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Filed pursuant to Rule 424(B)(4)
SEC File No. 333-65691
[LOGO OF NETSOLVE APPEARS HERE]
3,700,000 Shares
Common Stock
NetSolve, Incorporated is offering 3,530,000 shares of its common stock and
the selling stockholders are offering an additional 170,000 shares. This is our
initial public offering and no public market currently exists for our shares.
Our shares have been approved for quotation on the Nasdaq National Market under
the symbol "NTSL."
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Investing in our common stock involves risks.
See "Risk Factors" beginning on page 6.
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<CAPTION>
Per Share Total
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<S> <C> <C>
Public offering price.................................... $13.00 $48,100,000
Underwriting discounts and commissions................... $ 0.91 $ 3,367,000
Proceeds to NetSolve..................................... $12.09 $42,677,700
Proceeds to selling stockholders......................... $12.09 $ 2,055,300
</TABLE>
The Securities and Exchange Commission and state securities regulators have
not approved or disapproved these securities or determined if this prospectus
is truthful or complete. Any representation to the contrary is a criminal
offense.
We have granted the underwriters a thirty-day option to purchase up to an
additional 555,000 shares of our common stock. BancBoston Robertson Stephens
expects to deliver the shares of common stock to purchasers on October 4, 1999.
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BancBoston Robertson Stephens Thomas Weisel Partners LLC
The date of this prospectus is September 29, 1999.
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You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of the delivery of this
prospectus or any sale of our common stock.
Until October 24, 1999, all dealers that buy, sell or trade our common stock,
whether or not participating in this offering, may be required to deliver a
prospectus. This requirement is in addition to the dealers' obligation to
deliver a prospectus when acting as underwriters and with respect to their
unsold allotments or subscriptions.
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TABLE OF CONTENTS
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Page
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Summary.................................................................. 4
Risk Factors............................................................. 6
Use of Proceeds.......................................................... 14
Dividend Policy.......................................................... 14
Capitalization........................................................... 15
Dilution................................................................. 16
Selected Consolidated Financial Data..................................... 17
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 19
Business................................................................. 33
Management............................................................... 45
Transactions with Related Parties........................................ 53
Principal and Selling Stockholders....................................... 53
Description of Capital Stock............................................. 56
Shares Eligible for Future Sale.......................................... 58
Underwriting............................................................. 60
Legal Matters............................................................ 62
Experts.................................................................. 62
Where You Can Find More Information...................................... 62
Index to Consolidated Financial Statements............................... F-1
</TABLE>
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We have federal trademark registrations for the NetSolve(R) logo, the name
NetSolve(R) and the trade names ProWatch(R), ProWatch IV(R), ProWatch for
WANs(R), ProWatch for LANs(R) and ProWatch Secure(R). We have a federal service
mark application pending for the trade name ProWatch Exchange SM. Trade names,
trademarks and service marks of other companies appearing in this prospectus
are the property of the respective holders.
3
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SUMMARY
This summary may not contain all the information that is important to you.
You should read the entire prospectus, including the consolidated financial
statements and related notes, before deciding to invest in shares of our common
stock.
Unless otherwise indicated, all information in this prospectus assumes the
underwriters do not exercise their over-allotment option and reflects the
conversion of all of our outstanding preferred stock into common stock, which
will take effect immediately before the closing of this offering.
NetSolve
We offer a range of services that allow companies to outsource some or all of
the activities relating to the design, implementation, management and security
of their computer networks. Our network management and security services are
designed to increase network reliability and up-time, reduce overall network
costs, and simplify timely migration to new technologies. We also resell third-
party networking equipment as a convenience to our network management services
customers.
Businesses increasingly depend on the ability to access and share electronic
information reliably. As a result, networks have become a more critical part of
day-to-day operations and businesses are seeking ways to implement responsive,
reliable and secure networks. Many companies are large enough to employ large
computer networks across multiple sites, referred to as wide area networks, or
WANs, but may be too small to afford or may prefer not to devote the
information technology personnel necessary to manage and secure their networks.
Facing rapid advances in technology and a continuing shortage of information
technology professionals, these companies are beginning to turn to third-party
service providers for network management and security solutions.
Our network management services address all or selected parts of the full
life cycle of network management, which consists of the following elements:
<TABLE>
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. design . monitoring . reporting
. configuration . fault diagnosis . upgrading
. implementation . fault resolution . documentation
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We furnish our network management services remotely 24 hours per day, seven
days per week from our network management center in Austin, Texas. As a
standard part of our services, we enable customers to access, through standard
web-based browsers, up-to-date network status reports. We also provide around-
the-clock remote security services for networks' Internet and intranet
perimeter points.
We target middle market companies, roughly defined as companies that have
between 100 and 1,000 employees and annual revenues between $25 million and
$1.0 billion. More than 600 middle market companies currently use our services
to manage approximately 9,500 network sites. We market our services through
relationships with resellers, including telecommunications carriers, Internet
service providers and value-added resellers, as well as through our direct
sales force. Sales to AT&T, which resells our services to its customers,
accounted for 59% of our total revenues in our fiscal year ended March 31, 1999
and 69% of our total revenues in the three months ended June 30, 1999. We
derive our revenues from both recurring and non-recurring network management
services, as well as from equipment resales. While revenues from equipment
resales have accounted for approximately one half of our total revenues in the
past, we are focusing on providing our network management and security services
and expect our equipment resale revenues to decrease as a percentage of our
total revenues. We support selected providers of networking equipment and
carrier services.
Our executive offices are located at 12331 Riata Trace Parkway, Austin, Texas
78727. Our telephone number is (512) 340-3000, and our web site is located at
www.netsolve.com. Information contained on our web site is not a part of this
prospectus.
4
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The Offering
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Common stock offered by NetSolve........ 3,530,000 shares
Common stock offered by selling
stockholders........................... 170,000 shares
Common stock to be outstanding after
this offering.......................... 13,408,516 shares
Use of proceeds......................... General corporate purposes, including
working capital and potential
acquisitions.
Nasdaq National Market symbol........... NTSL
</TABLE>
The number of shares of our common stock to be outstanding after this
offering is based on shares outstanding as of June 30, 1999. It excludes:
. 2,584,411 shares issuable upon exercise of outstanding options with a
weighted average exercise price of $3.39 per share;
. 107,500 shares issuable upon exercise of outstanding warrants with a
weighted average exercise price of $2.01 per share; and
. 2,986,020 shares reserved for future issuance under our stock-based
compensation plans.
Summary Consolidated Financial Data
The following tables summarize the financial data of our business. The pro
forma income from continuing operations per share and pro forma net income per
share are described in notes 2 and 4 of the notes to consolidated financial
statements included elsewhere in this prospectus. The pro forma balance sheet
data reflect the conversion of all of our outstanding preferred stock into
common stock that will occur immediately before the closing of this offering.
The pro forma as adjusted data reflect the sale of 3,530,000 shares of common
stock offered by us at a public offering price of $13.00 and our application of
our estimated net proceeds of this offering. Additional per share information
is disclosed on the consolidated statements of operations in the consolidated
financial statements included elsewhere in this prospectus.
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<CAPTION>
Three Months
Year Ended March 31, Ended June 30,
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1997 1998 1999 1998 1999
------- -------- -------- ------- -------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of operations data:
Total revenues................... $ 6,316 $ 14,523 $ 26,716 $ 5,562 $ 9,076
Total cost of revenues........... 5,072 11,131 18,923 4,129 6,208
Operating income (loss).......... (3,753) (3,369) 780 (293) 719
Discontinued operations, net..... 12,757 506 98 -- --
Net income (loss)................ 10,295 (2,226) 952 (245) 1,901
Basic net income (loss) per share
from:
Continuing operations........... $ (1.75) $ (1.76) $ (0.51) $ (0.27) $ 0.38
Net income (loss)............... $ 2.72 $ (1.59) $ (0.48) $ (0.27) $ 0.38
Weighted average shares used in
basic per share calculation..... 2,851 2,995 3,297 3,280 3,361
Diluted net income (loss) per
share from:
Continuing operations........... $ (1.75) $ (1.76) $ (0.51) $ (0.27) $ 0.25
Net income (loss)............... $ 2.72 $ (1.59) $ (0.48) $ (0.27) $ 0.25
Weighted average shares used in
diluted per share calculation... 2,851 2,995 3,297 3,280 5,055
Pro forma diluted income per
share from:
Continuing operations........... $ 0.07 $ 0.17
Net income...................... $ 0.08 $ 0.17
Pro forma weighted average shares
used in diluted per share
calculation..................... 11,341 11,450
</TABLE>
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<CAPTION>
June 30, 1999
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Pro Forma
Actual Pro Forma As Adjusted
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(in thousands)
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Balance sheet data:
Cash and cash equivalents..................... $ 6,582 $ 6,582 $48,410
Working capital............................... 7,836 7,836 49,664
Total assets.................................. 18,389 18,389 60,217
Capital lease obligations, net of current
portion...................................... 763 763 763
Redeemable convertible preferred stock........ 44,776 -- --
Total stockholders' equity (deficit).......... (33,179) 11,597 53,425
</TABLE>
5
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RISK FACTORS
Investing in shares of our common stock involves risks. You should be able to
bear a complete loss of your investment. You should carefully consider the
following factors and other information in this prospectus before deciding to
invest in shares of our common stock.
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 69% of our
total revenues in the three months ended June 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 attempt 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.
6
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Our quarterly results may fluctuate and cause the price of our common stock to
fall.
Our revenues and results of operations are difficult to predict and may
fluctuate significantly from quarter to quarter. If either our revenues or
results of operations fall below the expectations of investors or public market
analysts, the price of our common stock could fall dramatically.
Our revenues are difficult to forecast and may fluctuate for a number of
reasons:
. the market for network management services is relatively new, and we
have no reliable means to assess overall customer demand;
. we derive a majority of our revenues from AT&T and other resellers, and
our revenues therefore depend significantly on the willingness and
ability of AT&T and those other resellers to sell our services to their
customers;
. we may not be able to attract additional resellers to market our
services as expected;
. we expect to encourage end users to purchase equipment from other
sources, and we therefore anticipate that our revenues from equipment
resales will 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.
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
7
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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.
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
8
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. 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 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
9
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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:
. 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.
10
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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.
Our stock price may be volatile.
Volatility in our stock price may negatively impact the price investors may
receive for their shares of our common stock and increase the risk that we
could be the subject of costly securities litigation. The market price of our
common stock may fluctuate substantially due to a variety of factors,
including:
. the reaction of the market to the negotiated public offering price;
. quarterly fluctuations in our results of operations;
. changes in our relationship with AT&T;
. adverse circumstances affecting the introduction or market acceptance of
new products or services offered by us;
. announcements of new products or services by competitors;
. changes in our business strategies;
. changes in earnings estimates by public market analysts;
. inactivity in the trading market for our stock;
. loss of market-making or securities analyst coverage for our stock;
. changes in accounting principles;
. sales of common stock by existing holders; and
. loss of key personnel.
We may incur significant costs from securities litigation.
In the past, securities class action litigation often has been brought
against companies following periods of volatility in the market price of their
stock. We may in the future be the target of similar litigation. Securities
litigation against us could result in substantial costs and divert our
management's attention and resources.
11
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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 compliant and we are still in the
process of completing routine upgrades to some of our other internal systems,
including server and desktop computer operating systems, desktop computer
packaged software and desktop computer firmware. 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 costs and our operations could be
seriously disrupted. We have not developed a specific contingency plan for
handling year 2000 problems.
We could be subject to significant expenses and damages because of liability
claims.
Because our products are designed to provide critical network management
services, we may receive significant liability claims. Our agreements with
customers typically contain provisions intended to limit our exposure to
liability claims. These limitations may not, however, preclude all potential
claims.
Liability claims could require us to spend significant time and money in
litigation or to pay significant damages. As a result, any liability claims,
whether or not successful, could seriously damage our reputation and our
business.
Our remote network management service for WANs generally includes a guarantee
that the customer's end-to-end network will be available for at least 99.5% of
the time in any given month. If this guaranteed level of availability is not
achieved for an end user, we may be required to refund all of our WAN
management fees payable by the end user for that month. We may, in some
instances, refund amounts to customers for circumstances beyond our control.
Our existing stockholders will be able to control all matters requiring
stockholder approval and could prevent someone from acquiring or merging with
us.
After this offering, our executive officers and directors collectively will
beneficially own approximately 58.2% of our outstanding common stock. Thus,
they will continue to control our company and, if they act together, could
elect all of the directors and control all matters submitted to our
stockholders for a vote. This could delay or prevent someone from acquiring or
merging with us on terms favored by a majority of our independent stockholders.
Substantial sales of our common stock could cause our stock price to decline.
The market price of our common stock could decline as a result of sales by
our existing stockholders of shares of common stock in the market after this
offering, or the perception that these sales could occur. These sales might
also make it more difficult for us to sell equity securities at a time and at a
price that we deem appropriate.
We intend to file a registration statement approximately 90 days after the
completion of this offering covering 3,850,000 shares subject to outstanding
options or reserved for issuance under our stock plans.
12
<PAGE>
Our management will have broad discretion in using the net proceeds of this
offering.
We expect to use our net proceeds from this offering for general corporate
purposes, giving our management broad discretion in the allocation of the net
proceeds. Possible uses of these funds could include acquisitions of, or
investments in, complementary business and technologies. The failure of our
management to apply such funds effectively could seriously damage our business.
Anti-takeover provisions in our charter documents and Delaware law could
prevent or delay a change in control of our company.
Our board of directors will be able to use a number of mechanisms that could
make it more difficult for a third party to acquire control of our company,
even if a change of control might be beneficial to our stockholders. These
mechanisms include:
. the denial of cumulative voting contained in our charter, which could
make it more difficult to replace the board of directors;
. the provisions of the Delaware anti-takeover law that can be used to
discourage certain business combinations;
. the issuance of series of preferred stock in connection with share
rights plans or otherwise, pursuant to the "blank check" preferred stock
provisions of our charter, with disproportionate voting rights or other
features that could thwart a change of control; and
. the acceleration of the vesting of options or other incentive
compensation, in a manner that could make a business combination
significantly more expensive to conclude.
Investors will suffer dilution and may never be paid dividends.
Since our common stock has in the past been sold at prices substantially less
than the public offering price that you will pay, you will suffer immediate
dilution of $9.02 per share in pro forma net tangible book value. The exercise
of outstanding options and warrants may result in further dilution. We do not
currently anticipate paying cash dividends in the foreseeable future.
The forward-looking statements we make in this prospectus may prove inaccurate,
and our actual results and performance may differ materially from those
expressed in the forward-looking statements.
Some of the statements under "Summary," "Risk Factors," "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Business" and elsewhere in this prospectus constitute forward-looking
statements. In some cases, you can identify forward-looking statements by terms
such as "may," "will," "should," "could," "would," "expects," "plans,"
"intends," "anticipates," "believes," "estimates," "predicts," "potential,"
"continue" or comparable terms. These statements include known and unknown
risks and uncertainties that may cause our actual results, levels of activity,
performance or achievements to be materially different from any future results,
levels of activity, performance or achievements expressed or implied by such
forward-looking statements. These factors include those listed under "Risk
Factors" and elsewhere in this prospectus.
We cannot guarantee any future results, levels of activity, performance or
achievements. Neither we nor anyone else assumes responsibility for the
accuracy and completeness of these statements. We undertake no obligation to
update any of the forward-looking statements after the date of this prospectus.
13
<PAGE>
USE OF PROCEEDS
We estimate the net proceeds from our sale of 3,530,000 shares of common
stock will be approximately $41.8 million, at a public offering price of $13.00
per share and after deducting the underwriting discounts and commissions and
estimated offering expenses payable by us. We estimate that our expenses in
connection with this offering will total approximately $850,000. We estimate
that these net proceeds would be $48.5 million if the underwriters' over-
allotment option is exercised in full. We will not receive any proceeds from
the sale of shares of common stock by the selling stockholders.
The principal purposes of this offering are to:
.increase our capitalization and financial flexibility;
.increase our visibility in the marketplace;
.provide a public market for our common stock;
.facilitate our future access to public equity markets; and
.provide liquidity for our existing stockholders.
We believe that our enhanced financial position will provide us with needed
flexibility to respond to technological and market developments as well as
other future opportunities. We also believe that our completion of this
offering will improve our ability to attract and retain customers and
employees.
We intend to use our net proceeds from this offering for general corporate
purposes, including working capital and possible acquisitions of, and
investments in, complementary businesses and technologies. We are not currently
involved in negotiations with respect to, and we have no agreement or
understanding regarding, any acquisition or investment. Accordingly, we will
have broad discretion in the application of our net proceeds. Pending these
uses, we intend to invest our net proceeds in short-term, investment-grade,
interest-bearing securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock. We
intend to retain all available funds and any future earnings for use in the
operation of our business. Therefore, we do not anticipate paying any cash or
other dividends in the foreseeable future. Payment of future dividends, if any,
will be at the discretion of our board of directors after taking into account
various factors, including our financial condition, results of operations,
current and anticipated cash needs, and plans for expansion.
14
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of June 30, 1999:
. on an actual basis;
. on a pro forma basis giving effect to the conversion of our preferred
stock into common stock; and
. on a pro forma basis, as further adjusted to reflect the receipt of the
estimated net proceeds from our sale of 3,530,000 shares of common stock
at a public offering price of $13.00 per share and after deducting the
underwriting discounts and commissions and estimated offering expenses
payable by us.
This table should be read together with the consolidated financial statements
and related notes appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
June 30, 1999
--------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(in thousands)
<S> <C> <C> <C>
Capital lease obligations, net of current
portion....................................... $ 763 $ 763 $ 763
-------- -------- --------
Redeemable convertible preferred stock (Series
A and B), $0.10 par value; 7,500,000 shares
authorized; 6,394,727 shares issued and
outstanding, actual; no shares issued or
outstanding, pro forma and pro forma as
adjusted...................................... 44,776 -- --
-------- -------- --------
Stockholders' equity (deficit):
Common stock, $0.01 par value; 25,000,000
shares authorized; 3,483,789 shares issued
and outstanding, actual; 9,878,516 shares
issued and outstanding, pro forma;
13,408,516 issued and outstanding, pro forma
as adjusted................................. 35 99 134
Additional paid-in capital................... -- 28,975 70,768
Deferred compensation........................ (317) (317) (317)
Accumulated deficit.......................... (32,897) (17,160) (17,160)
-------- -------- --------
Total stockholders' equity (deficit)........... (33,179) 11,597 53,425
-------- -------- --------
Total capitalization........................... $ 12,360 $ 12,360 $ 54,188
======== ======== ========
</TABLE>
The number of shares of our common stock that will be outstanding after this
offering excludes as of June 30, 1999:
.2,584,411 shares issuable upon exercise of outstanding options with a
weighted average exercise price of $3.39 per share;
.107,500 shares issuable upon exercise of outstanding warrants with a
weighted average exercise price of $2.01 per share; and
.2,986,020 shares reserved for future issuance under our stock-based
compensation plans.
15
<PAGE>
DILUTION
The pro forma net tangible book value of our common stock as of June 30, 1999
was $11.6 million, or $1.17 per share. Pro forma net tangible book value per
share represents the amount of total tangible assets less total liabilities,
divided by the total pro forma number of shares of common stock outstanding,
after giving effect to the conversion of all of the outstanding shares of our
preferred stock into common stock. After giving effect to the sale of 3,530,000
shares of common stock offered by us in this offering at a public offering
price of $13.00 per share, and after deducting the underwriting discounts and
commissions and estimated offering expenses payable by us, the adjusted pro
forma net tangible book value at June 30, 1999, would have been approximately
$53.4 million, or $3.98 per share. This amount represents an immediate increase
in pro forma net tangible book value of $2.81 per share to existing
stockholders and an immediate dilution in pro forma net tangible book value of
$9.02 per share to new investors. The following table illustrates this per
share dilution:
<TABLE>
<S> <C> <C>
Public offering price per share............................... $13.00
Pro forma net tangible book value per share at June 30,
1999........................................................ $1.17
Increase per share attributable to new investors............. 2.81
-----
Adjusted pro forma net tangible book value per share after
this offering................................................ 3.98
------
Dilution per share to new investors........................... $ 9.02
======
</TABLE>
The following table summarizes, on a pro forma as adjusted basis as of June
30, 1999, the number of shares of common stock purchased from us, the total
consideration paid and the average price per share paid. These amounts are
based on a public offering price of $13.00 per share before deducting the
underwriting discounts and commissions and estimated offering expenses payable
by us.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ ------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders.. 9,878,516 74% $28,752,000 39% $ 2.91
New investors.......... 3,530,000 26 45,890,000 61 13.00
---------- --- ----------- ---
Total.............. 13,408,516 100% $74,642,000 100%
========== === =========== ===
</TABLE>
These tables assume no exercise of options and warrants outstanding at
June 30, 1999. Sales by selling stockholders will reduce the number of shares
of common stock held by existing stockholders to 9,708,516, or 72% of the total
number of shares of common stock outstanding after this offering, and will
increase the number of shares of common stock held by new investors to
3,700,000, or 28% of the total number of shares of common stock outstanding
after this offering. If the underwriters' overallotment option is exercised in
full, sales by selling stockholders will reduce the number of shares of common
stock held by existing stockholders to 70% of the total number of shares
outstanding after this offering and increase the number of shares held by new
investors to 4,255,000, or 30% of the total number of shares of common stock
outstanding after this offering.
16
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read together
with "Management's Discussion and Analysis of Financial Condition and Results
of Operation" and the consolidated financial statements and related notes
appearing elsewhere in this prospectus. The following selected consolidated
financial data for the years ended March 31, 1997, 1998 and 1999 and as of
March 31, 1998 and 1999 are derived from our consolidated financial statements
included elsewhere in this prospectus, which have been audited by Ernst & Young
LLP, independent auditors. The following selected consolidated financial data
for the years ended March 31, 1995 and 1996 and as of March 31, 1995, 1996 and
1997 are derived from our audited consolidated financial statements not
included in this prospectus. The following selected consolidated financial data
for the three months ended June 30, 1998 and 1999 and as of June 30, 1999 are
derived from our unaudited consolidated financial statements included elsewhere
in this prospectus. Our unaudited consolidated financial statements have been
prepared on the same basis as our audited consolidated financial statements and
in the opinion of our management include all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the data set forth.
<TABLE>
<CAPTION>
Three Months
Year Ended March 31, Ended June 30,
------------------------------------------- ----------------
1995 1996 1997 1998 1999 1998 1999
------- ------- ------- ------- ------- ------- -------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of operations
data:
Revenues:
Network management
services.............. $ 428 $ 782 $ 2,830 $ 7,324 $12,777 $ 2,560 $ 4,584
Equipment and other.... 1,846 2,888 3,486 7,199 13,939 3,002 4,492
------- ------- ------- ------- ------- ------- -------
Total revenues......... 2,274 3,670 6,316 14,523 26,716 5,562 9,076
Cost of revenues:
Cost of network
management services... 390 548 2,434 5,706 8,258 1,808 2,672
Cost of equipment and
other................. 1,138 1,998 2,638 5,425 10,665 2,321 3,536
------- ------- ------- ------- ------- ------- -------
Total cost of
revenues.............. 1,528 2,546 5,072 11,131 18,923 4,129 6,208
------- ------- ------- ------- ------- ------- -------
Gross profit............ 746 1,124 1,244 3,392 7,793 1,433 2,868
Operating expenses:
Development............ 1,081 1,132 1,262 2,040 1,762 446 579
Sales and marketing.... 383 732 2,246 2,562 3,153 739 943
General and
administrative........ 1,331 1,353 1,489 2,159 2,098 541 622
Amortization of
deferred
compensation.......... -- -- -- -- -- -- 5
------- ------- ------- ------- ------- ------- -------
Total operating
expenses.............. 2,795 3,217 4,997 6,761 7,013 1,726 2,149
------- ------- ------- ------- ------- ------- -------
Operating income
(loss)................. (2,049) (2,093) (3,753) (3,369) 780 (293) 719
Other income (expense),
net.................... (178) (110) 34 340 93 48 46
------- ------- ------- ------- ------- ------- -------
Income (loss) from
continuing operations
before income taxes.... (2,227) (2,203) (3,719) (3,029) 873 (245) 765
Income tax expense
(benefit).............. (599) (618) (1,257) (297) 19 -- (1,136)
------- ------- ------- ------- ------- ------- -------
Net income (loss) from
continuing operations.. (1,628) (1,585) (2,462) (2,732) 854 (245) 1,901
Discontinued operations:
Income from
discontinued
operations, net of
applicable income
taxes................. 1,244 2,041 2,142 165 -- -- --
Gain on sale of
discontinued
operations, net of
applicable income
taxes................. -- -- 10,615 341 98 -- --
------- ------- ------- ------- ------- ------- -------
Net income (loss)....... $ (384) $ 456 $10,295 $(2,226) $ 952 $ (245) $ 1,901
======= ======= ======= ======= ======= ======= =======
Basic income (loss) per
share from(1):
Continuing operations.. $ (3.45) $ (2.22) $ (1.75) $ (1.76) $ (0.51) $ (0.27) $ 0.38
======= ======= ======= ======= ======= ======= =======
Net income (loss)...... $ (2.42) $ (1.12) $ 2.72 $ (1.59) $ (0.48) $ (0.27) $ 0.38
======= ======= ======= ======= ======= ======= =======
Weighted average shares
used in basic per share
calculations(1)........ 1,204 1,860 2,851 2,995 3,297 3,280 3,361
======= ======= ======= ======= ======= ======= =======
Diluted income (loss)
per share from(1):
Continuing operations.. $ (3.45) $ (2.22) $ (1.75) $ (1.76) $ (0.51) $ (0.27) $ 0.25
======= ======= ======= ======= ======= ======= =======
Net income (loss)...... $ (2.42) $ (1.12) $ 2.72 $ (1.59) $ (0.48) $ (0.27) $ 0.25
======= ======= ======= ======= ======= ======= =======
Weighted average shares
used in diluted per
share calculations(1).. 1,204 1,860 2,851 2,995 3,297 3,280 5,055
Pro forma basic income
per share from(2):
Continuing operations.. $ 0.09 $ 0.19
======= =======
Net income ............ $ 0.10 $ 0.19
======= =======
Pro forma weighted
average shares used in
basic per share
calculations(2)........ 9,692 9,755
Pro forma diluted income
per share from(2):
Continuing operations.. $ 0.07 $ 0.17
======= =======
Net income ............ $ 0.08 $ 0.17
======= =======
Pro forma weighted
average shares used in
diluted per share
calculations(2)........ 11,341 11,450
</TABLE>
- --------------
(1) Calculated as described in note 2 of notes to consolidated financial
statements. Additional per share information is disclosed on the
consolidated statements of operations in the consolidated financial
statements included elsewhere in this prospectus.
(2) Reflects the conversion of our redeemable convertible preferred stock into
common stock. See note 4 of notes to consolidated financial statements.
17
<PAGE>
<TABLE>
<CAPTION>
March 31,
------------------------------------------------ June 30,
1995 1996 1997 1998 1999 1999
-------- -------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance sheet data:
Cash and cash
equivalents............ $ 361 $ 874 $ 8,128 $ 1,333 $ 2,764 $ 6,582
Working capital
(deficit).............. (859) (623) 9,464 5,399 5,282 7,836
Total assets............ 2,464 3,534 16,068 13,227 14,936 18,389
Capital lease
obligations, net of
current portion........ 248 235 175 1,146 1,027 763
Redeemable convertible
preferred stock........ 34,018 36,555 39,085 41,615 44,146 44,776
Total stockholders'
deficit................ (34,046) (36,104) (28,313) (33,029) (34,529) (33,179)
</TABLE>
18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This prospectus contains forward-looking statements which involve risks and
uncertainties. Actual results could differ materially from those anticipated in
these forward-looking statements.
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 fiscal year 1999, 67% 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 months ended June 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.
19
<PAGE>
Our network management services for WANs typically include a guarantee
providing end-to-end network availability for at least 99.5% of the time in any
given month. In the event the guaranteed availability is not achieved, we
generally are obligated to refund our WAN management fees for that month. This
guarantee covers some components of the end user's WAN, such as the transport
services provided by the end user's carrier, that are not directly under our
control. As a result, we may, in some instances, refund amounts to customers
for circumstances beyond our control. We establish a reserve against guarantees
we offer. Guarantee payments have not been significant 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
69% of our total revenues in the three months ended June 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 months
ended June 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.
Costs and expenses
In March 1998, we relocated all of our operations from our previous facility,
consisting of approximately 25,000 square feet leased at prices negotiated
originally in 1991 which were substantially below current market rates in 1998,
into a new leased facility of approximately 70,000 square feet. Concurrent with
this move, we upgraded our computing and network management infrastructure
environment. The impact of these changes increased costs by approximately
$300,000 per quarter. These costs are allocated across the cost of network
management services revenues, development, sales and marketing, and general and
administrative expenses.
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
20
<PAGE>
annual limitation may result in the expiration of the net operating losses
before utilization. We have 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. 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.
Discontinued operations
In December 1996, we decided to discontinue our data transport services
business segment and we sold a portion of that segment to Intermedia
Communications Inc. of Florida. The sale to Intermedia was closed on December
30, 1996 at a price of $12.3 million. As a part of this transaction, we
assigned to Intermedia all customer and supplier contracts related to a portion
of the business segment and we sold to Intermedia the capital equipment related
to this portion of the business segment. The agreement for this sale contains a
non-compete provision which prohibits us from competing in the data transport
business for five years. To ease the transition associated with this sale, we
agreed to provide management services to the transferred customer base through
October 1997. We recorded related revenues of $500,000 in fiscal year 1997,
$715,000 in fiscal year 1998 and $0 in fiscal year 1999, with respect to these
services. To complete the discontinuance of this business segment, on October
1, 1997, we assigned our rights and obligations to customer and supplier
contracts for other transport services to NetPlus, Inc. The purchase price,
initially established at 25% of NetPlus' gross profit from these services for a
period of three years beginning April 1, 1998 up to a maximum of $600,000, was
renegotiated to be a single payment of $100,000, which was received in fiscal
year 1999.
Results of operations
The following table sets forth statement of operations data expressed as
percentages of total revenues for the periods indicated:
<TABLE>
<CAPTION>
Three Months
Year Ended March 31, Ended June 30,
----------------------- -----------------
1997 1998 1999 1998 1999
------ ------ ------ ------- -------
<S> <C> <C> <C> <C> <C>
Revenues:
Network management services....... 44.8% 50.4% 47.8% 46.0% 50.5%
Equipment and other............... 55.2 49.6 52.2 54.0 49.5
------ ------ ------ ------- -------
Total revenues.................. 100.0 100.0 100.0 100.0 100.0
Total cost of revenues............. 80.3 76.6 70.8 74.2 68.4
------ ------ ------ ------- -------
Gross profit....................... 19.7 23.4 29.2 25.8 31.6
Operating expenses:
Development....................... 20.0 14.1 6.6 8.0 6.4
Sales and marketing............... 35.5 17.6 11.8 13.3 10.3
General and administrative........ 23.6 14.9 7.8 9.7 6.9
Amortization of deferred
compensation..................... -- -- -- -- 0.1
------ ------ ------ ------- -------
Total operating expenses........ 79.1 46.6 26.2 31.0 23.7
------ ------ ------ ------- -------
Operating income (loss)............ (59.4) (23.2) 3.0 (5.2) 7.9
Other income, net.................. 0.5 2.3 0.3 0.8 0.5
------ ------ ------ ------- -------
Income (loss) from continuing
operations before income taxes.... (58.9) (20.9) 3.3 (4.4) 8.4
Income tax expense (benefit)....... (19.9) (2.1) 0.1 -- (12.5)
------ ------ ------ ------- -------
Net income (loss) from continuing
operations........................ (39.0) (18.8) 3.2 (4.4) 20.9
Discontinued operations:
Income from discontinued
operations, net of applicable
income taxes..................... 33.9 1.1 -- -- --
Gain on sale of discontinued
operations, net of applicable
income taxes..................... 168.1 2.4 0.4 -- --
------ ------ ------ ------- -------
Net income (loss).................. 163.0% (15.3)% 3.6% (4.4)% 20.9%
====== ====== ====== ======= =======
</TABLE>
21
<PAGE>
Cost of network management services, expressed as percentages of network
management services revenues, and cost of equipment and other, expressed as
percentages of equipment and other revenues, were as follows:
<TABLE>
<CAPTION>
Three Months
Year Ended March 31, Ended June 30,
---------------------- ----------------
1997 1998 1999 1998 1999
------ ------ ------ ------- -------
<S> <C> <C> <C> <C> <C>
Cost of network management servic-
es................................ 86.0% 77.9% 64.6% 70.6% 58.3%
Cost of equipment and other........ 75.7 75.4 76.5 77.3 78.7
</TABLE>
Three months ended June 30, 1998 compared to three months ended June 30, 1999
Revenues
Total revenues. Total revenues increased 63%, from $5.6 million in the three
months ended June 30, 1998 to $9.1 million in the three months ended June 30,
1999.
Network management services. Revenues from network management services
increased 77%, from $2.6 million in the three months ended June 30, 1998 to
$4.6 million in the three months ended June 30, 1999, representing 46% of total
revenues in the three months ended June 30, 1998 and 51% of total revenues in
the three months ended June 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.
Equipment and other. Revenues from equipment and other increased 50%, from
$3.0 million in the three months ended June 30, 1998 to $4.5 million in the
three months ended June 30, 1999, primarily as a result of increased purchases
of CPE by AT&T and an increase of $500,000 from an increase in the number of
equipment maintenance contracts in place. 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. We therefore anticipate
that revenues from CPE sales will decline as we seek to manage our mix of
revenues.
Cost 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
50%, from $1.8 million in the three months ended June 30, 1998 to $2.7 million
in the three months ended June 30, 1999, representing 71% of network management
services revenues in the three months ended June 30, 1998 and 58% of such
revenues in the three months ended June 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 of $125,000 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 52%, from $2.3
22
<PAGE>
million in the three months ended June 30, 1998 to $3.5 million in the three
months ended June 30, 1999, representing 77% of equipment and other revenues in
the three months ended June 30, 1998 and 79% of such revenues in the three
months ended June 30, 1999. The increase in dollars and as a percent of
equipment and other revenues was due to higher volume of CPE sales in the three
months ended June 30, 1999 to our resellers at lower resale margins. This
increase in cost was partially offset by the higher percentage of these
revenues coming from maintenance services, which typically have higher gross
margins than CPE sales, increasing from 19% of equipment and other revenues in
the three months ended June 30, 1998 to 25% in the three months ended June 30,
1999.
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 30%, from $446,000 in the three months ended June 30, 1998
to $579,000 in the three months ended June 30, 1999, representing 8% of total
revenues in the three months ended June 30, 1998 and 6% of total revenues in
the three months ended June 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. The decrease was also affected by higher than
anticipated equipment revenues in the three months ended June 30, 1999. 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.
Sales 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 28%, from $739,000 in the
three months ended June 30, 1998 to $943,000 in the three months ended June 30,
1999, representing 13% of total revenues in the three months ended June 30,
1998 and 10% of total revenues in the three months ended June 30, 1999. The
increase in dollars was due to increased spending for advertising and other
promotional activities, as well as costs associated with the recruiting and
relocation of a new vice president of marketing. The decrease of sales and
marketing expenses as a percentage of total revenues reflects the increase in
total revenues and a move to reduce these expenditures as a percentage of total
revenues as we began to rely more on an indirect distribution strategy. 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.
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 15%, from $541,000 in
the three months ended June 30, 1998 to $622,000 in the three months ended June
30, 1999, representing 10% of total revenues in the three months ended June 30,
1998 and 7% of total revenues in the three months ended June 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 June 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 remained relatively flat, decreasing from $48,000 in the three
months ended June 30, 1998 to $46,000 in the three months ended June 30, 1999,
representing approximately 1% of total revenues in both periods.
23
<PAGE>
Income tax expense (benefit)
The income tax provision recorded for the three months ended June 30, 1998
was zero, compared to a benefit of $1.1 million for the three months ended June
30, 1999. The benefit in the three months ended June 30, 1999 is attributable
to a reduction in the deferred tax asset valuation allowance. During the three
months ended June 30, 1999, we determined that a portion of the deferred tax
asset, previously fully reserved, would more likely than not be utilized.
Accordingly, the valuation allowance was reduced.
Fiscal year ended March 31, 1998 compared to fiscal year ended March 31, 1999
Revenues
Total revenues. Total revenues increased 84%, from $14.5 million in fiscal
year 1998 to $26.7 million in fiscal year 1999.
Network management services. Revenues from network management services
increased 75%, from $7.3 million in fiscal year 1998 to $12.8 million in fiscal
year 1999, representing 50% of total revenues in fiscal year 1998 and 48% of
total revenues in fiscal year 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. Increased implementation fees in fiscal year
1999 were largely due to a change in company policy in the quarter ended March
31, 1998 which resulted in our charging fees for, rather than absorbing the
costs of, implementing new networks. These increases were partially offset by a
decrease of $715,000 in the revenues attributable to the management of the
customer base sold to Intermedia. The percentage of revenues from network
management services derived from our relationship with AT&T was approximately
equal to the percentage of total revenue derived from AT&T.
Equipment and other. Revenues from equipment sales and other increased 93%,
from $7.2 million in fiscal year 1998 to $13.9 million in fiscal year 1999,
primarily as a result of increased purchases of CPE by AT&T and an increase of
$1.5 million resulting from an increase in the number of equipment maintenance
contracts in place.
Cost of revenues
Cost of network management services. Cost of network management services
increased 46%, from $5.7 million in fiscal year 1998 to $8.3 million in fiscal
year 1999, representing 78% of network management services revenues in fiscal
year 1998 and 65% of such revenues in fiscal year 1999. The dollar increase was
due primarily to the addition of personnel to accommodate growth, upgrades to
the network management infrastructure including the addition of a separate
infrastructure support group, the upgrade of our facilities, and, to a lesser
extent, an increase of $535,000 in 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 98%, from
$5.4 million in fiscal year 1998 to $10.7 million in fiscal year 1999,
representing 75% of equipment and other revenues in fiscal year 1998 and 77% of
such revenues in fiscal year 1999. The increases in dollars and as a percent of
equipment and other revenues were due to higher volume of CPE sales in fiscal
year 1999 to our resellers at lower resale margins.
Operating expenses
Development. Development expenses decreased 10% from $2.0 million in fiscal
year 1998 to $1.8 million in fiscal year 1999, representing 14% of total
revenues in fiscal year 1998 and 7% of total revenues in fiscal year 1999. The
decrease in dollars was due primarily to a recovery in fiscal year 1999 of
$100,000 of contract development expenses written off in fiscal year 1998. The
decrease as a percentage of total revenues was due to the development of our
LAN product which was introduced in the first quarter of fiscal year 1998
24
<PAGE>
and reduced usage of third-party contract programming resources. The decrease
was also affected by our decision to manage development spending to a lower
level as a percentage of total revenues in fiscal year 1999, after having
accelerated spending in fiscal year 1998 in order to support future revenue
growth, cost reduction and service quality.
Sales and marketing. Sales and marketing expenses increased 23%, from $2.6
million in fiscal year 1998 to $3.2 million in fiscal year 1999, representing
18% of total revenues in fiscal year 1998 and 12% of total revenues in fiscal
year 1999. In fiscal year 1999, total sales and marketing salaries paid
increased as additional people were added to support resellers and to focus on
new product definition. The decrease of sales and marketing expenses as a
percentage of total revenues reflected the increase in total revenues and a
move to reduce these expenditures as a percentage of total revenues as we began
to rely more on an indirect distribution strategy.
General and administrative. General and administrative expenses decreased 5%,
from $2.2 million in fiscal year 1998 to $2.1 million in fiscal year 1999,
representing 15% of total revenues in fiscal year 1998 and 8% of total revenues
in fiscal year 1999. The decreases in dollars and as a percentage of total
revenues were due primarily to decreased legal and consulting fees and outside
recruiting and relocation fees. These decreases were partially offset by
increased salary costs of $125,000 primarily due to the addition of human
resource professionals who are responsible for enhancing training and
recruiting programs in preparation for growth.
Other income, net
Other income, net decreased 73%, from $340,000 in fiscal year 1998 to $93,000
in fiscal year 1999, representing 2% of total revenues in fiscal year 1998 and
less than 1% of total revenues in fiscal year 1999. The dollar decrease in
fiscal year 1999 was due to higher interest income in fiscal year 1998 earned
from a higher level of funds available for investment and increased interest
expense incurred from capital lease obligations in fiscal year 1999.
Fiscal year ended March 31, 1997 compared to fiscal year ended March 31, 1998
Revenues
Total revenues. Total revenues increased 130%, from $6.3 million in fiscal
year 1997 to $14.5 million in fiscal year 1998.
Network management services. Revenues from network management services
increased 161%, from $2.8 million in fiscal year 1997 to $7.3 million in fiscal
year 1998, representing 45% of total revenues in fiscal year 1997 and 50% of
total revenues in fiscal year 1998. Approximately 70% of the dollar increase
was due to increased recurring revenues 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 new
installed sites. The impact of changes in average revenues per device was not
significant. Increased implementation fees in fiscal year 1998 were largely due
to a change in company policy in the quarter ended March 31, 1998 which
resulted in our charging fees for, rather than absorbing the costs of,
implementing new networks. The percentage of revenues from network management
services derived from our relationship with AT&T was approximately equal to the
percentage of total revenue derived from AT&T.
Equipment and other. Revenues from equipment and other increased 106%, from
$3.5 million in fiscal year 1997 to $7.2 million in fiscal year 1998, primarily
as a result of increased sales of CPE.
Cost of revenues
Cost of network management services. Cost of network management services
increased 138%, from $2.4 million in fiscal year 1997 to $5.7 million in fiscal
year 1998, representing 86% of network management services revenues in fiscal
year 1997 and 78% of such revenues in fiscal year 1998. The dollar increase was
due primarily to the addition of personnel to accommodate growth, upgrades to
the network management infrastructure including the addition of a separate
infrastructure support group, facilities expansion to accommodate new
operations personnel, increased recruiting and relocation costs associated with
strengthening the management and technical talent of the operations groups and,
to a lesser extent an increase of $471,000
25
<PAGE>
subcontractor costs related to installation of CPE. The percentage decrease was
due primarily to a higher number of managed devices per operations employee.
Cost of equipment and other. Cost of equipment and other increased 108%, from
$2.6 million in fiscal year 1997 to $5.4 million in fiscal year 1998,
representing 76% of equipment and other revenues in fiscal year 1997 and 75% of
such revenues in fiscal year 1998. The dollar increase was due primarily to the
higher volume of CPE sales in fiscal year 1998 and an increase of $500,000 from
increased equipment maintenance revenues.
Operating expenses
Development. Development expenses increased 54%, from $1.3 million in fiscal
year 1997 to $2.0 million in fiscal year 1998, representing 20% of total
revenues in fiscal year 1997 and 14% of total revenues in fiscal year 1998. The
dollar increase was due to higher development spending in fiscal year 1998
enabled by the sale of our transport business in the third quarter of fiscal
year 1997. This sale provided a source of working capital to invest in our
relatively new network management services offerings. These additional
development expenses included the costs associated with hiring additional
people, including additional facilities space. The decrease as a percentage of
total revenues was primarily the result of higher total revenues in fiscal year
1998.
Sales and marketing. Sales and marketing expenses increased 18%, from $2.2
million in fiscal year 1997 to $2.6 million in fiscal year 1998, representing
36% of total revenues in fiscal year 1997 and 18% of total revenues in fiscal
year 1998. This dollar increase was due to one-time costs, including accrual of
future rentals on vacated spaces, related to the closing of most of our remote
sales offices as we began consolidating sales efforts at our Austin
headquarters as well as increased public relations and market awareness
efforts. The decrease as a percentage of total revenues reflected the increase
in recurring network management services revenues and a move to reduce these
sales and marketing expenditures as a percentage of total revenues as we began
to rely more on an indirect distribution strategy.
General and administrative. General and administrative expenses increased
47%, from $1.5 million in fiscal year 1997 to $2.2 million in fiscal year 1998,
representing 24% of total revenues in fiscal year 1997 and 15% of total
revenues in fiscal year 1998. The dollar increase was due primarily to the
addition of human resources professionals beginning in the first quarter of
fiscal year 1998 who were responsible for enhancing training and recruiting
programs in preparation for growth, and associated increases in facilities
space, additional spending for outside training programs and increased
recruiting costs. The decrease as a percentage of total revenues was primarily
the result of higher total revenues in fiscal year 1998.
Other income, net
Other income, net increased 900%, from $34,000 in fiscal year 1997 to
$340,000 in fiscal year 1998, representing 1% of total revenues in fiscal year
1997 and 2% of total revenues in fiscal year 1998. The dollar increase in
fiscal year 1998 was due to higher interest income in fiscal year 1998 earned
from a higher level of funds available for investment, partially offset by
increased interest expense incurred from capital lease obligations in fiscal
year 1998.
Quarterly results of operations
Although our total revenues have increased in each of the last nine 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
26
<PAGE>
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.
The following tables set forth quarterly statement of operations data in
dollars and, except as noted below, as a percentage of total revenues for each
of the nine quarters in the period ended June 30, 1999. This quarterly
information is unaudited and has been prepared on the same basis as our audited
annual consolidated financial statements and, in the opinion of our management,
includes all adjustments consisting only of normal recurring adjustments that
we consider necessary for a fair presentation of the information for the
periods presented. The information should be read together with the
consolidated financial statements and related notes appearing elsewhere in this
prospectus. Additional per share information is disclosed on the consolidated
statements of operations in the consolidated financial statements included
elsewhere in this prospectus. Operating results for any quarter are not
necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30,
1997 1997 1997 1998 1998 1998 1998 1999 1999
-------- --------- -------- -------- -------- --------- -------- -------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Network management
services.............. $1,524 $ 1,723 $1,811 $2,266 $2,560 $3,081 $3,335 $3,801 $4,584
Equipment and other.... 1,584 1,852 1,795 1,968 3,002 3,342 3,557 4,038 4,492
------ ------- ------ ------ ------ ------ ------ ------ ------
Total revenues....... 3,108 3,575 3,606 4,234 5,562 6,423 6,892 7,839 9,076
Cost of revenues:
Cost of network
management services... 1,325 1,476 1,407 1,498 1,808 1,974 2,098 2,378 2,672
Cost of equipment and
other................. 1,232 1,350 1,426 1,417 2,321 2,629 2,663 3,052 3,536
------ ------- ------ ------ ------ ------ ------ ------ ------
Total cost of
revenues............ 2,557 2,826 2,833 2,915 4,129 4,603 4,761 5,430 6,208
------ ------- ------ ------ ------ ------ ------ ------ ------
Gross profit............ 551 749 773 1,319 1,433 1,820 2,131 2,409 2,868
Operating expenses:
Development............ 494 602 465 479 446 459 364 493 579
Sales and marketing.... 627 771 561 603 739 723 791 900 943
General and
administrative........ 419 518 600 622 541 512 511 534 622
Amortization of
deferred
compensation.......... -- -- -- -- -- -- -- -- 5
------ ------- ------ ------ ------ ------ ------ ------ ------
Total operating
expenses............ 1,540 1,891 1,626 1,704 1,726 1,694 1,666 1,927 2,149
------ ------- ------ ------ ------ ------ ------ ------ ------
Operating income
(loss)................. (989) (1,142) (853) (385) (293) 126 465 482 719
Other income (expense),
net.................... 134 79 61 66 48 23 3 19 46
------ ------- ------ ------ ------ ------ ------ ------ ------
Income (loss) from
continuing operations
before income taxes.... (855) (1,063) (792) (319) (245) 149 468 501 765
Income tax expense
(benefit).............. (83) (104) (78) (32) -- -- 6 13 (1,136)
------ ------- ------ ------ ------ ------ ------ ------ ------
Net income (loss) from
continuing operations.. (772) (959) (714) (287) (245) 149 462 488 1,901
Discontinued operations:
Income (loss) from
discontinued
operations, net of
applicable income
taxes................. 72 97 5 (9) -- -- -- -- --
Gain (loss) on sale of
discontinued
operations, net of
applicable income
taxes................. -- 151 (4) 194 -- -- 98 -- --
------ ------- ------ ------ ------ ------ ------ ------ ------
Net income (loss)....... $ (700) $ (711) $ (713) $ (102) $ (245) $ 149 $ 560 $ 488 $1,901
====== ======= ====== ====== ====== ====== ====== ====== ======
Basic income (loss) per
share from:
Continuing
operations............ $(0.48) $ (0.54) $(0.46) $(0.28) $(0.27) $(0.15) $(0.05) $(0.04) $ 0.38
====== ======= ====== ====== ====== ====== ====== ====== ======
Net income (loss)...... $(0.45) $(0.46) $(0.46) $(0.22) $(0.27) $(0.15) $(0.02) $(0.04) $ 0.38
====== ======= ====== ====== ====== ====== ====== ====== ======
Weighted average shares
used in basic per share
calculations........... 2,912 2,930 2,947 3,193 3,280 3,286 3,298 3,340 3,361
Diluted income (loss)
per share from:
Continuing
operations............ $(0.48) $ (0.54) $(0.46) $(0.28) $(0.27) $(0.15) $(0.05) $(0.04) $ 0.25
====== ======= ====== ====== ====== ====== ====== ====== ======
Net income (loss)...... $(0.45) $ (0.46) $(0.46) $(0.22) $(0.27) $(0.15) $(0.02) $(0.04) $ 0.25
====== ======= ====== ====== ====== ====== ====== ====== ======
Weighted average shares
used in diluted per
share calculations..... 2,912 2,930 2,947 3,193 3,280 3,286 3,298 3,340 5,055
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
---------------------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30,
1997 1997 1997 1998 1998 1998 1998 1999 1999
-------- --------- -------- -------- -------- --------- -------- --------- --------
(As a percentage of total revenues)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Network management
services.............. 49.0 % 48.2 % 50.2 % 53.5 % 46.0 % 48.0% 48.4% 48.5% 50.5%
Equipment and other
revenues.............. 51.0 51.8 49.8 46.5 54.0 52.0 51.6 51.5 49.5
----- ----- ----- ----- ----- ----- ----- ----- -----
Total revenues........ 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Total cost of revenues.. 82.3 79.0 78.6 68.8 74.2 71.7 69.1 69.3 68.4
----- ----- ----- ----- ----- ----- ----- ----- -----
Gross profit............ 17.7 21.0 21.4 31.2 25.8 28.3 30.9 30.7 31.6
Operating expenses:
Development............ 15.9 16.8 12.9 11.3 8.0 7.1 5.3 6.3 6.4
Sales and marketing.... 20.1 21.6 15.6 14.3 13.3 11.2 11.5 11.5 10.3
General and
administrative........ 13.5 14.5 16.6 14.7 9.8 8.0 7.4 6.8 6.9
Amortization of
deferred
compensation.......... -- -- -- -- -- -- -- -- 0.1
----- ----- ----- ----- ----- ----- ----- ----- -----
Total operating
expenses............. 49.5 52.9 45.1 40.3 31.1 26.3 24.2 24.6 23.7
----- ----- ----- ----- ----- ----- ----- ----- -----
Operating income
(loss)................. (31.8) (31.9) (23.7) (9.1) (5.3) 2.0 6.7 6.1 7.9
Other income (expense),
net.................... 4.3 2.2 1.7 1.6 0.9 0.3 0.1 0.3 0.5
----- ----- ----- ----- ----- ----- ----- ----- -----
Income (loss) from
continuing operations,
before income taxes.... (27.5) (29.7) (22.0) (7.5) (4.4) 2.3 6.8 6.4 8.4
Income tax expense
(benefit).............. (2.7) (2.9) (2.2) (0.8) -- -- 0.1 0.2 (12.5)
----- ----- ----- ----- ----- ----- ----- ----- -----
Net income (loss) from
continuing operations.. (24.8) (26.8) (19.8) (6.7) (4.4) 2.3 6.7 6.2 20.9
Discontinued operations:
Income (loss) from
discontinued
operations, net of
applicable income
taxes................. 2.3 2.7 0.1 (0.2) -- -- -- -- --
Gain (loss) on sale of
discontinued
operations, net of
applicable income
taxes................. -- 4.2 (0.1) 4.5 -- -- 1.4 -- --
----- ----- ----- ----- ----- ----- ----- ----- -----
Net income (loss)....... (22.5)% (19.9)% (19.8)% (2.4)% (4.4)% 2.3% 8.1% 6.2% 20.9%
===== ===== ===== ===== ===== ===== ===== ===== =====
Cost of network management services, expressed as a percentage of network
management services revenues, and the cost of equipment and other, expressed as
a percentage of equipment and other revenues, were as follows:
<CAPTION>
Three Months Ended
---------------------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, March 31, June 30,
1997 1997 1997 1998 1998 1998 1998 1999 1999
-------- --------- -------- -------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Cost of network
management services.. 86.9% 85.7% 77.7% 66.1% 70.6% 64.1% 62.9% 62.6% 58.3%
Cost of equipment and
other................ 77.8 72.9 79.4 72.0 77.3 78.7 74.9 75.6 78.7
</TABLE>
The trends discussed in the annual comparisons of operating results from
fiscal year 1998 to fiscal year 1999 and the three months ended June 30, 1998,
to the three months ended June 30, 1999 are generally applicable to the
comparison of quarters within the nine quarters in the period ended June 30,
1999. The following supplemental explanations are provided with respect to
significant sequential changes in amounts.
The general trend of declining cost of network management services as a
percentage of network management services revenues is due primarily to
improvements in processes and tools which have resulted in
28
<PAGE>
a higher number of managed devices per operations employee. The relatively
slower sequential growth of network management services revenues in the quarter
ended December 31, 1997 was due to the expiration of the contract with
Intermedia under which we managed the customer base of the discontinued
transport business. The larger than usual sequential growth in equipment and
other revenues in the three months ended June 30, 1998 was due primarily to
increased sales of network management services to AT&T, which included higher
volumes of CPE sales.
The increase in cost of equipment and other as a percent of equipment and
other revenues in the quarter ended June 30, 1998 was due primarily to a higher
mix of CPE sales. 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. We therefore anticipate that revenues from CPE
sales will decline as we seek to manage our mix of revenues.
The fluctuations in general and administrative expenses on a quarter-to-
quarter basis reflect periodic changes in amounts spent for training,
recruiting and relocation, and consulting services.
Liquidity and capital resources
Since our inception we have funded our operations primarily through:
. private sales of capital stock totaling $28.3 million, including our
most recent sale of capital stock in fiscal year 1993 for $9.8
million;
. the sale of our discontinued transport business for $12.3 million in
December 1996;
. leases on capital equipment;
. working capital lines of credit; and
. cash provided by operations of $1.1 million in fiscal year 1995, $1.0
million in fiscal year 1996, $892,000 in fiscal year 1999 and $1.5
million in the three months ended June 30, 1999.
We used $1.5 million in cash during fiscal year 1997, $2.2 million during
fiscal year 1998, $1.6 million during fiscal year 1999, and $724,000 in the
first three months of fiscal year 2000 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 $218,000 in fiscal year 1997, $1.7 million in fiscal year
1998, $831,000 in fiscal year 1999, and $0 in the first three months of fiscal
year 2000. We paid $514,000 in 1997, $257,000 in 1998, $732,000 in 1999 and
$249,000 in the first three months of fiscal year 2000 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.
In December 1996, we terminated our $1.0 million bank line of credit prior to
the closing of the sale of the transport business. If desirable, we believe we
can obtain a similar working capital line of credit on acceptable terms.
As of June 30, 1999, we had $6.6 million in cash and cash equivalents and
$3.4 million in net accounts receivable. We believe that the net proceeds from
this offering, 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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<PAGE>
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 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;
. 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.
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<PAGE>
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 Systems upgraded or replaced as Completed
software systems used to appropriate, including validation
manage our business and testing
Non-information technology Systems upgraded or replaced as Completed
systems and services we appropriate, including validation
use to manage our business and testing
Communications hardware Systems upgraded or replaced as October 1, 1999
and software systems and appropriate, including validation
networks and testing, except for
previously planned replacements
of identified internal LAN
hardware
Computer operating systems Systems upgraded or replaced as October 15, 1999
appropriate, except for upgrades
to Windows NT 4.0
Computer hardware and Systems upgraded or replaced as October 31, 1999
software systems used to appropriate, including validation
provide services 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;
. 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
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<PAGE>
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>
BUSINESS
We offer a range of network management and security services that allow
companies to outsource some or all specific network activities in order to
increase network reliability and up-time, reduce overall network costs, and
simplify timely migration to new technologies. Our management services are
intended to address all or selected parts of the full life cycle of network
management, which consists of network design, configuration, implementation,
monitoring, fault diagnosis, fault resolution, reporting, upgrading and
documentation. We furnish our network management services remotely 24 hours per
day, seven days per week from our network management center in Austin, Texas,
and we offer software tools that allow companies to access up-to-date network
status reports through standard web browsers. We also offer around-the-clock
remote security protection services for the Internet and intranet perimeter
points of our customers' networks. Our security offerings currently include a
managed firewall service and a remote intrusion detection and response service.
We have offered network management services since 1995 and currently have over
600 end users representing approximately 9,500 managed sites. We target middle
market enterprises, and provide services both directly to end users as well as
indirectly through resellers such as AT&T.
Industry background
Businesses increasingly depend on the ability to access and share electronic
information reliably. To enable effective internal communication, more and more
companies are relying on client/server-based databases and applications, e-
mail, remote access by mobile workers and various forms of online information.
The proliferation of the use of the Internet and the emergence of e-commerce
are driving the need for businesses to exchange electronic information
externally with customers, business partners and vendors. In response to the
growing need to share information internally and externally, companies'
operations increasingly depend on data networks, including both wide area
networks, or WANs, which allow companies to communicate with a large number of
computers over a broad geographic area, and local area networks, or LANs, which
are generally more limited in the number of computers in the network and the
geographic area covered. This proliferation of networks has resulted in a
dramatic increase in network traffic as well as heightened requirements for
network performance. It has also increased the magnitude of sensitive corporate
information shared over networks, causing network security to become a high
priority for many businesses. As a result of these trends, a growing number of
businesses view responsive, reliable and secure networks as mission-critical to
their operations.
As networks have become a more integral part of day-to-day operations, many
companies are seeking to control network costs and improve operating
efficiencies. Economic and performance issues are especially important for
organizations operating WANs to connect geographically dispersed sites.
Providers of WAN equipment and services have responded to customer demand by
introducing switched data technologies which allow any user to be connected to
any other user in a more efficient manner than traditional network
architectures. Examples of these switched data technologies include Frame
Relay, Asynchronous Transfer Mode, or ATM, and Internet Protocol, or IP. These
new switched data technologies are able to share and allocate bandwidth, the
electronic frequencies used to transmit data over computer networks, based on
actual network use, while traditional network architectures use fixed bandwidth
and dedicated circuits regardless of network use. The shared bandwidth of
switched data technologies typically results in WANs that are more reliable and
less expensive than those based on traditional leased-line services. As a
result, switched data services have grown rapidly since WAN service providers
initially introduced Frame Relay services as a solution. ATM services, a
switched data technology characterized by higher capacities and higher speeds,
are less widely offered today but are expected to compete with Frame Relay and
experience rapid growth in the next several years. Likewise, services based on
IP are becoming an important option to the traditional dedicated circuit WAN
infrastructure.
The growth of the switched data market has been enabled by the rapid
development of sophisticated networking hardware such as routers, inverse
multiplexers and switches. At the same time, software companies have introduced
network management and security software designed to work with and optimize the
new hardware. Implementation and management of new hardware and software
technologies typically require
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<PAGE>
significant expertise in order to maintain reliability, performance and
security, especially since networks have grown more complex and heterogeneous
as new technologies have been integrated with legacy networks. Further, the
tools available to manage today's networks are complex and often require
incremental investments in hardware, software, personnel and training. The
proliferation of services available from WAN service providers, such as the
major telecommunications carriers, further complicates network management and
security.
Many companies have encountered difficulties implementing and managing
networks internally because of the significant shortage of qualified networking
and information technology, or IT, professionals. Based on information
published by the Gartner Group, we believe that between 15% and 30% of
permanent IT positions were unfilled in mid-1998. The United States Department
of Commerce, in a report released in June 1999, projects 75% growth in the
demand for core IT occupations in the decade ending in 2006 as compared to 14%
growth in demand for all occupations. Maintaining internal IT staffs is costly
since network management skills must be constantly upgraded to respond to the
rapid changes in networking and security technologies. This situation is even
more acute in the area of network security, an area that is increasing in
importance due to threats of security attacks via the Internet as well as
rapidly changing security technology. The resource scarcity and high cost of
internal IT staffs represent significant challenges for businesses, especially
mid-sized companies that are large enough to require sophisticated networks,
but too small to gain efficiencies of scale achievable by a large enterprise
that can amortize the costs of an in-house IT network management group across a
large organization.
Many companies are beginning to turn to third-party service providers for
network management and security, particularly when those skills are not core
business competencies. While some companies out-source their entire computing
environment, a growing number of companies are managing their computing
environments more actively and affordably by out-tasking a particular set of
activities. Businesses seeking to out-task network management services
typically need to migrate quickly to newer technologies as they become
available, increase the reliability of their networks and reduce the overall
cost of managing their networks. Further, these businesses' networks must be
available to internal and external users 24 hours per day, seven days per week.
Even if network management activities are out-tasked, internal IT managers need
access to network information and performance reporting at all times. In
addition, network security must be assured, with access to the networks limited
to authorized users, and then only to those applications and data for which the
users have been authorized. All of this network management must be done in an
environment of constant and rapid change in networking and security technology
where the time to implement new technologies can affect the time to market of
new products and services.
Our solution
We offer network management services that allow customers to out-task
network-specific activities in order to increase network reliability and up-
time, reduce overall network costs and migrate to new technologies and services
on a timely basis. We also offer security protection for network perimeter
points such as an enterprise's Internet or intranet connections. Our solutions
are designed to address the needs of middle market enterprises. We currently
have over 600 middle market end users that maintain approximately 9,500 managed
sites. We believe our solution offers the following key benefits:
Full breadth of network management services. Our network management services
cover the entire life cycle of an enterprise's network, including network
design, configuration, implementation, monitoring, fault diagnosis, fault
resolution, reporting, upgrading and documentation. End users have the ability
to outsource all of their network requirements to us, or they can retain
control over certain aspects of their network and out-task only selected
network management tasks.
Reduced costs. Substantial costs are incurred in retaining and maintaining an
internal IT staff that is qualified to manage a complex, multi-site network. We
are able to amortize these personnel-related costs, as well as costs of
necessary network infrastructure, software and tools, over hundreds of end
users. As a result,
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<PAGE>
we believe we are able to offer a better network solution at a lower cost than
if an end user attempted to manage its network in-house. Furthermore, we
evaluate, purchase, develop and integrate application-specific software and
tools that allow us to deliver reliable solutions at low costs. We support only
the relatively small number of providers of networking hardware and carrier
services that we believe collectively dominate the market. By focusing on the
leading equipment manufacturers and carriers, we are able to leverage economies
of scale in managing multiple end-user networks.
Increased network reliability, security and up-time. As enterprises continue
to increase their use of networks for internal and external communication and
for conducting e-commerce, the need for reliable and secure networks becomes
more critical. We provide our remote network management and security services
to end-user locations worldwide 24 hours per day, seven days per week. Our
remote network management services for WANs generally include a guarantee to
provide end-to-end network availability for at least 99.5% of the time in any
given month.
Ease of network maintenance and technology upgrades. Our network management
professionals act as an extension of the customer's IT staff. By relying on our
expertise, infrastructure and tools, end users are able to meet the challenges
posed by rapidly evolving technologies and move quickly and affordably to more
advanced network solutions as needed. We report to end users on an ongoing
basis and recommend upgrades or changes when appropriate.
Web-enabled network monitoring and reporting. End users can out-task to us
the complex, frustrating and expensive responsibilities of dealing with day-to-
day network management and security issues, yet still be able to understand and
see their networks in operation. End users can access our web-enabled network
management and monitoring tools and view on their computer screens a network
map that gives a current status of every site on their networks. We also
provide end users with reports of network activity periodically or on demand.
Strategy
Our goal is to be a leading provider of remote network management services.
The key elements of our strategy include the following:
Target middle market enterprises. We believe that a significant market
opportunity exists for our services among enterprises that are large enough to
employ WANs across multiple sites, but too small to amortize the costs of an
in-house IT network management staff across a large organization. These middle
market companies, which typically have between 100 and 1,000 employees and
annual revenues between $25 million and $1.0 billion, are facing a growing need
for network expertise and technology. At the same time, they are encountering
increased difficulties in attracting qualified and affordable networking
professionals. We believe that our network management and security services
offer an attractive solution for many middle market companies and we intend to
target these companies, as we market our existing services and develop new
services.
Support leading technologies. We have been able to provide cost-effective
solutions to our customers by supporting only the leading providers of
networking hardware and carrier services. The suppliers that we support include
AT&T, MCI/WorldCom, Qwest Communications and Sprint in the data transport
arena, and 3Com, Bay/Nortel and Cisco in the market for customer premise
equipment, or CPE. We believe these suppliers are the predominant providers of
networking hardware and carrier services to our target market. By designing our
services to support this select group of leading service and equipment vendors,
we seek to leverage our expertise, technologies and processes, while still
providing support for the needs of most middle market companies. We intend to
continue to develop our processes and tools to support new hardware and
services introduced by leading vendors. This ongoing support may require us to
modify existing services and, in some cases, develop new services. For example,
we recently began managing ATM devices and are actively attempting to define
new value added services.
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<PAGE>
Expand service offerings. We seek to expand our service offerings by
leveraging our existing expertise, technologies and processes in the network
management arena. In August 1996, we introduced a security service that
provides remote intrusion detection. In March 1999, we introduced an add-on
service to our WAN management service that offers customers increased
proactive network management capabilities, including our ability to identify
many network problems and faults before the customer's network goes down.
These offerings use our network management center and tools infrastructure and
are supplemented by additional proprietary and third-party tools. In addition,
the security service is enhanced by engineers with specific network security
expertise. In the future, we intend to further develop our proactive network
management service involving performance engineering and to add services
addressing capacity planning.
Add distribution partners. We believe that we can market our services to
middle market companies most effectively by partnering with resellers that
bundle our services with transport services or CPE. We believe that we can
expand our current distribution relationships to include other major carriers,
competitive local exchange carriers, or CLECs, and Internet service providers,
or ISPs, and that we can also establish sales referral relationships with
various manufacturers of networking hardware. We believe that these
relationships will provide us with a significant competitive advantage.
Network management services
Our network management services include one-time services such as design and
implementation of new networks, as well as ongoing, or recurring, management
and security services. Our current service offerings are grouped under three
general categories: remote network management services, Internet and intranet
security services, and web-enabled network management tools.
Remote network management services
Our services include the remote management of router-based WANs and LANs,
LAN switches and intelligent hubs, as well as the monitoring of servers. These
services are intended to address the full life cycle of network management,
which includes the activities depicted below:
Network Management Life Cycle Activities
[Three rectangles are linked by arrows pointing from left to right. The three
rectangles contain the following words:]
Design
Configure
Implement
[Six items linked by arrows circumscribe the words "Operate and Support." The
six items consist of the following words, beginning at the top and moving
clockwise:]
Alarm
Fix
Report & Trend
Upgrade
Document
Monitor
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<PAGE>
We provide services to address each of these life cycle activities. Customers
may elect to purchase full life cycle management services or may, in some
cases, purchase individual services, such as network design or monitoring.
Pricing for recurring services is generally established as a monthly fee on a
per-managed-device basis. The following highlights services performed by us for
each life cycle activity:
<TABLE>
<CAPTION>
Life cycle activity Our services
------------------- --------------------------------------------------------
<C> <S>
Design . Design network to meet specific end-user requirements
. Offer CPE and maintenance pricing information
Configure . Configure CPE to enhance initial and ongoing network
performance
. Determine addressing, packet filtering and routing
protocol
Implement . Provide project management
. Stage, configure and install equipment
. Verify operational readiness
Monitor . Monitor network 24 hours per day, 7 days per week from
our network management center
Diagnose . Proactively diagnose faults
. Notify end user of status
Resolve . Proactively resolve faults
. Notify end user of status
Report . Offer network performance, transport provider
performance and cost analysis reports
. Offer real-time reporting on network performance which
falls below predefined thresholds
Upgrade . Upgrade or change components in the network as
requirements or configurations change
. Review software releases
. Install and configure new software and equipment as
appropriate
Document . Download and archive on our management platform
information related to CPE configurations, carrier and
CPE service provider data and other network
connectivity information
. Create and update network maps
</TABLE>
We have two branded network management service offerings: ProWatch for WANs
and ProWatch for LANs.
ProWatch for WANs. We introduced our first WAN remote management
service in January 1994 to enable remote management of router-based
Frame Relay and ATM networks. This service is marketed by us and
certain of our resellers as ProWatch for WANs. It is also marketed by
other resellers, sometimes in modified versions, under the various
brands of those resellers. The managed elements in this service include
the WAN-attached router, the customer service unit, or CSU, connecting
the router to the transport provider's Frame Relay or ATM service; and
the transport provider's network services. Features offered in
different options of ProWatch for WANs include:
. performance engineering and fault management;
. proactive monitoring; and
. performance reporting.
The ProWatch for WANs service generally includes a guarantee to provide
the customer end-to-end network availability for at least 99.5% of the
time in any given month, with the customer generally receiving a refund
of the management fee in any month the guaranteed availability rate is
not achieved. Substantially all of our recurring network management
services revenues are derived from ProWatch for WANs and related WAN
services.
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<PAGE>
ProWatch for LANs. We introduced our LAN remote management service in
May 1997 to measure, monitor and manage the routers, switches and
intelligent hubs in corporate LANs. This service can also monitor the
availability of servers manageable by the Simple Network Management
Protocol, or SNMP. Our LAN management services are marketed by us and
certain of our resellers as ProWatch for LANs and are also marketed by
other resellers under the various brands of those resellers. In
developing the ProWatch for LANs service, we leveraged the expertise,
technologies and processes we developed in providing ProWatch for WANs.
The primary differences between ProWatch for LANs and ProWatch for WANs
are the exclusion of the transport provider's network services and the
inclusion of additional performance reporting capabilities.
Internet and intranet security services
Our network security services, marketed under the brand name ProWatch Secure,
provide protection 24 hours per day, seven days per week for networks' Internet
and intranet perimeter points. This security service includes the following
elements of remote network security management: security assessment and
recommendations; implementation; ongoing security management; assurance;
security reports and consultation; configuration management; and virtual
private network, or VPN, configuration management. The pricing for these
security services is generally established as a monthly fee on a per-managed-
device basis. We offer two different security services:
ProWatch Secure Managed Firewall Service. This service provides
active management of the firewall, the electronic barrier between
network segments. Our security engineers regularly review firewall logs
and alarms to detect suspicious activity. Through this monitoring we
can consult with the end user regarding potential changes in the
firewall configuration. ProWatch Secure Managed Firewall Service is
supported on Cisco's PIX Firewall series. The Cisco PIX Firewall is
configured by our security engineers to enforce the security policy
that best meets the end user's requirements to control access by
specified applications and source addresses. The ProWatch Secure
Managed Firewall Service was introduced in September 1998 as a more
basic security service than our Remote Intrusion Detection and Response
Service.
ProWatch Secure Remote Intrusion Detection and Response Service. For
more demanding security environments, such as those engaged in e-
commerce, customers can implement intrusion detection monitoring as a
second layer of network security. This service provides additional
perimeter security beyond that offered by the access protection of
ProWatch Secure Managed Firewall Service. ProWatch Secure Remote
Intrusion Detection and Response Service uses Cisco's NetRanger
intrusion detection system to detect suspicious activity on customer
networks, repel attack attempts and bar the potential intruder from
accessing the end user's network. We introduced our ProWatch Secure
Remote Intrusion Detection and Response Service in August 1996.
End users may purchase these services individually, together or as part of a
combined network management service offering.
Web-enabled tools
Our web-enabled network management tools provide end users with access to up-
to-date status information of their networks, giving end users greater control
and understanding of their networks while out-tasking day-to-day management to
us. Access to this information is included as a component of our standard
network management services and is provided to end users at no additional
charge. End users access these tools through a standard web browser using our
ProWatch Exchange application. ProWatch Exchange provides trouble ticket status
and history, plus network installation project status. An active network map
displays the status of all managed sites in an end user's network. ProWatch
Exchange also provides on-line viewing access to the monthly availability and
performance reports included with the various remote network management
services.
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<PAGE>
Equipment and other services
We resell customer premises 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
3Com, Bay/Nortel, Paradyne and others. Sales of this equipment are made only
to our network management services customers in conjunction with the sale of
our services. This equipment, including routers, CSUs and LAN switches,
constitutes the primary components of the end-user networks we manage.
Customers who purchase this equipment from us rather than from other sources
typically do so for the convenience of a single supplier solution.
We also resell on-site maintenance services, primarily to customers who have
purchased the associated equipment from us. These services address issues
associated with hardware failures and software bugs, as well as software
upgrades provided for under the equipment provider's maintenance contract.
These maintenance services are provided by 3Com, Bay/Nortel, Cisco and Racal.
Customers
Our solutions are designed to address the needs of middle market
enterprises, roughly defined as companies that have between 100 and 1,000
employees and annual revenues between $25 million and $1.0 billion. We
currently have over 600 middle market end users that maintain approximately
9,500 managed sites. Our end users consist of our direct customers as well as
customers of our resellers. The following is a selected list of our direct
customers grouped by industry.
Business Services Education High Technology
Complete Business Bucks County School Santa Cruz
Solutions, Inc. District Operation
The Kinetic Group Corinthian Colleges, Verifone, Inc.
Inc.
Chemicals Manufacturing
Financial Services/Real
Estate
CONDEA Vista Company Temple-Inland
Forest
Helena Chemical Company
Amresco Products Corp.
Distribution Security Capital Group Texas Industries
BT Office Products Food and Agricultural Medical
International Products
Computer Discount Warehouse American Medical
Kendall-Jackson Response
Sun Gro Horticulture YFCS, Inc.
When sold to end users by resellers, such as AT&T, our services are
typically sold under the reseller's trade or brand name. In some instances,
however, the reseller utilizes our brand names. In all cases, we receive our
revenues directly from the resellers. In some situations, the resellers
include the cost of our services in the pricing they establish for their
related services while in other cases the services and CPE we provide are
billed separately by the reseller. Our resellers include AT&T, NEC Business
Network Solutions, e.spire Communications and Intermedia.
We have derived a significant portion of our revenue from one reseller,
AT&T. No other customer accounted for more than 10% of our revenues in any of
the last three fiscal years. AT&T accounted for 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 69% of our total revenues in the three
months ended June 30, 1999. We anticipate that this concentration of revenue
from AT&T will continue at least through fiscal year 2000.
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<PAGE>
Relationship with AT&T
We have entered into reseller agreements with two separate business units of
AT&T: AT&T Solutions and AT&T Business Network Services. Both of these business
units market and resell our network management services to AT&T customers in
conjunction with AT&T's overall network solution offering using AT&T's trade
name. Our technicians work directly with AT&T's sales and marketing personnel
and the end users to design, implement and manage the end users' networks. As
with our other reseller arrangements, we receive our revenues for the resale of
our services to AT&T customers directly from AT&T. AT&T accounted for 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 69% of our total
revenues in the three months ended June 30, 1999. We anticipate that this
concentration of revenue from AT&T will continue at least through fiscal year
2000.
The reseller agreements with AT&T have separate terms for each of the two
business units. The arrangements with AT&T Solutions currently terminate on
December 31, 2001 with respect to placing new orders for service. Individual
orders received prior to July 1, 1999 may be canceled at AT&T's option at a
rate not to exceed 150 devices per month beginning in July 2000. This rate
represents approximately 4% per month of the orders eligible for this option as
of June 30, 1999. For orders placed after June 30, 1999, the agreement provides
for us to continue providing services until the earlier of the expiration of
the end-user customer service term or December 31, 2004. However, individual
orders placed after June 30, 1999 may be canceled at any time at AT&T's option
on thirty days' notice by paying a cancellation charge. These cancellations are
limited to ten percent of the beginning backlog of all orders in any twelve
month period. In addition, all orders may be cancelled at any time after July
1, 2001, upon 12 months' written notice. In the event of a cancellation, the
number of devices that may be cancelled by AT&T each month may not exceed 8% of
the number of devices billed in the last full month prior to cancellation.
Our reseller agreements with AT&T Business Network Services relate to
multiple carrier services: AT&T Frame Relay Plus Services, AT&T Inverse
Multiplexing Services, AT&T IP Enhanced Frame Relay Services and AT&T ATM Plus
Services. Our arrangements relating to Frame Relay Plus Services will terminate
December 31, 2000, except that, following the termination date, we will
continue to provide services until the earlier of the expiration of the end
user customer service term or December 31, 2003. Our arrangements in support of
Inverse Multiplexing Services will terminate December 31, 1999. Our
arrangements in support of IP Enhanced Frame Relay Services will terminate
April 4, 2000, except that, following the termination date, we may continue to
provide services for up to one year following the termination date if elected
by AT&T. The arrangements in support of ATM Plus Services will terminate
February 28, 2001, except that, following the termination date, we will
continue to provide services until the earlier of the expiration of the end-
user customer service term or February 28, 2004.
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.
Sales and marketing
We market our services directly to end users as well as to resellers.
Services sold to carrier resellers support the carriers' network operations or
are incorporated in services the carriers sell directly to end users. In fiscal
year 1999, 26% of network management service revenues was derived from direct
customers. Our strategy is to build our reseller channels and we expect that
these channels will represent an increasing percentage of our network
management revenues for the foreseeable future. Our resellers include AT&T, NEC
Business Network Solutions, e.spire Communications and Intermedia. All sales of
our services to date have been made in the U.S. However, we remotely manage
locations around the world for these U.S.-based customers.
At June 30, 1999, we employed eleven people in sales and sales support. Each
sales person is assigned one or more reseller channels to support. Certain
sales individuals are also responsible for direct sales to end
40
<PAGE>
users of our services. Reseller support by our sales organization includes
assistance with responses to requests for proposals, network design and
proposal generation, and participation in sales calls to potential customers.
Our sales organization also helps resellers define services and familiarize the
reseller's sales forces with our services and networking options. All of our
sales and marketing employees are based at our headquarters in Austin.
At June 30, 1999, we employed five people in marketing who are responsible
for marketing communications, public relations and new service introductions.
Primary marketing communications include direct mail promotions, seminars and
our web site. Public relations activities include obtaining media coverage and
public recognition. Marketing activities related to new service introductions
include service definition, pricing, competitive analysis, service beta test
and general availability launches, identification of potential reseller
partners and service creation program management. The marketing group also
works closely with our larger reseller partners to define, develop and
implement embedded carrier services.
Software development
The objective of our software development group, which consisted of 14 people
as of June 30, 1999, is to develop or integrate the tools we utilize to manage
networks and to develop software applications, such as ProWatch Exchange, which
become components of our services. While certain of our applications and tools
are proprietary, all are built using industry-standard protocols, tools and
development environments, including HyperText Markup Language, or HTML, Java,
Java Script, Microsoft Access, Oracle 8.x relational database software and
development tools, Remote Monitoring, or RMON, SNMP and Visual Basic.
Operations
Our operations organization, comprised of 94 individuals as of June 30, 1999,
is responsible for delivery of our services to end users. By defining network
management tasks into sets of tightly defined services, we are able to deliver
functionality to our end users at cost effective prices. Our services generally
are provided using a team approach where each customer is assigned to a team of
customer engineers, with one member of the team being assigned primary customer
responsibility and each member providing back-up when the primary engineer is
not available.
These customer engineer teams are supported by other groups within our
operations group. The first level of service delivery is our network management
center, which is staffed 24 hours per day, seven days per week with network
engineers and technicians who have a broad range of technical expertise. Our
network management center continuously monitors responses to polls to managed
devices and opens trouble tickets in response to network outages. The goal of
this group is to provide the end user with notice and a diagnosis within
fifteen minutes of a network failure. Upon isolation of the problem, the
appropriate service provider is dispatched to the end user's premises as
required to repair the outage. Network management center employees can
electronically enter trouble tickets into selected transport provider's systems
to enable faster resolution of carrier network issues.
Other groups within operations include project implementation managers,
installation engineers, equipment staging and configuration personnel, and a
network and tools infrastructure group. By using specialized teams for defined
processes, we can utilize network engineers with a broad range of skills and
experience.
Our approach to loss of the critical systems and management network
infrastructure utilized to manage customer networks is one of disaster-
avoidance backed up by selected disaster recovery. The network management
infrastructure is primarily Frame Relay-based providing the high availability
inherent in that technology. To minimize the potential loss of access to local
telecommunications infrastructure, we employ a SONET ring which is served from
two separate local exchange carrier serving offices. Our facility contains two
separate rooms with some redundant computing and networking equipment, each of
which is monitored 24 hours per day, seven days per week.
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<PAGE>
We deliver our services utilizing a workforce with a wide range of skills,
from entry-level to highly trained networking professionals. We use a strict
operational methodology combined with proprietary software tools to leverage
our workforce. We believe that we can meet our resource requirements by hiring
experienced networking professionals and by recruiting and training recent
college graduates. Nonetheless, qualified IT professionals are in short supply
and we face significant competition for these professionals.
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. We believe that the principal factors involved in competing
effectively with internal solutions include quality of service, price,
functionality and features, product reputation and quality of support. We
believe our services compete favorably with companies' internal solutions on
the basis of quality of service and support, price and features. Furthermore,
in competing with companies' internal resources, we have the advantage of
leveraging the knowledge we have gained from working with many different
customer networks.
The remote network management service market is new, highly fragmented,
rapidly evolving and largely undefined. There are few substantial barriers to
entry, and we expect that we will face additional competition from existing
competitors and new market entrants in the future. These competitors may have
significantly greater financial, technical and marketing resources and greater
name recognition than we have. We believe that the principal competitive
factors in this market include networking and security engineering expertise,
customer service, network and security capabilities, reliability and quality of
service, the ability to maintain and expand distribution channels, price, the
timing of introductions of new services, and conformity with industry
standards. While we believe that we currently are able to provide end users
with reliable network management and security services at prices that allow us
to compete favorably with respect to other service providers, there can be no
assurance that we will have the resources or expertise to compete successfully
in the future.
We currently face competition from other remote network management companies
such as Comdisco; telecommunications providers such as AT&T, Sprint, and
MCI/WorldCom; network equipment vendors such as Bay/Nortel; and computer
systems vendors such as Hewlett Packard. With respect to our security services,
we currently face competition from computer systems vendors such as IBM. We
also face potential competition from IT consulting firms, systems integrators,
VARs, and local and regional network services firms and other new entrants into
our markets. Many of these current and potential competitor companies have
significantly greater financial, technical and marketing resources and greater
name recognition and generate greater service revenue than we have. There can
be no assurance that we will be able to compete successfully against current or
potential competitors. Our failure to successfully compete would significantly
damage our business.
We also face potential competition from resellers with which we currently
partner, or could partner, to market and sell our services. These resellers
generally have substantially greater resources than we have and could directly
compete, rather than partner, with us. Such a decision by our resellers would
significantly damage our business.
With respect to the sale of equipment and on-site equipment maintenance
services, we compete primarily with the equipment manufacturers and their
resellers.
Intellectual property rights
We rely on a combination of patent, trademark, service mark and trade secret
laws and contractual restrictions to establish and protect certain proprietary
rights in technology underlying our services. We have applied for a patent with
the United States Patent Office. This patent relates to software technology
which allows us to poll, or communicate with, large numbers of routers or other
SNMP devices over multiple WANs. Although we currently have no patented
technology that would preclude or inhibit competitors from entering our market,
we intend to continue to evaluate the appropriateness of this protection and to
seek patent
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<PAGE>
protection for our inventions when appropriate. There can be no assurance that
patents will issue 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 the name NetSolve, our logo and the names ProWatch, ProWatch IV,
ProWatch for WANs, ProWatch for LANs and ProWatch Secure as separate service
marks in the United States and various state trademark offices. We also have a
service mark registration pending for ProWatch Exchange. We have not made any
foreign patent or trademark filings. We have entered into proprietary rights
and confidentiality agreements with our employees, and generally enter into
nondisclosure agreements with our suppliers, distributors and appropriate
customers in order to limit access to and disclosure of our proprietary
information.
There can be no assurance that these contractual arrangements or the other
steps taken by us to protect our intellectual property will prove sufficient to
prevent infringement or misappropriation of our technology or to deter
independent third-party development of similar technologies. Any infringement
or misappropriation, should it occur, could significantly damage our business.
Furthermore, litigation may be necessary to enforce our intellectual property
rights, to protect our trade secrets, to determine the validity and scope of
the proprietary rights of others, or to defend against claims of infringement
or invalidity. Litigation could result in substantial costs and diversion of
resources. We may be unable to protect our intellectual property, and we could
incur substantial costs defending our intellectual property from infringement
or claims of infringement.
In June 1996, in connection with our registration of the service mark
NetSolve, GRC International, Inc. claimed that our use of the name NetSolve
infringed GRC's common law intellectual property rights. This claim was settled
by an agreement with GRC and GRC withdrew its opposition and consented to our
service mark registration. GRC retains the right to use the name NetSolve to
describe a particular software product, and we retain the full right to our
corporate name. We also agreed with GRC to refrain from using NetSolve as a
brand name to describe products and services. We believe that the limited joint
use of the name NetSolve by GRC will not have a material adverse effect on us.
With the exception of GRC, we have not, to date, been notified that our
services infringe the proprietary rights of third parties; however, there can
be no assurance that third parties will not claim infringement or
indemnification by us with respect to current or future services or products.
We expect that participants in our markets will be increasingly subject to
infringement claims as the number of services and competitors in our industry
segment grows. Any of these claims, whether meritorious or not, could be time-
consuming, result in costly litigation, cause delays in product and service
installation and implementation, prevent us from using important technologies
or methods, subject us to substantial damages, or require us to enter into
royalty or licensing agreements. These royalty or licensing agreements might
not be available on terms acceptable to us or at all. As a result, any of these
claims could materially harm our business.
Employees
As of June 30, 1999, we had 135 full-time employees, including 16 in sales
and marketing, 14 in development, 94 in operations and 11 in finance and
administration. Our success depends to a significant degree upon the continued
contributions of our executive management, network management and engineering
teams. Our future success will depend in large part upon our continued ability
to attract and retain highly skilled and qualified personnel.
None of our employees is represented by a collective bargaining agreement. We
believe relations with our employees are good.
Facilities
Our corporate headquarters are located in a leased facility in Austin, Texas.
In March 1998, we relocated all of our operations, including all employees and
the network management center, into our current facility, which covers
approximately 70,000 square feet. In connection with this move, we upgraded our
computing and
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network management infrastructure environment, adding an uninterrupted power
supply system backed up by a power generator to guard against system failure
and to provide emergency power in the event of an outage. Our new facility
allows us to maintain dual computer rooms with some redundant equipment in
order to provide safeguards in the event of a fire or similar emergency.
The lease for our offices expires in November 2008, including a five-year
option to renew. We believe that our current facilities are adequate to meet
our foreseeable requirements or that suitable additional or substitute space
will be available on commercially reasonable terms.
Litigation
We are not currently a party to any material legal proceedings.
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<PAGE>
MANAGEMENT
Executive officers and directors
Our executive officers and directors and their ages as of July 15, 1999 are
as follows:
<TABLE>
<CAPTION>
Name Age Position(s)
- ---- --- -----------
<S> <C> <C>
Craig S. Tysdal......... 53 Director; president and chief executive officer
Kenneth C. Kieley....... 49 Vice president--finance, chief financial officer and secretary
Christopher D. Buffum... 50 Vice president--sales
Terrence S. Cheng....... 42 Vice president--software development
Robert C. Pojman........ 36 Vice president--operations
Harry S. Budow.......... 38 Vice president--marketing
J. Michael Gullard(1)... 54 Chairman of the board
Joel P. Adams(1)........ 42 Director
C. Richard Kramlich(2).. 64 Director
John S. McCarthy(2)..... 50 Director
H. Leland Murphy(1)..... 53 Director
Suzanne C. Narducci..... 57 Director
Howard D. Wolfe,
Jr.(2)................. 58 Director
</TABLE>
- ---------------
(1) Member of compensation committee.
(2) Member of audit committee.
Craig S. Tysdal became our president and chief executive officer and a member
of our board of directors in September 1993. From May 1990 to March 1993, Mr.
Tysdal was employed as senior vice president--worldwide sales at Network
Equipment Technologies, Inc., a worldwide supplier of WAN equipment. He was
also employed at Network Equipment Technologies, Inc. as its vice president--
product marketing from July 1989 to April 1990 and as its vice president--sales
from October 1986 to June 1989.
Kenneth C. Kieley joined us in September 1989 as our vice president--finance,
chief financial officer and secretary. From July 1985 to September 1989, Mr.
Kieley served as vice president--finance of VMX, Inc., a manufacturer of voice
messaging systems. Mr. Kieley worked for Ernst & Young LLP from 1975 to 1985.
Christopher D. Buffum became our vice president--sales in March 1998. From
December 1996 to February 1998, Mr. Buffum was employed as senior vice
president--OEM sales at Boca Research, Inc., a manufacturer of peripherals for
personal computers. He was also employed at Boca Research, Inc. as its vice
president, OEM sales from January 1996 to December 1996, its director OEM sales
from November 1994 to December 1995, and its OEM sales manager from August 1991
to November 1994.
Terrence S. Cheng joined us in April 1998, as our vice president--software
development. From April 1997 to March 1998, Mr. Cheng worked as director,
technology for Transactive Corporation, a government services firm. From
December 1995 to April 1997, he was employed as chief architect and director,
software development for Aetna, Inc., a provider of health and retirement
benefit plans and financial services. From December 1993 to December 1995, Mr.
Cheng served as senior architect, business technology for Advo, Inc., a
targeted direct mail marketing services company.
Robert C. Pojman has been our vice president--operations since February 1997.
From April 1995 to 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 operations services from July 1992 to June 1993.
Harry S. Budow commenced his employment with us as vice president--marketing
in July 1999. From April 1998 until joining us, Mr. Budow served as the
president and chief executive officer and a director of
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AXCESS Inc., a provider of technology focusing on the security access market;
and before AXCESS, Mr. Budow served as the president and chief operating
officer of AXCESS Inc.'s wholly owned subsidiary, Sandia Imaging Systems, Inc.
from June 1997 to April 1998. From January 1996 to February 1997, Mr. Budow was
employed as the vice president--marketing & business development of Bell
Packaging Corp., a manufacturing and distribution company serving the
packaging, paper and retail display industry. Mr. Budow was employed by
SpectraVision, an entertainment company, as its senior vice president--
marketing & business development from December 1991 to December 1995, and as
its vice president--marketing & technology from March 1990 to December 1991.
SpectraVision was the subject of a bankruptcy proceeding under Chapter 11 of
the U.S. Bankruptcy Code beginning in 1995 until its acquisition in 1996.
J. Michael Gullard is our chairman of the board and has been one of our
directors since October 1992. He is founding general partner of Cornerstone
Ventures, a venture capital firm, since 1984. Mr. Gullard is also the chairman
of the board of Merant PLC, a developer of enterprise application system
software and a director of JDA Software Group, Inc., a developer of software
for the retail industry.
Joel P. Adams has been a member of our board of directors since December
1989. Mr. Adams has served as president of Adams Capital Management, Inc. since
1994, and as a general partner of Fostin Capital Associates II since its
inception in 1989 and the APA/Fostin Fund since its inception in 1993. Each of
these entities is a venture capital firm.
C. Richard Kramlich has been a member of our board of directors since April
1991. He is the co-founder and has been a general partner of New Enterprise
Associates, a venture capital firm, since 1978. Mr. Kramlich is also a director
of Chalone Wine Group, Ltd., a producer and distributor of wine, Com21, Inc., a
provider of communications solutions for broadband access, Juniper Networks, a
network equipment infrastructure company, Healtheon Corporation, an Internet-
based health services company, Lumisys Incorporated, a producer of picture
archiving and communications systems, and Silicon Graphics, Inc., a developer
of workstations with computer graphics capabilities.
John S. McCarthy has been a member of our board of directors since August
1991. He has served as a general partner of Gateway Associates, L.P., a venture
capital firm, since its inception in 1984.
H. Leland Murphy was a member of our board of directors from November 1988
through April 1991. He was reelected as a director in March 1995. Mr. Murphy
has been employed by Southwest Enterprises Associates, Limited Partnership, a
venture capital firm, since 1985. Since December 1997, he has also served as a
general partner of Trellis Partners, L.P., a venture capital firm.
Suzanne C. Narducci has been a member of our board of directors since April
1999. She has been vice president for Service Provider Solutions Integration
and Alliances at Cisco Systems since February 1999. From July 1995 to February
1999 she held various positions at Cisco Systems, in which she was responsible
for sales and support to service providers within the continental United
States. Before joining Cisco, Ms. Narducci served as vice president of sales
and marketing at Eastern Telelogic, an access provider serving New Jersey,
Pennsylvania and Delaware from January 1993 to July 1995.
Howard D. Wolfe, Jr. has been a member of our board of directors since
October 1988. He has been the managing general partner of New Venture Partners,
L.P., New Venture Partners II, L.P., New Venture Partners III, L.P. and New
Venture Partners IV, L.P., all of which are venture capital firms, since the
inception of each firm. The initial firm, New Venture Partners, L.P., was
established in 1981.
Each director is elected for a period of one year and serves until his or her
successor is duly elected and qualified. Our executive officers are appointed
by, and serve at the discretion of, the board of directors.
There are no family relationships among any of our directors or executive
officers.
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<PAGE>
Board committees
The board of directors has two standing committees, an audit committee and a
compensation committee. The audit committee reviews our annual audit and meets
with our independent auditors to review the internal accounting procedures and
financial management practices. The compensation committee recommends to the
board of directors compensation and benefits for the executive officers,
reviews general policy relating to compensation and benefits of employees, and
administers our stock-based compensation plans.
Compensation committee interlocks and insider participation
No compensation committee member is currently or has been an officer or
employee of our company. None of our executive officers serves as a member of
the board of directors or compensation committee, or any entity serving an
equivalent function, of any other entity that has one or more executive
officers serving on our board or compensation committee.
Venture capital firms affiliated with Messrs. Gullard, Adams, Kramlich,
McCarthy and Wolfe have registration rights covering 604,541, 2,257,089,
3,182,734, 875,000, and 300,589 shares, respectively, of common stock. These
rights:
. are held by all venture capital firms that participated in our
financings;
. allow holders to require us to register their shares under the
Securities Act; and
. allow holders to include their shares in registration statements filed
by us.
Director compensation
Directors are entitled to receive cash compensation in an amount equal to
$2,000 for each board of directors meeting attended in person and $500 for each
board of directors meeting attended by teleconference. Additionally, directors
are reimbursed for their reasonable expenses incurred in attending meetings of
the board of directors. Directors are eligible to participate in our 1988 Stock
Option Plan and Long-Term Incentive Compensation Plan.
Limitation of liability and indemnification matters
Our certificate of incorporation limits the liability of directors to the
fullest extent permitted by Delaware law. Delaware law provides that a
corporation's certificate of incorporation may contain a provision eliminating
or limiting the personal liability of directors to the corporation or its
stockholders for monetary damages for breach of their fiduciary duties as
directors, except liability for:
. any breach of their duty of loyalty to the corporation or its
stockholders;
. acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. improper payments of dividends or improper stock repurchases or
redemptions as provided in Section 174 of the Delaware General
Corporation Law; or
. any transaction from which the director derived an improper personal
benefit.
Our bylaws provide that we shall indemnify our directors, officers, employees
and agents to the fullest extent permitted by law. We believe that
indemnification under our bylaws covers at least negligence and gross
negligence on the part of indemnified parties.
We have entered into agreements that indemnify our directors and executive
officers. These agreements, among other things, indemnify the directors and
executive officers for certain expenses, including attorneys' fees, and, in
some instances, judgments, fines and settlement amounts incurred by such
persons in any action or proceeding, including any action by us or on our
behalf, arising out of his or her service as a director or executive officer of
our company, any of our subsidiaries or any other company or enterprise to
which the
47
<PAGE>
person provides services at our request. We believe that these provisions and
agreements are desirable to attract and retain qualified directors and
executive officers.
At present, there is no pending litigation or proceeding involving any of our
directors, officers, employees or agents in which indemnification will be
required or permitted. We are not aware of any threatened litigation or
proceeding that might result in a claim for this indemnification.
EXECUTIVE COMPENSATION
The following table sets forth the total compensation earned during fiscal
year 1999 by our chief executive officer and our four other executive officers
whose bonus and salary exceeded $100,000. We refer to these individuals
collectively as the Named Executive Officers.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION
----------------------------------- ----------------
AWARDS
----------------
SALARY OTHER ANNUAL STOCK UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION ($) BONUS ($) COMPENSATION ($) OPTIONS (#) COMPENSATION ($)
- --------------------------- -------- --------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
Craig S. Tysdal,
president and
chief executive
officer................ $189,583 $ 1,746 -- 200,000 --
Robert C. Pojman, vice
president--operations.. 153,029 1,746 -- 50,000 --
Christopher D. Buffum,
vice president--sales.. 150,000 70,896 -- -- --
Kenneth C. Kieley, vice
president--finance,
chief financial officer
and secretary.......... 133,333 1,070 -- 50,000 $1,247
Michael R. Turner, vice
president--marketing... 123,333 1,814 -- -- 812
</TABLE>
Of the $70,896 reflected as a bonus for Mr. Buffum, $69,150 consisted of
sales commissions and reimbursement of relocation expenses and $1,746 consisted
of Mr. Buffum's annual bonus. The other compensation we paid to Messrs. Kieley
and Turner consisted of a reimbursement for long-term disability insurance
premiums.
Mr. Turner resigned his employment with us effective May 28, 1999. Harry S.
Budow accepted the position of our vice president--marketing commencing in July
1999 at an initial salary of $200,000 per year.
OPTION GRANTS
The following table provides certain summary information concerning the
shares of common stock represented by stock options granted to each of the
Named Executive Officers during fiscal year 1999.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF STOCK
PRICE APPRECIATION
INDIVIDUAL GRANTS FOR OPTION TERM
------------------------------------------------ ---------------------
NUMBER OF PERCENTAGE OF
SECURITIES TOTAL OPTIONS
UNDERLYING GRANTED TO EXERCISE
OPTION GRANTED EMPLOYEES IN PRICE EXPIRATION
(#) FISCAL YEAR ($/SH) DATE 5%($) 10%($)
-------------- ------------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Craig S. Tysdal......... 200,000 32% $7.50 7/21/2008 $2,735,000 $5,244,000
Robert C. Pojman........ 50,000 8 7.50 7/21/2008 684,000 1,311,000
Christopher D. Buffum... -- -- -- -- -- --
Kenneth C. Kieley....... 50,000 8 7.50 7/21/2008 684,000 1,311,000
Michael R. Turner....... -- -- -- -- -- --
</TABLE>
48
<PAGE>
All options were granted at their "fair market value" on the date of grant
and may be exercised at any time during the term of the option. Each option
vests over a four-year period with one fourth of the total amount vesting one
year from the date of grant and one-sixteenth of the total amount vesting in
each calendar quarter remaining. The unvested portion of any previously
exercised option is subject to our repurchase right upon termination of the
executive's employment. Under the terms of our Long-Term Incentive Compensation
Plan, the board of directors retains discretion, subject to certain limitations
provided for in the plan, to modify the terms of outstanding options. All
options were granted for a term of 10 years, subject to earlier termination in
certain events related to termination of employment. The exercise price for all
options may be paid in cash or shares of our common stock or a combination of
cash and shares.
In connection with his commencing employment in July 1999, Mr. Budow was
granted an option to purchase 100,000 shares of our common stock under our
Long-Term Incentive Compensation Plan at an exercise price of $9.00 per share.
Fiscal year-end option values
The following table provides information concerning the shares of common
stock represented by outstanding stock options held by each of the Named
Executive Officers as of March 31, 1999.
Fiscal 1999 Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised
Options at March 31, 1999 in-the-Money Options
(#) at March 31, 1999 ($)
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Craig S. Tysdal............. 569,375 220,625 $7,187,688 $1,329,313
Robert C. Pojman............ 60,000 110,000 654,000 929,000
Christopher D. Buffum....... 30,000 90,000 306,000 918,000
Kenneth C. Kieley........... 219,250 66,250 2,712,000 455,500
Michael R. Turner........... 112,500 7,500 1,416,250 81,750
</TABLE>
There was no public market for the common stock as of June 21, 1998 or March
31, 1999. Accordingly, the potential realizable values and the values of
unexercised in-the-money options in the tables above have been calculated by
determining the difference between a public offering price of $13.00 per share
and the per share exercise prices of the options.
No options were exercised by the Named Executive Officers during fiscal year
1999.
Long-term incentive compensation plan
Our Long-Term Incentive Compensation Plan, or Long-Term Incentive Plan, was
adopted by the board of directors and approved by the stockholders in July
1997. It is administered by the compensation committee. The purpose of the
Long-Term Incentive Plan is to assist us in attracting, retaining and
motivating executive officers, key employees and directors and consultants who
are essential to our success through performance-related incentives linked to
long-range performance goals. Performance goals under the Long-Term Incentive
Plan may be based on individual performance of the particular employee and/or
include criteria such as absolute or relative levels of total stockholder
return, revenues, sales, net income or net worth of our company or any of our
subsidiaries, divisions, business units or other areas, all as the compensation
committee may determine.
The Long-Term Incentive Plan is a comprehensive, stock-based incentive
compensation plan, providing for discretionary awards of incentive stock
options, nonqualified stock options, stock appreciation rights, restricted
stock, restricted stock units, performance shares, performance units, bonus
stock and other stock-based awards. All awards under the Long-Term Incentive
Plan are made in, or based on the value of, the common stock.
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<PAGE>
Our full-time employees, directors, and consultants are eligible to
participate in, and receive awards under, the Long-Term Incentive Plan. The
selection of participants under the Long-Term Incentive Plan, as well as all
terms, conditions, performance criteria and restrictions applicable to each
award, are determined by the compensation committee in its sole discretion.
The maximum number of shares of common stock for which awards may be granted
under the Long-Term Incentive Plan is 1,350,000 subject to adjustment in the
event of a merger, consolidation, reorganization, recapitalization, stock
dividend, stock split, or other similar event. Shares subject to previously
canceled, lapsed or forfeited awards, or awards paid in cash, may be reissued
under the Long-Term Incentive Plan. The shares to be issued under the Long-Term
Incentive Plan may consist of authorized but unissued shares, shares issued and
reacquired by us or shares purchased in the open market.
We expect that awards made under the Long-Term Incentive Plan will be fully
deductible for federal income tax purposes. In this connection, if we become
subject to Section 162(m) of the Internal Revenue Code, which limits the
deductions for awards to certain covered participants, performance-based
compensation that can be provided to any covered participant in any year will
be limited to stock options for up to 100,000 shares. No other types of awards
may be made under the Long-Term Incentive Plan to covered participants.
As of June 30, 1999, options covering an aggregate of 980,636 shares of
common stock had been granted under the Long-Term Incentive Plan at exercise
prices ranging from $2.80 to $9.00. Each of these options has a term of ten
years and may be exercised at any time during this term. The exercise price may
be paid in cash or shares of common stock already held by the exercising
participant, or a combination of cash and shares. Each option vests over a
four-year period with one-fourth of the total amount vesting one year from the
date of grant and one-sixteenth of the total amount vesting in each subsequent
calendar quarter. The unvested portion of any exercised options are subject to
our repurchase right upon termination of employment.
The Long-Term Incentive Plan may be amended, modified, suspended or
terminated by the board of directors at any time. No amendment will be
effective prior to approval of the stockholders to the extent that approval is
necessary to comply with any legal requirement. If not earlier terminated, the
Long-Term Incentive Plan will terminate on December 31, 2006.
Stock options. The Long-Term Incentive Plan authorizes:
. the grant of options to purchase common stock intended to qualify as
incentive stock options under Section 422(b) of the Internal Revenue
Code, or incentive options; and
. the grant of options that do not so qualify, or nonqualified
options.
The number of shares and other terms of each grant are determined by the
compensation committee. The exercise price of incentive options granted under
the Long-Term Incentive Plan must be at least equal to the fair market value of
the common stock on the date of grant. The exercise price of incentive options
granted to an optionee who owns stock possessing more than 10% of the voting
power of our outstanding capital stock must equal at least 110% of the fair
market value of the common stock on the date of grant. The exercise price of
non-qualified options granted under the Long-Term Incentive Plan must not be
less than 50% of the fair market value of the common stock on the grant date.
Incentive options may be granted under the Long-Term Incentive Plan to
employees, including officers and directors who are also employees. Non-
qualified options may be granted under the Long-Term Incentive Plan to our
employees, officers, consultants and directors, whether or not they are our
employees. The exercise price for options granted under the Long-Term Incentive
Plan may be paid in cash or with shares of common stock. Options granted under
the Long-Term Incentive Plan may remain outstanding for no more than ten years.
Stock appreciation rights. Stock appreciation rights, or SARs, entitle the
participant to receive, upon exercise of the SAR, cash or, at the election of
the administrator, shares of common stock or a combination thereof, in an
amount equal to the difference between the SAR exercise price and the fair
market value of the
50
<PAGE>
shares of common stock subject to the SAR. SARs may be granted to participants
under the Long-Term Incentive Plan on a freestanding basis or in tandem with a
stock option. The exercise price of SARs will not be less than 100% of the fair
market value of the common stock on the date of grant. SARs granted under the
Long-Term Incentive Plan will not be exercisable until at least six months
following the date of grant and no later than ten years thereafter. Incentive
options and SARs may not be transferred other than by will or the laws of
descent and distribution.
Stock and stock unit awards. The Long-Term Incentive Plan also provides for
the granting of restricted stock, restricted stock units, performance shares
and performance stock units, bonus stock and other stock-based awards. The
number of shares or units and all terms and conditions, including the
restriction period, performance criteria and other restrictions and conditions
applicable to each stock based award, are determined by the compensation
committee. During the restriction period, participants may exercise full voting
rights, and are entitled to receive all dividends and other distributions paid,
with respect to restricted stock they have been granted, provided that stock
dividends, if any, remain subject to the same restrictions as the underlying
stock. Payment to the participant may be in shares of common stock or cash, or
a combination thereof, and in a lump sum or installments, all as determined by
the compensation committee. Shares of common stock may also be awarded to
participants under the Long-Term Incentive Plan as a bonus. These shares may be
granted with or without restrictions. Shares awarded subject to performance
criteria or other restrictions which are not satisfied, are forfeited and must
be returned to us. In addition to the foregoing types of awards, the Long-Term
Incentive Plan permits the compensation committee to grant any other stock
based award as the administrator may determine. These stock based awards may be
in the form of common stock or other securities, the value of which is based,
in whole or in part, on the value of common stock on the award date.
Acceleration of vesting upon change in control. In the event of a change in
control of our company, all outstanding stock options and SARs shall
immediately become fully vested, and all restrictions and performance criteria
relating to all outstanding awards shall be deemed to have been fully
satisfied, unless the transaction or event constituting the change in control
was approved in advance by a majority of the board of directors. Under the
terms of the Long-Term Incentive Plan, a change in control shall be deemed to
have occurred if:
. any person becomes the beneficial owner of 20% or more of our voting
securities;
. we are involved in a merger, acquisition or similar transaction
pursuant to which our directors immediately before the transaction
cease to constitute a majority of our directors after the
transaction; or
. we are involved in a transaction pursuant to which we are not the
surviving corporation, our common stock is exchanged for, or
converted into securities of another entity, we become a subsidiary
of another entity, or 50% or more of our aggregate assets or earning
powers are sold to another entity.
1988 stock option plan
Our 1988 Stock Option Plan, or 1988 Option Plan, was adopted by our board of
directors and approved by our stockholders in November 1988. The principal
purpose of the 1988 Option Plan is to advance the interests of our company and
our stockholders by enabling us to attract qualified management and other key
personnel and encourage selected directors, officers, key employees and
consultants to acquire and retain a proprietary interest in our company through
the ownership of our common stock. A total of 1,636,395 shares of common stock
has been reserved for issuance under the 1988 Option Plan.
The 1988 Option Plan provides for the granting of incentive options to
employees, including officers and directors, and for the granting of
nonqualified options to employees and consultants, including nonemployee
directors, of nonqualified stock options. To the extent an optionee would have
the right in any calendar year to exercise for the first time one or more
incentive options that have been granted to the optionee under any of our
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<PAGE>
plans for shares having an aggregate fair market value in excess of $100,000,
any excess options shall be treated as nonqualified options.
As of June 30, 1999, there were options outstanding under the 1988 Option
Plan for 1,636,395 shares of common stock. As of this date, a total of 863,442
shares had been purchased pursuant to option exercises and we had repurchased
6,600 unvested shares pursuant to the provisions of the 1988 Option Plan. No
incentive options were allowed to be granted under the 1988 Option Plan after
November 20, 1998.
The 1988 Option Plan may be administered by the board of directors or a
committee of the board. The 1988 Option Plan is currently administered by the
compensation committee. The 1988 Option Plan administrator determines the terms
of options granted under the 1988 Option Plan, including the number of shares
subject to the option, exercise price, term and exercisability. The exercise
price of each incentive option granted under the 1988 Option Plan must be at
least equal to the fair market value of common stock on the date of grant. The
exercise price of any incentive option granted to an optionee who owns stock
representing more than 10% of the total combined voting power of all classes of
outstanding capital stock of our company or any parent or subsidiary
corporation of our company must equal at least 110% of the fair market value of
common stock on the date of grant. Payment of the exercise price may be made in
cash or by delivery of previously owned shares of common stock, or partly in
cash and partly in common stock.
The 1988 Option Plan administrator determines the term of options, which may
not exceed ten years. No option may be transferred by an optionee other than by
will or the laws of descent or distribution. Each option may be exercised
during the lifetime of an optionee only by the optionee. The 1988 Option Plan
administrator determines when options become exercisable. Options granted under
the 1988 Option Plan are generally exercisable at any time, but are subject to
a four-year vesting schedule with one-fourth of the stock vesting one year from
the date of grant and one-sixteenth of the stock underlying the option vesting
in each subsequent calendar quarter. The unvested portion of exercised options
may be repurchased by us at the original exercise price upon termination of
employment.
We have the authority to amend or terminate the 1988 Option Plan, except that
we may not increase the aggregate number of shares which may be issued under
options granted pursuant to the 1988 Option Plan, and we may not take any
action not expressly provided for in the 1988 Option Plan, in derogation of the
vested rights of any optionee under an option previously granted thereunder.
401(k) retirement plan
Effective December 1, 1988, we established a 401(k) defined contribution
retirement plan, or Retirement Plan, covering all employees who are at least 21
years of age and have satisfied certain service eligibility requirements.
Effective February 1, 1997, the Retirement Plan was amended to eliminate any
service eligibility requirements so that employees who otherwise met the
eligibility criteria could commence participation upon being hired by us. The
Retirement Plan provides for voluntary employee contributions in amounts
determined by the employees, subject to a maximum limit allowed by Internal
Revenue Service guidelines. For 1999, this limit is $10,000. We may contribute
these amounts to the accounts of participants in the Retirement Plan as
determined by the board of directors, subject to certain legal requirements. To
date, we have not made any contribution to the Retirement Plan, and we do not
anticipate making any contribution to the Retirement Plan in the foreseeable
future.
Bonus plan
In July 1998, we adopted a bonus plan pursuant to which selected employees
are eligible to receive cash bonuses on a quarterly basis beginning with the
quarter ended September 30, 1998 if, during such quarter, we meet certain
financial performance objectives established from time to time by us. We may
amend or terminate the bonus plan at any time.
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<PAGE>
TRANSACTIONS WITH RELATED PARTIES
Venture capital firms affiliated with Messrs. Gullard, Adams, Kramlich,
McCarthy and Wolfe have registration rights covering 604,541, 2,257,089,
3,182,734, 875,000, and 300,589 shares, respectively, of common stock. These
rights:
. are held by all venture capital firms that participated in our
financings;
. allow holders to require us to register their shares under the
Securities Act; and
. allow holders to include their shares in registration statements
filed by us.
We have entered into indemnification agreements with our executive officers
and directors. Among other terms, under these agreements, we would agree to:
. indemnify, to the fullest extent allowed by Delaware law, these
officers and directors against certain liabilities related to their
service or status as officers or directors; and
. in any proceeding in which they could be indemnified, advance to
these officers and directors the expenses they incur in those
proceedings.
We intend to execute similar indemnification agreements with our future
directors and executive officers.
As a matter of policy, all future transactions between us and any of our
directors or executive officers will be subject to approval by a majority of
the independent and disinterested members of the board of directors and will be
in connection with bona fide purposes of our company.
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of June 30, 1999, and as adjusted
to reflect the sale of the shares of common stock offered by this prospectus,
by:
. each of our directors;
. each of the Named Executive Officers;
. all of our current directors and executive officers as a group;
. each person we know to own beneficially more than five percent of
the outstanding shares of the common stock; and
. each of the selling stockholders.
The selling stockholders will bear none of the expenses of this offering other
than the underwriting discounts and commissions applicable to the shares of
common stock to be sold by them. Unless otherwise indicated, the address of
each of the named individuals is: c/o NetSolve, Incorporated, 12331 Riata Trace
Parkway, Austin, Texas 78727.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. Except pursuant to applicable community
property laws or as indicated in the paragraphs following this table, to our
knowledge, each stockholder identified in the table possesses sole voting and
investment power with respect to all shares of common stock shown as
beneficially owned by that stockholder. The number of shares beneficially owned
by a person includes shares of our common stock subject to options and warrants
held by that person that are currently exercisable within 60 days of June 30,
1999. The number of shares issuable pursuant to these options is identified in
a separate column in the following table. The shares issuable pursuant to these
options and warrants are deemed outstanding for computing the percentage
ownership of the person holding these options and warrants but are not deemed
outstanding for the purposes of computing the percentage ownership of any other
person. For purposes of this table, the number of shares of common stock
outstanding prior to the offering is deemed to be 9,878,516, consisting of
3,483,789 shares of common stock outstanding on June 30, 1999 and an additional
6,394,727 shares issuable upon conversion of our preferred stock. For purposes
of calculating the percentage beneficially owned by any person, shares of our
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<PAGE>
common stock issuable to that person upon the exercise of any options
exercisable within 60 days of June 30, 1999 are also assumed to be outstanding.
The number of shares of common stock deemed outstanding after this offering
includes the additional 3,530,000 shares being offered by us hereby, and
assumes no exercise of the underwriters' over-allotment option.
<TABLE>
<CAPTION>
Options
Shares Beneficially Attributed Shares Beneficially
Owned Prior to Offering to Shares Owned After Offering
--------------------------- Beneficially Shares -----------------------
Number Percent Owned Offered Number Percent
-------------- ------------ ------------ ------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
Directors, Named Executive Officers and
all directors and executive officers as
a group
- ---------------------------------------
C. Richard Kramlich.................... 3,197,734 32.3% 15,000 -- 3,197,734 23.8%
Joel P. Adams.......................... 2,272,089 23.0 15,000 -- 2,272,089 16.9
John S. McCarthy....................... 890,000 9.0 15,000 -- 890,000 6.6
Craig S. Tysdal........................ 790,000 7.4 790,000 -- 790,000 5.6
J. Michael Gullard..................... 619,541 6.1 215,000 -- 619,541 4.6
Howard D. Wolfe, Jr.................... 317,589 3.2 15,000 -- 317,589 2.4
Kenneth C. Kieley...................... 285,500 2.8 285,500 -- 285,500 2.1
Robert C. Pojman....................... 170,000 1.7 170,000 -- 170,000 1.3
Christopher D. Buffum.................. 120,000 1.2 120,000 -- 120,000 *
H. Leland Murphy....................... 65,000 * 65,000 -- 65,000 *
Suzanne C. Narducci.................... 15,000 * 15,000 15,000 *
All directors and executive officers as
a group (13 persons).................. 8,892,453 75.7 1,870,500 -- 8,892,453 58.2
Other 5% stockholders
- ---------------------
New Enterprise Associates IV........... 2,365,087 23.9 -- -- 2,365,087 17.6
Limited Partnership
C. Richard Kramlich
1119 St. Paul Street
Baltimore, MD 21202
APA/Fostin Pennsylvania................ 1,187,020 12.0 -- -- 1,187,020 8.9
Venture Capital Fund
Joel P. Adams
518 Broad Street
Sewickley, PA 15143
Gateway Venture Partners III, L.P. .... 875,000 8.9 -- -- 875,000 6.5
John S. McCarthy
8000 Maryland Avenue, Suite 1190
St. Louis, MO 63105
Southwest Enterprise Associates, L.P... 817,647 8.3 -- -- 817,647 6.1
C.V. Prothro
C. Richard Kramlich
14305 Inwood Road, Suite 101-44
Dallas, TX 75244-3944
Fostin Capital Associates II........... 640,827 6.5 -- -- 640,827 4.8
Joel P. Adams
518 Broad Street
Sewickley, PA 15143
Selling stockholders
- --------------------
Otis Brinkley.......................... 139,392 1.4 -- 120,000 19,392 *
Robert Karasch......................... 16,666 * -- 8,000 8,666 *
Steve Kelley........................... 76,313 * -- 26,000 50,313 *
Rob Lynch.............................. 55,000 * -- 2,000 53,000 *
John Merritt........................... 95,703 * -- 4,476 91,227 *
Sequoia Partners and related entities.. 1,024 * -- 1,024 -- --
Darren Spohn........................... 87,500 * -- 8,500 79,000 *
</TABLE>
- --------
*Less than 1%.
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Several members of our board of directors are affiliated with some of our
stockholders and are therefore considered to have beneficial ownership of the
shares held by those particular stockholders. As indicated below, these
directors are affiliated with stockholders owning more than 5% of our
outstanding shares of common stock. Each of the directors identified below
disclaims beneficial ownership of the shares held by the respective affiliated
stockholders, expect with respect to any proportional pecuniary interest
therein.
C. Richard Kramlich. Of the 3,197,734 shares beneficially owned by Mr.
Kramlich, 2,365,087 shares are held by New Enterprise Associates IV, Limited
Partnership ("NEA IV") and 817,647 shares are held by Southwest Enterprise
Associates, Limited Partnership ("SEA"). Mr. Kramlich is a general partner of
NEA Partners IV, Limited Partnership ("NEA Partners"), the general partner of
NEA IV, and a general partner of NEA Partners Southwest, L.P., a general
partner of SEA. He shares voting and investment power with respect to shares
held by NEA IV with NEA Partners and shares voting and investment power with
respect to shares held by SEA.
Joel P. Adams. Of the 2,272,089 shares beneficially owned by Mr. Adams,
2,257,089 shares are held by APA/Fostin Pennsylvania Venture Capital Fund,
Fostin Capital Associates II and Loyalhanna Commonwealth Fund. Mr. Adams serves
as a general partner of each of these entities.
John S. McCarthy. Of the 890,000 shares beneficially owned by Mr. McCarthy,
875,000 shares are held by Gateway Venture Partners III, L.P. of which Mr.
McCarthy has been a general partner for over fifteen years.
J. Michael Gullard. Of the 619,541 shares beneficially owned by Mr. Gullard,
404,541 represents shares held by Cornerstone Ventures and Cornerstone Ventures
International C.V. and 200,000 represents shares which may be acquired within
60 days of June 30, 1999, upon the exercise of options held by these entities.
Mr. Gullard serves as a general partner of both Cornerstone Ventures and
Cornerstone Ventures International C.V.
Howard D. Wolfe, Jr. Of the 317,589 shares beneficially owned by Mr. Wolfe,
300,589 shares are held by New Ventures Partners II, L.P. of which Mr. Wolfe
serves as managing general partner.
Rob Lynch and Darren Spohn. These two selling stockholders are former
officers of NetSolve. Mr. Lynch served as our vice president-sales from August
1994 to October 1996. Mr. Spohn served as our vice president-development from
March 1994 to March 1998.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of 25,000,000 shares of common stock,
$0.01 par value per share, and 7,500,000 shares of undesignated preferred
stock, $0.10 par value per share.
Common stock
As of June 30, 1999, we had 139 stockholders that owned a total of 9,878,516
shares of common stock, including shares issuable upon conversion of all
outstanding preferred stock. Options to purchase an aggregate of 2,584,411
shares of our common stock and warrants to purchase an aggregate of 107,500
shares of our common stock were also outstanding. Assuming no exercise of
outstanding warrants or options after June 30, 1999, there will be 13,408,516
shares of our common stock outstanding after this offering.
Each share of our common stock is allowed one vote on all matters submitted
to a vote of the stockholders. Subject to preferences that may be applicable to
the holders of outstanding preferred stock issued in the future, if any,
holders of common stock are entitled to receive dividends as may be declared by
our board of directors. If we liquidate or dissolve, subject to the rights of
the holders of outstanding shares of preferred stock issued in the future, if
any, the holders of our common stock shall receive a share in all assets
remaining after liabilities are paid and preferential rights of any outstanding
preferred stock are satisfied. The common stock has no preemptive or conversion
rights or other subscription rights. All shares of our common stock are, and
those to be issued in this offering will be, fully paid and non-assessable.
Preferred stock
Each share of our preferred stock outstanding as of June 30, 1999 will be
converted into one share of our common stock and automatically retired upon the
closing of this offering. Thereafter, our board of directors is authorized to
issue up to 7,500,000 shares of preferred stock. Our board of directors may
designate one or more series of preferred stock and may assign differing
rights, preferences, privileges and restrictions, including dividend rights,
dividend rates, conversion rights, voting rights, terms of redemption,
redemption prices, liquidation preferences and the number of shares
constituting any series or the designation of such series, without further
stockholder vote or action.
If we issue preferred stock, this may delay, defer or prevent a change in
control of our company without further stockholder action. The issuance of
preferred stock with voting and conversion rights may adversely affect the
voting power of the holders of our common stock. In certain circumstances, the
market price of our common stock may decrease as a result. As of the closing of
this offering, no shares of preferred stock will be outstanding and we
currently have no plans to issue any shares of preferred stock.
Warrants
As of June 30, 1999, we had outstanding exercisable warrants to purchase
107,500 shares of our common stock with a weighted average exercise price of
$2.01 per share. These warrants will expire between 1999 and 2001.
Registration rights
Following this offering, the holders of 9,408,511 shares of common stock will
be entitled to rights relating to the registration of these shares under state
and federal securities laws. These rights, which are assignable, are outlined
in an agreement between us and the holders of these shares of common stock. The
holders of at least 30% of these shares may generally require that we register
their shares for public resale. If we register any of our common stock, either
for our own account or for the account of other security holders, the holders
of these shares are entitled to include their shares in the registration,
subject to the ability of the underwriters to limit the number of shares
included in the offering. Holders of at least 20% of these shares may also
require us, not more than one time in any 12-month period, to register all or a
portion of their shares on Form S-3, when use
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<PAGE>
of that form becomes available, provided that, among other limitations, the
proposed aggregate selling price is at least $1,000,000, net of any
underwriters' discounts or commissions. These registration rights terminate at
the earlier of:
. that time as the holder may, within a three-month period, offer and sell
all of his shares pursuant to Rule 144 under the Securities Act without
any adverse effect on the price at which these shares may be sold, the
determination as to such adverse effect to be made by such holder acting
in good faith; or
. 48 months from the closing of this offering.
Delaware law and charter provisions
Provisions of Delaware law and our certificate of incorporation could
complicate our acquisition by means of a tender offer, a proxy contest or
otherwise. In addition, it might be difficult to remove incumbent officers and
directors. These provisions are expected to discourage certain types of
coercive takeover practices and inadequate takeover bids and to encourage
negotiation between our management and those persons seeking control. We
believe it is more advantageous to protect our potential ability to negotiate,
rather than discourage, unfriendly or unsolicited third parties attempting to
acquire or restructure us. Among other things, negotiating these proposals
could result in an improvement of their terms.
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law. In general, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date that the person became
an interested stockholder unless the business combination or the transaction in
which the person became an interested stockholder is approved in a prescribed
manner. Generally, a "business combination" includes a merger, asset or stock
sale, or other transaction resulting in a financial benefit to the stockholder.
Generally, an "interested stockholder" is a person who, together with
affiliates and associates, owns, or owned within the prior three years, 15% or
more of the corporation's voting stock. This provision may delay, defer or
prevent a change in control of our company without the stockholders taking
further action.
It is more difficult for our existing stockholders to replace the board of
directors as well as for another party to obtain control of our company by
replacing our board of directors because cumulative voting is eliminated. Our
board of directors has the power to retain and discharge officers, making it
more difficult for existing stockholders or another party to change the
management.
The foregoing provisions could have the effect of making it more difficult
for a third party to effect a change in the control of our board of directors.
In addition, these provisions could make it more difficult for a third party to
acquire, or discourage a third party from attempting to acquire, a majority of
our outstanding voting stock.
Transfer agent and registrar
The transfer agent and registrar for the common stock is American Stock
Transfer & Trust Company.
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<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Before this offering, there has been no public market for our common stock,
and no prediction can be made as to the effect, if any, that future sales of
common stock or the availability of common stock for sale in the public market
will have on prevailing market prices of our common stock. Furthermore, because
only a limited number of shares will be available for sale for 180 days after
this offering as a result of resale restrictions, sales of substantial amounts
of our common stock in the public market after these restrictions lapse could
lower the prevailing market price and our ability to raise equity capital in
the future. These resale restrictions are described below.
Assuming neither the underwriters' over-allotment option nor any option or
warrant outstanding as of June 30, 1999 is exercised, we will have outstanding
an aggregate of 13,408,516 shares of our common stock. Of these shares, the
3,700,000 shares sold in this offering will be freely tradeable without
restriction or further registration under the Securities Act, except that
shares purchased by an existing "affiliate" of ours as that term is defined in
Rule 144 under the Securities Act may be sold only in compliance with the
limitations described below. The remaining 9,708,516 shares of common stock
held by existing stockholders are "restricted securities" as that term is
defined in Rule 144 under the Securities Act.
Subject to these lock-up agreements, the shares of outstanding common stock
will be available for sale in the public market as follows:
<TABLE>
<CAPTION>
Number of
Shares Date
--------- ----
<C> <S>
3,700,000 After the date of this prospectus, consisting of shares sold in
the offering.
211,665 After the date of this prospectus, subject in some cases to volume
limitations and other restrictions of Rule 144.
48,919 At various times during the 180 day period after the date of this
prospectus, subject in some cases to volume limitations and other
restrictions of Rule 144.
9,447,932 After 180 days from the date of this prospectus, subject in some
cases to volume limitations and other restrictions of Rule 144.
</TABLE>
In addition, as of June 30, 1999, there were outstanding 2,584,411 options
and 107,500 warrants to purchase shares of common stock. Of these options, held
primarily by affiliates, 2,035,100 will be subject to 180-day lock-up
agreements. After 180 days from the date of this prospectus 1,470,882 of these
options will be vested and exercisable. All of these warrants are exercisable
and will be eligible for sale, subject to the restrictions of Rule 144.
Lock-up agreements. All of our officers and directors, the selling
stockholders and approximately 20 of our other stockholders and optionholders
have entered into lock-up agreements with the underwriters under which they
agree not to transfer or dispose of, directly or indirectly, any shares of our
common stock or any securities convertible into, or exercisable or exchangeable
for shares of our common stock owned by them, for a period of 180 days after
the date of this prospectus. Transfers or dispositions can be made sooner:
. to affiliates of the transferor who sign identical lock-up agreements;
or
. if the transfer is a bona fide gift, to a donee who signs an identical
lock-up agreement.
BancBoston Robertson Stephens may, in its sole discretion and at any time
without notice, release all or any portion of the securities subject to the
lock-up restrictions; however, BancBoston Robertson Stephens currently has no
plans to release any portion of the securities subject to these lock-up
agreements. Additionally, the lock-up agreements do not place restrictions on
the resale of shares purchased in the public market.
Rule 144. In general, under Rule 144 as currently in effect, beginning 90
days after the date of this prospectus, a person may, subject to volume
limitations, sell restricted shares that the person has beneficially
58
<PAGE>
owned for a holding period which, when added to the holding period of prior
owners not affiliated with us, is at least one year. The number of those shares
that a person may sell within any 90-day period may not exceed the greater of:
. 1% of the number of shares of our common stock then outstanding, which
is expected to be approximately 134,085 shares immediately after this
offering; or
. the average weekly trading volume of our common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to that sale.
Sales under Rule 144 are also subject to manner-of-sale provisions, notice
requirements and the availability of current public information about us.
Rule 144(k). Under Rule 144(k), a person may sell shares if the person has
not been our affiliate at any time during the 90 days preceding a sale and has
beneficially owned the shares proposed to be sold for a holding period which,
when added to the holding period of prior owners not affiliated with us, is at
least two years. The person may sell those shares without complying with the
manner for sale, public information, volume limitation or notice provisions of
Rule 144. Therefore, unless otherwise restricted, "144(k) shares" may be sold
immediately upon the closing of this offering.
Rule 701. In general, Rule 701 of the Securities Act may be relied upon with
respect to the resale of securities originally purchased from us by our
directors, officers, employees, consultants or advisors before the date of this
prospectus, in connection with written compensatory benefit plans or written
contracts relating to the compensation of these persons. In addition, Rule 701
will apply to the stock options granted by us before the date of this
prospectus, along with the shares acquired upon exercise of these options,
regardless of when they are exercised. Shares issued under Rule 701 are
restricted securities and, subject to the contractual restrictions described
above, may be sold beginning 90 days after the date of this prospectus by:
. persons other than affiliates, subject only to the manner-of-sale
provisions of Rule 144; and
. affiliates without compliance with certain restrictions contained in
Rule 144, including the one-year minimum holding period.
Stock plans. Approximately 90 days after this offering, we intend to file a
registration statement under the Securities Act covering approximately
3,850,000 shares of common stock subject to outstanding options or reserved for
issuance under our Long-Term Incentive Plan and 1988 Option Plan. Shares
registered under this registration statement, and not subject to a 180-day
lock-up agreement will, subject to Rule 144 volume limitations applicable to
affiliates, be available for sale in the open market.
Registration rights. After this offering, the holders of approximately
9,408,511 shares or their transferees will be entitled to certain rights with
respect to the registration of those shares under the Securities Act.
Approximately all of these shares will be subject to 180-day lock-up
agreements. A registration of these shares under the Securities Act would
result in these shares becoming freely tradeable without restriction under the
Securities Act immediately upon the effectiveness of the registration.
59
<PAGE>
UNDERWRITING
The underwriters named below, acting through their representatives,
BancBoston Robertson Stephens and Thomas Weisel Partners, have severally agreed
with us and the selling stockholders, subject to the terms and conditions of
the underwriting agreement, to purchase from us and the selling stockholders
the number of shares of common stock set forth opposite their names below. The
underwriters are committed to purchase and pay for all these shares if any are
purchased.
<TABLE>
<CAPTION>
Number
Underwriters of Shares
------------ ---------
<S> <C>
BancBoston Robertson Stephens Inc. ................................ 1,888,800
Thomas Weisel Partners LLC......................................... 1,251,200
Dain Rauscher Wessels.............................................. 120,000
First Albany Corporation........................................... 120,000
Needham & Company, Inc. ........................................... 120,000
E*trade Securities, Inc. .......................................... 100,000
Suretrade.......................................................... 100,000
---------
Total............................................................ 3,700,000
=========
</TABLE>
The representatives have advised us and the selling stockholders that the
underwriters propose to offer the shares of common stock to the public at the
public offering price set forth on the cover page of this prospectus and to
certain dealers at this price less a concession of not in excess of $0.55 per
share, of which $0.10 may be reallowed to other dealers. After this offering,
the public offering price, concession and reallowance to dealers may be reduced
by the representatives. No reduction shall change the amount of proceeds to be
received by us and the selling stockholders as set forth on the cover page of
this prospectus.
We have granted to the underwriters an option, exercisable during the 30-day
period after the date of this prospectus, to purchase up to 555,000 additional
shares of common stock at the same price per share as we and the selling
stockholders will receive for the 3,700,000 shares that the underwriters have
agreed to purchase. To the extent that the underwriters exercise this option,
each of the underwriters will have a firm commitment to purchase approximately
the same percentage of these additional shares that the number of shares of
common stock to be purchased by it shown in the above table represents as a
percentage of the 3,700,000 shares offered hereby. If purchased, these
additional shares will be sold by the underwriters on the same terms as those
on which the 3,700,000 shares are being sold. We and the selling stockholders
will be obligated, pursuant to the option, to sell shares to the extent the
option is exercised. The underwriters may exercise this option only to cover
over-allotments made in connection with the sale of the shares of common stock
offered hereby.
The underwriting agreement contains covenants of indemnity among the
underwriters, us and the selling stockholders against certain civil
liabilities, including liabilities under the Securities Act and liabilities
arising from breaches of representation and warranties contained in the
underwriting agreement.
All of our officers and directors, the selling stockholders and approximately
20 of our other stockholders and optionholders have entered into lock-up
agreements with the underwriters under which they agree not to transfer or
dispose of, directly or indirectly, any shares of our common stock or any
securities convertible into, or exercisable or exchangeable for shares of our
common stock owned by them, for a period of 180 days after the date of this
prospectus. Transfers or dispositions can be made sooner:
. to affiliates of the transferor who sign identical lock-up agreements;
or
. if the transfer is a bona fide gift, to a donee who signs an identical
lock-up agreement.
BancBoston Robertson Stephens may, in its sole discretion and at any time
without notice, release all or any portion of the securities subject to the
lock-up restrictions; however, BancBoston Robertson Stephens currently has no
plans to release any portion of the securities subject to these lock-up
agreements. In addition,
60
<PAGE>
we have agreed that during the 180-day lock-up period we will not, without the
prior written consent of BancBoston Robertson Stephens, (1) consent to the
disposition of any shares held by stockholders subject to lock-up agreements
prior to the expiration of the 180-day lock-up period or (2) issue, sell,
contract to sell, or otherwise dispose of, any shares of common stock, any
options or warrants to purchase any shares of common stock or any securities
convertible into, exercisable for or exchangeable for shares of common stock
other than our sale of shares in this offering, the issuance of common stock
upon the exercise of outstanding options, and our issuance of options and
shares under existing stock option and incentive plans.
The underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
Prior to this offering, there has been no public market for our common stock.
Consequently, the public offering price for the common stock offered by this
prospectus has been determined through negotiations among us, the selling
stockholders and the representatives. Among the factors considered in these
negotiations were prevailing market conditions, certain of our financial
information, market valuations of other companies that we and the
representatives believe to be comparable to our company, estimates of our
business potential, the present state of our development and other factors
deemed relevant.
Thomas Weisel Partners, one of the representatives of the underwriters, was
organized and registered as a broker-dealer in December 1998. Since December
1998, Thomas Weisel Partners has been named as a lead or co-manager on 67 filed
public offerings of equity securities, of which 36 have been completed, and has
acted as a syndicate member in an additional 32 public offerings of equity
securities. Thomas Weisel Partners does not have any material relationship with
us or any of our officers, directors or other controlling persons, except with
respect to its contractual relationship with us pursuant to the underwriting
agreement to be entered into in connection with this offering.
Stabilization. The representatives have advised us that, pursuant to
Regulation M under the Securities Act, certain persons participating in this
offering may engage in transactions, including stabilizing bids, syndicate
covering transactions or the imposition of penalty bids, that may have the
effect of stabilizing or maintaining the market price of the common stock at a
level above that which might otherwise prevail in the open market. A
"stabilizing bid" is a bid for or the purchase of common stock on behalf of the
underwriters for the purpose of fixing or maintaining the price of the common
stock. A "syndicate covering transaction" is the bid for or the purchase of
common stock on behalf of the underwriters to reduce a short position incurred
by the underwriters in connection with this offering. A "penalty bid" is an
arrangement permitting the representatives to reclaim the selling concession
otherwise accruing to an underwriter or syndicate member in connection with
this offering if the common stock originally sold by the underwriter or
syndicate member is purchased by the representatives in a syndicate covering
transaction and has therefore not been effectively placed by the underwriter or
syndicate member. The representatives have advised us that these transactions
may be effected on the Nasdaq National Market or otherwise and, if commenced,
may be discontinued at any time.
61
<PAGE>
LEGAL MATTERS
The validity of the shares offered hereby will be passed upon for us by
Worsham, Forsythe & Wooldridge, L.L.P., Dallas, Texas. Legal matters will be
passed upon for the underwriters by Foley, Hoag & Eliot LLP, Boston,
Massachusetts.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at March 31, 1998 and 1999 and for each of the three years
in the period ended March 31, 1999, as set forth in their report. We have
included financial statements in the prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report, given on
their authority as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the SEC for our
common stock offered hereby. This prospectus does not contain all of the
information set forth in the registration statement. You should refer to the
registration statement and its exhibits for additional information. Whenever we
make reference in this prospectus to any of our contracts, agreements or other
documents, the references are not necessarily complete and you should refer to
the exhibits attached to the registration statement for the copies of the
actual contract, agreement or other document. When we complete this offering,
we will also be required to file annual, quarterly and special reports, proxy
statements and other information with the SEC.
You can read our SEC filings, including the registration statement, over the
Internet at the SEC's Web site at http://www.sec.gov. You may also read and
copy any document we file with the SEC at its public reference facilities at
Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549;
Suite 1400, 500 West Madison Street, Chicago, Illinois 60661 and 7 World Trade
Center, Thirteenth Floor, New York, New York 10048. You may also obtain copies
of the documents at prescribed rates by writing to the Public Reference Section
of the SEC at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on
the operation of the public reference facilities.
We intend to send our stockholders annual reports containing audited
consolidated financial statements and quarterly reports containing unaudited
consolidated financial statements for the first three quarters of each fiscal
year.
62
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................ F-2
Consolidated Balance Sheets as of March 31, 1998 and 1999 and June 30,
1999 (unaudited)........................................................ F-3
Consolidated Statements of Operations for each of the three years in the
period ended March 31, 1999 and the three months ended June 30, 1998 and
1999 (unaudited)........................................................ F-4
Consolidated Statements of Stockholders' Equity (Deficit) for each of the
three years in the period ended March 31, 1999 and the three months
ended June 30, 1999 (unaudited)......................................... F-5
Consolidated Statements of Cash Flows for each of the three years in the
period ended March 31, 1999 and the three months ended June 30, 1998 and
1999 (unaudited)........................................................ F-6
Notes to Consolidated Financial Statements............................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders
NetSolve, Incorporated
We have audited the accompanying consolidated balance sheets of NetSolve,
Incorporated as of March 31, 1998 and 1999, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for
each of the three years in the period ended March 31, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of NetSolve, Incorporated, at March 31, 1998 and 1999, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended March 31, 1999, in conformity with generally accepted
accounting principles.
/s/ Ernst & Young LLP
Austin, Texas
April 29, 1999
F-2
<PAGE>
NETSOLVE, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
Pro Forma
Redeemable
Convertible
Preferred Stock
and
Stockholders'
Equity
March 31, (Deficit) at
------------------ June, 30 June 30,
1998 1999 1999 1999
-------- -------- ----------- ---------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..... $ 1,333 $ 2,764 $ 6,582
Restricted cash............... 155 642 599
Certificates of deposit....... 4,532 2,000 --
Accounts receivable, net of
allowance for doubtful
accounts of $209 at March 31,
1998, $227 at March 31, 1999
and $260 at June 30, 1999 ... 1,602 2,622 3,441
Inventory..................... 616 279 600
Prepaid expenses and other
assets....................... 656 1,267 1,492
Deferred tax assets........... -- -- 1,151
-------- -------- --------
Total current assets........... 8,894 9,574 13,865
Restricted cash................ 1,491 1,638 497
Property and equipment:
Network communications
equipment.................... 77 71 71
Computer equipment and
software..................... 1,882 2,601 3,376
Other equipment............... 305 173 216
Furniture, fixtures and
leasehold improvements....... 730 865 1,113
Equipment held under capital
leases....................... 2,185 3,108 2,716
-------- -------- --------
5,179 6,818 7,492
Less accumulated depreciation
and amortization............. (2,337) (3,571) (3,922)
-------- -------- --------
Net property and equipment..... 2,842 3,247 3,570
Other assets................... -- 477 457
-------- -------- --------
Total assets................... $ 13,227 $ 14,936 $18,389
======== ======== ========
LIABILITIES, REDEEMABLE
CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.............. $ 1,361 $ 1,569 $ 3,243
Accrued liabilities........... 1,543 1,914 1,962
Capital leases obligation..... 591 809 824
-------- -------- --------
Total current liabilities...... 3,495 4,292 6,029
Capital leases obligation, net
of current portion............ 1,146 1,027 763
Redeemable convertible
preferred stock, $.10 par
value; 7,500,000 shares
authorized; 6,394,727 issued
and outstanding at March 31,
1997, March 31, 1998, and June
30, 1999; aggregate
liquidation preferences of
$41,615 at March 31, 1998,
$44,146 at March 31, 1999 and
$44,776 at June 30, 1999; none
issued and outstanding on a
pro forma basis at
June 30, 1999................. 41,615 44,146 44,776 $ --
Stockholders' equity (deficit)
Common stock, $.01 par value;
14,000,000, 25,000,000 and
25,000,000 shares authorized
at March 31, 1998, March 31,
1999 and June 30, 1999,
respectively; 3,265,094,
3,336,444 and 3,483,789
issued and outstanding at
March 31, 1998, March 31,
1999 and June 30, 1999,
respectively; 25,000,000
shares authorized and
9,878,516 shares issued and
outstanding on a pro forma
basis at June 30, 1999....... 33 33 35 99
Additional paid-in capital.... -- -- -- 28,975
Deferred compensation......... -- -- (317) (317)
Accumulated deficit........... (33,062) (34,562) (32,897) (17,160)
-------- -------- -------- --------
Total stockholders' equity
(deficit)..................... (33,029) (34,529) (33,179) $ 11,597
-------- -------- -------- --------
Total liabilities, redeemable
convertible preferred stock
and stockholders' equity
(deficit)..................... $ 13,227 $ 14,936 $ 18,389
======== ======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE>
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Three Months Ended
Year Ended March 31, June 30,
-------------------------------- ---------------------
1997 1998 1999 1998 1999
--------- --------- ---------- --------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Revenues:
Network management
services.............. $ 2,830 $ 7,324 $ 12,777 $ 2,560 $ 4,584
Equipment and other.... 3,486 7,199 13,939 3,002 4,492
--------- --------- ---------- --------- ----------
Total revenues......... 6,316 14,523 26,716 5,562 9,076
Costs of revenues:
Cost of network
management services... 2,434 5,706 8,258 1,808 2,672
Cost of equipment and
other................. 2,638 5,425 10,665 2,321 3,536
--------- --------- ---------- --------- ----------
Total cost of
revenues.............. 5,072 11,131 18,923 4,129 6,208
--------- --------- ---------- --------- ----------
Gross profit............ 1,244 3,392 7,793 1,433 2,868
Operating expenses:
Development............ 1,262 2,040 1,762 446 579
Selling and marketing.. 2,246 2,562 3,153 739 943
General and
administrative........ 1,489 2,159 2,098 541 622
Amortization of
deferred
compensation.......... -- -- -- -- 5
--------- --------- ---------- --------- ----------
Total operating
expenses.............. 4,997 6,761 7,013 1,726 2,149
--------- --------- ---------- --------- ----------
Operating income
(loss)................. (3,753) (3,369) 780 (293) 719
Other income (expense):
Interest income........ 163 470 441 103 83
Interest expense....... (116) (159) (254) (59) (37)
Other, net............. (13) 29 (94) 4 --
--------- --------- ---------- --------- ----------
34 340 93 48 46
--------- --------- ---------- --------- ----------
Income (loss) from
continuing operations
before income taxes.... (3,719) (3,029) 873 (245) 765
Income tax expense
(benefit).............. (1,257) (297) 19 -- (1,136)
--------- --------- ---------- --------- ----------
Net income (loss) from
continuing operations.. (2,462) (2,732) 854 (245) 1,901
Discontinued operations:
Income from
discontinued
operations, net of
applicable income
taxes................. 2,142 165 -- -- --
Gain on sale of
discontinued
operations, net of
applicable income
taxes................. 10,615 341 98 -- --
--------- --------- ---------- --------- ----------
Net income (loss)....... $ 10,295 $ (2,226) $ 952 $ (245) $ 1,901
========= ========= ========== ========= ==========
Dividends on redeemable
convertible preferred
stock.................. $ (2,530) $ (2,530) $ (2,531) $ (630) $ (630)
--------- --------- ---------- --------- ----------
Net income (loss)
applicable to common
stock.................. $ 7,765 $ (4,756) $ (1,579) $ (875) $ 1,271
========= ========= ========== ========= ==========
Basic net income (loss)
per share from:
Continuing operations.. $ (1.75) $ (1.76) $ (0.51) $ (0.27) $ 0.38
Discontinued
operations............ 4.47 0.17 0.03 -- --
--------- --------- ---------- --------- ----------
Net income (loss)...... $ 2.72 $ (1.59) $ (0.48) $ (0.27) $ 0.38
========= ========= ========== ========= ==========
Weighted average shares
used in basic per share
calculation............ 2,850,565 2,995,070 3,297,010 3,280,444 3,360,510
========= ========= ========== ========= ==========
Diluted net income
(loss) per share from:
Continuing operations.. $ (1.75) $ (1.76) $ (0.51) $ (0.27) $ 0.25
Discontinued
operations............ 4.47 0.17 0.03 -- --
--------- --------- ---------- --------- ----------
Net income (loss)...... $ 2.72 $ (1.59) $ (0.48) $ (0.27) $ 0.25
========= ========= ========== ========= ==========
Weighted average shares
used in diluted per
share calculation...... 2,850,565 2,995,070 3,297,010 3,280,444 5,054,952
========= ========= ========== ========= ==========
Pro forma basic net
income per share from:
Continuing operations.. $ 0.09 $ 0.19
Discontinued
operations............ 0.01 --
---------- ----------
Net income ............. $ 0.10 $ 0.19
========== ==========
Pro forma weighted
average shares used in
basic per share
calculation............ 9,691,737 9,755,237
========== ==========
Pro forma diluted net
income per share from:
Continuing operations.. $ 0.07 $ 0.17
Discontinued
operations............ 0.01 --
---------- ----------
Net income ............ $ 0.08 $ 0.17
========== ==========
Pro forma weighted
average shares used in
diluted per share
calculation............ 11,340,578 11,449,679
========== ==========
</TABLE>
See accompanying notes.
F-4
<PAGE>
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share data)
<TABLE>
<CAPTION>
Common Stock Additional Total
---------------- Paid-In Deferred Accumulated Stockholders'
Shares Amount Capital Compensation Deficit Equity (Deficit)
--------- ------ ---------- ------------ ----------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Balance, March 31,
1996................... 2,813,564 $28 $ -- $ -- $(36,132) $(36,104)
Exercise of common
stock options and
warrants............. 96,963 1 25 -- -- 26
Dividends on
redeemable
convertible preferred
stock................ -- -- (25) -- (2,505) (2,530)
Net income............ -- -- -- -- 10,295 10,295
--------- --- ----- ----- -------- --------
Balance, March 31,
1997................... 2,910,527 29 -- -- (28,342) (28,313)
Exercise of common
stock options and
warrants............. 354,567 4 36 -- -- 40
Dividends on
redeemable
convertible preferred
stock................ -- -- (36) -- (2,490) (2,530)
Net loss.............. -- -- -- -- (2,226) (2,226)
--------- --- ----- ----- -------- --------
Balance, March 31,
1998................... 3,265,094 33 -- -- (33,062) (33,029)
Exercise of common
stock options and
warrants............. 71,352 -- 79 -- -- 79
Dividends on
redeemable
convertible preferred
stock................ -- -- (79) -- (2,452) (2,531)
Net income ........... -- -- -- -- 952 952
--------- --- ----- ----- -------- --------
Balance, March 31,
1999................... 3,336,446 33 -- -- (34,562) (34,529)
Exercise of common
stock options and
warrants
(unaudited).......... 147,343 2 72 -- -- 74
Dividends on
redeemable
convertible preferred
stock (unaudited).... -- -- (394) -- (236) (630)
Deferred compensation
(unaudited).......... -- -- 322 (322) -- --
Amortization of
deferred compensation
(unaudited).......... -- -- -- 5 -- 5
Net income
(unaudited).......... -- -- -- -- 1,901 1,901
--------- --- ----- ----- -------- --------
Balance, June 30, 1999
(unaudited)............ 3,483,789 $35 $ -- $(317) $(32,897) $(33,179)
========= === ===== ===== ======== ========
</TABLE>
See accompanying notes.
F-5
<PAGE>
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Three Months
Year ended March 31, Ended June 30,
-------------------------- ----------------
1997 1998 1999 1998 1999
-------- ------- ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net income (loss)............... $ 10,295 $(2,226) $ 952 $ (245) $ 1,901
Adjustments to reconcile net
income (loss) to net cash
provided by (used in) operating
activities:
Depreciation and amortization... 776 863 1,234 305 405
Deferred tax assets............. -- -- -- -- (1,151)
(Gain) loss on disposition of
property and equipment......... 29 (20) (4) (5) 1
Gain on sale of discontinued
operations..................... (10,615) (341) (98) -- --
Change in assets and
liabilities:
Accounts receivable, net....... (1,628) 992 (1,020) (603) (819)
Inventory and prepaid expenses
and other assets.............. (478) (409) (751) (108) (526)
Accounts payable............... 784 (581) 208 399 1,674
Accrued liabilities............ 741 (1,182) 371 269 48
-------- ------- ------- ------- -------
Net cash provided by (used in)
operating activities............ (96) (2,904) 892 12 1,533
Cash flows from investing
activities:
Investments in certificates of
deposit........................ (3,000) (1,532) -- (14) --
Proceeds from sale of
certificates of deposit........ -- -- 2,532 -- 2,000
Transfer of funds from (to)
restricted cash................ -- (1,646) (634) -- 1,184
Purchases of property and
equipment...................... (1,541) (2,236) (1,639) (668) (724)
Proceeds from sale of property
and equipment.................. 231 34 4 6 --
Proceeds from sale of
discontinued operations........ 12,280 -- 98 -- --
-------- ------- ------- ------- -------
Net cash provided by (used in)
investing activities............ 7,970 (5,380) 361 (676) 2,460
-------- ------- ------- ------- -------
Cash flows from financing
activities:
Payments under line of credit... (350) -- -- -- --
Proceeds from capital lease
financing...................... 218 1,706 831 -- --
Payments under capital lease
obligations.................... (514) (257) (732) (155) (249)
Proceeds from exercise of common
stock options and warrants..... 26 40 79 21 74
-------- ------- ------- ------- -------
Net cash provided by (used in)
financing activities............ (620) 1,489 178 (134) (175)
-------- ------- ------- ------- -------
Net increase (decrease) in cash
and cash equivalents............ 7,254 (6,795) 1,431 (798) 3,818
Cash and cash equivalents,
beginning of period............. 874 8,128 1,333 1,333 2,764
-------- ------- ------- ------- -------
Cash and cash equivalents, end of
period.......................... $ 8,128 $ 1,333 $ 2,764 $ 535 $ 6,582
======== ======= ======= ======= =======
Supplemental disclosure of cash
flow information:
Cash paid for interest.......... $ 116 $ 168 $ 242 $ 58 $ 37
======== ======= ======= ======= =======
Income taxes paid............... $ 39 $ 196 $ 24 $ 10 $ 12
======== ======= ======= ======= =======
</TABLE>
See accompanying notes.
F-6
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
Information with respect to the three months ended June 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, and ongoing network management. The Company also resells data
networking equipment manufactured by selected leading suppliers of these
products. The Company's services are designed to allow its clients to
selectively outsource, or "out-task" network specific tasks in order to migrate
to new technology, increase network reliability, and reduce overall network
costs.
The Company also previously provided data transport services to clients.
These services consisted of Private Line and Frame Relay networks (using the
Company's own nationwide network, which utilized network transmission
facilities leased by the Company from major carriers), as well as the resale of
a major carrier's Frame Relay service offering. The data transport services
business segment was discontinued in December 1996 (see Note 3).
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of NetSolve,
Incorporated and its wholly-owned subsidiaries, Specialized Network Services,
Inc. and SNS Credit Corporation. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
Inventory
Inventory consists of purchased finished goods held for sale to customers.
Inventory is stated at the lower of cost or market with cost determined on a
specific identification basis. Inventory reserves were $63,000 at March 31,
1998, $85,000 at March 31, 1999 and $93,000 at June 30, 1999.
Property and Equipment
Property and equipment are recorded at historical cost. Maintenance and
repairs are charged to expense as incurred and betterments which increase the
value or extend the useful life of the equipment are capitalized.
Depreciation is provided using the straight-line method over the estimated
useful lives of the related assets. The Company's assets are currently
depreciated over periods ranging from three to seven years. Leasehold
improvements are amortized over the life of the related lease or assets,
whichever is shorter. Amortization of assets recorded under capital leases is
included in depreciation expense.
In accordance with Statement of Financial Accounting Standards (SFAS) 121,
the Company reviews its long-lived assets for impairment. Based on the results
of a periodic review of equipment for obsolescence the Company recorded a
$77,000 charge to cost of equipment and other revenues in fiscal 1998. This
write-off was related to data networking equipment which had been discontinued
by the Company's suppliers and for which the Company could find no buyers.
Accordingly, this equipment was presumed to have no market value.
F-7
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
Income Taxes
The Company accounts for income taxes in accordance with SFAS 109, Accounting
for Income Taxes. This statement prescribes the use of the liability method
whereby deferred tax asset and liability account balances are determined based
on differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.
Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees ("APB 25") and related interpretations
in accounting for its employee stock options because, as discussed in Note 5,
the alternative fair value accounting provided for under SFAS 123, Accounting
for Stock-Based Compensation, requires use of option valuation models that were
not developed for use in valuing employee stock options. Under APB 25, no
compensation expense has been recognized because all of the Company's options
were granted at prices equal to or in excess of the fair market value of the
underlying stock at the date of grant as determined by the Board of Directors.
Earnings Per Share
The Company's earnings per share data are presented in accordance with SFAS
128, Earnings Per Share. Basic income (loss) per share is computed using the
weighted average number of common shares outstanding. Diluted income (loss) per
share is computed using the weighted average number of common shares
outstanding adjusted for the incremental shares attributed to outstanding
securities with the ability to purchase or convert into common stock. The
treasury stock method, using the average price of the Company's common stock
for the period, is applied to determine dilution from options and warrants. The
if-converted method is used for convertible securities. Potentially dilutive
common stock options and warrants that were excluded from the calculation of
diluted income (loss) per share because their effect is antidilutive totaled
1,317,224, 1,265,861 and 1,648,841 in 1997, 1998 and 1999, respectively, and
1,687,424 for the three months ended June 30, 1998. For 1997, 1998, 1999 and
the three months ended June 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.
F-8
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
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
------------------------
Three months
Three months ended Year ended ended
Year ended March 31, June 30, March 31, June 30,
------------------------------------- --------------------- ----------- ------------
1997 1998 1999 1998 1999 1999 1999
----------- ----------- ----------- --------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Numerator:
Net income (loss) from
continuing
operations............ $(2,462,000) $(2,732,000) $ 854,000 $(245,000) $1,901,000 $ 854,000 $ 1,901,000
Dividends on redeemable
convertible
preferred stock....... (2,530,000) (2,530,000) (2,531,000) (630,000) (630,000) -- --
----------- ----------- ----------- --------- ---------- ----------- -----------
Numerator for basic and
diluted net income
(loss) per share from
continuing
operations............ $(4,992,000) $(5,262,000) $(1,677,000) $(875,000) $1,271,000 $ 854,000 $ 1,901,000
=========== =========== =========== ========= ========== =========== ===========
Denominator:
Denominator for basic
net income (loss) per
share from continuing
operations--weighted
average common stock
outstanding........... 2,850,565 2,995,070 3,297,010 3,280,444 3,360,510 9,691,737 9,755,237
Dilutive common stock
equivalents--common
stock options and
warrants.............. -- -- -- -- 1,694,442 1,648,841 1,694,442
----------- ----------- ----------- --------- ---------- ----------- -----------
Denominator for diluted
net income (loss) per
share from continuing
operations--weighted
average common stock
outstanding and
dilutive common stock
equivalents........... 2,850,565 2,995,070 3,297,010 3,280,444 5,054,952 11,340,578 11,449,679
=========== =========== =========== ========= ========== =========== ===========
</TABLE>
Revenue Recognition
Network management services revenues are recognized in the period services
are provided by NetSolve, whether sold directly or through resellers, based
upon rates established by contract net of any availability credits. The typical
contract terms are from 24 to 36 months and provide for one-time services,
consisting primarily of project implementation services at a fixed fee per
customer site or device, as well as recurring services which are provided at a
fixed monthly fee per customer site or device over the life of the contract.
Revenues for project implementation services are recognized upon completion of
the implementation of the site, and recurring revenues are recognized on a
monthly basis as the services are performed. Equipment revenues are recognized
in the period the equipment is shipped to the customer. Equipment revenues from
assets leased by the Company's lease financing subsidiary are recognized upon
the sale of the equipment and the related lease to a third party lessor on a
non-recourse basis following installation of the equipment. Other revenues,
which consist primarily of equipment maintenance services, are recognized in
the period services are provided. The Company's remote network management
services for WANs typically include a guarantee providing end-to-end network
availability for at least 99.5% of the time in any given month. In the event
the guaranteed availability is not achieved, the Company generally is obligated
to refund its WAN management fees for that month. The Company provides a
reserve based on the estimated costs of these refunds. Historically, guarantee
payments have not been significant.
F-9
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense for
the years ended March 31, 1997 and 1998 and 1999 was approximately $242,000,
$370,000 and $419,000 respectively.
Research and Development
Expenditures for research and development are expensed as incurred.
Cash, Cash Equivalents and Certificates of Deposit
The Company considers all investments purchased with an original maturity of
three months or less to be cash equivalents. Certificates of deposit consist of
investments that mature within one year.
Concentrations of Credit Risk
Financial instruments which potentially expose the Company to concentrations
of credit risk as defined by SFAS 105, Disclosure of Information about
Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments
with Concentrations of Credit Risk, consist primarily of cash and cash
equivalents (including restricted cash), investments and accounts receivable.
The Company places its temporary cash investments with FDIC-insured financial
institutions in accounts which, at times, may exceed federally insured limits.
The Company has not experienced any losses in such accounts. The Company
believes it is not exposed to any significant credit risk on cash and cash
equivalents. The Company performs credit evaluations of its customers'
financial condition when management deems it appropriate and generally requires
no collateral from its customers. Concentrations of credit risk with respect to
accounts receivable are generally limited due to the credit-worthiness of the
customers. Accounts receivable from AT&T represented 47% and 69% of the
outstanding accounts receivable balance at March 31, 1998 and 1999,
respectively.
The following table summarizes the changes in the allowance for doubtful
accounts for 1997, 1998 and 1999 (in thousands):
<TABLE>
<S> <C>
Balance at March 31, 1996............................................. $ 225
Additions charged to costs and expenses............................. 205
Write-off of uncollectible accounts................................. (254)
-----
Balance at March 31, 1997............................................. 176
Additions charged to costs and expenses............................. 80
Write-off of uncollectible accounts................................. (47)
-----
Balance at March 31, 1998............................................. 209
Additions charged to costs and expenses............................. 59
Write-off of uncollectible accounts................................. (41)
-----
Balance at March 31, 1999............................................. $ 227
=====
</TABLE>
Concentrations of Revenues
Revenues from AT&T amounted to 30%, 52%, 59% and 69% of the Company's net
revenues for the years ended March 31, 1997, 1998, 1999 and the three months
ended June 30, 1999, respectively. The Company currently is providing multiple
services to AT&T under a single agreement with separate amendments for each
service. Management believes its relationship with this customer is good and
that the contract and the related amendments, which expire at various dates
from December 1999 to December 2001, will be renewed or replaced. No other
customer accounted for greater than 10% of revenue in fiscal year 1997, 1998,
1999 and the three months ended June 30, 1999.
F-10
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
Comprehensive Income (Loss)
In June 1997, the Financial Accounting Standards Board issued SFAS 130,
Reporting Comprehensive Income. The Company adopted SFAS 130 in the year ended
March 31, 1999. There was no impact to the Company as a result of the adoption
of SFAS 130, as there were no significant differences between net income (loss)
and comprehensive income (loss) for all periods presented.
Segments
In June 1997, the Financial Accounting Standards Board issued SFAS 131,
Disclosures about Segments of an Enterprise and Related Information. The
Company adopted SFAS 131 in the year ended March 31, 1999. The implementation
of this standard had no impact on its financial disclosures as the Company had
no reportable operating segments.
Unaudited Pro Forma Information
The Company's historical capital structure is not indicative of its
prospective structure due to the automatic conversion of all shares of
redeemable convertible preferred stock into common stock concurrent with the
closing of the Company's anticipated initial public offering. Therefore, the
pro forma calculations reflect the conversion of all outstanding shares of
redeemable convertible preferred stock into 6,394,727 shares of common stock
upon the Company's initial public offering using the if-converted method.
Unaudited Interim Results
The accompanying consolidated balance sheet as of June 30, 1999, the
consolidated statements of operations and cash flows for the three months ended
June 30, 1998 and 1999 and the consolidated statements of stockholders' equity
(deficit) for the three months ended June 30, 1999 are unaudited. In the
opinion of management, the statements have been prepared on the same basis as
the audited consolidated financial statements and include all adjustments,
consisting only of normal recurring adjustments, necessary for the fair
statement of the results of the interim periods. Operating results for the
three months ended June 30, 1999 are not necessarily indicative of the results
that may be expected for the year ending March 31, 2000.
Reclassifications
Certain reclassifications have been made to prior period balances to conform
to the current period presentation.
3. Sale of Transport Business Segment
In December 1996, the Company made a decision to discontinue its data
transport services business segment and closed a transaction with Intermedia
Communications Inc. of Florida ("Intermedia") for the sale of a portion of that
segment. The sale to Intermedia was closed on December 30, 1996 at a price of
$12,280,000 of which $2,000,000 was placed in an escrow account. The escrowed
funds were released to the Company in November 1997.
As a part of this transaction, all customer and supplier contracts related to
a portion of the business segment were assigned to Intermedia, and the capital
equipment related to this portion of the business segment was sold to
Intermedia. The agreement for this sale contains a non-compete provision which
prohibits the Company from competing in the data transport business for five
years.
In connection with this sale, the Company agreed to provide management
services to assist Intermedia in supporting the acquired customer base for a
period of 12 months. These services were provided through
F-11
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
October 1997. The Company recorded revenue of $500,000, $715,000, and $0 in
fiscal years 1997, 1998 and 1999, respectively, with respect to these services.
To complete the discontinuance of this business segment, the Company assigned
its rights and obligations to customer contracts for other transport services
resold by the Company, and its obligations under a supplier contract, effective
October 1, 1997 to NetPlus, Inc. The purchase price, which was initially
established at 25% of NetPlus' gross profit from these services (as defined in
the purchase agreement) for a period of three years beginning April 1, 1998 up
to a maximum of $600,000, was renegotiated to $100,000 which was received in
fiscal year 1999. Revenues in fiscal year 1998, prior to the assignment to
NetPlus in October 1997, totaled approximately $1,072,000, and related costs of
providing such services approximated $826,000. Revenues from this business
segment were $13,223,000 and $1,072,000 for the years ended March 31, 1997, and
1998, respectively.
During the fiscal year ended March 31, 1998, upon conclusion of all remaining
activities of this business segment, the Company reversed unused accruals
totaling approximately $557,000 (including $250,000 which was provided to
absorb potential reductions in the purchase price if billings to the sold
customer base fell below levels set forth in the agreement with Intermedia).
4. Redeemable Convertible Preferred Stock
The Company had issued and outstanding shares of redeemable convertible
preferred stock as follows:
<TABLE>
<CAPTION>
March 31, March 31, March 31,
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Series A convertible preferred stock........... 3,944,184 3,944,184 3,944,184
Series B convertible preferred stock........... 2,450,543 2,450,543 2,450,543
</TABLE>
The Series A redeemable convertible preferred stock is redeemable at the
option of the Board of Directors of the Company. The redemption price for each
share of Series A redeemable convertible preferred stock is an amount equal to
the original issue price per share ($4.00), plus $.033 per share for each month
that has passed since the date of issuance (the "Premium"). The Series A
redeemable convertible preferred stock was issued during April through August
1991, resulting in a per share premium of $3.011 to $3.158 at March 31, 1999
and an aggregate redemption price of $28,102,000.
The Series A redeemable convertible preferred stock is convertible into
shares of common stock of the Company at the option of the holder at any time
after the date of issuance and prior to the date of redemption. Generally, the
conversion price will be the lower of the original issue price of the Series A
redeemable convertible preferred stock ($4.00 per share) or the price per share
of any subsequent equity financing which is less than the original issue price
(there have been no such subsequent offerings through March 31, 1999). In
addition, all convertible preferred stock will be automatically converted into
common stock upon a public offering of the Company's common stock which results
in aggregate cash proceeds in excess of $10,000,000 and at an offering price of
at least $6.00 per share. The Company has reserved 3,944,184 shares of common
stock for issuance upon conversion of the Series A redeemable convertible
preferred stock.
In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, holders of all the Series A redeemable
convertible preferred stock shall be entitled to receive an amount per share
equal to the sum of the original issue price plus the Premium prior and in
preference to any distribution of the Company's assets to holders of common
stock. In the event of a consolidation or merger in which the holders of all
series of convertible preferred stock hold less than 51% of the new entity,
such consolidation or
F-12
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
merger shall, at the option of each holder, be deemed to be a liquidation. If
the assets of the Company are insufficient to satisfy the full amount of
liquidation preference, then the Company's assets will be distributed among the
holders of the Series A redeemable convertible preferred stock pari passu with
holders of any other series of redeemable convertible preferred stock.
Holders of Series A redeemable convertible preferred stock are entitled to
annual per share dividends of $0.40 when and as declared by the Company's Board
of Directors. Such dividends are not cumulative. Dividends on redeemable
convertible preferred stock are prior and in preference to any declaration or
payment of any dividend on the Company's common stock. Dividends must be
declared and paid on all series of redeemable convertible preferred stock if
declared or paid on any series of redeemable convertible preferred stock. No
dividends have been declared to date.
The holders of all series of redeemable convertible preferred stock are
entitled to one vote for each share of common stock into which such redeemable
convertible preferred stock could then be converted.
The Series A redeemable convertible preferred stock purchase agreement
contains various covenants, restrictions and provisions, including a
restriction on the payment of dividends on the Company's common stock other
than dividends payable solely in common stock of the Company. In addition, this
agreement restricts the Company's ability to make loans or advances to, or
investments in securities and obligations of, other entities and provides
restrictions as to the repurchase of outstanding shares of capital stock except
pursuant to the terms of any shareholder agreements with employees of the
Company or the redemption of redeemable convertible preferred stock.
The Series B redeemable convertible preferred stock has redemption and
conversion rights, liquidation preferences and voting rights identical to those
of the Series A redeemable convertible preferred stock. Additionally, the
Series B redeemable convertible preferred stock purchase agreement contains
covenants, restrictions and provisions similar to those described above in the
Series A redeemable convertible preferred stock purchase agreement. The Series
B redeemable convertible preferred stock has a per share premium of $2.382 to
$2.551 at March 31, 1999 and an aggregate redemption price of $16,044,000. The
Company has reserved 2,450,543 shares of common stock for issuance upon
conversion of the Series B redeemable convertible preferred stock.
5. Stockholders' Equity (Deficit)
Stockholder Repurchase Rights
The Company has entered into stockholder agreements with certain
stockholders, and with all employees and consultants who have received grants
of options pursuant to the Company's stock option plans. These agreements
generally grant the Company certain repurchase rights with respect to common
stock purchased by the stockholders. The percentage of shares subject to
repurchase generally decreases by 25% on the first anniversary of the granting
of a stock option and quarterly (at 6.25% per quarter) thereafter. The
Company's repurchase rights are exercisable upon termination of employment of
the employee or consultant. The agreements also provide the Company a right of
first refusal on the sale of any shares issued pursuant to the agreements. At
March 31, 1999, total outstanding options subject to repurchase rights were
942,638.
Stock Option Plans
In November 1988, the Company adopted a stock option plan providing for the
granting of options to purchase shares of the Company's common stock to key
employees, directors, officers and consultants as designated by the Company's
Board of Directors. As of March 31, 1999, an aggregate of 2,601,976 shares was
F-13
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
approved for issuance under the Plan. The Plan provides for the issuance of
both Incentive Stock Options ("ISOs") as well as options not qualifying as ISOs
within the meaning of the Internal Revenue Code of 1986, as amended. Under the
terms of the Plan, the option price per share of ISOs may not be less than 100%
of the fair market value of the Company's common stock per share at date of
grant. Options may not be granted with a term exceeding 10 years and are
immediately exercisable. Shares acquired pursuant to the exercise of options
are subject to certain vesting and repurchase requirements as set forth above.
In July 1997, the Company adopted a long-term incentive compensation plan.
This plan is a comprehensive, stock-based incentive compensation plan,
providing for discretionary awards of incentive stock options within the
meaning of the Internal Revenue Code of 1986, as amended, nonqualified stock
options, stock appreciation rights, restricted stock, restricted stock units,
performance shares, performance units, bonus stock and other stock-based
awards. All awards will be made in, or based on the value of, the Company's
common stock. The plan will be administered by the Compensation Committee of
the Company's Board of Directors, which consists entirely of outside directors.
Regular, full-time employees of the Company, as well as directors of, and
consultants to, the Company will be eligible to participate in, and receive
awards under the plan. The maximum number of shares of common stock for which
awards may be granted under the plan is 1,350,000. The price payable upon
exercise of an option which is intended to constitute an incentive stock option
may not be less than 100% of the fair market value of the common stock at the
time of grant.
The Company has also granted non-qualified options other than pursuant to the
above plans. Options granted totaled 3,250 shares representing grants to two
outside directors at exercise prices of $.80 and $1.20 per share. During fiscal
1999, 1,250 of these options were exercised.
At March 31, 1999 the Company had reserved 3,148,723 shares of common stock
for issuance upon exercise of all options.
Statement of Financial Accounting Standards No. 123
Pro forma information regarding net income (loss) is required by SFAS 123,
and has been determined as if the Company had accounted for its stock options
under the fair value method of that Statement. The fair value for options
granted prior to the Company's initial filing on Form S-1 dated October 15,
1998 was estimated as of the date of grant using a minimum value option pricing
model with weighted-average risk free interest rates for 1997, 1998 and 1999 of
6.45%, 5.69% and 5.56%, respectively; no dividends; and a weighted-average
expected life of the option of five years. The fair value for options granted
subsequent to the initial filing date was estimated as of the date of grant
using the Black-Scholes pricing model and a volatility of 40%.
The minimum value option valuation model with a near zero volatility results
in an option value similar to the option value that would result from using the
Black-Scholes option valuation model with a near zero volatility. The Black-
Scholes option valuation model was developed for use in estimating the fair
value of traded options which have no vesting restrictions and which are fully
transferable. In addition, option valuation models in general require the input
of highly subjective assumptions, including the expected stock price
volatility. Because the Company's stock options have characteristics
significantly different than those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value estimate,
in management's opinion the existing models do not necessarily provide a
reliable single measure of the fair value of its stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The impact on
the pro forma results which follow may not be representative of compensation
expense in future periods when the effect of the amortization of multiple
awards may be reflected
F-14
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
in the amounts. The Company's pro forma net loss from continuing operations
(net of income taxes) and pro forma basic and diluted net loss per share
follows:
<TABLE>
<CAPTION>
Year ended March 31,
----------------------------------
1997 1998 1999
----------- ----------- --------
<S> <C> <C> <C>
Pro forma net income (loss) from
continuing operations................. $(2,501,000) $(2,779,000) $679,000
Pro forma basic and diluted net income
(loss) per share...................... $ (1.75) $ (1.76) $ (0.56)
</TABLE>
A summary of the Company's stock option activity under the Plan(s) and
related information follows (since options under the Plan(s) are immediately
exercisable, outstanding exercisable options at the end of the period are shown
both in total and for vested amounts which would not be subject to repurchase
if exercised):
<TABLE>
<CAPTION>
March 31, 1997 March 31, 1998 March 31, 1999 June 30, 1999
-------------------- -------------------- -------------------- --------------------
Weighted- Weighted- Weighted- Weighted-
Average Average Average Average
Exercise Exercise Exercise Exercise
Options Price Options Price Options Price Options Price
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding--beginning
of period.............. 1,745,087 $0.35 2,005,859 $0.81 2,007,647 $3.03 2,438,939 $2.50
Granted................ 582,500 $2.10 388,844 $2.57 618,176 $7.23 321,960 $9.00
Exercised.............. (96,963) $0.27 (124,633) $0.30 (70,102) $1.10 (145,343) $0.50
Canceled............... (224,765) $0.82 (262,423) $1.96 (116,782) $3.11 (31,145) $5.08
--------- ----- --------- ----- --------- ----- --------- -----
Outstanding and
exercisable--end of
period--total.......... 2,005,859 $0.81 2,007,647 $1.03 2,438,939 $2.50 2,584,411 $3.39
========= ===== ========= ===== ========= ===== ========= =====
Outstanding and
exercisable--end of
period--vested......... 1,188,793 $0.27 1,464,123 $0.53 1,498,301 $0.63 1,417,340 $0.72
========= ===== ========= ===== ========= ===== ========= =====
Weighted-average fair
value of options
granted during the
period................. $0.52 $0.64 $2.02 $4.71
</TABLE>
Exercise prices for options outstanding are as follows:
<TABLE>
<CAPTION>
March 31, 1999 June 30, 1999
------------------------------- -------------------------------
Weighted- Weighted-
Weighted- Average Weighted- Average
Average Remaining Average Remaining
Exercise Exercise Contractual Exercise Contractual
Price Range Options Price Life Options Price Life
- ----------- --------- --------- ----------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
$0.20-$0.30 1,070,637 $0.20 4.2 949,637 $0.20 4.0
$0.40-$0.50 73,075 $0.40 2.3 72,200 $0.40 2.0
$0.80-$1.20 95,350 $1.20 5.9 93,100 $1.20 5.7
$1.70-$2.10 371,281 $2.10 7.5 343,813 $2.10 7.3
$2.30-$2.80 284,960 $2.76 8.8 275,225 $2.76 8.6
$7.50-$8.50 543,636 $7.68 9.4 528,476 $7.67 9.1
$9.00 -- -- -- 321,960 $9.00 9.9
- ----------- --------- ----- --------- -----
$0.20-$9.00 2,438,939 $2.50 2,584,411 $3.39
=========== ========= ===== ========= =====
</TABLE>
Warrants
The Company issued warrants at various dates between 1991 and 1993 to
purchase up to 88,750 shares of Series A and Series B redeemable convertible
preferred stock in connection with certain equipment financing
F-15
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
leases. These warrants are exercisable at a price of $4.00 per share and 60,000
expired in the three months ended June 30, 1999 with the remaining expiring in
1999 and 2001. In 1993, additional warrants to purchase up to 28,750 shares of
common stock at an exercise price of $.01 per share were issued under the anti-
dilution provisions of the warrants for Series A and B redeemable convertible
preferred stock and expire in 2001. In 1993, the Company issued a warrant to a
bank to purchase up to 25,000 shares of Series B redeemable convertible
preferred stock at an exercise price of $4.00 per share and a warrant to
purchase up to 25,000 shares of common stock at an exercise price of $.01 per
share. The warrants issued to the bank expire in 2000. These warrants were
accounted for at the fair value of the warrants on the date of issuance.
6. Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred taxes are as follows:
<TABLE>
<CAPTION>
March 31, March 31, June 30,
1998 1999 1999
----------- ----------- -----------
(unaudited)
<S> <C> <C> <C>
Deferred tax assets:
Tax carryforwards................... $ 6,923,000 $ 6,544,000 $ 6,241,000
Depreciable assets.................. 159,000 130,000 126,000
Accruals, reserves and other........ 365,000 421,000 435,000
----------- ----------- -----------
Gross deferred tax assets............. 7,447,000 7,095,000 6,802,000
Valuation allowance................... (7,447,000) (7,095,000) (5,651,000)
----------- ----------- -----------
Net deferred taxes.................... $ -- $ -- $ 1,151,000
=========== =========== ===========
</TABLE>
The valuation allowance increased by approximately $813,000 during the year
ended March 31, 1998. The valuation allowance decreased by approximately
$352,000 during the year ended March 31, 1999 primarily as a result of
utilization of net operating losses which were not previously benefited. During
the period ended June 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 $1,151,000 to
reflect this change in judgment. Additionally, the valuation allowance was
reduced by $293,000 during the period ended June 30, 1999 due to the
utilization of operating losses which were not previously benefited.
As of March 31, 1999 and June 30, 1999, the Company had federal net operating
loss carryforwards of approximately $17,157,000 and $16,360,000, respectively
which will expire beginning in 2004, if not utilized. The Company had
alternative minimum tax credit carryforwards of $196,000 and $212,000 as of
March 31, 1999 and June 30, 1999, respectively,which do not expire. Utilization
of the net operating losses and credit carryforwards may be subject to a
substantial annual limitation due to the "change in ownership" provisions of
the Internal Revenue Code of 1986. The annual limitation may result in the
expiration of net operating losses before utilization.
Significant components of the expense (benefit) for income taxes attributable
to continuing operations are as follows:
<TABLE>
<CAPTION>
Three months ended
Year ended March 31, June 30,
------------------------------- ------------------
1997 1998 1999 1999
----------- --------- ------- ------------------
(unaudited)
<S> <C> <C> <C> <C>
Current................... $(1,257,000) $ -- $19,000 $ 15,000
Deferred.................. -- (297,000) -- (1,151,000)
----------- --------- ------- -----------
$(1,257,000) $(297,000) $19,000 $(1,136,000)
=========== ========= ======= ===========
</TABLE>
F-16
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
Income tax expense (benefit) is included in the financial statements as
follows:
<TABLE>
<CAPTION>
Three months ended
Year ended March 31, June 30,
------------------------------- ------------------
1997 1998 1999 1999
----------- --------- ------- ------------------
(unaudited)
<S> <C> <C> <C> <C>
Continuing operations... $(1,257,000) $(297,000) $19,000 $(1,136,000)
Income from discontinued
operations............. 366,000 97,000 2,000 --
Gain on sale of
discontinued
operations............. 1,161,000 200,000 -- --
----------- --------- ------- -----------
$ 270,000 $ -- $21,000 $(1,136,000)
=========== ========= ======= ===========
</TABLE>
The tax benefit attributed to continuing operations in the years ended March
31, 1997 and 1998 results from the application of SFAS 109 to the sale of
discontinued operations (see Note 3). It is not expected that similar tax
benefits will be available to reduce future losses, if any.
The Company's expense (benefit) for income taxes attributable to continuing
operations differs from the expected tax benefit amount computed by applying
the statutory federal income tax rate of 34% to income before income taxes as a
result of the following:
<TABLE>
<CAPTION>
Three months ended
Year ended March 31, June 30,
------------------------ ------------------
1997 1998 1999 1999
------ ------ ------ ------------------
(unaudited)
<S> <C> <C> <C> <C>
Federal statutory rate....... (34.0)% (34.0)% 34.0 % 34.0 %
Operating losses not
benefitted.................. -- 26.8 -- --
Reduction in valuation
allowance................... -- -- (36.7) (187.3)
Permanent items and other.... 0.2 (2.6) 4.9 4.8
------ ------ ------ ------
Total expense (benefit)...... (33.8)% (9.8)% 2.2 % (148.5)%
====== ====== ====== ======
</TABLE>
7. Defined Contribution Plan
Effective December 1, 1988, the Company adopted a 401(k) plan for all full-
time employees who have reached age 21 and completed certain service
requirements. Employer contributions may be made by the Company at the
discretion of the Board of Directors. No such employer contributions have been
made to date.
8. Commitments and Contingencies
The Company leases equipment and office space under noncancelable operating
leases. Future minimum lease payments under these leases as of March 31, 1999,
are as follows:
<TABLE>
<CAPTION>
Year ended March 31,
--------------------
<S> <C>
2000........................................................... $1,532,000
2001........................................................... 1,500,000
2002........................................................... 1,581,000
2003........................................................... 1,576,000
2004........................................................... 1,048,000
----------
Total minimum lease payments..................................... $7,237,000
==========
</TABLE>
F-17
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
June 30, 1999
9. Capital Leases
The Company leases various computer, networking and other equipment under
capital lease arrangements. The following is a schedule by years of future
minimum lease payments under these capital leases together with the present
value of the net minimum lease payments as of March 31, 1999.
<TABLE>
<CAPTION>
Year ended March 31,
--------------------
<S> <C>
2000........................................................... $1,112,000
2001........................................................... 586,000
2002........................................................... 337,000
----------
Total minimum lease payments..................................... 2,035,000
Less amount representing interest................................ (199,000)
----------
Present value of net minimum lease payments...................... 1,836,000
----------
Less current portion............................................. (809,000)
----------
Non-current obligation........................................... $1,027,000
==========
</TABLE>
10. Restricted Cash
At March 31, 1999, the Company had purchased irrevocable letters of credit
totaling $1,280,000 in favor of a lessor under a capital lease for equipment
representing seventy-five percent (75%) of the amount financed. These letters
of credit decline annually by 25%-33% of the original amount as long as no
event of default has occurred. These letters of credit are collateralized by
certificates of deposit.
Under the lease agreement covering the Company's headquarters facility, the
Company was required to purchase a $1,000,000 irrevocable letter of credit. At
March 31, 1999, a certificate of deposit in the amount of $1,000,000 was
classified as restricted cash to be used as collateral for the potential
issuance of this letter of credit. The requirement for the letter of credit
extended through the earlier of the expiration of the lease (November 2003) or
four consecutive quarters of profitability. As of June 30, 1999, the
requirement of the letter of credit was removed as a result of the Company
attaining the fourth consecutive quarter of profitability in the three months
ended June 30, 1999.
F-18
<PAGE>
[The inside back cover contains the following:]
[1. The following text appears at the top of the page:]
NetSolve Customer Locations
[2. A map of the continental United States appears in the middle of the page.
Dots on the map illustrate locations of NetSolve's end users.]
[3. The following text appears below the map:]
Managing Hundreds of Networks Throughout the United States
From our central network management center in Austin, Texas, we manage over
9,500 network sites for more than 600 companies. Customers are
headquartered across the United States, with network locations throughout
North America as well as overseas.
Our customers are in a broad range of industries, including manufacturing,
distribution, and financial services. We distribute our services through
resellers such as carriers, Internet service providers and value-added
resellers, as well as directly to end users.
[4. The NetSolve name and logo appear in the bottom right hand corner of the
page]
<PAGE>
[LOGO OF NETSOLVE APPEARS HERE]
