1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1997
[ ] 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)
CALIFORNIA 68-0132939
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
9855 SCRANTON ROAD, SAN DIEGO, CALIFORNIA 92121
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, ZIP CODE)
(619) 623-2200
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
There were 12,452,989 of the registrant's Common Stock, no par value,
outstanding on April 30, 1997.
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APPLIED DIGITAL ACCESS, INC.
INDEX TO FORM 10-Q
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
March 31, 1997 and December 31, 1996 3
Condensed Consolidated Statement of Operations for
the three months ended March 31, 1997
and March 31, 1996 4
Condensed Consolidated Statement of Cash Flows for
the three months ended March 31, 1997 and
March 31, 1996 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7-10
Risks and Uncertainties 10-13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 2. Changes in Securities 14
Item 3. Defaults Upon Senior Securities 14
Item 4. Submission of Matters to a Vote of Security Holders 14
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 14
SIGNATURES 15
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Item 1.
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
1997 1996
---- ----
(UNAUDITED)
(DOLLARS IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents $1,731 $1,504
Investments - current 19,767 19,957
Accounts receivable, net 6,153 6,798
Inventory, net 7,098 7,363
Deferred income taxes 130 130
Prepaid expenses and other current assets 1,009 1,089
---------- -----------
Total current assets 35,888 36,841
Property and equipment, net 4,757 4,936
Deferred income taxes 1,372 1,372
Other, net 2,590 2,823
---------- -----------
$44,607 $45,972
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $2,265 $2,120
Accrued expenses 1,257 1,507
Accrued warranty 1,393 1,398
Deferred revenue 496 587
---------- -----------
Total current liabilities 5,411 5,612
Obligations under capital leases, net of
current portion 29 33
---------- ----------
Total liabilities 5,440 5,645
---------- ----------
Shareholders' equity:
Preferred stock, no par value, 7,500,000
shares authorized, no shares issued - -
Common stock, no par value, 30,000,000 shares
authorized, 12,394,971 and 12,255,334 shares
issued and outstanding at March 31, 1997 and
December 31, 1996, respectively 50,929 50,631
Additional paid-in capital 2,487 2,492
Unrealized gain on investments 9 25
Deferred compensation (37) (50)
Accumulated deficit (14,221) (12,771)
----------- -----------
Total shareholders' equity 39,167 40,327
----------- -----------
$44,607 $45,972
=========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
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APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS
--------------------
ENDED MARCH 31,
---------------
1997 1996
---- ----
(Amounts in thousands except
per share amount)
Revenue $6,388 $6,637
Cost of revenue 3,211 3,020
------- -------
Gross profit 3,177 3,617
Operating expenses:
Research and development 2,001 1,667
In-process research and development
related to asset acquisition - 1,186
Sales and marketing 1,458 1,441
General and administrative 1,355 680
------ ------
Total operating expenses 4,814 4,974
------ -----
Operating loss (1,637) (1,357)
Interest income 243 474
Other income (expense), net (4) 15
------ ------
Loss before income taxes (1,398) (868)
Provision for income taxes 51 -
------ ------
Net loss ($1,449) ($868)
====== ======
Net loss per share ($0.12) ($0.07)
====== ======
Number of shares used in per share
computations 12,310 11,939
The accompanying notes are an integral part of the consolidated financial
statements.
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APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS
ENDED MARCH 31,
1997 1996
---- ----
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net loss ($1,449) ($868)
Adjustments to reconcile net loss to net
cash provided (used) by operating activities:
In-process research and development related to
asset acquisition - 1,186
Depreciation and amortization 661 255
Other 51 15
Changes in assets and liabilities:
Accounts receivable 645 2,266
Inventory 240 94
Prepaid expenses and other current assets 80 151
Accounts payable 145 163
Accrued expenses (251) 168
Accrued warranty (5) 37
Deferred revenue (91) -
----------- ----------
Net cash provided by
operating activities 26 3,467
----------- ----------
Cash flows from investing activities:
Purchases of investments (6,789) (8,042)
Maturities of investments 6,944 8,926
Purchases of property and equipment (249) (200)
Purchase costs related to asset acquisitions - (1,900)
----------- ----------
Net cash used by investing activities (94) (1,216)
----------- ----------
Cash flows from financing activities:
Principal payments on capital leases (3) (9)
Proceeds from the issuance of common
stock under stock option plans 298 191
----------- ----------
Net cash provided by financing activities 295 182
----------- ----------
Net increase in cash and cash equivalents 227 2,433
Cash and cash equivalents, beginning of period 1,504 1,673
---------- ---------
Cash and cash equivalents, end of period $1,731 $4,106
========== =========
The accompanying notes are an integral part of the consolidated financial
statements.
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APPLIED DIGITAL ACCESS, INC.
Notes to Condensed Consolidated Financial Statements
March 31, 1997
(Unaudited)
1. Basis of Presentation
The accompanying Unaudited condensed consolidated financial statements
include the accounts of Applied Digital Access, Inc. ("the Company" or
"ADA") and its wholly owned subsidiary: Applied Digital Access - Canada,
Inc. All significant intercompany balances and transactions have been
eliminated in consolidation. These financial statements have been prepared
in accordance with the interim reporting requirements of Form 10-Q, pursuant
to the rules and regulations of the Securities and Exchange Commission
("SEC"). Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
In the opinion of management, all adjustments (consisting of only normal
recurring adjustments) considered necessary for a fair presentation have
been included. Operating results for the three month period ended March 31,
1997 are not necessarily indicative of the results that may be expected for
the year ending December 31, 1997. 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, 1996 filed with the SEC.
2. Inventory
Inventory is valued at the lower of cost (determined using the first-in,
first-out method) or market.
Inventory was as follows:
March 31, 1997 December 31, 1996
-------------- -----------------
(Dollars in thousands)
Raw materials $3,825 $4,211
Work-in-process 2,447 2,558
Finished goods 1,320 1,063
----- -----
7,592 7,832
Less inventory reserve (494) (469)
----- -----
$7,098 $7,363
====== ======
3. Per Share Information
Per share information is computed using the weighted average number of
common shares and common equivalent shares (when the effect is dilutive)
outstanding during the periods presented. Common equivalent shares result
from outstanding options and warrants to purchase common stock.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128 Earnings per Share
("SFAS No. 128"). SFAS No. 128 requires dual presentation of newly defined
basic and diluted earnings per share on the face of the income statement for
all entities with a complex capital structure. The accounting standards is
effective for fiscal years ending after December 15, 1997, including interim
periods. The Company does not believe that the adoption of SFAS No. 128 will
have a material impact on the computation of its earning per share in future
periods.
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Item 2.
APPLIED DIGITAL ACCESS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
March 31, 1997
Except for the historical information contained herein, the matters discussed in
this Form 10-Q may contain forward-looking statements which involve risk and
uncertainties. Factors that may affect the Company's results of operations
include but are not limited to concentration of major customers, telephone
company qualification requirements, high dependence on single product line,
competition, management of changing business, mergers, rapid technological
change and dependence on new products, dependence on suppliers and
subcontractors, product recall, government regulation, proprietary technology,
dependence on key personnel, and volatility of stock price. The Company believes
that deregulation and the resulting increased number of competitors providing
telecommunications services could result in an expansion of the Company's
customer base and increased competition with regard to service levels and costs,
ultimately causing an increased demand for the Company's products. However,
additional delays in the deployment of the Company's products and continued
uncertainty surrounding the telecommunications industry may have a material
adverse impact on the Company's business, operating results and financial
condition. As a result of the uncertainties faced by the Company's customers,
the Company continues to have limited visibility with regard to future customer
orders and the timing of such orders. Customers have been placing orders
quarterly and the Company has been operating in a book and ship mode. With a
small customer base and fluctuating order size, this trend has resulted in
quarter-to-quarter revenue fluctuations that are likely to continue for the
foreseeable future.
The following should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Risks and
Uncertainties", contained in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1996 filed with the Securities and Exchange
Commission.
Overview
ADA is a leading provider of network performance management products that
include systems, software, and services used to manage the quality, performance,
availability and reliability of telecommunications service providers' networks.
ADA's products are designed to enable service providers 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
service providers in addressing the rapidly increasing demand for new services,
higher bandwidth and access to the Internet. ADA's systems and software provide
network management functions such as provisioning, configuration management,
performance management, testing and traffic management. ADA has approached the
industry demand for network management products with a three-faceted approach;
(1) Network Systems and Sensors that provide testing and performance monitoring
functions as well as selected transport functions; (2) Network Management
software that enables service providers to manage their network operations; and
(3) Services that are customized to meet the evolving needs of the service
provider market. In 1996, the Company formed two strategic business units: the
Network Systems and Sensors business unit and the Network Management business
unit. The business units are synergistic with the evolution of the Company from
a single product line to multiple product lines. The Network Systems and Sensors
business unit is built around the Company's T3AS products and services including
its T3AS system, Centralized Test System ("CTS") and Protocol Analysis Access
System ("PAAS"), and the Remote Module, a DS1 network interface unit ("NIU").
The Network Management business unit focuses on Operations Systems ("OS")
software products including the Traffic Data Collection and Engineering System
("TDC&E"), the Fault Management System ("FMS") and OS design services all
acquired through acquisitions, as well as Graphical Test Assistant ("GTA") and
Sectionalizer. The Company is currently transitioning portions of the OS design
service business to a product-oriented business.
Recent Developments
On April 15, 1997, the Company reached a non-binding agreement with Northern
Telecom Limited ("Nortel") to acquire Nortel's Digital Support System II(TM)
("DSS II(TM)") operations system software product. The non-binding agreement
calls for the Company to acquire from Nortel an exclusive worldwide license,
subject to certain residual rights retained by Nortel, to the DSS II(TM)
software for cash and common stock of the Company. Nortel will retain the right
to and will continue to support its current DSS II(TM) customers based outside
of North America, as part of its Integrated Network Management ("INM") portfolio
for managed Broadband Network solutions. The proposed acquisition is subject to
negotiation and the execution of definitive documents.
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The proposed acquisition represents the completion of a two-part plan to acquire
software development capability in the telephone company operations system
software arena and convert that capability to a product-based business. The
first part of the plan involved the acquisition by the Company of its Vancouver
based development team known as British Columbia Group ("BCG") from MPR Teltech,
Ltd., a subsidiary of BC TELECOM, Inc., in July 1996. BCG has been responsible
for design, development, and maintenance of DSS II(TM) and its predecessor DSS
since 1986, most recently under contract to Nortel's Network Services Management
Division.
The proposed acquisition of DSS II(TM) is part of the Company's strategic plan
to enter the network management operations system software business and build a
portfolio of products which are essential to the operation of telecommunication
services providers networks.
Results of Operations
Revenue totaled $6,388,000 for the three months ended March 31, 1997, a 4%
decrease from revenue of $6,637,000 for the three months ended March 31, 1996.
The decrease is primarily due to fewer sales of T3AS products, which were offset
by an increase in OS software and services revenue. Revenue for the quarter
ended March 31, 1997 included approximately $2.8 million from the Company's T3AS
products and services compared to $6.6 million in the same quarter a year ago.
This decrease in T3AS sales was primarily the result of decreased capital
expenditures by several of the Company's customers, the highly competitive
market for the Company's CTS and NIU products, and the impact of regulatory
actions on the Company's customers. Revenue for the quarter ended March 31, 1997
included approximately $3.6 million from OS services and products compared to
$48,000 for the same prior year period. The Company's OS product and service
revenue is mostly the result of the acquisition of assets from Applied Computing
Devices, Inc. ("ACD") in February 1996 and the Special Services Network Division
("SSN") of MPR Teltech, Ltd. in July 1996. The Company expects that revenue from
sales of the T3AS product family and recently acquired OS products and services
will account for a majority of the Company's revenue for the foreseeable future.
Gross profit was $3,177,000 for the three months ended March 31, 1997, a
decrease of 12% from $3,617,000 in the first quarter of 1996. Gross profit as a
percent of revenue was 50% for the three months ended March 31, 1997 compared to
54% for the three months ended March 31, 1996. The decrease in gross profit is
the result of a change in the mix of products sold in the first quarter of 1997.
In the quarter ended March 31, 1997 the majority of the Company's revenue was
generated from OS software design services, which have a lower margin than T3AS
products. There can be no assurance that the Company will be able to maintain
current gross profit or gross profit as a percent of revenue levels. Factors
which may materially and adversely affect the Company's gross profit in the
future include its level of revenue, competitive pricing pressure in the
telecommunication network management market, new product introductions by the
Company or its competitors, potential inventory obsolesce and scrap, possible
recalls, production or quality problems, timing of development expenditures,
changes in material cost, disruptions in sources of supply, regulatory changes,
seasonal patterns of bookings, capital spending, and changes in general economic
conditions.
Research and development expenses totaled $2,001,000 for the three months ended
March 31, 1997, a 20% increase from $1,667,000 for the three months ended March
31, 1996. The majority of the increase was attributable to the addition of
research and development personnel related to the acquisition of certain assets
of ACD. The Company believes that its future success depends on its ability to
maintain its technological leadership through enhancement of its existing
products and
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development of innovative new products and services that meet customer needs.
Therefore, the Company intends to continue to make significant investments in
research and product development in association with planned development
projects.
In the three months ended March 31, 1996 the Company recorded a one-time charge
of approximately $1.2 million for purchased research and development costs
related to the ACD asset acquisition.
Sales and marketing expenses were $1,458,000 for the three months ended March
31, 1997, a 1% increase from $1,441,000 for the three months ended March 31,
1996. While the expenses have remained consistent quarter to quarter, there was
a change in the makeup of the expenses. Additional customer support and
marketing personnel expense, required to support the OS system sales, increased
over the same period in 1996, which was offset by a decrease in commission
expenses. The Company expects that sales and marketing expenses will continue to
increase in absolute dollars as the Company continues to hire additional sales,
marketing and technical support personnel to support planned product
introductions in both network systems and network management business areas..
General and administrative expenses totaled $1,355,000 for the three months
ended March 31, 1997, a 99% increase from $680,000 for the three months ended
March 31, 1996. The majority of the increase was due to the amortization of
goodwill and intangible assets associated with the SSN acquisition in the third
quarter of 1996 and additional personnel expenses related to the 1996
acquisitions. The Company expects that general and administrative expenses will
increase in absolute dollars as the administrative support needs of the Company
increase.
Interest income totaled $243,000 for the first quarter of 1997, a 49% decrease
from $474,000 in the same quarter a year ago. This decrease is mostly the result
of decreased cash investments compared to the same period last year.
For the three months ended March 31, 1997 the Company provided for income taxes
related to the operations of the Company's Canadian subsidiary, based on an
annual effective Canadian tax rate of 46%. The Company did not provide for U.S.
income taxes for the three months ended March 31, 1997 or March 31, 1996 due to
a net loss in both quarters. The Company expects to provide for foreign, federal
and state income taxes for 1997 at applicable statutory rates, after giving
effect to net operating losses, remaining available net operating loss
carryforwards, and any available tax credits.
As a result of the factors discussed above, the Company incurred a net loss of
$1,449,000, or $.12 per share, for the three months ended March 31, 1997
compared to a net loss of $868,000, or $.07 per share, for the three months
ended March 31, 1996.
Liquidity and Capital Resources
At March 31, 1997 the Company had approximately $21,498,000 in cash and
investments, compared to $21,461,000 at December 31, 1996. The increase in cash
and investments is primarily due to issuance of stock as part of the employee
stock purchase plan offset by purchases of capital equipment.
Working capital decreased approximately 2% or $752,000 from $31,229,000 at
December 31, 1996 to $30,477,000 at March 31, 1997. The decrease in working
capital was primarily the result of the net operating loss for the quarter, less
adjustments for non-cash expenditures such as depreciation and amortization.
For the three months ended March 31, 1997 the Company's operating activities
provided $27,000 in cash, primarily as a result of a decrease in accounts
receivable and inventory, compared to $3,467,000 provided by operating
activities for the three months ended March 31, 1996.
For the three months ended March 31, 1997 cash used for capital expenditures
totaled approximately $249,000 compared to $200,000 for the three months ended
March 31, 1996. Most of the capital equipment additions were related to the
Vancouver office moving to a new location and to the purchase of computer and
lab equipment to support the Company's expanded research and development
efforts. The Company expects the level of capital expenditures will increase in
1997 as a result of increased research and development efforts.
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. Significant
additional capital resources, however, may be required to fund acquisitions of
complementary businesses, products or technologies. Alternatively, the Company
may need to issue additional shares of its capital stock or incur indebtedness
in connection with any such acquisitions. At present, the Company does not have
any agreements or commitments with respect to any such acquisitions, other than
the proposed acquisition by ADA of the DSS II(TM) operations system software
product, that is
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the subject of a non-binding agreement, discussed above.
The Company believes the impact of inflation on its business activities has not
been significant to date.
RISKS AND UNCERTAINTIES
Concentration of Major Customers; Telephone Company Qualification
Requirements. The market for the Company's products currently consists of the
seven RBOCs, other local telephone companies, Competitive Access Providers
("CAPs") and long distance telephone companies. The Company's marketing efforts
to date have focused on the RBOCs which accounted for 73% of the Company's
revenue in 1996 and 26% of the Company's revenue in the first quarter of 1997.
Accordingly, at present the Company's customer base is highly concentrated and
there can be no assurance that its customer base will become less concentrated.
Further, 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, or a
delay in deployment of the Company's products could materially and adversely
affect the Company's business, operating results and financial condition. Prior
to selling products to a telephone company, a vendor must first undergo a
product qualification process with the telephone company 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, six of the seven RBOCs have qualified and deployed
the Company's T3AS products. Any failure on the part of any of the RBOCs or
other telephone companies to maintain their qualification of the Company's T3AS
products, failure of any of the RBOCs or other telephone companies to deploy the
Company's T3AS products, or any attempt by any of the RBOCs or other telephone
companies to seek out alternative suppliers could have a material adverse effect
on the Company's business, operating results and financial condition. BellSouth,
Ameritech, Southwestern Bell and U S West have entered into purchase contracts
with the Company. Other RBOCs, independent telephone companies, and other
telephone service providers purchase the Company's T3AS products under standard
purchase orders. Since the RBOC contracts may be terminated at the convenience
of the RBOC, the Company believes that the purchase contracts are not materially
different than purchasing under purchase orders. 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, telephone company
work force reductions and staff reassignments 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 Single Product Line. Historically, the majority of the
Company's revenue to date has been derived from the sale of T3AS products and
services. The Company expects that a majority of its revenue will continue to be
derived from T3AS products and services in the near term. However, the Company
is investing in the expansion of its product lines through the enhancement,
development and marketing of its NIU, CTS, Protocol Analysis Access
System("PAAS"), and OS products. Failure by the Company to enhance either its
existing T3AS products and services including CTS and PAAS. or its NIU and OS
products, and 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.
Competition. The Company believes there are currently no competitors that
provide an integrated comprehensive solution to performance monitoring and
testing of the DS3 circuit as does the Company's T3AS system. The Company
believes the principal competitive factors in this market are conformance with
Bellcore and other industry transmission standards and specifications; product
features, including price, performance and reliability; technical support; and
the maintenance of close working relationships with customers. There can be no
assurance that the Company will compete successfully in the future with respect
to these factors and others that may arise. Although the Company believes that
there are fewer than 10 current competitors that provide partial solutions to
either performance monitoring or testing of the DS1 or DS0 circuits that make up
the DS3 circuit, this market is fiercely competitive. Such competitors and
prospective competitors include a number of companies, such as manufacturers of
DSI test and monitoring equipment, manufacturers of NIUs, manufacturers of
digital cross-connect test and performance monitoring equipment and
manufacturers of large transmission equipment. Many of these companies
manufacture products that are directly competitive with the Company's Low-Speed
Subsystems, T3AS Centralized Test Systems and Remote Module, and many of these
competitors have significantly greater technical, financial, manufacturing and
marketing resources than the Company. In addition, the Company believes that
there are an increasing number of current
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competitors in the OS market that provide OS applications for testing,
surveillance, performance monitoring and traffic management of
telecommunications functions. In each of the NIU, CTS and OS markets,
competition is expected to increase significantly in the future. For instance,
the NIU market is fiercely competitive with respect to price, product features,
established supplier, and conformance with industry standards, and in the OS
market, improved technologies and tool sets have made the barriers to entry in
this market relatively small. Additionally, several of the Company's competitors
have long-established relationships with the Company's current prospective
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.
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
faces significant management challenges related to the integration of the
business operations of the new products, services and technologies acquired. In
1996, the Company formed two strategic business units: the Network Systems and
Sensors business unit and the Network Management business unit. The business
units are synergistic with the evolution of the Company from a single product
line to multiple product lines. The Network Systems and Sensors business unit is
built around the Company's T3AS products and services including CTS and PAAS, as
well as the Remote Module product. The Network Management business unit focuses
on OS products including Traffic Data Collection and Engineering ("TDC&E"),
Fault Management System("FMS") and OS design services all acquired through
acquisitions, as well as Graphical Test Assistant ("GTA") and Sectionalizer.
There can be no assurance that the Company will be successful in managing its
new business unit structure. The Company is currently transitioning portions of
the OS design service business to a product-oriented business. This 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. 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 hiring sufficient numbers of
qualified personnel to support the expansion of the business. 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 the 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.
Mergers. Of the eight major Telephone Service Providers ("TSPs") currently
involved in merger transactions, six are customers of the Company. Several of
the mergers involve companies that purchase network systems, software and
services from the Company's competitors. Consequently, the completion of certain
of these mergers may result in the loss of business and customers for the
Company. Additionally, the impact of capital spending constraints during the
merger transitions could have a material adverse effect on the Company's
business, operating results and financial condition.
Rapid Technological Change and Dependence on New Products. The market for
the Company's products is characterized by rapid technological advances,
evolving industry standards, changing regulatory environments, changes in
customer requirements, and frequent new product introductions and enhancements.
The introduction of telephone network test and performance-monitoring products
involving superior technologies or the evolution of alternative technologies or
new industry transmission standards, such as Asynchronous Transfer Mode ("ATM"),
Frame Relay and Synchronous Optical Network ("SONET"), 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 current products, to develop and introduce new products for the
telephone network test and performance-monitoring market, the OS market, and
other markets, to address new industry transmission standards and changing
customer needs, and to achieve broad market acceptance for its products. In
particular, the Company anticipates that the SONET and Synchronous Digital
Hierarchy ("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 T3AS products 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, as they evolve. The widespread adoption of SONET and/or
SDH as industry transmission standards before the Company is able to
successfully develop a product which addresses such transmission standards could
adversely affect the sale and deployment of the Company's T3AS products. 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.
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Dependence on Suppliers and Subcontractors; Need to Make Advance Purchase
Commitments. Certain components used in the Company's T3AS products and Remote
Module product, including its VLSI Application Specific Integrated Circuits
("ASICs") and other components, are available from a single source. The Company
has no 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 subassemblies. 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. 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. To procure adequate supplies of certain components, the Company must make
advance commitments to purchase relatively large quantities of such components
in a number of circumstances. A large portion of the Company's purchase
commitments consists of custom parts, some of which are sole-source such as VLSI
ASICs, for which there is no alternative use or application. The inability of
the Company to incorporate such components in its products could have a material
adverse effect on the Company's business, operating results and financial
condition.
Product Recall. Producers of telephone network equipment, including test
access and performance monitoring systems 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 its customers. The Company's systems are
also required to interface in a complex and changing environment with
telecommunication network equipment made by numerous suppliers. 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.
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. 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 regulatory rulings by federal
and state agencies on the Company's customers may adversely impact the Company's
business, operating results and financial condition.
Proprietary Technology. The Company relies on a combination of technical
leadership, 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 customer's
needs. Currently, the Company has nine U.S. patents granted and two U.S. patent
applications allowed. One of the granted patents relates to the Company's Remote
Module product. Additionally, the Company has nine pending U.S. patent
applications and two international (Patent Cooperation Treaty) 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. As part of its confidentiality procedures,
the Company generally enters into non-disclosure agreements with its employees
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. 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 not aware
of infringement by its products or technology of the proprietary rights of
others. There can be no assurance that third parties will not assert
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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 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.
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.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL 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.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit
Number Description
------ -----------
10.1 License Agreement between Northern Telecom, Ltd. and
Applied Digital Access, Inc. dated as of January 24, 1997
11.1 Statement regarding computation of net income (loss) per
share.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K.
None.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Applied Digital Access, Inc.
Date: May 15, 1997 /s/ Peter P. Savage
------------ --------------------
Peter P. Savage
Director
President and Chief Executive
Officer
Date: May 15, 1997 /s/ James L. Keefe
------------ -------------------
James L. Keefe
Vice President Finance and
Administration and Chief
Financial Officer