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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
Commission File Number: 000-23699
VISUAL NETWORKS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 52-1837515
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification
No.)
2092 Gaither Road, Rockville, 20850
Maryland
(Address of Principal Executive (Zip Code)
Office)
Registrant's telephone number, including area code: (301) 296-2300
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Documents incorporated by reference: Specified portions of the Definitive
Proxy Statement to be filed with the Commission pursuant to Regulation 14A in
connection with the 2002 Annual Meeting are incorporated herein by reference
into Part III of this Report. Such proxy statement will be filed with the
Securities and Exchange Commission not later than 120 days after the
Registrant's fiscal year ended December 31, 2001.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of March 28, 2002 was approximately $90,576,000. The
number of outstanding shares of the Registrant's common stock as of March 28,
2002 was 31,967,492 shares.
TABLE OF CONTENTS
PART I
Item 1. Business
Overview
Industry Background
Problems Managing Networks Based on IP and the Internet
The Visual Networks Solution
The Visual Networks Strategy
Products
The Visual Networks Selling Strategy
Product Development
Customers
Strategic Partnership
Competition
Manufacturing
Patents and Other Intellectual Property Rights
Employees
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for Our Common Stock and Related Stockholder
Matters
Item 6. Selected Consolidated Financial Data
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosure about Market
Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
PART III
Item 10. Our Directors and Executive Officers
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and
Management
Item13. Certain Relationships and Related Transactions
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K
Signatures
FORWARD LOOKING STATEMENTS
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT ON FORM 10-K
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY. FACTORS THAT MIGHT CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
IN THE SECTION ENTITLED "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS." READERS SHOULD CAREFULLY REVIEW THE RISKS
DESCRIBED IN OTHER DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE
SECURITIES AND EXCHANGE COMMISSION, INCLUDING THE QUARTERLY REPORTS ON FORM 10-Q
TO BE FILED BY THE COMPANY IN 2002. READERS ARE CAUTIONED NOT TO PLACE UNDUE
RELIANCE ON THE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF
THIS ANNUAL REPORT ON FORM 10-K. THE COMPANY UNDERTAKES NO OBLIGATION TO
PUBLICLY RELEASE ANY REVISIONS TO THE FORWARD-LOOKING STATEMENTS OR REFLECT
EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS DOCUMENT.
PART I
Item 1. Business.
Overview
We design, manufacture, sell and support comprehensive service management
systems for providers and users of new world connectivity services. Our systems
combine software components, or agents, installed at key places in a network
with centralized software applications designed for performance monitoring,
real-time troubleshooting and network capacity planning. We manufacture and sell
hardware devices that embody these software agents as well as perform other
network infrastructure functions. Our products, Visual UpTime, Visual IP InSight
and Cell Tracer, provide network performance measurement and analysis that allow
network service providers to achieve the service levels required by their
subscriber customers and to lower operating costs associated with new world
networks. The availability of performance monitoring and troubleshooting
software agents also allows customers to verify service levels supplied by their
service providers and monitor traffic traversing their networks, a requirement
for many enterprises wishing to use public telecommunications services to carry
mission-critical data. These applications are essential to both service provider
and enterprise customers in generating revenue, attracting and retaining
customers, and maintaining a competitive position. We believe that our systems
are deployed in configurations managing up to 4,500 transport circuits and
Internet access for up to 1.5 million desktop computers.
We believe that we are a worldwide leader in providing service management
systems, having shipped systems for deployment on an aggregate of over 155,000
transport circuits and over 40 million desktops. We have developed relationships
with major service providers including AT&T, BellSouth, Earthlink, Equant,
Prodigy, SBC, Sprint, Verizon and WorldCom. These service providers either
resell our systems to their subscribers or integrate our systems into their
network infrastructure to enable them to offer enhanced network services. For
the year ended December 31, 2001, we had consolidated revenue of approximately
$74.2 million, of which 77% was attributable to service providers.
Vertical Systems Group, a leading industry analyst, estimates that
approximately 791,000 frame relay circuits and 51,000 ATM circuits will be
installed worldwide from 2002 through 2004. International Data Corporation, or
IDC, a leading industry analyst, estimates that the number of Internet capable
devices in the United States will grow from 306 million in 2002 to more than 786
million by 2006. The Yankee Group, another leading industry analyst, estimates
that the annual market for e-commerce and Web site implementation and management
services will grow from $370 million in 2000 to $850 million in 2003. Vertical
Systems estimates that worldwide frame relay and ATM service revenue will grow
from $12.3 billion in 2000 to $26.8 billion in 2004. To support these
applications and services, networks are growing in size and complexity. We plan
to apply our comprehensive product portfolio for service level performance
monitoring and troubleshooting to improve the quality and performance of these
networks so that they are suitable for mission critical applications. To take
advantage of the projected growth in these markets, we plan to continue to
expand our relationships with our service provider customers which together
account for the majority of Internet Protocol, or IP, network traffic worldwide.
Our company was incorporated in Maryland in August 1993 under the name
Avail Networks, Inc. and reincorporated in Delaware in December 1994 as Visual
Networks, Inc. Our principal executive offices are located at 2092 Gaither Road,
Rockville, Maryland 20850. Our telephone number is (301) 296-2300.
Industry Background
Wide Area Network Services Market
The Wide Area Network, or WAN, services market has grown rapidly with the
increase in computing and the associated data traffic volumes carried over WANs.
WAN services are used to interconnect the computing facilities of geographically
dispersed sites within an enterprise, to connect the computing facilities of one
enterprise to another and to allow remote users to utilize the enterprise
computing facilities. Businesses and other organizations are becoming ever more
dependent on data communications and the myriad of computers and devices that
facilitate data communications. We believe that WAN data traffic volumes will
continue to expand rapidly due to four key trends driving telecommunications
markets worldwide:
- proliferation of distributed computing applications such as electronic
mail, electronic transaction processing, enterprise resource planning and
inter-enterprise information transfer based on Web technologies;
- deregulation of the telecommunications services industry, which has
intensified competition and resulted in decreasing prices of WAN services;
- availability of high capacity fiber-optic networks and the emergence of
high bandwidth network access technologies that increase the ability to transfer
large volumes of electronic information; and
- rapid growth of remote applications that access enterprise resources such
as telecommuting and e-commerce, and the availability of broadband access
technologies that enable them.
Today's networks are deployed using a supply chain of various wholesale and
retail network service providers for network access, backbone transport and
hosting, including traditional telephone companies and new world broadband
network providers. These service providers may either be competing or
cooperating with one another to provide the complete connectivity service
solution to the ultimate customer, the enterprise. In this environment, a high
premium has been placed on network performance and availability. This results in
the need for tools that offer a consistent, reliable way to measure service
quality, end-to-end, across many ownership boundaries, vendors and types of
access media.
WAN Service Management Market Dynamics
Frame relay and ATM are the generally accepted technologies for corporate
backbone WANs. However, the use of IP technologies and networks to support
mission-critical applications is increasing. Telecommuters and field sales and
support people are dependent on remote access Virtual Private Networks, or VPNs,
to perform their jobs. In addition, mission-critical corporate applications and
e-commerce are being provided over corporate intranets and Internet
technologies.
The rapid proliferation of new technologies to deliver IP services adds to
the complexity of these services. For example, the Vertical Systems Group
predicts that the worldwide number of business and residential Digital
Subscriber Line, or DSL, subscribers will grow from 8.4 million in 2001 to 26.7
million in 2004. The combination of mission-criticality and the increased
complexity of managing multiple technologies causes difficulties for network
providers and their subscribers alike. The scarcity of skilled labor strains
enterprise information technology, or IT, staffs, causing the need for solutions
that can help to manage the complexity.
As a result, enterprises are delegating more responsibility to their
service providers. Both the service providers and their enterprise IT customers
need solutions to manage their out-sourced relationships. Service providers need
service management solutions for the myriad of new technologies that they are
deploying. IDC predicts that between 2001 and 2003 products explicitly focused
on managing IP services will experience an increase in popularity as service
providers seek to get the most out of their IP equipment investments.
The simultaneous increase in complexity and mission-criticality and the
dependence on service providers lead to opportunities for creating new
value-added services. Service providers, in a constant quest to protect margins
and retain customers, are aggressively competing on quality and other high-value
services such as bundled hosting services. Service providers must now provide
comprehensive service offerings across all of the pertinent technologies. This
convergence requires service management solutions that can manage across a wide
spectrum of services.
At the same time, economic conditions and fierce service price competition
have forced service providers to become intensely focused on improving their
margins through operational cost savings. As a result, service providers are
deploying systems and technologies that speed the resolution of customer trouble
tickets or prevent them altogether.
WAN Network Deployment
A typical WAN deployment supporting mission-critical applications includes
various types of customer premises equipment, or CPE, owned by the subscriber,
deployed at the subscriber's site and interconnected by the WAN service. It may
also include Web servers and applications that may be hosted at the customer
site or in a service provider's Web data center. The point at which the
subscriber CPE connects to the WAN service is known as the service demarcation
(the "demarc"), or the point where the service provider hands off the service to
the subscriber, and ultimately, is the point where the services are defined. The
subscriber is generally responsible for network performance on its side of the
demarc while the service provider is responsible for network performance on its
side of the demarc.
The equipment used for frame relay, ATM, IP and Internet services includes
both the access equipment located at the subscriber premises and the switches
located at the service provider's central office. Vertical Systems projects that
the market for this equipment will grow from approximately $10.3 billion in 2000
to approximately $14.2 billion in 2004. The equipment used for hosted services
includes firewalls, routers, content caches, servers and databases. IDC's
current forecast shows annual market revenue increasing from $4.8 billion at the
end of 2001 to nearly $20.8 billion by the end of 2006.
WAN Network Architectures
WAN services are provided through two network architectures, time division
multiplexing, or TDM, and statistical multiplexing. TDM services, such as
leased-line and integrated services digital network, or ISDN, rely on
architectures which provide dedicated circuits between computing facilities and
provide fixed bandwidth regardless of traffic flow. Unless information is
continuously transmitted, the dedicated bandwidth is often idle resulting in the
inefficient use of expensive bandwidth. The use of dedicated bandwidth does,
however, provide guaranteed throughput and fixed delay, ensuring high quality of
service for all network traffic. TDM services are suitable for the large
installed base of mainframe computing environments running mission-critical,
host-centric applications where the variability in traffic volume is low and the
traffic volume is relatively predictable. Statistical multiplexing technologies
and their derivative services are based on the concept of logical connectivity
and shared bandwidth which is dynamically allocated in real time according to
prevailing traffic patterns. As a result of this shared bandwidth, WANs based on
these statistical multiplexing services over private networks can be up to 50%
less expensive than WANs based on TDM services for distributed computing
applications. Because bandwidth in the WAN is shared among multiple subscribers,
however, these services are generally characterized by "best effort" throughput
and variable delay. WANs based on statistical multiplexing over the public
Internet using technologies such as VPNs can be quite inexpensive, but have the
least reliable performance. The challenge in each of these cases is to achieve
the cost savings and yet still provide network performance and availability
suitable for mission-critical applications.
Logical connectivity is provided via frame relay, ATM and public IP VPN, or
private IP VPN running over frame relay and ATM. Frame relay and ATM are the
predominant technologies used today for mission-critical applications. Private
IP VPN is rapidly emerging to broaden the scope of coverage. Vertical Systems
estimates that worldwide revenue for frame relay service, the most widely used
service, will grow at a compound annual growth rate of 19% from 2000 through
2004. The worldwide number of installed frame relay ports is projected to grow
from approximately 1.5 million in 2000 to more than 2.6 million in 2004. The
worldwide number of installed ATM ports is projected by Vertical Systems to grow
from approximately 26,400 in 2000 to approximately 87,700 in 2004.
There are many established and emerging technologies for accessing the
service provider's logical network. The predominant access technologies
facilitate dedicated service as well as traditional dial-up access over
traditional telephone networks. More recently, broadband access technologies
such as DSL, cable and fixed wireless are gaining momentum for branch and small
office/home office connectivity. At high capacity data centers, the use of
optical access to achieve extremely high transmission speeds is gaining
momentum.
The growth of logical connectivity services has resulted in increased focus
by subscribers on WAN service levels defined by parameters such as service
availability, throughput and delay. Because of the importance of
mission-critical applications such as enterprise resource planning, transaction
processing, work group collaboration, remote telecommuting, sales force
automation and electronic order entry, subscribers are demanding that their
service providers offer, guarantee and achieve higher service levels.
The proliferation of logical connectivity services has also resulted in
increased administrative costs for subscribers as network managers are
responsible for multiple networks consisting of older leased-line services as
well as multiple access and logical connectivity options. The high cost of
administering multiple networks coupled with the attractive pricing of logical
connectivity services is driving the need for subscribers to outsource some of
the service management to their service provider, without forfeiting control or
visibility of performance. Subscriber demand for multiple, guaranteed and
verified WAN service levels presents challenges to service providers that must
be able to offer these service levels while maintaining profitability.
When the complexity of the network supply chain is added to the complexity
of multiple technologies and derived service offerings, the result is the new
world of wide area networking, and it is often characterized by confusion and
chaos. The goal of new world service management solutions is to bring order to
the chaos while meeting the requirements of both the service providers and their
enterprise customers.
Where Service Provider and Enterprise Requirements Meet
Service providers want solutions that will enable the delivery of higher
performing services to the enterprise customers. Service providers want to
differentiate themselves by the quality and breadth of their service offerings.
They want to rapidly provision network services and troubleshoot network
problems without the costly effort of dispatching technicians. In this highly
competitive industry, service providers must be able to get services up and
running quickly. By being alerted to degradations of services before their
customers are affected, service providers ensure customer satisfaction with the
services, thereby reducing customer turnover. Subscribers demand high network
performance and want the appropriate tools to hold their respective service
providers accountable.
Both parties want returns on their network investments. Service providers
want to charge more for enhanced services and save on operations costs.
Enterprises want to optimize the performance of their network and minimize their
IT expenses. By optimizing network resources, service providers and enterprises
will be able to reduce the cost of downtime.
The requirements of the service provider and the enterprise meet at the
point of service delivery, the service demarc. Service Level Agreements, or
SLAs, are defined in terms of performance attributes such as average and peak
throughput, availability and delay. Service management solutions must provide a
representation of the service performance against their defining SLAs. In cases
where a service is not performing as defined, service level management becomes
the tool set for rapidly isolating problem conditions and enabling the
restoration of service performance to required levels. It is important to
understand that service-affecting conditions can arise in either the service
provider's or the subscriber's infrastructure. Effective service level
management software must be able to distinguish between the two and monitor the
performance of the network at the point of service delivery.
Problems Managing Networks Based on IP and the Internet
In leased-line environments, the performance, quality and maintainability
of the service are independent of the volume and type of traffic running over
the service. The diagnostic and measurement capabilities required to
sufficiently maintain these services are fairly simple and are focused largely
on physical transmission characteristics such as bit error rates or line coding
violations. These capabilities are widely available within the service
providers' facilities and work in conjunction with simplistic devices deployed
by the subscribers. By contrast, the performance, quality and maintainability of
logical connectivity services are highly dependent on the volume and type of
traffic running over the service. This extensive interplay between the
subscriber's data traffic and the service provider service requires
sophisticated diagnostic and measurement capabilities that not only analyze
physical transmission characteristics but the traffic itself. Historically, this
level of measurement and analysis capability has generally required the use of
expensive portable protocol analyzers, which are typically not deployed on a
continuous basis at the demarc. This inability to measure service performance
and quality has created the following difficulties for both subscribers and
service providers:
Suspect service levels inhibit subscriber acceptance of services.
Subscribers want to be continuously assured that logical connectivity services
are performing sufficiently to support mission-critical applications. As the
demand for higher service levels and multiple service levels has increased,
subscribers and their service providers need a mechanism to measure, verify and
improve service levels.
Operational cost models are not scaleable. The inability to
cost-effectively measure performance at the demarc, and thereby demonstrate to
subscribers the WAN service level being provided, results in service providers
requiring many highly skilled personnel to provision and operate logical
connectivity services. This cost is exacerbated by the gap between the high
demand for and limited supply of trained personnel. The implication of this
model is that operating costs are driven up and service providers' WAN service
businesses are not scaleable to the levels required to generate the necessary
economies of scale. The specific areas of concern are:
-Inefficient service provisioning. The service provider has difficulty
determining whether the WAN service is properly deployed until the subscriber's
network has been connected to the service and the subscriber's applications are
operational. This often results in multiple dispatches of personnel to the
subscriber site and extensive interaction with the subscriber for its equipment
and applications to be configured properly. The service provider is typically
restricted from billing the subscriber for the service until the subscriber's
applications are working properly over the service.
-Extensive troubleshooting and high maintenance. When subscribers
experience degraded network performance, they generally assume there is a
problem with the service supplied by their service provider. It can often take
days, weeks or even months to diagnose the causes of degraded performance
requiring highly skilled personnel with sophisticated instrumentation and
diagnostic tools. Although these degraded performance conditions are frequently
caused by faulty or misconfigured subscriber equipment or applications, the
service provider is forced to expend significant time and effort without
reimbursement to help diagnose the problem.
-Inaccurate network engineering and planning. The shared bandwidth nature
of WAN services coupled with subscriber demand for many class of service levels
increases the importance of accurate network planning and design to ensure that
the network architecture is optimized for performance and cost. If the network
is engineered with excess capacity, it may improve the performance of subscriber
applications, but it will tend to negate the inherent bandwidth efficiencies of
logical connectivity technologies. By contrast, if the network is designed with
inadequate capacity, performance will suffer. Successful network engineering and
planning is dependent on accurate historical usage information which, because of
the inability of traditional equipment to measure traffic at the demarc, is
difficult to ascertain for these services.
We believe that an essential element of logical connectivity services being
demanded by subscribers is the ability to manage and verify service levels. We
believe that service providers will experience difficulty meeting the increasing
demand for logical connectivity services without having systems for managing
service levels. The labor-intensity of provisioning and maintaining the service
inhibits the service providers' ability to scale the WAN services profitably
without service level management capability. As the service providers' focus
shifts to profitability, the growth in frame relay, ATM, IP and Internet
services will depend, in part, on the ability of service providers to implement
systems that can manage service levels, lower operational costs and increase
scalability.
The Visual Networks Solution
We offer a market-leading family of WAN service level management systems
that combine WAN access functionality with planning, monitoring and
troubleshooting capabilities that enable customers to implement required service
levels while simultaneously decreasing the costs and complexity of achieving the
levels. Our systems measure and analyze network performance at the demarc
through innovative software applications that address the historical problems of
managing service levels. Our service management systems apply to services that
account for 90% of wide area connectivity. Our systems also provide service
management for hosted application services. We believe that our systems offer
customers the following benefits:
Increased confidence in service levels. Our systems enable service
providers and their subscribers to accurately measure, report on and improve
service levels. These abilities serve to clarify the relationship between
subscriber and service provider, resulting in increased subscriber confidence in
running mission-critical computing applications on these services.
Increased scalability and lower costs of service providers' and
subscribers' operational models. Our systems can reduce the labor-intensive
nature of deploying logical connectivity services, thereby decreasing both
service providers' and subscribers' costs and increasing their ability to
generate revenue, by enabling:
-Rapid and cost-effective service provisioning. Our systems allow the
service provider to verify that its service is properly provisioned without
waiting for the subscriber network or applications to be connected and
configured. This tends to reduce customer support costs during initiation of
service and allows the service provider to begin billing for the service earlier
than was previously possible.
-Reduced need for reactive troubleshooting. Our systems reduce the need
for service providers to perform troubleshooting after the fact, by continuously
monitoring network performance at the demarc and proactively alerting the
service provider and subscriber to anomalous performance characteristics. These
early warnings allow the network operator to take corrective action before the
performance of any application on the network is impaired. Because many of the
anomalous characteristics are subscriber-related, the subscriber is more likely
to take corrective action without involving the service provider. The net result
is that fewer maintenance personnel are required to solve fewer problems,
thereby increasing service provider efficiency and subscriber satisfaction.
-More rapid and less costly troubleshooting. Because our systems provide
information that enables isolation of problems between the service provider
network and subscriber equipment and applications, the service provider can more
quickly diagnose the cause of faulty or degraded performance. Many problems that
would otherwise last for days and require on-site visits of highly skilled
personnel can be diagnosed remotely within minutes by our systems. Because our
systems are designed to allow both the service provider and the subscriber to
access the same reports and analyses simultaneously, more problem conditions can
be resolved collaboratively.
-Reduced impact of problem conditions. Our systems automatically identify
applications and users that are effected by problem conditions. This enables
maintenance personnel to attack those problems that have the largest business
impact first, thus reducing the overall business impact of faults.
-More accurate network engineering and planning. Our systems continuously
provide an accurate and detailed view of historical WAN service usage patterns
along with automated guidance regarding the need to change circuit capacities.
This allows subscribers and service providers to implement a network design
optimized for cost and performance.
The Visual Networks Strategy
Our overall strategy is to maintain and build upon our market leadership in
the deployment of WAN service level management systems for networks based on IP
and the Internet. Key elements of our strategy include:
Capitalizing on our strong incumbency position with major service
providers. We have an outstanding customer list of top-tier service providers,
including AT&T, BellSouth, Earthlink, Equant, Prodigy, SBC, Sprint, Verizon and
WorldCom. These service providers have standardized many of their offerings
around our service management solutions. The Visual Networks brand is well
recognized and highly respected in this community. As the financial condition of
many of the emerging carriers has weakened, we have seen a flight to quality and
stability in the communications services market that will benefit our
traditional customer base. Because of the requirement to provide complete
services solutions regardless of the underlying technology, we believe that
these well-capitalized service providers are in the best position for long-term
success and will be the driving force behind converged service offerings. We
intend to capitalize on these relationships to expand market coverage and
introduce new features and functions.
Deploying our systems as part of service provider networks. We believe that
service providers will become the predominant means for the deployment of
service management systems. Although these systems can be deployed by either
service providers or subscribers, we believe that maximum benefit is usually
achieved when the systems are deployed by the service providers supplying
subscribers with access to performance data. In this deployment model, service
providers can employ collaborative fault and performance management techniques
that lead to greater network quality. More important, we believe the benefits of
lower provisioning and maintenance costs are generally most effectively captured
if the system is deployed by the service provider.
Embedding agent technology in the equipment of other manufacturers. In
order to fully instrument the network and achieve the highest possible port
penetrations of our management capabilities on both new and previously deployed
services, we are partnering with leading manufacturers of access equipment to
embed our agent technology into their systems. To this end, we have entered into
strategic partnerships with Cisco Systems and Kentrox. Cisco Systems has
embedded our agent technology into the operating system software (IOS) of its
router products and made other system software improvements to support tight
interoperability with the Visual UpTime back office system. Likewise, Kentrox
has embedded our agent technology into its ATM access concentrator product line.
Visual Networks will receive license revenue from the end customers that use
Visual UpTime to manage these agents.
Extending our technology leadership. We believe a combination of
technological competencies have been crucial to our success. These competencies
include network analysis technology and its application to the effective
operation of WANs, the integration of network analysis with WAN access
technology and collaborative subscriber/service provider system architectures.
We continue to invest in our core competencies by focusing on feature
development, architectural enhancements and cost reductions. We intend to
continue to invest in the development of our systems, with particular emphasis
on features and architectural improvements designed to accommodate large-scale
deployment by service providers. This includes leveraging our current remote
access, frame relay, ATM, IP and Internet technologies to provide customers with
a single vender solution for end-to-end service level management as well as to
address emerging opportunities such as VPNs.
Deploying our systems to support e-commerce and application hosting. We
believe that our systems for e-commerce and Web-hosting applications will be
deployed predominantly for performance management of Intranet and Web-based
services. Used in conjunction with other types of management systems, our
systems can significantly improve network availability for key business users
and applications.
Expanding our business globally. Many of our largest service provider and
subscriber customers are multinational corporations. We intend to develop a
presence outside of the U.S. with particular focus on the service providers that
have the largest share of the worldwide markets for remote access, frame relay,
ATM, IP and Internet services.
Products
Visual UpTime
Visual UpTime is the de facto standard for service management of frame
relay and ATM networks. This complete service management system helps users
optimize network performance and reduce overall costs of network ownership.
Visual UpTime won Network World's Best of Test award for the best WAN
management product of 2000. The award was based on customer reviews conducted
throughout the year. Also, Visual UpTime 7.0, our latest release, was selected
as a Finalist for the ComNet New Product Achievement Award in January 2002.
Visual UpTime is a service level management system consisting of analysis
service elements, or ASEs, performance archive managers, or PAMs, and platform
applicable clients, or PACs, that perform data collection, data interpretation
and presentation. By intelligently monitoring network-wide performance, Visual
UpTime enables users to track and solve service level problems either on the
subscriber or service provider side of the demarc.
ASE. The ASE is a combination of embedded proprietary software and hardware
that performs detailed analysis of network performance at the demarc. Most
versions of the ASE provide the functionality of WAN access equipment, such as a
DSU/CSU. Visual UpTime ASEs use sophisticated proprietary software in
conjunction with networking-specific microprocessors and integrated circuits to
perform detailed analysis of every bit, frame and packet traversing the demarc.
The ASEs generally store the analysis results locally in memory and wait for the
PAM to request the results. When the ASE detects an anomalous condition, it
sends an unsolicited alert to the PAM so that network operators can take prompt
action. Depending on customer requirements, our core ASE technology can be
deployed in a number of configurations based on physical circuit speed, number
of virtual circuits supported, type of access functionality and the local area
network environment.
PAM. The PAM is the system database and request broker between the PACs and
either the database or ASEs. Unlike traditional data transfer management
architectures which depend on continuous polling between the manager (PAM) and
agents (ASEs), a bandwidth consuming process, Visual UpTime distributes most of
the processing burden to the ASE, allowing the PAM-ASE data sharing to take
place less frequently, typically once a day. This feature is critical in WAN
environments where costly bandwidth makes continuous management polling
impractical.
PAC. The PAC is Visual UpTime's client software for packaging and
presenting information stored in the PAM and ASE. Multiple PACs may access a
single PAM or ASE. The PAC includes three integrated toolsets:
-Performance monitoring. This toolset is an early warning system, alerting
network operators to impending service degradation that allows corrective action
to be taken before the subscriber's application performance degrades. This
toolset displays network performance related events and alarms. The performance
monitoring toolset is tightly linked to the troubleshooting toolset, allowing an
operator to evaluate quickly and precisely the conditions that caused the event
or alarm.
-Troubleshooting. This toolset enables an operator to rapidly perform
detailed diagnostics to identify the cause of service level problems. This
toolset displays real-time and historical network performance statistics. The
troubleshooting toolset includes a protocol capture and analysis capability used
by network operators to isolate problems arising from the interplay between a
subscriber's CPE or applications and the WAN service.
-Planning and reporting. This toolset is a report generation tool that
creates a wide variety of reports from the network performance data stored in
the PAM. This toolset is used primarily for capacity planning and network
engineering, management of service level agreements between service provider and
subscriber and executive reporting from the network operations staff to senior
management personnel. The planning and reporting toolset is accessible through a
PAC or a Web-browser.
The Visual UpTime components are sold as a complete system which requires
at least one PAC/PAM per deployment along with one ASE deployed at the demarc of
each circuit on which service level management is required. We believe the
system is currently deployed in configurations managing up to 4,500 transport
circuits. System pricing varies by size of deployment and relative mix between
circuit speeds.
Visual IP InSight
Visual IP InSight is a WAN service management system for remote access
network technologies utilizing IP and the Internet. It helps both service
providers and enterprises provide the highest quality IP services to their
customers. Visual IP InSight helps operations managers, network managers and
customer care (help desk) personnel proactively manage the complete service
experience whether it is for a service subscriber or an internal enterprise
user. Visual IP InSight has also become a cornerstone for credible SLA offerings
of Internet service providers. Visual IP InSight won Internet Telephony
magazine's Product of the Year Award for 2001 in the category of Performance
Monitoring, Network Management and Quality of Service from a field of over 150
entrants.
The product includes three software applications:
-IP InSight Service Operations. This function provides information
regarding problems in real-time and monitors performance of IP applications,
such as e-mail and domain name system using metrics such as availability,
throughput, latency and packet loss.
-IP InSight Customer Care. This feature allows customer care personnel to
call up a customer's history of network connections and PC configurations.
-IP InSight Service Level Manager. This function makes it easy to define,
monitor and administer SLAs. Its unique tools also map users to their specific
services, service providers and SLAs.
System components for Visual IP InSight include agents, data collectors and
a data repository. These components communicate with each other over an IP
network providing a steady stream of real-time information. Visual IP InSight's
architecture is distributed and fault-tolerant, and it scales to carrier class
networks.
The system's agents are the origin of quality-of-service and test data.
There are two types of agents: dedicated agents and client agents. Dedicated
agents are software that is embedded in hardware devices called IP Service
Elements, or ISEs, that are connected to the network at suitable monitoring
points. ISEs perform active tests on command as configured by the network
manager. Client agents are software that is installed on the PCs of service
subscribers. It runs transparently until end-user help is required.
Context-sensitive online help suggests solutions to more than 150 dial-access
problems and keeps a descriptive error log that customer care personnel can use
to solve problems that end users cannot resolve on their own. In parallel, the
client agent can passively monitor user activity on the network or perform
active tests when requested by the network manager. The client agent can be
deployed in any remote access environment: dial modem, cable modem, Digital
Subscriber Line, ISDN or wireless service. All varieties of dedicated agents and
client agents can be used together in the same network with the same IP InSight
systems.
Visual IP InSight Collectors collect data from the various agents and send
it to the back-end database. A collector can be deployed either behind a
firewall or in key points in the public IP network, and a single collector can
handle hundreds of thousands of active agents.
Visual IP InSight Aggregators are servers positioned at key locations in
the network or data center. Collectors pass the client agent and service agent
data they have collected to one or more aggregators for data validation and
loading into various data repositories. All of the performance data gathered is
stored in a high performance relational database. Data is presented using a
secure web interface, allowing detailed information on the performance of the
network and applications to be quickly distributed throughout an organization or
between customers and partners.
Cell Tracer
Our network analyzer product, Cell Tracer, is a combination of embedded
proprietary software and hardware and Microsoft Windows presentation software
that performs detailed analysis of network performance on ATM circuits. The
Windows software, running on a Pentium-based computer, connects either locally
or remotely to the hardware to perform detailed analysis of every bit, cell and
packet traversing the ATM circuit. Cell Tracer is designed to meet both the
network monitoring and troubleshooting needs of field support personnel and the
centralized operational needs for supporting remote ATM circuits. Depending on
customer requirements, Cell Tracer can be utilized in a number of configurations
based on physical circuit speed, access line type and monitoring applications.
The Visual Networks Selling Strategy
We implement a push - pull sales strategy where market demand is generated
by marketing programs, cultivated by the direct sales force and fulfilled by
channel partners. The channel partners are traditional service providers, such
as AT&T, Equant, Sprint and WorldCom and the traditional local telephone
companies; emerging service providers, including ISPs and competitive
telecommunications providers; value added resellers, or VARs; and system
integrators.
In our sales model, marketing activities generate subscriber demand through
a variety of focused marketing programs. The result of this demand generation
activity is a set of qualified leads that are cultivated by our direct field
sales force or our inside sales force depending on the size and complexity of
the opportunity. Direct sales drives the opportunity towards closure by applying
Visual systems to the prospective customer's network environment and describing
the associated value proposition, typically a lengthy process. Upon completion
of these steps, direct sales will determine the prospect's preferred fulfillment
channel and steer the opportunity through that channel. Direct sales will remain
engaged until the demand is satisfied.
We have several fulfillment channels. Customer requirements may be met
through the subscription to a service provider's managed service that embeds our
technology, or by the acquisition of our products from a service provider or
VAR. Demand could also be fulfilled by a system integrator or service provider
partner who provides out-sourced, or hosted, management services using
our technology.
The development of a service provider service based on our technology is a
complex sale to multiple departments within a service provider's organization.
We work with the service provider to develop a service definition and business
plan for the integration of Visual products into the service provider's existing
service.
We provide pre-sale technical support to each of our channels. The time
required to develop a relationship with a channel partner can take from two to
12 months for VARs and system integrators, and from 12 to 24 months for service
providers. The sales cycle for subscriber deployment through an established
channel is typically four to six months long.
We have sales and technical support teams assigned to each major service
provider account. In addition, our senior management team devotes significant
time furthering the business relationships with these service providers and we
invest significant marketing resources to stimulate sales with these service
providers.
As of December 31, 2001, we employed 87 people in sales and marketing. Our
expenditures for sales and marketing activities were approximately $24.4 million
in 1999, $41.9 million in 2000 and $33.5 million in 2001.
Product Development
We have developed core competencies in network analysis technology and its
application to the effective operation of WANs, the integration of network
analysis with WAN access technology and collaborative subscriber/service
provider system architectures.
We have made significant investments in system architecture and feature
development. Through the acquisitions of Net2Net Corporation, Inverse Network
Technology and Avesta Technologies, Inc., we accelerated the pace of product
development in order to provide customers with a single vendor solution for
end-to-end service encompassing frame relay, ATM, IP and the Internet. We will
continue to expand Visual UpTime for managing frame relay, ATM or IP
connectivity over broadband access services. We will continue to expand Visual
IP InSight for broadband access technologies as well. We are focused on the
further enhancement and refinement of our systems, including the development of
the architectural scalability that will be required for wide-scale
implementation through the service provider deployment model. Additionally, we
expect to invest in system refinements that will increase the economic benefit
of deployments outside North America.
As of December 31, 2001, there were 59 persons working in our research and
development area. Our research and development expenditures were approximately
$16.7 million in 1999, $27.3 million in 2000 and $19.3 million in 2001.
Customers
Since mid-1996, we have developed business relationships, currently at
different levels of maturity, with a number of service providers, including
AT&T, BellSouth, Earthlink, Equant, Prodigy, SBC, Sprint, Verizon and WorldCom.
Sales of products or services to AT&T, Sprint and WorldCom accounted for 29%,
14% and 10%, respectively, of consolidated revenue for 2001.
AT&T Relationship. In December 1997, we entered into a non-exclusive
procurement agreement with AT&T. The agreement had an initial term of three
years and has automatically renewed with the right by either party to terminate
the agreement upon 30 days' notice. Prices and discounts for all equipment
purchased by AT&T are fixed, except in certain limited circumstances. The
equipment carries a five-year warranty. If we offer more favorable prices and
terms to any other customer for the same quantity of products during the term of
the agreement, we are obligated to amend the agreement to provide AT&T with the
same or comparable overall terms. The agreement does not obligate AT&T to make
any minimum purchases from us. We also provide certain support services to AT&T.
WorldCom Relationship. In August 1997, we entered into a non-exclusive
three-year reseller agreement with WorldCom, which has automatically renewed for
a second one-year term. Prices and discounts for all equipment purchased by
WorldCom are fixed. The equipment carries a five-year warranty. If we offer more
favorable prices to any other customer for the same quantity of products
purchased over a similar period of time, we are obligated to adjust the pricing
to WorldCom to the more favorable price. The reseller agreement does not
obligate WorldCom to make any minimum purchases from us.
Sprint Relationship. In May 2000, we entered into a new non-exclusive
three-year reseller agreement with Sprint, in effect extending the basic terms
of our earlier agreement with Sprint made in August 1996. Prices for all
equipment purchased by Sprint are fixed for the term. The equipment carries a
five-year warranty. If we offer more favorable prices and terms to any other
customer during the term of the agreement, such terms and prices will be
applicable to Sprint's orders. The reseller agreement does not obligate Sprint
to make any minimum purchases from us. We also provide certain support services
to Sprint.
Equant Relationship. In June 2001, we entered into a non-exclusive one-year
reseller agreement with Equant. Prices and discounts for all equipment purchased
by Equant are fixed, except in certain limited circumstances. The equipment
carries a five-year warranty. If we offer more favorable prices to any other
customer purchasing in the same or lesser volumes and upon the same terms during
the term of the agreement, such prices will be applicable to Equant's orders.
The agreement does not obligate Equant to make any minimum purchases from us. We
also provide certain support services to Equant.
Strategic Partnerships
An increasingly important means for us to achieve our goals is through
strategic partnerships. Our agent software technologies need to reside on
hardware devices that are attached to the network in locations that are
interesting to monitor and analyze, such as the demarcation point. While we have
developed and sold various devices for this purpose and will continue to do so,
fully meeting our customer's requirements for broad and cost effective support
of myriad access technologies requires that we also expand our agent deployment
through devices produced by other vendors. These partnerships will generally
involve transfer of our proprietary technology under license, significant
development activities on the part of one or both partners, as well as joint
sales, marketing and support activities.
Cisco Systems Relationship. In December 2000, we entered into an
interoperability and marketing agreement with Cisco Systems, Inc. to provide
Cisco customers with integrated access solutions.
Kentrox Relationship. In October 2000, we entered into a development and
licensing agreement with ADC Telecommunications, Inc. to deliver a comprehensive
ATM managed service solution to Kentrox customers.
Competition
The markets for telecommunications equipment and software are intensely
competitive. Our products integrate key functionality traditionally found in
five distinct market segments: the WAN access equipment market; the bandwidth
management equipment market; the network test and analysis market; the market
for operational support systems, or OSSs; and the market for client-based
network management and Internet infrastructure testbeds. We believe that our
products are the only systems that integrate functional attributes from all
these market segments to cost-effectively provide WAN service level management.
Because of the size and growth opportunity associated with the WAN service level
management market, we expect to encounter increased competition from current and
potential participants in each of these segments. Increased competition may
result in price reductions, reduced profitability and loss of market share, any
of which would have a material adverse effect on our business, financial
condition and results of operations.
WAN access equipment. The WAN access equipment market is highly fragmented.
Leading vendors in this segment include Kentrox, Paradyne and Adtran. These
companies may partner with companies offering network test and analysis products
in order to compete in the WAN service level management market. We are aware of
such an arrangement between Paradyne and NetScout Systems. Internetworking
providers may integrate WAN access functionality with routers, which may
adversely affect Visual UpTime's cost justification. We are working to mitigate
this risk and turn it to our advantage through a partnership with Cisco Systems
whereby our product's agent capabilities have been integrated into such products
and the cost justification is actually improved.
Bandwidth management equipment. There exists a class of devices whose
primary purpose is to adjust the flows of customer traffic into the network to
improve the perceived performance of the networking services. To understand and
manage the traffic flows, these devices must provide a certain degree of
functionality which is also found in performance management systems. The major
supplier in this market segment is Packeteer.
Network test and analysis. An essential element of a WAN service level
management system is technology and expertise associated with network test and
analysis. Products in this market include portable and distributed protocol
analyzers and transmission test instruments. The major suppliers in this market
segment are Network Associates, Agilent Technologies, Acterna, Fluke, Spirent
and NetScout.
Telecommunications operational support systems. OSSs encompass all of the
systems related to service deployment including provisioning systems, billing
systems, trouble-ticketing systems, and fault and performance management
systems. Historically, OSSs have been developed by the in-house staffs of the
service providers and have sometimes been a source of competitive advantage to
service providers. A number of vendors also produce suites of OSS components for
the service provider market. Major vendors in the OSS components market include
Telcordia, Agilent, Amdocs and Narus. Visual UpTime provides a significant
portion of the functionality that might otherwise be found in a fault and
performance management system for statistically multiplexed WAN services.
However, in some cases, a service provider may consider in-house development as
an alternative to deployment of Visual UpTime.
Client-based network management and Internet infrastructure test-beds. An
emerging trend in network management is increased emphasis on visibility of
actual user experience. Installing clients on end user desktops is a
particularly effective way to gather this type of data. This technology can be
deployed either as a service offering using simulated desktops or sold as
standalone software.
Major suppliers of standalone software include Lucent Technologies, NetIQ,
Concord, Jyra Research and NetScout Systems. Major suppliers of service-based
solutions include Keynote Software and Northgate Information Solutions.
We intend to compete by offering superior features, performance,
reliability and flexibility at competitive prices. We also intend to compete on
the strength of our relationships with service providers. As competition in the
WAN service level management market intensifies, we believe that the industry
may be characterized by price competition similar to that present in the broader
networking market. In response to competitive trends, we expect to continue to
reduce the cost of our systems in order to avoid a deterioration of gross
margins.
Manufacturing
We have moved to a predominately out-sourced manufacturing model in order
to achieve significant scalability. We are ISO 9001 certified for design,
development and manufacturing of WAN Service Management Systems (hardware and
software) in our Rockville, Maryland facility. We have not experienced any
significant delays or material unanticipated costs resulting from the use of
subcontractors; however, such a strategy involves certain risks, including the
potential absence of adequate capacity and reduced control over delivery
schedules, manufacturing yields, quality and costs. Although we attempt to
maintain appropriate back-up suppliers, in the event that any significant
subcontractor was to become unable or unwilling to continue to manufacture
and/or test our products in required volumes, we would have to identify and
qualify acceptable replacements. This qualification process could be lengthy and
no assurance could be given that any additional sources would become available
to us on a timely basis. A delay or reduction in component shipments, or a delay
or increase in costs in the assembly and testing of products by third party
subcontractors, could materially and adversely affect our business, financial
condition and results of operations.
Although we generally use standard parts and components for our products,
several key components are currently purchased only from sole, single or limited
sources. Any interruption in the supply of these components or the inability to
procure these components from alternate sources at acceptable prices and within
a reasonable time could have a material adverse effect upon our business,
financial condition and results of operations.
Patents and Other Intellectual Property Rights
We presently have four patents issued in the United States: (i) a "Method
and Apparatus for Non-Intrusive Measurement of Round Trip Delay in
Communications Networks", which expires in May 2015; (ii) a "Method and
Apparatus for Measurement of Peak Throughput in Packetized Data Networks", which
expires in November 2016; (iii) a "Method and Apparatus for Performing Service
Level Analysis of Communications Network Performance Metrics", which expires in
November 2018; and (iv) a "Method and Apparatus for Performing In-Service
Quality of Service Testing", which expires in December 2017. Additionally, we
have been notified by the United States Patent and Trademark Office that our
application for a patent on a 'Method and Application for Dynamic Modeling of
Complex Networks and Prediction of Impacts of Faults Therein' has been allowed
and should be issued shortly. We also have a number of patent applications
pending in the United States and our key foreign markets. No assurance can be
given that competitors will not successfully challenge the validity or scope of
our patents or that such patents will provide a competitive advantage to us.
We expect that software and communications product developers will
increasingly be subject to claims of infringement of patents as the number of
products and competitors in our industry segment grows and the functionality of
products in the industry segment overlaps. We are not aware that any of our
products infringe the property rights of third parties.
In October 1997, a lawsuit was filed against Avesta and one of its
employees alleging infringement of two patents, unfair competition, breach of
contract and interference with contractual relations resulting in unjust
enrichment. See Item 3 for additional disclosure.
As part of our confidentiality procedures, we generally enter into
non-disclosure agreements with our employees, business partners and customers
with respect to our software, documentation and other proprietary information.
Despite these precautions, it may be possible for a third party to copy or
otherwise obtain and use our products or technology without authorization, or to
develop similar technology independently. Policing unauthorized use of our
products is difficult. Effective protection of intellectual property rights is
unavailable or limited in certain foreign countries. There can be no assurance
that protection of our proprietary rights will be adequate or that our
competitors will not independently develop similar technology, duplicate our
products or design around any of our patents or other intellectual rights.
Employees
As of December 31, 2001, we had 210 full-time employees, including 59 in
product development, 78 in sales, 9 in marketing, 12 in manufacturing, 9 in
customer service and 43 in finance, centralized services and administration.
Our future success will depend in significant part on the continued service
of our key technical, sales and senior management personnel. Competition for
such personnel is intense and there can be no assurance that we can retain our
key managerial, sales and technical employees, or that we can attract,
assimilate or retain other highly qualified technical, sales and managerial
personnel in the future. None of our employees are represented by a labor union.
We have not experienced any work stoppages and consider our relations with our
employees to be good.
Item 2. Properties.
Our principal administrative, sales and marketing, research and development
and customer support facilities are located in approximately 75,000 square feet
of office space in Rockville, Maryland, that we occupy under leases that expire
in December 2006. A third party currently occupies approximately 10,000 square
feet of this space under a sublease that expires in October 2002.
Item 3. Legal Proceedings.
In July, August and September 2000, several purported class action
complaints were filed against us and certain of the our former executives, these
complaints have since been combined into a single consolidated amended complaint
(the "complaint"). The complaint alleges that between February 7, 2000 and
August 23, 2000, the defendants made false and misleading statements which had
the effect of inflating the market price of our stock, in violation of Sections
10(b) and 20 (a) of the Securities Exchange Act of 1934. The complaint does not
specify the amount of damages sought. We believe that the plaintiffs' claims are
without merit and intend to defend against these allegations vigorously. We have
filed a motion to dismiss the complaint, which is now pending before the court.
We anticipate that a substantial portion of the legal costs that we might incur
related to this matter will be paid by our directors' and officers' insurance
policy. We cannot presently determine the ultimate outcome of this action. A
negative outcome could have a material adverse effect on our financial position
or results of operations. Failure to prevail in the litigation could result in,
among other things, the payment of substantial monetary or punitive damages.
In October 1997, a lawsuit was filed against Avesta and one of its
employees alleging infringement of two patents, unfair competition, breach of
contract and interference with contractual relations resulting in unjust
enrichment. Avesta answered the complaint, denying all allegations, and also
asserted counterclaims against the plaintiff for patent misuse, unfair
competition and interference with business and patent invalidity. Pursuant to an
agreement between the parties, on June 13, 2001, the court dismissed the action
without prejudice, preserving to the parties the right to refile the action
pending future developments of the Visual Trinity product.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5. Market for Our Common Stock and Related Stockholder Matters.
Our common stock is traded on the Nasdaq National Market under the symbol
"VNWK." The following table sets forth, for the indicated periods, the range of
high and low closing per share sales prices for the common stock as reported on
the Nasdaq National Market.
High Low
---- ---
2000
----
First Quarter ............................ $ 83.50 $ 50.31
Second Quarter ........................... 60.50 24.31
Third Quarter ............................ 26.75 5.88
Fourth Quarter ........................... 6.94 2.03
2001
----
First Quarter .............................. $ 6.53 $ 2.50
Second Quarter ............................. 8.75 3.03
Third Quarter .............................. 8.61 2.12
Fourth Quarter ............................. 4.62 1.77
2002
----
First Quarter (from January 1, 2002 through
March 28, 2002) ......................... $ 4.94 $ 2.94
On March 28, 2002, the last reported sale price of our common stock was
$2.94 per share. As of March 28, 2002, we had approximately 538 stockholders of
record.
We have never paid or declared any cash dividends on our common stock. It
is our present policy to retain earnings, if any, to finance the growth and
development of the business and, therefore, we do not anticipate declaring or
paying cash dividends on our common stock in the foreseeable future.
Item 6. Selected Consolidated Financial Data.
The selected consolidated financial data below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements, notes
thereto and other financial information included elsewhere in this Form 10-K.
The selected consolidated financial data as of and for the years ended December
31, 1999, 2000 and 2001, are derived from our consolidated financial statements
which have been audited by Arthur Andersen LLP, independent public accountants.
The selected consolidated financial data for the years ended December 31, 1997
and 1998 is derived from audited consolidated financial statements not included
in this Form 10-K.
Years Ended December 31,
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
(in thousands, except per share data)
Consolidated Statement of Operations Data:
Revenue................................... $ 29,300 $ 56,088 $ 91,719 $ 89,041 $ 74,248
Cost of revenue........................... 11,179 20,829 30,888 32,515 29,431
------ ------ ------ ------ ------
Gross profit.......................... 18,121 35,259 60,831 56,526 44,817
Operating expenses:
Research and development.............. 9,148 13,771 16,677 27,277 19,320
Write-off of in process research and
development(1)...................... - - - 39,000 -
Sales and marketing................... 14,555 19,759 24,447 41,907 33,484
General and administrative............ 3,798 5,528 7,928 11,247 8,895
Merger-related costs(2)............... - 4,318 6,776 - -
Restructuring and impairment charges(3) (4) - 751 - 335,810 9,328
Amortization of acquired intangibles(1) - - - 53,426 805
------- ------- -------- ------ --------
Total operating expenses......... 27,501 44,127 55,828 508,667 71,832
Income (loss) from operations............. (9,380) (8,868) 5,003 (452,141) (27,015)
Interest income, net...................... 165 2,413 2,270 2,598 325
--- ----- ----- ----- ---------
Income (loss) before income taxes......... (9,215) (6,455) 7,273 (449,543) (26,690)
Benefit (provision) for income taxes...... - - (3,722) 34,058 (272)
------- ------- ------ ------ ---------
Net income (loss)......................... (9,215) (6,455) 3,551 (415,485) (26,962)
====== ====== ===== ======== =======
Dividends and accretion on preferred stock (1,457) (171) - - -
Net income (loss) attributable to common
stockholders............................ (10,672) (6,626) 3,551 (415,485) (26,962)
Basic earnings (loss) per share........... (1.44) (0.30) 0.14 (14.46) (0.85)
Diluted earnings (loss) per share......... (1.44) (0.30) 0.13 (14.46) (0.85)
Basic weighted-average shares(5).......... 7,431 21,946 24,583 28,733 31,585
Diluted weighted-average shares(5)........ 7,431 21,946 26,547 28,733 31,585
Consolidated Balance Sheet Data:
Cash and cash equivalents................. 9,601 51,655 54,629 17,369 5,921
Working capital........................... (782) 43,146 50,353 (2,482) (6,576)
Total assets.............................. 21,036 71,780 83,154 74,057 28,902
Long-term debt, net of current portion.... 138 1,011 782 243 -
Redeemable convertible preferred stock.... 14,855 - - - -
Stockholders' equity (deficit)............ (13,251) 48,322 58,252 26,085 (515)
(1) In 2000, we acquired Avesta in a purchase business combination. The
purchase price allocation included $39.0 million of in-process technology which
was expensed as of the acquisition date. The amortization of acquired
intangibles in 2000 and 2001 relates to goodwill and other intangible assets
recorded in connection with the Avesta acquisition. See Notes 1 and 5 of Notes
to Consolidated Financial Statements.
(2) During 1998, we incurred certain merger-related costs in connection
with our acquisition of Net2Net Corporation. During 1999, we incurred certain
merger-related costs in connection with our acquisition of Inverse Network
Technology. See Note 1 of Notes to Consolidated Financial Statements.
(3) In 1998, we recorded a restructuring charge related to the
consolidation of certain functions and the discontinuation of certain product
development efforts related to the acquisition of Net2Net. In 2000, we recorded
a restructuring charge of $7.0 million that consisted primarily of severance and
other termination benefits related to a workforce reduction and lease costs and
associated leasehold improvement write-offs related to the closure of certain
facilities. In the second quarter of 2001, we reversed $723,000 of the
restructuring charge recorded in the fourth quarter of 2000 resulting primarily
from lower than estimated lease costs. In the second quarter of 2001, we also
recorded a restructuring charge of $3.9 million that consisted primarily of
employee termination costs including severance and other benefits, lease costs
and associated leasehold improvement write-offs related to the closure of
certain facilities resulting from the discontinuation of the Visual Trinity
product, other contractual obligations and the write-off of an investment.
During the fourth quarter of 2001, we reversed $1.2 million of the restructuring
charge recorded in the second quarter of 2001 due to lower than estimated,
facility closure costs and other contractual obligations. During the fourth
quarter of 2001, we also recorded a restructuring charge of $385,000 that
consisted of severance and other termination benefits related to a workforce
reduction. See Notes 1 and 6 of Notes to Consolidated Financial Statements.
(4) In 2000, we recorded an impairment charge of $328.8 million for the
write-off of goodwill and other intangibles related to the acquisition of
Avesta. In 2001, we recorded an impairment charge of $7.1 million related to all
of the remaining intangible assets from the Avesta acquisition based on the
discontinuation of the Visual Trintiy product and plans for the Visual eWatcher
product. The impairment charge also included the write-off of an investment of
$3.7 million. See Notes 1, 5 and 6 of Notes to Consolidated Financial
Statements.
(5) For an explanation of the determination of the weighted-average number
of shares used in computing earnings (loss) per share amounts, See Note 1 of
Notes to Consolidated Financial Statements.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following discussion of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements, the related notes thereto, and other financial information included
elsewhere in this Form 10-K. References to "we", "us" or "our" refer to Visual
Networks, Inc. on a consolidated basis.
Overview
From our incorporation in August 1993 through December 1996, our principal
objective was to secure sufficient equity financing to enable us to accelerate
product development efforts of Visual UpTime for frame relay deployment and
create the infrastructure necessary to support these efforts. We first shipped
Visual UpTime in mid-1995 and began generating significant revenue during 1996.
Since our inception, we have focused on establishing relationships with service
providers with the goal of having these service providers include our products
into their infrastructure or in their service offerings to their subscribers.
Consistent with this goal, we have established agreements with AT&T, Equant,
Sprint and WorldCom. During 1998, 1999 and 2000, we continued to focus on
selling Visual UpTime and added to our product portfolio as a result of a series
of acquisitions - the Net2Net product, Cell Tracer, in 1998; the Inverse
products, Visual IP InSight and Visual Internet Benchmark, in 1999; and the
Avesta products, Visual Trinity and Visual eWatcher, in 2000. During 2001, we
discontinued development and sales efforts of Visual Trinity and sold the Visual
Internet Benchmark product. During 2001, we also made a decision to combine
certain functionality of the web performance management technology of the Visual
eWatcher product with the Visual IP InSight product. Development efforts
relating to incorporating this functionality are expected to begin in 2002 and
be included in a future release of the Visual IP InSight product in 2003. We
continue to focus on sales of Visual UpTime, Visual IP InSight and Cell Tracer.
We prepare our financial statements in conformity with generally accepted
accounting principles in the United States. As such, we are required to make
certain estimates, judgments and assumptions that we believe are reasonable
based upon the information available. These estimates and assumptions affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the periods
presented. Actual results could differ from those estimates. The estimates
included in the preparation of our financial statements relate to accounts
receivable allowances, inventory reserves, estimates of expense accruals and the
cash flow estimates used in evaluating impairment of long-lived assets under
Statement of Financial Accounting Standards No. 121. Our significant accounting
policies are described fully in Note 2 of Notes to Consolidated Financial
Statements. We believe that our accounting policies related to revenue
recognition and the impairment of long-lived assets are the most critical to aid
in fully understanding and evaluating our reported financial results.
We recognize revenue from our service management products and services
including hardware, software, benchmark services, professional services and
technical support. We generally recognize revenue from the sale or license of
our products upon delivery and passage of title to the customer. Where
agreements provide for evaluation or customer acceptance, we recognize revenue
upon the completion of the evaluation process and acceptance of the product by
the customer. Revenue from multiple-element software arrangements is recognized
using the residual method whereby the fair value of any undelivered elements,
such as customer support and services, is deferred and any residual value is
allocated to the software and recognized as revenue upon delivery and passage of
title. The fair values of professional services, technical support and training
have been determined based on our specific objective evidence of fair value. Our
maintenance contracts require us to provide technical support and software
updates to customers. We recognize technical support revenue, including
maintenance revenue that is bundled with product sales, ratably over the term of
the contract period, which generally ranges from one to five years. We recognize
revenue from services when the services are performed. Subscription fees for our
benchmark reports are recognized upon delivery of the reports.
While substantially all of our product sales to date have been made to
customers in the United States, we plan to sell our products to foreign
customers at prices denominated in U.S. dollars. However, if we commence selling
material volumes of product to such customers at prices not denominated in U.S.
dollars, we intend to adopt a strategy to hedge against fluctuations in foreign
currency.
With the acquisition of Avesta in May 2000, we allowed our business
strategy to become less focused, which increased the complexity of our business
and adversely affected our results of operations. Our revenue decreased from
$91.7 million in 1999 to $89.0 million in 2000 while our operating expenses
increased resulting in significant losses from operations. Our historical trend
of increasing revenue each quarter began to reverse in the second quarter of
2000. These revenue decreases were due to lower than expected revenue related to
the Visual Trinity and Visual eWatcher products (the products added through the
Avesta acquisition) as well as decreases in the revenue provided by our other
products. Despite these revenue decreases, our operating expenses increased
significantly in the corresponding periods due, in large part, to the addition
of the Avesta operations. In an attempt to refocus our efforts, we announced a
plan in the fourth quarter of 2000 to realign our product portfolio, streamline
our operations and devote resources to the markets and products that offer us
the greatest growth opportunities. In connection with this plan, we recorded a
restructuring charge of $7.0 million in the fourth quarter of 2000. In the
second quarter of 2001, we discontinued development and sales efforts on the
Visual Trinity product and sold the Visual Internet Benchmark product in an
effort to further focus our product portfolio and streamline our operations and
resources. In the fourth quarter of 2001, we completed a workforce reduction to
continue focusing on reducing our operating expenses. In connection with these
efforts, we recorded restructuring charges of $3.9 million in the second quarter
of 2001 and $385,000 in the fourth quarter of 2001.
In determining the carrying amount of our long-lived assets, we review our
long-lived assets, including property and equipment, identifiable intangibles
and goodwill whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be fully recoverable. To determine
recoverability of our long-lived assets, we evaluate the probability that future
estimated undiscounted net cash flows will be less than the carrying amount of
the assets. If future estimated undiscounted net cash flows are more likely than
not to be less than the carrying amount of the long-lived assets, then such
assets are written down to their fair value.
Due to the significance of the developments in 2000, we performed an
evaluation of the recoverability of our long-lived assets in accordance with
Statement of Financial Accounting Standards No. 121, including those assets
related to the Avesta acquisition. Based upon this evaluation, we concluded that
the remaining values of the goodwill and other intangible assets related to the
Avesta acquisition were impaired. This conclusion was based upon our revised
estimate of the undiscounted cash flows expected to be provided by the Avesta
operations. The estimate of such cash flows was substantially less than the
carrying values of the related long-lived assets. As a result, we recorded an
impairment charge of $328.8 million in the fourth quarter of 2000. This charge
included $203.2 million related to goodwill, which represented the entire
remaining unamortized balance, and $125.6 million related to the other acquired
intangibles including the completed technology, the assembled workforce and the
trademarks and tradenames. In the second quarter of 2001, we announced a
decision to discontinue development and sales efforts on the Visual Trinity
product. In the fourth quarter of 2001, we also made a decision to combine
certain functionality of the web performance management technology of the Visual
eWatcher product with the Visual IP InSight product. As a result of these
decisions, we performed an evaluation of the recoverability of our long-lived
assets, including those related to the Avesta acquisition and concluded that the
remaining intangibles were impaired as the Visual Trinity product and the Visual
eWatcher product were the only products acquired with Avesta. We recorded
impairment charges of $3.1 million in the second quarter of 2001 and $197,000 in
the fourth quarter of 2001 related to the remaining intangibles from the Avesta
acquisition.
During 2001, our revenue decreased from $89.0 million in 2000 to $74.2
million in 2001. This revenue decrease during 2001 was due, in part, to the
discontinuation of the Visual Trinity product and the sale of the Visual
Internet Benchmark product as well as decreases in all of our other product
lines. In response to these revenue decreases, we focused on implementing our
comprehensive plan to strengthen our business by:
|X| Strengthening our product portfolio: We released Visual UpTime 6.0 and
Visual IP Insight 5.5 and eliminated Visual Trinity and Visual Internet
Benchmark;
|X| Strengthening our senior management team: During 2001, Elton King was
hired as President and Chief Executive Officer and in January 2002, John
Saunders became our Chief Financial Officer;
|X| Concentrating our sales, marketing, research and product development
initiatives around service providers and their end user customers: We
established a new service provider relationship with Equant for IP VPN services
worldwide and increased our total revenue from service providers, as a
percentage of total revenue, from 70% in 2000 to 77% in 2001; and
|X| Reducing our operating expenses: We reduced our workforce by
approximately 230 people since October 2000, closed our facilities in Ottawa,
Canada; Sunnyvale, California; and New York, New York, and reduced our
facilities in Rockville, MD, resulting in a 23% reduction in operating expenses
(excluding charges related to acquisitions and restructuring and impairment),
from $80.4 million in 2000 to $61.7 million in 2001.
Results of Operations
The following table presents certain consolidated statement of operations
data as a percentage of our revenue:
Years Ended December 31,
1999 2000 2001
---- ---- ----
Revenue............................................. 100.0% 100.0% 100.0%
Cost of revenue..................................... 33.7 36.5 39.6
---- ---- ----
Gross profit...................................... 66.3 63.5 60.4
Operating expenses:
Research and development.......................... 18.2 30.6 26.0
Write-off of purchased research and development... - 43.8 -
Sales and marketing............................... 26.7 47.1 45.0
General and administrative........................ 8.6 12.6 12.0
Merger-related costs.............................. 7.3 - -
Restructuring and impairment charges.............. - 377.2 12.6
Amortization of goodwill and other intangibles.... - 60.0 1.1
------ ---- -------
Total operating expenses................. 60.8 571.3 96.7
Income (loss) from operations....................... 5.5 (507.8) (36.3)
Interest income, net................................ 2.4 2.9 0.4
----- -------- --------
Net income (loss) before income taxes............... 7.9 (504.9) (35.9)
Benefit (provision) for income taxes................ (4.0) 38.3 (0.4)
-------- --------- --------
Net income (loss)................................... 3.9% (466.6)% (36.3)%
====== ======== ========
The following table presents the revenue by product (in thousands):
Years Ended December 31,
1999 2000 2001
---- ---- ----
Visual UpTime........................ $ 78,490 $ 59,754 $ 55,557
Visual Cell Tracer................... 6,056 7,946 2,980
Visual IP InSight.................... 4,557 9,466 8,095
Continuing product revenue..... 89,103 77,166 66,632
Visual Internet Benchmark............ 2,616 4,607 4,025
Visual Trinity and eWatcher.......... - 7,268 3,591
Discontinued product revenue... 2,616 11,875 7,616
Total revenue.............. $ 91,719 $ 89,041 $ 74,248
======== ======== ========
2001 Compared with 2000
Revenue. Revenue was $89.0 million in 2000 compared to $74.2 million in
2001, a decrease of $14.8 million. The overall decrease in revenue of 16.6% was
primarily due to a decrease in Visual Cell Tracer revenue of $5.0 million, from
one customer, a decrease in Visual UpTime revenue of $4.2 million, primarily
from value added resellers and service providers, a decrease in Visual IP
Insight revenue of $1.4 million and a decrease in Visual Trinity revenue of $3.7
million as a result of the discontinuation of the product. The decrease in Cell
Tracer revenue was attributable to reduced demand from our sole customer for the
product. The decrease in sales of Visual UpTime was primarily attributable to a
decrease in purchases from one of our major service provider customers. Sales to
all service providers increased from approximately 70% of revenue for 2000 to
77% for 2001.
As a result of the discontinuation of the Visual Trinity product, we
anticipate that future revenue for the product will consist primarily of
technical support revenue, all of which is currently included in deferred
revenue. We plan to provide technical support for the Visual Trinity product
through September 2002.
We will continue to recognize revenue from the Visual Internet Benchmark
product that we sold during 2001, for existing contracts, under which we are
still required to perform services. We receive royalty payments from the
purchaser on new contracts.
Gross profit. Cost of revenue consists of subcontracting costs, component
parts, direct compensation costs, communication costs, warranty and other
contractual obligations, royalties, license fees and other overhead expenses
related to manufacturing operations and support of our software products and
benchmark services. Gross profit was $56.5 million for 2000 compared to $44.8
million for 2001, a decrease of $11.7 million. Gross margin was 63.5% of revenue
for 2000 as compared to 60.4% of revenue for 2001. The decrease in gross margin
percentage was due primarily to significant fixed manufacturing and other costs
supporting a lower revenue base, fewer high margin software sales primarily due
to the discontinuation of the Visual Trinity product and higher fixed costs to
support the Visual Benchmark service for existing contracts. Our future gross
margins may be affected by a number of factors, including product mix, the
proportion of sales to service providers, competitive pricing, manufacturing
volumes and an increase in the cost of component parts.
Research and development expense. Research and development expense consists
of compensation for research and development staff, depreciation of test and
development equipment, certain software development costs and costs of prototype
materials. Research and development expense was $27.3 million for 2000 compared
to $19.3 million in 2001, a decrease of $8.0 million. The decrease in research
and development expense was due primarily to workforce reductions and facility
closures during 2000 and 2001. Research and development expense was 30.6% and
26.0% of revenue for 2000 and 2001, respectively. We intend to incur research
and development expenses at a level consistent with the fourth quarter of 2001
or decrease them in absolute dollars during 2002 as a result of our continued
focus on the reduction of operating expenses.
Write-off of purchased research and development. A write-off of purchased
research and development costs of $39.0 million was recorded in 2000 in
connection with the acquisition of Avesta, Avesta had in-process technology
which represented research and development projects of Avesta that had not
reached technological feasibility and that had no alternative future use in
research and development activities or otherwise. We must charge to expenses as
of the date of the acquisition date amounts assigned to in-process research and
development ("IPR&D") meeting the foregoing.
The evaluated projects were future releases of the Trinity, eWatcher and
other products. The products in process included both upgrades to existing
products as well as major modifications for future releases. Additional products
that had been started but not yet assigned a numerical designation and were
considered to be only 1% complete were excluded from the evaluation. The Trinity
related projects represented the majority of the value assigned to the IPR&D
projects. We valued the acquired IPR&D based upon an independent appraisal. The
values of the IPR&D projects were determined by estimating the future cash flows
from the projects, once commercially feasible, discounting the net cash flows
back to their present values and then applying a percentage of completion to the
calculated values to reflect the uncertainty of technical success of the
projects. The rates used to discount the net cash flows to their present values
were based on Avesta's weighted average cost of capital. The percentage of
completion was based on management's estimates of the amount of resources spent
to date and on the expected use of future resources.
As of the valuation date, Avesta was offering version 1.3 of the Trinity
product. Versions 2.0, 2.1 and 3.0 were considered IPR&D projects and were
estimated to be 95%, 15% and 5% complete, respectively. The eWatcher product had
been acquired by Avesta in 1998 and versions 2.0 and 2.5 were considered IPR&D
projects and were estimated to be 25% and 4% complete, respectively. Certain
risks and uncertainties are associated with the completion of the development of
these products within a reasonable projected period of time. Each of the
acquired IPR&D projects had not demonstrated technological feasibility as of the
acquisition date.
Sales and marketing expense. Sales and marketing expense consists of
compensation for the sales and marketing staff, commissions, pre-sales support,
travel and entertainment expense, trade shows and other marketing programs.
Sales and marketing expense was $41.9 million for 2000 compared to $33.5 million
for 2001, a decrease of $8.4 million. The decrease in sales and marketing
expense was due primarily to workforce reductions during 2000 and 2001. Sales
and marketing expense was 47.1% and 45.1% of revenue for 2000 and 2001,
respectively. We intend to incur sales and marketing expenses at a level
consistent with the fourth quarter of 2001 or decrease them in absolute dollars
during 2002 as a result of our continued focus on the reduction of operating
expenses.
General and administrative expense. General and administrative expense
consists of the costs of executive management, finance, administration, and
other activities. General and administrative expense was $11.2 million for 2000
compared with $8.9 million for 2001, a decrease of $2.3 million. The decrease in
general and administrative expense was due primarily to workforce reductions and
facility closures during 2000 and 2001. General and administrative expense was
12.6% and 12.0% of revenue for 2000 and 2001, respectively. We intend to incur
general and administrative expenses at a level consistent with the fourth
quarter of 2001 or decrease them in absolute dollars during 2002 as a result of
our continued focus on the reduction of operating expenses.
Restructuring and impairment charges. We recorded a restructuring charge of
$7.0 million in the fourth quarter of 2000 that consisted primarily of severance
and other termination benefits related to a workforce reduction of approximately
140 employees and lease costs and leasehold improvement write-offs related to
the closure of facilities in Ottawa, Canada and Sunnyvale, California and the
reduction in size of our facilities in Rockville, Maryland and New York, New
York. During the second quarter of 2001, we reversed $723,000 of the
restructuring charge recorded in the fourth quarter of 2000 due primarily to
lower than estimated costs related to facility closure costs. We recorded a
restructuring charge of $3.9 million in the second quarter of 2001 that
consisted primarily of severance and other termination benefits related to a
workforce reduction of approximately 50 employees and lease costs and leasehold
improvement write-offs related to the closure of our New York, New York facility
following our announcement to discontinue the Visual Trinity product. During the
fourth quarter of 2001, we reversed $1.2 million of the restructuring charge
recorded in the second quarter of 2001 due to lower than estimated costs related
to facility closures and other contractual obligations. We recorded another
restructuring charge of $385,000 in the fourth quarter of 2001 that consisted of
severance and other termination benefits related to a workforce reduction of
approximately 40 people resulting from our continued focus on the reduction of
our operating expenses.
We recorded an impairment charge of $328.8 million in the fourth quarter of
2000 for the write-off of goodwill and other intangibles related to the Avesta
acquisition. We recorded an additional impairment charge of $3.1 million in the
second quarter of 2001 as a result of our discontinuation of the Visual Trinity
product. We also recorded an impairment charge of $3.9 million in the fourth
quarter of 2001 related to the impairment of an investment acquired with the
Avesta acquisition and the write-off of the remaining intangible assets related
to the Avesta acquisition as a result of our plans for the eWatcher product
(see Note 6 of Notes to Consolidated Financial Statements).
Amortization of acquired intangibles. We recorded $53.4 million in
amortization of goodwill and other intangibles in 2000 related to the Avesta
acquisition compared with $805,000 in 2001. The decrease was the result of
decreased goodwill and intangibles resulting from the impairment charges
recorded in 2000 and 2001.
Interest income, net. Interest income, net, was $2.6 million for 2000
compared to $325,000 for 2001. The decrease of $2.3 million was primarily due to
decreased cash balances.
Income taxes. The provision for income taxes for 2001 was $272,000 and
related primarily to state income taxes and other non-recoverable income tax
payments.
Net loss. Net loss for 2000 was $415.5 million as compared to $27.0 million
for 2001, a decrease of $388.5 million. The decrease was due primarily to a
decrease in restructuring and impairment charges, amortization of intangibles
and operating expenses, offset in part by decreases in revenue, gross profit,
interest income and income tax benefits.
2000 Compared with 1999
Revenue. We recognized $91.7 million in revenue for 1999 compared to $89.0
million in revenue for 2000, a 2.9% decrease. The decline was due primarily to a
decrease in Visual UpTime revenue of $18.7 million, primarily from service
providers, offset by increases in revenue related to Visual Cell Tracer, Visual
IP InSight and Visual Internet Benchmark and the effect of the acquisition of
the Avesta Trinity and eWatcher products. The decrease in sales of Visual UpTime
was primarily attributable to a change in purchasing behavior of two major
service providers. Sales to all service providers accounted for approximately
72% of revenue for 1999 as compared to 70% for 2000.
Gross profit. Gross profit was $60.8 million for 1999 compared to $56.5
million for 2000, a decrease of $4.3 million. Gross margin was 66.3% of revenue
for 1999 compared to 63.5% of revenue for 2000. The decrease in gross margin
percentage was due primarily to higher fixed costs supporting a lower revenue
base and approximately $1.9 million in inventory write-downs offset, in part, by
the addition of higher-margin software sales of Visual Trinity and Visual
eWatcher.
Research and development expense. Research and development expense was
$16.7 million for 1999 as compared to $27.3 million for 2000, an increase of
$10.6 million. The increase in research and development expense was due
primarily to the costs of the Avesta research and development staff subsequent
to the date of acquisition, increased staffing levels and related support costs,
and purchases of materials and services used in the development of new or
enhanced products. Research and development expense was 18.2% and 30.6% of
revenue for 1999 and 2000, respectively.
Write-off of purchased research and development. A write-off of purchased
research and development costs of $39.0 million was recorded in 2000 in
connection with the acquisition of Avesta, as described above.
Sales and marketing expense. Sales and marketing expense was $24.4 million
for 1999 compared to $41.9 million for 2000 an increase of $17.5 million. The
increase in sales and marketing expense was due primarily to the costs of Avesta
sales and marketing staff and programs subsequent to the date of acquisition and
continued growth in staffing, commissions and marketing programs. Sales and
marketing expense was 26.7% and 47.1% of revenue for 1999 and 2000,
respectively.
General and administrative expense. General and administrative expense was
$7.9 million for 1999 compared to $11.2 million for 2000, an increase of $3.3
million. The increase in general and administrative expense was due primarily to
the additional costs of the Avesta staff and professional services incurred
subsequent to the date of acquisition and increased staffing, professional
services and corporate facilities and network infrastructure costs. General and
administrative expense was 8.6% and 12.6% revenue for 1999 and 2000,
respectively.
Restructuring and impairment charges. We recorded a restructuring charge of
$7.0 million in the fourth quarter of 2000 that consisted primarily of severance
and other termination benefits related to a workforce reduction of approximately
140 employees and lease costs and leasehold improvement write-offs related to
the closure of facilities in Ottawa, Canada and Sunnyvale, California and the
reduction in size of our facilities in Rockville, Maryland and New York, New
York. We also recorded an impairment charge of $328.8 million for the write-off
of goodwill and other intangibles related to the Avesta acquisition (see Note 6
of Notes to Consolidated Financial Statements).
Amortization of acquired intangibles. We recorded $53.4 million in
amortization of goodwill and other intangibles related to the Avesta acquisition
in 2000.
Interest income, net. Interest income, net, for 1999 was approximately $2.3
million as compared to $2.6 million for 2000. The increase of $0.3 million was
primarily due to decreased interest expense related to capital leases and other
borrowings.
Income taxes. The benefit for income taxes for 2000 was $34.1 million. The
effective tax rate of 8% differed from the statutory rates primarily due to the
income tax effect of the Avesta acquisition and increases in the valuation
allowance.
Net income (loss). Net loss for 1999 was $3.6 million for 1999 as compared
to $415.5 million for 2000, an increase of $419.1 million. The decrease was due
primarily to decreases in revenue and gross profit, increased operating
expenses, the write-off of purchased research and development, the amortization
of goodwill and other intangible assets and the restructuring and impairment
charges.
Liquidity and Capital Resources
At December 31, 2001, our unrestricted cash balance was $5.9 million
compared to $17.4 million as of December 31, 2000, a decrease $11.5 million.
This decrease is primarily attributable to cash used in operations, due to
operating losses as well as the payment of certain restructuring charges
recorded in 2000. Net cash used in operating activities in 2001 was $19.7
million. During the year, we also used cash of $692,000 to purchase equipment
and other fixed assets, and we made principal payments on capital lease
obligations of $564,000. Cash provided by the maturities of short-term
investments was $6.2 million, the sale of common stock pursuant to the exercise
of employee stock options and our employee stock purchase plan was $1.3 million,
and net borrowings from our bank were $2.0 million.
We require substantial working capital to fund our business, particularly
to finance inventories, accounts receivable, research and development activities
and capital expenditures as well as to fund our operating losses. To date, we
have financed our operations and capital expenditures primarily with the
proceeds from our initial public offering completed in February 1998 and from
our operating income generated through the first quarter of 2000. In 2001, as
indicated above, we became dependent on cash that was provided by our bank under
a credit facility. In addition, from time to time, we have obtained advance
payments in connection with certain customer purchase orders. In the fourth
quarter of 2001, we received an advance payment of approximately $3.6 million
that was classified as a customer deposit in the accompanying consolidated
balance sheet as of December 31, 2001; the related customer orders were
fulfilled in February 2002. We do not anticipate receiving customer advance
payments in the future. Our future capital requirements will depend on many
factors, including the rate of revenue growth, if any, as well as our gross
margin and our levels of operating expenses, including product research and
development, sales and marketing and general and administrative expenses.
In response to the trends of decreasing revenue and increasing operating
expenses, we initiated a restructuring plan in the fourth quarter of 2000 to
realign our product portfolio, streamline our operations and devote resources to
the markets and products that we believe have the greatest opportunity for
growth. In the second quarter of 2001, we announced a plan to discontinue
development and sales efforts on the Visual Trinity product and eliminate the
related costs. In the fourth quarter of 2001, we made additional reductions in
workforce and other operating costs. As a result of these actions, operating
expenses, excluding charges related to acquisitions and restructuring and
impairment charges, have been reduced from a level of $24.0 million in the
fourth quarter of 2000 to $11.9 million in the fourth quarter of 2001.
Although our revenue for the fourth quarter of 2001 was $17.3 million
compared to revenue of $15.3 million in the comparable period of last year, our
fourth quarter 2001 revenue decreased from $19.2 million and $20.3 million for
the quarters ended September 30, 2001 and June 30, 2001, respectively. Revenue
decreased from $89.0 million for the year ended December 31, 2000 to $74.2
million for the year ended December 31, 2001. Our ability to generate operating
income in the future is dependent upon not only our continued success in
reducing operating expenses, but also our ability to sustain revenue. General
market conditions, competitive pressures and other factors beyond our control
may adversely affect our ability to generate sufficient revenue to enable us to
become profitable. There can be no assurances that we will be able to sustain
revenue or become profitable. In the event that the anticipated cost reductions
are not realized or we do not meet our revenue goals, we may be required to
further reduce our cost structure.
The significant operating losses incurred by us since the third quarter of
2000 have resulted in a significant reduction in our cash. Our balance of cash
and cash equivalents has decreased from $54.6 million at December 31, 1999 to
$5.9 million at December 31, 2001. Accounts payable and accrued liabilities
totaled $11.7 million at December 31, 2001, and current liabilities exceeded
current assets by approximately $6.64 million.
In order to strengthen our financial position and provide cash for working
capital purposes, in March 2002, we issued senior secured convertible debentures
in the aggregate amount of $10.5 million in a private placement offering. The
debentures are due March 25, 2006, payable in common stock or cash at our option
provided certain conditions are satisfied, bear interest at an annual rate of 5%
payable quarterly, and are secured by a first priority lien on substantially all
of our assets. The debentures may be converted into our common stock at the
option of the holders at a price of $3.5163 per share, subject to certain
adjustments. The debentures are convertible into a number of shares of common
stock equal to the principal amount of the debentures divided by the conversion
price, or 2,986,093 shares on the date of issuance. We are required to adjust
the conversion price if we issue certain additional shares of our common stock
or instruments convertible into common stock at a price that is less than the
conversion price of the debentures. We have the right to require the holders to
convert their debentures into common stock if the closing price of our common
stock exceeds 175% of the conversion price for 20 consecutive days after
September 26, 2003.
The debentures include certain financial covenants related to earnings
before interest, taxes, depreciation and amortization for 2002 and 2003. If the
financial covenants are not met, the holders may cause us to redeem the
debentures at a price equal to the principal amount of the debentures plus
accrued interest. The redemption may be made in cash or common stock at our
option subject to certain conditions. Redemption of the debentures also may be
required upon a specified change of control or upon the occurrence of any one of
the other triggering events including, but not limited to, our default on other
indebtedness, our failure to register the shares of common stock that may be
issued to the debenture holders and our failure to maintain our common stock
listing on an eligible market.
We also issued warrants to purchase 828,861 shares of our common stock at
an initial exercise price of $4.2755 per share. The exercise price may be
adjusted if we issue certain additional shares of our common stock or
instruments convertible into common stock at a lower price than the initial
exercise price. The warrants expire on March 25, 2007. The debentures also give
the holders the right to purchase 575 shares of to-be-created Series A preferred
stock for $5.8 million prior to May 6, 2002. The Series A preferred stock will
accrue dividends at an annual rate of 5% that are payable quarterly beginning on
June 30, 2002. We will have the right to cause the redemption of the Series A
preferred stock on the fourth anniversary of the issuance of such stock based on
similar terms to the debentures. We have also granted to the debenture holders
the right to purchase $4.75 million of additional shares of to-be-created
preferred stock at any time after the six-month anniversary but before the
fifteen-month anniversary of the issuance of the debentures. The debenture
holders were also granted certain equity participation and registration rights.
In connection with the issuance of the debentures, the outstanding amounts
borrowed from the bank under our accounts receivable-based and our equipment
financing arrangements were repaid, and the related loan agreements were
terminated. The standby letter of credit, as amended, issued by the bank in
December 2000 in the amount of $2.5 million with an expiration date of September
30, 2002 remains outstanding and secured with our pledge of a certificate of
deposit in the amount of $2.5 million that matures on October 31, 2001.
The future success of our company will be dependent upon, among other
factors, our