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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 Exchange
Act of 1934
For the fiscal year ended June 30, 1999
or
[ ] Transition report pursuant to Section 13 of 15(d) of the Securities
Exchange Act of 1934
Commission file number: 0-26886
OBJECTIVE SYSTEMS INTEGRATORS, INC.
(Exact name of registrant as specified in its charter)
Delaware 68-0239619
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
100 Blue Ravine Road, Folsom, California 95630
(Address of principal executive office) (zip code)
Registrant's telephone number, including area code: (916) 353-2400
Securities registered pursuant to section 12(b) of the act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)
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 _______.
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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 the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on August 31,
1999 as reported on The Nasdaq Stock Market, was approximately $38,681,758
Shares of Common Stock held by each officer and director and by each person who
owns 5% or more of the outstanding Common Stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
As of August 31, 1999, the registrant had outstanding 35,866,761 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant has incorporated by reference into Part III of this Form 10-K
portions of its Proxy Statement for the Annual Meeting of Stockholders to be
held December 9, 1999.
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OBJECTIVE SYSTEMS INTEGRATORS, INC.
FISCAL YEAR 1999 FORM 10-K ANNUAL REPORT
Table of Contents
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PART I. Page
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Item 1. Business.................................................................... 1
Item 2. Properties.................................................................. 7
Item 3. Legal Proceedings........................................................... 7
Item 4. Submission of Matters to a Vote of Security Holders......................... 8
Item 4A. Executive Officers of the Registrant........................................ 8
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....... 9
Item 6. Selected Financial Data..................................................... 10
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................... 10
Item 7a. Quantitative and Qualitative Disclosure About Market Risk................... 20
Item 8. Financial Statements and Supplementary Data................................. 20
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure........................................................ 20
PART III.
Item 10. Directors and Executive Officers of the Registrant.......................... 20
Item 11. Executive Compensation...................................................... 20
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 21
Item 13. Certain Relationships and Related Transactions.............................. 21
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............. 21
Signatures.................................................................. 23
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PART I
ITEM 1. BUSINESS
Forward-Looking Statements
Some of the statements in this Report are "forward-looking statements" as
defined in the Private Securities Litigation Reform Act of 1995. They have been
identified with an asterisk (*). Underlying these statements are a number of
assumptions regarding risks, both known and unknown, which may cause the actual
results of Objective Systems Integrators, Inc. ("OSI") or its industry to differ
materially from those that are expressed or implied. Additional information
regarding these risks (including but not limited to, concentration of product
and customers; growth of sales, customer support and development organizations;
competition and technological change in the industry; international licensing;
dependence on third party relationships; risk of product defect; fluctuations of
quarterly results; "Year 2000" issues; and retention of key personnel) can be
found throughout Item 1 Business, Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations, and Item 7a Quantitative and
Qualitative Disclosure About Market Risk.
General
OSI was established in 1989 to provide operations support system ("OSS")
software that would simplify the integration and management of communications
networks in large-scale, complex, multi-vendor environments. Our products are
designed to address the service management and network management needs of
communications service providers. The current global communications market is
one of both growth and transition. Deregulation is causing intense competition,
new technologies are rapidly evolving, the expansion of the Internet has been
explosive, and customers increasingly are demanding more and better services.
Faced with the need to offer mobile (wireless), circuit (wireline), and virtual
(data) services, communications service providers need comprehensive OSS systems
that have the flexibility to accommodate change and allow them to differentiate
their services. Since its introduction in 1989, our primary product, NetExpert,
has evolved into a platform for delivering integrated, reusable solutions to
service providers around the world. In fiscal 1999, we announced the
next-generation framework product, NetExpert Virtual Service Management(TM)
("VSM"), and the NetExel(TM) Solution Service suite of modular, applications
that can be integrated for service delivery, assurance and usage. In addition,
we announced NetExpert Virtual Process Management(TM) ("VPM"), advanced software
for capturing and controlling business processes. This product offering -- based
on our NetEx(TM) Unified Management Architecture(TM) ("UMA") -- has been
designed specifically to meet the needs of the communications marketplace in a
time of rapid growth and change.
Objective Systems Integrators(TM), NetExpert(R), OSI(TM), NetEx(TM),
WebOperator(TM), NetExel(TM), NetExpert VSM(TM), Virtual Process Management(TM),
and the OSI's logo are trademarks of Objective Systems Integrators, Inc. This
report also includes trademarks of companies other than Objective Systems
Integrators, Inc.
Industry Background
A Market in Transition. Over the past 12 months, global communications markets
have become even more competitive. Increasing numbers of customers are seeking
access to a wider variety of communications services and, at the same time, are
demanding more from those services. A number of analysts have begun to refer to
the current environment as a "revolution" in communications. Change is being
driven by (1) deregulation resulting from the U.S. Telecommunications Act of
1996 and the World Telecommunications Organization Pact of 1998; (2) increased
industry competition and consolidation; (3) the phenomenal growth of the
Internet; (4) the introduction of new, enhanced customer services; and (5) the
rapid development of new technologies. Tremendous amounts of capital have been
poured into communications infrastructure, with even greater levels of
investment predicted. It has been estimated that during calendar 1999,
approximately $9.9 billion will be spent worldwide on OSS's (including hardware,
software and external services). It has also been estimated that this level of
investment will to grow at a 13% compound annual rate through 2002 to $14
billion.1 The need to provision services more rapidly, operate networks at peak
efficiency and do both with fewer people is forcing new approaches in the
software systems used by service providers.
New services and network infrastructure remain one of the chief vehicles that
communications providers have to differentiate themselves from their
competition. The impact of new services -- particularly those that use the
Internet -- has strained the current communications infrastructure and created a
demand for greater capacity. In response, service providers have begun
implementing new technologies to augment or replace their traditional copper
wireline infrastructure with networks that use fiber optics, hybrid fiber
coaxial cable, radio frequency signals, or satellite transmission. They have
also begun to implement a variety of new technologies so that they can offer
greater bandwidth and higher-quality services. In conjunction with these
changes, providers are increasingly turning to new, state-of-the-art OSS's to
replace their legacy OSS's.
The Role of Operations Support Systems and Service & Network Management. Service
providers use OSS's to develop, deploy and manage their networks and the
services that depend on those networks. Through their ability to control,
monitor, and manage
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/1/ Source: Dataquest/G2R
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network functions and equipment, OSS's can improve the quality of service
delivery, assurance, and usage. Service delivery is the process of introducing
new services and updating existing ones. Service assurance involves monitoring
and managing existing services to ensure their quality and that they meet
service-level obligations to customers. Service usage involves the collection of
billing and account management detail for the products and services that are
delivered to customers. OSI's approach to this market is based on our belief
that an OSS which enables the efficient sharing of data among these three areas
can save service providers time, money, and effort, thereby giving them a
distinct advantage over competitors who do not have such an integrated system.
Legacy OSS's. Traditional OSS's were developed and deployed in an era of limited
competition, slow technological change, and basic phone services. Many network
management products now used by the regional U.S. telephone companies were
developed by BellCore (now Telcordia/TM/ Technologies, a subsidiary of SAIC),
formerly the applied research and development laboratory of the Regional Bell
Operating Companies. Created primarily to manage basic voice services, these
older systems -- generally mainframe-based, written in older programming
languages and using first-generation database management systems -- are not well
adapted to deploying new services rapidly and supporting heterogeneous networks
consisting of equipment and software produced by different vendors.*
Point Solutions. Some OSS vendors market products that provide a limited number
of OSS functions, such as fault management or performance management. These are
generally not based on a flexible framework architecture. As a result, they may
not integrate easily with other OSS functions for more efficient operations, nor
may they easily scale to the needs of service providers as their customer base
and service offerings grow.*
The OSI Solution
An Architecture for Change. OSI's NetEx Unified Management Architecture, or UMA,
was designed as a comprehensive blueprint for open service and network
management that would support current and future business processes.* UMA
provides a model for managing converging circuit (wireline), mobile (wireless)
and virtual (data/IP) services and networks. It identifies standards-based
dependencies, interactions and data across all service, network and element
management functions, so that service providers can focus on their business
needs, unhindered by differences between systems and standards. Its modular
approach was also designed to allow service providers to automate the management
of their network and services as their needs arise and their revenues permit.
A Framework for the Future. NetExpert VSM was designed as an object-oriented
OSS software framework for the unified management of services and networks. It
is a vendor, standards, and protocol-neutral framework that will allow for
integration of service delivery, service assurance, and service usage
functions on a consolidated management platform. Designed to facilitate the
NetEx UMA, NetExpert VSM has been structured to allow for the rapid deployment
of new services without compromising network availability or service quality.*
Our customers can use NetExpert VSM to help them build their own applications
or to configure and deploy any of our NetExel(TM) Solution Service
applications in circuit, mobile and virtual domains. It also provides the
foundation for NetExpert VPM, a complementary technology for controlling, and
automating evolving business processes, systems and resources.
NetExpert VSM is a flexible tool that supports accepted industry standards, such
as Common Object Request Broker Architecture (CORBA), Simple Network
Management Protocol (SNMP) and the Telecommunications Management Network (TMN)
architecture established by the Telecommunications Standardization Section of
the International Telecommunications Union. Our UMA supports the
implementation of TMN's layered management architecture. NetExpert VSM enables
the development and deployment of applications in the TMN areas of fault,
configuration, performance and accounting management. We believe the market
outlook for TMN-based systems is strong as service providers are increasingly
pushing their suppliers to provide integrated, packaged solutions.* We expect
demand to come from both emerging carriers deploying new infrastructure and
from traditional carriers as they deploy new services or migrate from their
existing legacy systems.*
NetExpert VSM-based solutions run on UNIX platforms offered by Hewlett Packard,
Sun and IBM. WebOperator, an interface that allows users access to the
functionality of the NetExpert VSM framework via a corporate intranet or
extranet, is a Java application that offers cross-platform functionality. It
supports UNIX, Windows 98 and Windows NT client platforms. In addition,
NetExpert VSM can be used with databases from Oracle, Sybase and Informix.
NetExpert VSM was also designed to allow service providers to keep pace with new
network technologies. Next-generation transport networks are being data-
optimized, and VSM can accommodate these changes with carrier-grade management
capabilities. Intelligent Gateways provide two-way communication with the
equipment management ports using common communications such protocols such as
SNMP and Common Management Information Protocol. They can also be configured
to allow for custom OSS interfaces. We designed NetExpert VSM with the
flexibility to accommodate new gateways as communications technologies evolve.
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Integrated Solutions. The NetExel Solution Series comprises a suite of
configurable applications that automate and integrate the management of service
delivery (configuration), service assurance (fault and performance), and service
usage (accounting). As part of our Unified Management Architecture, the NetExel
products were developed incorporating reusable functions of NetExpert VSM and
other technologies. Each NetExel application solution is configurable to meet a
particular service provider's requirements. One or several of our NetExel
solutions can be configured and deployed for fault, configuration, accounting
and performance management. This can be done either by our existing professional
services staff, by one of our systems integrator partners or by a provider's
internal development organization. When OSI does not provide the OSS, a
customer can use NetExpert VSM's Gateway and CORBA Access modules to integrate
a third party OSS with their NetExel product.
Automated Business Processes for Competitive Advantage. A business process is a
logical sequence of tasks that accomplishes a business function, such as
validating an order or activating a service. This may include tasks that involve
system interaction, manual intervention or computer-based decision making.
Making business processes more efficient offers service providers a large
opportunity for competitive advantage. NetExpert VPM gives managers and others
in the service provider organization the ability to capture, control and
automate their processes visually, without disrupting underlying OSS's. Built on
UMA, it allows service providers to link business processes flexibly with
network operations, provide universal access to information, consolidate
processes for rapid service delivery, and design and modify process flows for
specific business results. This product, announced in the fourth quarter of
fiscal 1999, expands our integrated offerings for the communication service
provider market.
Customers may choose the configuration of our NetExpert VSM-based Solution
Series products that meets their specific requirements. They can also add new
functions as their needs grow. License fees for NetExpert VSM installations
typically begin at approximately $250,000 and can increase to many millions of
dollars depending on the scope of the network and the functionality required for
a given service provider's application. We are also introducing price scaling,
which will base license fees on volume of usage by the service provider. This
should allow us to penetrate smaller accounts with entry-level solutions, which
can then be expanded as the service provider's needs grow. We generally enter
into support agreements with our customers that provide for ongoing service and
product upgrades for a fixed annual fee
Distribution
OSI sells through its direct sales force and through indirect channels. In North
America we primarily engage in direct selling. A small portion of our U.S. sales
are made to government and enterprise customers, in most cases through systems
integrators and value-added resellers. In 1999, revenues derived from the U.S.
were 55% of our total revenues. Outside of the U.S., our regional sales
organizations typically work through indirect channels and provide support to
network equipment manufacturers, systems integrators and local value-added
resellers. Sales outside of the U.S. accounted for 45% of our revenues in 1999.
Customers
One of our key assets is a premier customer base of major communications service
providers worldwide, including:
. Local exchange carriers (LECs), such as the Regional Bell Operating Companies,
including Bell South, SBC Communications, Pacific Bell and Ameritech
. Emerging carriers, including competitive local exchange carriers (CLECs), such
as Qwest Communications, Level 3, WinStar, e.spire Communications, Williams
Communications, Frontier, Adelphia , AllTel, Swisscom (Switzerland) and Siris
(France)
. Cellular and personal communications services (PCS) providers, including AT&T
Wireless Services, Omnipoint, Nextel, Airtouch and Hong Kong Telecom CLS
. Interexchange carriers (IXCs), including Sprint and MCI WorldCom
. International IXCs, such as Telmex, NTT (Japan), Telecom New Zealand, Bayantel
International (Philippines), Hanaro (Korea) and the Communications Authority
of Thailand
. Leading operators of voice, data, video networks and internet service,
including TCI, @Home, Time Warner Cable and Verio.
As of June 30, 1999, we had directly or indirectly licensed our products to over
250 customers around the world. Our primary target markets are circuit
(wireline), mobile (cellular/wireless/PCS) and virtual (IP/data) communications
service providers.
A significant portion of our revenues in each fiscal period generally has
involved substantial orders from large organizations. As a result, our revenues
have often been concentrated among a relatively small number of customers. In
fiscal 1999, 1998 and 1997,
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revenues from the license of our products and services to our five largest
customers were approximately 28%, 30% and 23% of total revenues, respectively.
No customer accounted for greater than 10% of total revenues in fiscal 1999. One
customer, a global telecommunications company, accounted for approximately 12%
of total revenues in fiscal 1998. No customer accounted for more than 10% of
total revenues in fiscal 1997. We expect that we will continue to depend on
large orders for a significant portion of our future revenues.* As a result, our
business, operating results and financial condition will be materially adversely
affected if anticipated orders do not materialize, are deferred or are canceled,
due to changes in customer requirements.* There can also be no assurance that
revenues from key customers, individually or as a group, will continue at
historical levels.
Sales and Marketing
We have a sales organization, consisting of account managers, sales engineers
and sales management staff, that sells directly to end-users and assists in
sales by strategic partners, systems integrators and value-added resellers. In
addition, we have domain experts in our marketing organization who are highly
knowledgeable about the products and technologies of specific market segments.
These domain experts work directly with our sales force to define product
objectives, customer needs and market requirements.
We expect to continue expanding our direct sales force, opening additional
customer support and sales offices, adding value-added resellers and pursuing
additional strategic partnerships.* This will require significant management
attention and financial resources.* We expect to fund this expansion by growth
in our revenues. However, doing so could adversely affect our operating results
during any particular reporting period depending on the relative timing of
expenditures and the recognition of offsetting revenue.*
In North America, we have 11 sales and customer support offices in the
following greater metropolitan areas: Atlanta, Chicago, Dallas, Denver, Ft.
Lauderdale, Mexico City, Philadelphia, Sacramento, Seattle, Toronto and
Washington, D.C.
Outside of North America, we license our products and services principally
through systems integrators, value-added resellers and local distributors that
have cultural familiarity, specific industry expertise and the ability to
respond to customer needs on a timely basis. We currently have sales engineering
and technical support offices in Japan, Australia, Thailand, Taiwan,
Philippines, Korea, Singapore and France.
Revenues outside of the United States accounted for 45%, 34% and 28% of total
revenues in fiscal 1999, 1998 and 1997, respectively. A breakdown of revenues
derived from sales outside of the United States, can be found in Note 9 to the
Consolidated Financial Statements included in this Form 10-K. We expect that
international revenues will continue to account for a significant portion of our
total revenues.*
To the extent that we do not establish additional operations outside of the
United States in a timely manner, our ability to grow international sales will
be limited.* This would, in turn, materially adversely affect our business,
operating results and financial condition.* In addition, our international
operations involve a number of inherent risks, such as (1) longer sales cycles
and collection periods; (2) greater difficulty in collections, staffing and
management; (3) unexpected changes in regulatory requirements, including a
slowdown in the rate of privatization of telecommunications service providers;
(4) reduced protection for intellectual property rights in some countries; (5)
variable economic conditions; and (6) other trade barriers.*
To supplement our direct sales efforts, we have also established relationships
with strategic partners, including systems integrators, value-added resellers,
distributors and network equipment vendors. Whenever possible, we work closely
with partners to facilitate a complete customer solution. In addition to
assisting our sales efforts, these relationships provide us with insight into
new and emerging customer applications.
We expect to strengthen our relationships with existing partners, and to add new
partners, over the course of the current fiscal year.* There can be no assurance
that we will be able to retain our current partners or attract new partners that
can market our products effectively. We believe that our success in penetrating
new markets depends in large part on our ability to maintain these
relationships, to cultivate additional relationships and to cultivate
alternative relationships as our distribution needs change.*
We changed the focus of our marketing organization signficantly this year in
terms of people, products, and process. We appointed a new vice president of
marketing and realigned the reporting structure of our marketing organization.
We refocused our products and our product marketing to better reflect industry
needs and to present a more coherent, unified approach. We initiated a rigorous
process for designing, development, deploying and distributing our products. We
also implemented a business tracking system to improve the accuracy and
timeliness of our product deliveries.
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Professional Services and Customer Support
We believe that highly competent professional services and technical customer
support organizations are critical to our continuing success in developing
long-term relationships with our customers.
To augment our sales efforts, we offer comprehensive professional services.
Professional services engineers work closely with our product developers, direct
sales personnel, partners, applications specialists and others to assist with
pre- and post-sales consulting support, including the implementation and use of
our products. We offer a range of services, including requirements analysis;
project management; system design, sizing, customization, installation and
tuning; training; ongoing consultation; and upgrade management. We also offer
12-month product support contracts to our customers. These contracts entitle the
customer to technical support, product updates and product maintenance during
the support period. Substantially all of our customer base was covered by
support contracts in fiscal 1999. Services and other revenue (as opposed to
revenue from the licensing of software products) accounted for 44%, 45% and 39%
of our total revenues in fiscal 1999, fiscal 1998 and fiscal 1997, respectively.
We can make no assurances that our professional services and customer support
resources will be sufficient to manage the future growth of our business.
Failure to expand our professional services and customer support organizations
commensurate with the expansion of our installed base, or failure to train those
organizations properly in our products, would have a material adverse effect on
our business, operating results and financial condition.*
Research and Development
Our research and development organization is responsible for the technology
research, design, development, and initial deployment of our full suite of
service and network management products. We develop most technology and
products internally. We also frequently review opportunities to license
technologies or products from others to accelerate the introduction of new and
enhanced products or to add value and function that will appeal to our
customers. To improve our ability to succeed in a highly competitive
marketplace, we increased expenditures for research and development from $14.2
million to $21.2 million over the past 3 fiscal years, representing a
substantial investment in new technologies and new and enhanced products.
We believe that these investments will pay off by allowing us to offer better,
more sophisticated systems for the new generation of networks and network
services. Last year alone, we introduced a common class library that can be
shared by various OSI applications and thereby enable more effective OSS
integration. This capability can help service providers operate more
efficiently and meet their service-level commitments to their customers. We
introduced new, next-generation framework software for Virtual Service
Management. This new framework gives service providers the flexibility to
incorporate industry standards and new technologies into installed management
systems, greater ability to increase network capacity, and compatibility with
Internet protocol (IP), a key requirement in today's market.
We also introduced a Virtual Process Management framework product that will
enable our customers to capture, control, and automate their business
processes. This will allow them to link business processes, such as order
management and customer service, with day-to-day network operations for greater
efficiency and cost control.
As noted, the market for our products is characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and on-going changes in customer requirements. This can rapidly render existing
products obsolete and unmarketable. As a result, the life cycles for our
products are difficult to estimate. Our success depends on our ability to
enhance our existing products while developing and introducing, on a timely and
cost-effective basis, new products and product features.* No assurances can be
made that we will be able to do so. If we cannot, our business, operating
results and financial condition would be materially, adversely affected.*
Furthermore, software products of the size and complexity that we offer are
likely to contain defects. While we test our products during development and
before general release, errors may well be found in existing and new products
after commercial licensing has begun.* This could result in delayed or lost
revenues, loss of market share, or failure to gain market acceptance.* Any of
these would materially, adversely effect our business, operating results and
financial condition.*
Competition
Competition in our markets is intense. To maintain and improve our competitive
position, we must continually develop and introduce, on a timely and
cost-effective basis, new products and features that keep pace with the
increasingly sophisticated needs of our customers.* The principal competitive
factors for our business are product reputation, product quality, performance
and price, the availability and quality of professional services and customer
support, and product functionality, such as adaptability, scalability, ability
to integrate with other products and ease of use.
Our competitors offer a variety of OSS solutions that address the service
provider market. These companies generally fall into one of the following four
categories:
. Custom software developers, which include a provider's in-house development
staff, independent integrators and independent software vendors whose
products are not based on a framework;
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. Communications equipment vendors, such as Lucent Technologies, Alcatel and
Cisco Systems, that offer software for managing their own network
equipment;
. Hardware and software vendors that offer network management functionality,
such as IBM, Sun, Hewlett Packard and Compaq; and
. Providers of "point" applications for a limited number of OSS functions,
such as Architel, Micromuse and ADC Metrica.
Many of our competitors have longer operating histories, greater name
recognition, a larger installed base and significantly greater financial,
technical, sales, customer support, marketing and other resources. Our goal is
to differentiate OSI from our competition by offering integrated flexible
framework-based solutions under a unified architecture.
Both existing and potential customers for our products regularly evaluate
whether they should develop their own OSS systems or license them from outside
vendors. They sometimes have large internal staffs responsible for meeting their
internal needs. As a result, we must continuously address the advantages of our
products over internally developed OSS's and the products of competitors. In
fiscal 1997 and continuing in fiscal 1998 and 1999, we focused our sales,
marketing and product development efforts on emerging wireline, wireless and
IP/data service providers. While these companies typically do not have large
internal staffs, they need to introduce new services quickly. We also focused
on traditional carriers for their new services, where time-to-market is a
priority. Increasingly, we are positioning our solutions as the best choice
for a changing environment and for the convergence that is taking place in
network services and technologies.
While our open systems architecture differentiates our product in the
marketplace, an open systems architecture can itself lead to increased
competition from third-party OSS systems.* Competitors may be able to respond
more quickly to new or emerging technologies and changes in customer
requirements.* They may also be able to devote greater resources to the
development, promotion and sale of their products.*
We believe that our products offer more functionality and a higher degree of
interoperability than do those of our competitors.* Therefore, our products have
historically been priced at a premium. At the end of fiscal 1999, we introduced
a new pricing model designed to help us increase our market share in certain
market segments. This new model is based on the volume of usage rather than
fixed price components. Usage-based pricing should allow our customers to
license products more cost-effectively to meet their short term usage levels
while giving them the flexibility to increase their usage as they grow.* Both
pricing models will continue to be available to customers in the future.*
Although we believe that usage based pricing will be effective in increasing our
market share, increased competition could result in further price reductions,
reduced margins or a loss of market share, any of which could materially,
adversely affect our business, operating results and financial condition.*
Intellectual Property
To protect our proprietary rights, we rely on a combination of trade secret,
copyright and trademark laws, a variety of technical measures and nondisclosure
or other contractual agreements. We currently have several patent applications
pending. As part of our confidentiality procedures, we generally enter into
invention assignment and proprietary information agreements with our employees
and consultants, and into nondisclosure agreements with our customers, system
integrators, value-added resellers and distributors. We also limit access to and
distribution of our software, documentation and other proprietary information.
Despite these efforts, others may attempt to copy our products or to obtain and
use information that we regard as proprietary.* In addition, effective copyright
and trade secret protection may be unavailable or limited in certain countries,
making the possibility of misappropriation more likely.* The steps that we have
taken may prove insufficient to protect proprietary technology or prevent
misappropriation.* Moreover, they may not stop competitors from developing
products with functionality or features similar to our products.* We believe
that, because of the rapid pace of technological change in the market for our
products, legal protections of our proprietary technology are not as significant
to our success as the knowledge, technical expertise, ability and experience of
our employees, the frequency of our product enhancements and the quality of the
professional services and customer support we provide.*
We do not believe that our products infringe on the proprietary rights of third
parties, and there are currently no pending claims to that effect. However, we
expect that software companies will be increasingly subject to infringement
claims as the number of products and competitors grows and the functionality of
products in different industry segments overlaps.* Claims of this kind, with or
without merit, could be time-consuming, result in costly litigation and divert
our technical and management personnel, cause product shipment delays and
require us to develop non-infringing technology or enter into royalty or
licensing agreements.* Moreover,
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royalty or licensing agreements, if required, may not be available or may be
available only on terms that we find unacceptable.* A successful claim of
product infringement, if non-infringing technology could be not be developed or
licensed, would materially, adversely affect our business, operating results and
financial condition.
We also rely on software that is licensed from others, including software that
is integrated with our internally developed software and used to perform key
functions. This third-party software may, at some future point, be unavailable
to us on commercially reasonable terms.* The suppliers of that software also may
not adequately support or enhance their current products or develop new products
on a timely and cost-effective basis.* We may not be able to replace the
functionality provided by third-party software if it is defective or becomes
obsolete or incompatible with future versions of our products.* The loss of any
of this software, or the inability of our suppliers to enhance their products,
could result in delays or reductions in our product shipments until we could
internally develop equivalent software or identify, license and integrate
alternative third-party products.* Any of these factors could also have a
material adverse effect on our business, operating results and financial
condition.*
Employees
As of June 30, 1999, we had 376 employees, including 132 engaged in research and
development, 97 in sales and marketing, 85 in professional services and customer
support, and 62 in administration and finance. None of our employees is
represented by a collective bargaining agreement, nor have we experienced any
work stoppages. We believe that our relations with our employees are good.
Our success depends to a significant degree on continuing contributions by key
personnel, the loss of whom could have a material, adverse effect on our
business.* Our future success will also depend in large part on our ability to
attract and retain highly skilled employees. Competition for qualified personnel
in the software industry is intense, and we may not be successful in attracting
and retaining such personnel.* Failure to do so would have a material, adverse
effect on our business, operating results and financial condition.*
ITEM 2. PROPERTIES
Our principal administrative, sales and marketing, customer support and product
development facilities are located in two buildings, of approximately 55,000
square feet and 35,000 square feet respectively, in Folsom, California. Both
facilities are leased. The lease on the 35,000 square-foot facility expires in
1999.
To provide for future expansion, we purchased a 14-acre parcel of land in 1997
with the intention of replacing certain of our facilities. In 1998, we
subdivided the parcel, entered into a sale-leaseback arrangement with a
developer and constructed a 55,000-square-foot building. This building currently
houses our research and development and other technical personnel. A similar
sale-lease back arrangement has been entered into, and a second
55,000-square-foot building is currently under construction, at the same site.
We expect to take occupancy of the second building in fiscal 2000.*
We also lease offices in the following greater metropolitan areas: Atlanta,
Bangkok, Chicago, Dallas, Denver, Ft. Lauderdale, Manilla, Mexico City, New
York, Nice, Philadelphia, Reno, Seattle, Seoul, Singapore, Sydney, Taipei,
Tokyo, Toronto, and Washington, D.C.
We believe that our existing facilities are adequate to meet our current needs
and that, as required, suitable additional or alternative space will be
available to us in the future on commercially reasonable terms.*
ITEM 3. LEGAL PROCEEDINGS
From time to time, we may be a party to litigation incidental to the ordinary
course of our business. As of the date of this Report, we do not believe that
there is any material litigation pending against us. However, any litigation
involving OSI, whether as plaintiff or defendant and regardless of the outcome,
could result in substantial costs and significant diversion of effort by
technical and management personnel.* In addition, we can give no assurances that
material litigation, either by or against us, will not be necessary to resolve
issues that may arise in the future. Given the uncertainties of litigation, any
litigation could have a material adverse effect on business, financial condition
or operating results.*
-7-
<PAGE>
On March 18, 1999, proceedings were filed against OSI with the Bureau de
Conciliation in Grasse, France, by Patric R. Olenczak, a former employee of OSI,
for various matters involving the termination of his employment. We believe that
this action is without merit and intend to vigorously defend it. However, we can
give no assurances that we will prevail. If we do not prevail, we could be
required to pay monetary damages in an amount that might have a material adverse
effect on our operating results and financial condition.*
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and key employees are as follows:
Name Age Position
- ---- --- --------
Jeffrey T. Boone 35 Vice President, Products and Technology
Philip N. Cardman 51 Vice President, General Counsel and Secretary
Lawrence F. Fiore 44 Vice President and Chief Financial Officer
Tom L. Johnson 54 Co-Chief Executive Officer, Co-Chairman of the
Board and Acting Chief Technology Officer
James K.R. Souders 40 Executive Vice President, Sales and Marketing
Richard G. Vento 59 Co-Chief Executive Officer and Co-Chairman of
the Board
Mr. Boone became Vice President, Products and Technology, in August, 1999, after
having served as Vice President, Technical Support Services, since July 1997.
From January 1996 to July 1997, he was Director, Technical Support Services, and
from November 1994 to January 1996, he was Manager, International Professional
Services. Mr. Boone has held various technical management positions with OSI
starting in November of 1993. He holds a BS degree in computer science from
California State University, Sacramento.
Mr. Cardman joined OSI as Vice President, General Counsel and Secretary in May
1996. From 1989 to May 1996, he was Vice President and General Counsel as well
as Vice President, Business Development, at Convex Computer Corporation, a
manufacturer of supercomputer systems. Mr. Cardman holds a BA degree from
Washington University and a JD degree from Duke University. He is a member of
the California and Texas Bars.
Mr. Fiore became Vice President, and Chief Financial Officer in June
1999 after having served as Vice President, Finance and Administration, since
March, 1999. He joined OSI as corporate controller just prior to our initial
public offering in November, 1995. Before joining OSI, he was Director of
Financial Operations at a Silicon Valley software company. Mr. Fiore holds a BBA
degree in accounting from Texas Tech University and is a Certified Public
Accountant.
Mr. Johnson is Co-Chief Executive Officer, Co-Chairman of the Board of Directors
and Acting Chief Technology Officer. He co-founded Objective Systems
Integrators, a partnership and the predecessor to OSI, in January of 1989. He
was Co-Chief Executive Officer and Chairman of the Board of Directors from 1989
to 1995. He also was President from May 1991 to June 1994, Chief Financial
Officer from July 1989 to November 1993, and Vice President, Product Development
from July 1990 to July 1995. Mr. Johnson holds a BS degree in abstract
mathematics with a minor in business management from the University of Houston.
Mr. Souders became Executive Vice President, Sales and Marketing in January
1998. From July 1996 to December 1997, he was Vice President, Asia Pacific
Operations. From October 1994 to July 1996, he was Managing Director, Asia
Pacific Operations. From
-8-
<PAGE>
February 1993 to October 1994, he was OSI's Managing Director, New Business
Development, Asia-Pacific Region. Mr. Souders holds a BS degree in accounting
from Lewis & Clark College.
Mr. Vento is Co-Chief Executive Officer and Co-Chairman of the Board of
Directors. He co-founded Objective Systems Integrators, a partnership and the
predecessor to OSI, in January 1989. He served as President from June 1994 to
July 1995, as Secretary from July 1989 to November 1993, and as Vice President,
Sales and Marketing from July 1990 to June 1994. Mr. Vento holds a BA degree in
mathematics and a BS degree in business and economic statistics from San
Francisco State University. He also holds an AA degree in liberal arts from
Foothill College.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Common Stock Prices And Dividends
OSI's common stock has been traded on The Nasdaq Stock Market since our initial
public offering in November 1995. It trades under the symbol OSII. According to
the records of our transfer agent, we had approximately 167 stockholders of
record as of June 30, 1999. Because many of our shares are held by brokers and
other institutions on behalf of stockholders, we are not able to estimate the
total number of stockholders represented by the record holders. In October 1998,
we distributed proxy materials to approximately 6,500 stockholders for the 1998
Annual Stockholders' Meeting. The following table sets forth the high and low
sales price for our common stock:
FISCAL 1999: High Sale Price Low Sale Price
--------------- --------------
First Quarter............ $ 9.31 $ 4.25
Second Quarter .......... $ 6.06 $ 3.13
Third Quarter ........... $ 5.25 $ 2.56
Fourth Quarter........... $ 3.56 $ 2.13
FISCAL 1998: High Sale Price Low Sale Price
--------------- --------------
First Quarter............ $ 15.12 $ 5.00
Second Quarter .......... $ 15.63 $ 7.50
Third Quarter ........... $ 14.63 $ 8.00
Fourth Quarter........... $ 14.06 $ 5.75
Our policy has been to reinvest earnings for future growth. Accordingly, we have
not paid dividends and do not anticipate declaring dividends in the foreseeable
future.*
-9-
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
Selected Consolidated Financial Data
(in thousands, except per share amounts)
Consolidated Statements of Operation Data:
<TABLE>
<CAPTION>
As of June 30, 1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Total revenues....................................... $ 64,790 $ 60,575 $ 51,712 $ 55,918 $ 36,011
Gross profit......................................... 44,421 35,809 27,283 41,985 26,421
1ncome (loss) from operations........................ (12,270) (20,171) (31,228) 13,847 11,822
Net income (loss).................................... (34,137) (12,170) (18,464) 9,675 7,178
Net income (loss) per share, diluted................. $ (0.97) $ (0.36) $ ( 0.58) $ 0.29 $ 0.23
Shares used in per share computation................. 35,142 33,724 32,080 33,447 31,410
</TABLE>
Consolidated Balance Sheet Data:
<TABLE>
<CAPTION>
As of June 30, 1999 1998 1997 1996 1995
---- ---- ----- ---- ----
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents and short-term
investments....................................... $ 31,582 $ 41,286 $ 43,241 $ 53,988 $ 763
Working capital...................................... 27,786 59,410 63,169 85,370 3,925
Total assets......................................... 66,424 101,358 108,031 107,078 21,011
Long-term debt....................................... -- -- -- -- --
Total stockholders' equity........................... 43,862 77,520 85,443 95,058 14,062
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
OSI provides OSS software that simplifies the integration and management of
communications networks in large-scale, complex, multi-vendor environments. We
were founded in June 1989 and began shipments of our NetExpert product line in
August of 1990. In fiscal 1999, we announced our next-generation framework
product, NetExpert Virtual Service Management ("VSM") and the NetExel Solution
Services applications. These new products reduce deployment time and reduce the
expertise needed for customization of our products. As of June 30, 1999, we had
directly or indirectly licensed our products to over 250 customers around the
world.
Revenue from licenses, service and support of the NetExpert product line has
accounted for substantially all of our revenues since our inception. A typical
NetExpert sale generally includes a combination of license fees, fees for
professional services and fees for customer support and training. We believe
that revenue from the license, service and support of our NetExpert product line
including VSM, will account for substantially all of our total revenue for the
foreseeable future.* A significant portion of revenues has been, and will
continue to be, derived from substantial orders placed by large
organizations.* The timing of these orders and their fulfillment has caused,
and may continue to cause, material fluctuations in operating results,
particularly on a quarterly basis.* We believe that our quarterly revenues and
operating results are likely to vary significantly in the future and that
period-to-period comparisons of revenue and results of operations are not
necessarily meaningful.* We also believe that quarterly revenues should not be
relied on as indications of future performance.*
We distribute and sell NetExpert products to end users in North America
primarily through a direct sales organization. Outside of North America, we sell
through systems integrators, local value-added resellers and, to a lesser
extent, an in-region direct sales force. We intend to enter into additional
international markets and to continue to grow our international operations by
expanding our direct sales force, opening new in-region customer support and
sales offices, adding value-added resellers and pursuing additional strategic
relationships.*
-10-
<PAGE>
Results of Operations
<TABLE>
<CAPTION>
Revenues:
(in thousands, except percentages) Fiscal Year Fiscal Year Fiscal Year
1999 Change 1998 Change 1997
------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Licenses............................... $ 36,296 9% $ 33,252 6% $ 31,376
Percentage of revenues................. 56% 55% 61%
Services and other..................... $ 28,494 4% $ 27,323 34% $ 20,336
Percentage of revenues................. 44% 45% 39%
Total revenues.................... $ 64,790 7% $ 60,575 17% $ 51,712
</TABLE>
Our revenues are derived from license fees and fees for services that complement
our products, including professional services, software support, customer
support and training. In fiscal 1999, total revenues increased over those in
fiscal 1998. This was primarily due to increased sales in our European, Latin
American and Asia Pacific regions. These increases were partially offset by
decreased domestic sales. Service revenues also increased in fiscal 1999 because
of higher maintenance and support revenues from a larger customer base.
In fiscal 1998, total revenues grew over those in fiscal 1997 because of
increased sales to new and existing customers, coupled with an overall increase
in our services revenues. The increase in service revenue was a reflection of a
higher percentage of sales being made to emerging service providers, who
typically require a higher level of professional services to implement new
solutions.
List prices for our products and services did not change significantly during
the comparison periods. However, we are currently instituting a new pricing
model which will provide customers with additional choices when purchasing
software licenses.
License Revenues. Software licenses have generally been granted and priced on a
per-server basis, although we have granted site, network-wide or enterprise-wide
licenses for larger installations. In future periods, licenses may be granted on
either a per-server basis or on other bases. We generally recognize license
revenues when a non-cancelable license agreement has been signed, product has
been shipped, there are no uncertainties surrounding product acceptance, the
fees are fixed and determinable, and collection is probable. We recognize
revenue under contracts requiring significant customization using the
percentage-of-completion method of contract accounting, based on the ratio of
incurred costs to total estimated costs. Although generally our license
agreements do not provide for a right of return, we maintain reserves for
returns and potential credit losses. In fiscal 1999, fiscal 1998 and fiscal
1997, we expensed approximately $1.1 million, $2.9 million and $5.4 million
respectively, to reserves for sales returns. This was done to reflect perceived
risks associated with actual and potential customer returns.
License revenues increased in fiscal 1999 over our license revenues in fiscal
1998, both in actual dollars and as a percentage of revenues. This can mainly be
attributed to increased sales in our data/IP and wireline market segments.
In fiscal 1998, license revenues increased over those in fiscal 1997 in actual
dollars, but and declined as a percentage of our total revenues. The decline as
a percentage of revenues was primarily a function of increased sales, the timing
of completion of network deployment cycles and increased orders for
customization services.
We anticipate that our license revenues will continue to represent a majority of
our total revenues for the foreseeable future.* However, we also believe that
historic growth rates in our license revenues should not be used as an
indication of growth rates for future periods.* We expect that implementation of
new strategies or pricing models may have an effect on our revenues.* While the
number of orders placed by new and existing customers may increase, the license
revenue per customer may potentially be reduced in any given reporting period.*
We also believe that competition in our markets is increasing.* This could
result in price reductions, reduced gross margins or loss of market share, any
of which would have a material adverse effect on our business, operating results
and financial condition.*
Services and Other Revenues. We recognize revenues for training, consulting and
professional services as the services are performed and acceptance criteria have
been met. We offer 12-month support contracts to our customers. These contracts
provide telephone support, updates and maintenance of NetExpert framework during
the support period. Maintenance revenues from our support contracts are deferred
and recognized ratably over the term of the support agreement. Payments for
support fees are generally made in advance and are nonrefundable.
-11-
<PAGE>
During fiscal 1999, service and other revenues increased over those in fiscal
1998 in absolute dollars, but declined as a percentage of our total revenues.
The growth in absolute dollars represents increased maintenance revenues from a
larger customer base with an increased number of NetExpert licenses. The
decrease as a percentage of revenues reflects our increased license revenues.
During fiscal 1999, revenues from our professional services declined over those
we reported in fiscal 1998. This decrease was primarily due to decreased orders
in the emerging service provider market. In fiscal 1997 and fiscal 1998 we
experienced an increase in the orders from the emerging service providers as
they built and deployed their network operations. In fiscal 1999, the emerging
service providers had their networks in place and we experienced a reduced
demand for professional services. OSI's revenues were associated with framework
and the expansion of the customers' existing network systems.
Our services and other revenues increased as a percentage of our total revenues
in fiscal 1998. This was mainly a function of the higher percentage of revenues
we derived from new and emerging service providers. As noted above in the
"Overview" section, the nature of the solutions acquired by these customers and
their lack of sufficient staff to implement them internally often leads to a
higher reliance on OSI's professional services.
We expect that our services and other revenues will continue to represent a
significant portion of our total revenues in future periods.* We anticipate a
continued demand for professional services in connection with licenses of
NetExpert VSM, the renewal of existing support contracts and incremental support
revenues attributable to a growing installed base of our products.* We also
believe that prior growth rates for services and other revenues may not be
sustainable and should not be relied on as an indication of growth rates in the
future.*
International Revenues. Revenues from outside of the United States represented
45%, 34% and 28% of total revenues for fiscal 1999, fiscal 1998 and fiscal 1997,
respectively. Revenues from customers in the Asia-Pacific region accounted for
19% of total revenues in fiscal 1999. This compares with 14% of total revenues
in fiscal 1998 and 17% of total revenues in fiscal 1997. We believe that the
weakened economic conditions in this region have had a slightly negative effect
on our growth rate over the last two years. However, we also believe that, if
the overall economic climate in the region continues to improve, the impact on
our business will lessen.* Further, there can be no assurances that the
economies in Asia-Pacific will recover in the near term, or that similar
economic problems will not occur in other parts of the world. There can also be
no assurances that if economies in Asia-Pacific do improve, this will positively
impact our business.* Revenues from European customers accounted for 14% of
total revenues in fiscal 1999. This compares with 10% of total revenues in
fiscal 1998 and 7% of total revenues in fiscal 1997.
We expect that international revenues will continue to account for a material
portion of our total revenues in future periods.* We intend to enter additional
international markets and to continue expanding our existing international
operations.* Our international business involves a number of inherent risks,
including longer receivable collection periods, greater difficulty in
collections, fluctuations in the real cost of our products given changes in
relative exchange rates, difficulty in staffing and managing operations, a
longer sales cycle, potentially unstable political and economic conditions,
language barriers, cultural differences, unexpected changes in regulatory
requirements, including a slowdown in the rate of privatization of
telecommunications services providers, reduced protection for intellectual
property rights, potentially adverse tax consequences, and tariffs and other
trade barriers. In addition, access to foreign markets is often difficult due to
the established relationships between government-owned or controlled
communications providers and local suppliers of communications products. We
cannot give any assurances that we will be able to continue penetrating
international markets successfully. In addition, we cannot give any assurances
we will be able to sustain or increase revenue from international licensing and
services or that the factors listed above will not adversely affect our future
international business. Any of these factors could have a material, adverse
effect on our business, operating results and financial condition.*
Cost of Revenues:
<TABLE>
<CAPTION>
(in thousands, except percentages) Fiscal Year Fiscal Year Fiscal
1999 Change 1998 Change Year 1997
--------------- ---------- -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Cost of license revenues............... $ 1,978 3% $ 1,922 20% $ 1,599
Percentage of revenues................. 3% 3% 3%
Cost of services and other revenues.... $18,391 (19%) $ 22,844 0% $ 22,830
Percentage of revenues................. 28% 38% 44%
Total cost of revenues............ $ 20,369 (18%) $ 24,766 1% $ 24,429
Percentage of revenues................. 31% 41% 47%
Gross profit........................... $ 44,421 24% $ 35,809 31% $ 27,283
Percentage of revenues................. 69% 59% 53%
</TABLE>
-12-
<PAGE>
Cost of License Revenues. Cost of license revenues consists primarily of license
fees paid to third-party software vendors and the costs of product media and
duplication, manuals, packaging materials, shipping expenses, amortization of
capitalized software costs and related labor costs. In fiscal 1999, the cost of
license revenues, both in absolute dollars and as a percentage of revenues,
remained relatively flat compared with fiscal 1998. Although our license
revenues increased in fiscal 1999 over those in fiscal 1998, the cost of our
license revenues did not increase proportionately because we were able to
achieve cost savings by reducing the cost of third party software licenses.
However, these cost savings were partially offset by increased costs related to
the amortization of purchased technologies.
In fiscal 1998, our cost of license revenues in actual dollars increased over
fiscal 1997, while our cost of license revenues as a percentage of revenues
remained constant. This can be attributed to the increase in our services and
other revenues. The 1998 increase was due mainly to the increased volume of
business, which yielded increased costs for third-party products and technology
embedded in our products.
Gross profit from license revenues was 95%, 94% and 95% in fiscal 1999, fiscal
1998 and fiscal 1997 respectively. The costs for license fees paid for
third-party software decreased slightly during the period. However, we expect to
continue licensing third-party software and expect these costs are likely to
increase in absolute dollars.*
Cost of Services and Other Revenues. Cost of services and other revenues
consists primarily of personnel costs related to providing professional services
and maintenance services in connection with the licensing of our products. It
also includes outside service fees paid to third-party providers of professional
services, related travel costs, overhead and estimated losses related to
professional services contracts. Professional services costs decreased in fiscal
1999 over those in fiscal 1998 due to lower head count and associated personnel
costs, such as salaries, facilities and communications costs. Costs of service
revenues for maintenance services increased in fiscal 1999 over those in fiscal
1998. This can be attributed to increased computer-related costs and services
performed for customer support by other functional areas within OSI. We expect
costs of services and other revenues may continue to increase in absolute
dollars.*
Cost of service and other revenues remained relatively unchanged between fiscal
1997 and fiscal 1998. This is primarily because total professional services
costs were flat in fiscal 1998 when compared with fisca1 1997. In fiscal 1998,
we spent $4.3 million for contractors. In 1997, we spent $5.9 million for
contractors and accrued $2.2 million for estimated losses on professional
services contracts. However, the savings in contractor costs was offset by the
addition of head count over the course of the year.
The overall result was a slight increase in cost of services and other revenues.
Gross profit (loss) percentages from service and other revenues were 35%, 16%
and (12%) in fiscal 1999, fiscal 1998 and fiscal 1997 respectively. We expect to
maintain a gross profit in services; however, if costs for providing such
services increase there could be losses in the future.*
Operating Expenses:
<TABLE>
<CAPTION>
(in thousands, except percentages) Fiscal Year Fiscal Fiscal
1999 Change Year 1998 Change Year 1997
------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Sales and marketing.................... $ 28,712 (12%) $32,509 20% $26,981
Percentage of revenues................. 44% 54% 52%
Research and development............... $ 21,247 30% $16,295 14% $14,234
Percentage of revenues................. 33% 27% 28%
General and administrative............. $ 6,732 (6%) $ 7,176 (59%) $17,296
Percentage of revenues................. 10% 12% 33%
Total operating expenses.......... $ 56,691 1% $55,980 (4%) $58,511
Percentage of revenues............ 87% 92% 113%
</TABLE>
Sales and Marketing. Sales and marketing expenses consist mainly of salaries,
commissions and bonuses for sales and marketing personnel, facilities costs
associated with sales and customer support offices, promotional expenses and
contract administration. In fiscal 1999, sales and marketing expenses decreased
over those fiscal 1998, both in absolute dollars and as a percentage of
revenues. This decline can be attributed to lower head count and a reduction in
associated costs such as travel, communications and computer expenses. In
addition, there was a reduction in our use of outside contractors for strategic
marketing efforts during the comparison period.
-13-
<PAGE>
The increase in sales and marketing expenses in absolute dollars during fiscal
1998 when compared with fiscal 1997 was mainly caused by a higher average head
count and higher commission expenses resulting from increased revenues. During
this period, there were also increased expenses in product marketing, travel,
communications and facilities.
We expect that our sales and marketing expenses in future periods will continue
to increase in absolute dollars due, in part, to our active hiring program and
to agreements with various partners who are involved in the marketing of our
products.* We believe that sales and marketing expenses could increase as a
percentage of total revenues as we continue to roll out our new products.*
Research and Development. Research and development expenses increased in fiscal
1999 over those in fiscal 1998. The increase results primarily from higher head
count attributable to completion of new products. Higher costs were also
incurred in fiscal 1999 for travel, facilities, communications and
computer-related expenses because of the increased head count in research and
development.
In fiscal 1998, research and development expenses increased over those in fiscal
1997. This was mainly the result of increased head count, salary levels and
associated equipment, facilities and support for technical personnel. We expect
that we will continue committing significant resources to research and
development to enhance and extend our core technology and product lines.* We
also expect that research and development expenses will continue to increase in
absolute dollars.* Research and development expenses may increase as a
percentage of total revenues.*
General and Administrative. General and administrative expenses consist mainly
of personnel costs for finance, human resources, legal affairs and general
management. Also included are outside legal and accounting fees, corporate
insurance expenses, provision for bad debts, and in 1997, a $2.0 million
management restructuring charge. In fiscal 1999, general and administrative
expenses decreased over those in fiscal 1998, both in actual dollars and as a
percentage of total revenues. This was the result of lower head count and
reduced travel expenses.
General and administrative expenses decreased in fiscal 1998, both in absolute
terms and as a percentage of total revenues, from those in fiscal 1997. The
decline was due mainly to a decrease in bad debt expenses. We recorded bad debt
expenses of $400,000 in fiscal 1998 and $8.8 million in fiscal 1997. Employee
relocation expenses were also reduced from $400,000 in fiscal 1997 to $50,000 in
fiscal 1998.
General and administrative expenses may increase in the future with continued
growth and the hiring of additional personnel.* Although we believe our
allowance for doubtful accounts is adequate at the end of fiscal 1999, we will
continue to review this allowance and adjust it as needed. This could result in
additional charges to general and administrative expenses.*
We have recorded deferred compensation expense for certain stock options granted
since February 1994. The amortization of deferred compensation expense is
allocated among sales and marketing, research and development, and general and
administrative expenses. The amortization resulted in a charge to operations of
$211,000, $370,000 and $415,000 for fiscal 1999, fiscal 1998 and fiscal 1997,
respectively. The deferred compensation expense has been completely amortized as
of June 30, 1999.
Other Income, Net:
<TABLE>
<CAPTION>
(in thousands, except percentages) Fiscal Year Fiscal Year Fiscal
1999 Change 1998 Change Year 1997
------------- ----------- ------------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Other income, net ..................... $ 1,596 (12%) $ 1,823 (28%) $ 2,537
Percentage of revenues................. 2% 3% 5%
</TABLE>
Other Income, Net. Other income, net is primarily interest income from
marketable securities and cash accounts. The decline in other income, net was
due to lower interest income from reduced levels of cash and short-term
investments.
Provision (Benefit) for Income Taxes:
<TABLE>
<CAPTION>
(dollars in thousands) Fiscal Year Fiscal Year Fiscal Year
1999 Change 1998 Change 1997
------------- ----------- ------------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Provision (benefit) for income
taxes............................. 23,463 * (6,178) (40%) $(10,227)
Percentage of revenues................. 36% * (10%) * (20%)
</TABLE>
*Not meaningful
-14-
<PAGE>
Provision (benefit) for Income Taxes. Our effective tax rate was 41%, 36% and
39% in fiscal 1999, fiscal 1998 and fiscal 1997, respectively. The effective tax
rates for these periods differ from the federal statutory rate due primarily to
state income taxes, partially offset by certain research and development tax
credits. In fiscal year 1999, we set up a reserve for the balance of our
deferred tax assets. For a further explanation, see Note 5 of Notes to
Consolidated Financial Statements.
Year 2000 Readiness
We are continuing our program to assess the extent to which our internal systems
and products evaluate date information ("Year 2000 dependencies") and, if so,
whether they can properly process and evaluate dates on or after the Year 2000
(i.e. whether they are "Year 2000-compliant"). We have been taking remedial
action where systems and products are not Year 2000-compliant. We also regularly
re-evaluate our contingency plans for continuing operations if Year 2000
problems arise despite steps to avoid them. We expect that remediation
activities will continue throughout fiscal 2000.*
We believe that we have identified the Year 2000 dependencies in our internal
systems. We have examined all critical systems including manufacturing, sales,
development, communications and financial systems. We have also examined many of
our non-computer electronic devices that contain microprocessors (for example,
telephones, security systems, and HVAC systems). As dependencies are identified,
we have taken the remediation measures necessary for our internal systems to be
Year 2000-compliant. No significant internal systems projects are being deferred
due to Year 2000 remediation costs. In most instances, installation of new
software or hardware that is Year 2000-compliant has been occurring in the
normal course of our business.
We currently expect that the Year 2000 problem will not pose significant
internal operational issues.* We are not aware of any material operational
issues or costs associated with preparing our internal systems for the Year
2000. However, we can give no assurances that we will not experience
unanticipated material costs caused by undetected errors or defects in those
systems. Delays in or a failure to fully identify all of our Year 2000
dependencies in our internal systems could result in delays in the delivery or
sale of products.* This could have material adverse consequences on our
business.* Therefore, we have put in place, and are regularly re-evaluating,
contingency plans for continuing operations should these types of problems
arise.
We depend on critical suppliers and vendors, and therefore on the proper
functioning of their information systems and software, this means that their
failure to address Year 2000 issues could have a material effect on our
operations and financial results.* As of this date, we are not aware of any
critical systems suppliers or vendors that will not be year 2000-compliant.
However, we will continue our assessments and, depending on the particular
situation, may identify alternative suppliers or vendors.* We have developed
contingency plans for critical system failures or delays involving suppliers
that are not Year 2000-compliant. We expect to continue revisiting these plans
through most of fiscal 2000.
We have contacted key suppliers to determine the extent to which they believe
their products and operations are Year 2000-compliant. We have contacted
providers of both products and services in areas such as network and
communications infrastructure, manufacturing, facilities management, finance and
human resources. Our suppliers were asked to notify us if they would not be
Year 2000-compliant. To date there has been no indication from key suppliers
that they are not, or will not be, Year 2000-compliant. We will continue
testing and analyzing vendor systems as necessary.
We are also continuing to work with key suppliers of third-party software
products and services that are used in connection with NetExpert VSM-based
products. We continue to monitor their reported progress toward Year 2000
compliance and compatibility with Year 2000-compliant versions of NetExpert VSM.
We are not aware of any material operational issues or costs associated with
these suppliers regarding Year 2000 compliance. However, no assurances can be
given that we will not experience unanticipated material costs caused by
undetected errors or defects in these third-party software products.* Delays in
remediation or a failure to identify all of our Year 2000 dependencies could
result in material adverse consequences to our business and results of
operations.*
We have evaluated all of our current products and have taken measures to bring
them into Year 2000 compliance. We do not intend to develop modifications to
early versions of our products or to customized deliverables that are no longer
under warranty.
We have advised each of our customers of our Year 2000 compliance standards.
Year 2000-compliant versions of available products have been offered at no
additional charge to those customers who have maintenance and support contracts.
Most of our customers have already migrated to Year 2000-compliant versions of
our products. We have also offered our customers professional services to assist
in the migration of their NetExpert-based implementations to Year 2000-compliant
versions.
Despite our remediation efforts, we can give no assurances that our Year
2000-compliant products will function properly when they are integrated with
other non-compliant products, including previously customized OSI software,
third-party software, and hardware. Our products are used in numerous operating
environments and we can also give no assurance that they will be compliant in
all environments. Even though we believe we have taken measures to bring our
current products into Year 2000 compliance, our
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customers may nevertheless experience Year 2000 difficulties because of the
noncompliance of other products that interoperate with them, whether they are
provided by us, the customer or a third party. If our products are not able to
manage and manipulate data related to the Year 2000, the result could be a
material adverse effect on our business.*
We will be offering fee based additional support to cover the time period before
and after the new year. This support will cover any production system failures
that occur at our customer sites. We plan to have additional professional
services and customer support personnel on call to handle any customer's
production system failure.
To date, we have incurred costs related to our Year 2000 readiness program but
have not maintained separate cost accounting for them. Year 2000 readiness
efforts have been undertaken by existing employees, and costs have been treated
as normal operating expense. These costs have included testing and modifying our
computer network and our principal products. They have also included
modification of certain products and other deliverables (including customized
OSI software rulesets and applications) where we have contractually agreed to
provide Year 2000-compliant versions. As of June 30, 1999, we estimate these
costs to be approximately $8.0 million.
We expect to incur additional costs for our Year 2000 readiness program related
to customer support and customer service requests.* We currently estimate these
additional costs will not exceed $1.0 million over the remainder of the calendar
year.* This does not include potential costs related to customer or other
claims, or costs related to internal software and hardware replaced in the
normal course of business.
We believe we have adequate general corporate funds with which to pay for
expected costs and expenditures related to Year 2000 readiness.* This belief is
based on our current assessment and is subject to change as our Year 2000
readiness program progresses.
We have provided our customers with limited assurances regarding those of our
products that comply with the Year 2000 standards that we have adopted. Except
as specifically provided for in the contracts and limited written assurances
that we have provided, we do not believe we are legally responsible for costs
incurred by our customers to ensure the Year 2000 compliance of their software,
systems and operations.* Our customer agreements typically contain provisions
designed to limit liability for these types of claims. However, it is possible
that these provisions will not provide adequate protection from liability under
applicable laws, regulations, codes or ordinances, or under unfavorable judicial
decisions.* Even if we have disclaimed responsibility for any Year 2000
problems, or identified and notified our customers of them, a given customer may
nevertheless make claims against all suppliers of the component parts of their
operating environment.* Any Year 2000 claims, whether with or without merit,
could result in a material adverse effect on our business, financial condition
and results of operations.*
We believe that the "most reasonably likely worst case scenario" involving Year
2000 will involve the corruption of data contained in internal information
systems, hardware failures and the failure of third-party systems.* We believe
our greatest risk lies with the potential failure of third-party systems rather
than with our internal systems or products.* We have only minimal ability to
assess and remediate the Year 2000 problems of third parties. We believe the
greatest detrimental effect on our business would occur if infrastructure
services such as electricity, telecommunications, transportation supply chains
or suppliers of materials were inoperable.* We rely on local private and
governmental suppliers for electricity, water, sewer and other needed supplies.
Failure of an electrical grid or an uneven supply of power could completely shut
down the affected facility. It could also shut down airports and other means of
transportation.* Critical suppliers could be partially or completely shut down
and unable to provide supplies on a timely basis.* We may not be able to obtain
a replacement supplier in a timely manner, on acceptable terms or at all.* While
we do not maintain the ability to replace third-party supplies with internal
production, contingency planning includes the ongoing assessment and
identification of substitute suppliers. Among other things, contingency plans
for a major infrastructure failure might include a shift in production to
another unaffected site. We plan to install a back-up generator in our new
facility to provide partial power to our core functional areas.
We believe that the purchasing patterns of our customers and potential customers
will be affected by the Year 2000 issues as they bring their current software
systems into Year 2000 compliance.* Funds available to purchase new products
could be reduced.* Given the overall uncertainty of the situation, customers or
potential customers may delay the purchase and introduction of any new
functionality until after the Year 2000 transition has been completed.* Although
unknown at this time, potential changes in purchasing patterns such as these
could have a material adverse effect on our business, operating results or
financial condition.*
Factors That May Affect Future Results
Quarterly Results. Our quarterly operating results have varied significantly in
the past and can be expected to vary significantly in the future.* The
fluctuation in quarterly license revenues is caused by the timing of large
orders by our customers, including global
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telecommunication providers and the emerging communication service providers
described in the "Overview" section. Orders are typically preceded by long sales
cycles and, accordingly, it has been and will continue to be difficult to
predict when they will be received.* We expect that quarterly license revenues
will continue to vary significantly depending on the timing of our orders.* The
failure to obtain an order during any given reporting period, for whatever
reason, would have a material adverse effect on our business.
We typically receive a significant portion of our orders, and record the
resulting revenue, in the last month of a quarter and frequently in the last
weeks or even days of a quarter. Expense levels are based, in part, on our
expectations of future revenues. If actual revenues are below expectations,
operating results can be adversely affected. In particular, because only a small
portion of our expenses vary with revenue, net income may be disproportionately
affected by a decrease from anticipated revenue. We believe this pattern will
continue.*
Our quarterly operating results have also varied and will vary significantly
based on factors such as the capital spending patterns of our customers; changes
in our pricing policies or those of our competitors; increased competition;
cancellation of licenses or support agreements; changes in operating expenses;
personnel changes; fluctuation in demand for NetExpert VSM-based products; the
number, timing and significance of new products and product enhancements by us
and by our competitors; our ability to develop, introduce and market new and
enhanced versions of NetExpert VSM-based products on a timely basis; the mix of
direct and indirect sales; our assessment of our allowance for bad debts; sales
returns; and general economic factors, among others.*
Because of these factors, quarterly revenue and operating results have been and
will continue to be difficult to forecast.*
Sales Cycle. Revenues are also difficult to forecast because the sales cycle,
from initial evaluation to product installation, varies substantially from
customer to customer. Purchase of an OSS application generally involves a
significant commitment of capital, with the attendant time requirements often
associated with a customer's internal approval procedures. It also involves the
need to test and accept new technologies that affect crucial operations. For
these and other reasons, the sales cycle for our products is typically lengthy
and subject to a number of significant risks over which we have little or no
control.
Key Personnel. Our future success depends, to a significant degree, on the
continuing contributions of key management, sales, professional services,
customer support and product development personnel.* The loss of, or the
inability to attract and retain, key personnel could adversely affect our
business.* We have experienced and continue to experience difficulty in
recruiting qualified personnel. There is intense competition for qualified
employees in the software industry, and there can be no assurance that we will
be successful in attracting and retaining the people we need. The complex nature
of customers' networks requires that we recruit and hire personnel with
expertise in, and a broad understanding of, the telecommunications industry.
There are only a limited number of qualified personnel available for employment.
Failure to attract and retain key personnel would have a material adverse effect
on our business condition.*
Growth. To compete effectively and manage future growth, we also need to improve
our internal operational, financial and management information systems,
procedures and controls in a timely manner to accommodate a larger numbers of
transactions and customers. Management of future growth also means that we must
expand, train, motivate and manage our workforce. We can give no assurances that
our personnel, systems, procedures and controls will be adequate to support
existing and future operations. The failure to improve operational, financial
and management systems, or to expand, train, motivate and manage employees,
could have a material adverse effect on our financial business.*
Product Defects. In addition, software products as complex as those we offer are
highly likely to contain defects when they are introduced or when new versions
are released. Although we are not aware of any material software defects in our
products, we can give no assurances, despite extensive testing both by us and by
our customers, that errors will not be found after commercial licensing begins.
This could result in delayed or lost revenue, loss of market share or failure to
achieve market acceptance.* Any of these could have a material adverse effect on
our business.
Competition. Our products are designed for use in an evolving network operations
support and management applications market. Competition in this market is
intense, with rapidly changing technologies, evolving industry standards,
frequent new product introductions and rapid changes in customer requirements.
Our competitors offer a variety of solutions to address this market. We believe
that competition will increase.* Most of our customers regularly evaluate
whether to design and develop their own network operations support and
management applications or to purchase them from outside vendors. There can be
no assurance that our current or potential competitors will not develop products
that are comparable or superior to ours or that they will no be able to adapt
more quickly than we are to new technologies, evolving industry trends or
changes in customer requirements. If we are not able to compete successfully
against our current and future competitors, our business will be materially and
adversely affected.
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International Business. We expect that our international business will continue
to account for a significant portion of our total revenues in future periods.*
We intend to enter into additional international markets and to continue
expanding our operations outside of North America.* This will require
significant management attention and the expenditure of significant financial
resources.* The result could adversely affect our operating margins.
Historically, our transactions have been primarily in U.S. dollars. However, as
we further expand our operations outside the United States, transactions in
non-U.S. currencies will necessarily increase.* This will result in a
corresponding increase in our exchange rate risk. If exchange rates change
unfavorably, this could result in charges to operations. Although we have tried
to reduce the risk of fluctuations in exchange rates by pricing our products and
services in U. S. dollars, we pay our local expenses in local currencies. We do
not engage in hedging transactions with respect to those obligations. Currency
exchange fluctuations in countries where we license our products could have a
materially adverse effect on our business by making our pricing non-competitive
with products priced in local currencies.*
Reseller Relationships. A key element of our future business strategy is to
develop relationships with leading companies that manufacture and market
telecommunications equipment. Another key element of that strategy is to expand
system integrator and value-added reseller channels of distribution. We are
currently investing and plan to continue investing significant resources to
develop these relationships and channels of distribution.* We can give no
assurances that we will be able to attract additional systems integrators and
resellers that can market our product effectively. If we are unable to develop
these relationships and market our products effectively, our business operating
results and financial condition could be materially and adversely affected.*
Proprietary Technology. Our success and ability to compete depends in large part
on our proprietary software technology. We rely on a combination of various
technical measures, trade secret, copyright and trademark laws, and
nondisclosure and other contractual agreements to protect proprietary rights.
Despite our efforts, unauthorized parties may attempt to copy our products or to
obtain and use our proprietary information.* We can give no assurances that the
steps we have taken will prevent misappropriation of our technology. These
precautions may also not preclude competitors from developing products with
functionality or features similar to our products. In addition, effective
copyright and trade secret protection may be unavailable or limited in certain
foreign countries. While we believe that our products and trademarks do not
infringe upon the proprietary rights of third parties, we can give no assurances
that there will not be infringement claims in the future as the number of
products and competitors in the industry increases. Any such claim, with or
without merit, could be time consuming, result in costly litigation and divert
the attention of our technical and management personnel.* This could result in a
material adverse impact on our business.*
Third Party Software. Finally, we rely on software licensed from third parties,
including software that is integrated with internally developed software and
used to perform key functions. We can give no assurances that these third-party
software licenses will continue to be available to us on commercially reasonable
terms. Absence of these licenses could have a material adverse effect on our
business.*
Based upon all of the above, we believe that our quarterly revenues and
operating results may vary significantly in the future.* We also believe that
period-to-period comparisons of results are not necessarily meaningful and
should not be relied on as indications of future performance.* Further, we
believe that it is likely that our revenue or operating results will be below
the expectations of public market analysts and investors in some future
quarter.* If this occurs, the price of our Common Stock could be materially,
adversely affected.*
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Liquidity And Capital Resources
In fiscal 1999, we experienced a net decrease in cash and cash equivalents of
$8.8 million. This compares with a net increase of $6.8 million in fiscal 1998
and a net decrease of $36.2 million in fiscal 1997. The decline in fiscal 1999
can mainly be attributed to net cash used for operations of $4.5 million,
purchases of property and equipment and other assets of $6.0 million, and the
purchase of treasury stock of $2.2 million. The net cash used for operations was
derived primarily from our $34.1 million net loss, partially offset by our
adjustment for deferred income taxes of $22.3 million. Net cash provided from
financing activities ($2.3 million) was generated by the exercise of stock
options.
In fiscal 1998, the net increase in our cash and cash equivalents came mainly
from sale of short-term investments ($5.4 million) and from the sale of stock
options ($4.4 million). These sources of cash were offset by $2.9 million of
cash used in our operations. The decline in net cash was primarily caused by a
loss from operations ($12.2 million), partially offset by depreciation,
amortization ($7.8 million), an increase in accounts receivable ($4.1 million)
and an increase in deferred revenue ($3.9 million).
In fiscal 1997, our net decrease in cash and cash equivalents resulted primarily
from our purchases of $25.4 million in short term investments, $12.2 million in
property and equipment and the purchase of assets from our Australian
distributor. This was partially offset by net cash generated by operations of
$5.2 million. This occurred because our $18.5 million net loss was more than
offset by adjustments for depreciation and amortization, net decreases in
accounts receivable, decreases in income tax refunds receivable, an increase in
accounts payable and increases in accrued liabilities.
As of June 30, 1999, we had working capital of approximately $27.8 million. This
included $31.6 million in cash, cash equivalents and short-term investments. We
also have a $2.5 million unsecured revolving line of credit. Under this line of
credit, which expires in December 1999, borrowings bear interest at either (1) a
fluctuating rate per year equal to the prime lending rate then in effect, or (2)
a fixed rate per year that is 2% above the London Inter-Bank Offered Rate. As of
June 30, 1999, no amounts had been borrowed under the line of credit. The
agreement for the line has certain financial covenants and, as of June 30, 1999,
we complied with those covenants.
Some of our accounts receivable are beyond their payment terms. We maintain an
allowance for doubtful accounts that we believe is adequate to cover potential
credit losses.* In fiscal 1997, we increased our allowance for doubtful accounts
by $8.8 million to reflect what we believed to be increased exposure on certain
accounts receivable. In fiscal 1999, we increased our allowance for doubtful
accounts by $0.6 million and in fiscal 1998 it was increased by $0.4 million. On
June 30, 1999, reserves for bad debt and sales returns were about $3.0 million.
We believe our present reserves are adequate to provide for potential credit
losses or sales returns.*
We currently have material commitments of approximately $1.4 million for tenant
improvements and computer equipment for our new facilities. We also intend to
continue growing our operations.* In fiscal 1999, we spent $3.1 million for
capital items, principally computer hardware, computer software and
communications equipment. We expect that capital expenditures will continue to
be significant in fiscal 2000 and in the future.*
We believe that our cash balances and our cash flow from operations are
sufficient to support our working capital requirements for at least the next
twelve months. Thereafter, if cash generated from operations cannot satisfy
working capital requirements, we may need to raise additional funds. Financing
may not be available or, if it is, it may not be obtainable on terms that are
favorable to us or our stockholders.* If we raise additional capital by issuing
equity or convertible debt securities, ownership dilution to stockholders will
result. If funds are unavailable, our business may be adversely affected.*
In September 1998, our Board of Directors authorized a stock repurchase program
under which we were authorized to purchase up to 1,000,000 shares of our common
stock on the open market. As of June 30, 1999, we had repurchased 493,000 shares
of common stock, at an average purchase price of $4.47, for $2,208,000. We may
continue repurchasing shares in the future.*
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ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest Rate Risk
Our exposure to market rate risk based on a change in interest rates relates
primarily to our investment portfolio, which consists of cash equivalents and
short-term investments. Cash equivalents are highly liquid investments with
original maturities of three months or less and are stated at cost. We do not
believe our exposure to interest rate risk is material for these balances, which
were $14.3 million on June 30, 1999. The securities in our short-term investment
portfolio are generally classified as available-for-sale. Short-term investments
were $15.8 million on June 30, 1999. We do not use derivative financial
investments in our short-term investment portfolio, we place our investments
with high quality issuers, and by policy, limit our credit exposure to any one
issuer. We are averse to principal loss and attempt to ensure the safety of our
investment funds by limiting default, market and reinvestment risk. If market
interest rates were to change immediately and uniformly by 10% from the rates in
effect on June 30, 1999, the fair value of our cash equivalents and short-term
investments would change by an insignificant amount.
Foreign Currency Exchange Rate Risk
As a global business, we face exposure to adverse movements in foreign currency
exchange rates. These exposures may change over time as business practices
evolve and they could have a material adverse impact on our business, operating
results and financial position.* Historically, our primary exposure has related
to local currency expenses in Europe, the Asia Pacific region and Australia. The
functional currencies of our foreign subsidiaries are local. A hypothetical 10%
change in foreign currency rates would have an insignificant impact on our
business, operating results and financial position.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section Part IV, Item
14(a)(1) and (2).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item concerning members of our Board of
Directors is incorporated by reference from the section "Election of Directors"
in the Proxy Statement for the Annual Meeting of Stockholders, to be held
December 9, 1999, which we will file with the Securities and Exchange Commission
within 120 days of the end of our fiscal year ("Proxy Statement"). The
information required by this item concerning executive officers is set forth in
Part I of this Report. The information required by this item regarding
compliance with Section 16(a) of the Exchange Act is incorporated by reference
from the section captioned "Compliance with Section 16(a) of the Exchange Act"
in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
section captioned "Executive Compensation and Other Matters" in the Proxy
Statement.
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by this item is incorporated by reference from the
section captioned "Record Date and Principal Share Ownership" in the Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
sections captioned "Compensation Committee Interlocks and Insider Participation"
and "Certain Transactions With Management" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
The following financial statements are filed as part of this report:
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Page
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<S> <C>
Independent Auditor's Report......................................................................... 24
Consolidated Financial Statements:
Consolidated Balance Sheets at June 30, 1999, and 1998 ................................... 25
Consolidated Statements of Operations for Years Ended June 30,
1999, 1998, and 1997................................................................... 26
Consolidated Statements of Stockholders' Equity for the Years Ended June 30,
1999, 1998,and 1997 ................................................................... 27
Consolidated Statements of Cash Flows for the Years Ended June 30,
1999, 1998, and 1997................................................................... 28
Notes to Consolidated Financial Statements................................................ 29
</TABLE>
(a)(2) Financial Statement Schedules
II - Valuation and Qualifying Accounts
Additional schedules are not required under the related schedule instructions or
are inapplicable and therefore have been omitted.
(a)(3) Exhibits
3.1/4/ Certificate of Incorporation
3.2/4/ Bylaws, as amended to date
10.1/1/ Stock Option Plan and form of agreement
10.2/5/ 1994 Stock Option Plan, as amended and Form of Agreement
thereto
10.3/3/ 1995 Employee Stock Purchase Plan, as amended and Form of
Agreement thereto
10.4/1/ 1995 Director Stock Option Plan
10.4/1/ Forms of Agreement to 1995 Director Stock Option Plan
10.5/1/ Form of Indemnification Agreement between the Registrant and
its officers and directors
10.6/1/ Standard Office Lease-Gross between Registrant and PIWI
Investments dated February 14, 1994
10.7/1/* Stockholder Rights Agreement among Registrant, Tom L. Johnson,
Richard G. Vento and the purchasers of Preferred Stock named
therein dated Sept. 27, 1995
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10.8/1/ Voting Agreement among Registrant, Tom L. Johnson, Richard G.
Vento and the purchasers of Preferred Stock named therein
dated September 27, 1995
10.9/4/ Form of Indemnification Agreement between the Registrant and
its directors and officers
10.10/5/ Business Sale Agreement between the Registrant and Open
Technology Pty. Limited dated March 14, 1997
10.11/5/ Contract of Purchase and Sale for purchase of real property
between Registrant and The John A. Sobrato 1979 Trust dated
April 7, 1997
10.12/6/ Lease between Objective Systems Integrators, Inc. and Redsky
Enterprises, Inc. dated January 13, 1997, as amended on March
30, 1998
10.13/6/ Agreement to Purchase Real Property between Objective Systems
Integrators, Inc. and Redsky Enterprises, Inc. dated March 30,
1998
10.14/6/ Relocation Loan Agreement between Objective Systems
Integrators, Inc. and James K.R. Souders dated April 14, 1998
10.15/6/ Promissory Note Secured by Deed of Trust between Objective
Systems Integrators, Inc. and James K.R. Souders dated April
14, 1998
10.16/6/ Deed of Trust with James K.R. Souders as Grantor and Objective
Systems Integrators, Inc. as Beneficiary dated April 14, 1998
10.17/3/ Letter Agreement for Philip N. Cardman.
10.18/3/ Letter Agreement for Jerry P. Johnson.
10.19/3/ Employment Agreement for James K.R. Souders
10.20/3/ Employment Agreement for Patric Olenczak
23.1 Independent Auditors' Consent
24.1 Power of Attorney (See page 23.)
27.1 Financial Data Schedule
________________________
* Confidential treatment has been granted with respect to certain
portions of this exhibit. Omitted portions have been filed separately
with the SEC.
/1/ Incorporated by reference to exhibits filed with OSI's Registration
Statement on Form S-1 (Reg. No. 33-97506) as declared effective by the
Commission on November 30, 1995
/2/ Incorporated by reference to exhibits filed with OSI's Quarterly Report
on Form 10-Q for the quarter ended December 31, 1995
/3/ Incorporated by reference to exhibits filed with OSI's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1998
/4/ Incorporated by reference to exhibits filed with OSI's Registration
Statement on Form 8-B (Reg. No. 000-26886) as declared effective by the
SEC on February 4, 1997
/5/ Incorporated by reference to exhibits filed with OSI's Annual Report on
Form 10-K for the fiscal year ended June 30, 1997
/6/ Incorporated by reference to exhibits filed with OSI's Quarterly Report
on Form 10-Q for the quarter ended March 31, 1998
(b) Reports on Form 8-K. OSI did not file any reports on Form 8-K
during the quarter ended June 30, 1998.
(c) Exhibits. See Item 14(a)(3) above.
(d) Financial Statement Schedules. See Item 14(a)(2) above.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Dated: September 27, 1999 OBJECTIVE SYSTEMS INTEGRATORS, INC.
By: /s/ Tom L. Johnson
________________________________________
Tom L. Johnson, Co-Chief Executive
Officer, Co-Chairman of the Board of
Directors and Acting Chief Technology
Officer
Dated: September 27, 1999 OBJECTIVE SYSTEMS INTEGRATORS, INC.
By: /s/ Richard G. Vento
________________________________________
Richard G. Vento, Co-Chief Executive
Officer and Co-Chairman of the Board of
Directors
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS that each person whose signature appears
below constitutes and appoints Tom L. Johnson, Richard G. Vento and Lawrence F.
Fiore, and each of them, his true and lawful attorneys-in-fact and agents, each
with full power of substitution and resubstitution, to sign any and all
amendments (including post-effective amendments) to this Annual Report on Form
10-K and to file the same, with all exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in connection therewith, as fully to all intents and purposes as he or she might
or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, or any of
them, shall do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
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<CAPTION>
Signature Title Date
- ----------------------------------------- ------------------------------------------ ----------------------------------------
<S> <C> <C>
/s/ (Richard G. Vento)
_________________________________________ Co-Chief Executive Officer and September 27, 1999
(Richard G. Vento) Co-Chairman of the Board of Directors
/s/ (Tom L. Johnson)
_________________________________________ Co-Chief Executive Officer , September 27, 1999
(Tom L. Johnson) Co-Chairman of the Board of Directors and
Acting Chief Technology Officer
/s/ (Lawrence F. Fiore)
_________________________________________ Vice President, Chief Financial Officer September 27, 1999
(Lawrence F. Fiore) (Principal Financial and Accounting Officer)
/s/ (Gary D. Cuccio)
_________________________________________ Director September 27, 1999
(Gary D. Cuccio)
/s/ (George F. Schmitt)
_________________________________________ Director September 27, 1999
(George F. Schmitt)
/s/ (Dr. Kornel Terplan)
_________________________________________ Director September 27, 1999
(Dr. Kornel Terplan)
</TABLE>
-23-
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Objective Systems Integrators, Inc.
We have audited the accompanying consolidated balance sheets of Objective
Systems Integrators, Inc. and subsidiaries (the "Company") as of June 30, 1999
and 1998, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended June 30,
1999. Our audits also included the financial statement schedule listed in Item
14(a)(2). These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedule based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Objective Systems Integrators, Inc.
and subsidiaries at June 30, 1999 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
1999, in conformity with generally accepted accounting principles. Also, in our
opinion, such financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly in all
material respects the information contained therein.
/s/
DELOITTE & TOUCHE LLP
San Jose, California
August 9, 1999
-24-
<PAGE>
OBJECTIVE SYSTEMS INTEGRATORS, INC.
CONSOLIDATED BALANCE SHEETS
As of June 30, 1999 and 1998
(in thousands, except share data)
<TABLE>
<CAPTION>
June 30,
------------------------------------
1999 1998
---------------- ----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 15,811 $ 24,568
Short-term investments........................................................... 15,771 16,718
Accounts receivable, net of allowances of $1,865 in 1999 and $1,517 in 1998...... 17,251 16,846
Deferred income taxes............................................................ -- 22,918
Prepaid expenses and other current assets........................................ 1,515 1,612
---------------- ----------------
Total current assets.......................................................... 50,348 82,662
Property and equipment, net.......................................................... 11,319 15,129
Other assets, net.................................................................... 4,757 3,567
---------------- ----------------
Total assets.................................................................. $ 66,424 $ 101,358
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................. $ 5,822 $ 5,162
Accrued compensation............................................................. 5,315 5,667
Accrued liabilities.............................................................. 1,347 2,037
Deferred revenue................................................................. 10,078 10,386
---------------- ----------------
Total current liabilities..................................................... 22,562 23,252
Deferred income taxes................................................................ -- 586
Commitments (Note 6)
Stockholders' equity:
Preferred stock, $0.001 par value; authorized 5,000,000 shares;
None issued and outstanding,.................................................. -- --
Common stock, $0.001 par value; authorized 100,000,000 shares;
shares outstanding: 35,614,000 in 1999 and 34,792,000 in 1998................. 86,703 86,434
Accumulated other comprehensive income (loss)................................. (917) (1,127)
Accumulated deficit........................................................... (41,924) (7,787)
---------------- ----------------
Total stockholders' equity.................................................... 43,862 77,520
---------------- ----------------
Total liabilities and stockholders' equity.................................... $ 66,424 $ 101,358
================ ================
</TABLE>
See notes to consolidated financial statements.
-25-
<PAGE>
OBJECTIVE SYSTEMS INTEGRATORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended June 30, 1999, 1998 and 1997
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------
1999 1998 1997
--------- ----------- -------------
<S> <C> <C> <C>
Revenues:
License.................................................................. $ 36,296 $ 33,252 $ 31,376
Service and other........................................................ 28,494 27,323 20,336
--------- ----------- -------------
Total revenues....................................................... 64,790 60,575 51,712
--------- ----------- -------------
Cost of revenues:
License.................................................................. 1,978 1,922 1,599
Service and other........................................................ 18,391 22,844 22,830
--------- ----------- -------------
Total cost of revenues............................................... 20,369 24,766 24,429
--------- ----------- -------------
Gross profit................................................................. 44,421 35,809 27,283
--------- ----------- -------------
Operating expenses:
Sales and marketing...................................................... 28,712 32,509 26,981
Research and development................................................. 21,247 16,295 14,234
General and administrative............................................... 6,732 7,176 17,296
--------- ----------- -------------
Total operating expenses............................................. 56,691 55,980 58,511
--------- ----------- -------------
Loss from operations......................................................... (12,270) (20,171) (31,228)
Other income, net............................................................ 1,596 1,823 2,537
--------- ----------- -------------
Loss before income taxes..................................................... (10,674) (18,348) (28,691)
Provision (benefit) for income taxes......................................... 23,463 (6,178) (10,227)
========= =========== =============
Net loss..................................................................... $(34,137) $ (12,170) $ (18,464)
========= =========== =============
Loss per share:
Basic................................................................... $ (0.97) $ (0.36) $ (0.58)
========= =========== =============
Diluted................................................................. $ (0.97) $ (0.36) $ (0.58)
========= =========== =============
Shares used in loss per share calculations:
Basic................................................................... 35,142 33,724 32,080
========= =========== =============
Diluted................................................................. 35,142 33,724 32,080
========= =========== =============
</TABLE>
See notes to consolidated financial statements.
-26-
<PAGE>
OBJECTIVE SYSTEMS INTEGRATORS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Years Ended June 30, 1999, 1998 and 1997
(in thousands)
<TABLE>
<CAPTION>
Accumulated Retained
Other Earnings
Common Stock Comprehensive (Accumulated Comprehensive
Shares Amount Income (Loss) Deficit) Total Income (Loss)
----------- ----------- ------------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE at June 30, 1996.......... 31,301 $ 72,211 $ -- $ 22,847 $ 95,058
Common stock issued under stock
option plans, net............... 1,270 1,986 -- -- 1,986
Amortization and adjustment of
deferred stock compensation..... -- 370 -- -- 370
Tax benefit of exercise of stock
options......................... -- 6,819 -- -- 6,819
Translation adjustment............ -- -- (326) -- (326) $ (326)
Net loss.......................... -- -- -- (18,464) (18,464) (18,464)
----------- ----------- ------------ ------------- ------------ -------------
BALANCE at June 30, 1997.......... 32,571 81,386 (326) 4,383 85,443 $ (18,790)
=============
Common stock issued under stock
option plans, net............... 2,221 4,377 -- -- 4,377
Amortization of deferred stock
compensation.................... -- 370 -- -- 370
Tax benefit of exercise of stock
options......................... -- 301 -- -- 301
Translation adjustment............ -- -- (801) -- (801) $ (801)
Net loss.......................... -- -- -- (12,170) (12,170) (12,170)
----------- ----------- ------------ ------------- ------------ -------------
BALANCE at June 30, 1998.......... 34,792 86,434 (1,127) (7,787) 77,520 $(12,971)
=============
Common stock issued under stock
option plans, net............... 1,315 2,266 -- -- 2,266
Purchase of treasury stock ....... (493) (2,208) -- -- (2,208)
Amortization and adjustment of
deferred stock compensation..... -- 211 -- -- 211
Translation adjustment............ -- -- 210 -- 210 $ 210
Net loss.......................... -- -- -- (34,137) (34,137) (34,137)
=========== =========== ============ ============= ============ =============
BALANCE at June 30, 1999.......... 35,614 $ 86,703 $ (917) $ (41,924) $ 43,862 $(33,927)
=========== =========== ============ ============= ============ =============
</TABLE>
See notes to consolidated financial statements.
-27-
<PAGE>
OBJECTIVE SYSTEMS INTEGRATORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended June 30, 1999, 1998 and 1997
(in thousands)
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss......................................................... $ (34,137) $ (12,170) $ (18,464)
Adjustments to reconcile net loss to net cash provided by (used
for) operating activities:
Depreciation and amortization.................................. 8,085 7,765 5,020
Deferred income taxes.......................................... 22,332 (6,382) (8,050)
Stock compensation expense..................................... 211 370 370
Loss on disposal of fixed assets............................... 114 -- --
Effect of changes in:
Accounts receivable, net................................... (367) 4,119 11,159
Income tax refund receivable............................... -- 2,058 5,376
Prepaid expenses and other current assets.................. 47 (661) 58
Accounts payable........................................... 379 (2,201) 3,938
Accrued liabilities........................................ (845) 523 4,597
Income taxes payable....................................... -- (215) --
Deferred revenue........................................... (308) 3,868 1,169
------------- ------------- -------------
Net cash provided by (used for) operating activities............. (4,489) (2,926) 5,173
------------- ------------- -------------
Cash flows from investing activities:
Sales (purchases) of short-term investments, net............... 947 8,706 (25,424)
Purchases of property and equipment............................ (3,142) (3,943) (12,186)
Purchases of other assets...................................... (2,819) -- (5,705)
Proceeds from sale of property and equipment................... 702 598 --
------------- ------------- -------------
Net cash provided by (used for) investing activities............. (4,312) 5,361 (43,315)
------------- ------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net.................... 2,266 4,377 1,986
Repurchase of common stock..................................... (2,208) -- --
------------- ------------- -------------
Net cash provided by financing activities........................ 58 4,377 1,986
------------- ------------- -------------
Effect of exchange rates on cash................................... (14) (61) (15)
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents............. (8,757) 6,751 (36,171)
Cash and cash equivalents:
Beginning of the year............................................ 24,568 17,817 53,988
------------- ------------- -------------
End of the year.................................................. $ 15,811 $ 24,568 $ 17,817
============= ============= =============
Cash paid during the year for:
Interest.......................................................... $ -- $ -- $ --
Income taxes..................................................... $ -- $ -- $ --
</TABLE>
See notes to consolidated financial statements.
-28-
<PAGE>
OBJECTIVE SYSTEMS INTEGRATORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Objective Systems Integrators, Inc. ("OSI") provides OSS software that
simplifies the integration and management of communications networks in
large-scale, complex, multi-vendor environments. Our NetExpert VSM family of
products includes a software framework, high-level development tools, service
and management application components, and related professional services. These
products and services are designed for use in complex, critical networks to
enable the rapid deployment of new and enhanced services and management of other
services and business processes.
Principles of Consolidation
The consolidated financial statements include the accounts of OSI and its wholly
owned subsidiaries after elimination of significant intercompany transactions
and balances.
Use of Estimates
The preparation of financial statements that conform to generally accepted
accounting principles requires management to make estimates and assumptions that
affect (1) the reported amounts of assets and liabilities, (2) disclosure of
contingent assets and liabilities as of the date of the financial statements,
and (3) the reported amounts of revenues and expenses during the reporting
period. Actual results inevitably will differ from those estimates and the
differences may be material.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on deposit with banks and high-quality
money market instruments with remaining maturities of 90 days or less when
purchased. Because of the short period to maturity, fair values of cash
equivalents approximate cost.
Short term Investments
Short-term investments are classified as available-for-sale. On June 30, 1999
and 1998, respectively, investments consisted of approximately $6.0 million and
$4.0 million of debt securities issued by U.S. Government agencies, and
approximately $9.8 million and $12.7 million of corporate debt securities, both
carried at fair value. On June 30, 1999 and 1998, gross unrealized gains and
losses on available-for-sale investments were not significant. Amortized cost
approximates fair value. Contractual maturities of short-term investments on
June 30, 1999 and 1998, were generally within one year.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed using the
straight-line method over the estimated useful life of the asset, which range
from three to seven years. Amortization of leasehold improvements is taken over
the shorter of the useful life of the asset or the related lease term.
Other Assets
Other assets consist primarily of goodwill, and purchased technology. Costs for
the research and development of new software products and substantial
enhancements to existing software products are expensed as incurred until
technological feasibility has been established. Once feasibility has been
established, additional costs are capitalized until product is available for
general release to customers. Software development costs are amortized over the
estimated economic life of the products, not to exceed three years. Intangible
assets are amortized over the estimated useful life of the asset, which range
from three to seven years.
Long-Lived Assets
Whenever events indicate that the carrying values of long-lived assets or
identifiable intangibles may not be recoverable, we evaluate the carrying values
of those assets using future, undiscounted cash flows. If the sum of the
anticipated, undiscounted future cash flows
-29-
<PAGE>
is less than the carrying amount of the asset, we recognize an impairment loss
equal to the difference between the fair value and the carrying value of the
asset.
Revenue Recognition
For fiscal 1999, we adopted SOP No. 97-2, Software Revenue Recognition (as
amended), which provides guidance on applying generally accepted accounting
principles for software revenue recognition transactions. Adoption of SOP No.
97-2 did not have a material impact on our financial condition or results of
operations.
Revenues consist primarily of fees for licenses of our software products,
maintenance, customer support and consulting contracts.
License Revenue: Software licenses have been generally granted and priced on a
per-server basis, although we have granted site, network-wide or enterprise-wide
licenses for larger installations. License revenues are generally recognized
when a noncancelable license agreement has been signed, the product has been
shipped, there are no uncertainties surrounding product acceptance, the fees are
fixed and determinable, and collection is probable. Revenue and profits under
contracts requiring significant customization are recognized using the
percentage-of-completion method of contract accounting, based on the ratio of
incurred costs to total estimated costs. Although our license agreements
generally do not provide for a right of return, reserves are maintained for
returns and estimated credit losses.
Service and Other Revenue: Revenue from customer support contracts is recognized
ratably over the term of the agreement, which is typically one year. Other
revenue is derived primarily from professional services. This revenue is
generally recognized using the percentage-of-completion method or on a
time-and-materials basis. On June 30, 1999, 1998 and 1997, respectively, accrued
liabilities included an accrual of $0.4 million, $0.7 million and $2.2 million
for estimated losses on service contracts in progress.
Deferred Revenue: Deferred revenue includes unearned amounts received under
support contracts, amounts billed to customers but not recognized as revenue and
reserves for sales returns.
Concentration of Credit Risks
We license our products primarily to customers in the communications industry.
We perform periodic credit evaluations of our customers and generally do not
require collateral or other security to support accounts receivable. An estimate
of credit losses has been provided for in the consolidated financial statements.
Net Income (Loss) Per Share
We compute net income (loss) per share using two different methods, basic and
diluted. Basic net income (loss) per share is calculated using the weighted
average number of shares outstanding during the period. Diluted net income
(loss) per share is computed based on the weighted average number of common
shares outstanding plus the dilutive effect of outstanding stock options using
the "treasury stock" method. During loss periods, we exclude the outstanding
options from the calculation as doing so would be antidilutive.
We do not include common stock equivalents that may be dilutive in the future
when we calculate diluted shares outstanding because if we did so it would have
an antidilutive effect on net loss per share. Common stock equivalents not
included in the calculation were 0.5 million, 2.3 million and 2.4 million in
1999, 1998 and 1997, respectively.
Stock-Based Compensation
We account for stock-based awards to our employees using the intrinsic value
method under Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and its related interpretations.
Foreign Currency Translation
The functional currency of our foreign operations is local currency.
Consequently, we translate assets and liabilities of operations outside of the
United States into U.S. dollars using year-end exchange rates. We translate
results of operations using average rates. We include the effects of foreign
currency translation adjustments as a component of stockholders' equity.
Income Taxes
-30-
<PAGE>
Deferred tax assets and liabilities reflect the anticipated future tax
consequences of temporary differences that exist between the amounts we carry on
our financial statements and the tax bases of those assets and liabilities. We
record a valuation allowance to reduce deferred tax assets so that their
realization is more likely than not.
Comprehensive Income (Loss)
In fiscal 1998, we adopted SFAS No. 130, Comprehensive Income, which requires us
to report a new, additional measure of income (loss). "Comprehensive income
(loss)" includes foreign currency translation gains and losses that have we have
previously excluded from net income and reflected instead in equity. Our
adoption of this Statement resulted in a change in the presentation of our
financial statements, but had no impact on our consolidated financial position,
results of operations or cash flows.
Segment Reporting
In May 1998, we adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. This Statement establishes standards for the
reporting of information about operating segments, including related disclosures
about products and services, geographic areas and major customers. It also
requires selected information about operating segments in interim financial
statements. Our adoption of this Statement did not impact our consolidated
financial position, results of operations, or cash flows.
New Accounting Pronouncements
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, (as
amended) establishes accounting years and reporting standards for derivative
instruments and hedging activities. Its application is required for fiscal years
beginning after June 15, 2000. The Statement mandates balance sheet recognition
of derivatives as assets or liabilities measured at fair value. Accounting for
gains and losses resulting from changes in the values of derivatives depends on
the use of the derivatives and whether they qualify for hedge accounting. We are
currently evaluating what impact, if any, the adoption of SFAS No. 133 will have
on our financial position or results of operations.
Reclassification
Certain prior-year balances have been reclassified to conform to current-year
presentation.
2. PROPERTY AND EQUIPMENT
Property and equipment on June 30 consists of dollars (in thousands, except
estimated useful lives in parenthesis):
<TABLE>
<CAPTION>
1999 1998
----------- ----------
<S> <C> <C>
Land................................................ $ 1,329 $ 2,022
Computer equipment and software (3 to 7 years)...... 24,489 22,371
Furniture and fixtures (7 years).................... 2,772 2,286
Machinery and equipment (5 years)................... 2,307 2,243
Trade show equipment (5 years)...................... 461 557
Leasehold improvements (lesser of 5 years or lease term) 928 686
----------- ----------
Total............................................ 32,286 30,165
Accumulated depreciation and amortization........... (20,967) (15,036)
----------- ----------
Property and equipment, net...................... $ 11,319 $ 15,129
=========== ==========
</TABLE>
3. OTHER ASSETS
Other assets at June 30 consists of (in thousands):
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Software development costs........................... $ 221 $ 438
Purchased technology ................................ 3,184 690
Deposits............................................. 369 405
Goodwill and other intangibles....................... 2,829 4,068
----------- -----------
</TABLE>
-31-
<PAGE>
<TABLE>
<S> <C> <C>
Total.............................................. 6,603 5,601
Accumulated amortization.............. (1,846) (2,034)
=========== ===========
Other assets, net................................. . $ 4,757 $ 3,567
=========== ===========
</TABLE>
4. LINE OF CREDIT
We have a $2.5 million unsecured revolving line of credit. Under this line,
which expires in December 1999, borrowings bear interest at either (1) a
fluctuating annual rate equal to the prime lending rate then in effect, or (2) a
fixed annual rate that is 2% above the London Inter-Bank Offered Rate. As of
June 30, 1999, no amounts had been borrowed under the line. The agreement for
the line has certain financial covenants and, as of June 30, 1999, we complied
with those covenants. In addition, as of June 30, 1999, we had two letters of
credit outstanding, one collateralized by the line of credit in the amount of
$17,000 and the other collaterilized by one of our foreign bank accounts in the
amount of $78,000.
5. INCOME TAXES
The expense (benefit) for income taxes for the years ended June 30 consists of
(in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- ------------
<S> <C> <C> <C>
Current:
Fedaral $ -- $ -- $ (2,334)
State 135 -- --
Foreign 999 204 157
----------- ----------- ------------
Total current 1,134 204 (2,177)
----------- ----------- ------------
Deferred:
Federal 16,811 (5,245) (6,642)
State 5,518 (1,137) (1,408)
----------- ----------- ------------
Total deferred 22,329 (6,382) (8,050)
----------- ----------- ------------
Total provision (benefit) for income taxes $ 23,463 $ (6,178) $ (10,227)
=========== =========== ============
</TABLE>
The income tax benefit related to the exercise of stock options reduces taxes
currently payable and is credited to common stock. There was no tax benefit
related to the exercise of stock options in 1999. The amount of benefit was
approximately $0.3 million and $6.8 million in 1998 and 1997, respectively.
Total income tax (benefit) expense for the years ended June 30 differs from the
amount computed by applying the statutory federal income tax rate to income
before taxes as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
----------- ------------ ------------
<S> <C> <C> <C>
Income tax benefit at statutory federal rate $ (3,736) $ (6,422) $ (10,042)
State tax benefit, net of federal benefit (342) (209) (940)
Benefit of exempt FSC income -- -- --
Research and other tax credits (846) (616) (482)
Other 459 1,069 1,237
Valuation Allowance 27,928 -- --
=========== ============ ============
Total provision (benefit) for income taxes $ 23,463 $ (6,178) $ (10,227)
=========== ============ ============
</TABLE>
The components of deferred tax assets and liabilities on June 30 consist of (in
thousands):
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards and tax credit carryforwards $ 32,822 $ 19,276
Allowances for doubtful accounts and sales returns 1,158 604
Deferred compensation -- 1,083
Accrued expense 1,530 1,955
</TABLE>
-32-
<PAGE>
<TABLE>
<S> <C> <C>
----------- -----------
Total deferred tax assets 35,510 22,918
----------- -----------
Deferred tax liabilities:
Depreciation and amortization (228) (278)
Capitalized software (4) (17)
Goodwill and intangible assets 6 (227)
Other 1,716 (64)
----------- -----------
Total deferred tax liabilities (1,942) (586)
----------- -----------
Deferred income taxes 33,568 22,332
Valuation Allowance (33,568) --
----------- -----------
Deferred income taxes, net $ -- $22,332
=========== ===========
</TABLE>
Because of our recent history of operating losses and the uncertainty regarding
our future earnings, we recorded a valuation allowance of $33.6 million in
fiscal 1999. As of June 30, 1999, we had net operating loss carryforwards for
federal and state purposes of approximately $66.8 million and $27.3 million,
respectively. These expire at various dates between 2000 and 2014. We also have
federal and state tax credit carryforwards of approximately $5.5 million and
$3.1 million, respectively. These will expire at various dates between 2000 and
2014. Our ability to use our net operating loss carryforwards may be subject to
certain limitations if there is a change in our ownership.
6. LEASE OBLIGATIONS AND COMMITMENTS
We lease office facilities under operating lease agreements. Rent expense was
approximately $2.9 million, $2.7 million and $1.9 million for fiscal 1999, 1998
and 1997, respectively.
Future minimum lease payments under noncancelable operating leases are as
follows (in thousands):
Year Ending June 30,
--------------------
2000...................... $ 2,346
2001...................... 1,984
2002...................... 1,725
2003...................... 1,504
2004...................... 1,267
Thereafter................ 6,807
----------------
Total..................... $ 15,633
================
In 1997, we purchased a parcel of land for $2.6 million to replace our existing
headquarters facilities. In conjunction with this purchase, we subdivided the
parcel with the object of entering into sale-lease back arrangements with a
developer as buildings are constructed. In fiscal 1998, the first parcel was
transferred to the developer. The second parcel was transferred in fiscal 1999.
The lease on the first building began in December 1998, and the start of the
second lease depends on when the second building is completed. We expect this to
occur during the quarter ending December 31.
7. EMPLOYEE BENEFIT PLAN
We have a 401(k) Profit Sharing Plan under which we may contribute a
discretionary matching contribution as a percentage of an employee's
contribution. We currently make a discretionary matching contribution of 50% of
the employee's contribution. The maximum employee contribution matched is 4%.
Our matching contributions to the 401(k) Plan were approximately $383,000,
$391,000 and $557,000 in 1999, 1998 and 1997, respectively. We may make also a
discretionary lump sum profit sharing contribution to the Plan, which would vest
over seven years. No discretionary lump sum contributions were made in 1999,
1998 or 1997.
8. RELATED-PARTY TRANSACTIONS
In fiscal 1998 and fiscal 1997, we had revenues of approximately $0.3 and $1.0
million, respectively, from Omnipoint Communications, Inc. ("Omnipoint"). We had
no revenue from Omnipoint in fiscal 1999. The President and Chief Executive
Officer
-33-
<PAGE>
of Omnipoint is a member of our Board of Directors. Accounts receivable
from Omnipoint were approximately $144,000 as of June 30, 1998.
In 1997, we had revenues of approximately $3.0 million from Cisco Systems, Inc.
("Cisco"). A Vice President of Cisco was a member of our Board of Directors
until March 1999. We had no revenue from Cisco in fiscal 1999 or fiscal 1998.
9. SEGMENT AND GEOGRAPHIC INFORMATION
We conduct our business in one business segment. In fiscal 1999, no customer
accounted for more than 10% of our total revenues. In fiscal 1998, revenues from
one customer, a global telecommunications company, accounted for approximately
12% of our total revenues. In fiscal 1997, no customer accounted for more than
10% of our total revenues.
The following shows our net revenues for the years ended June 30, 1999, 1998 and
1997, and long-lived assets as of June 30, 1999, 1998 and 1997 by geographic
area (in thousands). Net revenues are based on the country where the product was
sold. No revenues from any one country outside the United States were 10% or
more of our total revenues for the years ended June 30, 1999, 1998 and 1997.
Year Ended June 30,
----------------------------------------------
1999 1998 1997
------------ ------------- -------------
Revenues:
United States............. $ 35,473 $ 39,981 $ 37,233
Europe.................... 9,334 6,057 3,620
Asia and Pacific Rim...... 12,019 8,481 8,791
Other..................... 7,964 6,056 2,068
------------ ------------- -------------
Total..................... $64,790 $ 60,575 $ 51,712
============ ============= =============
Long-lived assets:
United States............. $ 14,349 $ 15,888 $ 17,799
Asia and Pacific Rim...... 1,592 2,689 5,859
Europe.................... 135 119 97
------------ ------------- -------------
Total Consolidated........ $ 16,076 $ 18,696 $ 23,755
============ ============= =============
10 STOCKHOLDERS' EQUITY
Stock Option Plans
Our 1994 Non-Qualified Stock Option Plan provides for grants of nonqualified
stock options to officers, key employees, consultants and directors. Options are
priced not less than fair market value on the date of grant. Options granted
under the Non-Qualified Plan generally vest over five years and expire ten years
from the date of grant. No shares are available for future grant under this
Plan.
Under our 1994 Stock Option Plan, 3,624,500 shares of common stock, were
reserved for issuance to employees and consultants. Options granted under the
1994 Plan generally vest ratably over four years and expire ten years from the
date of grant. On June 30, 1999, there were 2,699,928 shares were available for
grant under the 1994 Plan. On July 24, 1999, the Board of Directors amended the
1994 Plan to provide for the grant of stock options to non-employee directors.
Under our 1995 Director Stock Option Plan, 550,000 shares of common stock were
reserved for issuance. Non-employee directors are granted options to purchase
common stock at fair market value on the date of grant. Initial options vest
ratably over four years and expire ten years from the date of grant. Subsequent
options vest ratably over one year and expire ten years from the date of grant.
On June 30, 1999, there were 450,000 shares available for grant under the
Director Plan. On July 24, 1999, the Board of Directors elected to terminate the
Director Plan.
Option activity under all plans was as follows (shares in thousands, except
prices):
-34-
<PAGE>
<TABLE>
<CAPTION>
Options Weighted
Outstanding Average Price
---------------- -----------------
<S> <C> <C>
Balance at June 30, 1996............. 4,943 $ 5.14
Granted........................... 3,529 $ 9.76
Exercised......................... (977) $ 20.84
Canceled.......................... (1,873) $ 18.98
----------------
Balance at June 30, 1997............. 5,622 $ 4.29
Granted........................... 1,414 $ 9.16
Exercised......................... (1,629) $ 1.36
Canceled.......................... (429) $ 5.19
----------------
Balance at June 30, 1998............. 4,978 $ 6.58
Granted........................... 1,570 $ 3.99
Exercised......................... (771) $ 0.38
Canceled.......................... (1,340) $ 5.80
----------------
Balance at June 30, 1999............. 4,437 $ 6.98
================
</TABLE>
In April 1997, we repriced outstanding options to purchase approximately
1,430,000 shares of common stock having exercise prices ranging from $10.18 to
$43.25 per share. The new exercise price was $6.00 per share. The closing price
of the common stock on the date of the repricing was $4.38. Repriced options are
included as both canceled and granted options in the table above.
A summary of outstanding and exercisable stock options as of June 30, 1999, is
as follows (in thousands, except prices):
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------ --------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- ----------------- --------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
$0.08-$0.18 220 4.97 $ 0.12 210 $ 0.12
$3.06-$4.38 1,705 9.12 $ 3.58 285 $ 4.38
$5.19-$7.00 896 6.95 $ 6.10 691 $ 6.01
$7.81-$14.50 1,416 8.47 $ 10.08 666 $ 11.01
$25.50 200 7.05 $ 25.50 146 $ 25.50
=============== =============
$0.08-$25.50 4,437 8.17 $ 6.98 1,998 $ 8.26
=============== =============
</TABLE>
At June 30, 1998 and 1997, 1,960 and 2,102 of the outstanding options were
exercisable at weighted average exercise prices of $5.31 and $2.13 respectively.
Employee Stock Purchase Plan
Under our Employee Stock Purchase Plan, eligible employees may purchase common
stock at a price that is 85% of the lower of the fair market value at the
beginning of each six-month offering period or the fair market value at the end
of the period. The six-month periods begin in May and November. Purchases are
limited to 15% of an employee's compensation. In 1999, 1998 and 1997,
respectively, 544,000, 592,000 and 260,000 shares of common stock were issued
under the Purchase Plan. As of June 30, 1999, 1,054,000 shares were reserved for
future issuance.
Additional Stock Plan Information
We follow the provisions of APB No. 25, Accounting for Stock Issued to
Employees, for financial reporting purposes. We have adopted the disclosure-only
provisions of SFAS No. 123, Accounting for Stock-Based Compensation.
The weighted average "estimated grant date fair value," as defined by SFAS No.
123, for options granted under our stock option plans in fiscal 1999, 1998 and
1997, respectively, was $2.89, $5.67 and $5.96 per share. The weighted average
"estimated grant date fair value," for purchases under our Employee Stock
Purchase Plan in fiscal 1999, 1998 and 1997, respectively, was $3.48, $4.09 and
$4.37 per share. These estimates are calculated using the Black-Scholes model.
The Black-Scholes model was developed to estimate the fair value of freely
tradable, fully transferable options without vesting restrictions. This differs
significantly from the situation here. The Black-Scholes model also requires
highly subjective assumptions, including future stock price volatility and
expected time until exercise, which greatly affect the calculated grant date
fair value.
The following weighted average assumptions are included in the estimated grant
date fair value calculations for our stock option and stock purchase programs:
-35-
<PAGE>
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ---------
<S> <C> <C> <C>
Stock Option Plans:
Expected dividend yields................................ -- -- --
Expected stock price volatility......................... 91.0% 77.0% 80.0%
Risk free interest rate................................. 4.9% 5.7% 6.8%
Expected life following vesting (years)................. 1.7 1.7 1.7
Stock Purchase Plan:
Expected dividend yields................................ -- -- --
Expected stock price volatility......................... 91.0% 77.0% 80.0%
Risk free interest rate................................. 4.7% 5.5% 5.4%
Expected life (years)................................... 0.5 0.5 0.5
</TABLE>
Pro Forma Net Loss and Net Loss Per Share:
Under SFAS No. 123, had we recorded compensation expense based on the estimated
grant date fair value for awards based on grants under our stock option and
stock purchase plans, our net loss and net loss per share would have changed.
The amounts below represent the pro forma amounts for fiscal 1999, 1998 and 1997
(in thousands, except for per share amounts):
<TABLE>
<CAPTION>
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Net loss as reported......................... $ (34,137) $ (12,170) $ (18,464)
Pro forma net loss........................... $ (38,274) $ (22,984) $ (26,915)
Diluted loss per share....................... $ (0.97) $ (0.36) $ (0.58)
Pro forma diluted loss per share............. $ (1.09) $ (0.68) $ (0.84)
</TABLE>
In accordance with SFAS No. 123, we have excluded the impact of outstanding
stock options granted before fiscal 1996 from this pro forma calculation. As a
result, the calculation does not reflect future period adjustments that will
apply to all stock options.
Deferred Stock Compensation
In fiscal 1996, we recorded deferred compensation of $2,272,000 to reflect the
difference between the grant price and the deemed fair value of certain stock
options granted in 1995 and 1994. This amount was amortized over the vesting
period of the options, generally four years. Amortization of this compensation
expense was $211,000, $370,000 and $415,000 for fiscal 1999, fiscal 1998 and
fiscal 1997, respectively.
* * * * * *
-36-
<PAGE>
SCHEDULE II
OBJECTIVE SYSTEMS INTEGRATORS, INC.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
Balance at Additions Balance at
Beginning of Charged to End of
Classification Period Operations Deductions Period
- -------------- -------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Allowance for Doubtful Accounts:
Year Ended:
June 30, 1997........................ $ 987 $ 8,846 $ (5,621) $ 4,212
============== ============= ============== =============
June 30, 1998........................ $ 4,212 $ 400 $ (3,095) $ 1,517
============== ============= ============== =============
June 30, 1999....................... $ 1,517 $ 642 $ (294) $ 1,865
============== ============= ============== =============
Allowance for Sales Returns:
Year Ended:
June 30, 1997........................ $ 100 $ 5,371 $ (3,171) $ 2,300
============== ============= ============== =============
June 30, 1998........................ $ 2,300 $ 2,894 $ (2,882) $ 2,312
============== ============= ============== =============
June 30, 1999........................ $ 2,312 $ 1,130 $ (2,280) $ 1,162
============== ============= ============== =============
</TABLE>
-37-
<PAGE>
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements Nos.
333-00986, 333-18189, 333-43215 and 333-70341 of Objective Systems Integrators,
Inc. on Form S-8 of our report dated August 9, 1999, appearing in this Annual
Report on Form 10-K of Objective Systems Integrators, Inc. for the year ended
June 30, 1999.
/s/ Deloitte & Touche LLP
_____________________________
DELOITTE & TOUCHE LLP
San Jose, California
September 27, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 15,811
<SECURITIES> 15,774
<RECEIVABLES> 19,116
<ALLOWANCES> (1,865)
<INVENTORY> 0
<CURRENT-ASSETS> 50,348
<PP&E> 32,286
<DEPRECIATION> (20,967)
<TOTAL-ASSETS> 66,424
<CURRENT-LIABILITIES> 22,562
<BONDS> 0
0
0
<COMMON> 86,703
<OTHER-SE> (42,841)
<TOTAL-LIABILITY-AND-EQUITY> 66,424
<SALES> 0
<TOTAL-REVENUES> 64,790
<CGS> 20,369
<TOTAL-COSTS> 77,060
<OTHER-EXPENSES> (1,596)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (10,674)
<INCOME-TAX> 23,463
<INCOME-CONTINUING> (34,137)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (34,137)
<EPS-BASIC> (0.97)
<EPS-DILUTED> (0.97)
</TABLE>
