SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2001
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934.
Commission File Number 0-24707
INET TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-2269056
(State or other jurisdiction of ( I.R.S. employer
incorporation or organization) identification no.)
1500 North Greenville Avenue
Richardson, Texas 75081
(Address of principal executive offices, including zip code)
(469) 330-4000
(Registrant's telephone number, including area code)
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 / /
Number of shares of common stock outstanding at July 27, 2001: 46,632,005
Page 1 of 26
INET TECHNOLOGIES, INC.
INDEX
PAGE NO.
--------
Part I - Financial Information (Unaudited)
Item 1. Financial Statements
Consolidated Balance Sheets .................................. 3
Consolidated Statements of Operations ........................ 4
Consolidated Statement of Stockholders' Equity ............... 5
Consolidated Statements of Cash Flows ........................ 6
Notes to Consolidated Financial Statements ................... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .......................... 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk ... 25
Part II - Other Information
Item 2. Changes in Securities and Use of Proceeds .................... 26
Item 4. Submission of Matters to a Vote of Security Holders .......... 26
Item 6. Exhibits and Reports on Form 8-K ............................. 26
Signatures ..................................................................... 26
Page 2 of 26
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INET TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
JUNE 30, DECEMBER 31,
2001 2000
-------- ------------
(In thousands,
except share data)
Current assets:
Cash and cash equivalents ............................ $146,231 $131,419
Trade accounts receivable, net of allowance for
doubtful accounts of $795 at June 30, 2001
and $1,065 at December 31, 2000 .................... 14,832 47,634
Unbilled receivables ................................. 1,875 1,925
Income taxes receivable .............................. 4,577 12,179
Inventories .......................................... 14,017 9,381
Deferred income taxes ................................ 907 1,667
Other current assets ................................. 4,760 3,254
-------- --------
Total current assets ......................... 187,199 207,459
Property and equipment, net ............................ 20,986 18,408
Other assets ........................................... 170 340
-------- --------
Total assets ................................. $208,355 $226,207
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ..................................... $ 3,252 $ 4,629
Accrued compensation and benefits .................... 2,766 7,885
Deferred revenues .................................... 14,675 22,744
Other accrued liabilities ............................ 3,758 5,040
-------- --------
Total current liabilities .................... 24,451 40,298
Deferred tax liability ................................. 707 489
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares -- 25,000,000
Issued shares -- None ............................. -- --
Common stock, $.001 par value:
Authorized shares -- 175,000,000
Issued shares -- 46,632,005 at June 30, 2001
and 46,319,633 at December 31, 2000 ............. 47 46
Additional paid-in capital ........................... 70,824 69,935
Retained earnings .................................... 112,326 115,439
-------- --------
Total stockholders' equity ................... 183,197 185,420
-------- --------
Total liabilities and stockholders' equity ... $208,355 $226,207
======== ========
See accompanying notes to consolidated financial statements.
Page 3 of 26
INET TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
2001 2000 2001 2000
-------- -------- -------- --------
(In thousands, except per share data)
Revenues:
Product and license fees .................................. $ 18,530 $ 32,586 $ 44,541 $ 62,483
Services .................................................. 5,477 4,242 10,910 7,306
-------- -------- -------- --------
Total revenues ....................................... 24,007 36,828 55,451 69,789
Cost of revenues:
Product and license fees .................................. 9,040 7,506 19,057 13,520
Services .................................................. 2,071 2,126 4,677 3,871
-------- -------- -------- --------
Total cost of revenues ............................... 11,111 9,632 23,734 17,391
-------- -------- -------- --------
Gross profit ..................................... 12,896 27,196 31,717 52,398
Operating expenses:
Research and development .................................. 9,918 7,818 21,624 14,921
Sales and marketing ....................................... 5,137 3,983 10,876 8,214
General and administrative ................................ 2,534 3,032 5,270 5,491
Restructuring ............................................. 1,726 -- 2,252 --
-------- -------- -------- --------
19,315 14,833 40,022 28,626
-------- -------- -------- --------
Income (loss) from operations ..................... (6,419) 12,363 (8,305) 23,772
Other income (expense):
Interest income ........................................... 1,571 2,113 3,537 3,885
Other expense ............................................. (54) (7) (96) (21)
-------- -------- -------- --------
1,517 2,106 3,441 3,864
-------- -------- -------- --------
Income (loss) before provision for income taxes ... (4,902) 14,469 (4,864) 27,636
Provision (benefit) for income taxes ........................ (1,764) 4,919 (1,751) 9,396
-------- -------- -------- --------
Net income (loss) ................................. $ (3,138) $ 9,550 $ (3,113) $ 18,240
======== ======== ======== ========
Earnings (loss) per common share:
Basic ............................................. $ (0.07) $ 0.21 $ (0.07) $ 0.40
======== ======== ======== ========
Diluted ........................................... $ (0.07) $ 0.20 $ (0.07) $ 0.39
======== ======== ======== ========
Weighted-average shares outstanding:
Basic ............................................. 46,613 46,090 46,542 45,993
======== ======== ======== ========
Diluted ........................................... 46,613 46,833 46,542 46,832
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
Page 4 of 26
INET TECHNOLOGIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
COMMON STOCK ADDITIONAL TOTAL
-------------------------- PAID-IN RETAINED STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS EQUITY
---------- ---------- ---------- ---------- -------------
(In thousands, except share data)
Balance at December 31, 2000 .................... 46,319,633 $ 46 $ 69,935 $ 115,439 $ 185,420
Issuance of common stock under stock option and
stock purchase plans ........................ 312,372 1 889 -- 890
Net loss ...................................... -- -- -- (3,113) (3,113)
---------- ---------- ---------- ---------- ----------
Balance at June 30, 2001 ........................ 46,632,005 $ 47 $ 70,824 $ 112,326 $ 183,197
========== ========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
Page 5 of 26
INET TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
SIX MONTHS ENDED
JUNE 30,
-------------------------
2001 2000
--------- ---------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ................................................ $ (3,113) $ 18,240
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation ................................................... 3,504 2,352
Deferred income taxes .......................................... 978 266
Issuance of common stock and stock options charged to expense... -- 115
Changes in operating assets and liabilities:
(Increase) decrease in trade accounts receivable ............ 32,802 (2,721)
(Increase) decrease in unbilled receivables ................. 50 (846)
(Increase) decrease in income taxes receivable .............. 6,331 (714)
Increase in inventories ..................................... (4,636) (1,067)
Increase in other assets .................................... (1,336) (1,184)
Increase (decrease) in accounts payable ..................... (1,377) 195
Decrease in taxes payable ................................... -- (213)
Increase (decrease) in accrued compensation and benefits .... (5,119) 398
Decrease in deferred revenues ............................... (8,069) (4,820)
Increase (decrease) in other accrued liabilities ............ (1,282) 2,033
--------- ---------
Net cash provided by operating activities ........................ 18,733 12,034
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment .............................. (6,082) (3,197)
--------- ---------
Net cash used in investing activities ............................ (6,082) (3,197)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock upon exercise
of stock options and purchases under employee stock
purchase plan ................................................. 2,161 1,910
--------- ---------
Net cash provided by financing activities ........................ 2,161 1,910
--------- ---------
Net increase in cash and cash equivalents ........................ 14,812 10,747
Cash and cash equivalents at beginning of period ................. 131,419 127,903
--------- ---------
Cash and cash equivalents at end of period ....................... $ 146,231 $ 138,650
========= =========
SUPPLEMENTAL DISCLOSURES:
Income taxes paid ............................................. $ 415 $ 4,615
========= =========
See accompanying notes to consolidated financial statements.
Page 6 of 26
INET TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
We are a global provider of communications software solutions that enable
carriers to more effectively design, deploy, diagnose, monitor and manage
communications networks that carry signaling information used to control
and deliver communications sessions and services. These communications
sessions include phone calls, dial-up Internet access and other service
transactions or sessions. Our solutions also address the fundamental
business needs of communications carriers, such as improved billing,
targeted sales and marketing, fraud prevention and enhanced routing. We
provide these comprehensive offerings through our network intelligence,
business intelligence and diagnostics solutions.
CONSOLIDATION
The consolidated financial statements include the accounts of our
wholly-owned subsidiaries. Intercompany balances and transactions have been
eliminated.
UNAUDITED INTERIM FINANCIAL STATEMENTS
We have prepared the accompanying unaudited consolidated financial
statements in accordance with accounting principles generally accepted in
the United States for interim financial information and the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. In our opinion, all adjustments necessary, consisting solely of
normal recurring adjustments, for a fair statement of the results for the
interim periods presented have been included. These financial statements
should be read in conjunction with the audited financial statements and
related notes for the three years ended December 31, 2000, included in our
Annual Report on Form 10-K filed with the Securities and Exchange
Commission, or SEC, on March 26, 2001. Financial results for the three- and
six-month periods ended June 30, 2001 are not necessarily indicative of the
results that may be expected for any other interim period or for the year
ending December 31, 2001.
CASH AND CASH EQUIVALENTS
All highly liquid securities with original maturities of three months or
less are classified as cash equivalents. The carrying value of cash
equivalents approximates fair market value.
INVENTORIES
Inventories are valued at the lower of standard cost, which approximates
actual cost determined on a first-in, first-out basis, or market. At June
30, 2001 and December 31, 2000, inventories consisted of the following (in
thousands):
JUNE 30, DECEMBER 31,
2001 2000
------- -----------
Raw materials ........... $ 7,241 $ 4,183
Work-in-process ......... 1,513 241
Finished goods .......... 5,263 4,957
------- -------
$14,017 $ 9,381
======= =======
Page 7 of 26
REVENUE RECOGNITION
Effective January 1, 2000, we adopted Statement of Position, or SOP, 98-9,
MODIFICATION OF SOP 97-2, `SOFTWARE REVENUE RECOGNITION' WITH RESPECT TO
CERTAIN TRANSACTIONS, which did not require a significant change to our
revenue recognition policies. In December 1999, the SEC issued Staff
Accounting Bulletin, or SAB, No. 101, REVENUE RECOGNITION IN FINANCIAL
STATEMENTS, which we adopted in the fourth quarter of 2000 retroactive to
January 1, 2000. The adoption of SAB 101 did not materially affect our
revenue recognition policies.
We derive revenues primarily from the sale of products and software license
fees as well as services, which include product installation, product
integration, training, warranty and product support services.
Except as otherwise discussed below, revenues from product and license fees
are recognized in the period we have completed all hardware manufacturing
and/or software development to contractual specifications, factory testing
has been completed, the product has been shipped to the customer, the fee
is fixed and determinable and collection is considered probable. When we
have significant obligations subsequent to shipment, for example,
installation and system integration, revenues are recognized when there are
no significant unfulfilled obligations. Revenues from arrangements that
include significant acceptance terms are recognized when acceptance has
occurred.
Revenues for fixed-priced contracts that require significant software
development and are generally in duration in excess of nine months are
recognized using the percentage-of-completion method. Revenues from these
contracts are recognized upon attainment of scheduled performance
milestones. Anticipated losses on fixed-priced contracts are recognized
when estimable.
Revenues from product installation, product integration and other services,
excluding product support services, are recognized when the services have
been completed.
We offer our customers product support services, which include the
correction of software problems, telephone access to our technical
personnel and the right to receive unspecified product updates, upgrades
and enhancements, when and if they become available. Revenues from these
services, including product support services included in initial licensing
fees, are recognized ratably over the contract period. Product support
services included in the initial licensing fee are allocated from the total
contract amount based on the relative fair value of these services
determined using vendor-specific objective evidence, or VSOE.
Deferred revenues represent amounts billed to customers, but not yet
recognized as revenue. Unbilled receivables represent amounts recognized as
revenue, but not yet billed to customers.
ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires us to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from these
estimates.
NOTE 2 - RELATED PARTY TRANSACTION
Effective January 1, 2000, we sold our membership interest in Inet Global
Research, L.L.C., to an entity controlled by a related party for a cash
purchase price of $82,000. No gain or loss was recorded for the sale. This
entity is currently performing services for us for which it is paid a
monthly fee per dedicated full-time programmer plus reimbursement of
reasonable business expenses. We paid approximately $835,000 for these
services for the six months ended June 30, 2001, and approximately $180,000
for the six months ended June 30, 2000.
Page 8 of 26
NOTE 3 - RESTRUCTURING
In March 2001, we recorded a restructuring charge of $526,000 primarily
related to a workforce reduction of approximately 40 employees. The
reduction affected all areas of the company. The charge primarily consisted
of employee severance costs, professional fees and outplacement services.
At June 30, 2001, the balance of these costs that remained to be paid
totaled approximately $164,000.
In May 2001, we announced our decision to refocus our strategy and
streamline operations to reduce our cost structure in response to the
generally weakened economic environment and changing demand characteristics
in some of our markets. As part of this decision, we discontinued all
efforts with respect to our softswitch offering, VIA-TM-, and reduced our
workforce by approximately 115 employees. The reduction affected all areas
of the company. We recorded a restructuring charge of approximately $1.7
million, which consisted of employee severance costs of approximately $1.1
million, professional fees and outplacement services of approximately
$300,000 and the write-off of assets related to the VIA softswitch product
of approximately $300,000. At June 30, 2001, the balance of these costs
that remained to be paid totaled approximately $700,000.
NOTE 4 - EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted
earnings (loss) per share (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2001 2000 2001 2000
-------- ------- -------- -------
Numerator:
Net income (loss) for basic and diluted
earnings (loss) per share ......................... $ (3,138) $ 9,550 $ (3,113) $18,240
======== ======= ======== =======
Denominator:
Denominator for basic earnings (loss) per
share -- weighted-average shares .................. 46,613 46,090 46,542 45,993
Dilutive securities: Employee stock options and
purchase rights ................................... -- 743 -- 839
-------- ------- -------- -------
Denominator for diluted earnings
(loss) per share-- adjusted
weighted-average shares ........................... 46,613 46,833 46,542 46,832
======== ======= ======== =======
Basic earnings (loss) per common share ................ $ (0.07) $ 0.21 $ (0.07) $ 0.40
======== ======= ======== =======
Diluted earnings (loss) per common share .............. $ (0.07) $ 0.20 $ (0.07) $ 0.39
======== ======= ======== =======
NOTE 5 - COMPREHENSIVE INCOME
For all periods presented, we had no material components of comprehensive
income other than net income.
Page 9 of 26
NOTE 6 - SEGMENT INFORMATION
We operate in a single industry segment, providing communications software
solutions and associated services to our customers through our sales
personnel and certain foreign distributors. As a result, the financial
information disclosed in this report represents all material financial
information related to our sole operating segment. The geographic
distribution of our revenues as a percentage of total revenues is as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
------- ------- ------- -------
United States ...................... 42.6% 36.3% 38.0% 47.8%
Export:
Asia/Pacific ..................... 7.9 4.9 6.8 6.4
Europe, Middle East and Africa ... 44.2 56.0 50.9 42.0
Other ............................ 5.3 2.8 4.3 3.8
------- ------- ------- -------
Total export revenue ..... 57.4 63.7 62.0 52.2
------- ------- ------- -------
100.0% 100.0% 100.0% 100.0%
======= ======= ======= =======
For the both the three- and six-month periods ended June 30, 2001, revenues
from Deutsche Telekom AG accounted for more than 10% of total revenues. For
the same prior-year periods, revenues from British Telecom and Worldcom
each accounted for more than 10% of total revenues.
We have no significant long-lived assets deployed outside of the United
States.
NOTE 7 - DERIVATIVES
On January 1, 2001, we adopted Statement of Financial Accounting Standards,
or SFAS, No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES, as amended. SFAS 133 requires that all derivatives be
recognized at fair value on the balance sheet, and that the corresponding
gains or losses be included in comprehensive income, depending on the type
of hedging relationship that exists. Adoption of this standard did not have
a material effect on our financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS 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. ALL STATEMENTS OTHER THAN HISTORICAL OR CURRENT FACTS, INCLUDING,
WITHOUT LIMITATION, STATEMENTS ABOUT OUR BUSINESS STRATEGY, PLANS AND
OBJECTIVES OF MANAGEMENT AND OUR FUTURE PROSPECTS, ARE FORWARD-LOOKING
STATEMENTS. ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS REFLECTED IN SUCH
FORWARD-LOOKING STATEMENTS ARE REASONABLE, SUCH FORWARD-LOOKING STATEMENTS
ARE SUBJECT TO RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THESE EXPECTATIONS. SUCH RISKS AND UNCERTAINTIES
INCLUDE, WITHOUT LIMITATION, THE FOLLOWING:
o OUR FINANCIAL RESULTS ARE DIFFICULT TO PREDICT AND ARE LIKELY TO VARY
SIGNIFICANTLY FROM QUARTER TO QUARTER IN THE FUTURE;
o WE COULD BE MATERIALLY HARMED IN THE EVENT OF A FURTHER GENERAL
ECONOMIC SLOWDOWN;
o WE COULD BE MATERIALLY HARMED IN THE EVENT OF A REVERSAL OR SLOWDOWN
IN THE PACE OF THE PRIVATIZATION, RESTRUCTURING OR DEREGULATION OF THE
TELECOMMUNICATIONS INDUSTRY, A SIGNIFICANT SLOWDOWN IN THE GROWTH OF
THAT INDUSTRY OR CONSOLIDATIONS INVOLVING OUR CURRENT OR PROSPECTIVE
CUSTOMERS;
Page 10 of 26
o ANY REDUCTION IN DEMAND FOR OUR NETWORK INTELLIGENCE, BUSINESS
INTELLIGENCE AND DIAGNOSTICS SOLUTIONS COULD MATERIALLY HARM OUR
BUSINESS;
o WE COULD BE MATERIALLY HARMED IF THE MARKET FOR CONVERGING AND
NEXT-GENERATION NETWORK SOLUTIONS FAILS TO GROW AS WE CURRENTLY
ANTICIPATE;
o CONTINUED COMPETITION IS LIKELY TO RESULT IN PRICE REDUCTIONS, REDUCED
MARGINS AND LOSS OF MARKET SHARE; AND
o OTHER RISKS INDICATED BELOW UNDER THE CAPTION "RISK FACTORS".
THESE RISKS AND UNCERTAINTIES ARE BEYOND OUR CONTROL AND, IN MANY CASES, WE
CANNOT PREDICT THE RISKS AND UNCERTAINTIES THAT COULD CAUSE OUR ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY THE FORWARD-LOOKING
STATEMENTS. WHEN USED IN THIS DOCUMENT, THE WORDS "BELIEVES," "PLANS,"
"EXPECTS," "ANTICIPATES," "INTENDS," "CONTINUE," "MAY," "WILL," "COULD,"
"SHOULD," "FUTURE," "POTENTIAL," "ESTIMATE" OR THE NEGATIVE OF SUCH TERMS
AND SIMILAR EXPRESSIONS AS THEY RELATE TO US OR OUR MANAGEMENT ARE INTENDED
TO IDENTIFY FORWARD-LOOKING STATEMENTS.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH, AND IS
QUALIFIED IN ITS ENTIRETY BY, THE CONSOLIDATED FINANCIAL STATEMENTS AND
RELATED NOTES INCLUDED IN ITEM 1 OF THIS QUARTERLY REPORT AND THE
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES AND MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS IN
OUR ANNUAL REPORT ON FORM 10-K FILED WITH THE SEC ON MARCH 26, 2001.
HISTORICAL RESULTS AND PERCENTAGE RELATIONSHIPS AMONG ANY AMOUNTS IN THE
FINANCIAL STATEMENTS ARE NOT NECESSARILY INDICATIVE OF TRENDS IN FINANCIAL
RESULTS FOR ANY FUTURE PERIODS.
OVERVIEW
We were founded in 1989 and during the early stages of our operations we
focused primarily on developing and selling diagnostics tools for a
predecessor to the Signaling System #7, or SS7, signaling protocol. As the
telecommunications industry increasingly adopted SS7, we shifted our focus
to developing and deploying SS7-based solutions as well as broadening our
product offerings. Our diagnostics solution, Spectra, was first introduced
in December 1990 and is currently in its tenth generation release.
Beginning in 1993, we focused a significant portion of our product
development efforts on developing a complete monitoring and surveillance
solution for SS7 networks, culminating in the introduction of our network
intelligence solution, the GeoProbe-TM-, in late 1995. Beginning in late
1999 and through 2000, we introduced a suite of business intelligence
solutions called IT:seven-TM-. These applications enable carriers to
protect and generate additional revenues within their networks and at
interconnection boundaries. In June 2001, we introduced our next-generation
diagnostics solution, Spectra2 MG-TM-. We continue to focus significant
resources on the development of enhancements, new features and new
applications for our existing product areas.
Historically, we have generated substantially all of our revenues from
sales of our network intelligence and diagnostics solutions. Specifically,
revenues attributable to the GeoProbe have represented a majority of our
total revenues since 1998. Although we expect diagnostics revenues to
continue to represent a significant portion of total revenues for the
foreseeable future, these revenues are expected to continue to decline as a
percentage of total revenues as a result of higher growth rates for the
network intelligence and business intelligence offerings. Our remaining
revenues are derived from services relating to these and other products.
These services include product installation, product integration, training,
warranty and product support.
RESULTS OF OPERATIONS
The following table sets forth, for the periods presented, certain data
derived from our unaudited consolidated statements of operations expressed
as a percentage of total revenues. The financial results for the three- and
six-month periods ended June 30, 2001 are not necessarily indicative of the
results that may be expected for any other interim period or for the year
ending December 31, 2001.
Page 11 of 26
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2001 2000 2001 2000
------- ------- ------- -------
Revenues:
Product and license fees ........................ 77.2% 88.5% 80.3% 89.5%
Services ........................................ 22.8 11.5 19.7 10.5
------- ------- ------- -------
Total revenues ................................ 100.0 100.0 100.0 100.0
Cost of revenues:
Product and license fees ........................ 37.7 20.4 34.4 19.4
Services ........................................ 8.6 5.7 8.4 5.5
------- ------- ------- -------
Total cost of revenues ........................ 46.3 26.1 42.8 24.9
------- ------- ------- -------
Gross profit .................................... 53.7 73.9 57.2 75.1
Operating expenses:
Research and development ........................ 41.3 21.3 39.0 21.4
Sales and marketing ............................. 21.4 10.8 19.6 11.8
General and administrative ...................... 10.5 8.2 9.5 7.8
Restructuring ................................... 7.2 -- 4.1 --
------- ------- ------- -------
Total operating expenses ...................... 80.4 40.3 72.2 41.0
------- ------- ------- -------
Income (loss) from operations ..................... (26.7) 33.6 (15.0) 34.1
Other income ...................................... 6.3 5.7 6.2 5.5
------- ------- ------- -------
Income (loss) before provision for income taxes ... (20.4) 39.3 (8.8) 39.6
Provision (benefit) for income taxes .............. (7.3) 13.4 (3.2) 13.5
------- ------- ------- -------
Net income (loss) ................................. (13.1)% 25.9% (5.6)% 26.1%
======= ======= ======= =======
REVENUES
PRODUCT AND LICENSE FEES. Revenues from product and license fees decreased
43.1% to $18.5 million for the three months ended June 30, 2001 from $32.6
million for the three months ended June 30, 2000. For the six months ended
June 30, 2001, revenues from product and license fees decreased 28.7% to
$44.5 million from $62.5 million for the six months ended June 30, 2000.
The decline in revenues from product and license fees is primarily
attributable to fewer GeoProbe and IT:seven installations being completed
to the point of enabling revenue recognition and a decrease in demand
for our diagnostics products, both of which are primarily driven by the
slowdown in the economy.
SERVICES. Revenues from services increased 29.1% to $5.5 million for the
three months ended June 30, 2001 from $4.2 million for the three months
ended June 30, 2000. For the six months ended June 30, 2001, revenues from
services increased 49.3% to $10.9 million from $7.3 million for the six
months ended June 30, 2000. The increase in services revenues is primarily
related to the recurring fees associated with product support services
realized from our larger installed customer base.
CONCENTRATION OF REVENUES. For both the three- and six-month periods
ended June 30, 2001, revenues from Deutsche Telekom AG accounted for
more than 10% of total revenues. For the same prior-year periods,
revenues from British Telecom and Worldcom each accounted for more than
10% of total revenues.
INTERNATIONAL REVENUES. For the three months ended June 30, 2001,
international revenues accounted for 57.4% of total revenues compared to
63.7% of total revenues for the three months ended June 30, 2000. For the
six months ended June 30, 2001, international revenues accounted for 62.0%
of total revenues compared to 52.2% of total revenues for the six months
ended June 30, 2000. Variations in the percentage of total revenues derived
from international markets may occur given that a large percentage of our
revenues are typically derived from a small number of customers, the
specific make up of which varies from one quarter to the next.
Page 12 of 26
COST OF REVENUES
PRODUCT AND LICENSE FEES. Cost of product and license fees consists
primarily of hardware expenses and personnel and overhead costs related to
the manufacturing, integration and installation of our products. Cost of
product and license fees was $9.0 million, or 37.7% of total revenues, for
the three months ended June 30, 2001, compared to $7.5 million, or 20.4% of
total revenues, for the three months ended June 30, 2000. The increase in
absolute dollars is primarily related to a $867,000 charge to cost of goods
sold for excess and obsolete materials and canceled purchase commitments as
well as increased installation related costs on a per project basis. The
increase as a percentage of total revenues was primarily attributable to
the charge to cost of goods sold for excess and obsolete materials and
canceled purchase commitments as well as the decreased level of revenues.
For the six months ended June 30, 2001, cost of product and license fees
was $19.1 million, or 34.4% of total revenues, compared to $13.5 million,
or 19.4% of total revenues, for the six months ended June 30, 2000. The
increase in absolute dollars resulted primarily from increases in hardware
costs attributable to our continued support of our legacy systems and to
hardware design changes required to support new version releases. Also, in
certain expansions, additional hardware is required to make the system
compatible with the current generation of the GeoProbe platform. The
increase in absolute dollars is also attributable to the charge to cost of
goods sold for excess and obsolete materials and canceled purchase
commitments. The increase as a percentage of total revenues was primarily
attributable to that charge as well as the decreased level of revenues.
SERVICES. Cost of services consists of expenses, primarily personnel costs,
related to product support, training, and warranty and non-warranty work.
Cost of services was $2.1 million, or 8.6% of total revenues, for the three
months ended June 30, 2001 and $2.1 million, or 5.7% of total revenues, for
the three months ended June 30, 2000. Cost of services was $4.7 million, or
8.4% of total revenues, for the six months ended June 30, 2001 and $3.9
million, or 5.5% of total revenues, for the six months ended June 30, 2000.
Cost of services as a percentage of total revenues has historically
fluctuated on a period-to-period basis based upon the relative mix of
product support, training and warranty and non-warranty work for the
period.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist primarily of personnel, contract labor, travel and facilities
costs. These expenses increased to $9.9 million for the three months ended
June 30, 2001 from $7.8 million for the three months ended June 30, 2000.
The increase in absolute dollars was primarily due to increased staffing
dedicated to research and development activities and higher wage levels
required to retain qualified technical and engineering personnel. Research
and development expenses as a percentage of total revenues were 41.3% for
the three months ended June 30, 2001 and 21.3% for the three months ended
June 30, 2000. The increase as a percentage of total revenues was
attributable to the increase in staffing dedicated to research and
development activities as well as a decreased level of revenues.
For the six months ended June 30, 2001, research and development expenses
increased to $21.6 million from $14.9 million for the comparable prior-year
period. The increase in absolute dollars was primarily due to increased
staffing levels, higher wage levels required to retain qualified technical
and engineering personnel and outsourced research and development. Research
and development expenses as a percentage of total revenues were 39.0% for
the six months ended June 30, 2001, and 21.4% for the six months ended June
30, 2000. The increase as a percentage of total revenues was attributable
to the increase in staffing dedicated to research and development
activities and the decreased level of revenues.
Software development costs are expensed as incurred until technological
feasibility has been established, at which time subsequent costs are
permitted to be capitalized until the product is available for general
release to customers. To date, either the establishment of technological
feasibility of our products has substantially coincided with their general
release, or costs incurred subsequent to the achievement of
Page 13 of 26
technological feasibility have not been material. As a result, software
development costs qualifying for capitalization have been insignificant,
and we have not capitalized any software development costs.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of personnel, travel, facilities, distributor commissions, and
expenses for trade shows and advertising. These expenses increased to $5.1
million for the three months ended June 30, 2001 from $4.0 million for the
three months ended June 30, 2000. The increase in absolute dollars was
primarily due to increased personnel costs related to increased average
headcount. Sales and marketing expenses as a percentage of total revenues
were 21.4% for the three months ended June 30, 2001 and 10.8% for the three
months ended June 30, 2000. The increase as a percentage of total revenues
was attributable to the combination of the increase in personnel costs
related to increased average headcount and the decreased level of revenues.
Sales and marketing expenses increased to $10.9 million for the six months
ended June 30, 2001 from $8.2 million for the six months ended June 30,
2000. The increase was primarily due to increased personnel costs related
to increased average headcount and, to a lesser extent, increased
international sales activities and increased promotional activities. Sales
and marketing expenses as a percentage of total revenues were 19.6% for the
six months ended June 30, 2001, and 11.8% for the six months ended June 30,
2000. The increase as a percentage of total revenues was attributable to
the combination of the increase in personnel costs related to increased
average headcount and the decreased level of revenues.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of personnel, facilities and other costs of our finance,
administrative and executive departments, as well as professional fees and
expenses associated with legal and accounting requirements. These expenses
decreased to $2.5 million for the three months ended June 30, 2001 from
$3.0 million for the three months ended June 30, 2000. The decrease in
absolute dollars was primarily related to decreased professional fees and
decreased staffing levels. General and administrative expenses as a
percentage of total revenues were 10.5% for the three months ended June 30,
2001 and 8.2% for the three months ended June 30, 2000. The increase as a
percentage of total revenues was attributable to the decreased level of
revenues.
General and administrative expenses decreased to $5.3 million for the six
months ended June 30, 2001 from $5.5 million for the six months ended June
30, 2000. The decrease was primarily related to decreased professional
fees. General and administrative expenses as a percentage of total revenues
were 9.5% for the six months ended June 30, 2001 and 7.8% for the six
months ended June 30, 2000. The increase as a percentage of total revenues
was attributable to the decreased level of revenues.
RESTRUCTURING COSTS. We recorded a restructuring charge for the three
months ended March 31, 2001 of $526,000 primarily related to a workforce
reduction of approximately 40 employees. The reduction affected all areas
of the company. The charge primarily consisted of employee severance costs,
professional fees and outplacement services. At June 30, 2001, the balance
of these costs that remained to be paid totaled approximately $164,000.
In May 2001, we announced our decision to refocus our strategy and
streamline operations to reduce our cost structure in response to the
generally weakened economic environment and changing demand characteristics
in some of our markets. As part of this decision, we discontinued all
efforts with respect to our softswitch offering, VIA, and reduced our
workforce by approximately 115 employees. The reduction affected all areas
of the company. We recorded a restructuring charge for the three months
ended June 30, 2001 of approximately $1.7 million, which consisted of
employee severance costs of approximately $1.1 million, professional fees
and outplacement services of approximately $300,000 and the write-off of
assets related to the VIA softswitch of approximately $300,000. At June 30,
2001, the balance of these costs that remained to be paid totaled
approximately $700,000.
OTHER INCOME
Other income is primarily interest income earned on our cash and cash
equivalents. Other income was $1.5 million for the three months ended June
30, 2001 compared to $2.1 million for the three months ended June 30, 2000.
Other income was $3.4 million for the six months ended June 30, 2001
compared to
Page 14 of 26
$3.9 million for the six months ended June 30, 2000. The decrease for both
the three- and six-month periods ended June 30, 2001 is attributable to the
overall decrease in interest rates.
PROVISION FOR INCOME TAXES
The effective income tax rate for both the three and six months ended
June 30, 2001 was a 36.0% benefit compared to a 34.0% provision for both
the three and six months ended June 30, 2000.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have funded our operations and met our capital
expenditure requirements primarily through cash flows from operations. We
had working capital of $162.7 million at June 30, 2001 and $167.2 million
at December 31, 2000. At June 30, 2001, we had $146.2 million in cash and
cash equivalents, an increase of $14.8 million from $131.4 million in cash
and cash equivalents at December 31, 2000. The increase in cash and cash
equivalents is primarily attributable to a decrease in trade accounts
receivable due to collections on these accounts, receipt of an income tax
refund and proceeds from the issuance of common stock upon the exercise of
stock options and purchases under our employee stock purchase plan.
We have a credit facility with a bank providing for borrowings of up to
$10.0 million. This credit facility will expire on August 15, 2001. Up to
$5.0 million may be utilized to support letters of credit. The per annum
usage fee on unused portions of the line is 0.125%. At our option,
borrowings under this facility bear interest at either (i) the bank's prime
rate reduced by up to 0.50% or (ii) the London interbank offered rate, or
LIBOR, as adjusted to meet specified Federal Reserve requirements with
respect to Eurocurrency liabilities, increased by up to 1.50%. This
facility is collateralized by our accounts receivable, inventories and
property and equipment. The credit facility restricts the payment of cash
dividends without the bank's consent and includes covenants requiring us to
maintain specified financial ratios and to not incur net losses in two
consecutive quarters. At June 30, 2001, no amounts were outstanding under
the credit facility and we had no outstanding letters of credit.
Net cash provided by operating activities was $18.7 million for the six
months ended June 30, 2001, compared to $12.0 million during the same
period in 2000. Net cash provided by operating activities resulted
primarily from a decrease in trade accounts receivable due to collections
of these accounts and a decrease in income taxes receivable.
Net cash used in investing activities was $6.1 million for the six months
ended June 30, 2001 compared to $3.2 million during the same period in
2000. Net cash used in investing activities for both periods related to
purchases of property and equipment.
Net cash provided by financing activities was $2.1 million for the six
months ended June 30, 2001 and $1.9 million during the same period of 2000.
Net cash provided by financing activities in both periods resulted from
proceeds from the issuance of common stock upon the exercise of stock
options and purchases under our employee stock purchase plan.
In January 2000, we signed a ten-year lease agreement for our corporate
headquarters facility in Richardson, Texas. We estimate that our remaining
commitment for leasehold improvements for this office space is less than
$100,000. We have no other material commitments for capital expenditures.
Our current cash balances are sufficient to cover these estimated capital
expenditures.
Any material acquisition or joint venture could result in a decrease in our
working capital, depending on the amount, timing and nature of the
consideration to be paid. Absent any such acquisition or joint venture, we
anticipate that current cash balances, potential cash flows from operations
and available borrowings under any revolving credit facility then in place
will be sufficient to meet our anticipated cash needs for working capital,
capital expenditures and other activities for at least the next 12 months.
Thereafter, if current sources are not sufficient to meet our needs, we may
seek additional equity or debt financing. In addition, any material
acquisition of complementary businesses, products or technologies or
Page 15 of 26
material joint venture could require us to obtain additional equity or debt
financing. There can be no assurance that additional financing would be
available on acceptable terms, if at all.
RISK FACTORS
OUR QUARTERLY FINANCIAL RESULTS FLUCTUATE AND ARE DIFFICULT TO PREDICT.
Since our future financial results are likely to vary significantly from
quarter to quarter, you should not rely on our results of operations during
any particular quarter as an indication of our future performance in any
fiscal year or quarterly period. Our quarterly financial results have
varied significantly in the past and are likely to vary significantly from
quarter to quarter in the future based on a number of factors, many of
which are outside of our control. These factors include but are not limited
to:
o the size, timing and terms of specific orders by customers;
o competition;
o the degree of market acceptance of new products and technologies
introduced by us and our competitors;
o the mix of products and services sold by us;
o the timing of product shipments and product installations by us;
o the timing of customer acceptance of products we deliver to them;
o the capital spending patterns of our customers;
o the mix of domestic and international sales;
o the mix of new installations and system expansions;
o the timing of and level of our expenses;
o the relative percentages of products sold through our direct and
indirect sales channels;
o customer order deferrals in anticipation of enhancements or new
products;
o the timing of and level of our investments in research and
development activities;
o changes in, and our ability to implement, our strategy;
o changes in the availability or cost of materials needed to
produce our products;
o the progress and timing of the privatization and restructuring of
telecommunications markets and the worldwide deregulation of the
international telecommunications industry;
o defects and product quality problems;
o intellectual property disputes;
o expansion of and risks associated with our international
operations; and
o changes in general economic conditions.
Page 16 of 26
Furthermore, a large portion of our operating expenses, including rent and
salaries, is largely fixed in nature. Accordingly, if revenues are below
expectations, our financial results are likely to be adversely and
disproportionately affected because these operating expenses are not
variable in the short term, and cannot be quickly reduced to respond to
unanticipated decreases in revenues.
The amount of revenues associated with particular product sales can vary
significantly. The deferral or loss of one or more individually significant
sales could harm our financial results in a particular quarter.
Our financial results also are likely to fluctuate due to factors that
impact our current and prospective customers. Expenditures by customers
tend to vary in cycles that reflect overall economic conditions and
individual budgeting and buying patterns and, in some cases, the ability of
some of our customers to obtain the financing they require to make capital
expenditures. Our business has been adversely affected by a softening
economy and we would be further harmed by a further decline in the economic
prospects of our customers or the economy in general. These adverse
economic conditions could be expected to alter current or prospective
customers' capital spending priorities or budget cycles, or extend our
sales cycle with respect to some of our customers. Our business also could
be harmed by changes in customer spending patterns reflecting industry
trends. In addition, our financial results historically have been
influenced by seasonal fluctuations, with revenues tending to be strongest
in the fourth quarter of each year. We believe that this seasonality has
been due to the capital appropriation practices of many of our customers.
We expect that in future periods this seasonal trend may contribute to our
first quarter revenues to remain consistent with, or decrease from, the
level achieved in the preceding quarter.
As a result of all of the foregoing, we cannot assure you that our revenues
will grow in future periods or that we will be profitable. In addition, in
some future quarters our financial results again may be below the
expectations of public market analysts. In such event, the market price of
our common stock likely would fall.
CONSOLIDATIONS IN THE TELECOMMUNICATIONS INDUSTRY OR A FURTHER SLOWDOWN IN
TELECOMMUNICATIONS SPENDING COULD HARM OUR BUSINESS, FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
We have derived substantially all of our revenues from sales of products
and related services to the telecommunications industry. In recent months,
we and a number of other companies have experienced reduced spending by
telecommunications carriers and equipment manufacturers. Our business,
financial condition and results of operations could be materially harmed in
the event of a further significant slowdown in this industry or in the
event there are consolidations of our current or prospective customers.
Slowdowns in spending often cause delays in sales and installations and
could cause cancellations, any of which would harm our financial results in
a particular period.
CHANGES OR DELAYS IN IMPLEMENTATION OF OUR PRODUCTS COULD HARM OUR
FINANCIAL RESULTS.
Revenues for our network intelligence and business intelligence solutions
are typically recognized upon the completion of installation, unless the
contract provides for significant additional obligations. Customer- or
Inet-caused delays in the commencement or completion of scheduled product
installations, which from time to time result from site-readiness delays,
lack of resources or other issues and lengthening of implementation
schedules due to the introduction of new features or applications, could
materially harm our financial results. With respect to contracts providing
for a significant payment or performance milestone tied to customer
acceptance or allowing customer return, termination or similar rights prior
to acceptance, revenue will generally not be recognized until the customer
provides acceptance. Further, for new products, we also recognize revenue
upon acceptance until a track record of installation is achieved, after
which revenue recognition generally is tied to completion of installation.
In cases where the recognition of revenue is tied to customer acceptance,
the failure or delay in receiving such acceptance could harm our expected
financial results for a particular period.
Page 17 of 26
ANY REVERSAL OR SLOWDOWN IN DEREGULATION OF TELECOMMUNICATIONS MARKETS
COULD MATERIALLY HARM THE MARKET FOR OUR PRODUCTS.
Future growth in the markets for our products will depend in part on
continued privatization, deregulation and the restructuring of
telecommunications markets worldwide. Any reversal or slowdown in the pace
of this privatization, deregulation or restructuring could materially harm
the markets for our products. Moreover, the consequences of deregulation
are subject to many uncertainties, including judicial and administrative
proceedings that affect the pace at which the changes contemplated by
deregulation occur, and other regulatory, economic and political factors.
Any invalidation, repeal or modification of the requirements imposed by the
Telecommunications Act of 1996, the local telephone competition rules
adopted by the U.S. Federal Communications Commission to implement that Act
or similar international regulation could materially harm our business,
financial condition and results of operations. Furthermore, the
uncertainties associated with deregulation have in the past, and could in
the future, cause our customers to delay purchasing decisions pending the
resolution of these uncertainties.
THE SALES CYCLE FOR OUR PRODUCTS IS LONG, WHICH COULD HARM OUR QUARTERLY
FINANCIAL RESULTS.
Sales of our network intelligence and business intelligence products and
solutions are made predominately to large communications service providers
and involve significant capital expenditures and lengthy implementation
processes. Prospective customers generally commit significant resources to
an evaluation of our product offerings and our competitors' product
offerings and require each vendor to expend substantial time, effort and
money educating the prospective customer about the value of each vendor's
solutions. Consequently, sales to this type of customer generally require
an extensive sales effort throughout the customer's organization and final
approval by an executive officer or other senior level employee. We
frequently experience delays following initial contact with a prospective
customer and expend substantial funds and management effort pursuing these
sales. Additionally, delays associated with potential customers' internal
approval and contracting procedures, procurement practices, testing and
acceptance processes are common and may cause potential sales to be delayed
or foregone. As a result of these or other factors, the sales cycle for our
solutions is long, historically ranging from six to 12 months for our
network intelligence and business intelligence solutions (excluding the
cycle for subsequent applications and enhancements, which varies widely)
and up to three months for occasional, large sales of our diagnostics
solutions, and we have experienced lengthening sales cycles during the
current soft economy. Accordingly, our ability to forecast the timing and
amount of specific sales is limited, and the deferral or loss of one or
more significant sales could materially harm anticipated financial results
in a particular quarter, particularly if there are significant sales and
marketing expenses associated with any deferred or lost sales.
ANY DECREASE IN DEMAND FOR OUR PRODUCTS COULD SIGNIFICANTLY DECREASE OUR
SALES.
Our principal products, the GeoProbe, IT:seven and Spectra, generate
substantially all of our revenues today and are expected to continue to
account for substantially all of our revenues for the foreseeable future.
Any downturn in the demand for these products would materially harm our
business, financial condition and results of operations. We cannot assure
you that we will be successful in developing any other products or taking
any other steps to reduce the risk associated with any slowdown in demand
for the GeoProbe, IT:seven and/or Spectra.
IF THE MARKET FOR CONVERGING AND NEXT-GENERATION NETWORK SOLUTIONS FAILS TO
DEVELOP OR GROWS MORE SLOWLY THAN WE ANTICIPATE, OUR FINANCIAL RESULTS
COULD BE HARMED.
Our future financial results are dependent in significant part on the
continued viability and expansion of SS7 signaling networks, the
convergence of the public switched telephone network, or PSTN, with new
packet-based networks (for example, Internet protocol, or IP, and
asynchronous transfer mode, or ATM) and the build out of next-generation
networks. Our business, financial condition and results of operations could
be materially harmed if the market for converging and next-generation
network solutions fails to develop or grows more slowly than we currently
anticipate.
Page 18 of 26
COMPETITION COULD REDUCE OUR MARKET SHARE, WHICH WOULD LIKELY HARM OUR
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The market for signaling-based communications network solutions is
relatively new, intensely competitive, both in the U.S. and
internationally, and subject to rapid technological change, evolving
industry standards and regulatory developments. Competition for all of our
solutions is expected to continue and in some cases intensify in the
future. We compete with a number of U.S. and international suppliers that
vary in size, and in the scope and breadth of the products and services
offered. Certain of our competitors have, in relation to us, longer
operating histories, larger installed customer bases, longer-standing
relationships with customers, greater name recognition and significantly
greater financial, technical, marketing, customer service, public
relations, distribution and other resources. Additionally, it is possible
that new competitors or alliances among competitors could emerge and
rapidly acquire significant market share. As a result, these competitors
may be able to more quickly develop or adapt to new or emerging
technologies and changes in customer requirements, or devote greater
resources to the development, promotion and sale of their products.
Increased competition is likely to result in price reductions, reduced
margins and loss of market share. The competitive pressures we face could
materially harm our business, financial condition and results of
operations.
RAPID GROWTH AND EXPANSION OF OUR BUSINESS MAY STRAIN OUR RESOURCES AND
HINDER OUR ABILITY TO IMPLEMENT OUR BUSINESS STRATEGY.
We have historically experienced rapid and significant growth that has
placed, and may continue to place, a significant strain on our management,
information systems and operations. Any significant additional growth will
require us to improve our financial, operational and management information
and control systems and procedures.
We anticipate that continued growth, if any, could require us to recruit
and hire a substantial number of new employees, particularly sales and
marketing personnel and technical personnel with signaling and IP knowledge
and experience, both in the U.S. and internationally. Competition for
personnel is intense, and we have at times experienced difficulty in
recruiting qualified personnel. We historically have filled a portion of
our new personnel needs with non-U.S. citizens holding temporary work visas
that allow these individuals to work in the U.S. for only a limited period
of time. Accordingly, any change in U.S. immigration policy further
limiting the issuance of temporary work visas could adversely affect our
ability to recruit new personnel. Furthermore, the addition of significant
numbers of new personnel requires us to incur significant start-up
expenses, including recruiting fees, procurement of office space and
equipment, and initial training costs; and, we often experience low
utilization rates with new personnel. We may be unable to successfully
recruit or retain additional personnel as needed. In addition, the start-up
expenses incurred in connection with the hiring of additional personnel
could harm our future financial results.
OUR BUSINESS DEPENDS ON RETAINING OUR EXISTING KEY PERSONNEL.
Our business depends to a significant extent upon the continued service and
performance of a relatively small number of key senior managers, technical
personnel and sales and marketing personnel, few of whom are bound by an
employment agreement. The loss of any existing key personnel, or the
inability to attract, motivate and retain additional key personnel, could
harm our business, financial condition and results of operations.
WE MAY BE UNABLE TO ADAPT TO RAPID TECHNOLOGICAL CHANGE AND EVOLVING
CUSTOMER REQUIREMENTS.
The market for our products is characterized by rapid technological
advances, evolving industry and customer-specific protocol standards,
changes in customer requirements and frequent new product introductions and
enhancements. The introduction of communications network management
products involving superior technologies or the evolution of alternative
technologies or new industry protocol standards could render our existing
products, as well as products currently under development, obsolete
Page 19 of 26
and unmarketable. We believe that our future success will depend in part
upon our ability, on a timely and cost-effective basis, to continue to:
o enhance our network intelligence, business intelligence and
diagnostics solutions;
o develop and introduce new products for the communications network
management market and other markets;
o keep pace with evolving industry protocol standards and changing
customer needs; and
o achieve broad market acceptance for our products.
We cannot assure you that we will achieve these objectives.
OUR FUTURE SUCCESS WILL DEPEND ON OUR ABILITY TO DEVELOP NEW PRODUCTS BASED
ON EMERGING TECHNOLOGIES.
We expect carrier spending for legacy networks to decrease over time, which
requires that we develop solutions for networks based on emerging packet
technologies and standards, such as IP and ATM. These emerging technologies
and standards are likely to be characterized by continuing technological
developments, evolving industry standards and changing customer
requirements. We may not successfully develop competitive products for
these emerging technologies and standards, which could harm our business,
financial condition and results of operations.
Products as complex as those currently under development by us frequently
are subject to delays, and we cannot assure you that we will not encounter
difficulties that could delay or prevent the successful and timely
development, introduction and marketing of these potential new products.
Even if such potential new products are developed and introduced, we cannot
assure you that they will achieve any significant degree of market
acceptance. Failure to release these or any other potential new products on
a timely basis, or failure of these or any other potential new products, if
and when released, to achieve any significant degree of market acceptance,
could materially harm our business, financial condition and results of
operations.
WE HAVE INTERNATIONAL CUSTOMERS, AND, AS A RESULT, OUR BUSINESS MAY BE
HARMED BY POLITICAL AND ECONOMIC CONDITIONS IN FOREIGN MARKETS AND THE
CHALLENGES ASSOCIATED WITH OPERATING INTERNATIONALLY.
Our international operations are subject to the risks inherent in
international business activities. We believe that continued growth, if
any, could require expansion of our efforts in international markets. This
expansion may be costly and time-consuming and may not generate returns for
a significant period of time, if at all. The risks inherent in
international operations include:
o management of geographically dispersed operations;
o a longer sales cycle, especially in areas of recent expansion;
o longer accounts receivable payment cycles, and greater difficulty
in the collection of past due accounts;
o difficulty in establishing relationships with government-owned or
subsidized communications providers;
o general economic conditions in each country;
o currency controls and exchange rate fluctuations;
o seasonal reductions in business activity specific to certain
markets;
Page 20 of 26
o loss of revenues, property and equipment from expropriation,
nationalization, war, insurrection, terrorism and other political
risks;
o foreign taxes and the overlap of different tax structures,
including modifications to the U.S. tax code as a result of
international trade regulations;
o greater difficulty in safeguarding intellectual property;
o import and export licensing requirements and other trade
restrictions;
o involuntary renegotiation of contracts with foreign governments
and communications carriers; and
o existence or adoption of laws and regulations affecting the pace
of deregulation, taxation of our business and the general
business climate for foreign companies.
Continued international expansion of our business will require further
significant management attention and financial resources. In order to
further expand internationally, we may be required to establish
relationships with additional distributors and third-party integrators. We
cannot assure you that we will effectively establish such relationships. If
international revenues are not adequate to offset the additional expenses
of expanding international operations, it could harm our business,
financial condition and results of operations.
To date, a very high percentage of international sales have been
denominated in U.S. dollars, and accordingly we have not been significantly
exposed to fluctuations in non-U.S. currency exchange rates. As a result,
our revenues in international markets may be harmed by a strengthening U.S.
dollar. However, we expect that in future periods a greater portion of
international sales may be denominated in currencies other than U.S.
dollars, thereby exposing us to exchange rate gains and losses on non-U.S.
currency transactions. We may choose to limit such exposure by entering
into various hedging strategies. We cannot be certain that any hedging
strategies that we undertake would be successful in avoiding
exchange-related losses.
WE MAY BE UNABLE TO PRODUCE SUFFICIENT QUANTITIES OF OUR PRODUCTS BECAUSE
WE OBTAIN KEY COMPONENTS FROM SOLE AND LIMITED SOURCE SUPPLIERS. IF WE ARE
UNABLE TO OBTAIN THESE COMPONENTS, WE COULD BE UNABLE TO SHIP OUR PRODUCTS
IN A TIMELY MANNER.
Currently, our products utilize certain semiconductors that are available
from only one manufacturer and other components that are available from
only one or a limited number of suppliers. While alternative suppliers have
been identified for a variety of key components, those alternative sources
have not been qualified by us. Our qualification process could be lengthy,
and we cannot assure you that additional sources would become available to
us on a timely basis, or if such sources were to become available, that the
components would be comparable in price and quality to our current
components. We have no long-term agreements with our suppliers and, in the
case of many components, make our purchases with purchase orders on an
"as-needed basis." Certain components require an order lead-time of
approximately nine months. Other components that currently are readily
available may become difficult to obtain in the future. Our failure to
order sufficient quantities of these components in advance of product
delivery deadlines could prevent us from adequately responding to
unanticipated increases in customer orders. In the past, we have
experienced delays in the receipt of a variety of our key components, which
have resulted in delays in product deliveries. We could experience delays
or reductions in product shipments or increases in product costs if we are
unable to obtain sufficient key components as required or to develop
alternative sources if and as required in the future.
Page 21 of 26
OUR INVENTORY MAY BECOME OBSOLETE OR UNUSABLE.
We make advance purchases of certain components in relatively large
quantities to ensure that we have an adequate and readily available supply.
Our failure to accurately project our needs for these components and the
demand for our products that incorporate them, or changes in our business
strategy that reduce our need for these components could result in these
components becoming obsolete prior to their intended use or otherwise
unusable in our business. For example, during the three months ended June
30, 2001, we wrote-off approximately $300,000 of assets related to the VIA
softswitch product following our decision to refocus our strategy and
streamline operations to reduce our cost structure in response to the
generally weakened economic environment and changing demand characteristics
in some of our markets.
WE RELY ON THIRD-PARTY SUBCONTRACTORS TO MANUFACTURE AND DEVELOP OUR
PRODUCTS. OUR ABILITY TO SELL PRODUCTS TO OUR CUSTOMERS COULD BE IMPAIRED
IF THESE SUBCONTRACTORS DO NOT MEET THEIR COMMITMENTS TO US.
We rely exclusively upon third-party subcontractors to manufacture our
subassemblies, and we have retained, from time to time, third-party design
services in the development of application-specific integrated circuits or
the layout of circuit boards. We also frequently subcontract the
development of specific features and enhancements of our products. Our
reliance on third-party subcontractors involves a number of risks,
including the potential absence of adequate capacity, the unavailability of
or interruption in access to certain process technologies, and reduced
control over product quality, delivery schedules, manufacturing yields and
costs. Any disruption in our relationships with third-party subcontractors
and our inability to develop alternative sources if and as required in the
future could result in delays or reductions in product shipments or
increases in product costs.
WE RELY UPON SOFTWARE LICENSED FROM THIRD PARTIES. IF WE ARE UNABLE TO
MAINTAIN THESE SOFTWARE LICENSES ON COMMERCIALLY REASONABLE TERMS, OUR
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE HARMED.
We rely upon software that we license from third parties, including
software that is integrated with our internally developed software and used
in our products to perform key functions. The inability to maintain any
software licenses on commercially reasonable terms could result in shipment
delays or reductions until equivalent software could be developed or
licensed and integrated into our products, which could harm our business,
financial condition and results of operations.
WE MAY NOT RECEIVE THE INTENDED BENEFITS OF FUTURE ACQUISITIONS, JOINT
VENTURES OR OTHER BUSINESS RELATIONSHIPS.
We may in the future pursue acquisitions of businesses, products and
technologies, or the establishment of joint venture, strategic partnership
or other arrangements that could expand our business. The negotiation of
potential acquisitions or strategic relationships, as well as the
integration of an acquired or jointly developed business, technology or
product, could cause diversion of management's time and resources. Future
acquisitions and strategic relationships by us could result in potentially
dilutive issuances of equity securities, the incurrence of debt and
contingent liabilities, amortization of intangibles, research and
development write-offs and other acquisition-related expenses. We cannot
assure you that any acquisition or joint venture will be successfully
integrated with our operations. If we were to pursue any such acquisition
or strategic relationship, we may not receive the intended benefits of the
acquisition or strategic relationship. Also, we may pursue arrangements
with third parties to perform specified activities for us such as the
development of products or product features. We cannot assure you that
these arrangements will produce to the level of quality or in the time
frame expected, which could materially harm our business.
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WE MAY RELY ON STRATEGIC DISTRIBUTION AND MARKETING RELATIONSHIPS WITH
MANUFACTURERS OF COMPLIMENTARY PRODUCTS. IF WE FAIL TO DERIVE BENEFITS FROM
OUR FUTURE STRATEGIC RELATIONSHIPS, OUR BUSINESS MAY SUFFER.
We may in the future develop distribution and marketing relationships with
other companies as part of our business strategy. If we cannot successfully
enter and maintain these types of relationships on favorable terms, our
business may suffer.
There are various risks associated with our reliance on these
relationships, including:
o the number of different companies that we may be able to support
will be limited by the finite amount of our resources available
to support the varying levels of customized engineering required
to achieve and maintain interoperability and feature/function
performance;
o these companies may not develop or deliver their products on a
timely basis, or may not develop products that perform as
expected or are priced competitively;
o these companies may subsequently change the design of their
products in a manner that requires substantial additional
development by us to keep our products compatible;
o these companies may develop a fully-integrated solution that
alleviates the need for non-integrated products, including our
products; and
o some of our current and potential strategic partners are either
actual or potential competitors, which may impair the viability
of these relationships.
Many of these risks are outside of our control. Any of these risks could
materially harm our business, financial condition and results of
operations.
WE MAY BE ACCUSED OF INFRINGING THE PROPRIETARY RIGHTS OF OTHERS, WHICH
COULD SUBJECT US TO COSTLY AND TIME-CONSUMING LITIGATION.
The communications industry is characterized by the existence of a large
number of patents and frequent allegations of patent infringement. We have
received, and may receive in the future, notices from holders of patents
that raise issues as to possible infringement by our products. As the
number of competitive products increases and the functionality of these
products further overlaps, we believe that we may become increasingly
subject to allegations of infringement. To date, we have engaged in
correspondence with two third-party holders of patents as a result of such
notices. While we believe that our products do not infringe on any valid
patents cited in the notices, questions of infringement and the validity of
patents in the field of communications signaling technologies involve
highly technical and subjective analyses. We cannot assure you that any of
these patent holders, or others, will not initiate legal proceedings in the
future against us, or that if any proceedings were initiated, we would be
successful in defending ourselves. Any proceeding could be time consuming
and expensive to defend or resolve, result in substantial diversion of
management resources, cause product shipment delays, or force us to enter
into royalty or license agreements rather than dispute the merits of any
such proceeding initiated against us. We cannot assure you that any such
royalty or license agreements would be available on terms acceptable to us,
if at all.
OUR LIMITED ABILITY OR FAILURE TO PROTECT OUR INTELLECTUAL PROPERTY MAY
MATERIALLY HARM OUR ABILITY TO COMPETE.
Our continued success is dependent in part upon our proprietary technology.
To protect our proprietary technology, we rely on a combination of
technical innovation, trade secret, copyright and trademark laws,
non-disclosure agreements and, to a lesser extent, patents, each of which
affords only limited protection. In addition, the laws of some foreign
countries do not protect our proprietary rights in the products to the
Page 23 of 26
same extent as do the laws of the U.S. Despite the measures taken by us, it
may be possible for a third party to copy or otherwise obtain and use our
proprietary technology and information without authorization. Policing
unauthorized use of our products is difficult, and litigation may be
necessary in the future to enforce our intellectual property rights. Any
litigation could be time consuming and expensive to prosecute or resolve,
result in substantial diversion of management resources, and materially
harm our business, financial condition and results of operations. We cannot
assure you that we will be successful in protecting our proprietary
technology or that our proprietary rights will provide us a meaningful
competitive advantage.
WE MAY FACE POTENTIAL LIABILITY FOR PRODUCT DEFECTS.
Products as complex as ours may contain undetected defects or errors when
first introduced or as enhancements are released that, despite our testing,
are not discovered until after a product has been installed and used by
customers, which could result in delayed market acceptance of the product
or damage to our reputation and business. To date, we have not been
materially harmed by products containing defects or errors. We attempt to
include provisions in our agreements with customers that are intended to
limit our exposure to potential liability for damages arising out of
defects or errors in our products. However, the nature and extent of these
limitations vary from customer to customer and it is possible that these
limitations may not be effective as a result of unfavorable judicial
decisions or laws enacted in the future. Although we have not experienced
any product liability suits to date, the sale and support of our products
entail the risk of these claims. Any product liability claim brought
against us, regardless of its merit, could result in material expense to
us, diversion of management time and attention, and damage to our business
reputation and our ability to retain existing customers or attract new
customers.
OUR THREE FOUNDERS OWN APPROXIMATELY 78% OF OUR COMMON STOCK, WHICH ALLOWS
THEM TO CONTROL THE MANAGEMENT AND AFFAIRS OF OUR COMPANY OR PREVENT A
CHANGE OF CONTROL.
As of June 30, 2001, our three founders, Samuel S. Simonian, Elie S.
Akilian and Mark A. Weinzierl, beneficially owned approximately 78% of the
outstanding shares of our common stock. Consequently, two or more of these
individuals, acting together, could control the outcome of all matters
submitted for stockholder action, including the election of our board of
directors and the approval of significant corporate transactions. They
effectively control the management and affairs of our company, which could
have the effect of delaying or preventing a change in control of our
company. In addition, Messrs. Simonian, Akilian and Weinzierl are each
members of our board of directors and have significant influence in
directing the actions taken by our board.
OUR BUSINESS AND REPUTATION COULD SUFFER IF WE DO NOT PREVENT SECURITY
BREACHES.
We have included security features in some of our products that are
intended to protect the privacy and integrity of customer data. Despite the
existence of these security features, our products may be vulnerable to
breaches in security due to unknown defects in the security mechanisms, as
well as vulnerabilities inherent in the operating system or hardware
platform on which the product runs and/or the networks linked to that
platform. Security vulnerabilities, regardless of origin, could jeopardize
the security of information stored in and transmitted through the computer
systems of our customers. Any security problem may require significant
capital expenditures to solve and could materially harm our reputation and
product acceptance.
WE HAVE ADOPTED ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN
ACQUISITION OF OUR COMPANY.
Our certificate of incorporation and bylaws and Delaware law contain
provisions that may have the effect of discouraging, delaying or preventing
a change in control of our company or unsolicited acquisition proposals
that a stockholder may consider favorable. For example, we have a
classified board of directors with three-year terms, our stockholders are
unable to take action by written consent and our stockholders are limited
in their ability to make proposals at stockholder meetings.
Page 24 of 26
VOLATILITY IN OUR STOCK PRICE COULD RESULT IN CLAIMS AGAINST US.
The market price of our common stock has been, and is likely to continue to
be, highly volatile and may be significantly affected by factors such as:
o variations in our results of operations;
o changes in our business strategy;
o future sales of common stock;
o the announcement of technological innovations or new products by
us, our competitors and others;
o market analysts' estimates of our performance;
o general market and economic conditions; and
o equity market conditions and industry-specific equity market
trends.
The public markets have experienced significant volatility that has
particularly affected the market prices of securities of many technology
and telecommunications companies for reasons that have often been unrelated
to financial results. This volatility has and may continue to materially
harm the market price of our common stock as well as our visibility and
credibility in our markets.
Additionally, in the past, securities class action litigation often has
been brought against a company following periods of volatility in the
market price of its common stock. We may be the target of similar
litigation in the future. Securities litigation could result in substantial
costs and divert our management's attention and resources.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to immaterial levels of market risk. Revenues from customers
located outside of the U.S. represented 62.0% of total revenues for the six
months ended June 30, 2001, 55.8% of total revenues in 2000, 51.7% of total
revenues in 1999 and 52.2% of total revenues in 1998. To date, a very high
percentage of international revenues have been denominated in U.S. dollars,
and accordingly, we have not been significantly exposed to fluctuations in
currency exchange rates.
Our international business is subject to the typical risks of any
international business, including, but not limited to, the risks described
in Item 2 - "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Risk Factors". Accordingly, our future results
could be materially harmed by changes in these or other factors.
Currently, our cash is solely invested in money market funds denominated in
U.S. dollars. We account for these investments in accordance with SFAS No.
115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES.
These cash equivalents are treated as available-for-sale under SFAS No.
115. The carrying value of these cash equivalents approximates fair market
value.
Page 25 of 26
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Securities and Exchange Commission on May 26, 1999 declared effective
the Registration Statement on Form S-1 (File No. 333-59753) relating to the
initial public offering of our common stock. As of June 30, 2001, we have
used all of the net offering proceeds for the purchase of temporary
investments, consisting of cash, cash equivalents, and short-term
investments. We currently intend to use the net proceeds of the offering
for working capital and general corporate purposes, including financing
accounts receivable and capital expenditures made in the ordinary course of
business. We also may apply a portion of the proceeds of the offering to
acquire businesses, products and technologies, or enter into joint venture
arrangements, that are complementary to our business and product offerings;
however, at this time we have not identified a specific acquisition or
joint venture or allocated a specific amount for this purpose.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our 2001 Annual Meeting of Stockholders held on May 16, 2001, our
stockholders voted on and approved the following matter:
The election of two Class I Directors to serve until our 2004 Annual
Meeting of Stockholders, or until their successors have been elected and
qualified.
NAME OF NOMINEE NUMBER OF VOTES FOR NUMBER OF VOTES WITHHELD
--------------- ------------------- ------------------------
James R. Adams 45,694,654 46,927
Grant A. Dove 45,693,854 47,727
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER EXHIBIT
------- -------
10.1 Renewal, Extension, and Third Amendment to Loan Agreement
entered into to be effective as of June 15, 2001, between
Bank of America, N.A., f/k/a NationsBank, N.A., and the
Company
10.2 First Amendment to the Inet Technologies, Inc. 1998 Employee
Stock Purchase Plan
(b) We did not file any Current Reports on Form 8-K during the quarter
ended June 30, 2001.
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.
INET TECHNOLOGIES, INC.
By: /s/ Jeffrey A. Kupp
----------------------------
Jeffrey A. Kupp
Vice President and Chief Financial Officer
(Principal accounting and financial officer)
Date: July 27, 2001
Page 26 of 26
INET TECHNOLOGIES, INC.
INDEX TO EXHIBITS
EXHIBIT
NUMBER EXHIBIT
------- -------
10.1 Renewal, Extension, and Third Amendment to Loan Agreement
entered into to be effective as of June 15, 2001, between
Bank of America, N.A., f/k/a NationsBank, N.A., and the
Company
10.2 First Amendment to the Inet Technologies, Inc. 1998 Employee
Stock Purchase Plan