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 SEPTEMBERJUNE 30, 19981999

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

                         COMMISSION FILE NUMBER 000-23698

                           APPLIED DIGITAL ACCESS, INC.
              (Exact name of registrant as specified in its charter)(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

           DELAWARE                                      68-0132939
(State or other jurisdiction of(STATE OR OTHER JURISDICTION OF               (IRS Employer Identification No.EMPLOYER IDENTIFICATION NO.)
 incorporation or organization)INCORPORATION OR ORGANIZATION)

                  9855 SCRANTON ROAD, SAN DIEGO, CALIFORNIA 92121
                (Address of principal executive offices, zip code)(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, ZIP CODE)

                                  (619) 623-2200
               (Registrant's telephone number, including area code)(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)


                             __________________________

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

There were 12,832,19713,147,507 shares of the registrant'sRegistrant's Common Stock, $.001$0.001 par
value, outstanding as of OctoberJuly 31, 1998.


                                                                      11999.




                            APPLIED DIGITAL ACCESS, INC.

                                 INDEX TO FORM 10-Q

PAGE

PART I.   FINANCIAL INFORMATION    

Item 1.   Financial Statements     

          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
PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets at June 30, 1999 and December 31, 1998..................................................3 Condensed Consolidated Statements of Operations and Comprehensive Loss for the three and six months ended June 30, 1999 and June 30, 1998...........................4 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1999 and June 30, 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....................................................................23 Item 6. Exhibits and Reports on Form 8-K.....................................................23 SIGNATURES........................................................................................24
2 PART I FINANCIAL INFORMATIONSTATEMENTS Item 1. FINANCIAL STATEMENTSFinancial Statements APPLIED DIGITAL ACCESS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)- ------------------------------------------------------------------------------
SEPTEMBERJUNE 30, DECEMBER 31, 1999 1998 1997 ------------- ------------ (DOLLARS IN THOUSANDS) ASSETS-------------- Unaudited (Dollars in Thousands, except per share data) ASSETS Current assets: Cash and cash equivalents $ 5,6049,465 $ 4,40012,513 Investments 6,544 8,779 Accounts4,867 - Trade accounts receivable, net 5,746 12,9815,161 6,111 Inventory, net 7,884 5,8594,227 5,679 Deferred income taxes 130 130 Prepaid expenses and other current assets 1,825 3,775 -------------1,365 1,700 ------------ -------------- Total current assets 27,733 35,92425,215 26,133 Property and equipment, net 5,921 6,1653,472 5,466 Intangible assets, net 681 1,247 Deferred income taxes 1,510 1,426 1,372 Other, net 1,500 2,822 ------------- ------------ -------------- Total assets $ 36,58030,878 $ 46,283 -------------34,272 ------------ --------------------------- ------------ -------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 4,8993,089 $ 3,478 Acquisition payments due to licensor -- 8672,922 Accrued expenses 1,489 1,9971,491 2,374 Accrued warranty 1,288 1,323expense 1,149 1,264 Deferred revenue 2,188 1,471 -------------3,003 2,817 ------------ -------------- Total current liabilities 9,864 9,136 Obligations under capital leases, net of current portion 0 15 -------------8,732 9,377 ------------ Total liabilities 9,864 9,151 --------------------------- ------------ -------------- 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; 13,118,571 and 12,605,08212,909,315 shares issued and outstanding at SeptemberJune 30, 19981999 and December 31, 1997,31,1998 respectively 52,215 51,61013 13 Additional paid-in capital 2,519 2,492 Unrealized gain on investments 70 8455,289 54,897 Accumulated other comprehensive income 191 163 Accumulated deficit (28,088) (17,054) -------------(33,347) (30,178) ------------ -------------- Total shareholders' equity 26,716 37,132 -------------22,146 24,895 ------------ -------------- Total liabilities and shareholders' equity $ 36,58030,878 $ 46,283 -------------34,272 ------------ --------------------------- ------------ --------------
The accompanying notes are an integral part of the condensed consolidated financial statements. 3 APPLIED DIGITAL ACCESS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)AND COMPREHENSIVE LOSS - ------------------------------------------------------------------------------
FOR THE THREE MONTHS ENDED JUNE 30, FOR THE NINESIX MONTHS ENDED SEPTEMBERJUNE 30, ENDED SEPTEMBER 30, ------------------------ ------------------------1999 1998 19971999 1998 1997 ----------- ---------- ----------- ---------- (AMOUNTS IN THOUSANDS, (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) EXCEPT PER SHARE AMOUNTS)(Dollars in thousands, (Dollars in thousands, except per share data) except per share data) (Unaudited) (Unaudited) Revenue $6,764 $8,750 $20,616 $23,302$ 8,863 $ 8,580 $ 16,065 $ 13,852 Cost of revenue 2,747 3,873 10,152 10,795 ----------- ---------- ----------- ----------3,531 3,741 6,425 7,405 ------------ ------------- -------------- -------------- Gross profit 4,017 4,877 10,464 12,5075,332 4,839 9,640 6,447 ------------ ------------- -------------- -------------- Operating expenses: Research and development 3,583 1,963 10,904 6,498 In-process research and development related to asset acquisition -- -- -- 1,5782,761 3,777 5,946 7,320 Restructuring charge - - 1,335 - Engineering Reimbursement - - (1,361) - Sales and marketing 2,458 2,230 7,289 5,5902,147 2,551 4,426 4,831 General and administrative 1,258 1,379 3,672 3,816 ----------- ---------- ----------- ----------1,353 1,295 2,614 2,414 ------------ ------------- -------------- -------------- Total operating expenses 7,299 5,572 21,865 17,482 ----------- ---------- ----------- ----------6,261 7,623 12,960 14,565 ------------ ------------- -------------- -------------- Operating loss (3,282) (695) (11,401) (4,975)(929) (2,784) (3,320) (8,118) Interest income 165 236 508 746134 168 254 342 Other income (expense),expense, net (14) (24) (31) (13) ----------- ---------- ----------- ----------(7) (6) (8) (16) ------------ ------------- -------------- -------------- Loss before income taxes (3,131) (483) (10,924) (4,242)(802) (2,622) (3,074) (7,792) Provision for income taxes 37 43 110 107 ----------- ---------- ----------- ----------41 36 95 73 ------------ ------------- -------------- -------------- Net loss $(3,168) $(526) $(11,034) $(4,349) ----------- ---------- ----------- ---------- ----------- ---------- ----------- ----------$ (843) $ (2,658) $ (3,169) $ (7,865) ------------ ------------- -------------- -------------- ------------ ------------- -------------- -------------- Other comprehensive income (loss): Foreign currency translation adjustments 67 (93) 28 (12) ------------ ------------- -------------- -------------- Comprehensive loss $ (776) $ (2,751) $ (3,141) $ (7,877) ------------ ------------- -------------- -------------- Net loss per share, $(0.25) $(0.04) $(0.87) $(0.35) ----------- ---------- ----------- ---------- ----------- ---------- ----------- ---------- Number of sharesbasic and diluted (.06) $ (.21) $ (.24) $ (.62) ------------ ------------- ------------------------------ Shares used in per share computations 12,712 12,512 12,671 12,425 Comprehensive loss $(3,171) $(509) $(11,049) $(4,318) ----------- ---------- ----------- ---------- ----------- ---------- ----------- ----------13,037,132 12,675,219 12,977,203 12,649,983 ------------ ------------- -------------- --------------
The accompanying notes are an integral part of the condensed consolidated financial statements. 4 APPLIED DIGITAL ACCESS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)- ------------------------------------------------------------------------------
FOR THE NINESIX MONTHS ENDED SEPTEMBERJUNE 30, -------------------1999 1998 1997 ------- ----- (DOLLARS IN THOUSANDS)---------- ----------- Dollars in Thousands (Unaudited) Cash flows from operating activities:CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(11,034) $(4,349)$(3,169) $(7,865) 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 2,1671,783 1,853 Writeoff of assets associated with restructuring 866 - Other (88) 87108 (101) Changes in operating assets and liabilities: AccountsTrade accounts receivable 7,235 (2,961)950 3,978 Inventory (2,025) (808)1,452 (65) Prepaid expenses and other current assets 1,950 (1,726) Deferred income taxes (54) --251 1,340 Accounts payable 1,421 537 Acquisition167 1,647 Acquistion payments due licensor - (867) 1,733 Accrued expenses (652) 137(851) (743) Accrued warranty (34) 51expense (115) (8) Deferred revenue 867 (157) -------- --------186 1,047 ---------- ----------- Net cash usedprovided by operating activities (575) (3,711) -------- ------- Cash flows from investing activities:1,628 216 ---------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of investments (10,901) (12,716)(4,867) (7,854) Maturities of investments 13,210 20,743- 6,835 Purchases of property and equipment (1,641) (1,475)(169) (1,370) Purchase costs related to asset acquisitionsacquistion - 500 (3,383) -------- ------------------------------ Net cash provided (used)used by investing activities 1,168 3,169 -------- ------- Cash flows from financing activities:(5,036) (1,889) ---------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on capital leases (21) (12)lease obligations (32) (9) Proceeds from the issuance of common stock under stock option plans 632 708 -------- -------392 416 ---------- ----------- Net cash provided by financing activities 611 696 -------- -------360 407 ---------- ----------- Net increase (decrease)decrease in cash and cash equivalents 1,204 154(3,048) (1,266) Cash and cash equivalents at beginning of period 12,513 4,400 1,504 -------- ----------------- ----------- Cash and cash equivalents at end of period $ 5,6049,465 $ 1,658 -------- ------- -------- -------3,134 ---------- -----------
The accompanying notes are an integral part of the condensed consolidated financial statements. 5 APPLIED DIGITAL ACCESS, INC. Notes to Condensed Consolidated Financial Statements SeptemberNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 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 ninesix month periodsperiod ended SeptemberJune 30, 19981999 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 PRONOUNCEMENTS In June 1997,1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting StandardsSFAS No. 131, "Disclosures about Segments of an Enterprise133, "Accounting for Derivative Instruments and Related Information" ("SFAS 131"), which supersedes Statement of Financial Accounting Standards, "Financial Reporting of Segments of a Business Enterprise" ("SFAS 14")Hedging Activities". SFAS 131 changes current practice underNo. 133 establishes accounting and reporting standards for derivative and hedging activities. In accordance with SFAS 14 by establishing a new framework on which to base segment reportingNo. 133 all derivatives must be recognized as assets or liabilities and also requires interim reporting of segments information.measured at fair value. This statement isStatement will 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.2001. 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:
SEPTEMBERJUNE 30, DECEMBER 31, 1999 1998 1997 ------------- ------------ (DOLLARS IN THOUSANDS)----------- -------------- Inventories: Raw materials $ 4,574 $ 3,419$2,649 $3,266 Work-in-process 2,881 2,2231,641 2,389 Finished goods 913 787 ------------- ------------ 8,368 6,429667 698 ----------- -------------- 4,957 6,353 Less inventory reserve (484) (570) ------------- ------------ $ 7,884 $ 5,859 ------------- ------------ ------------- ------------reserves (730) (674) ----------- -------------- $4,227 $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 6 4. Per Share InformationAPPLIED DIGITAL ACCESS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (DOLLARS IN THOUSANDS) 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. For the six months ended June 30, 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, a facility closure in Richardson, Texas and other costs. The significant components of the restructuring charge are:
- ------------------------------------------------------------------------------------------------------------------- COMPONENT Amount Amounts incurred as of Estimated amounts to be June 30, 1999 paid in the future - ------------------------------------------------------------------------------------------------------------------- Severance and related personnel costs $ 264 $ 264 $ 0 Capital asset writeoffs 866 866 0 Facility Closure 152 72 80 Excess inventory writedown 100 100 0 Other costs 53 10 43 --------- ------ ---- Total restructuring costs $ 1,435 $1,312 $123 - -------------------------------------------------------------------------------------------------------------------
Severance costs related to the termination of approximately 65 people, the majority of which were engineers focused on the JDA. The capital asset writeoffs related to software development tool kits acquired specifically for the JDA that had no 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 services 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 majority of basic and diluted earnings per share.the expenditures have been concluded however, there may be costs associated with the closure of the leased facility in Richardson, Texas that could continue in to the future. 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 128. In accordance with the disclosure requirements of SFAS 128, a reconciliation ofThere are no reconciling items in the numerator and denominator offor basic and diluted EPSEPS. 6. SEGMENTS In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", information regarding the Company's business segments is provided as follows (dollarsreported for financial statement purposes consistently with the manner in thousands, except per share amounts).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 has two business units, Network Systems and Network Management, that 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"), Remote Module, a network interface unit ("NIU"), OPTIS (previously named Test OS), , Network Embedded Protocol Access System ("NEPA"), and Sectionalizer. The Network Management business unit focuses on the Company's Operations Support System ("OSS") software products 7 APPLIED DIGITAL ACCESS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (DOLLARS IN THOUSANDS) 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 and six months ended June 30:
Three Months Ended Nine Months Ended ------------------ ------------------- Sept.THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, Sept.JUNE 30, 1999 1998 19971999 1998 1997 -------- -------- -------- ------------------- -------------- ------------- -------------- Numerator - basicREVENUES: Network Systems $5,821 $5,437 $10,616 $8,929 Network Management 3,042 3,143 5,449 4,923 ------------ -------------- ------------- -------------- Consolidated totals $8,863 $8,580 $16,065 $13,852 ------------ -------------- ------------- -------------- ------------ -------------- ------------- -------------- OPERATING LOSS: Network Systems $(36) $(2,342) $(1,265) $(5,934) Network Management 354 861 373 164 ------------ -------------- ------------- -------------- Total for reportable segments 318 (1,481) (892) (5,770) Reconciling items (1,247) (1,303) (2,428) (2,348) ------------ -------------- ------------- -------------- Consolidated totals $(929) $(2,784) $(3,320) $(8,118) ------------ -------------- ------------- -------------- ------------ -------------- ------------- --------------
The table below presents the reconciliation of operating loss for reportable segments to consolidated loss before income taxes for the three and six months ended June 30:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 1999 1998 1999 1998 ------------ -------------- ------------- -------------- Operating loss for reportable segments $318 $(1,481) $ (892) $(5,770) Other unallocated segment expenses (1,254) (1,309) (2,436) (2,364) Other unallocated income 134 168 254 342 ------------ -------------- ------------- -------------- Consolidated loss before income taxes $(802) $(2,622) $(3,074) $(7,792) ------------ -------------- ------------- -------------- ------------ -------------- ------------- --------------
Operating 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. 8 APPLIED DIGITAL ACCESS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (DOLLARS IN THOUSANDS) The table below presents the reconciliation of total assets for reportable segments to consolidated total assets at:
JUNE 30, DECEMBER 31, 1999 1998 --------------- ----------------- Total assets for reportable Segments $12,859 $17,256 Other unallocated assets: Cash and diluted EPS: Net loss $(3,168) $ (526) $(11,034) $(4,349) Denominator - basic and diluted EPS: Weighted average common stock outstanding 12,712 12,512 12,671 12,425 Basic and diluted earnings per $ (0.25) $ (0.04) $ (0.87) $( 0.35) shareinvestments 14,332 12,513 Other 3,687 4,503 --------------- ----------------- Consolidated total assets $30,878 $34,272 --------------- ----------------- --------------- -----------------
7Total assets for reportable segments includes amounts attributable to trade accounts receivable, inventory and property and equipment. Other unallocated assets principally consists of deferred taxes, intangible assets obtained in conjunction with certain acquisitions 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," "CONTINUE,"PLAN," AND "EXPECT""EXPECT," ARE FORWARD LOOKING STATEMENTS. THESE FORWARD LOOKING STATEMENTS, INCLUDING STATEMENTS REGARDING THE COMPANY'S (I) PLANS FOR DEVELOPMENT OR ACQUISITION AND INTRODUCTION OF NEW PRODUCTS OR ENHANCEMENT OF EXISTING PRODUCTS, (II) STRATEGY, AND INCLUDING ITS FOCUS ON ITS CORE BUSINESS,(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 JDA with Nortel. The following should be readCompany and Nortel entered into the JDA in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risks and Uncertainties", contained in the Company's Annual Report on Form 10-KSeptember 1997 to develop SONET network element products for the fiscal year ended December 31, 1997 filedtelecommunications industry. The intellectual property rights associated with the Securitiesjointly developed technology became the property of the Company. Under the JDA, the Company and Exchange Commission. OVERVIEW ADA is a leading provider of network performance management products that include systems, software,Nortel each contributed technology and services used to manage the quality, performance, availability and reliability of telecommunications service providers' ("TSP") networks. ADA's products are designed to enable TSPs to improve their quality of service, to increase productivity, to lower operating expenses and to effectively deploy new services. ADA has positioned its business to assist TSPs in addressing the rapidly increasing demand for new services, higher bandwidth and accessdevelopment resources to the Internet. ADA's systemsproject and software provide network management functions suchshared the development costs. The Company's development costs associated with the JDA were expensed as service activation and circuit provisioning, network configuration management, network performance management, circuit and facilities testing, and traffic management of the public switched network. ADA has addressed the industry demand for network management products with a three-faceted approach: (1) network systems that provide testing and performance monitoring functions as well as selected transport functions; (2) network management software that enables TSPs to manage their network operations; and (3) services that are customized to meet the evolving needs of the Company's TSP market.incurred. The Company has tworeduced expenses associated with the development conducted under the JDA and continues to explore alternatives for maximizing the value of the jointly developed technology. There can be no assurance that the Company will be successful in it 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 workforce reduction of approximately 65 people. The Company determined the reduction was necessary in order to align its current operations with the Company's objectives of focusing on market opportunities in its core business, units:reducing expenses including expenses related to its recently terminated JDA with Nortel and improving operating results. The majority of the Network Systems business unit andreduction in workforce were engineers focused on development conducted under the Network Management business unit. The business units are theJDA. As a result of the evolutionreduction in workforce, the Company has closed its office in Richardson, Texas. In the quarter ended March 31,1999 the Company incurred a restructuring charge of $1,435,000 related to the reduction in workforce, the closure of the Company from a single product line to multiple product lines. The Network Systems business unit is built aroundTexas facility, and the Company's testwrite-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$8,863,000 for the three months ended SeptemberJune 30, 1998,1999, a 23% decrease3% increase from revenue of $8,750,000$8,580,000 for the three months ended SeptemberJune 30, 1997.1998. The decreaseincrease is primarily the result of increased revenue from the sale of network systems products partially offset by decreased revenue from the sale of network management OSS products. Revenue generated from the sale of the Company's network systems products and services totaled $5,821,000 for the quarterthree months ended June 30,1999, a 7% increase from $5,437,000 for the three months ended June 30, 1998. The increase was primarily the result of decreased salesincreased licensing revenues related to the Remote Module product line. Revenue generated from the sale of the Company's network management OS software products. Revenue from network management OS software products and services totaled $3,042,000 for the three months ended SeptemberJune 30, 1998 totaled $3,628,000,1999, a 34%3% 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$3,143,000 for the three months ended SeptemberJune 30, 1998 totaled $3,136,000, a 2% decrease from $3,216,000 in the same period last year.1998. 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 resulting from the impact 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 design 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 products for the nine months ended September 30, 1998 totaled $11,266,000, an 8% increase from $10,405,000 in the same period last year. The majority of the increase resulted from increased sales of the Company's Remote Module product partially offset by decreased sales of the Company's CTS products. Revenue from network management OS software products and services for the nine 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 sales of the Company's OS design services and TDC&E products largely offset by increased revenues from the Company's FMS software product. For the three months ended June 30, 1999, BellSouth, MCI WorldCom and Bell Atlantic accounted for 33%, 12%, and 10% of the Company's total revenue, respectively. For the three months ended June 30, 1998, MCI WorldCom and BellSouth accounted for 36% and 32% of the Company's total revenue, respectively. Revenue totaled $16,065,000 for the six months ended June 30, 1999, a 16% increase from $13,852,000 for the six months ended June 30, 1998. The increase is primarily the result of increased revenue from the sale of network systems products as well as increased revenue related to Northern Telecom, Ltd. ("Northern Telecom")network management OSS products. Revenue 10 generated from the sale of the Company's network systems products and services totaled $10,616,000 for the six months ended June 30,1999, a 19% increase from $8,929,000 for the six months ended June 30, 1998. The increase was primarily the result of increased sales of the Company's T3AS and CTS products and increased licensing revenues related to the Remote Module product line. Revenue generated from the sale of the Company's network management OSS products and services totaled $5,449,000 for the six months ended June 30, 1999, an 11% increase from $4,923,000 for the six months ended June 30, 1998. The increase was the result of increased revenue related to the Company's .Provisioner and FMS OSS products partially offset by decreased sales of the Company's Test OS software product partially offset by increased salesdesign services.. For the six months ended June 30, 1999, BellSouth, Bell Atlantic and MCI WorldCom accounted for 32%, 12%, and 8% of the Company's TDC&Etotal revenue, respectively. For the six months ended June 30, 1998, BellSouth and .Provisioner software products. The decreased revenue from OS design servicesMCI WorldCom accounted for 33% and increased sales31% 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. Unliketotal 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 $5,332,000 for the three months ended SeptemberJune 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 have1999, 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 $4,017,00010% increase from $4,839,000 for the three months ended SeptemberJune 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.1998. Gross profit as a percent of revenue was 59%60% for the three months ended SeptemberJune 30, 19981999 compared to 56% 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 ofimproved gross profit margins on 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.product resulting from manufacturing cost reductions. Gross profit totaled $10,464,000$9,640,000 for the ninesix months ended SeptemberJune 30, 1998,1999, a 16% decrease50% increase from $12,507,000 in$6,447,000 for the same period last year.six months ended June 30, 1998. Gross profit as a percent of revenue was 51%60% for the ninesix months ended SeptemberJune 30, 19981999 compared to 54% in47% for the same period last year.in 1998. The decreaseincrease in gross profit levels was primarily the result of a network systems product mix weighted toward T3AS products, which carry higher gross margins than the Company's lower-marginCTS and Remote Module NIU, decreased revenueproduct 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 higher revenue levels and lower revenueinventory write-downs resulted in higher overall gross profit levels in the first nine monthshalf 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$2,761,000 for the three months ended SeptemberJune 30, 1998, an 83% increase1999, a 27% decrease from $1,963,000$3,777,000 for the three months ended SeptemberJune 30, 1997. Research and development expenses totaled $10,904,000 for1998. The decrease is primarily the nine months ended September 30, 1998, a 68% increase from $6,498,000 for the nine months ended September 30, 1997. The majorityresult 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 operatinglower personnel expenses as a result of the .Provisioner license acquisition discussed above in the gross profit analysis, the additiontermination 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 forand the telecommunications industry. Nortel and ADA both contribute technology and development resources to projects conducted under the JDA and equally share the development costs.subsequent reduction in engineering staff. For the three and nine months ended SeptemberJune 30, 1999 and June 30, 1998, the Company's net research and development expenses include a $1.1 million$300,000 and $2.8 million reduction,$1,006,000 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 millionJDA. Research and development expenses totaled $5,946,000 for the three and ninesix months ended SeptemberJune 30, 1997.1999, a 19% decrease from $7,320,000 for the six months ended June 30, 1998. The decrease is primarily the result of lower personnel and non-recurring development expenses as a result of the termination of the JDA with Nortel and subsequent reduction in engineering staff. In addition, during the first quarter of 1999, Nortel agreed to increase its proportionate share of total development costs incurred under the JDA from 50% to 60%. As a result, a greater portion of expenses incurred under the JDA during the first quarter of 1999 were reimbursed by Nortel, resulting in a larger offset to research and development expenses. For the six months ended June 30, 1999 and 1998, the Company's net research and development expenses included $2,141,000 and $1,704,000 offsets, respectively, representing Nortel's proportionate share of development costs incurred for the project conducted under the JDA. The Company believes that its future success depends on its ability to maintain its technological leadership through enhancement of its existing products and development of innovative new products and services that meet customer needs. Therefore,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 ninesix months ended SeptemberJune 30, 1997 the Company recorded1999 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. Also included in the results of operations for the six months ended June 30, 1999 is a one-time credit adjustment of $1,361,000, which represents 11 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$2,147,000 for the three months ended SeptemberJune 30, 1998,1999, a 10% increase16% decrease from $2,230,000$2,551,000 for the three months ended SeptemberJune 30, 1997.1998. The decrease is primarily attributable to lower travel and promotional expenses. Sales and marketing expenses totaled $7,289,000$4,426,000 for the ninesix months ended SeptemberJune 30, 1998, a 30% increase1999, an 8% decrease from $5,590,000$4,831,000 for the ninesix months ended SeptemberJune 30, 1997.1998. The majority of the increases for the threedecrease is primarily due to lower travel 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 designprofessional services business to an OS software product-based business.expenses. The Company expects that sales and marketing expenses will continue to increase in absolute dollarsduring the second half of 1999 as the Company continues to hireit adds additional sales, marketing and technical support personnel to support both current productsincreased focus on new customer markets and planned product introductions. General and administrative expenses totaled $1,258,000$1,353,000 for the three months ended SeptemberJune 30, 1998,1999, a 9% decrease4% increase from $1,379,000$1,295,000 for the three months ended SeptemberJune 30, 1997.1998. The increase is attributable to increased personnel costs associated with the business unit restructuring partially offset by decreased legal and professional services. General and administrative expenses totaled $3,672,000$2,614,000 for the ninesix months ended SeptemberJune 30, 1998, a 4% decrease1999, an 8% increase from $3,816,000$2,414,000 for the ninesix months ended SeptemberJune 30, 1997.1998. The majority ofincrease is attributable to higher personnel costs associated with 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 costsbusiness unit restructuring partially offset by increased expenses for the amortization of intangible assets and legal expenses.a decrease in professional services. 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$134,000 for the three months ended SeptemberJune 30, 1998,1999, a 30%20% decrease from $236,000 in$168,000 for the same quarter a year ago.three months ended June 30, 1998. Interest income totaled $508,000$254,000 for the ninesix months ended SeptemberJune 30, 1998,1999, a 32%26% decrease from $746,000$342,000 for the ninesix months ended SeptemberJune 30, 1997.1998. The decreases resulted from decreased levelsdecrease for the three and six months ended June 30 is primarily due to lower rates of cash investmentsreturn on invested balances in 1999 compared to the same periods last year. 10 1998. For the three and ninethe six months ended SeptemberJune 30, 19981999 and SeptemberJune 30, 1997,1998, 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,$843,000 or $.25$.06 per basic and diluted share for the three months ended SeptemberJune 30, 19981999 compared to a net loss of $526,000,$2,658,000, or $.04$.21 per basic and diluted share for the three months ended SeptemberJune 30, 1997.1998. The Company incurred a net loss of $11,034,000,$3,169,000 or $.87$.24 per basic and diluted share for the ninesix months ended SeptemberJune 30, 19981999 compared to a net loss of $4,349,000,$7,865,000, or $.35$.62 per basic and diluted share for the ninesix months ended SeptemberJune 30, 1997.1998. Excluding the above referenced $1.6 millionone time credit adjustment of $1,361,000 and the restructuring charge for purchased research and development associated with the .Provisioner license acquisition,of $1,435,000, the Company would have incurredrecorded a net loss of $2,771,000$3,095,000, or $.22$.24 per basic and diluted share for the ninesix months ended SeptemberJune 30, 1997.1999. LIQUIDITY AND CAPITAL RESOURCES At September 30, 1998 the Company had approximately $12,148,000 in cash, cash equivalentsCash and investments totaled $14,332,000 at June 30, 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 reductions in trade receivables and investments was primarily the result of netinventory offset by a reduction in accrued expenses and decreased operating losses and, to a lesser extent, purchases of capital equipment. Workingfor the period. Net working capital totaled $17,869,000$16,483,000 at SeptemberJune 30, 1998, a decrease of $8,919,000 from $26,788,0001999 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 receivablea decrease in inventory and other current assets as well astrade receivables significantly offset by an increase in accounts payablecash and other current liabilities. For the nine months ended September 30, 1998investments and a decrease in accrued expenses. Cash provided from the Company's operating activities used $575,000 intotaled $1,628,000 for the six months ended June 30, 1999 compared to $216,000 for the six months ended June 30, 1998. The cash provided for the first six month 12 of 1999 was primarily the result of netreductions in trade receivables and inventory offset by a reduction in accrued expenses and lower 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 for the nine months ended September 30, 1997. For the nine months ended September 30, 1998 cashperiod. Cash used for capital expenditures totaled approximately $1,641,000.$169,000 for the six months ended June 30, 1999 compared to $1,370,000 for the six months ended June 30, 1998. Most of the capital equipment additions in the first six months of 1999 were for the purchase of software development tool kits and computer workstations and lab equipment relatedworkstations. 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 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 September 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. 13 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 current versions of its products are Year 2000 compliant. The Company does not expect additional efforts, if required, to complete Year 2000 compliance for its products will be material. Internal validation testing was conducted as products were 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 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 14 impact on the Company's operating income in that quarter and may result in fluctuations in the price of the Company's Common Stock. As the impact of the Company's Network Management business unit on the Company's revenue increases, the Company may be faced with greater fluctuations in operating income. The licensing and implementation of the Company's OS products generally involves a significant capital expenditure and a commitment of resources by prospective customers. Accordingly, the Company is dependent on its customers' decisions as to the timing and level of commitment and expenditures. In addition, the Company typically realizes a significant portion of license revenues in the last weeks or even days of a quarter. As a result, the magnitude of quarterly fluctuations in the Network Management business unit may not become evident until late in, or after the close of, a particular quarter. In addition, the Company does not recognize service revenues until the services are rendered. The time required to implement the Company's OS products can vary significantly with the needs of its customers and is generally a process that extends for several months. Because of their complexity, larger implementations may take multiple quarters to complete. Additionally, quarter-to-quarter product mix variations, customer orders tending to be placed late in the quarter, and competitive pressures on pricing could have a materially adverse effect on the Company's operating results in any one quarter. The Company's expenses are based in part on the Company's expectations as to future revenues and to a large extent are fixed in the short term. If revenues do not meet expectations, the Company's business, operations and financial condition are likely to be materially adversely affected. The Company has experienced losses in the past and there can be no assurance that the Company will not experience losses in the future. COMPETITION. Competition in the Company's markets is intense and is characterized by rapidly changing technologies, conformance with evolving industry standards, frequent new product introductions and enhancements, rapid changes in customer requirements, and price-competitive bidding. To maintain and improve its competitive position, the Company must continue to develop and introduce, in a timely and cost-effective manner, new products and features that keep pace with increasing customer requirements. The Company expects competition in its markets to increase from existing competitors and from other companies which may enter the Company's current or future markets. The Company believes the principal competitive factors affecting the market for its network systems test and performance monitoring products are product features, price, conformance with BellCore and other industry transmission standards and specifications, performance and reliability, technical support, and the maintenance of close working relationships with customers. The Company's network systems products, especially CTS and Remote Module, are currently focused in highly competitive market niches. The environment for CTS and Remote Module is fiercely competitive with respect to price, product features, established customer-supplier relationships and conformance with industry standards. The Company believes the current competitors that provide partial solutions to either performance monitoring or testing of the DS3, and the DS1 and DS0 circuits that make up the DS3 circuit, include Hekimian, Laboratories, Inc., Telecommunications Techniques Corporation, 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 15 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 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%52% of the Company's total revenue in 1995, 1996, 1997, 1998, and the first ninesix months of 1998,ended June 30, 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%52% and 20% of the Company's total revenue in 1997, and 46%, 31% and 0%9% of the Company's total revenue for the first ninesix months of 1998.ended June 30, 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%66% of the Company's total revenues in 1996, 1997for the year ended December 31, 1998 and first ninethe six months of 1998,ended June 30, 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%34% of the Company's total revenue in 1996, 1997for the year ended December 31, 1998 and first ninesix months of 1998,ended June 30, 1999, 16 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. 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 17 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. 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 18 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 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 JuneSeptember 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 majoritycurrent versions of its current products are Year 2000 compliant. It is expected that the remainingThe Company does not expect additional efforts, if required, to complete Year 2000 compliance for its products will be Year 2000 compliant by December 31, 1998.material. Internal validation testing is beingwas conducted as products are beingwere 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. 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. None.HOLDERS The Annual Meeting of Stockholders was held on May 12, 1999. At the meeting, the stockholders elected Gary D. Cuccio, John F. Malone, Kenneth E. Olson, Christopher B. Paisley, Peter P. Savage and Donald L. Strohmeyer as directors of the Company for the ensuing year and until their respective successors are elected. The following tables sets forth the results of voting in this election:
FOR AGAINST WITHHELD ------------- ---------- ----------- Gary D. Cuccio 11,754,981 -- 100,263 John F. Malone 11,745,881 -- 109,363 Kenneth E. Olson 11,753,051 -- 102,193 Christopher B. Paisley 11,745,565 -- 109,679 Peter P. Savage 11,693,986 -- 161,258 Donald L. Strohmeyer 11,755,722 -- 99,522
In addition, the stockholders voted on the following proposals: (a) To amend the Company's 1998 Employee Stock Purchase Plan to increase the maximum aggregate number of shares reserved for issuance thereunder by 300,000:
FOR AGAINST WITHHELD ------------- ---------- ----------- 9,332,405 2,491,609 31,230
This proposal was approved. (b) To ratify the appointment of PricewaterhouseCoopers, LLP as the Company's independent public accountants for the fiscal year ending December 31, 1999:
FOR AGAINST WITHHELD ------------- ---------- ----------- 11,751,847 66,353 38,044
This proposal was approved. 22 ITEM 5. OTHER INFORMATION.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, 1998.13, 1999. 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 datedDated December 23, 199723,1997 (File No. 0-23698). (2) Incorporated by reference to the Company's Current Report on Form 8-K/A datedDated January 12, 1998 (File No. 0-26398).0-23698) (b) Reports on Form 8-K. None. 2023 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 August 16, 1999 ---------------------------- (Donald L. Strohmeyer) Officer and Director (Principal Executive Officer) By: /s/ James L. Keefe Vice President, Finance and August 16, 1999 ---------------------------- (James L. Keefe) Administration, Chief Financial Officer, Secretary (Principal Accounting Officer)
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