10-K405/A 1 g72042e10-k405a.txt TELEMATE.NET SOFTWARE, INC. 1 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-K/A AMENDMENT NO. 1 FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 [ ] 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: 000-26735 TELEMATE.NET SOFTWARE, INC. (Exact Name of Registrant Specified in Its Charter) GEORGIA 58-1656726 (State or Other Jurisdiction of Incorporation (I.R.S. Employer Identification No.) or Organization) 400 GALLERIA PARKWAY, SUITE 200 30339 ATLANTA, GEORGIA (Zip Code) (Address of Principal Executive Offices)
Registrant's telephone number, including area code: (678) 589-1623 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 $.01 PER SHARE (Title of Class) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the average of the closing bid and ask quotations for the Registrant's common stock on March 23, 2001 as reported by The Nasdaq Stock Market, was approximately $4,270,513. The shares of common stock held by each officer and director and by each person known to the Registrant who owns 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of March 23, 2001, Registrant had outstanding 7,995,086 shares of common stock. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 EXPLANATORY NOTE The Report on Form 10-K/A amends and restates in their entirety Items 7 and 14 of the Annual Report on Form 10-K of Telemate.Net Software, Inc., a Georgia corporation (the "Company"), for the fiscal year ended December 31, 2000. PART II ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion should be read in conjunction with the Financial Statements of Telemate.Net Software, Inc. and notes thereto included elsewhere in this report. OVERVIEW In October 1999, we completed our initial public offering, raising net proceeds of $43 million to fuel our planned expansion. From the date of our initial public offering through the second quarter of 2000, we expanded our sales and marketing activities and increased our product development activities. By the end of the second quarter, we had identified several key challenges that were restricting our sales growth including inefficient processes that hampered our ability to identify and qualify prospects and ensure high sales productivity. Additionally, our products had substantially different positioning, features, and sales attributes which resulted in our sales and marketing efforts, within a single organizational structure, to become diluted. At the beginning of the third quarter of 2000, we refocused to align our sales and marketing for each product line into separate divisions. This refocusing and reorganization of the Company impacted growth and, as a result, at the beginning of the fourth quarter of 2000, we reduced our work force approximately 20% to align our expense structure to our revenue. On February 14, 2001, we announced plans to introduce NetSpective WebFilter, an advanced Internet filtering solution, and NetSpective Reporter 5.0, an enhanced version of our Internet reporting software, in the second quarter of 2001. As we enter 2001 and complete the development of our enhanced product line, we believe we are poised to resume growth and return to profitability in late 2002. Our revenue consists of product and service revenue. Product revenue is derived primarily from licensing our software products. We also resell complementary hardware, which has historically accounted for less than 10% of our total annual revenue. Service revenue consists of fees paid for maintenance services, product updates, and professional services. Maintenance services include diagnosis and correction of errors in the current version of the product and telephone consultation to discuss general support questions. Product updates include error correction and minor enhancements to the product models purchased, and periodic updates to tariff information for call accounting products. Substantially all of our license agreements are perpetual. Support agreements are typically for a term of one year and renew automatically upon payment of an annual maintenance fee by the customer. This support fee typically represents 20% of the current list price of the products licensed. Professional services includes installation, training, and custom report generation. We recognize revenue from software licenses in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 97-2, Software Revenue Recognition, SOP 98-4, Deferral of the Effective Date of a Provision of SOP 97-2, and SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. Revenue derived from software license fees and hardware is recognized upon shipment. Revenue derived from software support services primarily involves annual contracts and is recognized ratably over the service period. Revenue related to professional services is recognized as services are provided. Deferred revenue generally represents advance payments received from customers and billings invoiced to customers for software support and professional services in advance of the time revenue is recognized. 1 3 We identify revenue as call accounting revenue or Internet/integrated revenue based upon the types of data sources licensed and the delivery of call accounting product features. If a customer is delivered tariff information for all data sources they have licensed, the product revenue is identified as call accounting. All other product revenue is identified as Internet/integrated. Service revenue is identified based on the associated product identification. We sell our products through a combination of direct sales by our sales personnel and indirect sales primarily through resellers and distributors. While our direct sales force is expected to continue to generate a large proportion of future revenue, we are increasingly utilizing indirect distribution channels, such as network resellers, systems integrators and distributors, as an important complement to our direct sales force. Distributors and resellers purchase the product for resale at a discount from our standard price list. This discount ranges from 20% to 65% and varies based on a number of factors including their volume of business, whether they distribute to other resellers, and whether they provide product support. We also maintain relationships with leading networking and network security product vendors that help to market and distribute our products. These vendors assist in the sales and marketing of our products by bundling them with their own products, selling our products through their sales forces, and promoting our products at trade shows, seminars and through their web sites. We have entered into marketing partnerships with major firewall and proxy server suppliers including Cisco Systems, Check Point Software Technologies, Microsoft Corporation, and Symantec/Axent. We intend to continue to focus sales resources on strengthening existing relationships and creating new relationships with strategic organizations. The Cisco partnership is comprised of an OEM agreement and a cooperative marketing agreement. Cisco buys and resells our VoIP reporting application and we are provided a web link from relevant product pages on the Cisco web site. In addition, for a fee we are able to appear within Cisco's tradeshow space. The initial term of the February 2000 agreement is for three years. The Check Point partnership is a cooperative marketing agreement. Our Internet products report on Check Point's firewall products and in turn we receive a link on Check Point's web site. In addition, for a fee we can be in Check Point's booth at tradeshows. The agreement is renewable on an annual basis through 2002. The Microsoft partnership is a cooperative marketing agreement. Our Internet products generate reports on Microsoft's firewall products and in turn we receive a link on Microsoft's web site. As long as our products meet Microsoft's criteria, we can maintain this relationship. In addition, for a fee we can be in Microsoft's booth at tradeshows. We have a reseller agreement with Axent, which has been acquired by Symantec. The agreement allows for cooperative marketing programs. Such programs have been utilized over the last several years. With the acquisition of Axent by Symantec, we expect less cooperative marketing efforts. We expect to continue to focus our sales resources on strengthening existing relationships and creating new strategic relationships. From our inception in 1986 until June 1999, we elected to operate under subchapter S of the Internal Revenue Code of 1986, as amended, and comparable provisions of state income tax laws. An S corporation generally is not subject to income tax at the corporate level. The S corporation's income generally passes through to shareholders and is taxed on their personal income tax returns. As a result, our earnings through June 1999 had been taxed directly to our existing shareholders. On June 16, 1999, we terminated our status as an S corporation under the tax code. In connection with the termination of our S corporation status, we distributed $269,000 and we reclassified the accumulated deficit of $296,000 through the S corporation termination date, limited to the amount of paid-in capital, to additional paid-in capital. Certain amounts in the 1998 and 1999 financial statements have been reclassified to conform to the presentation adopted in the 2000 financial statements. In January 2001, the Company announced its retention of an investment banking firm to explore a range of strategic alternatives to enhance shareholder value, including a possible sale of the Company. 2 4 RESULTS OF OPERATIONS The following tables set forth our Internet/integrated and call accounting revenue, both in absolute dollars and as a percentage of total revenue:
YEAR ENDED DECEMBER 31, --------------------------- 1998 1999 2000 ------- ------- ------- (IN THOUSANDS) Revenue: Internet/integrated: Product revenue........................................ $ 971 $ 2,946 $ 1,978 Services revenue....................................... 82 1,102 2,184 ------- ------- ------- Total Internet/integrated revenue................. 1,053 4,048 4,162 Call accounting: Product revenue........................................ 4,479 3,785 1,701 Services revenue....................................... 4,850 5,132 4,827 ------- ------- ------- Total call accounting revenue..................... 9,329 8,917 6,528 ------- ------- ------- Total revenue..................................... $10,382 $12,965 $10,690 ======= ======= =======
YEAR ENDED DECEMBER 31, ----------------------- 1998 1999 2000 ----- ----- ----- Revenue: Internet/integrated: Product revenue........................................ 9.4% 22.7% 18.5% Services revenue....................................... 0.8 8.5 20.4 ----- ----- ----- Total Internet/integrated revenue................. 10.2 31.2 38.9 Call accounting: Product revenue........................................ 43.1 29.2 15.9 Services revenue....................................... 46.7 39.6 45.2 ----- ----- ----- Total call accounting revenue..................... 89.8 68.8 61.1 ----- ----- ----- Total revenue..................................... 100.0% 100.0% 100.0% ===== ===== =====
3 5 The following table sets forth for the periods indicated statement of operations data expressed as a percentage of total revenue:
YEAR ENDED DECEMBER 31, ------------------------ 1998 1999 2000 ----- ----- ------ STATEMENT OF OPERATIONS DATA: Revenue: Product revenue........................................... 52.5% 51.9% 34.4% Service revenue........................................... 47.5 48.1 65.6 ----- ----- ------ Total revenue..................................... 100.0 100.0 100.0 Costs of revenue: Product costs............................................. 9.2 10.8 14.4 Service costs............................................. 14.5 18.0 34.1 ----- ----- ------ Total cost of revenue............................. 23.7 28.8 48.5 Gross profit................................................ 76.3 71.2 51.5 Operating expenses: Research and development.................................. 18.6 17.1 34.8 Sales and marketing....................................... 46.3 52.5 122.3 General and administrative................................ 23.0 24.4 52.4 Restructuring............................................. 0.0 0.0 2.9 Non-cash compensation..................................... 0.0 1.5 0.0 ----- ----- ------ Total operating expenses.......................... 87.9 95.5 212.4 Operating income (loss)..................................... (11.6) (24.3) (160.9) Increase in redeemable stock purchase warrants.............. 0.0 (12.3) 0.0 Other income (expense)...................................... (1.0) 2.6 18.5 ----- ----- ------ Net income (loss)................................. (12.6)% (34.0)% (142.4)% ===== ===== ======
Years Ended December 31, 2000 and 1999 Total Revenue. Total revenue was $10.7 million in 2000, representing a 17.5% decrease from $13.0 million in 1999. Total product revenue was $3.7 million, or 34.4% of total revenue, in 2000, representing a 45.3% decrease from $6.7 million, or 51.9% of total revenue, in 1999. Total service revenue was $7.0 million, or 65.6% of total revenue, in 2000, representing a 12.5% increase from $6.2 million, or 48.1% of total revenue, in 1999. The overall decease in revenue was the result of the decrease in both call accounting and Internet/integrated product revenue partially offset by an increase in Internet/integrated support revenue. $700,000 of the decrease was attributable to a sales agreement with Electronic Data Systems, a third-party contractor, to provide software, hardware and installation services for 51 different Army National Guard sites. This sale agreement comprised $1.8 million or 13.9% of total revenue in 1999, but accounted for only $1.1 million or 10.5% in 2000. We have delivered all software and hardware under the agreement and are currently providing support services. We expect support revenue to be less than $300,000 during 2001. There can be no assurance that support will be renewed beyond 2001. Further, for the first half of 2000, we had reassigned sales resources from call accounting to Internet products, but these resources failed to productively generate sales as they had previously. As a result, management restructured the company by product line at mid-year and began development of our enhanced Internet reporting product and our Internet filtering appliance. Based on these new products, management anticipates restoring revenue growth in the second half of 2001 through increased channel leverage and higher sales force productivity. Internet/Integrated Revenue. Total Internet/integrated revenue was $4.2 million, or 38.9% of total revenue in 2000, representing a 2.8% increase from $4.0 million, or 31.2% of total revenue, in 1999. 4 6 Internet/integrated product revenue was $2.0 million, or 18.5% of total revenue in 2000, representing a 32.9% decrease from $2.9 million, or 22.7% of total revenue, in 1999. Internet/integrated service revenue was $2.2 million, or 20.4% of total revenue in 2000, representing a 98.2% increase from $1.1 million, or 8.5% of total revenue, in 1999. The overall decrease in Internet/integrated product revenue and percentage of total revenue was largely due to the decrease in revenue from the aforementioned single major customer. This sale agreement comprised $1.2 million of product revenue in 1999 compared to $494,000 in 2000. The increase in Internet/integrated service revenue was driven by the increase in Internet/integrated support revenue. Our Internet customer base has grown since 1998 resulting in increased support renewals. Additionally, in conjunction with our reorganization at mid-year, we stopped selling our integrated product and focused on selling separate call accounting and Internet products. The integrated product reports on both Internet and telephony data sources and therefore contains a component of call accounting revenue. Therefore, while total Internet/integrated revenue was relatively consistent, we were successful in increasing total Internet revenue to replace the call accounting revenue in the Internet/integrated revenue category. However, a significant increase in sales resources was required to produce these results, resulting in substantial losses. Therefore, management began development efforts to improve and expand our Internet product offerings in order to create products which our sales force would be able to sell profitably. Call Accounting Revenue. Total call accounting revenue was $6.5 million, or 61.1% of total revenue in 2000, representing a 26.8% decrease from $8.9 million, or 68.8% of total revenue, in 1999. Call accounting product revenue was $1.7 million, or 15.9% of total revenue in 2000, representing a 55.1% decrease from $3.8 million, or 29.2% of total revenue, in 1999. Call accounting service revenue was $4.8 million, or 45.2% of total revenue in 2000, representing a 5.9% decrease from $5.1 million, or 39.6% of total revenue, in 1999. The decline in call accounting revenue and percentage share of total revenue for the year was due to the increased focus of our sales force on selling our Internet/integrated products during the first half of the year. Additionally, the hardware component of call accounting product revenue declined as management attempted to shift sales focus away from lower margin hardware sales and toward software sales. We anticipate this reduced emphasis on hardware sales will continue for the foreseeable future. Cost of Product Revenue. Cost of product revenue includes employee compensation, costs of complementary hardware, costs of materials related to production, shipment and fulfillment, amortization of a software license, and payments under third-party licensing agreements. Cost of product revenue was $1.5 million, or 14.4% of total revenue in 2000, representing a 9.0% increase from $1.4 million, or 10.9% of total revenue, in 1999. The increase in product cost is attributable primarily to amortization of purchased software. The increase in the percentage of revenue reflects a change in product revenue mix as well as increases in overhead expenses and the aforementioned software amortization. We expect cost of product revenue to decrease slightly as a percentage of product revenue due to reductions in staffing and higher average selling prices associated with our new products partially offset by the hardware associated with our new WebFilter product. Cost of Service Revenue. Cost of service revenue is comprised primarily of service employee compensation. Cost of service revenue was $3.6 million, or 34.0% of total revenue in 2000, representing a 55.5% increase from $2.3 million, or 18.0% of total revenue, in 1999. The increase in both absolute dollars and as a percentage of revenue resulted from increased service staffing levels to improve service levels to existing customers and in anticipation of future support and service requirements. As part of our reduction in force in October 2000, management reduced service staff levels to correspond more directly with current revenue levels. Management believes this reduction will result in improved margins on service revenue while maintaining service levels. Research and Development Expenses. Research and development expenses include salaries and related costs for software developers, quality assurance personnel, and documentation personnel involved in our research and development efforts. Research and development expenses were $3.7 million, or 34.8% of total revenue, in 2000, representing a 68.3% increase from $2.2 million, or 17.1% of total revenue, in 1999. 5 7 The increase in total research and development expenses reflects increased research and development personnel to accelerate new product development. With the anticipated release of our WebFilter product in the second quarter of 2001, we expect slight increases in research and development expenses in the first half of 2001, with a declining trend during the second half of the year. On a year-over-year basis, we anticipate research and development expenses to be slightly lower in 2001 than 2000. Sales and Marketing Expenses. Sales and marketing expenses include salaries and related costs, commissions, travel, facilities, communications costs, and promotional expenses for our sales organization and marketing staff. Sales and marketing expenses were $13.1 million, or 122.3% of total revenue, in 2000, representing a 92.1% increase from $6.8 million, or 52.5% of total revenue, in 1999. The increases in both absolute dollars and as a percentage of total revenue were due to several factors, primarily the addition of sales and marketing personnel and initiation of marketing lead generation programs in an effort to accelerate our revenue growth following our initial public offering. We expect sales and marketing expenses to decrease in both absolute dollars and as a percentage of revenue in 2001 due to the reduction of sales and marketing staff that occurred in October 2000 and due to a decrease in our promotional activities. General and Administrative Expenses. General and administrative expenses include administrative salaries and related benefits, depreciation and amortization, management fees, recruiting, and relocation expenses, as well as legal, accounting, and other professional fees. General and administrative expenses were $5.6 million, or 52.4% of total revenue, in 2000, representing a 77.2% increase from $3.2 million, or 24.4% of total revenue, for the same period in 1999. This increase was primarily due to staff related costs, insurance, and professional service fees largely related to the requirements of being a public company. We expect general and administrative costs will be relatively flat in absolute dollars in 2001. Restructuring Expenses. Restructuring expense of $310,000, or 2.9% of total revenue, represents the charges taken in connection with the Company's reduction in force which occurred at the beginning of the fourth quarter of 2000. This charge primarily represents severance compensation. Non-cash Compensation Expenses. Non-cash compensation of $188,000, or 1.5% of total revenue in 1999, was charged in connection with stock options granted at a price below market value, primarily to an executive officer. No options were granted below market value in 2000. Redeemable Stock Purchase Warrant. Charges for the increase in value of our redeemable common stock purchase warrant were zero in 2000, as compared to $1.6 million, or 12.3% of total revenue, for 1999. This charge represents the increase in the value of the warrant granted in connection with a $1,000,000 loan. The warrant was exercised and the loan was repaid in September 1999. Other Income (Expense). Interest income (expense) was $2.0 million, or 18.5% of total revenue, for 2000, compared to $336,000, or 2.6% of total revenue, for 1999. Proceeds from investment of the funds received in the initial public offering for the full year account for this interest income. Interest income in the future will be dependent on cash levels maintained. Years Ended December 31, 1999 and 1998 Total Revenue. Total revenue was $13.0 million in 1999, representing a 24.9% increase from $10.4 million in 1998. Total product revenue was $6.7 million, or 51.9% of total revenue, in 1999, representing a 23.5% increase from $5.4 million, or 52.5% of total revenue, in 1998. Total service revenue was $6.2 million, or 48.1% of total revenue, in 1999, representing a 26.4% increase from $4.9 million, or 47.5% of total revenue, in 1998. This increase was the result of the increase in Internet/integrated revenue and professional services sold. Part of the increase was attributable to a sales agreement with Electronic Data Systems, a third-party contractor, to provide software, hardware and installation for 51 different Army National Guard sites. This sales agreement comprised 13.9% of total revenue in 1999. This agreement did not contribute as significantly to revenue in 2000. Internet/Integrated Revenue. Total Internet/integrated revenue was $4.0 million, or 31.2% of total revenue, in 1999, representing a 284.4% increase from $1.1 million, or 10.2% of total revenue, in 1998. Internet/integrated product revenue was $2.9 million, or 22.7% of total revenue, in 1999, representing a 6 8 203.4% increase from $971,000, or 9.4% of total revenue, in 1998. Internet/integrated service revenue was $1.1 million, or 8.5% of total revenue, in 1999, representing a 1,243.9% increase from $82,000, or 0.8% of total revenue, in 1998. The increase in Internet/integrated product revenue and percentage of total revenue was due to the increased focus of our sales force on selling our Internet/integrated products. The increase in Internet/integrated service revenue was driven by the increase in Internet/integrated product sales, including the sales agreement mentioned under Total Revenue above. Call Accounting Revenue. Total call accounting revenue was $8.9 million, or 68.8% of total revenue, in 1999, representing a 4.4% decrease from $9.3 million, or 89.8% of total revenue, in 1998. Call accounting product revenue was $3.8 million, or 29.2% of total revenue, in 1999, representing a 15.5% decrease from $4.5 million, or 43.1% of total revenue, in 1998. Call accounting service revenue was $5.1 million, or 39.6% of total revenue, in 1999, representing a 5.8% increase from $4.8 million, or 46.7% of total revenue, in 1998. The decline in call accounting revenue and percentage share of total revenue for the year was due to the increased focus of our sales force on selling our Internet/integrated products as compared to selling call accounting only products. Cost of Product Revenue. Cost of product revenue includes employee compensation, costs of materials related to production, shipment and fulfillment and payments under third-party licensing agreements. Cost of product revenue was $1.4 million, or 10.9% of total revenue, in 1999, representing a 47.7% increase from $958,000, or 9.2% of total revenue, in 1998. This increase in cost and the corresponding increase as a percentage of total revenue was primarily attributable to higher hardware costs on a number of large product sales requiring an unusually large amount of hardware and an increase in the percentage of total costs for royalty payments for third-party licensing. Cost of Service Revenue. Cost of service revenue is comprised primarily of service employee compensation. Cost of service revenue was $2.3 million, or 18.0% of total revenue, in 1999, representing a 55.7% increase from $1.5 million, or 14.5% of total revenue, in 1998. This increase was due to an increase in staff to handle the expansion of the number of companies under annual maintenance contracts and the increase in professional services sold. Research and Development Expenses. Research and development expenses include salaries and related costs for software developers, quality assurance personnel and documentation personnel involved in our research and development efforts. Research and development expenses were $2.2 million, or 17.1% of total revenue, in 1999, representing a 14.7% increase from $1.9 million, or 18.6% of total revenue, in 1998. The increase in total research and development expenditures reflects the increased headcount during the second half of the year as we accelerated our new product development. Sales and Marketing Expenses. Sales and marketing expenses include salaries and related costs, commissions, travel, facilities, communications costs and promotional expenses for our sales organization and marketing staff. Sales and marketing expenses were $6.8 million, or 52.5% of total revenue, in 1999, representing a 41.7% increase from $4.8 million, or 46.3% of total revenue, 1998. This increase in expenditures and percentage of total revenue is the result of higher commissions on greater sales and expansion of both the Sales and Marketing staffs in the second half of the year, as we positioned ourselves for expected future growth. General and Administrative Expenses. General and administrative expenses include administrative salaries and related benefits, depreciation and amortization, management fees, recruiting and relocation expenses, as well as legal, accounting and other professional fees. General and administrative expenses were $3.2 million, or 24.4% of total revenue, in 1999, representing a 32.4% increase from $2.4 million, or 23.0% of total revenue, for the same period in 1998. This increase was primarily due to an increased provision for uncollectible accounts, an increase in a sales tax provision, recruiting fees and other professional services. Non-cash Compensation Expenses. Non-cash compensation of $188,000, or 1.5% of total revenue, was charged in connection with stock options granted at a price below market value, primarily to an executive officer. 7 9 Redeemable Stock Purchase Warrant. Changes for the increase in value of our redeemable common stock purchase warrant was $1.6 million, or 12.3% of total revenue for 1999. This change represents the increase in the value of the warrant granted in connection with a $1,000,000 loan. The warrant was exercised and the loan was repaid in September 1999. Other Income (Expense). Other income was $336,000, or 2.6% of total revenue, for 1999 compared to expense of $107,000 or 1.0% in 1998. The net interest income reflects the impact of the proceeds from investment of the funds received in the initial public offering for the fourth quarter of 1999. QUARTERLY RESULTS OF OPERATIONS The following table presents unaudited quarterly statements of operations data for each of our last eight quarters. The unaudited quarterly financial statements have been prepared on substantially the same basis as the audited financial statements contained herein. In the opinion of management, the unaudited quarterly financial statements include all adjustments, consisting only of normal recurring adjustments, that we consider to be necessary to fairly present this information when read in conjunction with our financial statements and related notes appearing elsewhere in this report. The results of operations for any quarter are not necessarily indicative of the results to be expected for any future period.
THREE MONTHS ENDED --------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, 1999 1999 1999 1999 2000 2000 2000 2000 -------- -------- --------- -------- -------- -------- --------- -------- (IN THOUSANDS) Revenue: Product revenue....... $ 1,364 $1,442 $ 1,798 $ 2,127 $ 1,106 $ 1,109 $ 785 $ 679 Service revenue....... 1,294 1,323 1,685 1,932 2,012 1,663 1,696 1,640 ------- ------ ------- ------- ------- ------- ------- ------- Total revenue..... 2,658 2,765 3,483 4,059 3,118 2,772 2,481 2,319 Costs of revenue: Product costs......... 272 296 412 435 499 410 373 260 Service costs......... 428 444 621 846 897 1,015 1,042 684 ------- ------ ------- ------- ------- ------- ------- ------- Total cost of revenue..... 700 740 1,033 1,281 1,396 1,425 1,415 944 ------- ------ ------- ------- ------- ------- ------- ------- Gross profit............ 1,958 2,025 2,450 2,778 1,722 1,347 1,066 1,375 Operating expenses: Research and development........ 398 401 612 801 898 937 877 1,011 Sales and marketing... 1,027 1,244 1,724 2,810 3,412 4,151 3,358 2,154 General and administrative..... 803 574 743 1,041 1,066 1,484 1,497 1,553 ------- ------ ------- ------- ------- ------- ------- ------- Restructuring......... -- -- -- -- -- -- -- 310 Non-cash compensation....... -- -- 153 35 -- -- -- -- ------- ------ ------- ------- ------- ------- ------- ------- Total operating expenses.... 2,228 2,219 3,232 4,687 5,376 6,572 5,732 5,028 ------- ------ ------- ------- ------- ------- ------- ------- Operating loss.......... (270) (194) (782) (1,909) (3,654) (5,225) (4,666) (3,653) Increase in redeemable stock purchase warrants.............. (734) -- (856) -- -- -- -- -- Other income (expense)............. (41) (37) (89) 503 518 510 493 453 ------- ------ ------- ------- ------- ------- ------- ------- Net loss...... $(1,045) $ (231) $(1,727) $(1,406) $(3,136) $(4,715) $(4,173) $(3,200) ======= ====== ======= ======= ======= ======= ======= =======
LIQUIDITY AND CAPITAL RESOURCES Historically, we have funded our operations from cash generated from operations and the issuance of long-term debt. In October 1999, we completed our initial public offering that provided us approximately 8 10 $43 million in net cash proceeds. We had cash and cash equivalents of $28.3 million at December 31, 2000 and $42.8 million at December 31, 1999. Cash used in operating activities during 2000 and 1999 was $13.3 million and $1.77 million, respectively. This increase reflects the net impact of the increase in our net loss, which was offset by decreases in accounts receivable, accounts payable and accrued expenses, and in deferred revenue. Our investing activities primarily include expenditures for fixed assets in support of our product development activities and infrastructure. Net cash used in investing activities increased to $1.8 million in 2000, compared to $1.0 in 1999. This increase resulted from an increase in fixed assets purchased during our expansion. Net cash provided by financing activities was $594,000 in 2000, compared to $45.5 million in 1999. This change was due primarily to our initial public offering that provided $43.0 million in cash proceeds in October 1999. In 2000, funds provided by financing activity primarily resulted from proceeds from the exercise of options which vested during the year. Other significant events in 1999 were the sale of Series A redeemable convertible preferred stock for $6.0 million, the redemption of common stock for $4.0 million, the repayment of the loan from Sirrom Investments, Inc. for $1.0 million, and the sale of common stock for $500,000. Because we have not generated significant revenue from sales outside the United States, we have not sustained material foreign currency exchange losses and presently do not attempt to hedge our exposure to fluctuations in foreign currency exchange rates. Should our revenue from international sales increase, and should such sales be denominated in foreign currencies, we intend to adopt a hedging strategy against foreign currency fluctuations. We believe that our existing liquidity and capital resources will be sufficient to satisfy our cash requirements for at least the next 12 months. Beyond the next 12 months, we expect to remain cash flow positive from operations and to fund any ongoing investments in capital equipment from cash flow from operations and the remaining proceeds from the IPO. However, to the extent that income from operations is insufficient to implement our business strategies, or if we identify additional strategic investments in our business, technology or products, we may be required to raise additional funds through equity or debt financing. If adequate funds are not available on acceptable terms or at all, our ability to implement our business strategies or take advantage of unanticipated opportunities or otherwise respond to competitive pressures would be limited. There can be no assurance that we will be able to raise these additional funds on terms acceptable to us, or at all. On January 10, 2001, we announced we had retained the investment banking firm of Robinson-Humphrey Company LLC to explore a range of strategic alternatives to enhance shareholder value, including a possible sale of our company. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) The following documents are filed as part of this report: 1. Financial Statements The financial statements are submitted as a separate section of this report, beginning on page F-1. 2. Financial Statement Schedule (b) Reports on Form 8-K. None. 9 11 (c) Exhibits. The following exhibits are filed as part of, or are incorporated by reference into, this report on Form 10-K/A:
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1 -- Amended and Restated Articles of Incorporation of Telemate.Net Software, Inc. (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 3.2 -- Amended and Restated Bylaws of Telemate.Net Software, Inc. (incorporated by reference to Exhibit 3.3 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 4.1 -- See Exhibits 3.1 and 3.2 for provisions of the Amended and Restated Articles of Incorporation and Amended and Restated Bylaws of the Registrant defining rights of the holders of common stock of Telemate.Net Software, Inc. 4.2 -- Specimen Stock Certificate (incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.1 -- Lease Agreement, dated January 28, 1992, between KGE Associates, LP and Complementary Solutions, Inc. (incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.2 -- First Amendment to Lease, dated June 11, 1993, between KGE Associates, LP and LP and Complementary Solutions, Inc. (incorporated by reference to Exhibit 10.3 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.3 -- Second Amendment to Lease, dated June 22, 1994, between KGE Associates, LP and LP and Complementary Solutions, Inc. (incorporated by reference to Exhibit 10.4 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.4 -- Third Amendment to Lease, dated March 30, 1995, between KGE Associates, LP and LP and Complementary Solutions, Inc. (incorporated by reference to Exhibit 10.5 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.5 -- Fourth Amendment to Lease, dated June 14, 1996, between KGE Associates, LP and LP and Telemate Software, Inc. (incorporated by reference to Exhibit 10.6 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.6 -- Fifth Amendment to Lease, dated July 26, 1996, between KGE Associates, LP and Telemate Software, Inc. (incorporated by reference to Exhibit 10.7 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.7 -- Sixth Amendment to Lease, dated August 2, 1996, between KGE Associates, LP and Telemate Software, Inc. (incorporated by reference to Exhibit 10.8 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.8 -- Seventh Amendment to Lease, dated July 16, 1998, between KGE Associates, LP and Telemate Software, Inc. (incorporated by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.9 -- Eighth Amendment to Lease, dated November 9, 1999, between KGE Associates, LP and Telemate.Net Software, Inc. (incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form K for the year ended December 31, 1999 (File No. 000-26735)) 10.10 -- Ninth Amendment to Lease, dated November 10, 1999, between KGE Associates, LP and Telemate.Net Software, Inc. (incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form K for the year ended December 31, 1999 (File No. 000-26735)) 10.11 -- Tenth Amendment to Lease, dated November 15, 1999, between KGE Associates, LP and Telemate.Net Software, Inc. (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form K for the year ended December 31, 1999 (File No. 000-26735))
10 12
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.12 -- Eleventh Amendment to Lease, dated May 24, 2000 between Telemate.Net Software, Inc. and KGE Associates, LP and Telemate.Net Software, Inc. (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 000-26735)) 10.13 -- Amended and Restated Employment Agreement of Richard L. Mauro dated March 2, 2001 (incorporated by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 000-26735)) 10.14 -- Form of Executive Employment Agreements (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 000-26735)) 10.15 -- Telemate Software, Inc. Stock Incentive Plan (incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.16 -- Telemate.Net Software, Inc. 1999 Stock Incentive Plan (incorporated by reference to Exhibit 10.13 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.17 -- Amendment to Telemate.Net Software, Inc. 1999 Stock Incentive Plan (incorporated by reference to Exhibit 10.14 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 10.18 -- Second Amendment to Telemate.Net Software, Inc. 1999 Stock Incentive Plan (incorporated by reference to Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 000-26735)) 10.19 -- Telemate.Net Software, Inc. Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.18 to the Company's Registration Statement on Form S-1 (File No. 33-81443)) 23.1 -- Consent of KPMG LLP 24.1 -- Powers of Attorney (included on signature page) 99.1 -- Safe Harbor Compliance Statement for Forward-Looking Statements (incorporated by reference to Exhibit 99.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 000-26735))
11 13 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 12th day of October, 2001. TELEMATE.NET SOFTWARE, INC. By: /s/ JANET VAN PELT ------------------------------------ Janet Van Pelt Senior Vice President, Finance & Operations, and Chief Financial Officer 12 14 TELEMATE.NET SOFTWARE, INC. FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999, AND 1998 (WITH INDEPENDENT AUDITORS' REPORT THEREON) F-1 15 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders Telemate.Net Software, Inc.: We have audited the accompanying balance sheets of Telemate.Net Software, Inc. as of December 31, 2000 and 1999, and the related statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2000. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Telemate.Net Software, Inc. as of December 31, 2000 and 1999, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG LLP February 6, 2001 F-2 16 TELEMATE.NET SOFTWARE, INC. BALANCE SHEETS
DECEMBER 31, --------------------- 2000 1999 --------- --------- (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS Current assets: Cash and cash equivalents................................. $ 28,263 $ 42,755 Trade accounts receivable, net of allowances of $500 and $300 for 2000 and 1999, respectively............... 2,264 3,467 Prepaid expenses and other current assets................. 511 518 -------- -------- Total current assets.............................. 31,038 46,740 Property and equipment, net................................. 2,215 1,474 Other assets................................................ 75 60 -------- -------- $ 33,328 $ 48,274 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 615 $ 1,212 Accrued expenses and other liabilities.................... 2,089 1,705 Deferred revenue.......................................... 2,933 3,041 -------- -------- Total liabilities................................. 5,637 5,958 -------- -------- Shareholders' equity: Preferred stock, $.01 par value; 19,700,000 authorized and undesignated, none issued.......................... -- -- Common stock, $.01 par value; 100,000,000 shares authorized, 7,958,486 and 7,359,962 shares issued and outstanding at December 31, 2000 and 1999, respectively........................................... 80 73 Additional paid-in capital................................ 53,123 52,537 Accumulated deficit....................................... (25,491) (10,267) Notes receivable and accrued interest from shareholders... (21) (27) -------- -------- Total shareholders' equity........................ 27,691 42,316 -------- -------- Commitments and contingencies -------- -------- $ 33,328 $ 48,274 ======== ========
See accompanying notes to financial statements. F-3 17 TELEMATE.NET SOFTWARE, INC. STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------------ 2000 1999 1998 ---------- ---------- ---------- (IN THOUSANDS, EXCEPT SHARE DATA) Revenue: Product sales............................................ $ 3,679 $ 6,731 $ 5,450 Service revenue.......................................... 7,011 6,234 4,932 ---------- ---------- ---------- Total revenue.................................... 10,690 12,965 10,382 ---------- ---------- ---------- Cost of revenue: Product costs............................................ 1,542 1,415 958 Service costs............................................ 3,638 2,339 1,502 ---------- ---------- ---------- Total cost of revenue............................ 5,180 3,754 2,460 ---------- ---------- ---------- Gross profit..................................... 5,510 9,211 7,922 ---------- ---------- ---------- Operating expenses: Research and development................................. 3,723 2,212 1,929 Sales and marketing...................................... 13,075 6,805 4,804 General and administrative............................... 5,600 3,349 2,388 Restructuring............................................ 310 -- -- ---------- ---------- ---------- Total operating expenses......................... 22,708 12,366 9,121 ---------- ---------- ---------- Operating loss................................... (17,198) (3,155) (1,199) ---------- ---------- ---------- Interest income (expense): Increase in redeemable stock purchase warrant............ -- (1,590) -- Other interest expense................................... -- (198) (142) Interest income.......................................... 1,974 534 35 ---------- ---------- ---------- Total interest income (expense).................. 1,974 (1,254) (107) ---------- ---------- ---------- Net loss before income taxes..................... (15,224) (4,409) (1,306) Income taxes............................................... -- -- -- ---------- ---------- ---------- Net loss......................................... $ (15,224) $ (4,409) $ (1,306) ========== ========== ========== Basic and diluted net loss per share....................... $ (1.96) $ (1.07) $ (0.40) ========== ========== ========== Basic and diluted weighted-average shares outstanding...... 7,750,614 4,102,999 3,261,813 ========== ========== ==========
See accompanying notes to financial statements. F-4 18 TELEMATE.NET SOFTWARE, INC. STATEMENTS OF SHAREHOLDERS' EQUITY
NOTE RECEIVABLE TOTAL COMMON STOCK ADDITIONAL AND ACCRUED SHAREHOLDERS' ------------------ PAID-IN ACCUMULATED INTEREST FROM EQUITY SHARES AMOUNT CAPITAL DEFICIT SHAREHOLDERS (DEFICIT) --------- ------ ---------- ----------- ------------- ------------- (IN THOUSANDS, EXCEPT SHARE DATA) Balance at December 31, 1997...... 3,261,813 $33 $ 170 $ (585) $(361) $ (743) Grant of compensatory stock options......................... -- -- 6 -- -- 6 Accrued interest on shareholder notes........................... -- -- -- -- (22) (22) Net loss.......................... -- -- -- (1,306) -- (1,306) --------- --- ------- -------- ----- -------- Balance at December 31, 1998...... 3,261,813 33 176 (1,891) (383) (2,065) Issuance of common stock for software product................ 30,000 -- 306 -- -- 306 Effects of change from S corporation to C corporation for income taxes: Distributions................... -- -- -- (269) 264 (5) Reclassification of accumulated deficit to additional paid-in capital....................... -- -- (296) 296 -- -- Purchase and retirement of common stock........................... (600,000) (6) -- (3,994) -- (4,000) Sale of common stock.............. 75,000 1 499 -- -- 500 Conversion of Series A redeemable convertible preferred stock to common stock.................... 900,000 9 5,941 -- -- 5,950 Rescission of put feature on redeemable stock purchase warrant and issuance of common stock........................... 122,418 1 1,713 -- -- 1,714 Stock option exercises............ 121,731 1 106 -- -- 107 Proceeds from initial public offering, net of costs.......... 3,449,000 34 43,904 -- -- 43,938 Grant of compensatory stock options......................... -- -- 188 -- -- 188 Repayment of notes receivable from shareholders.................... -- -- -- -- 109 109 Accrued interest on shareholder notes........................... -- -- -- -- (17) (17) Net loss.......................... -- -- -- (4,409) -- (4,409) --------- --- ------- -------- ----- -------- Balance at December 31, 1999...... 7,359,962 73 52,537 (10,267) (27) 42,316 Issuance of common stock under Employee Stock Purchase Plan.... 53,656 1 82 -- -- 83 Stock option exercises............ 544,868 6 497 -- -- 503 Compensatory stock options........ -- -- 7 -- -- 7 Repayment of notes receivable from shareholders.................... -- -- -- -- 8 8 Accrued interest on shareholder notes........................... -- -- -- -- (2) (2) Net loss.......................... -- -- -- (15,224) -- (15,224) --------- --- ------- -------- ----- -------- Balance at December 31, 2000...... 7,958,486 $80 $53,123 $(25,491) $ (21) $ 27,691 ========= === ======= ======== ===== ========
See accompanying notes to financial statements. F-5 19 TELEMATE.NET SOFTWARE, INC. STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- ------- ------- (IN THOUSANDS) Cash flows from operating activities: Net loss.................................................. $(15,224) $(4,409) $(1,306) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.......................... 1,017 467 353 Provision for bad debts, returns and allowances........ 718 525 404 Compensation on stock options.......................... 7 188 6 Interest earned on shareholder notes................... (2) (17) (22) Amortization of discount on redeemable stock purchase warrants............................................. -- 91 33 Accretion of common stock put warrants................. -- 1,590 -- Changes in operating assets and liabilities: Trade accounts receivable............................ 485 (2,183) (643) Prepaid expenses and other current assets............ 7 (391) 77 Other assets......................................... (15) 43 24 Accounts payable, accrued expenses, and other liabilities....................................... (213) 1,679 54 Deferred revenue..................................... (108) 651 249 -------- ------- ------- Net cash used in operating activities............. (13,328) (1,766) (771) -------- ------- ------- Cash flows from investing activities: Purchases of property and equipment....................... (1,758) (1,044) (306) -------- ------- ------- Cash flows from financing activities: Proceeds (payments) from/on credit facility............... -- (80) 80 Proceeds (payments) from/on issuance of long-term debt, net.................................................... -- (1,000) 965 Proceeds from issuance of common stock under Employee Stock Purchase Plan.................................... 83 -- -- Proceeds from the exercise of stock options............... 503 107 -- Proceeds from issuance of common stock, net............... -- 44,438 -- Proceeds from issuance of Series A redeemable convertible preferred stock, net................................... -- 5,950 -- Purchase and retirement of common stock................... -- (4,000) -- Payments received on notes receivable from shareholders... 8 109 -- Shareholder distributions................................. -- (5) -- -------- ------- ------- Net cash provided by financing activities......... 594 45,519 1,045 -------- ------- ------- Net change in cash and cash equivalents........... (14,492) 42,709 (32) Cash and cash equivalents at beginning of year.............. 42,755 46 78 -------- ------- ------- Cash and cash equivalents at end of year.................... $ 28,263 $42,755 $ 46 ======== ======= ======= Supplemental disclosure of cash paid for interest........... $ -- $ 106 $ 110 ======== ======= ======= Supplemental disclosure of reduction of notes from shareholders in exchange for distributions................ $ -- $ 264 $ -- ======== ======= =======
See accompanying notes to financial statements. F-6 20 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE DATA) 1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) BUSINESS Telemate.Net Software, Inc. (the "Company") develops, markets and supports internet and voice network usage management software which allows customers to manage the use of their voice and data networks. Organizations utilize the Company's products to help improve employee productivity, enhance network security, and control and recover network costs. Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities as of the balance sheet dates and revenues and expenses for the reporting periods to prepare these financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from those estimates. (B) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition and Deferred Revenue The Company recognizes revenue in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") No. 97-2, Software Revenue Recognition, SOP 98-4, Deferral of the Effective Date of a Provision of SOP 97-2 and SOP No. 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. Product revenue primarily consists of software license fees. Hardware sales are also included in product revenue and represent less than 10% of total revenue. Service revenue includes installation, training and support services. The Company uses the residual method to recognize revenue under multi-element arrangements. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement is recognized as revenue. Any discounts offered are applied to the delivered elements. The Company has established fair value for the undelivered elements based on the price charged when such elements are sold separately. Revenue from license fees and hardware is recognized when persuasive evidence of an agreement exists (in the form of a signed order confirmation or purchase order), delivery of the product has occurred, the fee is fixed or determinable and collectibility is reasonably assured. Although the Company does not typically offer a contractual right of return, revenue is reduced for estimated customer allowances. Such estimates are based on historical allowance rates. Revenue from installation and training is recognized upon performance of the related services. Installation and training services are offered separately and are not essential to the functionality of the software. Software support is offered separately and includes the right to unspecified upgrades on a when-and-if available basis. Support revenue is deferred and recognized ratably over the term of the related contract, usually one year. Specified upgrades are not typically offered to customers. Deferred revenue represents payments received from customers and billings invoiced to customers in advance of revenue recognition. Cash and Cash Equivalents The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. F-7 21 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA) Property and Equipment Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using accelerated and straight-line methods over the shorter of the estimated useful life or lease term. The estimated useful lives of the assets are as follows: Computer equipment and purchased software................... 3 -- 5 years Furniture and office equipment.............................. 5 -- 7 years Leasehold improvements...................................... 5 years
Computation of Net Loss Per Share The Company has presented net loss per share pursuant to Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share, and the Securities and Exchange Commission Staff Accounting Bulletin No. 98. Pursuant to SEC Staff Accounting Bulletin No. 98, common stock and convertible preferred stock issued for nominal consideration, prior to the effective date of the initial public offering ("IPO"), are required to be included in the calculation of basic and diluted net income (loss) per share, as if they were outstanding for all periods presented. The Company has not had any such issuances or grants for nominal consideration. The Company has excluded all outstanding stock options (note 7) from the calculation of diluted net loss per share because the shares are antidilutive. As a result, basic and diluted net loss per share are identical for all periods presented. Research and Development and Software Development Costs Research and development costs are expensed as incurred. Costs incurred subsequent to establishing technological feasibility, in the form of a working model, are capitalized and amortized over their estimated useful lives. To date, software development costs incurred after technological feasibility has been established have not been material. Income Taxes Through June 16, 1999, the shareholders of the Company elected that the earnings of the Company be taxed under the S Corporation provisions of the Internal Revenue Code. As a result of this election, the Company had not provided for federal or state income tax expense or any deferred income taxes as earnings were passed through to, and the related income tax liabilities became the individual responsibility of, the shareholders of the Company. On June 16, 1999, the Company's S corporation status terminated upon closing of the Series A preferred stock sale (note 6(c)). Subsequent to June 16, 1999, income taxes were accounted for under the asset and liability method. In accordance with the asset and liability method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of changes in tax rates is recognized in income in the period that includes the enactment date. F-8 22 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA) Stock Compensation Plan The Company accounts for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board ("APB") No. 25, Accounting for Stock Issued to Employees, and complies with the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation. Under APB No. 25, compensation cost for fixed plan accounting is recognized to the extent that the estimated fair value of the underlying stock exceeds the exercise price on the date of grant. Comprehensive Income No statement of comprehensive income has been included in the accompanying financial statements since the results would not differ from the accompanying statements of operations or shareholders' equity. Industry Segment Under SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, the Company operates and manages its business in one reportable segment, that being a software and services provider to the network usage management market. Fair Value of Financial Instruments The carrying value of the Company's financial instruments approximates fair value due to their short-term nature. Recent Accounting Pronouncements SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, is effective for the Company beginning January 2001. The new Statement requires all derivatives to be recorded on the balance sheet at fair value and establishes accounting treatment for three types of hedges: hedges of changes in the fair value of assets, liabilities or firm commitments, hedges of the variable cash flows of forecasted transactions, and hedges of foreign currency exposures of net investments in foreign operations. The Company does not anticipate there will be a material impact on the result of operations or financial position upon adoption of this standard. In March 2000, the FASB issued Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation ("Interpretation No. 44"), with an effective date of July 1, 2000. Interpretation No. 44 clarifies guidance for certain issues that arose in the application of APB No. 25. The adoption of Interpretation No. 44 did not have an impact on the Company's results of operations or financial position. Reclassification Certain amounts in the 1998 and 1999 financial statements have been reclassified to conform to the presentation adopted in the 2000 financial statements. F-9 23 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA) 2. PROPERTY AND EQUIPMENT Property and equipment consists of the following at December 31:
2000 1999 ------ ------ Computer equipment and purchased software................... $3,891 $2,619 Furniture and office equipment.............................. 713 484 Leasehold improvements...................................... 378 121 ------ ------ 4,982 3,224 Less accumulated depreciation and amortization.............. 2,767 1,750 ------ ------ $2,215 $1,474 ====== ======
3. ACCRUED EXPENSES AND OTHER LIABILITIES Accrued expenses and other liabilities consist of the following at December 31:
2000 1999 ------ ------ Accrued bonuses............................................. $ 553 $ 408 Personnel related accruals.................................. 690 490 Other accruals.............................................. 846 807 ------ ------ $2,089 $1,705 ====== ======
4. NOTE PAYABLE AND REDEEMABLE STOCK PURCHASE WARRANT In March 1998, the Company obtained $1 million from the issuance of a secured promissory note. The proceeds of the note provided working capital for the Company's continued product development activities. During September 1999, the outstanding balance was repaid. In connection with the note, the Company issued a warrant for the purchase of common stock at an exercise price of $.003 per share. The terms of the stock purchase warrant provide for the number of shares available for exercise to increase at certain future dates if the note payable remains outstanding. The lender exercised its warrants in September 1999 in a cashless exercise using 30 shares at the current market value at the date of exercise. The terms of the stock purchase warrant included many rights and privileges in favor of the lender, including but not limited to certain registration rights and put rights for cash for a period of 30 days immediately prior to the expiration thereof at a price equal to the fair market value of the common stock issuable to the holder upon exercise, as defined. In accordance with Emerging Issues Task Force No. 96-13, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, the Company estimated the fair value of the warrant at the date of issuance. The Company anticipated repaying the indebtedness in February 2000; accordingly, the Company amortized the initial fair value of the warrant to the extent of 122,448 shares, or $123, over 23 months as additional interest cost. The Company adjusted the carrying value of the warrant to fair value with changes in fair value reported in interest expense. At the exercise date, the fair value was $14.00 per share, as determined by the Black-Scholes pricing model and, accordingly, the Company increased the redeemable stock purchase warrant carrying value and recorded a charge of $1,590 to interest expense. F-10 24 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA) 5. NOTES RECEIVABLE FROM SHAREHOLDERS In 1997 and prior years, the Company issued shares of common stock for options that were exercised under the terms of the Company's Stock Incentive Plan. Upon exercise, the Company received cash and full recourse promissory notes payable to the Company secured by this common stock. The notes accrue interest at 110% of the applicable federal rate, as adjusted each January 1, and are due at various dates through 2007. In addition, funds were also advanced to certain shareholders in 1997 and prior years for various reasons. The shareholders signed promissory notes for the advanced funds. The notes bore interest at rates ranging from 6.00% to 7.11%. These notes were repaid in 1999. 6. SHAREHOLDERS' EQUITY (A) AMENDMENT IN THE ARTICLES OF INCORPORATION Effective June 16, 1999, the articles of incorporation of the Company were amended whereby the amount of common stock authorized for issuance was increased from 10 million shares to 100 million shares. Additionally, the articles of incorporation were amended whereby 20 million shares of preferred stock with a par value of $.01 per share were authorized, part or all of which shares of preferred stock will be established and designated from time to time by the Board of Directors in such series and with such preferences, limitations, and relative rights as may be determined by the Board of Directors. Of the preferred shares authorized, Series A redeemable convertible preferred stock ("Preferred Stock") was established and had many rights and privileges, including, but not limited to, those included herein. The Series A Preferred Stock was automatically converted into three shares of common stock for each share of preferred upon the completion of the Company's public offering (note 6(d)). (B) COMMON STOCK On June 8, 1999, the Company entered into an asset purchase agreement whereby the Company issued 30,000 shares of common stock in exchange for a software product from an unrelated party. The purchase was valued at $306,000 based on the estimated fair value of common stock at the time of the accomplishment of certain milestones. The seller has certain rights, privileges, and restrictions, including, but not limited to, piggyback registration rights. On June 16, 1999, the Company purchased and retired an aggregate of 600,000 shares of common stock from two principal shareholders, one of which is a member of the Company's Board of Directors, for $4,000,000. On June 21, 1999, the Company sold 75,000 shares of common stock to a board member for $500,000 in total proceeds. The purchaser has certain rights, including, but not limited to, registration rights and piggyback rights. On September 2, 1999, the Company consummated a three-for-one stock split in the form of a stock dividend. The information in the accompanying financial statements has been retroactively restated to reflect the effects of the stock split. (C) SALE OF SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK On June 16, 1999, the Company issued 300,000 shares of Series A Preferred Stock for cash totaling $6,000,000 ($5,950,000 after expenses of $50,000). Upon the completion of the Company's initial public offering, the Preferred Stock automatically converted into three shares of common stock for each share of preferred stock. F-11 25 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA) The holders of Preferred Stock were entitled to receive a 12% accruing dividend, compounded annually, payable only upon liquidation or redemption. Holders of the Preferred Stock were also entitled to participate equally (on an as-converted basis) in any cash dividends paid to any other class of equity securities of the Company. The Preferred Stock had voting rights, and the holders of the Preferred Stock were entitled to representation by two board members. The holders of Preferred Stock also had the right of first refusal for sale of additional shares. (D) COMPLETION OF INITIAL PUBLIC OFFERING On October 4, 1999, the Company successfully completed its initial public offering of common stock. The Company sold 3,284,000 shares of common stock in the initial public offering for approximately $42,758 less issuance costs of $968. On November 1, 1999, the Company sold 165,000 shares of common stock as part of the underwriters' overallotment from the initial public offering for $2,148. 7. STOCK OPTION PLANS AND EMPLOYEE STOCK PURCHASE PLAN (A) STOCK OPTION PLANS In June 1999, the Board of Directors and Shareholders approved the 1999 Stock Incentive Plan (the "1999 Plan"), ultimately authorizing 2,055,384 options to acquire common stock. The 1999 Plan provides for the grant of incentive stock options, nonqualified stock options, and restricted stock awards to selected employees. The stock options vest and become exercisable over a period determined by the Board of Directors not to exceed 10 years after the date of grant. The Company also has a previously existing Stock Incentive Plan (the "Plan"), under which the Board of Directors was authorized to grant selected employees, including officers, options to purchase the Company's common stock. Options granted pursuant to the Plan are exercisable for shares of common stock at a price not less than 100% of the fair market value on the date of grant. The Plan provided for the grant of incentive stock options, nonqualified stock options, and restricted stock awards to selected employees. The stock options vest and become exercisable over a period determined by the Board of Directors not to exceed ten years after the date of grant. F-12 26 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA) A summary of stock option activity under the 1999 Plan and the Stock Incentive Plan is as follows:
WEIGHTED- AVERAGE NUMBER OF EXERCISE SHARES PRICE --------- --------- Options outstanding at December 31, 1997.................... 2,712,687 $0.82 Granted..................................................... 674,025 0.96 Canceled.................................................... (458,025) 0.91 --------- Options outstanding at December 31, 1998.................... 2,928,687 0.84 Granted..................................................... 1,398,446 9.51 Canceled.................................................... (136,332) 2.11 Exercised................................................... (121,731) 0.88 --------- Options outstanding at December 31, 1999.................... 4,069,070 3.77 Granted..................................................... 1,741,700 2.25 Canceled.................................................... (887,250) 6.33 Exercised................................................... (544,868) 0.92 --------- Options outstanding at December 31, 2000.................... 4,378,652 3.00 --------- Options available for grant at December 31, 2000............ 27,434 =========
The following table summarizes information about stock options outstanding at December 31, 2000:
OPTIONS EXERCISABLE ----------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE ------------------ ----------- ----------- -------------- ----------- --------- $ 0.53 -- 0.96 2,530,602 6.0 years $ 0.76 1,915,702 $ 0.80 $ 1.19 -- 3.13 1,025,050 9.4 years 2.82 14,667 3.13 $ 6.67 282,000 8.4 years 6.67 54,000 6.67 $11.50 451,500 8.7 years 11.50 140,001 11.50 $14.00 -- 14.19 89,500 8.8 years 14.00 60,000 14.00 --------- --------- 4,378,652 7.3 years 3.00 2,184,370 2.01 ========= =========
The weighted-average fair value of options granted during the years ended December 31, 2000, 1999, and 1998 was $2.25, $2.79, and $0.32, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: expected dividend yield of 0%; expected volatility of 0% for the period of January 1, 1999 to October 1, 1999 and for the year ended December 31, 1998 and 75% for the period of October 1, 1999 to December 31, 1999 and for the year ended December 31, 2000; risk-free interest rate of 6.12%, 5.52%, and 5.25% for 2000, 1999, and 1998, respectively; and expected lives of six years. F-13 27 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA) During 1999, the Company granted 31,482 options with an exercise price less than the market value per share at the date of grant. As a result, a compensation charge totaling approximately $167 will be expensed over the vesting period. These options vest over periods ranging from immediately to three years. The Company applies APB No. 25 and related interpretations in accounting for its plans. Accordingly, no other compensation cost has been recognized for its stock option plan because the exercise price of the option equals or exceeds the fair value of the underlying stock at the date of the grant. Had compensation costs for the Company's stock-based compensation plans been determined in accordance with SFAS No. 123, the Company's net loss would have been increased to the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31, ---------------------------- 2000 1999 1998 -------- ------- ------- Net loss: As reported............................................ $(15,224) $(4,409) $(1,306) Pro forma.............................................. (16,300) (5,590) (1,433) Basic and diluted net loss per common share: As reported............................................ (1.96) (1.07) (0.40) Pro forma.............................................. (2.10) (1.36) (0.43)
(B) EMPLOYEE STOCK PURCHASE PLAN In 2000, the Company adopted an Employee Stock Purchase Plan under which 500,000 shares of the Company's common stock can be sold to employees. Under the terms of the plan, substantially all employees can choose each year to have up to 10% of their annual earnings withheld to purchase the Company's common stock. The purchase price of the stock is equal to 85% of the lower of the stock's beginning or end of the quarter market price. At December 31, 2000, 53,656 shares had been purchased by and issued to employees under the Plan. 8. INCOME TAXES The Company did not record any income taxes through June 16, 1999 since it was operating as an S corporation. On June 16, 1999, the Company converted to a C corporation for income tax purposes and reclassified the accumulated deficit totaling approximately $296 on this date to additional paid-in capital which represented undistributed estimated losses during the S corporation period limited to the amount of paid-in capital. The following table reconciles the expected corporate federal income tax (computed by multiplying the Company's net loss before income taxes by 34%) to the Company's actual provision for income taxes:
YEAR ENDED JUNE 17 THROUGH DECEMBER 31, DECEMBER 31, 2000 1999 ------------ --------------- Expected tax benefit....................................... $(5,176) $(1,054) State benefit, net of federal tax.......................... (474) (142) Permanent differences...................................... 13 299 Change in valuation allowance.............................. 5,882 897 Other, net................................................. (245) -- ------- ------- $ -- $ -- ======= =======
F-14 28 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA) The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liability as of December 31, 2000 and 1999, are presented below:
2000 1999 ------- ------- Deferred income tax assets: Allowances and deferrals.................................. $ 283 $ 210 Accrued bonuses and vacation pay.......................... 96 160 Research and development capitalization................... 134 368 Depreciation.............................................. 101 -- Stock option grants....................................... 60 62 Net operating loss carryforwards.......................... 6,829 821 ------- ------- Gross deferred income tax assets.................. 7,503 1,621 Valuation allowance....................................... (7,503) (1,621) ------- ------- $ -- $ -- ======= =======
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. At December 31, 2000, the Company had net operating loss carryforwards for federal income tax purposes of approximately $17,511 which are available to offset future federal taxable income, if any, through 2021. Following are the provisions for income taxes on an unaudited pro forma basis, using the asset and liability method, as if the Company had been a C corporation, fully subject to federal and state income taxes. The components of unaudited pro forma income taxes are as follows:
JANUARY 1 THROUGH YEAR ENDED JUNE 16, DECEMBER 31, 1999 1998 --------- ------------ Pro forma income taxes: Current: Federal................................................ $ (9) $ 9 State.................................................. (4) 4 ---- --- Total current..................................... (13) 13 ---- --- Deferred: Federal................................................ -- -- State.................................................. -- -- ---- --- Total deferred.................................... -- -- ---- --- Total pro forma income taxes...................... $(13) $13 ==== ===
F-15 29 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA) The following table reconciles the expected corporate federal income taxes (computed by multiplying the Company's net loss before income taxes by 34%) to the Company's unaudited pro forma provision for (benefit from) income taxes:
JANUARY 1 THROUGH YEAR ENDED JUNE 16, DECEMBER 31, 1999 1998 --------- ------------ Expected pro forma provision for (benefit from) income taxes..................................................... $(445) $(444) State income taxes, net of federal tax effect............... (2) 2 Permanent differences....................................... 261 52 Change in valuation allowance............................... 192 486 Other, net.................................................. (19) (83) ----- ----- $ (13) $ 13 ===== =====
Pro forma net loss is actual net loss adjusted for unaudited pro forma income tax expense (benefits) as follows:
JANUARY 1 THROUGH YEAR ENDED JUNE 16, DECEMBER 31, 1999 1998 --------- ------------ Unaudited pro forma net loss data: Pro forma provision for (benefit from) income taxes....... $ (13) $ 13 ======= ======= Pro forma net loss........................................ $(4,396) $(1,319) ======= ======= Unaudited pro forma basic and diluted net loss per share:... $ (1.07) $ (0.40) ======= =======
9. COMMITMENTS (A) LEASES In the ordinary course of business, the Company had entered into noncancelable operating lease agreements for its office facilities. Rental expense under the operating leases was $805, $418, and $324 for the years ended December 31, 2000, 1999, and 1998, respectively. The lease term for the office facility is through September 2003. Future minimum annual lease payments under the noncancelable operating lease agreements with remaining terms greater than one year are as follows:
YEARS ENDING DECEMBER 31, ------------ 2001........................................................ $ 714 2002........................................................ 739 2003........................................................ 497 ------ $1,950 ======
(B) EMPLOYEE BENEFIT PLAN Effective January 1, 1993, the Company adopted the Telemate Software 401(k) Savings and Investment Plan (the "401(k) Plan"). In order to participate in the 401(k) Plan, employees must be at least 21 years of age. The terms of the 401(k) Plan allow employees to contribute up to 20% of pretax compensation up to the maximum allowed under Internal Revenue Service ("IRS") regulations. The Company may make discretionary matching contributions up to the maximum allowed under IRS F-16 30 TELEMATE.NET SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA) regulations. In addition, the Company may make a discretionary profit-sharing contribution to the 401(k) Plan. The discretionary matching and profit-sharing contributions vest at the rate of 20% per year. For the years ended December 31, 2000, 1999, and 1998, the Company made discretionary matching contributions of $122, $72, and $73, respectively, to the 401(k) Plan. The Company did not make any discretionary profit sharing contributions during 2000, 1999, or 1998. 10. MAJOR CUSTOMER In 1999 the Company entered into a sales agreement with a third-party contractor to provide software, hardware, and installation services for 51 different sites. This sales agreement comprised 10.5% and 13.9%, of 2000 and 1999 revenue, respectively. Accounts receivable from this customer totaled $289 and $710 at December 31, 2000 and 1999, respectively. 11. RESTRUCTURING COSTS On October 30, 2000, the Company entered into a plan of termination, whereby 34 employees either resigned or were terminated. As a result of the restructuring, the Company incurred expenses totaling $310, which was comprised mainly of severance pay, outplacement services, and legal fees. Approximately $11 in severance remained unpaid at December 31, 2000 which was included in the accompanying financial statements. 12. SUBSEQUENT EVENT In January 2001, the Company announced its retention of an investment banking firm to explore a range of strategic alternatives to enhance shareholder value, including a possible sale of the Company. F-17 31 VALUATION AND QUALIFYING ACCOUNTS SCHEDULE II TELEMATE.NET SOFTWARE, INC. YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998 ACCOUNTS RECEIVABLE ALLOWANCES
ADDITIONS BALANCE AT CHARGED ADDITIONS BALANCE AT BEGINNING OF TO COSTS CHARGED TO END OF YEAR ENDED YEAR AND EXPENSE REVENUE DEDUCTIONS YEAR ---------- ------------ ----------- ---------- ---------- ---------- December 31, 1998........................ $ 60,000 $ 35,000 $368,501 $368,501 $ 95,000 December 31, 1999........................ $ 95,000 $245,000 $280,091 $320,091 $300,000 December 31, 2000........................ $300,000 $301,258 $416,607 $517,900 $499,965
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