SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended March 31, 2004
OR
o 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 |
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75-2269056 |
(State or other jurisdiction |
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(I.R.S. employer |
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1500 North Greenville Avenue |
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(Address of principal executive offices, including zip code) |
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(469) 330-4000 |
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(Registrants 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 ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ý No o
Number of shares of common stock outstanding at April 20, 2004: 39,220,388
Inet Technologies, Inc.
Index
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Managements Discussion and Analysis of Financial Condition and |
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Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities |
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2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
INET TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
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March 31, |
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December 31, |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
72,898 |
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$ |
118,527 |
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Short-term investments |
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99,267 |
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55,034 |
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Trade accounts receivable, net of allowance for doubtful accounts of $514 at March 31, 2004 and December 31, 2003 |
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15,066 |
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10,870 |
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Unbilled receivables |
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236 |
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146 |
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Inventories |
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8,957 |
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7,924 |
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Deferred income taxes |
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1,829 |
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1,628 |
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Other current assets |
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6,007 |
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5,055 |
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Total current assets |
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204,260 |
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199,184 |
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Property and equipment, net |
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10,741 |
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11,330 |
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Deferred income taxes |
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201 |
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217 |
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Other assets |
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614 |
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613 |
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Total assets |
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$ |
215,816 |
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$ |
211,344 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
2,037 |
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$ |
1,919 |
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Income taxes payable |
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3,181 |
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2,408 |
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Accrued compensation and benefits |
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2,593 |
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4,115 |
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Deferred revenues |
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20,977 |
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21,554 |
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Other accrued liabilities |
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4,365 |
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3,724 |
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Total current liabilities |
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33,153 |
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33,720 |
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Commitments and contingencies |
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Stockholders equity: |
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Preferred stock, $.001 par value: |
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Authorized shares 25,000,000 |
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Common stock, $.001 par value: |
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Authorized shares 175,000,000 |
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47 |
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47 |
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Additional paid-in capital |
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78,191 |
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77,866 |
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Unearned compensation |
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(2,423 |
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(2,610 |
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Retained earnings |
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138,208 |
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134,932 |
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Treasury stock, 7,939,255 common shares at March 31, 2004 and 8,240,060 common shares at December 31, 2003, at cost |
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(31,360 |
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(32,611 |
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Total stockholders equity |
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182,663 |
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177,624 |
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Total liabilities and stockholders equity |
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$ |
215,816 |
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$ |
211,344 |
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See accompanying notes to our condensed consolidated financial statements.
3
INET TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)
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Three months ended |
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2004 |
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2003 |
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Revenues: |
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Product and license fees |
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$ |
19,647 |
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$ |
17,518 |
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Services |
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7,565 |
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7,524 |
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Total revenues |
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27,212 |
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25,042 |
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Cost of revenues: |
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Product and license fees |
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5,227 |
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2,902 |
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Services |
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3,188 |
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4,167 |
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Total cost of revenues |
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8,415 |
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7,069 |
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Gross profit |
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18,797 |
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17,973 |
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Operating expenses: |
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Research and development |
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8,126 |
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7,685 |
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Sales and marketing |
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4,307 |
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3,515 |
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General and administrative |
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2,261 |
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2,419 |
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14,694 |
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13,619 |
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Income from operations |
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4,103 |
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4,354 |
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Other income (expense): |
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Interest income |
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369 |
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426 |
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Other income (expense) |
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(155 |
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16 |
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214 |
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442 |
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Income before provision for income taxes |
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4,317 |
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4,796 |
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Provision for income taxes |
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1,041 |
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1,541 |
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Net income |
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$ |
3,276 |
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$ |
3,255 |
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Earnings per common share: |
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Basic |
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$ |
0.08 |
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$ |
0.08 |
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Diluted |
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$ |
0.08 |
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$ |
0.08 |
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Weighted-average shares outstanding: |
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Basic |
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39,119 |
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40,395 |
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Diluted |
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39,788 |
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40,563 |
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See accompanying notes to our condensed consolidated financial statements.
4
INET TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
(Unaudited)
(In thousands, except share data)
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Additional |
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Unearned |
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Retained |
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Total |
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Common Stock |
Treasury Stock |
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Shares |
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Amount |
Shares |
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Amount |
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Balance at December 31, 2003 |
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47,159,643 |
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$ |
47 |
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$ |
77,866 |
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$ |
(2,610 |
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$ |
134,932 |
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8,240,060 |
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$ |
(32,611 |
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$ |
177,624 |
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Issuance of common stock under employee stock option and stock purchase plans, including tax benefit of $240 |
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325 |
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(300,805 |
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1,251 |
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1,576 |
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Net income |
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3,276 |
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3,276 |
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Amortization of restricted stock awards |
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187 |
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187 |
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Balance at March 31, 2004 |
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47,159,643 |
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$ |
47 |
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$ |
78,191 |
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$ |
(2,423 |
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$ |
138,208 |
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7,939,255 |
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$ |
(31,360 |
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$ |
182,663 |
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See accompanying notes to our condensed consolidated financial statements.
5
INET TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
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Three months ended |
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2004 |
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2003 |
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Cash flows from operating activities: |
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Net income |
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$ |
3,276 |
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$ |
3,255 |
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Adjustments to reconcile net income to net cash provided by operating activities: |
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Depreciation |
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1,449 |
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1,803 |
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Amortization of purchase discounts on investments |
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(205 |
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Stock compensation |
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187 |
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141 |
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Deferred income taxes |
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(185 |
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Changes in operating assets and liabilities: |
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Increase in trade accounts receivable |
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(4,196 |
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(1,527 |
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Increase in unbilled receivables |
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(90 |
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(25 |
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Increase in inventories |
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(1,033 |
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(967 |
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Increase in other assets |
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(953 |
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(217 |
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Increase in accounts payable |
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118 |
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395 |
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Increase in taxes payable |
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1,013 |
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1,316 |
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Decrease in accrued compensation and benefits |
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(1,522 |
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(1,302 |
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Increase (decrease) in deferred revenues |
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(577 |
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5,688 |
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Increase in other accrued liabilities |
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641 |
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1,250 |
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Net cash provided by (used in) operating activities |
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(2,077 |
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9,810 |
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Cash flows from investing activities: |
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Purchases of short-term investments |
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(44,028 |
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Purchases of property and equipment |
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(860 |
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(932 |
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Net cash used in investing activities |
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(44,888 |
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(932 |
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Cash flows from financing activities: |
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Repurchase of common stock |
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(35,431 |
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Proceeds from issuance of common stock upon exercise of stock options and purchases under employee stock purchase plan |
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1,336 |
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616 |
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Net cash provided by (used in) financing activities |
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1,336 |
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(34,815 |
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Net decrease in cash and cash equivalents |
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(45,629 |
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(25,937 |
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Cash and cash equivalents at beginning of period |
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118,527 |
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189,076 |
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Cash and cash equivalents at end of period |
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$ |
72,898 |
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$ |
163,139 |
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Supplemental disclosure: |
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Income taxes paid |
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$ |
48 |
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$ |
155 |
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See accompanying notes to our condensed consolidated financial statements.
6
INET TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Summary of Significant Accounting Policies
The Company
Inet Technologies, Inc. is a global provider of communications software products that enable communications carriers to more strategically and profitably operate their businesses. Our Unified Assurance SolutionTM and our Diagnostics products help our customers reduce capital and operating expenditures, improve customer acquisition and retention rates, protect and grow revenues, and more quickly and effectively develop products or services. Our products address next-generation networks, including mobile data and voice-over-packet technologies, and traditional networks.
Consolidation
The condensed 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 condensed consolidated financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these statements 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, 2003 included in our Form 10-K filed with the Securities and Exchange Commission, or SEC, on January 30, 2004. Operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2004.
Accounting Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. As discussed below, we make significant estimates and assumptions in the areas of revenue recognition, accounts receivable, inventories and taxes. Although we believe that our estimates and assumptions are reasonable, actual results may differ, and such differences could be significant to our financial results.
Basis of Presentation
Certain prior period amounts have been reclassified to conform to the current period presentation.
Cash and Cash Equivalents
Cash and cash equivalents consist of bank deposits, money-market funds and commercial paper. All highly-liquid securities with original maturities of three months or less are classified as cash equivalents.
7
The carrying value of our bank deposits and money-market funds approximates fair market value. Our commercial paper is classified as held to maturity and carried at amortized cost.
Short-term Investments
Our short-term investments are classified as held to maturity and carried at amortized cost. Interest income includes amortization of the purchase discounts.
At March 31, 2004, our short-term investments were as follows (in thousands):
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Amortized |
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Unrealized |
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Unrealized |
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Estimated |
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U.S. Treasury bills |
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$ |
75,242 |
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$ |
3 |
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$ |
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$ |
75,245 |
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U.S. government agency discount notes |
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24,025 |
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2 |
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24,023 |
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Total short-term investments |
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$ |
99,267 |
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$ |
3 |
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$ |
2 |
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$ |
99,268 |
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At December 31, 2003, our short-term investments were as follows (in thousands):
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Amortized |
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Unrealized |
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Unrealized |
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Estimated |
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U.S. Treasury bills |
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$ |
55,034 |
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$ |
55,034 |
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Allowance for Doubtful Accounts
A large portion of our revenues and accounts receivable are attributable to our carrier customers in the communications industry and, to a lesser extent, to our equipment manufacturer customers who supply equipment into the communications industry. Our trade accounts receivable balance is recorded net of allowances for amounts not expected to be collected from our customers. Because our accounts receivable are usually unsecured, we periodically evaluate the collectibility of our accounts based on a combination of factors, including a particular customers ability to pay and the age of the receivables. To evaluate a specific customers ability to pay, we analyze the customers payment history, if any, financial statements or other information provided by the customer, or third-party credit analysis reports or other publicly-available information. In cases where the evidence suggests a customer may not be able to satisfy its obligations to us, we set up a specific reserve in an amount we determine appropriate for the perceived risk. Most of our contracts include multiple payment milestones, some of which occur in advance of revenue recognition, which mitigates our risk both in terms of collectibility and adjustments to recorded revenue. We have not historically experienced significant losses on uncollectible accounts and our allowance has been less than 5% of recorded receivables.
8
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 March 31, 2004 and December 31, 2003, inventories consisted of the following (in thousands):
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March 31, |
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December 31, |
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Raw materials |
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$ |
3,430 |
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$ |
3,498 |
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Work-in-process |
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128 |
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219 |
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Finished goods |
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5,399 |
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4,207 |
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$ |
8,957 |
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$ |
7,924 |
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Inventories are recorded net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. We evaluate on a quarterly basis the status of our inventory to ensure the amount recorded in our financial statements reflects the lower of our cost or the value we expect to receive when we sell the inventory. This estimate is based on several factors, including the condition and salability of our inventory and the forecasted demand for the particular products incorporating inventory components. Based on current backlog, expected orders and other expected demand, we forecast the usage of current stock. We record reserves for obsolete and slow-moving parts of up to 100% for excess parts with insufficient demand or obsolete parts. Amounts in work-in-process and finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk.
Revenue Recognition
We derive revenues primarily from product and license fees as well as services, which include training, warranty and product support services. The majority of the contracts for our Unified Assurance products contain multiple billing milestones, such as contract award, shipment, installation, ready for acceptance and acceptance, not all of which are associated with revenue recognition. Except as otherwise discussed below, revenues from product and license fees are recognized in the period that 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 of the fee is considered probable. When we have significant obligations subsequent to shipment, such as installation and system integration, revenues are recognized when there are no significant unfulfilled obligations. Revenues from arrangements that include significant acceptance terms and/or provisions and revenues from arrangements that include significant developmental items are recognized when acceptance has occurred. Revenues from our Diagnostics products are typically recognized when title and risk of loss pass to the customer, which typically occurs at shipment. For these products, we typically have no significant obligations subsequent to shipment. If a significant obligation were to exist, we would defer revenue recognition until such obligation was satisfied. All shipping costs are included in cost of revenues in our condensed consolidated statements of income.
Contracts for our Unified Assurance products typically involve multiple deliverables. We determine the fair value of each of the contract deliverables using vendor-specific objective evidence, or VSOE. VSOE for each element is based on the price for which we would sell the element on a stand-alone basis. We offer our customers product support services, which include the correction of software problems, hardware replacements, 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 post-contract support included in initial licensing fees, are recognized ratably over the service period. Post-contract support included in the initial licensing fee is allocated from the total
9
contract amount based on the fair value of these services determined using VSOE. Revenues from other services, such as training, are recognized when the services have been completed. If we determine that we do not have VSOE on an undelivered element of an arrangement, we will not recognize revenue until all elements of the arrangement are delivered.
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.
Income Taxes
Our income taxes are computed using the asset and liability method of accounting. Under the asset and liability method, a deferred tax asset or liability is recognized for estimated future tax effects attributable to temporary differences and carryforwards.
In the preparation of our provision for income taxes, there may be many transactions and calculations where the ultimate tax outcome is uncertain. The calculation of tax liabilities and the determination of whether deferred tax assets will be realized in full or in part involves dealing with uncertainties in the application of complex and potentially changing tax laws. Therefore, we must estimate several factors. For example, when it is more likely than not that all or some portion of a deferred tax asset will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that are determined not to be realizable. As of March 31, 2004 and December 31, 2003, a valuation for deferred tax assets was not deemed necessary. If the facts underlying our determination or our financial results were to change in a manner impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied to determine the amount of valuation allowance required in any given period. Additionally, because our income tax returns are subject to review and examination in the various jurisdictions in which we operate, the Company recognizes potential liabilities for anticipated tax issues and adjusts those potential liabilities based on an estimate of the ultimate resolution of whether, and the extent to which, additional taxes will be due. We are currently not aware of any material issues that have been raised by taxing jurisdictions, and management believes that all income tax issues that may be raised as a result of such reviews and examinations in the future will be resolved with no material impact on our financial condition or results of operations. However, in the event there was an assessment by any of these jurisdictions, it could impact our tax provision.
Our annual effective tax rate is currently expected to be 29.5% for the year ending December 31, 2004. This tax rate differs from the 35% statutory corporate tax rate primarily due to the effect of the extraterritorial income exclusion and research and development tax credits. This tax rate currently reflects the impact of research and development tax credits through June 2004 at which time the statute expires. As such, our effective tax rate could be impacted if the research and development tax credit was extended or reinstated. Our tax rate could also be impacted by our adjustment of certain tax accounts if the statute of limitations were to expire on open tax years.
During the three months ended March 31, 2004, our effective tax rate of approximately 24.1% was also impacted by the effect of adjustments to the balance of our state tax liability and the balance of our deferred tax assets based on information developed in the quarter.
Stock Options
We have elected to follow Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for our employee stock options. Under APB 25, if the exercise price of an employees stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized. At March 31, 2004, we had three stock-based compensation plans covering employees and directors. We account for stock-based compensation for non-employees under the fair value method prescribed by Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation. Through March 31, 2004, there have been no grants to non-employees other than grants to our non-employee directors under our automatic option grant program. As of March 31, 2004, unearned stock compensation related to restricted stock grants was approximately $2.4 million. As of December 31, 2003, unearned stock compensation related to restricted stock grants was approximately $2.6 million.
10
Although SFAS 123 allows us to continue to follow the present APB 25 guidelines in accounting for employee stock options and employee stock purchase rights, we are required to disclose pro forma net income and net income per share as if we had adopted SFAS 123 in accounting for employee stock options and restricted stock issuances and employee stock purchase rights. The pro forma impact of applying SFAS 123 in the three months ended March 31, 2004 and the three months ended March 31, 2003 will not necessarily be representative of the pro forma impact in future periods. Our pro forma information is as follows (in thousands, except per share data):
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Three months ended |
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||||
|
|
2004 |
|
2003 |
|
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|
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Net income, as reported |
|
$ |
3,276 |
|
$ |
3,255 |
|
Stock compensation expense recorded under the intrinsic value method, net of income taxes |
|
135 |
|
96 |
|
||
Pro forma stock compensation expense computed under the fair value method, net of income taxes |
|
(1,988 |
) |
(2,499 |
) |
||
Pro forma net income |
|
$ |
1,423 |
|
$ |
852 |
|
|
|
|
|
|
|
||
Basic earnings per common share, as reported |
|
$ |
0.08 |
|
$ |
0.08 |
|
Diluted earnings per common share, as reported |
|
$ |
0.08 |
|
$ |
0.08 |
|
|
|
|
|
|
|
||
Pro forma basic earnings per common share |
|
$ |
0.04 |
|
$ |
0.02 |
|
Pro forma diluted earnings per common share |
|
$ |
0.04 |
|
$ |
0.02 |
|
Inputs used for the fair value method for our employee stock options are as follows:
|
|
Three months ended |
|
||||
|
|
2004 |
|
2003 |
|
||
|
|
|
|
|
|
||
Volatility |
|
0.89 |
|
0.97 |
|
||
Weighted-average expected lives |
|
3.00 |
|
3.68 |
|
||
Expected dividend yields |
|
|
|
|
|
||
Weighted-average risk-free interest rates |
|
1.94 |
% |
2.10 |
% |
||
Weighted-average fair value of options granted |
|
$ |
7.23 |
|
$ |
4.15 |
|
11
Inputs used for the fair value method for our employee stock purchase rights are as follows:
|
|
Three months ended |
|
||||
|
|
2004 |
|
2003 |
|
||
|
|
|
|
|
|
||
Volatility |
|
0.91 |
|
0.98 |
|
||
Weighted-average expected lives |
|
0.50 |
|
0.50 |
|
||
Expected dividend yields |
|
|
|
|
|
||
Weighted-average risk-free interest rates |
|
1.15 |
% |
1.32 |
% |
||
Weighted-average fair value of employee stock purchase rights |
|
$ |
5.17 |
|
$ |
2.52 |
|
Note 2 - Related Party Transactions
Epygi Technologies, Ltd., an entity controlled by Samuel S. Simonian, one of our founders and chairman of our board, currently performs development services for us pursuant to a consulting agreement for which it is paid a monthly fee per full-time programmer plus reimbursement of reasonable business expenses. We expensed approximately $0.1 million for these services in both the three months ended March 31, 2004 and the three months ended March 31, 2003.
On January 21, 2003, we repurchased in a privately-negotiated transaction 8,969,984 restricted shares of our common stock from Mark A. Weinzierl, one of our founders and a member of our board of directors until the closing of the transaction, for an aggregate cash purchase price of approximately $35.4 million. We funded the transaction with available cash. The shares repurchased represented approximately 19% of our total shares outstanding immediately prior to the transaction. Effective as of the closing of the transaction, Mr. Weinzierl resigned from our board of directors.
Note 3 - Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):
|
|
Three months ended |
|
||||
|
|
2004 |
|
2003 |
|
||
|
|
|
|
|
|
||
Numerator: |
|
|
|
|
|
||
Net income for basic and diluted earnings per share |
|
$ |
3,276 |
|
$ |
3,255 |
|
Denominator: |
|
|
|
|
|
||
Denominator for basic earnings per share weighted-average shares |
|
39,119 |
|
40,395 |
|
||
Dilutive securities: Employee stock options and purchase rights |
|
669 |
|
168 |
|
||
Denominator
for diluted earnings per
share adjusted |
|
39,788 |
|
40,563 |
|
||
|
|
|
|
|
|
||
Basic earnings per common share |
|
$ |
0.08 |
|
$ |
0.08 |
|
Diluted earnings per common share |
|
$ |
0.08 |
|
$ |
0.08 |
|
12
Note 5 - 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 resellers. 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 |
|
||
|
|
2004 |
|
2003 |
|
|
|
|
|
|
|
United States |
|
37.8 |
% |
19.2 |
% |
Export: |
|
|
|
|
|
Asia/Pacific |
|
5.2 |
|
8.0 |
|
Europe, Middle East and Africa |
|
54.7 |
|
71.2 |
|
Other |
|
2.3 |
|
1.6 |
|
Total export |
|
62.2 |
|
80.8 |
|
|
|
100.0 |
% |
100.0 |
% |
In the three months ended March 31, 2004, revenues from one international wireline customer accounted for approximately 18% of total revenues, revenues from one international wireless customer accounted for approximately 15% of total revenues, revenues from one domestic wireless customer accounted for 11% of total revenues and revenues from one domestic wireline customer accounted for 11% of total revenues. For the three months ended March 31, 2003, revenues from one international wireline customer accounted for approximately 44% of total revenues.
We have no significant long-lived assets deployed outside of the United States.
Item 2. Managements 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:
our operating results are difficult to predict and are likely to vary significantly from quarter to quarter in the future;
we could be materially harmed in the event of a general economic slowdown, decreased spending by communications carriers and equipment manufacturers or consolidations or bankruptcies involving our current or prospective customers;
we could be materially harmed if demand for our products is less than we anticipate;
we could be materially harmed if the market for current- and next-generation network products and applications fails to develop as we currently anticipate;
13
we expect to face increased competition that could result in price reductions and reduced margins, as well as loss of market share; and
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 condensed consolidated financial statements and notes thereto included in Item 1 of this Quarterly Report and the condensed consolidated financial statements and notes thereto and Managements Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K filed with the SEC on January 30, 2004. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.
Overview
Inet Technologies, Inc. is a global provider of communications software products that enable communications carriers to more strategically and profitably operate their businesses. Our Unified Assurance Solution and our Diagnostics products help our customers reduce capital and operating expenditures, improve customer acquisition and retention rates, protect and grow revenues, and more quickly and effectively develop products or services. Our products address next-generation networks, including mobile data and voice-over-packet technologies, and traditional networks.
This Managements Discussion and Analysis of Financial Condition and Results of Operations provides information that our management believes to be necessary to achieve a clear understanding of our financial statements and results of operations.
Our management monitors and analyzes a number of key performance indicators in order to manage our business and evaluate our financial and operating performance. Those indicators include:
Revenues. We derive revenues from product and license fees and services relating to our products. These revenues vary based on such factors as demand for our products, the number and size of transactions within the reporting period and the impact of changes in our sales prices. In addition to monitoring the amount of our product and license fees revenues, services revenues and total revenues, we also consider revenue concentration by customer and by geographic region to be possible indicators of current and future trends in our business.
Cost of revenues and gross margins. We strive to control our cost of revenues and thereby maintain or improve our gross margins. The major items impacting cost of product and license fees are hardware and third-party software, personnel and overhead expenses. Hardware and third-party software costs will vary significantly from quarter to quarter based on the relative mix of implementations during a reporting period. Implementations related to new systems and expansion projects involving increased physical network coverage involve a greater use of hardware. In contrast, expansions of system capacity and software-only application sales require less hardware. Cost of services is driven primarily by personnel expenses. These costs tend to fluctuate as a result of the relative mix of product support and training activities during a specific period.
14
Operating expenses. Operating expenses are substantially driven by personnel and overhead expenses. Other significant operating expenses that we monitor include travel, professional fees and facilities and communication expenses.
Liquidity and cash flows. The primary source of our liquidity is our cash reserves and short-term investments. The primary driver of our cash flows is our net income. From period to period, we see fluctuations in various items, including our working capital accounts, capital expenditures and proceeds from the exercise of employee stock options and stock purchases.
Balance sheet. We view cash, short-term investments, working capital, inventory, accounts receivable balances and days sales outstanding as important indicators of our financial health.
Revenues
The following table sets forth, for the periods indicated, a year-over-year comparison of the key components of our revenues:
($ in millions) |
|
Three months ended |
|
Variance |
|
|||||||
|
|
2004 |
|
2003 |
|
$ |
|
% |
|
|||
Product and license fees |
|
$ |
19.6 |
|
$ |
17.5 |
|
$ |
2.1 |
|
12 |
% |
Services |
|
7.6 |
|
7.5 |
|
0.1 |
|
1 |
|
|||
Total revenues |
|
$ |
27.2 |
|
$ |
25.0 |
|
$ |
2.2 |
|
9 |
% |
|
|
|
|
|
|
|
|
|
|
|||
Top 10 customers as % of total revenues |
|
73 |
% |
69 |
% |
|
|
|
|
|||
|
|
|
|
|
|
|
|
|
|
|||
Revenues from international markets: |
|
|
|
|
|
|
|
|
|
|||
Asia/Pacific |
|
5.2 |
% |
8.0 |
% |
|
|
|
|
|||
Europe, Middle East and Africa |
|
54.7 |
|
71.2 |
|
|
|
|
|
|||
Other |
|
2.3 |
|
1.6 |
|
|
|
|
|
|||
Total |
|
62.2 |
% |
80.8 |
% |
|
|
|
|
Product and license fees. The increase in product and license fees for the three months ended March 31, 2004 compared to March 31, 2003 reflected a 50% increase in the number of Unified Assurance product implementations. This increase was somewhat mitigated by a lower average value per implementation and a decrease in our sales prices compared to the same prior-year period. Prices for our most basic GeoProbe system generally decreased by approximately 8% in the three months ended March 31, 2004 compared to the same prior-year period. We experience the greatest pressure on sales prices in highly competitive situations involving prospective customers and we anticipate that we will continue to experience pricing pressure for our products during the remainder of 2004.
Services. In the three months ended March 31, 2004 compared to the same prior-year period, the increase in services revenues was primarily attributable to a larger installed base of products with customers for which we provide product support services, offset by continued price pressure on prices for product support contracts. In the three months ended March 31, 2004, approximately 87% of our total revenues were from expansions of existing systems. Going forward, we expect to sell additional applications to or expand the footprint of our products with existing customers, and to add new customers, which should continue to increase our installed base of products and corresponding services revenues;
15
however, we expect that continued sales pressure on prices may partially offset the effect of this anticipated increase in our installed base.
Concentration of revenues. In the three months ended March 31, 2004, revenues from one international wireline customer accounted for approximately 18% of total revenues, revenues from one international wireless customer accounted for approximately 15% of total revenues, revenues from one domestic wireless customer accounted for approximately 11% of total revenues and revenues from one domestic wireline customer accounted for 11% of total revenues. For the three months ended March 31, 2003, revenues from one international wireline customer accounted for approximately 44% of total revenues. A large percentage of our revenues are typically derived from a small number of customers, the specific make up of which typically varies from one quarter to the next. On a quarterly basis, the 10 largest customers for the quarter typically account for approximately 50% to 80% of total revenues. For the three months ended March 31, 2004, approximately 73% of our revenues were derived from our 10 largest customers for that period. We expect these trends to continue for the foreseeable future.
International revenues. Variations in the percentage of total revenues derived from international markets primarily occur as a result of the concentration of revenues in a particular period from a small number of customers and the economic conditions in the regions in which we operate. For the remainder of 2004, we expect revenues from international markets to represent the majority of our total revenues.
Cost of Revenues
The following table sets forth, for the periods indicated, a year-over-year comparison of the key components of our cost of revenues and gross margins:
Cost of
Revenues |
|
Three months ended |
|
Variance |
|
|||||||
|
|
2004 |
|
2003 |
|
$ |
|
% |
|
|||
Product and license fees |
|
$ |
5.2 |
|
$ |
2.9 |
|
$ |
2.3 |
|
79 |
% |
Services |
|
3.2 |
|
4.2 |
|
(1.0 |
) |
(24 |
) |
|||
Total cost of revenues |
|
$ |
8.4 |
|
$ |
7.1 |
|
$ |
1.3 |
|
18 |
% |
|
|
|
|
|
|
|
|
|
|
|||
Average headcount |
|
127 |
|
121 |
|
|
|
|
|
Gross
Margin |
|
Three months ended |
|
Variance |
|
|||||||
|
|
2004 |
|
2003 |
|
$ |
|
% |
|
|||
Product and license fees |
|
$ |
14.4 |
|
$ |
14.6 |
|
$ |
(0.2 |
) |
(1 |
)% |
Services |
|
4.4 |
|
3.4 |
|
1.0 |
|
29 |
|
|||
Total gross margin |
|
$ |
18.8 |
|
$ |
18.0 |
|
$ |
0.8 |
|
4 |
% |
|
|
|
|
|
|
|
|
|
|
|||
Gross margin as a percentage of revenues: |
|
|
|
|
|
|
|
|
|
|||
Gross margin product and license fees |
|
73.4 |
% |
83.4 |
% |
|
|
|
|
|||
Gross margin services |
|
57.9 |
|
44.6 |
|
|
|
|
|
|||
Gross margin total |
|
69.1 |
|
71.8 |
|
|
|
|
|
Product and license fees. Cost of product and license fees consists primarily of hardware, third-party software, personnel and overhead expenses related to the integration, installation and configuration of our products. In the three months ended March 31, 2004 compared to the three months ended March 31, 2003, hardware costs increased approximately $1.4 million due to a majority of our revenues being derived from increasing the physical network coverage of existing systems for current customers, which
16
inherently involves a greater use of hardware. In addition, personnel costs increased approximately $0.3 million in the three months ended March 31, 2004 compared to the same prior-year period due to increased headcount and salary adjustments. We expect a slight increase in headcount during the remainder of 2004.
Services. Cost of services consists of expenses, primarily personnel costs, related to our product support, training and warranty activities. In the three months ended March 31, 2004 compared to the three months ended March 31, 2003, cost of services decreased due to a higher percentage of man-hours being used to perform product-related installations than service-related tasks, such as product support, training and warranty activities. Historically, cost of services as a percentage of services revenues has fluctuated as a result of the relative mix of product support and training activities during a specific period. We expect these fluctuations to continue into the foreseeable future.
Research and Development Expenses
The following table sets forth, for the periods indicated, a year-over-year comparison of the key components of our research and development expenses:
($ in millions) |
|
Three months ended |
|
Variance |
|
|||||||
|
|
2004 |
|
2003 |
|
$ |
|
% |
|
|||
Research and development |
|
$ |
8.1 |
|
$ |
7.7 |
|
$ |
0.4 |
|
5 |
% |
Percent of total revenues |
|
29.9 |
% |
30.7 |
% |
|
|
|
|
|||
Average headcount |
|
250 |
|
247 |
|
|
|
|
|
|||
Research and development expenses consist primarily of personnel, contract labor and facilities expenses incurred by our research and development organization. Our research and development efforts include expenditures relating to new products and applications, and new features or enhancements for existing products, primarily in the areas of next-generation wireless and packet-based technologies. Research and development expenses increased in absolute dollars primarily due to increased staffing dedicated to research and development activities and increased use of third-party research and development services, which was approximately $0.2 million more in the three months ended March 31, 2004 compared to the three months ended March 31, 2003. As a percentage of total revenues, research and development expenses decreased primarily due to the increase in total revenues. We expect research and development expenses to remain relatively flat during the remainder of 2004.
Software development costs are expensed as incurred until technological feasibility has been established, at which time subsequent costs are permitted to be capitalized until the product is available for general release to customers. To date, either the establishment of technological feasibility of our products has substantially coincided with their general release, or costs incurred subsequent to the achievement of technological feasibility have not been material. As a result, software development costs qualifying for capitalization have been insignificant, and we have not capitalized any software development costs.
Sales and Marketing Expenses
The following table sets forth, for the periods indicated, a year-over-year comparison of the key components of our sales and marketing expenses:
17
($ in millions) |
|
Three months ended |
|
Variance |
|
|||||||
|
|
2004 |
|
2003 |
|
$ |
|
% |
|
|||
Sales and marketing |
|
$ |
4.3 |
|
$ |
3.5 |
|
$ |
0.8 |
|
23 |
% |
Percent of total revenues |
|
15.8 |
% |
14.0 |
% |
|
|
|
|
|||
Average headcount |
|
71 |
|
62 |
|
|
|
|
|
|||
Sales and marketing expenses consist primarily of expenses associated with personnel, including commissions from direct sales, travel, facilities and marketing, such as trade show and advertising expenses. The increases in sales and marketing expenses in absolute dollars and as a percentage of total revenues were primarily attributable to increased personnel costs due to increased headcount, salary adjustments and increased commissions which reflect higher bookings in the three months ended March 31, 2004 compared to the same prior-year period. We expect sales and marketing expenses to increase in the remainder of 2004.
General and Administrative Expenses
The following table sets forth, for the periods indicated, a year-over-year comparison of the key components of our general and administrative expenses:
($ in millions) |
|
Three months ended |
|
Variance |
|
|||||||
|
|
2004 |
|
2003 |
|
$ |
|
% |
|
|||
General and administrative |
|
$ |
2.3 |
|
$ |
2.4 |
|
$ |
(0.1 |
) |
(4 |
)% |
Percent of total revenues |
|
8.3 |
% |
9.7 |
% |
|
|
|
|
|||
Average headcount |
|
46 |
|
42 |
|
|
|
|
|
|||
General and administrative expenses consist primarily of personnel, facilities and professional expenses of our finance and accounting, legal and executive departments. The decrease in absolute dollars and as a percentage of total revenues was primarily attributable to decreased professional fees of approximately $0.2 million. In the three months ended March 31, 2003, professional fees were higher than the three months ended March 31, 2004 due to professional fees related to our repurchase of restricted common stock outstanding in January 2003. We expect general and administrative expenses to increase in the remainder of 2004.
The following table sets forth, for the periods indicated, a year-over-year comparison of the key components of our other income:
($ in millions) |
|
Three months ended |
|
Variance |
|
|||||||
|
|
2004 |
|
2003 |
|
$ |
|
% |
|
|||
Investment income |
|
$ |
0.4 |
|
$ |
0.4 |
|
$ |
|
|
|
|
Foreign currency translation loss |
|
(0.2 |
) |
|
|
(0.2 |
) |
|
|
|||
Total other income |
|
$ |
0.2 |
|
$ |
0.4 |
|
$ |
(0.2 |
) |
(50 |
)% |
|
|
|
|
|
|
|
|
|
|
|||
Rate of return on average cash and short-term investments |
|
0.9 |
% |
1.0 |
% |
|
|
|
|
18
Other income consists primarily of interest income earned on our cash and cash equivalents and investment income earned on our investment in U.S. Treasury bills and U.S. government agency discount notes, partially offset by foreign currency translation adjustments and losses on the disposal of assets. The decrease in other income was primarily attributable to the overall decrease in interest rates received on our investments and foreign translation adjustments. Foreign currency translation gains or losses primarily arise from translation adjustments for our international operations, including the United Kingdom and German sales and support organizations and, to a lesser extent, to the small percentage of our business denominated in non-U.S. currencies. To date, we have not engaged in hedging activities for our international operations or our non-U.S. dollar business.
The following table sets forth, for the periods indicated, a year-over-year comparison of our provision for income taxes:
($ in millions) |
|
Three months ended |
|
Variance |
|
|||||||
|
|
2004 |
|
2003 |
|
$ |
|
% |
|
|||
Income tax expense |
|
$ |
1.0 |
|
$ |
1.5 |
|
$ |
(0.5 |
) |
(33 |
)% |
Effective tax rate |
|
24.1 |
% |
32.1 |
% |
|
|
|
|
|||
Federal income taxes for the periods presented have been calculated on the basis of an estimated annual rate. Our effective tax rate during the first quarter differs from the 35% statutory corporate tax rate primarily due to the effect of the extraterritorial income exclusion, research and development tax credits, and adjustments to the balance of our state tax liability and the balance of our deferred tax assets based on information developed in the quarter. For 2004, we currently anticipate our annual effective tax rate will be approximately 29.5%.
Our financial statements reflect net deferred tax assets of $2.0 million as of March 31, 2004, comprised of deductible temporary differences. We have concluded that it is more likely than not that the net deferred tax assets will be realized based on the scheduling of deferred tax amounts and projected taxable income, although we cannot assure you that such assets will be realized. The amount of the net deferred tax assets actually realized could vary if there are differences in the timing or amount of future reversals of existing deferred tax amounts or changes in the actual amounts of future taxable income.
Our anticipated annual effective tax rate of approximately 29.5% for 2004 differs from the 35% statutory corporate tax rate primarily due to the effect of the extraterritorial income exclusion and research and development tax credits. This tax rate currently reflects the impact of research and development tax credits through June 2004 at which time the statute expires. As such, our effective tax rate could be impacted if the research and development tax credit was extended or reinstated. Our tax rate could also be impacted by our adjustment of certain tax accounts if the statute of limitations were to expire on open tax years.
Net Income
The following table sets forth, for the periods indicated, a year-over-year comparison of our net income:
($ in millions) |
|
Three months ended |
|
Variance |
|
|||||||
|
|
2004 |
|
2003 |
|
$ |
|
% |
|
|||
Net income |
|
$ |
3.3 |
|
$ |
3.3 |
|
$ |
|
|
|
|
Percent of total revenues |
|
12.0 |
% |
13.0 |
% |
|
|
|
|
|||
19
In terms of absolute dollars and as a percentage of total revenues, net income decreased slightly due to the significant decrease in gross margins, reflecting the higher hardware-based content in our product implementations in the three months ended March 31, 2004 compared to the three months ended March 31, 2003.
The following table sets forth, for the periods indicated, a year-over year comparison of key components of our liquidity and capital resources:
($ in millions) |
|
Three months ended |
|
Variance |
|
|||||||
|
|
2004 |
|
2003 |
|
$ |
|
% |
|
|||
Operating cash flows |
|
$ |
(2.1 |
) |
$ |
9.8 |
|
$ |
(11.9 |
) |
(121 |
)% |
Investing cash flows |
|
(44.9 |
) |
(0.9 |
) |
(44.0 |
) |
* |
|
|||
Financing cash flows |
|
1.3 |
|
(34.8 |
) |
36.1 |
|
* |
|
|||
|
|
|
|
|
|
|
|
|
|
|||
Capital expenditures |
|
$ |
0.9 |
|
$ |
0.9 |
|
|
|
|
|
|
|
|
March 31, |
|
December 31, |
|
$ |
|
% |
|
|||
Cash and cash equivalents |
|
$ |
72.9 |
|
$ |
118.5 |
|
$ |
(45.6 |
) |
(39 |
)% |
Short-term investments |
|
99.3 |
|
55.0 |
|
44.3 |
|
81 |
|
|||
Accounts receivable, net |
|
15.1 |
|
10.9 |
|
4.2 |
|
39 |
|
|||
Inventories |
|
9.0 |
|
7.9 |
|
1.1 |
|
14 |
|
|||
Working capital |
|
171.1 |
|
165.5 |
|
5.6 |
|
3 |
|
|||
|
|
|
|
|
|
|
|
|
|
|||
Days sales outstanding in accounts receivable, including unbilled receivables |
|
51.2 |
|
43.0 |
|
|
|
|
|
|||
Inventory turns |
|
3.8 |
|
3.4 |
|
|
|
|
|
|||
* These percentages are affected by one-time transactions and are not meaningful to the understanding of our financial condition and results of operations.
Since our inception, we have funded our operations and met our capital expenditure requirements primarily through cash flows from operations and to a lesser extent during our initial years of operations through bank borrowings. We have consistently invested the proceeds from our initial public offering in temporary investments, including cash, cash equivalents and short-term investments. The decrease in cash was offset by an increase in short-term investments due to our investment in U.S. Treasury bills and U.S. government agency discount notes with maturities greater than 90 days, but less than one year, which are classified as short-term investments.
Operating cash flows in the three months ended March 31, 2004 compared to the three months ended March 31, 2003 decreased primarily due to changes in trade accounts receivable and deferred revenues. In the three months ended March 31, 2004, accounts receivable increased due to increased levels of business and the timing of billings for our Unified Assurance product implementations.
Net cash used in investing activities related to purchases of short-term investments and purchases of property and equipment. In the three months ended March 31, 2004, we used $44.0 million to purchase short-term investments. In both the three months ended March 31, 2004 and the three months ended March 31, 2003, we used $0.9 million to purchase property and equipment. We anticipate that cash used
20
to purchase property and equipment will increase on a quarterly basis for the remainder of 2004 from levels experienced in the current quarter.
Net cash provided by financing activities in both the three months ended March 31, 2004 and the three months ended March 31, 2003 resulted from proceeds from the issuance of common stock upon the exercise of stock options and purchases under our employee stock purchase plan. In the three months ended March 31, 2003, we used approximately $35.4 million to repurchase 8,969,984 restricted shares of common stock in a privately-negotiated transaction.
We may in the future pursue acquisitions of businesses, products or technologies, or enter into joint venture arrangements, that could complement or expand our business and product offerings. 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. From time to time we also consider various other alternatives to utilize any cash and cash equivalents that exceed our working capital requirements, including payment of cash dividends, additional stock repurchases or other similar transactions.
At March 31, 2004, we had no long-term debt. We believe that our current cash balances and expected future cash flows will be sufficient to meet our anticipated cash needs for working capital, capital expenditures and other activities for at least the next 12 months. Beyond that, if current sources are not sufficient to meet our needs, we may seek additional equity or debt financing. In addition, any material acquisition of other businesses, products or technologies or material investments in joint ventures 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.
Off-Balance Sheet Arrangements and Contractual Obligations
It is not our usual business practice to enter into off-balance sheet arrangements, except for off-balance sheet arrangements related to inventory purchase commitments and operating lease commitments, as disclosed in the table of contractual obligations below. In addition, it is not our normal policy to issue guarantees to third parties.
We are obligated to make future payments under various contracts, including non-cancelable inventory purchase commitments and the operating leases for our corporate office facility and our facilities near the cities of London, England; Frankfurt, Germany and Paris, France and in Milan, Italy. The following table summarizes our contractual cash obligations as of March 31, 2004 (in thousands):
|
|
Remainder of |
|
2005 |
|
2006 |
|
2007 |
|
2008 |
|
Thereafter |
|
||||||
Purchase commitments |
|
$ |
3,209 |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
|
Capital commitments |
|
419 |
|
|
|
|
|
|
|
|
|
|
|
||||||
Operating leases |
|
4,618 |
|
6,294 |
|
6,364 |
|
6,364 |
|
6,364 |
|
11,645 |
|
||||||
Total |
|
$ |
8,246 |
|
$ |
6,294 |
|
$ |
6,364 |
|
$ |
6,364 |
|
$ |
6,364 |
|
$ |
11,645 |
|
During the remainder of 2004, we expect quarterly capital expenditures to increase slightly compared to the level experienced in the first three months of 2004.
Related Party Transactions
Epygi Technologies, Ltd., an entity controlled by Samuel S. Simonian, one of our founders and chairman of our board, currently performs development services for us pursuant to a consulting agreement for which it is paid a monthly fee per full-time programmer plus reimbursement of reasonable business
21
expenses. We expensed approximately $0.1 million for these services in both the three months ended March 31, 2004 and the three months ended March 31, 2003.
On January 21, 2003, we repurchased in a privately-negotiated transaction 8,969,984 restricted shares of our common stock from Mark A. Weinzierl, one of our founders and a member of our board of directors until the closing of the transaction, for an aggregate cash purchase price of approximately $35.4 million. We funded the transaction with available cash. The shares repurchased represented approximately 19% of our total shares outstanding immediately prior to the transaction. Effective as of the closing of the transaction, Mr. Weinzierl resigned from our board of directors.
Accounting Policies
In preparing our condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles, we use certain estimates and assumptions that affect the reported amounts and related disclosures and may vary from actual results. We consider the following accounting policies as those most important to the portrayal of our financial condition and those that require the most judgment or the greatest use of estimates. Although we believe that our estimates and assumptions are reasonable, actual results may differ, and such differences could be significant to our financial results.
Revenue Recognition
General. We derive revenues primarily from product and license fees as well as services, which include training, warranty and product support services. The majority of the contracts for our Unified Assurance products contain multiple billing milestones, such as contract award, shipment, installation, ready for acceptance and acceptance, not all of which are associated with revenue recognition. Except as otherwise discussed below, revenues from product and license fees are recognized in the period that 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 of the fee is considered probable. When we have significant obligations subsequent to shipment, such as installation and system integration, revenues are recognized when there are no significant unfulfilled obligations. Revenues from arrangements that include significant acceptance terms and/or provisions and revenues from arrangements that include significant developmental items are recognized when acceptance has occurred. Revenues from our Diagnostics products are typically recognized when title and risk of loss pass to the customer, which typically occurs at shipment. For these products, we typically have no significant obligations subsequent to shipment. If a significant obligation were to exist, we would defer revenue recognition until such obligation was satisfied. All shipping costs are included in cost of revenues in our condensed consolidated statements of income.
Multiple-element arrangements. Contracts for our Unified Assurance products typically involve multiple deliverables. We determine the fair value of each of the contract deliverables using vendor-specific objective evidence, or VSOE. VSOE for each element is based on the price for which we would sell the element on a stand-alone basis. We offer our customers product support services, which include the correction of software problems, hardware replacement, 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 post-contract support included in initial licensing fees, are recognized ratably over the service period. Post-contract support included in the initial licensing fee are allocated from the total contract amount based on the fair value of these services determined using VSOE. Revenues from other services, such as training, are recognized when the services have been completed. If we determine that we do not have VSOE on an undelivered element of an arrangement, we will not recognize revenue until all elements of the arrangement are delivered. This occurrence could materially impact our financial results because of the significant dollar amount of many
22
of our contracts and the significant portion of total revenues that a single contract may represent in any particular period.
Trade Accounts Receivable and Allowance for Doubtful Accounts
A large portion of our revenues and accounts receivable are attributable to our carrier customers in the communications industry and, to a lesser extent, to our equipment manufacturer customers who supply equipment into the communications industry. Our trade accounts receivable balance is recorded net of allowances for amounts not expected to be collected from our customers. Because our accounts receivable are usually unsecured, we periodically evaluate the collectibility of our accounts based on a combination of factors, including a particular customers ability to pay and the age of the receivables. To evaluate a specific customers ability to pay, we analyze the customers payment history, if any, financial statements or other information provided by the customer, or third-party credit analysis reports or other publicly-available information. In cases where the evidence suggests a customer may not be able to satisfy its obligations to us, we set up a specific reserve in an amount we determine appropriate for the perceived risk. Most of our contracts include multiple payment milestones, some of which occur in advance of revenue recognition, which mitigates our risk both in terms of collectibility and adjustments to recorded revenue. We have not historically experienced significant losses on uncollectible accounts and our allowance has been less than 5% of recorded receivables.
Inventory Reserves
Inventories are recorded net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. We evaluate on a quarterly basis the status of our inventory to ensure the amount recorded in our financial statements reflects the lower of our cost or the value we expect to receive when we sell the inventory. This estimate is based on several factors, including the condition and salability of our inventory and the forecasted demand for the particular products incorporating inventory components. Based on current backlog, expected orders and other expected demand, we forecast the usage of current stock. We record reserves for obsolete and slow-moving parts of up to 100% for excess parts with insufficient demand or obsolete parts. Amounts in work-in-process and finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk. If market conditions deteriorate or the expected future demand for our products otherwise decreases, or if changes in our business strategy reduce our need for these components, our estimate of the carrying value of our inventory could be reduced by a material amount.
Income Taxes
In the preparation of our provision for income taxes and determination of whether deferred tax assets will be realized in full or in part, we must estimate several factors. When it is more likely than not that all or some portion of the deferred tax asset will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that is determined not to be realizable. As of March 31, 2004 and December 31, 2003, a valuation for deferred tax assets was not deemed necessary. If the facts underlying our determination or financial results on which our estimates are based were to change in a manner impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied to determine the amount of valuation allowance required in any given period. Additionally, our income tax returns are subject to review and examination in the various jurisdictions in which we operate. We are currently not aware of any material issues that have been raised by taxing jurisdictions, and management believes that all income tax issues which may be raised as a result of such reviews and examinations in the future will be resolved with no material impact on our financial condition or future results of operations. However, in the event there was an assessment by any of these jurisdictions, it could impact our tax provision. In addition, we review the tax provision on a component basis and reflect changes in
23
estimate in the period in which they are identified. The tax provision is based on tax statutes in affect as of the date of the balance sheet.
Risk Factors
You should carefully consider the risks described below before making an investment decision regarding our common stock. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we do not presently know or that we currently deem immaterial may also impair our business operations. This document is qualified in its entirety by these risk factors.
If any of the following risks actually occur, they could materially harm our business, financial condition or results of operations. In that case, the market price of our common stock could decline.
Our quarterly financial results fluctuate and are difficult to predict.
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. As a result, you should not rely on our results of operations during any particular quarter as an indication of our future performance in any quarterly period or fiscal year. The factors that could affect our quarterly financial results include:
the size, timing, pricing structure and other terms of specific orders by our customers;
the timing of the delivery to and the installation and acceptance of our products by our customers;
the timing of our development and introduction of new products or applications;
the relative mix of product and license fees and services fees included in our revenues;
the relative mix of hardware- and software-related revenues in our total revenues;
the relative percentages of products sold through our direct and indirect sales channels;
the timing and level of our investments in research and development activities, and the timing and magnitude of our sales and marketing and general and administrative expenses;
changes in, and our ability to implement, our strategy; and
other risks described below.
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.
Our financial results are also 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, 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 harmed by a soft economy, and we would be further harmed by a decline in the economic prospects of our customers or the
24
economy in general. This harm would be exacerbated by a decline in the economic prospects of our current and prospective customers in Europe, as revenues from this region have historically represented the majority of our total revenues. In many cases, these adverse economic conditions have altered current and prospective customers capital spending priorities or budget cycles, which have extended our sales cycle. These adverse effects could continue and could impact our customers ability to meet their financial obligations to us. Our business also could be harmed by changes in customer spending patterns reflecting industry trends. For example, customer budgetary constraints have contributed to downward sales price pressure on some of our products and on renewals of product support agreements for our Unified Assurance products, which have adversely affected our revenues. In addition, our financial results historically have been influenced by seasonal fluctuations, with orders tending to be strongest in the fourth quarter of each year and orders in our first quarter tending to be lower than the levels achieved in the preceding quarter. We believe that this seasonality has been due in large part to the capital appropriation practices of many of our customers.
As a result of all of the foregoing, we cannot assure you that our revenues will grow or remain stable in future periods or that we will remain profitable. In addition, in some future quarters our financial results may be below the expectations of public market analysts or investors. In such event, the market price of our common stock would likely fall.
Reduced communications spending, or consolidations or bankruptcies in the communications industry, 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 communications industry. Since early 2001, we and a number of other companies have been impacted by reduced spending by communications carriers and equipment manufacturers, and spending levels for future periods are difficult to predict. Our business, financial condition and results of operations could be materially harmed in the event that economic or business conditions in our industry do not continue to improve. We could also be impacted in the event that there are consolidations of our current customers, which could result in the displacement of our products by a competitors products preferred by the other party to the consolidation, or bankruptcies of our current or prospective customers, which could result in reduced revenues or significant write-offs of uncollectible accounts receivable. Additionally, decreases in spending often cause delays in sales and installations and could cause cancellations of current or planned projects, any of which could harm our financial results in a particular period.
Our financial results could be materially harmed if demand for our new products is less than we anticipate or the performance of our products falls below the levels required by our customers.
A key component of our strategy is the ability to successfully develop, introduce and market new Unified Assurance and Diagnostics products and applications. Although we have obtained input from our customers and potential customers regarding our development and product strategy, we have made certain assumptions as to the needs of our customers and the features, functionality and performance expected by them. Our current or prospective customers may not order these new products and applications.
Also, purchase decisions regarding certain of our Unified Assurance products and applications may be influenced or made by individuals within organizations with which we have no significant existing relationships, such as customer service, sales and marketing, or information technology departments. We may not be successful in developing the relationships necessary to sell certain of our Unified Assurance products and applications.
In addition to the service quality management features of our Unified Assurance products, communications carriers also require systems to manage the quality of service of the other aspects of their
25
customer-related activities, such as billing, trouble ticket management and inventory control. As a result, in certain cases a communications carrier may seek the functionality that we offer as a component of a broader service quality management system, addressing all of these quality management needs, rather than through specific offerings from multiple vendors. In such cases, and as a result of the complexity surrounding the integration of these various functionalities, the opportunity to provide these systems may only be offered to our competitors who have a broader product offering or to system integrators who would develop such functionality internally or purchase it from other vendors. We cannot assure you that we would be considered by such system integrators to provide our products as part of the overall service quality management system.
Our revenues are highly concentrated among a small number of customers.
A large percentage of our revenues are typically derived from a small number of customers, and we expect this trend to continue. For example, in the three months ended March 31, 2004, approximately 73% of our revenues were derived from our 10 largest customers in the period, with four customers each accounting for more than 10% of total revenues. On a combined basis, our four 10% customers in this three-month period accounted for approximately 54% of our total revenues. Although the customer make-up of our largest projects varies from quarter to quarter, a small number of significant repeat customers frequently account for a significant portion of our revenues in a given period. If we were to lose one or more of our significant repeat customers, our financial results could be harmed. Additionally, if one or more of these significant repeat customers experiences adverse conditions in its industry or operations, including the impact of any economic downturn or reduction in communications spending, these customers may not be able to meet their ongoing financial obligations to us or purchase additional products.
Changes or delays in the implementation or customer acceptance of our products could harm our financial results.
Revenues for our Unified Assurance products, which account for the majority of our total revenues, are typically recognized upon the completion of system installation or customer acceptance. Delays caused by us or our customers in the commencement or completion of scheduled product installations and acceptance testing may occur from time to time due to site-readiness delays, the often comprehensive processes for testing and acceptance required by certain of our customers, insufficient personnel on the part of us or our customers to complete a project, the lengthening of implementation schedules due to the introduction of new features or applications, or other issues. Because a significant portion of our total revenues on a quarterly basis is derived from a small number of customer projects, product installation delays could materially harm our financial results for a particular period. 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, we generally do not recognize revenue until acceptance is achieved. For new products, we typically recognize revenue initially upon acceptance. As a result, in cases where the recognition of revenue is tied to customer acceptance, the failure to obtain acceptance or delayed acceptance could harm our financial results for a particular period. Additionally, we may be subject to penalties or other customer claims for a failure to meet contractually agreed upon milestones or deadlines.
The sales cycle for our products is long, which could harm our quarterly financial results.
Sales of our Unified Assurance products, which since 1998 have accounted for the majority of our total revenues, are made predominantly to large communications carriers and involve significant capital expenditures as well as lengthy sales cycles and implementation processes. Sales to this type of customer generally require an extensive sales effort throughout the customers organization and final approval by
26
an executive officer or other senior-level approval. We expend substantial funds and management effort pursuing these sales. Additionally, potential customers often maintain comprehensive processes for internal approval, contracting and procurement, which may cause potential sales to be delayed or foregone. As a result of these and other factors, the sales cycle for our products is long, historically ranging from six to 18 months for our Unified Assurance products (excluding the cycle for subsequent applications and enhancements, which varies widely) and averaging three months for occasional, large sales of our Diagnostics products. 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 our financial results in a particular quarter, especially if there are significant sales and marketing expenses associated with any deferred or lost sales.
Competition is intense, may intensify and could result in increased downward pricing pressure, reduced margins and the loss of market share.
Competition for all of our products is intense, is expected to continue and in some cases may intensify. We compete principally with a number of U.S. and international hardware and software suppliers that vary in size and in the scope and breadth of the products and services offered. We compete to a lesser extent with systems integrators and with the international development organizations of current and prospective customers. 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. 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. Additionally, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. Increased competition could result in increased downward pricing pressure, reduced margins and the loss of market share. We continue to experience pressure on sales prices for our most basic GeoProbe system and certain of our Orion applications, especially for those applications for which there is a competitive offering, or in highly competitive situations involving prospective customers.
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 agreement to remain in our employ. 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 introduction by others of 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 unsalable. We believe that our future success will depend in part upon our ability, on a timely and cost-effective basis, to continue to:
develop and introduce new products or applications for the communications market;
enhance our Unified Assurance and Diagnostics products;
keep pace with evolving industry protocol standards, next-generation technologies and changing customer needs;
27
establish and maintain interoperability between our products and the third-party products forming other components of our customers operation support systems; and
achieve broad market acceptance for our products.
We cannot assure you that we will achieve these objectives.
Over the long term, we expect carrier spending for traditional networks to continue to decrease, which requires that we continue to develop products and applications for networks based on emerging next-generation wireless and packet-based technologies and standards. We may not successfully develop or acquire additional competitive products for these emerging technologies and standards.
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, such as the inability to assign a sufficient number of qualified technical personnel to key projects or other unanticipated causes, 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. In addition, our products are implemented with our purpose-specific hardware platform and certain third-party hardware and software. We cannot assure you that we will be able to design and manufacture, or procure from third parties, the hardware and software necessary to successfully implement our new products and applications.
A majority of our revenues have historically come from our 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.
Historically, revenues from international markets have represented the majority of our total revenues, and international revenues as a percentage of total revenues have increased in recent years. We expect revenues from international markets to continue to represent the majority of our total revenues for the foreseeable future. International business activities involve certain risks, including:
management of our geographically dispersed operations;
longer sales cycles in certain countries, especially on initial entry into a new geographical market;
greater difficulty in evaluating a customers ability to pay, longer accounts receivable payment cycles and greater difficulty in the collection of past-due accounts;
general economic conditions in each country;
currency controls and exchange rate fluctuations;
challenges associated with operating in diverse cultural and legal environments;
seasonal reductions in business activity specific to certain markets;
loss of revenues, property and equipment from expropriation, nationalization, war, insurrection, terrorism and other political risks;
28
foreign taxes and the overlap of different tax structures, including modifications to the U.S. tax code as a result of international trade regulations;
greater difficulty in safeguarding intellectual property;
import and export licensing requirements and other trade restrictions;
involuntary renegotiation of contracts with foreign governments and communications carriers; and
existence or adoption of laws and regulations affecting the operation and taxation of our business and the general business climate for foreign companies.
We may be unable to produce sufficient quantities of our products because we obtain various key components from sole and limited source suppliers. If we are unable to obtain these components, or if the prices of these components increase, we could be unable to ship our products in a timely manner or our product costs could be materially impacted.
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 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 or activated 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 generally do not execute long-term supply agreements with our suppliers and, in the case of many components, make our purchases with purchase orders on an as-needed basis. Some of the components our products utilize require long order lead-times, in certain cases up to 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. In addition, the cost of various key components of our products has fluctuated significantly in the past based on supply and demand factors. Significant changes in supply and demand characteristics in the future could cause the cost of various components to increase, which could adversely impact our product costs.
Key components used in our products may become obsolete. If we are unable to find and design in replacement parts, we may be unable to ship our products in sufficient quantities.
From time to time, components used in our products are declared obsolete and no longer produced by our suppliers. Historically, we have typically received adequate notice from these suppliers so that we may procure quantities of these parts sufficient to allow us time to find and design new parts into our products; however, we cannot assure you that we will always be provided adequate notice. If we are not given adequate notice, we may be unable to produce sufficient quantities of our products to satisfy demand. Also, we cannot assure you that replacement parts will be readily available or that we will be able to design new parts into our products on a timely basis at a reasonable cost. If we are not able to produce sufficient quantities of our products, our financial results could be harmed.
29
Our inventory may become obsolete or unusable.
From time to time, 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, which in turn could result in significant write-offs of inventory.
We rely in part on third-party subcontractors in the manufacture and development of 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 layout of circuit boards. We also frequently subcontract the development of specific features or enhancements for 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 various 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 Oracle Corporation, Cognos Incorporated and other third parties, including software that is integrated with our internally-developed software and used in our products to perform key functions. In certain cases, we are unable to obtain long-term pricing commitments for this software. 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. Additionally, the presence of defects or errors in the licensed software or allegations that the licensed software infringes on the intellectual property rights of others could result in reductions or delays in shipments, claims against us or damage to our reputation and business, recourse for which might not be available against the related licensors.
Our strategy may require that we pursue acquisitions, joint ventures or other business relationships. We may not successfully develop these relationships to support our strategy or we may not receive the intended benefits of any future acquisitions, joint ventures or other business relationships.
Although in the past we have developed or licensed substantially all of our product technologies, some of the technologies, features and functionalities we are contemplating or which may be required to meet the perceived needs of our customers and potential customers may be more effectively and timely obtained through the acquisition of businesses, products or technologies from third-parties, or the establishment of joint venture, strategic partnership or other arrangements with firms already possessing such technologies. We may also pursue such acquisitions or arrangements to expand our business, addressable markets and product offerings. There can be no assurance that suitable and interested candidates for these activities will be identified, or if they are identified that any such acquisition or arrangement can be consummated on terms acceptable to us.
30
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 managements time and resources. Future acquisitions and strategic relationships by us could result in potentially dilutive issuances of equity securities, a material reduction in cash reserves, the incurrence of debt and contingent liabilities, 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.
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. In the past, 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. Questions of infringement and the validity of patents in the field of communications signaling technologies involve highly technical and subjective analyses. Patent holders may initiate legal proceedings in the future against us, and if any proceedings are initiated, we may not be successful in defending ourselves. Any claim or 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 claim made or proceeding initiated against us. Any such royalty or license agreements may not 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 our 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 attention and resources, and materially harm our business, financial condition and results of operations. We may not be successful in protecting our proprietary technology, or our proprietary rights may not 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, especially 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. Defects or errors could result in delayed market acceptance of the product, claims against us or damage to our reputation and business. We generally 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 agreement to agreement, and it is possible that these limitations may not be effective as a result of unfavorable judicial decisions or current or future laws enacted in one or more of
31
the jurisdictions in which we do business. Although we have not experienced any product liability suits to date, the sale and support of our products entail the risk of these claims. We carry insurance that mitigates our risk associated with certain product liability claims, but the policy is subject to coverage limits, various exceptions and options to cancel prior to term and may not be sufficient to cover all claims. Any product liability claim brought against us, regardless of its merit, could result in material expense to us, diversion of management attention and resources, and damage to our business reputation and our ability to retain existing customers or attract new customers.
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.
Our two largest stockholders own approximately 39% of our common stock, which gives them effective control over the management and affairs of our company and could delay or prevent a change of control.
Two of our founders, Samuel S. Simonian, chairman of our board, and Elie S. Akilian, our president and chief executive officer and a director, collectively beneficially own approximately 39% of the outstanding shares of our common stock. Consequently, if these individuals were to act together, they could effectively 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 also 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, as two of the five members of our board of directors, Messrs. Simonian and Akilian have significant influence in directing the actions taken by our board.
We have previously 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 staggered, three-year terms, our stockholders are unable to take action by written consent, our stockholders are limited in their ability to make proposals at stockholder meetings, and our board of directors is empowered to issue blank-check preferred stock without any need to obtain stockholder approval.
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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. In the periods listed below, the market price of our common stock has ranged as follows:
|
|
High |
|
Low |
|
||
2004 |
|
|
|
|
|
||
First Quarter |
|
$ |
17.20 |
|
$ |
10.76 |
|
|
|
|
|
|
|
||
2003 |
|
|
|
|
|
||
Fourth Quarter |
|
$ |
14.60 |
|
$ |
11.09 |
|
Third Quarter |
|
16.00 |
|
9.76 |
|
||
Second Quarter |
|
10.50 |
|
5.87 |
|
||
First Quarter |
|
8.25 |
|
5.78 |
|
Our stock price may be significantly affected by factors such as:
variations in our results of operations;
changes in our business strategy;
future sales of our common stock, particularly by institutional investors with large holdings and by our founders;
the announcement of technological innovations or new products by us, our competitors or others;
market analysts estimates of our performance, our customers or competitors performance or the performance of the communications industry in general;
the financial and other announcements made by us, our competitors or customers;
general market and economic conditions; and
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 communications companies for reasons that have often been unrelated to financial results. This volatility has and may in the future 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 diversion of management attention and resources.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Historically, we have been exposed to immaterial levels of market risk and have not been significantly exposed to fluctuations in currency exchange rates. In the three months ended March 31, 2004, approximately 4% of total revenues was denominated in currencies other than the U.S. dollar. In the full-year 2003, approximately 3% of total revenues was denominated in currencies other than the U.S. dollar, principally the Euro. In future periods, we believe a greater portion of total revenues could be
33
denominated in currencies other than the U.S. dollar, thereby increasing our exposure to exchange rate gains and losses on non-U.S. currency transactions. Currently, we do not engage in hedging activities for our non-U.S. dollar business.
Our international subsidiaries operate in currencies other than the U.S. dollar, which results in foreign currency translation gains and losses; however, the U.S. dollar is the functional currency of all our subsidiaries. Currently, we do not engage in hedging activities for our international operations. However, we may engage in hedging activities in the future.
Our international business is subject to the typical risks of any international business, including, but not limited to, the risks described in Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations Risk Factors. Accordingly, our future results could be materially harmed by the actual occurrence of any of these or other risks.
Currently, our cash is invested in bank deposits and money market funds denominated in U.S. dollars. We account for these investments in accordance with SFAS 115, Accounting for Certain Investments in Debt and Equity Securities. These cash equivalents are treated as available-for-sale under SFAS 115. The carrying value of these cash equivalents approximates fair market value. We also invest in U.S. Treasury bills, U.S. government agency discount notes and commercial paper. U.S. Treasury bills, U.S. government agency discount notes and commercial paper with maturities that are less than 90 days are classified as cash equivalents. U.S Treasury bills, U.S. government agency discount notes and commercial paper with maturities that are more than 90 days but less than one year are classified as short-term investments. All U.S. Treasury bills, U.S. government agency discount notes and commercial paper are classified as held to maturity and carried at amortized cost. Our investments are subject to interest rate risk, which is the risk that our financial condition and results of operations could be adversely affected due to movements in interest rates. Assuming current levels of cash, if the per annum rate of interest earned on our invested cash were to change by 50 basis points, or 0.5%, our investment income would be impacted by approximately $0.4 million on an annual basis.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in the periodic reports we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the rules of the SEC. We carried out an evaluation as of March 31, 2004, under the supervision and the participation of our management, including our chief executive officer and chief financial officer, of the design and operation of these disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the company (including our consolidated subsidiaries) required to be included in our periodic SEC filings.
(b) Changes in internal control over financial reporting. There was no change in our internal control over financial reporting that occurred during the three months ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Item 2. Changes in Securities, Use of Proceeds and Issuer Repurchases of Equity Securities
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 March 31, 2004, 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. We also may apply a portion of the proceeds to the payment of cash dividends or for additional stock repurchases or other similar transactions.
We did not repurchase any shares of our common stock during the three months ended March 31, 2004.
Item 6. Exhibits and Reports on Form 8-K
(a) |
Exhibits |
|
|
|
|
|
10.1 |
Employment Agreement dated June 27, 1990 between the registrant and Michael J. Reiman. |
|
31.1 |
Certification of Elie S. Akilian, President and Chief Executive Officer of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
31.2 |
Certification of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
32.1 |
Certification of Elie S. Akilian, President and Chief Executive Officer of the Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|
32.2 |
Certification of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
(b) Reports on Form 8-K
During the three months ended March 31, 2004 we furnished one Report on Form 8-K. Information regarding each item reported on is listed below.
Date Filed
or |
|
Item No. |
|
Description |
January 27, 2004 |
|
Item 12 |
|
On January 27, we announced our results of operations for our fiscal quarter and year ended December 31, 2003.* |
*This furnished Form 8-K is not to be deemed filed or incorporated by reference into any filing.
35
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 |
||
|
|
|||
Date: April 21, 2004 |
|
36
INET
TECHNOLOGIES, INC.
INDEX TO EXHIBITS
Exhibit |
|
Description |
|
|
|
10.1 |
|
Employment Agreement dated June 27, 1990 between the registrant and Michael J. Reiman. |
31.1 |
|
Certification of Elie S. Akilian, President and Chief Executive Officer of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 |
|
Certification of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1 |
|
Certification of Elie S. Akilian, President and Chief Executive Officer of the Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2 |
|
Certification of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
37