0000912057-01-537526.txt : 20011107 0000912057-01-537526.hdr.sgml : 20011107 ACCESSION NUMBER: 0000912057-01-537526 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011102 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INET TECHNOLOGIES INC CENTRAL INDEX KEY: 0001065351 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 752269056 STATE OF INCORPORATION: DE FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-24707 FILM NUMBER: 1774126 BUSINESS ADDRESS: STREET 1: 1255 WEST 15TH STREET, SUITE 600 CITY: PLANO STATE: TX ZIP: 75075-7270 BUSINESS PHONE: 9725786100 10-Q 1 a2062307z10-q.txt 10Q 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 September 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 November 1, 2001: 46,734,009 Page 1 of 25
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 ......................................................... 11 Item 3. Quantitative and Qualitative Disclosures about Market Risk..................... 25 Part II - Other Information Item 2. Changes in Securities and Use of Proceeds ..................................... 25 Item 6. Exhibits and Reports on Form 8-K............................................... 25 Signatures ............................................................................... 25
Page 2 of 25 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INET TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS (Unaudited) ASSETS
SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------ ------------ (In thousands, except share data) Current assets: Cash and cash equivalents......................................................... $ 144,950 $ 131,419 Trade accounts receivable, net of allowance for doubtful accounts of $881 at September 30, 2001 and $1,065 at December 31, 2000........................... 20,822 47,634 Unbilled receivables.............................................................. 2,426 1,925 Income taxes receivable........................................................... 1,498 12,179 Inventories....................................................................... 13,368 9,381 Deferred income taxes............................................................. 1,424 1,667 Other current assets.............................................................. 4,618 3,254 ----------- ----------- Total current assets...................................................... 189,106 207,459 Property and equipment, net......................................................... 20,507 18,408 Other assets........................................................................ 175 340 ----------- ----------- Total assets.............................................................. $ 209,788 $ 226,207 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.................................................................. $ 1,671 $ 4,629 Accrued compensation and benefits................................................. 2,134 7,885 Deferred revenues................................................................. 15,866 22,744 Other accrued liabilities......................................................... 4,544 5,040 ----------- ----------- Total current liabilities................................................. 24,215 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 -- 46,734,009 at September 30, 2001 and 46,319,633 at December 31, 2000.......................................... 47 46 Additional paid-in capital........................................................ 71,624 69,935 Retained earnings................................................................. 113,195 115,439 ----------- ----------- Total stockholders' equity................................................ 184,866 185,420 ----------- ----------- Total liabilities and stockholders' equity................................ $ 209,788 $ 226,207 =========== ===========
See accompanying notes to consolidated financial statements. Page 3 of 25 INET TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- ---------------------- 2001 2000 2001 2000 ---------- ------------- ---------- -------- (In thousands, except per share data) Revenues: Product and license fees........................ $ 20,145 $ 36,410 $ 64,686 $ 98,893 Services........................................ 5,262 5,015 16,172 12,321 --------- --------- --------- --------- Total revenues............................. 25,407 41,425 80,858 111,214 Cost of revenues: Product and license fees........................ 8,918 8,017 27,975 21,537 Services........................................ 2,024 2,429 6,701 6,300 --------- --------- --------- --------- Total cost of revenues..................... 10,942 10,446 34,676 27,837 --------- --------- --------- --------- Gross profit........................... 14,465 30,979 46,182 83,377 Operating expenses: Research and development........................ 8,984 9,194 30,608 24,115 Sales and marketing............................. 3,968 5,420 14,844 13,634 General and administrative...................... 2,117 3,356 7,387 8,847 Restructuring................................... -- -- 2,252 -- -------- -------- -------- -------- Total operating expenses................... 15,069 17,970 55,091 46,596 --------- --------- --------- --------- Income (loss) from operations.............. (604) 13,009 (8,909) 36,781 Other income (expense): Interest income................................. 1,198 2,157 4,735 6,043 Other expense................................... (17) (33) (113) (55) --------- --------- --------- --------- Total other income (expense)............... 1,181 2,124 4,622 5,988 --------- --------- --------- --------- Income (loss) before provision for income taxes............................ 577 15,133 (4,287) 42,769 Provision (benefit) for income taxes.............. (292) 4,994 (2,043) 14,390 ----------- ---------- ----------- ---------- Net income (loss).......................... $ 869 $ 10,139 $ (2,244) $ 28,379 ========== ========== =========== ========== Earnings (loss) per common share: Basic...................................... $ 0.02 $ 0.22 $ (0.05) $ 0.62 ========== ========== =========== ========== Diluted.................................... $ 0.02 $ 0.22 $ (0.05) $ 0.61 ========== ========== =========== ========== Weighted-average shares outstanding: Basic...................................... 46,700 46,205 46,595 46,063 ========== ========== ========== ========== Diluted.................................... 46,825 46,864 46,595 46,840 ========== ========== ========== ==========
See accompanying notes to consolidated financial statements. Page 4 of 25 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....... 414,376 1 1,689 -- 1,690 Net loss................................ -- -- -- (2,244) (2,244) ------------- ---- --------- --------- ---------- Balance at September 30, 2001............. 46,734,009 $ 47 $ 71,624 $ 113,195 $ 184,866 ============ ==== ========= ========= ==========
See accompanying notes to consolidated financial statements. Page 5 of 25 INET TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
NINE MONTHS ENDED SEPTEMBER 30, ---------------------- 2001 2000 ---------- ---------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)....................................... $ (2,244) $ 28,379 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation.......................................... 5,361 3,615 Deferred income taxes................................. 461 267 Issuance of common stock and stock options charged to expense................................... -- 173 Changes in operating assets and liabilities: (Increase) decrease in trade accounts receivable... 26,812 (5,108) Increase in unbilled receivables................... (501) (1,098) (Increase) decrease in income taxes receivable..... 9,410 (847) Increase in inventories............................ (3,987) (3,656) Increase in other assets........................... (1,199) (2,254) Increase (decrease) in accounts payable............ (2,958) 1,880 Decrease in taxes payable.......................... -- (213) Increase (decrease) in accrued compensation and benefits...................................... (5,751) 1,889 Decrease in deferred revenues...................... (6,878) (4,109) Increase (decrease) in other accrued liabilities... (496) 2,029 ---------- ---------- Net cash provided by operating activities............... 18,030 20,947 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment..................... (7,460) (9,740) --------- ----------- Net cash used in investing activities................... (7,460) (9,740) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock upon exercise of stock options and purchases under employee stock purchase plan......................... 2,961 3,332 --------- ---------- Net cash provided by financing activities............... 2,961 3,332 --------- ---------- Net increase in cash and cash equivalents............... 13,531 14,539 Cash and cash equivalents at beginning of period........ 131,419 127,903 --------- ---------- Cash and cash equivalents at end of period.............. $ 144,950 $ 142,442 ========= ========== SUPPLEMENTAL DISCLOSURES: Income taxes paid.................................... $ 504 $ 15,172 ========= ==========
See accompanying notes to consolidated financial statements. Page 6 of 25 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, consisting solely of normal recurring adjustments, necessary 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 nine-month periods ended September 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 September 30, 2001 and December 31, 2000, inventories consisted of the following (in thousands): SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------ ------------ Raw materials.......... $ 8,038 $ 4,183 Work-in-process........ 1,005 241 Finished goods......... 4,325 4,957 ----------- ---------- $ 13,368 $ 9,381 =========== ========== Page 7 of 25 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 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. 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. Revenues from other services, such as training, are recognized when the services have been completed. 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 $1.3 million for these services for the nine months ended September 30, 2001, and approximately $0.4 million for the nine months ended September 30, 2000. Page 8 of 25 NOTE 3 - RESTRUCTURING In March 2001, we recorded a restructuring charge of approximately $0.5 million 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 September 30, 2001, the balance of these costs that remained to be paid totaled approximately $0.1 million. 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 $0.3 million and the write-off of assets related to the VIA softswitch product of approximately $0.3 million. At September 30, 2001, the balance of these costs that remained to be paid totaled approximately $0.4 million. 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 NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------- ----------------------- 2001 2000 2001 2000 --------- --------- ---------- --------- Numerator: Net income (loss) for basic and diluted earnings (loss) per share.............. $ 869 $ 10,139 $ (2,244) $ 28,379 ========= ========= ========== ========= Denominator: Denominator for basic earnings (loss) per share-- weighted-average shares........ 46,700 46,205 46,595 46,063 Dilutive securities: Employee stock options and purchase rights............ 125 659 -- 777 --------- --------- ---------- --------- Denominator for diluted earnings (loss) per share-- adjusted weighted-average shares................ 46,825 46,864 46,595 46,840 ========= ========= ========== ========= Basic earnings (loss) per common share..... $ 0.02 $ 0.22 $ (0.05) $ 0.62 ========= ========= ========== ========= Diluted earnings (loss) per common share... $ 0.02 $ 0.22 $ (0.05) $ 0.61 ========= ========= ========== =========
NOTE 5 - COMPREHENSIVE INCOME For all periods presented, we had no material components of comprehensive income other than net income (loss). Page 9 of 25 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 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 NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ------------------ 2001 2000 2001 2000 -------- ------- -------- ------- United States............... 49.5% 48.3% 41.6% 48.0% Export: Asia/Pacific.............. 3.7 3.7 5.9 5.4 Europe, Middle East and 45.2 40.4 49.1 41.4 Africa................... Other..................... 1.6 7.6 3.4 5.2 -------- ------- -------- ------- Total export revenue 50.5 51.7 58.4 52.0 -------- ------- -------- ------- 100.0% 100.0% 100.0% 100.0% ======== ======= ======== =======
For the three months ended September 30, 2001, revenues from each of three customers accounted for more than 10% of total revenues. For the three months ended September 30, 2000, revenues from one customer accounted for more than 10% of total revenues. For the nine months ended September 30, 2001, revenues from one customer accounted for more than 10% of total revenues. For the nine months ended September 30, 2000, revenues from each of two customers accounted for more than 10% of total revenues. We have no significant long-lived assets deployed outside of the United States. NOTE 7 - PROVISION FOR INCOME TAXES Federal income taxes for the interim periods presented have been included in the accompanying financial statements on the basis of an estimated annual rate. The primary reason the effective annualized tax rate for 2001 differs from the 35 percent statutory corporate tax rate is due to decreased income levels combined with tax benefits such as the research and development tax credit. NOTE 8 - 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. NOTE 9 - RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board, FASB, issued SFAS No. 141, BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS No. 141 requires that all business combinations initiated after June 30, 2001, be accounted for using the purchase method of accounting and prohibits the use of the pooling-of-interest method. SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. We do not anticipate that adoption of these standards will have a material effect on our financial statements. In August 2001, the FASB issued SFAS No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS, which requires entities to record the fair value of a liability for an asset retirement obligation in the period in Page 10 of 25 which it is incurred. We do not anticipate that adoption of this standard will have a material effect on our financial statements. In October 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, which changes the criteria for assets-held-for-sale and changes the reporting requirements for the disposal of a business segment. We do not anticipate that adoption of this standard will 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 CONTINUED 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 CONTINUED SIGNIFICANT SLOWDOWN IN THE GROWTH OF THAT INDUSTRY OR CONSOLIDATIONS INVOLVING OUR CURRENT OR PROSPECTIVE CUSTOMERS; 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 INCREASED COMPETITION IS LIKELY TO RESULT IN FURTHER 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. Page 11 of 25 OVERVIEW We were founded in 1989 and during the early years 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-TM-, 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 into 2001, 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. We expect revenues from our network intelligence and business intelligence offerings to continue to represent a majority of our revenues given the relatively higher growth rates expected for these solutions. Our remaining revenues are derived from services relating to these and other products. These services include 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 nine-month periods ended September 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.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 2001 2000 2001 2000 --------- --------- --------- -------- Revenues: Product and license fees......................... 79.3% 87.9% 80.0% 88.9% Services......................................... 20.7 12.1 20.0 11.1 ------ ------ ------ ------ Total revenues................................. 100.0 100.0 100.0 100.0 Cost of revenues: Product and license fees......................... 35.1 19.3 34.6 19.4 Services......................................... 8.0 5.9 8.3 5.6 ------ ------ ------ ------ Total cost of revenues......................... 43.1 25.2 42.9 25.0 ------ ------ ------ ------ Gross profit..................................... 56.9 74.8 57.1 75.0 Operating expenses: Research and development......................... 35.4 22.2 37.8 21.7 Sales and marketing.............................. 15.6 13.1 18.4 12.3 General and administrative....................... 8.3 8.1 9.1 7.9 Restructuring.................................... -- -- 2.8 -- ------ ------ ------ ------ Total operating expenses....................... 59.3 43.4 68.1 41.9 ------- ------- ------- ------- Income (loss) from operations...................... (2.4) 31.4 (11.0) 33.1 Other income....................................... 4.7 5.1 5.7 5.4 ------- ------- ------- ------- Income (loss) before provision for income taxes.... 2.3 36.5 (5.3) 38.5 Provision (benefit) for income taxes............... (1.1) 12.0 (2.5) 13.0 -------- ------- -------- ------- Net income (loss).................................. 3.4% 24.5% (2.8)% 25.5% ======= ======= ======== =======
Page 12 of 25 REVENUES PRODUCT AND LICENSE FEES. Revenues from product and license fees decreased 44.7% to $20.1 million for the three months ended September 30, 2001 from $36.4 million for the three months ended September 30, 2000. For the nine months ended September 30, 2001, revenues from product and license fees decreased 34.6% to $64.7 million from $98.9 million for the nine months ended September 30, 2000. The decline in revenues from product and license fees is primarily attributable to lower sales volume reflecting a decrease in demand for our solutions, which is primarily driven by the slowdown in the economy, and also to a lesser extent relatively lower sales prices for certain basic applications of our network intelligence solutions. SERVICES. Revenues from services consisted primarily of recurring fees associated with product support services and increased 4.9% to $5.3 million for the three months ended September 30, 2001 from $5.0 million for the three months ended September 30, 2000. For the nine months ended September 30, 2001, revenues from services increased 31.3% to $16.2 million from $12.3 million for the nine months ended September 30, 2000. The increase in services revenues is due to an increase in the number of customers and a larger installed base of products. CONCENTRATION OF REVENUES. For the three months ended September 30, 2001, three customers each accounted for more than 10% of total revenues. For the three months ended September 30, 2000, revenues from one customer accounted for more than 10% of total revenues. For the nine months ended September 30, 2001, revenues from one customer accounted for more than 10% of total revenues. For the nine months ended September 30, 2000, revenues from two customers each accounted for more than 10% of total revenues. INTERNATIONAL REVENUES. For the three months ended September 30, 2001, international revenues accounted for 50.5% of total revenues compared to 51.7% of total revenues for the three months ended September 30, 2000. For the nine months ended September 30, 2001, international revenues accounted for 58.4% of total revenues compared to 52.0% of total revenues for the nine months ended September 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. 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 $8.9 million, or 35.1% of total revenues, for the three months ended September 30, 2001, compared to $8.0 million, or 19.3% of total revenues, for the three months ended September 30, 2000. The increase in absolute dollars is primarily related to increased costs for third-party contract labor and increased reserves for excess and obsolete inventory. The increase as a percentage of total revenues was primarily attributable to increased costs for third party contract labor and increased reserves for excess and obsolete inventory as well as the decreased level of revenues. For the nine months ended September 30, 2001, cost of product and license fees was $28.0 million, or 34.6% of total revenues, compared to $21.5 million, or 19.4% of total revenues, for the nine months ended September 30, 2000. The increase in absolute dollars resulted primarily from increased hardware costs, increased costs for third-party contract labor, increased reserves for excess and obsolete inventory, increased personnel costs due to higher average headcount and costs associated with the decision to cancel purchase commitments for certain product components. The increase in hardware costs reflects lower margins primarily for our GeoProbe solutions and increased costs associated with supporting new versions of our GeoProbe solutions. The increase as a percentage of total revenues was attributable to these factors combined with 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 $2.0 million, or 8.0% of total Page 13 of 25 revenues, for the three months ended September 30, 2001 and $2.4 million, or 5.9% of total revenues, for the three months ended September 30, 2000. Cost of services was $6.7 million, or 8.3% of total revenues, for the nine months ended September 30, 2001 and $6.3 million, or 5.6% of total revenues, for the nine months ended September 30, 2000. Cost of services as a percentage of total revenues has historically fluctuated as a result of the relative mix of product support, training and warranty and non-warranty work for a specific period. OPERATING EXPENSES RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses consist primarily of personnel, contract labor, travel and facilities costs. These expenses decreased to $9.0 million for the three months ended September 30, 2001 from $9.2 million for the three months ended September 30, 2000. Research and development expenses as a percentage of total revenues were 35.4% for the three months ended September 30, 2001 and 22.2% for the three months ended September 30, 2000. The increase as a percentage of total revenues was attributable primarily to the decreased level of revenues. For the nine months ended September 30, 2001, research and development expenses increased to $30.6 million from $24.1 million for the comparable prior-year period. The increase in absolute dollars was primarily due to increased average headcount, higher average wage levels required to retain qualified technical and engineering personnel and greater use of third-party research and development. Research and development expenses as a percentage of total revenues were 37.8% for the nine months ended September 30, 2001, and 21.7% for the nine months ended September 30, 2000. The increase as a percentage of total revenues was attributable to these factors combined with 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 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 and marketing expenses such as trade shows and advertising expenses. These expenses decreased to $4.0 million for the three months ended September 30, 2001 from $5.4 million for the three months ended September 30, 2000. The decrease in absolute dollars was primarily attributable to a decrease in sales commissions due to lower order levels and cost reduction efforts primarily related to travel. Sales and marketing expenses as a percentage of total revenues were 15.6% for the three months ended September 30, 2001 and 13.1% for the three months ended September 30, 2000. The increase as a percentage of total revenues was attributable primarily to the decreased level of revenues. Sales and marketing expenses increased to $14.8 million for the nine months ended September 30, 2001 from $13.6 million for the nine months ended September 30, 2000. The increase was primarily due to increased personnel costs related to increased average headcount. Sales and marketing expenses as a percentage of total revenues were 18.4% for the nine months ended September 30, 2001, and 12.3% for the nine months ended September 30, 2000. The increase as a percentage of total revenues was attributable to the combination of the increase in personnel costs from 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 $2.1 million for the three months ended September 30, 2001 from $3.4 million for the three months ended September 30, 2000. The decrease in absolute dollars was primarily related to decreased incentive compensation and decreased professional fees. General and administrative expenses as a percentage of total revenues were 8.3% for the three months ended September 30, 2001 and 8.1% for the Page 14 of 25 three months ended September 30, 2000. The slight increase as a percentage of total revenues was attributable to the decreased level of revenues. General and administrative expenses decreased to $7.4 million for the nine months ended September 30, 2001 from $8.8 million for the nine months ended September 30, 2000. The decrease in absolute dollars was primarily related to decreased incentive compensation and decreased professional fees. General and administrative expenses as a percentage of total revenues were 9.1% for the nine months ended September 30, 2001 and 7.9% for the nine months ended September 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 approximately $0.5 million 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 September 30, 2001, the balance of these costs that remained to be paid totaled approximately $0.1 million. 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 VIA softswitch offering 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 September 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 $0.3 million and the write-off of assets related to the VIA softswitch of approximately $0.3 million. At September 30, 2001, the balance of these costs that remained to be paid totaled approximately $0.4 million. OTHER INCOME Other income is primarily interest income earned on our cash and cash equivalents. Other income was $1.2 million for the three months ended September 30, 2001 compared to $2.1 million for the three months ended September 30, 2000. Other income was $4.7 million for the nine months ended September 30, 2001 compared to $6.0 million for the nine months ended September 30, 2000. The decrease for both the three- and nine-month periods ended September 30, 2001 is primarily attributable to the overall decrease in interest rates paid on our investments. PROVISION FOR INCOME TAXES We recorded an income tax benefit of $0.3 million for the three months ended September 30, 2001 compared to income tax expense of $5.0 million for the three months ended September 30, 2000. Our effective tax rates for these periods were (50.6%) and 33.0%, respectively. We recorded an income tax benefit of $2.0 million for the nine months ended September 30, 2001 compared to income tax expense of $14.4 million for the nine months ended September 30, 2000. Our effective tax rates for these periods were 47.7% and 33.6%, respectively. Federal income taxes for the interim periods presented have been calculated on the basis of an estimated annual rate. Our effective tax rates for 2001 differ from the 35% U.S. statutory rate primarily due to decreased income levels combined with the availability of the research and development tax credit. 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 $164.9 million at September 30, 2001 and $167.2 million at December 31, 2000. At September 30, 2001, we had $145.0 million in cash and cash equivalents, an increase of $13.6 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 Page 15 of 25 proceeds from the issuance of common stock as a result of the exercise of stock options and purchases under our employee stock purchase plan. Net cash provided by operating activities was $18.0 million for the nine months ended September 30, 2001, compared to $20.9 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 $7.5 million for the nine months ended September 30, 2001 compared to $9.7 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 $3.0 million for the nine months ended September 30, 2001 and $3.3 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 as a result of the exercise of stock options and purchases under our employee stock purchase plan. Our revolving credit facility expired on August 15, 2001, and was not renewed or replaced. At September 30, 2001, we had no material commitments for capital expenditures. Any material acquisition or joint venture could result in a decrease to 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 combined with potential cash flows from operations 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 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 You should carefully consider the risks described below before making an investment decision. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties that we do not presently know or that we currently deem immaterial may also impair our business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, they could materially adversely affect our business, financial condition or results of operations. In that case, the trading price of our common stock could decline. 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 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; Page 16 of 25 o the capital spending patterns of our customers; 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; and o other risks described below. Furthermore, a significant 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. A significant portion of our revenues is derived from a small number of transactions. Any delay in the implementation of one or more large transactions could materially 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 continued decline in the economic prospects of our customers or the economy in general. These adverse economic conditions are 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 and revenues in our first quarter tending to be consistent with, or decreasing from, the level achieved in the preceding quarter. We believe that this seasonality has been due to the capital appropriation practices of many of our customers; however, it is unclear how these historical trends will be affected by the slowdown in the telecommunications industry. 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. Since early 2001, 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 THE 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 we have significant additional obligations. Customer- or Inet- Page 17 of 25 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 acceptance. For new products, we typically 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. 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. 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 expend substantial funds and management effort pursuing these sales. Additionally, 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. Our business has been adversely affected by a softening economy, and we would be further harmed by a continued decline in the economic prospects of our customers or the economy in general. Any further downturn in the demand for our 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. Page 18 of 25 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. COMPETITION COULD RESULT IN PRICE REDUCTIONS, REDUCED MARGINS AND LOSS OF MARKET SHARE. Competition for all of our solutions is intense and 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. 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 in the future 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 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. Page 19 of 25 WE MAY BE UNABLE TO ADAPT TO RAPID TECHNOLOGICAL CHANGE AND EVOLVING CUSTOMER REQUIREMENTS. 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 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. 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. 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 25 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 arrangements. 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. 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. 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. Page 21 of 25 OUR INVENTORY MAY BECOME OBSOLETE OR UNUSABLE. We make advance purchases of various component parts 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. 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. 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 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. 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. 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 Page 22 of 25 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 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 September 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 members of our board of directors and have significant influence in directing the actions taken by our board. Page 23 of 25 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. 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. Page 24 of 25 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 58.4% of total revenues for the nine months ended September 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 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. PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS The Securities and Exchange Commission on May 26, 1999 declared effective our registration statement on Form S-1 (File No. 333-59753) relating to the initial public offering of our common stock. As of September 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 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - None (b) We did not file any Current Reports on Form 8-K during the quarter ended September 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: November 2, 2001 Page 25 of 25