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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
Commission file number 0-24983
NetSolve, Incorporated
(Exact name of the registrant as specified in its charter)
Delaware 75-2094811-2
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
12331 Riata Trace Parkway
Austin, Texas 78727
(Address of principal executive offices, including zip code)
(512) 340-3000
(Registrant's telephone number, including area code)
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 No X
--- ---
Number of shares outstanding of the issuer's common stock, $.01 par value
as of November 10, 1999: 13,454,570
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1
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NETSOLVE, INCORPORATED
INDEX
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 1999 and September 30,
1999 (unaudited)............................................................................. 3
Condensed Consolidated Statements of Operations for the three and six month
periods ended September 30, 1998 and 1999 (unaudited)........................................ 4
Condensed Consolidated Statements of Cash Flows for the six month periods
ended September 30, 1998 and 1999 (unaudited)................................................ 5
Notes to Condensed Consolidated Financial Statements......................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........ 9
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
Use of proceeds.............................................................................. 24
Item 6. Exhibits and Reports on Form 8-K............................................................. 24
</TABLE>
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
NETSOLVE, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
March 31, September 30,
--------- -------------
1999 1999
---- ----
(unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents .......................... $ 2,764 $ 5,655
Restricted cash .................................... 642 528
Certificates of deposit ............................ 2,000 --
Accounts receivable, net of allowance for doubtful
accounts of $227 at March 31, 1999 and $252
at September 30, 1999 ............................ 2,622 4,210
Inventory .......................................... 279 278
Prepaid expenses and other assets .................. 1,267 2,080
Deferred tax assets ................................ -- 2,238
-------- --------
Total current assets ................................. 9,574 14,989
Restricted cash ...................................... 1,638 427
Property and equipment:
Network communications equipment ................... 71 71
Computer equipment and software .................... 2,601 3,847
Other equipment .................................... 173 216
Furniture, fixtures and leasehold improvements ..... 865 1,174
Equipment held under capital leases ................ 3,108 2,716
-------- --------
6,818 8,024
Less accumulated depreciation and.................... (3,571) (4,355)
amortization ...................................... -------- --------
Net property and equipment ........................... 3,247 3,669
Other assets ......................................... 477 605
-------- --------
Total assets........................................... $ 14,936 $ 19,690
======== ========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ................................... $ 1,569 $ 2,466
Accrued liabilities ................................ 1,914 2,184
Capital leases obligation .......................... 809 751
-------- --------
Total current liabilities ............................ 4,292 5,401
Capital leases obligation, net of current portion .... 1,027 627
Redeemable convertible preferred stock, $.10 par value;
7,500,000 shares authorized at March 31, 1999 and
September 30, 1999; 6,394,727 and 0 issued and
outstanding at March 31, 1999 and September 30, 1999,
respectively; aggregate liquidation preferences
of $44,146 at March 31, 1999 and $0 at
September 30, 1999 ................................. 44,146 --
Stockholders' equity (deficit):
Common stock, $.01 par value; 25,000,000 shares
authorized at March 31, 1999 and September 30, 1999;
3,336,444 and 13,451,570 issued and outstanding
at March 31, 1999 and September 30, 1999,
respectively ....................................... 33 135
Additional paid-in capital........................... -- 29,625
Deferred compensation .............................. -- (297)
Accumulated deficit ................................ (34,562) (15,801)
-------- --------
Total stockholders' equity (deficit) ................. (34,529) 13,662
-------- --------
Total liabilities, redeemable convertible
preferred stock and stockholders' equity
(deficit)............................................. $ 14,936 $ 19,690
======== ========
</TABLE>
See accompanying notes.
3
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NETSOLVE, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
------------------ --------------------
1998 1999 1998 1999
-------- -------- -------- --------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues:
Network management services ................................................ $ 3,081 $ 5,502 $ 5,641 $ 10,086
Equipment and other ........................................................ 3,342 3,790 6,344 8,282
------- ------- ------- -------
Total revenues ......................................................... 6,423 9,292 11,985 18,368
Costs of revenues:
Cost of network management services ........................................ 1,974 3,132 3,782 5,804
Cost of equipment and other ................................................ 2,629 2,973 4,950 6,509
------- ------- ------- -------
Total cost of revenues ................................................. 4,603 6,105 8,732 12,313
------- ------- ------- -------
Gross profit.................................................................. 1,820 3,187 3,253 6,055
Operating expenses:
Development ................................................................ 459 591 905 1,170
Selling and marketing ...................................................... 723 1,025 1,462 1,968
General and administrative ................................................. 512 663 1,053 1,285
Amortization of deferred compensation ...................................... -- 20 -- 25
------- ------- ------- -------
Total operating expenses ............................................... 1,694 2,299 3,420 4,448
------- ------- ------- -------
Operating income (loss) ..................................................... 126 888 (167) 1,607
Other income (expense):
Interest income ............................................................ 79 60 182 143
Interest expense ........................................................... (74) (29) (133) (66)
Other, net ................................................................. 18 -- 22 --
------- ------- ------- -------
23 31 71 77
------- ------- ------- -------
Income (loss) from continuing operations before income taxes ................ 149 919 (96) 1,684
Income tax expense (benefit) ................................................ -- (1,070) -- (2,206)
------- ------- ------- -------
Net income (loss) ........................................................... $ 149 $ 1,989 $ (96) $ 3,890
======= ======= ======= =======
Dividends on redeemable convertible preferred stock ......................... $ (630) $ (630) $(1,260) $(1,260)
------- ------- ------- -------
Net income (loss) applicable to common stock ................................ $ (481) $ 1,359 $(1,356) $ 2,630
======= ======= ======= =======
Basic net income (loss) per share............................................. $(0.15) $0.37 $(0.41) $0.74
Weighted average shares used in basic per share calculation ................. 3,286 3,713 3,283 3,538
Diluted net income (loss) per share........................................... $(0.15) $0.11 $(0.41) $0.22
Weighted average shares used in diluted per share calculation ............... 3,286 11,877 3,283 11,699
Pro forma basic net income (loss) per share................................... $0.02 $0.20 $(0.01) $0.39
Pro forma weighted average shares used in basic per share calculation......... 9,681 9,969 9,678 9,863
Pro forma diluted net income (loss) per share................................. $0.01 $0.17 $(0.01) $0.33
Pro forma weighted average shares used in diluted per share calculation....... 11,441 11,877 9,678 11,699
</TABLE>
See accompanying notes.
4
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NETSOLVE, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended
September 30
------------
1998 1999
--------- ---------
(unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) .................................................................. $ (96) $ 3,890
Adjustments to reconcile net income (loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization ..................................................... 667 826
Amortization of deferred compensation............................................... -- 25
Deferred tax assets ............................................................... -- (2,238)
(Gain) loss on disposition of property and equipment .............................. (6) 1
Change in assets and liabilities:
Accounts receivable, net .......................................................... (1,327) (1,588)
Inventory and prepaid expenses and other assets ................................... (291) (940)
Accounts payable .................................................................. 559 897
Accrued liabilities ............................................................... 68 270
------- -------
Net cash provided by (used in) operating activities ................................. (426) 1,143
------- -------
Cash flows from investing activities:
Proceeds from sale of certificates of deposit ...................................... 441 2,000
Transfer of funds from (to) restricted cash ........................................ (423) 1,325
Purchases of property and equipment ................................................ (1,067) (1,250)
Proceeds from sale of property and equipment ....................................... 4 --
------- -------
Net cash provided by (used in) investing activities ................................. (1,045) 2,075
------- -------
Cash flows from financing activities:
Proceeds from capital lease financing .............................................. 562 --
Payments under capital lease obligations ........................................... (328) (457)
Proceeds from exercise of common stock options and warrants ........................ 21 130
------- -------
Net cash provided by (used in) financing activities ................................. 255 (327)
------- -------
Net increase (decrease) in cash and cash equivalents ................................ (1,216) 2,891
Cash and cash equivalents, beginning of period ...................................... 1,333 2,764
------- -------
Cash and cash equivalents, end of period ............................................ $ 117 $ 5,655
======= =======
Supplemental disclosure of cash flow information:
Cash paid for interest ............................................................. $ 133 $ 66
======= =======
Income taxes paid .................................................................. $ 15 $ 28
======= =======
</TABLE>
See accompanying notes.
5
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NETSOLVE, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
Information with respect to the three and six months ended
September 30, 1998 and 1999 is unaudited.
1. Organization and Description of the Company
NetSolve, Incorporated, a Delaware corporation, (the "Company") engages in
the business of providing enterprise data networking management services within
the U.S. These services include network design, installation and implementation
coordination, ongoing network management and security. The Company also resells
data networking equipment manufactured by selected leading suppliers of these
products. The Company's services are designed to allow its clients to outsource
some or all network specific tasks in order to migrate to new technology,
increase network reliability and reduce overall network costs.
On September 29, 1999, the Company's common stock began publicly trading in
connection with an initial public offering. The Company offered 3,530,000
shares of its common stock for net proceeds to the Company of $41.8 million. At
the commencement of trading on September 29, 1999, each outstanding share of the
Company's redeemable convertible preferred stock was automatically converted
into one share of common stock of the Company, resulting in the issuance of
6,394,727 shares of common stock. Additionally, on October 28, 1999 the Company
sold an additional 555,000 shares of common stock for net proceeds to the
Company of $6.7 million, pursuant to the exercise of the underwriters'
overallotment option.
The net proceeds resulting from the initial public offering had not been
received as of September 30, 1999 and therefore are not presented in the balance
sheet or statement of cash flows as of September 30, 1999.
2. Basis of Presentation
The quarterly financial information presented herein should be read in
conjunction with the Company's annual financial statements for the year ended
March 31, 1999, which can be found in the Company's registration statement filed
on Form S-1, as amended and declared effective on September 28, 1999 (File No.
333-65691). The accompanying unaudited interim financial statements reflect all
adjustments (which include only normal, recurring adjustments) that are, in the
opinion of management, necessary to state fairly the results for the periods
presented. The results for such periods are not necessarily indicative of the
results to be expected for the full fiscal year.
3. Inventory
Inventory consists of purchased finished goods held for sale to customers.
Inventory is stated at the lower of cost or market with cost determined on a
specific identification basis. Inventory reserves were $85,000 at March 31, 1999
and $93,000 at September 30, 1999.
4. Earnings Per Share
The Company's earnings per share data are presented in accordance with SFAS
128, Earnings Per Share. Basic income (loss) per share is computed using the
weighted average number of common shares outstanding. Diluted income (loss) per
share is computed using the weighted average number of common shares outstanding
adjusted for the incremental shares attributed to outstanding securities with
the ability to purchase or convert into common stock. The treasury stock method,
using the average price of the Company's common stock for the period, is applied
to
6
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NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
September 30, 1999
determine dilution from options and warrants. The if-converted method is used
for convertible securities. Potentially dilutive common stock options and
warrants that were excluded from the calculation of pro forma diluted income
(loss) per share because their effect is antidilutive totaled 1,468,000 for the
six month period ended September 30, 1998. On a historical basis, potentially
dilutive common stock options and warrants that were excluded from the
calculation for the dilutive income (loss) per share because their effect is
antidilutive totaled 1,760,000 and 1,468,000 for the three and six month periods
ended September 30, 1998. Historically, for the three and six month periods
ended September 30, 1998 and 1999, 6,394,727 shares of convertible preferred
stock were excluded from the calculation of diluted income (loss) per share as
their effect is also antidilutive.
A reconciliation of the numerators and denominators used in computing per
share net income (loss) from continuing operations is as follows:
<TABLE>
<CAPTION>
Pro forma Pro forma
------------------ -----------------
Three months ended Six months ended Three months ended Six months ended
September 30, September 30, September 30, September 30,
-------------------- ------------------- ------------------ -----------------
1998 1999 1998 1999 1998 1999 1998 1999
-------- -------- ------- -------- --------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Numerator:
Net income (loss) from
Continuing operations............ $ 149 $ 1,989 $ (96) $ 3,890 $ 149 $ 1,989 $ (96) $ 3,890
Dividends on redeemable
convertible preferred stock...... (630) (630) (1,260) (1,260) -- -- -- --
------- ------- ------- ------- ------ ------ ------ -------
Numerator for basic and
diluted net income (loss)
per share from continuing
operations..................... $ (481) $ 1,359 $(1,356) $ 2,630 $ 149 $ 1,989 $ (96) $ 3,890
====== ======= ======= ======= ======= ======= ====== =======
Denominator:
Denominator for basic net
income (loss) per share from
continuing operations--
weighted average common
stock outstanding................ 3,286 3,713 3,283 3,538 9,681 9,969 9,678 9,863
Dilutive common stock
equivalents--common stock
options, warrants and
redeemable convertible
preferred stock.................. -- 8,164 -- 8,161 1,760 1,908 -- 1,836
------ ------- ------- ------- ------- ------- ------ -------
Denominator for diluted net
income (loss) per share
from continuing
operations--weighted
average common stock
outstanding and dilutive
common stock
equivalents.................... 3,286 11,877 3,283 11,699 11,441 11,877 9,678 11,699
====== ======= ======= ======= ======= ======= ====== =======
</TABLE>
7
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NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
September 30, 1999
5. Income Taxes
During the three and six months periods ended September 30, 1999 management
determined that it was more likely than not that a portion of the previously
reserved deferred tax asset would be realized. Accordingly, the valuation
allowance was reduced by $1.1 million and $2.2 million and an income tax benefit
was realized of $1.1 million and $2.2 million for the three and six month
periods ended September 30, 1999, respectively. Additionally, the valuation
allowance was reduced during the three and six month periods ended September 30,
1999 by $293,000 and $640,000, respectively, due to the utilization of operating
losses which were not previously benefited.
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-looking Statements
This report and other presentations made by the Company contain "forward-
looking statements" within the meaning of Section 21E of the Securities Exchange
Act of 1934, as amended. Such statements involve known and unknown risks,
uncertainties and other factors that could cause the actual results of the
Company to differ materially from the results expressed or implied by such
statements, including general economic and business conditions, conditions
affecting the industries served by the Company, conditions affecting the
Company's customers and suppliers, competition, the overall market acceptance of
the Company's services, and other factors disclosed in the Company's Final
Prospectus dated September 29, 1999 and this report. Accordingly, although the
Company believes that the expectations reflected in such forward-looking
statements are reasonable, there can be no assurance that such expectations will
prove to be correct.
Any forward-looking statement speaks only as of the date on which such
statement was made, and the Company does 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 the
Company to predict all of such factors, nor can it assess the impact of each
such factor or the extent to which any factor, or combination of factors, may
cause results to differ materially from those contained in any forward-looking
statement.
Overview
We provide network management services that allow enterprises and carriers
to outsource some or all network-specific activities in order to increase
network reliability and up-time, reduce overall network costs, and simplify
timely migration to new technologies. We were incorporated in September 1985 in
the State of Delaware and began operating in the second half of 1987. Until
December 1996, substantially all of our services revenues were derived from the
sale of data transport services. To provide these transport services, we leased
network transmission facilities from major carriers, and we also resold AT&T's
transport services. We began developing our first remote network management
service offering for WANs in early 1993 and began offering that service,
together with AT&T's transport services, in the quarter ended March 31, 1994. We
began selling network management services separately from our data transport
services in the quarter ended March 31, 1995. We introduced our first security
service in the quarter ended September 30, 1996. We discontinued our data
transport business in the quarter ended December 31, 1996. We began offering
network management services for LANs in the quarter ended June 30, 1997.
Revenues
Our revenues consist of network management services revenues as well as
equipment resales and other revenues. Our network management services include
both recurring and nonrecurring revenues:
. Revenues from recurring services represent monthly fees charged to
resellers or end users for our network management services. Recurring
network management services revenues are typically based on the number
of devices under management and are recognized in the period in which
the services are rendered. In the six months ended September 30, 1999,
approximately 60% of network management services revenues were from
recurring services.
. Non-recurring network management services consist of data network
design, project implementation services and equipment installation
services, as well as one-time project and development assignments that
assist resellers in defining and creating new network management
services. Non-recurring network management services revenues are
generally recognized upon completion of the assignment or service. For
example, we charge fees for project implementation services on a per-
location basis and we recognize revenues associated with these services
upon completion of the network implementation for a location.
Our network management services revenues are derived from contracts with
telecommunications carriers, value-added resellers of networking equipment and
services, and enterprises sold to by our direct sales force. Typical contracts
for our services include an initial implementation fee plus a fixed monthly fee
per managed device. Our contracts with end users are generally for terms of 24
to 36 months, although customers may cancel services prior to the end of the
service terms. Cancellations due to reasons other than closings of managed
locations, which to date have not been material, are generally subject to
cancellation fees ranging from 20% to 80% of the recurring charges payable for
the remainder of the service term. Cancellation fees as a percentage of network
management services revenues were less than 1% in each of fiscal years 1997,
1998 and 1999 and the three and six month periods ended September 30, 1999. We
recognize revenues from cancellation fees on a cash basis unless collection is
assured. Our contracts with resellers typically extend from 12 to 36 months and,
in some cases, require that we continue providing services throughout the term
of the reseller's contract with the end user. In these cases, we continue to
recognize revenues upon performance of the services, even if performance occurs
after the term of the contract with the reseller.
Our network management services for WANs typically include a guarantee
providing end-to-end network availability for at least 99.5% of the time in any
given month. In the event the guaranteed availability is not achieved, we
generally are obligated to refund our WAN management fees for that month. This
guarantee covers some components of the end user's WAN, such as the transport
services provided by the end user's carrier, that are not
8
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directly under our control. As a result, we may, in some instances, refund
amounts to customers for circumstances beyond our control. We establish a
reserve against guarantees we offer. Guarantee payments have not been
significant in relation to network management services revenue in any month,
other than in May 1998 when a major carrier's network was inoperable for an
extended number of hours. In order to enhance our relationships with direct
customers using that carrier's service, we refunded all of the management fees
for that month to those direct customers, even though the outage was outside the
coverage of our guarantee. The cost of that refund was $64,000. In the future,
refunds made under our guarantees or otherwise could have a material adverse
impact on the results of our operations.
We derive equipment and other revenues from the resale of customer premise
equipment, or CPE, and from the sale of CPE maintenance contracts to our network
management services customers. CPE is networking equipment which usually resides
at the customer's location and includes routers, customer service units or CSUs,
and LAN switches. We utilize CPE produced by Cisco and, to a lesser extent, by
3Com, Bay/Nortel, Paradyne and others. We recognize revenues from the sale of
CPE upon shipment to the end user. However, if the transaction is financed
through our lease financing subsidiary, we recognize the revenues upon sale of
the underlying lease contract on a non-recourse basis. We recognize revenues
from CPE maintenance contracts on a monthly basis as the services are provided.
We only resell CPE to our network management services customers. We expect to
limit discounts on CPE and encourage end users to purchase equipment from other
sources. Further, as an alternative to selling CPE to our resellers, we have
recently amended some of our reseller agreements such that we receive management
fees for ordering CPE and managing CPE inventories for these resellers. Although
we believe some of our customers will continue to purchase CPE from us, our
strategy is to focus on our network management services which generate higher
margins. We therefore anticipate that revenues from CPE sales will decline as we
seek to manage our mix of revenues.
We currently have a network management services contract with two business
units within AT&T: AT&T Solutions and AT&T Business Network Services. AT&T
accounted for 30% of our total revenues in fiscal year 1997, 52% of our total
revenues in fiscal year 1998, 59% of our total revenues in fiscal year 1999 and
71% of our total revenues for the six month period ended September 30, 1999. We
anticipate that sales to AT&T will continue to comprise a substantial percentage
of our revenues at least through fiscal year 2000 and it is possible that this
percentage could increase. No other customer accounted for more than 10% of our
revenues in fiscal year 1997, 1998 or 1999 or in the three and six month periods
ended September 30, 1999.
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
Three months ended September 30, 1998 compared to three months ended September
30, 1999
Revenues
Total revenues. Total revenues increased 45%, from $6.4 million in the
three months ended September 30, 1998 to $9.3 million in the three months ended
September 30, 1999.
Network management services. Revenues from network management services
increased 79%, from $3.1 million in the three months ended September 30, 1998 to
$5.5 million in the three months ended September 30, 1999, representing 48% of
total revenues in the three months ended September 30, 1998 and 59% of total
revenues in the three months ended September 30, 1999. Approximately one-half of
the dollar increase was due to increased recurring revenues resulting from a
growth in the number of managed devices under contract. The remainder of the
increase was due to increased implementation and installation revenues resulting
from higher volumes of newly installed sites and increased management fees for
ordering and managing CPE for selected resellers.
10
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Equipment and other. Revenues from equipment and other increased 13%, from
$3.3 million in the three months ended September 30, 1998 to $3.8 million in the
three months ended September 30, 1999, as a result of an increase in the number
of equipment maintenance contracts in place. Revenues from equipment sales
decreased slightly as a result of amendments we have made to some of our
reseller agreements whereby we receive management fees for ordering CPE and
managing CPE inventories for these resellers. In addition, we expect to limit
discounts on CPE and encourage end users to purchase equipment from other
sources. We therefore anticipate that revenues from CPE sales will continue to
decline as we seek to manage our mix of revenues.
Costs of revenues
Cost of network management services. Cost of network management services
includes salary and other costs of personnel, depreciation of equipment utilized
to manage customer networks, the network management infrastructure utilized to
provide remote network management services, and the costs of third-party
providers of CPE installation services. Cost of network management services is
expensed as incurred. Cost of network management services increased 59%, from
$2.0 million in the three months ended September 30, 1998 to $3.1 million in the
three months ended September 30, 1999, representing 64% of network management
services revenues in the three months ended September 30, 1998 and 57% of such
revenues in the three months ended September 30, 1999. The dollar increase was
due primarily to the addition of personnel to accommodate growth, upgrades to
the network management infrastructure and, to a lesser extent, increased
subcontractor costs related to installation of CPE. The percentage decrease was
due primarily to improvements in processes and tools which have resulted in a
higher number of managed devices per operations employee.
Cost of equipment and other. Cost of equipment and other includes the
purchase of CPE from manufacturers and distributors, maintenance contracts
purchased for resale to end users, and capital equipment maintained by us for
replacement of failed units. These costs are expensed in the period the related
revenues are recognized, other than costs associated with capital equipment
maintained by us for the replacement of failed units. The cost of replacement
units is amortized generally over three years, with the unamortized balance
expensed when the replacement unit is used. Cost of equipment and other
increased 13%, from $2.6 million in the three months ended September 30, 1998 to
$3.0 million in the three months ended September 30, 1999, representing 79% of
equipment and other revenues in the three months ended September 30, 1998 and
78% of such revenues in the three months ended September 30, 1999. The increase
in dollars was due to a higher number of equipment maintenance contracts in
place during the three months ended September 30, 1999, partially offset by
reduced costs of resold equipment resulting from the decrease in equipment
resales.
Operating expenses
Development. Development expenses consist primarily of salaries and related
costs of development personnel, including contract programming services.
Development employees are responsible for developing internal software systems,
selecting and integrating purchased software applications, developing software
tools for our network management services, developing our web-enabled software
applications that give customers access to network management information, and
defining and developing operating processes for new services. Development
expenses increased 29%, from $459,000 in the three months ended September 30,
1998 to $591,000 in the three months ended June 30, 1999, representing 7% of
total revenues in the three months ended September 30, 1998 and 6% of total
revenues in the three months ended September 30, 1999. The increase in dollars
was due to an increase in the number of software and service development
personnel devoted to the development and enhancement of network management tools
and our network management services. The decrease as a percentage of total
revenues was affected by our decision to manage development spending to a lower
level as a percentage of total revenues. We anticipate that development costs
may increase as a percentage of total revenues over the remainder of fiscal year
2000 as additional development personnel are added.
Selling and marketing. Sales and marketing expenses consist primarily of
salaries, commissions, travel and costs associated with creating awareness of
our services. Sales and marketing expenses increased 42%, from
11
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$723,000 in the three months ended September 30, 1998 to $1.0 million in the
three months ended September 30, 1999, representing 11% of total revenues in the
three months ended September 30, 1998 and 1999. The increase in dollars was due
to increased spending for advertising and other promotional activities,
including a planned customer summit meeting, as well as costs related to the
addition of sales and marketing personnel. We anticipate that sales and
marketing costs may increase slightly as a percentage of total revenues over the
remainder of fiscal year 2000, as additional sales and marketing personnel are
added or promotional activities are expanded.
General and administrative. General and administrative expenses consist
primarily of expenses related to our human resources, finance and executive
departments. Included in human resources spending is all employee training
sponsored by us, as well as most costs of recruiting and relocating new
employees. General and administrative expenses increased 29%, from $512,000 in
the three months ended September 30, 1998 to $663,000 in the three months ended
June 30, 1999, representing 8% of total revenues in the three months ended
September 30, 1998 and 7% of total revenues in the three months ended September
30, 1999. The dollar increase was due primarily to additional spending related
to recruiting of new employees. The decrease as a percentage of total revenues
is primarily the result of higher total revenues in the three months ended
September 30, 1999.
Other income, net
Other income, net consists primarily of interest expense from our leases
for capital equipment, offset by interest income earned on our cash balances.
Other income, net increased from $23,000 in the three months ended September 30,
1998 to $31,000 in the three months ended September 30, 1999, representing less
than 1% of total revenues in both periods. The dollar increase was due primarily
to lower interest expense in the three months ended September 30, 1999.
Income tax expense (benefit)
The income tax provision recorded for the three months ended September 30,
1998 was zero, compared to a benefit of $1.1 million for the three months ended
September 30, 1999. The benefit in the three months ended September 30, 1999 is
attributable to a reduction in the deferred tax asset valuation allowance. In
August, 1999, we determined that a portion of the deferred tax asset, which had
been fully reserved at March 31, 1999, would more likely than not be utilized.
Accordingly, the valuation allowance was reduced.
Six months ended September 30, 1998 compared to six months ended September 30,
1999
Revenues
Total revenues. Total revenues increased 53%, from $12.0 million in the six
months ended September 30, 1998 to $18.4 million in the six months ended
September 30, 1999.
Network management services. Revenues from network management services
increased 79%, from $5.6 million in the six months ended September 30, 1998 to
$10.1 million in the six months ended September 30, 1999, representing 47% of
total revenues in the six months ended September 30, 1998 and 55% of total
revenues in the six months ended September 30, 1999. Approximately one-half of
the dollar increase was due to increased recurring revenues resulting from a
growth in the number of managed devices under contract. The remainder of the
increase was due to increased implementation and installation revenues resulting
from higher volumes of newly installed sites and increased management fees for
ordering and managing CPE for selected resellers.
Equipment and other. Revenues from equipment and other increased 31%, from
$6.3 million in the six months ended September 30, 1998 to $8.3 million in the
six months ended September 30, 1999, primarily as a result of an increase in the
number of equipment maintenance contracts in place and, to a lesser extent,
increased sales of CPE.
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Revenues from CPE sales grew at a slower rate as a result of amendments we have
made to some of our reseller agreements whereby we receive management fees for
ordering CPE and managing CPE inventories for these resellers. In addition, we
expect to limit discounts on CPE and encourage end users to purchase equipment
from other sources. We therefore anticipate that revenues from CPE sales will
continue to decline as we seek to manage our mix of revenues.
Costs of revenues
Cost of network management services. Cost of network management services
increased 53%, from $3.8 million in the six months ended September 30, 1998 to
$5.8 million in the six months ended September 30, 1999, representing 67% of
network management services revenues in the six months ended September 30, 1998
and 58% of such revenues in the six months ended September 30, 1999. The dollar
increase was due primarily to the addition of personnel to accommodate growth,
upgrades to the network management infrastructure and, to a lesser extent,
increased subcontractor costs related to installation of CPE. The percentage
decrease was due primarily to improvements in processes and tools which have
resulted in a higher number of managed devices per operations employee.
Cost of equipment and other. Cost of equipment and other increased 31%,
from $5.0 million in the six months ended September 30, 1998 to $6.5 million in
the six months ended September 30, 1999, representing 78% of equipment and other
revenues in the six months ended September 30, 1998 and 79% of such revenues in
the six months ended September 30, 1999. The increase in dollars was due to a
higher number of equipment maintenance contracts in place and to a lesser extent
an increased volume of CPE sales in the six months ended September 30, 1999.
Operating expenses
Development. Development expenses increased 29%, from $905,000 in the six
months ended September 30, 1998 to $1.2 million in the six months ended June 30,
1999, representing 8% of total revenues in the six months ended September 30,
1998 and 6% of total revenues in the six months ended September 30, 1999. The
increase in dollars was due to an increase in the number of software and service
development personnel devoted to the development and enhancement of network
management tools and our network management services. The decrease as a
percentage of total revenues was affected by our decision to manage development
spending to a lower level as a percentage of total revenues.
Selling and marketing. Sales and marketing expenses increased 35%, from
$1.5 million in the six months ended September 30, 1998 to $2.0 million in the
six months ended September 30, 1999, representing 12% of total revenues in the
six months ended September 30, 1998 and 11% of total revenues in the six months
ended September 30, 1999. The increase in dollars was due to increased spending
for advertising and other promotional activities, including a planned customer
summit. The increase was also caused by the addition of sales and marketing
personnel.
General and administrative. General and administrative expenses increased
22%, from $1.1 million in the six months ended September 30, 1998 to $1.3 in the
six months ended June 30, 1999, representing 9% of total revenues in the six
months ended September 30, 1998 and 7% of total revenues in the six months ended
September 30, 1999. The dollar increase was due primarily to additional spending
related to recruiting of new employees. The decrease as a percentage of total
revenues is primarily the result of higher total revenues in the six months
ended September 30, 1999.
Other income, net
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Other income, net increased from $71,000 in the six months ended September
30, 1998 to $77,000 in the six months ended September 30, 1999, representing
less than 1% of total revenues in both periods. The increase is primarily due to
lower interest expense in the six months ended September 30, 1999.
Income tax expense (benefit)
The income tax provision recorded for the six months ended September 30,
1998 was zero, compared to a benefit of $2.2 million for the six months ended
September 30, 1999. The benefit in the six months ended September 30, 1999 is
attributable to a reduction in the deferred tax asset valuation allowance. In
August, 1999, we determined that a portion of the deferred tax asset, which had
been fully reserved at March 31, 1999, would more likely than not be utilized.
Accordingly, the valuation allowance was reduced.
Quarterly results of operations
Although our total revenues have increased in each of the last ten
quarters, results of operations have varied from quarter to quarter.
Accordingly, we believe that period-to-period comparisons of results of
operations are not necessarily meaningful and should not be relied upon as
indications of future performance. Our operating results may fluctuate as a
result of many factors, including our ability to renew or retain existing end-
user and reseller relationships, the cost of introducing new service offerings
and the profitability of such offerings, and the level and nature of
competition. Further, we may be unable to adjust spending rapidly enough to
compensate for any significant fluctuations in the number of new managed devices
implemented in a given period. Any significant shortfall in the number of new
managed devices could therefore seriously damage our business. Finally, there
can be no assurance that we will be profitable in the future or, if we are
profitable, that our levels of profitability will not vary significantly between
quarters.
Liquidity and capital resources
Net cash used in operating activities for the six months ended September
30, 1998 was $426,000. Net cash provided by operating activities for the six
months ended September 30, 1999 was $1.1 million.
We used $1.1 million and $1.3 million in the six month periods ended
September 30, 1998 and September 30, 1999 to purchase capital assets primarily
used in the delivery of our network management services. We currently have no
material commitments for capital expenditures. Proceeds from leases of capital
equipment totaled $562,000 for the six month period ended September 30, 1998 and
$0 for the six month period ended September 30, 1999. We paid $328,000 for the
six month period ended September 30, 1998 and $457,000 for the six month period
ended September 30, 1999, toward our lease obligations for capital equipment. We
intend to continue to add sales, marketing and development resources over the
next 12 months; however, we anticipate that costs associated with sales,
marketing and development initiatives will not materially increase as a
percentage of revenues and will not result in significant uses of working
capital.
As of September 30, 1999, we had $5.7 million in cash and cash equivalents,
$4.2 million in net accounts receivable and $9.6 million in working capital. We
believe that the net proceeds received from the initial public offering, which
totaled $48.5 million including the underwriters' overallotment, together with
cash generated from operations, will be sufficient to fund our anticipated
working capital needs, capital expenditures and any potential future
acquisitions for at least 12 months. In the event our plans or assumptions
change or prove to be inaccurate, or if we consummate any unplanned acquisitions
of businesses or assets, we may be required to seek additional sources of
capital. Sources of additional capital may include public and private equity and
debt financings, sales of nonstrategic assets and other financing arrangements.
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In October 1999, the Company received aggregate proceeds from its initial
public offering of its common stock in an amount (net of expenses) of
approximately $48.5 million. These funds will be invested in short-term,
investment-grade, interest-bearing securities pending their use.
As of March 31, 1999, we had net operating loss carryforwards of
approximately $17.2 million available to offset future net income for U.S.
federal income tax purposes. These net operating loss carryforwards will expire
beginning in 2004 if not utilized. We have alternative minimum tax credit
carryforwards of $196,000 which do not expire. Our utilization of these net
operating loss and tax credit carryforwards may be subject to a substantial
annual limitation due to the ''change in ownership'' provisions of the Internal
Revenue Code. The annual limitation may result in the expiration of the net
operating losses before utilization. We provided a full valuation allowance on
the deferred tax asset at March 31, 1999 because of uncertainty regarding its
realization. During the quarter ended June 30, 1999, we determined that a full
valuation allowance was no longer warranted and accordingly reduced the
allowance by $1.2 million. For the quarter ended September 30, 1999, we further
reduced the valuation allowance by $1.1 million. In determining the appropriate
amount of valuation allowance required, we considered factors such as the
history of operating losses, the recent consecutive quarters of income, future
profitability expectations, and the nature of the deferred tax assets.
Year 2000 readiness
Many existing computer systems and software products are coded to accept
only two digit entries in the date code field. As a result, software that
records only the last two digits of the calendar year may not be able to
distinguish whether ''00'' means 1900 or 2000. This may result in software
failures or the creation of erroneous results.
Our state of readiness. Our business depends on the operation of numerous
systems that could potentially be impacted by year 2000 related problems. These
systems include:
. computer hardware and software systems used to provide services;
. computer hardware and software applications used to manage our business;
. computer operating systems;
. communications hardware and software systems, and networks such as Frame
Relay, the Internet and private intranets used to provide services or
to manage our business; and
. non-information technology systems and services we use to manage our
business, such as telephone, security and building management systems.
We utilize a number of hardware platforms to operate our software
applications and primarily utilize Windows 95/98, Windows NT, Unix and Linux
operating systems. Our software applications are therefore dependent upon the
correct processing of dates by these systems. In addition, we use other software
systems for internal business purposes, including accounting, email, and
development. All of these applications have been purchased or upgraded within
the preceding twelve months. In July 1999, we completed a conversion of our
financial and accounting system for accounts payable, accounts receivable and
general ledger accounts, in order to upgrade the systems' functionality and to
make the system year 2000 compliant.
We have completed our assessment of our year 2000 readiness and are in the
final stages of completing the required corrective actions we have identified.
Based on an analysis of all systems potentially impacted by conducting business
in year 2000 and beyond, we have pursued a phased approach to making our systems
and our operations ready for the year 2000. This process has included the
following:
. identifying and reviewing internally-developed systems for year 2000
compliance;
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. identifying third party hardware and software systems for year 2000
compliance;
. conducting research with third party suppliers of the systems and
software that we believe are critical to our business regarding their
year 2000 readiness;
. reviewing information published by third-party suppliers regarding the
year 2000 compliance of their products;
. modifying internally developed systems and upgrading third party
provided systems as required based on our assessment of year 2000
readiness; and
. validating and testing technologically compliant year 2000 solutions
after completing any modifications or upgrades.
Each of the third party suppliers has indicated through publicly available
information or through its web site that it believes its applications or systems
are year 2000 compliant. Based on this review, and our internal procedures
outlined above, we do not believe that the underlying hardware and operating
systems that we utilize to operate our software applications contain material
year 2000 deficiencies.
The table below provides a summary of the status and timing of our internal
readiness activities:
<TABLE>
<CAPTION>
Targeted
Systems Status Completion
- ------- ---------------------------------------- ----------
<S> <C> <C>
Computer hardware and software systems used Systems upgraded or replaced as Completed
to manage our business appropriate, including validation and
testing
Non-information technology systems and Systems upgraded or replaced as Completed
services we use to manage our business appropriate, including validation and
testing
Communications hardware and software Systems upgraded or replaced as 11/30/99
systems and networks appropriate, including validation and
testing, except for previously planned
replacements of identified internal LAN
hardware
Computer operating systems Systems upgraded or replaced as Completed
appropriate, except for upgrades to
Windows NT 4.0
Computer hardware and software systems used Systems upgraded or replaced as Completed
to provide services appropriate, including validation and
testing, except for one third party tool
</TABLE>
Contingency plans. We have not yet developed a specific contingency plan
for handling year 2000 problems that are not detected and corrected prior to
their occurrence. Depending on our systems affected, our year 2000 contingency
actions could include:
. accelerated replacement of affected equipment or software, resulting in
higher equipment expense and depreciation;
. short to medium term use of backup equipment and software;
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<PAGE>
. increased work hours for our staff, resulting in higher compensation
expense and possibly higher employee turn-over; and
. use of contract personnel to correct any year 2000 problems that arise
or to develop manual work-arounds for information systems, each on an
accelerated schedule.
While we may be materially adversely affected by year 2000 problems attributable
to a third party such as a telecommunications carrier, the resolution of those
problems may be outside of our control.
Costs to address year 2000 issues. To date, the costs for conducting our
assessment have not been material, and we expect total costs incurred in
connection with completing our year 2000 project to be less than $100,000 based
on the nature of the remaining work as determined from our assessment of the
year 2000 readiness of our systems. We cannot be sure that additional year 2000
issues will not be discovered in our internal or external software systems. If
any issues are discovered with respect to a product or system, we cannot be sure
that the costs of making that product or system year 2000 ready will not harm
our business and financial condition.
Potential adverse effects of failure to timely resolve year 2000 issues.
Despite our assessment, corrective actions and testing, our software
applications and the underlying hardware systems and protocols running the
software may contain undetected errors or defects associated with year 2000 date
functions. Our software applications operate in complex network environments and
directly and indirectly interact with a number of other hardware and software
systems. We are unable to predict to what extent our business may be affected if
our software or the systems that operate in conjunction with our software
experience a material year 2000 failure. Known or unknown errors or defects that
affect the operation of our software could result in:
. delay or loss of revenues;
. cancellation of customer contracts;
. increased service and guarantee costs;
. damage to our reputation;
. diversion of development resources; and
. litigation costs.
Any of these results could adversely affect our business, financial condition
and results of operations.
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<PAGE>
Risk Factors
We may be unable to operate profitably in the future.
We may not operate profitably. Although we began operating in 1987, we did
not introduce our first network management service until the quarter ended March
31, 1994. Our track record of operating profitably in the network management
services business is short, and it is difficult to predict our future revenues
and operating results. We have previously incurred substantial net losses. Our
ability to operate profitably in the future depends on increasing sales of our
services while maintaining sufficient gross profit margins. We must, among other
things:
. maintain satisfactory relationships with resellers such as AT&T, our
largest customer, and network equipment manufacturers such as Cisco;
. establish relationships with additional marketing partners for the
resale of our services;
. develop software to make our principal existing service, ProWatch for
WANs, more efficient and economical;
. develop and sell other network management services; and
. maintain reliable, uninterrupted service from our network management
center 24 hours per day, seven days per week.
Our revenues will decline significantly and our business will be adversely
affected if AT&T discontinues, or materially reduces, sales of our services.
Sales to AT&T, which resells our services to its customers, accounted for
59% of our total revenues in the fiscal year ended March 31, 1999 and 74% and
71% of our total revenues for the three and six months ended September 30, 1999.
We expect sales to AT&T to continue to comprise a substantial percentage of our
revenues at least through fiscal year 2000 and it is possible this percentage
could increase. To the extent we continue to depend on AT&T for a large portion
of our sales, our total revenues will decline materially if AT&T discontinues
selling our services or significantly reduces its sales of our services. We
cannot be sure that we will be successful in reducing our dependence on AT&T in
the future.
Our existing agreements with AT&T expire at various dates beginning in
December 1999. In addition, a number of the orders for services that we provide
to AT&T's customers under an agreement expiring in December 2001 can be
cancelled beginning in July 2000 and all new orders placed after June 30, 1999
can be cancelled beginning July 2001. Our agreements with AT&T are not exclusive
arrangements. We will need to maintain a good working relationship with
different business units of AT&T in order to maintain the business we currently
provide to AT&T's customers and to encourage AT&T to sell our services to
additional customers. Problems in our relationship with AT&T would seriously
damage our business. We cannot assure you that AT&T will continue to sell our
services to existing or additional AT&T customers. A substantial reduction in
our AT&T business would result in diminished revenues for an extended period of
time as we attempted to replace that business.
On December 9, 1998, AT&T announced that it was acquiring IBM's Global
Network business, which services the networking needs of global companies, mid-
sized businesses and individual Internet users. We are unable to predict what
impact, if any, this acquisition will have on our relationship with AT&T.
Our quarterly results may fluctuate and cause the price of our common stock to
fall.
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<PAGE>
Our revenues and results of operations are difficult to predict and may
fluctuate significantly from quarter to quarter. If either our revenues or
results of operations fall below the expectations of investors or public market
analysts, the price of our common stock could fall dramatically.
Our revenues are difficult to forecast and may fluctuate for a number of
reasons:
. the market for network management services is relatively new, and we
have no reliable means to assess overall customer demand;
. we derive a majority of our revenues from AT&T and other resellers, and
our revenues therefore depend significantly on the willingness and
ability of AT&T and those other resellers to sell our services to
their customers;
. we may not be able to attract additional resellers to market our
services as expected;
. we expect to encourage end users to purchase equipment from other
sources, and we therefore anticipate that our revenues from equipment
resales will continue to decline as we seek to manage our mix of
revenues;
. we may not add new end users as rapidly as we expect;
. we may lose existing end users as the result of competition, problems
with our services or, in the case of end users who are customers of
our resellers, problems with the reseller's services; and
. we may not be able to develop new or improved services as rapidly as
they are needed.
Most of our expenses, particularly employee compensation and rent, are
relatively fixed. As a result, variations in the timing of revenues could
significantly affect our results of operations from quarter to quarter and could
result in quarterly losses.
Our future operating results may vary by season, which will make it difficult to
predict our future performance.
As a result of seasonal factors, we believe that quarter-to-quarter
comparisons of our results of operations are not necessarily meaningful. These
factors may adversely affect our operating results or cause our operating
results to fluctuate, resulting in a decrease in our stock price. You should not
rely on our quarterly results of operations to predict our future performance.
Our bookings may be slower during the months of July and August due to the
vacation schedules of our resellers' sales and marketing employees. This
situation may lead to lower levels of revenues earned during the following
fiscal quarter, which ends December 31.
Our revenues during our third and fourth fiscal quarters may be more
volatile and difficult to predict due to the budgeting and purchasing cycles of
our end users. End users typically purchase our services at the same time they
purchase new network equipment such as routers. As a result, the timing of their
large capital expenditures could affect the timing of their purchases of our
services. Some end users may not be able to purchase network equipment and our
services near the end of a calendar year due to depleted budgets. Other end
users may accelerate purchases in order to use an unspent portion of their
budget.
The market for our services is new and evolving rapidly, and our business will
be seriously damaged if the market does not develop as we expect.
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<PAGE>
Our long-term viability depends significantly upon the acceptance and use
of remote network management services by mid-sized companies. The market for
remote network management services is new and rapidly evolving. This market
environment makes it more difficult to determine the size and growth of the
market and to predict how this market will develop. Changes in technology, the
availability of qualified information technology professionals and other factors
that make internal network management more cost effective than remote network
management would adversely affect the market for our services. Our business may
be seriously damaged if this market fails to grow, grows more slowly than we
expect or develops in some way that is different from our expectations.
We must establish relationships with additional resellers in order to increase
our revenues and become consistently profitable.
We expect to rely increasingly on resellers such as telecommunications
carriers, Internet service providers and data networking value-added resellers
to market our services. We must establish these alternative sales channels in
order to increase our revenues and become consistently profitable. We have
limited experience in managing sales through resellers. We have only recently
begun to develop these sales channels, and we have established relationships
with only a few resellers. Except for AT&T, these resellers have not generated
significant sales of our services to date and may not succeed in marketing our
services in the future.
Our agreements with resellers, including AT&T, generally do not require
that the resellers sell any minimum level of our services and generally do not
restrict the resellers' development or sale of competitive services. We cannot
be sure that these resellers will dedicate resources or give priority to selling
our services. In addition, resellers may seek to make us reduce the prices for
our services in order to lower the total price of their equipment, software or
service offerings.
Reseller relationships may adversely affect our business by weakening our
relationships with end users, decreasing the strength of our brand name and
limiting our ability to sell services directly to resellers' customers.
If we succeed in increasing our sales through resellers, we may have weaker
relationships with the end users of our services. This may inhibit our ability
to gather customer feedback that helps us improve our services, develop new
services and monitor customer satisfaction. We may also lose brand
identification and brand loyalty, since our services may be identified by
private label names or may be marketed differently by our resellers. A failure
by any of our resellers to provide their customers with satisfactory products,
services or customer support could injure our reputation and seriously damage
our business. Our agreements with these resellers may limit our ability to sell
our services directly to the resellers' customers in the future.
Any material decrease in sales of our WAN management services will significantly
reduce our total revenues and adversely affect our business.
Competitive pressures or other factors that adversely affect sales of our
wide area network, or WAN, management services or that cause significant
decreases in the prices of our WAN management services could significantly limit
or reduce our revenues. Sales of our ProWatch for WANs and similar WAN
management services accounted for 98% of our recurring network management
services revenues in the fiscal year ended March 31, 1999. Likewise, a
substantial portion of our nonrecurring network management services and
equipment resale revenues depend on the successful sale of these WAN management
services. We expect that these WAN management services will continue to generate
substantially all of our revenues for the foreseeable future. Our financial
performance therefore depends directly on continued market acceptance of our WAN
management services, as well as our ability to introduce enhanced versions of
these services that make these services more efficient and economical.
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<PAGE>
Our failure to develop and sell additional services could impair our financial
results and adversely affect our business.
Our future financial performance will depend in part on our ability to
develop, introduce and sell new and enhanced network management services other
than WAN management services, including services that:
. address the increasingly sophisticated needs of current and prospective
end users; and
. respond on a timely and cost-effective basis to technological advances
and emerging industry standards and protocols.
Although we have developed new services, such as network management
services for local area networks, or LANs, and network security services, we
have not derived significant revenues from these services to date. We cannot be
sure that we will be successful selling these services or developing additional
services on time or on budget. The development of new services is a complex and
uncertain process. The newness of the market for remote network management
services makes it difficult to determine whether a market will develop for any
particular network management service. If we succeed in increasing the
percentage of our revenues that is derived from resellers, we may have weaker
relationships with the end users of our services, making it even more difficult
for us to identify services acceptable to our target market of mid-sized
companies. We cannot assure you that future technological or industry
developments will be compatible with our business strategy or that we will be
successful in responding to these changes in a timely or cost-effective manner.
Our failure to develop and sell services other than WAN management services
could seriously damage our business.
Our business may be harmed if we lose the services of our chief executive
officer.
Our ability to build our business and compete effectively depends to a
significant degree on the skills, experience and efforts of our executive
officers, particularly Craig S. Tysdal, our president and chief executive
officer. Mr. Tysdal has led us during our transition from our data transport
business to the network management services field. He is our key representative
in our relationship with AT&T. We do not have employment contracts requiring Mr.
Tysdal or any of our other personnel to continue their employment for any period
of time, and we do not maintain key man life insurance on Mr. Tysdal or any of
our other personnel. The loss of the services of Mr. Tysdal would seriously
damage our business.
In order to support our business, we must hire additional information technology
professionals, who are in extremely short supply.
We derive all of our revenues from network management services and related
resales of equipment. These services can be extremely complex, and in general
only highly qualified, highly trained information technology, or IT,
professionals have the skills necessary to develop and provide these services.
In order to continue to support our current and future business, we need to
attract, motivate and retain a significant number of qualified IT professionals.
Qualified IT professionals are in short supply, and we face significant
competition for these professionals, from not only our competitors but also our
end users, marketing partners and other companies throughout the network
services industry. Other employers may offer IT professionals significantly
greater compensation and benefits or more attractive career paths or geographic
locations than we are able to offer. Any failure on our part to hire, train and
retain a sufficient number of qualified IT professionals would seriously damage
our business.
We could incur significant costs if we are unable to retain our information
technology professionals.
Because of the limited availability of IT professionals, we seek to hire
persons who have obtained college bachelor's degrees and then train those
persons to provide our services. As a result, we invest a significant amount of
time and money in training these new employees before they begin to support our
business. We do not enter into
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employment agreements requiring these employees to continue in our employment
for any period of time. Departures of trained employees could limit our ability
to generate revenues and would require us to incur additional costs in training
new employees.
We currently compete most directly with our customers' internal solutions, and
we expect increasing competition from other network services companies.
To compete successfully, we must respond promptly and effectively to the
challenges of technological change, evolving standards and our competitors'
innovations by continuing to enhance our services, as well as our sales programs
and channels. Any pricing pressures, reduced margins or loss of market share
resulting from increased competition, or our failure to compete effectively,
could seriously damage our business.
We face competition from different sources. Currently, we compete
principally with potential end users' and resellers' internal network
administration organizations. These organizations may have developed tools and
methodologies to manage their network processes and may be reluctant to adopt
applications offered by third parties like us.
If the market for out-sourced network management services grows as we
expect, we believe this market will become highly competitive. Competition is
likely to increase significantly as new network management services companies
enter the market and current competitors expand their service and product lines.
Many of these potential competitors are likely to enjoy substantial competitive
advantages, including:
. larger technical staffs;
. more established sales channels;
. more software development experience;
. greater name recognition; and
. substantially greater financial, marketing, technical and other
resources.
If our operations are interrupted, we may lose customers and revenues.
We must be able to operate our network management infrastructure 24 hours
per day, seven days per week without interruption. If our operations are
interrupted, we may lose customers and revenues. All of our network management
services are provided remotely from our network management center, which is
located at a single site in Austin, Texas. We do not have any redundant systems
or facilities at a separate geographic location. In order to operate without
interruption, we must guard against:
. power outages, fires, tornados and other natural disasters at our
network management center;
. telecommunications failures;
. equipment failures or ''crashes;''
. security breaches; and
. other potential interruptions.
Any interruptions could:
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. require us to make payments on the contractual performance guarantees we
offer our customers;
. cause end users to seek damages for losses incurred;
. require us to spend more money replacing existing equipment or adding
redundant facilities;
. damage our reputation for reliable service;
. cause existing end users and resellers to cancel our contracts; or
. make it more difficult for us to attract new end users and resellers.
Our revenues would decline and our business would be adversely affected if the
networking equipment and carrier services we support become obsolete or are
otherwise not used by a large part of our target market.
As part of our strategy, we have elected to support only selected providers
of networking equipment and carrier services. For example, we support routers
manufactured by 3Com, Bay/Nortel and Cisco, but not by other equipment
providers. Our services cannot be used by companies with networking equipment
and carrier services that we do not support. Our business would be seriously
damaged if, in the future, the networking equipment manufacturers and carrier
services that we support were not the predominant providers to our target market
or if their equipment or services became unavailable or significantly more
expensive. Technological advances that make obsolete any of the networking
equipment and carrier services that we support, or that offer significant
economic or functional advantages over the equipment and services, also could
limit or reduce our revenues or could force us to incur significant costs
attempting to support other networking equipment and carrier services.
We may be unable to protect our intellectual property, and we could incur
substantial costs defending our intellectual property from infringement or
claims of infringement made by others.
Our business and financial performance depends to a significant degree upon
our software and other proprietary technology. The software industry has
experienced widespread unauthorized reproduction of software products. We have
no patents. The steps we have taken may not be adequate to deter competitors
from misappropriating our proprietary information, and we may not be able to
detect unauthorized use and take appropriate steps to enforce our intellectual
property rights.
We could be the subject of claims alleging infringement of third-party
intellectual property rights. In addition, we may be required to indemnify our
distribution partners and end users for similar claims made against them. Any
infringement claim could require us to spend significant time and money in
litigation, pay damages, develop non-infringing intellectual property or acquire
licenses to intellectual property that is the subject of the infringement
claims. As a result, any infringement claim could seriously damage our business.
Problems related to the year 2000 issue could cause internal system failures
that impair our operations.
Many currently installed computer systems and software products only accept
two digits to identify the year in any date. Thus, the year 2000 will appear as
''00,'' which the system might consider to be the year 1900 rather than 2000.
This could result in system failures, delays or miscalculations. Computer
systems and software that have not been developed or enhanced recently may need
to be upgraded or replaced to comply with year 2000 requirements.
We have only recently completed the conversion of our internal financial
and accounting system to make it year 2000. We expect to spend less than
$100,000 to complete all remaining hardware and software upgrades in order to be
year 2000 compliant. If, however, we discover significant year 2000 errors or
defects, we could incur substantial
23
<PAGE>
costs and our operations could be seriously disrupted. We have not developed a
specific contingency plan for handling year 2000 problems.
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
Use of Proceeds
The Company's registration statement on Form S-1 (File No. 333-65691) was
declared effective on September 28, 1999. An offering of the Company's common
stock was commenced on September 29, 1999. The offering, for which BancBoston
Robertson Stephens Inc. and Thomas Weisel Partners LLC served as managing
underwriters, terminated following the sale of all of the shares offered.
During the period from the effective date of the registration statement until
September 30, 1999, no offering expenses were incurred by the Company and no
disposition of net proceeds of the offering was made by the Company. Proceeds
of the offering were received by the Company on October 4, 1999 and October 28,
1999.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
No reports were filed on Form 8-K during the quarter ended September 30, 1999.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 15, 1999 NETSOLVE, INCORPORATED
By: /s/ Craig S. Tysdal
---------------------------------------
Craig S. Tysdal
President and Chief Executive Officer
By: /s/ Kenneth C. Kieley
---------------------------------------
Kenneth C. Kieley
Vice President-Finance, Chief Financial
Officer and Secretary
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE NETSOLVE
INCORPORATED CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED) FOR SEPTEMBER 30,
1999 AND THE CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) FOR THE SIX
MONTHS ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-END> SEP-30-1999
<CASH> 5,655
<SECURITIES> 0
<RECEIVABLES> 4,462
<ALLOWANCES> 252
<INVENTORY> 278
<CURRENT-ASSETS> 14,989
<PP&E> 8,024
<DEPRECIATION> 4,355
<TOTAL-ASSETS> 19,690
<CURRENT-LIABILITIES> 5,401
<BONDS> 0
0
0
<COMMON> 135
<OTHER-SE> 13,527
<TOTAL-LIABILITY-AND-EQUITY> 19,690
<SALES> 18,368
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 12,313
<OTHER-EXPENSES> 4,448
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 66
<INCOME-PRETAX> 1,684
<INCOME-TAX> (2,206)
<INCOME-CONTINUING> 3,890
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,630
<EPS-BASIC> 0.74
<EPS-DILUTED> 0.22
</TABLE>
