTime in mid-1995. Visual IP InSight was
introduced in 1997. Accordingly, we have only a limited operating history upon
which an evaluation of our products and prospects can be based. As of December
31, 2001, we had an accumulated deficit of approximately $473.9 million.
Although we reported net income of $3.6 million for 1999, we have incurred
consolidated net losses in the years ended December 31, 2000 and 2001 of
approximately $415.5 million and $27.0 million, respectively. The loss in 2000
related to the year-end write-down of impaired intangible assets recorded in the
Avesta acquisition, the write-off of purchased research and development related
to the Avesta acquisition, the amortization of the acquired intangibles
including goodwill prior to the write-down, the restructuring charge recorded in
the fourth quarter as well as reduced revenue and increased operating expenses.
The loss in 2001 was due to a reduction in revenue as well as the write-off of
the remaining intangible assets related to the Avesta acquisition, restructuring
charges recorded in the second and fourth quarters, and the write-off of an
investment. While we believe that our restructuring activities and new product
strategies will result in sufficient revenue and reduced operating expenses
compared to 2001 such that we will return to profitability in 2002, there can be
no assurances that we will become profitable.
Failure to achieve expected revenue levels may adversely affect future
operating results.
Our revenue in any period depends primarily on the volume and timing of
orders received during the period, which are difficult to predict. Our expense
levels are based, in part, on the expectation of future revenue. If revenue
levels are below expectations due to delays associated with customers'
decision-making processes or for any other reason, operating results are likely
to be materially and adversely affected. Results of operations may be affected
disproportionately by a reduction in revenue because a large portion of our
expenses are fixed and cannot be easily reduced without adversely affecting our
business. In addition, we currently intend to sustain funding of research and
product development efforts and sales, marketing and customer support operations
and to expand distribution channels. To the extent such expenses precede or are
not promptly followed by increased revenue, our business, financial condition
and results of operations could be adversely affected.
The loss of AT&T, WorldCom or Sprint as customers could harm our business.
Our primary sales and marketing strategy depends predominantly on sales to
service providers. We expect that a significant portion of our revenue in 2002
will be attributable to sales of Visual UpTime and Visual IP InSight to service
providers. The loss of any one of AT&T, WorldCom or Sprint, which together have
historically provided a majority of our revenue, would result in a substantial
loss of revenue that could have a material adverse effect on our business,
financial condition and results of operations. For 2001, AT&T, WorldCom and
Sprint accounted for 29%, 10% and 14%, respectively, of our consolidated
revenue. This concentration should continue as our customer base will consist
predominantly of service providers. Existing service provider customers are not
easily replaced because of the relatively few participants in that market. High
barriers to entry due to extraordinary capital requirements and the likelihood
that mergers of existing service providers may further reduce their number mean
that replacing a significant network provider company customer will be even more
difficult in the future. Furthermore, the small number of customers means that
the reduction, delay or cancellation of orders or a delay in shipment of our
products to any one service provider customer could have a material adverse
effect on our business, financial condition and results of operations. Our
anticipated dependence on sizable orders from a limited number of service
providers will make the relationship between us and each service provider
critically important to our business. As our relationships with these service
providers evolve over time, we will make adjustments to product specifications,
forecasts and delivery timetables in response to service provider demands and
expectations. Further, because none of our agreements contain minimum purchase
requirements, there can be no assurance that the issuance of a purchase order
will result in significant recurring business. Any inability to manage our
service provider relationships successfully could have a material adverse effect
on our business, financial condition and results of operations.
Failure of service providers to incorporate our products into their
infrastructure may adversely affect the level of future revenue.
Our service provider deployment strategy depends on the sale of Visual
UpTime and Visual IP InSight to service providers for their own network
infrastructures. However, capital expenditures by service providers have
decreased as they attempt to recover from the deep and sudden decline in the
telecommunications markets. The success of our strategy in 2002 will depend, in
part, on our ability to demonstrate that our product solutions reduce service
provider operating expenses and enable the creation of new revenue-generating
services. We cannot be sure that we will be successful in demonstrating the
value of our products to service providers. If we are unsuccessful, our future
revenue could be significantly lower than anticipated. We believe that the
success of the service provider deployment strategy depends on a number of
factors over which we may have little or no control, including:
-acceptance of and satisfaction with our systems by service providers and
their customers;
-our ability to convince the service providers of the operational benefits
of Visual UpTime and Visual IP InSight;
-the realization of operating cost efficiencies by service providers and
their customers upon the deployment of Visual UpTime and Visual IP InSight;
-the demand generation for these systems from customers and support for
the systems by the service provider sales forces;
-the competitive dynamics between service providers that provide
communication networks for wide area use and the development of service for new
world networks overall;
-our successful development of systems and products that address the
requirements for systems deployed as part of a service provider's
infrastructure;
-the timing and successful completion of integration development work by
service providers to incorporate our service management functionality into their
operational infrastructure; and
-the absence of new technologies that make our products and systems
obsolete before they become standardized in network systems.
The failure of our products to become an accepted part of the service
providers' infrastructures or a slower than expected increase in the volume of
sales by us to these companies could have a material adverse effect on our
business, financial condition and results of operations.
Our long sales cycle requires us to expend significant resources on
potential sales opportunities that may never be consummated.
If we do not generate additional revenue from our sales and marketing
efforts, the expended resources and lack of increased revenue could have a
material adverse affect on our business, financial condition and results of
operations. Our future business prospects depend on growing the sales of our
products and services. The incorporation of our products into the infrastructure
of service providers is characterized by a long sales cycle to turn
opportunities into sales. The risks inherent in the long sales cycle for Visual
UpTime and Visual IP InSight, over which we have little or no control over,
include:
-service providers' internal acceptance reviews;
-service providers' budgetary constraints and technology assessment;
-service providers' lengthy decision-making processes;
-the attendant delays frequently associated with service providers'
internal procedures to approve large capital expenditures; and
-the substantial commitment of capital from service providers.
Sales of Visual UpTime and Visual IP InSight generally involve significant
testing by and education of both service providers and their customers as well
as a substantial commitment of our sales and marketing resources. As a result,
we may expend significant resources pursuing potential sales opportunities that
will not be consummated. Even if service providers do deploy our products, the
curtailment or termination of service provider marketing programs, the reduction
in demand by service provider customers, decreases in service provider capital
budgets or the reduction in the purchasing priority assigned to our products,
particularly if significant and unanticipated by us, could have a material
adverse effect on our business, financial condition and results of operations.
An unanticipated interruption or delay in the scheduled receipt of products
from our subcontract manufacturer could reduce revenue.
We have outsourced the manufacture of substantially all of our ASE units
(the analysis service element of our Visual UpTime system) to a single
subcontract manufacturing firm. We derive a substantial portion of our revenue
from the sale of these units. Our ability to meet the delivery dates requested
by customers depends on the timely supply of such products from the subcontract
manufacturer. Our bank has issued an irrevocable letter of credit on their
behalf in the amount of $2.5 million that expires on September 30, 2002. This
letter of credit mitigates, but does not eliminate entirely, the credit and
inventory risk for the supplier. The withdrawal of the letter of credit by the
bank or our inability to obtain an extension to its current expiration date, if
required by the subcontract manufacturer, could harm our business. Similarly, a
decision by the subcontract manufacturer to reduce or eliminate the amount of
credit extended to us or to stop the shipment of products due to concerns about
our financial condition or the amount of their credit and inventory risk could
harm our business. Any resulting interruption or delay in the supply of our
products by the subcontract manufacturer could result in a loss of revenue.
Failure of the market to accept new world network services would reduce the
demand for our products.
Because our systems are deployed predominantly on new world networks such
as frame relay, ATM, IP, remote access and VPNs, our near term success will
depend on the continued market acceptance of these technologies as preferred
networking solutions. If these services do not maintain widespread market
acceptance, the market for our products will be substantially reduced which
could have a material adverse effect on our business, financial condition and
results of operations. Although we are currently devoting significant resources
to the development of additional products, there can be no assurance that we
will complete the development of these or any future products in a timely
fashion, that we will successfully manage the transition from existing products,
that our future products will achieve market acceptance or, if market acceptance
is achieved, that we will be able to maintain such acceptance for a significant
period of time. If we are unable to develop products on a timely basis that
address changing customer needs and technologies, we may lose market share to
competitors or be required to substantially increase development expenditures.
Such an unanticipated increase in research and development expenditures could
have a material adverse effect on our business, financial condition and results
of operations. There also can be no assurance that products or technologies
developed by others will not adversely affect our competitive position or render
our products or technologies noncompetitive or obsolete.
Failure of broadband access services to achieve significant market
penetration could impact the effectiveness of our new product strategy.
Our new product strategy anticipates that customers will provide
comprehensive service management for the new world networks running over
broadband access facilities such as DSL, fixed wireless, and cable. There is no
assurance that these access technologies will achieve broad-based market
acceptance for mission-critical applications for the business customers of the
service providers. Failure of these technologies to achieve broad-based market
acceptance could adversely affect future revenue, financial condition, and
results of operations.
Failure of businesses to use the Internet for corporate networking purposes
would reduce the demand for our products.
Because our service management products and services are based on providing
performance measurement and diagnostics for the Internet and corporate IP
networks, the Internet must be widely adopted, in a timely manner, as a means of
electronic commerce, or e-commerce, and communications. If such adoption should
not occur, our business, financial condition and results of operations could be
adversely affected. Because e-commerce and communications over the Internet are
new and evolving, it is difficult to predict the size of this market and its
sustainable growth rate. In addition, we believe that the use of the Internet
for conducting business transactions could be hindered for a number of reasons,
including, but not limited to:
-security concerns including the potential for fraud or theft of stored
data and information communicated over the Internet;
-inconsistent quality of service, including well-publicized outages of
popular web sites;
-lack of availability of cost-effective, high-speed service;
-limited numbers of local access points for corporate users;
-delay in the development of enabling technologies or adoption of new
standards;
-inability to integrate business applications with the Internet;
-the need to operate with multiple and frequently incompatible products;
and
-a lack of tools to simplify access to and use of the Internet.
Improvements to the infrastructure of the Internet could reduce or
eliminate demand for our Internet performance measurement products and services.
The demand for our service management products and services could be
reduced or eliminated if future improvements to the infrastructure of the
Internet lead companies to conclude that measuring and evaluating the
performance of their networks is no longer important to their business. The
Internet is a complex, heterogeneous network of communications networks with
multiple operators and vendors supplying and managing the underlying
infrastructure as well as connections to this infrastructure. Because the
inherent complexity of the Internet currently causes significant e-commerce
quality-of-service problems for companies, the vendors and operators that supply
and manage the underlying infrastructure are continuously seeking to improve the
speed, availability, reliability and consistency of the Internet. If these
vendors and operators succeed in significantly improving the performance of the
Internet, which would result in corresponding improvements in the performance of
companies' networks, demand for our products and services would likely decline
which could have a material adverse effect on our business, financial condition
and results of operations.
Failure to adapt to rapid technological change could adversely affect our
ability to compete effectively.
The market for our products is characterized by rapid changes, including
continuing advances in technology, frequent new product introductions, changes
in customer requirements and preferences and changes in industry standards. If
we are unable to develop and introduce new products and product enhancements in
a timely fashion that accommodate future changes, we will likely lose customers
and business which could have a material adverse effect on our business,
financial condition and results of operations. The introduction of new
technologies or advances in techniques for network services or the integration
of service level management functionality into other network hardware components
could render our products obsolete or unmarketable. There can be no assurance
that (i) our existing products will continue to compete successfully; (ii) our
future product offerings will keep pace with the technological changes
implemented by our competitors; (iii) our products will satisfy evolving
industry standards or preferences of existing or prospective customers; or (iv)
we will be successful in developing and marketing products for any future
technology. Failure to achieve any one of these objectives could have a material
adverse effect on our business, financial condition and results of operations.
We face growing competition that could make it difficult for us to acquire
and retain customers.
The market for service management systems for new world connectivity
services is new and rapidly evolving. We expect competition in this market to
intensify in the future. Our competitors vary in size and in the scope and
breadth of the products and services that they offer. Many of these competitors
have greater financial, technical, marketing and other resources than us, and
some have well-established relationships with our current and potential
customers. As a result, these competitors may be able to respond to new or
emerging technologies and changes in customer requirements more effectively than
us, or devote greater resources than us to the development, promotion and sale
of products. Increased competition may result in price reductions, reduced
profitability and loss of market share, any of which could have a material
adverse effect on our business, financial condition and results of operations.
We may experience competition from less expensive products and services that
provide only a portion of the functionality provided by our products and
services. In particular, as prices for network equipment components such as data
service units/channel service units decrease, customers may decide to purchase
these less expensive products even though they lack certain features offered by
our products, particularly when these units are integrated in customer routers
and switches. For example, we expect that participants with strong capabilities
in these various segments could partner with each other to offer products that
supply functionality approaching that provided by Visual UpTime. The success of
such products could have a material adverse effect on our business, financial
condition and results of operations. If we expand the scope of our products and
services, we may encounter many additional, market-specific competitors. These
potential competitors include large companies that sell network management
software. The success of such products could have a material adverse effect on
our business, financial condition and results of operations.
The consolidation of the telecommunications industry could result in a
lengthened sales cycle.
Many companies in the telecommunications industry, particularly Internet
service providers, DSL providers and competitive local exchange carriers, are
consolidating with each other. As a result, the managements of these companies
may be more focused on internal integration and other integration issues and
less focused on the purchasing of additional equipment and services for service
creation. This is likely to affect our business by lengthening our sales cycle,
which could adversely affect our business, financial condition and results of
operations.
The pending break-up of AT&T could lengthen sales cycles and adversely
affect our business.
Potential disruption caused by the pending break-up of AT&T could result in
delays by AT&T's customers in ordering services based on our equipment and
delays in installation of services by AT&T. Both of these conditions could
adversely affect our business, financial condition and results of operations.
The separation by AT&T of its Business unit, Broadband unit and Wireless unit
into three different companies could impact adversely the potential synergies
realized from integrated service management across multiple broadband access
technologies, resulting in a reduction in the demand for our products which
would have a material adverse effect on our business, financial condition and
results of operations.
Errors in our products or services could discourage customers and damage
our reputation.
If our existing or future products or services contain errors that are not
detected before shipment, we could experience a loss of or delay in market
acceptance of our products, diversion of development resources, damage to our
reputation or increases in service or warranty costs, any of which could have a
material adverse effect upon our business, financial condition and results of
operations. Products and services as complex as those we offer may contain
undetected errors or failures when first introduced or as new versions are
released. There can be no assurance that, despite testing by us and by current
and potential customers, errors will not be found in new products and services
until commercial shipments have commenced.
Our dependence on sole and limited source suppliers makes the price we pay for
important components in our products more volatile.
Many key components used in the manufacture of our products are purchased
only from sole or limited sources. If a sole or limited source supplier raises
their prices, delays shipments or becomes unable or unwilling to supply a key
component, we may be forced to obtain these components from alternative sources
if they are available, which could impair our ability to deliver our products to
our customers in a timely and cost-effective manner, or could force us to
increase our prices or reduce our gross profit margins. Any of these events
could have a material adverse effect on our business, financial condition and
results of operations and could jeopardize our relationships with those
customers. The risks associated with being dependant on sole or limited source
suppliers of key components include the following:
-we have not identified alternative suppliers for all of our key
components and we may not be able to find alternative suppliers, if necessary,
or find alternative components of comparable quality;
-we will have to qualify alternative suppliers before components are
purchased from them which will, even if successful, necessarily delay the
process of procuring the replacement components;
-most of our suppliers do not have long-term agreements with us, so these
suppliers could suddenly increase component prices;
-even minor delays in shipments of key components from suppliers, which we
have experienced in the past, could delay the shipment of our products;
-although all of our sole or limited source suppliers are based in the
United States, some of them may manufacture or acquire components from outside
of the United States and thus they may be unable to deliver their components if
their own supplies are interrupted by events in other countries; and
-some of the components, including dynamic random access memories and
embedded communications processors, are subject to significant price
fluctuations.
Sole-source components presently include framers, certain semiconductors,
embedded communications processors, communication controllers and line interface
components.
Claims by others that we infringe their intellectual property rights may
harm our business.
If others claim that our products infringe on their intellectual property
rights, whether the claims are valid or not, we may be forced to spend
significant sums in litigation, pay damages, delay product shipments, reengineer
our products or acquire licenses to the claimant's intellectual property. We
expect that these claims may become more common as the number of products in the
network management industry increases and the functionality of these products
further overlaps. If a claimant is successful in a lawsuit arising from such a
claim, it could have a material adverse effect on our business, financial
condition and results of operations.
Failure to protect our own intellectual property rights may harm our
business.
Our success is dependent on our proprietary technology and intellectual
property rights. We currently hold four United States patents and one foreign
patent, and also rely on copyright and trade secret laws, trademarks,
confidentiality procedures and contractual provisions to protect our proprietary
software, documentation and other proprietary information. These protection
methods may not be adequate to prevent competitors from developing similar
technology. Moreover, in the absence of patent protection, our business may be
adversely affected by competitors that develop functionally equivalent
technology. Litigation to enforce our intellectual property rights, regardless
of its success or failure, could be burdensome and expensive and could involve a
high degree of uncertainty. In addition, legal proceedings may divert
management's attention from growing our business. We may be subject to
additional risk as we enter into transactions in countries where intellectual
property laws are not well developed or enforced effectively. Legal protection
of our rights may be ineffective in such countries, and technology developed or
used in such countries may not be protected in jurisdictions where protection is
ordinarily available. Failure to adequately protect our intellectual property
rights could have a material adverse effect on our business, financial condition
and results of operations.
The loss of key people could jeopardize our growth prospects.
The loss of the services of Elton King, our President and Chief Executive
Officer; Steven Hindman, our Executive Vice President, Sales and Marketing; or
John Saunders, our Chief Financial Officer, or any other key employee could
adversely affect our ability to execute our business plan and could have a
material adverse effect on our business, financial condition and results of
operations. Our success depends to a significant degree upon the continuing
contributions of our key management and technical employees, particularly
Messrs. King, Hindman and Saunders.
Our inability to recruit and retain employees may hurt our growth prospects.
Our future success depends on our ability to attract and retain highly
skilled managerial, sales, marketing, customer support and product development
personnel. Intense competition for technically trained sales and product
development personnel makes recruiting and keeping qualified personnel
difficult. There can be no assurance that we will be successful in continuing to
attract and retain skilled employees. Failure to do so could have a material
adverse effect on our business, financial condition and results of operations.
Our defense of the litigation relating to our alleged false and misleading
statements may result in costly litigation, divert the efforts and attention of
our management, and be unsuccessful.
We are defending ourselves against the claims discussed in "Item 3. Legal
Proceedings." We believe that the plaintiffs' claims are without merit and we
intend to defend this case vigorously. We may, however, incur significant legal
costs related to this litigation. We cannot presently determine the ultimate
outcome of this action and the effects, if any, on our financial statements. A
negative outcome could have a material adverse effect on our business, financial
condition and results of operations. Failure to prevail in the shareholder's
suit could result in the payment of substantial damages and the reimbursement of
plaintiffs' legal costs.
We may face difficulties assimilating and may incur costs associated with
any future acquisitions.
We may seek to acquire or invest in businesses, products or technologies
that we feel could complement or expand our business, augment our market
coverage, enhance our technical capabilities or that may otherwise offer growth
opportunities. Acquisitions could create risks for us, including:
-difficulties in assimilation of acquired personnel, operations and
technologies;
-unanticipated costs associated with the acquisition;
-diversion of management's attention from our core business;
-adverse effects on existing business relationships with channel partners
of our products and services and our customers; and
-use of substantial portions of our available cash to consummate the
acquisition.
Our failure to successfully assimilate companies or technologies acquired
by us or the occurrence of unanticipated costs that may arise in connection with
such acquisitions could have a material adverse effect on our business,
financial condition and results of operations.
We have anti-takeover protections that may delay or prevent a change in
control that could benefit our stockholders.
Terms of our certificate of incorporation and bylaws make it more difficult
for another individual or company to acquire control of our company, even if a
change of control would benefit our stockholders. These terms include:
-our board of directors, without stockholder approval, may issue up to
5,000,000 shares of preferred stock on terms that they determine. This preferred
stock could be issued quickly with terms that delay or prevent the change in
control of our company, make removal of management more difficult or depress the
price of our stock;
-certain provisions of our certificate of incorporation and bylaws and of
Delaware law could delay or make more difficult a merger, tender offer or proxy
contest;
-we are subject to the anti-takeover provisions of Section 203 of the
Delaware General Corporation Law which prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business
combination is approved in a prescribed manner;
-our board of directors is "staggered" so that only a portion of its
members are elected each year;
-only our board of directors, our chairman of the board, our president or
stockholders holding a majority of our stock can call special stockholder
meetings; and
-special procedures must be followed in order for stockholders to present
proposals at stockholder meetings.
In addition, our credit facility with Silicon Valley Bank prohibits us from
engaging in a merger with or being acquired by another entity without their
consent, unless we are the surviving entity and the transaction does not
otherwise create an event of default.
Risks Pertaining to Arthur Andersen LLP
Our access to capital markets and timely financial reporting may be
impaired if we need to engage a new independent public accounting firm. On March
14, 2002, our independent public accountant, Arthur Andersen LLP, was indicted
on federal obstruction of justice charges arising from the government's
investigation of Enron. Arthur Andersen has indicated that it intends to contest
vigorously the indictment. The SEC has said that it will continue accepting
financial statements audited by Arthur Andersen, and interim financial
statements reviewed by it, so long as Arthur Andersen is able to make certain
representations to its clients. Our access to the capital markets and its
ability to make timely SEC filings could be impaired if the SEC ceases accepting
financial statements audited by Arthur Andersen, if Arthur Andersen becomes
unable to make the required representations to us or if for any other reason
Arthur Andersen is unable to perform required audit-related services for us. In
such a case, we would promptly seek to engage a new independent public
accounting firm or take such other actions as may be necessary to enable us to
maintain access to the capital markets and to timely file our financial reports.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
We are exposed to market risk from changes in interest rates. Our
investment policy restricts us to investing only in investment-grade securities.
A failure of these investment securities to perform at their historical levels
could reduce the interest income realized by us. We have cash flow exposure to
changing interest rates on our borrowings against our equipment financing line
at variable interest rates. Any borrowings under our credit facility are also
sensitive to changes in interest rates. As of December 31, 2001, we had $1.7
million outstanding under our accounts receivable-based credit facility and
$376,000 outstanding under our equipment financing facility (see Note 2 of Notes
to Consolidated Financial Statements). The estimated fair value of such debt is
also subject to market risk. As of December 31, 2001, the fair value of our
long-term debt did not differ materially from its carrying value.
Item 8. Financial Statements and Supplementary Data.
The information required by Item 8 of Part II is incorporated herein by
reference to the Consolidated Financial Statements and financial statement
schedule filed with this report; see Item 14 of Part IV.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Our Directors and Executive Officers.
The information required by Item 10 is hereby incorporated by reference
from the Proxy Statement for our 2002 Annual Meeting of Stockholders.
Item 11. Executive Compensation.
The information required by Item 11 is hereby incorporated by reference
from the Proxy Statement for our 2002 Annual Meeting of Stockholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by Item 12 is hereby incorporated by reference
from the Proxy Statement for our 2002 Annual Meeting of Stockholders.
Item 13. Certain Relationships and Related Transactions.
The information required by Item 13 is hereby incorporated by reference
from the Proxy Statement for our 2002 Annual Meeting of Stockholders.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Documents filed as part of the report:
(1) Report of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 2000 and 2001
Consolidated Statements of Operations for the years ended
December 31, 1999, 2000 and 2001
Consolidated Statements of Changes in Stockholders'
Equity for the years ended December 31, 1999, 2000 and 2001
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 2000 and 2001
Notes to Consolidated Financial Statements
(2) Financial Statement Schedule
(3) Exhibits
The following exhibits are filed or incorporated by reference as stated below:
Exhibit Number Description
3.1 Amended and Restated Certificate of Incorporation of the Company
3.1.1 Certificate of Amendment to Amended and Restated Certificate of Incorporation
3.2 Restated By-Laws of the Company.
10.1 1994 Stock Option Plan.
10.2 1997 Omnibus Stock Plan, as amended.
10.3 * Amended and Restated 1997 Directors' Stock Option Plan.
10.4 !! 2000 Stock Incentive Plan, as amended.
10.5 *t Reseller/Integration Agreement, dated August 29, 1997, by and between the Company and
MCI Telecommunications Corporation.
10.5.1$$$tt Second Amendment, dated November 4, 1998, to the Reseller/Integration Agreement between
the Company and MCI Telecommunications Corporation (relating to Exhibit 10.5).
10.6 ****tt Master Purchase of Equipment and Services Agreement, dated as of May 22, 2000, between
Sprint/United Management Company and the Company.
10.7 *t General Agreement for the Procurement of Equipment, Services and Supplies, dated
November 26, 1997, between the Company and AT&T Corp.
10.8 * Lease Agreement, dated December 12, 1996, by and between the Company and The Equitable
Life Assurance Society of the United States.
10.8.1 * Lease Amendment, dated September 2, 1997, by and between the Company and The Equitable
Life Assurance Society of The United States (related to Exhibit 10.8).
10.8.2 $$$ Second Lease Amendment, dated February 8, 1999, by and between the Company and TA/Western,
LLC, successor to The Equitable Life Assurance Society of The United States
(relating to Exhibit 10.8).
10.8.3 *** Third Lease Amendment, dated January 10, 2000, by and between the Company and TA/ Western,
LLC (relating to Exhibit 10.8).
10.8.4 !! Fourth Lease Amendment, dated May 17, 2000, by and between the Company and TA/ Western,
LLC (relating to Exhibit 10.8).
10.10 * Employment Agreement, dated December 15, 1994, by and between the Company and Scott
E. Stouffer, as amended.
10.11 !! Lease Agreement, dated April 7, 2000, by and between Visual Networks, Inc. and TA/ Western, LLC.
10.12 * Terms of Employment, dated June 11, 1997, by and between the Company and Peter J. Minihane, as amended.
10.17 ** Net2Net 1994 Stock Option Plan.
10.20 $$ 1999 Employee Stock Purchase Plan, as amended April 11, 2001.
10.22 % Inverse Network Technology 1996 Stock Option Plan.
10.23 !! Avesta Technologies 1996 Stock Option Plan.
10.24 **** Loan and Security Agreement, dated February 28, 2001, by and between Silicon Valley Bank and the Company.
10.24.1 !!! First Loan Modification to the Loan and Security Agreement, dated May 24, 2001 (related to Exhibit 10.24).
10.24.2 Second Loan Modification to the Loan and Security Agreement, dated December 20, 2001
(related to Exhibit 10.24).
10.25 **** Accounts Receivable Financing Agreement dated February 28, 2001, by and between Silicon Valley Bank and
the Company.
10.25.1 !!! First Loan Modification to the Accounts Receivable Financing Agreement, dated May 24, 2001
(related to Exhibit 10.25).
10.25.2 Second Loan Modification to the Accounts Receivable Financing Agreement, dated December 20, 2001
(related to Exhibit 10.25).
10.25.3 Third Loan Modification to the Accounts Receivable Financing Agreement, dated February 28, 2002
(related to Exhibit 10.25).
10.26 **** Intellectual Property Security Agreement dated February 28, 2001, by and between Silicon Valley Bank
and the Company.
10.28 !!! Employment Agreement, dated May 3, 2001, by and between the Company and Elton King.
10.29 !!! Nonstatutory Stock Option Grant Agreement, dated May 3, 2001, by and between the Company and Elton King.
10.30 !!! Terms of Employment, dated July 27, 2000, by and between the Company and Steve Hindman.
10.31 Terms of Employment, dated October 23, 2001 by and between the Company and John Saunders.
10.32 Consulting Agreement, dated February 16, 2002, by and between the Company and Peter J. Minihane.
21.1 **** List of subsidiaries of the Company.
23.1 Consent of Arthur Andersen LLP.
24.1 Powers of Attorney (included in signature pages).
99.1 Letter regarding Arthur Andersen as our Independent Public Accountants.
* Incorporated herein by reference to the Company's Registration Statement on Form S-1, No. 333-41517.
** Incorporated herein by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-8,
No. 333-53153.
*** Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended
December 31, 1999.
**** Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended
December 31, 2000.
% Incorporated herein by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-8,
No. 333-88719.
@ Incorporated herein by reference to the Company's Registration Statement on Form S-4, No. 333-33946.
$ Incorporated herein by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q
for the three months ended June 30, 1999.
$$ Incorporated herein by reference to the Company's Definitive Proxy Statement on Schedule 14A filed
April 30, 2001.
$$$ Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998.
t Portions of this Exhibit were omitted and have been filed separately with the Secretary of the
Commission pursuant to the Company's Application Requesting Confidential Treatment under Rule 406
of the Securities Act, filed on December 22, 1997, January 28, 1998 and February 4, 1998.
tt Portion's of this Exhibit were omitted and have been filed separately with the Secretary of the
Commission pursuant to the Company's Application Requesting Confidential Treatment under Rule 24b-2
of the Securities Exchange Act.
!! Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the three months
ended June 30, 2000.
!!! Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the three months
ended June 30, 2001.
(b) Reports on Form 8-K
None.
(c) Exhibits
The exhibits required by this Item are listed under Item 14(a)(3).
(d) Financial Statement Schedules
The consolidated financial statement schedules required by the Item are listed
under Item 14(a)(2).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Company has duly caused this Report to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Rockville, Maryland, on the 1st day of April, 2002.
VISUAL NETWORKS,INC.
By: /s/ JOHN H. SAUNDERS
________________________________________
John H. Saunders
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed below by the following persons in the
capacities and on the date indicated.
Each person whose signature appears below in so signing also makes,
constitutes and appoints Elton R. King, John H. Saunders and Nancy A. Spangler,
and each of them acting alone, his true and lawful attorney-in-fact, with full
power of substitution, for him in any and all capacities, to execute and cause
to be filed with the Securities and Exchange Commission any and all amendments
to this Report, with exhibits thereto and other documents in connection
therewith, and hereby ratifies and confirms all that said attorney-in-fact or
his substitute or substitutes may do or cause to be done by virtue hereof.
Signature Title Date
--------- ----- ----
/s/ ELTON R. KING President and Chief 4/01/02
Elton R. King Executive Officer, Director
/s/ SCOTT E. STOUFFER Chairman of the Board 4/01/02
Scott E. Stouffer of Directors
/s/ MARC F. BENSON Director 4/01/02
Marc F. Benson
/s/ GEORGE MICHAEL CASSITY Director 4/01/02
George Michael Cassity
/s/ TED MCCOURTNEY Director 4/01/02
Ted McCourtney
/s/ PETER J. MINIHANE Director 4/01/02
Peter J. Minihane
/s/ WILLIAM J. SMITH Director 4/01/02
William J. Smith
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 2000 and 2001
Consolidated Statements of Operations for the years ended
December 31, 1999, 2000 and 2001
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
for the years ended December 31, 1999, 2000 and 2001
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 2000 and 2001
Notes to Consolidated Financial Statements
Financial Statement Schedule
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Visual Networks, Inc.:
We have audited the accompanying consolidated balance sheets of Visual
Networks, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2000
and 2001, and the related consolidated statements of operations, changes in
stockholders' equity (deficit) and cash flows for each of the three years in the
period ended December 31, 2001. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Visual Networks, Inc. and
subsidiaries as of December 31, 2000 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and are not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audits of the basic financial statements and, in our opinion, fairly
states, in all material respects, the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Vienna, Virginia
March 27, 2002
VISUAL NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
December 31,
2000 2001
---- ----
Assets
Current assets:
Cash and cash equivalents .......................... $ 17,369 $ 5,921
Restricted short-term investments .................. ------- 2,503
Short-term investments ............................. 3,700 --------
Accounts receivable, net of allowance of $1,103
and $554, respectively ........................... 7,615 7,488
Inventory .......................................... 13,474 5,768
Other current assets ............................... 3,089 1,161
----- --------
Total current assets ....................... 45,247 22,841
Property and equipment, net .......................... 10,738 6,061
Intangible assets .................................... 8,510 --
Restricted investments ............................... 5,037 --
Other assets ......................................... 4,525 --
----- --------
Total assets ............................... $ 74,057 $ 28,902
========= =========
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable and accrued expenses .............. $ 29,354 $ 11,723
Deferred revenue ................................... 17,769 11,782
Customer deposits .................................. -- 3,588
Line of credit ..................................... -- 1,663
Current portion of long-term debt .................. 606 661
------ ------
Total current liabilities .................. 47,729 29,417
Long-term debt, net of current portion ............... 243 --
------ ------
Total liabilities .......................... 47,972 29,417
------ ------
Commitments and contingencies (Note 9)
Stockholders' equity (deficit):
Common stock, $.01 par value; 200,000,000 shares
authorized, 31,296,383 and 31,915,752 shares
issued and outstanding, respectively ............ 313 319
Additional paid-in capital ......................... 473,108 473,132
Deferred compensation .............................. (402) (80)
Accumulated other comprehensive income ............. 11 21
Accumulated deficit ................................ (446,945) (473,907)
-------- --------
Total stockholders' equity (deficit) ....... 26,085 (515)
-------- -------
Total liabilities and stockholders' equity . $ 74,057 $ 28,902
(deficit) .................................. ========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
VISUAL NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years Ended December 31,
1999 2000 2001
---- ---- ----
Revenue ........................................ $ 91,719 $ 89,041 $ 74,248
Cost of revenue ................................ 30,888 32,515 29,431
------ ------ ------
Gross profit ................................. 60,831 56,526 44,817
------ ------ ------
Operating expenses:
Research and development ..................... 16,677 27,277 19,320
Write-off of in-process research and
development ................................. -- 39,000 --
Sales and marketing .......................... 24,447 41,907 33,484
General and administrative ................... 7,928 11,247 8,895
Merger-related costs ......................... 6,776 -- --
Restructuring and impairment charges ......... -- 335,810 9,328
Amortization of goodwill and other intangibles -- 53,426 805
------ -------- ------
Total operating expenses .................. 55,828 508,667 71,832
Income (loss) from operations .................. 5,003 (452,141) (27,015)
----- -------- -------
Interest income, net ........................... 2,270 2,598 325
-------- -------- ------
Income (loss) before income taxes .............. 7,273 (449,543) (26,690)
Benefit (provision) for income taxes ........... (3,722) 34,058 (272)
-------- -------- ------
Net income (loss) .............................. 3,551 (415,485) (26,962)
======== ========== ==========
Basic income (loss) per share .................. 0.14 (14.46) (0.85)
======== ========== ==========
Diluted income (loss) per share ................ 0.13 (14.46) (0.85)
======= ========== ==========
Basic weighted-average shares outstanding ...... 24,583 28,733 31,585
======= ========== ==========
Diluted weighted-average shares outstanding .... 26,547 28,733 31,585
========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
VISUAL NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share data)
Notes
Additional Receivable
Paid-in from
Common Stock Capital Stockholders
Shares Amount
Balance, December 31, 1998 .................... 24,190,219 $ 242 $ 83,977 $ (147)
Exercise of stock options and
warrants ................................. 699,266 7 2,047 -
Income tax benefit from exercise of .........
stock options - - 3,722 -
Issuance of common stock under
employee stock purchase plan .............. 4,182 - 132 -
Repurchase of common stock .................. (60,058) (1) - -
Repayment of shareholder notes .............. - - - 147
Deferred compensation ....................... - - 291 -
Amortization of deferred compensation ....... - - - -
Net income .................................. - - - -
Balance, December 31, 1999 .................... 24,833,609 248 90,169 -
Issuance of common stock options
and warrants in acquisition................ 5,413,530 54 378,793 -
Exercise of stock options and
warrants .................................. 866,366 9 3,173 -
Issuance of common stock under
employee stock purchase plan .............. 182,878 2 1,047 -
Deferred compensation adjustments ........... - - (74) -
Amortization of deferred
compensation ............................. - - - -
Foreign currency translation
adjustment ............................... - - - -
Net loss .................................... - - - -
Balance, December 31, 2000 .................... 31,296,383 313 473,108 -
Return of shares in settlement of
indemnification claims related to acquisition (134,000) 1 (989) -
Exercise of stock options and warrants ...... 435,091 4 520 -
Issuance of common stock under
employee stock purchase plan .............. 337,675 3 746 -
Repurchase of common stock .................. (19,397) - (11) -
Deferred compensation adjustments ........... - - (242) -
Amortization of deferred
compensation .............................. - - - -
Foreign currency translation
adjustment ................................ - - - -
Net loss .................................... - - - -
Balance, December 31, 2001..................... 31,915,752 $ 319 $ 473,132 $ -
========== ========= ============ ===========
Accumulated
Other
Deferred Comprehensive Accumulated Total
Compensation Income Deficit
------------ -------------- ----------- -------
Balance, December 31, 1998 .................... $ (739) $ - $(35,011) $ 48,322
Exercise of stock options and
warrants ................................. - - - 2,054
Income tax benefit from exercise
of stock options............................ - - - 3,722
Issuance of common stock under
employee stock purchase plan .............. - - - 132
Repurchase of common stock .................. - - - (1)
Repayment of shareholder notes .............. - - - 147
Deferred compensation ....................... (291) - - -
Amortization of deferred
compensation .............................. 325 - - 325
Net income .................................. - - 3,551 3,551
Balance, December 31, 1999 .................... (705) - (31,460) 58,252
Issuance of common stock,
options and warrants in acquisition.......... - - - 378,847
Exercise of stock options and
warrants .................................. - - - 3,182
Issuance of common stock under
employee stock purchase plan .............. - - - 1,049
Deferred compensation adjustments ........... 74 - - -
Amortization of deferred
compensation ............................. 229 - - 229
Foreign currency translation
adjustment ............................... - 11 - 11
Net loss .................................... - - (415,485) (415,485)
Balance, December 31, 2000 .................... (402) 11 (446,945) 26,085
Return of shares in settlement of
indemnification claims related to acquisition - - - (990)
Exercise of stock options and warrants ...... - - - 524
Issuance of common stock under
employee stock purchase plan .............. - - - 749
Repurchase of common stock .................. - - - (11)
Deferred compensation adjustments ........... 242 - - -
Amortization of deferred
compensation .............................. 80 - - 80
Foreign currency translation
adjustment ................................ - 10 - 10
Net loss .................................... - - (26,962) (26,962)
Balance, December 31, 2001........... $ (80) $ 21 $ (473,907) $ (515)
=========== =========== ============ =============
The accompanying notes are an integral part of these consolidated financial statements.
VISUAL NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended December 31,
1999 2000 2001
---- ---- ----
Cash Flows from Operating Activities:
Net income (loss)......................................... $ 3,551 $ (415,485) $ (26,962)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization........................... 4,033 59,666 5,657
Write-off of purchased research and development......... - 39,000 -
Non-cash restructuring and impairment charges........... - 329,910 8,203
Deferred taxes.......................................... - (34,058) -
Changes in assets and liabilities:
Accounts receivable.................................. (3,426) 5,152 127
Inventory............................................ (2,912) (5,476) 7,706
Other assets......................................... (312) (113) 2,185
Accounts payable and accrued expenses................ 6,235 8,312 (16,094)
Deferred revenue..................................... 3,841 (3,834) (4,155)
Customer deposits.................................... (4,613) - 3,588
Net cash provided by (used in) operating activities..... 6,397 (16,926) (19,745)
Cash Flows from Investing Activities:
Net (purchases) sales/maturities of short-term
investments.......................................... 1,002 (3,145) 6,234
Proceeds from sale leaseback transactions............... 750 - -
Expenditures for property and equipment................. (5,828) (7,623) (692)
Investment in joint venture............................. - (797) -
Merger-related transaction costs, net of cash acquired.. - (10,234) -
Net cash provided by (used in) investing activities..... (4,076) (21,799) 5,542
Cash Flows from Financing Activities:
Exercise of stock options and warrants and employee
stock purchase plan, net of stock repurchases.......... 2,185 4,231 1,262
Repayments of notes receivable from stockholders........ 147 - -
Net borrowings (repayments) under credit agreements..... (1,079) (1,658) 2,039
Principal payments on capital lease obligations......... (600) (1,119) (564)
Net cash provided by financing activities............... 653 1,454 2,737
Effect of exchange rate changes........................... - 11 18
Net Increase (Decrease) in Cash and Cash Equivalents...... 2,974 (37,260) (11,448)
Cash and Cash Equivalents, Beginning of Year.............. 51,655 54,629 17,369
Cash and Cash Equivalents, End of Year.................... $54,629 $ 17,369 $ 5,921
====== ====== =====
Supplemental Cash Flow Information:
Cash paid for income taxes.............................. $ 18 $ 9 $ 22
====== ====== =====
Cash paid for interest.................................. $ 232 $ 211 $ 199
====== ====== =====
Supplemental Disclosure of Non-Cash Investing and
Financing Activities:
Issuance of common stock, options and warrants in
acquisition.......................................... $ - $ 378,847 $ -
======= ======= =======
Return of shares in settlement of indemnification
claims related to acquisition........................ $ - - $ (990)
======= $ ======== ======
The accompanying notes are an integral part of these consolidated financial statements.
VISUAL NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Operations and Summary of Significant Accounting Policies:
Visual Networks, Inc. ("Visual" or the "Company") designs, manufactures,
sells and supports comprehensive service management systems for providers and
users of new world connectivity services and out-sourced Web services.
Risks and Other Important Factors
The Company incurred net losses of $415.5 million and $27.0 million for the
years ended December 31, 2000 and 2001, respectively. The deterioration of the
operating results in 2000, excluding the effects of the impairment and
restructuring charges and the write-off of in-process research and development
("IPR&D"), was due primarily to decreased revenue and increased operating
expenses compared to 1999. In response to these results, the Company made
significant reductions in operating expenses in 2001. Excluding the effects of
the impairment and restructuring charges, amortization of intangible assets and
the write-off of IPR&D, operating expenses decreased from $80.4 million in 2000
to $61.7 million in 2001. However, revenue declined from $89.0 million in 2000
to $74.2 million in 2001. The Company's ability to generate operating income in
the future is, in large part, dependent on its success in sustaining revenue and
reducing operating expenses. Due to market conditions, competitive pressures,
and other factors beyond its control, there can be no assurances that the
Company will be able to adequately sustain revenue in the future. The Company
believes that it has reduced operating expenses to a sufficient level such that
when combined with the anticipated revenue, the Company will return to
profitability. In the event that the anticipated cost reductions are not
realized or revenue goals are not met, the Company may be required to further
reduce its cost structure. There can be no assurance that the Company will
become profitable.
The success of the Company is also dependent on its ability to generate
adequate cash for operating and capital needs. The Company is relying on its
existing cash and cash equivalents, investments and the net proceeds from the
issuance of the convertible debentures (see Note 10), together with future sales
and the collection of the related accounts receivable to meet its future cash
requirements. If cash provided by these sources is not sufficient to fund future
operations, the Company will be required to further reduce its expenditures for
operations or to seek additional capital through other means which may include
the sale of assets, the sale of equity securities or additional borrowings.
There can be no assurances that additional capital will be available, or
available on terms that are reasonable or acceptable to the Company.
The Company's operations are subject to certain other risks and
uncertainties, including among others, dependence on major service provider
customers, successful incorporation of the Company's products into service
providers' infrastructures, long sales cycle, changes in the market's acceptance
of and demand for the Company's products, rapidly changing technology, current
and potential competitors with greater financial, technological, production, and
marketing resources, changes in the telecommunications industry including
consolidation and break-up of significant customers, dependence on sole and
limited source suppliers, limited protection of intellectual property and
proprietary rights, dependence on key management personnel, ability to recruit
and retain employees, defense against pending litigation, and uncertainty of
future profitability and possible fluctuations in financial results.
Business Combinations and Basis of Presentation
On September 30, 1999, Visual acquired Inverse Network Technology
("Inverse") in a merger transaction accounted for as a pooling of interests.
Inverse was a provider of service level management software solutions and
Internet measurement services. Visual issued 4,096,429 shares of its common
stock in exchange for all of the outstanding preferred and common stock of
Inverse. In addition, outstanding Inverse stock options and warrants were
converted into options and warrants to purchase 425,088 shares of Visual common
stock. In connection with the Inverse acquisition, the Company recorded
merger-related transaction costs of approximately $6.8 million that consisted
primarily of fees for investment bankers, attorneys, and accountants.
The accompanying consolidated financial statements have been retroactively
restated to reflect the combined financial position and combined results of
operations and cash flows for all periods presented, giving effect to the
acquisition of Inverse as if it had occurred at the beginning of the earliest
period presented.
Results of operations for the separate and combined companies prior to the
pooling transaction are as follows (in thousands):
Six Months Ended
June 30, 1999
-------------
(unaudited)
Revenue:
Visual.......... $36,005
Inverse......... 3,793
$39,798
=======
Net Income (Loss):
Visual.......... $ 6,178
Inverse......... (5,074)
$ 1,104
=======
On May 24, 2000, Visual acquired Avesta Technologies, Inc. ("Avesta") in a
merger transaction accounted for using the purchase method of accounting. Avesta
was a provider of fault management and application performance monitoring
software systems to e-business customers (see Note 5). The results of operations
of Avesta have been included in the accompanying consolidated statements of
operations from the date of acquisition (hereafter, Visual, Inverse and Avesta
are collectively referred to as the "Company").
Principles of Consolidation
The consolidated financial statements include the accounts of Visual
Networks, Inc. and its wholly owned subsidiaries. All significant intercompany
account balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid instruments with an original
maturity of three months or less at the time of purchase to be cash equivalents.
The Company maintains its cash and cash equivalents with high credit quality
financial institutions. The Company's cash equivalents as of December 31, 2000
consistd primarily of investments in money market funds that invest in U.S.
Treasury obligations, repurchase agreements collateralized by U.S. Treasury
securities, and high quality corporate obligations. The Company had
approximately $10.8 million invested in money market funds as of December 31,
2000. The Company did not have any cash equivalents as of December 31, 2001
Investments
Investments in marketable securities are classified as available-for-sale
and are reported at fair value in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The fair values are based on quoted market prices.
Unrealized gains and losses on marketable securities are reported as a separate
component of comprehensive income, if significant. As of December 31, 2000, the
Company held short-term investments in U.S. Treasury obligations maturing within
one year. The Company also held a $5.0 million certificate of deposit related to
a letter of credit issued to its contract manufacturer that was included as a
restricted investment in the accompanying consolidated balance sheet as of
December 31, 2000. During 2001, the certificate of deposit was reduced to $2.5
million; it matures on October 31, 2002. The certificate of deposit has been
included as a restricted short-term investment in the accompanying consolidated
balance sheet as of December 31, 2001. As of December 31, 2000 and 2001,
unrealized gains and losses were not material.
As of December 31, 2000, the Company had an investment in an entity,
accounted for using the equity method of accounting, in which the Company had
less than a majority ownership interest but over which the Company could
exercise significant influence. The carrying value of this investment of
$747,000 was included in other assets in the accompanying consolidated balance
sheet as of December 31, 2000. The entity was established as a distributor for
the Visual Trinity product but the Company did not have any sales to the entity.
As a result of the Company's announcement to discontinue development and sales
efforts on the Visual Trinity product, the Company wrote-off the remaining
carrying value of $656,000 during the three months ended June 30, 2001. During
the fourth quarter of 2001, the Company completed a settlement agreement with
the entity and other partner whereby the Company forfeited its ownership
interest in the entity for no consideration. The write-off is included in the
restructuring and impairment charge in the accompanying consolidated statement
of operations for the year ended December 31, 2001.
The Company also has an investment in an entity in which the Company
exercises no control or significant influence. Such investment was accounted for
under the cost method and its carrying value of approximately $3.7 million was
included in other assets in the accompanying consolidated balance sheet as of
December 31, 2000. The Company reviewed the carrying value of this investment
for impairment throughout 2001 and determined that there was an other than
temporary decline in the value of the investment based primarily on the
Company's assessment of the continued declining financial condition of the
entity in the fourth quarter of 2001. The Company wrote-off of the entire
balance of approximately $3.7 million. The write-off is included in the
restructuring and impairment charge in the accompanying consolidated statement
of operations for the year ended December 31, 2001.
Inventory
Inventory is stated at the lower of average cost or market, and consists of
the following (in thousands):
December 31,
2000 2001
---- ----
Raw materials... $ 4,301 $ 1,137
Work-in-progress 151 238
Finished goods.. 9,022 4,393
$ 13,474 $ 5,768
======== ========
Property and Equipment
Property and equipment is carried at cost and depreciated over its
estimated useful life, ranging from three to five years, using the straight-line
method. Equipment held under capital leases is recorded at the present value of
the future minimum lease payments and is amortized on a straight-line basis over
the shorter of the assets' useful lives or the relevant lease term, ranging from
three to seven years. Property and equipment consists of the following (in
thousands):
December 31,
2000 2001
---- ----
Equipment and software..... $ 17,480 $ 18,046
Furniture and fixtures..... 2,370 2,351
Leasehold improvements..... 2,942 2,208
------- -------
22,792 22,605
Less-Accumulated depreciation (12,054) (16,544)
$ 10,738 $ 6,061
========= =========
Intangible Assets
As of December 31, 2000, intangible assets consisted of identifiable
intangibles related to the acquisition of Avesta (see Note 5). During 2001, the
Company determined that all of the remaining intangible assets were impaired and
recorded an impairment charge to write-off the remaining balances. Intangible
assets consisted of the following (in thousands) at December 31, 2000:
Assembled workforce........ $ 224
Trademarks/trade names..... 1,064
Completed technology....... 7,222
Total................. $ 8,510
=======
Long Lived Assets
In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," the Company
reviews its long-lived assets, including property and equipment, identifiable
intangibles and goodwill, whenever events or changes in circumstances indicate
that the carrying amount of the assets may not be fully recoverable. To
determine recoverability of its long-lived assets, the Company evaluates the
probability that future estimated undiscounted net cash flows will be less than
the carrying amount of the assets. If future estimated undiscounted net cash
flows are more likely than not to be less than the carrying amount of the
long-lived assets, then such assets are written down to their fair value. The
Company recorded an impairment charge of $328.8 million in the fourth quarter of
2000. This charge included $203.2 million related to goodwill, which represented
the entire remaining unamortized balance, and $125.6 million related to the
other acquired intangibles including the completed technology, the assembled
workforce and the trademarks/trade names related to the Avesta acquisition. The
Company also recorded impairment charges of $3.3 million during 2001. The
impairment charge related to the remaining acquired intangibles from the Avesta
acquisition and resulted from the discontinuation of the Visual Trinity product
and the Company's plans to combine certain functionality of the Visual eWatcher
product with the Visual IP InSight product (see Notes 5 and 6). The impairment
charges for the years ended December 31, 2000 and 2001 are included in the
restructuring and impairment charge in the accompanying consolidated statements
of operations. The Company's estimates of anticipated revenue and profits and
the remaining estimated lives of long-lived assets, could be reduced
significantly in the future. As a result, the carrying amount of long-lived
assets could be reduced in the future.
Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following (in thousands):
December 31,
2000 2001
---- ----
Accounts payable..... $ 4,391 $ 2,644
Accrued compensation. 6,936 1,794
Accrued restructuring 4,306 1,421
Other accrued expenses 13,721 5,864
$29,354 $11,723
======= =======
Revenue Recognition
The Company's service management products and services include hardware,
software, benchmark services, professional services and technical support. The
Company generally recognizes revenue from the sale or license of its products
upon delivery and passage of title to the customer. Where agreements provide for
evaluation or customer acceptance, the Company recognizes revenue upon the
completion of the evaluation process and acceptance of the product by the
customer. Revenue from multiple-element software arrangements is recognized
using the residual method whereby the fair value of any undelivered elements,
such as customer support and services, is deferred and any residual value is
allocated to the software and recognized as revenue upon delivery and passage of
title. The fair values of professional services, technical support and training
have been determined based on the Company's specific objective evidence of fair
value. Maintenance contracts require the Company to provide technical support
and software updates to customers. The Company recognizes technical support
revenue, including maintenance revenue that is bundled with product sales,
ratably over the term of the contract period, which generally ranges from one to
five years. Revenue from services is recognized when the services are performed.
Subscription fees for the Company's benchmark reports are recognized upon
delivery of the reports.
The Company examines the specific facts and circumstances of all sales
arrangements with payment terms extending beyond its normal payment terms to
make a determination of whether the sales price is fixed and determinable. In
the year ended December 31, 2001, the Company recognized software license
revenue of approximately $2.6 million on new arrangements with previously
existing customers that contain payment terms beyond the normal payment terms.
Payments become due under these arrangements through July 2002. As of March
2002, all scheduled payments had been made in accordance with the terms of the
relevant arrangements.
The Company has agreements with certain service providers that provide
price protection in the event that more favorable prices and terms are granted
to any other customer. When required, reserves for estimated price protection
credits are established by the Company concurrently with the recognition of
revenue. The Company monitors the factors that influence the pricing of its
products and service provider inventory levels and makes adjustments to these
reserves when management believes that actual price protection credits may
differ from established estimates.
In May 2001, the Company announced the release of the discontinuance the
Visual Trinity product. This product was the primary product acquired with
Avesta, and the Company does not plan to continue development efforts on the
Visual Trinity product. As a result, future revenue related to this product will
consist primarily of technical support revenue, all of which is currently
included in deferred revenue. The Company plans to provide technical support for
the Visual Trinity product through September 2002.
In June 2001, the Company announced the sale of the Visual Internet
Benchmark product. The Company will continue to recognize revenue from the
Visual Internet Benchmark product for existing contracts, under which the
Company is still required to perform services. The Company will receive royalty
payments from the purchaser on new contracts.
Credit Risk and Significant Customers
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents,
investments and accounts receivable. The Company generally sells its products to
large telecommunications and Internet service providers' companies primarily in
the United States. The Company grants credit terms without collateral to its
customers and has not experienced any significant credit related losses.
Accounts receivable include allowances to record receivables at their estimated
net realizable value. For the year ended December 31, 1999, two customers each
represented 25% of revenue. For the year ended December 31, 2000, three
customers individually represented 20%, 18% and 14% of revenue. For the year
ended December 31, 2001, three customers individually represented 29%, 14% and
10% of revenue. As of December 31, 2000, three customers individually
represented 29%, 13% and 11% of accounts receivable. As of December 31, 2001,
three customers individually represented 24%, 17% and 15% of accounts
receivable. As of December 31, 2000 and 2001, the Company had approximately $1.8
million in accounts receivable balances that were also included in deferred
revenue.
Warranty
The Company warrants its hardware products for periods of up to five years.
Estimated warranty costs are charged to cost of revenue in the period in which
revenue from the related product sale is recognized.
Research and Development
Research and development costs are expensed as incurred.
The Company accounts for software development costs in accordance with SFAS
No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed." Costs incurred prior to establishment of technological
feasibility are expensed as incurred and reflected as research and development
costs in the accompanying consolidated statements of operations. For the years
ended December 31, 1999, 2000 and 2001, the Company did not capitalize any costs
related to software development. During these periods, the time between the
establishment of technological feasibility and general release of products was
very short. Consequently, costs otherwise capitalizable after technological
feasibility were expensed as they were immaterial.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Under SFAS No. 109, deferred tax assets and
liabilities are computed based on the difference between the financial statement
and income tax bases of assets and liabilities using the enacted marginal tax
rate. SFAS No. 109 requires that the net deferred tax asset be reduced by a
valuation allowance if, based on the weight of available evidence, it is more
likely than not that some portion or all of the net deferred tax asset will not
be realized.
Fair Value of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosures of fair value information about financial instruments,
whether or not recognized in the consolidated balance sheet, for which it is
practicable to estimate that value. In cases where quoted market prices are not
available, fair values are based on estimates of future cash flows. In that
regard, the derived fair value estimates cannot be substantiated by comparison
to independent markets and, in many cases, could not be realized in immediate
settlement of the instrument. The carrying values of current assets and current
liabilities approximate fair value because of the relatively short maturities of
these instruments. The fair value of the Company's long-term debt, which was
comprised of capital leases as of December 31, 2000, is estimated using a
discounted cash flow analysis based on the Company's borrowing cost for similar
credit facilities. The Company estimates that as of December 31, 2000, the fair
value of its long-term debt did not differ materially from its carrying value.
During 2001, the Company also had borrowings under its equipment financing
facility that were classified as long-term debt. The Company paid off the
balance of $376,000 subsequent to year-end and therefore, these amounts are
classified as current in the accompanying consolidated balance sheet as of
December 31, 2001.
Foreign Currency and International Operations
The functional currency of one of the Company's subsidiaries is the local
currency. The financial statements of this subsidiary are translated to U.S.
dollars using period-end rates for assets and liabilities and average rates
during the relevant period for revenue and expenses. Translation gains and
losses are accumulated as a component of other comprehensive income in
stockholders' equity (deficit). Such gains and losses have not been material.
Comprehensive Income
The Company reports comprehensive income in accordance with SFAS No. 130,
"Reporting Comprehensive Income," which establishes rules for the reporting and
display of comprehensive income and its components. SFAS No. 130 requires
foreign currency translation adjustments and the unrealized gains and losses on
marketable securities to be included in other comprehensive income. Because the
Company has not had any significant components of other comprehensive income,
the reported net income (loss) does not differ materially from comprehensive
income (loss) for the years ended December 31, 1999, 2000 and 2001.
Segment Reporting
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information," establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that these enterprises report selected information about operating
segments in interim financial reports. SFAS 131 also establishes standards for
related disclosures about products and services, geographic areas and major
customers. The revenue and assets of the Company's foreign subsidiaries have not
been significant. Management has concluded that the Company's operations occur
in one segment only based upon the information used by management in evaluating
the performance of the business.
The following table presents the Company's revenue by product (in thousands):
Years Ended December 31,
1999 2000 2001
---- ---- ----
Visual UpTime....................... $ 78,490 $ 59,754 $ 55,557
Visual Cell Tracer.................. 6,056 7,946 2,980
Visual IP InSight................... 4,557 9,466 8,095
------- ------- -------
Continuing products........... 89,103 77,166 66,632
Visual Internet Benchmark........... 2,616 4,607 4,025
Visual Trinity and eWatcher......... - 7,268 3,591
Discontinued products..... 2,616 11,875 7,616
Total revenue............ $ 91,719 $ 89,041 $ 74,248
======== ======== ========
Basic and Diluted Earnings (Loss) Per Share
SFAS No. 128, "Earnings Per Share," requires dual presentation of basic and
diluted earnings per share. Basic earnings (loss) per share includes no dilution
and is computed by dividing net income (loss) available to common stockholders
by the weighted-average number of common shares outstanding for the period.
Diluted earnings (loss) per share includes the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. The treasury stock effect of options
to purchase 3,953,444 shares of common stock that were outstanding as of
December 31, 1999 was included in the computation of diluted earnings per share
for the year ended December 31, 1999. Options and warrants to purchase 3,121,313
and 8,613,245 shares of common stock that were outstanding at December 31, 2000
and December 31, 2001, respectively, were not included in the computation of
diluted loss per share as their effect would be anti-dilutive.
The following details the computation of the income (loss) per share (in
thousands, except per share data):
Years Ended December 31,
1999 2000 2001
---- ---- ----
Net income (loss) ...................... $ 3,551 $ (415,485) $ (26,962)
======= ========== ==========
Weighted-average share calculation:
Basic weighted-average shares outstanding:
Average number of shares of common stock
outstanding........................ 24,583 28,733 31,585
Diluted weighted-average shares
outstanding:
Treasury stock effect of options and
warrants........................... 1,964 - -
Diluted weighted-average shares
outstanding............................. 26,547 28,733 31,585
====== ====== ======
Earnings (loss) per common share:
Basic earnings (loss) per share....... $ 0.14 $ (14.46) $ (0.85)
==== ====== =====
Diluted earnings (loss) per share..... $ 0.13 $ (14.46) $ (0.85)
==== ====== =====
Reclassifications
Certain reclassifications have been made in the 1999 and 2000 financial
statements to conform to the 2001 presentation.
New Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 prospectively
prohibits the pooling of interest method of accounting for business combinations
initiated after June 30, 2001. SFAS No. 142 requires companies to cease
amortizing goodwill on December 31, 2001 that existed at June 30, 2001. Any
goodwill resulting from acquisitions completed after June 30, 2001 will not be
amortized. SFAS No. 142 also establishes a new method of testing goodwill for
impairment on an annual basis or on an interim basis if an event occurs or
circumstances change that would reduce the fair value of a reporting unit below
its carrying value. The Company did not have any outstanding goodwill or other
intangibles as of December 31, 2001. Therefore, the Company does not believe
that SFAS No. 142 will have a material effect on the Company's financial
position or results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." It requires an entity to recognize the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred if a reasonable estimate of fair value can be made. If a reasonable
estimate of fair value cannot be made in the period the asset retirement
obligation is incurred, the liability shall be recognized when a reasonable
estimate of fair value can be made. This new standard is effective in the first
quarter of 2003. The Company does not believe that SFAS No. 143 will have a
material effect on the Company's financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." Though it retains the basic requirements of SFAS No. 121
regarding when and how to measure impairment loss, SFAS No. 144 provides
additional implementation guidance. SFAS No. 144 is effective in the first
quarter of 2002. The Company does not believe that SFAS No. 144 will have a
material effect on the Company's financial position or results of operations.
2. Credit Agreements and Long-Term Debt:
During 2000 and 2001, the Company had a credit facility, as amended, that
included an accounts receivable-based arrangement providing for borrowings up to
the lesser of $10.0 million or 80% of eligible accounts receivable (as defined
in the credit facility and determined by the bank) with a maximum of $5.0
million available for issuing standby letters of credit, provided that the
Company either maintain a minimum of $10.0 million cash on deposit with the
bank, secure with cash any outstanding letters of credit, or treat any unsecured
letters of credit as borrowings. In December 2000, the bank issued a standby
letter of credit, as amended, that expires on September 30, 2002 in the amount
of $2.5 million. The Company secured the letter of credit with a pledge of a
certificate of deposit in an original amount of $5.0 million that was recorded
as a restricted investment as of December 31, 2000. The certificate of deposit
was reduced to $2.5 million in 2001, which is recorded as a restricted
short-term investment in the accompanying consolidated balance sheet as of
December 31, 2001 . The bank credit facility also included an equipment
financing facility. During 2001, the Company borrowed approximately $451,000
under the equipment financing facility, of which $376,000 was outstanding as of
December 31, 2001. The borrowing is repayable over 36 months beginning in July
2001 at an interest rate of prime plus 2%, or 6.75% at December 31, 2001. As of
December 31, 2001, the Company also had approximately $1.7 million outstanding
at an interest rate of 6.75% for borrowings under the accounts receivable-based
arrangement. The credit facility, as amended, was anticipated to mature on April
29, 2002. In connection with the issuance of the convertible debentures (see
Note 10), the outstanding amounts borrowed from the bank under the accounts
receivable based and equipment financing arrangements were paid, and the related
loan agreements were terminated. As a result, the borrowings under the accounts
receivable based and equipment financing arrangements are classified as current
in the accompanying consolidated balance sheet as of December 31, 2001. The
standby letter of credit remains outstanding and secured with the Company's
pledge of a certificate of deposit in the amount of $2.5 million.
The credit facility contained restrictive financial covenants, including,
but not limited to, requirements related to liquidity and operating results as
well as restrictions related to other borrowings, acquisitions, dispositions of
assets, distributions and investments. In May 2001, modifications to the credit
facility were completed that revised the financial covenants and eliminated the
ability to make additional borrowings under the equipment financing arrangement.
For the third quarter of 2001, the Company's net loss, as defined, exceeded the
covenant amount permitted by the bank. The Company received a waiver of the
noncompliance from the bank, and the bank agreed to reduce the net income
covenant amount for the fourth quarter. The Company complied with all covenants,
as amended, for the fourth quarter of 2001.
Long-term debt as of December 31, 2000, consisted of capital lease
obligations (see Note 9).
3. Stockholders' Equity:
Common Stock
During the second quarter of 2000, the Board of Directors and shareholders
approved an increase in the number of authorized shares of common stock from
50,000,000 to 200,000,000.
1999 Employee Stock Purchase Plan
In May 1999, the Company adopted the 1999 Employee Stock Purchase Plan (the
"1999 Purchase Plan") which, as amended, provides for the issuance of a maximum
of 1,150,000 shares of common stock pursuant to options granted to participating
employees. All employees of the Company, except employees who own 5% or more of
the Company's common stock, whose customary employment is more than 20 hours per
week and more than five months in any calendar year are eligible to participate
in the 1999 Purchase Plan. To participate, an employee must authorize the
Company to deduct an amount, subject to certain limitations, from his or her pay
during defined six-month periods ("Option Periods"). Option Periods begin on
November 1 and May 1 of each year. In no case will an employee be entitled to
purchase more than the number of whole shares determined by dividing $12,500 by
the fair market value of the common stock on the first day of the Option Period.
The purchase price for each share of common stock purchased pursuant to an
option is 85% of the closing price of the common stock on either the first or
last trading day of the applicable Option Period, whichever price is lower. The
Company issued 4,182, 182,878 and 337,675 shares of common stock pursuant to the
provisions of the 1999 Purchase Plan during 1999, 2000 and 2001, respectively.
4. Stock Options:
Employee Stock Option Plans
The Company's employee stock option plans (the "Option Plans") authorize
the issuance of an aggregate of 12,982,291 shares of common stock pursuant to
the exercise of stock options. The Option Plans provide for grants of options to
employees, consultants, and directors of the Company. The Option Plans provide
for the granting of both incentive stock options and non-statutory options. The
Option Plans are administered by the Compensation Committee of the Board of
Directors, which has sole discretion and authority, consistent with the
provisions of the Option Plans, to determine which eligible participants will
receive options, when options will be granted, the terms of options granted, and
the number of shares that will be subject to options granted under the Option
Plans.
For any option intended to qualify as an incentive stock option, the
exercise price must not be less than 100% of the fair market value of the common
stock on the date the option is granted (110% of the fair market value of such
common stock with respect to any optionee who immediately before any option is
granted, directly or indirectly, possesses more than 10% of the total combined
voting power of all classes of stock of the Company ("10% Owners")). In the case
of non-statutory options, the exercise price may be equal to or greater than 85%
of the fair value of the common stock at the time of the grant. The Compensation
Committee has the authority to determine the time or times at which options
granted under the Option Plans become exercisable (typically up to five years);
provided that, for any option intended to qualify as an incentive stock option,
such option must expire no later than ten years from the date of grant (five
years with respect to 10% Owners). Unless terminated sooner by the Board, the
Option Plans terminate at various dates from December 2004 through December
2010 or the date on which all shares available for issuance shall have been
issued pursuant to the exercise or cancellation of options granted under the
Option Plans.
1997 Directors' Stock Option Plan
The 1997 Directors' Stock Option Plan (the "Director Plan") was adopted in
October 1997. Under the terms of the Director Plan, directors of the Company who
are not employees of the Company (the "Eligible Directors") are eligible to
receive non-statutory options to purchase shares of common stock. A total of
300,000 shares of common stock may be issued upon exercise of options granted
under the Director Plan. Unless terminated sooner by the Board of Directors, the
Director Plan will terminate in October 2007, or the date on which all shares
available for issuance under the Director Plan shall have been issued pursuant
to the exercise of options granted under the Director Plan.
Upon a member's initial election or appointment to the Board of Directors,
such member will be granted options to purchase 24,000 shares of common stock,
vesting over four years, with options to purchase 6,000 shares vesting at the
first anniversary of the grant and options to purchase the remaining 18,000
shares vesting thereafter, in 36 equal monthly installments. Annual options to
purchase 6,000 shares of common stock (the "Annual Options") will be granted to
each Eligible Director on the date of each annual meeting of stockholders.
Annual Options will vest at the rate of one-twelfth of the total grant per
month, and will vest in full at the earlier of (i) the first anniversary of the
date of the grant or (ii) the date of the next annual meeting of stockholders.
The exercise price of options granted under the Director Plan will equal the
fair market value per share of the common stock on the date of grant.
A summary of the Company's stock option activity is presented below:
Option Price Weighted-Average
Options Per Share Exercise Price
------- --------- ----------------
Options outstanding at December 31, 1998 2,600,019 $ 0.03 - $34.50 $ 6.50
Granted.............................. 2,394,873 0.06 - 59.00 31.48
Canceled............................. (345,836) 0.17 - 34.50 14.91
Exercised............................ (695,612) 0.03 - 32.25 3.27
-------- ---- ----- ----
Options outstanding at December 31, 1999 3,953,444 0.03 - 59.00 21.41
Granted.............................. 7,248,440 0.40 - 63.06 12.93
Canceled............................. (7,647,979) 0.29 - 54.45 18.64
Exercised............................ (636,326) 0.07 - 32.25 4.49
-------- ---- ----- ----
Options outstanding at December 31, 2000 2,917,579 0.03 - 63.06 11.49
Granted.............................. 8,363,039 1.85 - 7.42 4.19
Canceled............................. (2,373,510) 0.19 - 63.06 10.89
Exercised............................ (435,091) 0.19 - 3.00 1.23
-------- ---- ---- --------
Options outstanding at December 31, 2001 8,472,017 $ 0.07 - $59.00 $ 4.88
========= ====== ====== =========
As of December 31, 2001, options to purchase 2,981,278 shares of common
stock were exercisable with a weighted-average exercise price of $6.61. The
weighted-average remaining contractual life and weighted-average exercise price
of options outstanding at December 31, 2001, for selected exercise price ranges
are as follows:
Options Outstanding Options Exercisable
Weighted
Number Average Weighted- Number of Weighted-
Range of Exercise of Options Remaining Average Exercise Options Average
----------------- ---------- Contractual Price ------- Exercise Price
----------- ----- --------------
$ 0.07 - $ 1.85 396,430 4.37 $ 1.48 228,082 $ 1.22
1.90 - 1.90 1,140,601 9.67 1.90 63,234 1.90
3.00 - 3.90 761,966 6.71 3.35 232,736 3.31
3.92 - 3.92 2,101,139 9.34 3.92 613,855 3.92
4.00 - 4.07 961,698 9.34 4.02 347,396 4.02
4.19 - 4.69 1,139,357 8.93 4.49 489,116 4.40
4.72 - 6.66 1,357,069 9.39 5.96 543,593 5.97
6.70 - 35.65 587,918 7.39 16.52 431,654 18.46
38.75 - 38.75 24,000 8.39 38.75 24,000 38.75
54.45 - 54.45 1,839 7.92 54.45 1,362 54.45
$ 0.07 - $ 54.45 8,472,017 8.73 $ 4.88 2,975,078 $ 6.50
====== ====== ========= ==== ======= ========= =======
In October 2000, the Company offered each employee an opportunity to cancel
certain stock options (the "Option Trade-In") in exchange for the right to
receive a future stock option grant for the same number of shares six months and
one day from the date of cancellation with a strike price equal to the market
price on the new date of grant. Options to purchase 5,382,588 shares were
cancelled in 2000 pursuant to the Option Trade-In. Options to purchase 5,303,984
shares were granted in 2001 pursuant to the Option Trade-In. The new options
vested 20% on the grant date. The remaining 80% vests monthly over 36 months.
The Company granted the stock options as a combination of incentive options and
non-statutory options consistent with the proportion of options that were
cancelled.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." SFAS No. 123 defines a "fair value based method" of accounting
for stock-based compensation. Under the fair value based method, compensation
cost is measured at the grant date based on the fair value of the award and is
recognized over the service period. Prior to the issuance of SFAS No. 123,
stock-based compensation was accounted for under the "intrinsic value method" as
defined by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
Stock Issued to Employees." Under the intrinsic value method, compensation is
the excess, if any, of the market price of the stock at grant date or other
measurement date over the amount an employee must pay to acquire the stock.
SFAS No. 123 allows an entity to continue to use the intrinsic value
method. However, entities electing the accounting in APB Opinion No. 25 must
make pro forma disclosures as if the fair value based method of accounting had
been applied. The Company applies APB Opinion No. 25 and the related
interpretations in accounting for its stock-based compensation. Under APB
Opinion No. 25, the Company recorded deferred compensation of approximately
$291,000 related to stock option grants in 1999. The Company amortized
approximately $325,000, $229,000 and $80,000 of deferred compensation in the
years ended December 31, 1999, 2000 and 2001, respectively. During 2001,
deferred compensation was reduced by $242,000 for cancelled options resulting
from workforce reductions.
If compensation expense had been determined based on the fair value of the
options at the grant dates consistent with the method of accounting under SFAS
No. 123, the Company's net income (loss) and earnings (loss) per share would
have decreased or increased to the pro forma amounts indicated below (in
thousands, except per share amounts):
Years Ended December 31,
1999 2000 2001
---- ---- ----
Net income (loss) attributable to
common
stockholders:
As reported....................... $ 3,551 $ (415,485) $ (26,962)
Pro forma......................... (4,620) (435,794) (72,005)
Diluted earnings (loss) per share:
As reported....................... 0.13 (14.46) (0.85)
Pro forma......................... (0.19) (15.17) (2.28)
The fair value of each option is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions used for
grants during the years ended December 31, 1999, 2000 and 2001: no dividend
yield, expected volatility from 81% to 100%, risk-free interest rates from 4.6%
to 6.9% and an expected term of 5 years.
5. Avesta Acquisition:
The acquisition of Avesta was completed on May 24, 2000 and has been
accounted for as a purchase business combination. At closing, all of the
outstanding preferred and common stock of Avesta was exchanged for 5,413,530
shares of Visual common stock. In addition, the outstanding stock options and
warrants of Avesta were converted into options and warrants to purchase 673,338
and 445,463 shares of Visual common stock, respectively. The equity holders of
Avesta also were entitled to receive up to an aggregate of 2,000,000 additional
shares (the "Additional Shares") of Visual common stock, which were placed into
escrow, if certain sales goals of Avesta were achieved in calendar 2000. None of
the Additional Shares were earned and all of the Additional Shares were returned
to Visual. The determination of the aggregate purchase price includes only the
fair value of the equity securities that were issued by Visual to the Avesta
equity holders at closing. The fair value of the Additional Shares was not
included in the determination of the purchase price. During the second quarter
of 2001, 134,000 shares from the initial merger consideration were returned to
the Company by the Avesta equity holders as settlement of certain
indemnification claims made by the Company. For purposes of determining the
purchase price, the shares of Visual common stock issued at closing were valued
at $59.30 per share based upon the average closing price of Visual common stock
surrounding and including the date that the merger was agreed to and announced.
Avesta's outstanding options and warrants were converted to equivalent
options and warrants of Visual. The number of shares exercisable under these
options and warrants and the exercise prices were adjusted such that Visual
options and warrants issued for Avesta options and warrants had an equivalent
intrinsic value per option and warrant. The terms and vesting periods of the
options and warrants were not modified. Accordingly, the estimated fair value of
these options and warrants, based upon the Black-Scholes valuation model, was
included in the determination of the purchase price.
The aggregate purchase price was determined as follows (in thousands):
Fair value of common stock.... $ 315,790
Fair value of options and
warrants.................... 62,067
Transaction costs and other... 14,874
------
Total............... $ 392,731
=========
The merger resulted in an allocation of purchase price to the net tangible
and intangible assets of Avesta, as well as a write-off of the portion of the
purchase price allocated to IPR&D. Visual has allocated the purchase price based
upon the fair values of the assets and the liabilities acquired and allocated
the purchase price accordingly.
The purchase price has been allocated as follows (in thousands):
Completed technology........... $ 125,302
In-process technology.......... 39,000
Assembled workforce............ 3,885
Trademarks/trade names......... 18,455
Goodwill....................... 238,723
Net tangible assets............ 1,424
Deferred tax liability......... (34,058)
-------
Total................ $ 392,731
=========
Of the total purchase price, $39.0 million was allocated to in-process
technology, which represented research and development projects of Avesta that
had not reached technological feasibility as of the date of the acquisition and
that had no alternative future use in research and development activities or
otherwise. In accordance with SFAS No. 2, "Accounting for Research and
Development Costs," as interpreted by the FASB Interpretation No. 4, amounts
assigned to IPR&D meeting the above criteria must be charged to expense at the
date of consummation of the purchase business combination. As a result, the
Company recorded an expense of $39.0 million during the year ended December 31,
2000. The Company valued the acquired IPR&D based upon an independent appraisal
of the projects under development which were related to future releases of the
Trinity, eWatcher and other products. The values of the IPR&D projects were
determined by estimating the future cash flows from the projects, once
commercially feasible, discounting the net cash flows back to their present
values and then applying a percentage of completion to the calculated values to
reflect the uncertainty of technical success of the projects. The rates used to
discount the net cash flows to their present values were based on Avesta's
weighted average cost of capital. The percentage of completion was based on
management's estimates of the amount of resources spent to date and on the
expected use of future resources.
In connection with the Avesta acquisition, the Company recognized
approximately $900,000 in liabilities as the cost of closing a redundant
facility and terminating certain employees. The accrual consisted primarily of
severance and other employee termination costs. These activities resulted in the
termination of approximately 20 employees in connection with a facility closure,
the elimination of duplicate positions and the consolidation of certain
operations. For the year ended December 31, 2000, the Company charged $806,000
against the accrual for amounts paid. The remaining amounts were paid in 2001.
The pro forma information presented below (in thousands, except per share
data) reflects the Avesta acquisition as if it had occurred on January 1, 1999
but excludes the write-off of purchased research and development and the
impairment charge of $328.8 million (see Note 6). These results are not
necessarily indicative of future operating results or those that would have
occurred had the merger been consummated on that date.
Years Ended
December 31,
(unaudited)
1999 2000
---- ----
Pro forma net revenue......................... $ 98,689 $ 94,851
Pro forma net loss............................ (98,851) (92,944)
Pro forma basic and diluted loss per share.... $ (3.31) $ (3.02)
In December 1999, Avesta acquired all of the outstanding stock of Telecoms
Data Systems SAS ("TDS") for a combination of cash and shares of Avesta common
stock. In the event that Avesta did not consummate an initial public offering
within eight months from the date of closing, the former stockholder of TDS had
the right to repurchase the TDS stock and related technology. As a result of the
Avesta merger, the stockholder held 71,541 shares of Visual common stock. In
October 2000, the stockholder notified the Company of his intent to exercise the
repurchase option and the shares of Visual common stock were returned in 2001.
Accordingly, the value of these shares was not included in the determination of
the purchase price of Avesta. Because of this repurchase option, the Company did
not consolidate TDS. However, amounts paid by the Company to fund the operations
of TDS that were not expected to be repaid were charged to expense in the
accompanying consolidated statement of operations for the year ended December
31, 2000.
6. Restructuring and Impairment Charges:
In the fourth quarter of 2000, the Company announced a plan to realign its
product portfolio, consolidate its operations and devote resources to the
markets and products that offer the Company the greatest growth opportunities.
The Company's revised strategic focus and reorganization included a workforce
reduction of approximately 140 employees throughout the Company and a plan to
close its facilities in Ottawa, Canada and Sunnyvale, California, and to reduce
the size of its facilities in Rockville, Maryland and New York, New York. In
connection with this plan, the Company recorded a $7.0 million restructuring
charge that consisted of $4.2 million in employee termination costs including
severance and other benefits, $1.7 million in lease obligations related to
facilities and $1.1 million in leasehold improvement write-offs.
In the second quarter of 2001, the Company reversed $723,000 of this
restructuring charge resulting primarily from the lower than estimated costs
related to facility closures. In the second quarter of 2001, the Company
announced a plan to discontinue development and sales efforts on the Visual
Trinity product. As a result, the Company reduced its workforce by approximately
50 employees and closed the New York, New York facility. The Company recorded a
$3.9 million restructuring charge that consisted of $1.4 million in employee
termination costs including severance and other benefits, $1.3 million related
to leases and other contractual obligations and the write-off of a $656,000
investment (see Note 1) and $487,000 in leasehold improvements and related
assets. In October 2001, the Company announced a plan for an additional
reduction in workforce of approximately 40 employees to further reduce operating
expenses and recorded a restructuring charge of $385,000 for severance and other
benefits. During the fourth quarter of 2001, the Company reversed $1.2 million
of the restructuring charge recorded in the second quarter of 2001 due to lower
than estimated facility closure costs and other contractual obligations.
The Company recorded approximately $386.4 million in goodwill and other
intangibles, excluding purchased research and development, related to the
acquisition of Avesta. During the third and fourth quarters of 2000, the
Company's results of operations deteriorated. In particular, revenue decreased
significantly while operating expenses increased. The revenue decreases were due
to lower than expected revenue related to the Avesta products as well as
decreases in the revenue provided by the Company's other products. The addition
of the Avesta products and markets did not result in the revenue growth
anticipated at the time of the acquisition. Despite these results, the Company's
operating expenses increased significantly in the corresponding periods, due in
large part, to the addition of the Avesta operations. In response to these
trends, the Company initiated a restructuring plan in the fourth quarter of 2000
to realign its product portfolio and streamline its operations. Due to the
significance of these developments, management performed an evaluation of the
recoverability of its long-lived assets, including those related to the Avesta
acquisition, in accordance with SFAS No. 121. Based upon this evaluation, the
Company concluded that the goodwill and other intangible assets related to the
Avesta acquisition were impaired. This conclusion was based upon the Company's
revised estimate of the undiscounted cash flows expected to be derived from the
Avesta operations. The estimate of such cash flows was substantially less than
the carrying values of the related long-lived assets. As a result, the Company
recorded an impairment charge of $328.8 million in the fourth quarter of 2000.
This charge included $203.2 million related to goodwill, which represented the
entire remaining unamortized balance, and $125.6 million related to the other
acquired intangibles including the completed technology, the assembled workforce
and the trademarks/trade names. The fair values of the remaining Avesta
long-lived assets were determined based upon the estimated discounted cash flows
to be derived from the Avesta operations. The discount rate used was based upon
an assessment of the risks associated with these cash flows.
Due to the discontinuation of the Visual Trinity product in the second
quarter of 2001 and the Company's decision to combine certain functionality of
the Visual eWatcher product with the Visual IP InSight product in the fourth
quarter of 2001, management performed an evaluation of the recoverability of its
remaining long-lived assets related to the Avesta acquisition in accordance with
SFAS No. 121. Based upon these evaluations, the Company concluded that these
intangible assets were impaired as Visual Trinity and Visual eWatcher were the
only products acquired with Avesta. The conclusion was based upon the Company's
revised estimate of the undiscounted cash flows expected to be derived from the
remaining Avesta operations. The estimate of such cash flows was substantially
less than the carrying values of the related long-lived assets. As a result, the
Company recorded an impairment charge of $3.1 million in the second quarter of
2001 and $197,000 in the fourth quarter of 2001.
7. Employee Benefit Plans:
Effective January 1, 1996, the Company adopted a defined contribution plan
(the "Visual 401(k) Plan"), available to all eligible full-time employees upon
employment. Employee contributions are voluntary and are determined on an
individual basis with a maximum annual amount equal to 15% of compensation paid
during the plan year, not to exceed the annual Internal Revenue Service
contribution limitations. All participants are fully vested in their
contributions. There have been no employer contributions under the Visual 401(k)
Plan. The Company has additional 401(k) plans obtained through acquisitions.
Subsequent to December 31, 2001, the Company merged all of the acquired plans
into the Visual 401(k) Plan. There were no contributions to these plans during
the three years ended December 31, 2001.
8. Income Taxes:
The components of the provision (benefit) for income taxes consist of the
following for the years ended December 31, 2000 and 2001 (in thousands):
December 31,
2000 2001
---- ----
Income tax provision (benefit):
Current.................... $ (9,585) $ 272
Deferred................... (24,473) -
------- -------
Total provision (benefit).. $ (34,058) $ 272
========= ======
The provision for income taxes results in an effective rate that differs
from the Federal statutory rate as follows for the years ended December 31, 2000
and 2001:
Years Ended
December 31,
1999 2000 2001
---- ---- ----
Statutory federal income tax rate... 35% (35)% (35)%
Effect of graduated rates........... (1) 1 1
State income taxes, net of federal
benefit............................. 4 (4) (3)
Net operating loss carryforward..... 28 - -
Non-deductible expenses............. 41 21 6
Increase in valuation allowance..... - 9 32
---- ---- -----
Total effective rate...... 51% (8)% (1)%
==== ====== ======
The components of the Company's net deferred tax asset (liability) are as
follows (in thousands):
December 31,
2000 2001
---- ----
Deferred tax asset:
Net operating loss carryforwards... $ 35,038 $ 39,659
Depreciation....................... (836) (684)
Allowance for doubtful accounts.... 419 210
Inventory valuation................ 1,128 1,800
Accrued liabilities................ 2,658 1,288
Deferred revenue................... 2,558 1,408
Tax credit carryforwards........... 2,203 3,402
Basis differences attributable to
purchase accounting............... (3,733) -
Valuation allowance................ (39,435) $(47,083)
------- --------
Total net deferred tax asset $ - -
========= =========
The Company had net operating loss carryforwards to offset future taxable
income of approximately $104.4 million as of December 31, 2001. These net
operating loss carryforwards expire through 2021. In computing its income tax
expense, the Company recognizes the tax benefits of current and prior years'
stock option deductions after the utilization of net operating losses from
operations (operating losses determined without deductions for exercised stock
options) to reduce income tax expense. Net operating loss carryforwards, when
realized related to stock option deductions, are credited to stockholders'
equity. Under the provisions of the Tax Reform Act of 1986, when there has been
a change in an entity's ownership, utilization of net operating loss
carryforwards may be limited. Because of the changes in the ownership of
Net2Net, Inverse and Avesta, the use of the Net2Net, Inverse and Avesta net
operating losses will be limited and may not be available to offset future
taxable income.
9. Commitments and Contingencies:
Leases
The Company leases office space and office equipment under non-cancelable
operating leases expiring through December 2006. The Company recorded rent
expense of approximately $1.7 million, $3.3 million and $1.9 million during
1999, 2000 and 2001, respectively.
In May 1999, Inverse entered into a master lease agreement, as amended,
with a leasing company to provide up to $1.8 million in financing to purchase
furniture and equipment through April 2000. During 1999, Inverse purchased
approximately $1.4 million of furniture and equipment under the master lease
agreement. Inverse also entered into a sale-leaseback transaction with the
leasing company in which equipment was sold at its net book value and leased
back under non-cancelable capital leases. No gain or loss was recognized on the
transaction. In connection with the master lease and sale-leaseback transaction,
Inverse issued the leasing company a warrant to purchase common stock. The fair
value of this warrant was not material.
Future minimum lease payments as of December 31, 2001 under non-cancelable
capital and operating leases are as follows (in thousands):
Capital Operating
Leases Leases
2002...................................... $ 296 $ 1,985
2003...................................... - 1,686
2004...................................... - 1,676
2005...................................... - 1,608
2006...................................... - 1,575
Thereafter................................ - -
------ --------
Total minimum lease payments.... 296 $ 8,530
===== ========
Interest element of lease payment......... (11)
Present value of future minimum lease
payments............................... 285
Current portion........................... (285)
----
Long-term portion......................... $ -
=======
The Company has a sublease for a portion of the operating leases that
expires in October 2002. Future minimum lease payments due from the lessee are
approximately $180,000 for 2002.
Litigation
In July, August and September 2000, several purported class action
complaints were filed against the Company and certain of the Company's former
executives. These complaints have since been combined into a single consolidated
amended complaint (the "complaint"). The complaint alleges that between February
7, 2000 and August 23, 2000, the defendants made false and misleading statements
which had the effect of inflating the market price of the Company's stock, in
violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.
The complaint does not specify the amount of damages sought. The Company
believes that the plaintiffs' claims are without merit and intends to defend
against these allegations vigorously. The Company has filed a motion to dismiss
the complaint, which is now pending before the court. The Company expects that a
substantial portion of the legal costs that it might incur related to this
matter will be paid by its directors' and officers' insurance policy. The
Company cannot presently determine the ultimate outcome of this action. A
negative outcome could have a material adverse effect on the Company's financial
position or results of operations. Failure to prevail in the litigation could
result in, among other things, the payment of substantial monetary or punitive
damages.
In October 1997, a lawsuit was filed against Avesta and one of its
employees alleging infringement of two patents, unfair competition, breach of
contract and interference with contractual relations resulting in unjust
enrichment. Avesta answered the complaint, denying all allegations, and also
asserted counterclaims against the plaintiff for patent misuse, unfair
competition and interference with business and patent invalidity. Pursuant to an
agreement between the parties, on June 13, 2001, the court dismissed the action
without prejudice, preserving to the parties the right to refile the action
pending future developments of the Visual Trinity product.
The Company is periodically a party to disputes arising from normal
business activities including various employee-related matters. In the opinion
of management, resolution of these matters will not have a material adverse
effect upon the financial position or future operating results.
10. Subsequent Events:
In March 2002, the Company issued senior secured convertible debentures
(the "Debentures") in the aggregate amount of $10.5 million in a private
placement offering. The Debentures are due March 25, 2006, payable in common
stock or cash at the Company's option provided certain conditions are satisfied,
bear interest at an annual rate of 5% payable quarterly, and are secured by a
first priority lien on substantially all of the Company's assets. The Debentures
may be converted into the Company's common stock at the option of the holders at
a price of $3.5163 per share, subject to certain adjustments. The Debentures are
convertible into a number of shares of common stock equal to the principal
amount of the Debentures divided by the conversion price, or 2,986,093 shares on
the date of issuance. The Company is required to adjust the conversion price if
the Company issues certain additional shares of common stock or instruments
convertible into common stock at a price that is less than the conversion price
of the Debentures. The Company has the right to require the holders to convert
their Debentures into common stock if the closing price of the Company's common
stock exceeds 175% of the conversion price for 20 consecutive days after
September 26, 2003.
The Debentures include certain financial covenants related to earnings
before interest, taxes, depreciation and amortization for 2002 and 2003. If the
financial covenants are not met, the holders may cause the Company to redeem the
Debentures at a price equal to the principal amount of the Debentures plus
accrued interest. The redemption may be made in cash or common stock at the
Company's option subject to certain conditions. Redemption of the Debentures
also may be required upon a specified change of control or upon the occurrence
of any one of the other triggering events, including but not limited to, default
on other indebtedness, failure to register the shares of common stock that may
be issued to the Debenture holders and failure to maintain the common stock
listing on an eligible market.
The Company also issued warrants to purchase 828,861 shares of its common
stock at an initial exercise price of $4.2755 per share. The exercise price may
be adjusted if the Company issues certain additional shares of common stock
or instruments convertible into common stock at a lower price than the initial
exercise price. The warrants expire on March 25, 2007. The Debentures also give
the holders the right to purchase 575 shares of to-be-created Series A preferred
stock for $5.8 million prior to May 6, 2002. The Series A preferred stock will
accrue dividends at an annual rate of 5% that are payable quarterly beginning on
June 30, 2002. The Company will have the right to cause the redemption of the
Series A preferred stock on the fourth anniversary of the issuance of such stock
based on similar terms to the Debentures. The Company has also granted to the
Debenture holders the right to purchase $4.75 million of additional shares of
to-be-created preferred stock at any time after the six-month anniversary but
before the fifteen-month anniversary of the issuance of the Debentures. The
Debenture holders were also granted certain equity participation and
registration rights.
In connection with the issuance of the Debentures, the outstanding amounts
borrowed from the bank under the Company's accounts receivable-based and
equipment financing arrangements were repaid, and the related loan agreements
were terminated. The standby letter of credit, as amended, issued by the bank in
December 2000 in the amount of $2.5 million with an expiration date of September
30, 2002 remains outstanding and secured with the Company's pledge of a
certificate of deposit in the amount of $2.5 million that matures on October
31, 2002.
11. Interim Financial Data - Unaudited:
The following table of quarterly financial data has been prepared from the
financial records of the Company, without audit, and reflects all adjustments
that are, in the opinion of management, necessary for a fair presentation of the
results of operations for the interim periods presented:
March 31, June 30, September 30, December 31,
2000 2001 2000(1) 2001(3) 2000 2001 2000(2) 2001(4)
---- ---- ------- ------- ---- ---- ------- -------
(in thousands, except per share amounts)
Revenue....................... $ 30,494 $ 17,386 $ 28,644 $ 20,329 $ 14,607 $ 19,208 $ 15,296 $ 17,325
Gross profit.................. 21,199 10,424 19,154 11,028 7,100 12,109 9,073 11,256
Income (loss) from operations 6,914 (7,954) (46,594) (12,427) (39,142) (2,989) (373,319) (3,645)
Net income (loss)............. 5,541 (7,667) (42,319) (12,330) (30,709) (2,979) (347,998) (3,986)
Basic income (loss) per share. 0.22 (0.24) (1.54) (0.39) (0.99) (0.09) (11.17) (0.13)
Diluted income (loss) per
share......................... 0.20 (0.24) (1.54) (0.39) (0.99) (0.09) (11.17) (0.13)
(1) The net loss for the three months ended June 30, 2000 includes the
write-off of IPR&D of $39.0 million (see Note 5).
(2) The net loss for the three months ended December 31, 2000 includes a
restructuring charge of approximately $7.0 million and an impairment charge of
approximately $328.8 million related to the write-off of goodwill and other
intangibles from the Avesta acquisition (see Note 6).
(3) The net loss for the three months ended June 30, 2001 includes a
reversal of the restructuring charge recorded in December 2000 of approximately
$723,000, an additional restructuring charge of approximately $3.9 million and
an impairment charge of $3.1 million related to the write-off of intangible
assets from the Avesta acquisition (see Note 6).
(4) The net loss for the three months ended December 31, 2001 includes the
reversal of $1.2 million of the restructuring charge recorded in the second
quarter of 2001, an additional restructuring charge of approximately $385,000
and an impairment charge of $3.9 million (see Note 6).
The sum of the per share amounts may not equal the annual amounts because
of the changes in the weighted-average number of shares outstanding during the
year.
SCHEDULE II
VISUAL NETWORKS, INC.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Balance at Beginning Additions Charged to Balance at End
Description of Period Costs and Expenses Deductions of Period
----------- --------- ------------------ ---------- ---------
For the year ended December 31,
1999:
Deducted from asset accounts:
Allowance for doubtful
accounts............... $493 301 40 $ 754
For the year ended December 31,
2000:
Deducted from asset accounts:
Allowance for doubtful
accounts............... 754 430 81 1,103
Included in current liabilities:
Reserves related to
restructuring.......... - 6,800 2,494 4,306
For the year ended December
31, 2001:
Deducted from asset accounts:
Allowance for doubtful
accounts............... 1,103 5 554 554
Included in current liabilities:
Reserves related to
restructuring.......... 4,306 3,092 5,977(1) 1,421
(1)Included in these deductions were costs of $4,010,000 charged against
the reserve and the reversal of $1,967,000 of the restructuring charges for the
year ended December 31, 2001. See Note 6 of the Notes to Consolidated Financial
Statements.
EXHIBIT INDEX
Exhibit Number Description
-------------- -----------
3.1 $ Amended and Restated Certificate of Incorporation of the Company
3.1.1 @ Certificate of Amendment to Amended and Restated Certificate of Incorporation
3.2 * Restated By-Laws of the Company.
10.1 * 1994 Stock Option Plan.
10.2 * 1997 Omnibus Stock Plan, as amended.
10.3 * Amended and Restated 1997 Directors' Stock Option Plan.
10.4 !! 2000 Stock Incentive Plan, as amended.
10.5 *t Reseller/Integration Agreement, dated August 29, 1997, by and between the Company
and MCI Telecommunications Corporation.
10.5.1 $$$tt Second Amendment, dated November 4, 1998, to the Reseller/Integration Agreement
between the Company and MCI Telecommunications Corporation (relating to Exhibit 10.5).
10.6 ****tt Master Purchase of Equipment and Services Agreement, dated as of May 22, 2000, between
Sprint/United Management Company and the Company.
10.7 *t General Agreement for the Procurement of Equipment, Services and Supplies,
dated November 26, 1997, between the Company and AT&T Corp.
10.8 * Lease Agreement, dated December 12, 1996, by and between the Company and The Equitable
Life Assurance Society of the United States.
10.8.1 * Lease Amendment, dated September 2, 1997, by and between the Company and The Equitable
Life Assurance Society of The United States (related to Exhibit 10.8).
10.8.2 $$$ Second Lease Amendment, dated February 8, 1999, by and between the Company and
TA/Western, LLC, successor to The Equitable Life Assurance Society of The United States
(relating to Exhibit 10.8).
10.8.3 *** Third Lease Amendment, dated January 10, 2000, by and between the Company and
TA/ Western, LLC (relating to Exhibit 10.8).
10.8.4 !! Fourth Lease Amendment, dated May 17, 2000, by and between the Company and TA/ Western,
LLC (relating to Exhibit 10.8).
10.10 * Employment Agreement, dated December 15, 1994, by and between the Company and Scott E.
Stouffer, as amended.
10.11 !! Lease Agreement, dated April 7, 2000, by and between Visual Networks, Inc. and
TA/ Western, LLC.
10.12 * Terms of Employment, dated June 11, 1997, by and between the Company and Peter J.
Minihane, as amended.
10.17 ** Net2Net 1994 Stock Option Plan.
10.20$$ 1999 Employee Stock Purchase Plan, as amended April 11, 2001.
10.22 % Inverse Network Technology 1996 Stock Option Plan.
10.23 !! Avesta Technologies 1996 Stock Option Plan.
10.24 **** Loan and Security Agreement, dated February 28, 2001, by and between Silicon Valley
Bank and the Company.
10.24.1 !!! First Loan Modification to the Loan and Security Agreement, dated May 24, 2001
(related to Exhibit 10.24).
10.24.2 Second Loan Modification to the Loan and Security Agreement, dated December 20, 2001
(related to Exhibit 10.24).
10.25 **** Accounts Receivable Financing Agreement dated February 28, 2001, by and between Silicon
Valley Bank and the Company.
10.25.1 !!! First Loan Modification to the Accounts Receivable Financing Agreement, dated
May 24, 2001 (related to Exhibit 10.25).
10.25.2 Second Loan Modification to the Accounts Receivable Financing Agreement, dated
December 20, 2001 (related to Exhibit 10.25).
10.25.3 Third Loan Modification to the Accounts Receivable Financing Agreement, dated
February 28, 2002 (related to Exhibit 10.25).
10.26 **** Intellectual Property Security Agreement dated February 28, 2001, by and between
Silicon Valley Bank and the Company.
10.28 !!! Employment Agreement, dated May 3, 2001, by and between the Company and Elton King.
10.29 !!! Nonstatutory Stock Option Grant Agreement, dated May 3,2001, by and between the Company
and Elton King.
10.30 !!! Terms of Employment, dated July 27, 2000, by and between the Company and Steve Hindman.
10.31 Terms of Employment, dated October 23, 2001, by and between the Company and John Saunders.
10.32 Consulting Agreement, dated February 16, 2002, by and between the Company and Peter J. Minihane.
21.1 List of subsidiaries of the Company.
23.1 **** Consent of Arthur Andersen LLP.
24.1 Powers of Attorney (included in signature page.
99.1 Letter regarding Arthur Andersen as our Independent Public Accountants.
* Incorporated herein by reference to the Company's Registration Statement on Form S-1, No. 333-41517.
** Incorporated herein by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-8,
No. 333-53153.
*** Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1999.
**** Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2000.
% Incorporated herein by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-8, No. 333-88719.
@ Incorporated herein by reference to the Company's Registration Statement on Form S-4, No. 333-33946.
$ Incorporated herein by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the three months
ended June 30, 1999.
$$ Incorporated herein by reference to the Company's Definitive Proxy Statement on Schedule 14A filed April 30, 2001.
$$$ Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1998.
t Portions of this Exhibit were omitted and have been filed separately with the Secretary of the Commission pursuant to
the Company's Application Requesting Confidential Treatment under Rule 406 of the Securities Act, filed on
December 22, 1997, January 28, 1998 and February 4, 1998.
tt Portion's of this Exhibit were omitted and have been filed separately with the Secretary of the Commission pursuant to
the Company's Application Requesting Confidential Treatment under Rule 24b-2 of the Securities Exchange Act.
!! Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the three months ended June 30, 2000.
!!! Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the three months ended June 30, 2001.