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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
(Commission file number: 000-30931)
OPNET TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 7372 52-1483235
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or organization) Classification Code Number) Identification No.)
7255 Woodmont Avenue
Bethesda, MD 20814
(Address of principal executive office)
(240) 497-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
At October 31, 2002, there were outstanding 19,287,263 shares of common
stock of the registrant.
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TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
ITEM Page
---- ----
1. - Condensed Consolidated Financial Statements (unaudited) ................. 3
- Condensed Consolidated Balance Sheets as of September 30,
and March 31, 2002 .................................................. 3
- Condensed Consolidated Statements of Operations for the Six Months
Ended September 30, 2002 and 2001 ................................... 4
- Condensed Consolidated Statements of Cash Flows for the Six Months
Ended September 30, 2002 and 2001 ................................... 5
- Notes to Condensed Consolidated Financial Statements .................. 6
2. - Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................. 9
3. - Quantitative and Qualitative Disclosures About Market Risk .............. 21
4. - Controls and Procedures ................................................. 21
PART II
OTHER INFORMATION
ITEM Page
---- ----
1. - Legal Proceedings ....................................................... 22
2. - Changes in Securities and Use of Proceeds ............................... 22
4. - Submission of Matters to a Vote of Security Holders ..................... 22
6. - Exhibits and Reports on Form 8-K ........................................ 22
Signatures .............................................................. 23
Certifications .......................................................... 23
Exhibit Index ........................................................... 26
2
PART I. FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements
OPNET TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(unaudited)
September 30, March 31,
2002 2002
------------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 65,639 $ 62,240
Accounts receivable, net of $383 and $203 in allowance for doubtful
accounts at September 30 and March 31, 2002, respectively 5,768 7,403
Unbilled accounts receivable 2,337 1,331
Refundable income taxes 426 1,253
Prepaid expenses and other current assets 1,442 910
----------- -----------
Total current assets 75,612 73,137
Property and equipment, net 7,213 7,670
Intangible assets, net 1,817 2,067
Goodwill 12,212 12,212
Deferred income taxes and other assets 572 70
----------- -----------
Total assets $ 97,426 $ 95,156
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 643 $ 544
Accrued liabilities 2,382 2,362
Deferred and accrued income taxes 412 156
Deferred revenue 8,276 8,019
----------- -----------
Total current liabilities 11,713 11,081
Note payable 150 150
Deferred rent 513 381
Deferred revenue 478 506
Deferred income taxes - 43
----------- -----------
Total liabilities 12,854 12,161
----------- -----------
Commitments and contingencies - -
Stockholders' equity:
Preferred stock- par value $0.001; 5,000 shares authorized, no shares
issued and outstanding at September 30 and March 31, 2002 - -
Common stock-par value $0.001; 100,000 authorized; 25,414 and 25,220
shares issued at September 30 and March 31, 2002, respectively;
19,280 and 19,086 shares outstanding at September 30 and March 31,
2002, respectively 25 25
Additional paid-in capital 73,206 72,655
Deferred compensation (45) (74)
Retained earnings 15,507 14,499
Accumulated other comprehensive loss (21) (10)
Treasury stock - 6,134 shares at September 30 and March 31, 2002 (4,100) (4,100)
----------- -----------
Total stockholders' equity 84,572 82,995
----------- -----------
Total liabilities and stockholders' equity $ 97,426 $ 95,156
=========== ===========
See accompanying notes to condensed consolidated financial statements.
3
OPNET TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Six Months Ended
September 30, September 30,
--------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
(in thousands, except per share data)
Revenues:
Software licenses $ 7,203 $ 6,585 $ 14,385 $ 13,115
Services 3,971 4,690 7,966 9,290
-------- -------- -------- --------
Total revenues 11,174 11,275 22,351 22,405
-------- -------- -------- --------
Cost of revenues:
Software licenses 204 160 404 270
Services 1,490 1,440 3,160 2,959
-------- -------- -------- --------
Total cost of revenues 1,694 1,600 3,564 3,229
-------- -------- -------- --------
Gross Profit 9,480 9,675 18,787 19,176
-------- -------- -------- --------
Operating expenses:
Research and development 3,234 3,298 6,374 6,452
Sales and marketing 4,452 4,154 8,970 8,323
General and administrative 1,183 1,090 2,368 2,075
Amortization of acquired technology 126 112 252 212
-------- -------- -------- --------
Total operating expenses 8,995 8,654 17,964 17,062
-------- -------- -------- --------
Income from operations 485 1,021 823 2,114
Interest and other income, net 241 517 524 1,168
-------- -------- -------- --------
Income before provision for income taxes 726 1,538 1,347 3,282
Provision for income taxes 165 476 337 1,045
-------- -------- -------- --------
Net income $ 561 $ 1,062 1,010 $ 2,237
======== ======== ======== ========
Basic net income per common share $ 0.03 $ 0.06 $ 0.05 $ 0.12
======== ======== ======== ========
Diluted net income per common share $ 0.03 $ 0.05 $ 0.05 $ 0.11
======== ======== ======== ========
Weighted average common shares outstanding (basic) 19,263 18,952 19,213 18,881
======== ======== ======== ========
Weighted average common shares outstanding (diluted) 19,918 19,861 19,879 20,025
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
4
OPNET TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended
September 30,
--------------------
2002 2001
-------- --------
(in thousands)
Cash flows from operating activities: $ 1,010 $ 2,237
Net income
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 1,059 985
Provision for losses on accounts receivable 180 -
Deferred income taxes (255) (30)
Expense related to employee stock options and other 29 48
Changes in assets and liabilities:
Accounts receivable 449 (2,345)
Prepaid expenses and other current assets (532) 597
Loans to employees - 231
Refundable income taxes 827 238
Deposits and other assets (70) 31
Accounts payable 99 315
Accrued liabilities 20 (2,478)
Accrued income taxes 35 120
Tax benefit from exercise of employee stock options 179 53
Deferred revenue 229 (199)
Deferred rent 132 167
-------- --------
Net cash provided by (used in) operating activities 3,391 (30)
-------- --------
Cash flows from investing activities:
Acquisition - (1,156)
Purchase of property and equipment (352) (2,205)
Investment in affiliate - (461)
-------- --------
Net cash used in investing activities (352) (3,822)
-------- --------
Cash flows from financing activities:
Proceeds from exercise of common stock options 206 285
Proceeds from issuance of common stock under employee stock purchase plan 165 209
-------- --------
Net cash provided by financing activities 371 494
-------- --------
Effect of exchange rate changes on cash and cash equivalents (11) (8)
-------- --------
Net increase (decrease) in cash and cash equivalents 3,399 (3,366)
Cash and cash equivalents, beginning of period 62,240 62,623
-------- --------
Cash and cash equivalents, end of period $ 65,639 $ 59,257
======== ========
See accompanying notes to condensed consolidated financial statements.
5
OPNET TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation and Nature of Operations
OPNET Technologies, Inc. ("OPNET", "we" or "us") provides intelligent
network management software solutions that enable users in network operations,
planning, engineering and application development to optimize the performance
and availability of their networks and networked applications. We sell our
products to corporate enterprises, government and defense agencies, network
service providers, and network equipment manufacturers. We market our product
suite in North America primarily through a direct sales force and, to a lesser
extent, several resellers and original equipment manufacturers. Internationally,
we market our products through our wholly-owned subsidiaries, third-party
distributors and value-added resellers. OPNET is headquartered in Bethesda,
Maryland and has offices in Cary, NC; Dallas, TX; Santa Clara, CA; Paris,
France; Oxford, United Kingdom; Sydney, Australia; and Ghent, Belgium.
The accompanying condensed consolidated financial statements include our
results and the results of our wholly owned subsidiaries. All intercompany
accounts and transactions have been eliminated in consolidation. The interim
financial statements included herein are unaudited and have been prepared in
accordance with generally accepted accounting principles ("GAAP") and applicable
rules and regulations of the Securities and Exchange Commission (the "SEC")
regarding interim financial reporting. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with GAAP have been condensed or omitted pursuant to such rules and regulations.
Accordingly, these interim financial statements should be read in conjunction
with the audited consolidated financial statements and accompanying notes
thereto contained in the Company's Annual Report on Form 10-K for the year ended
March 31, 2002, filed with the SEC. The March 31, 2002 consolidated balance
sheet included herein was derived from the audited financial statements as of
that date, but does not include all disclosures including notes required by
GAAP. In the opinion of management, these interim financial statements reflect
all adjustments of a normal and recurring nature necessary to present fairly our
results for the interim periods. The preparation of financial statements in
conformity with GAAP requires management to make certain estimates and
assumptions. These estimates and assumptions affect the reported amounts of
assets and liabilities as of the date of the financial statements, as well as
the reported amount of revenues and expenses during the reporting period. Actual
results could differ from those estimates. In addition, our operating results
for the three and six months ended September 30, 2002 may not be indicative of
the operating results for the full fiscal year or any other future period.
2. Credit Agreement
Effective June 10, 2002, we entered into a $10.0 million line of credit
facility with a commercial bank. The line of credit permits the use of funds for
general corporate purposes and the issuance of letters of credit up to a maximum
of $10.0 million. Borrowings under the credit facility are limited to 80% of
eligible accounts receivable. We used the facility to issue a letter of credit
for approximately $3.4 million to satisfy the security deposit requirements for
our corporate office lease. Interest is payable monthly, based on LIBOR plus the
applicable margin ranging from 2% to 2.5% as stated in the loan agreement. The
credit facility includes a fee in the amount of 0.25% per annum on the unused
portion of the line of credit. The credit facility is collateralized by our
accounts receivable and there are also certain financial ratios and conditions
that we must maintain under the terms of the loan agreement, as well as certain
covenants with which we must comply. The line of credit facility expires June
10, 2004. As of September 30, 2002, we had no borrowings under the available
line of credit.
3. Stockholders' Equity
During the three and six months ended September 30, 2002, we received
proceeds of approximately $50,000 and $206,000 and issued 28,625 and 171,948
shares of Common Stock, respectively, pursuant to employee exercises of stock
options. During the six months ended September 30, 2002 employees purchased
21,708 shares of Common Stock under the 2000 Employee Stock Purchase Plan,
resulting in proceeds to us of approximately $165,000. Tax benefit from exercise
of employee stock options was $179,000 and $53,000 for the six months ending
September 30, 2002 and 2001, respectively.
6
4. Net Income per Common Share
The following is a reconciliation of the amounts used in calculating basic
and diluted net income per common share for the three and six months ended
September 30, 2002 and 2001:
Three Months Ended Six Months Ended
September 30, September 30,
-------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
(in thousands, except per share data)
Income (Numerator):
Net income (basic and diluted) $ 561 $ 1,062 $ 1,010 $ 2,237
======== ======== ======== =======
Shares (Denominator):
Weighted average shares outstanding (basic) 19,263 18,952 19,213 18,881
Plus:
Effect of other dilutive securities--options 655 909 666 1,144
-------- -------- -------- -------
Weighted average shares outstanding (diluted) 19,918 19,861 19,879 20,025
======== ======== ======== =======
Net income per common share:
Basic net income per common share $ 0.03 $ 0.06 $ 0.05 $ 0.12
Diluted net income per common share $ 0.03 $ 0.05 $ 0.05 $ 0.11
5. Business Segment and Geographic Information
We operate in one industry segment, the development and sale of computer
software programs and related services. Revenues from transactions with U.S.
government agencies were approximately 31.8% and 24.7% for the quarter ended
September 30, 2002 and 2001, respectively. Revenues from transactions with U.S.
government agencies were approximately 32.2% and 24.8% for the six months ended
September 30, 2002 and 2001, respectively. Total receivables from transactions
with U.S. government agencies represented approximately 45.8% of total accounts
receivable at September 30, 2002. Substantially all assets were held in the
United States at September 30 and March 31, 2002. Revenues by geographic
destination and as a percentage of total revenues follows:
Three Months Ended Six Months Ended
September 30, September 30,
-------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
(in thousands)
Geographic Area by Destination:
United States $ 9,174 $ 9,538 $ 17,926 $ 18,753
International 2,000 1,737 4,425 3,652
-------- -------- -------- --------
Total revenue $ 11,174 $ 11,275 $ 22,351 $ 22,405
======== ======== ======== ========
Geographic Area by Destination:
United States 82.1% 84.6% 80.2% 83.7%
International 17.9 15.4 19.8 16.3
-------- -------- -------- --------
Total revenue 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ========
7
6. Supplemental Cash Flow Information
Six Months Ended
September 30,
----------------------------
2002 2001
------------ -----------
(in thousands)
Supplemental disclosure of cash flow information:
Cash paid for income taxes $ 4 $ 651
Cash paid for interest 10 -
Supplemental disclosure of non-cash activities:
Accrued tenant allowance $ - $ 359
Post-closing acquisition adjustments - 217
7. Comprehensive Income
Comprehensive income includes net income and foreign currency translation
adjustments. Total comprehensive income is summarized as follows:
Three Months Ended Six Months Ended
September 30, September 30,
-------------------- ------------------
2002 2001 2002 2001
-------- -------- -------- --------
(in thousands)
Net income $ 561 $ 1,062 $ 1,010 $ 2,237
Foreign currency translation adjustments (22) (2) (11) (8)
-------- -------- -------- --------
Total comprehensive income $ 539 $ 1,060 $ 999 $ 2,229
======== ======== ======== ========
8. New Accounting Pronouncement
In July 2002, the Financial Accounting Standards Board (FASB) issued
Statement No. 146 (SFAS No. 146), "Accounting for Costs Associated with Exit or
Disposal Activities". SFAS No. 146 replaces Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)". SFAS No. 146 requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan. Examples of costs covered by the
standard include lease termination costs and certain employee severance costs
that are associated with a restructuring, discontinued operation, plant closing,
or other exit or disposal activity. SFAS No. 146 is to be applied prospectively
to exit or disposal activities initiated after December 31, 2002. We do not
expect the adoption of SFAS No. 146 to have a material effect on our
consolidated financial position, results of operations, or cash flows.
8
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis relates to our financial condition
and results of operations for the three and six months ended September 30, 2002
and 2001, and should be read in conjunction with our condensed consolidated
financial statements and the related notes included elsewhere in this report.
You should also read the following discussion and analysis in conjunction with
our consolidated financial statements and the related notes and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
contained in our Annual Report on Form 10-K for the year ended March 31, 2002,
filed with the SEC.
This report contains forward-looking statements that involve substantial
risks and uncertainties. You can identify these statements by forward-looking
words such as "anticipate," "believe," "could," "estimate," "expect," "intend,"
"may," "plan," "potential," "should," "will," and "would" or similar words. You
should read statements that contain these words carefully because they discuss
our future expectations, contain projections of our future results of operations
or of our financial position, or state other forward-looking information. We
believe that it is important to communicate our future expectations to our
investors. However, there may be events in the future that we are not able to
predict or control accurately. The factors listed in this section, as well as
any cautionary language contained herein, provide examples of risks,
uncertainties, and events that may cause our actual results to differ materially
from the expectations we describe in our forward-looking statements. You should
also carefully review the risks outlined in other documents that we file from
time to time with the Securities and Exchange Commission, including our
Quarterly Reports on Form 10-Q that we will file in fiscal 2003.
Overview
Introduction. Founded in 1986, we are the pioneer and leading provider of
intelligent network management software. OPNET software embeds expert knowledge
on how network devices, network protocols, applications, and servers operate.
This intelligence enables users in network operations, engineering, planning,
and application development to be far more effective in optimizing performance
and availability of their networks and applications. We believe our software
solutions generate significant return on investment to a broad customer base,
including corporate enterprises, government and defense agencies, network
service providers, and network equipment manufacturers by empowering them to
rapidly make better use of resources, reduce operational problems and improve
competitiveness.
We market focused software solutions for each of our target markets. OPNET
IT Guru, which was launched in August 1998 and OPNET SP Guru, which was launched
in June 2001, are our platform intelligent network management products for
enterprises and service providers, respectively. OPNET WDM Guru, which was
launched in December 2001, is an optical network planning product for network
equipment manufacturers and service providers. OPNET Modeler, our first product
that was launched in 1987, is a modeling and simulation product for network R&D,
mainly sold to network equipment manufacturers. OPNET Netbiz applications are
custom solutions developed with the OPNET Development Kit (ODK), which were
launched in August 1998, and are sold primarily to network equipment
manufacturers. Finally, OPNET VNE Server, which was launched in June 2002, is an
on-line continuously operating software product that maintains a valid
comprehensive view of the network, including infrastructure, configuration, and
performance data. OPNET VNE Server merges and validates multiple sources of
information into a cohesive model. This product is sold mainly to enterprises
and service providers. We sell each of these products to government and defense
agencies.
Revenues. We generate revenues principally from licensing our intelligent
network management software products and providing related services, including
maintenance and technical support, consulting, and training. Our software
license revenues consist of perpetual and term license sales of our software
products and fees associated with periodic unspecified product upgrades.
Our service revenues consist of fees from maintenance and technical support
agreements, consulting services, and training. The maintenance agreements
covering our products provide for technical support and periodic unspecified
product upgrades. In July 2001, we changed our business practice to allow our
customers to separately purchase periodic unspecified product upgrades without
purchasing technical support. Revenue related to periodic unspecified product
upgrades is now included in license revenue. Revenue related to technical
support is included in service revenue. License revenue from unspecified product
upgrades was approximately $2.1 million and $3.7 million for the three and six
months ended September 30, 2002, respectively. License revenue from unspecified
product upgrades was $0.1 million for the three and six months ended September
30, 2001. We offer consulting services, generally under fixed-price agreements,
primarily to provide product customization and enhancements. We provide
classroom and on-site training to our customers on a daily fee basis.
Revenues from sales outside of the United States represented approximately
17.9% and 15.4% for the three months ended September 30, 2002 and 2001,
respectively. Revenues from sales outside the United States represented
approximately 19.8%
9
and 16.3% for the six months ended September 30, 2002 and 2001, respectively.
Sales outside the United States were primarily made through our Paris, France
and Oxford, United Kingdom offices as well as third-party distributors and
value-added resellers, who are generally responsible for providing technical
support and service to customers within their territory. We expect revenues from
sales outside the United States to continue to account for a significant portion
of our total revenues in the future. We believe that continued growth and
profitability will require further expansion of our sales, marketing, and
customer service functions in international markets.
Results of Operations
The following table sets forth items from our statements of operations
expressed as a percentage of total revenues for the periods indicated:
Three Months Ended Six Months Ended
September 30, September 30,
-------------------- --------------------
2002 2001 2002 2001
-------- -------- -------- --------
Revenues:
Software licenses 64.5% 58.4% 64.4% 58.5%
Services 35.5 41.6 35.6 41.5
-------- -------- -------- --------
Total revenues 100.0 100.0 100.0 100.0
-------- -------- -------- --------
Cost of revenues:
Software licenses 1.8 1.4 1.8 1.2
Services 13.4 12.8 14.1 13.2
-------- -------- -------- --------
Total cost of revenues 15.2 14.2 15.9 14.4
-------- -------- -------- --------
Gross Profit 84.8 85.8 84.1 85.6
-------- -------- -------- --------
Operating expenses:
Research and development 28.9 29.2 28.6 28.8
Sales and marketing 39.8 36.8 40.1 37.1
General and administrative 10.6 9.7 10.6 9.3
Amortization of acquired intangibles 1.2 1.0 1.1 1.0
-------- -------- -------- --------
Total operating expenses 80.5 76.7 80.4 76.2
-------- -------- -------- --------
Income from operations 4.3 9.1 3.7 9.4
Interest and other income, net 2.2 4.5 2.3 5.2
-------- -------- -------- --------
Income before provision for income taxes 6.5 13.6 6.0 14.6
Provision for income taxes 1.5 4.2 1.5 4.6
-------- -------- -------- --------
Net income 5.0% 9.4% 4.5% 10.0%
======== ======== ======== ========
The following table sets forth, for each component of revenues, the cost of
these revenues as a percentage of the related revenues for the periods
indicated:
Three Months Ended Six Months Ended
September 30, September 30,
-------------------- ------------------
2002 2001 2002 2001
------ ------ ------ ------
Cost of software license revenues 2.8% 2.4% 2.8% 2.1%
Cost of service revenues 37.5 30.7 39.7 31.9
10
Revenues
Software License Revenues. Software license revenues increased 9.4% to $7.2
million for the three months ended September 30, 2002 from $6.6 million for the
three months ended September 30, 2001. Software license revenues increased 9.7%
to $14.4 million for the six months ended September 30, 2002 from $13.1 million
for the six months ended September 30, 2001. This growth is due to revenue
contributions from the change in business practice in July 2001 to allow
customers to separately purchase unspecified product upgrades without purchasing
technical support (approximately $2.1 million and $3.7 million for the three and
six months ended September 30, 2002, respectively), new products, and increased
penetration of international markets. However, revenue contributions from the
aforementioned were partially offset by discounts associated with pricing
strategies and product bundling in fiscal 2003. For the three and six months
ended September 30, 2002, growth in sales to (i) enterprises of OPNET IT Guru,
Application Characterization Environment ("ACE"), ACE Decode Module, NetDoctor
and Flow Analysis, and (ii) enterprises and service providers of OPNET SP Guru
offset a significant decline in sales to network equipment manufacturers of
OPNET Modeler.
We may experience a slower rate of growth in overall software license
revenues in the near-term due to potentially lower spending levels by enterprise
IT organizations, service providers, and network equipment manufacturers as a
result of a challenging economy.
Service Revenues. Service revenues decreased 15.3% to $4.0 million for the
three months ended September 30, 2002 from $4.7 million for the three months
ended September 30, 2001. Service revenues decreased 14.3% to $8.0 million for
the six months ended September 30, 2002 from $9.3 million for the six months
ended September 30, 2001. The decrease results from the adverse impact on
service revenues from the change in business practice in July 2001 to allow
customers to separately purchase unspecified periodic product upgrades (license
revenue) and technical support (service revenue). This decrease is partially
offset by growing demand for our consulting services, including engagements with
U.S. government agencies, renewals of technical support contracts by our
installed base of customers, and additional technical support contracts related
to new license sales. We expect service revenues to decline in the near-term due
to the mix of consulting contracts and as our customers purchase unspecified
periodic product upgrades separately from technical support. Our ability to grow
service revenues will be dependent on our ability to expand our installed base
of customers and our ability to maintain several large consulting contracts with
U.S. government agencies. A consulting contract with the U.S. Department of
Defense that contributed 30% and 27% of service revenue for the three and six
months ended September 30, 2002, respectively, expires December 31, 2002. The
U.S. Department of Defense issued a request for proposal for this program. We
believe that we are uniquely qualified to perform the services under this
program and plan to submit our proposal during the quarter ending December 31,
2002. In the event that we are not awarded the contract under this program, our
results of operations will be adversely and materially impacted.
Cost of Revenues
Cost of software license revenues consists primarily of royalties, media,
manuals, and distribution costs. Cost of service revenues consists primarily of
personnel-related costs in providing technical support, consulting, and training
to customers. Gross margin on software license revenues is substantially higher
than gross margin on service revenues due to the low materials, packaging, and
other costs of software products compared with the relatively high personnel
costs associated with providing services.
Cost of Software License Revenues. Cost of software license revenues was
$204,000 and $160,000 for the three months ended September 30, 2002 and 2001,
respectively. Gross margin on software licenses revenue decreased to 97.2% for
the three months ended September 30, 2002 from 97.6% for the three months ended
September 30, 2001. Cost of software license revenues was $404,000 and $270,000
for the six months ended September 30, 2002 and 2001, respectively. Gross margin
on software licenses revenue decreased to 97.2% for the six months ended
September 30, 2002 from 97.9% for the six months ended September 30, 2001. The
increases in cost of software license revenues and the resulting lower gross
margins are primarily due to an increase in sales requiring royalty payments
under licensing agreements.
Cost of Service Revenues. Cost of service revenues increased 3.5% to $1.5
million for the three months ended September 30, 2002 from $1.4 million for the
three months ended September 30, 2001. Gross margin on service revenues
decreased to 62.5% for the three months ended September 30, 2002 from 69.3% for
the three months ended September 30, 2001. Cost of service revenues increased
6.8% to $3.2 million for the six months ended September 30, 2002 from $3.0
million for the six months ended September 30, 2001. Gross margin on service
revenues decreased to 60.3% for the six months ended September 30, 2002 from
68.1% for the six months ended September 30, 2001. The increases in cost of
services revenues and the resulting lower gross margins are primarily due to a
higher proportion of service revenues derived from consulting services, which
provide lower gross margins than maintenance services. We expect cost of service
revenues as a percentage of service revenues to vary
11
based primarily on the profitability of individual consulting engagements.
Operating Expenses
Research and Development. Research and development expenses decreased 1.9%
to $3.2 million for the three months ended September 30, 2002 from $3.3 million
for the three months ended September 30, 2001. Research and development expenses
decreased 1.2% to $6.4 million for the six months ended September 30, 2002 from
$6.5 million for the six months ended September 30, 2001. These decreases were
associated with increased deployment of personnel to sales and marketing efforts
relating to preparation and execution of OPNETWORK 2002, the Company's annual
technology conference, and no discretionary bonus expense for the three and six
months ended September 30, 2002. The decreases for the three and six months
ended September 30, 2002 were partially offset by increases in personnel costs
as a result of the WDM NetDesign acquisition in January 2002.
We believe that a significant level of research and development investment
will be required to maintain our competitive position and broaden our product
lines, as well as to enhance the features and functionality of our current
products. We expect the absolute dollar amount of these expenditures to grow but
generally decrease as a percentage of total revenues in future periods. Our
ability to decrease these expenses as a percentage of revenue will depend upon
our revenue growth, among other factors.
Sales and Marketing. Sales and marketing expenses increased 7.2% to $4.5
million for the three months ended September 30, 2002 from $4.2 million for the
three months ended September 30, 2001. Sales and marketing expenses increased
7.8% to $9.0 million for the six months ended September 30, 2002 from $8.3
million for the six months ended September 30, 2001. The increases are primarily
due to an increase in the size of our direct sales force from the addition of
sales offices in the United Kingdom and Australia in the second half of fiscal
year 2002, and increases in certain marketing costs. The increases were
partially offset by no discretionary bonus expense for the three and six months
ended September 30, 2002 and lower travel and entertainment expenses.
As a percentage of total revenues, sales and marketing expenses increased
to 39.8% for the three months ended September 30, 2002 from 36.8% for the three
months ended September 30, 2001 and increased to 40.1% for the six months ended
September 30, 2002 from 37.1% for the six months ended September 30, 2001. These
increases were due to our additional investment of resources associated with
developing market awareness for our products and increased costs related to our
direct sales force. We anticipate that we will continue to commit substantial
resources to sales and marketing in the future and that sales and marketing
expenses may increase in absolute dollars and as a percentage of total revenue
in future periods.
General and Administrative. General and administrative expenses increased
8.5% to $1.2 million for the three months ended September 30, 2002 from $1.1
million for the three months ended September 30, 2001. General and
administrative expenses increased 14.1% to $2.4 million for the six months ended
September 30, 2002 from $2.1 million for the six months ended September 30,
2001. The increases are primarily due to higher personnel costs, bad debt
expense, and insurance costs, and were partially offset by no discretionary
bonus expense for the three and six months ended September 30, 2002.
We expect the dollar amount of general and administrative expenses to
increase as we continue to expand our operations but generally decrease as a
percentage of total revenues in future periods. Our ability to decrease these
expenses as a percentage of revenues will depend upon our revenue growth, among
other factors.
Amortization of Acquired Technology. In connection with our acquisitions of
NetMaker in March 2001 and WDM NetDesign in January 2002, we recorded acquired
technology of $2.5 million. Amortization of acquired technology was $126,000 and
$112,000 for the three months ended September 30, 2002 and 2001, respectively,
and $252,000 and $212,000 for six months ended September 30, 2002 and 2001,
respectively.
Interest and Other Income, Net
Interest and other income, net, were $241,000 and $517,000 for the three
months ended September 30, 2002 and 2001, respectively, and $524,000 and
$1,168,000 for the six months ended September 30, 2002 and 2001, respectively.
The decreases are primarily due to a reduction in interest income earned on our
cash and cash equivalents due to the decline in interest rates throughout the
periods.
Provision for Income Taxes
Our effective tax rates were 23% and 31% for the three months ended
September 30, 2002 and 2001, respectively, and 25%
12
and 32% for the six months ended September 30, 2002 and 2001, respectively. The
effective tax rate differs from the statutory tax rate and varies from period to
period due principally to the amount of income before taxes from various tax
jurisdictions and the amount of tax credits available to us in each period from
incremental research expenditures.
We expect our effective tax rate in the near-term to range from 25% to 30%;
however, future provisions for taxes will depend, among other things, on the mix
and amount of worldwide income, the tax rates in effect for various tax
jurisdictions and the amount of research tax credits.
Liquidity and Capital Resources
Since inception, we have funded our operations primarily through cash
provided by operating activities and through the sale of equity securities. In
August 2000, we completed our initial public offering in which we raised
approximately $54.1 million, net of underwriting discounts and offering expenses
payable by us. As of September 30, 2002, we had cash and cash equivalents
totaling $65.6 million.
Cash provided by (used in) operating activities was $3.4 million and
($30,000) for the six months ended September 30, 2002 and 2001, respectively.
Cash provided by operating activities is primarily derived from net income, as
adjusted for depreciation and amortization and changes in assets and
liabilities. The increase in cash provided by operations in six months ended
September 30, 2002 from the six month ended September 30, 2001 was generated, in
part, by (i) the collection of refundable income taxes from tax credits for
incremental research expenditures, (ii) no discretionary bonus payments, and
(iii) improved collection of receivables during the six months ended September
30, 2002. Total receivables, excluding allowance for doubtful accounts,
decreased $449,000 from March 31, 2002 to September 30, 2002 as collections were
partially offset by billing terms of certain consulting contracts.
Cash used in investing activities was $352,000 and $3.8 million for the six
months ended September 30, 2002 and 2001, respectively. The funds were used to
purchase property and equipment for our corporate headquarters in Bethesda,
Maryland. Cash used in investing activities for the six months ended September
30, 2001 also includes the costs incurred for the NetMaker and WDM NetDesign
acquisitions.
Cash provided by financing activities was $371,000 and $494,000 for the six
months ended September 30, 2002 and 2001, respectively. Cash provided by
financing activities reflects the proceeds received from the exercise of stock
options and the sale of common stock under our 2000 Employee Stock Purchase
Plan.
As discussed in Note 2 to our condensed consolidated financial statements,
effective June 10, 2002, we entered into a $10.0 million line of credit with a
commercial bank, which expires in June 2004. Borrowings under our line of credit
bear interest at an annual rate equal to LIBOR plus 2% to 2.5%. We have
currently used $3.4 million of the facility for a letter of credit that secures
the lease for our headquarters in Bethesda, Maryland. There was no balance
outstanding on this line of credit as of September 30, 2002.
As of September 30, 2002, we did not have any significant contractual
commitments other than operating leases for office facilities.
We expect working capital needs to increase in the foreseeable future in
order for us to execute our business plan. We anticipate that operating
activities, as well as planned capital expenditures, will constitute a material
use of our cash resources. In addition, we may utilize cash resources to fund
acquisitions or investments in complementary businesses, technologies or
products.
We believe that our current cash and cash equivalents and cash generated
from operations, along with available borrowings under our line of credit, will
be sufficient to meet our anticipated cash requirements for working capital and
capital expenditures for at least the next 12 months.
Critical Accounting Policies
The preparation of our financial statements in conformity with generally
accepted accounting principles requires us to utilize accounting policies and
make estimates and assumptions that affect our reported amounts. Future results
may differ from these estimates under different assumptions or conditions. We
consider the following accounting policies to be both important to the
13
portrayal of our financial position and results of operations and require the
exercise of significant, subjective, or complex judgment and/or estimates.
Revenue Recognition. We recognize revenue in accordance with Statement of
Position ("SOP") No. 97-2, "Software Revenue Recognition", as amended by SOP No.
98-9, "Modification of SOP No. 97-2, Software Revenue Recognition, With Respect
to Certain Transactions", SOP No. 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts" and the Securities and
Exchange Commission Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements."
For our software arrangements, a determination needs to be made for each
arrangement regarding whether the percentage-of-completion contract accounting
method should be used to recognize revenue or whether revenue can be recognized
when the software is delivered and all of the conditions of SOP 97-2 are met.
Contract accounting is required if our services are essential to the
arrangement. In some cases, our services are essential to the arrangement
because they involve customization and enhancements, and our fees are paid in
stages based upon the completion of defined service deliverables. As a result,
we typically recognize revenue from these arrangements using contract
accounting, which generally results in recording revenue over a longer period of
time. In other cases, our services are not essential to the arrangement and the
realization of our license fee is not dependent on the completion of such
services. In these situations, we recognize software license revenue when (1)
persuasive evidence of an arrangement exists, (2) the product has been
delivered, (3) the fee is fixed or determinable, and (4) collectibility is
probable, which generally results in recording revenue earlier than when
contract accounting is used. The determination of whether our services are
essential involves significant judgment and could have a material impact on our
results of operations from period to period to the extent that significant new
arrangements are not accounted for using contract accounting.
Under the percentage-of-completion contract accounting method, we recognize
revenue from the entire arrangement based on the percentage of hours incurred
related to our services compared to the total hours of such services. Using the
percentage-of-completion method requires us to make estimates about the future
cost of services and estimated hours to complete, which are subject to change
for a variety of internal and external factors. A change in these estimates
could result in a material adjustment to the amount of revenue recorded in any
period under the arrangement.
Allowance for Doubtful Accounts. We maintain an allowance for doubtful
accounts receivable for estimated losses resulting from the inability of our
customers to make required payments and for the limited circumstances when the
customer disputes the amounts due us. Our methodology for determining this
allowance requires significant estimates. In estimating the allowance,
management considers the age of the receivable, the creditworthiness of the
customer, the economic conditions of the customer's industry, and general
economic conditions. While we believe that the estimates we use are reasonable,
should any of these factors change, the estimates made by management will also
change, which could impact the amount of our future allowance for doubtful
accounts as well as future operating income. Specifically, if the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments to us, additional allowances may be required.
Valuation of Intangible Assets and Goodwill. We account for our goodwill
and intangible assets in accordance with Statement of Financial Accounting
Standard ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill
and Other Intangible Assets". Our intangible assets consist of acquired
technology. They are recorded at cost and amortized on a straight-line basis
over their expected useful lives of five years. We use the projected discounted
cash flow method in valuing our acquired technology, using certain assumptions
including revenue growth, cost levels, present value discount rate and working
capital requirements. While we believe the assumptions used are reasonable,
actual results will more likely than not differ from those assumptions. Future
cash flows are subject to change for a variety of internal and external factors.
We will periodically review the value of acquired technology for reasonableness.
Changes in our assumptions at the time of future periodic reviews could result
in impairment losses.
Goodwill is recorded when the consideration paid for acquisitions exceeds
the fair value of net tangible and intangible assets acquired. Goodwill is not
amortized. We perform an annual review during our fourth quarter to identify any
facts or circumstances that indicate the carrying value of goodwill is impaired.
The review is based on various analyses including cash flow and profitability
projections and the market capitalization of our common stock. Impairment, if
any, is based on the excess of the carrying amount of goodwill over its fair
value. No impairment has been indicated to date. Changes in our assumptions at
the time of future periodic reviews could result in impairment losses.
Accounting for Software Development Costs. Costs incurred in the research
and development of new software products are expensed as incurred until
technological feasibility is established. Development costs are capitalized
beginning when a product's technological feasibility has been established and
ending when the product is available for general release to our customers.
Technological feasibility is reached when the product reaches the working model
stage. To date, products and enhancements
14
have generally reached technological feasibility and have been released for sale
at substantially the same time and all research and development costs have been
expensed. Consequently, no research and development costs were capitalized in
Quarter 2003 and Quarter 2002.
Certain Factors That May Affect Future Results
The following important factors, among others, could cause actual results
to differ materially from those indicated by forward-looking statements made in
this report and presented elsewhere by management from time to time.
Our operating results may fluctuate significantly as a result of factors
outside of our control, which could cause the market price of our stock to
decline
Our operating results have fluctuated in the past, and are likely to
fluctuate significantly in the future. Our financial results may as a
consequence fall short of the expectations of public market analysts or
investors, which could cause the price of our common stock to decline. Our
revenues and operating results may vary significantly from quarter to quarter
due to a number of factors, many of which are beyond our control. Factors that
could affect our operating results include:
.. the timing of large orders;
.. software arrangements requiring contract accounting;
.. changes in the mix of our sales, including the mix between higher margin
software products and somewhat lower margin services and maintenance, and
the proportion of our license sales requiring us to make royalty payments;
.. the timing and amount of our marketing, sales, and product development
expenses;
.. the cost and time required to develop new software products;
.. the introduction, timing, and market acceptance of new products introduced
by us or our competitors;
.. changes in network technology or in applications, which could require us to
modify our products or develop new products;
.. general economic conditions, which can affect our customers' purchasing
decisions and the length of our sales cycle;
.. changes in our pricing policies or those of our competitors; and
.. the timing and size of potential acquisitions by us.
We expect to make significant expenditures in all areas of our business,
particularly sales and marketing operations, in order to promote future growth.
Because the expenses associated with these activities are relatively fixed in
the short term, we may be unable to adjust spending quickly enough to offset any
unexpected shortfall in revenue growth or any decrease in revenue levels. In
addition, our revenues in any quarter depend substantially on orders we receive
and ship in that quarter. We typically receive a significant portion of orders
in any quarter during the last month of the quarter, and we cannot predict
whether those orders will be placed and shipped in that period. If we have lower
revenues than we expect, we probably will not be able to reduce our operating
expenses quickly in response. Therefore, any significant shortfall in revenues
or delay of customer orders could have an immediate adverse effect on our
operating results in that quarter.
For all of these reasons, quarterly comparisons of our financial results
are not necessarily meaningful and you should not rely on them as an indication
of our future performance.
The market for intelligent network management software is new and evolving,
and if this market does not develop as anticipated, our revenues could decline
We derive all of our revenues from the sale of products and services that
are designed to allow our customers to manage the performance of networks and
applications. Accordingly, if the market for intelligent network management
software does not continue to grow, we could face declining revenues, which
could ultimately lead to our becoming unprofitable. The market for intelligent
network management software solutions is in an early stage of development.
Therefore, we cannot accurately assess the size of the market and may be unable
to identify an effective distribution strategy, the competitive environment that
will
15
develop, and the appropriate features and prices for products to address
the market. If we are to be successful, our current and potential customers must
recognize the value of intelligent network management software solutions, decide
to invest in the management of their networks, and, in particular, adopt and
continue to use our software solutions.
Our customers are primarily in four target markets and our operating
results may be adversely affected by changes in one or more of these markets
As part of our focus on four targeted markets, our financial results
depend, in significant part, upon the economic conditions of enterprise, U.S.
government agencies, service provider, and network equipment manufacturer
markets. An economic downturn or adverse change in the regulatory environment or
business prospects for one or more of these markets may decrease our revenues or
lower our growth rate.
A decline in information technology spending may result in a decrease in
our revenues or lower our growth rate
A decline in the demand for information technology among our current and
prospective customers may result in decreased revenues or a lower growth rate
for us because our sales depend, in part, on our customers' level of funding for
new or additional information technology systems and services.
A continued economic downturn may cause our customers to reduce or
eliminate information technology spending and cause price erosion for our
solutions, which would substantially reduce the number of new software licenses
we sell and the average sales price for these licenses. Accordingly, we cannot
assure you that we will be able to increase or maintain our revenues.
If our newest products, particularly those targeted primarily for
enterprises, do not gain widespread market acceptance, our revenues might not
increase and it is possible that they would decline
We expect to derive a substantial portion of our revenues in the future
from sales to enterprises of version 9.0 of OPNET IT Guru, which was released in
October 2002, and its associated modules including Application Characterization
Environment, ACE Decode Module, NetDoctor, Flow Analysis, and OPNET VNE Server,
which was released in June 2002. Our business depends on customer acceptance of
these products and our revenues may not increase, or may decline, if our target
customers do not adopt and expand their use of our products. To date, we have
not achieved widespread market acceptance of our products. In addition, if our
OPNET Modeler product, which we have been selling since 1987, continues to
encounter declining sales, which could occur for a variety of reasons, including
market saturation and the financial condition of network equipment
manufacturers, and sales of our newer products do not grow at a rate sufficient
to offset the shortfall, our revenues would decline.
We may not be able to grow our business if service providers do not buy our
products
An element of our strategy is to increase sales to service providers of
OPNET SP Guru and OPNET WDM Guru, both launched in fiscal 2002. Accordingly, if
our products fail to perform favorably in the service provider environment or to
gain wider adoption by service providers, our business and future operating
results could suffer.
Our lengthy and variable sales cycle makes it difficult to predict
operating results
It is difficult for us to forecast the timing and recognition of revenues
from sales of our products because prospective customers often take significant
time evaluating our products before licensing them. The period between initial
customer contact and a purchase by a customer may vary from three months to more
than a year. During the sales process, the customer may decide not to purchase
or may scale down proposed orders of our products for various reasons, including
changes in budgets and purchasing priorities. Our prospective customers
routinely require education regarding the use and benefit of our products. This
may also lead to delays in receiving customers' orders.
If we do not successfully expand our sales force, we may be unable to
increase our sales
We sell our products primarily through our direct sales force, and we must
expand the size of our sales force to increase revenues. If we are unable to
hire or retain qualified sales personnel, if newly hired personnel fail to
develop the necessary skills to be productive, or if they reach productivity
more slowly than anticipated, our ability to increase our revenues and grow our
business could be compromised. Our sales people require a long period of time to
become productive, typically three to six months. The time required to reach
productivity, as well as the challenge of attracting, training, and retaining
qualified candidates, may make it difficult to meet our sales force growth
targets. Further, we may not generate sufficient sales to offset the increased
expense resulting from growing our sales force or we may be unable to manage a
larger sales force.
16
Our ability to increase our sales will be impaired if we do not expand and
manage our indirect distribution channels
To increase our sales, we must, among other things, further expand and
manage our indirect distribution channels, which consist primarily of
international distributors and original equipment manufacturers and resellers.
If we are unable to expand and manage our relationships with our distributors,
our distributors are unable or unwilling to effectively market and sell our
products, or we lose existing distributor relationships, we might not be able to
increase our revenues. Our international distributors and original equipment
manufacturers and resellers have no obligation to market or purchase our
products. In addition, they could partner with our competitors, bundle or resell
competitors' products, or internally develop products that compete with our
products.
We may not be able to successfully manage our expanding operations, which
could impair our ability to operate profitably
We may be unable to operate our business profitably if we fail to manage
our growth. Our growth has sometimes strained, and may in the future continue to
strain, our managerial, administrative, operational, and financial resources and
controls. We plan to continue to expand our operations and increase the number
of our full-time employees. Our ability to manage growth will depend in part on
our ability to continue to enhance our operating, financial, and management
information systems. Our personnel, systems, and controls may not be adequate to
support our growth. In addition, our revenues may not continue to grow at a
sufficient rate to absorb the costs associated with a larger overall employee
base.
If we are unable to introduce new and enhanced products on a timely basis
that respond effectively to changing technology, our revenues may decline
Our market is characterized by rapid technological change, changes in
customer requirements, frequent new product and service introductions and
enhancements, and evolving industry standards. If we fail to develop and
introduce new and enhanced products on a timely basis that respond to these
changes, our products could become obsolete, demand for our products could
decline, and our revenues could fall. Advances in network management technology,
software engineering, and simulation technology, or the emergence of new
industry standards, could lead to new competitive products that have better
performance, more features, or lower prices than our products and could render
our products unmarketable. In addition, the introduction and adoption of future
network technologies or application architectures could reduce or eliminate the
need for intelligent network management software.
Our future revenue is substantially dependent upon our installed customer
base continuing to license additional products, renew maintenance agreements and
purchase additional services
Our installed customer base has traditionally generated additional revenue
from consulting services, renewed maintenance agreements, and license of other
products. The maintenance agreements are generally renewable at the option of
the customers and there are no mandatory payment obligations or obligations to
license additional software. In addition, customers may decide not to purchase
additional products or services. If our customers fail to renew their
maintenance agreements or purchase additional products or services, our revenues
could decrease.
Increases in service revenues as a percentage of total revenues could
decrease overall margins and adversely affect our operating results
We realize lower margins on service revenues than on software license
revenues. As a result, if service revenues increase as a percentage of total
revenues, our gross margins will be lower and our operating results may be
adversely affected.
If we fail to retain our key personnel and attract and retain additional
qualified personnel, we might not be able to maintain our revenue base
Our future success and our ability to maintain our revenue base depend upon
the continued service of our executive officers and other key sales and research
and development personnel. The loss of any of our key employees, in particular
Marc A. Cohen, our chairman of the board and chief executive officer, and Alain
J. Cohen, our president and chief technology officer, could adversely affect our
ability to pursue our growth strategy. We do not have employment agreements or
any other agreements that obligate any of our officers or key employees to
remain with us.
We must also continue to hire highly qualified individuals, particularly
software engineers and sales and marketing personnel. Our failure to attract and
retain technical personnel for our product development, consulting services, and
technical support teams may limit our ability to develop new products or product
enhancements. Competition for these individuals is
17
intense, and we may not be able to attract and retain additional highly
qualified personnel in the future. In addition, limitations imposed by federal
immigration laws and the availability of visas could impair our ability to
recruit and employ skilled technical professionals from other countries to work
in the United States.
Our international operations subject our business to additional risks,
which could cause our sales or profitability to decline
We plan to increase our international sales activities, but these plans are
subject to a number of risks that could cause our sales to decline or could
otherwise cause a decline in profitability. These risks include:
.. difficulty in attracting distributors that will market and support our
products effectively;
.. greater difficulty in accounts receivable collection and longer collection
periods;
.. the need to comply with varying employment policies and regulations that
could make it more difficult and expensive to manage our employees if we
need to establish more direct sales or support staff outside the United
States;
.. potentially adverse tax consequences;
.. the effects of currency fluctuations; and
.. political and economic instability.
We expect to face intense competition, which could cause us to lose sales,
resulting in lower profitability
Increasing competition in our market could cause us to lose sales and
become unprofitable. The market for intelligent network management software is
evolving rapidly and is highly competitive. We believe that this market is
likely to become more competitive as the demand for intelligent network
management solutions continues to increase. At least one of our current
competitors and many of our potential competitors are larger and have
substantially greater financial and technical resources than we do. In addition,
it is possible that other vendors as well as some of our customers or
distributors will develop and market solutions that compete with our products in
the future.
If our products contain errors and we are unable to correct those errors,
our reputation could be harmed and could cause our customers to demand refunds
from us or assert claims for damages against us
Our software products could contain significant errors or bugs that may
result in:
.. the loss of or delay in market acceptance and sales of our products;
.. the delay in introduction of new products;
.. diversion of our resources;
.. injury to our reputation; and
.. increased support costs.
Bugs may be discovered at any point in a product's life cycle. We expect
that errors in our products will be found in the future, particularly in new
product offerings and new releases of our current products.
Because our customers use our products to manage networks that are critical
to their business operations, any failure of our products could expose us to
product liability claims. In addition, errors in our products could cause our
customers' networks and systems to fail or compromise their data, which could
also result in liability to us. Product liability claims brought against us
could divert the attention of management and key personnel, could be expensive
to defend, and may result in adverse settlements and judgments.
Our software products rely on our intellectual property, and any failure to
protect our intellectual property could enable our competitors to market
products with similar features that may reduce our revenues and could allow the
use of our products by users who have not paid the required license fee
18
If we are unable to protect our intellectual property, our competitors
could use our intellectual property to market products similar to our products,
which could reduce our revenues. In addition, we may be unable to prevent the
use of our products by persons who have not paid the required license fee, which
could reduce our revenues. Our success and ability to compete depend
substantially upon the internally developed technology that is incorporated in
our products. Policing unauthorized use of our products is difficult, and we may
not be able to prevent misappropriation of our technology, particularly in
foreign countries where the laws may not protect our proprietary rights as fully
as those in the United States. Others may circumvent the patents, copyrights,
and trade secrets we own. In the ordinary course of business, we enter into a
combination of confidentiality, non-competition and non-disclosure agreements
with our employees.
These measures afford only limited protection and may be inadequate,
especially because our employees are highly sought after and may leave our
employ with significant knowledge of our proprietary information. In addition,
any confidentiality, non-competition and non-disclosure agreements we enter into
may be found to be unenforceable, or our copy protection mechanisms embedded in
our software products could fail or could be circumvented.
Our products employ technology that may infringe on the proprietary rights
of others, and, as a result, we could become liable for significant damages
We expect that our software products may be increasingly subject to
third-party infringement claims as the number of competitors in our industry
segment grows and the functionalities of products in different industry segments
overlap.
Regardless of whether these claims have any merit, they could:
.. be time-consuming to defend;
.. result in costly litigation;
.. divert our management's attention and resources;
.. cause us to cease or delay product shipments; or
.. require us to enter into royalty or licensing agreements.
These royalty or licensing agreements may not be available on terms
acceptable to us, if at all. A successful claim of product infringement against
us or our failure or inability to license the infringed or similar technology
could adversely affect our business because we would not be able to sell the
affected product without redeveloping it or incurring significant additional
expense.
Possible adverse impact of interpretations of existing accounting
pronouncements
Based on our reading and interpretations of SOPs 81-1, 97-2 and 98-9, and
SAB 101, we believe that our current contract terms and business arrangements
have been properly reported. However, the American Institute of Certified Public
Accountants and its Software Revenue Recognition Task Force continue to issue
interpretations and guidance for applying the relevant standards to a wide range
of sales contract terms and business arrangements that are prevalent in the
software industry. Future interpretations of existing accounting standards or
changes in our business practices could result in future changes in our revenue
recognition accounting policies that could have a material adverse effect on our
business, financial condition, and results of operations.
As with other software vendors, we may be required to delay revenue
recognition into future periods, which could adversely impact our operating
results.
We have in the past had to, and in the future may have to, defer
recognition for license fees due to several factors, including whether:
.. software arrangements include undelivered elements for which we do not have
vendor specific evidence of fair value;
.. we must deliver services for significant customization, enhancements and
modifications of our software;
.. the transaction involves material acceptance criteria or there are other
identified product-related issues;
19
.. the transaction involves contingent payment terms or fees;
.. we are required to accept a fixed-fee services contract; or
.. we are required to accept extended payment terms.
Because of the factors listed above and other specific requirements under
accounting principles generally accepted in the United States for software
revenue recognition, we must have very precise terms in our software
arrangements in order to recognize revenue when we initially deliver software or
perform services. Negotiation of mutually acceptable terms and conditions can
extend the sales cycle, and sometimes we do not obtain terms and conditions that
permit revenue recognition at the time of delivery.
If we undertake acquisitions, they may be expensive and disruptive to our
business and could cause the market price of our common stock to decline
We completed the NetMaker and WDM NetDesign acquisitions in March 2001 and
January 2002, respectively. We may continue to acquire or make investments in
companies, products or technologies if opportunities arise. Any acquisition
could be expensive, disrupt our ongoing business, distract our management and
employees, and adversely affect our financial results and the market price of
our common stock. We may not be able to identify suitable acquisition or
investment candidates, and if we do identify suitable candidates, we may not be
able to make these acquisitions or investments on commercially acceptable terms
or at all. If we make an acquisition, we could have difficulty integrating the
acquired technology, employees, or operations. In addition, the key personnel of
the acquired company may decide not to work for us.
We also expect that we would incur substantial expenses if we acquired
other businesses or technologies. We might use cash on hand, incur debt, or
issue equity securities to pay for any future acquisitions. If we issue
additional equity securities, our stockholders could experience dilution and the
market price of our stock may decline.
Our products are subject to changing computing environments, including
operating system software and hardware platforms, which could render our
products obsolete
The evolution of existing computing environments and the introduction of
new popular computing environments may require us to redesign our products or
develop new products. Computing environments, including operating system
software and hardware platforms, are complex and change rapidly. Our products
are designed to operate in currently popular computing environments. Due to the
long development and testing periods required to adapt our products to new or
modified computing environments, our research and development efforts could be
distracted and we could also experience significant delays in product releases
or shipments, which could result in lost revenues and significant additional
expense.
20
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
We consider all highly liquid investments purchased with a maturity of
three months or less to be cash equivalents, and those with maturities greater
than three months are considered to be marketable securities. Cash equivalents
and marketable securities are stated at amortized cost plus accrued interest,
which approximates fair value. Cash equivalents and marketable securities
consist primarily of money instruments and U.S. Treasury bills. We currently do
not hedge interest rate exposure, but do not believe that an increase in
interest rates would have a material effect on the value of our marketable
securities.
ITEM 4. Controls and Procedures
We maintain a system of internal controls and procedures that are designed
to provide reasonable assurance that information required to be disclosed by us
in the reports that we file under the Exchange Act is recorded, processed,
summarized and reported within required time periods. Our Chief Executive
Officer and our Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures as of a date within 90 days before the filing
of this quarterly report, and have each concluded that, as of the evaluation
date, such controls and procedures were effective, in all material respects, to
ensure that required information will be disclosed on a timely basis in our
reports filed under the Exchange Act.
Subsequent to the date of our evaluation, there have been no significant
changes to our internal controls or in other factors that could significantly
affect our internal controls.
21
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
OPNET is involved in various claims and legal proceedings arising from its
normal operations. Management does not consider any of those matters to be
material.
ITEM 2. Changes in Securities and Use of Proceeds
In August 2000, we closed an initial public offering of our common stock.
The Registration Statement on Form S-1 (No. 333-32588) was declared effective by
the Securities and Exchange Commission on August 1, 2000 and we commenced the
offering on that date. After deducting the underwriting discounts and
commissions and the offering expenses, the net proceeds from the offering were
approximately $54.1 million.
As of September 30, 2002, the proceeds from the offering were used to fund
approximately (i) $7.6 million of general corporate expenses, working capital
and capital expenditures, including $4.8 million for capital expenditures and
leasehold improvements related to our headquarters facility in Bethesda,
Maryland, (ii) $6.2 million of acquisition and acquisition-related expenses for
the NetMaker acquisition, and (iii) $1.4 million of the purchase price for WDM
NetDesign. None of these amounts were paid directly or indirectly to any
director, officer, or general partner of us or their associates, persons owning
10% or more of any class of our equity securities, or any affiliate of us. We
have not allocated any of the remaining net proceeds to any identifiable uses.
We may also use a portion of the net proceeds to acquire businesses, products,
or technologies that are complementary to our business. Pending their use, we
have invested the net proceeds in investment grade, interest-bearing securities.
ITEM 4. Submission of Matters to a Vote of Security Holders
At the Annual Meeting of Stockholders of the Company held on September 10,
2002, (i) the Company's nominees for Class II Directors for the ensuing three
years were elected and the selection of Deloitte & Touche LLP as the Company's
independent auditor's for the current fiscal year was ratified.
With respect to the election of the Class II Directors, the voting was as
follows:
Nominees For Withheld
Alain J. Cohen 15,779,228 1,079,283
Dr. Steven G. Finn 16,464,273 394,238
With respect to the ratification of the selection of Deloitte & Touche LLP
as the Company's independent auditors for the current fiscal year, the voting
was as follows:
For 16,848,076
Against 5,700
Abstain 4,735
ITEM 6. Exhibits and Reports on Form 8-K
A. Exhibits: See Exhibit Index
B. Reports on Form 8-K
None.
22
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OPNET TECHNOLOGIES, INC.
(Registrant)
By: /s/ Joseph W. Kuhn
---------------------------
Date: October 31, 2002 Name: Joseph W. Kuhn
Title: Vice President of Finance
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
CERTIFICATIONS
Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 and Item 307 of Regulation S-K
I, Marc A. Cohen, certify that:
1. I have reviewed this quarterly report on Form 10-Q of OPNET Technologies,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
23
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: October 31, 2002 By: /s/ Marc A. Cohen
Marc A. Cohen
Chairman and Chief Executive Officer
(Principal Executive Officer)
Certification of Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
In connection with this quarterly report on Form 10-Q of OPNET Technologies,
Inc., I, Marc A. Cohen, Chief Executive Officer of OPNET Technologies, Inc.,
certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
Dated: October 31, 2002 By: /s/ Marc A. Cohen
Marc A. Cohen
Chairman and Chief Executive Officer
(Principal Executive Officer)
Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 and Item 307 of Regulation S-K
I, Joseph W. Kuhn, certify that:
1. I have reviewed this quarterly report on Form 10-Q of OPNET Technologies,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
d) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
e) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
f) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
24
c) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
d) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: October 31, 2002 By: /s/ Joseph W. Kuhn
Joseph W. Kuhn
Vice President and Chief Financial
Officer (Principal Financial and
Accounting Officer)
Certification of Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
In connection with this quarterly report on Form 10-Q of OPNET Technologies,
Inc., I, Joseph W. Kuhn, Chief Financial Officer of OPNET Technologies, Inc.,
certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
Dated: October 31, 2002 By: /s/ Joseph W. Kuhn
Joseph W. Kuhn
Vice President and Chief Financial
Officer (Principal Financial and
Accounting Officer)
25
OPNET TECHNOLOGIES, INC.
EXHIBIT INDEX
Exhibit
Number Description Source
3.1 Third Amended and Restated Certificate of Incorporated by reference from exhibit 3.2 to the
Incorporation of the Registrant Registrant's Registration Statement on Form S-1 (File No.
333-2588).
3.2 Amended and Restated By-Laws of the Registrant Incorporated by reference from exhibit 3.4 to the
Registrant's Registration Statement on Form S-1 (File No.
333-2588).
4.1 Specimen common stock certificate Incorporated by reference from exhibit 4.1 to the
Registrant's Registration Statement on Form S-1 (File No.
333-2588).
4.2 See Exhibits 3.1 and 3.2 for provisions of the Incorporated by reference from exhibit 4.2 to the
Certificate of Incorporation and By-Laws of the Registrant's Registration Statement on Form S-1 (File No.
Registrant defining the rights of holders of 333-2588).
common stock of the Registrant
10.1 Amended and Restated Registration Rights Incorporated by reference from exhibit 10.1 to the
Agreement, dated as of March 30, 2001, by and Registrant's Annual Report on Form 10-K for the period
among the Registrant, Summit Ventures IV, L.P., ended March 31, 2001 as filed with the SEC on June 29,
Summit Investors III, L.P., Alain J. Cohen, 2001.
Marc A. Cohen and Make Systems, Inc.
10.2 Asset Purchase Agreement, dated as of March 20, Incorporated by reference from exhibit 2.1 to the
2001, by and among the Registrant, Make Registrant's Current Report on Form 8-K dated March 22,
Systems, Inc. and Metromedia Company 2001 filed the Securities and Exchange Commission ("SEC")
on March 23, 2001 (File No. 000-30931).
10.3 Stock Purchase and Option Agreement, dated as Incorporated by reference from exhibit 10.6 to the
of November 1, 1999, between the Registrant and Registrant's Registration Statement on Form S-1 (File No.
Steven G. Finn 333-2588).
10.4 Stock Purchase and Option Agreement, dated as Incorporated by reference from exhibit 10.7 to the
of November 1, 1999, between the Registrant and Registrant's Registration Statement on Form S-1 (File No.
William F. Stasior 333-2588).
10.5 Amended and Restated 1993 Incentive Stock Incorporated by reference from exhibit 10.10 to the
Option Plan Registrant's Registration Statement on Form S-1 (File No.
333-2588).
10.6 2000 Employee Stock Purchase Plan Incorporated by reference from exhibit 10.12 to the
Registrant's Registration Statement on Form S-1 (File No.
333-2588).
10.7 2000 Director Stock Option Plan Incorporated by reference from exhibit 10.13 to the
Registrant's Registration Statement on Form S-1 (File No.
333-2588).
10.8 Non-competition Agreement, dated as of Incorporated by reference from exhibit 10.15 to the
September 30, 1997, between the Registrant Registrant's Registration Statement on Form S-1 (File No.
and Marc A. Cohen 333-2588).
26
10.9 Non-competition Agreement, dated as of Incorporated by reference from exhibit 10.16 to the
September 30, 1997, between the Registrant Registrant's Registration Statement on Form S-1 (File No.
and Alain J. Cohen 333-2588).
10.10 Change-in Control Agreement, dated as of June Incorporated by reference from exhibit 10.19 to the
1, 2000, between the Registrant Registrant's Annual Report on Form 10-K for the period
and Pradeep K. Singh ended March 31, 2001 as filed with the SEC on June 29,
2001.
10.11 Office Lease Agreement, dated May 2000, between Incorporated by reference from exhibit 10.21 to the
the Registrant and Street Retail, Inc. Registrant's Annual Report on Form 10-K for the period
ended March 31, 2001 as filed with the SEC on June 29,
2001.
10.12 Amended and Restated 2000 Stock Incentive Plan Incorporated by reference from exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the period
ended September 30, 2001 as filed with the SEC November
14, 2001.
10.13 Loan Agreement, dated June 10, 2002, between Incorporated by reference from exhibit 10.1 to the
Registrant and Bank of America, N.A. Registrant's Quarterly Report on Form 10-Q for the period
ended June 30, 2002 as filed with the SEC August 9, 2002.
10.14 Promissory Note, dated June 10, 2002, between Incorporated by reference from exhibit 10.2 to the
Registrant and Bank of America, N.A. Registrant's Quarterly Report on Form 10-Q for the period
ended June 30, 2002 as filed with the SEC August 9, 2002.
21 Subsidiaries of the Registrant Incorporated by reference from exhibit 21 to the
Registrant's Annual Report on Form 10-K for the period
ended March 31, 2002 as filed with the SEC on June 20,
2002.
27