UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31,JUNE 30, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 000-23698
APPLIED DIGITAL ACCESS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)(Exact name of registrant as specified in its charter)
DELAWARE 68-0132939
(STATE OR OTHER JURISDICTION OF(State or other jurisdiction of (IRS EMPLOYER IDENTIFICATION NO.Employer Identification No.)
INCORPORATION OR ORGANIZATION)incorporation or organization)
9855 SCRANTON ROAD, SAN DIEGO, CALIFORNIA 92121
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, ZIP CODE)(Address of principal executive offices, zip code)
(619) 623-2200
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
There were 12,674,29412,704,148 shares of the registrant's Common Stock, $0.001$.001 par value,
outstanding on April 30,as of July 31, 1998.
APPLIED DIGITAL ACCESS, INC.
INDEX TO FORM 10-Q
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
March 31, 1998 and December 31, 1997 . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statement of Operations for the
three months ended March 31, 1998 and March 31, 1997 . . . . . . . . . . . . . . 4
Condensed Consolidated Statement of Cash Flows for the three
months ended March 31, 1998 and March 31, 1997 . . . . . . . . . . . . . . . . . 5
Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . . 6 - 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 -10
Risks and Uncertainties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10-16
Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Item 2. Changes in Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . . . . . . . . . . . . . . 17
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . 17
Item 5. Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . 17
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at June 30, 1998
and December 31, 1997 .................................... 3
Condensed Consolidated Statements of Operations for the
three and six months ended June 30, 1998 and
June 30, 1997 ............................................ 4
Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 1998 and June 30, 1997 ..... 5
Notes to Condensed Consolidated Financial Statements ..... 6-7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ...................... 8-11
Risks and Uncertainties .................................. 12-17
Item 3. Quantitative and Qualitative Disclosures About Market
Risk ..................................................... 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ........................................ 18
Item 2. Changes in Securities and Use of Proceeds ................ 18
Item 3. Defaults Upon Senior Securities .......................... 18
Item 4. Submission of Matters to a Vote of Security Holders ..... 18
Item 5. Other Information ........................................ 18
Item 6. Exhibits and Reports on Form 8-K ......................... 19
SIGNATURES .......................................................... 20
2
PART I
FINANCIAL INFORMATION
ITEMItem 1. FINANCIAL STATEMENTS
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
MARCH 31,JUNE 30, DECEMBER 31,
1998 1997
--------- ------------
(UNAUDITED)------------------------------
(DOLLARS IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents $ 3,2913,134 $ 4,400
Investments - current 9,3209,876 8,779
Accounts receivable, net 9,1329,003 12,981
Inventory, net 5,3455,924 5,859
Deferred income taxes 130 130
Prepaid expenses and other current assets 3,6112,381 3,775
--------- --------------- -------
Total current assets 30,82930,448 35,924
Property and equipment, net 6,2166,260 6,165
Deferred income taxes 2,5381,426 1,372
Other, net 1,3721,753 2,822
--------- --------
$40,955 $46,283
--------- --------
--------- --------------- -------
$ 39,887 $ 46,283
------- -------
------- -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,334 $ 3,478$5,125 $3,478
Acquisition payments due to licensor -- 867
Accrued expenses 1,281 2,8641,255 1,997
Accrued warranty 1,3181,315 1,323
Deferred revenue 1,695and other current liabilities 2,518 1,471
--------- --------------- -------
Total current liabilities 8,62810,213 9,136
Obligations under capital leases, net of
current portion 105 15
--------- --------------- -------
Total liabilities 8,63810,218 9,151
------- -------
Shareholders' equity:
Preferred stock, $0.001$.001 par value, 7,500,000
shares authorized, no shares issued - --- --
Common stock, $0.001$.001 par value, 30,000,000
shares authorized, 12,671,26712,704,148 and 12,605,082
shares issued and outstanding at March 31,June 30,
1998 and December 31, 1997, respectively 51,89451,998 51,610
Additional paid-in capital 2,519 2,492
Unrealized gain on investments 16672 84
Accumulated deficit (22,262)(24,920) (17,054)
--------- --------------- -------
Total shareholders' equity 32,31729,669 37,132
--------- --------
$40,955------- -------
$39,887 $46,283
--------- --------
--------- --------------- -------
------- -------
The accompanying notes are an integral part of the
consolidated financial statements.
3
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS
ENDED MARCH 31,
-----------------------------
1997 1998
------------ ------------
(AMOUNTS IN THOUSANDS EXCEPT
PER SHARE AMOUNT)(Unaudited)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
--------------------------------- ---------------------------------
1998 1997 1998 1997
--------- ---------- ---------- ----------
(AMOUNTS IN THOUSANDS (AMOUNTS IN THOUSANDS
EXCEPT PER SHARE AMOUNTS) EXCEPT PER SHARE AMOUNTS)
Revenue $5,272 $6,388$8,580 $8,164 $13,852 $14,552
Cost of revenue 3,664 3,211
--------- ---------3,741 3,711 7,405 6,922
------- ------- ------- -------
Gross profit 1,608 3,1774,839 4,453 6,447 7,630
Operating expenses:
Research and development 3,544 2,0013,777 2,534 7,320 4,535
In-process research and
development related to
asset acquisition -- 1,578 -- 1,578
Sales and marketing 2,280 1,4582,551 1,902 4,831 3,360
General and administrative 1,119 1,355
--------- ---------1,295 1,082 2,414 2,437
------- ------- ------- -------
Total operating expenses 6,943 4,814
--------- ---------7,623 7,096 14,565 11,910
------- ------- ------- -------
Operating loss (5,335) (1,637)(2,784) (2,643) (8,118) (4,280)
Interest income 175 243168 268 342 510
Other income (expense), net (11) (4)
--------- ---------(6) 14 (16) 11
------- ------- ------- -------
Loss before income taxes (5,171) (1,398)(2,622) (2,361) (7,792) (3,759)
Provision for income taxes 37 51
--------- ---------36 13 73 64
------- ------- ------- -------
Net loss ($5,208)2,658) ($1,449)
--------- ---------2,374) ($7,865) ($3,823)
------- ------- ------- -------
------- ------- ------- -------
Net loss per basic and diluted share ($0.41)0.21) ($0.12)
--------- ---------
--------- ---------0.19) ($0.62) ($0.31)
------- ------- ------- -------
------- ------- ------- -------
Number of shares used in per share
computations 12,624 12,31012,675 12,452 12,650 12,381
Comprehensive Loss ($5,127)2,751) ($1,465)
--------- --------
--------- --------2,344) ($7,877) ($3,809)
------- ------- ------- -------
------- ------- ------- -------
The accompanying notes are an integral part of the
consolidated financial statements.
4
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS
ENDED MARCH 31,
-----------------------------
1998 1997
------------ ------------(Unaudited)
FOR THE SIX MONTHS
ENDED JUNE 30,
----------------------
1998 1997
----------------------
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net loss ($5,208)7,865) ($1,449)3,823)
Adjustments to reconcile net loss to net
cash provided (used) by operating activities:
In-process research and development related to
asset acquisition -- 1,578
Depreciation and amortization 918 6611,853 1,335
Other 17 51(101) (116)
Changes in assets and liabilities:
Accounts receivable 3,849 6453,978 (2,893)
Inventory 514 240(65) 256
Prepaid expenses and other current 164 80
assets 1,394 (114)
Deferred income taxes (54) --
Accounts payable 856 1451,647 1,992
Acquisition payments due licensor (867) 2,600
Accrued expenses (1,584) (251)(743) 64
Accrued warranty (5) (5)(8) (24)
Deferred revenue 224 (91)1,047 393
-------- --------
Net cash provided (used) by operating activities: (255) 26activities 216 1,248
-------- --------
Cash flows from investing activities:
Purchases of investments (3,413) (6,789)(7,854) (9,778)
Maturities of investments 2,935 6,9446,835 14,017
Purchases of property and equipment (684) (249)(1,370) (826)
Purchase costs related to asset acquisitions 500 (3,383)
-------- --------
Net cash usedprovided (used) by investing
activities (1,162) (94)(1,889) 30
-------- --------
Cash flows from financing activities:
Principal payments on capital leases (4) (3)(9) (8)
Proceeds from the issuance of common
stock under stock option plans 312 298416 447
-------- --------
Net cash provided by financing activities 308 295407 439
-------- --------
Net increase (decrease)increase(decrease) in cash and
(1,109) 227
cash equivalents (1,266) 1,717
-------- --------
Cash and cash equivalents, beginning of period 4,400 1,504
period
-------- --------
Cash and cash equivalents, end of period $3,291 $1,731
-------- --------$3,134 $3,221
-------- --------
The accompanying notes are an integral part of the
consolidated financial statements.
5
APPLIED DIGITAL ACCESS, INC.
Notes to Condensed Consolidated Financial Statements
March 31,June 30, 1998
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of Applied Digital Access, Inc. (the "Company" or
"ADA") and its wholly owned subsidiary: Applied Digital Access - Canada,
Inc. All significant intercompany balances and transactions have been
eliminated in consolidation. These financial statements have been
prepared in accordance with the interim reporting requirements of Form
10-Q, pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC"). Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements.
In the opinion of management, all adjustments (consisting of only normal
recurring adjustments) considered necessary for a fair presentation have
been included. Operating results for the three and six month periodperiods
ended March 31,June 30, 1998 are not necessarily indicative of the results that
may be expected for the year ending December 31, 1998. These financial
statements should be read in conjunction with the Company's audited
financial statements and notes thereto, together with Management's
Discussion and Analysis of Financial Condition and Results of
Operations, and Risks and Uncertainties, contained in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1997
filed with the SEC.
2. New Accounting Pronouncements
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 130, "Reporting of Comprehensive Income,"
effective January 1, 1998. This statement requires the disclosure of
comprehensive income and its components in a full set of
general-purpose financial statements. Comprehensive income is defined
as net income plus revenues, expenses, gains and losses that, under
generally accepted accounting principles, are excluded from net income.
The components of comprehensive income, which are excluded from net
income are foreign currency gains/losses and unrealized gains/losses on
securities and have been included in the calculation of comprehensive
income.
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("SFAS 131"), which supersedes
Statement of Financial Accounting Standards, "Financial Reporting of
Segments of a Business Enterprise" ("SFAS 14"). SFAS 131 changes current
practice under SFAS 14 by establishing a new framework on which to base
segment reporting and also requires interim reporting of segments
information. This statement is effective for fiscal years beginning after
December 15, 1997. This statement's interim reporting disclosures are not
required until the first quarter immediately subsequent to the fiscal year
in which SFAS 131 is effective.
3. Inventory
Inventory is valued at the lower of cost (determined using the first-in,
first-out method) or market. Inventory was as follows:
MARCHJUNE 30, DECEMBER 31,
1998 DECEMBER 31, 1997
-------------- ----------------------------- ------------
(DOLLARS IN THOUSANDS)
Raw materials $2,855$3,703 $3,419
Work-in-process 2,2202,021 2,223
Finished goods 716660 787
------- -------
5,791------ ------
6,384 6,429
Less inventory reserve (446)(460) (570)
------- -------
$5,345------ ------
$5,924 $5,859
------- -------
------- ------------- ------
------ ------
6
4. Per Share Information
The Company has adopted the provisions of SFASStatement of Financial
Accounting Standards No. 128, EARNINGS PER SHARE,"Earnings per Share" ("SFAS 128"),
effective December 31, 1997. SFAS No. 128 requires the presentation of basic
and diluted earnings per share. Basic EPS is computed by dividing income
available to common stockholders by the weighted average number of
common shares outstanding for the period. Diluted EPS is computed giving
effect to all dilutive potential common shares that were outstanding
during the period. Dilutive potential common shares consist of the
incremental common shares issuable upon the conversion of convertible
preferred stock (using the "if converted") method and exercise of stock
options and warrants for all periods. All prior period earnings per
share amounts have been restated to comply with SFAS No. 128.
In accordance with the disclosure requirements of SFAS No. 128, a
reconciliation of the numerator and denominator of basic and diluted EPS is
provided as follows (dollars in thousands, except per share amounts).
THREE MONTHS ENDED MARCH 31,Three Months Ended June 30, Six Months Ended June 30,
---------------------------- ---------------------------
1998 1997 -------- --------1998 1997
---- ---- ---- ----
Numerator - basis and diluted EPS:
Net Loss $(2,658) $(2,374) $(7,865) $(3,823)
Denominator - basic and diluted EPS:
Net loss $(5,208) $(1,449)
Denominator - basis and diluted EPS:
Weighted averageAverage common stock 12,675 12,452 12,650 12,381
outstanding 12,624 12,310
Basic and diluted earnings per share $ (0.41) $ (0.12)$(0.21) $(0.19) $(0.62) $(0.31)
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE STATEMENTS CONTAINED IN THIS FORM 10-Q THAT ARE NOT PURELY HISTORICAL ARE
FORWARD LOOKING STATEMENTS.STATEMENT. STATEMENTS WHICH USE THE WORDS "OBJECTIVE," "SEEK," "INTEND,"
"WILL," "ANTICIPATE," "CAN," "CONTINUE," AND "EXPECT" ARE FORWARD LOOKING
STATEMENTS. THESE FORWARD LOOKING STATEMENTS, INCLUDING STATEMENTS REGARDING
THE COMPANY'S (I) PLANS FOR DEVELOPMENT OR ACQUISITION OF NEW PRODUCTS OR
ENHANCEMENT OF EXISTING PRODUCTS, (II) STRATEGY AND (III) EXPANDED SALES AND
MARKETING EFFORTS, ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY AS OF
THE DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH
FORWARD LOOKING STATEMENT. IT IS IMPORTANT TO NOTE THAT THE COMPANY'S ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD LOOKING
STATEMENTS. AMONG THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY ARE THE FACTORS SET FORTH BELOW UNDER THE HEADING "RISKS AND
UNCERTAINTIES."
The following should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Risks and
Uncertainties", contained in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997 filed with the Securities and Exchange
Commission.
OVERVIEW
ADA is a leading provider of network performance management products that
include systems, software, and services used to manage the quality,
performance, availability and reliability of telecommunications service
providers' ("TSP") networks. ADA's products are designed to enable TSPs to
improve their quality of service, to increase productivity, to lower
operating expenses and to effectively deploy new services. ADA has
positioned its business to assist TSPs in addressing the rapidly increasing
demand for new services, higher bandwidth and access to the Internet. ADA's
systems and software provide network management functions such as circuit
provisioning, network configuration management, network performance
management, circuit testing, and traffic management of the public switched
network. ADA has addressed the industry demand for network management
products with a three-faceted approach: (1) network systems that provide
testing and performance monitoring functions as well as selected transport
functions; (2) network management software that enables TSPs to manage their
network operations; and (3) services that are customized to meet the evolving
needs of ourthe Company's TSP market. The Company has two business units: the
Network Systems business unit and the Network Management business unit. The
business units are the result of the evolution of the Company from a single
product line to multiple product lines. The Network Systems business unit is
built around the Company's test and performance management products and
services, including its T3AS Test and Performance Monitoring System ("T3AS"),
Centralized Test System ("CTS"), Remote Module, a DS1 network interface unit
("NIU"), and Protocol Analysis Access System ("PAAS"). The Network Management
business unit focuses on Operations Systems ("OS") software products,
including .Provisioner, Test OS, Graphical Test Assistant ("GTA"),
Sectionalizer, Fault Management System ("FMS"), Traffic Data Collection and
Engineering System ("TDC&E"), and OS design services.
RESULTS OF OPERATIONS
Revenue totaled $5,272,000$8,580,000 for the three months ended March 31,June 30, 1998, a 17%
decrease5%
increase from revenue of $6,388,000$8,164,000 for the three months ended March 31,June 30, 1997.
The decreaseincrease for the quarter was primarily due to decreased revenue fromthe result of increased sales of
the Company's network systems test and performance management products
partially offset by decreases sales of the Company's network management OS
design services. Revenue from the Company's network systems test and
performance management products for the three months ended June 30, 1998
totaled $5,014,000, a 13% increase from $4,430,000 in the same period last
year. Increased sales of the Company's Remote Module and T3AS products
accounted for the majority of the increase. Revenue from network management
OS software products and services totaled $2,155,000 for the quarterthree months ended March
31,June 30, 1998
totaled $3,566,000, a 41%4% decrease from $3,629,000$3,734,000 in the same prior year period.period last
year. The decrease resulted from decreased sales of the Company's OS design
services to Northern Telecom, Ltd. ("Northern Telecom") partiallysubstantially offset
by increased sales of the Company's . Provisioner.Provisioner, TDC&E and Test OS software
products. The Company acquireddecreased revenue from OS design services resulted from the
Company's acquisition of an exclusive license to Northern Telecom's DSS II
software product in June 1997. The Company markets and supports the DSS II product and
technology under the new name . Provisioner. Prior to the acquisition, the Company
provided OS design services to Northern Telecom that supported the DSS II
product. As a result of the acquisition, the Company's OS design services
business supporting DSS II shifted to a product-based business. The Company
now markets and supports the DSS II product based business.and technology under the new name
.Provisioner. Unlike revenue from OS software design services which is
recognized as the service is performed, revenue from OS software product
sales requires the satisfaction of specific delivery and acceptance criteria
prior to revenue recognition. As a result, the Company has experienced and
may in the future continue to experience increased quarterly revenue
fluctuations that could have a material adverse affect on the Company's
business, operating results and financial condition. See "Risks and
Uncertainties -- Fluctuations in Quarterly Operating Results; History of
Losses".
Revenue for the six months ended June 30, 1998 totaled $13,852,000, a 5%
decrease from
8
$14,552,000 in the same period last year. The decrease infor the six months
ended June 30, 1998 is a result of decreased revenue from the Company's
network management OS software products
anddesign services revenue was partiallysubstantially offset by
an increase inincreased sales of the Company's network systems test and performance
management products and services revenue.products. Revenue from the Company's network systems test and
performance management products totaled $3,117,000 for the quartersix months ended March 31,June 30, 1998
totaled $8,131,000, a 13% increase from $2,759,000$7,189,000 in the same quarter a year ago.period last
year. The netmajority of the increase was primarily the
result ofresulted from increased sales of the
Company's Remote Module product largelypartially offset by decreased sales of the
Company's T3AS systems.CTS product. Revenue from network management OS software products
and services for the six months ended June 30, 1998 totaled $5,721,000, a 22%
decrease from $7,363,000 in the same period last year. The decrease for the
six month period ended June 30, 1998 was the result of the same reasons
discussed above for the three month period ended June 30, 1998.
The Company believes that revenue infor the first quarter ofsix months ended June 30, 1998 was
also negatively impacted by customer order delays resulting from prolonged
contract negotiations with a current RBOC customer for the Company's T3AS,
CTS and seasonality of booking patterns
in the telecommunications industry that typically result in decreased orders
in calendar first quarter.Remote Module products. There can be no assuranceassurances that customer
order delays and seasonal factors will not continue in the future, each of which could have a
material adverse effect on the Company's business, operating results and
financial condition. SEE "RISKS AND UNCERTAINTIESSee "Risks and Uncertainties -- FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; HISTORY OF LOSSES" ANDFluctuations in
Quarterly Operating Results; History of Losses" and "-- CONCENTRATION OF MAJOR CUSTOMERS; TELEPHONE COMPANY QUALIFICATION
REQUIREMENTS.Concentration of
Major Customers; Telephone Company Qualification Requirements."
Gross profit totaled $1,608,000$4,839,000 for the three months ended March 31,June 30, 1998, a
decrease of 49%9% increase from $3,177,000$4,453,000 in the first quarter of 1997.same period last year. Gross profit as a
percent of revenue was 31%56.4% for the three months ended March 31,June 30, 1998
compared to 50%54.5% for the three months ended March 31,June 30, 1997. The decreaseincrease in
gross profit was primarily the result of decreased revenue, a product mix weighted toward the Company's
Remote Module NIU and CTS products which carry lower gross profit margins than
T3AS systems, and the impact of a $378,000 one-time inventory obsolescence
charge in the first quarter of 1998. The highly competitive NIU and CTS markets
are subject to severe pricing pressures which have contributed to significantly
lower overall gross profits on these products. In addition, the Company's
relatively fixed manufacturing overhead costs allocated over lower revenue
levels in the first quarter of 1998 resulted in lower overall gross profit
levels. The decrease in gross profit as a percent of revenue resulted from the
factors discussed above partially offset by an increase in gross profit as a
percent of revenue due to a shift in the majority of the
Company's OS software design services business to an OS software
product-based business.business and increased revenue. As a result of the
.Provisioner (formerly DSS II) license acquisition, from Northern Telecom, a majority of engineering
labor previously associated with OS design services revenue shifted from the
cost of revenue line to research and development operating expenses
supporting OS software product development. In addition, the Company's
relatively fixed manufacturing overhead costs allocated over greater revenue
levels in the second quarter of 1998 resulted in increased overall gross
profit levels. The increase in gross profit as a percent of revenue resulted
from the factors discussed above partially offset by increased sales of the
Company's Remote Module NIU product which carries a lower gross profit margin
than the Company's OS software, CTS and T3AS products. The highly
competitive NIU market is subject to severe pricing pressures which have
contributed to significantly lower overall gross profits on this product.
Gross profit totaled $6,447,000 for the six months ended June 30, 1998, a 16%
decrease from $7,630,000 in the same period last year. Gross profit as a
percent of revenue was 46.5% for the six months ended June 30, 1998 compared
to 52.4% in the same period last year. The decrease in gross profit was the
result of a product mix weighted toward the Company's lower-margin Remote
Module NIU product (described in the previous paragraph), decreased revenue
and the impact of a $378,000 one-time inventory obsolescence charge in the
first quarter of 1998. The Company's relatively fixed manufacturing overhead
costs allocated over lower revenue levels in the first half of 1998 resulted
in lower overall gross profit levels. The net decrease in gross profit as a
percent of revenue resulted from the factors discussed above substantially
offset by the shift in the Company's OS software design services business to
an OS software product-based business (described in the previous paragraph).
There can be no assurance that the Company will be able to maintain current
gross profit or gross profit as a percent of revenue levels. Factors which
may materially and adversely affect the Company's gross profit in the future
include its level of revenue, competitive pricing pressure in the
telecommunication network management market, fluctuations in quarterly order
bookings and revenue, new product introductions by the Company or its
competitors, potential inventory obsolesceobsolescence and scrap, possible recalls,
production or quality problems, timing of development expenditures, changes
in material cost, disruptions in sources of supply, regulatory changes,
capital spending, and changes in general economic conditions.
Research and development expenses totaled $3,544,000$3,777,000 for the three months
ended March 31,June 30, 1998, a 77%49% increase from $2,001,000$2,534,000 for the three months
ended March
31,June 30, 1997. Research and development expenses totaled $7,320,000
for the six months ended June 30, 1998, a 61% increase from $4,535,000 for
the six months ended June 30, 1997. The majority of the increase for the
three and six months ended June 30, 1998 was due to the shift in engineering
labor from cost of revenue to research and development operating expenses as
a result of the .Provisioner license acquisition discussed above in the gross
profit analysis and the addition of research and development personnel to
support the Joint Development Agreement ("JDA") with Northern Telecom Inc.
("Nortel"). and increased non-recurring engineering expenses related to the
JDA and other product developments. In September 1997, the Company entered
into the JDA with Nortel to develop unique synchronous optical network
("SONET") products for the telecommunications industry. Nortel and ADA both
contribute technology and development resources to projects conducted under
the JDA and equally share the development costs. For the quarterthree and six months
ended March 31,June 30, 1998, the Company's research and development expenses include
a $700,000$1 million and $1.7 million reduction, respectively, representing Nortel's
proportionate share of first quarter 1998 development costs incurred under the initial project
being conducted under the JDA. The Company believes that its future success
depends on its ability to maintain its technological leadership through
enhancement of its existing products and development of innovative new
products and services that meet customer needs. Therefore, the Company
intends to continue to make significant investments in research and product
development in association with planned development projects.
9
In the three and six months ended June 30, 1997 the Company recorded a charge of
approximately $1.6 million for purchased research and development costs related
to the acquisition of the .Provisioner license and related assets from Northern
Telecom.
Sales and marketing expenses totaled $2,280,000$2,551,000 for the three months ended March
31,June
30, 1998, a 56%34% increase from $1,458,000$1,902,000 for the three months ended March 31,June 30,
1997. Sales and marketing expenses totaled $4,831,000 for the six months ended
June 30, 1998, a 44% increase from $3,360,000 for the six months ended June 30,
1997. The majority of the increaseincreases for the three and six months is the result
of increased staff in sales and marketing to support increased sales and marketing efforts and new customer
accounts and increased personnel costs in technical support and marketing to
support the shift of a majority of the Company's OS design services business to
an OS software product basedproduct-based business. The Company expects that sales and
marketing expenses will continue to increase in absolute dollars as the Company
continues to hire additional sales, marketing and technical support personnel to
support both current products and planned product introductions.
General and administrative expenses totaled $1,119,000$1,295,000 for the three months
ended March 31,June 30, 1998, a 17% decrease20% increase from $1,355,000$1,082,000 for the three months ended
March 31,June 30, 1997. General and administrative expenses totaled $2,414,000 for the
six months ended June 30, 1998, a 1% decrease from $2,437,000 for the six months
ended June 30, 1997. The majority of the increase for the three months ended
June 30, 1998 resulted from increased expense related to the amortization of
intangible assets associated with the .Provisioner license acquisition that
occurred in June 1997 and increased legal expenses related to general
administrative issues. The majority of the decrease is due tofor the six months ended
June 30, 1998 resulted from lower consulting and recruiting costs offset by
increased expenses for the amortization of intangible assets and consulting costs
and a general decrease in administrative expenditures in the first quarter of
1998.increased legal
expenses. The Company expects that general and administrative expenses will
increase in absolute dollars in the future as the Company expands its internal
networking capabilities to support the integration of its geographically
distributed organization.
Interest income totaled $175,000$168,000 for the first quarter ofthree months ended June 30, 1998, a
28%37% decrease from $243,000$268,000 in the same quarter a year ago. Interest income
totaled $342,000 for the six months ended June 30, 1998, a 33% decrease from
$510,000 for the six months ended June 30, 1997. The decrease was the result of adecreases resulted from
decreased levellevels of cash investments compared to the same periodperiods last year.
For the three and six months ended March 31,June 30, 1998 and March 31,June 30, 1997, the Company
provided for income taxes related to the operations of the Company's Canadian
subsidiary, based on an annual effective Canadian tax rate of 46%. The Company
did not provide for U.S. income taxes for the three or six months ended March 31,June 30,
1998 or March 31,June 30, 1997 due to a net loss in both quarters.losses. The Company expects
9
to provide for
foreign, federal and state income taxes for 1998 at applicable statutory rates,
after giving effect to net operating losses, remaining available net operating
loss carryforwards, and any available tax credits.
As a result of the factors discussed above, the Company incurred a net loss
of $5,208,000,$2,658,000, or $.41$.21 per basic and diluted share, for the three months
ended March 31,June 30, 1998 compared to a net loss of $1,449,000,$2,374,000, or $.12$.19 per basic
and diluted share, for the three months ended March 31,June 30, 1997. The Company
incurred a net loss of $7,865,000, or $.62 per basic and diluted share, for
the six months ended June 30, 1998 compared to a net loss of $3,823,000, or
$.31 per basic and diluted share, for the six months ended June 30, 1997.
Excluding the above referenced $1.6 million charge for purchased research and
development associated with the .Provisioner license acquisition, the Company
would have incurred a net loss of $796,000, or $.06 per share, for the three
months ended June 30, 1997 and a net loss of $2,245,000, or $.18 per share,
for the six months ended June 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES
At March 31,June 30, 1998 the Company had approximately $12,611,000$13,010,000 in cash and
investments, compared to $13,179,000 at December 31, 1997, a decrease of
$568,000.$169,000. The decrease in cash and investments was primarily due tothe result of net
operating losses an $867,000 payment for the final installmentand, to a lesser extent, purchases of the DSS II
license acquisition from Northern Telecom, and capital equipment purchases.equipment.
Working capital decreased approximately 17% or $4,587,000totaled $20,235,000 at June 30, 1998, a decrease of $6,553,000
from $26,788,000 at December 31, 1997 to $22,201,000 at March 31, 1998.1997. The decrease in working capital was
primarily the result of net operating losses, the license payment
and decreased accounts receivable.receivable and
other current assets as well as an increase in accounts payable and other
current liabilities.
For the threesix months ended March 31,June 30, 1998 the Company's operating activities
used $255,000provided $216,000 in cash, primarily the result of a net operating loss in the
quarterdecreased accounts receivable
and the license paymentother current assets and increased accounts payable and other current
liabilities significantly offset by decreases in accounts
receivable and inventory, compared to $26,000 provided bynet operating activities
forlosses.
10
For the threesix months ended March 31, 1997.
For the three months ended March 31,June 30, 1998 cash used for capital expenditures
totaled approximately $684,000 compared to $249,000 for the three months ended
March 31, 1997.$1,370,000. Most of the capital equipment additions
were for software tool kits, computer workstations and lab equipment related
to the Company's expanded research and development efforts and the
Richardson, Texas office moving to a new location. The Company expects the
level of capital expenditures will increase in 1998 as a result of
investments in research and development projects.
Assuming no material changes in the Company's current operating plans, the
Company believes that cash generated from operations, and the total of its cash
and investments, will be sufficient to meet its working capital and capital
expenditure requirements for at least the next twelve months. Thereafter,However, the
Company may seek additional capital resources to meet working capital and
capital expenditure requirements. Additionally, significant additional capital
resources may be required to fund acquisitions of complementary businesses,
products or technologies. The Company may need to issue additional shares of
its capital stock or incur indebtedness in connection with any such acquisitions
or future operations. At present, the Company does not have any agreements or
commitments with respect to any such acquisitions.
The Company believes the impact of inflation on its business activities has not
been significant to date.
11
RISKS AND UNCERTAINTIES
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; HISTORY OF LOSSES. The Company has
experienced significant fluctuations in bookings, revenue and operating results
from quarter to quarter due to a combination of factors and expects such
fluctuations to continue in future periods. Factors that may cause the Company's
results of operations to vary significantly from quarter to quarter include but
are not limited to the size and timing of customer orders and subsequent
shipment of systems products and implementation of OS software products to major
customers, timing and market acceptance of product introductions or enhancements
by the Company or its competitors, customer order deferrals in anticipation of
new products, technological changes in the telecommunications industry,
competitive pricing pressures, changes in the Company's operating expenses,
personnel changes, management of a changing business, changes in the mix of
products sold and licensed, disruption in sources of supply, changes in pricing
policies by the Company's suppliers, regulatory changes, capital spending,
delays of payments by customers and general economic conditions. The Company
believes that in late 1997 it began experiencing seasonality in its product
shipments and OS software licensing. Generally, TSPs place more orders for
products and licenses in the second and fourth quarters, with the orders
significantly down in the first quarter and relatively flat in the third quarter
of each year. The Company expects that revenue may begin to reflect these
seasonal order cycles more closely, which could result in quarterly
fluctuations. There can be no assurance that the TSPs will not defer or delay
orders contrary to the historical seasonal pattern or that they will not change
their ordering patterns. Because of the relatively fixed nature of most of the
Company's costs, including personnel and facilities costs, any unanticipated
shortfall in revenue in any fiscal quarter would
10
have a proportionately greater
impact on the Company's operating income in that quarter and may result in
fluctuations in the price of the Company's Common Stock.
As the impact of the Company's Network Management business unit on the Company's
revenue increases, the Company may be faced with greater fluctuations in
operating income. The licensing and implementation of the Company's OS products
generally involves a significant capital expenditure and a commitment of
resources by prospective customers. Accordingly, the Company is dependent on its
customers' decisions as to the timing and level of commitment and expenditures.
In addition, the Company typically realizes a significant portion of license
revenues in the last weeks or even days of a quarter. As a result, the magnitude
of quarterly fluctuations in the Network Management business unit may not become
evident until late in, or after the close of, a particular quarter. In addition,
the Company does not recognize service revenues until the services are rendered.
The time required to implement the Company's OS products can vary significantly
with the needs of its customers and is generally a process that extends for
several months. Because of their complexity, larger implementations may take
multiple quarters to complete. Additionally, quarter-to-quarter product mix
variations, customer orders tending to be placed late in the quarter, and
competitive pressures on pricing could have a materially adverse effect on the
Company's operating results in any one quarter. The Company's expenses are based
in part on the Company's expectations as to future revenues and to a large
extent are fixed in the short term. If revenues do not meet expectations, the
Company's business, operations and financial condition are likely to be
materially adversely affected. The Company has experienced losses in the past
and there can be no assurance that the Company will not experience losses in the
future.
COMPETITION. Competition in the Company's markets is intense and is
characterized by rapidly changing technologies, conformance with evolving
industry standards, frequent new product introductions and enhancements,
rapid changes in customer requirements, and price-competitive bidding. To
maintain and improve its competitive position, the Company must continue to
develop and introduce, in a timely and cost-effective manner, new products
and features that keep pace with increasing customer requirements. The
Company expects competition in its markets to increase from existing
competitors and from other companies which may enter the Company's current or
future markets. The Company believes the principal competitive factors
affecting the market for its network systems test and performance monitoring
products are product features, price, conformance with BellCore and other
industry transmission standards and specifications, performance and
reliability, technical support, and the maintenance of close working
relationships with customers. The Company's network systems products,
especially CTS and Remote Module, are currently focused in highly competitive
market niches. The environment for CTS and Remote Module is fiercely
competitive with respect to price, product features, established
customer-supplier relationships and conformance with industry standards. The
Company believes the current competitors that provide partial solutions to
either performance monitoring or testing of the DS3, and the DS1 and DS0
circuits that make up the DS3 circuit, include Hekimian Laboratories, Inc.,
Telecommunications Techniques Corporation, Anritsu Wiltron Corporation and
some of the manufacturers of large transmission equipment and digital
cross-connect test and performance monitoring equipment such as Lucent
Technologies, Inc. ("Lucent"), Alcatel Data Networks, Ericsson Communication
Inc. ("Ericsson"), ADC Telecommunications, and Tellabs, Inc. The Company's
Remote Module product addresses the DS1 NIU market in which current
competitors include Westell Inc., Teltrend Inc., and Troncom, Inc. Many of
these competitors have significantly greater technical, financial,
manufacturing, and marketing resources than the Company. In addition, in
1997, ANSI adopted certain of the Company's technology as an industry
standard. As a result, the Company is obligated to grant licenses of this
technology to third parties, including competitors, on fair and equitable
terms and maythus, also facefaces competition from the licensees of its own
technology.
12
The Company believes there are an increasing number of current competitors in
the network management OS market that provide network management OS applications
for circuit and services provisioning and services management, testing and test
management, fault and alarm management and surveillance, network and circuit
performance monitoring and traffic management telecommunications functions. The
OS market is characterized by a wide range of companies that have varying
degrees of market influence. The nature of the network management OS market is
such that improved technologies and tool sets have made the barriers to entry in
this market relatively small resulting in fierce competition. The principal
competitive factors affecting the Company's network management OS products
include product quality, performance, price, customer support, corporate
reputation, and product features such as scalability, interoperability,
functionality and ease of use. The Company's existing and potential competitors
offer a variety of solutions to address network management needs. Competitors
include suppliers of standard off-the-shelf products, custom software
developers, large telecommunications equipment vendors that offer software
applications to manage their own and other suppliers' equipment, such as Lucent,
Northern Telecom, Inc., Fujitsu, and Ericsson, hardware and software vendors,
including IBM, Sun Microsystems and Hewlett Packard, and providers of specific
network management and OS applications, such as BellCore, Objective Systems
Integrators, Inc., TCSI Corporation, Architel Systems Corporation and others.
Additionally, many of the Company's existing and potential customers
continuously evaluate whether they should develop their own network management
and OS applications or license them from outside vendors. The Company expects
competition in the OS market to increase significantly in the future.
Additionally, several of the Company's competitors have long-established
relationships with the Company's current and prospective 11
customers which may
adversely affect the Company's ability to successfully compete for business with
these customers. In addition, product price reductions resulting from market
share penetration initiatives or competitive pricing pressures could have a
material and adverse effect on the Company's business, operating results, and
financial condition. There can be no assurance that the Company will have the
financial resources, technical expertise or manufacturing, marketing,
distribution and support capabilities to compete successfully in the future.
CONCENTRATION OF MAJOR CUSTOMERS; TELEPHONE COMPANY QUALIFICATION REQUIREMENTS.
The market for the Company's products and services currently consists of the
five regional Bell operating companies ("RBOCs"), long distance or
"interexchange carriers" ("IXCs"), local exchange carriers ("LECs"), competitive
local exchange carriers ("CLECs"), competitive access providers ("CAPs"),
Internet service providers ("ISPs"), enterprise networks and other TSPs.
Historically, the Company's marketing efforts focused primarily on the RBOCs,
which accounted for approximately 99%, 73%, 31%, and 50% of the Company's total
revenue in 1995, 1996, 1997, and the first quartersix months of 1998, respectively.
However, the Company's strategy has been to focus its efforts on diversifying
its customer base. RBOCs, IXCs and enterprise customers accounted for 31%, 27%
and 20% of the Company's total revenue in 1997, and 50%, 29%35% and 0% of the
Company's total revenue for the first quarter insix months of 1998. The increased customer
base is primarily a function of the Company's acquisitions in 1996 of Applied
Computing Devices, Inc. ("ACD") and the Special Services Network ("SSN")
division of MPR Teltech Inc. and the acquisition of the DSS II license from
Northern Telecom in 1997. As a result of these acquisitions, the Company added
OS related products and services that the Company has been able to market to a
wider group of customers. In addition, the Company added a number of TSPs that
were new customers to the Company. To date, the OS customers tend to be IXCs,
CAPs and enterprise vendors who have not invested in legacy systems from
BellCore. While the Company believes its customer base diversification is
beneficial to the Company, there can be no assurances that the Company will be
able to continue expanding the distribution of its OS and system products and
services to additional prospective customers. In addition, the Company's
customers are significantly larger than the Company and may be able to exert a
high degree of influence over the Company. The loss of one or more of the
Company's major customers, the reduction of orders, a delay in deployment of the
Company's products, a labor strike at one or more of the Company's major
customers, such as the recent Bell Atlantic strike, or the cancellation,
modification or non-renewal of license or maintenance agreements could
materially and adversely affect the Company's business, operating results and
financial condition. BellSouth, Bell Atlantic, Ameritech, Southwestern Bell and
MCI have entered into purchase contracts with the Company. MCI has also entered
into license agreements with the Company. Other TSPs purchase the Company's
network system products and license OS products under standard purchase orders.
Since the RBOC and MCI contracts may be terminated at either the customer's or
the Company's convenience, the Company believes that the purchase contracts and
license agreements are not materially different than purchasing or licensing
under purchase orders. Prior to selling products to RBOCs and certain other
TSPs, a vendor must often first undergo a product qualification process with the
TSP for its products. Although the qualification process for a new product
varies somewhat among these prospective customers, the Company's experience is
that the process often takes a year or more. Currently, the five RBOCs, MCI,
Worldcomm and several other customers have qualified the Company's products,
when required. Any failure on the part of any of the Company's customers to
maintain their qualification of the Company's products, failure of any of the
TSPs to deploy the Company's products, or any attempt by any of the TSPs to seek
out alternative suppliers could have a material adverse effect on the Company's
business, operating results and financial condition. There can be no assurance
that the Company's products will be qualified by new customers, or that such
qualification will not be significantly delayed. Furthermore, work force
reductions and staff reassignments by some of the Company's customers have in
13
the past delayed the product qualification process, and the Company expects
such reductions and reassignments to continue in the future. There can be no
assurance that such reductions and reassignments will not have a material
adverse effect on the Company's business, operating results and financial
condition.
HIGH DEPENDENCE ON TWO PRODUCT LINES. Historically, the majority of the
Company's revenue has been derived from the sale of its network systems products
and services. However, as a result of acquisitions completed in 1996 and 1997,
the Company added additional product lines and derived revenue from a product
mix of both network systems products and services and network management OS
software products and services. Revenue from network systems products and
services, including CTS, T3AS and Remote Module, generated 74%, 50% and 59% of
the Company's total revenues in 1996, , 1997 and first quartersix months of 1998,
respectively. Revenue from network management OS products and services,
including software design services, .Provisioner, Test OS, TDC&E and FMS,
generated 26%, 50% and 41% of the Company's total revenue in 1996, 1997 and
first quartersix months of 1998, respectively. However, there can be no assurance that
the Company's future revenues will not be heavily dependent on sales from one of
its primary product lines. The Company is investing in the expansion of these
two product lines through the enhancement, development and marketing of its
Remote Module, CTS, PAAS, T3AS and OS products. Failure by the Company to
enhance either its existing products and services or to develop new product
lines and new markets could materially and adversely affect the Company's
business, operating results and financial condition. There is no assurance that
the Company will be able to develop and market new products and technology or
otherwise diversify its source of revenue.
12
MANAGEMENT OF CHANGING BUSINESS. As a result of acquisitions in 1996, the
Company obtained additional office space and hired additional personnel in both
Terre Haute, Indiana and British Columbia, Canada to support the business
operations of the new products, services and technologies acquired. The Company
continues to face significant management challenges related to the integration
of the business operations of the new organizations' personnel, products,
services and technologies acquired. In 1996, the Company formed two business
units: the Network Systems business unit and the Network Management business
unit. The business units are a result of the evolution of the Company from a
single product line to multiple product lines. The Network Management business
unit focuses on OS software products including .Provisioner, Test OS, GTA,
Sectionalizer, FMS, TDC&E, and OS design services. The Network Systems business
unit is built around the Company's test and performance management products,
including T3AS, CTS, Remote Module and PAAS products. There can be no assurance
that the Company will be successful in managing its new business unit structure.
In June 1997, the Company acquired a license from Northern Telecom to its DSS II
software product and technology. The Company markets and supports the DSS II
product and technology under the new name .Provisioner. The Company is
integrating the licensed technology into new product development. The
acquisition of the software license has generated a shift in the Company's
Canadian subsidiary's operations from a software design services business to a
product business and the transition will likely place a significant strain on
the Company's management, information systems and operations and there can be no
assurance that such a transition can be successfully managed. In addition, in
November 1997, the Company opened an office in Richardson, Texas to expand new
product development efforts. The acquisitions and resultant growth in the
Company's infrastructure have placed, and are expected to continue to place, a
significant strain on the Company's management, information systems and
operations. The strain experienced to date has chiefly been in management of a
geographically distributed organization, and in hiring sufficient numbers of
qualified personnel to support the expansion of the business. The Company may
also make future acquisitions where it believes it can acquire new products or
otherwise rapidly enter new or emerging markets. Mergers and acquisitions of
high technology companies are inherently risky and can place significant strains
on the Company's management, information systems and operations. The Company is
not able to forecast additional strains that may be placed on the Company's
management, information systems and operations as a result of recent or future
acquisitions or in the future. The Company's potential inability to manage its
changing business effectively could have a material adverse effect on the
Company's business, operating results, and financial condition.
CUSTOMER MERGERS. Of the nine major TSPs currently involved in or that have
recently completed merger transactions, seven are customers of the Company.
Several of the mergers involve companies that purchase network systems and
software products and services from the Company's competitors. Consequently,
the completion of certain of these mergers may result in the loss of
business and customers for the Company. Additionally, the impact of capital
spending constraints during the merger transitions and thereafter could
have a material adverse effect on the Company's business, operating results
and financial condition. In addition, future merger transactions involving or
contemplated by the Company's current or prospective customers may cause
increased concentration among some of the Company's major customers or delays
or decreases in their capital spending decisions, any of which could have a
material adverse effect on the Company's business, operating results and
financial condition.
RAPID TECHNOLOGICAL CHANGE AND DEPENDENCE ON NEW PRODUCTS. The market for
the Company's products is characterized by rapid technological advances,
evolving industry transmission standards, changing regulatory environments,
price-competitive bidding, changes in customer requirements, and frequent new
product introductions and enhancements. The introduction
14
of telecommunications network performance management products involving
superior technologies or the evolution of alternative technologies or new
industry transmission standards could render the Company's existing products,
as well as products currently under development, obsolete and unmarketable.
The Company believes its future success will depend in part upon its ability,
on a cost-effective and timely basis, to continue to enhance its products, to
develop and introduce new products for the telecommunications network
performance management market, to address new industry standards and changing
customer needs and to achieve broad market acceptance for its products. In
particular, the Company anticipates that the SONET and SDH optical
transmission standards will become the industry transmission standards over
the coming years for the North American and international networks,
respectively. The Company's current network circuit test and performance
monitoring systems do not address either the SONET or SDH transmission
standards. The Company intends to extend its current products and develop new
products to accommodate such new transmission standards and other advances in
technology, as they evolve. The widespread adoption of SONET and/or SDH as
industry transmission standards before the Company is able to successfully
develop products which address such transmission standards could in the
future adversely affect the sale and deployment of the Company's products.
The Company's OS products are designed to operate on a variety of hardware and
software platforms and with a variety of databases employed by its customers in
their networks. The Company must continually modify and enhance its OS products
to keep pace with changes in hardware and software platforms and database
technology. As a result, uncertainties related to the timing and nature of new
product announcements, introductions or modifications by systems vendors,
particularly, Sun Microsystems and Hewlett Packard, and by vendors of relational
database software, particularly, Oracle Corporation, could materially adversely
impact the
13
Company's business, operating results and financial condition. In
addition, the failure of the Company's OS products to operate across the various
existing and evolving versions of hardware and software platforms and database
environments employed by customers would have a material adverse effect on the
Company's business, operating results and financial condition.
The introduction or announcement of products by the Company or one or more of
its competitors embodying new technologies, or changes in industry standards or
customer requirements, could render the Company's existing products and
solutions obsolete and unmarketable. The introduction of new or enhanced
versions of its products requires the Company to manage the transition from
older products in order to minimize disruption in customer ordering. There can
be no assurance that the introduction or announcement of new product offerings
by the Company or its competitors will not cause customers to defer licensing or
purchasing of existing Company products or engaging the Company's services. Any
deferral of revenues could have a material adverse effect on the Company's
business, operating results and financial condition.
Any failure by the Company to anticipate or respond on a cost-effective and
timely basis to technological developments, changes in industry transmission
standards or customer requirements, or any significant delays in product
development or introduction could have a material adverse effect on the
Company's business. There can be no assurance that the Company will be able to
successfully develop new products to meet customer requirements, to address new
industry transmission standards and technological changes or to respond to new
product announcements by others, or that such products will achieve market
acceptance.
DEPENDENCE ON SUPPLIERS AND SUBCONTRACTORS. Certain components used in the
Company's T3AS, CTS, PAAS and Remote Module products, including its VLSI ASICs,
are available from a single source and other components are available from only
a limited number of sources. The Company has few supply agreements and generally
makes its purchases with purchase orders. Further, certain components require an
order lead time of up to one year. Other components that currently are readily
available may become difficult to obtain in the future. Failure of the Company
to order sufficient quantities of these components in advance could prevent the
Company from increasing production in response to customer orders in excess of
amounts projected by the Company. In the past, the Company has experienced
delays in the receipt of certain of its key components, which have resulted in
delays in product deliveries. There can be no assurance that delays in key
component and part deliveries will not occur in the future.
The inability to obtain sufficient key components as required or to develop
alternative sources if and as required in the future could result in delays
or reductions in product shipments, which in turn could have a material
adverse effect on the Company's customer relationships and operating results.
Additionally, the Company uses third-party subcontractors for the manufacture
of its sub-assemblies, some of which are located in Asia. This reliance on
third-party subcontractors involves several risks, including the potential
absence of adequate capacity, the unavailability of or interruption in access
to certain process technologies, and reduced control over product quality,
delivery schedules, manufacturing yields and costs. The Company believes that
the recent significant economic downturns in Asia may increase these risks
with respect to its Asian third-party subcontractors. Shortages of raw
materials or production capacity constraints at the Company's subcontractors
could negatively affect the Company's ability to meet its production
obligations and could result in increased prices for affected parts.
15
HIGH INVENTORY LEVELS AND NEED TO MAKE ADVANCE PURCHASE COMMITMENTS. To respond
to anticipated customer demand, the Company maintains high inventory levels.
Maintaining high inventory levels substantially increases the risk that the
Company's profitability and results of operations may from time to time be
materially and adversely affected by inventory obsolescence. To procure adequate
supplies of certain products or components, the Company must make advance
commitments to purchase relatively large quantities of such products or
components in a number of circumstances. A large portion of the Company's
purchase commitments consists of custom parts, some of which are sole-source
such as VLSI ASICs, for which there is no alternative use or application. The
inability of the Company to sell such products or incorporate such components in
its other products could have a material adverse effect on the Company's
business, operating results and financial condition.
YEAR 2000 COMPLIANCE. Many installed computer systems and software products are
coded to accept only two digit entries in the date code field. As the year 2000
approaches, these code fields will need to accept four digit entries to
distinguish years beginning with "19" from those beginning with "20" dates. As a
result, in less than two years, computer systems and/or software products used
by many companies may need to be upgraded to comply with such year 2000
requirements. The Company is assessing its products, as well as its internal
management information systems in order to identify and modify those products
and systems that are not year 2000 compliant. Based upon a preliminary
assessment, the Company expects such modifications will be made on a timely
basis and does not believe that the cost of such modifications will have a
material effect on the Company's operating results or financial condition. There
can be no assurance, however, that the Company's preliminary assessment is
accurate. If the Company encounters any unanticipated
14
delays in or costs
associated with the implementation of such changes, in particular with
respect to the Company's products, the Company's business, operating results
and financial condition could be materially adversely affected.
PRODUCT RECALL AND DEFECTS. Producers of telecommunications network performance
management products such as those being marketed by the Company, are often
required to meet rigorous standards imposed by BellCore, the research and
development entity created following the divestiture of AT&T to provide ongoing
engineering support to the RBOCs. In addition, the Company must meet specialized
standards imposed by many of its customers. The Company's products are also
required to interface in a complex and changing environment with
telecommunication network equipment made by numerous other suppliers. Since many
of these suppliers are competitors of the Company, there can be no assurance
that they will cooperate with the Company. In the event there are material
deficiencies or defects in the design or manufacture of the Company's systems,
or if the Company's systems become incompatible with existing third-party
network equipment, the affected products could be subject to a recall. The
Company has experienced two significant product recalls in its history and there
can be no assurance that the Company will not experience any product recalls in
the future. The cost of any subsequent product recall and associated negative
publicity could have a material adverse effect on the Company's business,
operating results and financial condition. In addition, the Company's
development and enhancement of its complex OS products entails substantial risks
of product defects. There can be no assurance that software errors will not be
found in existing or new products or releases after commencement of commercial
licensing, which may result in delay or loss of revenue, loss of market share,
failure to achieve market acceptance, or may otherwise adversely impact the
Company's business, operating results and financial condition.
GOVERNMENT REGULATION. The majority of the Company's customers operate within
the telecommunications industry which is subject to regulation in the United
States and other countries. Most of the Company's customers must receive
regulatory approvals in conducting their businesses. Although the
telecommunications industry has recently experienced government deregulation,
there is no assurance this trend will continue. Moreover, the federal and state
courts and the FCC continue to interpret and clarify the provisions of the 1996
Telecommunications Act. In fact, recent regulatory rulings have affected the
ability of the Company's customers to enter new markets and deliver new services
which could impact their ability to make significant capital expenditures. The
effect of judicial or regulatory rulings by federal and state agencies on the
Company's customers may adversely impact the Company's business, operating
results and financial condition.
POTENTIAL COMPETITION FROM RBOCS. The 1996 Telecommunications Act has generally
eliminated the restrictions which had previously prohibited the RBOCs from
manufacturing telecommunications equipment (subject to first satisfying certain
conditions designed to facilitate local exchange competition and receipt of
prior approval by the FCC). These restrictions had been imposed under the
Modification of Final Judgment, which governed the structure of the 1984
divestiture by AT&T of its local operating telephone company subsidiaries. The
passage of the 1996 Telecommunications Act may have an adverse effect on the
Company because the RBOCs, which are presently the Company's principal
customers, may now become manufacturers of some or all of the products currently
manufactured and sold by the Company and, consequently, may no longer purchase
telecommunications equipment produced by the Company at the levels historically
experienced.
16
PROPRIETARY TECHNOLOGY. The Company relies on a combination of technical
leadership, patent, trade secret, copyright and trademark protection and
non-disclosure agreements to protect its proprietary rights. Although the
Company has pursued and intends to continue to pursue patent protection of
inventions that it considers important and for which such protection is
available, the Company believes its success will be largely dependent on its
reputation for technology, product innovation, affordability, marketing
ability and response to customers needs. Currently, the Company has elevenfourteen
U.S. patents granted and threefive U.S. patent applications allowed. OneFour of the
granted patents relates to the Company's Remote Module product.
Additionally, the Company has sixfive pending U.S. patent applications and four
international (Patent Cooperation Treaty and European Patent Office)
applications on file covering various circuit and system aspects of its
products. There can be no assurance that the Company will be granted
additional patents or that, if any patents are granted, they will provide the
Company's products with significant protection or will not be challenged.
Additionally, should a third party challenge any of the Company's current or
future patents, there can be no assurance that the Company will be successful
in defending its patents or that any litigation, regardless of outcome, will
not result in substantial cost to and diversion of efforts by the Company. As
part of its confidentiality procedures, the Company generally enters into
non-disclosure agreements with its employees, consultants and suppliers, and
limits access to and distribution of its proprietary information. Despite
these precautions, it may be possible for a third party to copy or otherwise
obtain and use the Company's technology without authorization. Accordingly,
there can be no assurance that the Company will be successful in protecting
its proprietary technology or that ADA's proprietary rights will preclude
competitors from developing products or technology equivalent or superior to
that of the Company.
15
The telecommunications industry is characterized by the
existence of a large number of patents and frequent litigation based on
allegations of patent infringement. The Company is currently not party to any
litigation regarding any patents or other intellectual property rights.
However, there can be no assurance that third parties will not assert
infringement claims against the Company in the future or that any such
assertions will not result in costly litigation or require the Company to
obtain a license to intellectual property rights of such parties. There can
be no assurance that any such licenses would be available on terms acceptable
to the Company, if at all. Further, litigation, regardless of outcome, could
result in substantial cost to and diversion of efforts by the Company. Any
infringement claims or litigation by or against the Company could materially
and adversely affect the Company's business, operating results and financial
condition. Moreover, the laws of some foreign countries do not protect the
Company's proprietary rights in the products to the same extent as do the
laws of the United States.
The Company relies on certain software that it licenses from third parties,
including software that is integrated with internally developed software and
used in the Company's products to perform key functions. There can be no
assurance that these third party software licenses will continue to be available
to the Company on commercially reasonable terms or that such licenses will not
be terminated. Although the Company believes that alternative software is
available from other third party suppliers, the loss of or inability of the
third parties to enhance their products in a timely and cost-effective manner
could result in delays or reductions in product shipments by the Company until
equivalent software could be developed internally or identified, licensed, and
integrated, which could have a material adverse effect on the Company's
business, operating results and financial condition.
DEPENDENCE ON KEY PERSONNEL. The success of the Company is dependent, in part,
on its ability to attract and retain highly qualified personnel. Competition for
such personnel is intense and the inability to attract and retain additional key
employees or the loss of one or more current key employees could adversely
affect the Company. There can be no assurance that the Company will be
successful in hiring or retaining requisite personnel.
VOLATILITY OF STOCK PRICE. The Company's future earnings and stock price may
be subject to significant volatility, particularly on a quarterly basis. Any
shortfall in revenue or earnings from levels expected by public market analysts
and investors could have an immediate and significant adverse effect on the
trading price of the Company's Common Stock. Fluctuation in the Company's stock
price may also have an effect on customer decisions to purchase the Company's
products which could have a material adverse effect on the Company's business,
operating results and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
1617
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGSPROCEEDINGS.
From time to time, ADA may be involved in litigation relating to claims
arising out of its operations in the normal course of business. As of the
date of this Quarterly Report, the Company is not a party to any legal
proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIESSECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.HOLDERS.
The Annual Meeting of Stockholders was held on May 21, 1998. At the
meeting, the stockholders elected Kenneth E. Olson, Christopher B. Paisley,
Peter P. Savage and Edward F. Tuck as directors of the Company for the
ensuing year and until their respective successors are elected. The
following tables sets forth the results of voting in this election:
FOR AGAINST WITHHELD
--- ------- --------
Kenneth E. Olson 10,280,182 -- 115,231
Christopher B. Paisley 10,284,820 -- 110,593
Peter P. Savage 10,283,972 -- 111,441
Edward F. Tuck 10,287,458 -- 107,955
In addition, the stockholders voted on the following proposals:
(a) To approve the adoption of the Company's 1998 Employee Stock Purchase
Plan:
FOR AGAINST ABSTAIN
--- ------- -------
9,093,861 1,245,499 56,053
This proposal was approved.
(b) To approve the adoption of the amendment to the Company's 1994 Stock
Option/Stock Issuance Plan:
FOR AGAINST ABSTAIN
--- ------- -------
8,170,229 2,177,409 47,525
This proposal was approved.
(c) To ratify the appointment of Coopers and Lybrand L.L.P. as the
Company's independent public accountants for the fiscal year ending
December 31, 1998:
FOR AGAINST ABSTAIN
--- ------- -------
10,314,229 42,315 38,869
This proposal was approved.
ITEM 5. OTHER INFORMATION
None.INFORMATION.
Proposals of stockholders intended to be presented at the next Annual
Meeting of the Stockholders of the Company must be received by the Company
at its offices at 9855 Scranton Road, San Diego, CA, 92121 not later than
December 14, 1998.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K8-K.
(a) Exhibits.
EXHIBIT
NUMBER DESCRIPTION
-------- ------------------------------
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.3(1) Certificate of Incorporation of the Company.
3.4(2) Certificate of Agreement of Merger of the Company and its
California predecessor.
3.5(1) Bylaws of the Company.
10.1* Agreement between Telesector Resources Group, Inc. ("Bell Atlantic")
and Applied Digital Access, Inc. executed July 15, 1998.
27.1 Financial Data Schedule.
- ----------
(1) Incorporated by reference to the Company's Current Report on Form 8-K
dated December 23, 1997 (File No. 0-23698).
(2) Incorporated by reference to the Company's Current Report on Form 8-K/A
dated January 12, 1998 (File No. 0-26398).
* Certain confidential portions of this Exhibit were omitted by means of
deleting the text and replacing it with an asterisk (the "Mark"). This
Exhibit has been filed separately with the Secretary of the Commission
without the Mark pursuant to the Company's Application Requesting
Confidential Treatment under rule 24b-2 under the Securities Exchange Act of
1934.
(b) Reports on Form 8-K.
None.
1719
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Applied Digital Access, Inc.
Date: May 15,August 14, 1998 /s/ PETER P. SAVAGE
----------------------------
Peter P. Savage
Director
President and Chief Executive Officer
Date: May 15,August 14, 1998 /s/ JAMES L. KEEFE
----------------------------
James L. Keefe
Vice President Finance and
Administration and Chief
Financial Officer
18
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