Form 10-K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended March 31, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 000-30931

 

 

OPNET TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE   52-1483235

(State or other jurisdiction of

Incorporation or organization)

 

(I.R.S. Employer

Identification No.)

7255 Woodmont Avenue, Bethesda, Maryland 20814-7900

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (240) 497-3000

Securities registered pursuant to Section 12(b) of the Act: Common Stock, $0.001 par value

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ¨    NO  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer”, or “smaller reporting company in Rule 12b-2 of the Exchange Act (check one).

 

Large accelerated filer  ¨   Accelerated filer  x   Non-accelerated filer  ¨   Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ¨    NO  ¨

The aggregate market value of the voting stock held by non-affiliates of the registrant, computed using the closing sale price of the registrant’s Common Stock on September 30, 2010, as reported on the NASDAQ Global Select Market, was approximately $209,970,798. 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 because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily conclusive for other purposes.

The number of shares of the registrant’s Common Stock outstanding on May 31, 2011 was 22,308,857.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the registrant’s definitive Proxy Statement for the 2011 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

 

 

 


OPNET TECHNOLOGIES, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED MARCH 31, 2011

 

ITEM

        TABLE OF CONTENTS    PAGE  
      PART I   
1.      

Business

     1   
1A.      

Risk Factors

     13   
1B.      

Unresolved Staff Comments

     21   
2.      

Properties

     21   
3.      

Legal Proceedings

     21   
4.      

Removed and Reserved

     21   
      PART II   
5.      

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     22   
6.      

Selected Financial Data

     24   
7.      

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     25   
7A.      

Quantitative and Qualitative Disclosures About Market Risk

     43   
8.      

Financial Statements and Supplementary Data

     44   
9.      

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     44   
9A.      

Controls and Procedures

     44   
9B.      

Other Information

     47   
      PART III   
10.      

Directors, Executive Officers and Corporate Governance

     48   
11.      

Executive Compensation

     48   
12.      

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     48   
13.      

Certain Relationships and Related Transactions, and Director Independence

     48   
14.      

Principal Accounting Fees and Services

     48   
      PART IV   
15.      

Exhibits and Financial Statement Schedules

     49   

SIGNATURES

     50   

EXHIBIT INDEX

     82   


PART I

Forward Looking Information

This Annual Report contains forward-looking statements that involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “should,” and “would” or similar words. You should read statements that contain these words carefully because they discuss our future expectations, contain projections of our future results of operations or of our financial position, or state other forward-looking information. We believe that it is important to communicate our future expectations to our investors. However, there may be events in the future that we are not able to predict accurately or control. The factors listed in this Annual Report on Form 10-K under “Risk Factors,” as well as any cautionary language in this Annual Report on Form 10-K, provide examples of risks, uncertainties, and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. You should also carefully review the risks outlined in other documents that we file from time to time with the Securities and Exchange Commission, including our Quarterly Reports on Form 10-Q that we will file in fiscal 2012.

The forward-looking statements provided in this Annual Report on Form 10-K represent our expectations as of June 3, 2011. We anticipate that subsequent events and developments may cause our expectations to change. However, while we may elect to update this forward-looking information at some point in the future, we specifically disclaim any obligation to do so. This forward-looking information should not be relied upon as representing our expectations as of any date subsequent to June 3, 2011.

Fiscal Year Convention

The years ended March 31, 2011, 2010, and 2009, are referred to as “fiscal 2011,” “fiscal 2010,” and “fiscal 2009,” respectively, in this Annual Report on Form 10-K.


ITEM 1. BUSINESS

In this Annual Report on Form 10-K, or Annual Report, the “Company”, “we,” “us,” and “our” refer to OPNET Technologies, Inc. and its wholly-owned and wholly-controlled subsidiaries unless the context otherwise indicates.

OPNET Technologies, Inc. is a provider of application and network performance management solutions. Our software products address application performance management, or APM, network operations, capacity management, and network research and development. Our customers include corporate enterprises, government and defense agencies, network service providers, and network equipment manufacturers. Our software products and related services are designed to help our customers make better use of resources, reduce operational problems and improve competitiveness.

In many business environments, applications that were once largely static for long intervals must now be managed as dynamic systems due to the rapid rate of change affecting all of their components. Dynamic aspects of service delivery include: change in the network infrastructure, which is shared among all applications; change in the computing infrastructure, especially with the deployment of server virtualization; and finally, the business-driven need to rapidly deploy new functionality and “bug fixes” into the code of the application itself.

Within this rapidly evolving, complex environment, traditional approaches to managing the performance of applications and networks are no longer sufficient to empower information technology, or IT, to provide the requisite level of service to the enterprise. These traditional approaches provide the ability to monitor, record, and alert on basic health and status metrics of the individual elements that constitute the service delivery infrastructure. However, traditional approaches fall short for two fundamental reasons: the information that is gathered is insufficiently fine-grained; and there is an absence of the analytical tools needed to combine and correlate the many sources of information to deliver actionable information.

OPNET differentiates itself from other providers of application and network performance management by offering solutions that directly tackle the challenges that have emerged in IT service management. Central to OPNET’s approach is its “High Definition” blueprint for APM, which describes both technology architecture and go-to-market strategy, highlighting differentiating characteristics of OPNET’s approach. OPNET’s High Definition APM offerings embody the critical attributes of an effective APM solution, and are characterized by the following;

 

   

Breadth: Applications are implemented across many functional domains in the IT infrastructure. All of these domains affect application performance. An APM solution with breadth provides visibility into all or most of these areas.

 

   

Depth: The nature of the collected data is also a key determinant of APM functional scope. Depth is the “high resolution” part of High Definition. It means that the collected information is rich enough to characterize problems, uncover behavioral patterns, and isolate the root cause of performance issues. OPNET’s APM approach emphasizes a combined analysis of two types of data: performance data and forensic data. Performance data consists of metrics recorded over time; this data is also frequently aggregated over regular time intervals. Forensic data digs deeper into the inner workings of transactions as they proceed through the infrastructure. Forensic information includes code level traces, such as method calls and their parameters; detailed resource tracking, such as memory allocations; and deep packet inspection of network traffic.

 

   

Analytics: Breadth and depth multiply to yield a challenge: vast quantities of data. Putting that data to work to solve problems requires advanced tools. OPNET calls these tools “Analytics”: an array of algorithms and techniques for extracting useful information from data collected by the APM instrumentation. OPNET has been a pioneer in introducing advanced, yet practical, analytics in APM solutions.

 

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Integration: To address each of the domains of an application requires specialized tools. These tools, by their nature, have different workflows and manipulate different types of information. However, using the tools in a coordinated fashion delivers support and efficiency to APM users. OPNET’s integrated solution suite provides workflows that transition between domains contextually, as well as true correlation and data fusion.

 

   

Low overhead: All of these capabilities become impractical to deploy if they impose overhead that noticeably degrades application performance. OPNET has specialized in developing zero-overhead passive monitoring and low-overhead agent-based technologies to collect data for its APM solutions. All of OPNET’s APM solutions are designed for production environments.

We believe our software products appeal to a broad customer base, including corporate enterprises, government and defense agencies, network service providers, and network equipment manufacturers, empowering them to make better use of resources, rapidly troubleshoot operational problems, and improve competitiveness.

We market focused software products for each of our target markets. We sell our products to both Fortune 1000 and mid-size companies. Some examples of our customers include:

 

   

Corporate enterprises, such as Amgen, BNP Paribas, Canadian Broadcasting Corporation, Del Monte Food Corporation, Ergon Energy, GameStop, GlaxoSmithKline, Healthcare Partners, Hyundai Securities, infoUSA, International Rescue Committee, Jostens, Kuwait International Bank, Major League Baseball, Manpower Midway USA, Midway USA, Moody’s, National Collegiate Athletic Association, Omnicom Media Group, Philadelphia Stock Exchange, Starwood Hotels & Resorts, United Arab Shipping Company, and Visteon;

 

   

Government agencies, such as the California Highway Patrol CHiPs, Florida Department of Education, Federal Bureau of Investigations, the Federal Communications Commission, the Internal Revenue Service, the United States Department of Defense, the United States Department of Homeland Security, and the United States Government Printing Office;

 

   

Service providers, such as Asia Pacific Telecom Group, British Telecom, France Telecom, Cox Communications, NTT, Telus, and WilTel; and

 

   

Network equipment manufacturers, such as Cisco Systems, Ericsson, Research in Motion, and Samsung.

Industry Background

Growth and Increased Complexity of Networks and Dependence on Applications

Organizations rely on enterprise software applications and networks to successfully execute their strategies. The increasing use of applications, such as enterprise resource planning, business intelligence, corporate intranets, e-mail, web meetings, virtualization, portals, web services, voice over IP, wireless, and streaming multimedia has resulted in significant growth in underlying network and application infrastructures. In addition, the proliferation and widespread adoption of the Internet and web services architectures have expanded the role of networks beyond organizational boundaries.

Enterprises and service providers must now manage the convergence of voice, data, and video traffic over traditional, wireless, and optical architectures by integrating numerous existing and emerging technologies. The complexity is exacerbated by the current corporate regulatory environment, which requires improved management processes and documentation. As a result of these factors, businesses and government entities are forced to confront significant challenges related to the cost, risk, and performance of IT.

IT infrastructures are sophisticated, dynamic systems that evolve on a daily basis. Applications are typically distributed across many clients, servers, and network segments. New and enhanced business applications are

 

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regularly being deployed and re-deployed. The geographic distribution of users relative to IT services shifts due to the consolidation of organizations and resources. Traffic levels exhibit steady growth, necessitating constant evaluation of and improvements to the underlying network infrastructure in order to maintain business and application performance. However, due to the dependencies among network, server, and application configurations, it is very difficult for IT professionals to identify the true root cause of performance problems when they occur. The data required to diagnose problems is often difficult to obtain, and processes for analyzing this data are often manual and time consuming, requiring significant experience and expertise. When an end-user experiences performance problems with an important business application, the challenge facing a typical IT manager is to determine: whether there is enough bandwidth available; whether the database server has enough capacity; whether network routing protocols are tuned properly; whether protocols on the client and server are likewise tuned properly; and whether the application was designed and implemented efficiently with end-user performance in mind.

Within this rapidly evolving, complex environment, traditional approaches to managing the performance of IT services are no longer sufficient to empower IT to provide the requisite level of service to the enterprise. These traditional approaches provide the ability to monitor, record, and alert on basic health and status metrics of the individual elements that constitute the service delivery infrastructure. However, these traditional approaches fall short for two fundamental reasons: the information that is gathered is insufficiently fine-grained; and there is an absence of analytical tools needed to combine and correlate the many sources of information to deliver actionable information.

Without a clear understanding of the source of problems and the specific changes required to solve them, IT managers resort to uninformed decision-making that often results in wasteful spending on unnecessary and ineffective server and network upgrades. IT professionals need software products that enable them to focus their time and resources in the right places when problems occur in distributed enterprise applications, and to maximize the use of existing infrastructure. Further, since modifications to infrastructure have the potential to cause service level degradation or even network failures, there is a growing need to plan and implement network changes in a controlled manner, taking into account the potential consequences of each action.

Market Opportunity for OPNET Software Products

Organizations need application and network management software products that possess the analytics required to overcome the limitations of traditional tools for rapidly detecting and resolving complex problems and proactively preventing problems from occurring. OPNET software products are focused on these areas. Our software products have embedded knowledge and operational understanding of applications, networks, and systems for quickly troubleshooting problems and automatically predicting the impact of changes. We believe business executives and IT professionals require software products like ours to:

 

   

ensure fast response times for mission critical applications, including customer-facing web-based applications;

 

   

reduce down time of mission critical applications;

 

   

reduce operating and capital costs;

 

   

increase business productivity; and

 

   

manage risk, enabling faster deployment of critical, IT-dependent strategic business initiatives.

We believe the value proposition from OPNET software products apply to a broad range of potential customers including:

 

   

large and medium-sized enterprises that rely on IT to conduct business;

 

   

government/defense agencies;

 

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service providers, including telecommunications carriers, internet service providers, or ISPs, and managed service providers, or MSPs; and

 

   

network equipment manufacturers.

Enterprises require analytics for more effectively identifying the root causes of application performance problems, ensuring the successful deployment of new applications, auditing device configurations for security and policy compliance, validating changes, and performing critical operational and strategic planning functions.

Government and defense agencies have needs similar to those of enterprises, service providers, and network equipment manufacturers. These agencies also sometimes require specialized services to support large projects that incorporate OPNET’s technology. United States government customers, including the Department of Defense, utilize our software and professional services to take advantage of our extensive expertise and intellectual property in applications, networking, and protocols. For the Department of Defense, our software products and related services are used for both application and network performance management, as well as for analyzing and developing communications technologies for network-centric transformational programs. Our ability to model and simulate end-to-end application and network performance is valuable in determining the impact of tactical or strategic changes to networks, planning for contingencies, and evaluating the impact of new network technologies and protocols. In addition, our software products are scalable and address large, complex military systems and networks, such as mobile networks, with a variety of operationally proven, advanced predictive performance techniques.

Service providers require analytics for optimizing their investments in network infrastructure, more effectively troubleshooting network issues, ensuring network configuration integrity and security, planning for services based on new technologies including wireless and optical, and making better use of network resources to increase competitiveness.

Network equipment manufacturers require advanced modeling and simulation software products for accelerating network research and development, reducing time-to-market for new technologies, developing custom network design and analysis software, and for reducing sales cycles for sophisticated technology products.

OPNET Software Products

Our software products use a variety of advanced technologies to support the analysis of application, network, and server performance under a wide range of current and planned or modeled operating conditions. Many OPNET software products share a significant amount of core software based on an open architecture. Our software architecture enables us to create new software more efficiently, to foster interoperability of our software products, and to provide interfaces to a wide range of external data sources including third party management tools and network topology, traffic, and configuration information. We also deliver extensive cross-product integration, to enable our users to realize added value when products are deployed together.

The following sections summarize the OPNET software product portfolio by target market:

Primary Target Market: Enterprise IT (Corporate and Government/Defense)

 

   

AppCapacity Xpert, formerly called IT Guru Systems Planner, was introduced in December 2006. It provides capacity planning for servers, including planning for migration from physical-to-virtual server environments.

 

   

AppInternals Xpert was first introduced in December 2004. AppInternals Xpert delves into the complex software frameworks and operating systems of modern servers to extract large amounts of performance and forensic data to support all aspects of APM from the server perspective. AppInternals Xpert can provide analysis for any type of application, but particularly excels in Java and .NET environments. It continuously monitors thousands of system and application metrics and automatically

 

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detects and ranks performance and behavior anomalies. Its patented correlation technology automatically reveals relationships among metrics, highlighting the corresponding causal connections between components, resources, and code-level behavior in order to perform root cause analysis. AppInternals Xpert uses patented technology to automatically provide deep instrumentation in application code with very low overhead.

 

   

AppMapper Xpert was introduced in January 2011. AppMapper Xpert automatically produces run-time application maps, identifying the underlying application components and infrastructure components that enable a production application. This dynamic model of the application, captured at the time of execution, is essential for troubleshooting application performance problems. It also provides critical information to improve a host of other operational workflows, such as configuration and change management, and data center virtualization and consolidation. AppMapper Xpert provides visibility into the interaction between applications and the underlying infrastructure, enabling IT organizations to effectively assess and respond to events and conditions that affect application service levels.

 

   

AppResponse Xpert, previously called Ace Live, was introduced in December 2007. AppResponse Xpert is an appliance-based solution that continuously monitors and analyzes end-user experience for all users and transactions. The solution also supports in-depth monitoring and analysis of the underlying network, a domain that is vital to comprehensive APM. AppResponse Xpert leverages the central role of the network in transporting transaction data to obtain vital information about relationships among clients and servers, and also among server tiers. This information is useful for performance analysis and troubleshooting in AppResponse Xpert and also for application discovery and dependency mapping functions performed by AppMapper Xpert. On-board analytics extract transactions from application flows and break down application response time, identifying which parts of the infrastructure are contributing most to delays. Add-on modules provide analytics for voice over IP, or VOIP, and Netflow.

 

   

AppSQL Xpert was introduced in September 2010. AppSQL Xpert provides deep visibility into database performance through real-time monitoring of a broad range of metrics, with drilldowns to fine-grained forensic database transaction data for troubleshooting. It performs detailed tracking of database usage for trending and performance optimization. It also detects database policy violations, such as unauthorized access and suspicious usage patterns. AppSQL Xpert provides analysis of database performance while offering an agentless approach that imposes zero overhead on database operation.

 

   

AppTelemetry Xpert was introduced as APM Element Insight in June 2010. AppTelemetry Xpert uses remote instrumentation interfaces, such as SNMP to capture performance information from infrastructure components which may otherwise be difficult to access, including servers, application components, network devices, and vendor-specific management systems. AppTelemetry Xpert supplies this data, on both a historical and real-time basis, to the rest of OPNET’s APM solution suite for a more complete picture of end-to-end application performance.

 

   

AppTransaction Xpert, formerly called ACE Analyst, was first introduced in May 2000. AppTransaction Xpert is a powerful tool for detailed analysis of individual transactions. In today’s complex application architectures, a single transaction can involve many tiers and require thousands of messages to traverse the network. This solution, which processes and merges traces taken in the production environment, makes extensive use of visualization and analytics to accelerate troubleshooting in production, as well as pre-deployment testing and prediction. In production, the combination of AppResponse Xpert and AppTransaction Xpert provides a seamless workflow that spans monitoring, alerting, triage, root cause diagnosis, and remediation guidance. In pre-deployment, AppTransaction Xpert is our solution for application network readiness testing.

 

   

IT Guru Network Planner was first introduced in August 1998 as IT Guru. It provides predictive network capacity planning and design optimization, as well as validation of network configuration changes.

 

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IT Sentinel was first introduced in August 2004. IT Sentinel provides automatic and continuous network configuration integrity and security auditing, and proactive change validation.

 

   

nCompass for Enterprises was first introduced in September 2003 as NETCOP. It provides enterprises with centralized, real-time visibility of network topology, traffic, and status in a single, integrated view. nCompass for Enterprises provides a unified view to quickly recognize the impact of network events, and assisted troubleshooting to rapidly resolve problems.

 

   

VNE Server was first introduced in June 2002. VNE Server, or Virtual Network Environment Server, automatically maintains a detailed, near real-time data model of the production IT network. VNE Server includes a suite of adapters that obtain topology, traffic, and other information from network devices as well as a broad range of third-party data sources. VNE Server automates the data collection process for other OPNET products, including IT Guru Network Planner and SP Guru Network Planner. VNE Server capabilities are included in IT Sentinel and SP Sentinel.

Primary Target Market: Network Service Providers (both Commercial and Government/Defense)

 

   

SP Guru Network Planner was first introduced in June 2001. SP Guru Network Planner is built on the IT Guru Network Planner product, and contains analytics that are valuable to service providers for planning, network design optimization, and validation of configuration changes. SP Guru Network Planner includes modeling and analysis technologies for IP, MPLS, and ATM networks, and when combined with SP Guru Transport Planner, provides a single environment for network-level and optical transport-level analysis.

 

   

SP Guru Transport Planner, formerly WDM Guru, was first introduced in December 2001. SP Guru Transport Planner is an optical network-planning product for designing resilient, cost-efficient optical networks. SP Guru Transport Planner is also sold to network equipment manufacturers.

 

   

nCompass for Service Providers was first introduced in September 2003 as NETCOP. nCompass for Service Providers provides centralized, real-time visibility of network topology, traffic, and status in a single, integrated view. nCompass for Service Providers provides a unified view to quickly recognize the impact of network events, and assisted troubleshooting to rapidly resolve problems.

 

   

SP Sentinel was first introduced in August 2004. SP Sentinel provides automated and continuous network configuration integrity and security auditing for service providers, and proactive change validation.

 

   

AppResponse Xpert is used by service providers who deliver managed network and data center services to enterprises to ensure application performance.

Primary Target Market: Network R&D Organizations (Defense and Equipment Manufacturers)

 

   

OPNET Modeler was OPNET’s first product, introduced in 1987. OPNET Modeler is a network modeling and simulation product. It enables users to evaluate how networking equipment, communications technologies, systems, and protocols will perform under simulated network conditions.

 

   

Modeler Wireless Suite is based on OPNET Modeler, and incorporates additional functionality germane to wireless network R&D organizations.

 

   

Modeler Wireless Suite for Defense is based on OPNET Modeler, and incorporates additional functionality that supports unique network R&D undertaken by the defense community.

OPNET Modules

We develop and sell a variety of software modules that provide additional functions to our application and network management software products.

 

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OPNET Model Libraries

The model libraries are used by OPNET software to simulate and analyze major networking technologies and communication protocols. These libraries provide the building blocks used to generate models of networks. A network model consists of software objects that correspond to the devices, computers, and links that constitute the actual network of interest. The behavior of these objects is controlled by models of devices, computers, applications, communication protocols, and links. IT Guru Network Planner, IT Guru Systems Planner, IT Netcop, IT Sentinel, SP Guru Network Planner, SP Netcop, SP Sentinel, and OPNET Modeler include extensive libraries of popular and emerging networking technologies and communication protocols, such as TCP/IP, hypertext transfer protocol, or HTTP, open shortest path first routing, or OSPF, asynchronous transfer mode, or ATM, frame relay, IP-QoS, 802.11, or Wi-Fi, and 802.16, or WiMAX. Some of our model libraries are included in our base products and others are available for an additional fee as modules.

Our product agreements provide our customers with perpetual and term licenses for use by a specified number of concurrent users or for use by an unlimited number of concurrent users.

Customers

For fiscal 2011, 2010, and 2009 we generated 25.9%, 22.5%, and 21.1%, respectively, of our total revenue from customers located outside the United States. No single customer accounted for 10% or more of revenue for fiscal 2011, 2010 or 2009. Note 16 to our consolidated financial statements presents information regarding revenue generated in the United States and internationally.

We derive a substantial portion of our revenue from sales directly or indirectly to United States government agencies. For fiscal 2011, 2010 and 2009, revenue from transactions with United States government agencies was approximately 32.5%, 39.9%, and 35.3%, respectively, of our total revenue. Government sales are subject to a variety of risks, including appropriation of funds by the United States Congress, termination for convenience, contract renegotiations/extensions and a decline in government spending.

Sales and Marketing

We sell our software products and related services through our direct sales force, our international subsidiaries, alliances with third parties called the SYNERGY program, third-party distributors, and value-added resellers, or VARs. To date, VARs have not accounted for more than 10% of our revenue. In North America, our direct sales force accounts for the majority of our sales. As of March 31, 2011, our sales and marketing teams consisted of 186 employees, including 96 quota-carrying and inside salespersons located in our headquarters in Bethesda, Maryland and our domestic offices in Cary, North Carolina; Dallas, Texas; Nashua, New Hampshire; and Santa Clara, California; our overseas subsidiaries in Paris, France; Slough, United Kingdom; Mainz, Germany; Ghent, Belgium; and Singapore; and our branch office in Beijing, China.

Our international sales activities are also supported by 79 VARs that offer our products in Australia, Austria, Brazil, Finland, France, Germany, Greece, India, Indonesia, Israel, Japan, Netherlands, New Zealand, Norway, Poland, Romania, Russia, South Africa, South Korea, Spain, Sweden, Switzerland, Turkey and the United Kingdom. Our marketing division works internally with our engineering and sales teams to develop customer value propositions and product messages, and externally with various third parties to develop brand awareness and leads for sales. Our external marketing activities are aimed at existing customers, new customer prospects, the media, and industry analysts. These include:

 

   

participation in industry tradeshows;

 

   

technology seminars and user group meetings;

 

   

advertisements in trade journals and online;

 

   

direct mailings;

 

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product collateral development and maintaining OPNET’s website;

 

   

free software for academic use at universities;

 

   

specialized product sales support;

 

   

specialized sales support with OPNET resellers;

 

   

briefings with industry analysts; and

 

   

a variety of public relations activities.

For thirteen of the past fourteen years, we have sponsored OPNETWORK, an international technology conference convened in Washington, D.C. that focuses on application and network management for professionals in all areas of networking and information technology. OPNETWORK 2010, which was held in August 2010, included approximately 600 hours of classes, labs, and panels led by OPNET employees and outside experts. Not including OPNET employees, more than 1,800 IT and engineering professionals participated in the conference. We did not hold the event in 2009 due to travel restrictions imposed on many of our users in response to the economic climate. We intend to hold OPNETWORK again in August 2011.

Service and Support

Our service and support offerings include:

 

   

consulting services;

 

   

product updates, technical support and services, which includes product updates and training services on a when-and-if available basis for customers with current maintenance agreements, and technical support by telephone, e-mail or fax; and

 

   

training for customers without current maintenance agreements, which includes courses that enable our customers to more effectively use our products.

We offer consulting services to assist our clients, facilitate the adoption of our software products, and to provide installation services for our product offerings. Installation services are performed by our consulting staff, which consists of software development engineers, quality assurance engineers, technical documentation specialists, and project managers. Some customers also choose to engage our consulting services for troubleshooting application performance problems, network planning, network design, communication protocol design and customization services. As of March 31, 2011, our consulting staff consisted of 86 employees.

Our customers may purchase product updates, technical support and services, all of which except technical support are provided on a when-and-if available basis under our maintenance agreement. Payments for product updates, technical support and services whether on an initial order or on a renewal order, are generally made in advance and are nonrefundable.

Product updates consist of the right to unspecified software updates on a when-and-if-available basis and customers typically purchase this right in connection with the initial product purchase. Product updates, technical support and services may be renewed upon expiration of each contract term purchased, which is generally one year. Customers can purchase product updates separately from technical support and services. Customers purchasing technical support are still required to purchase periodic unspecified product updates.

We provide customer support from our support center at our headquarters in Bethesda, Maryland, as well as from support staff in France, the United Kingdom and Singapore. We have designed and implemented a comprehensive information system to ensure that customer inquiries are addressed promptly, tracked until fully resolved, and recorded for future reference. Reports on the overall responsiveness of the technical support infrastructure, and the status of pending customer inquiries, are provided regularly to our technical support staff, technical support management, and executive management.

 

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We have a core team of 20 technical support staff supplemented by a limited number of product developers and consultants who perform technical support on a rotational basis. We believe this staffing approach maximizes the access customers have to the best available product expertise, while providing product developers with direct customer feedback, which in turn helps us improve our software products.

We regularly offer training courses to our customers to assist them in maximizing the benefit they receive from using our products. Our training classes cover a broad range of topics. Training classes are offered at our headquarters in Bethesda, Maryland, our facilities in Santa Clara, California; Cary, North Carolina; Paris, France; and Slough, United Kingdom; and at our customers’ locations under separate contracts. As of March 31, 2011, our full-time training staff consisted of 5 employees.

Research and Development

We believe that our ability to enhance our current software products and create new software products in response to the needs of our customer base is an important factor for our future success. Accordingly, we intend to continue to commit significant resources to product research and development. We expect to accomplish a large part of our software product improvements and new software product development through internal development efforts. New capabilities may also be integrated into our product lines through the acquisition of technologies or businesses, or the licensing of externally developed technologies.

Our total research and development expense for fiscal 2011, 2010, and 2009 was approximately $34.7 million, $32.0 million, and $30.8 million, respectively. Our research and development efforts to date have been conducted at our offices in Bethesda, Maryland; Cary, North Carolina; Nashua, New Hampshire; Santa Clara, California: and Ghent, Belgium. All related costs have been expensed as incurred. As of March 31, 2011, our research and development staff consisted of 217 engineers and technical professionals.

Our research and development efforts are directed at increasing our revenue by expanding the scope of our software products and service offerings to address additional customer requirements. Our existing customers provide a meaningful source of information regarding customer requirements, which we use in order to guide our future research and development activities. In addition, we invest in third-party research and analysis of trends in our industry and our product markets in an effort to proactively reflect these trends in our future software products.

Competition

The market for our software products and related services is evolving rapidly and is highly competitive. We believe that this market is likely to become more competitive as the demand for intelligent application and network management software products continues to increase. Although we believe that none of our competitors offer software products that are identical to ours, we are subject to current and potential competition from:

 

   

software and hardware vendors with application and network performance management offerings, such as Computer Associates, Hewlett-Packard, Compuware Corporation, IBM Tivoli, NetScout Systems, and Quest Software;

 

   

consultants who offer advisory services related to application and network performance management; and

 

   

customers who develop their own application and network management capabilities, either internally or through outsourcing.

Also, it is possible that other vendors as well as some of our customers or distributors may develop and market competitive products in the future. Many of our current and potential competitors are larger and have substantially greater financial and technical resources than we do. We believe the principal competitive factors affecting the market for our software products and related services are the following:

 

   

scope, quality, and cost-effectiveness of application and network management software products;

 

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industry knowledge and expertise embedded in the software;

 

   

the interoperability of software products with existing network management software products;

 

   

product performance, accuracy, technical features, ease of use, and price;

 

   

customer service and support;

 

   

consultants who offer advisory services related to application and network performance management; and

 

   

customers who develop their own application and network management capabilities, either internally or through outsourcing.

Intellectual Property

We rely on a combination of copyright, trademark, patent, and trade secret laws, confidentiality agreements, and contractual provisions to protect our intellectual property. However, we believe that these laws and agreements afford us only limited protection. Despite our efforts to protect and oversee our intellectual property rights, there may be unauthorized parties who encroach upon our proprietary rights. In addition, the laws of some foreign countries do not provide as much protection of our proprietary rights as do the laws of the United States.

We currently hold registered trademarks in the United States for all of our primary marks, including OPNET, OPNETWORK, IT Guru, IT Sentinel, Netbiz, NetMapper, OPNET Modeler, SP Guru, SP Sentinel, VNE Server, WDM Guru, OPNET LoadScaler, OPNET TestCreator, OPNET Panorama, and OPNET nCompass. We have pending applications and additional registrations in the United States for many of our other marks including Ace Live Insights, Know Your Network, Service Insight and NetOne. We also hold additional registered and unregistered trademarks in the United States and around the world and register those marks when and where appropriate. We expect to add new marks to our trademark portfolio and maintain our current portfolio commensurate with the continued use of existing registered and unregistered marks, especially our house mark OPNET. We have applied for and obtained numerous registrations for our marks in foreign countries. For the term OPNET, we hold registrations in the following countries: Benelux, France, Germany, Japan, the Peoples Republic of China, Taiwan, Spain and the United Kingdom and have additional applications pending in Italy and Spain. Other trademarks or service marks appearing in this Annual Report on Form 10-K are the property of their respective holders.

In addition, we have 46 patents granted by the United States Patent and Trademark Office. Our patents will expire between 2018 and 2029. We also have 65 pending United States patent applications that, if granted, would expire approximately 20 years from their respective filing dates. Seven of these are provisional patent applications for which we expect to pursue non-provisional applications within the next year. With regard to foreign patent protection, we have one patent granted by the European Patent Office and eight pending European patent applications. Additionally, we plan on pursuing one more European patent application within the next year. We believe that, because of the rapid pace of change in our industry, intellectual property protection for our products and the knowledge, abilities, and experience of our employees will be significant factors for our future success.

Executive Officers and Directors of the Registrant

Our executive officers and directors, and their ages as of June 3, 2011, are as follows:

 

Name

   Age     

Position

Marc A. Cohen

     47      

Chairman of the Board and Chief Executive Officer

Alain J. Cohen

     44      

President, Chief Technology Officer and Director

Mel F. Wesley

     39      

Vice President and Chief Financial Officer

 

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Set forth below is information regarding the professional experience for each of our executive officers and directors. These executive officers and directors were elected to serve until their successors have been elected. Marc A. Cohen and Alain J. Cohen are brothers. There is no other family relationship between any of our other executive officers or between any of these officers and any of our directors.

Marc A. Cohen, one of our founders, has served as our Chairman of the Board since our inception in 1986 and as our Chief Executive Officer since 1994. From 1986 to 1992, Mr. Cohen was also a consultant with Booz Allen Hamilton Inc., or Booz Allen, an international management and consulting company. Mr. Cohen received a bachelor’s degree in engineering science from Harvard University and a master’s degree in electrical engineering from Stanford University. Mr. Cohen also serves as a Trustee and as a member of the Board of Directors of the Dana-Farber Cancer Institute in Boston, Massachusetts.

Alain J. Cohen, one of our founders, has served as our President and Chief Technology Officer and as a member of our Board of Directors since our inception in 1986. Mr. Cohen received a bachelor’s degree in electrical engineering from the Massachusetts Institute of Technology, or M.I.T.

Mel F. Wesley has served as our Vice President and Chief Financial Officer since July 2005. Mr. Wesley served as our Acting Chief Financial Officer from December 2004 to July 2005 and our Corporate Controller from June to December 2004. From August 2003 to June 2004, Mr. Wesley served as Corporate Controller for SteelCloud, Inc., a publicly traded corporation that provides design, development and manufacturing of network appliances and infrastructure server products. From October 2000 to August 2003, Mr. Wesley served as an Assistant Controller for Learning Tree International, Inc., a publicly traded corporation that provides training to information technology professionals and managers. Mr. Wesley received a bachelor’s degree in accounting and a master of business administration from George Mason University. Mr. Wesley is also licensed as a Certified Public Accountant in Virginia.

Employees

As of March 31, 2011, we had 578 full-time employees, 518 of whom were located in the United States. The 578 full-time employees included 186 in sales and marketing, 86 in professional services and support, 247 in engineering, research and development, and 59 in general and administrative functions. Our employees are not represented by a collective bargaining agreement and we consider our relations with our employees to be good.

Corporate Information

We are a Delaware corporation that was incorporated in November 1988, our principal executive office is located at 7255 Woodmont Avenue, Bethesda, Maryland 20814-7900 and our telephone number is (240) 497-3000. Our website address is www.opnet.com. The information on our website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered to be a part of this Annual Report on Form 10-K. Our website address is included in this Annual Report on Form 10-K as an inactive textual reference only.

Availability of SEC Reports

Our website address is www.opnet.com. We make available free of charge on our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission, or SEC.

We file our reports with the SEC electronically via the SEC’s Electronic Data Gathering, Analysis and Retrieval system, or EDGAR. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding companies that file electronically with the SEC via EDGAR. The address of this website is www.sec.gov.

 

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Any reports, statements or other information that we file with the SEC may be read or copied at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Copies of these documents can be requested upon payment of a duplicating fee, by writing to the SEC. Please call the SEC at 1 (800) SEC-0300 for further information on the operation of the Public Reference Room. Upon request, we make available free of charge, electronic or paper copies of any reports, statements or other information that we file with the SEC.

Code of Business Conduct and Ethics

On May 4, 2004 we adopted a code of business conduct and ethics for all directors, officers, and employees pursuant to Section 406 of the Sarbanes-Oxley Act of 2002. The Code of Business Conduct and Ethics is available on our website at www.opnet.com. Suspected violations of this Code may be reported on a confidential or anonymous basis by facsimile or by e-mail to our General Counsel and to the Chairman of the Audit Committee of the Board of Directors. We intend to disclose any amendment to, and any waiver from, any provision of this Code that applies to any director, the Chief Executive Officer, Chief Financial Officer, or any other executive officer and that relates to any element of this Code enumerated in Item 406(b) of Regulation S-K, on Form 8-K.

 

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ITEM 1A. RISK FACTORS

The following important factors, among others, could cause actual results to differ materially from those indicated by forward-looking statements made in this Annual Report and presented elsewhere by management from time to time. You should consider carefully the following information before making an investment in our securities.

General instability in the economy, including concerns regarding the after-effects of the global recession, or unfavorable economic conditions in a particular region, business or industry sector, may cause our customers to postpone or forego technology investments and could have other impacts, any of which could hurt our business, financial results and cash flow.

Our products are designed to enhance our customers’ ability to manage their applications and networks. However, general instability in the economy, including concerns regarding the after-effects of the global recession, or a general slowdown in the global economy, or in a particular region, or business or industry sector, such as the financial services sector, or tightening of credit markets, could cause our customers to:

 

   

have difficulty accessing credit sources;

 

   

delay contractual payments; or

 

   

postpone or forego decisions to purchase our products and services, or maintain them at originally purchased levels.

The global economy appears to be recovering from a severe recession, which hurt our product and services revenue in fiscal 2010 and fiscal 2009. Despite what appears to be a trend toward recovery, we cannot provide any assurance that instability in the global economy will end or not become more severe. The longer this global economic instability persists, the greater the probability that these factors could hurt our business, financial results and cash flow.

Our operating results may fluctuate significantly as a result of factors outside of our control, including current economic conditions, which could cause the market price of our stock to decline.

Our operating results have fluctuated in the past, and are likely to fluctuate significantly in the future. Our financial results may as a consequence fall short of the expectations of public market analysts or investors, which could cause the price of our common stock to decline. Our revenue and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are beyond our control. Factors that could affect our operating results include:

 

   

general economic conditions, which can affect our customers’ purchasing decisions, the length of our sales cycle, and our customers’ ability to pay us on time, if at all;

 

   

the timing of large orders;

 

   

changes in the proportion of software arrangements requiring contract accounting;

 

   

changes in the mix of our sales, including the mix between higher margin software products and maintenance and lower margin professional services, and the proportion of our product sales requiring us to make royalty payments;

 

   

the timing and amount of our marketing, sales, and product development expenses;

 

   

the cost and time required to develop new software products;

 

   

the introduction, timing, and market acceptance of new products introduced by us or our competitors;

 

   

changes in network technology or in applications, which could require us to modify our products or develop new products;

 

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changes in our pricing policies or those of our competitors; and

 

   

the timing and size of potential acquisitions by us.

We expect to make significant expenditures in all areas of our business, particularly sales and marketing operations, in order to promote future growth. Because the expenses associated with these activities are relatively fixed in the short term, we may be unable to adjust spending quickly enough to offset any unexpected shortfall in revenue growth or any decrease in revenue levels. In addition, our revenue in any quarter depends substantially on orders we receive and ship in that quarter. We typically receive a significant portion of orders in any quarter during the last month of the quarter, and we cannot predict whether those orders will be placed and shipped in that period. If we have lower revenue than we expect, we may not be able to respond quickly enough to reduce our operating expenses. Therefore, any significant shortfall in revenue or delay of customer orders could have an immediate adverse impact on our operating results in that quarter.

For all of these reasons, quarterly comparisons of our financial results are not necessarily meaningful, and you should not rely on them as an indication of our future performance.

If we do not successfully expand our sales force, we may be unable to increase our sales.

We sell our products primarily through our direct sales force, and we must expand the size of our direct sales force to increase revenue. If we are unable to hire or retain qualified sales personnel, if newly hired personnel fail to develop the necessary skills to be productive, or if they reach productivity more slowly than anticipated, our ability to increase our revenue and grow our business could be compromised. Our sales people require a long period of time to become productive, typically three to nine months. The time required to reach productivity, as well as the challenge of attracting, training, and retaining qualified candidates, may make it difficult to expand our direct sales force. Further, we may not generate sufficient sales to offset the increased expense resulting from growing our direct sales force, or we may be unable to manage a larger direct sales force.

The market for intelligent network management software is new and evolving, and if this market does not develop as anticipated, our revenue could decline.

We derive all of our revenue from the sale of products and services that are designed to allow our customers to manage the performance of applications and networks. Accordingly, if the market for intelligent application and network management software does not continue to grow, we could face declining revenue, which could ultimately lead to our becoming unprofitable. The market for intelligent application and network management software products is evolving. Therefore, we cannot accurately assess the size of the market and may be unable to identify an effective distribution strategy, the competitive environment that will develop, and the appropriate features and prices for products to address the market. If we are to be successful, our current and potential customers must recognize the value of intelligent network management software products, decide to invest in the management of their networks, and, in particular, adopt and continue to use our software products.

Our customers are primarily in four target groups and our operating results may be adversely affected by changes in one or more of these groups.

Our software products and related services are designed to meet the needs of enterprises, United States government agencies, service providers, and network equipment manufacturers, and we market our software products and related services to those four customer groups. Consequently, our financial results depend, in significant part, upon the economic conditions of enterprises, United States government agencies, service providers, and network equipment manufacturers. An economic downturn or adverse change in the regulatory environment or business prospects for one or more of these customer groups may decrease our revenue or lower our growth rate.

 

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A decline in information technology spending may result in a decrease in our revenue or lower our growth rate.

A decline in the demand for information technology among our current and prospective customers may result in decreased revenue or a lower growth rate for us because our sales depend, in part, on our customers’ budgets for new or additional information technology systems and services. A continued economic downturn may cause our customers to reduce or eliminate information technology spending and force us to lower prices of our software products and related services, which would substantially reduce the number of software products we sell and the average sales price for these products. Accordingly, we cannot be certain that we will be able to increase or maintain our revenue.

Our sales to United States government agencies subject us to special risks that could adversely affect our business.

We derive a substantial portion of our revenue from sales directly or indirectly to United States government agencies. Transactions with United States government agencies accounted for approximately 32.5%, 39.9%, and 35.3% of our total revenue for fiscal 2011, 2010, and 2009, respectively. Government sales entail a variety of risks including:

 

   

Government contracts are subject to the approval of appropriations by the United States Congress to fund the expenditures by the agencies under these contracts. Congress often appropriates funds for government agencies on a yearly basis, even though their contracts may call for performance over a number of years.

 

   

A significant decline in government expenditures generally, or a shift in budget priorities away from agencies or programs that we support, could cause a material decline in our government business. In particular, a decline in government spending on information technology or related services could hurt our government business.

 

   

A portion of our products and services are included on a General Services Administration, or GSA schedule. We believe that the GSA schedule facilitates our sales to United States government agencies. The loss of the GSA schedule covering our products and services could adversely affect our results of operations.

 

   

We must comply with complex federal procurement laws and regulations in connection with government contracts, which may impose added costs on our business.

 

   

Some of our government business requires that we maintain facility security clearances, and requires some of our employees to maintain individual security clearances. If we were to lose these clearances, our government business might decline.

 

   

The federal government audits and reviews the performance of federal contractors on contracts, pricing practices, cost structure, and compliance with applicable laws, regulations, and standards. An audit of our work could result in a finding that we overcharged the government, which could result in an adjustment to our previously reported operating results. If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or debarment from doing business with United States federal government agencies.

 

   

Many of our government contracts are firm fixed-price contracts. To the extent that the assumptions we have used in pricing these contracts prove inaccurate, we could incur and accrue losses on contracts, which would adversely affect our operating results.

 

   

A portion of our sales to the United States government are made indirectly as a subcontractor to another government contractor, referred to as the prime contractor, who has the direct relationship with the government. We also team with prime contractors to bid on competitive government opportunities

 

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for which we hope to serve as a subcontractor. If prime contractors lose existing business on which we serve as a subcontractor, or fail to win the competitive bids on which we team with them, our government business would be hurt.

 

   

We could face expense and delay if any of our competitors, or competitors of the prime contractors to which we serve as a subcontractor, protest or challenge contract awards made to us or to our prime contractors pursuant to competitive bidding.

 

   

Federal government contracts contain provisions and are subject to laws and regulations that provide government clients with rights and remedies not typically found in commercial contracts. These rights and remedies allow government clients, among other things, to terminate existing contracts, with short notice, for convenience without cause; reduce or modify contracts or subcontracts; and claim rights in products, systems, and technology produced by us.

Our lengthy and variable sales cycle makes it difficult to predict operating results.

It is difficult for us to forecast the timing and recognition of revenue from sales of our products because prospective customers often take significant time evaluating our products before purchasing them. The period between initial customer contact and a purchase by a customer may vary from one month to more than a year. During the sales process, the customer may decide not to purchase or may reduce proposed orders of our products for various reasons, including changes in budgets and purchasing priorities. Our prospective customers routinely require education regarding the use and benefit of our products. This may also lead to delays in receiving customers’ orders.

Our ability to increase our sales may be impaired if we do not expand and manage our indirect distribution channels.

To increase our sales, we must, among other things, further expand and manage our indirect distribution channels, which consist of alliances with third parties called the SYNERGY program, third-party distributors, and value-added resellers, or VARS. If we are unable to expand and manage our relationships with our indirect distributors, our indirect distributors are unable or unwilling to market and sell our products effectively, or we lose existing indirect distributor relationships, we might not be able to increase our revenue. Our indirect distributors have no obligation to market or purchase our products. In addition, they could partner with our competitors, bundle or resell competitors’ products, or internally develop products that compete with our products.

We may not be able to successfully manage our expanding operations, which could impair our ability to operate profitably.

We may be unable to operate our business profitably if we fail to manage our growth. Our growth has sometimes strained, and may in the future continue to strain, our managerial, administrative, operational, and financial resources and controls. We plan to continue to expand our operations and increase the number of our full-time employees. Our ability to manage growth may depend in part on our ability to continue to enhance our operating, financial, and management information systems. Our personnel, systems, and controls may not be adequate to support our growth. In addition, our revenue may not continue to grow at a sufficient rate to absorb the costs associated with a larger overall employee base.

If we are unable to introduce new and enhanced products on a timely basis that respond effectively to changing technology, our revenue may decline.

Our market is characterized by rapid technological change, changes in customer requirements, frequent new product and service introductions and enhancements, and evolving industry standards. If we fail to develop and introduce new and enhanced products on a timely basis that respond to these changes, our products could become

 

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obsolete, demand for our products could decline and our revenue could fall. Advances in network management technology, software engineering, and simulation technology, or the emergence of new industry standards, could lead to new competitive products that have better performance, more features, or lower prices than our products and could render our products unmarketable.

Our future revenue is substantially dependent upon our existing customers continuing to license additional products, renew maintenance agreements, and purchase additional services.

Our existing customers have traditionally generated additional revenue from consulting services, renewed maintenance agreements, and the purchase of additional software products, which represent the majority of our annual revenue. The maintenance agreements are generally renewable at the option of the customers and there are no mandatory payment obligations or obligations to license additional software. In addition, customers may decide not to purchase additional products or services. If our existing customers fail to renew their maintenance agreements or fail to purchase additional products or services, our revenue could decrease.

Increases in professional services revenue as a percentage of total revenue could decrease overall margin.

We realize significantly lower margin on professional service revenue than we do on other types of revenue. As a result, if professional services revenue increases as a proportion of total revenue, our gross margin will be lower. Although professional services revenue has been declining as a percentage of revenue, accounting for 15.0%, 21.2%, and 23.3% of our total revenue for fiscal 2011, 2010, and 2009, respectively, this trend may not continue.

If we fail to retain our key personnel and attract and retain additional qualified personnel, we might not be able to maintain our current level of revenue.

Our future success and our ability to maintain our current level of revenue depend upon the continued service of our executive officers and other key sales and research and development personnel. The loss of any of our key employees, in particular Marc A. Cohen, our Chairman of the Board and Chief Executive Officer, who is also our principal sales executive, and Alain J. Cohen, our President and Chief Technology Officer, could also adversely affect our ability to pursue our growth strategy. We do not have employment agreements or any other agreements that obligate any of our officers or key employees to remain with us.

We must also continue to hire highly qualified individuals, particularly software engineers and sales and marketing personnel. Our failure to attract and retain technical personnel for our product development, consulting services, and technical support teams may limit our ability to develop new products or product enhancements. Competition for these individuals is intense, and we may not be able to attract and retain additional highly qualified personnel in the future. In addition, limitations imposed by federal immigration laws and the availability of visas could impair our ability to recruit and employ skilled technical professionals from other countries to work in the United States.

Our international operations subject our business to additional risks, which could cause our sales or profitability to decline.

In fiscal 2011, 25.9% of our revenue, or $38.3 million, was generated from customers outside the United States. In fiscal 2010, 22.5% of our revenue, or $28.4 million, was generated from customers outside the United States. In fiscal 2009, 21.1% of our revenue, or $26.0 million, was generated from customers outside the United States. We plan to increase our international sales activities, but these plans are subject to a number of risks that could cause our sales to decline or could otherwise cause a decline in profitability. These risks include:

 

   

difficulty in attracting distributors that will market and support our software products effectively;

 

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greater difficulty in accounts receivable collection and longer collection periods;

 

   

the need to comply with varying employment policies and regulations that could make it more difficult and expensive to manage our employees if we need to establish more direct sales or support staff outside the United States;

 

   

potentially adverse tax consequences;

 

   

the effects of currency fluctuations; and

 

   

political and economic instability.

We expect to face increased competition, which could cause us to lose sales, resulting in lower profitability.

Increasing competition in our market could cause us to lose sales and become unprofitable. We believe that the market for intelligent application and network management software is likely to become more competitive as it evolves and the demand for intelligent application and network management software products continues to increase. At least one of our current competitors and many of our potential competitors are larger and have substantially greater financial and technical resources than we do. In addition, it is possible that other vendors as well as some of our customers or distributors may develop and market software products that compete with our software products in the future.

If our products contain errors and we are unable to correct those errors, our reputation could be harmed and our customers could demand refunds from us or assert claims for damages against us.

Our software products could contain significant errors or bugs that may result in:

 

   

the loss of or delay in market acceptance and sales of our products;

 

   

the delay in introduction of new products or updates to existing products;

 

   

diversion of our resources;

 

   

injury to our reputation; and

 

   

increased support costs.

Bugs may be discovered at any point in a product’s life cycle. We expect that errors in our products may be found in the future, particularly in new product offerings and new releases of our current products.

Because our customers use our products to manage networks that are critical to their business operations, any failure of our products could expose us to product liability claims. In addition, errors in our products could cause our customers’ networks and systems to fail or compromise their data, which could also result in liability to us. Product liability claims brought against us could divert the attention of management and key personnel, could be expensive to defend, and may result in adverse settlements and judgments.

Our software products rely on our intellectual property, and any failure to protect our intellectual property could enable our competitors to market products with similar features that may reduce our revenue and could allow the use of our products by users who have not paid the required license fee.

If we are unable to protect our intellectual property, our competitors could use our intellectual property to market products similar to our products, which could reduce our revenue. In addition, we may be unable to prevent the use of our products by persons who have not paid the required license fee, which could reduce our revenue. Our success and ability to compete depends substantially upon the internally-developed technology that is incorporated in our products. Policing unauthorized use of our products is difficult, and we may not be able to prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our

 

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proprietary rights as fully as those in the United States. Others may circumvent the patents, copyrights, and trade secrets we own. In the ordinary course of business, we enter into a combination of confidentiality, non-competition, and non-disclosure agreements with our employees.

These measures afford only limited protection and may be inadequate, especially because our employees are highly sought after and may leave our employ with significant knowledge of our proprietary information. In addition, any confidentiality, non-competition and non-disclosure agreements we enter into may be found to be unenforceable, or our copy protection mechanisms embedded in our software products could fail or could be circumvented.

Our products employ technology that may infringe on the proprietary rights of others, and, as a result, we could become liable for significant damages.

We expect that our software products may be increasingly subject to third-party infringement claims as the number of competitors in our industry segment grows and the functionalities of products in different industry segments overlap.

Regardless of whether these claims have any merit, they could:

 

   

be time-consuming to defend;

 

   

result in costly litigation;

 

   

divert our management’s attention and resources;

 

   

cause us to delay or cease product shipments; or

 

   

require us to enter into royalty or licensing agreements.

These royalty or licensing agreements may not be available on terms acceptable to us, or at all. A successful claim of product infringement against us or our failure or inability to license the infringed or similar technology could adversely affect our business because we would not be able to sell the affected product without redeveloping it or incurring significant additional expense.

As with other software vendors, we may be required to delay revenue recognition into future periods, which could adversely affect our operating results.

We have in the past had to, and in the future may have to, defer recognition of product revenue due to several factors, including whether:

 

   

product arrangements include undelivered elements for which we do not have vendor specific evidence of fair value;

 

   

we must deliver services for significant customization, enhancements and modifications of our products;

 

   

the transaction involves material acceptance criteria or there are other identified product-related issues;

 

   

the transaction involves contingent payment terms or fees; or

 

   

we are required to accept extended payment terms.

Because of the factors listed above and other specific requirements under accounting principles generally accepted in the United States of America for software revenue recognition, we must have very precise terms in our product arrangements in order to recognize revenue when we initially deliver products or perform services. Negotiation of mutually acceptable terms and conditions can extend the sales cycle, and sometimes we do not obtain terms and conditions that permit revenue recognition at the time of delivery.

 

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If we undertake acquisitions, they may be expensive and disruptive to our business and could cause the market price of our common stock to decline.

We have historically pursued acquisitions as a key part of our business strategy. We may continue to acquire or make investments in companies, products or technologies if opportunities arise. Any acquisition could be expensive, disrupt our ongoing business, distract our management and employees, and adversely affect our financial results and the market price of our common stock. We may not be able to identify suitable acquisition or investment candidates, and if we do identify suitable candidates, we may not be able to make these acquisitions or investments on commercially acceptable terms or at all. If we make an acquisition, we could have difficulty integrating the acquired technology, employees, or operations. In addition, the key personnel of the acquired company may decide not to work for us.

We also expect that we would incur substantial expenses if we acquire other businesses or technologies. We might use cash on hand, incur debt, or issue equity securities to pay for any future acquisitions. If we issue additional equity securities, our stockholders could experience dilution and the market price of our stock may decline.

Our products are subject to changing computing environments, including operating system software and hardware platforms, which could render our products obsolete.

The evolution of existing computing environments and the introduction of new popular computing environments may require us to redesign our products or develop new products. Computing environments, including operating system software and hardware platforms, are complex and change rapidly. Our products are designed to operate in currently popular computing environments. Due to the long development and testing periods required to adapt our products to new or modified computing environments, our research and development efforts could be distracted and we could experience significant delays in product releases or shipments, which could result in lost revenue and significant additional expense.

The impairment of a significant amount of goodwill on our balance sheet could result in a decrease in earnings and, as a result, our stock price could decline.

In the course of our operating history, we have acquired assets and businesses. Some of our acquisitions have resulted in the recording of a significant amount of goodwill on our financial statements. We had approximately $15.4 million of goodwill recorded on our balance sheet as of March 31, 2011. The goodwill reflects the fact that the fair value of the net tangible assets acquired in past acquisitions was less than the purchase price. We may not realize the full value of the goodwill. We evaluate goodwill for impairment on an annual basis or more frequently if events and circumstances suggest that the asset may be impaired. If goodwill is determined to be impaired, we will write off the unrecoverable portion as a charge to our earnings. If we acquire new assets and businesses in the future, we may record additional goodwill. The possible write-off of the associated goodwill could negatively impact our future earnings and, as a result, the market price of our common stock could decline.

The price of our common stock may decrease due to market volatility.

The market price of our common stock has historically been volatile and has fluctuated significantly. The market price of our common stock may continue to fluctuate in response to a number of factors, some of which are beyond our control. Trading activity of our stock has historically been relatively thin, in part as a result of officers and directors and institutional stockholders holding a significant percentage of our stock. In addition, the market price of securities of technology companies have been volatile and have experienced fluctuations that often have been unrelated or disproportionate to the operating performance of these companies. Also, broad market fluctuations could adversely impact the market price of our common stock, which in turn could cause impairment of goodwill that could materially and adversely impact our financial condition and results of operations.

 

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It is not uncommon when the market price of a stock has been volatile for holders of that stock to institute securities class action litigation against the company that issues that stock. If any of our stockholders brought such a lawsuit against us, even if the lawsuit is without merit, we could incur substantial costs defending the lawsuit beyond any insurance coverage which we may have for such risks. Such a lawsuit could also divert the time and attention of our management.

The Board may decide that future dividends will be in amounts that are different than the amounts we have historically paid or may decide to suspend or discontinue the payment of cash dividends altogether.

The declaration of cash dividends in the future is subject to final determination each quarter by the Board based on a number of factors, including our financial performance and available cash resources, our cash requirements and alternative uses of cash that the Board may conclude would represent an opportunity to generate a greater return on investment for us.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

 

ITEM 2. PROPERTIES

Our corporate office and principal facilities are located in Bethesda, Maryland and consist of approximately 82,000 square feet of office space held under two leases. The lease for 60,000 square feet expires on January 31, 2021, exclusive of renewal options, and the lease for 22,000 square feet expires on January 31, 2016, exclusive of renewal options. We also lease office space in the following locations: Cary, North Carolina; Dallas, Texas; Santa Clara, California; Nashua, New Hampshire; Colorado Springs, Colorado; Ghent, Belgium; Paris, France; Slough, United Kingdom; Singapore; Beijing China; and Mainz, Germany.

 

ITEM 3. LEGAL PROCEEDINGS

We are involved in various claims and legal proceedings arising from our normal operations. We do not regard any of those matters to be material.

 

ITEM 4. REMOVED AND RESERVED

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market for Common Stock

Our common stock began trading on the NASDAQ Stock Market on August 2, 2000, under the symbol “OPNT.” The following table sets forth, on a per share basis, for the indicated periods, the intra-day high and low sale prices of our common stock as reported by the NASDAQ Stock Market.

 

Quarter ended

   High      Low  

June 30, 2009

   $ 10.75       $ 6.92   

September 30, 2009

     11.56         8.24   

December 31, 2009

     12.70         10.01   

March 31, 2010

     16.20         11.70   

June 30, 2010

     17.12         14.46   

September 30, 2010

     19.60         13.01   

December 31, 2010

     27.28         16.80   

March 31, 2011

     39.00         24.38   

Number of Stockholders of Record

As of May 31, 2011, we had approximately 106 holders of record of common stock. Because many of these shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these holders of record.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information regarding our current equity compensation plans as of March 31, 2011.

Equity Compensation Plan Information

 

Plan Category

   Number of
securities to be
issued upon
exercise of
outstanding
options (a)
     Weighted-
average exercise
price of
outstanding
options
     Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected
in column (a))
 

Equity compensation plans approved by security holders

     1,131,997       $ 9.42         2,877,325 (1)(2) 

Equity compensation plans not approved by security holders

     —           —           —     
                          

Total

     1,131,997       $ 9.42         2,877,325   

 

(1) In addition to being available for future issuance upon exercise of options that may be granted after March 31, 2011, all of the remaining 2,198,337 shares under our Amended and Restated 2010 Stock Incentive Plan, or the 2010 Plan, may instead be issued in the form of restricted stock, stock appreciation rights or other stock-based awards.
(2)

Includes 678,988 shares issuable under our 2000 Employee Stock Purchase Plan, including shares issuable in connection with the current offering period which ends on July 31, 2011. Also includes 2,198,337 shares issuable under the 2010 Plan. Under the 2010 Plan, beginning with the 2011 calendar year, the number of

 

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shares available for issuance automatically increases on the first trading day of each calendar year by an amount equal to the lesser of (i) 3% of the shares of common stock outstanding on the last trading day of the preceding calendar year, or (ii) an amount determined by the Board of Directors, or the Board, in either case not to exceed an annual increase of 1,000,000 shares. See Note 2, “Stock-Based Compensation,” in the accompanying notes to our consolidated financial statements for more information.

Dividends

We did not declare or pay any dividends in fiscal 2009. The following table summarizes our quarterly cash dividend payments for fiscal 2011 and 2010 and our one-time special dividend payment in November of 2010:

 

Declaration Date

 

Stockholder Record Date

 

Payment Date

 

Amount per Share

May 13, 2009

  June 15, 2009   June 29, 2009   $0.09

July 30, 2009

  September 15, 2009   September 29, 2009   $0.09

October 28, 2009

  December 15, 2009   December 30, 2009   $0.09

January 27, 2010

  March 15, 2010   March 30, 2010   $0.09

May 5, 2010

  June 15, 2010   June 30, 2010   $0.10

August 4, 2010

  September 14, 2010   September 29, 2010   $0.10

October 27, 2010

  November 14, 2010   November 30, 2010   $0.75

October 27, 2010

  December 7, 2010   December 21, 2010   $0.10

January 26, 2011

  March 16, 2011   March 30, 2011   $0.10

The declaration of cash dividends in the future is subject to final determination each quarter by the Board based on a number of factors, including our financial performance and available cash resources, our cash requirements and alternative uses of cash that the Board may conclude would represent an opportunity to generate a greater return on investment for us. The Board may decide that future dividends will be in amounts that are different than the amount described above or may decide to suspend or discontinue the payment of cash dividends altogether.

Stock Repurchase Plan

Issuer Repurchases of Equity Securities

 

Period

   Total Number of
Shares Purchased
     Average Price Paid
per Share
     Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs (1)
     Maximum Number
of Shares That May
Yet Be Purchased
Under the Plans or
Programs
 

January 1– 31, 2011

     —           —           —           488,164   

February 1– 28, 2011

     9,524       $ 30.40         9,524         478,640   

March 1 – 31, 2011

     —           —           —           478,640   
                             

Total

     9,524       $ 30.40         9,524         478,640   
                             

 

(1) On January 31, 2005, we announced a stock repurchase program pursuant to which we are authorized to purchase up to 1,000,000 shares of common stock from time to time on the open market or in privately negotiated transactions. This program does not have a specified termination date. On February 4, 2008, we announced that our Board approved an increase of an additional 1,000,000 shares under our stock repurchase program. Any repurchased shares will be available for use in connection with our stock plans or other corporate purchases. As of March 31, 2011, we had repurchased 1,521,360 shares of common stock under this program.

 

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report. The statement of operations data for the years ended March 31, 2011, 2010, and 2009, and the balance sheet data as of March 31, 2011 and 2010, are derived from our audited consolidated financial statements included in this Annual Report. The balance sheet data as of March 31, 2009, 2008 and 2007 and the statement of operations data for the years ended March 31, 2008 and 2007 are derived from our consolidated financial statements that are not included in this Annual Report. Historical results are not necessarily indicative of results that may be expected for any future period.

 

     Year Ended March 31,  
     2011     2010     2009      2008     2007  
     (in thousands, except per share data)  

Statement of Operations Data:

           

Revenue:

           

Product

   $ 72,392      $ 52,252      $ 51,211       $ 38,838      $ 43,186   

Product updates, technical support and services

     53,392        47,264        43,067         34,787        28,062   

Professional services

     22,202        26,831        28,601         27,721        23,882   
                                         

Total revenue

     147,986        126,347        122,879         101,346        95,130   
                                         

Cost of revenue:

           

Product

     9,293        5,983        3,536         1,035        638   

Product updates, technical support and services

     5,260        4,859        4,665         4,514        3,264   

Professional services

     16,183        19,328        20,911         19,154        15,904   

Amortization of acquired technology

     2,050        1,835        2,172         1,486        723   
                                         

Total cost of revenue

     32,786        32,005        31,284         26,189        20,529   
                                         

Gross profit

     115,200        94,342        91,595         75,157        74,601   
                                         

Operating expenses:

           

Research and development

     34,718        32,043        30,791         27,471        21,688   

Sales and marketing

     48,733        43,181        42,533         39,357        34,133   

General and administrative

     12,947        11,011        11,857         11,747        10,994   
                                         

Total operating expenses

     96,398        86,235        85,181         78,575        66,815   
                                         

Income (loss) from operations

     18,802        8,107        6,414         (3,418     7,786   

Interest and other (expense) income, net

     (151     (70     1,246         3,579        3,834   
                                         

Income before provision for income taxes

     18,651        8,037        7,660         161        11,620   

Provision (benefit) for income taxes

     6,250        2,214        2,928         (372     3,655   
                                         

Net income

   $ 12,401      $ 5,823      $ 4,732       $ 533      $ 7,965   
                                         

Basic net income per common share

   $ 0.57      $ 0.28      $ 0.23       $ 0.03      $ 0.39   
                                         

Diluted net income per common share

   $ 0.55      $ 0.28      $ 0.23       $ 0.03      $ 0.37   
                                         

Basic weighted average shares outstanding

     21,429        20,529        20,296         20,342        20,357   

Diluted weighted average shares outstanding

     22,130        20,790        20,533         20,596        21,189   

Balance Sheet Data (end of period):

           

Cash, cash equivalents and marketable securities

   $ 114,728      $ 104,681      $ 91,989       $ 85,829      $ 91,381   

Total assets

   $ 191,823      $ 178,352      $ 166,064       $ 153,538      $ 147,658   

Dividends declared per common share (a)

   $ 1.15      $ 0.36      $ —         $ —        $ —     

Total stockholders’ equity

   $ 124,823      $ 118,676      $ 116,505       $ 110,645      $ 112,871   

 

(a) Includes special dividend of $0.75 per share in fiscal 2011.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under “Item 1A. Risk Factors” and elsewhere in this Annual Report on Form 10-K.

Overview

OPNET Technologies, Inc. is a provider of application and network performance management, or APM, solutions. Our software products address application performance management, network operations, capacity management, and network research and development. Our customers include corporate enterprises, government and defense agencies, network service providers, and network equipment manufacturers. Our software products and related services are designed to help our customers make better use of resources, reduce operational problems and improve competitiveness.

We operate in one reportable industry segment, the development and sale of computer software products and related services. Our operations are principally in the United States, and we have subsidiaries in Belgium, France, Germany, the United Kingdom and Singapore. We primarily depend upon our direct sales force to generate revenue in the United States. Sales outside the United States are made through our international sales team as well as third-party distributors and value-added resellers, who generally are responsible for providing technical support and service to customers within their territory.

Our revenue is derived from three primary sources: (1) product, (2) product updates, technical support and services, and (3) professional services, which include consulting and training services for customers without current maintenance agreements. Product revenue represents all fees earned from granting customers licenses to use our software and fees associated with hardware necessary to run our software, and excludes revenue derived from product updates, which are included in product updates, technical support, and services revenue. Our software master license agreement provides our customers with the right to use our software either perpetually, which we refer to as perpetual licenses, or during a defined term, generally for one to four years, which we refer to as term licenses. For the years ended March 31, 2011, 2010, and 2009, perpetual licenses represented approximately 91%, 92%, and 93% of product revenue, respectively. Substantially all of our product arrangements include both product licenses and product updates, technical support, and services. Product updates, technical support, and services revenue represent fees associated with the sale of unspecified product updates, technical support and when-and-if available training under our maintenance agreements. We offer professional services, under both time-and-material and fixed-price agreements, primarily to facilitate the adoption of our software products.

We consider our consulting services to be an integral part of our business model as they are centered on our software product offerings. Because our consulting services facilitate the adoption of our software product offerings, we believe that they ultimately generate additional sales of product licenses.

The key strategies of our business plan include increasing sales to existing customers, increasing deal size by selling modules and introducing new software products, improving our sales and marketing execution, establishing alliances to extend our market reach, increasing our international presence and increasing profitability. We have focused our sales, marketing, and other efforts on corporate enterprise and United States government opportunities, and to a much lesser extent, service provider and network equipment manufacturer opportunities. Our focus and strategies are designed to increase revenue and profitability. Because of the uncertainty surrounding the amount and timing of revenue growth, we expect to need to closely control the increases in our total expenses as we implement these strategies.

 

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In March 2008, we launched an initiative to extend our market reach by establishing sales alliances with third parties called the Synergy program. The Synergy program is designed to increase the penetration of our software products, particularly into mid-sized organizations. The Synergy program’s primary focus is on selling our application performance management software products, including AppResponse Xpert that provides end-user experience monitoring and real-time application performance analytics, as we believe these software products are particularly well-suited for indirect channel distribution. As of March 31, 2011, there were 139 third parties participating in our Synergy program.

Summary of Our Fiscal 2011 Financial Performance

During fiscal 2011, as compared to fiscal 2010, we generated growth in total revenue and expanded our income from operations and net income. The increase in total revenue was primarily the result of growth in sales of our APM products to corporate enterprise customers. We believe the increase in sales of our APM products is the result of competitive advantages offered by our products and increased sales efforts on our part, together with loosening customer budgets and more normal purchasing patterns as compared to fiscal 2010.

During fiscal 2011, as compared to fiscal 2010, we also generated an increase in deferred revenue and cash flows from operations. The increase in deferred revenue was largely the result of growth in the sale of new maintenance contracts. The increase in cash flows from operations was primarily the result of growth in sales of our products and maintenance contracts together with strong collections activity during fiscal 2011.

The following table summarizes information on some of our key financial and operating metrics.

 

     Fiscal
2011
    Fiscal
2010
    Amount
Change
    Percentage
Change
 
     (dollars in thousands, except per share data)  

Financial Data:

        

Total revenue

   $ 147,986      $ 126,347      $ 21,639        17.1

Total cost of revenue

   $ 32,786      $ 32,005      $ 781        2.4

Gross profit

   $ 115,200      $ 94,342      $ 20,858        22.1

Gross profit as a percentage of total revenue (gross margin)

     77.8     74.7    

Total operating expenses

   $ 96,398      $ 86,235      $ 10,163        11.8

Income from operations

   $ 18,802      $ 8,107      $ 10,695        131.9

Income from operations as a percentage of total revenue (operating margin)

     12.7     6.4    

Net income

   $ 12,401      $ 5,823      $ 6,578        113.0

Diluted net income per common share

   $ 0.55      $ 0.28      $ 0.27        96.4

Other Operations Data:

        

Total employees (period end)

     578        582        (4     (0.7 )% 

Total average employees

     567        580        (13     (2.2 )% 

Total consultants (period end)

     86        100        (14     (14.0 )% 

Total period end quota-carrying sales persons (excluding directors and inside sales representatives)

     73        72        1        1.4

Financial Condition and Liquidity Data:

        

Cash, cash equivalents, and marketable securities (period end)

   $ 114,728      $ 104,681      $ 10,047        9.6

Cash flows from operating activities

   $ 26,675      $ 21,777      $ 4,898        22.5

Total deferred revenue (period end)

   $ 47,497      $ 43,371      $ 4,126        9.5

 

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We achieved growth in product revenue and product updates, technical support and services revenue, offset by a decrease in professional services revenue during fiscal 2011, as compared to fiscal 2010. Product revenue increased by $20.1 million, or 38.5%, and product updates, technical support and services revenue increased by $6.1 million, or 13.0%, which was partially offset by a decrease in professional services revenue of $4.6 million, or 17.3%. The increase in product revenue was the result of growth in sales to corporate enterprise customers. The increase in revenue from product updates, technical support and services revenue reflects growth in the overall customer installed base. Increases in the overall customer installed base increase the demand for annual renewals of maintenance contracts. The sequential decrease in revenue from professional services was largely the result of a decrease in billable hours worked on projects for United States government customers. We believe the decrease in billable hours worked on projects for United States government customers was primarily related to budget constraints. We believe the sequential decrease in revenue from professional services is also due to an increase in the proportion of sales of our APM products as compared to our other products, as our APM products generally require less consulting services to implement. Total revenue generated from sales to United States government customers decreased by $2.2 million during fiscal 2011 as compared to fiscal 2010. The percentage of total revenue from United States government customers decreased to 32.5% in fiscal 2011 from 39.9% in fiscal 2010. We believe the decrease in revenue from United States government customers was due to budget constraints experienced by United States government customers during fiscal 2011.

Our international revenue increased 35% to $38.3 million, or 25.9% of total revenue, for fiscal 2011. We expect revenue from sales outside the United States to continue to account for a significant portion of our total revenue in the future. The increase in international revenue was primarily the result of growth in sales of our APM products to corporate enterprise customers. International revenue in fiscal 2011 also benefited from a more experienced direct sales force, an increased number of VARs, and our increased focus on sales to corporate enterprises. Sales to corporate enterprises accounted for the largest portion of our international revenue during fiscal 2011. We believe that continued growth and profitability will require further expansion of our sales, marketing and customer service functions in international markets.

During fiscal 2011, gross profit increased 22.1% to $115.2 million. Our gross margin increased to 77.8% for fiscal 2011 from 74.7% in fiscal 2010. The increase in our gross profit and gross margin was primarily due to an increase in product revenue of $20.1 million in fiscal 2011 and an increase in our product updates, technical support and services revenue of $6.1 million during fiscal 2011 as compared to fiscal 2010, as our gross margin on product revenue and product updates, technical support and services revenue during fiscal 2011 was 87.2% and 90.2%, respectively.

During fiscal 2011, operating income increased to $18.8 million from $8.1 million during fiscal 2010. The increase in operating income was largely the result of an increase in revenue of 17.1%, while holding our operating expense increase to 11.8%.

Trends that May Affect Our Business and Future Results

We anticipate the following trends and patterns over the next several quarters:

Total Revenue. We believe the current economic environment is showing signs of improvement, but our ability to generate increased revenue domestically and internationally will depend largely upon continued improvement in economic conditions. We expect future growth opportunities in product revenue and product updates, technical support and services revenue to come from sales to corporate enterprise customers and the United States government, as we believe our products offer competitive advantages in these markets. Our ability to generate increased revenue from United States government customers will be impacted by the length and severity of budget constraints. We expect product revenue and product updates, technical support and services revenue from sales to service providers and network equipment manufacturers to fluctuate from quarter to quarter with the potential for periods of declining revenue. Our ability to increase professional services revenue

 

27


will depend in part on our ability to attract and retain additional qualified consultants, including those with security clearances. We believe that continued increases in the proportion of sales of our APM products, as compared to our other products, would cause the percentage of our total revenue attributable to professional services revenue to decline and might also cause an absolute decline in professional services revenue because our APM products generally require less consulting time to implement. As a result of these factors, we believe that we will likely experience fluctuations in quarterly revenue.

Gross Profit Margin. Our overall gross profit margin will continue to be affected by the percentage of total revenue generated from product revenue and product updates, technical support and services revenue, as revenue from these sources have substantially higher gross margins than the gross margin on revenue from professional services. Our overall gross profit margin will also be affected by the profitability of individual consulting engagements. Amortization of technology associated with the purchase and/or acquisition of technology we may make in future periods may also affect our gross profit margin.

Research and Development Expense. We believe that continued investment in research and development will be required to maintain our competitive position and broaden our software product lines, as well as enhance the features and functionality of our current software products, especially our APM products. We believe there is more competition in the markets served by our APM products as compared to the markets for our other products. We made personnel investments in research and development during fiscal 2010 and 2011, and we plan to continue making investments in additional personnel during the next several quarters. We expect that the absolute dollar amount of these expenses will grow but generally decrease as a percentage of total revenue in future periods. Our ability to decrease this expense as a percentage of revenue will depend upon increases in our revenue, among other factors.

Sales and Marketing Expense. We depend upon our direct sales model to generate revenue and believe that increasing the size of our quota-carrying sales team is essential for long-term growth. During fiscal 2011, we focused on improving the productivity of our existing sales force and only made modest investments in additional direct sales personnel. We plan to accelerate our hiring of quota-carrying salespeople as compared to fiscal 2011 in order to address what we believe is a large and growing market for our products. We also plan to increase expenditures in areas we believe will enhance the visibility of our products in the marketplace, especially our APM products. While we expect that the absolute dollar amount of sales and marketing expense will increase in fiscal 2012 as compared to fiscal 2011, our ability to lower this expense as a percentage of revenue will depend upon increases in our revenue.

General and Administrative Expense. We expect the dollar amount of general and administrative expenses to increase as we continue to expand our operations but generally decrease as a percentage of total revenue in future periods. Our ability to decrease this expense as a percentage of revenue will depend upon increases in our revenue, among other factors.

Operating Margin. Since a significant portion of our product arrangements close in the latter part of each quarter, we may not be able to adjust our cost structure in the short-term to respond to lower than expected revenue, which would adversely impact our operating margin and earnings. Our operating margin increased to 12.7% during fiscal 2011 from 6.4% during fiscal 2010. We remain committed to increasing profitability and generating long-term growth. As the economy improves, we plan to strategically increase research and development and marketing expenditures in order to maintain our products’ competitive advantages and increase market share. While we intend to strategically increase expenditures in certain areas, we intend to closely monitor and control overall operating expense in order to maximize our operating margin.

Critical Accounting Policies and Use of Estimates

The accompanying discussion and analysis of our financial condition and results of operations are based upon our audited consolidated financial statements, which have been prepared in accordance with accounting

 

28


principles generally accepted in the United States of America, or GAAP. The preparation of these financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from the estimates made by management with respect to these and other items that require management’s estimates.

We have identified the accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and the more significant areas involving management’s judgments and estimates. These critical accounting policies relate to revenue recognition and deferred revenue, stock based compensation, allowance for doubtful accounts, valuation of long-lived assets, including intangible assets and impairment review of goodwill, software development costs, and income taxes. These policies, and our procedures related to these policies, are described in detail below. In addition, please refer to Note 1 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further discussion of our accounting policies.

Revenue Recognition. We derive revenue from three primary sources: (1) products, (2) product updates, technical support and services, which include product updates, certain training provided and offered on a when-and-if available basis to customers, and technical support, and (3) professional services, which include consulting and custom training services for customers without a current maintenance agreement. We recognize revenue based on the provisions of Accounting Standards Codification 605-985 Revenue Recognition—Software, or ASC 605-985.

Product Revenue

Product revenue represents all fees earned from granting customers perpetual and term licenses to use our software as well as the hardware that we use to deliver our AppResponse Xpert software products. It excludes revenue derived from product updates, which is included in product updates, technical support and services revenue. For the years ended March 31, 2011, 2010, and 2009, perpetual licenses represented approximately 91%, 92%, and 93% of product revenue, respectively. Product revenue is recognized when the following four criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery of the product has occurred, (iii) the product fee is fixed or determinable, and (iv) collectibility is probable. We analyze each of these four criteria as follows:

 

   

Persuasive evidence of an arrangement exists. For license arrangements with end-users, it is our customary practice to have a written software license agreement, which is signed by both the end user and us, and a purchase order or equivalent. A written contract can be executed based on the customer-specific format or on the standard “shrink wrap” software master license agreement. For those end users who have previously negotiated a software license agreement with us, the initial software license agreement is used as evidence of a written contract. Sales to distributors, resellers, and value-added resellers, which we collectively refer to as resellers, are evidenced by a master reseller agreement governing the relationship, which is signed by both the reseller and us, together with a purchase order on a transaction-by-transaction basis. To further evidence an arrangement, our master reseller agreement requires that the reseller provide us copies of the end user’s executed software master license agreements.

 

   

Delivery has occurred. Physical delivery of our software products to end users or resellers, which are collectively referred to as customers, is generally considered to have occurred upon the transfer of media containing our software products to a common carrier, usually FOB shipping point based on standard agreement terms. Software licenses may also be delivered electronically to end users. Electronic delivery is deemed to occur after end users have been provided with access codes that allow them to take immediate possession of the software. If a software arrangement includes undelivered

 

29


 

software products or services that are essential to the functionality of delivered software products, delivery is not considered to have occurred until these software products or services are delivered.

 

   

The fee is fixed or determinable. It is our policy to not provide customers the right to any adjustments or refund of any portion of their license fees paid, acceptance provisions, cancellation privileges, or rights of return. Our normal payment terms for our software products and services currently range from net 30 days to net 90 days and primarily vary based on the country in which an agreement is executed. Payments that extend beyond our normal payment terms from the contract date but that are due within six months are generally deemed to be fixed or determinable based on our successful collection history on such arrangements, and thereby satisfy the required criteria for revenue recognition. Arrangements with payment terms extending beyond six months are considered not to be fixed or determinable, and revenue from such arrangements is recognized as payments become due and payable.

 

   

Collectibility is probable. Collectibility is assessed on a customer-by-customer basis. We typically sell to customers for whom there is a history of successful collection. New customers are subject to a credit review process that evaluates the customer’s ability to pay. If we determine from the outset of an arrangement that collectibility is not probable, revenue is recognized as cash is collected.

In instances when any of the four criteria are not met, we defer recognition of product revenue until the criteria are met. When the sale of the software product requires us to make significant enhancements, customization or modifications to the software that are essential to its functionality, product revenue and consulting fees are recognized using contract accounting under ASC 605-35, Revenue Recognition—Construction-Type and Production. We estimate the percentage-of-completion, under ASC 605-35, based on our estimate of total hours to complete the project as a percentage of total hours incurred and the estimated hours to complete.

The process of estimation inherent in the application of the percentage-of-completion method of accounting for revenue is subject to judgments and uncertainties and may affect the amounts of product revenue and professional services revenue under certain contracts and related expenses reported in our consolidated financial statements. A number of internal and external factors can affect our estimates to complete client engagements, including skill level and experience of project managers, staff assigned to engagements and continuity and attrition level of professional services staff. Changes in the estimated stage of completion of a particular project could create variability in our revenue and results of operations if we are required to increase or decrease previously recognized revenue related to a particular project or if we expect to incur a loss on the project.

All fees billed to clients for shipping and handling are classified as product revenue. All costs associated with shipping and handling are classified as cost of product revenue.

Product Updates, Technical Support and Services Revenue

Product updates, technical support and services revenue represents fees associated with the sale of product updates, training, and technical support, all except technical support provided on a when-and-if-available basis under our maintenance agreement. Payments for product updates, technical support and services on initial order or on renewal are generally made in advance and are nonrefundable. Product updates consist of the right to unspecified software updates on a when-and-if-available basis and are typically entered into in connection with the initial product purchase. Product updates, technical support and services may be renewed upon expiration of the term. Customers can purchase product updates separately from technical support and services. Revenue from product updates, technical support and services is deferred and recognized as revenue on a straight-line basis over the term of the maintenance agreement.

We allocate revenue under multiple-element arrangements, which typically include product, consulting services, training and maintenance agreements sold together, to each element in the arrangement primarily using

 

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the residual method based upon the fair value of the undelivered elements, which is specific to our vendor-specific objective evidence of fair value, or VSOE. This means that we defer revenue from the arrangement fee equivalent to the fair value of the undelivered elements. We apply discounts, if any, to the delivered elements, usually product, under the residual method. For periodic unspecified product updates and technical support agreements, VSOE is based upon either the renewal rate specified in each contract or the price charged when sold separately. For consulting services and training for customers without a current maintenance agreement, VSOE is based upon the rates charged for these services when sold separately.

If we are unable to establish VSOE for an undelivered post contract support, or PCS, element, for example, in a two-year term license where the license term and PCS are coterminous and no PCS renewal period exists, all revenue is recognized ratably over the contract period. For income statement classification purposes, our allocation methodology is based on VSOE of fair value for our professional services which is determined by the price charged when sold separately, and the contractually stated renewal rates for our PCS, generally 18% to 21% of the license fee paid on perpetual licenses. We use the residual method to allocate any remaining arrangement fee to product revenue.

Professional Services Revenue

Professional services revenue consists of fees from consulting services and training for customers without a current maintenance agreement and is recognized as the services are performed. When we enter into consulting service arrangements that include significant modifications to the software that are essential to the customer’s use and the arrangement is bundled with software, we recognize revenue under the entire arrangement under the percentage-of-completion method. For income statement classification purposes, we have developed a revenue allocation methodology for these arrangements that is consistent with the residual method used, and described under ASC 605-985, when services are not essential to the functionality of the software. In these circumstances, we allocate revenue to the various elements of the arrangement based on our VSOE of fair value and the residual amount is allocated to product revenue.

We sell product, product updates, technical support and services agreements to distributors at predetermined prices. Sales to distributors are not contingent upon resale of the software to the end user. In most cases, we provide product updates, technical support and services agreements directly to distributors and the distributors provide support to the end customer. We record revenue from sales to distributors at the amounts charged to the distributor and in the same manner as product, product updates, technical support and services sales sold through our direct sales force. We classify amounts received in advance of revenue recognition as deferred revenue.

Sales taxes and other taxes collected from customers and remitted to governmental authorities are presented on a net basis and, as such, are excluded from revenues.

Income Taxes. We account for income taxes in accordance with ASC 740, Income Taxes. The income tax provision includes income taxes currently payable plus the net change during the year in deferred tax assets or liabilities. Under ASC 740, deferred tax assets and liabilities reflect the differences between the carrying value under GAAP and the tax basis of assets and liabilities using enacted statutory tax rates in effect for the period in which the differences are expected to reverse. Judgments and estimates are required in the calculation of the deferred tax assets, valuation allowance, research and development tax credits, and foreign tax credits.

ASC 740 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for these positions to be recognized in the financial statements. We continually review tax laws, regulations and guidance in order to properly record any uncertain tax positions. At March 31, 2011, the gross unrecognized benefit related to uncertain tax benefits was $691,000, $669,000 of which would favorably affect the effective income tax rate in future periods. The total amount of gross unrecognized tax benefits related to uncertain tax positions as of April 1, 2010 was $786,000. Of this total, $761,000 represents the amount of unrecognized tax benefits, net of federal benefit on state issues that,

 

31


if recognized, would favorably affect the effective income tax rate in any future periods. A reconciliation of the beginning and ending amount of unrecognized tax benefits for fiscal 2011, 2010, and 2009 follows:

 

     2011     2010     2009  
     (in thousands)  

Beginning balance

   $ 786      $ 804      $ 838   

Gross decreases – prior period tax positions

     —          45        —     

Gross increases – current period tax positions

     154        150        139   

Gross increase – prior period tax postions

     60        —          —     

Settlements

     (106     (19     —     

Lapse of statute of limitations

     (203     (197     (159

Foreign currency translation adjustment

     —          3        (14
                        

Ending balance

   $ 691      $ 786      $ 804   
                        

The following table summarizes the tax years that are either currently under audit or remain open under the statute of limitations and are subject to examination by the tax authorities in the most significant jurisdictions that we operate:

 

Australia

   FY08 – FY09

Belgium

   FY08 – FY10

France

   FY07 – FY10

Germany

   FY05 – FY09

Singapore

   FY08 – FY10

United Kingdom

   FY10

United States

   FY08 – FY10

Maryland

   FY07 – FY10

We are currently under an income tax audit in Germany for fiscal years 2005 through 2007.

Our continuing practice is to recognize interest, if any, related to income tax matters in interest expense in our consolidated statements of operations and penalties as part of general and administrative expense in our consolidated statements of operations. During fiscal 2011, we recognized $9,000 in potential interest expense associated with uncertain tax positions. During fiscal 2010, we recognized $6,000 in potential interest expense associated with uncertain tax positions and reversed $13,000 associated with potential claims barred by the statute of limitations. The total accrued interest and accrued penalties related to uncertain tax positions at March 31, 2011 was $17,000 and $107,000, respectively.

We believe it is reasonably possible that changes in the liability for uncertain tax positions will occur in the next twelve months as a result of final decisions related to the voluntary payments of our state and local income taxes. In the aggregate, we believe the liability for uncertain tax positions could decrease by $30,000 in the next twelve months.

Stock-Based Compensation. ASC 718 Compensation—Stock Compensation requires an entity to recognize an expense within its income statement for all share-based payment arrangements, which include employee stock option plans, restricted stock grants, and employee stock purchase plans. We have elected to use straight-line amortization of stock-based compensation expense for the entire award over the service period since the awards have only service conditions and graded vesting. Our stock options and nonvested stock do not contain performance conditions. There have been no modifications to awards in 2011 or 2010.

Our stock option grants are accounted for as equity awards. The expense is based on the grant-date fair value of the options granted, which we recognize over the requisite service period.

 

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To estimate the grant-date fair value of our stock options, we use the Black-Scholes option-pricing model. The Black-Scholes model estimates the per share fair value of an option on its date of grant based on the following: the option’s exercise price; the price of the underlying stock on the date of grant; the estimated dividend yield; a “risk-free” interest rate; the estimated option term; and the expected volatility. For the “risk-free” interest rate, we use a U.S. Treasury bond due in a number of years equal to the option’s expected term. To estimate expected volatility, we analyze the historic volatility of our common stock. We did not grant any stock options during fiscal 2011. As of March 31, 2011, nonvested stock-based deferred compensation associated with the stock options totaled $710,000, which we expect to recognize over a weighted average period of 2 years.

We recognize compensation cost for stock option grants on a straight-line basis over the requisite service period for the entire award from the date of grant through the period of the last separately vesting portion of the grant. We recognize compensation cost within the income statement in the same expense line as the cash compensation paid to the respective employees. ASC 718 also requires us to estimate forfeitures in calculating the expense related to stock-based compensation. We have concluded that our historical forfeiture rate is the best measure to estimate future forfeitures of granted stock options. We will recognize the impact on compensation cost due to changes in the expected forfeiture rate of 10% in the period that they become known. We do not apply a forfeiture rate to the options granted to certain key executives or directors. We have concluded that historically certain key executives and directors will perform the requisite service to vest in the award.

We account for our restricted stock grants as equity awards. The expense is based on the price of our common stock, and is recognized on a straight-line basis over the requisite service period. The restricted stock agreements do not contain any post-vesting restrictions. We have concluded that our historical forfeiture rate is the best measure to estimate future forfeitures of granted restricted stock. We will recognize the impact on compensation cost due to changes in the expected forfeiture rate of 10% in the period that they become known. We do not apply a forfeiture rate to the restricted stock granted to certain key executives or directors. As of March 31, 2011, nonvested stock-based deferred compensation associated with restricted stock totaled $2.3 million, which we expect to recognize over a weighted average period of 1 year.

Our 2000 Employee Stock Purchase Plan, or ESPP, provides all eligible employees to collectively purchase up to a total of 3,070,000 shares of our common stock. On September 14, 2009, our stockholders voted to increase the number of shares authorized for issuance under the ESPP from 820,000 shares to 3,070,000 shares, effective February 1, 2010. An employee may authorize a payroll deduction up to a maximum of 10% of his or her compensation during the plan period. The purchase price for each share purchased is the lesser of 85% of the closing price of the common stock on the first or last day of the plan period. The plan period for the ESPP ends on the last day of January and July of each year. To estimate the fair value of shares issued under our ESPP, we use the Black-Scholes option-pricing model. The Black-Scholes model estimates the per share fair value of an ESPP share at the beginning of the plan period based on the following: the price of the underlying stock on the first day of the plan period; the estimated dividend yield; a “risk-free” interest rate; the term of the plan period, which is six months; and the expected volatility. For the “risk-free” interest rate, we use a U.S. Treasury Bond due in six months. To determine expected volatility, we analyze the historical volatility of our stock over the 6 months prior to the first day of the plan period. We calculate the expense based on the difference between the fair market value of the shares purchased at the close of each plan period and the discounted price paid by the employee, and we recognize that expense on a straight-line basis over the plan period. As of March 31, 2011, nonvested stock-based deferred compensation associated with the ESPP totaled $197,000, which we expect to recognize over a weighted average period of 4 months.

Cash, Cash Equivalents, and Marketable Securities. We measure our cash and cash equivalents using the fair value measurement principles of ASC 820 Fair Value Measurements and Disclosures, or ASC 820, which requires that fair value be based on the assumptions that market participants would use when pricing an asset or liability. ASC 820 requires disclosures regarding the manner in which fair value is determined for assets and liabilities and establishes a three-tiered value hierarchy into which these assets and liabilities must be grouped, based upon significant levels of inputs as follows:

 

   

Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities.

 

33


   

Level 2 – Observable inputs, other than Level 1 prices, such as quoted prices in active markets for similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable inputs.

 

   

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The lowest level of significant input determines the placement of the entire fair value measurement in the hierarchy. We view corporate notes as Level 2 assets, and money market funds as Level 1 assets. We did not hold any marketable securities at March 31, 2010.

The following table summarizes the composition of our marketable securities at March 31, 2011:

 

     March 31, 2011  
     (in thousands)  
                                 Classification on Balance
Sheet
 
     Amortized
Cost
     Gross
Unrealized
Gain
     Gross
Unrealized
Loss
     Market
Value
     Short-Term
Investments
     Long-Term
Investments
 

United States government obligations

   $ 31,428       $ 4       $ —         $ 31,432       $ 31,432       $ —     
                                                     

Total marketable securities

   $ 31,428       $ 4       $ —         $ 31,432       $ 31,432       $ —     
                                                     

The following table details the fair value measurements within the three levels of fair value hierarchy of our financial assets, consisting of cash, cash equivalents, and marketable securities, at March 31, 2011 and 2010:

 

     Total Fair
Value
     Fair Value Measurement at
March 31, 2011 Using
 
      Level 1      Level 2      Level 3  
     (in thousands)  

Cash

   $ 30,821       $ 30,821       $ —         $ —     

Money market funds

     48,976         48,976         —           —     

United States government obligations included in cash & cash equivalents

     3,499         3,499         —           —     

United States government obligations included in marketable securities

     31,432         31,432         —           —     
                                   

Total

   $ 114,728       $ 114,728       $ —         $ —     
                                   

 

     Total Fair
Value
     Fair Value Measurement at
March 31, 2010 Using
 
      Level 1      Level 2      Level 3  
     (in thousands)  

Cash

   $ 21,545       $ 21,545       $ —         $ —     

Money market funds

     83,136         83,136         —           —     
                                   

Total

   $ 104,681       $ 104,681       $ —         $ —     
                                   

At March 31, 2011 and 2010, we valued money market funds and United States government obligations using a Level 1 valuation because market prices in active markets for identical assets were readily available. The per-share net asset value of our money market funds has remained at a constant amount of $1.00 per share. Also, as of March 31, 2011, there were no withdrawal limits on redemptions for any of the money market funds that we hold. We did not group any financial assets using Level 2 or Level 3 valuations at March 31, 2011 or 2010.

 

34


Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts receivable for estimated losses resulting from the inability of our customers to make required payments and for the limited circumstances when the customer disputes the amounts due us. Our methodology for determining this allowance requires significant estimates. In estimating the allowance, we consider the age of the receivable, the creditworthiness of the customer, the economic conditions of the customer’s industry and general economic conditions. While we believe that the estimates we use are reasonable, should any of these factors change, our estimates may also change, which could affect the amount of our future allowance for doubtful accounts as well as future operating income. Specifically, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments to us, additional allowances could be required. As of March 31, 2011 and 2010, accounts receivable and unbilled accounts receivable totaled $34.5 million and $32.8 million, net of an allowance for doubtful accounts of $346,000 and $336,000, respectively.

Valuation of Intangible Assets and Goodwill. We account for our goodwill and intangible assets in accordance with ASC 805, Business Combinations and ASC 350, Intangibles—Goodwill and Other. Our intangible assets consist of acquired technology related to our acquisitions of a software product for modeling voice communications in December 2003, Altaworks in October 2004, purchased technology we purchased from RadView Software, Ltd. in December 2005, SQMworks, Inc. in April 2006, Network Physics, Inc. in October 2007, and substantially all of the assets of Embarcadero Technologies, Inc. in August 2010. Our intangible assets also consist of customer relationships and acquired workforce assets we purchased from Network Physics, Inc. related to the purchase of specified assets of Network Physics in October 2007 and trade names, trademark, customer relationships, and non-compete agreements we acquired from Embarcadero, Inc. related to the acquisition of substantially all the assets associated with the DSAuditor product line in August 2010. The acquired and purchased technologies are stated at the lower of unamortized cost or net realizable value and are amortized on a straight-line basis over their expected useful lives of three to five years. We amortize our customer relationship and workforce intangible assets we purchased from Network Physics, Inc. on an accelerated depreciation basis over their expected useful lives of four and one half years and five years, respectively. We amortize our trade names, trademark, customer relationships, and non-compete agreements we acquired from Embarcadero, Inc. on a straight-line basis over the expected useful lives. The trade names, trademark and customer relationships have useful lives of five years. The non-compete agreements have a useful life of one year.

We use the projected discounted cash flow method in valuing our acquired technology and purchased customer relationships using certain assumptions including revenue growth, cost levels, present value discount rate, and working capital requirements. We use the lower of the amount of cash paid or the present value of projected discounted cash flows to value purchased technology. We valued the workforce asset associated with the purchase of specified assets of Network Physics, Inc. on a replacement cost basis. We valued the developed technology (now our DSAuditor product line) associated with the acquisition of substantially all of the assets of Embarcadero, Inc. using an income approach known as the Relief-From-Royalty Method. While we believe the assumptions used to value our acquired technology and developed technology related to acquisitions are reasonable, actual results will likely differ from those assumptions. Future cash flows are subject to change for a variety of internal and external factors. We will periodically review the value of acquired technology, developed technology, and purchased intangible assets for reasonableness in accordance with ASC 360, Property, Plant and Equipment. If changes in our assumptions at the time of future periodic reviews indicate that the carrying value of our acquired technology and purchased intangible assets exceeds their fair value and we determine that carrying amounts can not be recovered, it would result in impairment losses. As of March 31, 2011 and 2010, intangible assets totaled $4.5 million and $5.1 million, net of accumulated amortization of $11.9 million and $9.7 million, respectively. We have not recorded any impairment losses to date.

We record goodwill when the consideration paid for acquisitions exceeds the fair value of net tangible and intangible assets acquired. Goodwill is not amortized. We perform an annual review in the fourth quarter of each fiscal year, or more frequently if conditions dictate, to identify any facts or circumstances that indicate the carrying value of goodwill is impaired. The review is based on various analyses including cash flow and

 

35


profitability projections and the market capitalization of our common stock. Impairment, if any, is based on the excess of the carrying amount of goodwill over its fair value. We performed our annual impairment test of goodwill as of March 31, 2011 and 2010 and concluded that the fair value substantially exceeded the carrying value; therefore, we did not record any impairment. As of March 31, 2011 and 2010, goodwill was $15.4 million and $14.6 million, respectively. No impairment losses have been recorded to date.

Accounting for Software Development Costs. We expense costs incurred in the research and development of new software products as incurred until technological feasibility is established. Development costs are capitalized beginning when a product’s technological feasibility has been established and ending when the product is available for general release to our customers. Technological feasibility is reached when the product reaches the working model stage. To date, products and enhancements have generally reached technological feasibility and have been released for sale at substantially the same time, thus all research and development costs have been expensed. Consequently, we did not capitalize any research and development costs in fiscal 2011, 2010 or 2009.

Results of Operations

The following table sets forth items from our consolidated statements of operations expressed as a percentage of total revenue for the periods indicated:

 

     Fiscal
2011
    Fiscal
2010
    Fiscal
2009
 

Revenue:

      

Product

     48.9     41.4     41.7

Product updates, technical support and services

     36.1        37.4        35.0   

Professional services

     15.0        21.2        23.3   
                        

Total revenue

     100.0        100.0        100.0   
                        

Cost of revenue:

      

Product

     6.3        4.7        2.9   

Product updates, technical support, and services

     3.6        3.8        3.8   

Professional services

     10.9        15.3        17.0   

Amortization of acquired technology

     1.4        1.5        1.8   
                        

Total cost of revenue

     22.2        25.3        25.5   
                        

Gross profit

     77.8        74.7        74.5   
                        

Operating expenses:

      

Research and development

     23.5        25.4        25.1   

Sales and marketing

     32.9        34.2        34.6   

General and administrative

     8.7        8.7        9.6   
                        

Total operating expenses

     65.1        68.3        69.3   
                        

Income from operations

     12.7        6.4        5.2   

Interest and other (expense) income, net

     (0.1     0.0        1.0   
                        

Income before provision for income taxes

     12.6        6.4        6.2   

Provision for income taxes

     4.2        1.8        2.3   
                        

Net income

     8.4     4.6     3.9
                        

Revenue

Product Revenue. Product revenue was $72.4 million, $52.3 million, and $51.2 million, in fiscal 2011, 2010, and 2009, respectively, representing an increase of 38.5% in fiscal 2011 from fiscal 2010 and an increase of 2.0% in fiscal 2010 from fiscal 2009. For fiscal 2011, the increase in product revenue was primarily due to an increase

 

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in sales to corporate enterprise customers. For fiscal 2010, the increase in product revenue was primarily due to an increase in sales to United States government customers and corporate enterprise customers, partially offset by a decrease in sales to service providers and network equipment manufacturers. The increase in fiscal 2011 and 2010 was primarily due to an increase in revenue from sales of our APM products.

Product Updates, Technical Support and Services Revenue. Product updates, technical support and services revenue was $53.4 million, $47.3 million, and $43.1 million, in fiscal 2011, 2010, and 2009, respectively, representing increases of 13% in fiscal 2011 from fiscal 2010 and 9.7% in fiscal 2010 from fiscal 2009. Product updates, technical support and services revenue growth rates are affected by the overall product revenue growth rates, as well as the renewal rate of annual maintenance contracts by existing customers. The increase in product updates, technical support and services revenue in fiscal 2011 and fiscal 2010 primarily reflected increases in the overall customer installed base as compared to the prior fiscal year. Increases in the overall customer installed base increase the demand for annual renewals of maintenance contracts.

The dollar amount of our deferred revenue under our maintenance contracts at the end of each year is a key factor in determining the near-term growth of our product updates, technical support and services revenue. The balance of deferred revenue under our maintenance contracts generally increases when we sell product licenses and when we sell renewals of annual maintenance contracts. The amount of deferred revenue under our maintenance contracts was $41.1 million, $35.5 million, and $29.0 million at March 31, 2011, 2010, and 2009, respectively. The amount of deferred revenue under our maintenance contracts will generally be recognized as product updates, technical support and services revenue over the life of each individually purchased maintenance contract, which is typically a twelve-month period.

Professional Services Revenue. The components of professional services revenue for fiscal 2011, 2010, and 2009 were as follows:

 

     Fiscal
2011
     Fiscal
2010
     Fiscal
2009
 
     (in thousands)  

Consulting services

   $ 21,788       $ 26,399       $ 27,949   

Training and other revenue

     414         432         652   
                          

Professional services

   $ 22,202       $ 26,831       $ 28,601   
                          

Professional services revenue was $22.2 million, $26.8 million, and $28.6 million in fiscal 2011, 2010, and 2009, respectively, representing decreases of 17.3% in fiscal 2011 from fiscal 2010 and 6.2% in fiscal 2010 from fiscal 2009. Consulting services revenue accounted for 98.1%, 98.4%, and 97.7%, of professional services revenue for fiscal 2011, 2010, and 2009, respectively. For fiscal 2011, the decrease in professional services revenue was largely the result of a decrease in billable hours worked on projects for United States government customers. We believe the decrease in billable hours worked on projects for United States government customers was primarily related to budget constraints. We believe the sequential decrease in revenue from professional services is also due to an increase in the proportion of sales of our APM products as compared to our other products, as our APM products generally require less consulting services to implement. For fiscal 2010, the decrease in professional services revenue was primarily due to a decrease in billable hours worked on projects related to corporate enterprise customers and service providers. We believe the decrease in billable hours worked in fiscal 2011 and fiscal 2010 were related to the increase in the proportion of sales of our APM products as compared to our other products, as our APM products generally require less consulting services to implement. The percentage of total consulting revenue from United States government customers for fiscal 2011, 2010, and 2009 was 66.5%, 70.4%, and 65.8%, respectively, representing a decrease of 22.0% in fiscal 2011 from fiscal 2010, and an increase of 1.1% in fiscal 2010 from fiscal 2009.

 

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Training and other revenue was $414,000, $432,000, and $652,000 in fiscal 2011, 2010, and 2009, respectively. The decrease in training and other revenue was due to a decrease in custom trainings in fiscal 2011 as compared to fiscal 2010 and in fiscal 2010 as compared to fiscal 2009. We believe the decrease in custom training is largely related to the increase in the proportion of sales of our APM products as compared to our other products, as our APM products generally require less training to utilize.

International Revenue. International revenue was $38.3 million, $28.4 million, and $26.0 million in fiscal 2011, 2010, and 2009, respectively, representing increases of 35.0% in fiscal 2011 from fiscal 2010 and 9.3% in fiscal 2010 from fiscal 2009. International revenue was 25.9%, 22.5%, and 21.1% of total revenue in fiscal 2011, 2010, and 2009, respectively. The increase in international revenue in fiscal 2011 was primarily the result of an increase in sales to corporate enterprise customers, which was partially offset by a decrease in sales to service providers. The increase in international revenue in fiscal 2010 was primarily the result of an increase in sales to corporate enterprise customers, which was partially offset by a decrease in sales to network equipment manufacturers. Our international revenue is primarily generated in Europe and Asia. Our goal is to increase international sales to corporate enterprise customers. International revenue from corporate enterprise customers comprised the largest portion of international revenue for fiscal 2011. During each of fiscal 2011, 2010, and 2009, we expanded our operations outside the United States through the hiring of additional direct sales persons in our foreign subsidiaries.

Cost of Revenue

The following table sets forth, for each component of revenue, the cost of the revenue as a percentage of the related revenue for the periods indicated:

 

     Fiscal
2011
    Fiscal
2010
    Fiscal
2009
 

Cost of product

     12.8     11.5     6.9

Cost of product updates, technical support, and services

     9.9        10.3        10.8   

Cost of professional services

     72.9        72.0        73.1   

Cost of product revenue consists primarily of the cost of hardware platforms associated with the delivery of some software products, royalties, fees paid to indirect channel partners and, to a lesser extent, media, manuals, and distribution costs. Cost of product updates, technical support and services revenue consists of personnel-related costs necessary to provide technical support and training to customers with active maintenance contracts on a when-and-if-available basis, royalties, media, and distribution costs. Cost of professional services revenue consists primarily of personnel-related costs necessary to provide consulting and training to customers without active maintenance contracts. Gross margins on product revenue and product updates, technical support and services revenue are substantially higher than gross margin on professional services revenue, due to the low cost of delivering product revenue and providing technical support and maintenance compared with the relatively high personnel costs associated with providing consulting services and customer training.

Cost of Product Revenue. Cost of product revenue was $9.3 million, $6.0 million, and $3.5 million in fiscal 2011, 2010, and 2009, respectively. The increase in costs of 55.3% from fiscal 2010 to fiscal 2011 and 69.2% from fiscal 2009 to fiscal 2010 were primarily the result of increases in costs related to hardware platforms used to deliver our AppResponse Xpert, formerly ACE Live, software products of $2.4 million and $2.5 million, respectively. Total hardware platform costs related to the delivery of our AppResponse Xpert software products for fiscal 2011, 2010, and 2009 were $7.3 million, $4.9 million, and $2.4 million respectively. Gross margin on product revenue was 87.2%, 88.6%, and 93.1%, for fiscal 2011, 2010, and 2009, respectively.

Cost of Product Updates, Technical Support and Services Revenue. Cost of product updates, technical support and services revenue was $5.3 million, $4.9 million, and $4.7 million in fiscal 2011, 2010, and 2009, respectively. Gross margin on product updates, technical support and services revenue was 90.2%, 89.7%, and

 

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89.2%, for fiscal 2011, 2010, and 2009, respectively. The 8.3% increase in cost of product updates, technical support and services revenue for fiscal 2011 as compared to fiscal 2010 was primarily the result of a $272,000 increase in personnel costs necessary to provide technical support and a $67,000 increase in depreciation expense on hardware necessary to provide customer support. The 4.2% increase in cost of product updates, technical support and services revenue for fiscal 2010 as compared to fiscal 2009 was primarily the result of a $93,000 increase in personnel costs necessary to provide technical support and a $35,000 increase in the cost of supplies necessary to support our products. The increases in gross margin on product updates, technical support and services revenue for fiscal 2011 as compared to 2010 and fiscal 2010 as compared to fiscal 2009 were primarily the result of a 13.0% and 9.7% increase in product license updates, technical support and services revenue. Stock-based compensation expense included in cost of product updates, technical support and services was $20,000, $17,000, and $20,000 for fiscal 2011, 2010, and 2009, respectively.

Cost of Professional Services Revenue. Cost of professional services revenue was $16.2 million, $19.3 million, and $20.9 million in fiscal 2011, 2010, and 2009, respectively. Gross margin on professional services revenue decreased to 27.1% for fiscal 2011 from 28.0% in fiscal 2010. Gross margin on professional services revenue increased to 28.0% for fiscal 2010 from 26.9% in fiscal 2009. The decreases of 16.3% and 7.6% in cost of professional service revenue were largely due to a $2.5 million and $1.3 million decrease in direct labor expense in fiscal 2011 from 2010 and in fiscal 2010 from fiscal 2009, respectively. The decrease in direct labor expense was attributable to decreased staffing levels in response to weaker demand for our consulting services. We believe the weaker demand for our consulting services was due to the increase in the proportion of sales of our APM products to sales of our other products, as our APM products generally require less time to implement. The decrease in gross margin on professional services in fiscal 2011 from fiscal 2010 was primarily due to a decrease in the number of high margin fixed priced projects. The increase in gross margin on professional services in fiscal 2010 from fiscal 2009 was primarily due to the increase in profitability related to certain consulting engagements. We expect the cost of professional services revenue as a percentage of professional services revenue to vary based primarily on the profitability of individual consulting engagements. Stock-based compensation expense included in cost of professional services was $72,000, $83,000, and $113,000 for fiscal 2011, 2010, and 2009, respectively.

Operating Expenses

Research and Development. Research and development expense was $34.7 million, $32.0 million, and $30.8 million in fiscal 2011, 2010, and 2009, respectively, representing increases of 8.3% in fiscal 2011 from fiscal 2010 and 4.1% in fiscal 2010 from fiscal 2009. The increase in fiscal 2011 from fiscal 2010 was primarily due to a $2.6 million increase in compensation expense as a result of increased staffing levels required for developing new products as well as sustaining and upgrading existing products. The increase in fiscal 2010 from fiscal 2009 was primarily due to a $1.3 million increase in compensation expense as a result of increased staffing levels required for developing new products as well as sustaining and upgrading existing products. We do not capitalize research and development costs since we release our products to the market at the same time that technological feasibility is reached. Stock-based compensation expense included in research and development was $929,000, $676,000, and $591,000 for fiscal 2011, 2010, and 2009, respectively.

Sales and Marketing. Sales and marketing expenses were $48.7 million, $43.2 million, and $42.5 million in fiscal 2011, 2010, and 2009, respectively. The 12.9% increase in fiscal 2011 from fiscal 2010 was due to a $2.5 million increase in sales commissions resulting from sales growth, and a $2.2 million increase in conference and trade show expenses resulting from more normalized marketing expenditures following the economic recession. The 1.5% increase in fiscal 2010 from fiscal 2009 was due to a $2.2 million increase in compensation and commission expense as a result of increased staffing levels and higher bookings, travel costs of $337,000 and depreciation expense of $239,000, which were partially offset by a reduction in conference and marketing expenditures of $2.2 million in response to the economic recession. Stock-based compensation expense included in sales and marketing was $468,000, $343,000, and $376,000 for fiscal 2011, 2010, and 2009, respectively.

 

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General and Administrative. General and administrative expense was $12.9 million, $11.0 million, and $11.9 million, in fiscal 2011, 2010, and 2009, respectively. The 17.6% increase in fiscal 2011 from fiscal 2010 was largely due to a $1.3 million increase in performance-related variable executive compensation expense, a $288,000 increase in accounting and tax services, and a $274,000 increase in bad debt expense. The increase in accounting and tax services included costs associated with outside tax advisors working to address the audit of our fiscal 2007 federal tax returns, which was completed by the Internal Revenue Service, or IRS, in July 2010. The 7.1% decrease in fiscal 2010 from fiscal 2009 was largely due to a decrease in compensation expense and bad debt expense. Stock-based compensation expense included in general and administrative was $495,000, $440,000, and $433,000 for fiscal 2011, 2010, and 2009, respectively.

Interest and Other (Expense) Income, net. Interest and other (expense) income, net was an expense of $151,000 and an expense of $70,000 for fiscal 2011 and fiscal 2010 respectively. Interest and other (expense) income, net was income of $1.2 million in fiscal 2009. The 115.7% increase in expense in fiscal 2011 from fiscal 2010 was primarily the result of realized foreign currency losses, which were partially offset by an increase in interest income. The change to other expense in fiscal 2010 from other income in fiscal 2009 was primarily the result of a decrease in the interest rates earned on our investment holdings.

Provision for Income Taxes. Our effective tax rate was 33.5%, 27.5%, and 38.2%, for fiscal 2011, 2010, and 2009, respectively. For fiscal 2011, the effective tax rate differed from the statutory tax rate principally due to state income taxes, the difference between the U.S. and foreign tax rates, research and development credits, the domestic production activities deduction, and compensation expense booked under our ESPP which is not deductible for tax purposes. The increase in our effective tax rate in fiscal 2011 from fiscal 2010 was primarily due to a decrease in tax credits as a percentage of pre-tax net income. For fiscal 2010, the effective tax rate differed from the statutory tax rate principally due to state income taxes, the difference between the United States and foreign tax rates, research and development credits and the domestic production activities deduction. The decrease in our effective tax rate in fiscal 2010 from fiscal 2009 was primarily due to an increase in tax credits and a decrease in foreign tax expense. The effective tax rate differs from the statutory tax rate and varies from period to period due principally to the amount of income before taxes from various tax jurisdictions, foreign tax expense, and the amount of tax credits available to us in each period from incremental research expenditures. Future provisions for taxes will depend, among other things, on the mix and amount of worldwide income, the tax rates in effect for various tax jurisdictions and the amount of research and development tax credits, foreign tax credits and other items for which we are eligible.

Liquidity and Capital Resources

As of March 31, 2011 and 2010, we had cash, cash equivalents and short-term marketable securities totaling $114.7 million and $104.7 million, respectively.

Cash provided by operating activities was $26.7 million, $21.8 million, and $12.1 million for fiscal 2011, 2010, and 2009, respectively. Cash provided by operating activities is primarily derived from net income, as adjusted for non-cash items such as depreciation and amortization expense, tax benefits from the exercise of employee stock options, and changes in operating assets and liabilities. The increase in cash provided by operating activities in fiscal 2011 from fiscal 2010 was primarily attributable to increases in net income, deferred revenue and accrued liabilities. The increase in cash provided by operating activities in fiscal 2010 from fiscal 2009 was primarily attributable to increases in deferred revenue and net income in fiscal 2010, as compared to fiscal 2009, which were slightly offset by a decrease in accrued liabilities.

Net cash used in investing activities was $37.1 million and $2.6 million in fiscal 2011 and fiscal 2010, respectively. Net cash provided by investing activities was $8.3 million in fiscal 2009, respectively. Investing activities include the purchase, sale or maturity of marketable securities, acquisition of property and equipment, and net expenditures for business combinations and technology acquisitions. For fiscal 2011, we used funds of $50.6 million to purchase short-term marketable securities, funds of $3.4 million to purchase property and

 

40


equipment, and funds of $2.2 million to acquire substantially all the assets associated with the DSAuditor product line from Embarcadero Technologies, Inc., a privately held software company headquartered in San Francisco, California. For fiscal 2010, we used funds of $3.1 million to purchase property and equipment, and funds of $433,000 to acquire technology. We received proceeds of $1.0 million from the maturity of investments. For fiscal 2009, we used funds of $999,000 to purchase short-term marketable securities, and funds of $5.5 million to purchase property and equipment. We received proceeds of $14.8 million from the sale or maturity of short-term and long-term marketable securities for fiscal 2009.

Cash used in financing activities was $11.3 million and $5.7 million in fiscal 2011 and fiscal 2010, respectively. Cash provided by financing activities was $861,000 in fiscal 2009. We used $25.0 million during fiscal 2011 to pay a quarterly cash dividend of $0.10 per share to stockholders of record on June 15, 2010, September 14, 2010, December 7, 2010, and March 16, 2011, and a one-time special dividend of $0.75 per share to stockholders of record on November 14, 2010. We used $7.5 million during fiscal 2010 to pay a quarterly cash dividend of $0.09 per share to stockholders of record on June 15, 2009, September 15, 2009, December 15, 2009, and March 15, 2010. We used cash of $3.6 million, $2.3 million, and $955,000 to acquire 223,399, 186,550, and 75,724 shares of our common stock pursuant to our stock repurchase program during fiscal 2011, fiscal 2010, and fiscal 2009, respectively. During fiscal 2011, fiscal 2010, and fiscal 2009, 27,261, 26,352 and 15,724 shares, respectively, were withheld from employees to satisfy the minimum statutory tax withholding obligations with respect to the income recognized by these employees upon the vesting of their restricted stock shares during the period. Cash provided by financing activities reflects the proceeds received from the exercise of stock options and the sale of common stock under our employee stock purchase plan. During fiscal 2011, 2010, and 2009, we received proceeds of approximately $14.2 million, $2.7 million, and $644,000, respectively, and issued 1,250,735, 277,110, and 92,648 shares of common stock, pursuant to employee and director exercises of stock options. During fiscal 2011, 2010, and 2009, we received proceeds of approximately $1.5 million, $1.3 million and $1.1 million, respectively, and issued 132,933, 170,271, and 150,712 shares of common stock, respectively, pursuant to the issuance of common stock under our employee stock purchase plan. Excess tax benefits from the exercise of stock options are presented as a cash flow from financing activities. For fiscal 2011, 2010, and 2009, excess tax benefits from the exercise of stock options were $1.5 million, $51,000, and $49,000, respectively.

We have commitments under contractual arrangements to make future payments for goods and services. These contractual arrangements secure the rights to various assets and services to be used in future periods in the normal course of business. For example, we are contractually committed to make minimum lease payments for the use of property under operating lease agreements. In accordance with current accounting rules, the future rights and related obligations pertaining to such contractual arrangements are not reported as assets or liabilities on our consolidated balance sheets. Our liability for unrecognized tax benefits under ASC 740 is reported on our consolidated balance sheets. We expect to fund these contractual arrangements with our cash, cash equivalents and marketable securities as well as cash generated from operations in the normal course of business.

The following table summarizes our contractual operating lease arrangements and our liability for unrecognized tax benefits at March 31, 2011, and the timing and effect that such commitments are expected to have on our liquidity and cash flow in future periods.

 

     Payments Due by Period  

Contractual Obligations and Unrecognized Tax Benefits

(in thousands)

   Total      Fiscal 2012      Fiscal 2013 –
Fiscal 2014
     Fiscal 2015 –
Fiscal 2016
     After Fiscal
2016
 

Facilities Operating Lease Obligations

   $ 47,387       $ 5,050       $ 10,065       $ 9,628       $ 22,644   

Other Operating Lease Obligations

     60         32         15         13         —     

Unrecognized Tax Benefits

     691         30         437         224         —     
                                            

Total

   $ 48,138       $ 5,112       $ 10,517       $ 9,865       $ 22,644   
                                            

 

41


See Notes 10 and 11 to our consolidated financial statements for additional information related to our operating leases. As of March 31, 2011, we had no capital lease obligations.

Effective June 10, 2002, we entered into a credit facility with a commercial bank. The credit facility permitted the use of funds for general corporate purposes and the issuance of letters of credit up to a maximum of $10.0 million in the aggregate. As of March 31, 2011, the lender under our credit facility had issued letters of credit in favor of the beneficiaries under a number of our operating leases and a guarantee to satisfactorily complete a long-term professional services contract in the aggregate amount of $3.5 million. The long-term professional services contract was completed in fiscal 2012. Upon a default, as defined in the respective office lease agreement, the applicable landlord has the right to draw upon its letter of credit in whole or in part. Interest under this facility, including interest on any amounts drawn under the letters of credit, is payable monthly at an annual rate of 1.25%. The credit facility is collateralized by our accounts receivable.

We expect working capital needs to increase in the foreseeable future in order for us to execute our business plan and growth strategies. We anticipate that operating activities, as well as expected capital expenditures incurred in the normal course of business, will constitute a material use of our cash resources. In addition, we may utilize cash resources to fund acquisitions or investments in complementary businesses, technologies or products as well as repurchase our common stock in accordance with our stock repurchase program authorized by our Board in January 2005, and the payment of dividends to our stockholders.

We believe that our current cash and cash equivalents, marketable securities, and cash generated from operations will be sufficient to meet our anticipated cash requirements for working capital, capital expenditures, and dividends at least through fiscal 2012.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements with unconsolidated entities or related parties and, accordingly, there are no off-balance sheet risks to our liquidity and capital resources from unconsolidated entities.

Recently Issued Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU 2009-14, “Certain Revenue Arrangement That Include Software Elements,” (included in Accounting Standards Codification, or ASC, 985 “Software”) and Accounting Standards Update, or ASU, 2009-13, “Multiple Deliverable Revenue Arrangements,” which amends EITF Issue No. 08-1, “Revenue Arrangements With Multiple Deliverables” (as codified in ASC 605 “Revenue Recognition”). ASU 2009-14 amends the scoping guidance for software arrangements to exclude tangible products that contain software elements and nonsoftware elements that function together to interdependently deliver the product’s essential functionality. ASU 2009-13 amends the current guidance on arrangements with multiple elements to (1) eliminate the separation criterion that requires entities to establish objective and reliable evidence of fair value for undelivered elements, (2) establish a selling price hierarchy to help entities allocate arrangement consideration to the separate units of account, (3) require the relative selling price allocation method for all arrangements (i.e., eliminate the residual method), and (4) significantly expand required disclosures. ASU 2009-14 and ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, which the Company adopted on April 1, 2011. Early adoption is permitted. We have determined that ASU 2009-14 and ASU 2009-13 will not have a material impact on our results of operations or financial condition.

In December 2010, FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations (as codified in ASC 805 “Business Combinations”). The objective of ASU 2010-29 is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure

 

42


requirements for business combinations. The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures under Topic 805 “Business Combinations” to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 will be effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period after December 15, 2010. Early adoption is permitted. We will be impacted by ASU 2010-29 if we make an acquisition that is accounted for as a business combination.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents, and those with maturities greater than three months are considered to be marketable securities. Our cash equivalents and short-term marketable securities consist primarily of United States backed money market funds, United States Treasury bills, and United States Treasury notes with original maturities greater than three months and less than one year. We currently do not hedge interest rate exposure, but do not believe that an increase in interest rates would have a material effect on the value of our cash equivalents or marketable securities.

At March 31, 2011, we had $114.7 million in cash, cash equivalents, and marketable securities. As of March 31, 2010, we had $104.7 million in cash and cash equivalents. We did not hold any short-term marketable securities at March 31, 2010. Based on our cash, cash equivalents, and marketable securities as of March 31, 2011, a one percentage point increase or decrease in interest rates would increase or decrease our annual interest income and cash flows by approximately $1.1 million.

At March 31, 2011, $49.0 million of our $83.3 million in cash and cash equivalents was held in money market funds. The money market funds are predominately backed by United States government securities. The per-share net asset value of our money market funds has remained at a constant amount of $1.00 per share. Also, as of March 31, 2011, there were no withdrawal limits on redemptions for any of the money market funds that we hold.

Our consolidated financial statements are denominated in United States dollars and, accordingly, changes in the exchange rate between foreign currencies and the United States dollar will affect the translation of our subsidiaries’ financial results into United States dollars for purposes of reporting our consolidated financial results. The accumulated currency translation adjustment, recorded as a separate component of stockholder’s equity, was a loss of $649,000 and a loss of $999,000 at March 31, 2011 and 2010, respectively. A majority of our revenue transactions outside the United States are denominated in local currencies and the majority of operating expenses associated with our foreign subsidiaries are denominated in local currencies; therefore, our results of operations and financial condition are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the British pound and the European Union euro. We currently do not hedge foreign exchange rate risk. Approximately 25.9%, 22.5%, and 21.1% of our total revenue for fiscal 2011, fiscal 2010, and fiscal 2009, respectively, was generated from outside of the United States. Due to the limited nature of our foreign operations, we do not believe that a 10% change in exchange rates would have a material effect on our business, financial condition, or results of operations. Based on our revenue and operating expenses denominated in foreign currencies during fiscal 2011, fiscal 2010, and fiscal 2009, a 10% increase or decrease in exchange rates would increase or decrease our consolidated net income by approximately $43,000, $56,000, and $107,000, respectively.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our financial statements together with the related notes and the report of Deloitte & Touche LLP, our independent registered public accounting firm, are set forth in the Index to Financial Statements at Item 15 of this Form 10-K.

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the disclosure controls and procedures as of March 31, 2011. The “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2011, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Managements’ report on our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) and the independent registered public accounting firm’s related audit report on internal control over financial reporting are included in this Item 9A of this Form 10-K.

No change in our internal control over financial reporting occurred during the fiscal quarter ended March 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

44


MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of OPNET Technologies, Inc. and its subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;

(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorization of management and directors of the Company; and

(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management assessed the effectiveness of our internal control over financial reporting as of March 31, 2011. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment and those criteria, management concluded that the Company’s internal control over financial reporting was effective as of March 31, 2011.

OPNET Technologies, Inc.

June 3, 2011

 

45


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Audit Committee and Stockholders of OPNET Technologies, Inc.

Bethesda, Maryland

We have audited the internal control over financial reporting of OPNET Technologies, Inc., and its subsidiaries (the “Company”) as of March 31, 2011, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2011, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended March 31, 2011, of the Company and our report dated June 3, 2011, expressed an unqualified opinion on those consolidated financial statements.

/s/ DELOITTE & TOUCHE LLP

McLean, Virginia

June 3, 2011

 

46


ITEM 9B. OTHER INFORMATION

Not applicable.

 

47


PART III

Certain information required by Part III is omitted from this Annual Report as we intend to file our definitive Proxy Statement for the 2011 Annual Meeting of Stockholders (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than 120 days after the end of the fiscal year covered by this Annual Report, and certain information included in the Proxy Statement is incorporated herein by reference.

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information in the section entitled “Executive Officers and Directors of the Registrant” in Part I hereof is incorporated herein by reference. The information in the sections entitled “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Code of Business Conduct and Ethics” in the Proxy Statement is incorporated herein by reference.

 

ITEM 11. EXECUTIVE COMPENSATION

The information in the sections entitled “Summary Compensation Table,” “Compensation of Directors,” “Compensation Committee Interlocks and Insider Participation” and “Compensation Discussion and Analysis” in the Proxy Statement is incorporated herein by reference.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information in the section entitled “Equity Compensation Plan Information” in Part I hereof is incorporated by reference. The information in the section entitled “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement is incorporated herein by reference.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information in the section entitled “Certain Transactions” in the Proxy Statement is incorporated herein by reference.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information in the section entitled “Independent Registered Public Accounting Firm Fees and Other Matters” in the Proxy Statement is incorporated herein by reference.

 

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PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

  (a) The following documents are filed as part of this Form 10-K:

 

  1. Financial Statements. The following financial statements of OPNET Technologies, Inc. are filed as part of this Form 10-K on the pages indicated:

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page  

Report of Independent Registered Public Accounting Firm

     51   

Consolidated Balance Sheets as of March 31, 2011 and 2010

     52   

Consolidated Statements of Operations for the years ended March 31, 2011, 2010, and 2009

     53   

Consolidated Statements of Changes in Stockholders’ Equity for the years ended March  31, 2011, 2010, and 2009

     54   

Consolidated Statements of Cash Flows for the years ended March 31, 2011, 2010, and 2009

     55   

Notes to Consolidated Financial Statements

     56   

 

  (b) Exhibits. The exhibits listed in the exhibits index immediately preceding such exhibits are filed as part of this Annual Report on Form 10-K.

 

  (c) Financial Statement Schedules. Financial statement schedules are omitted as the required information is inapplicable or the information is presented in the financial statements or related notes in this Annual Report on Form 10-K.

 

49


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 3rd day of June, 2011.

 

OPNET TECHNOLOGIES, INC.

By:

 

/s/    MARC A. COHEN        

 

Marc A. Cohen

Chairman of the Board and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the 3rd day of June, 2011.

 

Signature

  

Title

/s/    MARC A. COHEN        

Marc A. Cohen

  

Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer)

 

Alain J. Cohen

   President, Chief Technology Officer and Director

/s/    MEL F. WESLEY        

Mel F. Wesley

  

Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

/s/    STEVEN G. FINN        

Steven G. Finn, PhD

   Director

/s/    RONALD W. KAISER        

Ronald W. Kaiser

   Director

/s/    WILLIAM F. STASIOR        

William F. Stasior

   Director

 

50


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Audit Committee and Stockholders of OPNET Technologies, Inc.

Bethesda, Maryland

We have audited the accompanying consolidated balance sheets of OPNET Technologies, Inc., and its subsidiaries (the “Company”) as of March 31, 2011 and 2010, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended March 31, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of OPNET Technologies, Inc. and its subsidiaries as of March 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of March 31, 2011, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 3, 2011, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

McLean, Virginia

June 3, 2011

 

51


OPNET TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

     March 31,  
     2011     2010  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 83,296      $ 104,681   

Marketable securities

     31,432        —     

Accounts receivable, net of $346 and $336 in allowance for doubtful accounts at March 31, 2011 and 2010, respectively

     32,597        28,015   

Unbilled accounts receivable

     1,915        4,765   

Inventory

     666        872   

Prepaid expenses and other current assets

     4,289        2,816   
                

Total current assets

     154,195        141,149   
                

Property and equipment, net

     12,701        13,245   

Intangible assets, net

     4,507        5,109   

Goodwill

     15,406        14,639   

Deferred income taxes and other assets

     5,014        4,210   
                

Total assets

   $ 191,823      $ 178,352   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 1,247      $ 1,405   

Accrued liabilities

     14,698        10,932   

Deferred and accrued income taxes

     186        498   

Deferred rent

     182        432   

Deferred revenue

     42,282        38,425   
                

Total current liabilities

     58,595        51,692   

Accrued liabilities

     107        145   

Deferred rent

     2,422        2,138   

Deferred revenue

     5,215        4,946   

Other income tax

     661        755   
                

Total liabilities

     67,000        59,676   
                

Commitments and contingencies (Note 10)

    

Stockholders’ equity:

    

Common stock – par value $0.001; 100,000,000 shares authorized; 29,883,409 and 28,386,958 shares issued at March 31, 2011 and 2010, respectively; 22,228,504 and 20,955,452 shares outstanding at March 31, 2011 and 2010, respectively

     30        28   

Additional paid-in capital

     121,230        99,229   

Retained earnings

     25,348        37,920   

Accumulated other comprehensive loss

     (649     (999

Treasury stock – 7,654,905 and 7,431,506 shares at March 31, 2011 and 2010, respectively, at cost

     (21,136     (17,502
                

Total stockholders’ equity

     124,823        118,676   
                

Total liabilities and stockholders’ equity

   $ 191,823      $ 178,352   
                

See accompanying notes to consolidated financial statements.

 

52


OPNET TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 

     Year Ended March 31,  
     2011     2010     2009  

Revenue:

      

Product

   $ 72,392      $ 52,252      $ 51,211   

Product updates, technical support and services

     53,392        47,264        43,067   

Professional services

     22,202        26,831        28,601   
                        

Total revenue

     147,986        126,347        122,879   
                        

Cost of revenue:

      

Product

     9,293        5,983        3,536   

Product updates, technical support and services

     5,260        4,859        4,665   

Professional services

     16,183        19,328        20,911   

Amortization of acquired technology

     2,050        1,835        2,172   
                        

Total cost of revenue

     32,786        32,005        31,284   
                        

Gross profit

     115,200        94,342        91,595   
                        

Operating expenses:

      

Research and development

     34,718        32,043        30,791   

Sales and marketing

     48,733        43,181        42,533   

General and administrative

     12,947        11,011        11,857   
                        

Total operating expenses

     96,398        86,235        85,181   
                        

Income from operations

     18,802        8,107        6,414   

Interest and other (expense) income, net

     (151     (70     1,246   
                        

Income before provision for income taxes

     18,651        8,037        7,660   
                        

Provision for income taxes

     6,250        2,214        2,928   
                        

Net income

   $ 12,401      $ 5,823      $ 4,732   
                        

Basic net income per common share

   $ 0.57      $ 0.28      $ 0.23   
                        

Diluted net income per common share

   $ 0.55      $ 0.28      $ 0.23   
                        

Basic weighted average common shares outstanding

     21,429        20,529        20,296   
                        

Diluted weighted average common shares outstanding

     22,130        20,790        20,533   
                        

See accompanying notes to consolidated financial statements.

 

53


OPNET TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(in thousands, except per share data)

 

    Common Stock     Additional
Paid in
Capital
    Treasury Stock     Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Stockholders’
Equity
 
    Shares
Issued
    Shares
Outstanding
    Amount       Shares     Amount        

Balance, April 1, 2008

    27,577        20,407      $ 28      $ 89,878        7,169      $ (14,259   $ 34,838      $ 160      $ 110,645   

Net income

                4,732          4,732   

Foreign currency translation

                  (1,712     (1,712

Reversal of unrealized loss on marketable securities, net of tax

                  381        381   
                       

Total comprehensive income

                    3,401   

Exercise of options

    93        93          644                644   

Employee stock purchase plan

    151        151          1,123                1,123   

Tax benefit from exercise of stock options and lapse of restricted stock

          114                114   

Restricted stock issuance, net of forfeitures

    83        83                    —     

Purchase of treasury shares

      (76         76        (955         (955

Stock based compensation expense

          1,533                1,533   
                                                                       

Balance, March 31, 2009

    27,904        20,658        28        93,292        7,245        (15,214     39,570        (1,171     116,505   

Net income

                5,823          5,823   

Foreign currency translation

                  172        172   
                       

Total comprehensive income

                    5,995   

Exercise of options

    277        277          2,720                2,720   

Employee stock purchase plan

    170        170          1,307                1,307   

Tax benefit from exercise of stock options and lapse of restricted stock

          351                351   

Restricted stock issuance, net of forfeitures

    36        36                    —     

Purchase of treasury shares

      (186         186        (2,288         (2,288

Stock based compensation expense

          1,559                1,559   

Dividends declared ($0.36 per share)

                (7,473       (7,473
                                                                       

Balance, March 31, 2010

    28,387        20,955        28        99,229        7,431        (17,502     37,920        (999     118,676   

Net income

                12,401          12,401   

Foreign currency translation

                  346        346   

Unrealized gain on marketable securities

                  4        4   
                       

Total comprehensive income

                    12,751   

Exercise of options

    1,251        1,251        2        14,240                14,242   

Employee stock purchase plan

    133        133          1,547                1,547   

Tax benefit from exercise of stock options and lapse of restricted stock

          4,225                4,225   

Restricted stock issuance, net of forfeitures

    113        113                    —     

Purchase of treasury shares

      (223         223        (3,634         (3,634

Stock based compensation expense

          1,989                1,989   

Dividends declared ($1.15 per share)(a)

                (24,974       (24,974

Other

    (1           1          1          1   
                                                                       

Balance, March 31, 2011

    29,883        22,229      $ 30      $ 121,230        7,655      $ (21,136   $ 25,348      $ (649   $ 124,823   
                                                                       
(a) Includes special dividend of $0.75 per share in fiscal 2011.

See accompanying notes to consolidated financial statements.

 

54


OPNET TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Year Ended March 31,  
     2011     2010     2009  

Cash flows from operating activities:

      

Net income

   $ 12,401      $ 5,823      $ 4,732   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     5,793        5,340        5,528   

Loss on disposition of fixed assets

     51        45        74   

Provision for losses on accounts receivable

     571        297        646   

Deferred income taxes

     (997     (328     (431

Non-cash stock-based compensation expense

     1,989        1,559        1,533   

Non-cash accretion of market discount on marketable securities

     45        (1     —     

Excess tax benefit from exercise of stock options

     (1,471     (51     (49

Changes in assets and liabilities, net of assets acquired:

      

Accounts receivable

     (2,332     (3,518     (3,926

Inventory

     718        197        569   

Prepaid expenses and other current assets

     (348     (364     (70

Other assets

     (714     (40     (434

Accounts payable

     (159     874        (10

Accrued liabilities

     3,473        158        1,682   

Accrued income taxes

     3,575        1,913        (130

Deferred rent

     34        (365     (248

Deferred revenue

     4,046        10,238        2,638   
                        

Net cash provided by operating activities

     26,675        21,777        12,104   
                        

Cash flows from investing activities:

      

Acquisition of business

     (2,225     —          —     

Acquired technology

     —          (433     —     

Purchase of property and equipment

     (3,407     (3,148     (5,466

Purchase of investments

     (50,554     —          (999

Proceeds from sale/maturity of investments

     19,083        1,000        14,800   
                        

Net cash (used in) provided by investing activities

     (37,103     (2,581     8,335   
                        

Cash flows from financing activities:

      

Acquisition of treasury stock

     (3,634     (2,288     (955

Excess tax benefit from exercise of stock options

     1,471        51        49   

Proceeds from exercise of stock options

     14,241        2,720        644   

Issuance of common stock under employee stock purchase plan

     1,547        1,307        1,123   

Payment of dividend to stockholders

     (24,974     (7,473     —     
                        

Net cash (used in) provided by financing activities

     (11,349     (5,683     861   
                        

Effect of exchange rate changes on cash and cash equivalents

     392        178        (1,720
                        

Net (decrease) increase in cash and cash equivalents

     (21,385     13,691        19,580   

Cash and cash equivalents, beginning of year

     104,681        90,990        71,410   
                        

Cash and cash equivalents, end of year

   $ 83,296      $ 104,681      $ 90,990   
                        

See accompanying notes to consolidated financial statements

 

55


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

1. Organization and Significant Accounting Policies

Organization. OPNET Technologies, Inc. and its subsidiaries, (hereafter, the Company or OPNET), provides application and network performance management solutions. The Company’s software products address application performance management, network planning, engineering and operations, and network research and development. The Company sells products to corporate enterprises, government and defense agencies, network service providers, and network equipment manufacturers. The Company markets software products and related services in North America primarily through a direct sales force and, to a lesser extent, several resellers and original equipment manufacturers. Internationally, the Company conducts research and development through a wholly-controlled subsidiary in Ghent, Belgium and markets software products and related services through wholly-owned subsidiaries in Paris, France; Mainz, Germany; Slough, United Kingdom; and Singapore; a sales office in Beijing, China; third-party distributors; and value-added resellers. The Company is headquartered in Bethesda, Maryland and has domestic offices in Cary, North Carolina; Dallas, Texas; Santa Clara, California; Nashua, New Hampshire; and Colorado Springs, Colorado.

Principles of Consolidation. The consolidated financial statements include the results of OPNET Technologies, Inc., its wholly-owned subsidiaries: OPNET Technologies Societe par Actions Simplifiee; OPNET Technologies Limited; OPNET Analysis, Inc.; OPNET Technologies, GmbH; and OPNET Technologies Asia, Pte. Ltd., and its wholly-controlled subsidiary OPNET Technologies b.v.b.a. All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America, or GAAP, requires management to make estimates, judgments and assumptions. These estimates, judgments, and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from these estimates. Significant items subject to such estimates, judgments, and assumptions include revenue recognition, the carrying amount and useful lives of long-lived assets, valuation allowances for accounts receivable and deferred tax assets, research and development tax credits, determination of uncertain tax position benefits under ASC 740 Income Taxes, or ASC 740, software development costs, valuation of acquired intangible assets, valuation of stock based compensation, and loss contingencies, such as litigation, claims and assessments.

Cash and Cash Equivalents. Cash and cash equivalents consist of deposits in banks and all highly liquid investments with maturities of three months or less when purchased.

Marketable Securities. The Company has determined that its investments in marketable securities are to be classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in stockholders’ equity in the accompanying consolidated balance sheets under the caption “Accumulated other comprehensive loss.” The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in the “Interest and other (expense) income, net” line item on the accompanying consolidated statements of operations. Realized gains and losses on available-for-sale securities are included in the “Interest and other (expense) income, net” line item on the consolidated statements of operations. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in the “Interest and other (expense) income, net” line item on the accompanying consolidated statements of operations.

 

56


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

Supplemental Cash Flow Information.

 

     Year ended March 31,  
     2011      2010      2009  
     (in thousands)  

Cash paid during the fiscal year for:

        

Income taxes

   $ 3,558       $ 527       $ 3,239   

Non-cash financing and investing activities:

        

Unrealized gain (loss) on marketable securities

   $ 4       $ —         $ 381   

Restricted stock issued

   $ 2,413       $ 622       $ 860   

Accrued liability for the purchase of property and equipment

   $ 149       $ 11       $ 72   

Tenant improvement allowance received from landlord

   $ —         $ —         $ 1,095   

Advertising Expense. Advertising costs are expensed when incurred. Advertising expense for fiscal 2011, 2010, and 2009 was $556,000, $497,000, and $389,000, respectively.

Concentration of Credit Risk. Financial instruments that potentially subject the Company to a concentration of credit risk consist principally of cash, cash equivalents, marketable securities and accounts receivable. The Company generally does not require collateral on accounts receivable, as the majority of its customers are large, well-established companies or government entities.

The Company maintains its cash balances at several financial institutions. The Federal Deposit Insurance Corporation fully insures the non-interest bearing bank accounts and interest bearing accounts up to $250,000. Although the Company’s interest bearing balances exceed $250,000, the Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk related to cash.

The Company’s cash equivalents and short-term marketable securities consist primarily of United States backed money market funds and securities with short-term maturities. The per-share net asset value of the Company’s money market funds has remained at a constant amount of $1.00 per share. Also, as of March 31, 2011, there were no withdrawal limits on redemptions for any of the money market funds that the Company held. Accordingly, the Company has no quantitative information concerning the market risks and believes that the risk is minimal.

Fair Value of Financial Instruments. The fair value of the Company’s accounts receivable, accounts payable, and accrued expenses approximates their respective carrying amounts.

The Company measures its cash equivalents and marketable securities using the fair value measurement principles of ASC 820 Fair Value Measurements and Disclosures, or ASC 820, which requires that fair value be based on the assumptions that market participants would use when pricing an asset or liability.

ASC 820 requires disclosures regarding the manner in which fair value is determined for assets and liabilities and establishes a three-tiered fair value hierarchy into which these assets and liabilities must be grouped, based upon significant levels of inputs as follows:

 

   

Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities.

 

   

Level 2 – Observable inputs, other than Level 1 prices, such as quoted prices in active markets for similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable inputs.

 

57


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

   

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The lowest level of significant input determines the placement of the entire fair value measurement in the hierarchy.

Software Development Costs. Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. The Company considers technological feasibility to be established when all planning, designing, coding, and testing has been completed according to design specifications. After technological feasibility has been established, any additional costs are capitalized in accordance with ASC 985 Software, or ASC 985. Through March 31, 2011, software development has been substantially completed concurrently with the establishment of technological feasibility and, accordingly, no costs have been capitalized to date.

Property and Equipment. Property and equipment are stated at cost. Depreciation on property and equipment is computed using the straight-line method over the estimated useful lives of the assets, of five to seven years. Leasehold improvements are depreciated over the shorter of the estimated useful life of the assets, the non-cancelable term of the related lease, or the non-cancelable lease term plus all periods for which executive management believes that the failure to renew the lease imposes a penalty in an amount such that the renewal appears, at the inception of the lease, to be reasonably assured. Repairs and maintenance are expensed as incurred.

Intangible Assets. The Company accounts for its goodwill and intangible assets in accordance with ASC 805 Business Combinations, or ASC 805, and ASC 350 Intangibles—Goodwill and Other, or ASC 350. The acquired and purchased technology are stated at the lower of unamortized cost or net realizable value and are amortized on a straight-line basis over their expected useful lives of three to five years. The Company’s customer relationship and workforce intangible assets are amortized on an accelerated basis over their expected useful lives of four and one-half years and five years, respectively. The Company uses the projected discounted cash flow method in valuing its acquired technology and purchased customer relationships using certain assumptions including revenue growth, cost levels, present value discount rate, and working capital requirements. The Company uses the lower of the amount of cash paid or the present value of projected discounted cash flows to value purchased technology. The workforce asset was valued on a replacement cost basis. While the Company believes the assumptions used to value its acquired technology related to acquisitions are reasonable, actual results will likely differ from those assumptions. Future cash flows are subject to change for a variety of internal and external factors. The Company periodically reviews the value of acquired technology and purchased intangible assets for reasonableness in accordance with ASC 360 Property, Plant and Equipment, or ASC 360. If changes in the Company’s assumptions at the time of future periodic reviews indicate that the carrying value of its acquired technology and purchased intangible assets exceeds their fair value and it determines that carrying amounts can not be recovered, it would result in impairment losses. As of March 31, 2011 and 2010, intangible assets totaled $4.5 million and $5.1 million, net of accumulated amortization of $11.9 million and $9.7 million, respectively. There has been no impairment as of March 31, 2011 or 2010.

Goodwill. In accordance with ASC 350, goodwill is not amortized but is tested for impairment annually during the Company’s fourth quarter and whenever events and circumstances occur indicating that the asset might be impaired. The Company performed its annual impairment test of goodwill as of March 31, 2011 and 2010 and concluded that the fair value exceeded the carrying value; therefore, it did not record any impairment. The Company has not recorded a goodwill impairment since it first recorded goodwill in fiscal 2001.

 

58


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

Valuation of Long-Lived Assets. In accordance with ASC 360, the Company reviews its long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be fully recoverable. If the total of the expected undiscounted future net cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between the fair value and carrying amount of the asset. There has been no impairment as of March 31, 2011 or 2010.

Revenue Recognition. The Company derives revenue from three primary sources: (1) product, (2) product updates, technical support and services, which include product updates, training services on a when-and-if-available basis, and technical support, and (3) professional services, which include consulting and custom training services for customers without a current maintenance agreement. The Company recognizes revenue based on the provisions of ASC 605-985 Software Revenue Recognition, or ASC 605-985.

Product Revenue

Product revenue represents all fees earned from granting customers perpetual and term licenses to use the Company’s software as well as the hardware that it uses to deliver its AppResponse Xpert software products. It excludes revenue derived from product updates, which are included in product updates, technical support and services revenue. For the years ended March 31, 2011, 2010, and 2009, perpetual licenses represented approximately 91%, 92%, and 93% of product revenue, respectively. Product revenue is recognized when the following four criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery of the software has occurred, (iii) the product fee is fixed or determinable, and (iv) collectibility is probable. The Company defines each of these four criteria as follows:

 

   

Persuasive evidence of an arrangement exists. For license arrangements with end-users, it is the Company’s customary practice to have a written software license agreement, which is signed by both the end user and the Company, and a purchase order or equivalent. A written contract can be executed based on the customer-specific format or on the standard “shrink wrap” software master license agreement. For those end users who have previously negotiated a software license agreement with the Company, the initial software license agreement is used as evidence of a written contract. Sales to distributors, resellers, and value-added resellers, which the Company collectively refers to as resellers, are evidenced by a master reseller agreement governing the relationship, which is signed by both the reseller and the Company, together with a purchase order on a transaction-by-transaction basis. To further evidence an arrangement, the Company’s master reseller agreement requires that the reseller provide the Company copies of the end user’s executed software master license agreements.

 

   

Delivery has occurred. Physical delivery of the Company’s software products to end users or resellers, which are collectively referred to as customers, is generally considered to have occurred upon the transfer of media containing the Company’s software products to a common carrier (usually FOB shipping point based on standard agreement terms). Software licenses may also be delivered electronically to end users. Electronic delivery is deemed to occur after end users have been provided with access codes that allow them to take immediate possession of the software. If a software arrangement includes undelivered software products or services that are essential to the functionality of delivered software products, delivery is not considered to have occurred until these software products or services are delivered.

 

   

The fee is fixed or determinable. It is the Company’s policy to not provide customers the right to any adjustments or refund of any portion of their license fees paid, acceptance provisions, cancellation privileges, or rights of return. The Company’s normal payment terms for its software products and services currently range from net 30 days to net 90 days and primarily vary based on the country in

 

59


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

 

which an agreement is executed. Payments that extend beyond the Company’s normal payment terms from the contract date but that are due within six months are generally deemed to be fixed or determinable based on its successful collection history on such arrangements, and thereby satisfy the required criteria for revenue recognition. Arrangements with payment terms extending beyond six months are considered not to be fixed or determinable, and revenue from such arrangements is recognized as payments become due and payable.

 

   

Collectibility is probable. Collectibility is assessed on a customer-by-customer basis. The Company typically sells to customers for whom there is a history of successful collection. New customers are subject to a credit review process that evaluates the customer’s ability to pay. If the Company determines from the outset of an arrangement that collectibility is not probable, revenue is recognized as cash is collected.

In instances when any of the four criteria are not met, the Company defers recognition of product revenue until the criteria are met. When the sale of the software product requires the Company to make significant enhancements, customization or modifications to the software that are essential to its functionality, product revenue and consulting fees are recognized using contract accounting under ASC 605-35 Revenue Recognition— Construction-Type and Production, or ASC 605-35. The Company estimates the percentage-of-completion, under ASC 605-35, based on its estimate of total hours to complete the project as a percentage of total hours incurred and the estimated hours to complete.

The process of estimation inherent in the application of the percentage-of-completion method of accounting for revenue is subject to judgments and uncertainties and may affect the amounts of product revenue and professional services revenue under certain contracts and related expenses reported in the Company’s consolidated financial statements. A number of internal and external factors can affect the Company’s estimates to complete client engagements, including skill level and experience of project managers, staff assigned to engagements, and continuity and attrition level of professional services staff. Changes in the estimated stage of completion of a particular project could create variability in the Company’s revenue and results of operations if the Company is required to increase or decrease previously recognized revenue related to a particular project or if the Company expects to incur a loss on the project.

All fees billed to clients for shipping and handling are classified as product revenue. All costs associated with shipping and handling are classified as cost of product revenue.

Product Update, Technical Support, and Services Revenue

Product updates, technical support and services revenue represents fees associated with the sale of product updates, training, and technical support, all provided on a when-and-if-available basis (except for technical support) under the Company’s maintenance agreement. Payments for product updates, technical support and services on initial order or on renewal are generally made in advance and are nonrefundable. Product updates consist of the right to unspecified software updates on a when-and-if-available basis and are typically entered into in connection with the initial software product purchase. Product updates, technical support and services may be renewed upon expiration of the term. Customers can purchase product updates separately from technical support and services. Revenue from product updates, technical support and services is deferred and recognized as revenue on a straight-line basis over the term of the maintenance agreement.

Revenue under multiple-element arrangements, which typically include product, consulting services, training and maintenance agreements sold together, are allocated to each element in the arrangement primarily

 

60


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

using the residual method based upon the fair value of the undelivered elements, which is specific to the Company vendor-specific objective evidence of fair value, or VSOE. This means that the Company defers revenue from the arrangement fee equivalent to the fair value of the undelivered elements. Discounts, if any, are applied to the delivered elements, usually product, under the residual method. For periodic unspecified product updates and technical support agreements, VSOE is based upon either the renewal rate specified in each contract or the price charged when sold separately. For consulting services and training for customers without a current maintenance agreement, VSOE is based upon the rates charged for these services when sold separately.

If the Company is unable to establish VSOE for an undelivered post-contract customer support, or PCS, element, for example, in a two-year term license where the license term and PCS are coterminous and no PCS renewal period exists, all revenue is recognized ratably over the contract period. For income statement classification purposes, the Company’s allocation methodology is based on VSOE of fair value for its professional services which is determined by the price charged when sold separately, and the contractually stated renewal rates for its PCS, generally 18% to 21% of the license fee paid, on perpetual licenses. The Company uses the residual method to allocate any remaining arrangement fee to product revenue.

Professional Services Revenue

Professional services revenue consists of fees from consulting services and training for customers without a current maintenance agreement and is recognized as the services are performed. When the Company enters into consulting service arrangements that include significant modifications to the software that are essential to the customer’s use and the arrangement is bundled with software, revenue under the entire arrangement is recognized under the percentage-of-completion method. For income statement classification purposes, the Company has developed a revenue allocation methodology for these arrangements that is consistent with the residual method used, and described under ASC 605-985, when services are not essential to the functionality of the software. In these circumstances, revenue is allocated to the various elements of the arrangement based on the Company’s VSOE of fair value and the residual amount is allocated to product revenue.

The Company sells product, product updates, technical support and services agreements to distributors at predetermined prices. Sales to distributors are not contingent upon resale of the software to the end user. In most cases, the Company provides product updates, technical support and services agreements directly to distributors and the distributors provide support to the end customer. Revenue from sales to distributors is recorded at the amounts charged to the distributor and in the same manner as product, product updates, technical support and services sales sold through the Company’s direct sales force. Amounts received in advance of revenue recognition are classified as deferred revenue.

Sales taxes and other taxes collected from customers and remitted to governmental authorities are presented on a net basis, and as such, are excluded from revenues.

Allowance for Doubtful Accounts. The Company maintains an allowance for doubtful accounts receivable for estimated losses resulting from the inability of its customers to make required payments and for the limited circumstances when the customer disputes the amounts due the Company. The Company’s methodology for determining this allowance requires significant estimates. In estimating the allowance, the Company considers the age of the receivable, the creditworthiness of the customer, the economic conditions of the customer’s industry and general economic conditions.

Income Taxes. Income taxes are accounted for in accordance with ASC 740. The income tax provision includes income taxes currently payable plus the net change during the year in deferred tax assets or liabilities.

 

61


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

Under ASC 740, deferred tax assets and liabilities reflect the differences between the carrying value under GAAP and the tax basis of assets and liabilities using enacted statutory tax rates in effect for the period in which the differences are expected to reverse. Judgments and estimates are required in the calculation of the deferred tax assets, valuation allowance, research and development tax credits, and foreign tax credits.

ASC 740 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for these positions to be recognized in the financial statements. The Company continually reviews tax laws, regulations and guidance in order to properly record any uncertain tax positions.

Foreign Currency Transactions. Revenue and expenses denominated in foreign currencies are translated at the average exchange rates during the period. Gains or losses on foreign exchange transactions are reported in the consolidated statements of operations.

Foreign Currency Translation. The results of operations for the Company’s international subsidiaries are translated from the designated functional currencies into United States dollars using average exchange rates during each period. Assets and liabilities are translated using exchange rates at the end of each period. Translation gains and losses are reported as a component of accumulated other comprehensive loss in stockholders’ equity.

Comprehensive Income. Certain revenues, expenses, gains and losses are recognized in comprehensive income but excluded from net income. Comprehensive income includes net income, foreign currency translation adjustments, and unrealized gains and losses on marketable securities.

Earnings per Share. The Company accounts for earnings per share, or EPS, in accordance with ASC 260 Earnings per Share, or ASC 260. ASC 260 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities” (as codified in ASC 260) is effective for fiscal years beginning after December 15, 2008. The Company applied the provisions of FSP EITF 03-6-1 in fiscal 2010. The Company’s participating securities include nonvested restricted stock. FSP EITF 03-6-1 was applied retrospectively and therefore prior period information was adjusted.

Stock-Based Compensation. The Company accounts for stock-based compensation given to employees in accordance with ASC 718 Compensation—Stock Compensation, or ASC 718. ASC 718 requires all share-based payments and nonvested shares (restricted stock) issued to employees, including grants of employee stock options, to be valued at fair value on the date of grant, and to be expensed over the applicable vesting period.

Recently Issued Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU 2009-14, “Certain Revenue Arrangement That Include Software Elements,” (included in Accounting Standards Codification, or ASC, 985 “Software”) and ASU, 2009-13, “Multiple Deliverable Revenue Arrangements,” which amends EITF Issue No. 08-1, “Revenue Arrangements With Multiple Deliverables” (as codified in ASC 605 “Revenue Recognition”). ASU 2009-14 amends the scoping guidance for software arrangements to exclude tangible products that contain software elements and nonsoftware elements that function

 

62


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

together to interdependently deliver the product’s essential functionality. ASU 2009-13 amends the current guidance on arrangements with multiple elements to (1) eliminate the separation criterion that requires entities to establish objective and reliable evidence of fair value for undelivered elements, (2) establish a selling price hierarchy to help entities allocate arrangement consideration to the separate units of account, (3) require the relative selling price allocation method for all arrangements (i.e., eliminate the residual method), and (4) significantly expand required disclosures. ASU 2009-14 and ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, which the Company adopted on April 1, 2011. Early adoption is permitted. The Company has determined that ASU 2009-14 and ASU 2009-13 will not have a material impact on its results of operations or financial condition.

In December 2010, FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations (as codified in ASC 805 “Business Combinations”). The objective of ASU 2010-29 is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures under Topic 805 “Business Combinations” to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 will be effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period after December 15, 2010. Early adoption is permitted. The Company will be impacted by ASU 2010-29 if it makes an acquisition that is accounted for as a business combination.

2. Stock-Based Compensation

In September 2009, the Company’s stockholders approved the adoption of the 2010 Stock Incentive Plan, or the 2010 Plan, in response to the pending expiration of the Company’s Amended and Restated 2000 Stock Incentive Plan, or the 2000 Plan. The 2010 Plan provides for the granting of stock options, restricted stock and other stock-based awards to employees, officers, directors, consultants and advisors. Subject to specified adjustments, the number of shares initially set aside and reserved for issuance under the 2010 Plan is 2,150,000 shares, which approximated the number of shares available for issuance under the 2000 Plan as of January 1, 2010, the effective date of the 2010 Plan. The Board approved a resolution to make no further grants for options or stock awards under the 2000 Plan upon approval of the 2010 Plan.

The number of shares available for issuance under the 2010 Plan will automatically increase from time to time by a number equal to (i) in the event any outstanding stock option granted under the 2000 Plan should for any reason expire or otherwise terminate, in whole or in part, without having been exercised in full, the number of shares that are not acquired under such stock option and (ii) in the event stock that has been issued to a participant under the 2000 Plan pursuant to restricted or unrestricted stock awards is subsequently forfeited or acquired by the Company as a result of a failure to vest or satisfy any other contingency, the number of such shares. The maximum aggregate number of additional shares that may become available for issuance in these situations is 2,000,000 shares, subject to specified adjustments.

The number of shares available for issuance under the 2010 Plan will automatically increase on the first trading day of each calendar year, beginning with 2011 and continuing through the term of the 2010 Plan, by an amount equal to the lesser of (i) three percent (3%) of the shares of the Company’s common stock outstanding on

 

63


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

the last trading day of the preceding calendar year, or (ii) an amount determined by the Board; provided, however, that in no event shall any such annual increase exceed 1,000,000 shares. This provision, commonly referred to as an “evergreen” provision, is similar to the provision in the 2000 Plan.

Options granted pursuant to the 2010 Plan will be exercisable at such times and subject to such terms and conditions as the Board may specify in the applicable option agreement, but no option may be granted for a term in excess of 10 years. The terms and conditions of any restricted stock awards granted under the 2010 Plan, including the conditions for repurchase or forfeiture and the issue price, if any, will be determined by the Board. The Board also has the right to grant other stock awards pursuant to the 2010 Plan having such terms and conditions as the Board may determine, including the grant of fully vested shares, the grant of securities convertible into shares of the Company’s common stock and the grant of stock appreciation rights.

ASC 718 requires an entity to recognize an expense within its income statement for all share-based payment arrangements, which includes employee stock option plans, restricted stock grants, and employee stock purchase plans. The Company has elected to use straight-line amortization of stock-based compensation expense for the entire award over the service period since the awards have only service conditions and graded vesting.

Compensation cost for option grants is recognized on a straight-line basis over the requisite service period for the entire award (from the date of grant through the period of the last separately vesting portion of the grant). Compensation cost is recognized within the income statement in the same expense line as the cash compensation paid to the respective employees. ASC 718 also requires the Company to estimate forfeitures in calculating the expense related to stock-based compensation. The impact on compensation cost due to changes in the expected forfeiture rate will be recognized in the period that they become known. The Company has concluded that its historical forfeiture rate is the best measure to estimate future forfeitures of granted stock options. The impact on compensation cost due to changes in the expected forfeiture rate of 10% will be recognized in the period that they become known. The Company does not apply a forfeiture rate to the options granted to certain key executives or directors. The Company has concluded that historically certain key executives and directors will perform the requisite service to vest in the award.

Excess tax benefits from the exercise of stock options are presented as a cash flow from financing activity. For fiscal 2011, 2010, and 2009, excess tax benefits from the exercise of stock options were $1.5 million, $51,000, and $49,000, respectively.

A summary of the total stock-based compensation expense for fiscal 2011, 2010, and 2009 is as follows:

 

     2011      2010      2009  
     (in thousands)  

Restricted stock

   $ 1,316       $ 941       $ 917   

ESPP shares

     467         490         444   

Stock options

     206         128         172   
                          

Total stock-based compensation

   $ 1,989       $ 1,559       $ 1,533   
                          

 

64


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

A summary of the total nonvested stock-based deferred compensation at March 31, 2011 and 2010 is as follows:

 

     2011      2010  
     (in thousands)  

Restricted stock

   $ 2,336       $ 1,178   

Stock options

     710         916   

ESPP shares

     197         139   
                 

Total nonvested stock-based deferred compensation

   $ 3,243       $ 2,233   
                 

The deferred compensation associated with the nonvested restricted stock, stock options and ESPP shares at March 31, 2011 are expected to be recognized over a weighted average period of 1 year, 2 years, and 4 months, respectively.

Stock Options

The Company’s stock option grants are accounted for as equity awards. The expense is based on the grant-date fair value of the options granted, and is recognized over the requisite service period.

A summary of the option transactions for fiscal 2011, 2010, and 2009 is as follows:

 

     2011  
     Options     Weighted
Average
Exercise Price
     Weighted
Average
Remaining
Contract Life
(Years)
     Aggregate
Intrinsic
Value

(in thousands)
     Weighted
Average
Grant Date
Fair Value
 

Outstanding at beginning of period

     2,494,082      $ 10.86         —         $ 68,797       $ 7.31   

Granted

     —        $ —           —         $ —         $ —     

Exercised

     (1,250,735   $ 11.39         —         $ 10,443       $ 8.24   

Forfeited or expired

     (111,350   $ 19.50         —         $ 2,109       $ 13.30   
                   

Outstanding at end of period

     1,131,997      $ 9.42         3.39       $ 32,851       $ 5.70   
                   

Exercisable at end of period

     856,997      $ 9.30         1.77       $ 24,972       $ 6.19   

Nonvested at end of period

     275,000      $ 9.79         8.44       $ 7,879       $ 4.17   

Nonvested expected to be exercised

     247,500      $ 9.79         8.45       $ 7,227       $ 4.17   

 

     2010  
     Options     Weighted
Average
Exercise Price
     Weighted
Average
Remaining
Contract Life
(Years)
     Aggregate
Intrinsic
Value

(in thousands)
     Weighted
Average
Grant Date
Fair Value
 

Outstanding at beginning of period

     2,556,723      $ 10.89         —         $ 13,569       $ 7.62   

Granted

     275,000      $ 9.79         —         $ 1,719       $ 4.17   

Exercised

     (277,110   $ 9.82         —         $ 1,112       $ 6.80   

Forfeited or expired

     (60,531   $ 12.11         —         $ 248       $ 8.53   
                   

Outstanding at end of period

     2,494,082      $ 10.86         2.82       $ 13,314       $ 7.31   
                   

Exercisable at end of period

     2,219,082      $ 10.99         2.00       $ 11,596       $ 7.70   

Nonvested at end of period

     275,000      $ 9.79         9.44       $ 1,719       $ 4.17   

 

65


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

     2009  
     Options     Weighted
Average
Exercise Price
     Weighted
Average
Remaining
Contract Life
(Years)
     Aggregate
Intrinsic
Value
(in thousands)
     Weighted
Average
Grant Date
Fair Value
 

Outstanding at beginning of period

     2,720,121      $ 10.79         —         $ 1,473       $ 7.56   

Granted

     —        $ —           —         $ —         $ —     

Exercised

     (92,648   $ 6.95         —         $ 459       $ 4.88   

Forfeited or expired

     (70,750   $ 12.45         —         $ 3       $ 8.90   
                   

Outstanding at end of period

     2,556,723      $ 10.89         2.94       $ 1,283       $ 7.62   
                   

Exercisable at end of period

     2,556,723      $ 10.89         2.94       $ 1,283       $ 7.62   

Nonvested at end of period

     —        $ —           —         $ —         $ —     

To estimate the grant-date fair value of its stock options, the Company uses the Black-Scholes option-pricing model. The Black-Scholes model estimates the per share fair value of an option on its date of grant based on the following; the option’s exercise price; the price of the underlying stock on the date of grant; the estimated dividend yield; a “risk-free” interest rate; the estimated option term; and the expected volatility. For the “risk-free” interest rate, the Company uses a United States Treasury Bond due in the number of years equal to the option’s expected term. The estimated option term is calculated based upon the simplified method set out in ASC 718—Compensation—Stock Compensation. The Company uses the simplified method to determine the estimated option term because it lacks sufficient historical share option exercise data. To determine expected volatility, the Company analyzes the historical volatility of its stock over the expected term of the option.

The Company granted 275,000 stock options during fiscal 2010. The Company did not grant any stock options during fiscal 2011 or fiscal 2009. No stock options vested during fiscal 2011 or 2010. The weighted average assumptions used to determine the grant-date fair value for stock options for fiscal 2010 are as follows:

 

     2010  

Risk-free interest rate

     3.07

Expected dividend yield

     3.68

Expected life

     7 years   

Volatility factor

     58

During fiscal 2011, 2010, and 2009, the Company received proceeds of approximately $14.2 million, $2.7 million, and $644,000, respectively, and issued 1,250,735, 277,110, and 92,648 shares of common stock, respectively, pursuant to employee exercises of stock options.

Restricted Stock

The Company’s restricted stock grants are accounted for as equity awards. The expense is based on the price of the Company’s common stock on the date the restricted stock award is granted, and is recognized on a straight-line basis over the requisite service period. The Company’s restricted stock agreements do not contain any post-vesting restrictions.

 

66


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

A summary of the restricted stock grants is as follows:

 

     2011  
     Restricted
Stock Grants
    Weighted
Average Grant
Date
Fair Value
 

Nonvested at beginning of period

     183,797      $ 10.87   

Granted

     114,340      $ 22.97   

Vested

     (105,967   $ 12.05   

Forfeited

     (1,557   $ 13.44   
          

Nonvested at end of period

     190,613      $ 17.45   

Nonvested expected to vest

     174,333      $ 17.42   
     2010  
     Restricted
Stock Grants
    Weighted
Average Grant
Date
Fair Value
 

Nonvested at beginning of period

     235,562      $ 10.66   

Granted

     55,856      $ 12.01   

Vested

     (87,872   $ 11.31   

Forfeited

     (19,749   $ 9.64   
          

Nonvested at end of period

     183,797      $ 10.87   
          
     2009  
     Restricted
Stock Grants
    Weighted
Average Grant
Date
Fair Value
 

Nonvested at beginning of period

     213,177      $ 11.07   

Granted

     87,070      $ 10.27   

Vested

     (61,370   $ 11.55   

Forfeited

     (3,315   $ 10.85   
          

Nonvested at end of period

     235,562      $ 10.66   
          

Employee Stock Purchase Plan

The Company’s 2000 Employee Stock Purchase Plan, or ESPP, provides all eligible employees to collectively purchase up to a total of 3,070,000 shares of its common stock. On September 14, 2009, the stockholders voted to increase the number of shares authorized for issuance under the ESPP from 820,000 shares to 3,070,000 shares, effective February 1, 2010. An employee may authorize a payroll deduction up to a maximum of 10% of his or her compensation during the plan period. The purchase price for each share purchased is the lesser of 85% of the closing price of the common stock on the first or last day of the plan period. The plan period for the ESPP ends on the last day of January and July of each year.

To estimate the fair value of shares issued under its ESPP, the Company uses the Black-Scholes option-pricing model. The Black-Scholes model estimates the per share fair value of an ESPP share at the beginning of the plan period based on the following: the price of the underlying stock on the first day of the plan period; the

 

67


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

estimated dividend yield; a “risk-free” interest rate; the term of the plan period (six months); and the expected volatility. For the “risk-free” interest rate, the Company uses a United States Treasury Bond due in six months. To determine expected volatility, the Company analyzes the historical volatility of its stock over the 6 months prior to the first day of the plan period.

A total of 132,933, 170,271, and 150,712 shares of the Company’s common stock were issued under the ESPP in fiscal 2011, 2010, and 2009, respectively. The issuance of the common stock resulted in proceeds to the Company of $1.5 million, $1.3 million, and $1.1 million, respectively.

The weighted average assumptions to determine the value for ESPP shares for fiscal 2011, 2010, and 2009 are as follows:

 

     Plan Period
Starting
February
2011
    Plan Period
Starting
August
2010
    Plan Period
Starting
February
2010
    Plan Period
Starting
August
2009
    Plan Period
Starting
February
2009
    Plan Period
Starting
August
2008
 

Risk-free interest rate

     0.18     0.20     0.17     0.28     0.39     1.88

Expected dividend yield

     1.35     2.60     2.95     3.70     0.00     0.00

Expected life

     0.5 years        0.5 years        0.5 years        0.5 years        0.5 years        0.5 years   

Volatility factor

     51     40     41     70     88     42

3. Acquisition of DSAuditor from Embarcadero Technologies, Inc.

On August 25, 2010, the Company acquired substantially all the assets associated with the DSAuditor product line from Embarcadero Technologies, Inc., or Embarcadero, a privately held software company headquartered in San Francisco, California. The Company paid approximately $2.3 million cash to Embarcadero to acquire such assets. An initial payment of $25,000 was made in September 2009, and the remaining purchase price of $2.25 million was made in August 2010. DSAuditor is a software product that provides visibility into database activity and performance. The acquisition contributed key capabilities to the Company’s product portfolio for application performance management.

The DSAuditor product line acquisition was accounted for as a business combination in accordance with the guidance outlined in ASC Topic 805. The operating results associated with the DSAuditor product line from August 25, 2010 and the transaction-related professional services costs have been included in the Company’s condensed consolidated statements of operations for the year ended March 31, 2011. The acquisition date fair value of the total consideration transferred was approximately $2.3 million.

 

68


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

The following table summarizes the estimated fair values of the DSAuditor product line acquired and liabilities assumed on the acquisition date:

 

    At August 25, 2010    

Amortization Method

  

Useful Life

    (in thousands)           

Property and equipment, net

  $ 14      Straight-line    1 month-3 years

Deferred revenue

    (79     

Identifiable intangible assets:

      

Developed technology – DS Auditor

    1,458      Straight-line    5 years

Trade names and trademark

    47      Straight-line    5 years

Customer relationships

    27      Straight-line    5 years

Non-compete agreements

    16      Straight-line    1 year
            

Total identifiable assets

    1,483        
            

Goodwill

    767        
            

Net assets acquired

  $ 2,250        
            

Intangible Assets

Intangible assets consist primarily of the developed technology associated with the DSAuditor product acquired. The Company determined that estimated acquisition date fair value of the DSAuditor developed technology was approximately $1.5 million. The Company utilized an income approach known as the Relief-From-Royalty Method to value the acquired developed technology assets.

Goodwill

The excess of the consideration transferred over the fair values assigned to the assets acquired and liabilities assumed was $767,000, which represents the goodwill resulting from the acquisition. The Company will test goodwill for impairment on an annual basis, or sooner if deemed necessary. As of March 31, 2011, there were no changes in the recognized amount of goodwill resulting from the acquisition of the DSAuditor product line.

4. Marketable Securities

At March 31, 2011, marketable securities consisted of United States Treasury bills and United States Treasury notes with original maturities greater than three months and less than one year. The Company did not hold any marketable securities at March 31, 2010.

The following table summarizes the Company’s marketable securities at March 31, 2011:

 

     March 31, 2011  
     Amortized
Cost
     Gross
Unrealized
Gains
     Market
Value
 
     (in thousands)  

United States government obligations

   $ 31,428       $ 4       $ 31,432   
                          

Total

   $ 31,428       $ 4       $ 31,432   
                          

 

69


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

5. Fair Value

The following table details the fair value measurements within the three levels of fair value hierarchy of the Company’s financial assets, consisting of cash, cash equivalents, and marketable securities at March 31, 2011 and 2010:

 

     Total Fair
Value
     Fair Value Measurement at March 31, 2011
Using
 
              Level 1                      Level 2                      Level 3          
     (in thousands)  

Cash

   $ 30,821       $ 30,821       $ —         $ —     

Money market funds

     48,976         48,976         —           —     

United States government obligations included in cash & cash equivalents

     3,499         3,499         —           —     

United States government obligations included in marketable securities

     31,432         31,432         —           —     
                                   

Total

   $ 114,728       $ 114,728       $ —         $ —     
                                   
     Total Fair
Value
     Fair Value Measurement at March 31, 2010
Using
 
      Level 1      Level 2      Level 3  
     (in thousands)  

Cash

   $ 21,545       $ 21,545       $ —         $ —     

Money market funds

     83,136         83,136         —           —     
                                   

Total

   $ 104,681       $ 104,681       $ —         $ —     
                                   

At March 31, 2011 and 2010, the Company valued money market funds and United States government obligations using a Level 1 valuation because market prices in active markets for identical assets were readily available. The per-share net asset value of the Company’s money market funds has remained at a constant amount of $1.00 per share. Also, as of March 31, 2011 and 2010, there were no withdrawal limits on redemptions for any of the money market funds that the Company holds. The Company did not value any financial assets using Level 2 or Level 3 valuations at March 31, 2011 or 2010.

6. Intangible Assets and Goodwill

Intangible assets consisted of the following:

 

     March 31, 2011  
     (in thousands)  

Intangible Asset

   Carrying Value      Accumulated
Amortization
     Net Value  

Acquired and purchased technology

   $ 14,823       $ 10,556       $ 4,267   

Customer relationships

     724         635         89   

Acquired workforce asset

     838         687         151   
                          

Total

   $ 16,385       $ 11,878       $ 4,507   
                          

 

70


OPNET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011, 2010, and 2009

 

     March 31, 2010  
     (in thousands)  

Intangible Asset

   Carrying Value      Accumulated
Amortization
     Net Value  

Acquired and purchased technology

   $ 13,275       $ 8,596       $ 4,679   

Customer relationships

     724         545