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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 JUNE 30, 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 12,513,195 shares of the registrant's Common Stock, no par value,
outstanding as of July 31, 1997.
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APPLIED DIGITAL ACCESS, INC.
INDEX TO FORM 10-Q
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
June 30, 1997 and December 31, 1996......................................................... 3
Condensed Consolidated Statements of Operations for the
three and six months ended June 30, 1997 and June 30, 1996.................................. 4
Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 1997 and June 30, 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............................................................ 15
SIGNATURES ............................................................................................ 16
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PART I
FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
JUNE 30, DECEMBER 31,
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents $ 3,221 $ 1,504
Investments - current 15,874 19,957
Accounts receivable, net 9,691 6,798
Inventory, net 7,107 7,363
Deferred income taxes 130 130
Prepaid expenses and other current assets 1,203 1,089
----------- -----------
Total current assets 37,226 36,841
Property and equipment, net 5,666 4,936
Deferred income taxes 1,372 1,372
Other, net 3,389 2,823
----------- -----------
$ 47,653 $ 45,972
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,112 $ 2,120
Acquisition payments due to licensor 2,600 --
Accrued expenses 1,573 1,507
Accrued warranty 1,374 1,398
Deferred revenue 980 587
----------- -----------
Total current liabilities 10,639 5,612
Obligations under capital leases, net of
current portion 24 33
----------- -----------
Total liabilities 10,663 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, 12,498,449 and 12,255,334 shares
issued and outstanding at June 30, 1997 and
December 31, 1996, respectively 51,078 50,631
Additional paid-in capital 2,530 2,492
Unrealized gain on investments -- 25
Deferred compensation (24) (50)
Accumulated deficit (16,594) (12,771)
----------- -----------
Total shareholders' equity 36,990 40,327
----------- -----------
$ 47,653 $ 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 FOR THE SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
----------------------- -----------------------
1997 1996 1997 1996
-------- -------- -------- --------
(AMOUNTS IN THOUSANDS (AMOUNTS IN THOUSANDS
EXCEPT PER SHARE AMOUNT) EXCEPT PER SHARE AMOUNT)
Revenue $ 8,164 $ 4,516 $ 14,552 $ 11,153
Cost of revenue 3,711 2,047 6,922 5,067
-------- -------- -------- --------
Gross profit 4,453 2,469 7,630 6,086
Operating expenses:
Research and development 2,534 1,905 4,535 3,572
In-process research and
development related to
asset acquisition 1,578 -- 1,578 1,186
Sales and marketing 1,902 1,760 3,360 3,201
General and administrative 1,082 750 2,437 1,430
-------- -------- -------- --------
Total operating expenses 7,096 4,415 11,910 9,389
======== ======== ======== ========
Operating loss (2,643) (1,946) (4,280) (3,303)
Interest income 268 479 510 953
Other income (expense), net 14 27 11 42
======== ======== ========= ========
Loss before income taxes (2,361) (1,440) (3,759) (2,308)
Provision for income taxes 13 -- 64 --
-------- -------- -------- --------
Net loss ($ 2,374) ($ 1,440) ($ 3,823) ($ 2,308)
======== ======== ======== ========
Net loss per share ($ 0.19) ($ 0.12) ($ 0.31) ($ 0.19)
======== ======== ======== ========
Number of shares used in per share
computations 12,452 11,983 12,381 11,961
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 SIX MONTHS
ENDED JUNE 30,
-----------------------
1997 1996
-------- --------
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net loss ($ 3,823) ($ 2,308)
Adjustments to reconcile net loss to net
cash provided (used) by operating activities:
In-process research and development related to
asset acquisition 1,578 1,186
Depreciation and amortization 1,335 630
Other (116) 25
Changes in assets and liabilities:
Accounts receivable (2,893) 1,947
Inventory 256 (869)
Prepaid expenses and other current assets (114) (350)
Accounts payable 1,992 (96)
Acquisition payments due licensor 2,600 --
Accrued expenses 64 257
Accrued warranty (24) 63
Deferred revenue 393 253
-------- --------
Net cash provided by operating activities 1,248 738
-------- --------
Cash flows from investing activities:
Purchases of investments (9,778) (12,026)
Maturities of investments 14,017 13,935
Purchases of property and equipment (826) (838)
Purchase costs related to asset acquisitions (3,383) (1,900)
-------- --------
Net cash provided (used) by investing activities 30 (829)
-------- --------
Cash flows from financing activities:
Principal payments on capital leases (8) (17)
Proceeds from the issuance of common
stock under stock option plans 447 318
-------- --------
Net cash provided by financing activities 439 301
-------- --------
Net increase in cash and cash equivalents 1,717 210
Cash and cash equivalents, beginning of period 1,504 1,673
-------- --------
Cash and cash equivalents, end of period $ 3,221 $ 1,883
======== ========
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
June 30, 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 and six month periods ended
June 30, 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:
JUNE 30, DECEMBER 31,
1997 1996
-------- ------------
(DOLLARS IN THOUSANDS)
Raw materials $ 3,143 $ 4,211
Work-in-process 3,050 2,558
Finished goods 1,433 1,063
------- -------
7,626 7,832
Less inventory reserve (519) (469)
------- -------
$ 7,107 $ 7,363
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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.
4. Recent Accounting Pronouncements
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. SFAS No. 128 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.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130 "Comprehensive Income" ("SFAS No. 130") and Statement of Financial
Accounting Standards No. 131 "Disclosure about Segments of an Enterprise and
Related Information" ("SFAS No. 131"). SFAS No. 130 establishes standards
for reporting and display of comprehensive income and its components in a
full set of general purpose financial statements. Comprehensive income is
defined as the change in equity of a business enterprise during a period
from transactions and other events and circumstances from nonowner sources.
SFAS No. 131 requires publicly-held companies to report financial and other
information about key revenue-producing segments of the entity for which
such information is available and is utilized by the chief operation
decision maker. Specific information to be reported for individual segments
includes profit or loss, certain revenue and expense items and total assets.
The impact of adopting SFAS No. 130 and SFAS No. 131, both effective for the
Company in 1998, has not yet been determined.
5. License Acquisition
On June 27, 1997, the Company acquired an exclusive worldwide license to
Nortel's Digital Support System II (TM) ("DSS II") operations system software
product, subject to certain residual rights retained by Nortel. The Company
acquired the license and certain assets related to the DSSII product for a net
amount of $3.1 million, $0.5 million of which is payable by the Company in cash
and the remainder of which is payable in cash and/or stock at the Company's
option in three equal quarterly installments beginning July 15, 1997. The first
installment payment of approximately $.9 million was paid in cash. The Company
recorded a charge of approximately $1.6 million for purchased research and
development associated with the acquisition of the license and assets. As
part of the transaction, the Company also issued Nortel a warrant to purchase
150,000 shares of the Company's common stock at an exercise
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price of $12 per share. The warrant has a three year term. Nortel retains the
right to and will continue to support its current DSS II customer base outside
of North America as part of its integrated Network Management (NM) portfolio
for Broadbank Network solutions. The Company has obtained exclusive worldwide
rights to market and sell the DSS II product under the new name, . Provisioner,
and has acquired substantially all of Nortel's North American DSS II customer
relationships.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
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 two product lines,
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,
which may result in 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 SEC.
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"), .Provisioner, a circuit and node
provisioning system formerly known as Nortel's DSS II product, and OS design
services all acquired through acquisitions, as well as Sectionalizer and
Graphical Test Assistant ("GTA").
Recent Developments
On June 27, 1997, the Company acquired an exclusive worldwide license to
Nortel's DSS II OS software product, subject to certain residual rights retained
by Nortel. The Company acquired the license and certain assets related to the
DSSII product for a net amount of $3.1 million, $0.5 million of which is payable
by the Company in cash and the remainder of which is payable in cash and/or
stock at the Company's option in three equal quarterly installments beginning
July 15, 1997. The first installment payment of approximately $.9 million was
paid in cash. The Company recorded a charge of approximately $1.6 million for
purchased research and development associated with the acquisition of the
license and assets. As part of the transaction, the
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Company also issued Nortel a warrant to purchase 150,000 shares of the Company's
common stock at an exercise price of $12 per share. The warrant has a three year
term. Nortel retains the right to and will continue to support its current DSS
II customer base outside of North America as part of its integrated Network
Management (NM) portfolio for Broadband Network solutions. The Company has
obtained exclusive worldwide rights to market and sell the DSS II product under
the new name, .Provisioner, and has acquired substantially all of Nortel's North
American DSS II customer relationships.
The acquisition relates to the Company's objective to acquire software
development capability in the telecommunications carrier OS 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 and its predecessor DSS since 1986, most
recently under contract to Nortel's Network Services Management Division.
In June, the Company signed a three year supply contract with MCI
Telecommunications Corporation ("MCI") for the Company's systems, software and
services products. This contract is a standard supply contract which specifies
the terms and conditions under which MCI will order and the Company will supply
products and services. The contract is not a commitment contract and does not
guarantee any purchases of products and services or any level of purchases.
Although MCI has purchased certain products of the Company under the terms of
this contract, the Company is uncertain whether this contract will result in any
future orders for the Company's products, or if it does, whether the orders will
result in significant revenue.
Results of Operations
Revenue totaled $8,164,000 for the three months ended June 30, 1997, an 81%
increase from revenue of $4,516,000 for the three months ended June 30, 1996.
For the six months ended June 30, 1997, revenue totaled $14,552,000, a 30%
increase from $11,153,000 in the same period last year. The increases were
mostly due to increased OS software design services generated from the BCG
operations acquired in July 1996.
For the three and six months ended June 30, 1997, revenue from T3AS products,
services and sensors totaled $4.4 million and $7.2 million, respectively,
compared to $3.7 million and $10.4 million, respectively, for the same periods
last year. The quarter-over-quarter revenue increase was due to an increase in
Remote Module product sales resulting from the purchases of the Company's NIU
product by BellSouth. The decrease in T3AS sales for the six months ended June
30, 1997 was primarily the result of decreased engineering and installation
("E&I") services provided to customers for the installation of T3AS products.
For the six months ended June 30, 1996, E&I revenue totaled $2.6 million, the
majority of which was provided to one RBOC customer compared to $24,000 for the
six months ended June 30, 1997. E&I services fluctuate significantly quarter to
quarter and while the Company intends to continue to offer E&I services to its
customers, future E&I services, if any, cannot be determined. For the three and
six months ended June 30, 1997, OS revenue totaled $3.7 million and $7.4
million, respectively, compared to $.8 million for the same periods last year.
The increase in OS revenue was primarily the result of increased software design
services. Included in OS revenue for the three and six months ended June 30,
1997 is $1.7 million for the completion and wind down of the OS software design
services agreement with Nortel for support of the DSS II product. These support
services were provided to Nortel pursuant to an agreement between the Company
and Nortel dated July 17, 1996 which was terminated on June 25, 1997. The
Company will continue to market the design services business in the future.
Nortel has indicated that it intends to continue to purchase software design
services from the Company although at levels significantly lower than in the
past.
The Company has acquired from Nortel a license to the DSSII product and
technology which it expects to market and enhance under the new name
.Provisioner. The Company also expects to integrate the licensed technology into
new product development. The acquisition has generated a shift in the Company's
BCG operations from a software design services business to a product business.
To date, the Company's BCG OS revenue has been generated from OS software design
services provided to Nortel for which revenue has been recognized as the
services were performed. Although the Company believes it will be successful in
transitioning the majority of its BCG operations from a design services business
to a product business, there can be no assurance the Company will be able to
maintain the historical BCG revenue levels in the future. As a result, the
Company may experience quarterly revenue fluctuations in the future that could
have a material adverse effect on the Company's business, operating results and
financial condition. The Company expects that revenue from sales of the T3AS
product family and OS products and services will account for a majority of the
Company's revenue for the foreseeable future.
Gross profit was $4,453,000 for the three months ended June 30, 1997, an
increase of 80% from $2,469,000 in the second quarter of 1996. Gross profit as a
percent of revenue was 55% for the three months ended June 30, 1997, unchanged
from the same period last year. The increase in gross profit for the second
quarter was primarily due to increased revenue from OS software design services.
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Gross profit totaled $7,630,000 for the six months ended June 30, 1997, an
increase of 25% from $6,086,000 for the same period last year. Gross profit as a
percent of revenue was 52% for the six months ended June 30, 1997 compared to
55% for the same period last year. The increase in gross profit for the six
months ended June 30, 1997 was also the result of increased revenue from OS
software design services partially offset by decreased sales of T3AS products
and services and a change in product mix for T3AS products and services. In
1997, sales of the Company's T3AS products have been weighted toward the
Company's CTS and Remote Module NIU products which carry lower product margins
as compared to its T3AS system. The highly competitive CTS and NIU markets are
subject to severe pricing pressures which have contributed to lower overall
gross profits on these 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 obsolescence 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 $2,534,000 for the three months ended
June 30, 1997, a 33% increase from $1,905,000 for the three months ended June
30, 1996. Research and development expenses totaled $4,535,000 for the six
months ended June 30, 1997, a 27% increase from $3,572,000 for the six months
ended June 30, 1996. The majority of the increases was attributable to the
addition of research and development personnel related to the ACD acquisition
and the shift in the BCG OS business toward product development as a result of
the DSS II license acquisition. The Company believes that its future success
depends on its ability to maintain its technological leadership through
enhancement of its existing products and development of innovative new products
and services that meet customer needs. Therefore, the Company intends to
continue to make significant investments in research and product development in
association with planned development projects.
In the three months ended June 30, 1997 the Company recorded a charge of
approximately $1.6 million for purchased research and development costs related
to the acquisition of the DSS II license and related assets from Nortel.
Sales and marketing expenses were $1,902,000 for the three months ended June 30,
1997, an 8% increase from $1,760,000 in the same period last year. For the six
months ended June 30, 1997, sales and marketing expenses totaled $3,360,000, a
5% increase from $3,201,000 in the same period last year. The increases were
due to additional customer support and marketing personnel expenses required to
support the OS business. The Company expects that sales and marketing expenses
will continue to increase in absolute dollars as the Company continues to hire
additional sales, marketing and technical support personnel to support planned
product introductions in both network systems and network management business
areas.
General and administrative expenses totaled $1,082,000 for the three months
ended June 30, 1997, a 44% increase from $750,000 in the same period last year.
For the six months ended June 30, 1997, general and administrative expenses
totaled $2,437,000 a 70% increase from $1,430,000 in the same period last year.
The majority of the increase was due to the amortization of goodwill and
intangible assets associated with the acquisition of the BCG operations
completed 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 $268,000 for the second quarter of 1997, a 44% decrease
from $479,000 in the same quarter a year ago. Interest income totaled $510,000
for the first half of 1997, a 46% decrease from $953,000 in the same period in
1996. This decrease is mostly the result of decreased cash investments compared
to the same period last year.
For the three and six months ended June 30, 1997 the Company provided for income
taxes related to the operations of the Company's Canadian subsidiary, based on
an annual effective Canadian tax rate of 46%. The Company did not provide for
U.S. income taxes for the three and six months ended June 30, 1997 or June 30,
1996 due to net losses. 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
$2,374,000, or $.19 per share, for the three months ended June 30, 1997 compared
to a net loss of $1,440,000, or $.12 per share, for the three months ended June
30, 1996. Excluding the $1.6 million charge for purchased research and
development associated with the purchase of the DSS II license, the Company
would have recorded a net loss of $796,000, or $.06 per share, for the three
months ended June 30, 1997. The Company incurred a net loss of $3,823,000, or
$.31 per share, for the six months ended June 30, 1997 compared to a net loss of
$2,308,000, or $.19 per share, for the
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same period last year. Excluding the above referenced $1.6 million charge and
the $1.2 million charge for purchased research and development associated with
the ACD acquisition in the first quarter of 1996, the Company would have
recorded a net loss of $2,245,000, or $.18 per share, for the six months ended
June 30, 1997 and a net loss of $1,122,000, or $.09 per share, for the six
months ended June 30, 1996.
Liquidity and Capital Resources
At June 30, 1997 the Company had approximately $19,095,000 in cash and
investments, compared to $21,461,000 at December 31, 1996. The decrease in cash
and investments is primarily due to cash payments associated with the
acquisition of the DSS II license and related assets, and purchases of capital
equipment.
Working capital decreased approximately 15% or $4,642,000 from $31,229,000 at
December 31, 1996 to $26,587,000 at June 30, 1997. The decrease in working
capital was primarily the result of an increase in accounts payable due to the
timing of inventory receipts and an increase in accrued payments related to the
DSSII license acquisition.
For the six months ended June 30, 1997 the Company's operating activities
provided $1,248,000 in cash, primarily as a result of an increase in accounts
payable and accrued payments related to the DSSII license acquisition offset by
an increase in accounts receivable, compared to $738,000 provided by operating
activities for the six months ended June 30, 1996.
For the six months ended June 30, 1997 cash used for capital expenditures
totaled approximately $826,000 compared to $838,000 for the six months ended
June 30, 1996. Most of the capital equipment additions were related to the
purchase of computer and lab equipment to support the Company's expanded
research and development efforts and the BCG operations moving to a new
location. 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.
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 29% of the Company's revenue in the first six months 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, U S West and MCI 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 and MCI contracts may be terminated at the convenience of
the RBOC or MCI, 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
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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 to date has been derived from the sale of T3AS products and
services. However, the Company expects that its future revenue will be derived
from both T3AS products and services and OS software products and services. The
Company is investing in the expansion of its product lines through the
enhancement, development and marketing of its NIU, CTS, 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
DS1 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 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 Operations Systems ("OS") software products including the Traffic Data
Collection and Engineering System ("TDC&E"), the Fault Management System
("FMS"), the circuit and node provisioning system, .Provisioner, 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.
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Mergers. Of the eight major Telephone Service Providers ("TSPs") currently
involved in or that have recently completed 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.
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
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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
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.
The Annual Meeting of Shareholders was held on May 20, 1997 and was
adjourned solely with respect to the Delaware reincorporation proposal
until May 30, 1997 and again to June 13, 1997, on which date the
proposal was adopted. At the meeting, the shareholders elected Kenneth
E. Olson, Christopher B. Paisley, Peter P. Savage and Edward F. Tuck as
directors of the Company for the ensuing year and until their
respective successors are elected. The following tables sets forth the
results of voting in this election:
For Against Withheld
--- ------- --------
Kenneth E. Olson 10,779,651 - 493,579
Christopher B. Paisley 10,675,451 - 597,779
Peter P. Savage 10,774,827 - 498,403
Edward F. Tuck 10,782,151 - 491,079
In addition, the shareholders voted on the following proposals:
(a) To approve the Company's reincorporation in Delaware, through the
merger of Applied Digital Access, Inc., a California corporation, with
and into a wholly-owned Delaware subsidiary of Applied Digital Access,
Inc.:
For Against Abstain Broker Non-Votes
------------------------------------------------------------------
6,237,368 2,064,125 28,080 2,991,162
This proposal was approved.
(b) To ratify the appointment of Coopers and Lybrand L.L.P. as the
Company's independent public accountants for the fiscal year ending
December 31, 1997:
For Against Abstain
------------------------------------------
11,228,320 23,927 20,883
This proposal was approved.
ITEM 5. OTHER INFORMATION.
None.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1* Asset Purchase Agreement between Applied Digital
Access, Inc. and Northern Telecom Limited dated June
27, 1997 ("the Asset Purchase Agreement"). Schedules
A, C, E, G, I and K to the Asset Purchase Agreement
have been omitted because they contain information
that is not material to an investment decision and is
otherwise discussed in the agreement (pursuant to Item
601.(b)(2) of Regulation S-K of the Securities
Exchange Act of 1934, as amended). Schedules B, D, F
and H of the Asset Purchase Agreement are included in
this Form 10-Q as or as part of Exhibits 10.1, 10.2,
10.3 and 10.3, respectively. The Company agrees to
furnish supplementally a copy of any omitted schedule
to the Commission upon request.
10.1* License Agreement between Northern Telecom Ltd. and
Applied Digital Access, Inc. dated as of June 27, 1997
10.2 Applied Digital Access, Inc. 1997 Registration Rights
Agreement between Applied Digital Access, Inc. and
Northern Telecom Limited dated as of June 27, 1997
10.3 Stock and Warrant Purchase Agreement between Applied
Digital Access, Inc. and Northern Telecom dated as of
June 27, 1997
10.4* Master Purchase Agreement between MCI
Telecommunications Corporation and Applied Digital
Access, Inc. dated June 16, 1997
10.5* Master Agreement between Northern Telecom Limited and
Applied Digital Access, Inc. dated as of June 26, 1997
11.1 Statement regarding computation of net income (loss)
per share.
27.1 Financial Data Schedule.
* Certain confidential portions of this Exhibit were omitted by
means of blacking out the text (the "Mark"). This Exhibit has
been filed separately with the Secretary of the Commission
without the Mark pursuant to the Company's Application
Requesting Confidential Treatment under Rule 24b-2 under the
Securities Exchange Act of 1934.
(b) Reports on Form 8-K.
None.
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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: August 14, 1997 /s/ PETER P. SAVAGE
-----------------------------------------
Peter P. Savage
Director
President and Chief Executive Officer
Date: August 14, 1997 /s/ JAMES L. KEEFE
-----------------------------------------
James L. Keefe
Vice President Finance and
Administration and Chief
Financial Officer
16