LHS GROUP INC (LHSG)Annual Report

This acquisition was accounted for under the purchase method of accounting and in accordance with Accounting Principles Board Opinion No. 16, "Accounting for Business Combinations." The Company allocated the cost of the acquisition to the assets acquired and the liabilities assumed based on their estimated fair values using valuation methods that were appropriate at the time. The acquired intangible assets included in-process technology projects, among other assets, which were related to research and development that had not reached technological feasibility and for which there was no alternative future use. The Company recorded a one time charge relating to the write-off of in-process research and development of $8.2 million for the year ended December 31, 1998, in accordance with applicable accounting pronouncements.


YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998


REVENUES. Total revenues increased 35.3% to $262.6 million in the year ended December 31, 1999 from $194.1 million in the year ended December 31, 1998. License revenues increased 38.5% to $108.8 million in 1999 from $78.6 million, while service revenues increased 33.1% to $153.8 million from $115.6 million for the same period. Total revenues increased primarily due to the addition of new customers and license revenue from subscriber growth of existing customers and increased implementation and support revenue from existing customers.

License revenues increased as a percentage of total revenues to 41.4% in 1999 from 40.5% in 1998, while service revenues decreased as a percentage of total revenues to 58.6% from 59.5% for the same period. This change in mix of revenues is primarily due to the timing of recurring license revenue from subscriber growth experienced by existing customers, the completion of implementation work for existing customers and the start of implementation work for new customers.

No individual customer accounted for more than 10% of total revenues in 1999.

COST OF SERVICES. Cost of services decreased as a percentage of total revenues to 34.0% in the year ended December 31, 1999 from 38.5% in the year ended December 31, 1998. Costs of services increased 19.5% to $89.4 million in 1999 from $74.8 million in 1998, primarily due to compensation expense associated with increased staffing for new projects in Europe, the Americas and Asia. This increase was partially offset by an increase in the productivity and efficiency of the implementation and services functions. Cost of services consists primarily of salaries and benefits of those employees associated with the installation of software products and other product support activities. It also includes third-party costs associated with systems integrators, hardware costs and costs related to providing software maintenance and end-user training to customers.

SALES AND MARKETING. Sales and marketing expenses increased as a percentage of total revenues to 11.6% in the year ended December 31, 1999 from 10.0% in the year ended December 31, 1998. Sales and marketing expenses



increased 56.8% to $30.5 million in 1999 from $19.5 million in 1998. The increase in sales and marketing expenses was principally due to the growth in the number of worldwide sales and marketing personnel responsible for developing business, particularly in Europe, Asia and Latin America and increased participation in trade shows and other worldwide marketing activities. Sales and marketing expenses consist primarily of the salaries, benefits and travel expenses of those employees responsible for acquiring new business and maintaining existing customer relationships, as well as marketing expenses related to trade publications, advertisements and trade shows.

RESEARCH AND DEVELOPMENT. Research and development expenses increased as a percentage of total revenues to 21.8% in the year ended December 31, 1999 from 20.5% in the year ended December 31, 1998. These expenses increased 44% to $57.2 million in 1999 from $39 million in 1998. This increase is the result of growth in the number of personnel associated with the development of new software releases in both the Americas and Europe, including ongoing development of the Company's new Targys technology. The Company has implemented its Targys Customer Server and Customer Inquiry Application for one customer in Europe and one customer in North America. The Company will continue a phased rollout of additional Targys applications during 2000.

GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased to 9.3% of total revenues in the year ended December 31, 1999 from 10.7% in the year ended December 31, 1998. These expenses increased 16.7% to $24.3 million in 1999 from $20.8 million in 1998. This increase was principally due to increases in the number of administrative personnel and increases in office rent and other expenses incurred as a result of the general growth of the Company's business. General and administrative expenses consist primarily of salaries and benefits of management and administrative personnel, general office administration expenses such as rent and occupancy, telephone expenses and other supply costs, and fees for legal, accounting and other professional services.

INCOME TAXES. The provision for income taxes was 37.6% and 47.7% of earnings before income taxes for the years ended December 31, 1999 and 1998, respectively. The effective tax rate was higher than the statutory tax rate of 34% primarily because of the partial deduction for merger charges in 1999 and the non-deductible write-off of in-process research and development in 1998, as well as higher tax rates in foreign countries.


YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997


REVENUES. Total revenues increased 54.6% to $194.1 million in the year ended December 31, 1998 from $125.5 million in the year ended December 31, 1997. License revenues increased 70.0% to $78.6 million in 1998 from $46.2 million, while service revenues increased 45.7% to $115.6 million from $79.3 million for the same period. Total revenues increased primarily due to the addition of new customers and increased implementation and support revenue from existing customers.

License revenues increased as a percentage of total revenues to 40.5% in 1998 from 36.8% in 1997, while service revenues decreased as a percentage of total revenues to 59.5% from 63.5% for the same period. This change in mix of revenues is primarily due to the timing of recurring license revenue from subscriber growth experienced by existing customers, the completion of implementation work for existing customers and the start of the implementation work for new customers.

No individual customer accounted for more than 10% of total revenues in 1998. During 1997, o-tel-o, an LHS customer in Europe, accounted for 12% of total revenues.

COST OF SERVICES. Cost of services decreased as a percentage of total revenues to 38.5% in the year ended December 31, 1998 from 45.1% in the year ended December 31, 1997. Costs of services increased 32.0% to $74.8 million in 1998 from $56.6 million in 1997, primarily due to compensation expense associated with increased staffing for new projects in Europe, the Americas and Asia. This increase was partially offset by an increase in the productivity and efficiency of the implementation and services functions. Cost of services consists primarily of salaries and benefits of those employees associated with the installation of software products and other product support activities. It also includes third-party costs associated with systems integrators, hardware costs and costs related to providing software maintenance and end-user training to customers.

SALES AND MARKETING. Sales and marketing expenses decreased as a percentage of total revenues to 10.0% in the year ended December 31, 1998 from 11.6% in the year ended December 31, 1997 although sales and marketing



expenses actually increased to $19.5 million in 1998 from $14.6 million in 1997. The increase in sales and marketing expenses was principally due to the growth in the number of worldwide sales and marketing personnel responsible for developing business, particularly in Europe and Asia and increased participation in trade shows and other worldwide marketing activities. Sales and marketing expenses consist primarily of the salaries, benefits and travel expenses of those employees responsible for acquiring new business and maintaining existing customer relationships, as well as marketing expenses related to trade publications, advertisements and trade shows.

RESEARCH AND DEVELOPMENT. Research and development expenses increased as a percentage of total revenues to 20.5% in the year ended December 31, 1998 from 17.6% in the year ended December 31, 1997. This increase in research and development costs as a percentage of revenues was principally due to increases in the number of personnel associated with the development of new releases of BSCS in both the Americas and Europe. Research and development expenses are comprised of salaries and benefits of the employees involved in product and enhancement development. All development costs are expensed by the Company as incurred.

GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased to 10.7% of total revenues in the year ended December 31, 1998 from 13.2% in the year ended December 31, 1997. These expenses increased 25.3% to $20.8 million in 1998 from $16.6 million in 1997. This increase was principally due to increases in the number of administrative personnel and increases in office rent and other expenses incurred as a result of the general growth of the Company's business. General and administrative expenses consist primarily of salaries and benefits of management and administrative personnel, general office administration expenses such as rent and occupancy, telephone expenses and other supply costs, and fees for legal, accounting and other professional services.

INCOME TAXES. The provision for income taxes was 47.7% and 41.7% of earnings before income taxes for the years ended December 31, 1998 and 1997, respectively. The effective tax rate was higher than the statutory tax rate of 34% primarily because the non-deductible write-off of in-process research and development in 1998 and higher tax rates in foreign countries in 1998 and 1997.

IN-PROCESS RESEARCH AND DEVELOPMENT. During 1998, the Company completed the acquisition of InfoCellular and, in conjunction with this acquisition, the Company allocated a portion of the purchase price to in-process research and development. Since the date of acquisition, the Company has used the acquired in-process technology to develop new product offerings and enhancements, which will become part of the Company's suite of products when completed. The Company completed the development of the remaining research and development projects referred to as Brookfield and Cohasset during 1999. The Company is currently offering products to its customers, which incorporate the functionality developed in these research and development projects.

No assurance can be given that actual revenues and operating profit attributable to acquired in-process research and development will not deviate from the projections used to value such technology. Ongoing operations and financial results for the acquired technology, and the Company as a whole, are subject to a variety of factors which may not have been known or estimateable at the date of such transaction, and the estimates discussed below should not be considered the Company's current projections for operating results for the acquired assets or licensed technology or the Company as a whole.

The fair value of the in-process technology was based on analyses of the markets, projected cash flows and risks associated with achieving such projected cash flows. In developing these cash flow projections, revenues were estimated based on relevant factors, including aggregate revenue growth rates for the business as a whole, individual service offering revenues, characteristics of the potential market for the service offerings and the anticipated life of the underlying technology. Operating expenses and resulting profit margins were estimated based on the characteristics and cash flow generating potential of the acquired in-process research and development. The Company assumed material net cash inflows would commence in 1999. Appropriate adjustments were made to operating income to derive net cash flow, and the estimated net cash flows of the in-process technologies were then discounted to present value using a rate of return that the Company believes reflects the specific risk/return characteristics of the research and development projects. The selection of discount rates for application was based on the consideration of: (i) the weighted average cost of capital, which measures a company's cost of debt and equity financing weighted by the percentage of debt and percentage of equity in its target capital structure; (ii) the corresponding weighted average return on assets which measures the after-tax return required on the assets employed in the business weighted by each asset group's percentage of the total asset portfolio; and (iii) venture



capital required rates of return which typically relate to equity financing for relatively high-risk business projects. The risk adjusted discount rate utilized in the valuation analysis of the acquired in-process technology was 20%.

Revenues attributable to the acquired in-process technology were assumed to increase between the first three years of the six-year projection period at annual rates of 46% to 569% before decreasing over the remaining years at rates of 3% to 40% as other products are released into the marketplace. Projected annual revenue attributable to the product ranged from $1.6 million to $15.7 million over the term of the projection. This projection was based on the aggregate revenue growth rate for the business as a whole, individual product revenues, anticipated growth rates for the billing software market, anticipated product development and product introduction cycles, and the estimated life of the underlying technology. Projected revenues from the in-process research and development were assumed to peak during 2000, and decline from 2001 to 2003 as other new products are expected to enter the market.

Gross profit was assumed to increase in the first three years of the projection period at annual rates of 46% to 569% before decreasing over the remaining years at rates of 3% to 40%, resulting in annual gross profits that ranged from $1.0 million to $10.2 million over the term of the projection.

Operating profit was assumed to increase in the first three years of the projection from $0.01 million to $5.6 million before decreasing over the remaining years at rates of 3% to 40%, resulting in annual operating profits that ranged from $0.01 million to $5.6 million over the term of the projection.

The Company used a discount rate of 20% for valuing the in-process research and development acquired in these transactions, which the Company believes reflected the risk associated with the completion of the individual research and development projects acquired and the estimated future economic benefits to be generated subsequent to the projects' completion.

The in-process research and development acquired from InfoCellular consisted of the Brookfield and Cohasset technology. These new releases of the Converge software product include new features that provide the ability to recognize/accommodate multi-language and multi-currency operations and functionality that extends beyond the basic level of POS functionality. The Company estimated that this project was approximately 80% complete at the date of acquisition. At the date of valuation, the expected cost to complete these projects was approximately $1.1 million. The Company completed the projects during the third quarter of 1999 within the estimated cost of completion.

There can be no assurance that the Company will not incur additional charges in subsequent periods to reflect costs associated with these transactions or that the Company will be successful in its efforts to integrate and further develop these technologies.


LIQUIDITY AND CAPITAL RESOURCES


Net cash provided by operating activities totaled $42.3 million in 1999 compared to $21.5 million in 1998 and $15.0 million 1997. The increase in cash provided by operations in 1999, 1998 and 1997 was primarily the result of increased earnings coupled with strengthened cost controls and cash management practices.

Net cash used in investing activities totaled $10.3 million, $28.5 million and $56.6 million during 1999, 1998 and 1997, respectively. The Company invested $10.8 million, $11.3 million and $6.8 million in furniture, fixtures and equipment during 1999, 1998 and 1997, respectively. These investments were primarily for computer hardware and software and improvements to new leased office space required to accommodate the growth in the number of employees.

Net cash from financing activities totaled $11.5 million, $14.0 million and $66.5 million during 1999, 1998 and 1997, respectively. During 1999, 1998 and 1997, the Company received proceeds from the exercise of employee stock options totaling $13.3 million, $14.0 million and $1.9 million, respectively. In May 1997, the Company sold 4,865,000 shares of its Common Stock in an Initial Public Offering ("IPO") in which it received approximately $70.6 million, net of $7.2 million in costs of the offering.



The Company has a short-term overdraft facility with a bank, which provides for borrowings of up to $2.5 million and bears interest at 7.5% per annum.

The Company's Priority Call subsidiary has a security agreement with a bank, which allows the Company to borrow the lesser of (i) $2 million or (ii) 80% of eligible accounts receivable (working capital line) and up to $1 million for equipment purchases (equipment line). Borrowings under the working capital line accrue interest at the bank's prime rate (7.75% at December 31, 1999) and borrowings under the equipment line accrue interest at the bank's prime rate plus 1/2%. At December 31, 1998, the Company had a $1 million advance against the equipment line and no borrowings against the working capital line. The Company made net payments on the security agreement totaling $1.5 million and $1.2 million during 1999 and 1998, respectively. The Company made net borrowings on the security agreement during 1997 totaling $0.7 million.

At December 31, 1999 no borrowings were outstanding under the short-term overdraft facility or the security agreement.

At December 31, 1999 the Company did not have any material commitments for capital expenditures. The Company believes that its existing cash balances, available credit facilities, and funds generated by operations, will be sufficient to meet its anticipated working capital and capital expenditure requirements for the foreseeable future.


IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS


On January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). The Company reported comprehensive income in its statement of stockholders' equity. The adoption of SFAS 130 resulted in revised and additional disclosures but had no effect on the financial position, results of operations, or liquidity of the Company.

In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), which establishes standards for the way public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. Operating segments are components of an enterprise about which separate financial information is available which is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company adopted SFAS 131 in 1998, and the effect of the adoption was not material to the consolidated financial statements. (see Note 12).

In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", which requires the recognition of all derivatives as either assets or liabilities in the balance sheet and the measurement of those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the planned use of the derivative and the resulting designation. The Company is required to implement the statement in the first quarter of the year 2001. The Company has not used derivative instruments and believes the impact of adoption of this statement will not have significant effect on the financial statements.

The American Institute of Certified Public Accountants issued SOP 97-2, SOP 98-4 and SOP 98-9 to clarify guidance on applying generally accepted accounting principles to software transactions and to provide guidance on when revenue should be recognized and in what amounts for licensing, selling, leasing, or otherwise marketing computer software. The Company adopted this guidance during 1997. Such adoption had no effect on the Company's methods of recognizing revenue.

On December 3, 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"). SAB 101 summarizes certain areas of the Staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company believes that its current revenue recognition principles comply with SAB 101.


                  RISK FACTORS AFFECTING FUTURE PERFORMANCE

A failure to complete our merger with Sema Group plc may result in a material adverse effect on our business and results of operations.
On March 14, 2000, we entered into a plan and agreement of merger with Sema Group plc pursuant to which LHS would become a subsidiary of Sema. We expect for this merger to be completed in the second half of 2000. The announcement of the pending transaction may have adverse effects on our business and operations. Employees that are key to our continuing successful operation may leave LHS as a result of the pending transaction. Customers who do not believe that the transaction will be favorable to their relationship with LHS in terms of the future quality of the products and services we provide to them or otherwise may decide to terminate or diminish in some way their relationship with LHS. Potential customers of LHS may delay entering into, or decide not to enter into, a business relationship with LHS because of the pending transaction with Sema. Any of the factors discussed above may result in a material adverse effect on our business and results of operations. In addition, if the transaction is not consummated on schedule or at all, for any reason, including without limitation, reasons that would result in our making substantial payments to Sema or other parties, our business, financial condition and results of operations would be materially adversely affected. See "Item 1 - Business."

We must adapt to changes in technology, products, industry standards and customer needs.

The telecommunications industry is characterized by rapidly changing technology and evolving industry standards. Also, customer needs frequently change, and competitors constantly introduce new products and services. To be successful, we must:


        -        use leading technologies effectively;
        -        continue developing our technical expertise;
        -        enhance our existing products and services;
        -        develop new products and services;
        -        meet changing customer needs on a timely and cost-effective
                 basis; and,
        -        introduce scaleable solutions that support our customers'
                 growing subscriber bases                  

If we fail to do any of these things, our customers may choose to purchase products and services from our competitors.
We continually introduce our products and services into new markets. If our products do not adequately meet the demands of these new markets, we could experience decreased revenues. We could experience difficulties in the development of products and services for new and existing markets that could delay or prevent the successful



development, introduction and marketing of these products and services. Our failure to develop and introduce new products and services in a timely manner, or the lack of success of a new release of a product in the market, would likely result in a material adverse effect on our business, operating results and financial condition.

We may not effectively manage our growth.

Over the last three years, we have greatly expanded our operations, placing considerable demand on our administrative, operational and financial personnel and systems. Further expansion may place additional strains on our resources. To address these expansion issues, we may have to make substantial expenditures and devote further management time and resources to:


        -        improve or replace our management information, financial and
                 other reporting systems;
        -        standardize installation methods;
        -        further develop our infrastructure;
        -        develop and coordinate strategies, operations and product
                 development among our operations in the Americas, Europe and
                 Asia;
        -        maintain customer satisfaction;
        -        manage changing business conditions; and
        -        recruit, train and retain qualified consulting, technical,
                 sales, financial, marketing and management personnel.
        -        integrate acquired businesses

We cannot assure you that our existing resources, systems and space will be able to adequately support our further expansion. Our failure to respond appropriately to growth and change would likely result in a material adverse effect on the quality of our services, our ability to retain key personnel and our business.
We depend on large contracts from a limited number of customers.

We provide customized billing and customer handling systems to communications service providers. Although no single customer accounted for more than 10% of our revenues in 1999, we have traditionally relied upon, and expect to continue to rely upon, large contracts from a limited number of customers. This can cause our revenues and earnings to fluctuate between quarters based on the timing of orders and realization of revenues from these orders.

Some of the communications industry's established players are forming alliances, while others are consolidating. If a consolidation or alliance involves one of our customers, that customer may switch to another billing system. In addition, none of our major customers has any obligation to purchase additional products or services from us. The loss of one or more of our major customers because of industry consolidation or otherwise would likely result in a material adverse effect on our business, operating results and financial condition.

Our success depends on developing relationships with new customers in a very competitive communications market.

The global communications services markets have grown significantly and become much more competitive in recent years. This growth may not continue, and we may not be able to successfully market and sell our products in these competitive markets. It is critical to our continued success that we develop relationships with new customers. Our failure to develop relationships with new customers, or the failure of our customers to compete effectively in the telecommunications market, would likely result in a material adverse effect on our business, operating results and financial condition.

Many of our potential customers are new entrants in the communications services markets and lack significant financial and other resources. We may be required to offer them alternative pricing arrangements, including deferred payments, if we want these new market entrants to be our customers. We may not be able to develop customer relationships with these new entrants, but even if we do, there is no guarantee that these customers will be successful. If they are not successful, they may reduce or discontinue their purchases from us and we may be



unable to collect payments from these customers. Any one of these factors could have a material adverse effect on our business, operating results and financial condition.

Expansion of our products and services into new geographic markets and applications may be unsuccessful.

We plan to continue expanding our products and services into new geographic markets and to service providers offering new applications of their communications services. Our failure to successfully establish ourselves in new markets would likely result in a material adverse effect on our business. Likewise, delays in the introduction of new communications technologies may result in decreased demand for our products and services for use in connection with new communications services.

Our strategy of expanding our business through acquisitions of and mergers with other businesses and technologies presents special risks.

LHS may continue to expand through the acquisition of and mergers with businesses, technologies, products, and services from other businesses. Acquisitions involve a number of special problems, including:


        -        difficulty integrating acquired technologies, operations and
                 personnel with the existing business;
        -        diversion of management attention in connection with both
                 negotiating the acquisitions and integrating the assets;
        -        strain on managerial and operational resources as management
                 tries to oversee larger operations;
        -        exposure to unforeseen liabilities of acquired companies;
        -        potential issuance of securities in connection with the
                 acquisition which securities lessen the rights of holders of
                 our currently outstanding securities;
        -        the need to incur additional debt; and
        -        the requirement to record additional future operating costs
                 for the amortization of goodwill and other intangible assets,
                 which amounts could be significant.

We may not be able to successfully address these problems. Moreover, our future operating results will depend to a significant degree on its ability to successfully manage growth and integrate acquisitions. In addition, companies whom we may acquire or with which we may merge may be early-stage companies with limited operating histories and limited or no revenues. We may not be able to successfully develop these young companies into profitable units of LHS.
Our success is dependent on our relationships with consulting firms and systems integration firms.

Consulting firms and systems integration firms help us with marketing, sales, lead generation, customer support and installation of our products. In order to grow successfully, we must maintain our relationships with these firms and generate new business opportunities through joint marketing and sales with them.

We also serve as subcontractor to consulting firms and systems integration firms where those firms provide information technology to end-user customers. In these cases we depend heavily on these firms to install our products and to train end-users to use our products. Incorrect product installation, failure to properly train the end-user, or general failure of the firm to satisfy the customer could have a negative effect on our relationships with the contracting firm and the customer. Such problems could damage our reputation and the reputation of our products and services.

Obstacles we may encounter to forging long-term relationships with consulting and systems integration firms include:


        -        we have no exclusive agreements with any consulting and
                 systems integration firms;
        -        many consulting and systems integration firms have more
                 established relationships with our principal competitors; and



        -        many consulting and systems integration firms have the
                 resources to compete with us by developing their own products
                 and services.

These firms may discontinue their relationships with us and/or develop relationships with our competitors. Our inability to establish and maintain effective, long-term relationships with these firms, and their failure to meet the needs of our customers, would likely adversely affect our business.
Prior to 1996, we had contracts pursuant to which we gave certain systems integration firms our kernel source code and the right to market and sell versions of our products that these firms independently modified. A few U.S. service providers had problems with our products as modified and installed by these firms. This damaged our reputation and credibility and that of our products, and we may have lost the confidence of the affected service providers. Although we have terminated all of these types of contracts, there may be further damage to our reputation and credibility in the U.S. that could have a material adverse effect on our business.

The communications billing and customer care and enhanced services systems industries are very competitive. We expect competition to increase in the future.

Some of the independent providers we compete with are:


        -        Alltel
        -        AMDOCS
        -        Convergys
        -        Kenan
        -        Kingston-SCL
        -        Portal Software
        -        SEMA Group
        -        Comverse Technology
        -        Brite Voice
        -        Glenayre
        -        Logica

We also compete with systems integrators and internal billing departments of larger telecommunications service providers.
Many of our competitors have advantages over us, including:


        -        longer operating histories;
        -        larger customer bases;
        -        substantially greater financial, technical, sales, marketing
                 and other resources; and
        -        greater name recognition.

Our current and potential competitors have established, and may continue to establish in the future, cooperative relationships among themselves or with third parties to increase their ability to compete with us. In addition, competitors may be able to adapt more quickly than us to new or emerging technologies and changes in customer needs, or to devote more resources to promoting and selling their products. New competitors or alliances among competitors could also result in these competitors quickly gaining significant market share.
We believe that our ability to compete successfully in our markets is affected by these principal factors:


        -        development of competing software and services;
        -        price of competing software and services;
        -        responsiveness to customer needs; and
        -        hiring, retaining and motivating key personnel.

Our failure to adapt to market demands and to compete successfully with existing and new competitors would have a material adverse effect on our business.


As we expand, we will market our products and services to service providers in markets that we do not currently serve. We may encounter new competitors upon entry into these markets that may have greater financial, technical, personnel and marketing resources than we do. We cannot assure you that we will be able to successfully identify and address the demands for these new markets or that we can continue to compete effectively in our current markets. Our failure to maintain our competitiveness in current or new markets would have a material adverse effect on our business, operating results and financial condition.

Our success depends upon our ability to attract and retain key personnel.

Our future success depends in large part on the continued service of our key management, sales, product development and operational personnel, including Gary Cuccio, our Chief Executive Officer. Since it is our goal to continue our expansion, our success also depends on our ability to attract and retain highly qualified technical, managerial, sales and marketing personnel. Competition is intense for the recruitment of highly qualified personnel in the software and telecommunications services industry. We may not be able to successfully retain or integrate existing personnel or identify and hire additional personnel. Our inability to hire and retain qualified personnel would likely have a material adverse effect upon our current business, new product development efforts and future business prospects. We do not currently maintain key person insurance coverage for any of our employees.

The success of our international business operations is subject to many uncertainties.

We conduct a substantial portion of our business outside of the Americas. In each of 1998 and 1999, our sales outside the Americas represented approximately 60% of our total revenues. We expect a majority of our revenues to continue to be provided from our European and Asian operations. Our international business may be adversely affected by the following:


        -        unexpected changes in regulatory requirements;
        -        tariffs and other trade barriers;
        -        difficulties in customizing our products for use in foreign
                 countries;
        -        longer accounts receivable payment cycles;
        -        difficulties in managing international operations;
        -        availability of trained personnel to install and implement our
                 systems;
        -        political instability;
        -        potentially adverse tax obligations; restrictions on the
                 repatriation of earnings; and, the burdens of complying with
                 a wide variety of foreign laws and regulations.

In addition, the laws of some foreign countries do not protect our intellectual property rights to as great an extent as the laws of the United States. There can be no assurance that such factors will not have a material adverse effect on our international revenues and earnings or our overall financial performance.
If we cannot provide financing for potential customers, we may not get their business.

Certain of our potential customers may require financing to fund purchases of our products. In particular, our ability to increase sales to start-up telecommunications service providers with limited financial resources in the future will depend significantly upon our ability to arrange financing for these customers. We may not be able to successfully implement a vendor financing program for these customers or to assist them in obtaining alternative financing for our products. In such event, we will have decreased revenues.

Exchange rate fluctuations between the U.S. dollar and other currencies in which we do business may result in currency translation losses.

A significant portion of our revenues are denominated in the German Deutsche Mark. We also have revenues denominated in the Swiss Franc and the Malaysian Ringgit. The value of the German Deutsche Mark against the Euro was fixed upon the introduction of the Euro in January 1, 1999. Consequently, fluctuations in


exchange rates between the U.S. Dollar and the Euro, Swiss Franc and Malaysian Ringitt may have a material adverse effect on our business, operating results and financial condition and could also result in significant exchange losses. Foreign currency transaction gains and losses are a result of transacting business in certain foreign locations in currencies other than the functional currency of the location. We attempt to balance our revenues and expenses in each currency to minimize net foreign currency risk. To the extent that we are unable to balance revenues and expenses in a currency, fluctuations in the value of the currency in which we conduct our business relative to the functional currency have caused and will continue to cause currency transaction gains and losses. We cannot accurately predict the impact of future exchange rate fluctuations on our results of operations.

We have not sought to hedge the risks associated with fluctuations in exchange rates but may undertake such transactions in the future. Any hedging techniques which we implement in the future may not be successful, and exchange rate losses could be exacerbated by hedging techniques that we use.

Our European operations expose us to heightened euro conversion risks.

Because of our significant operations in Europe, we are particularly exposed to risks resulting from the conversion by certain European Union member states of their respective currencies to the Euro as legal currency on January 1, 1999. The conversion rates between such European Union member states' currencies and the Euro have been fixed by the European Union's council; however, the mandatory switch to the Euro will not occur until June 30, 2002. We will be modifying our software during the period of conversion to the Euro and intend to complete such work and have our products Euro compliant by such time. Risks to us related to the conversion of the Euro include:


        -        effects on pricing due to increased cross-border price
                 transparency;
        -        costs of modifying information systems, including both
                 software and hardware;
        -        costs of modifying our software products to accommodate Euro
                 conversion;
        -        costs of relying upon third parties whose systems also require
                 modification;
        -        changes in the conduct of business; and
        -        changes in the currency exchange rate.

The actual effects of the Euro conversion could have a material adverse effect on our business, operating results and financial condition.
We have only limited protection of our proprietary rights and technology.

We rely primarily on a combination of registered patents, and statutory and common law copyright, trademark and trade secret laws, customer licensing agreements, employee and third-party nondisclosure agreements and other methods to protect our proprietary rights and technology. These laws and contractual provisions provide only limited protection. We have only a limited number of registered copyrights, trademarks and patents. It may be possible for a third party to copy or otherwise obtain and use our technology without authorization or to develop similar technology independently. Also, the laws of certain countries in which we sell our products do not offer as much protection of our proprietary rights as the laws of the United States. Unauthorized copying or misuse of our products or proprietary rights could have a material adverse effect on our business, operating results and financial condition.

We may not be successful in avoiding claims that we infringe others' proprietary rights.

Many patents, copyrights and trademarks have been issued in the general areas of information and communications. We expect that software developers will be increasingly subject to infringement claims as the number of products and competitors providing products and services to the telecommunications industry grows. Third parties may claim that our current or future products infringe their proprietary rights. Infringement claims, with or without merit, could


        -        result in costly litigation;
        -        require significant management resources;
        -        cause product shipment delays;



        -        require us to enter into unfavorable royalty or licensing
                 agreements
        -        cause us to discontinue the use of the challenged trade name,
                 service mark or technology; or
        -        pay money damages.

Consequently, infringement claims could have a material adverse effect on our business, operating results and financial condition.
Our software may contain undetected errors.

The software that we have developed and licensed to our customers may contain undetected errors. Although we test our software prior to installing it in a customer's network, we may discover errors after the installation. The cost to fix the errors or to develop the software further could be high. These errors may subject us to product liability claims. We have not experienced any product liability claims to date, but we may be subject to such claims in the future. We have insurance that would cover certain of these claims; however, a successful product liability claim brought against us could have a material adverse effect on our business, operating results and financial condition.

Certain measures that we have adopted may have anti-takeover effects.

The Board of Directors has the authority to issue up to 225,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares, without stockholder action. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock could discourage or make difficult the acquisition of a majority of our outstanding voting stock by a third party.

Certain provisions of our Certificate of Incorporation and By-Laws and the Delaware General Corporation Law could delay or make more difficult a merger, tender offer or proxy contest involving us. In addition, our Board of Directors is divided into three classes with only one class being elected each year, and directors may only be removed by the affirmative vote of 80% or more of all classes of voting stock. Also, pursuant to our Stock Incentive Plan, all stock options granted to employees automatically vest and become exercisable upon certain triggering events leading up to a change of control. These factors may have the effect of delaying or preventing a change of control.

The market price of our common stock may be volatile.

There may be significant volatility in the market price of our common stock. The stock market has from time to time experienced significant price and volume fluctuations that may be unrelated to the operating performance of particular companies. Factors such as the following will vary from period to period:


        -        actual or anticipated operating results;
        -        growth rates;
        -        changes in estimates by analysts;
        -        industry conditions;
        -        competitors' announcements;
        -        regulatory actions; and
        -        general economic conditions.

As a result of these and other factors, our operating results from time to time may be below the expectations of public market analysts and investors. Any such event would likely have a material adverse effect on the market price of the common stock.
Government regulation of our customers could negatively affect us.

Currently, our business is not subject to direct government regulation; however, our existing and potential customers are subject to extensive regulation in many jurisdictions. Regulatory changes which affect our existing



and potential customers could have a material adverse effect on our business, operating results and financial condition.

Additional shares will become eligible for sale in the future.

The market price of our common stock could drop as a result of sales of large numbers of shares in the market, or the perception that such sales could occur. Several of our principal stockholders hold a significant portion of the outstanding common stock.

We have approximately 59 million shares of common stock outstanding. Approximately 45 million of these shares are freely transferable without restriction or further registration under the Securities Act of 1933, except for any shares purchased by our "affiliates," as defined in Rule 144 under the Securities Act. Approximately 14 million of the shares of common stock outstanding are "restricted securities" as defined in Rule 144. These shares may be sold in the future without registration under the Securities Act to the extent permitted by Rule 144 or an exemption under the Securities Act. In addition, we have registered under the Securities Act 16 million shares of common stock issuable under our Long-Term Incentive Plan.

Certain of our stockholders are entitled to demand and piggyback registration rights with respect to the shares that they own. Once registered, such shares generally will be eligible for immediate sale in the public market.


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


A significant portion of the Company's operations consist of software license sales and software implementation, support and project consulting services in foreign countries, primarily in Europe (including Eastern Europe), Asia and Latin America. As a result, the Company's financial results could be significantly affected by factors such as changes in foreign currency exchange rates when the Company is paid in foreign currencies and weak economic conditions in the foreign markets in which the Company licenses and implements its software products. The Company's operating results are affected by changes in exchange rates between the U.S. Dollar and the Euro, German Deutsche Mark, Swiss Franc, and Malaysian Ringitt. When the U.S. Dollar strengthens against these foreign currencies, the value of our non-functional currency revenues decreases. When the U.S. Dollar weakens, the value of our functional currency revenues increases. Overall, the Company is a net receiver of currencies other than the U.S. Dollar and, as such, the Company benefits from a weaker U.S. Dollar and is adversely affected by a stronger U.S. Dollar relative to major currencies worldwide. However, the Company believes that its exposure to foreign currency exchange rate risk at December 31, 1999 was not material.

The Company does not engage in trading of market-risk sensitive instruments. The Company also does not purchase for investment, hedging or for purposes "other than trading", instruments that are likely to expose it to market risk, whether interest rate, foreign currency exchange, commodity price or equity price risk. The Company has issued no debt instruments, entered into no forward or futures contracts, purchased no options and entered into no swaps.

The Company's interest income and expense are most sensitive to changes in the general level of U.S. interest rates. In this regard, changes in the U.S. interest rates affect the interest earned on the Company's cash equivalents and short-term investments. To mitigate the impact of fluctuations in U.S. interest rates, the Company generally maintains the majority of its investments in fixed rate debt instruments. Because the Company has no outstanding balances in its loans or credit facilities, it is not exposed to interest rate risk in connection with its operating expenses.



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


The financial statements and financial statement schedules in Part IV, Item 14 of this annual report are incorporated by reference into this Item 8.



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

FINANCIAL DISCLOSURE.


Not applicable.






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Recent filings: Mar 31, 1999 (Annual Rpt) | May 17, 1999 (Qtrly Rpt) | Aug 13, 1999 (Qtrly Rpt) | Nov 15, 1999 (Qtrly Rpt) | Mar 29, 2000 (Annual Rpt)
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