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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended March 31, 2000
or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 0-24983
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NETSOLVE, INCORPORATED
(Exact Name of Registrant as Specified in its Charter)
Delaware 75-2094811-2
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
12331 Riata Trace Parkway
Austin, Texas 78727
(Address of principal executive offices, including zip code)
(512) 340-3000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
Par Value Per Share
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K, or any
amendment to this Form 10-K [_].
On May 10, 2000, the aggregate market value of the voting stock held by non-
affiliates of the registrant was $180,076,104 (affiliates being, for these
purposes only, directors, executive officers and holders of more than 5% of
Registrant's Common Stock). On May 10, 2000, there were 14,464,376 outstanding
shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement pursuant to
Regulation 14A for the registrant's 2000 Annual Meeting of Stockholders to be
held on July 11, 2000, which will be filed with the Commission on or about May
23, 2000, are incorporated by reference into Part III of this report.
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NETSOLVE, INCORPORATED
INDEX
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Page
Part I ----
<C> <S> <C>
Item 1. Business...................................................... 3
Item 2. Facilities.................................................... 12
Item 3. Litigation.................................................... 12
Item 4. Submission of Matters to a Vote of Security Holders........... 12
Executive Officers of the Registrant.......................... 13
Part II
Market for the Registrant's Common Equity and Related
Item 5. Stockholder Matters........................................... 14
Item 6. Selected Financial Data....................................... 16
Management's Discussion and Analysis of Financial Condition
Item 7. and Results of Operations..................................... 18
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.... 30
Item 8. Financial Statements and Supplementary Data................... 31
Changes in and Disagreements with Accountants on Accounting
Item 9. and Financial Disclosure...................................... 48
Part III
Item 10. Directors and Executive Officers of the Registrant............ 48
Item 11. Executive Compensation........................................ 48
Security Ownership of Certain Beneficial Owners and
Item 12. Management.................................................... 48
Item 13. Certain Relationships and Related Transactions................ 48
Part IV
Exhibits, Financial Statement Schedules, and Reports on Form
Item 14. 8-K........................................................... 48
</TABLE>
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PART I
Item 1. BUSINESS
We offer a range of network management and security services that allow
companies to outsource some or all 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
1,000 end users representing approximately 20,000 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 and NEC.
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
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hardware. Implementation and management of new hardware and software
technologies typically require 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 1,000 middle market end users that maintain approximately
20,000 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, we
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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 $500 million, 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, Sprint, various regional
bell operating companies and competitive local exchange carriers in the data
transport arena, and Bay/Nortel, Cisco and Visual Networks 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.
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
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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.
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, network equipment or consulting
and integration services. We believe that we can expand our current
distribution relationships to include other major carriers, equipment
manufacturers, and high-end tool providers. In addition, e-commerce service
providers such as Application Service Providers, or ASP's, competitive local
exchange carriers, or CLECs, and Internet service providers, or ISPs can also
provide established distribution or sales referral partnerships. 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 in the following table. 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:
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Life
cycle
activity Our services
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<S> <C>
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
Document Install and configure new software and equipment as appropriate
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>
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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.
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--ProWatch Secure
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. These security services include 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.
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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.
Equipment and other services
We resell customer premise equipment from leading network equipment
manufacturers or their resellers. This equipment typically includes routers,
CSUs and LAN switches and is obtained from Cisco and, to a lesser extent, from
Bay/Nortel, Paradyne and others. Sales of this equipment are made only to our
network management services customers in conjunction with the sale of our
services. This equipment constitutes the primary components of the end-user
networks we manage. Customers who purchase this equipment from us rather than
from other sources typically do so for the convenience of a single supplier
solution.
We also resell on-site maintenance services, primarily to customers who have
purchased the associated equipment from us. These services address issues
associated with hardware failures and software bugs, as well as software
upgrades provided for under the equipment provider's maintenance contract.
These maintenance services are provided by 3Com or successors, Bay/Nortel,
Cisco and Milgo Solutions.
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 $500 million. We
currently have over 1,000 end users and maintain approximately 20,000 managed
sites. Our end users consist of our direct customers as well as customers of
our resellers.
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 Communications.
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 52% of our total revenues in
fiscal year 1998, 59% of our total revenues in fiscal year 1999, and 71% of
our total revenues in fiscal year 2000.
Relationship with AT&T
We have entered into reseller agreements with two separate organizations
within AT&T: AT&T Solutions and AT&T Data and Internet Services. Both of these
organizations 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
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for the resale of our services to AT&T customers directly from AT&T. AT&T
accounted for 52% of our total revenues in fiscal year 1998, 59% of our total
revenues in fiscal year 1999 and 71% of our total revenues in fiscal year
2000.
The reseller agreements with AT&T have separate terms for each of the two
organizations. 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 10% 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 Data and Internet Services relate
primarily to AT&T's Frame Relay 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.
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 2000, 22% 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
Communications. All sales of our services to date have been made in the U.S.
However, we remotely manage locations in 42 countries around the world for
these U.S.-based customers.
At March 31, 2000, we employed 15 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 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 March 31, 2000, we employed 8 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 services.
Software and services development
Our software and services development groups consisted of 21 people as of
March 31, 2000. One objective of our software development group is to develop
or integrate the tools we utilize to manage networks and to develop software
applications, such as ProWatch Exchange, which become components of our
services. While
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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. The objective of our services
development group is to research new technologies and develop service
offerings, including early operations processes, that address the needs of our
target customers with respect to these technologies.
Operations
Our operations organization, comprised of 148 individuals as of March 31,
2000, 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. We currently plan to
begin operation of a second management facility in April 2001.
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.
10
<PAGE>
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,
scalable management tools, reliability and quality of service, large scale,
the ability to maintain and expand distribution channels, price, the timing of
introductions of new services, and conformity with industry standards. While
we believe that we currently are able to provide end users with reliable
network management and security services at prices that allow us to compete
favorably with respect to other service providers, there can be no assurance
that we will have the resources or expertise to compete successfully in the
future.
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 patents with
the United States Patent Office. These patents relate to software technology
which allows us to poll, or communicate with, large numbers of routers or
other SNMP devices over multiple WANs. We intend to continue to evaluate the
appropriateness of these protections and to seek patent additional protection
for our inventions when appropriate. There can be no assurance that additional
patents will be issued from our currently pending or any future applications,
or that any patents that may be issued will be sufficient in scope or strength
to provide meaningful protection or any commercial advantage to us. We have
registered 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.
11
<PAGE>
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 March 31, 2000, we had 208 full-time employees, including 23 in sales
and marketing, 21 in development, 148 in operations and 16 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.
Item 2. 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 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 this facility expires in November 2008,
including a five-year option to renew.
We are currently negotiating a lease agreement for an additional facility in
Austin, Texas covering approximately 80,000 square feet. This lease will
commence in April 2001 and will expire in March 2007. We believe these
facilities will be adequate to meet our foreseeable requirements or that
suitable additional or substitute space will be available on commercially
reasonable terms.
Item 3. LITIGATION
We are not currently a party to any material legal proceedings.
Item 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the three
months ended March 31, 2000.
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<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT
The following information is provided with respect to each executive officer
of the registrant as of April 30, 2000, pursuant to General Instruction G of
Form 10-K:
<TABLE>
<CAPTION>
Name Age Position(s)
---- --- -----------
<C> <C> <S>
Craig S. Tysdal........ 53 Director; president and chief executive officer
Vice president--finance, chief financial officer
Kenneth C. Kieley...... 49 and secretary
Christopher D. Buffum.. 50 Vice president--sales
Terrence S. Cheng...... 43 Vice president--software development
Robert C. Pojman....... 36 Vice president--operations
Harry S. Budow......... 37 Vice president--marketing
</TABLE>
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 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.
13
<PAGE>
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market information
Our common stock trades on the Nasdaq National Market under the symbol
"NTSL." The following table sets forth the high and low per share sales prices
of our common stock for each of the last three quarters in the period ended
March 31, 2000, as reported by the Nasdaq National Market System.
<TABLE>
<CAPTION>
Price Per
Share
-------------
Three Months Ended High Low
------------------ ------ ------
<S> <C> <C>
September 30, 1999............................................. $37.00 $17.19
December 31, 1999.............................................. 35.88 16.25
March 31, 2000................................................. 61.50 27.81
</TABLE>
Prior to September 29, 1999, a public market did not exist for our common
stock. Therefore, market information does not exist for the three months ended
June 30, 1999 and the information provided for the three months ended
September 30, 1999 reflects the high and low prices per share over the two
days of trading during that period.
Holders of our common stock
At the close of business on May 10, 2000, there were approximately 122
holders of record of our common stock and approximately 3,500 shareholders of
beneficial interest.
Dividends
We have not paid any dividends on our common stock and do not intend to pay
any dividends in the foreseeable future.
Recent Sales of Unregistered Securities
Between April 1, 1999 and January 11, 2000, we granted options to purchase
our common stock to our employees under the Long-Term Incentive Compensation
Plan as follows:
<TABLE>
<CAPTION>
Number Weighted Average
Number of Shares Exercise Price
Date of of Option Subject to of
Grant Grantees Options Options Granted
------- --------- ---------- ----------------
<S> <C> <C> <C>
4/13/99................................ 31 160,540 $ 9.00
6/21/99................................ 33 161,420 9.00
7/29/99................................ 17 31,604 13.00
10/21/99............................... 63 186,766 19.13
</TABLE>
Securities under the Long-Term Incentive Compensation Plan were registered
with the Securities and Exchange Commission on a Form S-8 Registration
Statement under the Securities Act of 1933 (File No. 333-94401) which became
effective on January 11, 2000.
Use of Proceeds
The Company's registration statement on Form S-1 (File No. 333-65691) was
declared effective on September 28, 1999. An offering of the Company's common
stock was commenced on September 29, 1999. The
14
<PAGE>
offering, for which BancBoston Robertson Stephens Inc. and Thomas Weisel
Partners LLC served as managing underwriters, terminated following the sale of
all of the shares offered. Gross proceeds of the offering were received by the
Company on October 4, 1999 and October 28, 1999 totaling $53.1 million.
Offering costs totaling $1,304,752 and underwriter discounts totaling
$3,717,350 were paid through December 31, 1999. There have been no other
expenses or costs paid during the three months ended March 31, 2000.
The remainder of the proceeds of this offering, $48.1 million, are
temporarily invested in short-term, investment-grade, interest bearing
securities pending their use for other purposes.
15
<PAGE>
Item 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read together
with "Management's Discussion and Analysis of Financial Condition and Results
of Operation" and the consolidated financial statements and related notes
appearing elsewhere in this document. The following selected consolidated
financial data for fiscal years 1998, 1999 and 2000 and as of March 31, 1999
and 2000 are derived from our consolidated financial statements included
elsewhere in this document, which have been audited by Ernst & Young LLP,
independent auditors. The following selected consolidated financial data for
fiscal years 1996 and 1997 and as of March 31, 1996, 1997 and 1998 are derived
from our audited consolidated financial statements not included in this
document.
<TABLE>
<CAPTION>
Year Ended March 31,
------------------------------------------
1996 1997 1998 1999 2000
------ ------- ------- ------- -------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of operations data:
Revenues:
Network management services...... $ 782 $ 2,830 $ 7,324 $12,777 $24,048
Equipment and other.............. 2,888 3,486 7,199 13,939 14,613
------ ------- ------- ------- -------
Total revenues................. 3,670 6,316 14,523 26,716 38,661
Cost of revenues:
Cost of network management
services........................ 548 2,434 5,706 8,258 13,095
Cost of equipment and other...... 1,998 2,638 5,425 10,665 11,202
------ ------- ------- ------- -------
Total cost of revenues......... 2,546 5,072 11,131 18,923 24,297
------ ------- ------- ------- -------
Gross Profit...................... 1,124 1,244 3,392 7,793 14,364
Operating expenses:
Development...................... 1,132 1,262 2,040 1,762 2,503
Sales and marketing.............. 732 2,246 2,562 3,153 4,486
General and administrative....... 1,353 1,489 2,159 2,098 3,095
Amortization of deferred
compensation.................... -- -- -- -- 65
------ ------- ------- ------- -------
Total operating expenses....... 3,217 4,997 6,761 7,013 10,149
------ ------- ------- ------- -------
Operating income (loss)........... (2,093) (3,753) (3,369) 780 4,215
Other income (expense), net....... (110) 34 340 93 1,463
------ ------- ------- ------- -------
Income (loss) from continuing
operations before income taxes... (2,203) (3,719) (3,029) 873 5,678
Income tax expense (benefit)...... (618) (1,257) (297) 19 (4,875)
------ ------- ------- ------- -------
Net income (loss) from continuing
operations....................... (1,585) (2,462) (2,732) 854 10,553
Discontinued operations:
Income from discontinued
operations, net of applicable
income taxes.................... 2,041 2,142 165 -- --
Gain on sale of discontinued
operations, net of applicable
income taxes.................... -- 10,615 341 98 --
------ ------- ------- ------- -------
Net income (loss)................. $ 456 $10,295 $(2,226) $ 952 $10,553
====== ======= ======= ======= =======
Basic income (loss) per share
from(1):
Continuing operations............ $(2.22) $ (1.75) $ (1.76) $ (0.51) $ 1.06
====== ======= ======= ======= =======
Net income (loss)................ $(1.12) $ 2.72 $ (1.59) $ (0.48) $ 1.06
====== ======= ======= ======= =======
Weighted average shares used in
basic per share calculations(1).. 1,860 2,851 2,995 3,297 8,800
====== ======= ======= ======= =======
Diluted income (loss) per share
from(1):
Continuing operations............ $(2.22) $ (1.75) $ (1.76) $ (0.51) $ 0.68
====== ======= ======= ======= =======
Net income (loss)................ $(1.12) $ 2.72 $ (1.59) $ (0.48) $ 0.68
====== ======= ======= ======= =======
Weighted average shares used in
diluted per share
calculations(1).................. 1,860 2,851 2,995 3,297 13,648
====== ======= ======= ======= =======
Pro forma basic income per share
from(2):
Continuing operations............ $ 0.09 $ 0.88
======= =======
Net income....................... $ 0.10 $ 0.88
======= =======
Pro forma weighted average shares
used in basic per share
calculations(2).................. 9,692 11,963
======= =======
Pro forma diluted income per share
from(2):
Continuing operations............ $ 0.07 $ 0.77
======= =======
Net income....................... $ 0.08 $ 0.77
======= =======
Pro forma weighted average shares
used in diluted per share
calculations(2).................. 11,341 13,648
======= =======
</TABLE>
16
<PAGE>
- --------
(1) Calculated as described in note 2 of notes to consolidated financial
statements. Additional per share information is disclosed on the
consolidated statements of operations in the consolidated financial
statements included elsewhere in this document.
(2) Reflects the conversion of our redeemable convertible preferred stock into
common stock. See note 4 of notes to consolidated financial statements.
<TABLE>
<CAPTION>
March 31,
-----------------------------------------------
1996 1997 1998 1999 2000
-------- -------- -------- -------- -------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance sheet data:
Cash and cash equivalents..... $ 874 $ 8,128 $ 1,333 $ 2,764 $57,185
Working capital (deficit)..... (623) 9,464 5,399 5,282 63,329
Total assets.................. 3,534 16,068 13,227 14,936 74,519
Capital lease obligations, net
of current portion........... 235 175 1,146 1,027 324
Redeemable convertible pre-
ferred stock................. 36,555 39,085 41,615 44,146 --
Total stockholders' equity
(deficit).................... (36,104) (28,313) (33,029) (34,529) 68,958
</TABLE>
17
<PAGE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-looking Statements
This report and other presentations made by us contain "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act
of 1934, as amended. Such statements involve known and unknown risks,
uncertainties and other factors that could cause our actual results to differ
materially from the results expressed or implied by such statements, including
general economic and business conditions, conditions affecting the industries
served by us, conditions affecting our customers and suppliers, competition,
the overall market acceptance of the Company's services, and other factors
disclosed in our final prospectus dated September 29, 1999 and this report.
Accordingly, although we believe that the expectations reflected in such
forward-looking statements are reasonable, there can be no assurance that such
expectations will prove to be correct.
Any forward-looking statement speaks only as of the date on which such
statement was made, and we do not undertake any obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement was made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time and it is not possible for us to
predict all of such factors, nor can we assess the impact of each such factor
or the extent to which any factor, or combination of factors, may cause
results to differ materially from those contained in any forward-looking
statement.
Overview
We provide network management services that allow enterprises and carriers
to outsource some or all network-specific activities in order to increase
network reliability and 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. For fiscal year 2000, approximately 58% 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.
18
<PAGE>
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
1998, 1999 and 2000. We recognize revenues from cancellation fees on a cash
basis unless collection is assured. Our contracts with resellers typically
extend from 12 to 36 months and, in some cases, require that we continue
providing services throughout the term of the reseller's contract with the end
user. In these cases, we continue to recognize revenues upon performance of
the services, even if performance occurs after the term of the contract with
the reseller.
Our network management services for WANs typically include a guarantee
providing end-to-end network availability for at least 99.5% of the time in
any given month. In the event the guaranteed availability is not achieved, we
generally are obligated to refund our WAN management fees for that month. This
guarantee covers some components of the end user's WAN, such as the transport
services provided by the end user's carrier, that are not directly under our
control. As a result, we may, in some instances, refund amounts to customers
for circumstances beyond our control. We establish a reserve against
guarantees we offer. Historically, guarantee payments have not been material
in relation to network management services. However, in the future, refunds
made under our guarantees or otherwise could have a material adverse impact on
the results of our operations.
We derive 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, Visual Networks, 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 amended some of our
reseller agreements in fiscal year 2000 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
slightly as we seek to manage our mix of revenues.
We currently have a network management services contract with two
organizations within AT&T: AT&T Solutions and AT&T Data and Internet Services.
AT&T accounted for 52% of our total revenues in fiscal year 1998, 59% of our
total revenues in fiscal year 1999 and 71% of our total revenues in fiscal
year 2000. We anticipate that sales to AT&T will continue to comprise a
substantial percentage of our revenues into fiscal year 2001 and it is
possible that this percentage could increase. No other customer accounted for
more than 10% of our revenues in fiscal years 1998, 1999 or in fiscal year
2000.
Historically, we have generated substantially all of our revenues from sales
to customers in the United States, although we manage devices in several
locations around the world for these U.S.-based customers.
Results of Operations
Fiscal year 1999 compared to fiscal year 2000
Revenues
Total revenues. Total revenues increased 45%, from $26.7 million in fiscal
year 1999 to $38.7 million in fiscal year 2000.
19
<PAGE>
Network management services. Revenues from network management services
increased 88%, from $12.8 million in fiscal year 1999 to $24.0 million in
fiscal year 2000, representing 48% of total revenues in fiscal year 1999 and
62% of total revenues in fiscal year 2000. 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 revenues resulting from higher
volumes of newly installed sites, increased management fees for ordering and
managing CPE for selected resellers, and increased equipment installation
revenue.
Equipment and other. Revenues from equipment and other increased 5%, from
$13.9 million in fiscal year 1999 to $14.6 million in fiscal year 2000,
primarily as a result of increased CPE maintenance revenue due to an increase
in the number of equipment maintenance contracts in place offset by a decrease
in CPE revenue. Revenues from CPE sales decreased as a result of amendments we
have made to some of our reseller agreements whereby we receive management
fees for ordering CPE and managing CPE inventories for these resellers. In
addition, we expect to limit discounts on CPE and encourage end users to
purchase equipment from other sources.
Costs of revenues
Cost of network management services. Cost of network management services
includes salary and other costs of personnel, depreciation of equipment
utilized to manage customer networks, the network management infrastructure
utilized to provide remote network management services, and the costs of
third-party providers of CPE installation services. Cost of network management
services is expensed as incurred. Cost of network management services
increased 59%, from $8.3 million in fiscal year 1999 to $13.1 million in
fiscal year 2000, representing 65% of network management services revenues in
fiscal year 1999 and 54% of such revenues in fiscal year 2000. The dollar
increase was due primarily to the addition of personnel to accommodate growth,
upgrades to the network management infrastructure and, to a lesser extent,
increased subcontractor costs related to installation of CPE. The percentage
decrease was due primarily to improvements in processes and tools which
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. These costs are expensed in the period the
related revenues are recognized. Cost of equipment and other increased 5%,
from $10.7 million in fiscal year 1999 to $11.2 million in fiscal year 2000,
representing 77% of equipment and other revenues in both fiscal years 1999 and
2000. The increase in dollars was due to an increased number of maintenance
contracts in place during fiscal year 2000 partially offset by lower costs of
CPE sales due to lower CPE sales.
Operating expenses
Development. Development expenses consist primarily of salaries and related
costs of development personnel, including contract programming services.
Development employees are responsible for developing internal software
systems, selecting and integrating purchased software applications, developing
software tools for our network management services, developing our web-enabled
software applications that give customers access to network management
information, and defining and developing operating processes for new services.
Development expenses increased 42%, from $1.8 million in fiscal year 1999 to
$2.5 million in fiscal year 2000, representing 7% of total revenues in fiscal
year 1999 and 6% of total revenues in fiscal year 2000. 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.
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 42%, from $3.2 million in
fiscal year 1999 to $4.5 million in fiscal year 2000, representing 12% of
total revenues in both fiscal years 1999 and 2000. The increase in dollars was
due to increased spending for advertising and customer relations as well as
costs related to the addition of sales and marketing personnel.
20
<PAGE>
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 48%, from $2.1
million in fiscal year 1999 to $3.1 in fiscal year 2000, representing 8% of
total revenues in both fiscal years 1999 and 2000. The dollar increase was due
primarily to additional spending related to recruiting of new employees and to
being a public company.
Other income, net
Other income, net consists primarily of interest income earned on our cash
balances, partially offset by interest expense from our leases for capital
equipment. Other income, net increased from $93,000 in fiscal year 1999 to
$1.5 million in fiscal year 2000, representing less than 1% of total revenues
in fiscal year 1999 and 4% of total revenues in fiscal year 2000. The increase
was due primarily to interest income earned on the net proceeds received from
the Company's initial public offering.
Income tax expense (benefit)
The income tax provision recorded for fiscal year 1999 was $19,000, compared
to a benefit of $4.9 million for fiscal year 2000. The benefit in fiscal year
2000 is attributable to a reduction in the deferred tax asset valuation
allowance. In August 1999, we determined that a portion of the deferred tax
asset, which had been fully reserved at March 31, 1999, would more likely than
not be utilized. As of March 31, 2000, we concluded that all of the remaining
deferred tax asset would more likely than not be utilized. As a result, the
valuation allowance was eliminated during fiscal year 2000.
Fiscal year 1998 compared to fiscal year 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
21
<PAGE>
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 in subcontractor costs related to installation of CPE. The percentage
decrease was due primarily to improvements in processes and tools which
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 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.
Quarterly results of operations
Although our management revenues have increased in each of the quarters
presented below, results of operations have varied from quarter to quarter.
Accordingly, we believe that period-to-period comparisons of results of
operations are not necessarily meaningful and should not be relied upon as
indications of future performance. Our operating results may fluctuate as a
result of many factors, including our ability to renew or retain existing end-
user and reseller relationships, the cost of introducing new service offerings
and the profitability of such offerings, and the level and nature of
competition. Further, we may be unable to adjust spending rapidly enough to
compensate for any significant fluctuations in the number of new managed
devices implemented in a given period. Any significant shortfall in the number
of new managed devices could therefore seriously damage our business. Finally,
there can be no assurance that we will continue to be profitable in the future
or, if we are profitable, that our levels of profitability will not vary
significantly between quarters.
22
<PAGE>
The following tables set forth quarterly consolidated statements of
operations data in dollars and, except as noted below, as a percentage of
total revenues for each of the eight quarters in the period ended March 31,
2000. The information should be read together with the consolidated financial
statements and related notes appearing elsewhere in this document. Additional
per share information is disclosed on the consolidated statements of
operations in the consolidated financial statements included elsewhere in this
document. Operating results for any quarter are not necessarily indicative of
results for any future period.
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------------------------------------------------
Dec. Dec.
June 30, Sept. 30, 31, Mar. 31, June 30, Sept. 30, 31, Mar. 31,
1998 1998 1998 1999 1999 1999 1999 2000
-------- --------- ------ -------- -------- --------- ------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Network management
services............. $2,560 $3,081 $3,335 $3,801 $ 4,584 $ 5,502 $ 6,300 $ 7,663
Equipment and other... 3,002 3,342 3,557 4,038 4,492 3,790 2,795 3,536
------ ------ ------ ------ ------- ------- ------- -------
Total revenues...... 5,562 6,423 6,892 7,839 9,076 9,292 9,095 11,199
Cost of revenues:
Cost of network
management services.. 1,808 1,974 2,098 2,378 2,672 3,132 3,296 3,993
Cost of equipment and
other................ 2,321 2,629 2,663 3,052 3,536 2,973 2,047 2,647
------ ------ ------ ------ ------- ------- ------- -------
Total cost of
revenues........... 4,129 4,603 4,761 5,430 6,208 6,105 5,343 6,640
------ ------ ------ ------ ------- ------- ------- -------
Gross profit............ 1,433 1,820 2,131 2,409 2,868 3,187 3,752 4,559
Operating expenses:
Development........... 446 459 364 493 579 591 611 723
Sales and marketing... 739 723 791 900 943 1,025 1,129 1,389
General and
administrative....... 541 512 511 534 622 663 888 922
Amortization of
deferred
compensation......... -- -- -- -- 5 20 20 20
------ ------ ------ ------ ------- ------- ------- -------
Total operating
expenses........... 1,726 1,694 1,666 1,927 2,149 2,299 2,648 3,054
------ ------ ------ ------ ------- ------- ------- -------
Operating income
(loss)................. (293) 126 465 482 719 888 1,104 1,505
Other income (expense),
net.................... 48 23 3 19 46 31 669 716
------ ------ ------ ------ ------- ------- ------- -------
Income (loss) from
continuing operations
before income taxes.... (245) 149 468 501 765 919 1,773 2,221
Income tax expense
(benefit).............. -- -- 6 13 (1,136) (1,070) (351) (2,318)
------ ------ ------ ------ ------- ------- ------- -------
Net income (loss) from
continuing operations.. (245) 149 462 488 1,901 1,989 2,124 4,539
Gain (loss) on sale of
discontinued
operations, net of
applicable income
taxes.................. -- -- 98 -- -- -- -- --
------ ------ ------ ------ ------- ------- ------- -------
Net income (loss)....... $ (245) $ 149 $ 560 $ 488 $ 1,901 $ 1,989 $ 2,124 $ 4,539
====== ====== ====== ====== ======= ======= ======= =======
Basic income (loss) per
share from:
Continuing
operations........... $(0.27) $(0.15) $(0.05) $(0.04) $ 0.38 $ 0.37 $ 0.15 $ 0.32
====== ====== ====== ====== ======= ======= ======= =======
Net income (loss)..... $(0.27) $(0.15) $(0.02) $(0.04) $ 0.38 $ 0.37 $ 0.15 $ 0.32
====== ====== ====== ====== ======= ======= ======= =======
Weighted average shares
used in basic per Share
calculations........... 3,280 3,286 3,298 3,340 3,361 3,713 13,873 14,269
====== ====== ====== ====== ======= ======= ======= =======
Diluted income (loss)
per share from:
Continuing
operations........... $(0.27) $(0.15) $(0.05) $(0.04) $ 0.25 $ 0.11 $ 0.13 $ 0.28
====== ====== ====== ====== ======= ======= ======= =======
Net income (loss)..... $(0.27) $(0.15) $(0.02) $(0.04) $ 0.25 $ 0.11 $ 0.13 $ 0.28
====== ====== ====== ====== ======= ======= ======= =======
Weighted average shares
used in diluted per
Share calculations..... 3,280 3,286 3,298 3,340 5,055 11,877 16,104 16,296
====== ====== ====== ====== ======= ======= ======= =======
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31,
1998 1998 1998 1999 1999 1999 1999 2000
-------- --------- -------- -------- -------- --------- -------- --------
(As a percentage of total revenues)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Network management
Services............. 46.0% 48.0% 48.4% 48.5% 50.5% 59.2% 69.3% 68.4%
Equipment and other
Revenues............. 54.0 52.0 51.6 51.5 49.5 40.8 30.7 31.6
----- ----- ----- ----- ----- ----- ----- -----
Total revenues...... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Total cost of
revenues........... 74.2 71.7 69.1 69.3 68.4 65.7 58.7 59.3
----- ----- ----- ----- ----- ----- ----- -----
Gross profit............ 25.8 28.3 30.9 30.7 31.6 34.3 41.3 40.7
Operating expenses:
Development........... 8.0 7.1 5.3 6.3 6.4 6.4 6.7 6.5
Sales and marketing... 13.3 11.2 11.5 11.5 10.3 11.0 12.4 12.4
General and
Administrative....... 9.8 8.0 7.4 6.8 6.9 7.1 9.8 8.2
Amortization of
deferred
Compensation......... -- -- -- -- 0.1 0.2 0.2 0.2
----- ----- ----- ----- ----- ----- ----- -----
Total operating
Expenses........... 31.1 26.3 24.2 24.6 23.7 24.7 29.1 27.3
----- ----- ----- ----- ----- ----- ----- -----
Operating income
(loss)................. (5.3) 2.0 6.7 6.1 7.9 9.6 12.2 13.4
Other income (expense),
net.................... 0.9 0.3 0.1 0.3 0.5 0.3 7.4 6.4
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) from
continuing Operations,
before income Taxes.... (4.4) 2.3 6.8 6.4 8.4 9.9 19.6 19.8
Income tax expense
(benefit).............. -- -- 0.1 0.2 (12.5) (11.5) (3.9) (20.7)
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss) from
Continuing operations.. (4.4) 2.3 6.7 6.2 20.9 21.4 23.5 40.5
Gain (loss) on sale of
Discontinued
operations, net of
applicable income
taxes.................. -- -- 1.4 -- -- -- -- --
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss)....... (4.4)% 2.3% 8.1% 6.2% 20.9% 21.4% 23.5% 40.5%
===== ===== ===== ===== ===== ===== ===== =====
</TABLE>
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:
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31, Mar. 31,
1998 1998 1998 1999 1999 1999 1999 2000
-------- --------- -------- --------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Cost of network
management services.... 70.6% 64.1% 62.9% 62.6% 58.3% 56.9% 52.3% 52.1%
Cost of equipment and
other.................. 77.3 78.7 74.9 75.6 78.7 78.4 73.2 74.9
</TABLE>
Liquidity and capital resources
Net cash used in operating activities was $2.9 million during fiscal year
1998. Net cash provided by operating activities was $892,000 during fiscal
year 1999 and $5.8 million during fiscal year 2000.
We used $2.2 million during fiscal year 1998, $1.6 million during fiscal
year 1999 and $2.8 million during 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 were $1.7 million during fiscal year 1998,
$831,000 during fiscal year 1999 and $0 during fiscal year 2000. We paid
$257,000 during fiscal year 1998, $732,000 during fiscal year 1999 and
$974,000 during 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. As discussed in Item 2. Facilities, in
May 2000, we were negotiating a
24
<PAGE>
lease for an additional facility in Austin, Texas covering approximately
80,000 square feet. This lease will commence in April 2001 and will expire in
March 2007.
As of March 31, 2000, we had $57.2 million in cash and cash equivalents,
$4.9 million in net accounts receivable and $63.3 million in working capital.
We believe that our current cash balances together with cash generated from
operations, will be sufficient to fund our anticipated working capital needs
and capital expenditures, including capital expenditures related to the
facility for which we are negotiating a lease, and any potential future
acquisitions for at least 12 months. Our current cash balances are kept in
short-term, investment-grade, interest-bearing securities pending their use.
In the event our plans or assumptions change or prove to be inaccurate, or if
we consummate any unplanned acquisitions of businesses or assets, we may be
required to seek additional sources of capital. Sources of additional capital
may include public and private equity and debt financings, sales of
nonstrategic assets and other financing arrangements.
As of March 31, 2000, we had net operating loss carryforwards of
approximately $11.7 million available to offset future net income for U.S.
federal income tax purposes. These net operating loss carryforwards will
expire beginning in 2007 if not utilized. We have alternative minimum tax
credit carryforwards of approximately $291,000 which do not expire. Our
utilization of these net operating loss and tax credit carryforwards may be
subject to a substantial annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code. The annual limitation may result in
the expiration of the net operating losses before utilization. During the year
ended March 31, 2000 we determined that it was more likely than not that these
tax assets would be utilized. Accordingly, the previously recorded valuation
allowance was eliminated. This conclusion was based on factors such as the
recent consecutive quarters of income, future profitability expectations, and
the nature of the deferred tax assets.
Impact of Year 2000
Year 2000 problems are caused by computer systems that only use a two-digit
year value and, accordingly, were subject to error or failure when the Year
2000 arrived. During calendar year 1999, we completed testing and remediation
of our systems and products for Year 2000 issues, as well as other Year 2000
planning that included investigating the Year 2000 readiness of equipment and
software provided by third parties. During and after the Year 2000 date
change, we experienced no significant disruptions in mission critical
information technology and non-information technology systems and we believe
those systems successfully responded to the Year 2000 date change. We are not
aware of any material problems resulting from Year 2000 issues, either with
our products, our internal systems, or the products and services of third
parties. We plan to monitor our mission critical computer applications for any
latent Year 2000 matters that may arise. To date, we have not made any
material expenditures in connection with any latent Year 2000 matters.
Risk Factors
We may be unable to operate profitably in the future.
We may not operate profitably. Although we began operating in 1987, we did
not introduce our first network management service until the quarter ended
March 31, 1994. Our track record of operating profitably in the network
management services business is short, and it is difficult to predict our
future revenues and operating results. We have previously incurred substantial
net losses. Our ability to operate profitably in the future depends on
increasing sales of our services while maintaining sufficient gross profit
margins. We must, among other things:
. maintain satisfactory relationships with resellers such as AT&T, our
largest customer, and network equipment manufacturers such as Cisco;
. establish relationships with additional marketing partners for the
resale of our services;
. develop software to make our principal existing service, ProWatch for
WANs, more efficient and economical;
. develop and sell other network management services; and
. maintain reliable, uninterrupted service from our network management
center 24 hours per day, seven days per week.
25
<PAGE>
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 fiscal year 1999 and 71% of our total revenues in
fiscal year 2000. We expect sales to AT&T to continue to comprise a
substantial percentage of our revenues at least through fiscal year 2001 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 2000. In addition, a number of the orders for services that we
provide to AT&T's customers under an agreement expiring in December 2001 can
be cancelled beginning in July 2000 and all new orders placed after June 30,
1999 can be cancelled beginning July 2001. Our agreements with AT&T are not
exclusive arrangements. We will need to maintain a good working relationship
with different business units of AT&T in order to maintain the business we
currently provide to AT&T's customers and to encourage AT&T to sell our
services to additional customers. Problems in our relationship with AT&T would
seriously damage our business. We cannot assure you that AT&T will continue to
sell our services to existing or additional AT&T customers. A substantial
reduction in our AT&T business would result in diminished revenues for an
extended period of time as we attempted to replace that business.
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 continue to decline as we seek to manage our mix of
revenues;
. we may not add new end users as rapidly as we expect;
. we may lose existing end users as the result of competition, problems
with our services or, in the case of end users who are customers of our
resellers, problems with the reseller's services; and
. we may not be able to develop new or improved services as rapidly as
they are needed.
Most of our expenses, particularly employee compensation and rent, are
relatively fixed. As a result, variations in the timing of revenues could
significantly affect our results of operations from quarter to quarter and
could result in quarterly losses.
Our future operating results may vary by season, which will make it difficult
to predict our future performance.
As a result of seasonal factors, we believe that quarter-to-quarter
comparisons of our results of operations are not necessarily meaningful. These
factors may adversely affect our operating results or cause our operating
26
<PAGE>
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 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.
27
<PAGE>
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 97% of our recurring network management
services revenues in fiscal year 2000. Likewise, a substantial portion of our
nonrecurring network management services and equipment resale revenues depend
on the successful sale of these WAN management services. We expect that these
WAN management services will continue to generate substantially all of our
revenues for the foreseeable future. Our financial performance therefore
depends directly on continued market acceptance of our WAN management
services, as well as our ability to introduce enhanced versions of these
services that make these services more efficient and economical.
Our failure to develop and sell additional services could impair our financial
results and adversely affect our business.
Our future financial performance will depend in part on our ability to
develop, introduce and sell new and enhanced network management services other
than WAN management services, including services that:
. address the increasingly sophisticated needs of current and prospective
end users; and
. respond on a timely and cost-effective basis to technological advances
and emerging industry standards and protocols.
Although we have developed new services, such as network management services
for local area networks, or LANs, 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
28
<PAGE>
professionals, from not only our competitors but also our end users, marketing
partners and other companies throughout the network services industry. Other
employers may offer IT professionals significantly greater compensation and
benefits or more attractive career paths or geographic locations than we are
able to offer. Any failure on our part to hire, train and retain a sufficient
number of qualified IT professionals would seriously damage our business.
We could incur significant costs if we are unable to retain our information
technology professionals.
Because of the limited availability of IT professionals, we seek to hire
persons who have obtained college bachelor's degrees and then train those
persons to provide our services. As a result, we invest a significant amount
of time and money in training these new employees before they begin to support
our business. We do not enter into employment agreements requiring these
employees to continue in our employment for any period of time. Departures of
trained employees could limit our ability to generate revenues and would
require us to incur additional costs in training new employees.
We currently compete most directly with our customers' internal solutions, and
we expect increasing competition from other network services companies.
To compete successfully, we must respond promptly and effectively to the
challenges of technological change, evolving standards and our competitors'
innovations by continuing to enhance our services, as well as our sales
programs and channels. Any pricing pressures, reduced margins or loss of
market share resulting from increased competition, or our failure to compete
effectively, could seriously damage our business.
We face competition from different sources. Currently, 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.
29
<PAGE>
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.
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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company invests its cash in money market funds or instruments which meet
high credit quality standards specified by the Company's investment policy.
The Company does not use financial instruments for trading or other
speculative purposes.
30
<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Auditors............................................ 32
Consolidated Balance Sheets as of March 31, 1999 and 2000................. 33
Consolidated Statements of Operations for each of the three years in the
period ended March 31, 2000.............................................. 34
Consolidated Statements of Stockholders' Equity (Deficit) for each of the
three years in the period ended March 31, 2000........................... 35
Consolidated Statements of Cash Flows for each of the three years in the
period ended March 31, 2000.............................................. 36
Notes to Consolidated Financial Statements................................ 37
</TABLE>
31
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
NetSolve, Incorporated
We have audited the accompanying consolidated balance sheets of NetSolve,
Incorporated as of March 31, 1999 and 2000, 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, 2000. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of NetSolve, Incorporated, at March 31, 1999 and 2000, and the consolidated
results of their operations and their cash flows for each of the three years
in the period ended March 31, 2000, in conformity with accounting principles
generally accepted in the United States.
/s/ Ernst & Young LLP
Austin, Texas
April 17, 2000
32
<PAGE>
NETSOLVE, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
Year Ended March 31,
----------------------
1999 2000
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 2,764 $ 57,185
Restricted cash........................................ 642 395
Certificates of deposit................................ 2,000 --
Accounts receivable, net of allowance for doubtful
accounts of $227 at March 31, 1999 and $219 at March
31, 2000.............................................. 2,622 4,913
Inventory.............................................. 279 252
Prepaid expenses and other assets...................... 1,267 2,139
Deferred tax assets.................................... -- 3,682
---------- ---------
Total current assets.................................... 9,574 68,566
Restricted cash......................................... 1,638 306
Property and equipment:
Network communications equipment....................... 71 71
Computer equipment and software........................ 2,601 5,625
Other equipment........................................ 173 363
Furniture, fixtures and leasehold improvements......... 865 1,765
Equipment held under capital leases.................... 3,108 1,701
---------- ---------
6,818 9,525
Less accumulated depreciation and amortization......... (3,571) (5,230)
---------- ---------
Net property and equipment.............................. 3,247 4,295
Other assets............................................ 477 47
Deferred tax assets, net of current portion............. -- 1,305
---------- ---------
Total assets............................................ $ 14,936 $ 74,519
========== =========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable....................................... $ 1,569 $ 2,174
Accrued liabilities.................................... 1,914 2,526
Capital leases obligation.............................. 809 537
---------- ---------
Total current liabilities............................... 4,292 5,237
Capital leases obligation, net of current portion....... 1,027 324
Redeemable convertible preferred stock, $.10 par value;
7,500,000 Shares authorized at March 31, 1999 and March
31, 2000; 6,394,727 and 0 issued and outstanding at
March 31, 1999 and March 31, 2000, respectively;
aggregate liquidation Preferences of $44,146 at March
31, 1999 and $0 at March 31, 2000...................... 44,146 --
Stockholders' equity (deficit):
Common stock, $.01 par value; 25,000,000 shares
authorized at March 31, 1999 and March 31, 2000;
3,336,446 and 14,485,586 issued and outstanding at
March 31, 1999 and March 31, 2000, respectively........ 33 145
Additional paid-in capital............................. -- 77,578
Deferred compensation.................................. -- (257)
Accumulated deficit.................................... (34,562) (8,508)
---------- ---------
Total stockholders' equity (deficit).................... (34,529) 68,958
---------- ---------
Total liabilities, redeemable convertible preferred
stock and stockholders' equity (deficit)............... $ 14,936 $ 74,519
========== =========
</TABLE>
See accompanying notes.
33
<PAGE>
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended March 31,
-------------------------
1998 1999 2000
------- ------- -------
<S> <C> <C> <C>
Revenues:
Network management services....................... $ 7,324 $12,777 $24,048
Equipment and other............................... 7,199 13,939 14,613
------- ------- -------
Total revenues.................................... 14,523 26,716 38,661
Costs of revenues:
Cost of network management services............... 5,706 8,258 13,095
Cost of equipment and other....................... 5,425 10,665 11,202
------- ------- -------
Total cost of revenues............................ 11,131 18,923 24,297
------- ------- -------
Gross profit....................................... 3,392 7,793 14,364
Operating expenses:
Development....................................... 2,040 1,762 2,503
Sales and marketing............................... 2,562 3,153 4,486
General and administrative........................ 2,159 2,098 3,095
Amortization of deferred compensation............. -- -- 65
------- ------- -------
Total operating expenses.......................... 6,761 7,013 10,149
------- ------- -------
Operating income (loss)............................ (3,369) 780 4,215
Other income (expense):
Interest income................................... 470 441 1,592
Interest expense.................................. (159) (254) (117)
Other, net........................................ 29 (94) (12)
------- ------- -------
340 93 1,463
------- ------- -------
Income (loss) from continuing operations before
income taxes...................................... (3,029) 873 5,678
Income tax expense (benefit)....................... (297) 19 (4,875)
------- ------- -------
Net income (loss) from continuing operations....... (2,732) 854 10,553
Discontinued operations:
Income from discontinued operations, net of
applicable income taxes.......................... 165 -- --
Gain on sale of discontinued operations, net of
applicable income taxes.......................... 341 98 --
------- ------- -------
Net income (loss).................................. $(2,226) $ 952 $10,553
======= ======= =======
Dividends on redeemable convertible preferred
stock............................................. $(2,530) $(2,531) $(1,260)
------- ------- -------
Net income (loss) applicable to common stock....... $(4,756) $(1,579) $ 9,293
======= ======= =======
Basic net income (loss) per share from:
Continuing operations............................. $ (1.76) $ (0.51) $ 1.06
Discontinued operations........................... 0.17 0.03 --
------- ------- -------
Net income (loss)................................. $ (1.59) $ (0.48) $ 1.06
Weighted average shares used in basic per share
calculation....................................... 2,995 3,297 8,800
Diluted net income (loss) per share from:
Continuing operations............................. $ (1.76) $ (0.51) $ .68
Discontinued operations........................... 0.17 0.03 --
------- ------- -------
Net income (loss)................................. $ (1.59) $ (0.48) $ .68
Weighted average shares used in diluted per share
calculation....................................... 2,995 3,297 13,648
Pro forma basic net income per share from:
Continuing operations............................. $ 0.09 $ 0. 88
Discontinued operations........................... 0.01 --
------- -------
Net income........................................ $ 0.10 $ 0. 88
Pro forma weighted average shares used in basic per
share calculation................................. 9,692 11,963
Pro forma diluted net income per share from:
Continuing operations............................. $ 0.07 $ 0.77
Discontinued operations........................... 0.01 --
------- -------
Net income........................................ $ 0.08 $ 0.77
Pro forma weighted average shares used in diluted
per share calculation............................. 11,341 13,648
</TABLE>
See accompanying notes.
34
<PAGE>
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share data)
<TABLE>
<CAPTION>
Total
Common Stock Additional Stockholders'
----------------- Paid-In Deferred Accumulated Equity
Shares Amount Capital Compensation Deficit (Deficit)
---------- ------ ---------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, March 31,
1997................... 2,910,527 $ 29 $ -- $ -- $(28,346) $(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............. 669,413 7 632 -- -- 639
Dividends on
redeemable
convertible preferred
stock................ -- -- (954) -- (306) (1,260)
Deferred
compensation......... -- -- 322 (322) -- --
Issuance of common
stock from Initial
Public Offering, net
of offering costs.... 4,085,000 41 48,043 -- -- 48,084
Conversion of
preferred stock to
common stock......... 6,394,727 64 29,535 -- 15,807 45,406
Amortization of
deferred
compensation......... -- -- -- 65 -- 65
Net income............ -- -- -- -- 10,553 10,553
---------- ---- ------- ----- -------- --------
Balance, March 31,
2000................... 14,485,586 $145 $77,578 $(257) $ (8,508) $ 68,958
========== ==== ======= ===== ======== ========
</TABLE>
See accompanying notes.
35
<PAGE>
NETSOLVE, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year Ended March 31,
-------------------------
1998 1999 2000
------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss).................................. $(2,226) $ 952 $10,553
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization.................... 863 1,234 1,733
Amortization of deferred compensation............ -- -- 65
Deferred tax assets.............................. -- -- (4,987)
(Gain) loss on disposition of property and
equipment....................................... (20) (4) 1
Gain on sale of discontinued operations.......... (341) (98) --
Change in assets and liabilities:
Accounts receivable, net....................... 992 (1,020) (2,291)
Inventory and prepaid expenses and other
assets........................................ (409) (751) (415)
Accounts payable............................... (581) 208 605
Accrued liabilities............................ (1,182) 371 612
------- ------- -------
Net cash provided by (used in) operating
activities........................................ (2,904) 892 5,876
Cash flows from investing activities:
Investments in certificates of deposit........... (1,532) -- --
Proceeds from sale of certificates of deposit.... -- 2,532 2,000
Transfer of funds from (to) restricted cash...... (1,646) (634) 1,579
Purchases of property and equipment.............. (2,236) (1,639) (2,782)
Proceeds from sale of property and equipment..... 34 4 --
Proceeds from sale of discontinued operations.... -- 98 --
------- ------- -------
Net cash provided by (used in) investing
activities........................................ (5,380) 361 797
------- ------- -------
Cash flows from financing activities:
Net proceeds from sale of stock.................. -- -- 48,084
Proceeds from capital lease financing............ 1,706 831 --
Payments under capital lease obligations......... (257) (732) (975)
Proceeds from exercise of common stock options
and warrants.................................... 40 79 639
------- ------- -------
Net cash provided by financing activities.......... 1,489 178 47,748
------- ------- -------
Net increase (decrease) in cash and cash
equivalents....................................... (6,795) 1,431 54,421
Cash and cash equivalents, beginning of period..... 8,128 1,333 2,764
------- ------- -------
Cash and cash equivalents, end of period........... $ 1,333 $ 2,764 $57,185
======= ======= =======
Supplemental disclosure of cash flow information:
Cash paid for interest........................... $ 168 $ 242 $ 117
======= ======= =======
Income taxes paid................................ $ 196 $ 24 $ 117
======= ======= =======
</TABLE>
See accompanying notes.
36
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2000
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.
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 $85,000 at March 31,
1999 and $98,000 at March 31, 2000.
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.
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.
37
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2000
Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed in Note 5, the alternative fair value accounting provided for under
SFAS 123, Accounting for Stock-Based Compensation, requires use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, compensation cost is recognized over the vesting period
based on the difference, if any, on the date of grant between the fair value
of the Company's stock and the price the employee must pay to acquire the
stock.
Earnings Per Share
The Company's earnings per share data are presented in accordance with SFAS
128, Earnings Per Share. Basic income (loss) per share is computed using the
weighted average number of common shares outstanding. Diluted income (loss)
per share is computed using the weighted average number of common shares
outstanding adjusted for the incremental shares attributed to outstanding
securities with the ability to purchase or convert into common stock. The
treasury stock method, using the average price of the Company's common stock
for the period, is applied to determine dilution from options and warrants.
The if-converted method is used for convertible securities. 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 1,265,861 and 1,648,841 in 1998 and 1999, respectively.
For 1998 and 1999, 6,394,727 shares of convertible preferred stock were
excluded from the calculation of diluted income (loss) per share as their
effect is also antidilutive.
A reconciliation of the numerators and denominators used in computing per
share net income (loss) from continuing operations is as follows:
<TABLE>
<CAPTION>
Proforma
Year ended March 31, Year ended March 31,
------------------------- --------------------
1998 1999 2000 1999 2000
------- ------- ------- --------------------
<S> <C> <C> <C> <C> <C>
Numerator:
Net income (loss) from
continuing operations....... $(2,732) $ 854 $10,553 $ 854 $ 10,553
Dividends on redeemable
convertible preferred
stock....................... (2,530) (2,531) (1,260) -- --
------- ------- ------- --------- ----------
Numerator for basic and
diluted net income (loss)
per share from continuing
operations.................. $(5,262) $(1,677) $ 9,293 $ 854 $ 10,553
======= ======= ======= ========= ==========
Denominator:
Denominator for basic net
income (loss) per share from
continuing operations--
weighted average common
stock outstanding........... 2,995 3,297 8,800 9,692 11,963
Dilutive common stock
equivalents--common stock
options, warrants and
redeemable convertible
preferred stock............. -- -- 4,848 1,649 1,685
------- ------- ------- --------- ----------
Denominator for diluted net
income (loss) per share from
continuing operations--
weighted average common
stock outstanding and
dilutive common stock
equivalents................. 2,995 3,297 13,648 11,341 13,648
======= ======= ======= ========= ==========
</TABLE>
38
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2000
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.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense for
the years ended March 31, 1998, 1999 and 2000 was approximately $370,000,
$419,000 and $839,000 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 a 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 69% and
56% of the outstanding accounts receivable balance at March 31, 1999 and 2000,
respectively.
39
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2000
The following table summarizes the changes in the allowance for doubtful
accounts for 1998, 1998 and 2000 (in thousands):
<TABLE>
<S> <C>
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
Additions charged to costs and expenses............................. 16
Write-off of uncollectible accounts................................. (24)
-----
Balance at March 31, 2000............................................. $ 219
=====
</TABLE>
Concentrations of Revenues
Revenues from AT&T amounted to 52%, 59%, and 71% of the Company's net
revenues for the years ended March 31, 1998, 1999, and 2000 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 2000 to December 2001,
will be renewed or replaced. No other customer accounted for greater than 10%
of revenue in fiscal year 1998, 1999, and 2000.
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 financial disclosures as the Company had no
reportable operating segments.
Recent Pronouncements
In June 1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 137, Accounting for Derivative Instruments
and Hedging Activities, Deferral of Effective Date of FASB Statement No. 133,
in which Statement 133 is now required to be adopted in the Company's fiscal
year 2001. The Company does not anticipate that the adoption of the new
Statement will have a material impact on the results of operations or the
financial position of the Company, as the Company has no derivatives.
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, Revenue Recognition (SAB 101), which
provides guidance on the recognition, presentation and
40
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2000
disclosure of revenue in financial statements. The Company will adopt the
provisions of SAB 101 for all transactions during the year ending March 31,
2001. The application of SAB 101 is not expected to have a material impact on
the results of operations or the financial position of the Company.
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 October 1997. The
Company recorded revenue of $715,000 in fiscal year 1998 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 $1,072,000 for fiscal year 1998.
During fiscal year 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).
41
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2000
4. Redeemable Convertible Preferred Stock
The Company had issued and outstanding shares of redeemable convertible
preferred stock as follows on March 31, 1999. Each share of preferred stock
outstanding as of September 29, 1999 was automatically converted into one
share of the Company's common stock and retired upon the closing of the
Company's initial public offering on October 4, 1999. Accordingly, no shares
of preferred stock were outstanding as of March 31, 2000.
<TABLE>
<CAPTION>
March 31, March 31,
1999 2000
--------- ---------
<S> <C> <C>
Series A convertible preferred stock..................... 3,944,184 --
Series B convertible preferred stock..................... 2,450,543 --
</TABLE>
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. Some of 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, 2000, total outstanding options subject to repurchase
rights were 1,162,248.
Stock Option Plans
In November 1988, the Company adopted a stock option plan providing for the
granting of options to purchase shares of the Company's common stock to key
employees, directors, officers and consultants as designated by the Company's
Board of Directors. The plan expired with respect to the granting of new
options in October 1998. The Plan provided for the issuance of both Incentive
Stock Options ("ISOs") as well as options not qualifying as ISOs within the
meaning of the Internal Revenue Code of 1986, as amended. Under the terms of
the Plan, the option price per share of ISOs must not have been be less than
100% of the fair market value of the Company's common stock per share at date
of grant. Options were be granted with a term of 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.
42
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2000
At March 31, 2000 the Company had reserved 2,539,367 shares of common stock
for issuance upon exercise of all options.
Deferred Compensation
The Company recorded gross deferred compensation of approximately $322,000
in fiscal year 2000. The amount recorded represents the difference between the
grant price and the deemed fair value of the Company's common stock for shares
subject to options granted in fiscal year 2000. In fiscal year 2000, 321,960
shares were granted below deemed fair value and the exercise price and deemed
fair values were $9.00 and $10.00, respectively. The deferred compensation is
amortized over the vesting period of each respective option, generally four
years. Approximately $65,000 was recorded as compensation expense in fiscal
year 2000.
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 1998, 1999
and 2000 of 5.69%, 5.56% and 5.71%, respectively; no dividends; and a
weighted-average expected life of the option of five years for options granted
before our initial public offering and four years for options granted
subsequent to our initial public offering. The fair value for options granted
subsequent to our initial filing date was established as of the date of grant
using the Black-Scholes pricing model with a volatility of 40% for options
granted subsequent to the initial filing date but prior to our initial public
offering and a volatility of 85% for options granted subsequent to our initial
public offering.
The minimum value option valuation model with a near zero volatility results
in an option value similar to the option value that would result from using
the Black-Scholes option valuation model with a near zero volatility. The
Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and which are
fully transferable. In addition, option valuation models in general require
the input of highly subjective assumptions, including the expected stock price
volatility. Because the Company's stock options have characteristics
significantly different than those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion the existing models do not necessarily
provide a reliable single measure of the fair value of its stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The impact
on the pro forma results which follow may not be representative of
compensation expense in future periods when the effect of the amortization of
multiple awards may be reflected in the amounts. The Company's pro forma net
loss from continuing operations (net of income taxes) and pro forma basic and
diluted net loss per share follows:
<TABLE>
<CAPTION>
Year ended March 31,
---------------------------------
1998 1999 2000
----------- -------- ----------
<S> <C> <C> <C>
Pro forma net income (loss) from
continuing operations.................. $(2,779,000) $679,000 $9,485,000
Pro forma basic net income (loss) per
share.................................. (1.76) (0.56) 0.93
Pro forma diluted net income (loss) per
share.................................. $ (1.76) $ (0.56) $ 0.60
</TABLE>
43
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2000
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, 1998 March 31, 1999 March 31, 2000
-------------------- -------------------- --------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding--beginning
of period.............. 2,005,859 $0.81 2,007,647 $3.03 2,438,939 $ 2.50
Granted............... 388,844 $2.57 618,176 $7.23 686,040 $17.04
Exercised............. (124,633) $0.30 (70,102) $1.10 (605,465) $ 0.93
Canceled.............. (262,423) $1.96 (116,782) $3.11 (95,995) $ 8.08
--------- ----- --------- ----- --------- ------
Outstanding and
exercisable--end of
Period--total.......... 2,007,647 $1.03 2,438,939 $2.50 2,423,519 $ 6.78
========= ===== ========= ===== ========= ======
Outstanding and
exercisable--end of
Period--vested......... 1,464,123 $0.53 1,498,301 $0.63 1,261,271 $ 1.76
========= ===== ========= ===== ========= ======
Weighted-average fair
value of Options
granted during the
Period................. $0.64 $2.02 $ 9.13
</TABLE>
Exercise prices for options outstanding at March 31, 2000 are as follows:
<TABLE>
<CAPTION>
Weighted-
Weighted- Average
Average Remaining
Exercise Exercise Contractual
Price Range Options Price Life
----------- --------- --------- -----------
<S> <C> <C> <C>
$ 0.20-$ 0.30................................ 638,350 $ 0.20 3.1
$ 0.40-$ 1.20................................ 133,000 $ 0.87 3.8
$ 1.90-$ 2.80................................ 518,696 $ 2.40 7.1
$ 7.50-$ 9.00................................ 781,113 $ 8.19 8.7
$12.00-$19.13................................ 209,150 $18.05 9.6
$33.25-$33.25................................ 143,210 $33.25 9.8
--------- ------ ---
$ 0.20-$33.25................................ 2,423,519 $ 6.78 6.7
========= ====== ===
</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 leases. These
warrants were exercisable at a price of $4.00 per share and all have expired
as of December 31, 1999 with the exception of 10,000 which expire in 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 were exercised by the bank in December 1999 and are no longer
outstanding. These warrants were accounted for at the fair value of the
warrants on the date of issuance.
44
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2000
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, March 31,
1998 1999 2000
----------- ----------- ----------
<S> <C> <C> <C>
Deferred tax assets:
Tax carryforwards.................... $ 6,923,000 $ 6,544,000 $4,581,000
Depreciable assets................... 159,000 130,000 52,000
Accruals, reserves and other......... 365,000 421,000 354,000
----------- ----------- ----------
Gross deferred tax assets.............. 7,447,000 7,095,000 4,987,000
Valuation allowance.................... (7,447,000) (7,095,000) --
----------- ----------- ----------
Net deferred taxes..................... $ -- $ -- $4,987,000
=========== =========== ==========
</TABLE>
The valuation allowance decreased by approximately $352,000 and $7,095,000
during fiscal years 1999 and 2000, respectively. The March 31, 1999 reduction
was the result of the utilization of net operating losses which were not
previously benefited. The March 31, 2000 reduction was due to the utilization
of net operating losses which were not previously benefited ($2.1 million) and
management's determination that the remaining deferred tax items would more
likely than not be realized ($5.0 million).
As of March 31, 1999 and March 31, 2000, the Company had federal net
operating loss carryforwards of approximately $17,157,000 and $11,671,000,
respectively which will expire beginning in 2007, if not utilized. The Company
had alternative minimum tax credit carryforwards of $196,000 and $291,000 as
of March 31, 1999 and March 31, 2000, 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>
Year ended March 31,
------------------------------
1998 1999 2000
--------- ------- -----------
<S> <C> <C> <C>
Current...................................... $ -- $19,000 $ 12,000
Deferred..................................... (297,000) -- (4,987,000)
--------- ------- -----------
$(297,000) $19,000 $(4,875,000)
========= ======= ===========
</TABLE>
Income tax expense (benefit) is included in the financial statements as
follows:
<TABLE>
<CAPTION>
Year ended March 31,
------------------------------
1998 1999 2000
--------- ------- -----------
<S> <C> <C> <C>
Continuing operations....................... $(297,000) $19,000 $(4,875,000)
Income from discontinued operations......... 97,000 2,000 --
Gain on sale of discontinued operations..... 200,000 -- --
--------- ------- -----------
$ -- $21,000 $(4,875,000)
========= ======= ===========
</TABLE>
45
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2000
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>
Year ended March
31,
----------------------
1998 1999 2000
----- ----- ------
<S> <C> <C> <C>
Federal statutory rate............................... (34.0)% 34.0 % 34.0 %
Operating losses not benefited....................... 26.8 -- --
Reduction in valuation allowance..................... -- (36.7) (125.0)
Permanent items and other............................ (2.6) 4.9 5.2
----- ----- ------
Total expense (benefit).............................. (9.8)% 2.2% 85.8%
===== ===== ======
</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 18 and completed certain service
requirements. Employer contributions may be made by the Company at the
discretion of the Board of Directors. No such employer contributions have been
made to date.
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, 2000,
are as follows:
<TABLE>
<CAPTION>
Year ended March 31,
--------------------
<S> <C>
2001........................................................... $1,500,000
2002........................................................... 1,581,000
2003........................................................... 1,576,000
2004........................................................... 1,048,000
----------
Total minimum lease payments..................................... $5,705,000
==========
</TABLE>
Total rental expense was approximately $812,000, $1,294,000 and $1,596,000
for the years ended March 31, 1998, 1999 and 2000, respectively.
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, 2000.
<TABLE>
<CAPTION>
Year ended March 31,
--------------------
<S> <C>
2001............................................................ $ 586,000
2002............................................................ 337,000
2003............................................................ --
---------
Total minimum lease payments...................................... 923,000
Less amount representing interest................................. (62,000)
---------
Present value of net minimum lease payments....................... 861,000
---------
Less current portion.............................................. (537,000)
---------
Non-current obligation............................................ $ 324,000
=========
</TABLE>
46
<PAGE>
NETSOLVE, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 2000
10. Restricted Cash
At March 31, 2000, the Company had outstanding irrevocable letters of credit
totaling $701,000 in favor of a lessor under a capital lease for equipment.
These letters of credit are declining 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.
47
<PAGE>
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
Part III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The section entitled "Proposal No. 1--Election of Directors" of our
definitive Proxy Statement pursuant to Regulation 14A for our 2000 Annual
Meeting of Stockholders to be held July 11, 2000, and to be filed on or about
May 23, 2000, is incorporated herein by reference.
Additional information with respect to our executive officers is found at
the end of Part I of this report under the heading "Executive Officers of the
Registrant."
Item 11. EXECUTIVE COMPENSATION
The subsection entitled "The Board of Directors--Director Compensation" and
the section entitled "Executive Compensation" of our definitive Proxy
Statement pursuant to Regulation 14A for our 2000 Annual Meeting of
Stockholders to be held July 11, 2000, and to be filed on or about May 23,
2000, are incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Security Ownership of Certain Beneficial Owners and
Management" of our definitive Proxy Statement pursuant to Regulation 14A for
our 2000 Annual Meeting of Stockholders to be held July 11, 2000, and to be
filed on or about May 23, 2000, are incorporated herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The subsection entitled "The Board of Directors--The Compensation Committee"
of our definitive Proxy Statement pursuant to Regulation 14A for our 2000
Annual Meeting of Stockholders to be held July 11, 2000, and to be filed on or
about May 23, 2000, are incorporated herein by reference.
Part IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
<TABLE>
<CAPTION>
Financial Statements (included in Item 8 of this report) Page No.
-------------------------------------------------------- --------
<S> <C>
Report of Independent Auditors..................................... 32
Consolidated Balance Sheets as of March 31, 1999 and 2000.......... 33
Consolidated Statements of Operations for each of the three years
in the period ended March 31, 2000................................ 34
Consolidated Statements of Stockholders' Equity (Deficit) for each
of the three years in the period ended March 31, 2000............. 35
Consolidated Statements of Cash Flows for each of the three years
in the period ended March 31, 2000................................ 36
Notes to Consolidated Financial Statements......................... 37
</TABLE>
48
<PAGE>
The consolidated financial statement schedules are omitted because they are
not applicable or because the required information is included in the
consolidated financial statements or notes thereto.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the three months ended March 31,
2000.
<TABLE>
<CAPTION>
Previously Filed*
-----------------------
With File
Exhibits Number As Exhibit Description
-------- ------------ ---------- -----------
<C> <C> <C> <S>
3.1 333-65691 3.3 Restated Certificate of Incorporation of
NetSolve, as filed.
3.2 333-65691 3.4 By-laws of NetSolve.
4.1 Amdt. No. 1 4.1 Specimen Form of Common Stock Certificate of
to 333-65691 NetSolve.
10.1 Amdt. No. 1 10.1 Contract Services Agreement between AT&T
to 333-65691 Corp. and NetSolve, dated December 21, 1995,
together with amendments relating thereto.+
10.2 333-65691 10.2 Lease between CarrAmerica Realty, L.P., t/a
Riata Corporate Park, as Landlord, and
NetSolve, as Tenant, dated as of September
30, 1997, relating to Riata Corporate Park.
10.3 333-65691 10.3 Master Lease Agreement between Leasing
Technologies International Inc., as Lessor
and NetSolve, as Lessee, dated October 30,
1995, relating to certain items of equipment.
10.4 333-65691 10.4 Master Lease Agreement between Trimarc
Financial, as Leasor, and NetSolve, as
Lessee, dated as of January 30, 1998,
relating to certain items of equipment.
10.5 333-65691 10.5 Asset Acquisition Agreement between
Intermedia Communications Inc. and NetSolve,
dated as of December 30, 1996.
10.6 333-65691 10.6 Series B Preferred Stock Purchase Agreement,
dated as of October 19, 1992, together with
all amendments relating thereto.
10.6.1 Amendment to Series B Preferred Stock
Purchase Agreement dated as of June 30, 1999.
10.7 Amdt. No. 1 10.7 Form of Indemnification Agreement.
to 333-65691
10.8** 333-65691 10.8 1988 Stock Option Plan, as amended.
10.9** Amdt. No. 1 10.9 Amended and Restated Long-Term Incentive
to 333-65691 Compensation Plan.
10.10 333-65691 10.10 Form of Proprietary Information and
Inventions Agreement entered into between
NetSolve and each officer.
10.11** 333-65691 10.11 Offer Letter from NetSolve to Craig S.
Tysdal, dated August 12, 1993.
10.12** 333-65691 10.12 Offer Letter from NetSolve to Christopher D.
Buffum, dated January 29, 1998.
10.13** 333-65691 10.13 Offer Letter from NetSolve to Terrence Cheng,
dated April 15, 1998.
10.14** 333-65691 10.14 Stock Option Agreement with Howard D. Wolfe.
10.15** 333-65691 10.15 Shareholder Agreement with Howard D. Wolfe.
</TABLE>
49
<PAGE>
<TABLE>
<CAPTION>
Previously Filed*
-----------------------
With File
Exhibits Number As Exhibit Description
-------- ------------ ---------- -----------
<C> <C> <C> <S>
10.16** Amdt. No. 1 10.16 Offer Letter from NetSolve to Harry S. Budow,
to 333-65691 dated June 17, 1999.
10.17** Amdt. No. 1 10.17 Form of Stock Option Agreement with
to 333-65691 Directors.
10.18** Amdt. No. 1 10.18 Form of Shareholder Agreement with Directors.
to 333-65691
22.1 333-65691 22.1 Subsidiaries of NetSolve.
23.1 Consent of Ernst & Young LLP, Independent
Auditors.
27 Financial Data Schedule
</TABLE>
- --------
* Incorporated herein by reference. Abbreviation used is Amdt. No. 1 to 333-
65691 is the Registrant's Amendment No. 1, dated July 26, 1999, to its
Registration Statement on Form S-1, File No. 333-65691.
** Management contract or compensation plan or arrangement required to be
filed as an exhibit hereto pursuant to Item 14(c).
+Portions of this exhibit have been omitted pursuant to a request for
confidential treatment.
50
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, NetSolve, Incorporated, has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
NetSolve, Incorporated
Date: May 23, 2000.
/s/ Craig S. Tysdal
By: _________________________________
Craig S. Tysdal,
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of NetSolve,
Incorporated and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Craig S. Tysdal Principal Executive May 23, 2000
______________________________________ Officer and Director
(Craig S. Tysdal, President and
Chief Executive Officer)
/s/ Kenneth C. Kieley - Principal Financial May 23, 2000
______________________________________ Officer and Principal
(Kenneth C. Kieley, Vice President- Accounting Officer
Finance
Chief Financial Officer and Secretary)
/s/ J. Michael Gullard Director May 23, 2000
______________________________________
(J. Michael Gullard, Chairman of the
Board)
/s/ Joel P. Adams Director May 23, 2000
______________________________________
(Joel P. Adams)
/s/ C. Richard Kramlich Director May 23, 2000
______________________________________
(C. Richard Kramlich)
/s/ H. Leland Murphy Director May 23, 2000
______________________________________
(H. Leland Murphy)
/s/ John S. McCarthy Director May 23, 2000
______________________________________
(John S. McCarthy)
/s/ Suzanne C. Narducci Director May 23, 2000
______________________________________
(Suzanne C. Narducci)
/s/ Howard D. Wolfe, Jr. Director May 23, 2000
______________________________________
(Howard D. Wolfe, Jr.)
</TABLE>
51
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-94401) pertaining to the NetSolve, Incorporated 1988 Stock Option
Plan and the NetSolve, Incorporated Long-term Incentive Compensation Plan of our
report dated April 17, 2000, with respect to the consolidated financial
statements of NetSolve, Incorporated included in the Annual Report (Form 10-K)
for the year ended March 31, 2000.
/s/ ERNST & YOUNG LLP
Austin, Texas
May 22, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY INFORMATION EXTRACTED FROM THE NETSOLVE
INCORPORATED CONSOLIDATED BALANCE SHEET FOR MARCH 31, 2000 AND THE CONSOLIDATED
STATEMENT OF INCOME FOR THE TWELVE MONTHS ENDED MARCH 31, 2000 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-END> MAR-31-2000
<CASH> 57,185
<SECURITIES> 0
<RECEIVABLES> 5,132
<ALLOWANCES> 219
<INVENTORY> 252
<CURRENT-ASSETS> 68,566
<PP&E> 9,525
<DEPRECIATION> 5,230
<TOTAL-ASSETS> 74,519
<CURRENT-LIABILITIES> 5,237
<BONDS> 0
0
0
<COMMON> 145
<OTHER-SE> 68,813
<TOTAL-LIABILITY-AND-EQUITY> 74,519
<SALES> 38,661
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 24,297
<OTHER-EXPENSES> 10,149
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 117
<INCOME-PRETAX> 5,678
<INCOME-TAX> (4,875)
<INCOME-CONTINUING> 10,553
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,293
<EPS-BASIC> 1.06
<EPS-DILUTED> 0.68
</TABLE>
