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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
_________
Commission File Number 0-24707
INET TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2269056
(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
1255 WEST 15TH STREET, SUITE 600 75075
PLANO, TEXAS (Zip code)
(Address of principal executive
offices)
Registrant's telephone number, including area code: (972) 578-6100
_________
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- -------------------
COMMON STOCK, $0.001 PAR VALUE NASDAQ
Securities registered pursuant to Section 12(g) of the Act:
NONE
_________
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL
REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER
PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS
BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES /X/ NO __
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO
ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED,
TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION
STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THE FORM 10-K OR ANY
AMENDMENT TO THIS FORM 10-K. YES /X/ NO __
THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES
OF THE REGISTRANT ON MARCH 1, 2000 WAS $423,565,349.
THE NUMBER OF SHARES OF COMMON STOCK OF THE REGISTRANT OUTSTANDING ON
MARCH 1, 1999 WAS 46,048,910
DOCUMENTS INCORPORATED BY REFERENCE
CERTAIN INFORMATION REQUIRED BY PART III OF THIS ANNUAL REPORT IS
INCORPORATED BY REFERENCE FROM THE REGISTRANT'S DEFINITIVE PROXY STATEMENT
FOR ITS ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON MAY 16, 2000.
INET TECHNOLOGIES, INC.
FORM 10-K
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business ...................................................................... 2
Item 2. Properties .................................................................... 15
Item 3. Legal Proceedings ............................................................. 15
Item 4. Submission of Matters to a Vote of Security Holders ........................... 15
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ......... 15
Item 6. Selected Financial Data ....................................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................................. 17
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ................... 28
Item 8. Financial Statements and Supplementary Data ................................... 28
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ................................................... 28
PART III
Item 10. Directors and Executive Officers of the Registrant ........................... 29
Item 11. Executive Compensation ....................................................... 29
Item 12. Security Ownership of Certain Beneficial Owners and Management ............... 29
Item 13. Certain Relationships and Related Transactions ............................... 29
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K .............. 30
Signatures ............................................................................. 32
Page 1
PART I
ITEM 1. BUSINESS.
OVERVIEW
Inet Technologies, Inc. (the "Company" or "Inet") provides
communications software solutions that enable carriers to more effectively
design, deploy, diagnose, monitor and manage communications networks that
carry signaling information used to manage communications sessions which
include phone calls, dial-up Internet access and other service transactions
("sessions"). Inet's products also address the fundamental business needs of
communications carriers, such as improved billing, targeted sales and
marketing, fraud prevention and enhanced routing. Inet provides these
comprehensive solutions primarily through its GeoProbe and Spectra product
offerings.
The GeoProbe system provides real-time monitoring of Common Channel
Signaling System #7 ("SS7") networks and serves as an open platform for
business applications developed by Inet, its customers or third parties.
GeoProbe's network-wide monitoring applications enable early warning of
network faults, collection of statistics for performance evaluation,
real-time session tracing and troubleshooting. The GeoProbe-based IT:seven
suite of business applications provides reconciliation of billing between
carriers, service quality reports and marketing data. The Spectra product can
be integrated within the GeoProbe platform or used on a stand-alone basis to
provide diagnostic, emulation and load generation capabilities for use by
service providers or equipment manufacturers in the design, deployment,
commissioning and diagnosis of signaling networks.
Inet's objective is to be a leading provider of communications software
solutions for next-generation networks worldwide. Key elements of Inet's
strategy to achieve this objective include: expanding its global market
share; increasing its domestic sales and penetration of its existing customer
base; enhancing its technological leadership position; expanding its product
offerings by leveraging its core competencies in SS7, Internet Protocol
("IP") and broadband communications protocols; and building relationships
with strategic partners.
As of December 31, 1999, the Company had sold its solutions to over 400
customers in more than 50 countries. The Company's target customers include
traditional wireline, wireless and next-generation communications carriers as
well as equipment manufacturers throughout North America, Latin America,
Europe, Middle East, and Africa ("EMEA") and the Asia/Pacific region. A
partial list of the Company's carrier customers include AT&T, Bell South,
British Telecom, Deutsche Telekom, Global Crossing, KPN Telecom, MCI
WorldCom, Nextel, Sprint, Swisscom, Telia, Telkom South Africa and Williams
Communications, and a partial list of its equipment manufacturer customers
include Alcatel, Cisco, Lucent, Motorola and Nortel. These customers
collectively accounted for approximately 60% of the Company's revenues in
1999.
INDUSTRY BACKGROUND
THE TELECOMMUNICATIONS INDUSTRY
Historically, telecommunications carriers operated in a highly regulated
environment with little or no competition. But recently, governments
worldwide have begun to deregulate the telecommunications industry.
Deregulation has increased the competitive landscape by allowing the
emergence of a new
Page 2
breed of communications carriers that are focused on serving a specific
market segment. New entrants to the global communications landscape include
competitive long distance and local exchange carriers; IP or
"next-generation" network providers; Internet Service Providers ("ISPs");
Internet Telephony Service Providers ("ITSPs"); competitors to government
post, telephone and telegraph companies ("PTTs") and other licensed operators
("OLOs") outside the U.S.; wireless carriers; and resellers such as prepaid
calling card providers. The combination of deregulation, the growth of the
Internet and the emergence of next-generation carriers is putting pressure on
the traditional telecommunications carriers to reduce costs, improve service
performance levels and offer a number of new and enhanced services.
The increased level of competition is forcing communications carriers to
differentiate themselves by providing advanced, value-added services and
features. Examples of these services include toll-free "800" numbers, prepaid
calling cards, Caller ID, customized routing and billing, voice messaging,
Local Number Portability ("LNP"), and Internet access.
The predominant form of Internet access today, and we believe in the
foreseeable future, will be via dial-up over the Public Switched Telephone
Network ("PSTN"). The dial-up method of access causes congestion in the
carrier's current networks which are engineered and optimized for voice call
delivery. As a result, carriers have the need to direct the Internet traffic
off of their voice trunk lines and divert it directly to the IP network. This
"enhanced routing" will result in network optimization for the carrier and
will help maximize the carrier's revenue opportunities by freeing up the
trunks for voice calls.
Competition is also forcing carriers to look closer at their network
cost structures. They must be able to provision, monitor and bill for
multiple services, including voice-over-packet service, in an efficient
manner to both manage costs and increase service to their customers. Although
the newer packet-based next-generation networks promise a lower life cycle
cost structure, they pose different risks that have not been an immediate
issue with traditional networks such as security and voice quality issues.
Traditional carriers must be able to secure their networks against potential
intrusion from the newer, more hacker-prone, IP networks. As a result,
current and new networks are being integrated and carriers need end-to-end
management and interoperability solutions without compromising service
quality or network security.
The growth of intelligent networks, coupled with a significant worldwide
increase in demand for communications and Internet-related data services, has
resulted in corresponding demand for communications infrastructure and
advanced networking technologies, including network management,
interoperability and diagnostic systems. Communications networks operate in
real time and are mission-critical to their end users. Thus, communications
carriers must provide the very highest quality and reliability of service to
remain competitive. This competition forces carriers to closely examine the
services they are providing in terms of performance and customer
satisfaction. The ability to provide high performance services to customers
is key to minimizing customer turnover, or "churn," in a carrier's customer
base.
SS7 AND MODERN COMMUNICATIONS NETWORK ARCHITECTURES
A communications network not only must convey information between
points, it must also determine the best routes for connections, control the
allocation of resources used to transfer the information and keep transaction
records for billing and measurement purposes. A simple communications
session, or other multi-service sessions, involves two types of information:
the session content (voice, computer data or video) and information about the
session (such as the party initiating the session and the destination party
identity) which is required to connect, manage and bill for the session. This
information about a communications session or other services is generally
referred to as "signaling."
Page 3
The first generation of telephone networks was designed to pass both
call content and signaling over a single internal network path, called a
"trunk," from the source of the call to the called destination. Signaling
information was passed via audio tones or voltage changes on the telephone
line or trunk connection. It became apparent, however, that the "single path"
method of transferring both call content and signaling was inefficient and
unreliable as network traffic grew, leading to network congestion and service
quality problems. Single path signaling also lacks flexibility because the
control information cannot be separated easily from the call content flowing
over a trunk. As a result, advanced services cannot be offered in networks in
which single path signaling is used.
These problems were first recognized during the 1960s and were
subsequently resolved through the development and deployment of "Common
Channel Signaling." In Common Channel Signaling, the call content is
separated from the signaling information. The signaling information is then
passed over an entirely separate path through the carrier's network, while
the call content is passed over a trunk. Signaling paths in the network are
connected to a set of systems that control and monitor the progress of calls
and other transactions and route the signaling information as required. The
signaling paths, or "links," and signaling network control systems comprise a
separate network infrastructure, called a "signaling network," that operates
in parallel with the network of trunks used to convey call content. The
technique is called Common Channel Signaling because signaling information
for multiple calls passes over a shared, or "common," set of signaling
channels. This method of combining signaling information for multiple calls
results in much higher overall network efficiency.
Modern signaling networks are based on a globally standardized
architecture and set of protocols called SS7, or sometimes referred to
internationally as "C7." Since the mid-1980s, SS7 has been implemented by
telecommunications carriers worldwide, including incumbent carriers, emerging
competitive service providers, Internet service providers and wireless
carriers. SS7 utilizes digital packet-switching technology and is designed to
be robust, flexible, and scalable, enabling telecommunications carriers to
provide new services quickly and to optimize the network bandwidth used for
trunk connections. When a call is placed, the originating location's call
switching equipment uses the SS7 network to "look ahead" and determine
whether the destination is busy or otherwise unavailable before allocating a
trunk to the call and connecting both parties. The look ahead operation also
enables information such as Caller ID to be passed before the call is
actually connected. The SS7 network's speed and power allow these operations
to occur almost instantly, which significantly reduces the time required to
process each call and improves service to the end user.
The increase in Internet usage has further complicated communications
networks. The widespread acceptance of the Internet is making possible a new
breed of services that combine voice, data and video. These service
applications integrate the use of existing voice or voice-over-packet
networks and data networks in a seamless manner. The use of SS7, along with
other signaling protocols, is making the implementation of these new services
possible.
The principal components of integrated communications networks are:
- SIGNALING SERVICE POINT ("SSP"). A subsystem of a telephone switch that
connects to the SS7 network and processes signaling information
associated with that particular switch. SSPs are the origination and
termination points for SS7 messages in the network. SSPs exchange
messages with other SSPs, STPs, and SCPs throughout the network.
- SIGNAL TRANSFER POINT ("STP"). A router that controls the flow of
messages among the other elements in the SS7 network. An STP may include
additional functionality that allows it to access external databases in
addition to performing simple routing based on the source and
destination address information included in network messages.
Page 4
- SERVICE CONTROL POINT ("SCP"). A database server that provides
additional information for call routing, billing and other services.
- LINKS. A set of dedicated digital channels through which the SS7
messages flow among SSPs, STPs, SCPs and other devices throughout the
signaling network. These are typically 56 or 64 kilobits-per-second
("kbps") standard digital connections.
- MEDIA GATEWAY. A hardware element at the edge of next-generation IP
networks that provides the media mapping and/or transcoding functions
between dissimilar networks (e.g. PSTN versus an IP network).
- MEDIA GATEWAY CONTROLLER. A software element within next-generation IP
networks that is physically separate from the Media Gateway elements but
provides the call processing and control functions for such gateways.
- SS7/IP SIGNALING GATEWAY. Typically a hardware and software element at
the edge of next-generation IP signaling networks that serves as the
portal between traditional PSTN SS7 signaling and signaling in IP
networks.
- GATEKEEPER: A software element within next-generation IP telephony
networks that sets up the communications path between originating and
terminating Media Gateways based on the destination IP address or phone
number.
- SOFTSWITCH. A software element that resides on standard computing
platforms and/or high-capacity/high-availability special purpose
platforms at the edge of next-generation IP networks. The softswitch
separates the call control functions of a phone call to handle call
routing, session connection control, service delivery and signaling
interworking within IP networks.
NETWORK INTEROPERABILITY: AN EXAMPLE
In order to better illustrate the critical role of signaling in the
convergence of communications networks, and to demonstrate the complexity of
inter-networking, consider the theoretical example of a person in New York
that is placing a call from an IP terminal/phone to a telephone number in
Dallas that is within the traditional PSTN. Furthermore, lets assume that the
dialed number may be ported as a result of Local Number Portability.
The dialed digits are first transported from the IP terminal/phone via
IP packets to the originating Gatekeeper within the IP telephony network. The
originating Gatekeeper examines the dialed digits (972-578-6100) and
determines that the exchange (578) has some numbers that have been ported to
another circuit switch within the PSTN. To determine this for sure regarding
the exact number that is being dialed, the originating Gatekeeper must launch
a query from the IP telephony network to the Intelligent Network of the PSTN.
The first step in accomplishing this is for the originating Gatekeeper to
send a LNP query to the SS7/IP Signaling Gateway within the IP telephony
network. The SS7/IP Signaling Gateway correctly reformats and routes the
originating Gatekeeper's query to the PSTN SS7 network. The PSTN SCP, which
receives the query, responds with the appropriate LNP information. This
response is routed back through the SS7 network via STPs, to the SS7/IP
Signaling Gateway. The Signaling Gateway then correctly reformats and routes
the response to the originating Gatekeeper in the IP network.
Page 5
With the LNP information, the originating Gatekeeper is now able to
determine the destination Gatekeeper in the IP telephony network that is able
to route the call to the true geographical location of the dialed number
within the PSTN. With this, the original Gatekeeper signals the destination
Gatekeeper and asks if there is availability on the destination Media Gateway
to handle the call. The destination Gatekeeper signals back with availability
status and information regarding what the correct IP address should be for
the call to reach the desired Media Gateway in the IP telephony network. The
original Gatekeeper now sends this information back to the originating IP
terminal/phone.
The originating IP terminal/phone now establishes a virtual circuit via
the IP network with the desired Media Gateway. The virtual circuit is
identified by certain references that will then be used by both the IP
terminal/phone and the Media Gateway to identify all IP packets flowing
between the two for the duration of the call. Concurrently with this, the
Media Gateway Controller orchestrates the connectivity of the Media Gateway
with the PSTN circuit switch. This is done (via the Signaling Gateway) by
sending a call setup message to the appropriate circuit switch via the PSTN's
SS7 STP routers. The Media gateway is then connected to a "trunk circuit" of
the PSTN's switch, and the PSTN signals back to the SS7/IP Signaling Gateway
that the call has been successfully established. Subsequently, the Signaling
Gateway sends the same indication of call establishment back to the
originating Gatekeeper. The exchange of IP packets proceeds until either
party terminates the call.
THE NEED FOR SIGNALING NETWORK MANAGEMENT AND OPTIMIZATION SOLUTIONS FOR
CONVERGING NETWORKS
As the example above illustrates, even a relatively simple transaction
like an LNP call requires a sophisticated series of signaling network
operations. Long-distance authorization codes, prepaid calling cards,
cellular phones, "800" and other advanced services increase the number of
signaling messages required for each network transaction, which in turn tends
to increase the number of elements and links required in the network.
Each signaling network typically contains equipment and software
manufactured by multiple vendors. Moreover, multiple signaling networks are
connected between carriers, often spanning international boundaries. The
entire "network of networks" must operate as a seamless whole, in real time,
with a minimal number of errors. Any indication of trouble in the network
must be detected and diagnosed as quickly as possible. Network capacity
utilization must be monitored continuously for "bottlenecks" and other
conditions. To maintain reliability, each new connection between two
carriers' networks must be certified and approved by the engineering staffs
at both carriers before traffic is allowed to flow through the connection.
In the past, when signaling was used exclusively on wireline networks to
complete standard telephone calls, it was sufficient for carriers to employ
localized diagnostic equipment and a large number of technicians who could be
dispatched in a reasonable timeframe to any point where trouble was suspected
or where new connections were being installed. However, this approach is not
readily scalable. It requires a significant number of people with specialized
domain expertise and does not adequately provide for diagnosis of
network-wide, interrelated conditions that tend to arise in complex
environments. The combination of new and different types of interconnected
signaling networks (such as satellite, cellular and packetized networks),
increased traffic levels and complexity within each signaling network, and
strict performance requirements has led to an increased need for systems and
software that enable carriers to get a complete picture of all signaling
network facilities and monitor any or all signaling message traffic in real
time. Comprehensive network management solutions are required to enable
advanced intelligent networks to reach their full potential.
There is also a growing need for signaling network management systems to
be fully integrated into the overall collection of systems that manage all
aspects of a carrier's operations, such as billing, service
Page 6
order entry, provisioning, repair, and service definition. Seamless
integration of signaling management with applications that enable a carrier
to use and leverage the information gathered in its signaling network allows
a carrier to improve its customer service, reduce costs, increase operational
efficiency and realize revenues where otherwise not possible. To provide a
carrier with these advantages, a signaling network management system must
offer a suite of software applications above and beyond more traditional
management functions such as monitoring and diagnostics.
THE INET SOLUTION
Inet provides communications software solutions that enable carriers to
more effectively design, deploy, diagnose, monitor and manage communications
networks that carry signaling information used to manage communications
sessions. Inet's products also address the fundamental business needs of
communications carriers, such as improved billing, targeted sales and
marketing, fraud prevention and enhanced routing. Inet provides these
comprehensive solutions through its network optimization and diagnostic
product offerings.
Inet's network optimization products are based on an open, real-time
platform upon which Inet, its customers or third parties can develop advanced
applications. Inet's flagship network optimization product currently is the
GeoProbe. The GeoProbe's network-wide monitoring applications enable early
warning of network faults, collection of statistics for service performance
evaluations, real-time session tracing and troubleshooting. The
GeoProbe-based IT:seven suite of business applications (GeoBill, GeoConnect
and GeoCare), provides reconciliation of billing between carriers, service
quality reports and marketing data. The GeoProbe provides many advantages,
including:
- GLOBAL NETWORK VIEW. GeoProbe is designed to provide a comprehensive
view of a carrier's entire signaling network. This design ensures that
all relevant events and/or signaling throughout the carrier's network,
regardless of their point of origin, path and termination point, are
properly correlated and processed for presentation to network management
systems or personnel. In the absence of such a global approach, carriers
must rely on a patchwork of systems scattered throughout their networks
in order to diagnose problems. Inet's proprietary tracking technology
enables a carrier to reconstruct an entire session and its related
transactions at any time during or after the session. Traditional
sampling techniques, by contrast, tend to produce erroneous and
inaccurate results because collected data is usually incomplete and only
local in scope.
- REAL-TIME FUNCTIONALITY. GeoProbe is designed to collect, process and
present data in real time, even under extreme network load conditions.
This key attribute makes real-time management and operation of signaling
networks possible. Without a real-time monitoring system, carrier
networks are more vulnerable to overloads, fraud and delayed problem
resolution, which can lead to customer dissatisfaction and compromised
network integrity.
- ADVANCED ENGINEERING AND PLANNING CAPABILITIES. GeoProbe continuously
provides an accurate and detailed view of real-time and historical
statistics on a carrier's signaling network usage and the service
applications delivered through the network. This allows carriers to
implement network designs optimized for cost and performance, and to
refine network configuration over time based on changes in demand. For
example, a carrier can use data collected by GeoProbe to identify a
point in the network that is constricting traffic flow. The carrier can
then install additional equipment at that point, increasing the
throughput of its entire network.
- FAST, COST-EFFECTIVE DIAGNOSTICS. GeoProbe's software applications
rapidly isolate problems between interconnected signaling elements and
networks, enabling communications carriers to reduce downtime,
maintenance and costs.
Page 7
- REDUNDANCY AND RELIABILITY. GeoProbe is available with various levels of
redundancy in order to guard against data loss and help ensure that
critical applications remain operational. Available redundancy features
include power, interfaces, processors, storage devices and transport
network access, and certain business applications such as billing.
- VENDOR INDEPENDENCE. All GeoProbe applications are based on data
captured directly from the signaling network, as opposed to information
provided in vendor-specific format by individual network elements such
as STPs, SCPs or next-generation network elements. As a result, carriers
can use GeoProbe regardless of which vendors' equipment is deployed in
their signaling network.
Inet's diagnostic products are vendor-independent tools that provide
diagnostic, emulation and load generation capabilities for use in the design,
deployment, commissioning and diagnosis of signaling networks as well as
quality of service measurement in voice-over-packet networks. Currently,
Inet's diagnostic products include Spectra and the Spectra Trunk Tester. These
can be integrated within the GeoProbe platform or used on a stand-alone basis
with a carrier's own equipment. These products also can be used by equipment
manufacturers to design and test signaling and next-generation network
equipment. Key benefits of Inet's diagnostic products are:
- EASE OF USE. These products provide a multitude of easy-to-access
emulation and diagnostic functions. These capabilities allow testing and
troubleshooting personnel to quickly and effectively perform tasks that
would otherwise require lengthy set-up times and programming efforts.
- COMPREHENSIVE CAPABILITIES. The diagnostic product line provides
customers with the ability to monitor, emulate and generate signaling
data for use in troubleshooting, validation, conformance and regression
testing of switches and other network equipment. The load generation
capabilities and multiple emulation functions can test the various
layers of the signaling protocol, up to and including the signaling
information involved with complex applications, such as LNP.
- MULTIPLE PROTOCOL SUPPORT. The diagnostic products enable network
equipment manufacturers and communications carriers to perform
end-to-end testing of applications utilizing multiple signaling
protocols, such as country-specific variations of signaling. They
alleviate the need to use multiple diagnostic tools and provide easy and
consolidated access to test results.
- VERSATILE CONFIGURATION AND COMPATIBILITY WITH GEOPROBE. Inet offers
these products in a rack-mounted version that supports up to 16 links
and a portable version that supports up to eight links. The versatility
is enhanced by the product's portability as well as the ability to
integrate with the GeoProbe system.
Together, Inet's network optimization and diagnostic products represent
an integrated and comprehensive set of solutions for signaling network
design, monitoring, management, testing and diagnosis.
THE INET STRATEGY
Inet's objective is to be a leading provider of communications software
solutions for next-generation networks worldwide. Key elements of Inet's
strategy to achieve this objective include:
EXPAND GLOBAL MARKET SHARE. The Company is pursuing business in markets
throughout the world that are in the process of being deregulated or privatized.
The percentage of the Company's revenues attributable to international markets
were approximately 52% in 1999 and is expected to remain a
Page 8
substantial portion of the Company's revenues going forward. The Company
believes that its future growth and profitability require continued expansion
in international markets. Inet also selectively pursues incumbent carriers in
newly emerging markets and in advanced but monopolistic markets in order to
establish its presence in these markets prior to the time at which such a
market is deregulated or privatized. The Company intends to expand its
international presence by adding offices or distributors in key global
markets.
ACCELERATE DOMESTIC SALES AND INCREASE PENETRATION OF EXISTING CUSTOMER
BASE. Inet intends to seek additional revenue opportunities by working
closely with its installed customer base to identify opportunities for the
sale of additional GeoProbe systems, add-on business applications and other
new products. Based on experience with its existing customers, the Company
believes that achieving early widespread deployment of the GeoProbe in a
particular carrier's network provides significant ongoing opportunities for
sales of additional GeoProbe systems, add-on applications and new products.
The Company is expanding its domestic sales force in order to pursue
opportunities with its installed customer base, as well as first-time sales
to new customers.
ENHANCE TECHNOLOGY LEADERSHIP POSITION. The Company intends to maintain
its position as a technological leader in signaling network management and
associated business solutions. To accomplish this objective, the Company
intends to, among other things, continue investing in research and
development for both new product development and enhancements to its current
products.
EXPAND PRODUCT OFFERINGS. Inet believes that it has gained significant
expertise in signaling, Internet Protocol and broadband communications
technologies in the course of the design, development and implementation of
its current product offerings and through its work with its existing customer
base. The Company intends to leverage its core competency in signaling to
expand its current product offerings and to develop new product offerings for
complementary signaling environments such as IP, Asynchronous Transfer Mode
("ATM") and Internet telephony.
BUILD RELATIONSHIPS WITH STRATEGIC PARTNERS. Inet intends to build
strategic relationships with complementary software vendors and signaling
equipment manufacturers worldwide in order to integrate the Company's product
offerings with others' products and/or to create joint-marketing
opportunities. In addition, the Company intends to augment its sales efforts
by establishing and expanding relationships with other communications
equipment vendors, systems consulting and integration firms and network
management providers.
PRODUCTS
NETWORK OPTIMIZATION PRODUCTS
Inet's flagship product in the network optimization area is currently
the GeoProbe. The GeoProbe system contains the following key elements:
- A core hardware platform designed as a scalable, distributed, RISC-based
multi-processing data input/output platform, which captures network data
traffic and processes that data through multiple software applications.
- Advanced signaling network monitoring software applications.
- The Company's OpenSeven application programming interface ("API"), which
enables customers and third-party developers to customize and extend the
features of the system.
Page 9
- A suite of business software applications (called IT:seven) which enable
a carrier to leverage the data collected by the GeoProbe system to
achieve minutes-of-use interconnect billing, usage measurement billing,
customer quality assurance and service level performance monitoring. The
applications, which were introduced in late 1999, include GeoBill,
GeoConnect and GeoCare. The raw signaling data gathered from a carrier's
network is taken a step further via these applications to provide
support for potential revenue generating opportunities such as improved
interconnect billing or marketing/customer care information.
The GeoProbe system provides a network-wide view regardless of topology
or number of protocols in use. GeoProbe passively (i.e., non-intrusively)
monitors all messages that flow over each signaling link and can
automatically correlate these messages to reconstruct every session in a
carrier's network. This capability provides comprehensive session analysis
for troubleshooting, problem detection, and network integrity assurance. In
addition, the information collected by GeoProbe improves a carrier's ability
to optimize its network and provide enhanced services to its customers.
GeoProbe provides session data and network status information to users
via a graphical user interface ("GUI") and through Web-based reporting
applications. GeoProbe displays maps that represent network elements (e.g.,
SSPs, STPs, SCPs and Gateways). When failures or user-specified events occur,
an icon representing the affected network element changes to alert the user
to potential trouble or the occurrence of the failure or event. GeoProbe also
provides users with the flexibility to configure their system to set up
triggers (i.e., event detection), filters, alarms and statistics based on
their specific needs.
The GeoProbe platform contains three elements: SpIprobes, SpIstations
and SpIservers. This modular design accommodates growth in a carrier's
network and facilitates the implementation of enhanced features simply by
adding processor cards to the SpIprobes or deploying additional SpIstations.
GEOPROBE SOFTWARE APPLICATIONS. Inet has developed a number of software
applications for use with GeoProbe. These applications incorporate Oracle's
relational database and the X-Windows OSF/Motif toolkit. In addition, Inet's
OpenSeven API provides the carrier's personnel or a third-party software
developer with the ability to expand or customize existing applications or
develop new applications to meet their needs. Some of the applications
include:
- NETWORK SURVEILLANCE. Enables detection of faults, alarming, mass call
onset detection and other network related performance measurements.
- NETWORK MONITORING AND TROUBLESHOOTING. Provides network wide protocol
analysis and call trace functions for use in troubleshooting call and
transaction-related failures.
- SERVICE PERFORMANCE MONITORING. Provides performance measurement of a
number of services such as "800," freephone, LNP, roaming and other
Intelligent Network applications.
-IT:SEVEN GEOBILL. Interconnect billing application that presents data in
the form of Call Detail Records ("CDRs") and Usage Measurement ("UM") data
and feeds the data to the carrier's revenue center and/or billing system.
Also provides capability for special studies.
-IT:SEVEN GEOCONNECT. Interconnect billing application for auditing and
invoicing. Organizes data from CDRs into user-friendly reports that can be
used to support invoices received from other carriers.
Page 10
-IT:SEVEN GEOCARE. Marketing and customer care application for dynamic
service and real-time customer management. Provides service level metrics
as well as data regarding interconnect performance and traffic management.
-FRAUD MANAGEMENT. Collects data and feeds it to real-time fraud detection
systems.
Pricing for a GeoProbe system varies based on a number of factors, such
as the amount of network traffic, network size, network configuration, number
of protocols present, and number and type of add-on applications. GeoProbe
system add-ons are priced according to similar metrics. Prices for GeoProbe
systems have ranged from approximately $350,000 to approximately $13 million.
Since 1995, the Company has sold GeoProbe systems to over 50 customers
worldwide.
DIAGNOSTIC PRODUCTS
Inet's diagnostic products, designed to serve either as stand-alone
tools or to be integrated with GeoProbe, provide communications carriers with
the ability to quickly and cost-effectively design, deploy and maintain their
networks. Currently, Inet's diagnostic products include Spectra and the
Spectra Trunk Tester. These products offer a wide array of filters, traps,
traces and other diagnostic capabilities. They also can be used by equipment
manufacturers in the design of new products through the extensive emulation
and conformance packages and their ability to simulate network conditions.
These multi-protocol diagnostic tools are targeted to the needs of
advanced IP, SS7/C7, PCS, GSM, IS-41, X.25 and ISDN networks and development
environments. They are designed for ease-of-use, with an intuitive user
interface featuring pop-up menus and single-keystroke commands. They can be
configured by the user to change message text and monitoring scenarios and to
save commonly used configurations, filters, tests and other settings for
quick setup. They translate complex signaling messages into plain language,
and the display format shows network statistics and test results in an
easy-to-understand format.
These products can be purchased in either a portable version, capable of
monitoring up to eight full-duplex links, or in a rack-mounted configuration
that can monitor up to 16 full-duplex links. Depending on configuration and
enhancements, prices for a unit generally have ranged from approximately
$15,000 to $150,000. Since the first diagnostic sale in 1990, over 3,000
units have been sold to over 400 customers worldwide.
PRODUCTS UNDER DEVELOPMENT
The Company utilizes a common standards-based open architecture approach
in the design of its products. This approach facilitates and accelerates the
development of new applications and products and permits the Company to
enhance existing products by substituting new hardware or software modules.
This modular approach also helps to extend the life cycles of the Company's
products, ensure compatibility among successive generations of products and
simplify the manufacturing process.
In terms of current product enhancements for the GeoProbe, the Company's
current and planned product development efforts include a high-speed link
interface module as well as the capability to monitor signaling in IP
networks. One of the enhancements being developed for the diagnostic product
line is a high-speed link interface.
In the area of new products, the Company has on-going product
development efforts to provide network optimization and interoperability
solutions between SS7 and IP networks in the form of the GeoGate platform and
associated applications. Initial applications on the GeoGate platform, which
will be
Page 11
introduced in 2000, include an Internet Access softswitch solution that will
divert Internet traffic from the PSTN directly to the IP network as well as a
"security gateway" application that will ensure secure passage of information
between current and next-generation networks. The GeoGate is expected to
target applications that provide seamless communications software solutions
for integrated networks.
Products as complex as those currently under development by the Company
frequently are subject to delays, and there can be no assurance that the
Company will not encounter difficulties that could delay or prevent the
successful and timely development, introduction and marketing of these
potential new products. Moreover, even if such potential new products are
developed and introduced, there can be no assurance that they will achieve
any significant degree of market acceptance. Failure to release these or any
other potential new products on a timely basis, or failure of these or any
other potential new products, if and when released, to achieve any
significant degree of market acceptance, could have a material adverse effect
on the Company's business, financial condition and results of operations.
CUSTOMERS
As of December 31, 1999, the Company had sold versions of its products
to over 400 customers in more than 50 countries. In 1997, British Telecom
accounted for approximately 14% of the Company's revenues. Other than British
Telecom in 1997, no individual customer accounted for 10% or more of the
Company's revenues in 1999, 1998 or 1997. The Company's target customers
include communications carriers and equipment manufacturers throughout North
America, Latin America, EMEA and the Asia/Pacific region.
The following is a representative list of customers in various market
segments which have purchased in excess of $250,000 worth of the Company's
products since 1997. These customers collectively accounted for approximately
71%, 69% and 66% of the Company's revenues in 1999, 1998 and 1997,
respectively.
LONG DISTANCE CARRIERS (IXCs) WIRELESS CARRIERS PTTs EQUIPMENT MANUFACTURERS
----------------------------- --------------------- ---------------- ------------------------
AT&T Airtouch British Telecom Alcatel
MCI WorldCom Alltel Cable & Wireless Telcordia (Bellcore)
Sprint AT&T Wireless Deutsche Telekom Cisco
LOCAL EXCHANGE CARRIERS Bell Atlantic Mobile Eircom Ericsson
----------------------- Bell South Mobility KPN Telecom Lucent
Bell Atlantic CellularOne-Maryland Latvia PTT Motorola
Brooks Fiber Entel-Chile o.tel.o Nortel
Cincinnati Bell LA Cellular Portugal Telecom
Intermedia Communications Nextel Singapore Telecom
LDI PrimeCo SPT Telecom
NEXT GENERATION CARRIERS Startel Telecom Italia
------------------------ Swisscom Telia
Global Crossing Telebahia Telkom So. Africa
Williams Communications Western Wireless Telstra
SALES, MARKETING AND SUPPORT
SALES AND MARKETING
The Company sells its products to communications carriers and equipment
manufacturers globally through both direct and indirect channels.
Domestically, the direct channel is used for all product lines with the
Company's sales force which is structured around a two-tier model: strategic
accounts and geographic areas. Internationally, the Company uses both
channels. GeoProbe is sold directly and in cooperation with system
integrators, distributors and consultants, while the diagnostic products are
sold primarily via distributors. The Company maintains six sales offices in
the U.S. and sales support facilities outside London, England and in
Frankfurt, Germany and Roissey, France.
Page 12
Sales of the Company's products are made predominately to large
communications service providers and involve significant capital expenditures
and lengthy implementation processes. Prospective customers generally commit
significant resources to an evaluation of the Company's and its competitors'
products and require each vendor to expend substantial time, effort and money
educating the prospective customer about the value of the vendor's solutions.
Consequently, sales to this type of customer generally require an extensive
sales effort throughout the customer's organization and final approval by an
executive officer or other senior level employee. The Company frequently
experiences delays following initial contact with a prospective customer and
expends substantial funds and management effort pursuing these sales.
Additionally, delays associated with potential customers' internal approval
and contracting procedures, procurement practices, testing and acceptance
processes are common and may cause potential sales to be delayed or foregone.
As a result of these or other factors, the sales cycle for the Company's
products is long, typically ranging from six to 12 months for GeoProbe sales
(excluding the cycle for subsequent applications and enhancements, which
varies widely) and up to six months for occasional, large diagnostic product
sales. Accordingly, the Company's 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 adversely affect operating results in a
particular quarter, particularly if there are significant sales and marketing
expenses associated with any deferred or lost sales.
The Company's primary marketing activities include raising potential
customer awareness of the benefits of actively managed signaling networks and
interoperability benefits as well as identification of new opportunities with
existing customers. To accomplish these tasks, Inet uses direct sales and
marketing efforts, advertising in trade magazines, exhibitions at industry
trade shows and presence on the Internet via the Company's website. These
activities focus on generating qualified sales leads and demonstration
opportunities for the Company's products.
The Company provides extensive training and support for its direct sales
force and its worldwide distributors, including classroom training, product
brochures, demonstration systems and promotional literature.
SERVICES, SUPPORT AND WARRANTY
The Company believes that customer service, support and training are
important to building and maintaining strong customer relationships. The
Company services, repairs and provides technical support for its products.
Support services include 24-hour technical support, remote access diagnostic
and servicing capabilities, installation support and advance replacements for
emergency situations. The extent and nature of customer interaction with the
support organization are shared with the sales organization via a common
database.
The Company maintains an in-house repair facility and provides on-going
telephone assistance to customers from its support center in Plano, Texas. In
addition, the Company services its customers in EMEA from product support
offices located outside London, England and in Frankfurt, Germany. As Inet's
customers become more geographically diverse, the Company may open service
centers in other key locations.
The Company typically warrants its products against defects in materials
and workmanship for one year after the sale and thereafter offers extended
service warranties.
The Company also provides varying levels of extended product support
under support services agreements. Support services agreements are typically
sold to customers for a one-year term and may be renewed for additional
one-year periods. Customers that do not renew their support services
agreements
Page 13
but wish to obtain product updates and new version releases generally are
required to purchase such items from the Company at market prices.
RESEARCH AND DEVELOPMENT
The Company's product development efforts include expenditures for
research and development, new product design and enhancement of existing
products. Research and development expenses were $21.8 million, $15.7 million
and $9.7 million in 1999, 1998, and 1997, respectively.
The Company's primary development facilities are located at its Plano,
Texas headquarters. The Company believes that recruiting and retaining
highly-skilled, engineering personnel is essential to its success. To the
extent that the Company is not successful in attracting and retaining
qualified technical personnel, its business, financial condition and results
of operations could be materially adversely affected.
The Company's products are designed to comply with a significant number
of standards and regulations, some of which are evolving as new technologies
are deployed. For sales to customers in the U.S., the Company's products must
comply with various standards established by Telcordia (formerly Bellcore)
and the American National Standards Institute. Internationally, the Company's
products must comply with standards established by telecommunications
authorities in various countries as well as with recommendations of the
International Telecommunications Union and the European Telephone Standards
Institute. The failure of the Company's products to comply, or delays in
compliance, with the various existing and evolving standards could have a
material adverse effect on the Company's business and operating results.
Page 14
MANUFACTURING
Inet's production process consists of procurement and inspection of
components, final assembly, burn-in, quality control testing and packaging.
Inet outsources the manufacturing of its hardware to a number of Texas-based
contract manufacturers. The Company has obtained ISO 9001 certification for
in-house processes and has obtained the CE certification for shipments to the
European Community.
Inet generally uses industry-standard components for its products which
are available from multiple sources. However, the Company's products
currently utilize certain semiconductors that are available from only one
manufacturer and other components that are available from a limited number of
suppliers. The Company attempts to minimize the need for sole and limited
source components by performing design reviews, prior to the manufacture of
any new product, during which the Company seeks to eliminate sole source
components. During manufacture, Inet forecasts annual parts usage and meets
with key vendors to obtain their commitment to meet forecast supply needs.
The Company periodically reevaluates the sources of components identified as
having potential delivery problems and the costs and benefits of redesigning
the Company's products to incorporate alternative components. If any sole or
limited source components should become unavailable, Inet believes that it
could design similar functionality into its product using other components.
COMPETITION
The market for signaling-based communications network management
applications is relatively new, intensely competitive, both in the U.S. and
internationally, and subject to rapid technological change, evolving industry
standards and regulatory developments. Competition is expected to persist,
intensify and increase in the future. The Company competes with a number of
U.S. and international suppliers that vary in size and in the scope and
breadth of the products and services offered. GeoProbe principally competes
with products offered by Agilent Technologies, a subsidiary of
Hewlett-Packard Company. The diagnostic tools principally compete with
products offered by Agilent Technologies, Tekelec and Tektronix, Inc. There
have been new entrants in both the network optimization and diagnostic
product areas, but to date they do not comprise a significant portion of the
market. Certain of the Company's competitors have, in relation to the
Company, 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.
The Company believes that its ability to compete successfully depends on
numerous factors, both within and outside the Company's control, including:
responsiveness to communications service providers' needs; the Company's
ability to support existing and new industry standards; the development of
technical innovations; the attraction and retention of qualified personnel;
regulatory changes; the quality, reliability and security of the Company's
and its competitors' products and services; sufficient market presence by the
Company; the ability to execute a strategy of rapid expansion; ease of use of
the Company's products; the pricing policies of the Company's competitors and
suppliers; the timing of introductions of new products and services by the
Company and its competitors; and general market and economic conditions.
PROPRIETARY RIGHTS
The Company's continued success is dependent in part upon its
proprietary technology. To protect its proprietary technology, the Company
relies 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 the
Page 15
Company's proprietary rights in the products to the same extent as do the
laws of the U.S. Moreover, although the Company holds two U.S. patents, has
additional patent applications pending and is in the process of preparing
additional patent applications for filing, there can be no assurance that the
Company will receive additional patents. Despite the measures taken by the
Company, it may be possible for a third party to copy or otherwise obtain and
use the Company's proprietary technology and information without
authorization. Policing unauthorized use of the Company's products is
difficult, and litigation may be necessary in the future to enforce the
Company's intellectual property rights. Any such litigation could be time
consuming and expensive to prosecute or resolve, result in substantial
diversion of management resources, and have a material adverse effect on the
Company's business, financial condition and results of operations. There can
be no assurance that the Company will be successful in protecting its
proprietary technology or that the Company's proprietary rights will provide
a meaningful competitive advantage to the Company.
The Company relies upon certain software that it licenses from third
parties, including software that is integrated with the Company's internally
developed software and used in its products to perform key functions.
EMPLOYEES
As of December 31, 1999, the Company had 457 employees, of whom 236 were
engaged in research and development, 58 were engaged in sales and marketing,
63 were engaged in customer support services, 50 were engaged in
manufacturing and 50 were engaged in administrative and other business
support functions. The Company believes it has experienced good employee
relations to date.
ITEM 2. PROPERTIES.
The Company is headquartered in Plano, Texas, where it currently leases
approximately 109,000 square feet of office space. On January 27, 2000, the
Company signed a lease to replace the existing leases for its operations. The
new lease agreement expires on June 30, 2010. Beginning in July 2000, the
Company will occupy approximately 190,000 square feet of office space in
Richardson, Texas. The Company also leases sales offices in Colorado,
Georgia, Illinois, Maryland, Pennsylvania and Washington. Additionally, the
Company leases four international offices, two outside of London, England
which provide product and sales support, and sales support facilities in
Frankfurt, Germany and Roissey, France.
ITEM 3. LEGAL PROCEEDINGS.
There are no material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the
fourth quarter of 1999.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK
Page 16
The Company effected its initial public offering on May 26, 1999 at a
price of $16.00 per share. Since that date, the Company's common stock has
traded on the Nasdaq National Market under the symbol "INTI." Prior to May
26, 1999, there was no established public trading market for any of the
Company's securities.
Page 17
The following table sets forth, for the periods indicated, the range of
high and low closing sales prices for the common stock as reported on the
Nasdaq National Market.
FISCAL 1999 HIGH LOW
----------- ---- ---
Second Quarter (from May 26, 1999) $ 24.00 $ 16.00
Third Quarter 39.91 23.25
Fourth Quarter 70.25 32.75
On March 1, 2000, the last reported sales price of the common stock was
$49.63 per share. As of March 1, 2000, there were approximately 174
stockholders of record (not including beneficial holders of stock held in
street name) of the Company's common stock.
DIVIDEND POLICY
The Company has never paid cash dividends on its common stock and does
not intend to pay cash dividends on its common stock in the foreseeable
future. The Company's revolving credit facility restricts the payment of cash
dividends without the bank's consent. Future dividends, if any, will be
determined by the Board of Directors.
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial data below should be read in
conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and Item 8, "Financial Statements and
Supplementary Data," included elsewhere in this Annual Report.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------
1999 1998 1997 1996 1995
---------- -------- -------- -------- ---------
(in thousands, except per share data)
STATEMENTS OF INCOME DATA:
Revenues...............................................$ 109,983 $ 77,428 $ 57,701 $ 42,041 $ 17,531
Income from operations.................................. 34,752 24,153 19,096 13,288 2,239
Income before provision for income taxes................ 44,663 24,980 19,112 13,260 2,303
Net income.............................................. 29,701 17,085 12,714 8,936 1,659
Earnings per share (1):
Basic........................................$ 0.68 $ 0.42 $ 0.31 $ 0.22 $ 0.04
Diluted....................................... 0.66 0.40 0.30 0.22 0.04
Weighted average shares outstanding (1):
Basic......................................... 43,449 40,879 40,855 40,615 39,600
Diluted....................................... 45,037 42,452 41,722 41,069 41,207
DECEMBER 31,
-------------------------------------------------------------
1999 1998 1997 1996 1995
---------- -------- -------- -------- ---------
(in thousands)
BALANCE SHEET DATA:
Cash and cash equivalents............................... $127,903 $ 21,914 $ 3,386 $ 742 $ 181
Working capital......................................... 123,909 38,313 24,290 15,101 6,130
Total assets............................................ 169,917 65,508 38,758 27,105 18,641
Stockholders' equity.................................... 133,423 46,813 29,386 16,614 7,629
- ----------
Page 18
(1) See Note 1 in Notes to Consolidated Financial Statements for the
determination of shares used in computing basic and diluted earnings per
share.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THIS ANNUAL REPORT ON FORM 10-K 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 FACT, INCLUDING, WITHOUT LIMITATION,
STATEMENTS ABOUT THE BUSINESS, FINANCIAL CONDITION, BUSINESS STRATEGY, PLANS
AND OBJECTIVES OF MANAGEMENT, AND PROSPECTS OF THE COMPANY ARE
FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES 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, FLUCTUATIONS IN
QUARTERLY FINANCIAL RESULTS, DEPENDENCE ON THE TELECOMMUNICATIONS INDUSTRY,
LENGTHY SALES CYCLES, PRODUCT CONCENTRATION, RELIANCE ON SIGNALING NETWORKS,
REGULATORY UNCERTAINTY, COMPETITION, DEPENDENCE ON KEY PERSONNEL, RAPID
TECHNOLOGICAL CHANGE, DEPENDENCE ON NEW PRODUCTS, INTERNATIONAL OPERATIONS,
POTENTIAL ACQUISITIONS, PROPRIETARY RIGHTS, PRODUCT LIABILITY, AND OTHER
RISKS INDICATED IN THIS FILING. THESE RISKS AND UNCERTAINTIES ARE BEYOND THE
ABILITY OF THE COMPANY TO CONTROL, AND IN MANY CASES, THE COMPANY CANNOT
PREDICT THE RISKS AND UNCERTAINTIES THAT COULD CAUSE ITS ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THOSE INDICATED BY THE FORWARD-LOOKING STATEMENTS.
WHEN USED IN THIS DOCUMENT, THE WORDS "BELIEVE," "EXPECT," "ANTICIPATE,"
"INTEND," "CONTINUE," "MAY," "WILL," "COULD" OR THE NEGATIVE OF SUCH TERMS
AND SIMILAR EXPRESSIONS AS THEY RELATE TO THE COMPANY OR ITS MANAGEMENT ARE
INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS.
OVERVIEW
Inet was founded in 1989, and during the early stages of its operations
it focused primarily on developing and selling diagnostic tools that
addressed a predecessor to the SS7 signaling protocol. As the
telecommunications industry increasingly adopted SS7, the Company shifted its
focus to developing and deploying SS7-based solutions as well as broadening
its product offerings. The diagnostic tool Spectra was first introduced in
December 1990 and is currently in its tenth generation release. Beginning in
1993, the Company focused a significant portion of its product development
efforts on developing a complete monitoring and surveillance solution for SS7
networks, culminating in the introduction of the GeoProbe in late 1995. The
Company continues to focus significant resources on the development of
enhancements to Spectra, enhancements and add-on applications to GeoProbe as
well as new products in the network optimization and interoperability areas
of next-generation networks.
Historically, the Company has generated substantially all of its
revenues from Spectra and GeoProbe. Revenues attributable to GeoProbe
represented a majority of total revenues in 1999 and 1998. Revenues
attributable to Spectra represented a majority of total revenues in 1997.
Although Inet expects Spectra revenues to continue to represent a significant
portion of total revenues for the foreseeable future, Spectra sales are
expected to continue to decline as a percentage of total revenues as a result
of increasing sales of GeoProbe and new products. The remaining revenues are
derived from sales of other products and training, warranty and support
services related to the Company's products.
Product revenues are generally recognized in the period the Company has
completed all hardware manufacturing and/or software development to
contractual specifications, factory testing has been completed, the product
has been shipped to the customer, the fee is fixed and determinable and
collection is considered probable by the Company's management. When the
Company has significant obligations subsequent to shipment (e.g.,
installation and system integration), revenues are not recognized prior to
the time the system has been delivered and installed at the customer's
premises and there are no significant
Page 19
unfulfilled obligations. Revenues from arrangements that include significant
acceptance terms are not recognized until acceptance has occurred. Revenues
from product support services, including product support services included in
initial licensing fees, are recognized ratably over the contract period.
Post-contract support services included in the initial licensing fee are
allocated from the total contract amount based on the relative fair value
determined using vendor-specific objective evidence.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
percentage of revenues represented by certain items reflected in the
Company's consolidated statements of income:
YEARS ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Revenues....................................... 100.0% 100.0% 100.0%
Cost of revenues............................... 28.9 28.9 27.4
----- ----- -----
Gross profit................................. 71.1 71.1 72.6
Operating expenses:
Research and development..................... 19.8 20.3 16.7
Sales and marketing.......................... 11.5 11.1 13.4
General and administrative................... 8.2 8.5 9.4
---- ----- -----
Total operating expenses............. 39.5 39.9 39.5
----- ----- -----
Income from operations......................... 31.6 31.2 33.1
Other income................................... 9.0 1.1 0.0
----- ----- -----
Income before provision for income taxes....... 40.6 32.3 33.1
Provision for income taxes..................... 13.6 10.2 11.1
----- ----- -----
Net income..................................... 27.0% 22.1% 22.0%
===== ===== =====
REVENUES
Revenues increased 42.1% to $110.0 million in 1999 from $77.4 million in
1998, and increased 34.2% in 1998 from $57.7 million in 1997. The increases
were primarily due to increased unit sales of GeoProbe and Spectra during
both 1999 and 1998. Revenues from products other than Spectra and GeoProbe
collectively accounted for less than 10% of total revenues in all three
years. International revenues were 51.7%, 52.2% and 52.6% in 1999, 1998 and
1997, respectively. No individual country, other than the United States,
accounted for 10% or more of total revenues in 1999 and 1998. During 1997,
revenue from customers in the United Kingdom accounted for approximately 14%
of total revenues. No individual customer accounted for 10% or more of total
revenues in 1999 and 1998. During 1997, revenues from British Telecom
accounted for approximately 14% of total revenues. The Company anticipates
that in the future, individual, large transactions may represent a large
percentage of revenues, particularly on a quarterly basis.
COST OF REVENUES
Cost of revenues consists primarily of hardware expenses and personnel
costs related to the manufacturing, installation and support of the Company's
products. Cost of revenues were $31.8 million, $22.4 million, and $15.8
million, representing 28.9%, 28.9% and 27.4% of revenues in 1999, 1998, and
1997, respectively. The increase in absolute dollars during both 1999 and
1998 primarily resulted from additional hardware costs associated with
increased unit sales, related installation expenses, and additional support
costs. New product offerings or changes in the Company's product mix can
affect the cost of revenues as a percentage of revenues. The Company believes
that at least through 2000 cost of revenues should not vary significantly as
a percentage of revenues from the level experienced in 1999.
Page 20
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
primarily consist of salaries and other related expenses associated with the
Company's research and development activities. Such expenses were $21.8
million, $15.7 million, and $9.7 million, representing 19.8%, 20.3% and 16.7%
of revenues in 1999, 1998, and 1997, respectively. The increase in absolute
dollars in 1999 compared to 1998 was primarily related to increased staffing
dedicated to research and development activities and increased expenses
associated with materials and equipment used in research and development
activities. The decrease as a percentage of revenues in 1999 compared to 1998
was partially attributable to the decrease in research and development
expenses associated with the wireless data asset product line, which was sold
in September 1999, as well as relatively higher revenues of the Company. The
increases in absolute dollars and as a percentage of revenues in 1998
compared to 1997 were primarily attributable to increased staffing dedicated
to research and development activities. The Company expects that research and
development expenses in future periods will increase in absolute dollars and
as a percentage of revenues as these investments are crucial to the Company's
ability to evolve its technologies and expand its product offerings to meet
its customers' needs.
Software development costs are expensed as incurred until technological
feasibility has been established, at which time subsequent costs are
capitalized until the product is available for general release to customers.
To date, either the establishment of technological feasibility of the
Company`s products and their general release have substantially coincided 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 the Company has not
capitalized any software development costs.
SALES AND MARKETING EXPENSES. Sales and marketing expenses primarily
consist of personnel and travel expenses related to sales and marketing,
distributor commissions and expenses of trade shows and advertising. Such
expenses were $12.6 million, $8.6 million, and $7.7 million, representing
11.5%, 11.1% and 13.4% of revenues in 1999, 1998, and 1997, respectively. The
increase in absolute dollars in 1999 compared to 1998 was attributable to the
continued expansion of the Company's direct sales force, continued investment
in expansion of international sales activities, and increased marketing and
promotion activities. The increase in absolute dollars in 1998 compared to
1997 was primarily attributable to increased staffing and related expenses as
the Company established new domestic sales offices and increased marketing
and promotional activities. The decrease as a percentage of revenues during
1998 was primarily attributable to relatively higher revenues. The Company
believes that sales and marketing expenses will continue to increase in
absolute dollars and as a percentage of sales at least through 2000 due to
planned expansion of its domestic and international sales and marketing
efforts and related expenses.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
primarily consist of personnel, facilities and other costs of the finance,
administrative and executive departments of the Company as well as fees and
expenses associated with legal and accounting requirements. Such expenses
were $9.0 million, $6.6 million, and $5.4 million, representing 8.2%, 8.5%
and 9.4% of revenues in 1999, 1998, and 1997, respectively. The increase in
absolute dollars in 1999 compared to 1998 was primarily attributable to
increased staffing costs associated with the growth of the Company and
increased accounting and professional fees related to being a public company.
The increase in absolute dollars in 1998 compared to 1997 was primarily
attributable to increased staffing costs. General and administrative expenses
decreased as a percentage of revenues during 1999 and 1998 primarily due to
relatively higher revenues and the Company's ability to leverage its base of
resources to support a larger organization. The Company anticipates that
general and administrative expenses will continue to increase in absolute
dollars as the Company continues to support its growth by adding necessary
Page 21
infrastructure. However, the Company does not expect general and
administrative expenses to grow at the same rate as revenues.
OTHER INCOME
Other income was $9.9 million, $827,000 and $16,000 in 1999, 1998 and
1997, respectively. For 1999, the increase primarily resulted from two
factors, a $5.9 million gain on the sale of the Company's wireless data
assets and an increase in interest income due to higher balances of cash and
cash equivalents. In general, the increase in cash and cash equivalents
resulted from proceeds from the Company's initial public offering completed
in June 1999, increased cash flows from operations, and proceeds from the
sale of the Company's wireless data assets. Proceeds from the offering were
approximately $55.7 million in cash, net of underwriting discounts,
commissions and other offering costs. For 1998, the increase resulted from
increased interest income due to higher balances of cash and cash equivalents
resulting from increased cash flow from operations.
PROVISION FOR INCOME TAXES
The Company recorded income tax expense of $15.0 million, $7.9 million
and $6.4 million in 1999, 1998 and 1997, respectively. The Company's
effective income tax rates were 33.5%, 31.6% and 33.5% in 1999, 1998 and
1997, respectively. The lower effective tax rate in 1998 was primarily the
result of state tax benefits realized in 1998.
SALE OF WIRELESS DATA ASSETS
In September 1999, the Company sold its wireless data product line and
related assets to Nextcell, Inc., an entity controlled by a related party,
for a cash purchase price of $7.0 million. The Company recorded a pre-tax
gain of $5.9 million and an after-tax gain of $3.9 million, or $0.09 per
share on a diluted basis, for 1999. Without the gain on the sale of the
wireless data assets, the Company's diluted earnings per share were $0.57 for
1999 compared to $0.40 for 1998. Revenues from the wireless data product line
were approximately $1.7 million for the year ended December 31, 1999.
SALE OF INET GLOBAL RESEARCH, L.L.C.
Effective January 1, 2000, the Company sold its membership interest in
Inet Global Research, L.L.C., to an entity controlled by a related party, for
a cash purchase price of $82,000. No gain or loss was recorded for the sale.
The Company intends to enter into an agreement whereby this entity will
perform contract services for the Company.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has funded its operations and met its
capital expenditure requirements primarily through cash flows from operations
and bank borrowings. The Company had working capital of $123.9 million at
December 31, 1999, compared with $38.3 million at December 31, 1998. At
December 31, 1999, the Company had $127.9 million in cash and cash
equivalents, an increase of $106.0 million from $21.9 million in cash and
cash equivalents at December 31, 1998. In June 1999, the Company completed
the initial public offering of its common stock. The Company issued 3,841,479
shares of its common stock at an initial public offering price of $16.00 per
share. Net proceeds to the Company, after deduction of the underwriting
discount and expenses, were approximately $55.7 million. The increase in cash
and cash equivalents is also partially attributable to higher levels of
income from operations, proceeds from the sale of its wireless data assets,
and increased deferred revenue.
Page 22
The Company has available a line of credit facility with a bank
providing for borrowings of up to $10.0 million which expires June 15, 2000.
Up to $5.0 million may be utilized to support letters of credit. The per
annum usage fee on unused portions of the line is 0.125%. Borrowings under
this facility bear interest payable quarterly at LIBOR plus 1.5% (7.5% at
December 31, 1999) and are collateralized by the Company's accounts
receivable, inventories, and property and equipment. The credit facility
includes covenants requiring the Company to maintain certain financial ratios
and restricts the payment of cash dividends without the bank's consent. At
December 31, 1999, no letters of credit or borrowings were outstanding under
the credit facility, and the amount available to the Company was $10.0
million.
Cash provided by operating activities was $48.1 million, $24.5 million
and $7.8 million in 1999, 1998 and 1997, respectively. Operating cash flows
in 1999 increased primarily due to increased levels of net income, an
increase in deferred revenue and an increase in accrued compensation and
benefits. Operating cash flows in 1998 increased primarily due to increased
levels of net income, an increase in deferred revenue and a decrease in
unbilled receivables, partially offset by an increase in trade accounts
receivable. Cash provided by investing activities was $1.8 million in 1999
compared to cash used in investing activities of $6.0 million and $3.8
million 1998 and 1997, respectively. Net cash provided by investing
activities in 1999 resulted from proceeds from the sale of the Company's
wireless data assets of $7.0 million less cash used to purchase property and
equipment of $5.2 million. Net cash used in investing activities in 1998 and
1997 was primarily related to purchases of property and equipment. Financing
activities provided cash of $56.1 million and $9,000 in 1999 and 1998,
respectively. Net cash used in financing activities was $1.4 million in 1997,
which was attributable to repayments of borrowings under the Company's line
of credit facility. The increase in net cash provided by financing activities
in 1999 resulted primarily from proceeds from the Company's initial public
offering.
The Company may in the future pursue acquisitions of businesses,
products or technologies, or enter into joint venture arrangements, that
could complement or expand the Company's business and product offerings. Any
material acquisition or joint venture could result in a decrease in the
Company's working capital depending on the amount, timing and nature of the
consideration to be paid.
The Company believes that current cash balances, potential cash flows
from operations and available borrowings under its line of credit facility
will be sufficient to meet its anticipated cash needs for working capital,
capital expenditures and other activities for at least the next 12 months.
Thereafter, if current sources are not sufficient to meet the Company's
needs, it may seek additional equity or debt financing. In addition, any
material acquisition of complementary businesses, products or technologies or
material joint venture could require the Company to obtain additional equity
or debt financing. There can be no assurance that such additional financing
would be available on acceptable terms, if at all.
IMPACT OF YEAR 2000
In prior years, the Company discussed the nature and progress of its
plans to become Year 2000 ready. In late 1999, the Company completed its Year
2000 project. As a result of the Company's efforts, the Company experienced
no significant disruptions related to Year 2000. The Company is not aware of
any material problems resulting from Year 2000 issues, either with its
products, its internal systems, or the products and services of suppliers.
The incremental costs related to the Year 2000 project were not material to
the Company's results of operations, financial position or cash flows. The
Company will continue to monitor throughout the year 2000 its critical
computer applications, and those of its suppliers, to ensure that any latent
Year 2000 matters that may arise are addressed promptly.
RISK FACTORS
Page 23
THIS REPORT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF THE FEDERAL SECURITIES LAWS. ACTUAL RESULTS AND THE TIMING OF
CERTAIN EVENTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN OR
CONTEMPLATED BY THE FORWARD-LOOKING STATEMENTS DUE TO A NUMBER OF FACTORS,
INCLUDING, WITHOUT LIMITATION, THOSE SET FORTH BELOW AND ELSEWHERE IN THIS
REPORT. IN ADDITION TO THE OTHER INFORMATION IN THIS REPORT, THE FOLLOWING
FACTORS, WHICH MAY AFFECT THE COMPANY'S CURRENT POSITION AND FUTURE
PROSPECTS, SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE COMPANY AND AN
INVESTMENT IN ITS COMMON STOCK.
FLUCTUATIONS IN QUARTERLY FINANCIAL RESULTS
The Company's quarterly operating 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 the Company's
control. Such factors include the size and timing of specific orders by
customers; competition; the market acceptance of new products and
technologies by the Company and its competitors; the mix of products and
services sold by the Company; the timing of product shipments and product
installations by the Company; in limited circumstances, customer product
acceptance; the capital spending patterns of the Company's customers; the mix
of domestic and international sales; changes in the timing and level of
expenses; the relative percentages of products sold through the Company's
direct and indirect sales channels; customer order deferrals in anticipation
of enhancements or new products; the Company's timing of and investments in
research and development activities; changes in and the Company's ability to
implement its strategy; changes in the availability of materials needed to
produce the Company's products; the progress and timing of the privatization
of telecommunications markets and the worldwide deregulation of the
international telecommunications industry; defects and product quality
problems; intellectual property disputes; expansion of and risks associated
with the Company's international operations; and changes in general economic
conditions. Furthermore, a large portion of the Company's operating expenses,
including rent and salaries, are set based upon expected future revenues.
Accordingly, if revenues are below expectations, the Company's operating
results are likely to be adversely and disproportionately affected because
such operating expenses are not variable in the short term, and cannot be
quickly reduced to respond to unanticipated decreases in revenues.
The amount of revenues associated with particular product sales can vary
significantly. The deferral or loss of one or more individually significant
sales could materially adversely affect operating results in a particular
quarter.
The Company's operating results are also likely to fluctuate due to
factors which impact prospective customers of the Company. Expenditures by
prospective customers tend to vary in cycles that reflect overall economic
conditions and individual budgeting and buying patterns. The Company's
business would be adversely affected by a decline in the economic prospects
of its customers or the economy generally, which could alter current or
prospective customers' capital spending priorities or budget cycles or extend
the Company's sales cycle with respect to certain customers. In addition, the
Company's operating results historically have been influenced by certain
seasonal fluctuations, with revenues tending to be strongest in the fourth
quarter of each year. The Company believes that this seasonality has been due
to the capital appropriation practices of many of its customers. The Company
expects that in future periods this seasonal trend may cause first quarter
revenues to remain consistent with, or decrease from, the level achieved in
the preceding quarter.
As a result of all of the foregoing, the Company believes that future
operating results are likely to vary significantly from quarter to quarter,
and historical operating results should not be relied upon as any indication
of future performance. Moreover, there can be no assurance that the Company's
revenues will grow in future periods or that the Company will remain
profitable. In addition, in some future quarters the Company's operating
results may be below the expectations of public market analysts. In such
event, the market price of the common stock could likely be materially and
adversely affected.
Page 24
DEPENDENCE ON TELECOMMUNICATIONS INDUSTRY
The Company has derived substantially all of its revenues from sales of
products and related services to the telecommunications industry. The
telecommunications industry has undergone a period of rapid growth and
consolidation during the past few years. The Company's business, financial
condition and results of operations could be materially adversely affected in
the event of a significant slowdown in the growth of this industry. Further,
consolidations of prospective customers of the Company may delay or cause
cancellations of significant sales of the Company's products, which could
materially adversely affect the Company's operating results in a particular
period.
REGULATORY UNCERTAINTIES
Future growth in the markets for the Company's products will depend in
part on privatization and deregulation of certain telecommunications markets
worldwide. Any reversal or slowdown in the pace of this privatization or
deregulation could have a material adverse effect on the markets for the
Company's products. Moreover, the consequences of deregulation are subject to
many uncertainties, including judicial and administrative proceedings that
affect the pace at which the changes contemplated by deregulation occur, and
other regulatory, economic and political factors. Any invalidation, repeal or
modification of the requirements imposed by the Telecommunications Act of
1996 or the local telephone competition rules adopted by the U.S. Federal
Communications Commission to implement that Act could have a material adverse
effect on the Company's business, financial condition and results of
operations. Furthermore, the uncertainties associated with deregulation have
in the past and could in the future cause customers of the Company to delay
purchasing decisions pending the resolution of such uncertainties.
LENGTHY SALES CYCLE
The sales cycle for the Company's products is long, typically ranging
from six to 12 months for GeoProbe sales (excluding the cycle for subsequent
applications and enhancements, which varies widely) and up to six months for
occasional, large Spectra sales. Accordingly, the Company's 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 adversely affect
operating results in a quarter, particularly if there are significant sales
and marketing expenses associated with the deferred or lost sales.
PRODUCT CONCENTRATION; RELIANCE ON SIGNALING NETWORKS
The Company's two principal products, GeoProbe and Spectra, generated
substantially all of the Company's revenues in 1999, 1998, and 1997 and are
expected to continue to account for a substantial majority of the Company's
revenues for the foreseeable future. Any downturn in the demand for either or
both of such products could have a material adverse effect on the Company's
business, financial condition and results of operations. Moreover, there can
be no assurance that the Company will be successful in developing any other
products or taking any other steps to reduce the risk associated with any
slowdown in demand for GeoProbe and Spectra.
Inet's future operating results are dependent in significant part on the
continued viability and expansion of SS7 signaling networks and the
convergence of the IP networks and the PSTN. The Company's business,
financial condition and results of operations could be materially adversely
affected if the market for SS7 and converging network solutions fails to grow
or grows more slowly than the Company currently anticipates.
COMPETITION
Page 25
The market for signaling-based communications network management
applications is relatively new, intensely competitive, both in the U.S. and
internationally, and subject to rapid technological change, evolving industry
standards and regulatory developments. Competition is expected to persist,
intensify and increase in the future. The Company competes with a number of
U.S. and international suppliers that vary in size and in the scope and
breadth of the products and services offered. GeoProbe principally competes
with products offered by Agilent Technologies, a subsidiary of
Hewlett-Packard Company. The diagnostic tools principally compete with
products offered by Agilent Technologies, Tekelec and Tektronix, Inc. There
have been new entrants in both the network optimization and diagnostic
product areas, but to date they do not comprise a significant portion of the
market. Certain of the Company's competitors have, in relation to the
Company, longer operating histories, larger installed customer bases,
longer-standing relationships with customers, greater name recognition and
significantly greater financial, technical, marketing, customer service,
public relations, distribution and other resources. Additionally, it is
possible that new competitors or alliances among competitors could emerge and
rapidly acquire significant market share. As a result, such competitors may
be able to more quickly develop or adapt to new or emerging technologies and
changes in customer requirements, or devote greater resources to the
development, promotion and sale of their products. Increased competition is
likely to result in price reductions, reduced margins and loss of market
share. There can be no assurance that competitive pressures faced by the
Company will not materially adversely affect its business, financial
condition and results of operations.
NEED TO MANAGE GROWTH AND EXPANSION
The Company has experienced rapid and significant growth that has
placed, and is expected to continue to place, a significant strain on the
Company's management, information systems and operations. For example, the
Company's revenues have increased from $17.5 million in 1995 to $110.0
million in 1999. The number of employees has increased from 116 at December
31, 1995 to 457 at December 31, 1999. The Company's ability to effectively
manage significant additional growth will require it to improve its
financial, operational and management information and control systems and
procedures and to effectively attract, train, motivate and manage its
employees. The failure to manage growth effectively could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company anticipates that continued growth, if any, will require it
to recruit and hire a substantial number of new employees, particularly sales
and marketing personnel and technical personnel with signaling and IP
knowledge and experience, both in the U.S. and internationally. Competition
for such personnel is intense, and the Company has at times experienced
difficulty in recruiting qualified personnel. The Company historically has
filled a portion of its new personnel needs with non-U.S. citizens holding
temporary work visas that allow such persons to work in the U.S. for only a
limited period of time. Accordingly, any change in U.S. immigration policy
limiting the issuance of temporary work visas could adversely affect the
Company's ability to recruit new personnel. Furthermore, the addition of
significant numbers of new personnel requires the Company to incur
significant start-up expenses, including procurement of office space and
equipment, initial training costs and low utilization rates of new personnel.
There can be no assurance that the Company will successfully recruit
additional personnel as needed or that the start-up expenses incurred in
connection with the hiring of additional personnel could not materially
adversely affect the Company's future operating results.
DEPENDENCE ON KEY PERSONNEL
The Company's future success will depend to a significant extent upon
the continued service and performance of a relatively small number of key
senior management, technical personnel, sales and
Page 26
marketing personnel, none of whom is bound by an employment agreement. The
Company's success also depends upon its ability to continue to attract,
motivate and retain other highly qualified personnel, particularly personnel
with signaling and IP knowledge and experience. The loss of any existing key
personnel or the inability to attract, motivate and retain additional
qualified personnel could have a material adverse effect on the Company's
business, financial condition and results of operations.
RAPID TECHNOLOGICAL CHANGE AND DEPENDENCE ON NEW PRODUCTS
The market for the Company's products is characterized by rapid
technological advances, evolving industry and customer-specific protocol
standards, changes in customer requirements and frequent new product
introductions and enhancements. The introduction of communications network
management products involving superior technologies or the evolution of
alternative technologies or new industry protocol standards could render the
Company's existing products, as well as products currently under development,
obsolete and unmarketable. The Company believes its future success will
depend in part upon its ability, on a timely and cost-effective basis, to
continue to: enhance the network optimization and diagnostic products;
develop and introduce new products for the communications network management
market and other markets; address evolving industry protocol standards and
changing customer needs; and achieve broad market acceptance for its
products. There can be no assurance the Company will achieve these objectives.
The Company's future success will also depend in part on the Company's
ability to develop solutions for networks based on emerging technologies
(e.g., Asynchronous Transfer Mode and Internet telephony) which are likely to
be characterized by continuing technological developments, evolving industry
standards and changing customer requirements. There can be no assurance that
the Company will successfully develop competitive products for these emerging
technologies, and the failure to do so could have a material adverse effect
on the Company's business, financial condition and results of operations.
INTERNATIONAL OPERATIONS
Revenues from customers located outside of the U.S. represented 51.7%,
52.2% and 52.6% of the Company's revenues in 1999, 1998 and 1997,
respectively. Inet believes that continued growth and profitability will
require expansion of its sales efforts in international markets. This
expansion may be costly and time-consuming and may not generate returns for a
significant period of time, if at all. The Company's international operations
are subject to various risks inherent in international operations, including:
management of geographically dispersed operations; longer accounts receivable
payment cycles; the ability to establish relationships with government-owned
or subsidized communications providers; general economic conditions in each
country; currency controls and exchange rate fluctuations; seasonal
reductions in business activity particular to certain markets; loss of
revenues, property and equipment from expropriation, nationalization, war,
insurrection, terrorism and other political risks; foreign taxes and the
overlap of different tax structures; greater difficulty in safeguarding
intellectual property; import and export licensing requirements; trade
restrictions; and involuntary renegotiation of contracts with foreign
governments and communications carriers. International expansion of the
Company's business will require significant management attention and
financial resources. Moreover, in order to further expand internationally,
the Company may be required to establish relationships with additional
distributors and third-party integrators. There can be no assurance that the
Company will effectively establish such relationships. If international
revenues are not adequate to offset the additional expense of expanding
international operations, the Company's business, financial condition and
results of operations could be materially adversely affected.
To date, international sales have been denominated solely in U.S.
dollars, and accordingly the Company has not been exposed to fluctuations in
non-U.S. currency exchange rates. As a result, the
Page 27
Company's revenues in international markets may be adversely affected by a
strengthening U.S. dollar. However, the Company expects that in future
periods a portion of international sales may be denominated in currencies
other than U.S. dollars, thereby exposing the Company to gains and losses on
non-U.S. currency transactions. The Company may choose to limit such exposure
by entering into various hedging strategies. There can be no assurance that
any such hedging strategies undertaken by the Company could be successful in
avoiding exchange-related losses.
DEPENDENCE ON SOLE AND LIMITED SOURCE SUPPLIERS; DEPENDENCE ON SUBCONTRACTORS
AND LICENSED TECHNOLOGY
At present, the Company's products utilize certain semiconductors that
are available from only one manufacturer and other components that are
available from a limited number of suppliers. While alternative suppliers
have been identified for certain key components, those alternative sources
have not been qualified by the Company. The Company's qualification process
could be lengthy, and there can be no assurance that additional sources would
become available to the Company on a timely basis, or if such sources were to
become available, that the components would be comparable in price and
quality to the Company's current components. The Company has no long-term
agreements with its suppliers and generally makes its purchases with purchase
orders on an "as-needed basis." Furthermore, certain components require an
order lead-time of approximately six months. Other components that currently
are readily available may become difficult to obtain in the future.
Accordingly, the Company makes advance purchases of certain components in
relatively large quantities to ensure that it has an adequate and readily
available supply. The Company's failure to order sufficient quantities of
these components sufficiently in advance of product delivery deadlines could
prevent the Company from adequately responding to unanticipated increases in
customer orders. In the past, the Company has experienced delays in the
receipt of certain of its key components, which have resulted in delays in
product deliveries. The inability to obtain sufficient key components as
required or 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, which in turn could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company relies exclusively upon third-party subcontractors to
manufacture its subassemblies. The Company has also retained, from time to
time, third-party design services in the development of application-specific
integrated circuits. The Company's reliance on third-party subcontractors
involves a number of risks, including the potential absence of adequate
capacity, the unavailability of or interruption in access to certain process
technologies, and reduced control over product quality, delivery schedules,
manufacturing yields and costs. Any disruption in the Company's relationships
with third-party subcontractors and the Company's 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, which in
turn could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company relies upon certain software that it licenses from third
parties, including software that is integrated with the Company's internally
developed software and used in its products to perform key functions. The
inability to maintain any such software licenses on commercially reasonable
terms could result in shipment delays or reductions until equivalent software
could be developed or licensed and integrated into the Company's products,
which could materially adversely affect the Company's business, financial
condition and results of operations.
POTENTIAL ACQUISITIONS
Page 28
The Company may in the future pursue acquisitions of businesses,
products and technologies, or the establishment of joint venture
arrangements, that could expand the Company's business. The negotiation of
potential acquisitions or joint ventures as well as the integration of an
acquired or jointly developed business, technology or product could cause
diversion of management's time and resources. Future acquisitions and joint
ventures by the Company could result in potentially dilutive issuances of
equity securities, the incurrence of debt and contingent liabilities,
amortization of goodwill and other intangibles, research and development
write-offs and other acquisition-related expenses. Further, no assurance can
be given that any acquisition or joint venture will be successfully
integrated with the Company's operations. If any such acquisition or joint
venture were to occur, there can be no assurance that the Company will
receive the intended benefits of the acquisition or joint venture.
PROPRIETARY RIGHTS
The communications industry is characterized by the existence of a large
number of patents and frequent allegations of patent infringement. The
Company has received, and may receive in the future, notices from holders of
patents that raise issues as to possible infringement by the Company's
products. As the number of communications network management products
increases and the functionality of these products further overlaps, the
Company believes that it may become increasingly subject to allegations of
infringement. To date, the Company has engaged in correspondence with
third-party holders of patents as a result of two such notices. The Company
believes that its products do not infringe any valid patents cited in the
notices received. However, questions of infringement and the validity of
patents in the field of communications signaling technologies involve highly
technical and subjective analyses. There can be no assurance that any such
patent holders or others will not in the future initiate legal proceedings
against the Company or that, if any such proceedings were initiated, the
Company could be successful in defending against such proceedings. Any such
proceeding could be time consuming and expensive to defend or resolve, result
in substantial diversion of management resources, cause product shipment
delays, or force the Company to enter into royalty or license agreements
rather than dispute the merits of any such proceeding initiated against the
Company. There can be no assurance that any such royalty or license
agreements could be available on terms acceptable to the Company, if at all.
Any such claims against the Company, with or without merit, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company's continued success is dependent in part upon its
proprietary technology. To protect its proprietary technology, the Company
relies 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 the Company's proprietary rights in the
products to the same extent as do the laws of the U.S. Despite the measures
taken by the Company, it may be possible for a third party to copy or
otherwise obtain and use the Company's proprietary technology and information
without authorization. Policing unauthorized use of the Company's products is
difficult, and litigation may be necessary in the future to enforce the
Company's intellectual property rights. Any such litigation could be time
consuming and expensive to prosecute or resolve, result in substantial
diversion of management resources, and have a material adverse effect on the
Company's business, financial condition and results of operations. There can
be no assurance that the Company will be successful in protecting its
proprietary technology or that the Company's proprietary rights will provide
a meaningful competitive advantage to the Company.
PRODUCT LIABILITY
Products as complex as those offered by the Company may contain
undetected defects or errors when first introduced or as enhancements are
released that, despite testing by the Company, are not discovered until after
a product has been installed and used by customers, which could result in
delayed market
Page 29
acceptance of the product or damage to the Company's reputation and business.
To date, the Company has not been materially adversely affected by products
containing defects or errors. The Company attempts to include provisions in
its agreements with customers that are intended to limit the Company's
exposure to potential liability for damages arising out of defects or errors
in or the use of the Company's products. However, the nature and extent of
such limitations tend to vary from customer to customer and it is possible
that such limitations may not be effective as a result of unfavorable
judicial decisions or laws enacted in the future. Although the Company has
not experienced any product liability suits to date, the sale and support of
the Company's products entails the risk of such claims. Any product liability
claim brought against the Company, regardless of its merit, could result in
material expense to the Company, diversion of management time and attention,
and damage to the Company's business reputation and its ability to retain
existing customers or attract new customers.
CONTROL BY PRINCIPAL STOCKHOLDERS
As of December 31, 1999, the Company's three founders, Samuel S.
Simonian, Elie S. Akilian and Mark A. Weinzierl beneficially owned
approximately 83% of the outstanding shares of common stock. Consequently,
two or more of such individuals, acting together, could control the outcome
of all matters submitted for stockholder action, including the election of
the Board of Directors of the Company and the approval of significant
corporate transactions, and could effectively control the management and
affairs of the Company, which could have the effect of delaying or preventing
a change in control of the Company. In addition, Messrs. Simonian, Akilian
and Weinzierl constitute three of the six members of the Board of Directors
and could have significant influence in directing the actions taken by the
Board.
SECURITY
The Company has included security features in certain of its products
that are intended to protect the privacy and integrity of customer data.
Despite the existence of these security features, the Company's products may
be vulnerable to breaches in security due to 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 the Company's customers. Solving any security problems
may require significant capital expenditures and could adversely affect the
Company's reputation and product acceptance which, in turn, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
ANTI-TAKEOVER PROVISIONS
Certain provisions of the Company's Certificate of Incorporation and
Bylaws may have the effect of discouraging, delaying or preventing a change
in control of the Company or unsolicited acquisition proposals that a
stockholder may consider favorable, including: provisions authorizing the
issuance of "blank check" preferred stock; providing for a classified Board
of Directors with staggered three-year terms; prohibiting cumulative voting
in the election of directors; requiring super-majority voting to effect
certain amendments to the Certificate of Incorporation and Bylaws; limiting
the persons who may call special meetings of stockholders; prohibiting
stockholder action by written consent; and establishing advance notice
requirements for nominations for election to the Board of Directors or for
proposing matters that can be acted upon at stockholders meetings. Certain
provisions of Delaware law and the Company's stock incentive plans may also
have the effect of discouraging, delaying or preventing a change in control
of the Company or unsolicited acquisition proposals.
POSSIBLE VOLATILITY OF STOCK PRICE
Page 30
The market price of our common stock has been, and is likely to continue
to be, highly volatile and may be significantly affected by factors such as
variations in the Company's results of operations; future sales of common
stock; the announcement of technological innovations or new products by the
Company, its competitors and others; market analysts' estimates of the
Company's performance; and general market conditions. The public markets have
experienced volatility that has particularly affected the market prices of
securities of many technology companies for reasons that have often been
unrelated to operating results. Such volatility may adversely affect the
market price of the common stock and the Company's visibility and credibility
in its markets.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to immaterial levels of market risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See the consolidated financial statements of the Company included herein
and listed under the heading "(a) (1) Consolidated Financial Statements" of
Part IV Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
Page 31
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information called for by Item 10 will be set forth under the caption
"ELECTION OF DIRECTORS" in the Company's definitive Proxy Statement for the
2000 Annual Meeting of Stockholders, which will be filed not later than 120
days after the end of the fiscal year ended December 31, 1999, and is
incorporated herein by this reference.
ITEM 11. EXECUTIVE COMPENSATION.
Information called for by Item 11 will be set forth under the caption
"EXECUTIVE COMPENSATION" in the Company's definitive Proxy Statement for the
2000 Annual Meeting of Stockholders, which will be filed not later than 120
days after the end of the fiscal year ended December 31, 1999, and is
incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information called for by Item 12 will be set forth under the caption
"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" in the
Company's definitive Proxy Statement for the 2000 Annual Meeting of
Stockholders, which will be filed not later than 120 days after the end of
the fiscal year ended December 31, 1999, and is incorporated herein by this
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information called for by Item 13 will be set forth under the caption
"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" in the Company's definitive
Proxy Statement for the 2000 Annual Meeting of Stockholders, which will be
filed not later than 120 days after the end of the fiscal year ended December
31, 1999, and is incorporated herein by this reference.
Page 32
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) (1) Consolidated Financial Statements
Report of Independent Auditors...................................................................... F-1
Consolidated Balance Sheets as of December 31, 1999 and 1998........................................ F-2
Consolidated Statements of Income for the years ended December 31, 1999, 1998 and 1997.............. F-3
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999,
1998 and 1997.................................................................................... F-4
Consolidated Statements of Cash Flows for the years ended December 31, 1999,
1998 and 1997.................................................................................... F-5
Notes to Consolidated Financial Statements.......................................................... F-6
Report of Independent Auditors...................................................................... S-1
Schedule II - Valuation and Qualifying Accounts for the years ended December 31, 1999,
1998 and 1997.................................................................................... S-2
(2) Financial Statement Schedules
The schedule listed in the Index to Financial Statements and Schedule
included in the Table of Contents on page 1 is filed as part of this
report. Other schedules have been omitted because the information
required to be set forth therein is not applicable or is shown in the
financial statements or the notes thereto.
(3) Exhibits
The following Exhibits are incorporated herein by reference or are
filed with this report as indicated below. The exhibits filed with this
report have been included only with the copy filed with the Securities
and Exchange Commission. Copies of exhibits will be furnished, upon
request, subject to payment of a reasonable fee to reimburse Inet
Technologies, Inc. for reproduction costs.
EXHIBIT
NUMBER DESCRIPTION
------ -----------
3.1* Certificate of Incorporation (filed as Exhibit 3.1
to the registrant's Registration Statement on Form
S-1 (Reg. No. 333-59753) (the "Form S-1"))
3.2* Amended and Restated Bylaws (filed as Exhibit 3.2
to the Form S-1)
4.1* Specimen Common Stock certificate (filed as
Exhibit 4.1 to the Form S-1)
4.2* See Exhibits 3.1 and 3.2 for provisions of the
Certificate of Incorporation and Bylaws of the
registrant defining the rights of holders of
common stock
10.1* Lease dated as of May 1, 1996 by and among Pitman
Partners, Ltd., Rosewood Property Company and the
registrant (filed as Exhibit 10.1 to the Form S-1)
10.2* Loan Agreement dated as of June 26, 1997 by and
between NationsBank of Texas, N.A. and the
registrant (filed as Exhibit 10.2 to the Form S-1)
10.3* Inet Technologies, Inc. 1998 Stock Option/Stock
Issuance Plan (filed as Exhibit 10.3 to the Form
S-1)
10.4* Form of Indemnification Agreement between the
registrant and each of its directors and executive
officers (filed as Exhibit 10.4 to the Form S-1)
Page 33
10.5* Form of Registration Rights Agreement, dated as of
July 17, 1998 by and among the registrant, Samuel
S. Simonian, Elie S. Akilian and Mark A. Weinzierl
(filed as Exhibit 10.5 to the Form S-1)
10.6* Renewal, Extension and First Amendment to Loan
Agreement entered into to be effective as of June
15, 1998 between the the registrant and
NationsBank of Texas, N.A. (filed as Exhibit 10.6
to the Form S-1)
10.7* Fourth Amendment to office lease dated as of July
15, 1998 by and among Pitman Partners, Ltd.,
Rosewood Property Company and the registrant
(filed as Exhibit 10.7 to the Form S-1)
10.8* Assumption and Modification Agreement, dated
effective as of July 16, 1998, between the
registrant and NationsBank of Texas, N.A. (filed
as Exhibit 10.8 to the Form S-1)
10.9 Employee Stock Purchase Plan (filed as Exhibit
99.11 to the registrant's Registration Statement
on Form S-8 (Reg. No. 333-83285)
10.10 Lease dated as of January 27, 2000 by and among
Collins Crossing, LTD., a Texas limited
partnership and the registrant
21.1 Subsidiaries of the registrant
23.1 Consent of Ernst & Young LLP
24.1 Power of Attorney, pursuant to which amendments to
this report may be filed, is included on the
signature page contained in Part IV hereof)
27.1 Financial data schedule for the year ended
December 31, 1999
* Incorporated herein by reference to the indicated filing.
(b) Reports on Form 8-K
Inet Technologies, Inc. did not file any Current Reports on Form 8-K
during the fourth quarter of 1999.
Page 34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
INET TECHNOLOGIES, INC.
Date: March 3, 2000 By: /s/ ELIE S. AKILIAN
--------------------------------------
Elie S. Akilian
President and Chief
Executive Officer
and Director
(principal executive officer)
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes and
constitutes Elie S. Akilian and Jeffrey A. Kupp, and each of them singly, his
true and lawful attorneys-in-fact with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities to sign and file any and all amendments to this report with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, and he hereby ratifies and confirms all
that said attorneys-in-fact or any of them, or their substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: March 3, 2000 By: /s/ Samuel S. Simonian
--------------------------------------
Samuel S. Simonian
Chairman of the Board
Date: March 3, 2000 By: /s/ Elie S. Akilian
--------------------------------------
Elie S. Akilian
President and Chief
Executive Officer
and Director
(principal executive officer)
Date: March 3, 2000 By: /s/ Mark A. Weinzierl
--------------------------------------
Mark A. Weinzierl
Secretary and Director
Date: March 3, 2000 By: /s/ William H. Mina
--------------------------------------
William H. Mina
Senior Vice President,
Page 35
Administration and Legal Affairs
and Director
Date: March 3, 2000 By: /s/ Jeffrey A. Kupp
--------------------------------------
Jeffrey A. Kupp
Vice President and Chief Financial
Officer
(principal financial and accounting
officer)
Date: March 3, 2000 By: /s/ James R. Adams
--------------------------------------
James R. Adams
Director
Date: March 3, 2000 By: /s/ Grant A. Dove
--------------------------------------
Grant A. Dove
Director
Page 36
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Inet Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Inet
Technologies, Inc. (the "Company") as of December 31, 1999 and 1998, and the
related consolidated statements of income, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1999.
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Inet
Technologies, Inc. at December 31, 1999 and 1998, and the consolidated
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States.
ERNST & YOUNG LLP
Dallas, Texas
January 27, 2000
Page F-1
INET TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
-----------------------
1999 1998
----------- ----------
(IN THOUSANDS, EXCEPT
SHARE DATA)
Current assets:
Cash and cash equivalents............................................................. $127,903 $21,914
Trade accounts receivable, net of allowance for doubtful
accounts of $939 and $659 at December 31, 1999
and 1998, respectively............................................................. 20,781 22,073
Unbilled receivables.................................................................. 2,196 1,602
Inventories........................................................................... 5,893 7,592
Deferred income taxes................................................................. 2,318 2,568
Other current assets.................................................................. 1,312 1,248
-------- -------
Total current assets.......................................................... 160,403 56,997
Property and equipment, net............................................................. 9,324 8,394
Deferred income taxes................................................................... 6 --
Other assets............................................................................ 184 117
-------- -------
Total assets.................................................................. $169,917 $65,508
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................................................... $ 2,599 $ 1,858
Accrued compensation and benefits..................................................... 5,252 2,159
Deferred revenue...................................................................... 26,432 13,073
Taxes payable......................................................................... 213 878
Other accrued liabilities............................................................. 1,998 716
-------- -------
Total current liabilities..................................................... 36,494 18,684
Deferred tax liabilities................................................................ -- 11
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares-- 25,000,000
Issued shares-- None............................................................... -- --
Common stock, $.001 par value:
Authorized shares -- 175,000,000
Issued shares -- 45,312,759 at December 31, 1999 and
40,934,422 at December 31, 1998.................................................. 45 41
Additional paid-in capital............................................................ 57,693 1,236
Unearned compensation................................................................. (233) (464)
Retained earnings..................................................................... 75,918 46,217
Treasury stock, no common shares at December 31, 1999,
38,842 common shares at December 31, 1998, at cost................................. -- (217)
-------- -------
Total stockholders' equity.................................................... 133,423 46,813
-------- -------
Total liabilities and stockholders' equity.................................... $169,917 $65,508
======== =======
See accompanying notes to consolidated financial statements.
Page F-2
INET TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-------------------------------------
1999 1998 1997
---------- ---------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues.......................................... $ 109,983 $ 77,428 $ 57,701
Cost of revenues.................................. 31,755 22,404 15,783
--------- --------- ---------
Gross profit............................ 78,228 55,024 41,918
Operating expenses:
Research and development expenses............... 21,793 15,667 9,658
Sales and marketing expenses.................... 12,646 8,612 7,741
General and administrative expenses............. 9,037 6,592 5,423
--------- --------- ---------
43,476 30,871 22,822
--------- --------- ---------
Income from operations.................. 34,752 24,153 19,096
Other income (expense):
Gain (loss) on sale of assets................... 5,924 (7) (8)
Interest income................................. 3,991 833 147
Other income (expense).......................... (4) 1 (123)
---------- --------- ----------
9,911 827 16
--------- --------- ---------
Income before provision for income
taxes................................. 44,663 24,980 19,112
Provision for income taxes........................ 14,962 7,895 6,398
--------- --------- ---------
Net income.............................. $ 29,701 $ 17,085 $ 12,714
========== ========== ==========
Earnings per common share:
Basic................................... $ 0.68 $ 0.42 $ 0.31
========== ========== ==========
Diluted................................. $ 0.66 $ 0.40 $ 0.30
========== ========== ==========
Weighted average shares outstanding:
Basic................................... 43,449 40,879 40,855
========== ========== ========
Diluted................................. 45,037 42,452 41,722
========== ========== ========
See accompanying notes to consolidated financial statements.
Page F-3
INET TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ADDITIONAL TREASURY STOCK TOTAL
------------------ PAID-IN UNEARNED RETAINED ------------------ STOCKHOLDERS'
SHARES AMOUNT CAPITAL COMPENSATION EARNINGS SHARES AMOUNT EQUITY
------ ------ ------- ------------ -------- ------ ------ ------
(IN THOUSANDS, EXCEPT SHARE DATA)
Balance at December 31, 1996... 40,850,422 $41 $ 372 $ -- $16,418 38,842 $(217) $16,614
Issuance of common stock..... 50,000 -- 58 -- -- -- -- 58
Net income................... -- -- -- -- 12,714 -- -- 12,714
---------- ---- ------- ------ ------- ------ ----- -------
Balance at December 31, 1997... 40,900,422 41 430 -- 29,132 38,842 (217) 29,386
Issuance of common stock..... 19,000 -- 106 -- -- -- -- 106
Issuance of common stock upon
exercise of employee stock
options.................... 15,000 -- 9 -- -- -- -- 9
Net income................... -- -- -- -- 17,085 -- -- 17,085
Stock option compensation.... -- -- 691 (464) -- -- -- 227
---------- ---- ------- ------ ------- ------ ----- -------
Balance at December 31, 1998... 40,934,422 $ 41 $ 1,236 $ (464) $46,217 38,842 $(217) $46,813
========== ==== ======= ====== ======= ====== ===== =======
Issuance of common stock for
cash in initial public
offering, net.............. 3,802,637 4 55,478 -- -- (38,842) 217 55,699
Issuance of common stock
upon exercise of employee
stock options.............. 575,700 -- 426 -- -- -- -- 426
Net income................... -- -- -- -- 29,701 -- -- 29,701
Stock option compensation.... -- -- 553 231 -- -- -- 784
---------- ---- ------- ------ ------- ----- ----- --------
Balance at December 31, 1999... 45,312,759 $ 45 $57,693 $ (233) $75,918 -- $ -- $133,423
========== ==== ======= ====== ======= ===== ===== ========
See accompanying notes to consolidated financial statements.
Page F-4
INET TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
1999 1998 1997
----------- ---------- --------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.......................................... $ 29,701 $ 17,085 $ 12,714
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation...................................... 3,955 2,752 1,521
(Gain) loss on sale or disposal of assets......... (5,924) 7 8
Deferred income taxes............................. 233 (3,427) 63
Issuance of common stock and stock options charged
to expense....................................... 231 333 58
Change in assets and liabilities:
(Increase) decrease in trade accounts receivable 1,119 (6,241) (2,596)
(Increase) decrease in unbilled receivables.... (594) 4,203 (2,392)
(Increase) decrease in inventories............. 1,669 (629) (450)
(Increase) decrease in other assets............ (139) 245 (1,303)
Increase (decrease) in accounts payable........ 741 529 (2,105)
Increase (decrease) in taxes payable........... (665) 618 121
Increase (decrease) in accrued compensation and
benefits..................................... 3,093 (78) 1,161
Increase in deferred revenue................... 13,359 8,912 1,629
Increase (decrease) in other accrued liabilities 1,282 201 (637)
---------- --------- ---------
Net cash provided by operating activities........... 48,061 24,510 7,792
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment................. (5,197) (5,991) (3,798)
Proceeds from sale of assets........................ 7,000 -- --
---------- --------- ---------
Net cash provided by (used in) investing activities. 1,803 (5,991) (3,798)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock in initial
public offering, net............................. 55,699 -- --
Proceeds from issuance of common stock upon exercise
of stock options................................. 426 9 --
Payments of note payable............................ -- -- (7,068)
Proceeds from note payable.......................... -- -- 5,718
---------- --------- ---------
Net cash provided by (used in) financing activities. 56,125 9 (1,350)
---------- --------- ---------
Net increase in cash and cash equivalents........... 105,989 18,528 2,644
Cash and cash equivalents at beginning of period.... 21,914 3,386 742
---------- --------- ---------
Cash and cash equivalents at end of period.......... $ 127,903 $ 21,914 $ 3,386
========== ========= =========
SUPPLEMENTAL DISCLOSURES:
Interest paid.................................... $ -- $ -- $ 123
========== ========= =========
Income taxes paid................................ $ 15,329 $ 9,263 $ 6,390
========== ========= =========
See accompanying notes to consolidated financial statements.
Page F-5
INET TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
Inet Technologies, Inc. (the "Company" or "Inet") provides
communications software solutions that enable carriers to more effectively
design, deploy, diagnose, monitor and manage communications networks that
carry signaling information used to manage communications sessions which
include phone calls, dial-up Internet access, and other service transactions.
The Company's products also address the fundamental business needs of
communications carriers, such as improved billing, targeted sales and
marketing, fraud prevention and enhanced routing. The Company currently
provides these comprehensive solutions primarily through its GeoProbe and
Spectra product offerings.
CONSOLIDATION
The consolidated financial statements include the accounts of the
Company's wholly-owned subsidiaries. Intercompany balances and transactions
have been eliminated.
CASH AND CASH EQUIVALENTS
All highly liquid securities with original maturities of three months or
less are classified as cash equivalents. The carrying value of cash
equivalents approximates fair market value.
INVENTORIES
Inventories are valued at the lower of standard cost, which approximates
actual cost determined on a first-in, first-out basis, or market. Inventories
consist of the following (in thousands):
DECEMBER 31,
---------------------
1999 1998
-------- ---------
Raw materials.................... $ 1,791 $ 1,895
Work-in-process.................. 241 2,289
Finished goods................... 3,861 3,408
-------- ---------
$ 5,893 $ 7,592
======== =========
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation
and amortization and are depreciated on a straight-line basis over their
estimated useful lives, as follows:
Computers and other equipment........... 3-5 Years
Software................................ 3 Years
Office furniture and fixtures........... 7 Years
Leasehold improvements.................. Term of lease
Page F-6
RESEARCH AND DEVELOPMENT EXPENDITURES
Software development costs are expensed as incurred until technological
feasibility has been established, at which time subsequent costs are
capitalized until the product is available for general release to customers.
To date, either the establishment of technological feasibility of the
Company's products and their general release have substantially coincided 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 the Company has not
capitalized any software development costs. Research and development
expenditures are charged to expense in the period incurred.
REVENUE RECOGNITION
Effective January 1, 1998, the Company adopted Statement of Position
("SOP") 97-2, SOFTWARE REVENUE RECOGNITION, as amended by SOP 98-4, DEFERRAL
OF THE EFFECTIVE DATE OF CERTAIN PROVISIONS OF SOP 97-2, which did not
require a significant change to the Company's revenue recognition policies.
The Company derives revenues from the sale of products and related
product installation, integration and post-contract support service to the
communications industry. Product revenues are generally recognized in the
period the Company has completed all hardware manufacturing and/or software
development to contractual specifications, factory testing has been
completed, the product has been shipped to the customer, the fee is fixed and
determinable and collection is considered probable by the Company's
management. When the Company has significant obligations subsequent to
shipment (e.g., installation and system integration), revenues are not
recognized prior to the time the system has been delivered and installed at
the customer's premises and there are no significant unfulfilled obligations.
Revenues from arrangements that include significant acceptance terms are not
recognized until acceptance has occurred.
The Company provides its customers with post-contract support services,
which include the correction of software problems, telephone access to the
Company's technical personnel and the right to receive unspecified product
updates, upgrades and enhancements. Revenues from these services, including
product support services included in initial licensing fees, are recognized
ratably over the contract period. Post-contract support services included in
the initial licensing fee are allocated from the total contract amount based
on the relative fair value of these services determined using vendor-specific
objective evidence ("VSOE").
Deferred revenue primarily represents amounts billed to customers
pursuant to terms specified in contracts but for which revenue has not been
recognized.
In December 1998, SOP 98-9, MODIFICATION OF SOP 97-2, `SOFTWARE REVENUE
RECOGNITION' WITH RESPECT TO CERTAIN TRANSACTIONS, was released. SOP 98-9
amends SOP 97-2 to require that an entity recognize revenue for multiple
element arrangements by means of the "residual method" when (1) there is VSOE
of the fair values of all of the undelivered elements that are not accounted
for by means of long-term contract accounting, (2) VSOE of fair value does
not exist for one or more of the delivered elements, and (3) all revenue
recognition criteria of SOP 97-2 (other than the requirement for VSOE of the
fair value of each delivered element) are satisfied.
The provisions of SOP 98-9 that extend the deferral of certain passages
of SOP 97-2 became effective December 15, 1998. All other provisions of SOP
98-9 will be effective for the Company's
Page F-7
fiscal year beginning January 1, 2000. Retroactive application is prohibited.
SOP 98-9 is not expected to have a material impact on the Company's current
revenue recognition policies.
STOCK OPTIONS
The Company has elected to follow Accounting Principles Board Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), in accounting
for its employee stock options. Under APB 25, if the exercise price of an
employee's stock options equals or exceeds the market price of the underlying
stock on the date of grant, no compensation expense is recognized.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash and cash equivalents
and trade accounts receivable. The Company sells products and services to
customers associated with the communications industry, both within the United
States and internationally. The Company continually evaluates the
creditworthiness of its customers' financial condition and generally does not
require collateral. The Company has not experienced significant losses on
uncollectible accounts. All cash equivalents are maintained with nationally
recognized financial institutions.
RISKS AND UNCERTAINTIES
The Company's future results of operations and financial condition could
be impacted by the following factors, among others: dependence on the
communications industry, lengthy sales cycle, product concentration, reliance
on signaling networks, competition, dependence on key personnel, rapid
technological change and dependence on new products, international
operations, potential acquisitions, proprietary rights, and product liability.
ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
BASIS OF PRESENTATION
Certain prior period amounts have been reclassified to conform to the
current period presentation.
EARNINGS PER SHARE
Basic earnings per common share data is computed using the weighted
average number of common shares outstanding for the relevant period. Diluted
earnings per common share data is computed using the weighted average number
of common shares outstanding plus common share equivalents represented by
stock options and purchase rights, if such stock options and purchase rights
have a dilutive effect in the aggregate.
Page F-8
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except share and per share data):
YEARS ENDED DECEMBER 31,
1999 1998 1997
-------- -------- --------
Numerator:
Net income for basic and diluted
earnings per share..................... $29,701 $17,085 $12,714
======= ======= =======
Denominator:
Denominator for basic earnings per
share-- weighted average shares........ 43,449 40,879 40,855
Effect of dilutive securities:
Employee stock options and purchase rights 1,588 1,573 867
------- ------- -------
Dilutive potential common shares......... 1,588 1,573 867
------- ------- -------
Denominator for diluted earnings
per share -- adjusted
weighted-average shares................ 45,037 42,452 41,722
======= ======= =======
Basic earnings per common share............ $ 0.68 $ 0.42 $ 0.31
======= ======= =======
Diluted earnings per common share.......... $ 0.66 $ 0.40 $ 0.30
======= ======= =======
DERIVATIVES
The Financial Accounting Standards Board ("FASB") recently issued
Statement No. 137, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES-DEFERRAL OF EFFECTIVE DATE OF FASB STATEMENT NO. 133. The
Statement defers for one year the effective date of FASB Statement No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. The rule now
will apply to all fiscal quarters of all fiscal years beginning after June
15, 2000. FASB Statement No. 133 will require the Company to recognize all
derivatives on the balance sheet at fair value. Derivatives that are not
hedges must be adjusted to fair value through income. If the derivative is a
hedge, depending on the nature of the hedge, changes in the fair value of
derivatives will either be offset against the change in fair value of the
hedged assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized
in earnings. The ineffective portion of a derivative's change in fair value
will be immediately recognized in earnings. The Company does not expect the
adoption of the Statement to have a material impact on the Company's
financial statements.
2. INITIAL PUBLIC OFFERING
In June 1999, the Company completed the initial public offering of its
common stock. The Company sold 3,841,479 shares of its common stock at an
initial public offering price of $16.00 per share. Net proceeds to the
Company, after deduction of the underwriting discount and expenses, were
approximately $55.7 million.
Page F-9
3. RELATED PARTY TRANSACTIONS
In September 1999, the Company sold its wireless data assets to
Nextcell, Inc., an entity controlled by a related party, for a total purchase
price of $7.0 million, resulting in a pre-tax gain of $5.9 million. The
Company recognized $553,000 of compensation expense related to the
accelerated vesting of certain stock options for employees affected by the
sale.
Effective January 1, 2000, the Company sold its membership interest in
Inet Global Research, L.L.C., to an entity controlled by a related party for
a cash purchase price of $82,000. No gain or loss was recorded for the sale.
The Company intends to enter into an agreement whereby this entity will
perform contract services for the Company.
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
DECEMBER 31,
---------- ----------
1999 1998
---------- ----------
Computer and other equipment.................................. $ 13,236 $ 9,709
Software...................................................... 3,297 2,990
Office furniture, fixtures, and leasehold improvements........ 2,299 1,768
---------- ----------
18,832 14,467
Less accumulated depreciation and amortization................ 9,508 6,073
---------- ---------
$ 9,324 $ 8,394
========== =========
5. LINE OF CREDIT FACILITY
The Company has available a line of credit facility with a bank
providing for borrowings of up to $10.0 million which expires June 15, 2000.
Up to $5.0 million may be utilized to support letters of credit. The per
annum usage fee on unused portions of the line is 0.125%. Borrowings under
this facility bear interest payable quarterly at LIBOR plus 1.5% (7.5% at
December 31, 1999) and are collateralized by the Company's accounts
receivable, inventories, and property and equipment. The credit facility
includes covenants requiring the Company to maintain certain financial ratios
and restricts the payment of cash dividends without the bank's consent. At
December 31, 1999, no letters of credit or borrowings were outstanding under
the credit facility, and the amount available to the Company was $10.0
million.
6. INCOME TAXES
Components of the provision for income taxes were as follows (in
thousands):
YEARS ENDED DECEMBER 31,
1999 1998 1997
---------- ---------- ---------
Current federal provision................ $ 13,731 $ 10,630 $ 5,706
Current state provision.................. 654 645 616
Deferred federal expense (benefit)....... 118 (2,830) (82)
Current foreign provision................ 344 47 13
Page F-10
Deferred state expense (benefit)......... 115 (597) 145
--------- --------- -------
Total income tax provision..... $ 14,962 $ 7,895 $ 6,398
========= ========= =======
The provision for income taxes is reconciled with the federal statutory
rate as follows (in thousands):
YEARS ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ---------- ----------
Provision computed at federal statutory rate........ $ 15,632 $ 8,743 $ 6,689
Research and development tax credits............... (836) (342) (305)
Foreign Sales Corporation income exemption.......... (783) (687) (500)
State income taxes, net of federal tax effect....... 639 31 481
Other............................................... 310 150 33
-------- -------- --------
$ 14,962 $ 7,895 $ 6,398
======== ======== ========
The significant components of the Company's deferred tax assets and
liabilities were as follows (in thousands):
DECEMBER 31,
-----------------------
1999 1998
--------- ----------
Deferred tax assets:
Deferred revenue...................................... $ 837 $ 1,498
Reserves and other accrued expenses not currently
deductible for tax purposes........................ 986 1,160
Research and development tax credit carryover......... 418 --
Other................................................. 259 85
--------- ---------
Total deferred tax assets..................... 2,500 2,743
--------- ---------
Deferred tax liabilities:
Depreciation.......................................... (176) (186)
---------- ----------
Total deferred tax liabilities................ (176) (186)
---------- ---------
Deferred income tax assets, net of deferred income tax
liabilities.......................................... $ 2,324 $ 2,557
========= =========
7. OPERATING LEASES
The Company leases its corporate office facility as well as certain
equipment under noncancelable operating lease agreements. Rental expense for
these operating leases was $1.9 million, $1.4 million, and $900,000 in 1999,
1998, and 1997, respectively.
At December 31, 1999, future minimum lease payments under noncancelable
operating leases were as follows (in thousands):
AMOUNTS
-------
2000..... $ 1,209
2001..... 120
2002..... 38
2003..... 7
----------
$ 1,374
==========
Page F-11
On January 27, 2000, the Company signed a ten-year lease agreement for
office space to replace its existing leases for the Company's operations.
Future minimum lease payments under the new lease are approximately $1.0
million in 2000 and $4.2 million in each of the following four years.
Page F-12
8. STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Board of Directors has the authority to issue up to 25,000,000
shares of Preferred Stock in one or more series and to fix the rights,
preferences, privileges and restrictions thereof, including dividend rights,
dividend rates, conversion rights, voting rights, terms of redemption,
redemption prices, liquidation preferences and the number of shares
constituting any series or the designation of such series, without further
vote or action by the stockholders.
EMPLOYEE STOCK OPTION AND STOCK PURCHASE PLANS
The Company's 1998 Stock Option/Stock Issuance Plan (the "1998 Plan") is
the successor equity incentive program to the Company's 1995 Employee Stock
Option Plan (the "1995 Plan"). The 1998 Plan became effective on July 23,
1998 upon adoption by the Board of Directors and was subsequently approved by
the stockholders on July 23, 1998. Common stock authorized for issuance under
the 1998 Plan is 6,750,000 shares. The share reserve will automatically be
increased on the last trading day of January each calendar year, beginning in
January 2000, by a number of shares equal to one percent (1%) of the total
number of shares of common stock outstanding on the last trading day of the
immediately preceding calendar year, but no such annual increase shall exceed
500,000 shares. However, in no event may any one participant in the 1998 Plan
receive option grants or direct stock issuances for more than 1,000,000
shares in the aggregate per calendar year. During the year ended December 31,
1999, all stock options granted were under the 1998 Plan.
The 1998 Plan is divided into three separate components: (i) the
Discretionary Option Grant Program under which eligible individuals in the
Company's employ or service (including officers, non-employee directors and
consultants) may, at the discretion of the plan administrator, be granted
options to purchase shares of common stock at an exercise price determined by
the plan administrator, which is generally the fair market value of those
shares on the grant date, (ii) the Stock Issuance Program under which such
individuals may, in the plan administrator's discretion, be issued shares of
common stock directly, through the purchase of such shares at a price
determined by the plan administrator or as a bonus tied to the performance of
services and (iii) the Automatic Option Grant Program under which option
grants will automatically be made at periodic intervals to eligible
non-employee directors to purchase shares of common stock at an exercise
price equal to 100% of the fair market value of those shares on the grant
date. Generally, options granted under the Discretionary Option Grant Program
become exercisable ratably over a period of four years and expire ten years
from the date of grant. Options granted under the Automatic Option Grant
Program are immediately exercisable, vest ratably over a period of three
years, and expire ten years from the date of grant.
The Company's 1995 Plan provided for incentive options and nonqualified
options that were granted to key employees, officers and directors of the
Company. Options were granted generally at prices not less than the fair
value of the Company's common stock as determined by the Stock Option
Committee of the Company's Board of Directors (the "Committee") at the dates
of grant. Options granted under the 1995 Plan vest at rates established by
the Committee and expire ten years after the date of grant.
Outstanding options under the 1995 Plan have been incorporated into the
1998 Plan, and no further option grants will be made under the 1995 Plan. The
incorporated options will continue to be governed by their existing terms,
unless the plan administrator elects to extend one or more features of the
1998 Plan
Page F-13
to those options. However, except as otherwise noted below, the outstanding
options under the 1995 Plan contain substantially the same terms and
conditions summarized below for the Discretionary Option Grant Program in
effect under the 1998 Plan.
Options granted in the first quarter of 1998 at $4.20 per share had a
fair market value of $5.57 per share, which resulted in a total of $692,000 of
compensation expense which is being recognized ratably over the vesting period
of three years beginning in the first quarter of 1998. The Company recorded
$231,000 and $227,000 of compensation expense in 1999 and 1998, respectively,
related to these grants. The Company recorded no compensation expense in 1997.
Stock option transactions for the years ended December 31, 1999, 1998,
and 1997, are summarized as follows:
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
1999 1998 1997
----------------------- ----------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------------- -------- ------------ -------- ------------ ---------
Outstanding at beginning of
period:.................. 1,947,000 $ 1.67 1,531,750 $ 0.80 1,220,000 $ 0.64
Granted.................... 489,250 27.88 506,000 4.20 381,750 1.31
Exercised.................. (575,700) 0.74 (15,000) 0.60 -- --
Forfeited.................. (18,600) 11.73 (75,750) 1.16 (70,000) 0.86
------------ ----------- -----------
Outstanding at end of
period................... 1,841,950 8.82 1,947,000 1.67 1,531,750 0.80
=========== =========== ===========
Weighted-average fair value
of options granted during
the period...................$ 17.21 $ 2.12 $ 0.26
=========== =========== ===========
At December 31, 1999, 700,900 shares were exercisable at a weighted
average exercise price of $1.88 and 6,268,350 shares were available for
future grants to employees under the 1998 Plan.
Information related to options outstanding at December 31, 1999, is
summarized below:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ -----------------------------------
WEIGHTED AVERAGE
NUMBER OF REMAINING WEIGHTED AVERAGE NUMBER OF WEIGHTED AVERAGE
EXERCISE PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE OPTIONS EXERCISE PRICE
- ------------------ ------------------ ------------------ -------------- ------------------ --------------
$ 0.60 - $ 4.20..... 1,361,900 6.76 $ 2.06 656,650 $ 0.81
$15.00 - $38.25....... 443,750 9.58 25.32 44,250 17.77
$51.63 - $67.00....... 36,300 9.97 60.46 -- --
The Company's Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors and approved by the stockholders on July 23,
1998. The Purchase Plan provides for the issuance of up to 750,000 shares of
common stock. Eligible employees can have up to 15% of their earnings
withheld, subject to certain limitations, to be used to purchase shares of the
Company's common stock on every January 31st and July 31st. The price of the
common stock purchased under the Purchase Plan will be equal to 85% of the
lower of the fair market value of the common stock on the commencement date of
the offering period or fair market value of the common stock on the specified
purchase date. The Purchase Plan has been implemented in a series of
successive offering periods, each with a maximum duration of 24 months, except
the initial offering period which will have a duration of 26 months. The
initial offering period began on June 1, 1999 and will end on the last
business day of July 2001. The next offering period will commence on the first
business day in August 2001, and subsequent offering periods will commence as
designated by the plan administrator. At December 31, 1999, no shares had been
issued under the Purchase Plan.
Page F-14
Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR
STOCK BASED COMPENSATION, ("SFAS 123") requires the disclosure of pro forma
net income and earnings per share information computed as if the Company had
accounted for its employee stock options granted subsequent to December 31,
1994 and the Purchase Plan, under the fair value method set forth in SFAS
123. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following
weighted-average assumptions for 1999, 1998, and 1997, respectively:
risk-free interest rates of 5.74%, 5.66%, and 6.29%; a dividend yield of 0%;
and volatility factors of 1.08, 0, and 0. In addition, the fair value of
these options was estimated based on an expected life of one-half year from
the vesting date using the multiple option method. The fair value for the
purchase rights under the Purchase Plan was estimated at the date of grant
using a Black-Scholes option pricing model with the following
weighted-average assumptions for 1999: a risk-free interest rate of 5.81%, a
dividend yield of 0%; and a volatility factor of 1.08. In addition, the fair
value of these purchase rights was estimated based on an expected life of
0.67 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including the expected
stock price volatility. Because the Company's employee stock options and
purchase rights have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options and purchase rights. In addition,
because options vest over several years and additional option grants and
purchase rights are expected, the effects of these hypothetical calculations
are not likely to be representative of similar future calculations.
For purposes of pro forma disclosures, the estimated fair value of the
options and purchase rights is amortized to expense over the options' vesting
period or purchase rights' purchase period. The Company's pro forma
information follows (in thousands except for per share information):
YEARS ENDED DECEMBER 31,
--------------------------------------
1999 1998 1997
---------- ---------- ----------
Pro forma net income................................ $ 26,756 $ 16,679 $ 12,609
Pro forma basic earnings per common share........... $ 0.62 $ 0.41 $ 0.31
Pro forma diluted earnings per common share......... $ 0.59 $ 0.39 $ 0.30
9. SEGMENT INFORMATION
The Company operates in a single industry segment, providing communications
equipment, software and associated services, and markets its products through
its sales personnel and certain foreign distributors. The distribution of the
Company's revenues as a percent of total revenues is as follows:
YEARS ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ----------- ----------
United States............................ 48.3% 47.8% 47.4%
Export:
Asia-Pacific........................... 7.0 7.5 17.4
Europe, Middle East and Africa......... 39.9 37.9 31.0
Page F-15
Other.................................. 4.8 6.8 4.2
------ ------- ------
Total export revenue 51.7 52.2 52.6
------ ------- ------
100.0% 100.0% 100.0%
====== ======= ======
The Company has no significant long-lived assets deployed outside of the
United States.
In 1997, British Telecom accounted for approximately 14% of total
revenues. No individual customer accounted for 10% or more of total revenues
in 1999 and 1998. Sales to customers in the United Kingdom accounted for
approximately 14% of total revenues during 1997. No individual countries
other than the United States accounted for 10% or more of total revenues in
1999 and 1998.
10. EMPLOYEE BENEFIT PROGRAM
The Company has a retirement savings plan structured under Section
401(k) of the Internal Revenue Code (the "Code"). The plan covers
substantially all employees meeting minimum service requirements. Under the
plan, employees may elect to reduce their current compensation by up to 15%,
subject to certain maximum dollar limitations prescribed by the Code, and
have the amount contributed to the plan as salary deferral contributions. The
Company may make contributions to the plan at the discretion of the Board of
Directors. The Company accrued and paid discretionary contributions to the
plan totaling $1.6 million, $1.2 million, and $1.0 million in 1999, 1998, and
1997, respectively.
11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following tables contain selected financial information from unaudited
consolidated statements of income for each quarter of 1999 and 1998.
QUARTER ENDED
------------------------------------------------------------------------------------
1999 1998
----------------------------------------- -----------------------------------------
DEC. 31 SEPT. 30 JUNE 30 MAR. 31 DEC. 31 SEPT. 30 JUNE 30 MAR. 31
---------- --------- -------- ------- ------- --------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues......................... $ 31,958 $ 29,010 $25,776 $23,239 $22,792 $ 20,470 $ 18,653 $15,512
Gross profit..................... 23,321 20,656 18,137 16,114 15,960 14,511 13,586 10,966
Net income (2)................... 8,880 10,974 5,493 4,354 5,333 4,503 4,211 3,037
Basic earnings per share (1)
(2)............................ $ 0.20 $ 0.24 $ 0.13 $ 0.11 $ 0.13 $ 0.11 $ 0.10 $ 0.07
Diluted earnings per share
(1) (2) ....................... $ 0.19 $ 0.24 $ 0.12 $ 0.10 $ 0.13 $ 0.11 $ 0.10 $ 0.07
Shares used in computing basic
earnings per share.............. 45,297 45,146 42,389 40,896 40,896 40,886 40,874 40,862
Shares used in computing diluted
earnings per share.............. 46,800 46,589 44,126 42,638 42,640 42,614 42,277 42,277
(1) Earnings per common share are computed independently for each of the
quarters presented. Therefore, the sum of the quarterly earnings per common
share information may not equal the annual earnings per common share due to
rounding differences.
(2) For the quarter ended September 30, 1999, net income and basic and diluted
earnings per share are affected by the one-time pre-tax gain of $5.9
million from the sale of the Company's wireless data assets.
Page F-16
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Inet Technologies, Inc.
We have audited the consolidated financial statements of Inet Technologies,
Inc. as of December 31, 1999 and 1998, and for each of the three years in the
period ended December 31, 1999, and have issued our report thereon dated
January 27, 2000. Our audits also included the financial statement schedule
listed in Item 14 of this Form 10-K. This schedule is the responsibility of
the Company's management. Our responsibility is to express an opinion based
on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Dallas, Texas
January 27, 2000
Page S-1
INET TECHNOLOGIES, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 1999, 1998, and 1997
(in thousands)
ADDITIONS
BALANCE AT CHARGED TO
BEGINNING OF COSTS AND BALANCE AT
YEAR EXPENSES DEDUCTIONS (1) END OF YEAR
------------ ---------- ------------- -----------
Year ended December 31, 1999:
Deducted from asset accounts--
Allowance for doubtful accounts.............. $ 659 $ 245 $ 35 $ 939
===== ====== ===== ======
Year ended December 31, 1998:
Deducted from asset accounts--
Allowance for doubtful accounts.............. $ 500 $ 392 $(233) $ 659
===== ====== ====== ======
Year ended December 31, 1997:
Deducted from asset accounts--
Allowance for doubtful accounts.............. $ 50 $ 452 $ (2) $ 500
===== ====== ====== ======
(1) Activity includes uncollectible accounts written off, net of recoveries.
Page S-2