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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

x Annual Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the fiscal year ended March 31, 2003

or

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities

Exchange Act of 1934

Commission File Number: 0-24983

NETSOLVE, INCORPORATED

(Exact Name of Registrant as Specified in its Charter)

9500 Amberglen Blvd

Austin, Texas 78729

(Address of principal executive offices, including ZIP code)

(512) 340-3000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 Par Value Per Share

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K.    ¨

On April 30, 2003, the aggregate market value of the voting stock held by non-affiliates of the Registrant was $27,817,315 (affiliates being, for these purposes only, directors, executive officers and holders of more than 5% of Registrant’s Common Stock). On April 30, 2003, there were 11,392,704 outstanding shares of the Registrant’s Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement pursuant to Regulation 14A for the Registrant’s 2003 Annual Meeting of Stockholders to be held on July 16, 2003, which will be filed with the Commission not later than 120 days subsequent to March 31, 2003, are incorporated by reference into Part III of this report.

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NETSOLVE, INCORPORATED

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Item 1. BUSINESS

NetSolve provides a range of information technology (IT) infrastructure management services offering businesses an efficient and reliable alternative to managing their IT infrastructure internally. These services allow enterprises to selectively outsource some or all of their IT infrastructure management to increase network availability, performance and security while reducing overall IT infrastructure operations cost, and simplifying timely migration to new technologies. Our primary services offerings are designed to operate our customers’ networks, including monitoring, fault diagnosis, fault resolution, performance management and reporting. We also offer optional IT infrastructure design and configuration services to our customers. We provide our IT infrastructure management services remotely 24 hours a day, 365 days a year from our Network Management Center (NMC) in Austin, Texas. We develop and operate software tools and processes that allow us to manage these networks and allow our customers to access real-time network status and other reports via a secure Internet portal. We have offered IT infrastructure management services since 1995 and currently have over 1,000 end user customers representing more than 40,000 managed sites in 57 countries. Our solutions are designed to meet the requirements of multiple industries and enterprises of all sizes. Our services are sold both indirectly through reseller channels such as AT&T, IBM and Berbee, and directly to end users.

Our solutions

Our solutions allow our customers to focus on their core business while we manage their IT infrastructure and enable the implementation of new technologies. Customers benefit from our expertise, breadth of services and knowledge gained from managing thousands of devices without incurring the expense of acquiring, operating and maintaining tools and resources to operate their network. We apply proven (i.e., learned and continually improving) processes and tools to customers of all sizes in order to meet their individual requirements. By applying a common set of tools and processes across hundreds of customers, we achieve economies of scale that result in price and performance value to our customers.

Full breadth of IT infrastructure management services. Our services are generally marketed under the brand name ProWatch^®. Our ProWatch suite of services covers issues encountered by customers in the LAN (local area network), IPT (IP Telephony), WAN (wide area network), network security, server and certain software infrastructure areas of their business. The ProWatch suite covers the entire operating lifecycle of an enterprise’s network requirements, including fault, configuration and performance management.

Reduced costs. Singularly focused on managing IT infrastructure, we are able to spread personnel-related costs, as well as costs of necessary network infrastructure, software and tools, across hundreds of end users. As a result, we are typically able to offer a more efficient management solution at a lower cost than internal management.

Increased business impact. Our end users do not have to use their internal resources to respond to the time-consuming and interrupt-driven responsibilities of daily IT infrastructure operations. Hence, these organizations can focus their resources on applying technology to improve their business.

Expertise. Our team of IT infrastructure professionals is continually trained on current and emerging IT infrastructure technology. As IT infrastructure management is our only business, this team can focus on operating networks without being encumbered or distracted by other IT tasks. Our IT infrastructure management professionals act as an extension to our customer’s internal IT staff. Additionally, our customers benefit by having a skilled team of networking professionals and tools applied to their IT infrastructure. Our tools and people have applied knowledge that has resulted from managing hundreds of sites over time. An issue may occur on our customer’s network that is unique to that network; nevertheless, because of our expertise, it may be an issue that is similar to ones we have faced in the past. Our team is able to apply that knowledge and potentially save time and costs associated with decreased downtime and shorter resolution. We also report to end users on a regular basis recommending upgrades or changes when appropriate.

Enhanced customer service. We take ownership of IT infrastructure problems when issues arise and we work on behalf of our customers through issue identification and resolution. Our services include guarantees that provide

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customers up to 100% of their management fees back for any month in which we do not meet specified performance requirements.

Ease of new technology adoption and IT infrastructure maintenance. We continually train our professionals on emerging technologies that are impacting the IT infrastructure, such as IPT. As a result, we are able to assist enterprises as they migrate their network to new technologies.

Enhanced IT infrastructure control. Our IT infrastructure management customers have access to Pro-Watch Exchange, our network management Web portal. With this tool, our customers can maintain ultimate control and visibility of critical network and device status and information through real-time status of every device we manage for them, as well as on-demand network performance reports.

Strategy

Our goal is to be the leading provider of selective outsourcing solutions for the remote management of IT infrastructure. The key elements of our strategy include the following:

Deliver targeted solutions and expand service offerings. We are focused on solving IT infrastructure management needs for enterprises that are assimilating new technology, attempting to solve complex IT issues, and/or wanting to reduce costs. We believe that the market to provide end-to-end IT infrastructure management services for enterprises on a remote basis is still emerging and that most providers do not have comprehensive solutions. We intend to expand the technologies we support in terms of types of devices, network transport technologies, and networking equipment providers. We also intend to use these expanded capabilities to create specific applications support services such as those we have previously introduced for infrastructure security and IPT.

Add and enhance our reseller channel relationships. We intend to continue to market our services primarily through reseller channels supplemented by direct sales efforts. We intend to adapt our services to be flexible add-ins to the needs of our larger reseller channels whose customers can benefit from the cost-effective, high quality management solutions we can jointly provide. In these instances, our goal will be for our reseller channels to utilize our services as a key component of their design solutions, transport services, consulting and integration services, or network equipment. By viewing these reseller channels as end-users and focusing on their requirements and business drivers as opposed to just the requirements of the end-user customer, we believe we can ultimately meet the needs of more end-user customers and accelerate growth.

IT infrastructure management services

Our focus is on growing our recurring IT infrastructure management services revenues. NetSolve’s service offerings combine core IT infrastructure management capabilities such as remote router, switch, server and firewall management into comprehensive solutions offerings that help our customers assimilate new technologies and address complex IT management issues.

Our services include the remote management of routers, switches, firewalls, network intrusion detection devices, host-based intrusion detection software, voice over IP devices, and servers. Historically, we have sold these services independently under our ProWatch brand such as ProWatch for WANs^®, ProWatch for LANs^® and ProWatch Secure^®.

The WAN service includes management of the WAN-attached router; the customer service unit (CSU), connecting the router to the transport provider’s Frame Relay, asynchronous transfer mode (ATM), or internet protocol (IP) service; and the transport provider’s network services. Our ProWatch for WANs^® service generally includes a guarantee to provide the customer end-to-end network availability for at least 99.5% of the time in any given month, with the customer generally receiving a refund of the management fee in any month the guaranteed

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availability rate is not achieved. Substantially all of our recurring IT infrastructure management services revenues are derived from our ProWatch for WANs and related WAN services.

In addition to the management of the WAN infrastructure between customer locations, we provide management of the LAN, server, and virtual private network (VPN). With our LAN management service we measure, monitor and manage the routers, switches and intelligent hubs.

ProWatch for Servers^SM is a server monitoring service that is available to ProWatch for LAN customers as an add-on service. The Server service provides for 24 X 365 monitoring, auto-ticketing and auto-notification for up/down availability; key Microsoft NT/Win2K services and Unix processes; environmentals (disk drives, fans, power supplies); key system parameters (CPU utilization, disk space, memory); basic application response for HTTP Server, E-mail server; and fault validation that detected issues are a server issue and not a LAN issue.

Our security offering addresses security needs of an enterprise 24 hours a day, 365 days a year. These remote security management capabilities include firewall management, intrusion detection management, host-based intrusion detection management, and VPN configuration and management. These security services are designed to protect an enterprise’s critical IT infrastructure with around-the-clock monitoring and policy management services. The services described below may be sold separately or be combined for a more complete offering.

Firewall Management. The firewall management service provides active management of the firewall, which is the electronic barrier between network segments. Security engineers review firewall logs and event streams to detect suspicious activity. Our ProWatch Secure^® Managed Firewall Service supports Cisco’s PIX Firewall series and Checkpoint firewalls.

Intrusion Detection Management. The intrusion detection management service uses Cisco’s IDS sensor to detect suspicious activity on customer networks, repel attacks and bar the potential intruder from accessing the end user’s network.

Host-Based Intrusion DetectionManagement. The host intrusion detection management service protects critical servers such as Web and mail servers. This service can prevent and alarm on those types of network attacks that cannot be fully prevented by a firewall or network intrusion detection device. This service utilizes Entercept’s Host IDS technology.

Virtual Private Network Management. The virtual private network configuration management service can be used by enterprises to establish and maintain point-to-point VPNs between routers and firewalls. NetSolve provides remote monitoring and management of this secure connection.

We combine remote router, switch, security and server management capabilities to provide a remote management solution for IPT. NetSolve’s IPT service currently delivers remote operations support services for Cisco’s Architecture for Voice, Video and Integrated Data (AVVID). AVVID integrates telephony functions onto IP-based LANs eliminating the need for PBX equipment and enabling converged applications. The IPT service is intended for use in conjunction with an AVVID IP Telephony Certified Cisco Partner that provides Plan, Design, Implement (PDI) services. Operations managed by NetSolve consist of the ongoing management and reporting services for an IP Network and its IP Telephony functionality after the PDI activities are complete.

Our Web-enabled IT infrastructure management tools provide end users with access to up-to-date status information of their networks and are designed to give end users increased understanding of their networks while they outsource the IT infrastructure management to NetSolve. Access to this information is included as a component of our standard IT infrastructure management services and is provided to end users at no additional charge. End users access these tools through a standard web browser using our ProWatch Exchange^® Web portal. ProWatch Exchange^® provides trouble ticket status and history. An active network map displays the status of all managed devices in an end user’s network and online viewing access to the monthly availability and on-demand performance reports included with the various IT infrastructure management services.

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Maintenance and equipment services

We resell on-site maintenance services, primarily to customers who have purchased the associated equipment from us. These services address issues associated with hardware failures and software bugs, as well as software upgrades provided for under the equipment provider’s maintenance contract. These maintenance services are provided by Cisco, Vital Networks, Equant and 3Com or their successors. Our strategy is to focus on sales of our IT infrastructure management services and to de-emphasize maintenance services. We therefore anticipate that sales of new maintenance contracts will decline over time as a result of our de-emphasizing these services and as current contracts expire and some are not renewed as a result of the migration of some of our AT&T business to internal AT&T centers.

We also resell customer premise equipment from leading network equipment manufacturers or their resellers. This equipment typically includes routers, CSUs and LAN switches and is obtained from Cisco and, to a lesser extent, from Bay/Nortel, Paradyne and others. Sales of this equipment are made only to our IT infrastructure management services customers in conjunction with the sale of our services. This equipment constitutes some of the primary components of the end-user networks we manage. Customers who purchase this equipment from us rather than from other sources typically do so for the convenience of a single supplier solution. We anticipate sales of equipment to continue to decline and, at some point, to possibly be eliminated from our offerings as a result of de-emphasizing this offering.

Customers and Reseller Channels

Our solutions have historically primarily addressed the needs of middle market enterprises, roughly defined as companies that have between 100 and 1,000 employees and annual revenues between $25 million and $500 million. While we believe this continues to be a key opportunity area for our solutions, we also provide services to larger enterprises that can utilize our standard packaged services without requiring significant customization and believe these enterprises also represent an opportunity for future sales. We currently have over 1,000 end users representing over 40,000 managed sites. Our end users consist of our direct customers as well as customers of our reseller channels. Substantially all sales of our services to date have been made in the U.S. However, we remotely manage locations in 56 other countries around the world for these U.S. based customers.

Most of our reseller channels use our brand; however, AT&T and some others resell our services under their trade and brand names. We receive our revenues directly from the resellers. In some situations, the resellers include the cost of our services in the pricing they establish for their related services while in other cases the services and customer premise equipment (CPE) we provide are billed separately by the reseller. Our resellers currently include AT&T, IBM, Berbee, Vital Networks, Intergraph, NDS and NEC Business Network Solutions.

Services sold to carrier resellers are primarily for incorporation in services the carriers sell directly to end users. Our strategy includes building our reseller channels, and we expect that these channels will continue to represent a large percentage of our IT infrastructure management revenues for the foreseeable future. In an effort to create greater value in these relationships, we are working with selected reseller channels to focus on providing our reseller channels component services that form a part of a comprehensive solution to end-user customers. Several of our channel partners fill important gaps in planning, design and implementation services in order to more completely meet our customers’ needs. With this model, we believe we can help our channel partners support customers in assimilating, managing and implementing new technologies, and then assume responsibility for the ongoing operation of these networks.

We have derived a significant portion of our revenue from one reseller, AT&T. No other customer or reseller accounted for more than 10% of our revenues in any of the last three fiscal years.

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Relationship with AT&T

We have three primary reseller agreements with AT&T, one for Managed Router Service; one for Managed DSU Service marketed by AT&T as part of its Frame Plus offering; and one for the management of the WAN for one large end user – The Home Depot. AT&T has sold these network management services to their customers in conjunction with AT&T’s overall network solution offering using AT&T’s trade and brand names. Our technicians have worked directly with AT&T’s sales and marketing personnel and the end users to design, implement and manage the end-users’ networks. As with our other reseller arrangements, we receive our revenues for the resale of our services to AT&T customers directly from AT&T. AT&T accounted for 69% of our total revenues in fiscal year 2001, 61% of our total revenues in fiscal year 2002, and 52% of our total revenues in fiscal year 2003.

The Managed Router Service agreement with AT&T was renewed in January 2002 and the Managed DSU Service agreement with AT&T was renewed in April 2002. These two agreements currently terminate on June 30, 2003 with respect to placing new orders for service. The term of The Home Depot agreement runs concurrent with the term of the agreement between AT&T and The Home Depot that we believe will expire sometime in fiscal year 2004.

In February of 2003, we were notified by AT&T of its intention to exercise its right under the agreement for Managed Router Service to terminate and transition all existing Managed Router Service orders beginning July 1, 2003, which will start an eight-month transition period under this agreement. Under the terms of the agreement, during each month of the ramp-down period, AT&T may transition no more than 12.5% of the existing sites away from NetSolve. After the eight-month ramp-down, NetSolve may continue to provide Managed Router Services to AT&T customers only if mutually agreed between NetSolve and AT&T. In addition to the cancellation by AT&T of all orders for Managed Router Service, AT&T may cancel individual orders upon 30 days notice under certain circumstances. Managed Router Service revenue under this agreement accounted for approximately 27% of recurring IT infrastructure management services revenues in fiscal year 2002, and 16% in fiscal year 2003; and 34% of total revenues in fiscal year 2002, and 22% in fiscal year 2003.

The agreement for Managed DSU Service provides for NetSolve to deliver the services for the original end-user service term of each order (subject to certain exceptions specifically set forth in the agreement), up to a maximum service term of 36 months, and further provides AT&T the option to continue the services on a month-to-month basis following the expiration of the service term for individual end users.

Sales and marketing

We market our services to reseller channels and directly to end users.

Primary marketing communications activities include lead generation, seminars, sales collateral and support, and design and maintenance of our web site. Our marketing organization is also responsible for public relations activities such as obtaining media coverage and public recognition of NetSolve and our services. Product marketing is primarily focused on ensuring that our services are designed to meet the needs of our reseller channels and end user customers. Activities include the creation of marketing, product, and business plans as well as the delivery of tools for our sales force and our reseller channels. These tools include service definitions and data sheets, pricing, competitive analysis, and sales presentation materials. The marketing group also works with our larger reseller channels to define, develop and implement their own services that embed a core NetSolve service. At March 31, 2003, we employed 8 people in marketing who are responsible for marketing communications, public relations, channel and product marketing.

Our sales organization is responsible for qualifying prospects and obtaining orders for our services. They work directly with customers and reseller channels to identify and define the service(s) that best fits their needs. Activities include the generation of proposals to potential customers and familiarizing the resellers’ sales forces with our services and networking options. In some cases these sales individuals sell our services directly to end users and in other cases they assist our resellers in their sales efforts. Additionally, a portion of our sales team is dedicated to only supporting reseller channel efforts. Reseller channel support by our sales organization includes training and

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engaging our reseller’s sales teams as well as assistance with responses to requests for proposals, IT infrastructure design and proposal generation, and participation in sales calls to potential customers. At March 31, 2003, we employed 25 people in sales and sales support.

Software and services development

The primary objective of our software development group is to develop or integrate the tools we utilize to manage networks and to develop software applications, such as ProWatch Exchange^®, which become components of our services. A key requirement of these tools is to provide flexible, scalable technologies that create a sustainable platform for NetSolve to continue to innovate and deliver services on a large scale at low cost as compared to off-the-shelf software products or competitive service offerings. The applications and tools we develop utilize industry-standard protocols, tools and development environments, including Microsoft’s .Net framework, C++, HTML, Java, and Oracle relational database software and development tools. Where appropriate, we integrate commercially available components into our tools, such as mapping functionality, that enrich the value of services we provide our customers.

The objective of our services development group is to research new technologies and develop new service offerings, including early operations processes that address the needs of our target customers with respect to these technologies.

Our software and services development groups consisted of 32 people as of March 31, 2003.

Operations

Our operations organization is responsible for delivery of our services to end users. By defining IT infrastructure management tasks into sets of tightly defined services, we are able to deliver functionality to our end users at cost-effective prices. Our services generally are provided using a team approach where each customer is assigned to a team of customer engineers, with one member of the team being assigned primary customer responsibility and each member providing backup when the primary engineer is not available.

Other groups within our operations group support these customer engineer teams. The first level of service delivery is our NMC, which is staffed 24 hours a day, 365 days a year with IT infrastructure engineers and technicians who have a broad range of technical expertise. Our NMC continuously monitors responses to polls to managed devices and opens trouble tickets in response to IT infrastructure outages. The goal of this group is to provide the end user with notice and a diagnosis within 15 minutes of an IT infrastructure failure. Upon isolation of the problem, the appropriate service provider is dispatched (to the end user’s premises if required) to repair the outage. NMC employees can electronically enter trouble tickets into selected transport provider’s systems to enable faster resolution of carrier network issues.

Other groups within operations include project managers, process managers, installation engineers, and equipment staging and configuration personnel. The Integrated Systems Support team handles all server, telephony and network infrastructure for internal business users as well as maintaining all customer connections. The process and tools automation team’s primary focus is to drive down the unit cost of our products while increasing quality of service to our customers.

We deliver our services utilizing a workforce having a wide range of skills, from entry-level to highly trained networking professionals. We use a strict operational methodology combined with proprietary software tools to leverage our workforce. We believe that we can meet our resource requirements by hiring experienced networking professionals and by recruiting and training recent college graduates.

Our approach to minimizing the possibility of loss of the critical systems and management network infrastructure utilized to manage customer networks is one of disaster avoidance. To minimize the potential for loss of network access to local telecommunications infrastructure, we employ a SONET ring which is served from two

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separate local exchange carrier serving offices and maintain on and off-site fail over technologies for critical server and database components. The customer network management infrastructure and major critical server and database components are replicated in a backup location in order to mitigate the impact of a complete loss of our primary facility. Using NetSolve branded services as well as other products, the infrastructure is monitored 24 hours a day, 365 days a year with certified professionals available to resolve any issues.

We have preventive and monitoring security measures in operation to control unauthorized access and respond to any unauthorized activity within our networks and to/from our customers’ networks. Customer networks are connected to NetSolve’s management infrastructure with separate connections (Frame Relay PVC or VPN, for example) for each customer, which, by their nature, restrict traffic flow to only the two endpoint networks. NetSolve also carefully screens all employees upon hiring. All prospective candidates undergo behavioral as well as technical interviews. NetSolve employs a range of physical site security measures to help prevent unauthorized access to NetSolve systems and information. Using third party security engineers, we periodically evaluate our security posture to ensure that we are providing a high level of protection and are diligent in detecting and controlling unauthorized activity within our own and to/from customers’ networks. This serves to periodically and independently validate the environment and controls for potential weaknesses.

Our operations organization consisted of 218 people as of March 31, 2003.

Competition

Currently, we compete primarily with the internal network administration organizations of actual or potential end users of our services. Many of these end users have internal network support capabilities and could choose to satisfy their needs through internal resources rather than through outside service providers. In order to compete effectively with internal organizations, NetSolve is focusing on helping customers assimilate new technology where internal resources are untrained and unproven, or helping customers manage complex technologies where internal resources are best focused on their core business or where there are ongoing problems. Our strategy to broaden the IT infrastructure components and technologies that our services support should help us compete with internal resources and move closer to a partnership with the customer as we address a broader set of needs. Other important factors necessary for our success include quality of service, price, functionality and features, product reputation, distribution and quality of support.

Selective outsourcing of IT infrastructure management is an emerging market, is highly fragmented, rapidly evolving and largely undefined. There are few substantial barriers to entry, and we expect that we will face additional competition from existing competitors and new market entrants in the future. We believe that the principal competitive factors in this market include skilled and targeted marketing, networking and security engineering expertise, scalable management tools, reliability and quality of service, large scale, the ability to maintain and expand distribution channels, price, the timing of introductions of new services, and conformity with industry standards. While we believe that we currently are able to provide end users with reliable network management and security services at prices that allow us to compete favorably with respect to other service providers, there can be no assurance that we will have the resources or expertise to compete successfully in the future.

While much of the competition we face remains with the internal IT departments, we also compete with other IT infrastructure management companies including telecommunications providers such as AT&T, Sprint and WorldCom; network equipment vendors such as Vanguard and Avaya; computer systems vendors such as Hewlett Packard/Compaq and Unisys; and other independent providers of IT infrastructure management services such as Nuvo Network Management. With respect to our security services, we compete with computer systems vendors such as IBM, network security software and services vendors such as ISS, and security services vendors such as Guardent and Counterpane. We face potential competition from IT consulting firms, systems integrators, VARs, and local and regional network services firms and other new entrants into our markets. Our competitors also include certain of our resellers, including AT&T and IBM.

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Many of these current and potential competitor companies have significantly greater financial, technical and marketing resources and greater name recognition than we have and generate greater service revenue than we do. There can be no assurance that we will be able to compete successfully against current or potential competitors. If we fail to successfully compete on a sustained basis it could significantly damage our business.

With respect to on-site equipment maintenance services and the sale of equipment, we compete primarily with the equipment manufacturers and their resellers.

Intellectual property rights

We rely on a combination of patent, trademark, service mark and trade secret laws and contractual restrictions to establish and protect certain proprietary rights in technology underlying our services. We have three patents and have applied for extensions and additional coverage with the United States Patent Office. These patents relate to software and computer technology, which allow us to poll, or communicate with, large numbers of devices over multiple WANs. We intend to continue to evaluate the appropriateness of these protections and to seek additional patent protection for our inventions when appropriate. There can be no assurance that additional patents will be issued from our currently pending or any future applications, or that any patents that may be issued will be sufficient in scope or strength to provide meaningful protection or any commercial advantage to us. We have registered our logo, and the NetSolve name together as one mark, and other marks, including ProWatch, ProWatch IV, ProWatch for WANs, ProWatch for LANs, ProWatch Secure and ProWatch Exchange as separate service marks in the U. S. We have also filed service mark and trademark applications in Japan to seek protection for these marks in Japan. We have not made any other foreign patent or trademark filings.

We have entered into proprietary rights and confidentiality agreements with our employees, and generally enter into nondisclosure agreements with our suppliers, distributors and appropriate customers in order to limit access to and disclosure of our proprietary information. There can be no assurance that these contractual arrangements or the other steps taken by us to protect our intellectual property will prove sufficient to prevent infringement or misappropriation of our technology or to deter independent third-party development of similar technologies. Any infringement or misappropriation, should it occur, could significantly damage our business. Furthermore, litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Litigation could result in substantial costs and diversion of resources. We may be unable to protect our intellectual property, and we could incur substantial costs enforcing our intellectual property against infringement or defending against claims of infringement.

In June 1996, in connection with our federal registration of a service mark that includes the NetSolve name, GRC International, Inc. claimed that our use of the name NetSolve infringed GRC’s common law intellectual property rights. This claim was settled by an agreement with GRC, and GRC withdrew its opposition and consented to our service mark registration. GRC retained the right to use the name NetSolve to describe a particular software product, and we retain the full right to our corporate name. We also agreed with GRC to refrain from using NetSolve as a brand name to describe a product. We believe that the limited joint use of the name NetSolve by GRC will not have a material adverse effect on us. With the exception of GRC, we have not, to date, been notified that our services infringe the proprietary rights of third parties; however, there can be no assurance that third parties will not claim infringement or indemnification by us with respect to current or future services or products. We expect that participants in our markets will be increasingly subject to infringement claims as the number of services and competitors in our industry segment grows. Any of these claims, whether meritorious or not, could be time-consuming, result in costly litigation, cause delays in product and service installation and implementation, prevent us from using important technologies or methods, subject us to substantial damages, or require us to enter into royalty or licensing agreements. These royalty or licensing agreements might not be available on terms acceptable to us or at all. As a result, any of these claims could materially harm our business.

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Employees

As of March 31, 2003, we had 305 full-time employees, including 33 in sales and marketing, 32 in development, 218 in operations and 22 in finance, administration and human resources. Our success depends to a significant degree upon the continued contributions of our executive management, IT infrastructure management and engineering teams, and our ability to attract and retain highly skilled and qualified personnel.

None of our employees are represented by a collective bargaining agreement. We believe relations with our employees are good.

Item 2. FACILITIES

Currently our new corporate headquarters are located in a leased facility in Austin, Texas which covers approximately 80,000 square feet. Previously, we had occupied an additional 70,000-square-foot facility. We consolidated operations in this new facility in the quarter ending June 2002. In March 2002, we recorded a one-time charge of $2.7 million as a result of a decision to reduce excess capacity in the Austin facilities. This charge primarily represents future rentals for the lease of the 70,000-square-foot facility that expires in November 2003. While the majority of operations have been consolidated, we retain approximately 6,400 square feet in the 70,000-square-foot facility for disaster recovery purposes. Moving to our new facility and exiting our previous one has allowed us to reduce excess capacity while retaining business continuity and disaster recovery capability and has allowed us to capitalize on the operational efficiencies delivered over the past two years. We maintain dual computer rooms in these two geographically separate facilities and have redundant mission critical equipment and customer connections in order to provide safeguards in the event of a fire or similar emergency. All mission critical portions of the 70,000-square-foot facility and all portions of the new facility are covered by uninterrupted power supply systems backed up by a power generator to guard against system failures and to provide emergency power in the event of an outage.

Item 3. LITIGATION

A consolidated putative class action complaint was filed on February 21, 2001 against the Company and certain of its officers in the United States District Court for the Western District of Texas, Austin Division. In re NetSolve Incorporated Securities Litigation, Civil Action No. A00-CA-591 SS. Plaintiffs sought to represent a class comprised of purchasers of the Company’s common stock between April 18, 2000 and August 18, 2000 (“Class Period”). They alleged that the defendants engaged in a fraudulent scheme by issuing false and materially misleading statements regarding the Company’s business during the Class Period.

On December 17, 2001, the Company and individual defendants settled this action. The plaintiff class received $2,750,000 in connection with the settlement, all of which was funded by the Company’s insurance carrier. On May 28, 2002, the Court preliminarily certified the class and approved the settlement. A Settlement Fairness Hearing was subsequently held before the Honorable Sam Sparks, at which time Judge Sparks approved the settlement. The case is thus concluded.

In December 2001, the Company and certain of our officers and directors, as well as the underwriters of our initial public offering (“IPO”) and hundreds of other companies (“Issuers”), directors and officers and IPO underwriters, were named as defendants in a series of class action shareholder complaints filed in the United States District Court for the Southern District of New York. Those cases are now consolidated under the caption In re Initial Public Offering Securities Litigation, Case No. 91 MC 92. In the amended complaint, the plaintiffs allege that the Company, certain of our officers and directors and our IPO underwriters violated section 11 of the Securities Act of 1933 based on allegations that the Company’s registration statement and prospectus failed to disclose material facts regarding the compensation to be received by, and the stock allocation practices of, the IPO underwriters. The complaint also contains a claim for violation of section 10(b) of the Securities Exchange Act of 1934 based on

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allegations that this omission constituted a deceit on investors. The plaintiffs seek unspecified monetary damages and other relief.

In October 2002, the parties agreed to toll the statute of limitations with respect to the Company’s officers and directors until September 30, 2003, and on the basis of this agreement, our officers and directors were dismissed from the lawsuit without prejudice. In February 2003, the court issued a decision denying the motion to dismiss the Section 11 claims against the Company and almost all of the other Issuers, and granting the motion to dismiss the Section 10(b) claims against NetSolve without leave to amend. Both the plaintiffs and the underwriters have presented tentative settlement offers. It is not feasible to predict or determine the final outcome of this proceeding, and if the outcome were to be unfavorable, the Company’s business, financial condition, cash flow and results of operations could be materially adversely affected.

Item 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the three months ended March 31, 2003.

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EXECUTIVE OFFICERS OF THE REGISTRANT

The following information is provided with respect to each executive officer of the registrant as of May 15, 2003, pursuant to General Instruction G of Form 10-K:

David D. Hood became our President and Chief Executive Officer and a Member of our Board of Directors in September 2002. Prior to his appointment, Mr. Hood served as Chief Executive Officer at BeVocal, a venture-funded voice recognition software company since July 2001. Before joining BeVocal, Mr. Hood was the Vice President and General Manager of Dell Home Systems, where he was in charge of Dell’s consumer PC business and the Web Business Unit since August 1997.

Kenneth C. Kieley joined us in September 1989 as our Vice President—Finance, Chief Financial Officer and Secretary. From July 1985 to September 1989, Mr. Kieley served as Vice President—Finance of VMX, Inc., a manufacturer of voice messaging systems. Mr. Kieley worked for Ernst & Young LLP from 1975 to 1985.

Jeffrey Guillot joined us in October 2002 as Vice President—Development and Chief Information Officer. Mr. Guillot added the duties of Chief Information Officer in November 2002. From November 2001 through October 2001, Mr. Guillot served as Product Strategy Director for Trilogy Software. From August 1997 through April 2000, Mr. Guillot served in several roles at Dell Computer Corporation including Senior Manager, Global Application Architecture and Tools, Director of Information Technology for Dellware and Gigabuys, and Director of Information Technology for Home and Small Business Technologies.

Gregory K. Jones was appointed to Vice President—Sales in April 2003. From August 2001 to October 2002, Mr. Jones served as Vice President—Sales at BeVocal Inc, a venture-funded voice recognition software company. From September 1999 to September 2001, Mr. Jones served as a Director in Dell’s Public Sector. From January 1984 to September 1999, Mr. Jones held several positions at AT&T including General Manager for AT&T’s Global Services.

Robert W. Kujawski was named Vice President—Operations in April 2001. Prior to his appointment as Vice President of Operations, Mr. Kujawski served as Director of NetSolve’s Network Management Center. From May of 1998 to May of 2000, Mr. Kujawski served as Group Area Development Manager and Director of Production Services for Norwest Mortgage Inc. Mr. Kujawski served in various positions at Deluxe Data Systems, Incorporated including Manager, Data Center Operations, Data Center Help Desk Manager, Data Center Shift Supervisor and Software Certification Analyst/Team Leader from October 1987 to May 1998.

Robert C. Pojman was appointed to Vice President—Business Development in April 2001. Prior to that he served as our Vice President—Operations since February 1997. Mr. Pojman was employed as First Vice President—Data Centers at Deluxe Data Systems, a software and services company which facilitates the processing and clearing of payments. He also worked at Deluxe Data Systems as Director, Technical Services from June 1993 to April 1995 as well as Director of Operations Services from July 1992 to June 1993.

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Terrence K. Sadowski joined us in December 2002 as Vice President—Marketing. From December 1998 to August 2001, Mr. Sadowski served in several roles at Dell Computer Corporation Small and Medium Business Group, including Director of Marketing, Vice President and General Manager, and Vice President of Marketing. From November 1996 to December 1998, Mr. Sadowski served as Vice President of Marketing at Bell South Telecommunications. Mr. Sadowski worked at the Dial Corporation from 1991 to 1996 and at the Quaker Oats Company from 1984 to 1991. Mr. Sadowski is also President of SKW-Austin Incorporated and SKW-Houston Incorporated, both private companies that are distributors of wireless phones and accessories.

Jeffrey J. Quade joined NetSolve in March 2003 as Vice President—Human Resources. From April 2001 to March 2003, Mr. Quade served as Vice President, Human Resources at GE Interlogix, Incorporated. Prior to that Mr. Quade served as Director, Human Resources for the Home and Small Business Group at Dell from 1999 to 2001. Mr. Quade served as the Vice President of Human Resources for the Mail and Messaging Technology Division of Bell & Howell Corporation from 1994 to 1999.

H. Perry Barth was named Principal Accounting Officer in April 2002. He has served as our Controller since April 1999. Mr. Barth was employed as Controller of Xetel Corporation, an electronics contract manufacturer, from May 1994 to April 1999. Mr. Barth worked for PricewaterhouseCoopers LLP from 1988 to 1994.

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PART II

Item 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market information

Our common stock trades on the Nasdaq National Market under the symbol “NTSL.” The following table sets forth the high and low per share sales prices of our common stock for each of the last eight quarters in the period ended March 31, 2003 as reported by the Nasdaq National Market System.

Holders of our common stock

At the close of business on May 19, 2003, there were approximately 118 holders of record of the common stock and approximately 2,855 shareholders of beneficial interest.

Dividends

We have not paid any dividends on our common stock and do not intend to pay any dividends in the foreseeable future.

Securities authorized for issuance under equity compensation plans

See Item 12 of this report.

Item 6. SELECTED FINANCIAL DATA

The following selected consolidated financial data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes appearing elsewhere in this document. The following selected consolidated financial data for fiscal years 2001, 2002 and 2003 and as of March 31, 2002 and 2003 are derived from our consolidated financial statements included elsewhere in this document, which have been audited by Ernst & Young LLP, independent auditors. The following selected consolidated financial data for fiscal years 1999 and 2000 and as of March 31, 1999, 2000 and 2001 are derived from our audited consolidated financial statements not included in this document.

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Item  7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking Statements

This report and other presentations made by us contain “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. We sometimes identify forward-looking statements with such words as “expects,” “anticipates,” “intends,” “believes” or similar words concerning future events. They include, among others, statements relating to trends and projections in revenue, company growth, sales, margin and expenses, and the drivers behind those trends; the size and grown potential of the IT infrastructure management industry; trends in sales of our services and products and resulting revenues; our ability to retain current customer arrangements and develop new arrangements; our ability to replace the business lost by the termination and transition of the AT&T Managed Router Service Agreement; our ability to develop new service offerings and the market acceptance of such offerings; our ability to develop new reseller arrangements; the level of any stock repurchases we may undertake; payments requested by customers regarding our WAN guarantee; the amount of any added costs from anticipated new sales, marketing and development efforts, our reliance on resellers, the continued development of new service offerings and competition; the outcome of pending litigation; revenues derived from AT&T and other customers; our ability to attract and retain a qualified workforce; our ability to protect our intellectual property rights; and the impact of changes in accounting rules.

Any forward-looking statement speaks only as of the date on which such statement was made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement was made or to reflect the occurrence of unanticipated events. New factors emerge from time to time and it is not possible for us to predict all of such factors, nor can we assess the impact of each such factor or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement.

Overview

We provide a range of IT infrastructure management services that allow enterprises and carriers to outsource some or all network-specific activities in order to increase network availability, performance and security while reducing overall IT infrastructure operations cost, and simplifying timely migration to new technologies. We were incorporated in September 1985 in the State of Delaware and began operating during the second half of 1987. Until December 1996, substantially all of our services revenues were derived from the sale of data transport services. To provide these transport services, we leased network transmission facilities from major carriers, and we also resold AT&T’s transport services. We began developing our first IT infrastructure management service offering for WANs in early 1993 and began offering that service, together with AT&T’s transport services, in the quarter ended March 31, 1994. We began selling IT infrastructure management services separately from our data transport services in the

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quarter ended March 31, 1995. We introduced our first security service in the quarter ended September 30, 1996. We discontinued our data transport business in the quarter ended December 31, 1996. We began offering IT infrastructure management services for LANs in the quarter ended June 30, 1997. We began offering VPN management services during the quarter ended September 30, 2000. On June 21, 2001, we announced that IBM Global Services would offer our ProWatch suite of IT infrastructure managed services worldwide. The acceptance of our first software licensing agreement occurred in the quarter ended September 30, 2001. This agreement allows another organization to utilize our technology to provide remote IT infrastructure management services to its customers. Additionally, on October 1, 2001, we announced the offering of remote IT infrastructure management for Cisco Systems, Inc. Architecture for Voice, Video and Integrated Data (AVVID) Internet Protocol IP Telephony (IPT).

Revenues

Our revenues consist of IT infrastructure management services revenues as well as maintenance and equipment resales. Our IT infrastructure management services include both recurring and nonrecurring revenues:

Our IT infrastructure management services revenues are derived from contracts with telecommunications carriers, value-added resellers of networking equipment and services, and enterprises to which we sell directly through our sales force. Our services include both initial implementation and project management services for a one-time fee per location as well as ongoing management services for a fixed monthly fee per managed device. IT infrastructure management services revenues also include software licensing, usage royalties, maintenance fees and professional fees. Our contracts with end users are generally for terms of 24 to 36 months, although customers may cancel services prior to the end of the service terms. Cancellations due to reasons other than closings of managed locations, which to date have not been material, are generally subject to cancellation fees ranging from 20% to 80% of the recurring charges payable for the remainder of the service term. Cancellation fees as a percentage of IT infrastructure management services revenues were less than 1% in each of fiscal years 2002 and 2003. We recognize revenues from cancellation fees on a cash basis unless collection is assured. Our contracts with resellers typically extend from 12 to 36 months and, in most cases, require that we continue providing services throughout the term of the reseller’s contract with the end user. In these cases, we continue to recognize revenues upon performance of the services, even if performance occurs after the term of the contract with the reseller.

Our IT infrastructure management services for WANs typically include a guarantee providing end-to-end network availability for at least 99.5% of the time in any given month. In the event the guaranteed availability is not achieved during a particular month, we generally are obligated to refund a portion, and in some cases all, of our WAN management fees for that month. This guarantee covers some components of the end user’s WAN, such as the transport services provided by the end user’s carrier, that are not directly under our control. As a result, we may, in some instances, refund amounts to customers for circumstances beyond our control. We establish a reserve against

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guarantees we offer for these WAN services. Historically, guarantee payments have not been material in relation to IT infrastructure management services revenues. However, in the future, refunds made under our guarantees or otherwise could have a material adverse impact on the results of our operations.

We derive maintenance and equipment revenues from the resale of CPE maintenance contracts and from the resale of customer premise equipment, or CPE, to certain of our IT infrastructure management services resellers or customers. CPE is networking equipment which usually resides at the customer’s location and includes routers, customer service units or CSUs, and LAN switches. We utilize CPE produced by Cisco and, to a lesser extent, by Bay/Nortel, Visual Networks and others. We recognize equipment revenues in the period the CPE is shipped to the customer. However, if the transaction is financed through our lease financing subsidiary, we recognize the revenues upon sale of the underlying lease contract on a nonrecourse basis. We recognize revenues from CPE maintenance contracts on a monthly basis as the services are provided. We generally only resell CPE to our IT infrastructure management services customers. Although we believe some of our customers will continue to purchase CPE from us, our strategy is to focus on our IT infrastructure management services which generate higher margins. We therefore anticipate that revenues from CPE sales will continue to decline as we seek to manage our mix of revenues.

We have three primary reseller agreements with AT&T, one for Managed Router Service; one for Managed DSU Service marketed by AT&T as part of its Frame Plus offering; and one for the management of the WAN for one large end user – The Home Depot. AT&T accounted for 69% of our total revenues in fiscal year 2001, 61% of our total revenues in fiscal year 2002, and 52% of our total revenues in fiscal year 2003. No other customer or reseller accounted for more than 10% of our revenues in fiscal years 2001, 2002 or 2003. In February of 2003, we were notified by AT&T of its intention to exercise its right to terminate and transition all existing Managed Router Service orders beginning July 1, 2003, which will start an eight-month transition period under this agreement. Managed Router Service revenue under this agreement accounted for approximately 27% of recurring IT infrastructure management services revenues in fiscal year 2002 (16% in fiscal year 2003) and 34% of total revenues in fiscal year 2002 (22% in fiscal year 2003).

Historically, we have generated substantially all of our revenues from sales to customers in the United States, although we manage devices in several locations around the world for these U.S. based customers.

Results of Operations

Fiscal year 2002 compared to fiscal year 2003

Revenues

Total revenues. Total revenues increased 4%, from $48.4 million in fiscal year 2002 to $50.4 million in fiscal year 2003.

IT infrastructure management services. Revenues from IT infrastructure management services increased 7%, from $38.0 million in fiscal year 2002 to $40.5 million in fiscal year 2003, representing 78% of total revenues in fiscal year 2002 and 80% of total revenues in fiscal year 2003. The dollar increase was due primarily to increased recurring revenues resulting from a growth in the number of managed devices under contract and to a lesser extent increased revenue from software licensing fees, partially offset by contractual discounts provided to AT&T relating to the Managed Router Services Agreement and a decrease in equipment installation services due to a decrease in the level of new installations from carrier agreements utilizing those services. The discounts to AT&T will no longer be a factor following the termination of the Managed Router Service Agreement. In the near term, revenue growth in IT infrastructure management services is expected to be adversely impacted by the July 1, 2003 termination of the AT&T Managed Router Service Agreement discussed above.

Maintenance and equipment. Revenues from maintenance and equipment decreased 5%, from $10.4 million in fiscal year 2002 to $9.9 million in fiscal year 2003. Revenues from maintenance and equipment decreased primarily as a result of lower equipment sales due to lower demand caused by a general slowdown of corporate spending on

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network infrastructures and to a lesser extent due to contractual discounts provided to AT&T relating to the Managed Router Services Agreement. The discounts to AT&T will no longer be a factor following the termination of the Managed Router Service Agreement.

Costs of revenues

Cost of IT infrastructure management services. Cost of IT infrastructure management services includes salary and other costs of personnel, depreciation of equipment utilized to manage customer networks, the network management infrastructure utilized to provide IT infrastructure management services, and the costs of third-party providers of CPE installation services. Cost of IT infrastructure management services is expensed as incurred. Cost of IT infrastructure management services increased 8%, from $22.3 million in fiscal year 2002 to $24.1 million in fiscal year 2003, representing 59% of IT infrastructure management services revenues in fiscal year 2002 and 2003. The dollar increase was due primarily to the addition of personnel, increased network circuit costs and increased depreciation expense resulting primarily from the addition of equipment placed in service for disaster recovery purposes. The July 1, 2003 termination of the AT&T Managed Router Service Agreement discussed above may have a beneficial impact on gross margins for these services.

Cost of maintenance and equipment. Cost of maintenance and equipment includes the purchase of maintenance contracts and CPE from manufacturers and distributors for resale to end users. These costs are expensed in the period the related revenues are recognized. Cost of maintenance and equipment decreased 3%, from $7.1 million in fiscal year 2002 to $6.9 million in fiscal year 2003, representing 69% of maintenance and equipment revenues in fiscal year 2002 and 70% of maintenance and equipment revenues in fiscal year 2003. The decrease in dollars was primarily due to the decrease in equipment sales. The increase in percentage is primarily the result of contractual sales discounts provided to AT&T relating to the Managed Router Services Agreement which did not have a corresponding decrease in costs. The discounts to AT&T will no longer be a factor following the termination of the Managed Router Service Agreement.

Operating expenses

Development. Development expenses consist primarily of salaries and related costs of development personnel including contract programming services. Development employees are responsible for developing internal software systems, selecting and integrating purchased software applications, developing software tools for our IT infrastructure management services, developing our Web-enabled software applications that give customers access to IT infrastructure management information, and defining and developing operating processes for new services. Development expenses increased 16%, from $3.5 million in fiscal year 2002 to $4.0 million in fiscal year 2003, representing 7% of total revenues in fiscal year 2002 and 8% of total revenues in fiscal year 2003. The increase in dollars and as a percentage of revenue was due to our decision to increase spending in this area to, among other things, enhance our ability to add additional services. The increase in spending reflected an increase in the number of software and service development personnel devoted to the development and enhancement of IT infrastructure management tools and our IT infrastructure management services and to a lesser extent costs of approximately $93,000 related to executive severance packages. Development costs of approximately $574,000 in fiscal year 2002 were capitalized to match against software license fees under a licensing agreement with a three-year term.

Selling and marketing. Selling and marketing expenses consist primarily of salaries, commissions, travel and costs associated with creating awareness of our services. Sales and marketing expenses increased 18%, from $6.4 million in fiscal year 2002 to $7.5 million in fiscal year 2003, representing 13% of total revenues in fiscal year 2002 and 15% in fiscal year 2003. The increase in dollars and as a percentage of revenue was due to our decision to increase spending in this area in an effort to increase orders for new business. The increase in spending was due primarily to costs of approximately $594,000 related to marketing studies and to a lesser extent expenses related to recruiting for new executives and executive severance packages, the addition of sales and marketing personnel, outside commissions for acquired customers and additional spending related to identifying software licensing opportunities overseas. These increases were partially offset by decreases in agency fees, expenses related to vendor relations and commissions to our direct sales forces.

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General and administrative. General and administrative expenses consist primarily of expenses related to our human resources, finance and executive departments and the cost of an idle facility for the five quarters ending June 30, 2002. Included in human resources spending is a majority of the costs of recruiting and relocating new employees. General and administrative expenses decreased 10%, from $5.2 million in fiscal year 2002 to $4.7 million in fiscal year 2003, representing 11% of total revenues in fiscal year 2002 and 9% of total revenues in fiscal year 2003. The dollar and percentage decrease was due primarily to approximately $1.1 million of lower spending in fiscal year 2003 related to rent and operating costs of an idle facility and to a lesser extent lower spending related to recruiting and relocation. This was partially offset by increased costs of approximately $481,000 related to strategic consulting services and executive severance packages.

Other income, net

Other income, net consists primarily of interest income earned on our cash balances. Other income, net decreased from $1.4 million in fiscal year 2002 to $749,000 in fiscal year 2003, representing 3% of total revenues in fiscal year 2002 and 1% of total revenues in fiscal year 2003. The decrease was primarily due to lower average interest rates earned on invested cash during fiscal year 2003 compared to fiscal year 2002.

Fiscal year 2001 compared to fiscal year 2002

Revenues

Total revenues. Total revenues increased 4%, from $46.5 million in fiscal year 2001 to $48.4 million in fiscal year 2002.

IT infrastructure management services. Revenues from IT infrastructure management services increased 15%, from $33.0 million in fiscal year 2001 to $38.0 million in fiscal year 2002, representing 71% of total revenues in fiscal year 2001 and 78% of total revenues in fiscal year 2002. The increase was due to increased recurring revenues resulting from a growth in the number of managed devices under contract.

Maintenance and equipment. Revenues from maintenance and equipment decreased 22%, from $13.4 million in fiscal year 2001 to $10.4 million in fiscal year 2002. Revenues from maintenance and equipment decreased primarily as a result of lower equipment sales due to lower demand caused by a general slowdown of corporate spending on network infrastructures.

Costs of revenues

Cost of IT infrastructure management services. Cost of IT infrastructure management services increased 16%, from $19.3 million in fiscal year 2001 to $22.3 million in fiscal year 2002, representing 58% of IT infrastructure management services revenues in fiscal year 2001 and 59% of such revenues in fiscal year 2002. The dollar and percentage increase was due primarily to the addition of personnel and network management infrastructure enhancements.

Cost of maintenance and equipment. Cost of maintenance and equipment decreased 25%, from $9.5 million in fiscal year 2001 to $7.1 million in fiscal year 2002, representing 71% of maintenance and equipment revenues in fiscal year 2001 and 69% of maintenance and equipment revenues in fiscal year 2002. The decrease in dollars was primarily due to the decrease in equipment sales. The decrease in percentage was due to an increase in CPE maintenance revenue as a percentage of maintenance and equipment revenue which generally has higher gross margins than equipment sales.

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Operating expenses

Development. Development expenses increased 9%, from $3.2 million in fiscal year 2001 to $3.5 million in fiscal year 2002, representing 7% of total revenues in both fiscal years 2001 and 2002. The increase in dollars was due to an increase in the number of software and service development personnel devoted to the development and enhancement of IT infrastructure management tools and our IT infrastructure management services, and increased use of software development consulting services. Development costs of approximately $574,000 in fiscal year 2002 and $550,000 in fiscal year 2001 were capitalized to match against software license fees under a licensing agreement with a three-year term.

Selling and marketing. Selling and marketing expenses increased 4%, from $6.1 million in fiscal year 2001 to $6.4 million in fiscal year 2002, representing 13% of total revenues in both fiscal years 2001 and 2002. The increase in dollars was due to increased costs related to the addition of sales and marketing personnel. This increase was partially offset by decreased spending for advertising during fiscal year 2002 as compared to fiscal year 2001 as well as the one-time costs incurred in fiscal year 2001 of $563,000 in connection with the acquisition of certain of Comdisco’s customers.

General and administrative. General and administrative expenses increased 47%, from $3.6 million in fiscal year 2001 to $5.2 million in fiscal year 2002, representing 8% of total revenues in fiscal year 2001 and 11% of total revenues in fiscal year 2002. The increase was due primarily to approximately $1.6 million of additional spending related to rent and operating costs of a leased facility that we will occupy in the quarter ending June 30, 2002 as we consolidate substantially all of our operations into the new facility as noted in Item 2. Facilities.

Other income, net

Other income, net decreased from $3.3 million in fiscal year 2001 to $1.4 million in fiscal year 2002, representing 7% of total revenues in fiscal year 2001 and 3% of total revenues in fiscal year 2002. The decrease was primarily due to lower average interest rates earned on invested cash during fiscal year 2002 compared to fiscal year 2001.

Quarterly results of operations

Results of operations have varied from quarter to quarter. Accordingly, we believe that period-to-period comparisons of results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Our operating results may fluctuate as a result of many factors, including our ability to renew or retain existing end user and reseller relationships, our ability to successfully enter into new reseller or end user relationships, our ability to develop and market new service offerings, the cost of introducing such offerings and the profitability thereof, and the level and nature of competition. Further, we may be unable to adjust spending rapidly enough to compensate for any significant fluctuations in the number of new managed devices implemented in a given period. Any significant shortfall in the number of new managed devices could therefore seriously damage our business. Finally, there can be no assurance that we will continue to be profitable in the future or, if we are profitable, that our levels of profitability will not vary significantly between quarters.

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The following tables set forth quarterly consolidated statements of operations data in dollars and, except as noted below, as a percentage of total revenues for each of the eight quarters in the period ended March 31, 2003. The information should be read together with the consolidated financial statements and related notes appearing elsewhere in this document. Additional per share information is disclosed on the consolidated statements of operations in the consolidated financial statements included elsewhere in this document. Operating results for any quarter are not necessarily indicative of results for any future period.

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