10-Q/A 1 g72051e10-qa.txt TELEMATE.NET SOFTWARE, INC. 1 =============================================================================== SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A AMENDMENT NO. 1 [MARK ONE] [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 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: 000-26735 TELEMATE.NET SOFTWARE, INC. (Exact Name of Registrant as Specified in Its Charter) GEORGIA 58-1656726 (State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) 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 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 [ ] The number of shares of the issuer's class of capital stock as of May 11, 2001, the latest practicable date, is as follows: 9,205,743 shares of Common Stock, $0.01 par value. =============================================================================== 2 TELEMATE.NET SOFTWARE, INC. FORM 10-Q/A QUARTER ENDED MARCH 31, 2001 TABLE OF CONTENTS EXPLANATORY NOTE This Report on Form 10-Q/A amends and restates in its entirety Item 2 of the Quarterly Report on Form 10-Q of Telemate.Net Software, Inc., a Georgia corporation (the "Company"), for the quarter ended March 31, 2001. PART I FINANCIAL INFORMATION

Form 10-Q/A Page 2 of 10 3 PART I FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain of the information included in this report, including statements regarding our growth and operating strategy, liquidity and capital expenditures, trends in our industry, and proposed merger with Verso Technologies, Inc. constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and we intend that such forward-looking statements be subject to the safe harbors created thereby. Examples of words indicating forward-looking statements include "believe," "expect", "goal," "plan," "intend," "estimate," "may," and "will" or similar words. These forward-looking statements reflect our current views with respect to future events and financial performance, but are subject to many uncertainties and factors relating to our operations and business environment that may cause our actual results to be materially different from any future results expressed or implied by such forward-looking statements. For further information about these and other factors that could affect our future results, please see Exhibit 99.1 attached to this quarterly report. OVERVIEW Telemate.Net Software, Inc. is a leading provider of network usage management solutions for businesses worldwide. Our Internet access management, eBusiness intelligence, and call accounting offerings enable companies to ensure productivity, reduce unnecessary expenses, enhance network performance, mitigate risk, and maximize e-commerce effectiveness. We expect the anticipated release of our new WebFilter product in the second quarter of 2001 to be as a critical milestone in our business. A combined Internet filtering and reporting appliance, WebFilter utilizes automated content recognition technology to deliver adaptive Internet filtering. This advanced architecture provides users with more accurate categorization of Internet activity than that of the "hit" or "keyword" lists currently used by competitors. 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 bug fixes in the current version of the product and telephone consultation to discuss general support questions. Product updates include Form 10-Q/A Page 3 of 10 4 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 licensed products. Professional services include installation, training, and custom report generation. We recognize revenue from software licenses in accordance with the American Institute of Certified Public Accountants Statement of Position 97-2, Software Revenue Recognition, and Statement of Position 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. Revenue derived from software license fees and hardware is typically recognized upon shipment. Revenue generated 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. 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 and third-party resellers and distributors. While our direct sales force is expected to continue to generate a 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 our products 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, Checkpoint Software Technologies, Microsoft Corporation, and Symantec/Axent. We expect to continue to focus our sales resources on strengthening existing relationships and creating new strategic relationships. 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. Form 10-Q/A Page 4 of 10 5 PROPOSED MERGER On May 4, 2001, we entered into an Agreement and Plan of Merger with Verso Technologies, Inc., a Minnesota corporation, and Titan Acquisition Sub, Inc., a Delaware corporation to be reincorporated in Georgia prior to closing and a wholly-owned subsidiary of Verso, in which each outstanding share of our common stock will be converted into the right to receive an aggregate number of Verso shares valued at $30 million, subject to reduction on a dollar-for-dollar basis if our available cash at closing after restructuring charges and other adjustments falls below $20 million. The number of Verso shares to be issued will be based on the average closing price of Verso shares from April 20 through May 17, 2001, but cannot be less than $.85 per share or exceed $1.15 per share. The merger with Verso is intended to constitute a reorganization under Section 368(a) of the Internal Revenue Code of 1986, as amended, and is to be accounted for as a purchase transaction. Consummation of the merger is subject to various conditions, including, among other things, receipt of the necessary approvals of our shareholders and the shareholders of Verso, regulatory approvals, and customary closing conditions. In connection with the proposed merger, a joint proxy statement and Registration Statement on Form S-4 will be filed with the SEC. We will jointly mail with Verso the Joint Proxy Statement/Prospectus to our shareholders and shareholders of Verso containing additional information about the proposed merger after approval from the SEC. The transaction is expected to close in the third quarter of 2001, but this expectation is subject to many factors, including whether the SEC reviews the Joint Proxy Statement/Prospectus. In the event the transaction does not close, under certain circumstances a break-up fee of $4 million plus expenses of up to $1 million would be payable. Telemate.Net also entered into an agreement to purchase up to 500,000 shares of Verso's non-voting Series B Preferred Stock for an aggregate purchase price of $10.0 million to help finance an acquisition meeting certain specific criteria. The preferred stock would accrue dividends at 10% per annum through December 31, 2001, increasing to 15% after December 31, 2001 should such shares remain outstanding after that time, and will have a liquidation preference and certain conversion rights. The preferred stock will be redeemable at par value by Verso on or before December 31, 2001, or with a 25% premium at the option of Telemate.Net after December 31, 2001. On May 7, 2001, in connection with the proposed merger, we announced our plan to reduce our workforce by approximately 90 employees, or approximately 60%, over the next several months to preserve cash, accelerate profitability, and eliminate redundant positions in anticipation of the upcoming merger transaction. We will provide employees affected by the reduction with severance packages and outplacement counseling. Management anticipates a one-time restructuring charge of between $2.5 million and $3.0 million in the second quarter of 2001 in connection with the reduction in force. Form 10-Q/A Page 5 of 10 6 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: REVENUE INFORMATION (Unaudited and in thousands)

Three Months Ended March 31, 2001 and 2000 Revenue. Total revenue was $2.2 million for the three months ended March 31, 2001, down 30.8% from $3.1 million for the first quarter of 2000. Total product revenue was $608,000, or 28.2% of total revenue, in the three months ended March 31, 2001, representing a 45.0% decrease from $1.1 million, or 35.5% of total revenue, for the same period in 2000. Revenue from the resale of complementary hardware included in product revenue was Form 10-Q/A Page 6 of 10 7 $102,000, representing 4.7% of total revenue for the three months ended March 31, 2001, a decrease from $446,000, or 14.3% of total revenue for the same period in 2000. Total service revenue was $1.6 million, or 71.8% of total revenue, in the three months ended March 31, 2001, representing a 22.9% decrease from $2.0 million, or 64.5% of total revenue, for the same period in 2000. During the first quarter of 2001, a sales agreement with a third-party contractor to provide software, hardware, and installation services for a single customer at 51 different sites represented approximately 4.7% of total revenue, compared to approximately 19.7% in the same quarter of 2000. We do not believe this agreement will generate significant revenue in the future. Internet/Integrated Revenue. Total Internet/integrated revenue was $591,000, or 27.3% of total revenue, in the three months ended March 31, 2001, a 59.6% decrease from $1.5 million, or 47.0% of total revenue, for the same period in 2000. Internet/integrated product revenue was $216,000, or 10.0% of total revenue, in the three months ended March 31, 2001, representing a 69.9% decrease from $719,000 or 23.1% of total revenue, for the same period in 2000. Internet/integrated service revenue was $375,000, or 17.3% of total revenue, in the three months ended March 31, 2001, representing a 49.6% decrease from $744,000, or 23.9% of total revenue, for the same period in 2000. The decrease in Internet/integrated product and service revenue resulted in part from a decrease in the sale of software, hardware, and the completion of professional services in connection with the major customer referred to under Revenue above. In addition, total Internet/integrated revenue was impacted by the shift in focus from the sale of an integrated solution to distinct Internet and call accounting applications. Call Accounting Revenue. Total call accounting revenue was $1.6 million, or 72.7% of total revenue, for the three months ended March 31, 2001, a 5.3% decrease from $1.7 million, or 53.0% of total revenue, for the same period in 2000. Call accounting product revenue was $392,000, or 18.2% of total revenue, for the three months ended March 31, 2001, representing a 1.3% increase from $387,000, or 12.4% of total revenue, for the same period in 2000. Call accounting service revenue was $1.2 million, or 54.5% of total revenue, in the three months ended March 31, 2001, representing a 7.3% decrease from $1.3 million, or 40.6% of total revenue, for the same period in 2000. Although Call Accounting product revenue was in line with last year, we saw a reduction in sales of low margin hardware in the first quarter of 2001 and a corresponding increase in software sales as a result of management's efforts to emphasize profit contribution in this division, more focused sales efforts and improved sales productivity. The decrease in Call Accounting service revenue was due in part to a delay in the support renewal process during a new invoicing system implementation which has now been completed. Cost of Product Revenue. Cost of product revenue was $224,000, or 10.4% of total revenue, in the three months ended March 31, 2001, a 55.1% decrease from $500,000, or 16.0% of total revenue, for the same period in 2000. This decrease in product costs was primarily attributable to a reduction in lower margin hardware sales as well as a reduction in direct product costs as a result of reduced product revenue. Management believes the hardware component of revenue will remain at the more traditional levels of prior years for the remainder of the year. The decrease in the percentage of total revenue reflects a change in revenue mix with service revenues having produced a higher percentage of total revenue. In addition, the reductions in the aforementioned hardware and royalty costs contributed to the decrease in the percentage of total revenue. Cost of Service Revenue. Cost of service revenue was $631,000, or 29.2% of total revenue, for the three months ended March 31, 2001, representing a 29.7% decrease from $897,000, or 28.8% of total revenue, for the same period in 2000. The decline in service costs resulted from decreased service personnel costs after our reduction in force in October 2000. The increase in the percentage of total revenue reflects a change in revenue mix with service revenues having produced a higher percentage of total revenue. The reduction in workforce during the second quarter 2001 will result in a further decline in cost of service revenue over the remainder of the year. Research and Development Expenses. Research and development expenses were $1.1 million, or 51.8% of total revenue, for the three months ended March 31, 2001, representing a 24.6% increase from $898,000, or 28.8% of total revenue, for the same period in 2000. The increase in total research and development expenses reflects Form 10-Q/A Page 7 of 10 8 increased personnel expenses to accelerate new product development and existing product enhancements. Due to our reduction in work force, we expect research and development expenses to show a declining trend during the second quarter and to remain flat for the remainder of the year. Sales and Marketing Expenses. Sales and marketing expenses were $2.1 million, or 97.4% of total revenue, for the three months ended March 31, 2001, representing a 38.4% decrease from $3.4 million, or 109.4% of total revenue, for the same period in 2000. The decrease in both absolute dollars and as a percentage of total revenue were due to several factors, primarily the reduction of sales and marketing personnel and more targeted, revenue-driving marketing programs. The effects of our second quarter reduction in force will be seen in a reduction in sales and marketing expenses for the remainder of the year. General and Administrative Expenses. General and administrative expenses were $1.4 million, or 64.2% of total revenue, in the three months ended March 31, 2001, representing a 29.9% increase from $1.1 million, or 34.2% of total revenue, for the same period in 2000. This increase was primarily due to personnel costs, insurance, and professional service fees largely related to the requirements of being a public company. We expect general and administrative costs to remain flat for the next several months. Other Interest Income. Other interest income was $356,000, or 16.5% of total revenue, for the three months ended March 31, 2001, compared to $518,000, or 16.6% of total revenue, for the same quarter of 2000. Proceeds from investment of the funds received in the initial public offering account for the interest income. LIQUIDITY AND CAPITAL RESOURCES Historically, we have funded our business from cash generated from operations and the issuance of long-term debt. However, in October 1999, we completed our initial public offering that provided us approximately $42.8 million in net cash proceeds. We had cash and cash equivalents of $25.6 million at March 31, 2001 and $38.5 million at March 31, 2000. Cash used in operating activities during the three months ended March 31, 2001 was $2.5 million, a 32.1% decrease from $3.7 million for the same period in 2000. This change reflects the net impact of decreases in our net loss, and changes in accounts receivable, accounts payable and deferred revenue. Our investing activities primarily include expenditures for fixed assets to support our operations. Net cash used in investing activities decreased to $239,000 in the first three months of 2001, compared to $878,000 for the same period in 2000. Net cash provided by financing activities was $31,000 for the three-month period ended March 31, 2001, compared to $245,000 for the period ended March 31, 2000. This change was due primarily to a decrease in the exercise of stock options by our employees. 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 anticipate the second quarter 2001 reduction in work force to result in a restructuring charge of between $2.5 million and $3.0 million. In Form 10-Q/A Page 8 of 10 9 the event the pending merger transaction does not close, we remain confident that our existing liquidity and capital resources, including the proceeds resulting from the sale of our common stock in our initial public offering, 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. Form 10-Q/A Page 9 of 10 10 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TELEMATE.NET SOFTWARE, INC. Date: October 12, 2001 /s/ Janet Van Pelt ----------------------------------------------- Janet Van Pelt Senior Vice President - Finance and Operations, Chief Financial Officer, and Treasurer (Principal Financial and Accounting Officer) Form 10-Q/A Page 10 of 10

TELEMATE NET SOFTWARE INC 10-Q/A