UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998MARCH 31, 1999
[ ] 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]X No
[ ]--- ---
There were 12,832,19713,028,849 shares of the registrant'sRegistrant's Common Stock, $.001$0.001 par value,
outstanding as of October 31, 1998.
1April 30, 1999.
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, 1999 and December 31, 1998..............................................................3
Condensed Consolidated Statement of Operations for the
three months ended March 31, 1999 and March 31, 1998..............................................4
Condensed Consolidated Statement of Cash Flows for the three
months ended March 31, 1999 and March 31, 1998....................................................5
Notes to Condensed Consolidated Financial Statements..............................................6 - 9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................................................10-14
Risks and Uncertainties...........................................................................14-21
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................................21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................................22
Item 2. Changes in Securities and Use of Proceeds.........................................................22
Item 3. Defaults Upon Senior Securities...................................................................22
Item 4. Submission of Matters to a Vote of Security Holders...............................................22
Item 5. Other Information.................................................................................22
Item 6. Exhibits and Reports on Form 8-K..................................................................22
SIGNATURES.....................................................................................................23
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
APPLIED DIGITAL ACCESS, INC.
Condensed Consolidated Balance Sheets
at September 30, 1998
and December 31, 1997 . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Operations for the
three and nine months ended September 30, 1998 and
September 30, 1997. . . . . . . . . . . . . . . . . . . . . . . . 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 1998 and September 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 . . . . . . . . . . . . . . . . . . . . .11-18
Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . 20
Item 2. Changes in Securities . . . . . . . . . . . . . . . . . . . . . . 20
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . . . 20
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . 20
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . 20
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . 20
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
2
PART I
FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)- -------------------------------------------------------------------------------
SEPTEMBER 30,MARCH 31, DECEMBER 31,
1999 1998
1997
------------- ------------
(DOLLARS IN THOUSANDS)
ASSETS---- ----
Unaudited
(Dollars in Thousands,
except per share data)
ASSETS
Current assets:
Cash and cash equivalents $ 5,60414,733 $ 4,400
Investments 6,544 8,779
Accounts12,513
Trade accounts receivable, net 5,746 12,9815,512 6,111
Inventory, net 7,884 5,8594,645 5,679
Deferred income taxes 130 130
Prepaid expenses and other current assets 1,825 3,775
------------- ------------1,893 1,700
------- -------
Total current assets 27,733 35,92426,913 26,133
Property and equipment, net 5,921 6,1653,997 5,466
Intangible assets, net 964 1,247
Deferred income taxes 1,510 1,426
1,372
Other, net 1,500 2,822
------------- ------------------- -------
Total assets $ 36,58033,384 $ 46,283
------------- ------------
------------- ------------34,272
------- -------
------- -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,8992,819 $ 3,478
Acquisition payments due to licensor -- 8672,922
Accrued expenses 1,489 1,9972,346 2,374
Accrued warranty 1,288 1,323expense 1,189 1,264
Deferred revenue 2,188 1,471
------------- ------------4,337 2,817
------- -------
Total current liabilities 9,864 9,136
Obligations under capital leases, net of
current portion 0 15
------------- ------------
Total liabilities 9,864 9,151
------------- ------------10,691 9,377
------- -------
Shareholders' equity:
Preferred stock, $.001no par value,value; 7,500,000 shares authorized,authorized;
no shares issued -- --
Common stock, $.001 par value,value; 30,000,000 shares authorized, 12,825,992authorized;
13,026,842 and 12,605,08212,909,315 shares issued and outstanding at
September 30, 1998March 31, 1999 and December 31, 1997,1998, respectively 52,215 51,61013 13
Additional paid-in capital 2,519 2,492
Unrealized gain on investments 70 8455,060 54,897
Accumulated other comprehensive income 124 163
Accumulated deficit (28,088) (17,054)
------------- ------------(32,504) (30,178)
------- -------
Total shareholders' equity 26,716 37,132
------------- ------------22,693 24,895
------- -------
Total liabilities and shareholders' equity $ 36,58033,384 $ 46,283
------------- ------------
------------- ------------34,272
------- -------
------- -------
The accompanying notes are an integral part
of the
condensed consolidatedthese financial statements.
3
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)Condensed Consolidated Statements of Operations and Comprehensive Loss
- --------------------------------------------------------------------------------
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ ------------------------MARCH 31,
1999 1998
1997 1998 1997
----------- ---------- ----------- ----------
(AMOUNTS IN THOUSANDS, (AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS) EXCEPT PER SHARE AMOUNTS)(Dollars in thousands,
except per share data)
(Unaudited)
Revenue $6,764 $8,750 $20,616 $23,302$ 7,202 $ 5,272
Cost of revenue 2,747 3,873 10,152 10,795
-----------2,894 3,664
---------- ----------- ----------
Gross profit 4,017 4,877 10,464 12,5074,308 1,608
---------- ----------
Operating expenses:
Research and development 3,583 1,963 10,904 6,498
In-process research
and development
related to asset
acquisition3,185 3,544
Restructuring charge 1,335 --
Engineering reimbursement (1,361) -- -- 1,578
Sales and marketing 2,458 2,230 7,289 5,5902,279 2,280
General and administrative 1,258 1,379 3,672 3,816
-----------1,261 1,119
---------- ----------- ----------
Total operating expenses 7,299 5,572 21,865 17,482
-----------6,699 6,943
---------- ----------- ----------
Operating loss (3,282) (695) (11,401) (4,975)(2,391) (5,335)
Interest income 165 236 508 746120 175
Other income (expense),expense, net (14) (24) (31) (13)
-----------(1) (11)
---------- ----------- ----------
Loss before income taxes (3,131) (483) (10,924) (4,242)(2,272) (5,171)
Provision for income taxes 54 37
43 110 107
----------- ---------- ----------- ----------
Net loss $(3,168) $(526) $(11,034) $(4,349)
-----------$ (2,326) $ (5,208)
---------- ----------- ----------
----------- ---------- ---------------------
Comprehensive loss $ (2,365) $ (5,127)
---------- ----------
---------- ----------
Net loss per share, $(0.25) $(0.04) $(0.87) $(0.35)
-----------basic and diluted $ (.18) $ (.41)
---------- ----------- ----------
----------- ---------- ----------- ----------
Number of sharesShares used in per share computations 12,712 12,512 12,671 12,425
Comprehensive loss $(3,171) $(509) $(11,049) $(4,318)
-----------12,916,606 12,624,462
---------- ----------- ----------
----------- ---------- ----------- ----------
The accompanying notes are an integral part
of the
condensed consolidatedthese financial statements.
4
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)Condensed Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------
FOR THE NINETHREE MONTHS ENDED SEPTEMBER 30,
-------------------MARCH 31,
1999 1998
1997
------- -----
(DOLLARS IN THOUSANDS)-------- --------
Dollars in Thousands
(Unaudited)
Cash flows from operating activities:CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(11,034) $(4,349)$ (2,326) $ (5,208)
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 2,706 2,167953 918
Writeoff of assets associated with restructuring 866 --
Other (88) 87(40) 17
Changes in operating assets and liabilities:
AccountsTrade accounts receivable 7,235 (2,961)599 3,849
Inventory (2,025) (808)1,034 514
Prepaid expenses and other current assets 1,950 (1,726)
Deferred income taxes (54) --(277) 164
Accounts payable 1,421 537
Acquisition payments due licensor (867) 1,733(103) 856
Accrued expenses (652) 137(12) (1,584)
Accrued warranty (34) 51expense (75) (5)
Deferred revenue 867 (157)1,520 224
-------- --------
Net cash provided (used) by operating activities 2,139 (255)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments -- (3,413)
Maturities of investments -- 2,935
Purchases of property and equipment (67) (684)
-------- --------
Net cash used by operating activities (575) (3,711)
-------- -------
Cash flows from investing activities:
Purchases of investments (10,901) (12,716)
Maturities of investments 13,210 20,743
Purchases of property and equipment (1,641) (1,475)
Purchase costs related to asset acquisitions 500 (3,383)
-------- -------
Net cash provided (used) by investing activities 1,168 3,169(67) (1,162)
-------- -------
Cash flows from financing activities:--------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital leases (21) (12)lease obligations (16) (4)
Proceeds from the issuance of common stock under stock option plans 632 708164 312
-------- ---------------
Net cash provided by financing activities 611 696148 308
-------- ---------------
Net increase (decrease) in cash and cash equivalents 1,204 1542,220 (1,109)
Cash and cash equivalents at beginning of period 12,513 4,400
1,504
-------- ---------------
Cash and cash equivalents at end of period $ 5,60414,733 $ 1,6583,291
-------- -------
--------
--------------- --------
The accompanying notes are an integral part
of the
condensed consolidatedthese financial statements.
5
APPLIED DIGITAL ACCESS, INC.
Notes to Condensed Consolidated Financial Statements
September 30,NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(Unaudited)(DOLLARS IN THOUSANDS)
1. Basis of PresentationBASIS 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 nine month periodsperiod ended September 30, 1998March 31, 1999 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1998.1999. 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, 19971998 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.NEW ACCOUNTING PRONOUCEMENTS
In June 1997,1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards for derivative and hedging
activities. In accordance with SFAS No. 133 all derivatives must be recognized
as assets or liabilities and measured at fair value. This 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
iswill be
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 theCompany's fiscal year in which SFAS 131 is
effective.2000. The Company has not yet determined
the impact of the adoption of this new accounting pronouncement on its
consolidated financial position or results of operations.
3. InventoryINVENTORY
Inventory is valued at the lower of cost (determined using the first-in,
first-out method) or market. Inventory was as follows:
SEPTEMBER 30,MARCH 31 DECEMBER 31
1999 1998
1997
------------------------ ------------
(DOLLARS IN THOUSANDS)
Inventories:
Raw materials $ 4,574 $ 3,419$3,026 $3,266
Work-in-process 2,881 2,2231,646 2,389
Finished goods 913 787
-------------673 698
----------- ------------
8,368 6,4295,345 6,353
Less inventory reserve (484) (570)
-------------reserves (700) (674)
----------- ------------
$ 7,884 $ 5,859
-------------$4,645 $5,679
----------- ------------
------------------------ ------------
4. RESTRUCTURING CHARGE FOR TERMINATION OF JOINT DEVELOPMENT AGREEMENT
On March 3, 1999, the Company announced the termination of its joint
development agreement ("JDA") with Northern Telecom, Inc. ("Nortel"). The
Company and Nortel entered into the JDA in September 1997 to develop
Synchronous Optical Network ("SONET") network element products for the
telecommunications industry. The intellectual property rights associated with
the jointly developed technology will become the property of the Company.
Under the JDA, the Company and Nortel each contributed technology and
development resources to the project and shared the development costs. The
Company's development costs
6
4. Per Share Informationassociated with the JDA have been expensed as incurred. Nortel
is obligated to continue funding its share of the development costs associated
with the JDA project through June 2, 1999.
For the three months ended March 31, 1999, the Company incurred a one-time
restructuring charge of $1,435, of which $1,335 is included as a separate
component of operating expenses and $100 is included in costs of revenue.
Cash expenditures are estimated to be $469 which consists of employee
severance costs, facility closure in Richardson, Texas and other costs. The
significant components of the restructuring charge are:
- --------------------------------------------------------------------------------
COMPONENT
---------
Estimated
Amounts incurred as of amounts to be paid in
Amount March 31, 1999 the Future
------ -------------- ----------
Severance and related personnel costs $ 264 $ 264 $ 0
Capital asset writeoffs 866 866 0
Facility closure 152 45 107
Excess inventory writedown 100 100 0
Other costs 53 0 53
------ ------ ----
Total restructuring costs $1,435 $1,275 $160
- --------------------------------------------------------------------------------
Severance costs are related to the termination of approximately 65 people,
the majority of which were engineers focused on the JDA. The capital assets
are primarily software development tool kits that were acquired specifically
for the JDA and do not have an on-going business use. The facility in
Richardson, Texas is a leased facility which the Company has the ability to
sub-lease. The Company has adoptedestimated the provisionscosts associated with leasing the
facility until a sub-lessee can be found. The inventory write down related to
excess quantities of Statementcomponents used in the JDA product design that were
purchased in advance. Other costs are associated with legal and other
professional services required to complete the termination of Financial Accounting
Standards No. 128, "Earnings per Share" ("SFAS 128"), effective December 31,
1997. SFAS 128 requires the presentationJDA. The
Company anticipates the majority of basic and diluted earnings per
share.the expenditures will be concluded by
June 30, 1999. However, there may be costs associated with the closure of the
leased facility in Richardson, Texas that could extend beyond that date.
5. PER SHARE INFORMATION
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).
7
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(DOLLARS IN THOUSANDS)
Three Months Ended Nine Months Ended
------------------ -------------------
Sept. 30, Sept. 30,THREE MONTHS ENDED MARCH 31,
1999 1998
1997 1998 1997
-------- -------- -------- ----------- ----
Numerator - basic and diluted EPS:
Net loss $(3,168) $ (526) $(11,034) $(4,349)$(2,326) $(5,208)
Denominator - basicbasis and diluted EPS:
Weighted average common stock outstanding 12,712 12,512 12,671 12,42512,917 12,624
Basic and diluted earnings per share $(0.18) $(0.41)
6. SEGMENTS
In accordance with SFAS No. 131, information regarding the Company's business
segments is reported for financial statement purposes consistently with the
manner in which these segments are evaluated for internal reporting and
management's assessment of performance. The Company evaluates the performance of
its segment and allocates resources to them based on segment earnings before
allocation of corporate costs.
The Company's two business units, Network Systems and Network Management, are
organized around the Company's product lines. The Network Systems business
unit is formed around the Company's network test and performance monitoring
products and services, including its T3AS Test and Performance Monitoring
System ("T3AS"), Centralized Test System ("CTS"), Test OS, Remote Module,
Network Embedded Protocol Access System ("NEPA"), and Sectionalizer. The
Network Management business unit focuses on the Company's Operations Systems
("OS") software products including .Provisioner, Traffic Data Collection and
Engineering System ("TDC&E"), Fault Management System ("FMS"), and OS design
services.
The table below presents information about revenues and operating loss for
reportable segments for the three months ended March 31:
OPERATING
REVENUES LOSS
---------------- ---------------
1998:
Network Systems $3,117 $(2,953)
Network Management 2,155 (595)
------ -------
Total for reportable segments 5,272 (3,548)
Reconciling items -- (1,787)
------ -------
Consolidated totals $5,272 $(5,335)
------ -------
------ -------
1999:
Network Systems $4,795 $ (0.25)(272)
Network Management 2,407 (127)
------ -------
Total for reportable segments 7,202 (399)
Reconciling items -- (1,992)
------ -------
Consolidated totals $7,202 $(2,391)
------ -------
------ -------
8
The table below presents the reconciliation of operating loss for reportable
segments to consolidated loss before income taxes for the three months ended
March 31:
1999 1998
------- -------
Operating loss for reportable
Segments $ (0.04) $ (0.87) $( 0.35)
share(399) $(3,548)
Other unallocated segment expenses (1,993) (1,798)
Other unallocated income 120 175
------- -------
Consolidated loss before
income taxes $(2,272) $(5,171)
------- -------
------- -------
7Operating loss for reportable segments includes segment revenues with
deductions made for related development and selling costs and certain
expenses controllable by segment managers. Other unallocated segment expenses
consist of corporate selling, general and administrative expenses allocated
to each segment based on segment revenues. Other unallocated income consists
of interest income on investments held at the corporate level.
The table below presents the reconciliation of total assets for reportable
segments to consolidated total assets at:
MARCH 31, DECEMBER 31,
1999 1998
------- -------
Total assets for reportable
Segments $14,155 $17,256
Other unallocated segment assets 2,918 2,925
Other unallocated assets:
Cash 14,733 12,513
Other 1,578 1,578
------- -------
Consolidated total assets $33,384 $34,272
------- -------
------- -------
Total assets for reportable segments includes amounts attributable to trade
accounts receivable, inventory and property and equipment. Other unallocated
segment assets consist primarily of intangible assets obtained in conjunction
with certain acquisitions. Other unallocated assets consists principally of
deferred taxes and prepaid expenses
9
ItemITEM 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. STATEMENTS WHICH USE THE WORDS "OBJECTIVE," SEEK,"SEEK,"
"INTEND," "WILL," "ANTICIPATE," "CAN," "MAY," "CONTINUE," AND "EXPECT""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 SALESMARKETING
EFFORTS, (IV) EXPECTED LEVELS OF EXPENDITURES, (V) GOAL OF MAXIMIZING THE VALUE
OF TECHNOLOGY AND MARKETING EFFORTS,(VI) THE COMPANY'S TIMING OF YEAR 2000 COMPLIANCE, ARE BASED
ON INFORMATION AVAILABLE TO THE COMPANY AS OFON THE DATE HEREOF.HEREOF, AND THE COMPANY
ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD LOOKINGFORWARD-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."
RECENT DEVELOPMENTS
On March 3, 1999, the Company announced the termination of its joint
development agreement ("JDA") with Nortel. The following shouldCompany and Nortel entered into
the JDA in September 1997 to develop SONET network element products for the
telecommunications industry. The intellectual property rights associated with
the jointly developed technology will become the property of the Company. Under
the JDA, the Company and Nortel each contributed technology and development
resources to the project and shared the development costs. The Company's
development costs associated with the JDA have been expensed as incurred. Nortel
is obligated to continue funding its share of the development costs associated
with the JDA project through June 2, 1999. The Company expects to substantially
reduce expenses associated with the development conducted under the JDA and will
explore alternatives for maximizing the value of the jointly developed
technology. There can be readno assurance that the Company will be successful in conjunctionit
efforts to maximize the value of the technology developed under the JDA or that
the jointly developed technology will provide future value to the Company.
On March 31, 1999, the Company announced a reduction in its
workforce of approximately 65 people, or 22% of its total workforce. Of the
reduction in workforce, 23 were temporary positions. The Company determined
the reduction was necessary in order to align its current operations with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Risks and
Uncertainties", contained in the
Company's Annual Reportobjectives of focusing on Form 10-K for the
fiscal year ended December 31, 1997 filedmarket opportunities in its core
business, reducing expenses including expenses related to its recently
terminated JDA with the SecuritiesNortel 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 lowerimproving 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 service
activation and circuit provisioning, network configuration management,
network performance management, circuit and facilities testing, and traffic
managementresults. The majority of
the public switched network. ADA has addressedreduction in workforce were engineers focused on development conducted
under the industry
demand for network management products withJDA. As 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 the 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 ofreduction in workforce, the Company fromwill
close its office in Richardson, Texas. In the quarter ended March 31, 1999
the Company incurred a single product linerestructuring charge of $1,435,000 related to multiple product
lines. The Network Systems business unit is built around the
Company's testreduction in workforce, the closure of its Texas facility, the write-down of
certain capital assets, 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 and services, 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.inventory.
RESULTS OF OPERATIONS
Revenue totaled $6,764,000$7,202,000 for the three months ended September 30, 1998,March 31,
1999, a 23% decrease37% increase from revenue of $8,750,000$5,272,000 for the three months ended September
30, 1997.March 31,
1998. The decreaseincrease is primarily the result of increased revenue from the sale
of network systems products and to a lesser extent increased revenue from the
sale of network management OS products. Revenue generated from the sale of
the Company's network systems products and services totaled $4,795,000 for
the quarterthree months ended March 31,1999, a 54% increase from $3,117,000 for the
three months ended March 31, 1998. The increase was primarily the result of decreased
sales of the Company's network management OS software products. Revenue
from network management OS software products and services for the three
months ended September 30, 1998 totaled $3,628,000, a 34% decrease from
$5,534,000 in the same period last year. The decrease resulted from
decreased sales of the Company's Test OS, .Provisioner and FMS software
products partially offset by increased sales of the Company's TDC&E software
product.
8
Revenue from the Company's network systems test and performance management
products for the three months ended September 30, 1998 totaled $3,136,000, a
2% decrease from $3,216,000 in the same period last year. The decrease was
the net result of decreased sales of the Company's Remote Module product
offset by
increased sales of the Company's T3AS and CTS products. The Company
believes revenue for the third quarter of 1998 was negatively impacted by
decreased spending by the Company's customers due to merger activity, capital
spending constraints, order delays for the Company's Remote Module product
due to customer inventory reductions and tightening of inventory control
procedures, and to a lesser extent, order delays resultingRevenue generated
from the impactsale of
short strikes and strike preparations at two of the Company's customers at
the beginning of the quarter. In addition, revenue for the third quarter was
negatively impacted by delays in the completion of an OS software
installation at one of the Company's customers. The Company recognizes
revenue from sales of its OS software products only upon satisfaction of the
customer's specific delivery and acceptance criteria. In any period,
significant revenue may be derived from a small number of large OS software
product sales and, as a result of various customer delivery and acceptance
criteria, the Company may experience fluctuations in quarterly revenue. As a
result of the factors discussed above, the Company has experienced and may in
the future continue to experience quarterly revenue fluctuations that could
have a material adverse effect 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 nine months ended September 30, 1998 totaled $20,616,000, a
12% decrease from $23,302,000 in the same period last year. The decrease for
the nine months ended September 30, 1998 resulted from a net decrease in
revenue from the Company's network management OS software designproducts and services
and
products partially offset by a net increase in sales from the Company's
network systems test and performance management products. Revenue from the
Company's network systems test and performance management productstotaled $2,407,000 for the ninethree months ended September 30, 1998 totaled $11,266,000, an 8%March 31, 1999, a 12% increase
from $10,405,000 in$2,155,000 for the same period last year.three months ended March 31, 1998. The majorityincrease was
the result of the increase
resulted from increased
10
sales of the Company's Remote Module product.Provisioner and TDC&E products partially offset by
decreased sales of the Company's CTSdesign services and TestOS software products.
Revenue
from network management OS software products and services forFor the ninethree months ended September 30, 1998 totaled $9,350,000, a 28% decrease from $12,897,000
in the same period last year. The majority of the decrease was the result of
decreased salesMarch 31, 1999, BellSouth, Bell Atlantic and
Ameritech accounted for 30%, 14%, and 11% of the Company's OS design services to Northern Telecom, Ltd.
("Northern Telecom")total revenue,
respectively. For the three months ended March 31, 1998, BellSouth and decreased salesMCI
WorldCom accounted for 34% and 29% of the Company's Test OS software
product partially offset by increased sales of the Company's TDC&E and
.Provisioner software products. The decreasedtotal revenue, from OS design
services and increased sales of the Company's .Provisioner product resulted
from the Company's acquisition of an exclusive license to Northern Telecom's
DSS II software product in June 1997. 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 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. The Company believes the same factors that
negatively impacted revenuerespectively.
Gross profit totaled $4,308,000 for the three months ended September 30, 1998
also negatively impacted revenue for the nine months ended September 30,
1998. There can be no assurances that the factors discussed above will not
continue in the future, or that revenue increases that occurred for
individual products during the three and nine months ended September 30, 1998
will continue in the future, each of which could haveMarch 31,
1999, a material adverse
effect on the Company's business, operating results and financial condition.
See "Risks and Uncertainties -- Fluctuations in Quarterly Operating Results;
History of Losses", "--Customer Mergers" and "--Concentration of Major
Customers; Telephone Company Qualification Requirements."
Gross profit totaled $4,017,000168% increase from $1,608,000 for the three months ended September 30,
1998, an 18% decrease from $4,877,000 in the same period last year. The
decrease in gross profit was the result of lower revenue levels.March 31,
1998. Gross profit as a percent of revenue was 59%60% for the three months ended
September 30, 1998March 31, 1999 compared to 56%31% for the three months ended September 30, 1997.same period in 1998. The increase in
gross profit as a percent of revenuelevels was primarily the result of a product
mix weighted towards T3AS and CTS products combined with decreased sales of
the Company's Remote Module NIU products partially offset by lower overall
sales of the Company's network management OS software products. Generally,
the Company's T3AS and CTS products have a higher gross profit margin than
NIU 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 $10,464,000 for the nine months ended September 30,
1998, a 16% decrease from $12,507,000 in the same period last year. Gross
profit as a percent of revenue was 51% for the nine months ended September
30, 1998 compared to 54% in the same period last year. The decrease in gross
profit was the result of asystems product mix
weighted toward T3AS products, which carry higher gross margins than the Company's
lower-marginCTS
and Remote Module NIU, decreased revenueproducts and improved gross profit margins on the impactRemote
Module product resulting from manufacturing cost reductions. Additionally,
the allocation 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 lowerhigher revenue levels and lower-inventory write-downs resulted in higher
overall gross profit levels in the first nine monthsquarter 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. As a result of the .Provisioner (formerly
DSS II) license acquisition, 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.1999. There can be no
assurance that the Company will be able to maintain the current gross profit
margins or gross profit as a percent of revenue levels. Factors which may
materially and adversely affect the Company's gross 9
profit in the future
include its level of revenue, competitive pricing pressurepressures in the
telecommunication network management market, fluctuations in
quarterly order bookings and revenue, new product introductions by the
Company or its competitors, potential inventory obsolescence and scrap,
possible recalls, production or quality problems, timing of development
expenditures, changes in material cost,costs, disruptions in sources of supply,
regulatory changes, seasonal patterns of bookings, capital spending, and
changes in general economic conditions.
Research and development expenses totaled $3,583,000$3,185,000 for the three
months ended September 30, 1998, an 83% increaseMarch 31, 1999, a 10% decrease from $1,963,000$3,544,000 for the three
months ended September 30, 1997. Research andMarch 31, 1998. The decrease is due to an increase in Nortel's
proportionate share of total development expenses totaled
$10,904,000costs it is responsible for under
the nine months ended September 30, 1998, a 68%JDA. During the first quarter of 1999, Nortel agreed to increase from
$6,498,000 for the nine months ended September 30, 1997. The majorityits
share of the increase for the three and nine months ended September 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, 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 conductedcosts incurred under the JDA and equally share
the development costs.from 50% to 60%. For the three
and nine months ended September 30,March 31, 1999 and 1998, the Company's net research and
development expenses include a $1.1 millionincluded $1,876,000 and $2.8 million reduction,$698,000 offsets, respectively,
representing Nortel's proportionate share of development costs incurred underfor
the initial project being conducted under the JDA, compared to an offset of $1.0 million for the three and nine
months ended September 30, 1997.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,Included in the Company
intends to continue to make significant investments in research and product
development in association with planned development projects.
Inresults of operations for the ninethree months ended
September 30, 1997 the Company recordedMarch 31, 1999 is a restructuring charge of approximately $1.6 million for purchased research$1,435,000, of which $1,335,000
is included as a separate component of operating expenses and development costs
related$100,000 that
is included as part of cost of revenue (see Note 4 of the Notes to the
acquisitionCondensed Consolidated Financial Statements contained herein). The
restructuring charge is a result of the .Provisioner licenseCompany's plan to focus its efforts
on market opportunities in its core business and related assetsthe termination of the JDA
with Nortel.
Included in the results of operations for the three months ended
March 31, 1999 is a one-time credit adjustment of $1,361,000 which represents
an increase from Northern Telecom.50% to 60% in Nortel's proportionate share of total
development expenses incurred under the JDA through December 31, 1998.
Sales and marketing expenses totaled $2,458,000$2,279,000 for the three
months ended September 30, 1998, a 10% increaseMarch 31, 1999, relatively unchanged from $2,230,000$2,280,000 for the
three months ended September 30, 1997. Sales and marketing expenses totaled $7,289,000 for the
nine months ended September 30, 1998, a 30% increase from $5,590,000 for the
nine months ended September 30, 1997. The majority of the increases for the
three and nine months is the result of increased staff in sales to support
increased sales 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-based
business.March 31, 1998. The Company expects that sales and marketing
expenses will continue to increase in absolute dollarsduring 1999 as the Company continues to hire
additionalit adds addtional sales, marketing and
technical support personnel to support both
current productsincreased focus on new customer
markets and planned product introductions.
11
General and administrative expenses totaled $1,258,000$1,261,000 for the three
months ended September 30, 1998,March 31, 1999, a 9% decrease13% increase from $1,379,000$1,119,000 for the three months
ended September 30, 1997. GeneralMarch 31, 1998. The increase is attributable to higher personnel costs
associated with the business unit restructuring and administrative expenses totaled
$3,672,000 forhigher legal and
professional services associated with the nine months ended September 30, 1998, a 4% decrease from
$3,816,000 for the nine months ended September 30, 1997. The majoritytermination of the decrease for the three months ended September 30, 1998 resulted from lower
corporate expenses. The majority of the decrease for the nine months ended
September 30, 1998 resulted from lower consulting and recruiting costs offset
by increased expenses for the amortization of intangible assets and legal
expenses.JDA. The Company
expects that general and administrative expenses may increase in absolute dollars in1999 as a
result of expected administrative costs related to the future astermination of the Company expands its
internal networking capabilitiesJDA
with Nortel and potential increased expenses related to support the integration of its
geographically distributed organization.Company's focus on
Year 2000 issues.
Interest income totaled $165,000$120,000 for the three months ended September 30,
1998,March 31,
1999, a 30%31% decrease from $236,000 in the same quarter a year ago. Interest
income totaled $508,000$175,000 for the ninethree months ended September 30, 1998,March 31, 1998.
The decrease is the result of a 32%
decrease from $746,000 for the nine months ended September 30, 1997. The
decreases resulted from decreased levels ofin cash investments during 1999
compared to the
same periods last year.
10
1998.
For the three and nine months ended September 30,March 31, 1999 and 1998, and September 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 50% and 46%.,
respectively. At December 31, 1998, the Company had federal income tax-loss
carry-forwards of approximately $27,642,000 and California state income tax-loss
carry-forwards of approximately $5,458,000. The Company did not provide for U.S. income taxes for the three or
nine months ended September 30, 1998 or September 30, 1997 due to net losses.
The Company expects to provide for foreign,Company's use of approximately
$1,166,000 of its federal tax-loss carry-forwards, and $408,000 of its federal
and state income taxes
for$105,000 of its California tax credit carry-forwards are significantly
limited as a result of ownership changes associated with equity financing in
January 1989 and March 1991. See footnote 9 to the Consolidated Financial
Statements in the December 31, 1998 at applicable statutory rates, after giving effect to net operating
losses, remaining available net operating loss carryforwards, and any
available tax credits.Form 10-K.
As a result of the factors discussed above, the Company incurred a
net loss of $3,168,000,$2,326,000 or $.25$.18 per basic and diluted share for the three
months ended September 30, 1998March 31, 1999 compared to a net loss of $526,000,$5,208,000, or $.04$.41 per
basic and diluted share for the three months ended September 30, 1997.
TheMarch 31, 1998. Excluding
the one time credit adjustment of $1,361,000 and the restructuring of
$1,435,000 charge the Company incurredwould have recorded a net loss of $11,034,000,$2,252,000,
or $.87$.17 per basic and diluted share for the ninethree months ended September 30, 1998 compared to a net loss of
$4,349,000, or $.35 per basic and diluted share, for the nine months ended
September 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 $2,771,000 or
$.22 per share, for the nine months ended September 30, 1997.March 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998 the Company had approximately $12,148,000 in cash, cash
equivalentsCash and investments totaled $14,733,000 at March 31, 1999 compared
to $13,179,000$12,513,000 at December 31, 1997, a
decrease of $1,031,000.1998. The decreaseincrease in cash cash equivalentsis primarily due to
advance payments received for annual maintenance, reductions in trade
receivables and investments was primarilyinventory offset by the result of net operating losses and, to a lesser
extent, purchases of capital equipment.
Workingloss for the period.
Net working capital totaled $17,869,000$16,222,000 at September 30, 1998, a decrease of
$8,919,000 from $26,788,000March 31, 1999 compared
to $16,756,000 at December 31, 1997.1998. The decrease in working capital was
primarily the result of net operating losses, decreased accounts
receivable and other current assets as well as an increase in accounts
payabledeferred revenue and other current liabilities.
For the nine months ended September 30, 1998 thedecreases in
inventory and trade receivables significantly offset by an increase in cash.
The Company's operating activities used $575,000for the three months ended March 31,
1999 provided $2,139,000 in cash primarily the result of net operating
losses offset by decreased accounts receivable and other current assets and
increased accounts payable compared to the use of $3,711,000 in cash$255,000 for the ninethree
months ended September 30, 1997.
ForMarch 31, 1998. The cash provided for the nine months ended September 30, 1998 cashfirst quarter of 1999
was primarily the result of decreased trade receivables and inventory and an
increase in deferred revenue off set by the net loss for the period.
Cash used for capital expenditures totaled approximately $1,641,000.$67,000 for
the three months ended March 31, 1999 compared to $684,000 for the three
months ended March 31, 1998. Most of the capital equipment
additions in the first
quarter of 1999 were for the purchase of software development tool kits and
computer workstations and labworkstations. The Company did not acquire any capital equipment
relatedthrough new capital lease arrangements during the three months ended March
31, 1999 or 1998, respectively. The Company expects that 1999 capital
expenditures will decrease substantially from 1998 levels due to the
termination of the JDA with Nortel. Planned expenditures will focus on
upgrades to the Company's expanded researchnetwork infrastructure and development
efforts and tenant improvementsspecific needs for
the Company's Richardson, Texas office.
The Company expects the level of capital expenditures will increase in 1998
and 1999 as a result of investments inongoing 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
12
capital expenditure requirements for at least the next twelve months. However,
there can be no assurance that the Company will not need to 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.technologies that are
focused on the Company's core business. 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.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. Without
modification, these systems and software will be unable to appropriately
interpret or recognize dates beyond the calendar year 1999. The Year 2000
computer issue could result in system failures or miscalculations causing
disruptions in business operations worldwide (including, without limitation,
disruptions in order processing, invoicing, manufacturing and similar
functions).
The risk to ADA exists in four areas: systems used by the Company to
run its business, systems used by the Company's suppliers, potential warranty
or other claims from Company customers, and the potential reduced spending by
telecommunication service providers ("TSPs") on network performance management
products as a result of significant information systems spending on Year 2000
remediation.
The Company is continuing to conduct an assessment and analysis of its
internal information technology ("IT") systems to determine the potential costs
and scope of any Year 2000 issues. Based on a preliminary assessment, ADA has
determined that certain of its IT systems need to be upgraded or replaced to
address Year 2000 issues. The Company believes that all necessary upgrades or
replacements of its IT systems will be completed by June 30, 1999. Validation
testing will be conducted as IT systems are upgraded and replaced. All IT
systems that have been purchased in 1999 or 1998 are Year 2000 compliant. The
upgrades are generally covered by service contracts previously entered into by
the Company in the ordinary course of business and the cost of the upgrades and
remediation is not expected to be material to the Company's operating results.
If implementation of upgrades or replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.
ADA has conducted a comprehensive evaluation of its non-IT systems and
equipment (e.g., facilities, and test equipment containing microprocessors or
other similar circuitry, etc.). Based on this evaluation, ADA does not expect
Year 2000 issues to have a material adverse effect on the Company's non-IT
systems and equipment. However, Year 2000 compliance for some of the Company's
non-IT systems and equipment is dependent upon upgrades to be provided by third
party vendors. The Company expects all upgrades required from third party
vendors to complete Year 2000 compliance for non-IT systems and equipment to be
completed by September 30, 1999. There can be no assurance that third party
vendor upgrades to non-IT systems and equipment will be Year 2000 complaint or
that the upgrades will be completed prior to the end of 1999 which could
negatively impact the functionality of non-IT systems and equipment that could
have a material adverse effect on the Company's revenue, operating results and
financial condition.
In addition, the Company has made inquiries of its third party
suppliers to determine if they have any Year 2000 issues that will materially
and adversely impact the Company. To date, the Company has not been made aware
of any material Year 2000 issues which would adversely affect ADA.
The Company believes that the majority of its current products are Year
2000 compliant. The remaining Company products are expected to be Year 2000
compliant by June 30, 1999. The Company had originally expected this process to
be completed by December 31, 1998. The Company does not expect additional
efforts required to complete Year 2000 compliance for these products will be
material. Internal validation testing is being conducted as products are being
upgraded. An independent third party also performed validation testing on one of
13
the Company's test and performance management products. However, since all
customer situations cannot be anticipated, particularly those involving third
party products, the Company may see an increase in warranty and other claims as
a result of the Year 2000 transition. In addition, litigation regarding Year
2000 compliance issues is expected to escalate. For these reasons, the impact of
customer claims could have a material adverse impact on the Company's operating
results or financial condition.
Year 2000 compliance is an issue for virtually all businesses, whose
computer systems and applications may require significant hardware and
software upgrades or modifications. TSPs have devoted a substantial portion
of their information systems' spending to fund such upgrades and
modifications and have diverted spending away from network performance
management products. Such changes in customers' spending patterns have had
and could continue to have a material adverse impact on the Company's sales,
operating results or financial condition.
The Company intends to continue the review, remediation and testing of
its Year 2000 status and, to the extent necessary, it will develop Year 2000
contingency plans for critical business purposes. In addition, there can be no
assurance that Year 2000 issues will not have a material adverse effect on the
Company if ADA and/or those with whom it conducts business are unsuccessful in
identifying or implementing timely solutions to any Year 2000 problems.
RISKS AND UNCERTAINTIES
CUSTOMER MERGERS. Many of the major TSPs currently involved in or that
have recently completed merger transactions are customers of the Company.
Several of these mergers involved companies that purchase network systems and
software products and services from the Company's competitors. Consequently,
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 has had and could continue to 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.
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
11
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 OSOperating System ("OS")
software licensing. Generally, TSPs placedplace 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 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
14
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, AnritsuTTC, 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 Remote Module signaling technology
12
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 thus, also faceswhich has resulted
in competition from the licensees of its own technology. Many of these
competitors have significantly greater technical, financial, manufacturing, and
marketing resources than the Company.
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.,Nortel, 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.,OSI, 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 customers which may
adversely affect the
15
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 exchangeRBOCs, IXCs, ILECs, CLECs, emerging carriers, ("LECs"),
competitive local exchange carriers ("CLECs"), competitive access providers
("CAPs"), Internet service providers ("ISPs"),ISPs,
enterprise networks and other TSPs. Historically, the Company's marketing
efforts focused primarily on the RBOCs, which accounted for approximately 99%, 73%, 31%,
47% and 46%57% of the Company's total revenue in 1995, 1996, 1997, 1998, and the first ninethree months
of
1998,ended March 31, 1999, respectively. However, the Company's strategy has been to
focus its efforts on diversifying its customer base. RBOCs, IXCsRBOC and enterpriseIXC customers
accounted for 31%, 27%57% and 20% of the Company's total revenue in
1997, and 46%, 31% and 0%3% of the Company's total revenue for the first ninethree months
of 1998.ended March 31, 1999 and 47% and 23% for the year ended December 31, 1998,
respectively. 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, CAPslong distance telephone companies, CLECs, emerging carriers 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 and US West strikes, 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
WorldCom have entered into purchase contracts with the Company. MCI WorldCom 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 WorldCom contracts may be
13
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 WorldcommWorldCom 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 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%56% and 55%67% of the
Company's total revenues in 1996, 1997for the year ended December 31, 1998 and first ninethe three
months of 1998,ended March 31, 1999, respectively. Revenue from network management OS
products and services, including software design services, .Provisioner, Test
OS, TDC&E and FMS, generated 26%, 50%44% and 45%33% of the Company's total revenue in 1996,
1997for the
year ended December 31, 1998 and first ninethree months of 1998,ended March 31, 1999,
respectively. However, there can be no assurance that the Company's future
revenues will not be heavily dependent on sales from only 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,NIU, CTS, PAAS,NEPA,
T3AS, Test OS, .Provisioner, TDC&E and OS products and through
new product development.FMS products.
16
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.
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 1996,1997, the Company formed two business units:units around the Company's product
lines: 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,
Sectionalizer, NEPA and PAAS products. There can be no assurance that the Company will be
successful in managing its newThe Network Management business unit
structure. In June 1997, the
Company acquired a license from Northern Telecom to its DSS IIfocuses on OS software productproducts including .Provisioner, TDC&E, Test OS, GTA,
FMS, and technology.OS design services. These business units operate in four separate
geographic locations. The Company markets and supportscontinues to face significant management
challenges related to the DSS II product
and technology under the new name .Provisioner. The Company is integrating
the licensed technology into new product development. The acquisitionintegration of the software license has generated a shift in the Company's Canadian subsidiary'sbusiness operations from a software design servicesof these
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.units. 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
14
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 customersAdditionally, as a result of the Company.
Severaltermination of the mergers involve companiesJDA,
the Company discontinued operations conducted at its Richardson, Texas
facility. There can be no assurance that purchase network systems and
software products and services from the Company's competitors. Consequently,Company will not incur
significant expenses related to the completionclosure 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 thereafterTexas facility that 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 effectimpact 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 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 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.
17
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.
15
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.sub-assemblies. 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.
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. In the
first quarter of 1998, the Company recorded a charge for inventory obsolescence
totaling $378,000. 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 currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. Without modification, these systems and software will be unable to
appropriately interpret or recognize dates beyond the calendar year 1999. The
Year 2000 computer issue could result in system failures or miscalculations
causing disruptions in business operations worldwide (including, without
limitation, disruptions in order processing, invoicing, manufacturing and
similar functions).
18
The risk to ADA exists in four areas: systems used by the Company to
run its business, systems used by the Company's suppliers, potential warranty or
other claims from Company customers, and the potential reduced spending by TSPs
on network performance management products as a result of significant
information systems spending on Year 2000 remediation.
The Company is continuing to conduct an assessment and analysis of its
internal information technology ("IT") systems to determine the potential costs
and scope of any Year 2000 issues. Based on a preliminary assessment, ADA has
determined that certain of its IT systems need to be upgraded or replaced to
address Year 2000 issues. The Company believes that all necessary upgrades or
replacements of its IT systems will be completed by June 30, 1999. Validation
testing will be conducted as IT systems are upgraded and replaced. All IT
systems that have been purchased in 1999 or 1998 are Year 2000 compliant. The
upgrades are generally covered by service contracts 16
previously entered into by
the Company in the ordinary course of business and the cost of the upgrades and
remediation is not expected to be material to the Company's operating results.
If implementation of upgrades or replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.
ADA is also in the process of conductinghas conducted a comprehensive evaluation of its non-IT systems and
equipment (e.g., facilities, and test equipment containing microprocessors or
other similar circuitry, etc.). Based on this evaluation, to date, ADA isdoes not aware of anyexpect
Year 2000 issues which are expected to have a material adverse effect on the Company's non-IT
systems and equipment. However, as the Company is still in the process of evaluating possible Year 2000 issues with respectcompliance for some of the Company's
non-IT systems and equipment is dependent upon upgrades to certain key testbe provided by third
party vendors. The Company expects all upgrades required from third party
vendors to complete Year 2000 compliance for non-IT systems and equipment thereto be
completed by September 30, 1999. There can be no assurance that ADAthird party
vendor upgrades to non-IT systems and equipment will not experiencebe Year 2000 complaint or
that the upgrades will be completed prior to the end of 1999 which could
negatively impact the functionality of non-IT systems and equipment that could
have a material adverse effect due to Year
2000 issues affecting this equipment. ADA anticipates completing its
assessmenton the Company's revenue, operating results and
analysis of this equipment by December 31, 1998.financial condition.
In addition, the Company is in the process of makinghas made inquiries of its third party
suppliers to determine if they have any Year 2000 issues that will materially
and adversely impact the Company. To date, the Company has not been made aware
of any material Year 2000 issues which would adversely affect ADA.
The Company expects to complete a survey of all such suppliers and
vendors by December 31, 1998.
The Company believes that the majority of its current products are Year
2000 compliant. It is expected that theThe remaining Company products willare expected to be Year 2000
compliant by June 30, 1999. The Company had originally expected this process to
be completed by December 31, 1998. The Company does not expect additional
efforts required to complete Year 2000 compliance for these products will be
material. Internal validation testing is being conducted as products are being
upgraded. An independent third party also performed validation testing on one of
the Company's test and performance management products. However, since all
customer situations cannot be anticipated, particularly those involving third
party products, the Company may see an increase in warranty and other claims as
a result of the Year 2000 transition. In addition, litigation regarding Year
2000 compliance issues is expected to escalate. For these reasons, the impact of
customer claims could have a material adverse impact on the Company's operating
results or financial condition.
Year 2000 compliance is an issue for virtually all businesses, whose
computer systems and applications may require significant hardware and software
upgrades or modifications. TSPs may plan to devotehave devoted a substantial portion of their
information systems' spending to fund such upgrades and modifications and divert
spending away from network performance management products. Such changes in
customers' spending patterns have had and could continue to have a material
adverse impact on the Company's sales, operating results or financial condition.
The Company intends to continue the review, remediation and testing of
its Year 2000 status and, to the extent necessary, it will develop Year 2000
contingency plans for critical business purposes. In addition, there can be no
assurance that Year 2000 issues will not have a material adverse effect on the
Company if ADA and/or those with whom it conducts business are unsuccessful in
identifying or implementing timely solutions to any Year 2000 problems.
19
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.
17
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.
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 fourteenfifteen U.S. patents
granted and five U.S. patent applications allowed. Four of the
granted patents relates to the Company's Remote Module product.granted. Additionally, the Company has fivethree 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.
20
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
18
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.
19required.
21
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.PROCEEDINGS
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.proceedings
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.HOLDERS
None.
ITEM 5. OTHER 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.INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.8-K
(a) Exhibits.EXHIBITS
EXHIBIT NUMBER
DESCRIPTION
------------- -----------
3.3(1)3.3 (1) Certificate of Incorporation of the Company.
3.4(2)Company
3.4 (2) Certificate of Agreement of Merger of the
Company and its California predecessor.
3.5(1)predecessor
3.5 (1) Bylaws of the Company.Company
27.1 Financial Data Schedule.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).0-23698)
(b) Reports on FormREPORTS ON FORM 8-K.
None.
2022
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the
registrantthis Report has duly caused this report to bebeen signed on its behalfbelow by the undersigned thereunto duly authorized.
Applied Digital Access, Inc.
Date: November 16, 1998 /s/ PETER P. SAVAGE
--------------------------
Peter P. Savage
Director
Presidentfollowing persons on behalf of the
Registrant in the capacities and Chief Executive Officer
Date: November 16, 1998 /s/ JAMES L. KEEFE
---------------------------
James L. Keefe
Vice President Finance and
Administration and Chief Financial Officer
21on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
By: /s/ Donald L. Strohmeyer President, Chief Executive May 17, 1999
--------------------------------- Officer and Director
(Donald L. Strohmeyer) (Principal Executive
Officer)
By: /S/ James L. Keefe Vice President, Finance May 17, 1999
--------------------------------- and Administration, Chief
(James L. Keefe) Financial Officer,
Secretary
(Principal Accounting
Officer)
23