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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 SEPTEMBER 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 12,561,374 shares of the registrant's Common Stock, no par value,
outstanding on October 31, 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
September 30, 1997 and December 31, 1996.................................... 3
Condensed Consolidated Statements of Operations for the
three and nine months ended September 30, 1997 and September 30, 1996....... 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 1997 and September 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............................................ 14
SIGNATURES ........................................................................... 15
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Item 1.
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1997 1996
--------------- -----------
(UNAUDITED)
(DOLLARS IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents $ 1,658 $ 1,504
Investments - current 11,911 19,957
Accounts receivable, net 9,759 6,798
Inventory, net 8,171 7,363
Deferred income taxes 130 130
Prepaid expenses and other
current assets 2,815 1,089
------- -------
Total current assets 34,444 36,841
Property and equipment, net 5,768 4,936
Deferred income taxes 1,372 1,372
Other, net 3,106 2,823
------- -------
$44,690 $45,972
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,657 $ 2,120
Acquisition payments due to
licensor 1,733 -
Accrued expenses 1,506 1,507
Accrued warranty 1,449 1,398
Deferred revenue 570 587
------- -------
Total current liabilities 7,915 5,612
Obligations under capital leases,
net of current portion 19 33
------- -------
Total liabilities 7,934 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,
12,551,948 and 12,255,334 shares
issued and outstanding at September
30, 1997 and December 31, 1996,
respectively 51,339 50,631
Additional paid-in capital 2,492 2,492
Unrealized gain on investments 56 25
Deferred compensation (11) (50)
Accumulated deficit (17,120) (12,771)
------- -------
Total shareholders' equity 36,756 40,327
------- -------
$44,690 $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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------- ----------------------------
1997 1996 1997 1996
------- ------- ------- -------
(AMOUNTS IN THOUSANDS EXCEPT (AMOUNTS IN THOUSANDS EXCEPT
PER SHARE AMOUNT) PER SHARE AMOUNT)
Revenue $ 8,750 $ 6,957 $23,302 $18,110
Cost of revenue 3,873 3,807 10,795 8,874
------- ------- ------- -------
Gross profit 4,877 3,150 12,507 9,236
Operating expenses:
Research and development 1,963 1,816 6,498 5,388
In-process research and
development related to
asset acquisition - 2,100 1,578 3,286
Sales and marketing 2,230 1,631 5,590 4,832
General and administrative 1,379 983 3,816 2,413
------- ------- ------- -------
Total operating expenses 5,572 6,530 17,482 15,919
------- ------- ------- -------
Operating loss (695) (3,380) (4,975) (6,683)
Interest income 236 384 746 1,337
Other income (expense), net (24) 4 (13) 46
------- ------- ------- -------
Loss before income taxes (483) (2,992) (4,242) (5,300)
Provision for income taxes 43 173 107 173
------- ------- ------- -------
Net loss ($526) ($3,165) ($4,349) ($5,473)
======= ======= ======= =======
Net loss per share ($0.04) ($0.26) ($0.35) ($0.45)
======== ======= ======== =======
Number of shares used in
per share computations 12,512 12,175 12,425 12,033
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 NINE MONTHS
ENDED SEPTEMBER 30,
1997 1996
-------------- ---------
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net loss ($4,349) ($5,473)
Adjustments to reconcile net loss
to net cash provided (used) by
operating activities:
In-process research and
development related to
asset acquisition 1,578 3,286
Depreciation and amortization 2,167 1,192
Other 87 38
Changes in assets and liabilities:
Accounts receivable (2,961) (514)
Inventory (808) (877)
Prepaid expenses and other
current assets (1,726) 245
Accounts payable 537 383
Acquisition payments due to
licensor 1,733 -
Accrued expenses (20) 639
Accrued warranty 51 83
Deferred revenue
Net cash used in
operating activities (3,711) (998)
------- -------
Cash flows from investing activities:
Purchases of investments (12,716) (16,016)
Maturities of investments 20,743 24,979
Purchases of property and equipment (1,475) (1,372)
Purchase costs related to asset
acquisitions (3,383) (6,356)
------- ------
Net cash provided by investing
activities 3,169 1,235
------ ------
Cash flows from financing activities:
Principal payments on capital leases (12) (26)
Proceeds from the issuance of common
stock under stock option plans 708 475
------ ------
Net cash provided by financing
activities 696 449
------ ------
Net increase in cash and cash
equivalents 154 686
Cash and cash equivalents,
beginning of period 1,504 1,673
------ ------
Cash and cash equivalents, end of
period $1,658 $2,359
====== ======
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
September 30, 1997
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of Applied Digital Access, Inc. and its wholly owned
subsidiaries (the "Company" or "ADA"). All significant intercompany balances
and transactions have been eliminated in consolidation. These financial
statements have been prepared in accordance with the interim reporting
requirements of Form 10-Q, pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). Accordingly, they do not include
all of the information and footnotes required by generally accepted
accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of only normal
recurring adjustments) considered necessary for a fair presentation have been
included. Operating results for the three and nine month periods ended
September 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:
SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------ ------------------
(DOLLARS IN THOUSANDS)
Raw materials $4,228 $4,211
Work-in-process 3,241 2,558
Finished goods 1,420 1,063
------ ------
8,889 7,832
Less inventory reserve (718) (469)
------ ------
$8,171 $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. The accounting standard 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 earnings 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
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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
In June 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 DSS II product for a net amount
of $3.1 million, $2.2 million of which has been paid by the Company in cash
with the remaining $0.9 million to be paid in cash and/or stock at the
Company's option on January 15, 1998. In June 1997 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 price of $12 per share.
The warrant has a three year term. Nortel retained the right to and continues
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.
6. Joint Development Agreement
In September 1997, the Company entered in to a Joint Development Agreement
("JDA") with Northern Telecom, Inc. ("Nortel") to develop unique SONET
network products for the telecommunications industry. Nortel and ADA will
each contribute technology and development resources to projects conducted
under the JDA and will equally share development costs. Development of the
first product under the JDA has commenced. Operating expenses for the three
and nine months ended September 30, 1997 include a $1 million offset to
research and development costs representing Nortel's proportionate share of
development costs that have been incurred through September 30, 1997 in
connection with the initial project being conducted under the JDA.
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, need to make advance purchase commitments, product recall,
government regulation, proprietary technology, dependence on key personnel, and
volatility of stock price. The Company believes that deregulation in the
telecommunications industry 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, 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
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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"), the .Provisioner System (".Provisioner"), and
OS design services all acquired through acquisitions, as well as Graphical Test
Assistant ("GTA"), the Integrated Test Access System ("ITAS") and Sectionalizer.
As a result of the software license acquisition from Nortel, the Company has
transitioned portions of the OS design service business to a product-oriented
business.
Recent Developments
In September 1997, the Company entered in to a Joint Development Agreement
("JDA") with Northern Telecom ("Nortel") to develop unique SONET network
products for the telecommunications industry. Nortel and ADA will each
contribute technology and development resources to projects conducted under the
JDA. The companies will equally share development costs, estimated to be several
million dollars per quarter. Development of the first product under the JDA has
commenced with initial availability expected in the first half of 1999. The
agreement also contemplates additional projects as agreed to in the future by
Nortel and ADA. Operating expenses for the three and nine months ended September
30, 1997 include a $1 million offset to research and development costs
representing Nortel's proportionate share of development costs that have been
incurred through September 30, 1997 in connection with the initial project being
conducted under the JDA.
In June 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 DSS II
product for a net amount of $3.1 million, $2.2 million of which has been paid by
the Company in cash with the remaining $0.9 million to be paid in cash and/or
stock at the Company's option on January 15, 1998. In June 1997, 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 price of $12 per share. The
warrant has a three year term. Nortel retained 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 all of Nortel's
North American DSS II customer relationships.
The acquisition related 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 1997, 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.
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Results of Operations
Revenue totaled $8,750,000 for the three months ended September 30, 1997, a 26%
increase from revenue of $6,957,000 for the three months ended September 30,
1996. Revenue for the nine months ended September 30, 1997 totaled $23,302,000
an increase of 29% over revenue of $18,110,000 for the same period in 1996. The
increases were the net result of increased sales of the Company's OS products
and services generated from the BCG operations acquired in July 1996 offset by
decreased sales of the Company's T3AS products and services.
For the three and nine months ended September 30, 1997, revenue from T3AS
products, services and sensors totaled $3.2 million and $10.4 million,
respectively, compared to $4.3 million and $14.6 million, respectively, for the
same periods last year. The quarter-to- quarter revenue decrease was the net
result of decreased T3AS product sales related to in-line applications offset by
increased sales of the Company's Remote Module NIU product to BellSouth. The
revenue decrease for the nine months ended September 30, 1997 was the net result
of decreased T3AS product sales related to in-line applications and decreased
engineering and installation ("E&I") services provided to customers for the
installation of T3AS products offset by increased sales of the Company's Remote
Module NIU product to BellSouth and increased sales of the Company's CTS product
to MCI. For the nine months ended September 30, 1996, E&I revenue totaled $2.7
million, the majority of which was provided to one RBOC customer compared to
$0.2 million for the nine months ended September 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 nine months ended September 30, 1997, revenue from OS products
and services totaled $5.5 million and $12.9 million, respectively, compared to
$2.7 million and $3.5 million, respectively, for the same periods last year. The
revenue increases were primarily the result of increased sales of the Company's
OS products and services generated from the BCG operations. The acquisition of
the software license from Nortel has generated a shift in the Company's BCG
operations from a software design services business to a product business. The
Company markets and supports the DSS II product and technology under the new
name .Provisioner. The Company also intends to integrate the licensed technology
into new product development. Although the Company has continued to market and
develop the design services business, revenue levels are significantly lower
than in the past due to the shift in BCG's operations. Although the Company
believes it will be successful in transitioning the majority of its OS
operations from a design services business to a product business, there can be
no assurance the Company will be able to maintain historical OS 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 the majority of the Company's revenue for the
foreseeable future.
Gross profit totaled $4,877,000 for the three months ended September 30, 1997, a
55% increase from $3,150,000 for the three months ended September 30, 1996.
Gross profit as a percent of revenue was 56% for the three months ended
September 30, 1997 compared to 45% for the three months ended September 30,
1996. The quarter-to-quarter increase was primarily the result of a product mix
weighted toward higher margin OS software products and increased sales of OS
software products partially offset by decreased sales of T3AS products and
services as well as a change in product mix for T3AS products and services
weighted toward the Company's Remote Module NIU and CTS products which carry
lower product margins compared to the Company's T3AS system. Gross profit
totaled $12,507,000 for the nine months ended September 30, 1997, a 35% increase
from $9,236,000 for the nine months ended September 30, 1996. Gross profit as a
percent of revenue was 54% for the nine months ended September 30, 1997 compared
to 51% for the nine months ended September 30, 1996. The increase in gross
profit for the nine months ended September 30, 1997 was mostly due to increased
sales of OS products and services generated from the BCG operations and a change
in product mix weighted toward higher margin OS software products partially
offset by decreased sales of T3AS products and services as well as a change in
product mix for T3AS products and services weighted toward the Company's CTS and
Remote Module NIU products which carry lower product margins compared to the
Company's 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. Additionally, gross profit for the three and nine months
ended September 30, 1997 increased due to the shift of a majority of engineering
labor previously associated with design services revenue from the cost of
revenue line to research and development operating expenses in relation to the
shift of the BCG operations from a design services business to a product
business. There can be no assurances 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.
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Research and development expenses totaled $1,963,000 for the three months ended
September 30, 1997, an 8% increase from $1,816,000 for the three months ended
September 30, 1996. Research and development expenses totaled $6,498,000 for the
nine months ended September 30, 1997, a 21% increase from $5,388,000 for the
nine months ended September 30, 1996. The increases were primarily the result of
a shift of a majority of engineering labor expenses previously associated with
design services revenue from the cost of revenue line to research and
development operating expense due to the shift in the BCG OS business from
design services to product development and increased research and development
personnel to support efforts related to OS software product development and the
JDA with Nortel all of which was largely offset by the Nortel credit for their
share of development costs incurred on the project. For the three and nine
months ended September 30, 1997, research and development expenses include a $1
million offset representing Nortel's proportionate share of development costs
that have been incurred through September 30, 1997 in connection with the
initial project being conducted under the JDA. The Company believes that its
future success depends on its ability to maintain its technological leadership
through enhancement of its existing products and development of innovative new
products and services that meet customer needs. Therefore, the Company intends
to continue to make significant investments in research and product development
in association with planned development projects.
In June 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 software license and related assets from Nortel.
Sales and marketing expenses totaled $2,230,000 for the three months ended
September 30, 1997, a 37% increase from $1,631,000 for the three months ended
September 30, 1996. Sales and marketing expenses totaled $5,590,000 for the nine
months ended September 30, 1997, a 16% increase from $4,832,000 for the nine
months ended September 30, 1996. The increases were primarily the result of
increased marketing and customer support personnel required to support the OS
business including the shift in BCG's operations. 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 $1,379,000 for the three months
ended September 30, 1997, a 40% increase from $983,000 for the three months
ended September 30, 1996. General and administrative expenses totaled $3,816,000
for the nine months ended September 30, 1997, a 58% increase from $2,413,000 for
the nine months ended September 30, 1996. The majority of the increases was due
to the amortization of goodwill and intangible assets associated with the Nortel
license acquisition and the BCG acquisition completed in the third quarter of
1996, and additional personnel expenses required to support the operations of
the Company's 1996 and 1997 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 $236,000 for the three months ended September 30, 1997,
a 39% decrease from $384,000 for the three months ended September 30, 1996.
Interest income totaled $746,000 for the nine months ended September 30, 1997, a
44% decrease from $1,337,000 for the nine months ended September 30, 1996. This
decrease is mostly the result of decreased cash investments compared to the same
period last year.
For the three and nine months ended September 30, 1997, the Company provided for
income taxes related to the operations of the Company's Canadian subsidiary,
based on an annual effective Canadian tax rate of 46%. The Company did not
provide for U.S. income taxes for the three and nine months ended September 30,
1997 and September 30, 1996, respectively, 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
$526,000, or $.04 per share, for the three months ended September 30, 1997
compared to a net loss of $3,165,000, or $.26 per share, for the three months
ended September 30, 1996. The Company incurred a net loss of $4,349,000, or $.35
per share, for the nine months ended September 30, 1997 compared to a net loss
of $5,473,000, or $.45 per share, for the nine months ended September 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 $2,771,000 or $.22 per share, for the nine months ended
September 30, 1997. Excluding the $1.2 and $2.1 million charges for purchased
research and development associated with 1996 acquisitions, the Company would
have recorded a net loss of $2,187,000, or $.18 per share, for the nine months
ended September 30, 1996.
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Liquidity and Capital Resources
At September 30, 1997 the Company had approximately $13,569,000 in cash and
investments, compared to $21,461,000 at December 31, 1996. The decrease in cash
and investments is primarily due to increased accounts receivable and inventory,
the purchase of capital equipment, cash payments associated with the acquisition
of the DSS II license and related assets, and the net loss from operations.
Working capital decreased approximately 15% or $4,700,000 from $31,229,000 at
December 31, 1996 to $26,529,000 at September 30, 1997. The decrease in working
capital was primarily the result of an increase in accrued payments related to
the DSS II license acquisition, purchases of capital equipment and an increase
in accounts payable due the timing of inventory receipts and the net loss from
operations.
For the nine months ended September 30, 1997, the Company's operating activities
used $3,711,000 in cash, primarily the result of an increase in accounts
receivable due to a majority of product deliveries occurring late in the
quarter, as well as an increase in inventory due to timing of remote module
receipts all of which was partially offset by an increase in accrued payments
due Nortel in conjunction with the DSS II license acquisition, compared to
$998,000 used by operating activities for the nine months ended September 30,
1996.
For the nine months ended September 30, 1997, cash used for capital expenditures
totaled approximately $1,475,000, compared to $1,372,000 for the nine months
ended September 30, 1996. The majority of the capital additions were for
purchases of computer and lab equipment to support expanded research and
development efforts, improvement of the network infrastructure to support the
Company's multiple locations, and the BCG operations move 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, long distance telephone companies, other local telephone companies,
Competitive Access Providers ("CAPs") and Internet Service Providers ("ISPs").
The Company's marketing efforts to date have focused on the RBOCs and long
distance telephone companies which accounted for 73% of the Company's revenue in
1996 and 51% of the Company's revenue in the first nine 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 and a major long distance
telephone company 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 and OS 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.
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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 Two Product Lines. Historically, the majority of the
Company's revenue has been derived from the sale of T3AS products and services.
As a result of acquisitions completed in 1996 and 1997, the Company's revenue
has been derived from a product mix of both T3AS products and services and OS
software products and services. The Company is investing in the expansion of
these two 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, provisioning, 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 resulting in fierce
competition with respect to price, performance, product features, product
reputation, quality, and customer support. Additionally, several of the
Company's competitors, especially in the NIU, CTS and OS markets, have
long-established relationships with the Company's current prospective customers
which may adversely affect the Company's ability to successfully compete for
business with these 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. In June 1997,
the Company acquired a license from Nortel to its DSS II software product and
technology. The Company markets and supports the DSS II product and technology
under the new name .Provisioner. The Company also intends to integrate the
licensed technology into new product development. The acquisition of the
software license has generated a shift in the Company's BCG operations from a
software design services business to a product business and the transition will
likely place a significant strain on the Company's management, information
systems and operations and there can be no assurance that such a transition can
be successfully managed. 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
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in hiring sufficient numbers of qualified personnel to support the expansion of
the business. The Company may also make future acquisitions where it believes it
can acquire new products or otherwise rapidly enter new or emerging markets.
Mergers and acquisitions of high technology companies are inherently risky and
can place significant strains on the Company's management, information systems
and operations. The Company is not able to forecast additional strains that may
be placed on the Company's management, information systems and operations as a
result of recent or future acquisitions or in the future. The Company's
potential inability to manage its changing business effectively could have a
material adverse effect on the Company's business, operating results, and
financial condition.
Mergers. Of the nine major Telephone Service Providers ("TSPs") currently
involved in or that have recently completed merger transactions, seven are
customers of the Company. Several of the mergers involve companies that purchase
network systems, 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.
In addition, future merger transactions involving or contemplated by the
Company's current or prospective customers may cause delays in their capital
spending decisions, which could have a material adverse effect on the Company's
business, operating results and financial condition.
Rapid Technological Change and Dependence on New Products. The market for the
Company's products is characterized by rapid technological advances, evolving
industry 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 few supply agreements and generally makes its purchases with purchase
orders. Further, certain components require an order lead time of up to one
year. Other components that currently are readily available may become difficult
to obtain in the future. Failure of the Company to order sufficient quantities
of these components in advance could prevent the Company from increasing
production in response to customer orders in excess of amounts projected by the
Company. In the past, the Company has experienced delays in the receipt of
certain of its key components, which have resulted in delays in product
deliveries. There can be no assurance that delays in key component and part
deliveries will not occur in the future. The inability to obtain sufficient key
components as required or to develop alternative sources if and as required in
the future could result in delays or reductions in product shipments, which in
turn could have a material adverse effect on the Company's customer
relationships and operating results. Additionally, the Company uses third-party
subcontractors for the manufacture of its 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
products or components, the Company must make advance commitments to purchase
relatively large quantities of such products or components in a number of
circumstances. A large portion of the Company's purchase commitments consists of
custom parts, some of which are sole-source such as VLSI ASICs, for which there
is no alternative use or application. The inability of the Company to sell such
products or incorporate such components in its other products could have a
material adverse effect on the Company's business, operating results and
financial condition.
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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, patent, trade secret, copyright and trademark protection and
non-disclosure agreements to protect its proprietary rights. Although the
Company has pursued and intends to continue to pursue patent protection of
inventions that it considers important and for which such protection is
available, the Company believes its success will be largely dependent on its
reputation for technology, product innovation, affordability, marketing ability
and response to 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. Additionally,
should a third party challenge any of the Company's current or future patents,
there can be no assurance that the Company will be successful in defending its
patents or that any litigation, regardless of outcome, will not result in
substantial cost to and diversion of efforts by the Company. As part of its
confidentiality procedures, the Company generally enters into non-disclosure
agreements with its employees 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 by or against the Company could materially and adversely
affect the Company's business, operating results and financial condition.
Moreover, the laws of some foreign countries do not protect the Company's
proprietary rights in the products to the same extent as do the laws of the
United States.
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* Joint Development Agreement between Northern Telecom, Inc. and
Applied Digital Access, Inc. dated September 30, 1997
11.1 Statement regarding computation of net (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 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: November 14, 1997 /s/ PETER P. SAVAGE
--------------------
Peter P. Savage
Director
President and Chief Executive Officer
Date: November 14, 1997 /s/ JAMES L. KEEFE
-------------------
James L. Keefe
Vice President Finance and
Administration and Chief
Financial Officer
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