<PAGE>
===============================================================================
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________
Form 8-K/A
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
November 1, 1999
Date of Report (Date of earliest event reported)
Commission file number 1-12657
______________
DYNATECH CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 04-2258582
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3 New England Executive Park
Burlington, Massachusetts 01803-5087
(Address of principal executive offices)(Zip code)
Registrant's telephone number, including area code: (781) 272-6100
================================================================================
<PAGE>
Item 2. Acquisition and Disposition of Assets.
-------------------------------------
As described in the Registrant's Current Report on Form 8-K filed on
November 9, 1999 (the "Initial 8-K"), pursuant to an Agreement and Plan of
Merger, dated September 7, 1999 (the "Merger Agreement"), among Applied Digital
Access, Inc., a Delaware Corporation ("Target"), Dynatech Corporation, a
Delaware Corporation (the "Registrant"), and Dynatech Acquisition Corporation, a
Delaware corporation and an indirect wholly owned subsidiary of the Registrant
("Purchaser"), Purchaser commenced a tender offer (the "Offer") on September 14,
1999, for all the outstanding shares of common stock, par value $.001 per share,
of Target (the "Shares") at a price of $5.37 per share, net to the sellers in
cash, without interest (the "Offer Price"). The Offer was made pursuant to the
Offer to Purchase, dated September 14, 1999, and the related Letter of
Transmittal of Purchaser and the Registrant.
The Offer expired at 12:00 midnight, New York City time, on
November 1, 1999. A total of 12,253,640 Shares, or approximately 91% of the
outstanding Shares, were tendered pursuant to the Offer. Following expiration of
the Offer, Purchaser accepted for payment, and paid for, all validly tendered
Shares resulting in a change in control of Target.
Pursuant to Section 253 of the Delaware General Corporation Law (the
"DGCL"), Purchaser was merged (the "Merger") with and into Target, effective on
November 8, 1999, when Purchaser filed a Certificate of Ownership and Merger
with the Secretary of State of Delaware. Under the DGCL, no action was required
by the stockholders of Target, other than Purchaser through its Board of
Directors, for the Merger to become effective. As a result of the Merger (i)
Target became a wholly owned subsidiary of Dynatech LLC, a Delaware limited
liability company and wholly owned subsidiary of the Registrant and (ii) each
Share issued and outstanding (other than Shares held by Purchaser or any other
direct or indirect subsidiary of the Registrant or subject to appraisal rights
under Delaware law) was converted into the right to receive $5.37 per share
in cash, without any interest (the "Merger Consideration").
This Current Report on Form 8-K/A supplements the Initial 8-K to
include financial statements and pro forma financial information required by
Item 7.
2
<PAGE>
Item 7. Financial Statements and Exhibits.
---------------------------------
The undersigned Registrant hereby amends Item 7 of its Current Report on
Form 8-K dated November 1, 1999 to read in its entirety as follows:
(a) Financial statements of business acquired attached to this Current
Report on Form 8-K/A as exhibits:
1. Applied Digital Access, Inc. Form 10-K as of December 31, 1998.
2. Applied Digital Access, Inc. Form 10-Q as of June 30, 1999.
(b) Pro forma financial information: See page 4 hereof
(c) Exhibits:
2.1 Agreement and Plan of Merger, dated September 7, 1999, between
Target, the Registrant and Purchaser (previously filed on
September 14, 1999, with the Securities and Exchange Commission
as an exhibit to the combined Schedule 14D-1 and Schedule 13D of
Purchaser and the Registrant and incorporated herein by
reference).
3.0 Applied Digital Access, Inc. Form 10-K as of December 31, 1998.
4.0 Applied Digital Access, Inc. Form 10-Q as of June 30, 1999.
5.0 Consent of Independent Accountants.
6.0 Consent of Independent Accountants.
99.1 Press Release of the Registrant, dated November 2, 1999
(previously filed on November 2, 1999 as an exhibit to Amendment
No. 3 to the combined Schedule 14D-1 and Schedule 13D of
Purchaser and the Registrant and incorporated herein by
reference).
99.2 Press Release of the Registrant, dated November 8, 1999
(previously filed on November 1, 1999 with the Securities and
Exchange Commission as an exhibit to the Registrant's Current
Report on Form 8-K and incorporated herein by reference).
3
<PAGE>
Pro Forma Financial Statements
------------------------------
On November 1, 1999 and subsequently on November 8, 1999, Dynatech Corporation
(the "Company"), through one of its wholly owned subsidiaries, acquired all the
outstanding stock of Applied Digital Access, Inc. ("ADA") for $5.37 per
outstanding share which approximated $81 million in the aggregate including
acquisition costs. The Company accounted for this acquisition using the purchase
method of accounting and generated approximately $40 million of goodwill which
will be amortized over three years.
The Company funded the purchase by expending from available funds $15 million
and by borrowing $65 million under its revolving credit facility.
ADA is headquartered in San Diego, CA and is a 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. The results of operations of ADA on a prospective
basis will be included with the Company's communications test business segment.
For purposes of this presentation, pro forma adjustments have been made to the
historical results of operations to provide information as to how the
acquisition of ADA might have affected the results of operations of the Company.
The unaudited pro forma consolidated statements of operations assume the
acquisition had taken place at the beginning of the corresponding periods
presented. The unaudited pro forma consolidated balance sheet assumes the
acquisition had taken place at September 30, 1999.
The Company operates on a fiscal year-end of March 31. Prior to the acquisition
by the Company, ADA operated on a calendar year-end of December 31. The
following pro forma Consolidated Statements of Operations include the results of
operations of ADA for the same periods as reported by the Company. This updating
was accomplished by adding subsequent interim period results to the most recent
fiscal year-end information and deducting the comparable preceding year interim
period results.
The following unaudited pro forma financial information is provided:
1. Pro Forma Consolidated Balance Sheet as of September 30, 1999
2. Pro Forma Consolidated Statement of Operations for the six months
ended September 30, 1999
3. Pro Forma Consolidated Statement of Operations for the twelve months
ended March 31, 1999
This unaudited pro forma information does not purport to be indicative of the
results of operations that would have been obtained if the acquisition had
occurred at the beginning of the fiscal year presented, and is not intended to
be a projection of future results. This information should be read in
conjunction with the audited financial statements of both organizations.
The final allocation of the purchase price may vary as additional information is
obtained and accordingly, the ultimate allocation may differ from that used in
the unaudited condensed pro forma combined financial statements.
4
<PAGE>
DYNATECH CORPORATION
Pro Forma Consolidated Statement of Operations
For the Six Months Ended September 30, 1999
(In thousands except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Applied
Dynatech Digital Pro Forma
Corporation Access Adjustments Results
----------- -------- ----------- ---------
<S> <C> <C> <C> <C>
Sales $ 316,919 $ 19,324 $ --- $ 336,243
Cost of sales 141,281 7,464 --- 148,745
----------- -------- ----------- ---------
Gross profit 175,638 11,860 --- 187,498
Selling, general & administrative expense 82,371 7,660 (152) /(1)/ 89,879
Product development expense 31,692 5,291 --- 36,983
Recapitalization and other related costs 13,259 --- --- 13,259
Amortization of intangibles 3,157 --- 6,628 /(2)/ 9,785
Amortization of unearned compensation 852 --- --- 852
----------- -------- ----------- ---------
Total operating expenses 131,331 12,951 6,476 150,758
----------- -------- ----------- ---------
Operating income (loss) 44,307 (1,091) (6,476) 36,740
Interest expense (25,443) --- (2,925) /(3)/ (28,368)
Interest income 1,303 297 (346) /(4)/ 1,254
Other income (expense) 28 (4) --- 24
----------- -------- ----------- ---------
Income (loss) before income taxes 20,195 (798) (9,747) 9,650
Income tax provision (benefit) 8,078 137 (1,486) /(5)/ 6,729
----------- -------- ----------- ---------
Net income (loss) $ 12,117 $ (935) $ ( 8,261) $ 2,921
=========== ======== =========== =========
Income (loss) per common share:
Basic $ 0.10 $ 0.02
Diluted $ 0.09 $ 0.02
=========== =========
Weighted average number of common shares:
Basic 120,928 120,928
Diluted 129,768 120,928
=========== =========
</TABLE>
_______________________
(1) Represents the elimination of duplicate general and administrative expenses
(2) Represents the amortized portion of the excess purchase price due to the
acquisition
(3) Represents the additional interest expense due to the additional debt
incurred
(4) Represents the reduction in interest income due to the lower cash balance
(5) Represents the income tax effect of the pro forma adjustments and
recognizes the tax benefit of loss generated by ADA not previously
recognized on ADA historical financial statements
5
<PAGE>
DYNATECH CORPORATION
Pro Forma Consolidated Statement of Operations
For the Twelve Months Ended March 31, 1999
(In thousands except per share data)
<TABLE>
<CAPTION>
Applied
Digital
Dynatech Access Pro Forma
Corporation (Unaudited) Adjustments Results
----------- ----------- ------------ ----------
<S> <C> <C> <C> <C>
Sales $ 522,854 $ 31,147 $ --- $ 554,001
Cost of sales 228,572 12,817 --- 241,389
----------- ----------- ------------ ----------
Gross profit 294,282 18,330 --- 312,612
Selling, general & administrative expense 149,006 14,926 (587) /(1)/ 163,345
Product development expense 54,023 12,738 --- 66,761
Recapitalization and other related costs 43,386 --- --- 43,386
Restructuring charge --- 1,335 --- 1,335
Amortization of intangibles 6,228 --- 13,256 /(2)/ 19,484
Amortization of unearned
compensation 1,519 --- --- 1,519
----------- ----------- ------------ ----------
Total operating expenses 254,162 28,999 12,669 295,830
----------- ----------- ------------ ----------
Operating income (loss) 40,120 (10,669) (12,669) 16,782
Interest expense (46,198) --- (5,850) /(3)/ (52,048)
Interest income 3,398 620 (692) /(4)/ 3,326
Gain on sale of subsidiary 15,900 --- --- 15,900
Other income 59 10 --- 69
----------- ----------- ------------ ----------
Income (loss) before income taxes 13,279 (10,039) (19,211) (15,971)
Income tax provision (benefit) 6,834 203 (5,992) /(5)/ 1,045
----------- ----------- ------------ ----------
Net income (loss) $ 6,445 $ (10,242) $ (13,219) $ (17,016)
=========== =========== ============ ==========
Income (loss) per common share:
Basic $ 0.06 $ (0.16)
Diluted $ 0.06 $ (0.16)
=========== ==========
Weighted average number of common shares:
Basic 106,212 106,212
Diluted 111,464 106,212
=========== ==========
</TABLE>
____________________
(1) Represents the elimination of duplicate general and administrative expenses
(2) Represents the amortized portion of the excess purchase price due to the
acquisition
(3) Represents the additional interest expense due to the additional debt
incurred
(4) Represents the reduction in interest income due to the lower cash balance
(5) Represents the income tax effect of the pro forma adjustments and
recognizes the tax benefit of loss generated by ADA not previously
recognized on ADA historical financial statements
6
<PAGE>
DYNATECH CORPORATION
Pro Forma Consolidated Balance Sheet
September 30, 1999
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Applied Pro Forma
Dynatech Digital Balance
Corporation Access Adjustments Sheet
ASSETS ----------- -------- ----------- ---------
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents $ 40,162 $ 13,153 $ (16,110) /(1)/ $ 37,205
Accounts receivable, net 77,613 6,538 (205) /(2)/ 83,946
Inventory, net 43,954 5,190 4,149 /(3)/ 53,293
Other current assets 24,167 2,337 (17) /(4)/ 26,487
----------- -------- ----------- ---------
Total current assets 185,896 27,218 (12,183) 200,931
Property and equipment, net 28,467 3,192 --- 31,659
Intangible assets, net 58,568 --- 38,956 /(5)/ 97,524
Other assets 54,781 2,088 16,685 /(4)/ 73,554
----------- -------- ----------- ---------
$ 327,712 $ 32,498 $ 43,458 $ 403,668
=========== ======== =========== =========
LIABILITIES & STOCKHOLDERS' DEFICIT
Current Liabilities:
Current portion of long-term debt $ 5,178 $ --- $ --- $ 5,178
Accounts payable 27,642 4,600 --- 32,242
Accrued expenses:
Compensation and benefits 20,514 1,110 750 /(6)/ 22,374
Deferred revenue 33,149 1,330 --- 34,479
Interest 10,209 --- --- 10,209
Other accrued expenses 19,674 2,734 250 /(6)/ 22,658
Accrued income taxes 7,395 182 --- 7,577
----------- -------- ----------- ---------
Total current liabilities 123,761 9,956 1,000 134,717
Long-term debt 506,098 --- 65,000 /(7)/ 571,098
Deferred compensation 6,434 --- --- 6,434
Stockholders' equity (deficit):
Common stock 1,214 13 (13) 1,214
Additional paid-in capital 318,941 55,773 (55,773) 318,941
Retained earnings (deficit) (617,824) (33,439) 33,439 (617,824)
Unearned compensation (9,484) --- --- (9,484)
Cumulative other comprehensive
income (loss) (1,428) 195 (195) (1,428)
----------- -------- ----------- ---------
Total stockholders' equity (deficit) (308,581) 22,542 (22,542) (308,581)
----------- -------- ----------- ---------
$ 327,712 $ 32,498 $ 43,458 $ 403,668
=========== ======== =========== =========
</TABLE>
_______________________
See Notes to Pro Forma Consolidated Balance Sheet on Page 8.
7
<PAGE>
Notes to Pro Forma Consolidated Balance Sheet
- ---------------------------------------------
(1) Represents the cash paid to fund a portion of the acquisition
(2) Represents an additional allowance for bad debts
(3) Represents an adjustment to the inventory valuation
(4) Represents an adjustment related to deferred taxes
(5) Represents the unamortized excess purchase price
(6) Represents the additional accruals for compensation and other expenses
(7) Represents the additional debt required to fund the acquisition
8
<PAGE>
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.
DYNATECH CORPORATION
-----------------------------------
Date January 14, 2000 /s/ ALLAN M. KLINE
- ---------------------- -----------------------------------
Allan M. Kline
Vice President, Chief Financial
Officer and Treasurer
Date January 14, 2000 /s/ ROBERT W. WOODBURY, JR.
- ---------------------- -----------------------------------
Robert W. Woodbury, Jr.
Vice President, Corporate
Controller and Principal Accounting
Officer
9
<PAGE>
EXHIBIT INDEX
Exhibit Description
_______ __________
2.1 Agreement and Plan of Merger, dated September 7, 1999, between
Target, the Registrant and Purchaser (previously filed on
September 14, 1999, with the Securities and Exchange Commission
as an Exhibit to the combined Schedule 14D-1 and Schedule 13D of
Purchaser and the Registrant and incorporated herein by
reference).
3.0 Applied Digital Access, Inc. Form 10-K as of December 31, 1998.
4.0 Applied Digital Access, Inc. Form 10-Q as of June 30, 1999.
5.0 Consent of Independent Accountants.
6.0 Consent of Independent Accountants.
99.1 Press Release of the Registrant, dated November 1, 1999
(previously Filed on November 2, 1999 as an exhibit to Amendment
No. 3 to the combined Schedule 14D-1 and Schedule 13D of
Purchaser and the Registrant and incorporated herein by
reference).
99.2 Press Release of the Registrant, dated November 8, 1999
(previously filed on November 1, 1999 with the Securities and
Exchange Commission as an exhibit to the Registrant's Current
Report on Form 8-K and incorporated herein by reference).
<PAGE>
EXHIBIT 3.0
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] 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)
DELAWARE 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)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
--------------------------
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__
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ___
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on February
28, 1999 as reported on the Nasdaq National Market, was approximately
$18,132,185. For the purposes of this calculation, shares owned by officers,
directors and 5% shareholders known to the registrant have been deemed to be
owned by affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. There were 12,918,599 shares of the
Registrant's Common Stock, $0.001 par value, outstanding as of February 28,
1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held May 12, 1999, referred to herein as the "Proxy
Statement", are incorporated by reference as provided in Part III.
<PAGE>
PART I
ITEM 1. BUSINESS
THE STATEMENTS CONTAINED IN THIS FORM 10-K THAT ARE NOT PURELY
HISTORICAL ARE FORWARD LOOKING STATEMENTS. STATEMENTS WHICH USE THE WORDS
"OBJECTIVE," "SEEK," "INTEND," "WILL," "ANTICIPATE," "CAN," "CONTINUE," AND
"EXPECT," ARE FORWARD LOOKING STATEMENTS. THESE FORWARD LOOKING STATEMENTS,
INCLUDING STATEMENTS REGARDING THE COMPANY'S (I) PLANS FOR DEVELOPMENT OR
ACQUISITION OF NEW PRODUCTS OR ENHANCEMENT OF EXISTING PRODUCTS, (II) STRATEGY,
(III) EXPANDED MARKETING EFFORTS, (IV) EXPECTED LEVELS OF EXPENDITURES, (V) GOAL
OF MAXIMIZING THE VALUE OF TECHNOLOGY AND (VI) THE COMPANY'S TIMING OF YEAR 2000
COMPLIANCE, ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE
HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING
STATEMENT. IT IS IMPORTANT TO NOTE THAT THE COMPANY'S ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD LOOKING STATEMENTS. AMONG THE
FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY ARE THE FACTORS SET
FORTH BELOW UNDER THE HEADING "RISKS AND UNCERTAINTIES."
Applied Digital Access, Inc. ("ADA" or the "Company"), was incorporated
in California in August 1987, and reincorporated in Delaware in December 1997
through its merger into a newly formed Delaware corporation. Unless otherwise
indicated, as used in this report, the "Company" and "ADA" refer to Applied
Digital Access, Inc., a Delaware corporation, and it predecessor entity. The
Company's principal executive offices are located at 9855 Scranton Road, San
Diego, California, 92121.
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' ("TSPs") networks. ADA's products are designed to enable TSPs to
improve their quality of service, to increase productivity, to lower operating
expenses and to effectively deploy new services. ADA has positioned its business
to assist TSPs in addressing the rapidly increasing demand for new services,
higher bandwidth and access to the Internet. ADA's systems and software provide
network management functions such as circuit provisioning, network configuration
management, network performance management, circuit testing, and traffic
management of the public switched network. ADA has addressed the industry demand
for network management products with a three-faceted approach: (1) network
systems that provide testing and performance monitoring functions as well as
selected transport functions; (2) network management software that enables TSPs
to manage their network operations; and (3) services that are customized to meet
the evolving needs of the TSP market. The Company has formed two business units
around the company's product lines: the Network Systems business unit and the
Network Management business unit.
The Network Systems business unit is built around the Company's test
and performance management products and services, including its T3AS Test and
Performance Monitoring System ("T3AS"), Centralized Test System ("CTS"), Remote
Module, a DS1 network interface unit ("NIU"), Sectionalizer, Network Embedded
Protocol Access system ("NEPA"), and Protocol Analysis Access System ("PAAS").
The Network Management business unit focuses on the Company's
Operations Systems ("OS") software products, including .Provisioner, Traffic
Data Collection and Engineering System ("TDC&E"), Test OS, Fault Management
System ("FMS"), Graphical Test Assistant ("GTA"), and OS design services. The
formation of the Network Management business unit resulted from strategic
acquisitions made in 1996 and 1997. The Company's 1996 acquisition of certain
assets from Applied Computing Devices, Inc. ("ACD") resulted in the addition of
the Company's TDC&E and FMS product lines. The Company's 1996 acquisition of
certain assets from MPR Teltech, Ltd. and the subsequent 1997 acquisition of a
software license from Northern Telecom, Ltd. resulted in the addition of the
Company's .Provisioner product line.
The Company's products are deployed by over 50 TSPs including the five
regional bell operating companies ("RBOCs"), long-distance or interexchange
carriers ("IXCs"), competitive local exchange carriers ("CLECs"), independent
local exchange carriers ("ILECs"), emerging carriers and cable companies.
2
<PAGE>
RECENT DEVELOPMENTS
On March 3, 1999, the Company announced the termination of its joint
development agreement ("JDA") with Nortel. The Company and Nortel entered into
the agreement in September 1997 to develop SONET network element products for
the telecommunications industry. The intellectual property rights associated
with the jointly developed technology will become the property of the Company.
Under the JDA, the Company and Nortel each contributed technology and
development resources to the project conducted under the JDA and shared the
development costs. The Company's development costs associated with the JDA have
been expensed as incurred. Nortel is obligated to continue funding its share of
the development costs associated with the JDA project through June 2, 1999. The
Company expects to substantially reduce expenses associated with the development
conducted under the JDA and will explore alternatives for maximizing the value
of the jointly developed technology. There can be no assurance that the Company
will be successful in its efforts to maximize the value of the technology
developed under the JDA or that the jointly developed technology will provide
future value to the Company. Under terms of the JDA, if the jointly developed
technology is successfully implemented into a marketable product, Nortel retains
the right to receive limited future royalties in order to recoup its share of
development costs incurred under the JDA.
On March 31, 1999 the Company announced a reduction in its workforce
of approximately 65 people, or 22% of its total workforce. Of the reduction in
workforce, 23 were temporary positions. The Company determined the reduction
was necessary in order to align its current operations with the Company's
objectives of focusing on market opportunities in its core business, reducing
expenses including expenses related to its recently terminated JDA with Nortel
and improving operating results. The majority of the reduction in workforce
were engineers focused on development conducted under JDA. As a result of the
reduction in workforce, the Company will close its office in Richardson, Texas.
The Company will incur a significant one-time charge in the first quarter
ending March 31, 1999, related to the reduction in workforce. The Company's
restructuring plan includes the identification of the affected personnel,
facility closures, asset write downs, and lease terminations. The Company has
not completed its analysis of the total dollar amount associated with the
restructuring charge, but will complete this process prior to issuing its first
quarter operating results.
BACKGROUND
The Telecommunications Deregulation Act of 1996 (the "1996
Telecommunications Act") has greatly increased the competitive nature of the
telecommunications industry and has changed traditional supplier-customer
relationships among local telephone companies and long distance providers. TSPs,
which include the RBOCs, IXCs, CLECs, ILECs, Internet service providers
("ISPs"), cable companies, and emerging carriers are entering the territories
and businesses of each other, fiercely competing to supply business customers
with highly profitable telecommunications networks and services. The competitive
climate has created significant challenges for TSPs as they strive to meet
objectives of increasing revenue and market share, while retaining current
customers and lowering operating costs.
The volume of digital information transmitted through the
telecommunication system has grown rapidly in recent years. This growth has been
driven primarily by the proliferation of personal computers and workstations,
the prevalence of networking and use of the Internet, the adoption of
client/server computing, the increase in cellular telephone and facsimile use,
and the deployment of new digital information applications including multimedia,
video conferencing, and image-processing. As a result, TSPs have been required
to rapidly deploy new high-speed data and voice circuits operating at a 1.54
megabit-per-second rate, called DS1, or T1, and at a 45 megabit-per-second rate,
called DS3 or T3. The DS3 transmission rate is the highest electrical
telecommunication circuit transmission rate currently available in North
America.
The present structure of the telecommunications industry in the United
States is largely a result of the court-mandated divestiture of AT&T in 1984.
The AT&T divestiture resulted in the creation of the RBOCs, the competitive IXC
market, and the emergence of CLECs and emering carriers who offer local
telephone service in competition with the RBOCs and ILECs. Regulation through
competition is the philosophy that resulted in the breakup of AT&T, and the
Company believes it continues to be the philosophy of the Federal Communications
Commission ("FCC"). The passage of the 1996 Telecommunications Act allows each
of these TSPs to enter the territories and businesses of the others and has
resulted in an unprecedented number of mergers and acquisitions among TSPs.
While the Company believes that the new law will bring new opportunities for
network equipment suppliers, it is too early to assess the long-term impact of
this new law on the telecommunications industry and ADA's business. RBOCs have
faced increased competition from CLECs and emerging carriers and from the local
service competitive initiatives of the IXCs and from non-traditional providers
of telephone service such as cable television companies. The Company believes
that many of the new competitive entrants will continue to focus their efforts
on corporate and government communications networks, which are among the most
profitable market segments. Customers in these segments require highly reliable
data and voice communications circuits to enable them to conduct their
day-to-day business without interruption. These new competitors are often able
to offer higher-quality and lower-cost service than local telephone companies,
and as a result, have gained significant market share in these segments. This
increased competition has brought pressure on RBOCs to protect their existing
revenue bases by improving the quality of their service and to reduce their
costs. At the same time, the RBOCs continue to re-engineer and downsize their
organizations. The large reductions in staff have often resulted in the loss of
highly experienced and technical people, leaving less experienced staff to
operate and maintain the networks.
3
<PAGE>
Long distance data or voice circuit often involves three or more
telephone companies: the local telephone companies on each end and the IXC
providing the connection between the two local companies. Responsibility for
service in long distance high-speed data and voice networks is transferred from
one carrier to another at their network boundaries.
The Company believes that the segmentation of the telecommunications
network has made it more difficult for telephone companies to identify and
respond to problems in their networks. For example, many stock brokerage firms
communicate real-time stock quotes and buy and sell orders to and from their
brokers over high-speed data communications lines. Such firms monitor their own
circuits and can detect when data communications service begins to degrade. When
degradation in service is noted, the telecommunications manager of the firm
contacts the telephone company that manages the network - typically the IXC.
Initially, the IXC does not know where the problem is located and must initiate
three trouble reports, one in each local telephone company and one in its own
company. Each telephone company then dispatches multiple repair crews with
portable test equipment to attempt to locate the problem. Typically, repair
crews are dispatched to a number of locations, including the network boundary
between the long distance and the local telephone company, the telephone
building nearest the user, and to outside facilities such as the cables and
equipment beneath streets and on poles between the central offices and the end-
user customer. This system of maintenance results in a number of inefficiencies.
For example, the Company believes telephone company repair crews often incur
needless expense only to report "no trouble found." Despite their best efforts,
repair crews often inadvertently interrupt or damage circuits that are working
and may make unnecessary repairs.
IXCs measure quality of service provided by the local telephone
companies in two principal ways: failure rate (customer-reported troubles per
100 circuits per month), and mean-time-to-restore (the time needed to respond to
and resolve a customer's complaint). These measures frequently influence IXCs
and end-user customer decisions about which local telephone company to use. To
date, local telephone companies' level of services measured by these standards
has often placed them at a competitive disadvantage. In order to reduce failure
rates and improve restoration times, the Company believes telephone companies
are motivated to change the traditional methods of handling service problems as
described above. They are looking for solutions that do not require dispatching
repair crews with portable test equipment when problems occur and, instead,
allow them to monitor circuits remotely from a central management site. They are
also seeking effective methods of remotely testing and monitoring DS3 and DS1
circuits at the network boundary. Finally, telephone companies are looking to
improve their quality of service by moving from reactive maintenance to
preventive maintenance through performance monitoring. These network quality and
performance requirements have created a need for a cost-effective solution to
network performance management.
THE APPLIED DIGITAL ACCESS SOLUTION
ADA focuses on providing network performance management solutions to
TSPs. These solutions are comprised of products that address traffic, fault,
performance, configuration, provisioning and test management. The Company has
focused its research and development activities on creating products that
provide answers, instead of data, to TSPs, and on making network management
easier.
ADA's test and monitoring systems, intelligent NIUs, and OS software,
in stand-alone applications, and in integrated solutions, help TSPs improve
performance to their business customers. The Company's products help TSPs
provide better service to their business customers by providing new services
faster, restoring service faster when circuits fail, optimizing performance on
in-service circuits, and maximizing the performance of the public switched
telephone network. When competing for profitable business customers, the
integration of network management functions are valuable assets to TSPs. Without
efficient integrated network management systems, TSPs are hard pressed to
increase market share.
The Company provides TSPs with network performance management products
to provision new circuits, test circuits, monitor telephone network building
blocks such as digital switches, digital cross-connect systems and SONET
transmission systems, monitor transmission performance on high-speed digital
circuits, and manage transmission facilities to optimize the performance of the
telecommunications network in the era of increased
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demand from Internet usage. The Company believes its network systems products
enable TSPs to greatly improve their reliability of service, reduce circuit
repair time, reduce network management expense, and proactively maintain network
quality.
STRATEGY
The Company seeks to maintain a leadership position as a supplier of
network performance management solutions for high-speed TSPs and to become a
leading provider of OS solutions for network management of telecommunications
networks:
1. DEVELOPING AND ENHANCING PRODUCTS FOR NETWORK BOUNDARY
APPLICATIONS.
The initial application for the Company's network systems products has
been at the network boundary between the IXC and the local TSP. Installation of
the T3AS system at these boundaries allows the local TSP to quickly determine if
a reported trouble is within its network. It also allows the local TSP to
continuously monitor its circuits and react to degradation of the signal before
service is affected. With the Company's Remote Module, a DS1 NIU, the boundary
between the local telephone company and the end-user can now be monitored
non-intrusively, either in a stand-alone application or continuously monitored
as part of an integrated system using the Company's test and monitoring systems
or test and monitoring capabilities in systems from other suppliers. While the
Remote Module provides valuable information about circuit performance when used
in a stand-alone mode, it provides better information when used in conjunction
with a test and monitoring system elsewhere in the network. The Company believes
the Remote Module provides the most valuable information when used in
conjunction with the Company's Sectionalizer Software and test and monitoring
systems also made by the Company. The combination of the products' capabilities
enables TSPs to improve their ability to address the increasingly competitive
business environment.
2. FOCUSING SALES AND MARKETING EFFORTS ON A BROADER RANGE OF TSPS.
ADA's initial sales have been to the RBOCs and their affiliates, all of
whom have a compelling need to improve the quality and reduce the cost of their
services. Competitive pressures are forcing telephone companies to move toward a
centralized network management infrastructure that uses integrated test and
performance monitoring systems. The Company has broadened its target market with
applications that are appropriate for IXCs, CLECs, emerging carriers, enterprise
networks and other TSPs.
3. DEVELOPING AND ENHANCING PRODUCTS AND SERVICES TO ADDRESS DATA
PROTOCOLS.
The Company believes that there are additional applications for ADA's
product lines that extend its utility to new service offerings by its customers
that address data protocols, including frame relay, asynchronous transfer mode
("ATM") and Internet protocols. The Company's NEPA and PAAS systems currently
provide customers with testing and monitoring capabilities for broadband
networks. The Company has additional protocol monitoring and analysis products
under development.
4. DEVELOPING AND ENHANCING PRODUCTS AND SERVICES TO ADDRESS OS.
The Company is extending its current product line and market to address
selected applications within the OS function. OS are computer software-based
systems that provide operations support for telecommunications functions. The OS
market is very large and companies such as Lucent Technologies, Inc. ("Lucent")
and BellCore (recently renamed Telcordia Technologies) have historically
addressed its applications. Some of the older products from these suppliers,
called "legacy systems," are limited in their ability to provide TSPs with the
real-time information that is needed to manage complex high-speed
telecommunications networks. The market for intelligent network management
systems has become fragmented, and the Company perceives a need for solutions
that address the OS applications of provisioning, configuration management,
testing, surveillance, performance monitoring and traffic management, among
others. The Company further believes that additional value can be provided to
its TSP customers through integration of multiple OS applications, and through
integration of the Company's OS applications with existing legacy systems.
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5. DEVELOPING PRODUCTS TO ADDRESS NEW TRANSMISSION STANDARDS.
The Company intends to extend its current products and develop new
products to accommodate new telecommunication transmission standards. The
Company anticipates that the SONET and SDH optical transmission standards will
become the industry transmission standards for the North American and
international networks, respectively. The Company's current network circuit test
and performance monitoring systems do not address either the SONET or SDH
transmission standards. The Company intends to extend its current products and
develop new products to accommodate such new transmission standards and other
advances in technology, as they evolve. See "Risks and Uncertainties--Rapid
Technological Change and Dependence on New Products."
6. EXPANDING TO OTHER APPLICATIONS.
The Company believes that there are additional applications for ADA's
product lines that extend its utility to network boundaries between TSPs and
other users, such as corporate customers, cellular telephone companies, and
cable television companies.
PRODUCTS
NETWORK SYSTEMS TEST AND PERFORMANCE MANAGEMENT PRODUCTS
CENTRALIZED TEST SYSTEM (CTS)
CTS is a sophisticated digital test system device for voice frequency
("VF"), digital data service ("DDS"), high-capacity digital service ("HCDS"),
DS3, and packet based services, such as frame relay and ATM. CTS functions as a
remote test unit ("RTU") and a test system controller for circuits transported
through digital cross-connect systems (DCS). CTS accesses DS0, DS1 and DS3
circuits carried through synchronous or asynchronous interfaces on DCS. CTS is
designed for applications with both centralized and distributed architectures.
Its modular design, scalability, test suite and integrated testing and fault
isolation functions provide an economic and flexible solution for DCS or non-DCS
based test and performance monitoring. CTS' evolutionary platform can be
reconfigured as an in-line T3AS system without obsolescence of original modules
to add new capabilities and full-time performance monitoring and non-intrusive
testing. CTS is installed where test access is highly critical and efficient use
of network resources is important.
T3AS TEST AND PERFORMANCE MONITORING SYSTEM (T3AS)
T3AS consists of digital test access units ("DTAU") that can be
co-located or placed at network boundaries between TSPs. The performance
monitoring capabilities of T3AS provide visibility to the services carried by
the network. T3AS is physically located at network boundaries between TSPs to
quickly isolate, identify and report the location of circuit troubles in these
networks. T3AS is an integrated test and performance monitoring device that
interfaces to the network at both the DS1 and DS3 transport rates while
providing visibility down to DS0, and subrate DS0, circuits. T3AS' technology
and flexible architecture enable T3AS to function either as a DTAU or RTU. The
T3AS system interfaces with the TSPs' network management OS using
industry-standard interfaces and protocols. T3AS can also function as a CTS to
interface with DCSs in the telephone network to provide additional test
capability when circuit access is provided through such systems. The T3AS system
supports up to 48 DS3 circuits, or 1,120 DS1 circuits when accessing the network
at the DS1 rate of transmission. T3AS' distributed architecture allows
individual high-speed or low-speed subsystems to be installed at locations
remote from the T3AS base system. T3AS' distributed architecture supports
applications where the number of DS3 or DS1 circuits at a particular remote
location does not warrant the cost of a full T3AS system, such as at network
boundaries with fewer than six DS3 circuits or 140 DS1 circuits between a local
telephone company and an IXC, and at network boundaries between the local
telephone company and the end-user. Users can easily upgrade their existing T3AS
systems by adding distributed system hardware modules and software. The
low-speed subsystem provides test and performance monitoring capabilities
similar to the high-speed subsystem, but for DS1 circuits. This subsystem is
intended for network boundaries where circuits cross at the DS1 rate. The
low-speed subsystem units are interchangeable with the high-speed subsystem
units in the T3AS racks. Each low-speed subsystem has a capacity of 140 DS1
circuits and can be deployed in a distributed system to share administration and
test resources with the other subsystems of the T3AS base system.
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REMOTE MODULE
ADA's Remote Module is an intelligent DS1 NIU that non-intrusively
monitors the performance of T1 circuits. Installed at network boundaries between
the local TSP and the end-user, the Remote Module enables the TSP to determine
whether circuit troubles originated in the TSP's network or in the end-user's
network. When installed at the local TSP's network boundary at the end-user
customer premises, and in tandem with a T3AS system at the network boundary
between the long distance telephone company and the local service provider, the
Remote Module provides a unique end-to-end view of the DS1 circuit. This view of
service level performance is critical to improve service quality and reliability
and to reduce costs. Telephone network management centers can view a DS1 circuit
within their network and beyond the boundaries of their network, and can quickly
identify and isolate failures from the performance monitoring information
available. The Remote Module can provide similar, although less extensive
functionality, in a stand-alone mode, or in conjunction with DTAUs and RTUs
provided by other suppliers.
SECTIONALIZER
Sectionalizer is expert system software that non-intrusively identifies
the location of DS1 circuit troubles and provides answers in seconds rather than
hours. Sectionalizer correlates and processes extended superframe performance
monitoring data and presents that information pictorially to technicians
enabling them to isolate problems in real time to determine whether they are on
the customer's premises or other portions of the network. Hard to isolate
sporadic troubles are identified through the software's correlation of
historical circuit events. Sectionalizer complements the deployment of Remote
Module, T3AS and CTS by utilizing the equipment to rapidly identify and isolate
network troubles and take a proactive perspective in network management.
Sectionalizer is the driving force behind ADA's Network Boundary
Sectionalization application. Sectionalizer executes on T3AS, CTS, and Remote
Module platforms.
NETWORK EMBEDDED PROTOCOL ACCESS (NEPA)
NEPA is a system that provides TSPs with the ability to remotely and
non-intrusively access, analyze and monitor Frame Relay, IP, and ATM networks.
NEPA probes the network and the embedded protocols within it, providing
real-time analysis of both the physical and logical network layers, including
fault isolation and notification, circuit turn-up, and systems testing. NEPA is
an SNMP standards based system that provides on-demand, non-intrusive remote
protocol analysis and testing of data communciations networks, circuits, and
devices. NEPA's intuitive user interface utilizes web browser technology to
provide remote access and analysis of network protocols via the Internet. The
systems architecture facilitates multiple remote monitoring, analysis and access
sessions supporting concurrent users and simultaneous testing sessions. The NEPA
system collects data out in the network and transports the information to a UNIX
or NT server. NEPA software applications interactively utilize the server's
collected data to allow support personnel network analysis from anywhere in the
network via the Internet. These access locations may be at the network backbone,
or at switching devices, routers, and other network access devices.
PROTOCOL ANALYSIS ACCESS SYSTEM
The T3AS platform can be configured to provide access to broadband
circuits that are provisioned for advanced data services such as frame relay,
SMDS or ATM. Surveillance and testing capabilities in broadband networks may not
be as automated as they are in traditional telephone networks. Diagnosing
troubles within the network often requires coordination among multiple
organizations and dispatches to customer sites. PAAS provides circuit testing
and connects circuits to a protocol analyzer for more detailed troubleshooting.
T3AS PAAS provides a cost-effective method to access circuits from a centralized
network management center.
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NETWORK MANAGEMENT OS SOFTWARE PRODUCTS
.PROVISIONER
Provisioner is an OS software application that provides service
initiation and service management capability for transport networks comprised of
multiplexers, DCSs, and other transport elements. .Provisioner enables TSPs to
activate new circuits and services, and to manage transport networks from a
single user interface concentrating on end-to-end services rather than on
individual network elements. .Provisioner is a turnkey solution for multi-vendor
operations. The modular architecture and object-oriented software support
current and future applications, including management of frame relay and ATM
networks.
TRAFFIC DATA COLLECTION AND ENGINEERING ("TDC&E")
TDC&E is a traffic management OS that provides the capability to
collect traffic data from a variety of existing network elements, predominantly
central office switches, in addition to emerging network elements such as ATM
and frame relay switches. TDC&E supports all major traffic engineering functions
and provides an accurate, quantifiable reporting mechanism for marketing and
quality assurance functions.
FAULT MANAGEMENT SYSTEM ("FMS")
FMS is an alarm and network surveillance OS that is used in combination
with other OS software installed in TSP networks. This application is designed
to receive and analyze alarm messages, fault messages, and information from
managed network elements. Key features of this system include real-time event
and alarm acquisition, event processing and correlation, and historical fault
analysis and reporting. In addition, automated reactions and responses can be
programmed based upon selected event occurrences. FMS provides operational
system features to manage the state of a multi-network-element, multi-vendor
hybrid network.
TEST OS & Graphical Test Assistant ("GTA")
Test OS is a browser-based test management operating system that
provides fast test access through point-and-click graphical user interfaces
("GUI") that replace cumbersome test commands and hide distinctions in test
equipment and software to simplify ease of use. Test OS is a highly scalable,
flexible application that supports multiple users at varying access levels for
tests at DS0, DS1 and DS3 rates. GTA is a Test OS application that functions as
a graphical test front-end system to T3AS and CTS for DS0, DS1 and DS3 testing.
GTA provides simple point-and-click access to all T3AS and CTS testing
functionality on a Windows NT or Windows 95 platform. While primarily designed
for TSPs without a test management OS, GTA also complements existing test OSs by
augmenting functionality.
CUSTOMERS
The Company sells its network performance management products and
services to the TSP market and several enterprise networks. Historically, the
majority of the Company's network test and performance monitoring products have
been sold to the RBOCs. The RBOCs accounted for approximately 73%, 31% and 47%
of the Company's total revenue in years 1996, 1997 and 1998, respectively. In
1997, the Company expanded its customer base for its network test and
performance monitoring products to include the long distance, or IXC, market
with sales of these products to MCI WorldCom. In 1996 and 1997, the Company
acquired and developed several network management OS software products. The
acquisitions added over 30 new customers to the Company's customer base.
Customers for the Company's network management OS software products and services
include MCI WorldCom, British Columbia Telecom, GTE, WinStar Communications,
IntelCom Group and other TSPs and enterprise networks. The Company has provided
software design services to Nortel Network Management Services Division, Telus,
BC Tel and Bell Canada. The Company has increased its sales and marketing
efforts aimed at CLECs, IXCs, emerging carriers and enterprise networks. There
can be no assurance that these efforts will be successful. See "Risks and
Uncertainties--Competition."
The Company currently has purchase contracts with MCI WorldCom,
Ameritech, BellAtlantic, BellSouth and Southwestern Bell. MCI WorldCom has also
entered into license agreements with the Company. Other TSPs purchase the
Company's network systems products and network management OS products under
standard purchase orders and software license agreements. Since the MCI
WorldCom, BellSouth, Ameritech and Southwestern Bell
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contracts may be terminated at either the customers' or the Company's
convenience, the Company believes that these purchase and license contracts are
not materially different than purchasing or licensing under standard purchase
orders. Most of the Company's customers are significantly larger than the
Company and may be able to exert a high degree of influence over the Company. In
addition, a small number of customers have historically accounted for
substantially all of the Company's revenue in any given fiscal period. In 1998,
BellSouth, MCI WorldCom and Bell Atlantic accounted for 26%, 23%, and 12% of the
Company's total revenue, respectively. In 1997, Nortel, MCI WorldCom and
BellSouth accounted for 20%, 28%, and 17% of the Company's total revenue,
respectively.
Prior to selling products to RBOCs and certain IXCs and ILECs, a vendor
must often first undergo a product qualification process for its product with
these carriers. The Company typically spends from six to eighteen months or more
discussing its products with a potential customer prior to the customer agreeing
to put the product through its qualification process. 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 and
generally consists of the following phases:
- LABORATORY EVALUATIOn. The product's function and performance are
tested against all relevant industry standards, including BellCore
standards. This process can take from two weeks to three months or
more depending on a variety of factors.
- FIELD TRIAl. A number of telephone lines are equipped with the
product for simulated operation in a field trial lasting from three
weeks to three months or more. These field trials are used to
evaluate performance, to assess the ease of installation and to
establish troubleshooting procedures. The evaluating carriers grant
conditional product approval upon successful completion of a field
trial, enabling field personnel to order limited quantities of the
product under one-time approvals.
- FIRST OFFICE APPLICATIOn. In a first office application, live
circuits are placed on the system under evaluation. The system is
then used on live circuits for periods ranging from one to six
months or more to verify functionality and operation.
- PRODUCT SELECTION AND DEPLOYMENt. Prior to product selection and
deployment which may take from one to four months or more, the
evaluating carrier develops and implements a variety of methods and
procedures that cover ordering, stocking, installation,
maintenance, returns and all other activities associated with the
use of the product.
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. Further, any failure on the part of any of the Company's customers to
maintain their approval of the Company's products, failure of any of the
Company's customers to deploy the Company's products or any attempt by any of
the Company's customers to seek out alternative suppliers could have a material
adverse effect on the Company's business, operating results and financial
condition. In addition, there can be no assurance that new customers will
approve the Company's products, or that such approval will not be significantly
delayed. Furthermore, work force reductions and staff reassignments by the
Company's customers have in the past delayed or indefinitely postponed the
product approval process and the Company expects such reductions and
reassignments to continue in the future. There can be no assurance that the
impact of such reductions and reassignments will not have a material adverse
effect on the Company's business, operating results and financial condition.
TECHNOLOGY
The T3AS system consists of a real-time operating system and an
extensive suite of proprietary applications software that is executed on
proprietary distributed processing hardware. The operating system implements the
distributed processing functionality of T3AS by linking, in a maximum capacity
system, more than 350 dedicated microprocessors in a real-time computing
environment. The T3AS software architecture is designed to enable new system
features and capabilities to be installed easily through field software
upgrades. Up to 145 simultaneous users can be supported by the T3AS system. All
performance monitoring parameters and telephone circuit tests have been verified
for compliance with BellCore-published technical requirements by BellCore, and
also independently verified by the Company's telephone company customers.
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The Company's software and hardware architecture facilitates important
system capabilities such as fault tolerance and hitless access. Fault tolerance
provides a one-to-one redundant circuit path that provides backup for each DS3
and DS1 circuit. DS3 and DS1 circuits may be transferred from the online main
path to the redundant standby path without disruption of the embedded data
streams. Transfers are accomplished automatically if a hardware or software
malfunction is detected in the T3AS system. Transfers can also be accomplished
manually when telephone company personnel initiate maintenance actions. "Hitless
access" is an industry term used to describe a method of obtaining access to a
low-speed circuit embedded in a high-speed circuit without affecting any other
circuit embedded in the high-speed circuit. In the T3AS system, the Company's
proprietary technology provides access to the DS3 circuit, any embedded DS1
circuit, DS0 circuit, or other subrate circuit, without affecting any other
circuit within the DS3 circuit.
The CTS contains many of the core technology building blocks present in
the T3AS. The T3AS is optimized for large cross sections of circuits and is
positioned in series with the network DS3 and DS1, or T1 traffic. CTS, by
contrast, contains DS3/T1/DS0 test resources that are shared among a cross
section of circuits that are passing through DCSs. CTS interfaces to DCS systems
to provide test capability. CTS provides firewall technology by taking in
commands from a tester in a centralized maintenance center and translating these
commands into a sequence of instructions that are sent to the DCS to configure
the circuit access appropriately. In this fashion, the risk of improper circuit
manipulation is minimized since the CTS system isolates the test technician from
the details of the access and automatically configures the DCS appropriately.
Both the in-line T3AS and the CTS systems are modularly expandable and
support distributed configurations. Subsystems can be optionally co-located in a
common rack or the individual subsystems can be located in remote locations many
miles away and connected to the base system via a packetized T1 link that is
used for transport of control information and DS0 circuits under test. This
technology provides for a virtual single network element configuration with a
single interface to the OS while at the same time allowing the flexibility to
locate modular subsystems in smaller remote locations. In addition, this
technology provides a significant cost benefit since the cost of the common
equipment located in the base location is shared among all remote subsystems.
The subsystems can then be configured in a low cost streamlined fashion since
they can rely on the shared base system to provide a significant amount of
functionality.
The Company has evolved its performance management technology,
originally focusing on the physical layer, and moving to higher levels
addressing logical layers and higher protocol layers. This technology provides
for end-to-end circuit performance management in a diverse network containing
multiple hierarchical transport protocols.
The Company's Remote Module introduces new technology that serves to
extend the performance management capabilities of the T3AS to the customer
premises boundary for use in NIU products. This capability facilitates
sectionalization of network faults on T1 circuits. This technology provides
support for T1 performance monitoring and the ability to convey performance
monitoring information into the network from the customer premises in a fashion
that is completely transparent to the customer's data. This new technology has
been offered up for standardization and the Company is working closely with the
ANSI, T1R1 and T1M1 standards bodies on incorporating this technology into the
new T1 standards. However, there can be no assurances that this new technology
will be adopted by the ANSI, T1R1 and T1M1 standards bodies as an industry
standard.
The Company's OS software products include systems that perform digital
cross-connect and add-drop multiplexer service activation, circuit provisioning,
node surveillance and switched fault management, and traffic data collection and
reporting. The products provide capabilities as stand-alone products or can be
integrated into a total solution offering with other ADA products or a TSP's
legacy or standards based service management framework. The software products
are designed using the latest object-oriented methodologies. The development
life cycle process is well documented and has been registered as ISO 9001
compliant. The enhanced products are written to support the latest in Relational
database, ODBC, JDBC, Corba compliant and client server technologies. GUI
versions of the TDC&E and .Provisioner products support JAVA web browser
enabling technology and all current versions of these products are either year
2000 compliant or have year 2000 support activities scheduled to complete in
1999. There can be no assurance that the Company will be successful in
implementing its year 2000 modifications in a cost-effective and timely manner.
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RESEARCH AND PRODUCT DEVELOPMENT
The Company believes its future success will depend in part on its
ability, on a cost-effective and timely basis, to continue to enhance its
products, to develop and introduce new products for the telecommunications
network performance management market, to address new industry standards and
changing customer needs and to achieve broad market acceptance for its products.
Product line extensions require the Company to work closely with its
current and potential customers. Using feedback received from such customers,
the Company identifies and then develops new products and enhancements to its
existing products that the Company believes will increase their usefulness or
extend their application. Examples of product extensions of the Company's T3AS
test and performance monitoring system include CTS, NEPA and PAAS. In addition,
the Company continually seeks to reduce the manufacturing costs of its products
by taking advantage of advances in hardware technology. Finally, new
technologies, such as SONET, frame relay, and ATM are the focus of significant
research and product development activity at ADA. The Company anticipates that
the SONET and SDH optical transmission standards will become the industry
standards over the coming years for the North American and international
networks, respectively. The Company's current network circuit test and
performance monitoring systems do not address either the SONET or SDH
transmission standards.
The market for the Company's products is characterized by rapid
technological advances, evolving industry transmission standards, changing
regulatory environments, price-competitive bidding, changes in customer
requirements and frequent new product introductions and enhancements. The
introduction of telecommunications network performance management products
involving superior technologies or the evolution of alternative technologies or
new industry transmission standards could render the Company's existing
products, as well as products currently under development, obsolete and
unmarketable.
In 1996, 1997, and 1998, the Company spent $7.4 million, $9.2 million
and $14.3 million, respectively, on research and development efforts. In 1997
and 1998, the Company's research and development operating expenses included
$2.2 million and $3.9 million offsets, respectively, representing Nortel's
proportionate share of development costs incurred for the initial project
conducted under the JDA. As a result of Nortel's termination of the JDA, the
Company expects to significantly reduce research and development expenses
previously associated with the JDA. Nortel is obligated to continue funding its
share of development costs associated with the JDA through June 2, 1999. The
Company cannot currently determine the impact the JDA termination will have on
the company's operating results.
MANUFACTURING AND SUPPLIERS
The Company's manufacturing operations focus on network systems
products and consist primarily of material planning and procurement, final
assembly, module testing, burn-in, final system testing and quality control. The
Company procures all components from outside manufacturers and believes it has
good relationships with its suppliers. The majority of final assembly and tests
are completed by the Company at its production facility. The Company utilizes
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contract manufacturing (both consignment and turnkey operations) for the
assembly of certain sub-assemblies, including printed circuit board modules. The
Company also purchases sub-assemblies that have been modified to the Company's
specifications from original equipment manufacturers.
The Company is registered under the ISO 9001 standard for its
headquarters facility in San Diego, California. ISO 9001 Quality Standards were
developed by the International Organization for Standardization. It is a quality
system standard for ensuring a total quality management system in engineering
and manufacturing. The scope of the Company's registration is for the design and
manufacture of telecommunications network performance management products,
including associated software that help TSPs manage their networks.
All products are rigorously tested prior to shipment to customers. All
printed circuit board modules are tested individually and as part of a system.
The Company's quality control program is modeled to support the BellCore
standards. To date, the Company has not experienced significant field failures.
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. There can be no assurance that the Company will
not experience product recalls in the future. The cost of any subsequent product
recall could have a material adverse effect on the Company's business, operating
results and financial condition. In addition, the Company could materially
suffer from the potential negative publicity associated with a recall.
Generally, the Company uses industry standard components for its
products. Some components, however, including VLSI ASICs, are custom made to the
Company's specifications. Certain components used in the Company's T3AS, CTS,
PAAS and Remote Module products, including its VLSI ASICs, are currently
available from only one source and other components are available from only a
limited number of sources. The Company has few supply agreements and generally
makes its purchases with purchase orders. Further, certain components require an
order lead time of up to one year. Other components that currently are readily
available may become difficult to obtain in the future. Failure of the Company
to order sufficient quantities of these components in advance could prevent the
Company from increasing production of products 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 product 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
reduction in product shipments, which in turn could have a material adverse
effect on the Company's customer relationships and operating results.
Additionally, the Company uses third-party subcontractors for the
manufacture of its sub-assemblies. This reliance on third-party subcontractors
involves several risks, including the potential absence of adequate capacity,
the unavailability or interruption of 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 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. The Company believes, however, that by relying on a
limited number of suppliers, it is in a better position to control quality,
reduce manufacturing costs and improve product standardization.
At December 31, 1998, the Company had open noncancelable purchase
commitments of approximately $3,003,000 covering several different components. A
large portion of the Company's purchase commitments consist 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.
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MARKETING, SALES AND CUSTOMER SUPPORT
The Company markets its products to TSPs through an experienced direct
sales force and strategic partnerships with third parties. Each of the Company's
sales managers operate from a site located near his or her strategic
responsibility.
The Company also provides engineering and installation services ("E&I")
for customers. These services are performed at the customer site and involve
assisting the customers with the installation of the Company's products into the
customer's network structure. These services are performed by customer support
field applications and field support engineers.
All service, repair and technical support of the Company's products are
performed in-house. The Company also provides comprehensive on-site field
support to its customers. The Company offers technical support to its customers
on a 24-hours-a-day, 7-days-a-week basis. The Company's standard hardware and
software warranties are two years and one year, respectively.
BACKLOG
At December 31, 1998, the Company had a firm backlog of approximately
$5,178,000, all of which is expected to be filled during fiscal 1999. At
December 31, 1997, backlog was approximately $2,672,000. The majority of backlog
represents orders for the Company's network management OS products. Orders for
network management OS products generally have longer lead times than network
systems products but are generally delivered within six months of the order
placement. The Company has been operating in a book and ship mode for network
systems products, a trend the Company anticipates will continue. There can be no
assurance that the current level of backlog will continue. In addition, since
orders constituting the Company's current backlog are subject to changes in
delivery schedules, the backlog is not necessarily an indication of future
revenue. In certain cases, ADA may permit orders to be canceled without penalty
where management believes it may be in the best interests of ADA to do so. To
date, cancellation of orders has not been material.
COMPETITION
Competition in the Company's markets is intense and is characterized by
rapidly changing technologies, conformance with evolving industry standards,
frequent new product introductions and enhancements, rapid change in customer
requirements, and price-competitive bidding. To maintain and improve its
competitive position, the Company must continue to develop and introduce, in a
timely and cost-effective manner, new products and features that keep pace with
increasing customer requirements. The Company expects competition in its markets
to increase from existing competitors and from other companies which may enter
the Company's current or future markets.
The Company believes the principal competitive factors affecting the
market for its network systems test and performance monitoring products are:
product features, price, conformance with BellCore and other industry
transmission standards and specifications, performance and reliability,
technical support, and the maintenance of close working relationships with
customers. The Company's network systems products, especially CTS and Remote
Module, are currently focused in highly competitive market niches. The
environment for CTS and Remote Module is fiercely competitive with respect to
price, product features, established customer-supplier relationships and
conformance with industry standards. The Company believes the current
competitors that provide partial solutions to either performance monitoring or
testing of the DS3, and the DS1 and DS0 circuits that make up the DS3 circuit,
include Hekimian Laboratories, Inc. ("Hekimian"), Telecommunications Techniques
Corporation ("TTC"), Anritsu Wiltron Corporation ("Wiltron") and some of the
manufacturers of large transmission equipment and digital cross-connect test and
performance monitoring equipment such as Lucent Technologies, Inc. ("Lucent"),
Alcatel Data Networks ("Alcatel"), Ericsson Communications Inc. ("Ericsson"),
ADC Telecommunications, and Tellabs, Inc. The Company's Remote Module product
addresses the DS1 NIU market in which current competitors include Westell Inc.,
Teltrend Inc., and Troncom, Inc. Many of these competitors have significantly
greater technical, financial, manufacturing, and marketing resources than the
Company. In addition, in 1997, ANSI adopted certain of the Company's technology
as an industry standard. As a result, the Company is obligated to grant licenses
of this technology to third parties, including competitors, on fair and
equitable terms and may also face competition from the licensees of its own
technology.
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The Company believes there are an increasing number of current
competitors in the network management OS market that provide network management
OS applications for circuit and services provisioning and services management,
testing and test management, fault and alarm management and surveillance,
network and circuit performance monitoring and traffic data collection and
management telecommunications functions. The OS market is characterized by a
wide range of companies that have varying degrees of market influence. The
nature of the network management and OS market is such that improved
technologies and tool sets have made the barriers to entry in this market
relatively small resulting in fierce competition. The principal competitive
factors affecting the Company's network management and OS products include
product quality, performance, price, customer support, corporate reputation, and
product features such as scalability, interoperability, functionality and ease
of use. The Company's existing and potential competitors offer a variety of
solutions to address network management needs. Competitors include suppliers of
standard off-the-shelf products, custom software developers, large
telecommunications equipment vendors that offer software applications to manage
their own and other suppliers' equipment, such as Lucent, Nortel, Fujitsu, and
Ericcson, hardware and software vendors, including IBM, Sun Microsystems and
Hewlett Packard, and providers of specific network management and OS
applications such as BellCore, Objective Systems Integrators ("OSI"), TCSI
Corporation ("TCSI"), Architel and others. Additionally, many of the Company's
existing and potential customers continuously evaluate whether they should
develop their own network management and OS applications or license them from
outside vendors. The Company expects competition in the OS market to increase
significantly in the future.
Additionally, several of the Company's competitors have
long-established relationships with the Company's current and prospective
customers which may adversely affect the Company's ability to successfully
compete for business with these customers. In addition, product price reductions
resulting from market share penetration initiatives or competitive pricing
pressures could have a material and adverse effect on the Company's business,
operating results, and financial condition. There can be no assurance that the
Company will have the financial resources, technical expertise or manufacturing,
marketing, distribution and support capabilities to compete successfully in the
future.
PROPRIETARY RIGHTS
ADA relies on a combination of technical leadership, trade secret,
patent, copyright and trademark protection and non-disclosure agreements to
protect its proprietary rights. Although the Company has pursued and intends to
continue to pursue patent protection of inventions that it considers important
and for which such protection is available, the Company believes its success
will be largely dependent on its reputation for technology, product innovation,
affordability, marketing ability and response to customers needs. Currently, the
Company has fifteen U.S. patents granted (each of which has a minimum of eleven
years remaining). Additionally, the Company has three pending U.S. patent
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.
The Company believes that the rapid rate of technological change and
the relatively long development cycle for integrated circuits are also
significant factors in the protection of the Company's proprietary position. The
Company's proprietary VLSI ASICs incorporate unique system architectures and
circuit approaches that have been developed through a broad, in-depth
understanding of the telephone network. Availability of these proprietary
devices, knowledge and experience of the Company's personnel, new product
development, market recognition and product support are key factors in the
protection of the Company's proprietary position. As part of its confidentiality
procedures, the Company generally enters into non-disclosure agreements with its
employees, consultants and suppliers, and limits access to and distribution of
its proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use the Company's technology without
authorization. Accordingly, there can be no assurance that the Company will be
successful in protecting its proprietary technology or that ADA's proprietary
rights will preclude competitors from developing products or technology
equivalent or superior to that of the Company.
The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. 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
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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, results of operations
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.
EMPLOYEES
As of February 28, 1999, ADA had approximately 261 employees, including
150 in engineering, 60 in sales, marketing and customer support, 21 in
operations and 30 in administration and finance. The Company also employs a
number of temporary and contract employees. As of February 28, 1999, the Company
employed approximately 31 temporary and contract employees mostly in research
and development. 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.
INDUSTRY SEGMENT AND GEOGRAPHICAL INFORMATION
The Company operates in one industry segment through two business units
focused on the Company's network systems and network management product lines,
respectively. Information with respect to the Company's operations in its
business units and geographical areas for the 1996, 1997 and 1998 fiscal years
is set forth in Note 6 on pages F-15 through F-19 of the Company's Financial
Statements and is incorporated herein by reference.
RISKS AND UNCERTAINTIES
CUSTOMER MERGERS. Many of the major TSPs currently involved in or that
have recently completed merger transactions are customers of the Company.
Several of these mergers involved companies that purchase network systems and
software products and services from the Company's competitors. Consequently,
these mergers may result in the loss of business and customers for the Company.
Additionally, the impact of capital spending constraints during the merger
transitions and thereafter has had and could continue to have a material adverse
effect on the Company's business, operating results and financial condition. In
addition, future merger transactions involving or contemplated by the Company's
current or prospective customers may cause increased concentration among some of
the Company's major customers or delays or decreases in their capital spending
decisions, any of which could have a material adverse effect on the Company's
business, operating results and financial condition.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; HISTORY OF LOSSES. The
Company has experienced significant fluctuations in bookings, revenue and
operating results from quarter to quarter due to a combination of factors and
expects such fluctuations to continue in future periods. Factors that may cause
the Company's results of operations to vary significantly from quarter to
quarter include but are not limited to the size and timing of customer orders
and subsequent shipment of systems products and implementation of OS software
products to major customers, timing and market acceptance of product
introductions or enhancements by the Company or its competitors, customer order
deferrals in anticipation of new products, technological changes in the
telecommunications industry, competitive pricing pressures, changes in the
Company's operating expenses, personnel changes, management of a changing
business, changes in the mix of products sold and licensed, disruption in
sources of supply, changes in pricing policies by the Company's suppliers,
regulatory changes, capital spending, delays of payments by customers and
general economic conditions. The Company believes that in late 1997 it began
experiencing seasonality in its product shipments and OS software licensing.
Generally, TSPs place more orders for products and licenses in the second and
fourth quarters, with the orders significantly down in the first quarter and
relatively flat in the third quarter of each year. The Company expects that
revenue may begin to reflect these seasonal order cycles more closely, which
could result in quarterly fluctuations. There can be no assurance that the TSPs
will not defer or delay orders contrary to the historical seasonal pattern or
that they will not change their ordering patterns. Because of the relatively
fixed nature of most of the Company's costs, including personnel and facilities
costs, any unanticipated shortfall in revenue in any fiscal quarter would have a
proportionately greater impact on the Company's operating income in that quarter
and may result in fluctuations in the price of the Company's Common Stock.
As the impact of the Company's Network Management business unit on the
Company's revenue increases, the Company may be faced with greater fluctuations
in operating income. The licensing and implementation of the Company's OS
products generally involves a significant capital expenditure and a commitment
of resources by prospective customers. Accordingly, the Company is dependent on
its customers' decisions as to the timing and level of commitment and
expenditures. In addition, the Company typically realizes a significant portion
of license revenues in the last weeks or even days of a quarter. As a result,
the magnitude of quarterly fluctuations in the Network Management business unit
may not become evident until late in, or after the close of, a particular
quarter. In addition, the Company does not recognize service revenues until the
services are rendered. The time required to implement the Company's OS products
can vary significantly with the needs of its customers and is generally a
process that extends for several months. Because of their complexity, larger
implementations may take multiple quarters to complete. Additionally,
quarter-to-quarter product mix variations, customer orders tending to be
placed late in the quarter, and competitive pressures on pricing could have
a materially adverse effect on the Company's operating results in any one
quarter. The Company's expenses are based in part on the Company's expectations
as to future revenues and to a large extent are fixed in the short term. If
revenues do not meet expectations, the Company's business, operations and
financial condition are likely to be materially adversely affected. The Company
has experienced losses in the past and there can be no assurance that the
Company will not experience losses in the future.
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COMPETITION. Competition in the Company's markets is intense and is
characterized by rapidly changing technologies, conformance with evolving
industry standards, frequent new product introductions and enhancements, rapid
changes in customer requirements, and price-competitive bidding. To maintain and
improve its competitive position, the Company must continue to develop and
introduce, in a timely and cost-effective manner, new products and features that
keep pace with increasing customer requirements. The Company expects competition
in its markets to increase from existing competitors and from other companies
which may enter the Company's current or future markets. The Company believes
the principal competitive factors affecting the market for its network systems
test and performance monitoring products are product features, price,
conformance with BellCore and other industry transmission standards and
specifications, performance and reliability, technical support, and the
maintenance of close working relationships with customers. The Company's network
systems products, especially CTS and Remote Module, are currently focused in
highly competitive market niches. The environment for CTS and Remote Module is
fiercely competitive with respect to price, product features, established
customer-supplier relationships and conformance with industry standards. The
Company believes the current competitors that provide partial solutions to
either performance monitoring or testing of the DS3, and the DS1 and DS0
circuits that make up the DS3 circuit, include Hekimian, TTC, Wiltron and some
of the manufacturers of large transmission equipment and digital cross-connect
test and performance monitoring equipment such as Lucent, Alcatel, Ericsson, ADC
Telecommunications, and Tellabs, Inc. The Company's Remote Module product
addresses the DS1 NIU market in which current competitors include Westell Inc.,
Teltrend Inc., and Troncom, Inc. In addition, in 1997, ANSI adopted certain of
the Company's Remote Module signaling technology as an industry standard. As a
result, the Company is obligated to grant licenses of this technology to third
parties, including competitors, on fair and equitable terms which has resulted
in competition from the licensees of its own technology. Many of these
competitors have significantly greater technical, financial, manufacturing, and
marketing resources than the Company.
The Company believes there are an increasing number of current
competitors in the network management OS market that provide network management
OS applications for circuit and services provisioning and services management,
testing and test management, fault and alarm management and surveillance,
network and circuit performance monitoring and traffic management
telecommunications functions. The OS market is characterized by a wide range of
companies that have varying degrees of market influence. The nature of the
network management OS market is such that improved technologies and tool sets
have made the barriers to entry in this market relatively small resulting in
fierce competition. The principal competitive factors affecting the Company's
network management OS products include product quality, performance, price,
customer support, corporate reputation, and product features such as
scalability, interoperability, functionality and ease of use. The Company's
existing and potential competitors offer a variety of solutions to address
network management needs. Competitors include suppliers of standard
off-the-shelf products, custom software developers, large telecommunications
equipment vendors that offer software applications to manage their own and other
suppliers' equipment, such as Lucent, Nortel, Fujitsu, and Ericsson, hardware
and software vendors, including IBM, Sun Microsystems and Hewlett Packard, and
providers of specific network management and OS applications, such as BellCore,
OSI, TCSI, Architel and others. Additionally, many of the Company's existing and
potential customers continuously evaluate whether they should develop their own
network management and OS applications or license them from outside vendors. The
Company expects competition in the OS market to increase significantly in the
future. Additionally, several of the Company's competitors have long-established
relationships with the Company's current and prospective customers which may
adversely affect the Company's ability to successfully compete for business with
these customers. In addition, product price reductions resulting from market
share penetration initiatives or competitive pricing pressures could have a
material and adverse effect on the Company's business, operating results, and
financial condition. There can be no assurance that the Company will have the
financial resources, technical expertise or manufacturing, marketing,
distribution and support capabilities to compete successfully in the future.
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CONCENTRATION OF MAJOR CUSTOMERS; TELEPHONE COMPANY QUALIFICATION
REQUIREMENTS. The market for the Company's products and services currently
consists of the five RBOCs, IXCs, ILECs, CLECs, emerging carriers, ISPs,
enterprise networks and other TSPs. Historically, the Company's marketing
efforts focused primarily on the RBOCs, which accounted for approximately 73%,
31% and 47% of the Company's total revenue in 1996, 1997, and 1998,
respectively. However, the Company's strategy has been to focus its efforts on
diversifying its customer base. RBOCs, and IXCs customers accounted for 47%, and
23% of the Company's total revenue in 1998 and 31% and 27% in 1997,
respectively. The increased customer base is primarily a function of the
Company's acquisitions in 1996 of Applied Computing Devices, Inc. ("ACD") and
the Special Services Network ("SSN") division of MPR Teltech Inc. and the
acquisition of the DSS II license from Nortel in 1997. As a result of these
acquisitions, the Company added OS related products and services that the
Company has been able to market to a wider group of customers. In addition, the
Company added a number of TSPs that were new customers to the Company. To date,
the OS customers tend to be long distance telephone companies, CLECs, emerging
carriers and enterprise vendors who have not invested in legacy systems from
BellCore. While the Company believes its customer base diversification is
beneficial to the Company, there can be no assurances that the Company will be
able to continue expanding the distribution of its OS and system products and
services to additional prospective customers. In addition, the Company's
customers are significantly larger than the Company and may be able to exert a
high degree of influence over the Company. The loss of one or more of the
Company's major customers, the reduction of orders, a delay in deployment of the
Company's products or the cancellation, modification or non-renewal of license
or maintenance agreements could materially and adversely affect the Company's
business, operating results and financial condition. BellSouth, Ameritech,
Southwestern Bell and MCI WorldCom have entered into purchase contracts with the
Company. MCI WorldCom has also entered into license agreements with the Company.
Other TSPs purchase the Company's network system products and license OS
products under standard purchase orders. Since the RBOC and MCI WorldCom
contracts may be terminated at either the customer's or the Company's
convenience, the Company believes that the purchase contracts and license
agreements are not materially different than purchasing or licensing under
purchase orders. Prior to selling products to RBOCs and certain other TSPs, a
vendor must often first undergo a product qualification process with the TSP for
its products. Although the qualification process for a new product varies
somewhat among these prospective customers, the Company's experience is that the
process often takes a year or more. Currently, the five RBOCs, MCI WorldCom and
several other customers have qualified the Company's products, when required.
Any failure on the part of any of the Company's customers to maintain their
qualification of the Company's products, failure of any of the TSPs to deploy
the Company's products, or any attempt by any of the TSPs to seek out
alternative suppliers could have a material adverse effect on the Company's
business, operating results and financial condition. There can be no assurance
that the Company's products will be qualified by new customers, or that such
qualification will not be significantly delayed. Furthermore, work force
reductions and staff reassignments by some of the Company's customers have in
the past delayed the product qualification process, and the Company expects such
reductions and reassignments to continue in the future. There can be no
assurance that such reductions and reassignments will not have a material
adverse effect on the Company's business, operating results and financial
condition.
DEPENDENCE ON TWO PRODUCT LINES. Historically, the majority of the
Company's revenue has been derived from the sale of its network systems products
and services. However, as a result of acquisitions completed in 1996 and 1997,
the Company added additional product lines and derived revenue from a product
mix of both network systems products and services and network management OS
software products and services. Revenue from network systems products and
services, including CTS, T3AS and Remote Module, generated 50% and 56% of the
Company's total revenues in 1997 and 1998, respectively. Revenue from network
management OS products and services, including software design services,
.Provisioner, Test OS, TDC&E and FMS, generated 50% and 44% of the Company's
total revenue in 1997 and 1998, respectively. However, there can be no assurance
that the Company's future revenues will not be heavily dependent on sales from
only one of its primary product lines. The Company is investing in the expansion
of these two product lines through the enhancement, development and marketing of
its NIU, CTS, NEPA, T3AS, Test OS, .Provisioner, TDC&E and FMS products. Failure
by the
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Company to enhance either its existing products and services or to develop new
product lines and new markets could materially and adversely affect the
Company's business, operating results and financial condition. There is no
assurance that the Company will be able to develop and market new products and
technology or otherwise diversify its source of revenue.
MANAGEMENT OF CHANGING BUSINESS. As a result of acquisitions in 1996
and 1997, the Company formed two business units around the Company's product
lines: the Network Systems business unit and the Network Management business
unit. The Network Systems business unit is built around the Company's test and
performance management products, including T3AS, CTS, Remote Module,
Sectionalizer, NEPA and PAAS products. The Network Management business unit
focuses on OS software products including .Provisioner, TDC&E, Test OS, GTA,
FMS, and OS design services. These business units operate in four separate
geographic locations. The Company continues to face significant management
challenges related to the integration of the business operations of these
business units. The acquisitions and resultant growth in the Company's
infrastructure have placed, and are expected to continue to place, a significant
strain on the Company's management, information systems and operations. The
strain experienced to date has chiefly been in management of a geographically
distributed organization, and in hiring sufficient numbers of qualified
personnel to support the expansion of the business. The Company may also make
future acquisitions where it believes it can acquire new products or otherwise
rapidly enter new or emerging markets. Mergers and 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. Additionally, as
a result of the termination of the JDA, the Company expects to discontinue
operations conducted at its Richardson, Texas facility. There can be no
assurance that the Company will not incur significant expenses related to the
closure of the Texas facility that could have a material impact on the Company's
business, operating results and financial condition.
RAPID TECHNOLOGICAL CHANGE AND DEPENDENCE ON NEW PRODUCTS. The market
for the Company's products is characterized by rapid technological advances,
evolving industry transmission standards, changing regulatory environments,
price-competitive bidding, changes in customer requirements, and frequent new
product introductions and enhancements. The introduction of telecommunications
network performance management products involving superior technologies or the
evolution of alternative technologies or new industry transmission standards
could render the Company's existing products, as well as products currently
under development, obsolete and unmarketable. The Company believes its future
success will depend in part upon its ability, on a cost-effective and timely
basis, to continue to enhance its products, to develop and introduce new
products for the telecommunications network performance management market, to
address new industry standards and changing customer needs and to achieve broad
market acceptance for its products. In particular, the Company anticipates that
the SONET and SDH optical transmission standards will become the industry
transmission standards over the coming years for the North American and
international networks, respectively. The Company's current network circuit test
and performance monitoring systems do not address either the SONET or SDH
transmission standards. The Company intends to extend its current products and
develop new products to accommodate such new transmission standards and other
advances in technology, as they evolve. The widespread adoption of SONET and/or
SDH as industry transmission standards before the Company is able to
successfully develop products which address such transmission standards could in
the future adversely affect the sale and deployment of the Company's products.
The Company's OS products are designed to operate on a variety of
hardware and software platforms and with a variety of databases employed by its
customers in their networks. The Company must continually modify and enhance its
OS products to keep pace with changes in hardware and software platforms and
database technology. As a result, uncertainties related to the timing and nature
of new product announcements, introductions or modifications by systems vendors,
particularly, Sun Microsystems and Hewlett Packard, and by vendors of relational
database software, particularly, Oracle Corporation, could materially adversely
impact the Company's business, operating results and financial condition. In
addition, the failure of the Company's OS products to operate across the various
existing and evolving versions of hardware and software platforms and database
environments employed by customers would have a material adverse effect on the
Company's business, operating results and financial condition.
The introduction or announcement of products by the Company or one or
more of its competitors embodying new technologies, or changes in industry
standards or customer requirements, could render the
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Company's existing products and solutions obsolete and unmarketable. The
introduction of new or enhanced versions of its products requires the Company to
manage the transition from older products in order to minimize disruption in
customer ordering. There can be no assurance that the introduction or
announcement of new product offerings by the Company or its competitors will not
cause customers to defer licensing or purchasing of existing Company products or
engaging the Company's services. Any deferral of revenues could have a material
adverse effect on the Company's business, operating results and financial
condition.
Any failure by the Company to anticipate or respond on a cost-effective
and timely basis to technological developments, changes in industry transmission
standards or customer requirements, or any significant delays in product
development or introduction could have a material adverse effect on the
Company's business. There can be no assurance that the Company will be able to
successfully develop new products to meet customer requirements, to address new
industry transmission standards and technological changes or to respond to new
product announcements by others, or that such products will achieve market
acceptance.
DEPENDENCE ON SUPPLIERS AND SUBCONTRACTORS. Certain components used in
the Company's T3AS, CTS, PAAS and Remote Module products, including its VLSI
ASICs, are available from a single source and other components are available
from only a limited number of sources. The Company has few supply agreements and
generally makes its purchases with purchase orders. Further, certain components
require an order lead time of up to one year. Other components that currently
are readily available may become difficult to obtain in the future. Failure of
the Company to order sufficient quantities of these components in advance could
prevent the Company from increasing production in response to customer orders in
excess of amounts projected by the Company. In the past, the Company has
experienced delays in the receipt of certain of its key components, which have
resulted in delays in product deliveries. There can be no assurance that delays
in key component and part deliveries will not occur in the future.
The inability to obtain sufficient key components as required or to
develop alternative sources if and as required in the future could result in
delays or reductions in product shipments, which in turn could have a material
adverse effect on the Company's customer relationships and operating results.
Additionally, the Company uses third-party subcontractors for the manufacture of
its sub-assemblies. 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.
HIGH INVENTORY LEVELS AND NEED TO MAKE ADVANCE PURCHASE COMMITMENTS. To
respond to anticipated customer demand, the Company maintains high inventory
levels. Maintaining high inventory levels substantially increases the risk that
the Company's profitability and results of operations may from time to time be
materially and adversely affected by inventory obsolescence. To procure adequate
supplies of certain products or components, the Company must make advance
commitments to purchase relatively large quantities of such products or
components in a number of circumstances. A large portion of the Company's
purchase commitments consists of custom parts, some of which are sole-source
such as VLSI ASICs, for which there is no alternative use or application. In the
first quarter of 1998, the Company recorded a charge for inventory obsolescence
totaling $378,000. The inability of the Company to sell such products or
incorporate such components in its other products could have a material adverse
effect on the Company's business, operating results and financial condition.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. Without modification, these systems and software will be unable to
appropriately interpret or recognize dates beyond the calendar year 1999. The
Year 2000 computer issue could result in system failures or miscalculations
causing disruptions in business operations worldwide (including, without
limitation, disruptions in order processing, invoicing, manufacturing and
similar functions).
The risk to ADA exists in four areas: systems used by the Company to
run its business, systems used by the Company's suppliers, potential warranty or
other claims from Company customers, and the potential reduced spending by TSPs
on network performance management products as a result of significant
information systems spending on Year 2000 remediation.
19
<PAGE>
The Company is continuing to conduct an assessment and analysis of its
internal information technology ("IT") systems to determine the potential costs
and scope of any Year 2000 issues. Based on a preliminary assessment, ADA has
determined that certain of its IT systems need to be upgraded or replaced to
address Year 2000 issues. The Company believes that all necessary upgrades or
replacements of its IT systems will be completed by June 30, 1999. Validation
testing will be conducted as IT systems are upgraded and replaced. All IT
systems that have been purchased in 1999 or 1998 are Year 2000 compliant. The
upgrades are generally covered by service contracts previously entered into by
the Company in the ordinary course of business and the cost of the upgrades and
remediation is not expected to be material to the Company's operating results.
If implementation of upgrades or replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.
ADA has conducted a comprehensive evaluation of its non-IT systems and
equipment (e.g., facilities, and test equipment containing microprocessors or
other similar circuitry, etc.). Based on this evaluation, ADA does not expect
Year 2000 issues to have a material adverse effect on the Company's non-IT
systems and equipment. However, Year 2000 compliance for some of the Company's
non-IT systems and equipment is dependent upon upgrades to be provided by third
party vendors. The Company expects all upgrades required from third party
vendors to complete Year 2000 compliance for non-IT systems and equipment to be
completed by September 30, 1999. There can be no assurance that third party
vendor upgrades to non-IT systems and equipment will be Year 2000 complaint or
that the upgrades will be completed prior to the end of 1999 which could
negatively impact the functionality of non-IT systems and equipment that could
have a material adverse effect on the Company's revenue, operating results and
financial condition.
In addition, the Company has made inquiries of its third party
suppliers to determine if they have any Year 2000 issues that will materially
and adversely impact the Company. To date, the Company has not been made aware
of any material Year 2000 issues which would adversely affect ADA.
The Company believes that the majority of its current products are Year
2000 compliant. The remaining Company products are expected to be Year 2000
compliant by June 30, 1999. The Company had originally expected this process to
be completed by December 31, 1998. The Company does not expect additional
efforts required to complete Year 2000 compliance for these products will be
material. Internal validation testing is being conducted as products are being
upgraded. An independent third party also performed validation testing on one of
the Company's test and performance management products. However, since all
customer situations cannot be anticipated, particularly those involving third
party products, the Company may see an increase in warranty and other claims as
a result of the Year 2000 transition. In addition, litigation regarding Year
2000 compliance issues is expected to escalate. For these reasons, the impact of
customer claims could have a material adverse impact on the Company's operating
results or financial condition.
Year 2000 compliance is an issue for virtually all businesses, whose
computer systems and applications may require significant hardware and software
upgrades or modifications. TSPs have devoted a substantial portion of their
information systems' spending to fund such upgrades and modifications and divert
spending away from network performance management products. Such changes in
customers' spending patterns have had and could continue to have a material
adverse impact on the Company's sales, operating results or financial condition.
The Company intends to continue the review, remediation and testing of
its Year 2000 status and, to the extent necessary, it will develop Year 2000
contingency plans for critical business purposes. In addition, there can be no
assurance that Year 2000 issues will not have a material adverse effect on the
Company if ADA and/or those with whom it conducts business are unsuccessful in
identifying or implementing timely solutions to any Year 2000 problems.
PRODUCT RECALL AND DEFECTS. Producers of telecommunications network
performance management products such as those being marketed by the Company, are
often required to meet rigorous standards imposed by BellCore, the research and
development entity created following the divestiture of AT&T to provide ongoing
engineering support to the RBOCs. In addition, the Company must meet specialized
standards imposed by many of its customers. The Company's products are also
required to interface in a complex and changing environment with
telecommunication network equipment made by numerous other suppliers. Since many
of these suppliers are competitors of the Company, there can be no assurance
that they will cooperate with the Company. In the event there are material
deficiencies or defects in the design or manufacture of the Company's systems,
or if the Company's systems become incompatible with existing third-party
network equipment, the affected products could be subject to a recall. The
Company has experienced two significant product recalls in its history and there
can be no assurance that the Company will not experience any product recalls in
the future. The cost of any subsequent product recall and associated negative
publicity could have a material adverse effect on the Company's business,
operating results and
20
<PAGE>
financial condition. In addition, the Company's development and enhancement of
its complex OS products entails substantial risks of product defects. There can
be no assurance that software errors will not be found in existing or new
products or releases after commencement of commercial licensing, which may
result in delay or loss of revenue, loss of market share, failure to achieve
market acceptance, or may otherwise adversely impact the Company's business,
operating results and financial condition.
GOVERNMENT REGULATION. The majority of the Company's customers operate
within the telecommunications industry which is subject to regulation in the
United States and other countries. Most of the Company's customers must receive
regulatory approvals in conducting their businesses. Although the
telecommunications industry has recently experienced government deregulation,
there is no assurance this trend will continue. Moreover, the federal and state
courts and the FCC continue to interpret and clarify the provisions of the 1996
Telecommunications Act. In fact, recent regulatory rulings have affected the
ability of the Company's customers to enter new markets and deliver new services
which could impact their ability to make significant capital expenditures. The
effect of judicial or regulatory rulings by federal and state agencies on the
Company's customers may adversely impact the Company's business, operating
results and financial condition.
POTENTIAL COMPETITION FROM RBOCS. The 1996 Telecommunications Act has
generally eliminated the restrictions which had previously prohibited the RBOCs
from manufacturing telecommunications equipment (subject to first satisfying
certain conditions designed to facilitate local exchange competition and receipt
of prior approval by the FCC). These restrictions had been imposed under the
Modification of Final Judgment, which governed the structure of the 1984
divestiture by AT&T of its local operating telephone company subsidiaries. The
passage of the 1996 Telecommunications Act may have an adverse effect on the
Company because the RBOCs, which are presently the Company's principal
customers, may now become manufacturers of some or all of the products currently
manufactured and sold by the Company and, consequently, may no longer purchase
telecommunications equipment produced by the Company at the levels historically
experienced.
PROPRIETARY TECHNOLOGY. The Company relies on a combination of
technical leadership, patent, trade secret, copyright and trademark protection
and non-disclosure agreements to protect its proprietary rights. Although the
Company has pursued and intends to continue to pursue patent protection of
inventions that it considers important and for which such protection is
available, the Company believes its success will be largely dependent on its
reputation for technology, product innovation, affordability, marketing ability
and response to customers needs. Currently, the Company has fifteen U.S. patents
granted. Additionally, the Company has three pending U.S. patent applications on
file covering various circuit and system aspects of its products. There can be
no assurance that the Company will be granted additional patents or that, if any
patents are granted, they will provide the Company's products with significant
protection or will not be challenged. Additionally, should a third party
challenge any of the Company's current or future patents, there can be no
assurance that the Company will be successful in defending its patents or that
any litigation, regardless of outcome, will not result in substantial cost to
and diversion of efforts by the Company. As part of its confidentiality
procedures, the Company generally enters into non-disclosure agreements with its
employees, consultants and suppliers, and limits access to and distribution of
its proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use the Company's technology without
authorization. Accordingly, there can be no assurance that the Company will be
successful in protecting its proprietary technology or that ADA's proprietary
rights will preclude competitors from developing products or technology
equivalent or superior to that of the Company.
The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. The Company is currently not party to any litigation regarding any
patents or other intellectual property rights. However, there can be no
assurance that third parties will not assert infringement claims against the
Company in the future or that any such assertions will not result in costly
litigation or require the Company to obtain a license to intellectual property
rights of such parties. There can be no assurance that any such licenses would
be available on terms acceptable to the Company, if at all. Further, litigation,
regardless of outcome, could result in substantial cost to and diversion of
efforts by the Company. Any infringement claims or litigation by or against the
Company could materially and adversely affect the Company's business, operating
results and financial condition. Moreover, the laws of some foreign countries do
not protect the Company's proprietary rights in the products to the same extent
as do the laws of the United States.
21
<PAGE>
The Company relies on certain software that it licenses from third
parties, including software that is integrated with internally developed
software and used in the Company's products to perform key functions. There can
be no assurance that these third party software licenses will continue to be
available to the Company on commercially reasonable terms or that such licenses
will not be terminated. Although the Company believes that alternative software
is available from other third party suppliers, the loss of or inability of the
third parties to enhance their products in a timely and cost-effective manner
could result in delays or reductions in product shipments by the Company until
equivalent software could be developed internally or identified, licensed, and
integrated, which could have a material adverse effect on the Company's
business, operating results and financial condition.
DEPENDENCE ON KEY PERSONNEL. The success of the Company is dependent,
in part, on its ability to attract and retain highly qualified personnel.
Competition for such personnel is intense and the inability to attract and
retain additional key employees or the loss of one or more current key employees
could adversely affect the Company. There can be no assurance that the Company
will be successful in hiring or retaining requisite personnel.
VOLATILITY OF STOCK PRICE. The Company's future earnings and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in revenue or earnings from levels expected by public
market analysts and investors could have an immediate and significant adverse
effect on the trading price of the Company's Common Stock. Fluctuation in the
Company's stock price may also have an effect on customer decisions to purchase
the Company's products which could have a material adverse effect on the
Company's business, operating results and financial condition.
ITEM 2. PROPERTIES
The Company currently maintains its headquarters in a leased facility
in San Diego, California, which contains all development, engineering, assembly,
marketing and administrative functions, in 62,368 square feet of space in one
building. The lease expires in 2003. The Company has sub-leased a portion of the
San Diego facility through 2000. The Company also leases additional office
facilities in Terre Haute, Indiana, Burnaby, British Columbia and Richardson,
Texas, all of which house product development and customer support operations.
The Company leases 12,600, 25,604 and 14,750 square feet of space in Terre
Haute, Burnaby and Richardson, respectively. The Terre Haute, Burnaby and
Richardson leases expire in September 1999, December 1999 and January 2005,
respectively. The Company believes that its existing facilities will be adequate
to meets its needs through 1999.
ITEM 3. 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 Annual Report, the Company is not a party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
STOCK MARKET INFORMATION
Applied Digital Access' Common Stock is listed on the Nasdaq National
Market and is traded on the over the counter market under the symbol "ADAX". The
following table sets forth the high and low sales prices the Company's Common
Stock for the periods indicated.
<TABLE>
<CAPTION>
1998 HIGH LOW
---- ---- ---
<S> <C> <C>
First Quarter $ 10.75 $ 6.06
</TABLE>
22
<PAGE>
<TABLE>
<S> <C> <C>
Second Quarter 8.75 4.31
Third Quarter 5.94 2.38
Fourth Quarter 3.69 2.00
</TABLE>
<TABLE>
<CAPTION>
1997 HIGH LOW
---- ---- ---
<S> <C> <C>
First Quarter $ 8.50 $ 4.88
Second Quarter 9.38 3.63
Third Quarter 10.00 6.50
Fourth Quarter 11.88 5.00
</TABLE>
There were 321 shareholders of record as of February 28, 1999.
DIVIDEND POLICY
Applied Digital Access has not declared or paid any cash dividends on
its Common Stock to date. The Company currently intends to retain all earnings,
if any, to fund the development and growth of its business and therefore does
not anticipate paying any cash dividends within the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
(Dollars in thousands, except
per share data)
Revenue $ 35,597 $ 20,470 $ 24,422 $ 34,050 $ 29,217
Gross profit 20,791 11,753 11,813 18,934 15,630
Operating expenses:
Research and development 5,335 5,807 7,356 9,164 14,313
In process research and development
related to acquisitions
- - 3,286 1,578 -
Sales and marketing 3,363 4,234 6,312 7,995 9,801
General and administrative 2,337 2,985 3,576 5,252 5,079
--------- --------- -------- ------- -------
Total operating expenses 11,035 13,026 20,530 23,989 29,193
--------- --------- -------- ------ ------
Net income (loss) $ 10,620 $ 759 $ (7,120) $ (4,283) $ (13,124)
========= ========= ======== ======= =======
Net income (loss) per share, $ 1.01 $ .06 $ (.59) $ (.34) $ (1.03)
========= ========= ======== ======= =======
basic (1)
Net income (loss) per share, $ .88 $ .06 $ (.59) $ (.34) $ (1.03)
========= ========= ======== ======= =======
diluted (1)
Weighted average number of shares, 10,542 11,806 12,084 12,460 12,711
basic (1)
Weighted average number of shares, 12,091 12,848 12,084 12,460 12,711
diluted (1)
Working capital $ 26,081 $ 36,728 $ 31,229 $ 26,788 $ 16,756
Total assets 48,919 49,936 45,972 46,283 34,272
Long-term debt 82 49 33 15 -
</TABLE>
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of the number of
23
<PAGE>
shares used in computing net income per share. Amounts have been restated
for the adoption of Statement of Financial Accounting Standard No. 128
"Earnings Per Share".
24
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT DEVELOPMENTS
On March 3, 1999, the Company announced the termination of its joint
development agreement ("JDA") with Nortel. The Company and Nortel entered into
the JDA in September 1997 to develop SONET network element products for the
telecommunications industry. The intellectual property rights associated with
the jointly developed technology will become the property of the Company. Under
the JDA, the Company and Nortel each contributed technology and development
resources to the project and shared the development costs. The Company's
development costs associated with the JDA have been expensed as incurred. Nortel
is obligated to continue funding its share of the development costs associated
with the JDA project through June 2, 1999. The Company expects to substantially
reduce expenses associated with the development conducted under the JDA and will
explore alternatives for maximizing the value of the jointly developed
technology. There can be no assurance that the Company will be successful in it
efforts to maximize the value of the technology developed under the JDA or that
the jointly developed technology will provide future value to the Company. Under
terms of the JDA, if the jointly developed technology is successfully
implemented into a marketable product, Nortel retains the right to receive
limited future royalties in order to recoup its share of development costs
incurred under the JDA.
On March 31, 1999 the Company announced a reduction in its workforce
of approximately 65 people, or 22% of its total workforce. Of the reduction in
workforce, 23 were temporary positions. The Company determined the reduction was
necessary in order to align its current operations with the Company's objectives
of focusing on market opportunities in its core business, reducing expenses
including expenses related to its recently terminated JDA with Nortel and
improving operating results. The majority of the reduction in workforce were
engineers focused on development conducted under JDA. As a result of the
reduction in workforce, the Company will close its office in Richardson, Texas.
The Company will incur a significant one-time charge in the first quarter ending
March 31, 1999, related to the reduction in workforce. The Company's
restructuring plan includes the identification of the affected personnel,
facility closures, asset write downs, and lease terminations. The Company has
not completed its analysis of the total dollar amount associated with the
restructuring charge, but will complete this process prior to issuing its first
quarter operating results.
25
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain statements of operations data as
a percent of revenue, for the years ended December 31, 1996, 1997 and 1998.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1996 1997 1998
------ ------- -------
<S> <C> <C> <C>
Revenue 100% 100% 100%
Cost of revenue 52% 44% 47%
----- ----- -----
Gross profit 48% 56% 53%
----- ----- -----
Operating expenses:
Research and Development 30% 27% 49%
Purchased in-process research and development
related to acquisitions 13% 5% -
Sales and marketing 26% 23% 34%
General and administrative 15% 15% 17%
----- ----- -----
Total operating expenses 84% 70% 100%
----- ----- -----
Operating loss (36)% (14)% (47)%
Other income, net 7% 3% 2%
----- ----- -----
Loss before income taxes (29)% (11)% (45)%
Provision for income taxes (1)% (1)% (1)%
----- ----- -----
Net loss (30)% (12)% (46)%
===== ===== =====
</TABLE>
1998 COMPARED WITH 1997
Revenue totaled $29,217,000 in 1998, a 14% decrease from $34,050,000 in
1997. The decrease is primarily the result of decreased revenue from the sale of
network management OS products and to a lesser extent decreased revenue from the
sale of network systems products. The Company believes the majority of the
revenue decreases resulted from decreased capital spending by TSPs for network
performance management products. Revenue generated from the sale of the
Company's network management OS services and products totaled $12,762,000 in
1998, a 25% decrease from $16,989,000 in 1997. The decrease was the net result
of decreased OS design services revenue partially offset by increased sales of
the Company's .Provisioner and TDC&E OS software products. The decreased revenue
from OS design services and increased sales of the Company's .Provisioner
product partially resulted from the Company's acquisition of an exclusive
license to Northern Telecom Ltd.'s ("Northern Telecom") DSS II software product
in June 1997. Prior to the acquisition, the Company provided OS design services
to Northern Telecom that supported the DSS II product. As a result of the
acquisition, the Company's OS design services business supporting DSS II shifted
to a product-based business. The Company now markets and supports the DSS II
product and technology under the new name .Provisioner. Unlike revenue from OS
software design services which is recognized as the service is performed,
revenue from OS software product sales requires the satisfaction of specific
delivery and acceptance criteria prior to revenue recognition. The timing of
product acceptance can have a material impact on revenue recognition in a
particular quarter or year. As a result, there can be significant quarterly or
yearly variations in revenue from OS product sales. Revenue generated from the
sale of the Company's network systems products and services totaled $16,455,000
in 1998, a 4% decrease from $17,061,000 in 1997. The decrease was the net result
of decreased sales of CTS products offset by increased sales of the Company's
T3AS and Remote Module products. In 1998, BellSouth, MCI WorldCom and Bell
Atlantic accounted for 26%, 23%, and 12% of the Company's total revenue,
respectively. In 1997, MCI WorldCom, Northern Telecom and BellSouth accounted
for 28%, 20%, and 17% of the Company's total revenue, respectively.
The Company believes decreased capital spending by its customers in
1998 resulted from several factors, including, but not limited to, large-scale
merger activity, capital budget constraints, Y2K concerns, and customer
inventory reductions and tightening of inventory control. There can be no
assurance that the Company's future revenue will not be negatively impacted by
these factors which could have a material adverse effect on the company's
operating results.
26
<PAGE>
Gross profit totaled $15,630,000 in 1998, a 17% decrease from
$18,934,000 in 1997. Gross profit as a percent of revenue was 53% in 1998
compared to 56% in 1997. The decrease in gross profit and gross profit as a
percent of revenue was the result of decreased sales of the Company's OS
software products, increased sales of the Company's lower-margin Remote Module
NIU, and the impact of a $378,000 one-time inventory obsolescence charge. The
Company's OS software products typically have significantly higher gross margins
than network systems products. The highly competitive Remote Module NIU market
is subject to severe pricing pressures which have contributed to significantly
lower overall gross profits on these products. Additionally, the Company's
relatively fixed manufacturing overhead costs allocated over lower revenue
levels in 1998 resulted in lower overall gross profit levels. The net decrease
in gross profit as a percent of revenue resulted from the factors discussed
above substantially offset by the shift in the Company's OS software design
services business to an OS software product-based business. As a result of the
.Provisioner (formerly DSS II) license acquisition in 1997, a majority of
engineering design labor previously associated with OS design services revenue
shifted from the cost of revenue line to research and development operating
expenses supporting OS software product development. There can be no assurance
that the Company will be able to maintain the current gross profit margins or
gross profit as a percent of revenue levels. Factors which may materially and
adversely affect the Company's gross profit in the future include its level of
revenue, competitive pricing pressures 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 costs,
disruptions in sources of supply, regulatory changes, seasonal patterns of
bookings, capital spending, and changes in general economic conditions.
Research and development expenses totaled $14,313,000 in 1998, a 56%
increase from $9,164,000 in 1997. The increase was primarily due to increased
personnel and non-recurring engineering costs associated with the Nortel JDA and
a shift in engineering labor from cost of revenue to research and development
operating expenses as a result of the .Provisioner license acquisition in June
1997 discussed above in the gross profit analysis. Research and development
personnel expenses increased 19% compared to 1997, mostly related to increased
personnel to support the JDA. In 1998 and 1997, the Company's net research and
development expenses included $3,926,000 and $2,190,000 offsets, respectively,
representing Nortel's proportionate share of development costs incurred for the
initial project conducted under the JDA. As a result of Nortel's termination of
the JDA, the Company expects to significantly reduce research and development
expenses previously associated with the JDA. Nortel is obligated to continue
funding its share of development costs associated with the JDA through June 2,
1999. The Company cannot currently determine the impact the JDA termination will
have on the Company's operating results. 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. The competition for highly
qualified engineering personnel is intense. There can be no assurance that the
Company will be successful in attracting and retaining key personnel required to
develop new products which could have a material adverse effect on the Company's
future operating results.
Sales and marketing expenses totaled $9,801,000 in 1998, a 23%
increase from $7,995,000 in 1997. The majority of the increase is the result of
increased staff and travel costs in sales to support increased sales efforts and
new customer accounts and increased personnel costs in technical support and
marketing to support the shift of a majority of the Company's OS design services
business to an OS software product-based business. The Company expects to
continue to increase the level of sales, marketing and technical support
personnel in order to support increased focus on existing and new markets and
planned product introductions.
General and administrative expenses totaled $5,129,000 in 1998, a 2%
decrease from $5,252,000 in 1997. The majority decrease is primarily due to
lower consulting and recruiting costs significantly offset by increased legal
expenses and increased expenses for the amortization of goodwill and intangible
assets associated with the Nortel license acquisition. The Company expects that
general and administrative expenses may increase in 1999 as a result of expected
administrative costs related to the termination of the JDA with Nortel and
potential increased expenses related to the Company's focus on Year 2000 issues.
Interest income totaled $675,000 in 1998, a 25% decrease from $904,000
in 1997. The decrease is the result of a decrease in cash investments during
1998 compared to 1997.
27
<PAGE>
In 1998 and 1997, the Company provided for income taxes related to the
operations of the Company's Canadian subsidiary, based on an effective Canadian
tax rate of 46%. At December 31, 1998, the Company had federal income tax-loss
carry-forwards of approximately $27,642,000 and California state income tax-loss
carry-forwards of approximately $5,458,000. The Company's use of approximately
$1,166,000 of its federal tax-loss carry-forwards, and $408,000 of its federal
and $105,000 of its California tax credit carry-forwards are significantly
limited as a result of ownership changes associated with equity financing in
January 1989 and March 1991. See Note 9 of Notes to Consolidated Financial
Statements. Management is not able to estimate levels of tax deductions which
will be generated as a result of these transactions in future periods.
As a result of the factors discussed above, the Company incurred a net
loss of $13,124,000, or $1.03 per basic and diluted share in 1998 compared to
net loss of $4,283,000, or $.34 per basic and diluted share in 1997. Excluding
$1,578,000 in one-time charges for purchased research and development costs
associated with the license acquisition from Nortel, the Company would have
recorded a net loss of $2,705,000, or $.22 per basic and diluted share in 1997.
1997 COMPARED WITH 1996
Revenue totaled $34,050,000 in 1997, a 39% increase from $24,422,000
in 1996. The increase is primarily the result of revenue generated from network
management OS software design services and products acquired through
acquisitions during 1997 and 1996. Revenue from the Company's network systems
products and services totaled $17,061,000 in 1997, a 6% decrease from
$18,144,000 in 1996. The decrease was the net result of decreased sales of the
Company's T3AS system offset by sales of the Company's CTS products to MCI
WorldCom and increased sales of the Company's Remote Module to BellSouth.
Revenue from network management OS services and products totaled $16,989,000 in
1997, a 171% increase from $6,278,000 in 1996. The majority of the increase was
the result of increased sales of software design services to Northern Telecom
and sales of the Company's .Provisioner software product to BC Tel and MCI
WorldCom. Since the Company acquired its software design services business in
July 1996, the increased revenue in 1997 was mostly the result of a full year of
software design services revenue. In June 1997, the Company acquired an
exclusive license from Nortel to its DSS II software product. The acquisition
generated a shift in the Company's Canadian 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. In 1997, MCI
WorldCom, Nortel and BellSouth accounted for 28%, 20%, and 17% of the Company's
revenue, respectively. In 1996, US WEST, NYNEX, and Nortel accounted for 31%,
23%, and 15% of the Company's revenue, respectively.
Gross profit totaled $18,934,000 in 1997, a 60% increase from
$11,813,000 in 1996. Gross profit as a percent of revenue was 56% in 1997
compared to 48% in 1996. The increases in gross profit and gross profit as a
percent of revenue resulted primarily from increased sales of higher margin
network management OS software products partially offset by decreased sales of
network systems products as well as a change in product mix for network systems
products from T3AS systems to a product mix 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 significantly lower overall
gross profits on these products. Additionally, gross profit for 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 as a result of the transition of most of the
Company's Canadian operations from design services to product development
resulting from the license acquisition.
Research and development expenses totaled $9,164,000 in 1997, a 25%
increase from $7,356,000 in 1996. The increase was primarily due to a 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 as
a result of the transition of most of the Company's Canadian operations from
design services to product development as discussed above in the gross profit
analysis, and the addition of research and development personnel as part of the
JDA with Nortel. Research and development personnel expenses increased 57%
compared to 1996, mostly related to the shift in the Company's Canadian
operations from OS design services to a product based business.
28
<PAGE>
In 1997, the Company recorded a one-time charge for purchased research
and development costs related to the acquisition of the DSS II software license
and related assets of $1,578,000. In 1996, the Company acquired certain assets
of both ACD in Terre Haute, Indiana and the SSN division of MPR Teltech, in
Vancouver, British Columbia. See Note 8 of Notes to Consolidated Financial
Statements for additional information. In conjunction with the ACD and SSN
acquisitions, the Company recorded one-time charges for purchased research and
development costs of $1,186,000 and $2,100,000, respectively.
Sales and marketing expenses totaled $7,995,000 in 1997, a 27%
increase from $6,312,000 in 1996. The increase was the result of increased
personnel costs in the network management business unit to support the shift
from a design services business to a product based business, increased personnel
expenses in 1997 as a result of the acquisitions made in 1996, and increased
commission expenses.
General and administrative expenses totaled $5,252,000 in 1997, a 49%
increase from $3,529,000 in 1996. The majority of the increase was attributable
to the amortization of goodwill and intangible assets associated with the SSN
acquisition in the third quarter of 1996 and the license acquisition from Nortel
in June 1997, as well as increased personnel and infrastructure expenses
required to support the expanded operations of the Company as a result of the
1996 and 1997 acquisitions.
Interest income totaled $904,000 in 1997, a 46% decrease from
$1,673,000 in 1996. The decrease is the result of a decrease in cash investments
during 1997 compared to 1996.
In 1997 and 1996, the Company provided for income taxes related to the
operations of the Company's Canadian subsidiary, based on an effective Canadian
tax rate of 46%. At December 31, 1997, the Company had federal income tax-loss
carry-forwards of approximately $15,644,000 and California state income tax-loss
carry-forwards of approximately $7,561,000. The Company's use of approximately
$1,166,000 of its federal tax-loss carry-forwards, and $408,000 of its federal
and $105,000 of its California tax credit carry-forwards are significantly
limited as a result of ownership changes associated with equity financing in
January 1989 and March 1991.
As a result of the factors discussed above, the Company incurred a net
loss of $4,283,000, or $.34 per basic and diluted share in 1997 compared to net
loss of $7,120,000, or $.59 per basic and diluted share in 1996. Excluding
$1,578,000 in one-time charges for purchased research and development costs
associated with the license acquisition from Nortel, the Company would have
recorded a net loss of $2,705,000, or $.22 per basic and diluted share in 1997.
Excluding $3,286,000 in one-time charges for purchased research and development
costs associated with the ACD and SSN asset acquisitions, the Company would have
recorded a net loss of $3,834,000, or $.32 per basic and diluted share in 1996.
QUARTERLY RESULTS
The Company has experienced significant fluctuations in bookings,
revenue and operating results from quarter to quarter due to a combination of
factors and expects such fluctuations to continue in future periods. Factors
that may cause the Company's results of operations to vary significantly from
quarter to quarter include but are not limited to the size and timing of
customer orders and subsequent shipment of systems products and implementation
of OS software products to major customers, timing and market acceptance of
product introductions or enhancements by the Company or its competitors,
customer order deferrals in anticipation of new products, technological changes
in the telecommunications industry, competitive pricing pressures, changes in
the Company's operating expenses, personnel changes, management of a changing
business, changes in the mix of products sold and licensed, disruption in
sources of supply, changes in pricing policies by the Company's suppliers,
regulatory changes, capital spending, delays of payments by customers and
general economic conditions. The Company believes its product shipments and OS
software licensing are subject to seasonality trends. Generally, TSPs place more
orders for products and licenses in the second and fourth quarters with the
orders significantly down in the first quarter and relatively flat in the third
quarter of each year. The Company expects that revenue may begin to reflect
these seasonal order cycles more closely, which could result in quarterly
fluctuations. There can be no assurance that the TSPs will not defer or delay
orders contrary to the historical seasonal pattern or that they will not change
their ordering patterns. Because of the relatively fixed nature of most of the
Company's costs, including personnel and facilities costs, any unanticipated
shortfall in revenue in any fiscal quarter would have a proportionately greater
29
<PAGE>
impact on the Company's operating income in that quarter and may result in
fluctuations in the price of the Company's Common Stock.
As the impact of the Company's Network Management business unit on the
Company's revenue increases, the Company may be faced with greater fluctuations
in operating income. The licensing and implementation of the Company's OS
products generally involves a significant capital expenditure and a commitment
of resources by prospective customers. Accordingly, the Company is dependent on
its customers' decisions as to the timing and level of commitment and
expenditures. In addition, the Company typically realizes a significant portion
of license revenues in the last weeks or even days of a quarter. As a result,
the magnitude of quarterly fluctuations in the Network Management business unit
may not become evident until late in, or after the close of, a particular
quarter. In addition, the Company does not recognize service revenues until the
services are rendered. The time required to implement the Company's OS products
can vary significantly with the needs of its customers and is generally a
process that extends for several months. Because of their complexity, larger
implementations may take multiple quarters to complete. Additionally,
quarter-to-quarter product mix variations, customer orders tending to be placed
late in the quarter, and competitive pressures on pricing could have a
materially adverse effect on the Company's operating results in any one quarter.
The Company's expenses are based in part on the Company's expectations as to
future revenues and to a large extent are fixed in the short term. If revenues
do not meet expectations, the Company's business, operations and financial
condition are likely to be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
Cash and investments totaled $12,513,000 at December 31, 1998 and
$13,179,000 at December 31, 1997. The decrease in cash and investments is
primarily due to the net loss incurred substantially offset by cash collections
from accounts receivable and payments received from Nortel under the JDA.
Net working capital totaled $16,756,000 at December 31, 1998 and
$26,788,000 at December 31, 1997. The decrease in working capital was primarily
the result of a decrease in accounts receivable and other current assets. The
decrease in other current assets is primarily related to payments received from
Nortel for their proportionate share of the development costs incurred under the
JDA
The Company's 1998 operating activities used $91,000 in cash primarily
as a result of the net loss incurred which was offset by decreases in accounts
payable and other current assets and an increase in deferred revenue. In 1997,
the Company's operating activities used $3,528,000 in cash primarily as a result
of increased accounts receivable resulting from a majority of the Company's
fourth quarter sales occurring late in the quarter and increased operating
expenses related to internal funding of the JDA with Nortel, partially offset by
increased accounts payable and decreased inventory levels.
Cash used for capital expenditures totaled approximately $1,806,000 in
1998 and $2,432,000 in 1997. Most of the capital additions were for the purchase
of software development tool kits, computer workstations and lab equipment
associated with the Company's expanded research and development efforts
associated with the JDA and tenant improvements for the Company's Richardson,
Texas office. The Company acquired capital equipment through capital lease
arrangements totaling $43,000 and $0 in 1998 and 1997, respectively. In 1997,
the purchase cost of the DSS II license acquisition from Nortel totaled
$3,382,000, of which $2,515,000 was paid in 1997 and $867,000 in 1998. The
tangible assets acquired as part of the DSS II license acquisition consisted
mostly of computer and lab equipment. The Company expects that 1999 capital
expenditures will decrease slightly from 1998 levels. Most of the planned
expenditures are for network computer servers and software development tool kits
related to planned research and development efforts and upgrades to the
Company's network infrastructure.
Assuming no material changes in the Company's current operating plans,
the Company believes that cash generated from operations, and the total of its
cash and investments, will be sufficient to meet its working capital and capital
expenditure requirements for at least the next twelve months. However, there can
be no assurance that the Company will not need to seek additional capital
resources to meet working capital and capital expenditure requirements.
Additionally, significant additional capital resources may be required to fund
acquisitions of complementary businesses, products or technologies that are
focused on the Company's core business. The Company may need to issue additional
shares of its capital stock or incur indebtedness in connection with any such
acquisitions or future operations. At present, the Company does not have any
agreements or commitments with
30
<PAGE>
respect to any such acquisitions.
The Company believes the impact of inflation on its business
activities has not been significant to date.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. Without modification, these systems and software will be unable to
appropriately interpret or recognize dates beyond the calendar year 1999. The
Year 2000 computer issue could result in system failures or miscalculations
causing disruptions in business operations worldwide (including, without
limitation, disruptions in order processing, invoicing, manufacturing and
similar functions).
The risk to ADA exists in four areas: systems used by the Company to
run its business, systems used by the Company's suppliers, potential warranty or
other claims from Company customers, and the potential reduced spending by TSPs
on network performance management products as a result of significant
information systems spending on Year 2000 remediation.
The Company is continuing to conduct an assessment and analysis of its
internal information technology ("IT") systems to determine the potential costs
and scope of any Year 2000 issues. Based on a preliminary assessment, ADA has
determined that certain of its IT systems need to be upgraded or replaced to
address Year 2000 issues. The Company believes that all necessary upgrades or
replacements of its IT systems will be completed by June 30, 1999. Validation
testing will be conducted as IT systems are upgraded and replaced. All IT
systems that have been purchased in 1999 or 1998 are Year 2000 compliant. The
upgrades are generally covered by service contracts previously entered into by
the Company in the ordinary course of business and the cost of the upgrades and
remediation is not expected to be material to the Company's operating results.
If implementation of upgrades or replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.
ADA has conducted a comprehensive evaluation of its non-IT systems and
equipment (e.g., facilities, and test equipment containing microprocessors or
other similar circuitry, etc.). Based on this evaluation, ADA does not expect
Year 2000 issues to have a material adverse effect on the Company's non-IT
systems and equipment. However, Year 2000 compliance for some of the Company's
non-IT systems and equipment is dependent upon upgrades to be provided by third
party vendors. The Company expects all upgrades required from third party
vendors to complete Year 2000 compliance for non-IT systems and equipment to be
completed by September 30, 1999. There can be no assurance that third party
vendor upgrades to non-IT systems and equipment will be Year 2000 complaint or
that the upgrades will be completed prior to the end of 1999 which could
negatively impact the functionality of non-IT systems and equipment that could
have a material adverse effect on the Company's revenue, operating results and
financial condition.
In addition, the Company has made inquiries of its third party
suppliers to determine if they have any Year 2000 issues that will materially
and adversely impact the Company. To date, the Company has not been made aware
of any material Year 2000 issues which would adversely affect ADA.
The Company believes that the majority of its current products are
Year 2000 compliant. The remaining Company products are expected to be Year 2000
compliant by June 30, 1999. The Company had originally expected this process to
be completed by December 31, 1998. The Company does not expect additional
efforts required to complete Year 2000 compliance for these products will be
material. Internal validation testing is being conducted as products are being
upgraded. An independent third party also performed validation testing on one of
the Company's test and performance management products. However, since all
customer situations cannot be anticipated, particularly those involving third
party products, the Company may see an increase in warranty and other claims as
a result of the Year 2000 transition. In addition, litigation regarding Year
2000 compliance issues is expected to escalate. For these reasons, the impact of
customer claims could have a material adverse impact on the Company's operating
results or financial condition.
Year 2000 compliance is an issue for virtually all businesses, whose
computer systems and applications may require significant hardware and software
upgrades or modifications. TSPs have devoted a substantial portion of their
information systems' spending to fund such upgrades and modifications and divert
spending away from network performance management products. Such changes in
customers' spending patterns have had and could continue to have a material
adverse impact on the Company's sales, operating results or financial condition.
The Company intends to continue the review, remediation and testing of
its Year 2000 status and, to the extent necessary, it will develop Year 2000
contingency plans for critical business purposes. In addition, there can be no
assurance that Year 2000 issues will not have a material adverse effect on the
Company if ADA and/or those with whom it conducts business are unsuccessful in
identifying or implementing timely solutions to any Year 2000 problems.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS
No. 133 establishes accounting and reporting standards for derivative and
hedging activities. In accordance with SFAS No. 133 all derivatives must be
recognized as assets or liabilities and measured at fair value. This Statement
will be effective for the Company's fiscal year 2000. The Company has not yet
determined the impact of the adoption of this new accounting pronouncement on
its consolidated financial position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Required.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements are set forth on pages F-1 through F-28 of
this Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Identification of Directors. The information under the caption
"Director Nominees," appearing in the Proxy Statement, is incorporated herein by
reference.
Identification of Executive Officers. The information under the
caption "Executive Officers," appearing in the Proxy Statement, is incorporated
herein by reference.
Section 16(a) Beneficial Ownership Reporting Compliance. The
information under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance," appearing in the Proxy Statement, is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information under the caption "Executive Compensation and Other
Matters," appearing in the Proxy Statement, is incorporated herein by reference.
31
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the heading "Security Ownership of Certain
Beneficial Owners and Management," appearing in the Proxy Statement, is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the heading "Certain Transactions," appearing in
the Proxy Statement, is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The following financial statements of the Company are included on
pages F-1 through F-28 of this Annual Report on Form 10-K:
Report of Independent Accountants
Consolidated Balance Sheets at December 31, 1997 and December 31, 1998
Consolidated Statements of Operations and Comprehensive loss for the years
ended December 31, 1996, 1997 and 1998
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1997 and 1998
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
The following financial statement schedules are included in Item 14 (d):
Schedule II - Valuation and Qualifying Accounts for the years ended
December 31, 1996, 1997 and 1998
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore have
been omitted.
(b) Reports on Form 8-K
None.
(c) Exhibits
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER NUMBER
--------------- --------------
<S> <C> <C>
2.1(5) Asset Purchase Agreement between
Applied Digital Access, Inc. and
Applied Computing Devices, Inc.
dated February
29, 1996
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER NUMBER
--------------- --------------
<S> <C> <C>
2.2(7) Asset Purchase Agreement between
Applied Digital Access, Inc. and
MPRTeltech, Ltd. dated July 16,
1996
2.3(11) Asset Purchase Agreement between the
Company and Northern Telecom Limited
dated June 27, 1997 (the "Asset
Purchase Agreement") (with certain
confidential portions omitted).
3.3(13) Certificate of Incorporation of the
Company
3.4(14) Certificate of Agreement of Merger of
the Company and its California
predecessor.
+3.5(15) Bylaws of the Company.
10.1(1) Registration Rights Agreement by and
between the Company and certain
shareholders of the Company, dated
May 22, 1992 as amended pursuant to the
Amendment to Registration Rights Agreement
dated April 9, 1993.
10.2(1) Lease for the Company's facilities at
9855 Scranton Road, dated June 15, 1993
10.3(1) Agreement dated July 1, 1991 by and
between the Company and BellSouth Services
Incorporated, as amended (with certain
confidential portions omitted).
10.4(1) Software License Agreement dated January 16,
1992 by and between the Company and GCOM
(with certain confidential portions omitted).
10.5(1) Master Agreement for Operations Systems
Modifications for the Integration of
Network Elements, dated June 17, 1991
by and between the Company and BellCore,
as amended.
10.6(1) Addendum #1 to Master Agreement for Operations
Systems Modifications for the Integration of
Network Elements, dated June 17, 1991 by and
between the Company and BellCore dated July 10,
1991.
10.7(1) Addendum #2 to Master Agreement for Operations
Systems Modifications for the Integration of
Network Elements, dated June 17, 1991 by and
between the Company and BellCore dated
November 19, 1993.
10.8(1) Addendum #3 to Master Agreement for Operations
Systems Modification for the Integration of
Network Elements dated June 17, 1991 by and
between the Company and BellCore dated
December 27, 1993.
+10.9(1) Severance Agreement dated November 27, 1990 by
and between the Company and Peter P. Savage.
+10.10(1) Severance Agreement dated June 20, 1988 by and
between the Company and Paul R. Hartmann.
+10.11(1) 1994 Stock Option/Stock Issuance Plan Form of
Stock Option Agreement.
+10.12(1) 1994 Stock Option/Stock Issuance Plan Form of
Stock Issuance Agreement.
+10.13(1) 1994 Employee Stock Purchase Plan Form of Stock
Purchase Agreement.
+10.14(1) Form of Employee Proprietary Information Agreement.
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER NUMBER
--------------- --------------
<S> <C> <C>
10.15(1) Binary Software License Agreement dated March 7,
1989 between the Company and Software Components
Group, Inc., as amended.
10.16(2) Reinstatement Agreement dated September 22, 1994 between
the Company and BellSouth Telecommunications Incorporated
(with certain confidential portions omitted) (Exhibit
10.2).
10.17(2) Purchase Agreement for Telecommunications Products and
Related Services between Ameritech Services, Inc. (with
certain confidential portions omitted) (Exhibit 10.3).
10.18(3) First Amendment to Office Lease dated September 23, 1994
between the Company and Sorrento Tech Associates.
10.19(4) Purchase Agreement for Telecommunications Products and
Related Services between Southwestern Bell Telephone
Company and the Company, dated September 8, 1995 (with
certain confidential portions omitted)
+10.20(6) Applied Digital Access, Inc. 1994 Stock Option/Stock
Issuance Plan, as amended
10.21(8) Master Agreement between Northern Telecom, Ltd. and
Applied Digital Access, Inc. dated July 16, 1996.
10.22(8) Stock Purchase Agreement between Applied Digital Access,
Inc. and MPR Teltech, Ltd. dated July 16, 1996.
10.23(8) License Agreement between Northern Telecom, Ltd. and
Applied Digital Access, Inc. dated July 16, 1996
10.24(8) Second Amendment to Lease between Sorrento Tech
Associates and Applied Digital Access, Inc. dated August
8, 1996.
10.25(8) Lease Agreement between Rose Hulman Institute of
Technology, through its authorized leasing agent, Ragle
and Company, and Applied Digital Access, Inc. dated
September 15, 1996.
10.26(9) Sublease agreement between the Company and ENOVA
Corporation dated December 9, 1996
10.27(9) First Amendment to Sublease between the Company and ENOVA
Corporation dated January 24, 1997.
10.28(9) Office Lease Agreement between 2725321 Canada Inc. and
Applied Digital Access - Canada, Inc. dated January 1,
1997.
10.29(10) License Agreement between Northern Telecom, Ltd. and the
Company dated as of January 24, 1997 (with certain
confidential portions omitted).
10.30(11) License Agreement between Northern Telecom, Ltd. and the
Company dated as of June 27, 1997 (with certain
confidential portions omitted).
10.31(11) Applied Digital Access, Inc. 1997 Registration Rights
Agreement between the Company and Northern Telecom, Ltd.
dated as of June 27, 1997.
10.32(11) Stock and Warrant Purchase Agreement between the Company
and Northern Telecom, Ltd. dated as of June 27, 1997.
10.33(11) Master Purchase Agreement between MCI Telecommunications
Corporation and the Company dated June 16, 1997 (with
certain confidential portions omitted).
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER NUMBER
--------------- --------------
<S> <C> <C>
10.34(11) Master Agreement between Northern Telecom, Ltd. and the
Company dated as of June 26, 1997 (with certain
confidential portions omitted).
10.35(12) Joint Development Agreement between Northern Telecom,
Inc. and the Company dated September 30, 1997 (with
certain confidential portions omitted).
+10.36(15) Applied Digital Access, Inc. Amended and Restated 1996
Non-qualified Stock Option Plan
+10.37(15) Amended and Restated 1996 Non-qualified Stock Option
Plan Form of Stock Option Agreement.
+10.38(16) Severance Agreement dated March 24, 1995 by and between
the Company and Donald J. O'Connor.
+10.39(16) Severance Agreement dated March 12, 1997 by and between
the Company and Steven F.X. Murphy.
10.40(16) Lease Agreement between Campbell Creek, Ltd. and the
Company dated as of October 1, 1997.
10.41(16) First Amendment to Lease Agreement between Campbell
Creek, Ltd. and the Company dated as of January 22,
1998.
10.42(16) Second Amendment to Sublease between the Company and
ENOVA Corporation dated December 31, 1997.
+10.43(16) Form of Indemnification Agreements between the Company
and each of its directors.
+10.44(16) Form of Indemnification Agreements between the Company
and each of its officers.
+10.45(16) Applied Digital Access, Inc. 1994 Employee Stock
Purchase Plan, as amended.
+10.46(16) Management Team Incentive Compensation Plan, as amended.
10.47(16) Agreement between Telesector Resources Group, Inc.
("Bell Atlantic") and Applied Digital Access, Inc.
executed July 15, 1998 (with certain confidential
portions omitted). (Exhibit 10.1)
+10.48 Form of Executive Officer Retention Agreement between
Applied Digital Access and the following Executive
Officers: Donald L. Strohmeyer, Paul R. Hartmann, James
L. Keefe, Wayne M. Lettiere, Donald J. O'Connor, and
Kevin T. Pope.
+10.49 President and Chief Executive Officer Retention
Agreement between Applied Digital Access and Peter P.
Savage dated November 3, 1998.
+10.50 Confidential Separation Agreement between Stephen F.X.
Murphy and Applied Digital Access, Inc. dated January
25, 1999.
23.1 Consent of Independent Accountants.
27.1 Financial Data Schedule.
+ Management contract or compensatory plan.
</TABLE>
(1) Incorporated by reference to the Company's Registration
Statement on Form S-1
35
<PAGE>
(No. 33-75258), as amended.
(2) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1994 (File No. 0-23698).
(3) Incorporated by reference to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1995
(File No. 0-23698).
(4) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1995 (File No. 0-23698).
(5) Incorporated by reference to the Company's Current Report
on Form 8-K dated March 15, 1996 (File No. 0-23698).
(6) Incorporated by reference to the Company's Registration
Statement on Form S-8 (No. 333-08297), as amended
(7) Incorporated by reference to the Company's Current Report
on Form 8-K dated July 31, 1996 (File No. 0-23698).
(8) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1995 (File No. 0-23698).
(9) Incorporated by reference to the Company's Annual Report
on Form 10-K for the year ended December 31, 1996 (File
No. 0-23698).
(10) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1997
(File No. 0-23698).
(11) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1997
(File No. 0-23698).
(12) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1997 (File No. 0-23698).
(13) Incorporated by reference to the Company's Current Report
on Form 8-K dated December 23, 1997 (File No. 0-23698).
(14) Incorporated by reference to the Company's Current Report
on Form 8-K/A dated January 12, 1998 (File No. 0-23698).
(15) Incorporated by reference to the Company's Registration
Statement on Form S-8 (File No. 333- 48105).
(16) Incorporated by reference to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997
(File No. 0-23698).
(17) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998
(File No. 0-23698).
36
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: March 31, 1999 By: /s/ Donald L. Strohmeyer
---------------------------
Donald L. Strohmeyer
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
By: /s/ Donald L. Strohmeyer President, Chief Executive March 31, 1999
--------------------------------- Officer and Director
(Donald L. Strohmeyer) (Principal Executive Officer)
By: /s/ James L. Keefe Vice President, Finance March 31, 1999
--------------------------------- and Administration, Chief
(James L. Keefe) Financial Officer, Secretary
(Principal Accounting Officer)
By: /s/ Gary D. Cuccio Director March 31, 1999
---------------------------------
(Gary D. Cuccio)
By: /s/ John F. Malone Director March 31, 1999
---------------------------------
(John F. Malone)
By: /s/ Kenneth E. Olson Director March 31, 1999
---------------------------------
(Kenneth E. Olson)
By: /s/ Christopher B. Paisley Director March 31, 1999
---------------------------------
(Christopher B. Paisley)
By: /s/ Peter P. Savage Director March 31, 1999
---------------------------------
(Peter P. Savage)
</TABLE>
37
<PAGE>
APPLIED DIGITAL ACCESS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
<S> <C>
1. CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Accountants F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 F-3
Consolidated Statements of Operations and Comprehensive Loss
for the Years Ended December 31, 1996, 1997 and 1998 F-4
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1996, 1997 and 1998 F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1997 and 1998 F-6
Notes to Consolidated Financial Statements F-7
2. FINANCIAL STATEMENT SCHEDULE:
Schedule II - Valuation and Qualifying Accounts for the
Years Ended December 31, 1996, 1997 and 1998 F-28
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Applied Digital Access, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 32 present fairly, in all material
respects, the financial position of Applied Digital Access, Inc. and its
subsidiary at December 31, 1997 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles. In
addition, in our opinion, the financial statement schedule listed in the index
appearing under Item 14(a)(2) on page 32 presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
January 28, 1999, except as to Note 10
which is as of March 31, 1999
F-2
<PAGE>
APPLIED DIGITAL ACCESS, INC.
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1998
(DOLLARS IN THOUSANDS,
except per share data)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,400 $ 12,513
Investments 8,779 -
Trade accounts receivable, net 12,981 6,111
Inventory, net 5,859 5,679
Deferred income taxes 130 130
Prepaid expenses and other current assets 3,775 1,700
--------- ---------
Total current assets 35,924 26,133
Property and equipment, net 6,165 5,466
Intangible assets, net 2,822 1,247
Deferred income taxes 1,372 1,426
--------- ---------
Total assets $ 46,283 $ 34,272
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,478 $ 2,922
Accrued expenses 2,846 2,333
Accrued warranty expense 1,323 1,264
Current portion of capital lease obligations 18 41
Deferred revenue 1,471 2,817
--------- ---------
Total current liabilities 9,136 9,377
Capital lease obligations, net of current portion 15 -
--------- ---------
Total liabilities 9,151 9,377
--------- ---------
Commitments and contingencies (Note 4)
Shareholders' equity:
Preferred stock, no par value; 7,500,000 shares authorized;
no shares issued - -
Common stock, $.001 par value; 30,000,000 shares authorized;
12,605,082 and 12,909,315 shares issued and outstanding at
December 31, 1997 and 1998, respectively 13 13
Additional paid-in capital 54,089 54,897
Accumulated other comprehensive income 84 163
Accumulated deficit (17,054) (30,178)
--------- ---------
Total shareholders' equity 37,132 24,895
========= =========
Total liabilities and shareholders' equity $ 46,283 $ 34,272
========= =========
</TABLE>
The accompanying notes are an integral part of these financial
statements.
F-3
<PAGE>
APPLIED DIGITAL ACCESS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1996 1997 1998
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Revenue $ 24,422 $ 34,050 $ 29,217
Cost of revenue 12,609 15,116 13,587
------------ ------------ ------------
Gross profit 11,813 18,934 15,630
------------ ------------ ------------
Operating expenses:
Research and development 7,356 9,164 14,313
In-process research and development related
to acquisitions 3,286 1,578 -
Sales and marketing 6,312 7,995 9,801
General and administrative 3,529 5,252 5,129
------------ ------------ ------------
Total operating expenses 20,483 23,989 29,243
------------ ------------ ------------
Operating loss (8,670) (5,055) (13,613)
Interest income 1,673 904 675
------------ ------------ ------------
Loss before income taxes (6,997) (4,151) (12,938)
------------ ------------ ------------
Provision for income taxes 123 132 186
------------ ------------ ------------
Net loss (7,120) (4,283) (13,124)
Other comprehensive income (loss)
Foreign currency translation adjustments (1) 68 91
Unrealized gains (losses) on securities (121) (9) (12)
------------ ------------ ------------
Other comprehensive income (loss) (122) 59 79
------------ ------------ ------------
Comprehensive loss $ (7,242) $ (4,224) $ (13,045)
============ ============ ============
Net loss per share, basic and diluted $ (.59) $ (.34) $ (1.03)
============ ============ ============
Shares used in per share computations 12,084,242 12,459,511 12,711,203
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-4
<PAGE>
APPLIED DIGITAL ACCESS, INC.
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- ---------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
---------------------- PAID-IN DEFERRED COMPREHENSIVE ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION INCOME (LOSS) DEFICIT TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 11,899,216 $ 12 $ 51,480 $ (101) $ 147 $ (5,651) $ 45,887
---------- ---------- ---------- ---------- ----------- ----------- ----------
Net loss - - - - - (7,120) (7,120)
Foreign currency
translation adjustment - - - - (1) - (1)
Unrealized loss on
investments - - - - (121) - (121)
Amortization of deferred
compensation for stock options - - - 51 - - 51
Issuance of common stock upon
exercise of stock options 149,261 - 115 - - - 115
Issuance of common stock
under stock purchase plan 56,857 - 428 - - - 428
Issuance of common stock in
connection with acquisition 150,000 - 1,088 - - - 1,088
---------- ---------- ---------- ---------- ----------- ----------- ----------
Balance, December 31, 1996 12,255,334 12 53,111 (50) 25 (12,771) 40,327
Net loss - - - - - (4,283) (4,283)
Foreign currency
translation adjustment - - - - 68 - 68
Unrealized loss on
investments - - - - (9) - (9)
Amortization of deferred
compensation for stock options - - - 50 - - 50
Issuance of common stock upon
exercise of stock options 221,235 1 380 - - - 381
Issuance of common stock
under stock purchase plan 128,513 - 598 - - - 598
---------- ---------- ---------- ---------- ----------- ----------- ----------
Balance, December 31, 1997 12,605,082 13 54,089 - 84 (17,054) 37,132
Net loss - - - - - (13,124) (13,124)
Foreign currency
translation adjustment - - - - 91 - 91
Unrealized loss on
investments - - - - (12) - (12)
Issuance of common stock upon
exercise of stock options 91,649 - 192 - - - 192
Issuance of common stock
under stock purchase plan 212,584 - 616 - - - 616
---------- ---------- ---------- ---------- ----------- ----------- ----------
Balance, December 31, 1998 12,909,315 $ 13 $ 54,897 $ - $ 163 $ (30,178) $ 24,895
========== ========== ========== ========== =========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-5
<PAGE>
APPLIED DIGITAL ACCESS, INC.
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ----------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
1996 1997 1998
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (7,120) $ (4,283) $ (13,124)
Adjustments to reconcile net loss to net cash used
by operating activities:
Depreciation and amortization 1,819 3,089 3,703
Amortization of discount (accretion of premium) on investments 95 (119) 41
Amortization of deferred compensation 51 50 -
Acquired in-process research and development 3,286 1,578 -
Change in inventory reserves (68) 101 104
Changes in operating assets and liabilities:
Trade accounts receivable (1,440) (6,183) 6,870
Inventory (723) 1,403 76
Deferred taxes - - (54)
Prepaid expenses and other current assets 207 (2,686) 2,075
Accounts payable 300 1,358 (556)
Accrued expenses 648 1,355 (513)
Accrued warranty expense 93 (75) (59)
Deferred revenue 587 884 1,346
---------- ---------- ----------
Net cash used by operating activities (2,265) (3,528) (91)
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (20,923) (18,517) (10,903)
Maturities of investments 30,923 29,792 19,640
Purchases of property and equipment (1,709) (2,432) (1,806)
Purchase costs related to asset acquisitions (6,356) (3,382) -
Reimbursement of costs related to acquisition - - 500
Purchase of license agreement (350) - -
---------- ---------- ----------
Net cash provided by investing activities 1,585 5,461 7,431
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations (32) (16) (35)
Proceeds from exercise of stock options and warrants 115 381 192
Proceeds from issuance of common stock 428 598 616
---------- ---------- ----------
Net cash provided by financing activities 511 963 773
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents (169) 2,896 8,113
Cash and cash equivalents at beginning of year 1,673 1,504 4,400
---------- ---------- ----------
Cash and cash equivalents at end of year $ 1,504 $ 4,400 $ 12,513
========== ========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 7 $ 4 $ 2
Cash paid during the year for income taxes - 229 104
Noncash investing and financing activities:
Issuance of common stock in connection with acquisition 1,088 - -
Assets acquired under capital lease - - 43
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-6
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Applied Digital Access, Inc. (the "Company") designs, engineers and
manufactures network test and performance monitoring systems and software
and provides services for the management and testing of
telecommunications circuits. The Company has two core business segments:
Network Systems and Network Management. The Network Systems business unit
provides test and performance management products and services whereas
the Network Management business unit focuses on the design and
manufacture of operations systems software.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary, Applied Digital Access Canada ("ADA
Canada"). All significant intercompany transactions and balances have
been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from estimates.
SEGMENT REPORTING
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 131 DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION during the year ended December 31, 1998. This Statement
establishes standards for reporting information about operating segments
in annual financial statements and requires selected information about
operating segments in interim financial reports issued to shareholders.
Under SFAS 131, operating segments are to be determined consistent with
the way that management organizes and evaluates financial information
internally for making operating decisions and assessing performance.
Disclosures required under this Statement include information about
products and services, geographic areas and major customers. The
presentation of segment information in prior periods has been
reclassified to conform to the current year presentation.
REVENUE RECOGNITION
The Company's revenues are primarily derived from hardware product sales,
software product sales and perpetual license fees. In addition, the
Company also derives revenues from installation and implementation
services, maintenance agreement sales and software royalties.
F-7
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Revenue from sales of hardware and software products is generally
recognized upon shipment. For shipments of products involving significant
acceptance requirements, revenue is recognized when the Company has met
substantially all its performance requirements and acceptance criteria
have been met.
Revenue from perpetual license arrangements is recognized upon delivery
of the related software and customer acceptance when the Company has no
significant continuing obligations and collection is probable.
Revenue from installation and implementation services is recognized as
the services are performed while revenue from maintenance contracts is
recognized ratably over the related contract terms.
Royalty revenue is generally recognized as earned in accordance with the
terms of respective license agreements. For certain of the Company's
license agreements, royalty revenue is recognized when reasonable
estimates of such amounts can be made.
Amounts received on uncompleted contracts in excess of incurred costs are
classified depending upon the nature of the contract as either deferred
revenue or payments in excess of billings on contracts.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and short-term investments with
original maturities of 90 days or less when purchased. At December 31,
1998, cash in excess of daily requirements was invested in marketable
securities consisting of obligations of the U.S. Government and
commercial paper with original maturities of less than 90 days.
INVESTMENTS
The Company determines the appropriate classification of its debt
securities at the time of purchase and assesses such designations at each
balance sheet date. Realized gains and losses are determined using the
specific identification method and are included in other income. Gross
unrealized holding gains or losses are excluded from earnings and
reported, net of the related tax effect, as a separate component of
shareholders' equity. The amortized cost of debt securities is adjusted
for the amortization of premiums and accretion of discounts to maturity.
Such amortization is included in interest income. Fair value is
determined based on quoted market prices.
INVENTORY
Inventory is stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.
F-8
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Significant renewals and
improvements are capitalized while maintenance and repairs are expensed
as incurred. Depreciation is computed over estimated useful lives using
the straight-line method.
Useful lives for property and equipment are as follows:
Computer equipment 3 - 6 years
Machinery and equipment 3 - 6 years
Office furniture and equipment 3 - 7 years
Purchased computer software 3 - 6 years
Leasehold improvements are amortized using the straight-line method over
the shorter of the lease term or the estimated useful lives of such
improvements.
Upon retirement or other disposition, the cost and related accumulated
depreciation or amortization are removed from the accounts and any
resulting gain or loss is reflected in income.
INTANGIBLE ASSETS
Intangible assets consist of goodwill, purchased technology, customer
contracts and license agreement fees. Goodwill represents the excess of
the purchase price over net assets of businesses acquired. Purchased
technology, customer contracts and license agreement fees are stated at
cost. Intangible assets are amortized on a straight-line basis over
periods of three to five years.
The carrying value of intangible assets is periodically reviewed by the
Company and impairment recognized if events indicate that the expected
future cash flows from such intangibles are less than their carrying
value. The Company did not recognize any impairment on its intangible
assets during the years ended December 31, 1996, 1997, and 1998.
During the year ended December 31, 1998, the Company received amounts
determined to be contingent consideration related to an acquisition in
the prior period. Accordingly, goodwill related to the acquisition was
decreased by the amount of $500 representing contingent consideration
received.
ADVERTISING
Advertising costs are expensed as incurred. Advertising expense was
approximately $217, $250 and $302 for the years ended December 31, 1996,
1997 and 1998, respectively.
F-9
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
STOCK-BASED COMPENSATION
The Company measures compensation cost for its stock-based employee and
non-employee director compensation plans using the intrinsic value
method. Pro forma disclosures of net loss and net loss per common share
are provided as if the fair value method had been applied in measuring
compensation expense.
FOREIGN CURRENCY TRANSLATION
The local currency is the functional currency for ADA Canada. Assets and
liabilities are translated at the exchange rate on the balance sheet date
while revenues and expenses are translated at average rates of exchange
prevailing during the year. Adjustments resulting from translating ADA
Canada's financial statements into U.S. dollars are reported as a
separate component of shareholders' equity and classified as other
comprehensive income (loss). For the years ended December 31, 1996, 1997
and 1998, the effect of exchange rate changes on cash has not been
significant.
CONCENTRATIONS
The market for the Company's products is characterized by rapid
technological advances, evolving industry transmission standards, 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 could
render the Company's existing products, as well as products currently
under development, obsolete and unmarketable.
The Company operates in an environment significantly affected by recent
merger and acquisition activity among its customers. Such activity may
substantially reduce the number of customers for the Company's products
and may have a material and adverse effect upon the Company's results of
operations and financial position.
A significant portion of the Company's revenues and trade receivables are
concentrated with a limited number of telecommunications service
providers or affiliated companies in the United States and Canada.
The Company's customers consist primarily of Regional Bell Operating
Companies, long distance carriers, local exchange carriers and
independent telephone companies. Sales are typically made on credit with
varying terms depending upon the customer and nature of the product. The
Company does not hold collateral to secure payment as the Company
considers its customers to be large companies with substantial financial
resources. Although the Company deems its reserve for uncollectible
receivables to be adequate, a default on payment of a significant
customer receivable could materially and adversely affect the Company's
operating results and financial position.
From time to time, the Company may have cash in excess of federally
insured limits held at certain banks. The Company has not experienced any
losses on its cash or cash equivalents to date.
F-10
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
All the Company's investments at December 31, 1997 consisted of
obligations of the U.S. Government and its agencies.
The Company currently buys certain key components of its products from a
limited number of suppliers. Although there are a limited number of
suppliers of the components, management believes that other suppliers
could provide similar key components on comparable terms. A change in
suppliers, however, could cause a delay in manufacturing and a possible
loss of sales, which would adversely affect operating results.
INCOME TAXES
The Company's current income tax expense is the amount of income taxes
expected to be payable for the current year. Deferred income taxes are
recognized for the tax consequences in future years for differences
between the tax basis of assets and liabilities ("temporary differences")
and their financial reporting amounts at each year end based on enacted
tax laws and statutory rates applicable to the periods in which the
temporary differences are expected to affect taxable income. Valuation
allowances are established when necessary to reduce deferred tax assets
to the amount expected to be realized.
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per common share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding during
the period. Diluted earnings (loss) per common share is computed by
dividing net income (loss) by the weighted average number of common
shares and potential common shares outstanding during the period using
the treasury stock method. For the years ended December 31, 1996, 1997,
and 1998, the weighted average number of common shares outstanding for
both basic and diluted earnings (loss) per common share is comparable as
the inclusion of potential common shares for diluted earnings (loss) per
share would have been antidilutive due to the Company's losses from
continuing operations. There are no reconciling items in calculating the
numerator and denominator for basic and diluted earnings (loss) per share
for any periods presented.
COMPREHENSIVE INCOME
The Company adopted SFAS No. 130, REPORTING COMPREHENSIVE INCOME during
the year ended December 31, 1998. This Statement requires the Company to
report all changes in equity from non-owner sources, including unrealized
gains and losses on certain investments in debt and equity securities and
foreign currency translation adjustments, as components of other
comprehensive income. Such amounts are presented as a separate component
of equity entitled "Accumulated Other Comprehensive Income" in the
statement of financial position. The individual components of other
comprehensive income are also reported with net income (loss) as
"Comprehensive Income" in the results of operations. The income tax
expense (benefit) related to items of other comprehensive income is not
significant for the years ended December 31, 1996, 1997, and 1998.
Financial statements for earlier periods have been reclassified for
comparative purposes.
F-11
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES. This Statement establishes accounting and reporting standards
for derivatives and hedging activities. In accordance with this
Statement, all derivatives must be recognized as assets or liabilities
and measured at fair value. This Statement will be effective for the
Company's fiscal year 2000. The Company has not yet determined the impact
of the adoption of this new accounting pronouncement on its consolidated
financial position or results of operations.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year financial
statements to conform to the current year presentation.
2. INVESTMENTS
At December 31, 1997, all marketable debt securities consisted of
obligations of the U.S. Government and its agencies and were classified
as available-for-sale. The estimated fair value of such investments
approximated its amortized cost and, therefore, there were no significant
unrealized gains or losses.
3. COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------
1997 1998
<S> <C> <C>
Inventories:
Raw materials $ 3,419 $ 3,266
Work-in-process 2,223 2,389
Finished goods 787 698
----------- ------------
6,429 6,353
Less reserves (570) (674)
----------- ------------
$ 5,859 $ 5,679
=========== ============
Property and equipment:
Computer equipment $ 5,655 $ 6,031
Machinery and equipment 2,967 4,062
Office furniture and equipment 1,815 1,166
Purchased computer software 1,371 2,136
Leasehold improvements 911 1,129
----------- ------------
12,719 14,524
Less accumulated depreciation and amortization (6,554) (9,058)
----------- ------------
$ 6,165 $ 5,466
=========== ============
</TABLE>
F-12
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Depreciation expense was $1,368, $1,904 and $2,629 for the years ended
December 31, 1996, 1997 and 1998, respectively. Of these amounts, $140,
$194 and $412 related to amortization of purchased software costs for the
years ended December 31, 1996, 1997 and 1998, respectively.
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------
1997 1998
<S> <C> <C>
Intangible Assets:
Goodwill $ 3,619 $ 3,119
Technology and customer contracts 337 337
Licenses 350 350
----------- ------------
4,306 3,806
Less accumulated amortization (1,484) (2,559)
----------- ------------
$ 2,822 $ 1,247
=========== ============
Accrued expenses:
Accrued payroll and related costs $ 902 $ 287
Accrued vacation 583 773
Accrued income taxes 388 425
Accrued contract costs - 448
Payments in excess of billings on contracts - 250
Acquisition costs payable 867 -
Other accrued liabilities 106 150
----------- ------------
$ 2,846 $ 2,333
=========== ============
</TABLE>
4. COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
The Company had unconditional purchase obligations under contracts for
inventory purchases. The portion of such obligations not completed at
year end represent unrecorded commitments of approximately $2,500 and
$3,003 at December 31, 1997 and 1998, respectively.
LEASES
The Company leases certain facilities and equipment under both operating
and capital leases.
F-13
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Commitments for minimum lease payments under non-cancelable leases with
the initial or remaining terms greater than twelve months as of December
31, 1998 are as follows:
<TABLE>
<CAPTION> CAPITAL OPERATING
YEAR ENDING DECEMBER 31, LEASES LEASES
<S> <C> <C>
1999 $ 43 $ 1,203
2000 - 897
2001 - 789
2002 - 1,047
2003 - 859
Thereafter 269
--------------- ----------------
43 $ 5,064
================
Less amounts representing interest (2)
---------------
Present value of net minimum lease
payments $ 41
===============
</TABLE>
Property and equipment includes the following amounts for capitalized
leases:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------
1997 1998
<S> <C> <C>
Machinery and equipment $ - $ 43
Office furniture and equipment 67 67
Leasehold improvements 149 149
----------- ------------
216 259
Less accumulated amortization (140) (182)
----------- ------------
$ 76 $ 77
=========== ============
</TABLE>
Capital lease agreements of certain equipment contain bargain purchase
options whereby the Company has the option to purchase the equipment for
a nominal amount at the end of the lease term.
Certain of the Company's operating leases contain purchase options and
renewal options. Rent expense incurred under such leases was
approximately $613, $673 and $1,259 for the years ended December 31,
1996, 1997 and 1998, respectively.
LITIGATION
Various claims arising in the ordinary course of business, seeking
monetary damages and other relief, are pending. The amount of the
liability, if any, from such claims cannot be determined with certainty.
F-14
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
5. COMMON STOCK WARRANTS
In conjunction with an acquisition in June 1997, the Company issued three
year warrants to purchase 150,000 shares of common stock at $12 per
share.
6. SEGMENT REPORTING
In accordance with SFAS No. 131, information regarding the Company's
business segments is reported for financial statement purposes
consistently with the manner in which these segments are evaluated for
internal reporting and management's assessment of performance. The
Company evaluates the performance of its segment and allocates resources
to them based on segment earnings before allocation of corporate costs.
The Company is organized primarily on the basis of products which are
broken down into Network Systems and Network Management. Network Systems
products include T3AS products and services, including CTS and PAAS, as
well as the Remote Module product. Network Management products focus on
Operating System ("OS") software products which include .Provisioner,
TDC&E, FMS and OS design services.
The table below presents information about revenues, operating income
(loss) and total assets for reportable segments for the years ended
December 31:
<TABLE>
<CAPTION>
OPERATING
INCOME TOTAL
REVENUES (LOSS) ASSETS
<S> <C> <C> <C>
1996:
Network Systems $ 18,144 $ (782) $ 14,565
Network Management 6,278 (2,603) 4,533
---------- ---------- ----------
Total for reportable segments 24,422 (3,385) 19,098
Reconciling items - (5,285) 26,874
---------- ---------- ----------
Consolidated totals $ 24,422 $ (8,670) $ 45,972
========== ========== ==========
1997:
Network Systems $ 17,061 $ (3,209) $ 18,573
Network Management 16,989 4,961 6,432
---------- ---------- ----------
Total for reportable segments 34,050 1,752 25,005
Reconciling items - (6,807) 21,278
---------- ---------- ----------
Consolidated totals $ 34,050 $ (5,055) $ 46,283
========== ========== ==========
</TABLE>
F-15
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING
INCOME TOTAL
REVENUES (LOSS) ASSETS
<S> <C> <C> <C>
1998:
Network Systems $ 16,455 $ (7,186) $ 13,312
Network Management 12,762 1,556 3,944
---------------- --------------- ----------------
Total for reportable segments 29,217 (5,630) 17,256
Reconciling items - (7,983) 17,016
---------------- --------------- ----------------
Consolidated totals $ 29,217 $ (13,613) $ 34,272
================ =============== ================
</TABLE>
The table below presents the reconciliation of operating income (loss)
for reportable segments to consolidated loss before income taxes for the
years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Operating income (loss) for reportable
segments $ (3,385) $ 1,752 $ (5,630)
Other segment expenses (5,285) (6,807) (7,983)
Other unallocated income 1,673 904 675
---------------- --------------- ----------------
Consolidated loss before
income taxes $ (6,997) $ (4,151) $ (12,938)
================ =============== ================
</TABLE>
Operating income (loss) for reportable segments includes segment revenues
with deductions made for related selling costs and certain expenses
controllable by segment managers. Other segment expenses consist of
corporate selling, general and administrative expenses allocated to each
segment based on segment revenues. Other unallocated income consists of
interest income on investments held at the corporate level.
F-16
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
The table below presents the reconciliation of total assets for
reportable segments to consolidated total assets at December 31:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Total assets for reportable
segments $ 19,098 $ 25,005 $ 17,256
Other segment assets 3,525 6,492 2,925
Other unallocated assets:
Cash 1,504 4,400 12,513
Investments 19,956 8,779 -
Other 1,889 1,607 1,578
---------------- ---------------- ----------------
Consolidated total assets $ 45,972 $ 46,283 $ 34,272
================ ================ ================
</TABLE>
Total assets for reportable segments includes amounts attributable to
trade accounts receivable, inventory and property and equipment. Other
segment assets consist primarily of intangible assets obtained in
conjunction with certain acquisitions. Other unallocated assets consists
principally of deferred taxes and prepaid expenses
The table below presents information about other significant items
included in segment operating income and segment assets as of and for the
years ended December 31:
<TABLE>
<CAPTION>
DEPRECIATION EXPENDITURES
AND FOR ADDITIONS
AMORTIZATION TO LONG-LIVED
EXPENSE ASSETS
<S> <C> <C>
1996:
Network Systems $ 1,024 $ 1,239
Network Management 344 374
Reconciling items 451 96
---------------- ---------------
Consolidated totals $ 1,819 $ 1,709
================ ===============
1997:
Network Systems $ 1,131 $ 1,573
Network Management 773 694
Reconciling items 1,185 165
---------------- ---------------
Consolidated totals $ 3,089 $ 2,432
================ ===============
</TABLE>
F-17
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DEPRECIATION EXPENDITURES
AND FOR ADDITIONS
AMORTIZATION TO LONG-LIVED
EXPENSE ASSETS
<S> <C> <C>
1998:
Network Systems $ 1,595 $ 1,449
Network Management 1,033 284
Reconciling items 1,075 73
---------------- ---------------
Consolidated totals $ 3,703 $ 1,806
================ ===============
</TABLE>
Depreciation expense on segment property and equipment included as a
component of total segment assets utilized by management in assessing
segment operating performance is included in operating income for
reportable segments. For each of the years ended December 31, 1996, 1997,
and 1998, the reconciling item to arrive at consolidated depreciation and
amortization expense consists of amortization expense related to
intangible assets.
The table below presents information about revenue and long-lived assets
by geographic area as of and for the years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Revenues:
United States $ 20,071 $ 24,189 $ 25,571
Canada 4,351 9,861 3,646
---------------- ---------------- ----------------
Consolidated totals $ 24,422 $ 34,050 $ 29,217
================ ================ ================
Long-lived assets:
United States $ 4,109 $ 4,515 $ 4,156
Canada 827 1,650 1,310
---------------- ---------------- ----------------
Consolidated totals $ 4,936 $ 6,165 $ 5,466
================ ================ ================
</TABLE>
F-18
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
The table below presents information about segment revenues from major
customers as a percentage of total revenues for the years ended December
31:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Network Systems:
US WEST 31% 4% 3%
Bell Atlantic (NYNEX) 23% 8% 12%
BellSouth 7% 17% 26%
MCI WorldCom - 18% 7%
Network Management:
Northern Telecom, Inc. 15% 20% -
MCI WorldCom - 10% 16%
</TABLE>
7. EMPLOYEE BENEFIT PLANS
EMPLOYEE SAVINGS AND RETIREMENT PLAN
The Company has a 401(k) defined contribution plan that allows eligible
employees who have been employed by the Company for a minimum of one
month to contribute up to 15% of their salary, subject to annual limits.
The Company may also elect to make discretionary contributions to the
accounts of employees who have completed 1,000 hours of service during
the plan year. Such discretionary employer contributions vest ratably
over a four year period. The Company did not make any contributions
related to this Plan for the years ended December 31, 1996, 1997, or
1998.
PROFIT SHARING PLAN
The Company has a profit sharing plan available to all employees which
provides compensation to employees when the Company exceeds certain
targeted performance objectives. Employees are eligible to participate in
the first full quarter after their employment with the Company begins. The
Compensation Committee of the Board of Directors determines the annual
amount allocable to the Plan and such amount expensed was $418 for the
year ended December 31, 1997. No amounts were expensed under the Plan for
either of the years ended December 31, 1996 or 1998.
STOCK OPTION PLANS
Options to purchase common stock of the Company have been granted to
employees and non-employee Directors under the 1994 Stock Option/Stock
Issuance Plan, as amended (the "1994 Plan"), and to non-officer, non-
director employees and consultants under the 1996 Non-Qualified Stock
Option Plan, as amended (the "1996 Plan"), which collectively comprise the
"Stock Option Plans." A description of each plan follows.
- The 1994 Plan superceded and consolidated the 1988 Stock Option Plan
and Restricted Stock Purchase Plan (the "1988 Plan"). Outstanding
stock options and unvested share issuances under the 1988 Plan were
incorporated into and assumed in the 1994 Plan.
F-19
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
The 1994 Plan authorizes up to 4,100,000 shares to be granted no
later than February 2004. The 1994 Plan provides for the grant of
both incentive and non-qualified stock options which are exercisable
for up to ten years from the grant date. The 1994 Plan has three
components as follows:
- The Discretionary Option Grant Program for selected employees and
consultants has both incentive and non-qualified components.
Non-qualified options granted under the Discretionary Option
Grant Program may be purchased at not less than 85% of fair
market value of the stock at the date of grant whereas incentive
options may be purchased at fair market value. Such options
generally vest over a period not exceeding five years.
- The Automatic Option Grant Program provides for non-qualified
stock options to be granted to non-employee directors at fair
market value. Options generally vest over a period not exceeding
five years.
- The Stock Issuance Program provides for the issuance of shares of
common stock which may be purchased by eligible employees and
certain other qualified individuals at a price not less than 85%
of fair market value. Such options may be immediately exercisable
or may vest over a period not exceeding five years.
- The 1996 Plan authorizes up to 1,450,000 shares to be granted no later
than September 2008. Under terms of the 1996 Plan, the Company may grant
options to selected non-officer non-director employees and consultants. The
options are generally exercisable at not less than 85% of fair market value.
Options generally vest over periods not exceeding five years and have a
maximum term of ten years.
- Additionally, a fully-exercisable non qualified option to purchase
17,087 shares of common stock at an exercise price of $0.14 was outstanding
at December 31, 1995, 1996, 1997, and 1998. This option was not issued
pursuant to any of the Company's stock option plans. This option expires in
May 2001.
In September 1998, the Compensation Committee of the Company's Board of
Directors authorized a program to cancel and regrant option grants made
under the 1994 and 1996 Plans that were granted at exercise prices
exceeding the fair market value of common stock as of the effective date
of the program, October 23, 1998. The exercise price of each regranted
option was $2.75, based on the closing market price of the Company's
common stock on October 23, 1998. Each optionee holding such an option
had the opportunity to (i) elect to retain the old option or (ii) accept
a new option with an exercise price equal to the fair market value of the
Company's common stock on the effective date and cancel the older,
higher-priced option. Each regranted option covered the same number
of shares subject to the higher-priced option at the time of cancellation
and maintained the same vesting period as the previously cancelled
option. The regranted option is subject to the condition that the options
cannot be exercised, and employment is not terminated, prior to April 23,
1999. Any employee voluntarily leaving the Company during the suspended
vesting period will lose the affected options, including previously
vested portions of those options.
In October 1998, the Compensation Committee of the Company's Board of
Directors authorized a program to cancel and regrant option grants made
under the 1994 Plan to officer employees of the Company that were granted
at exercise prices exceeding the fair market value of common stock as of
the effective date of the program, November 3, 1998. The exercise price
of each regranted option was $2.75, based on the closing market price of
the Company's common stock on November 3, 1998. Each optionee holding
such an option had the opportunity to (i) elect to retain the old option
or (ii) accept new options with exercise prices equal to the fair market
value of the Company's common stock on the effective date and cancel the
older, higher-priced option. Each regranted option covered one half the
number of shares subject to the higher-priced option at the time of
cancellation. One of the regranted options maintained the same vesting
period as the previously cancelled option. The other regranted option
vests in equal monthly installments over a 48 month period beginning on
the effective date of the program. The regranted options are subject to
the condition that the options cannot be exercised, and employment is not
terminated, prior to May 3, 1999. Any officer employee voluntarily
leaving the Company during the suspended vesting period will lose the
affected options, including previously vested portions of those options.
F-20
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
A summary of stock option transactions for the 1994 and 1996 Plans
described above is as follows:
<TABLE>
<CAPTION>
1994 AND 1996 STOCK OPTION PLANS
-------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------- -------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE
--------------- ------------ --------------- ------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995 1,671,309 $ 5.63 787,291 $ 2.17
Options granted 874,887 9.01
Options exercised (149,261) .77
Options canceled (598,732) 18.30
--------------- ------------ --------------- ------------
Balance at December 31, 1996 1,798,203 5.54 813,939 2.49
Options granted 1,404,976 6.58
Options exercised (252,337) 6.34
Options canceled (299,984) 7.65
--------------- ------------ --------------- ------------
Balance at December 31, 1997 2,650,858 6.20 1,185,372 5.02
Options granted 2,990,941 3.49
Options exercised (91,649) 5.23
Options canceled (2,571,217) 7.32
--------------- ------------ --------------- ------------
December 31, 1998 2,978,933 $ 2.60 675,253 $ 1.52
=============== ============ =============== ============
</TABLE>
The following table summarizes information about all stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
------------------------------ ------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------ ------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OF SHARES LIFE PRICE OF SHARES PRICE
----------------------------------- -------------- ------------ --------------- -----------
<S> <C> <C> <C> <C> <C>
$0.14 to $2.69 496,526 3.77 $ 0.36 475,713 $ 0.27
$2.75 2,295,415 8.71 2.75 142,525 2.75
$3.00 to $16.13 204,079 9.00 6.34 57,015 8.81
------------- -------------- ------------ --------------- -----------
2,996,020 7.91 $ 2.60 675,253 $ 1.52
============= ============== ============ =============== ===========
</TABLE>
EMPLOYEE STOCK PURCHASE PLANS
The Company has three Employee Stock Purchase Plans which provide
eligible employees the opportunity to purchase the Company's common stock
through payroll deductions. The Company's employees in the United States
are eligible to participate in the 1994 Employee Stock Purchase Plan, as
amended and the 1998 Employee Stock Purchase Plan whereas the Company's
Canadian employees are eligible to participate in a separate 1998
Employee Stock Purchase Plan. Each of the Plans has substantially
identical terms. Under the terms of the Plans, employees qualify if they
have
F-21
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
been employed at least 20 hours per week for more than five months. After
three months of service, qualifying employees are eligible to participate
in the Plans in the quarter following the period in which the eligibility
requirement is fulfilled. Employees may elect to have up to 15% of their
regular compensation withheld through regular payroll deductions. At each
quarter-end, amounts accumulated in the participant's account are used to
purchase shares of the Company's common stock at the lower of 85% of the
fair market value of the stock at either the date of the participant's
entry into the Plan or the last day of the quarter. The initial option
period for each of the Plans is generally twelve to twenty-four months
with subsequent option periods covering one twelve month period. Each
Plan terminates either at the end of the respective option periods or
when the maximum number of shares available for issuance under the Plan
have been issued. Under these Plans, 56,857, 128,513, and 212,584 shares
of common stock were issued during the years ended December 31, 1996,
1997, and 1998, respectively. At December 31, 1998, 218,443 shares of
common stock were available for future purchases. No shares remained
available for future purchases under the 1994 Employee Stock Purchase
Plan, as amended.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation plans in accordance
with Accounting Principles Board ("APB") Opinion No. 25 ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES and related Interpretations. Under the
provisions of APB 25, the Company measures compensation cost using the
intrinsic value method rather than the fair value method prescribed by
SFAS No. 123 ACCOUNTING FOR STOCK-BASED COMPENSATION. Accordingly, no
compensation cost has been recognized in the Company's results of
operations. The Company has adopted the disclosure-only provisions of
SFAS No. 123 which require the presentation of pro forma information
related to net income (loss) and net income (loss) per share as if the
Company accounted for its stock-based compensation plans using the fair
value method. Such pro forma information is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1996 1997 1998
<S> <C> <C> <C>
Net loss:
As reported $(7,120) $(4,283) $(13,124)
Pro forma (8,352) (6,830) (15,979)
Net loss per common share:
As reported, basic and diluted $(.59) $(.34) $(1.03)
Pro forma, basic and diluted $(.69) $(.55) $(1.26)
</TABLE>
F-22
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
The fair value of options granted under the Stock Option Plans and shares
issued under the Employee Stock Purchase Plans reported below have been
estimated at the date of grant using the Black-Scholes option-pricing
model based on the following weighted-average assumptions:
<TABLE>
<CAPTION>
STOCK OPTION PLANS EMPLOYEE STOCK PURCHASE PLANS
-------------------------------------- ---------------------------------------
1996 1997 1998 1996 1997 1998
<S> <C> <C> <C> <C> <C> <C>
Risk-free interest rate 6.21% 6.17% 5.10% 6.21% 6.17% 4.69%
Dividend yield 0% 0% 0% 0% 0% 0%
Expected volatility 65.09% 69.76% 74.17% 65.09% 69.76% 74.17%
Expected life (in years) 5 5 5 .25 .25 .25
</TABLE>
The estimated fair value of options granted under the Stock Option Plans
at December 31, 1996, 1997 and 1998 was $4.22, $3.40, and $2.33 per
share, respectively. The estimated fair value of shares issued under the
Employee Stock Purchase Plans at December 31, 1996, 1997, and 1998 was
$9.56, $6.58, and $1.05 per share, respectively.
8. ACQUISITIONS
In February 1996, the Company acquired certain assets of Applied
Computing Devices, Inc. ("ACD"), a company that developed and marketed
operations systems software used primarily by independent telephone
companies to manage certain functions in their networks. The customer set
and products of ACD complement those of the Company and the Company
intends to continue to market and enhance these products. The Company
acquired the assets for $1,700 in cash and incurred approximately $200 in
related costs. The assets were acquired at an auction held in Federal
Bankruptcy Court, Southern District of Indiana. The transaction, which
was accounted for as a purchase, included the acquisition of in-process
research and development valued at approximately $1,200, property and
equipment valued at approximately $377 and purchased technology valued at
approximately $337. The Company recorded a one-time charge in the first
quarter of 1996 for approximately $1,186 associated with purchased
research and development costs.
In July 1996, the Company acquired certain assets of MPR Teltech, a
subsidiary of British Columbia Telecom, Inc. The assets acquired were
part of MPR Teltech's operating unit commonly known as the Special
Services Network division ("SSN"). The Company and its Canadian
subsidiary, ADA Canada, acquired the assets for $4,200 in cash, 150,000
shares of the Company's common stock and incurred approximately $200 in
related costs. SSN was an operations systems software development group
with expertise in the development of network management systems for
public carriers. SSN developed operations systems software primarily for
Northern Telecom ("Nortel"). SSN has become part of ADA Canada and will
develop network performance management operations systems software
products for the Company and its customers, including Nortel. The
transaction, which was
F-23
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
accounted for as a purchase, included the acquisition of in-process
research and development valued at approximately $2,100, property and
equipment valued at approximately $900 and goodwill and know-how valued
at approximately $2,588. The Company recorded a one-time charge in the
third quarter of 1996 for the $2,100 associated with purchased research
and development costs.
In June 1997, the Company acquired an exclusive worldwide license to
Nortel's Digital Support System II-TM- ("DSSII") 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 purchase price of $3,100. Of this amount, $3,100 was paid
in cash. The Company recorded a charge of approximately $1,578 for
purchased research and development associated with the acquisition of the
license and the assets. As part of the transaction, the Company also
issued Nortel three-year warrants to purchase 150,000 shares of the
Company common stock at an exercise price of $12 per share.
The following condensed pro forma results of operations information has
been presented to give effect to the acquisitions as if such transactions
had occurred at the beginning of each of the periods presented. The
historical results of operations have been adjusted to reflect additional
depreciation and amortization expense based upon the value allocated to
assets acquired in the purchases. The pro forma results of operations
information is presented for information purposes only and is not
necessarily indicative of the operating results that would have occurred
had the acquisitions been consummated as of the beginning of the periods
presented, nor is it necessarily indicative of future operating results.
<TABLE>
<CAPTION>
CONDENSED PRO FORMA RESULTS OF OPERATIONS
(UNAUDITED)
YEAR ENDED DECEMBER 31
---------------------------
1996 1997
<S> <C> <C>
Revenue $29,660 $34,050
Net loss (7,474) (4,283)
Net loss per share, basic and diluted (.61) (.34)
Weighted average shares used in computation 12,165 12,605
</TABLE>
F-24
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
9. INCOME TAXES
The provision for income taxes for the years ended December 31, 1996,
1997 and 1998 consists of current taxes for foreign operations.
Differences between the statutory rate and the effective tax rate for the
year ended December 31, 1996, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Taxes at federal statutory rate (34.0%) (34.0%) (34.0%)
Foreign income taxes 1.8% 3.2% 1.4%
Net operating loss carryforwards and research and
development tax credits (utilized) not utilized 33.0% 33.0% 33.0%
Other 1.0% 1.0% 1.0%
----- ----- -----
Provision for income taxes 1.8% 3.2% 1.4%
===== ===== =====
</TABLE>
The components of the deferred tax assets at December 31, 1997 and 1998
are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
---------------------------------
1997 1998
<S> <C> <C>
Allowances and reserves $ 780 $ 818
Vacation accrual 178 250
Capitalized research and development 2,577 2,982
Net operating loss carryforwards 5,908 10,383
Tax credits 1,991 2,691
Accelerated depreciation (287) (145)
Other 10 10
--------------- ---------------
Total gross deferred tax asset 11,157 16,989
Less valuation allowance (9,655) (15,433)
--------------- ---------------
$ 1,502 $ 1,556
=============== ===============
</TABLE>
F-25
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Realizability of the deferred tax asset is dependent on the Company
generating sufficient taxable income or utilizing tax planning strategies
available to the Company prior to expiration of the net operating loss
carryforwards. Although realization is not assured, management believes
it is more likely than not that the net deferred tax asset will be
realized. The amount of the deferred tax asset considered realizable,
however, could be reduced in the near term if estimates of future taxable
income during the carryforward period are reduced.
At December 31, 1998, the Company has net operating loss carryforwards
for federal income tax purposes of approximately $27,642, of which $5,458
is attributable to disqualifying dispositions of stock options. The
Company also has net operating loss carryforwards for California tax
purposes of approximately $13,796 at December 31, 1998, of which $2,804
is attributable to disqualifying dispositions of stock options. The
amount attributable to the disposition of stock options will not impact
the Company's effective tax rate in future periods as the impact will be
reflected as a component of equity when recognized.
The Company also has research and development tax credit carryforwards of
approximately $2,162 for federal and $802 for California tax purposes at
December 31, 1998. These carryforwards will begin expiring, if unused, in
2003.
The Internal Revenue Code imposes limits on the availability of net
operating loss carryforwards and certain tax credits that arose prior to
certain cumulative changes in a corporation's ownership resulting in a
change of control of the Company. The Company's use of approximately
$1,166 of its federal net operating loss carryforwards and $408 of its
federal and $105 of its California tax credit carryforwards are
significantly limited because the Company underwent "ownership-changes"
in January 1989 and March 1991. In each year following the change, the
Company will be able to offset taxable income by a limited amount of the
pre-ownership change carryforwards. This limitation is determined by the
value of the Company immediately prior to the ownership change multiplied
by the long-term tax-exempt rate. Net operating losses and tax credits
that are unavailable in any year as a consequence of this limitation may
be carried forward for future use subject to certain restrictions.
F-26
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
10. SUBSEQUENT EVENTS
TERMINATION OF JOINT DEVELOPMENT AGREEMENT
On March 3, 1999, the Company's Joint Development Agreement (the
"Agreement") with Nortel was terminated. The Agreement, dated September
29, 1997, was for the development of SONET network element products for
the telecommunications industry. Under the terms of the Agreement, the
Company and Nortel each contributed technology and resources and shared
development costs related to the project. Nortel is obligated to continue
providing funding for the project for three months after the termination
date. While the Company has retained the intellectual property rights
associated with the jointly developed technology, Nortel has the right to
receive royalties to recover its portion of development costs paid to the
Company should the Company sell products utilizing the jointly developed
technology. The amount potentially reimbursable to Nortel was $6,117 at
December 31, 1998.
On March 31, 1999 the Company announced a reduction in its workforce of
approximately 65 people, or 22% of its total workforce. Of the reduction
in workforce, 23 were temporary positions. The Company determined the
reduction was necessary in order to align its current operations with the
Company's objectives of focusing on market opportunities in its core
business, reducing expenses including expenses related to its recently
terminated JDA with Nortel and improving operating results. The majority
of the reduction in workforce were engineers focused on development
conducted under JDA. As a result of the reduction in workforce, the
Company will close its office in Richardson, Texas. The Company will
incur a significant one-time charge in the first quarter ending March 31,
1999, related to the reduction in workforce. The Company's restructuring
plan includes the identification of the affected personnel, facility
closures, asset write downs, and lease terminations. The Company has not
completed its analysis of the total dollar amount associated with the
restructuring charge, but will complete this process prior to issuing its
first quarter operating results.
F-27
<PAGE>
APPLIED DIGITAL ACCESS, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS
BEGINNING CHARGED TO BALANCE AT
DESCRIPTION YEAR OF YEAR EXPENSES WRITEOFFS END OF YEAR
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts 1996 $50 $ - $ - $50
1997 50 - - 50
1998 50 50 100
Inventory reserve 1996 537 - (68) 469
1997 469 312 (211) 570
1998 570 757 (653) 674
</TABLE>
F-28
<PAGE>
EXHIBIT 10.48
EXECUTIVE OFFICER
RETENTION AGREEMENT
This Executive Officer Retention Agreement (the "Agreement") is made
and entered into as of November 3, 1998 (the "Effective Date"), by and between
Applied Digital Access, Inc., a Delaware corporation (the "Company") and
___________________________ ("Executive").
RECITALS
The Company recognizes that the possibility of a Change of Control may
change the nature and structure of the Company and that uncertainty regarding
the consequences of such events may adversely affect the Company's ability to
retain its executives and other key employees. The Company also recognizes that
Executive possesses an intimate and essential knowledge of the Company upon
which the Company may need to draw for objective advice and continued services
in connection with any Change of Control that is potentially advantageous to the
Company's stockholders. The Company believes that the existence of this
Agreement will serve as an incentive to Executive to remain in the employ of the
Company and will enhance its ability to call on and rely upon Executive in
connection with a Change of Control.
The Company and Executive desire to enter into this Agreement in order
to provide additional compensation and benefits to Executive upon a Covered
Termination and to encourage Executive to continue to devote full attention and
dedication to the Company and to continue employment with the Company.
1. DEFINITIONS. As used in this Agreement, unless the context requires
a different meaning, the following terms shall have the meanings set forth
herein:
(a) "BASE SALARY" means the Executive's then current annual base
salary.
(b) "BOARD" means the Board of Directors of the Company or any
successor corporation thereto.
(c) "CAUSE" means:
(i) a proven willful act or failure to act including theft, a
material act of dishonesty, fraud, or the intentional falsification of any
employment or Company records which substantially impairs Executive's ability to
perform his duties under this Agreement;
(ii) willful improper disclosure of the Company's
confidential, business or proprietary information by Executive;
(iii) willful failure to substantially perform, or gross
neglect of, Executive's duties, including the refusal to perform any reasonable
act requested by the Board; provided such condition(s) remain(s) in effect
twenty (20) days after written notice is delivered by the Board to Executive of
such condition(s);
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(iv) any willful and intentional failure by Executive
to take or prevent any action which, in the reasonable determination of the
Board, hinders the possibility of, or process surrounding, any possible Change
in Control, or
(v) the Executive's conviction (including any plea of guilty
or nolo contendere) for a felony causing material harm to the reputation and
standing of the Company.
No act or failure shall be considered willful unless committed without good
faith and without a reasonable belief that the act or omission was in the best
interests of the Company.
Notwithstanding the foregoing, Executive shall not have been deemed to been
terminated for Cause without an opportunity for Executive, together with counsel
(if any) to be heard before the Board.
(d) "CHANGE OF CONTROL" means:
(i) any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")),
other than a trustee or other fiduciary holding securities of the Company under
an employee benefit plan of the Company, becomes the "beneficial owner" (as
defined in Rule 13d-3 promulgated under the Exchange Act), directly or
indirectly, of securities of the Company representing fifty percent (50%) or
more of (A) the outstanding shares of common stock of the Company or (B) the
combined voting power of the Company's then-outstanding securities;
(ii) the Company is party to a merger or consolidation which
results in the holders of voting securities of the Company outstanding
immediately prior thereto failing to continue to represent (either by remaining
outstanding or by being converted into voting securities of the surviving
entity) at least fifty percent (50%) of the combined voting power of the voting
securities of the Company or such surviving entity outstanding immediately after
such merger or consolidation;
(iii) there occurs a change in the Board within a two-year
period, as a result of which fewer than a majority of the Directors are
Incumbent Directors. For purposes of this Agreement, an Incumbent Director is
any director who is either:
(A) a director of the Company as of the Effective Date; or
(B) a director who is elected or nominated for election to
the Board with the affirmative votes of at least a majority of the Incumbent
Directors at the time of such election or nomination (but shall not include an
individual whose election or nomination is in connection with an actual or
threatened proxy contest relating to the election of directors to the Company);
(iv) the sale or disposition of all or substantially all of the
Company's assets (or any transaction having similar effect is consummated); or
(v) the dissolution or liquidation of the Company.
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Notwithstanding any other provision herein to the contrary, for purposes of this
Agreement no Change of Control shall be deemed to have occurred as a result of
any ownership change which may occur as a result of an underwritten public
offering or private placement of the Company's stock.
(e) "COVERED TERMINATION" means:
(i) any termination of Executive's employment by the
Company without Cause within twelve (12) months after the date of a Change of
Control; or
(ii) any resignation by Executive for Good Reason within
twelve (12) months after the date of a Change of Control.
"Covered Termination" shall not include any termination of
Executive's employment (a) by the Company for Cause; (b) by the Company as a
result of the Permanent Disability of Executive; (c) as a result of the death of
Executive; or (d) as a result of Executive's voluntary termination of employment
for any reason other than Good Reason.
(f) "GOOD REASON" means the occurrence of any of the following
conditions, without Executive's written consent, which condition(s) remain(s) in
effect twenty (20) days after written notice is delivered by Executive to the
Board of such condition(s):
(i) a demotion which results in Executive no longer
holding a substantially similar position as an executive officer of the Company
with substantially similar pay. Any such determination under this subsection
shall be made by the Company; provided, however, that any decrease greater than
five percent (5%) in Executive's Base Salary following a Change of Control shall
not be deemed substantially similar pay;
(ii) the relocation of Executive's work place to a
location more than fifty (50) miles from the location of Executive's work place
prior to the Change of Control; or
(iii)any material breach of this Agreement by the
Company.
(g) "PERMANENT DISABILITY" means that:
(i) Executive has been incapacitated by bodily injury
or disease so as to be prevented thereby from engaging in the performance of
duties on behalf of the Company;
(ii) such total incapacity has continued for a period
of six (6) consecutive months; and
(iii)such incapacity will, in the opinion of a
qualified physician selected by the Company, be permanent and continuous during
the remainder of Executive's life.
2. POSITION AND DUTIES. Executive shall continue to be an at-will
employee of the Company employed in his current position at his current salary
rate. Executive shall also be entitled to continue to participate in and to
receive benefits on the same basis as other similarity-situated employees under
any and all of the Company's employee benefit plans as in effect from time to
time. In addition, Executive shall be entitled to the benefits afforded to other
similarly-
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situated employees under the Company's vacation, holiday and business expense
reimbursement policies. Executive agrees to devote Executive's full business
time, energy and skill to the duties of the Company. These duties shall include,
but not be limited to, any duties consistent with Executive's position which may
be assigned to Executive from time to time.
3. NO BENEFITS PAYABLE UNLESS A COVERED TERMINATION. This Agreement is
intended to address the benefits payable to Executive upon a Covered
Termination. As such, upon any termination of Executive which is not a Covered
Termination, Executive shall be entitled to only that compensation and those
benefits from the Company which have been earned under Section 2 above through
the date of such termination. PROVIDED, HOWEVER, that, pursuant to the terms of
one or more other written agreements, Executive may be entitled to benefits upon
a termination which is not a Covered Termination.
4. COVERED TERMINATION.
(a) SEVERANCE BENEFITS. In the event of a Covered Termination,
Executive shall be entitled to the following separation benefits:
(i) all accrued salary and accrued but unused vacation
earned through the date of Executive's termination;
(ii) twelve (12) months of Base Salary, paid in
accordance with the Company's then-existing payroll practices; provided,
however, that during such twelve (12) month-period (the "Consulting Period")
Executive shall be deemed to be a consultant of the Company, including for tax
purposes. Accordingly, Executive shall be liable for all income and employment
taxes;
(iii) continued vesting of Executive's then outstanding
stock options during the Consulting Period;
(iv) reimbursement for all expenses reasonably and
necessarily incurred by the Executive in connection with the business of the
Company prior to Executive's termination of employment; provided Executive
remits to the Company, within fourteen (14) days following the Covered
Termination, a proper and complete expense report;
(v) provided Executive elects continued medical insurance
coverage in accordance with the applicable provisions of federal law (commonly
referred to as "COBRA"), the payment by Company of Executive's COBRA premiums
for the duration of such Consulting Period; provided, further, if Executive's
medical coverage immediately prior to the date of the Covered Termination
included Executive's dependents, the Company-paid COBRA premiums shall include
such dependents. Notwithstanding the above, in the event Executive becomes
covered under another employer's group health plan (other than a plan which
imposes a preexisting condition exclusion, unless the preexisting condition
exclusion does not apply) during the Consulting Period, the Company shall cease
payment of the COBRA premiums; and
(vi) all benefits, if any, under the Company's 401(k) Plan
and other Company benefit plans to which Executive may be entitled pursuant to
the terms of such plan(s).
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5. CONFLICT OF INTEREST. During the Consulting Period, Executive
agrees not to compete with the Company, either directly or indirectly, without
the prior written consent of the Company, which shall not be unreasonably
withheld. Executive also agrees that during the Consulting Period, Executive
will not, directly or indirectly, solicit the services of or in any other manner
persuade employees or customers of the Company to discontinue that person's or
entity's relationship with or to the Company as an employee or customer, as the
case may be.
6. PAYMENT OF TAXES. All payments made to Executive under this
Agreement shall be subject to all applicable federal, state and local income,
employment and payroll taxes.
7. PARACHUTE PAYMENT. If the benefits provided under this Agreement
result in Executive being subject to any excise tax due to characterization of
any amounts payable hereunder as "excess parachute payments" (pursuant to
Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code")), the
Company agrees to offer the Executive the option of (i) receiving the full
parachute payment subject to the excise tax, or (ii) receiving a reduced
parachute payment that would not subject Executive to the excise tax (which in
some circumstances may maximize the net benefit to Executive). Unless the
Company and Executive otherwise agree in writing, any calculation required under
this Section shall be made in writing by independent public accountants agreed
to by the Company and Executive (the "Accountants"), whose calculation shall be
conclusive and binding upon Executive and the Company for all purposes. For
purposes of this Section, the Accountants may rely on reasonable, good faith
interpretations concerning the application of Sections 280G and 4999 of the
Code. The Company and Executive shall furnish to the Accountants such
information and documents as the Accountants may reasonably request in order to
make a determination. The Company shall bear all costs the Accountants may
reasonably incur in connection with any calculations contemplated by this
Section.
8. EXCLUSIVE REMEDY. The payments and benefits provided for in Section
4 shall constitute the Executive's sole and exclusive remedy for any alleged
injury or other damages arising out of the cessation of Executive's employment
relationship with the Company in connection with a Covered Termination. To the
extent Executive is entitled to severance or other benefits upon termination of
employment under this Agreement and any other agreement, the benefits payable
under this Agreement shall be reduced by the amounts paid to Executive under any
other such agreement. However, this Agreement is not intended to and shall not
affect, limit or terminate (i) any plans, programs, or arrangements of the
Company that are regularly made available to a significant number of employees
of the Company, (ii) any agreement or arrangement with Executive that has been
reduced to writing and which does not relate to the subject matter hereof, or
(iii) any agreements or arrangements hereafter entered into by the parties in
writing, except as otherwise expressly provided herein.
9. PROPRIETARY AND CONFIDENTIAL INFORMATION. The Executive agrees to
continue to abide by the terms and conditions of any confidentiality and/or
proprietary rights agreement previously entered into by the Executive and the
Company.
10. ARBITRATION. Any claim, dispute or controversy arising out of this
Agreement, the interpretation, validity or enforceability of this Agreement or
the alleged breach thereof shall be submitted by the parties to binding
arbitration by the American Arbitration Association in San Diego County,
California or elsewhere by mutual agreement. The selection of the arbitrator and
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the arbitration procedure shall be governed by the Commercial Arbitration Rules
of the American Arbitration Association. All costs and expenses of arbitration
(or litigation to enforce such arbitration), including but not limited to
attorneys fees and other costs reasonably incurred by Executive, shall be paid
by party which does not prevail. Judgment may be entered on the award of the
arbitration in any court having jurisdiction.
11. INTERPRETATION. The Company and Executive agree that this Agreement
shall be interpreted in accordance with and governed by the laws of the State of
California, without regard to such state's conflict of laws rules.
12. RELEASE OF CLAIMS. No severance benefits shall be paid to Executive
under this Agreement unless and until Executive shall, in consideration of the
payment of such severance benefit, execute a release of claims in a form
attached hereto; provided, however, that such release shall not apply to any
right of Executive may have to be indemnified by the Company.
13. SUCCESSORS AND ASSIGNS.
(a) SUCCESSORS OF THE COMPANY. The Company will require any
successor or assign (whether direct or indirect, by purchase, merger,
consolidation or otherwise) to all or substantially all of the business and/or
assets of the Company, expressly, absolutely and unconditionally to assume and
agree to perform this Agreement in the same manner and to the same extent that
the Company would be required to perform it if no such succession or assignment
had taken place. Failure of the Company to obtain such agreement prior to the
effectiveness of any such succession transaction shall be a breach of this
Agreement which entitles Executive to terminate employment with the Company for
Good Reason and receive the benefits provided under Section 4 of this Agreement.
As used in this Agreement, "Company" shall mean the Company and any successor or
assign to the Company's business and/or assets as aforesaid which executes and
delivers the agreement provided for in this Section 13 or which otherwise
becomes bound by all the terms and provisions of this Agreement by operation of
law.
(b) HEIRS OF EXECUTIVE. This Agreement shall inure to the benefit
of and be enforceable by the Executive's personal and legal representatives,
executors, administrators, successors, heirs, distributees, devisees and
legatees.
14. NOTICES. For purposes of this Agreement, notices and all other
communications provided for in the Agreement shall be in writing and shall be
deemed to have been duly given when delivered or mailed by United States
registered mail, return receipt requested, postage prepaid, as follows:
if to the Company: Applied Digital Access, Inc.
9855 Scranton Road
San Diego, CA 92121
Attn: Compensation Committee of the Board
and if to the Executive at the address specified below Executive's signature.
Notice may also be given at such other address as either party may furnish to
the other in writing in accordance herewith, except that notices of change of
address shall be effective only upon receipt.
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15. VALIDITY. If any one or more of the provisions (or any part
thereof) of this Agreement shall be held invalid, illegal or unenforceable in
any respect, the validity, legality and enforceability of the remaining
provisions (or any part thereof) shall not in any way be affected or impaired
thereby.
16. MODIFICATION. This Agreement may only be modified or amended by a
written agreement signed by Executive and the Company.
17. COUNTERPARTS. This Agreement may be executed in counterparts, each
of which shall be deemed an original.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
Effective Date.
APPLIED DIGITAL ACCESS, INC.
By:
_______________________________
Title:
_______________________________
EXECUTIVE:
_____________________________________
Address for Notice:
_____________________________________
_____________________________________
_____________________________________
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EXHIBIT A: RELEASE OF CLAIMS
In consideration for the benefits to be received under that Retention
Agreement to which this Release is attached as EXHIBIT A, Executive and his
successors release the Company and all affiliated companies, and their
shareholders, investors, directors, officers, employees, agents, attorneys,
legal successors and assigns of and from any and all claims, actions and causes
of action, whether now known or unknown, which Executive now has, or at any
other time had, or shall or may have against the released parties based upon or
arising out of any matter, cause, fact, thing, act or omission whatsoever
occurring or existing at any time up to and including the date on which this
Release becomes effective, including, but not limited to, any claims of breach
of contract, wrongful termination, fraud, defamation, infliction of emotional
distress or national origin, race, age, sex, sexual orientation, disability or
other discrimination or harassment under the Civil Rights Act of 1964, the Age
Discrimination In Employment Act of 1967, the Americans With Disabilities Act,
the Fair Employment and Housing Act or any other applicable law.
Notwithstanding the foregoing, Executive does not release any claim for
any additional benefits pursuant to the Agreement which Executive is entitled to
receive following the date on which this Release is executed. In addition,
Executive shall continue to be entitled to all of the rights and benefits set
forth in any indemnification agreement between Executive and the Company.
Further, notwithstanding anything in this Release, Executive shall continue to
be indemnified to the full extent permitted by law for any event or occurrence
related to Executive's status as an employee, director, officer, agent or
fiduciary of the Company or any affiliate thereof or by reason of any action or
inaction on the part of Executive while serving in such capacity.
Executive acknowledges that he has read Section 1542 of the Civil Code
of the State of California, which states in full:
A general release does not extend to claims which the creditor
does not know or suspect to exist in his favor at the time of
executing the release, which if known by him must have materially
affected his settlement with the debtor.
Executive waives any rights that he has or may have under Section 1542
to the full extent that he may lawfully waive such rights pertaining to this
release of claims, and affirms that he is releasing all known and unknown claims
that he has or may have against the parties listed above.
Executive understands that Executive should consult with an attorney
prior to signing this Release and that Executive is giving up any legal claims
Executive has against the parties released above by signing this Release.
Executive acknowledges that Executive is signing this Release knowingly,
willingly and voluntarily in exchange for the benefits described herein.
Executive further understands that, IF AND ONLY IF EXECUTIVE IS AGE 40 OR OLDER,
Executive has up to 21 days to consider this Release, that Executive may revoke
it at any time during the 7 days after the date it is signed, and that it shall
not become effective until that 7-day period has passed.
Signature: Date:
_____________________________ ____________________
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EXHIBIT 10.49
PRESIDENT AND CHIEF EXECUTIVE OFFICER
RETENTION AGREEMENT
This Executive Officer Retention Agreement (the "Agreement") is made
and entered into as of November 3, 1998 (the "Effective Date"), by and between
Applied Digital Access, Inc., a Delaware corporation (the "Company") and Peter
P. Savage ("Executive").
RECITALS
The Company recognizes that the possibility of a Change of Control may
change the nature and structure of the Company and that uncertainty regarding
the consequences of such events may adversely affect the Company's ability to
retain its executives and other key employees. The Company also recognizes that
Executive possesses an intimate and essential knowledge of the Company upon
which the Company may need to draw for objective advice and continued services
in connection with any Change of Control that is potentially advantageous to the
Company's stockholders. The Company believes that the existence of this
Agreement will serve as an incentive to Executive to remain in the employ of the
Company and will enhance its ability to call on and rely upon Executive in
connection with a Change of Control.
The Company and Executive desire to enter into this Agreement in order
to provide additional compensation and benefits to Executive upon a Covered
Termination and to encourage Executive to continue to devote full attention and
dedication to the Company and to continue employment with the Company.
1. DEFINITIONS. As used in this Agreement, unless the context requires
a different meaning, the following terms shall have the meanings set forth
herein:
(a) "BASE SALARY" means the Executive's then current annual base
salary.
(b) "BOARD" means the Board of Directors of the Company or any
successor corporation thereto.
(c) "CAUSE" means:
(i) a proven willful act or failure to act including theft,
a material act of dishonesty, fraud, or the intentional falsification of any
employment or Company records which substantially impairs Executive's ability to
perform his duties under this Agreement;
(ii) willful improper disclosure of the Company's
confidential, business or proprietary information by Executive;
(iii) willful failure to substantially perform, or gross
neglect of, Executive's duties, including the refusal to perform any reasonable
act requested by the Board; provided such condition(s) remain(s) in effect
twenty (20) days after written notice is delivered by the Board to Executive of
such condition(s);
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(iv) any willful and intentional failure by Executive to take
or prevent any action which, in the reasonable determination of the Board,
hinders the possibility of, or process surrounding, any possible Change in
Control, or
(v) the Executive's conviction (including any plea of guilty
or nolo contendere) for a felony causing material harm to the reputation and
standing of the Company.
No act or failure shall be considered willful unless committed without good
faith and without a reasonable belief that the act or omission was in the best
interests of the Company.
Notwithstanding the foregoing, Executive shall not have been deemed to been
terminated for Cause without an opportunity for Executive, together with counsel
(if any) to be heard before the Board.
(d) "CHANGE OF CONTROL" means:
(i) any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")),
other than a trustee or other fiduciary holding securities of the Company under
an employee benefit plan of the Company, becomes the "beneficial owner" (as
defined in Rule 13d-3 promulgated under the Exchange Act), directly or
indirectly, of securities of the Company representing fifty percent (50%) or
more of (A) the outstanding shares of common stock of the Company or (B) the
combined voting power of the Company's then-outstanding securities;
(ii) the Company is party to a merger or consolidation which
results in the holders of voting securities of the Company outstanding
immediately prior thereto failing to continue to represent (either by remaining
outstanding or by being converted into voting securities of the surviving
entity) at least fifty percent (50%) of the combined voting power of the voting
securities of the Company or such surviving entity outstanding immediately after
such merger or consolidation;
(iii) there occurs a change in the Board within a two-year
period, as a result of which fewer than a majority of the Directors are
Incumbent Directors. For purposes of this Agreement, an Incumbent Director is
any director who is either:
(A) a director of the Company as of the Effective Date;
or
(B) a director who is elected or nominated for election
to the Board with the affirmative votes of at least a majority of the Incumbent
Directors at the time of such election or nomination (but shall not include an
individual whose election or nomination is in connection with an actual or
threatened proxy contest relating to the election of directors to the Company);
(iv) the sale or disposition of all or substantially all of
the Company's assets (or any transaction having similar effect is consummated);
or
(v) the dissolution or liquidation of the Company.
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Notwithstanding any other provision herein to the contrary, for purposes of this
Agreement no Change of Control shall be deemed to have occurred as a result of
any ownership change which may occur as a result of an underwritten public
offering or private placement of the Company's stock.
(e) "COVERED TERMINATION" means:
(i) any termination of Executive's employment by the Company
without Cause within twelve (12) months after the date of a Change of Control;
or
(ii) any resignation by Executive for Good Reason within
twelve (12) months after the date of a Change of Control.
"COVERED TERMINATION" shall not include any termination of
Executive's employment (a) by the Company for Cause; (b) by the Company as a
result of the Permanent Disability of Executive; (c) as a result of the death of
Executive; or (d) as a result of Executive's voluntary termination of employment
for any reason other than Good Reason.
(f) "GOOD REASON" means the occurrence of any of the following
conditions, without Executive's written consent, which condition(s) remain(s) in
effect twenty (20) days after written notice is delivered by Executive to the
Board of such condition(s):
(i) a demotion which results in Executive no longer holding
a substantially similar position as an executive officer of the Company with
substantially similar pay. Any such determination under this subsection shall be
made by the Company; provided, however, that any decrease greater than five
percent (5%) in Executive's Base Salary following a Change of Control shall not
be deemed substantially similar pay;
(ii) the relocation of Executive's work place to a location
more than fifty (50) miles from the location of Executive's work place prior to
the Change of Control; or
(iii) any material breach of this Agreement by the Company.
(g) "PERMANENT DISABILITY" means that:
(i) Executive has been incapacitated by bodily injury or
disease so as to be prevented thereby from engaging in the performance of duties
on behalf of the Company;
(ii) such total incapacity has continued for a period of six
(6) consecutive months; and
(iii) such incapacity will, in the opinion of a qualified
physician selected by the Company, be permanent and continuous during the
remainder of Executive's life.
2. POSITION AND DUTIES. Executive shall continue to be an at-will
employee of the Company employed in his current position at his current salary
rate. Executive shall also be entitled to continue to participate in and to
receive benefits on the same basis as other similarity-situated employees under
any and all of the Company's employee benefit plans as in effect from
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time to time. In addition, Executive shall be entitled to the benefits afforded
to other similarly-situated employees under the Company's vacation, holiday and
business expense reimbursement policies. Executive agrees to devote Executive's
full business time, energy and skill to the duties of the Company. These duties
shall include, but not be limited to, any duties consistent with Executive's
position which may be assigned to Executive from time to time.
3. NO BENEFITS PAYABLE UNLESS A COVERED TERMINATION. This Agreement is
intended to address the benefits payable to Executive upon a Covered
Termination. As such, upon any termination of Executive which is not a Covered
Termination, Executive shall be entitled to only that compensation and those
benefits from the Company which have been earned under Section 2 above through
the date of such termination. PROVIDED, HOWEVER, that, pursuant to the terms of
one or more other written agreements, Executive may be entitled to benefits upon
a termination which is not a Covered Termination.
4. COVERED TERMINATION.
(a) SEVERANCE BENEFITS. In the event of a Covered Termination,
Executive shall be entitled to the following separation benefits:
(i) all accrued salary and accrued but unused vacation
earned through the date of Executive's termination;
(ii) eighteen (18) months of Base Salary, paid in accordance
with the Company's then-existing payroll practices; provided, however, that
during such eighteen (18) month-period (the "Consulting Period") Executive shall
be deemed to be a consultant of the Company, including for tax purposes.
Accordingly, Executive shall be liable for all income and employment taxes;
(iii) continued vesting of Executive's then outstanding stock
options during the Consulting Period;
(iv) reimbursement for all expenses reasonably and
necessarily incurred by the Executive in connection with the business of the
Company prior to Executive's termination of employment; provided Executive
remits to the Company, within fourteen (14) days following the Covered
Termination, a proper and complete expense report; (v) provided Executive elects
continued medical insurance coverage in accordance with the applicable
provisions of federal law (commonly referred to as "COBRA"), the payment by
Company of Executive's COBRA premiums for the duration of such Consulting
Period; provided, further, if Executive's medical coverage immediately prior to
the date of the Covered Termination included Executive's dependents, the
Company-paid COBRA premiums shall include such dependents. Notwithstanding the
above, in the event Executive becomes covered under another employer's group
health plan (other than a plan which imposes a preexisting condition exclusion,
unless the preexisting condition exclusion does not apply) during the Consulting
Period, the Company shall cease payment of the COBRA premiums; and
(vi) all benefits, if any, under the Company's 401(k) Plan
and other Company benefit plans to which Executive may be entitled pursuant to
the terms of such plan(s).
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5. CONFLICT OF INTEREST. During the Consulting Period, Executive
agrees not to compete with the Company, either directly or indirectly, without
the prior written consent of the Company, which shall not be unreasonably
withheld. Executive also agrees that during the Consulting Period, Executive
will not, directly or indirectly, solicit the services of or in any other manner
persuade employees or customers of the Company to discontinue that person's or
entity's relationship with or to the Company as an employee or customer, as the
case may be.
6. PAYMENT OF TAXES. All payments made to Executive under this
Agreement shall be subject to all applicable federal, state and local income,
employment and payroll taxes.
7. PARACHUTE PAYMENT. If the benefits provided under this Agreement
result in Executive being subject to any excise tax due to characterization of
any amounts payable hereunder as "excess parachute payments" (pursuant to
Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code")), the
Company agrees to offer the Executive the option of (i) receiving the full
parachute payment subject to the excise tax, or (ii) receiving a reduced
parachute payment that would not subject Executive to the excise tax (which in
some circumstances may maximize the net benefit to Executive). Unless the
Company and Executive otherwise agree in writing, any calculation required under
this Section shall be made in writing by independent public accountants agreed
to by the Company and Executive (the "Accountants"), whose calculation shall be
conclusive and binding upon Executive and the Company for all purposes. For
purposes of this Section, the Accountants may rely on reasonable, good faith
interpretations concerning the application of Sections 280G and 4999 of the
Code. The Company and Executive shall furnish to the Accountants such
information and documents as the Accountants may reasonably request in order to
make a determination. The Company shall bear all costs the Accountants may
reasonably incur in connection with any calculations contemplated by this
Section.
8. EXCLUSIVE REMEDY. The payments and benefits provided for in Section
4 shall constitute the Executive's sole and exclusive remedy for any alleged
injury or other damages arising out of the cessation of Executive's employment
relationship with the Company in connection with a Covered Termination. To the
extent Executive is entitled to severance or other benefits upon termination of
employment under this Agreement and any other agreement, the benefits payable
under this Agreement shall be reduced by the amounts paid to Executive under any
other such agreement. However, this Agreement is not intended to and shall not
affect, limit or terminate (i) any plans, programs, or arrangements of the
Company that are regularly made available to a significant number of employees
of the Company, (ii) any agreement or arrangement with Executive that has been
reduced to writing and which does not relate to the subject matter hereof, or
(iii) any agreements or arrangements hereafter entered into by the parties in
writing, except as otherwise expressly provided herein.
9. PROPRIETARY AND CONFIDENTIAL INFORMATION. The Executive agrees to
continue to abide by the terms and conditions of any confidentiality and/or
proprietary rights agreement previously entered into by the Executive and the
Company.
10. ARBITRATION. Any claim, dispute or controversy arising out of this
Agreement, the interpretation, validity or enforceability of this Agreement or
the alleged breach thereof shall be submitted by the parties to binding
arbitration by the American Arbitration Association in San
13
<PAGE>
Diego County, California or elsewhere by mutual agreement. The selection of the
arbitrator and the arbitration procedure shall be governed by the Commercial
Arbitration Rules of the American Arbitration Association. All costs and
expenses of arbitration (or litigation to enforce such arbitration), including
but not limited to attorneys fees and other costs reasonably incurred by
Executive, shall be paid by party which does not prevail. Judgment may be
entered on the award of the arbitration in any court having jurisdiction.
11. INTERPRETATION. The Company and Executive agree that this Agreement
shall be interpreted in accordance with and governed by the laws of the State of
California, without regard to such state's conflict of laws rules.
12. RELEASE OF CLAIMS. No severance benefits shall be paid to Executive
under this Agreement unless and until Executive shall, in consideration of the
payment of such severance benefit, execute a release of claims in a form
attached hereto; provided, however, that such release shall not apply to any
right of Executive may have to be indemnified by the Company.
13. SUCCESSORS AND ASSIGNS.
(a) SUCCESSORS OF THE COMPANY. The Company will require any
successor or assign (whether direct or indirect, by purchase, merger,
consolidation or otherwise) to all or substantially all of the business and/or
assets of the Company, expressly, absolutely and unconditionally to assume and
agree to perform this Agreement in the same manner and to the same extent that
the Company would be required to perform it if no such succession or assignment
had taken place. Failure of the Company to obtain such agreement prior to the
effectiveness of any such succession transaction shall be a breach of this
Agreement which entitles Executive to terminate employment with the Company for
Good Reason and receive the benefits provided under Section 4 of this Agreement.
As used in this Agreement, "Company" shall mean the Company and any successor or
assign to the Company's business and/or assets as aforesaid which executes and
delivers the agreement provided for in this Section 13 or which otherwise
becomes bound by all the terms and provisions of this Agreement by operation of
law.
(b) HEIRS OF EXECUTIVE. This Agreement shall inure to the benefit
of and be enforceable by the Executive's personal and legal representatives,
executors, administrators, successors, heirs, distributees, devisees and
legatees.
14. NOTICES. For purposes of this Agreement, notices and all other
communications provided for in the Agreement shall be in writing and shall be
deemed to have been duly given when delivered or mailed by United States
registered mail, return receipt requested, postage prepaid, as follows:
if to the Company: Applied Digital Access, Inc.
9855 Scranton Road
San Diego, CA 92121
Attn: Compensation Committee of the Board
and if to the Executive at the address specified below Executive's signature.
Notice may also be given at such other address as either party may furnish to
the other in writing in accordance herewith, except that notices of change of
address shall be effective only upon receipt.
14
<PAGE>
15. VALIDITY. If any one or more of the provisions (or any part
thereof) of this Agreement shall be held invalid, illegal or unenforceable in
any respect, the validity, legality and enforceability of the remaining
provisions (or any part thereof) shall not in any way be affected or impaired
thereby.
16. MODIFICATION. This Agreement may only be modified or amended by a
written agreement signed by Executive and the Company.
17. COUNTERPARTS. This Agreement may be executed in counterparts, each
of which shall be deemed an original.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
Effective Date.
APPLIED DIGITAL ACCESS, INC.
By:______________________________
Title:___________________________
EXECUTIVE:
James Keefe
------------------------------------
Address for Notice:
____________________________________
____________________________________
____________________________________
15
<PAGE>
EXHIBIT A: RELEASE OF CLAIMS
In consideration for the benefits to be received under that Retention
Agreement to which this Release is attached as EXHIBIT A, Executive and his
successors release the Company and all affiliated companies, and their
shareholders, investors, directors, officers, employees, agents, attorneys,
legal successors and assigns of and from any and all claims, actions and causes
of action, whether now known or unknown, which Executive now has, or at any
other time had, or shall or may have against the released parties based upon or
arising out of any matter, cause, fact, thing, act or omission whatsoever
occurring or existing at any time up to and including the date on which this
Release becomes effective, including, but not limited to, any claims of breach
of contract, wrongful termination, fraud, defamation, infliction of emotional
distress or national origin, race, age, sex, sexual orientation, disability or
other discrimination or harassment under the Civil Rights Act of 1964, the Age
Discrimination In Employment Act of 1967, the Americans With Disabilities Act,
the Fair Employment and Housing Act or any other applicable law.
Notwithstanding the foregoing, Executive does not release any claim for
any additional benefits pursuant to the Agreement which Executive is entitled to
receive following the date on which this Release is executed. In addition,
Executive shall continue to be entitled to all of the rights and benefits set
forth in any indemnification agreement between Executive and the Company.
Further, notwithstanding anything in this Release, Executive shall continue to
be indemnified to the full extent permitted by law for any event or occurrence
related to Executive's status as an employee, director, officer, agent or
fiduciary of the Company or any affiliate thereof or by reason of any action or
inaction on the part of Executive while serving in such capacity.
Executive acknowledges that he has read Section 1542 of the Civil Code
of the State of California, which states in full:
A general release does not extend to claims which the creditor
does not know or suspect to exist in his favor at the time of
executing the release, which if known by him must have materially
affected his settlement with the debtor.
Executive waives any rights that he has or may have under Section 1542
to the full extent that he may lawfully waive such rights pertaining to this
release of claims, and affirms that he is releasing all known and unknown claims
that he has or may have against the parties listed above.
Executive understands that Executive should consult with an attorney
prior to signing this Release and that Executive is giving up any legal claims
Executive has against the parties released above by signing this Release.
Executive acknowledges that Executive is signing this Release knowingly,
willingly and voluntarily in exchange for the benefits described herein.
Executive further understands that, IF AND ONLY IF EXECUTIVE IS AGE 40 OR OLDER,
Executive has up to 21 days to consider this Release, that Executive may revoke
it at any time during the 7 days after the date it is signed, and that it shall
not become effective until that 7-day period has passed.
Signature: Date:
______________________________ _______________________
<PAGE>
EXHIBIT 10.50
CONFIDENTIAL SEPARATION AGREEMENT
This Confidential Separation Agreement ("Agreement") is entered into as
of January 25, 1999 (hereinafter the "Effective Date"), by and between Steven F.
X. Murphy ("Murphy") and Applied Digital Access, Inc. (the "Company") with
respect to the following facts:
RECITALS
A. Murphy is currently an officer of the Company and holds the title
of Vice President of Sales and Marketing.
B. Pursuant to the terms of this Agreement, Murphy's employment with
the Company will terminate, and Murphy will be deemed to have resigned from his
employment with the Company.
AGREEMENT
WHEREFORE, the parties to this Agreement agree as follows:
1. TERMINATION OF EMPLOYMENT. On the Effective Date of this Agreement,
Murphy's employment with the Company will terminate, and he will be deemed to
have resigned from his employment.
2. SEVERANCE PAYMENTS TO MURPHY.
(a) In exchange for the valuable consideration described in this
Agreement, the Company agrees to pay Murphy severance pay in the total amount of
One Hundred Thousand Dollars ($100,000), less withholdings and applicable taxes,
a sum to which Murphy is not otherwise entitled.
(b) This severance pay will be paid to Murphy monthly in six (6)
equal monthly installments. The first payment of $16,666.67 will be made
immediately upon Murphy's execution of this Agreement, and the remaining five
payments will be made monthly on the 15th of each month from February 15, 1999
through June 15, 1999 by automatic deposit into an account to be designated by
Murphy. The time period from the Effective Date of this Agreement through the
date of the final severance payment will hereinafter be referred to as the
"Severance Period."
(c) The Company further agrees that, on or before January 29,
1999, it will reimburse Murphy for any remaining reasonable business expenses
Murphy has submitted to the Company for reimbursement. The Company further
agrees that, during the Severance Period, it will pay Murphy's COBRA premiums
unless and until Murphy obtains employment benefits from another employer during
the Severance Period. The Company further agrees that Murphy will be allowed to
exercise all stock options held by Murphy that have vested as of the Effective
Date of this Agreement. The Company further agrees that, during the Severance
Period, Murphy will be allowed to use the personal computer belonging to the
Company that is currently in
<PAGE>
Murphy's possession, provided the Company is first allowed the opportunity to
erase the hard drive of that computer. The computer will be returned by Murphy
to the Company at the end of the Severance Period.
(d) Murphy acknowledges and agrees that, other than the
compensation and benefits described in this paragraph, Murphy has received all
the compensation from the Company to which he is entitled, and he acknowledges
and agrees that he is not entitled to any additional employee benefits,
incentive compensation, vacation pay, stock option vesting, bonuses, profit
sharing, or any other compensation or benefits of any kind or character from the
Company.
3. RELEASE BY MURPHY. In exchange for the valuable consideration
described in this Agreement, Murphy unconditionally, irrevocably and absolutely
releases and discharges the Company and any related or subsidiary corporations
or organizations, as well as all present and former employees, officers,
directors, agents, successors and assigns of the Company (hereinafter
collectively "Releasees"), from any and all claims related in any way to the
transactions, affairs or occurrences between them to date, including but not
limited to Murphy's employment with the Company, the termination of his
employment, and all losses, liabilities, claims, charges, demands and causes of
action, known or unknown, suspected or unsuspected, arising directly or
indirectly out of or in any way connected with the termination of Murphy's
employment with the Company. This release is intended to have the broadest
possible application and includes but is not limited to any claim for unpaid
salary or employee benefits, incentive compensation, commissions, bonuses,
profit sharing, breach of contract, wrongful termination, tortious discharge,
defamation, false imprisonment, fraud, infliction of emotional distress or
employment discrimination arising under federal, state or local law, including
but not limited to the California Fair Employment and Housing Act, Title VII of
the Civil Rights Act of 1964 and the Employee Retirement Income Security Act,
but excludes claims under the Age Discrimination in Employment Act of 1967.
4. WAIVER OF UNKNOWN CLAIMS. Murphy expressly acknowledges and agrees
that the release set forth above is binding notwithstanding any facts he later
becomes aware of, any change in the law that might have affected his decision to
enter into this Agreement, or any discovery by him that the facts or the law
relative to the matters released herein are different from what he understood
them to be at the time of signing this Agreement. Murphy expressly waives all of
the benefits and rights granted to him pursuant to Civil Code Section 1542,
which provides and reads as follows:
A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES
NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING
THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED
HIS SETTLEMENT WITH THE DEBTOR.
5. PROMISE NOT TO PROSECUTE. The parties to this Agreement, for
themselves, their heirs, successors and assigns, agree that they will not
prosecute or allow to be prosecuted on their behalf, in any administrative
agency or court, whether state or federal, any claim or demand of any type
related to the matters released above. It is the intention of the parties that
with the
<PAGE>
execution of this Agreement, the Company and its officers, directors, employees
(past or present), agents, successors or assigns, and all subsidiary and
affiliated corporations will be absolutely, unconditionally and forever
discharged of and from all obligations to or on behalf of Murphy related in any
way to the matters discharged herein.
6. NONSOLICITATION OF COMPANY'S EMPLOYEES. Murphy further agrees that
for one year following the Effective Date of this Agreement, he will not, either
directly or indirectly, separately or in association with others, solicit any of
the Company's employees, encourage others to solicit any of the Company's
employees, or encourage any of the Company's employees to discontinue their
employment with the Company. Further, Murphy will not solicit any consultants
that have consulting agreements or consulting arrangements with the Company,
encourage any of the Company's consultants to discontinue their relationships
with the Company, or assist others in soliciting or encouraging any of the
Company's consultants to discontinue their relationships with the Company.
7. NONDISPARAGEMENT/PUBLIC STATEMENTS. Murphy agrees that he will
hereafter conduct himself in a manner that tends to increase the value of the
Company to its shareholders. To that end, Murphy agrees that he will not at any
time make any statements, written or verbal, that defame, disparage or denigrate
the personal and/or professional reputations of the Company and/or its officers,
directors, managers, employees, or anyone affiliated with the Company. Murphy
further agrees that, if questioned by anyone about the Company, he will take
affirmative steps to publicly support the Company, those affiliated with the
Company, and the Company's decisions and stated directions, and will encourage
employees of the Company to remain employed at the Company and work for its
success. The Company and its officers and directors agree that they will not at
any time make any public statements, written or verbal, that defame, disparage
or denigrate the personal and/or professional reputation of Murphy.
8. CONFIDENTIALITY. Murphy agrees that the terms and conditions of
this Agreement shall remain strictly confidential and shall not be disclosed to
any other person or entity except as provided below:
(a) Murphy may disclose the terms of this Agreement deemed in
good faith to be necessary to the California Franchise Tax Board, the United
States Internal Revenue Service, his spouse, his immediate family, his tax or
financial advisers and his legal counsel.
(b) Except as provided in Paragraph 7 above, Murphy will respond
to or in any way participate in or contribute to any public discussion, notice
or other publicity concerning or in any way related to the transaction or events
that are the subject of this Agreement or the execution of this Agreement.
(c) Without limiting the generality of the foregoing, Murphy
agrees that he will not disclose any information regarding this Agreement to any
current, former or future employee of the Company or any attorney or other
representative thereof.
<PAGE>
9. ACKNOWLEDGMENT OF EMPLOYEE PROPRIETARY INFORMATION AGREEMENT.
(a) Murphy acknowledges and affirms his obligations as set forth
in the Applied Digital Access Employee Proprietary Information Agreement
("EPIA") he executed on or about April 1, 1997, and Murphy specifically
acknowledges and agrees that the EPIA remains in full force and effect
notwithstanding any provision of this Agreement.
(b) Murphy further certifies and agrees that, pursuant to the
"Release of Assets" form attached as Exhibit B to the EPIA, he will preserve as
confidential all trade secrets, confidential knowledge, data or other
proprietary information relating to products, processes, know-how, designs,
formulas, development or experimental work, computer lists, business plans,
financial information or other subject matter pertaining to any business of the
Company or any of its clients, consultants or licensees.
(c) Murphy further certifies and agrees that, pursuant to the
"Release of Assets" form attached as Exhibit B to the EPIA, he does not have in
his possession, nor has he failed to return, any devices, records, data, notes,
proposals, lists, correspondence, specifications, drawings, blueprints,
sketches, materials, equipment, other documents or property, or reproductions of
any of the aforementioned items belonging to the Company, other than the
personal computer referenced in Paragraph 2 above.
10. REMEDIES FOR BREACH.
(a) The parties to this Agreement agree that, if Murphy or any of
his agents breach any of the terms of this Agreement during the Severance
Period, Murphy will forfeit his right to receive any remaining severance
payments described in this Agreement, to the extent those payments have not yet
been made.
(b) The parties further agree that if the Company fails to make
any of the payments described in Paragraph 1, other than for the reasons set
forth in this paragraph, the remaining payments to Murphy will become
immediately due and owing to Murphy, and Murphy will be entitled to interest at
the legal rate for the period during which the Company fails to make such
payment.
(c) The parties further agree that a breach of any of the terms
of this Agreement by Murphy or any of his agents will be deemed to cause
irreparable harm to the Company, such that the Company's remedy at law is
recognized to be inadequate to redress the harm to the Company. With this
understanding, the parties agree that, upon a breach of any of the terms of this
Agreement by Murphy or any of his agents, the Company may apply for immediate
injunctive relief in any court of competent jurisdiction to enforce the terms of
this Agreement, as well as for money damages, including punitive damages, for
breach of any of the terms of this Agreement. If the Company's application for
injunctive or other relief is denied by the court or is otherwise unsuccessful,
the parties understand and agree that no res judicata effect and no effect on
the Company's right to apply for any future relief shall flow therefrom.
(d) The parties further agree that, in the event of any
litigation concerning any controversy, claim or dispute between the parties
arising out of or relating to this Agreement or the breach hereof, or the
interpretation hereof, the prevailing party shall be entitled to recover
<PAGE>
from the losing party reasonable expenses, attorneys' fees, and costs incurred
therein or in the enforcement or collection of any judgment or award rendered
therein. The "prevailing party" means the party determined by the court to have
most nearly prevailed, even if such party did not prevail in all matters.
(e) The parties further agree that the remedies expressed in this
paragraph are in addition to all other remedies at law or in equity that may be
available to the Company upon a breach of this Agreement.
(f) The parties further agree that, before seeking any of the
remedies set forth in this paragraph against the other party to this Agreement,
the party seeking said remedy will notify the other party in writing of that
party's alleged breach of the terms of this Agreement and allow for a 20-day
opportunity to cure the alleged breach. If the breaching party fails to cure the
alleged breach with said 20-day period to the reasonable satisfaction of the
party alleging the breach, that party may seek to enforce any and all remedies
set forth in this paragraph.
11. VOLUNTARY AGREEMENT. Murphy acknowledges that he has executed this
Agreement after independent investigation and without coercion, duress, fraud or
undue influence. Murphy also acknowledges that he has read and understands the
terms of this Agreement. Murphy also agrees that he has been given a full
opportunity to consult with, and has consulted with, an attorney regarding this
Agreement and its terms. By signing this Agreement, Murphy acknowledges that he
does so freely, knowingly and voluntarily.
12. MISCELLANEOUS PROVISIONS.
(a) ENTIRE AGREEMENT. With the exception of the EPIA discussed in
Paragraph 9 above, this Agreement contains the entire agreement between the
parties with respect to the subject matter hereof. It is agreed that there are
no collateral agreements or representations, written or oral, that are not
contained in this Agreement. This Agreement may be amended only by a written
instrument executed by all parties hereto.
(b) SEVERABILITY. Should it be determined by a court that any
term of this Agreement is unenforceable, that term shall be deemed to be
deleted. However, the validity and enforceability of the remaining terms shall
not be affected by the deletion of the unenforceable term. Furthermore, in the
event of a breach of any provision of this Agreement, all other provisions of
this Agreement shall remain in full force and effect.
(c) APPLICABLE LAW. The validity, interpretation and performance
of this Agreement shall be construed and interpreted according to the laws of
the State of California.
(d) BINDING ON SUCCESSORS. The parties agree that this Agreement
shall be binding on and inure to the benefit of the successors, heirs and
assigns of the Company and Murphy.
(e) INTERPRETATION; CONSTRUCTION. The headings set forth in this
Agreement are for convenience only and shall not be used in interpreting this
Agreement. This Agreement has been drafted by legal counsel representing the
Company, but Murphy has participated in the negotiation of its terms.
Furthermore, Murphy acknowledges that he has had an opportunity to
<PAGE>
read, review and discuss each term of this Agreement with legal counsel, and
therefore the normal rule of construction to the effect that any ambiguities are
to be resolved against the drafting party shall not be employed in the
interpretation of this Agreement.
(f) SIGNATORIES' REPRESENTATIONS. The parties affixing their
signatures hereto represent and warrant that they have the authority to enter
into this Agreement on their own behalf and/or on behalf of their employer and
to bind all persons or entities who may claim through them; that they have
neither filed nor caused to be filed any claims or actions against any other
party to this Agreement that are not the subject of the release set forth above;
and that the claims released by this Agreement have not been assigned to any
other person or entity.
(g) COUNTERPARTS. This Agreement may be executed in identical
counterparts. The Agreement will be binding and enforceable when all parties
have signed an original counterpart of this Agreement.
* * *
REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK
<PAGE>
The parties have read the foregoing Agreement and fully understand each
and every provision contained herein and have been given the opportunity to
consult with counsel regarding this Agreement.
WHEREFORE, the parties have executed this Agreement on the dates shown
below.
APPLIED DIGITAL ACCESS, INC.
Dated: By:
____________________________ __________________________________
By:
Its:
Dated:
____________________________ _____________________________________
Steven F. X. Murphy
<PAGE>
[ARTICLE] 5
[MULTIPLIER] 1,000
<TABLE>
<S> <C>
[PERIOD-TYPE] YEAR
[FISCAL-YEAR-END] DEC-31-1998
[PERIOD-START] JAN-01-1998
[PERIOD-END] DEC-31-1998
[CASH] 12,513
[SECURITIES] 0
[RECEIVABLES] 6,211
[ALLOWANCES] (100)
[INVENTORY] 5,679
[CURRENT-ASSETS] 26,133
[PP&E] 14,524
[DEPRECIATION] (9,058)
[TOTAL-ASSETS] 34,272
[CURRENT-LIABILITIES] 9,377
[BONDS] 0
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[COMMON] 13
[OTHER-SE] 24,882
[TOTAL-LIABILITY-AND-EQUITY] 34,272
[SALES] 29,217
[TOTAL-REVENUES] 29,217
[CGS] 13,587
[TOTAL-COSTS] 13,587
[OTHER-EXPENSES] 29,191
[LOSS-PROVISION] 50
[INTEREST-EXPENSE] 2
[INCOME-PRETAX] (12,938)
[INCOME-TAX] 186
[INCOME-CONTINUING] (13,124)
[DISCONTINUED] 0
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] (13,124)
[EPS-BASIC] (1.03)
[EPS-DILUTED] (1.03)
</TABLE>
<PAGE>
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, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 000-23698
APPLIED DIGITAL ACCESS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 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 13,147,507 shares of the Registrant's Common Stock, $0.001 par value,
outstanding as of July 31, 1999.
<PAGE>
APPLIED DIGITAL ACCESS, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
June 30, 1999 and December 31, 1998.............................................. 3
Condensed Consolidated Statements of Operations and Comprehensive Loss for the
three and six months ended June 30, 1999 and June 30, 1998....................... 4
Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 1999 and June 30, 1998..................................... 5
Notes to Condensed Consolidated Financial Statements............................. 6-9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................................ 10-14
Risks and Uncertainties.......................................................... 14-21
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................... 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................ 22
Item 2. Changes in Securities and Use of Proceeds........................................ 22
Item 3. Defaults Upon Senior Securities.................................................. 22
Item 4. Submission of Matters to a Vote of Security Holders.............................. 22
Item 5. Other Information................................................................ 23
Item 6. Exhibits and Reports on Form 8-K................................................. 23
SIGNATURES.................................................................................... 24
</TABLE>
2
<PAGE>
PART I FINANCIAL STATEMENTS
Item 1. Financial Statements
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
------------ --------------
Unaudited
(Dollars in Thousands,
except per share data)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 9,465 $ 12,513
Investments 4,867 -
Trade accounts receivable, net 5,161 6,111
Inventory, net 4,227 5,679
Deferred income taxes 130 130
Prepaid expenses and other current assets 1,365 1,700
----------- -------------
Total current assets 25,215 26,133
Property and equipment, net 3,472 5,466
Intangible assets, net 681 1,247
Deferred income taxes 1,510 1,426
----------- -------------
Total assets $ 30,878 $ 34,272
=========== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,089 $ 2,922
Accrued expenses 1,491 2,374
Accrued warranty expense 1,149 1,264
Deferred revenue 3,003 2,817
----------- -------------
Total current liabilities 8,732 9,377
=========== =============
Shareholders' equity:
Preferred stock, no par value; 7,500,000 shares authorized;
no shares issued - -
Common stock, $.001 par value; 30,000,000 shares authorized;
13,118,571 and 12,909,315 shares issued and outstanding at
June 30, 1999 and December 31,1998 respectively 13 13
Additional paid-in capital 55,289 54,897
Accumulated other comprehensive income 191 163
Accumulated deficit (33,347) (30,178)
----------- -------------
Total shareholders' equity 22,146 24,895
----------- -------------
Total liabilities and shareholders' equity $ 30,878 $ 34,272
=========== =============
</TABLE>
The accompanying notes are an integral part of the
financial statements.
3
<PAGE>
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED JUNE 30, FOR THE SIX MONTHS ENDED JUNE 30,
1999 1998 1999 1998
(Dollars in thousands, (Dollars in thousands,
except per share data) except per share data)
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenue $ 8,863 $ 8,580 $ 16,065 $ 13,852
Cost of revenue 3,531 3,741 6,425 7,405
----------- ------------ ------------- -------------
Gross profit 5,332 4,839 9,640 6,447
----------- ------------ ------------- -------------
Operating expenses:
Research and development 2,761 3,777 5,946 7,320
Restructuring charge - - 1,335 -
Engineering Reimbursement - - (1,361) -
Sales and marketing 2,147 2,551 4,426 4,831
General and administrative 1,353 1,295 2,614 2,414
----------- ------------ ------------- -------------
Total operating expenses 6,261 7,623 12,960 14,565
----------- ------------ ------------- -------------
Operating loss (929) (2,784) (3,320) (8,118)
Interest income 134 168 254 342
Other expense, net (7) (6) (8) (16)
----------- ------------ ------------- -------------
Loss before income taxes (802) (2,622) (3,074) (7,792)
Provision for income taxes 41 36 95 73
----------- ------------ ------------- -------------
Net loss $ (843) $ (2,658) $ (3,169) $ (7,865)
============ ============ ============= =============
Other comprehensive income (loss):
Foreign currency translation adjustments 67 (93) 28 (12)
----------- ------------ -------------- --------------
Comprehensive loss $ (776) $ (2,751) $ (3,141) $ (7,877)
----------- ------------ -------------- --------------
Net loss per share, basic and diluted (.06) $ (.21) $ (.24) $ (.62)
----------- ------------ -------------- --------------
Shares used in per share computations 13,037,132 12,675,219 12,977,203 12,649,983
----------- ------------ -------------- --------------
</TABLE>
The accompanying notes are an integral part of the
financial statements.
4
<PAGE>
APPLIED DIGITAL ACCESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30,
1999 1998
---------- -----------
Dollars in Thousands
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(3,169) $(7,865)
Adjustments to reconcile net loss to net cash provided (used)
by operating activities:
Depreciation and amortization 1,783 1,853
Writeoff of assets associated with restructuring 866 -
Other 108 (101)
Changes in operating assets and liabilities:
Trade accounts receivable 950 3,978
Inventory 1,452 (65)
Prepaid expenses and other current assets 251 1,340
Accounts payable 167 1,647
Acquisition payments due licensor - (867)
Accrued expenses (851) (743)
Accrued warranty expense (115) (8)
Deferred revenue 186 1,047
--------- --------
Net cash provided by operating activities 1,628 216
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (4,867) (7,854)
Maturities of investments - 6,835
Purchases of property and equipment (169) (1,370)
Purchase costs related to asset acquisition - 500
--------- --------
Net cash used by investing activities (5,036) (1,889)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations (32) (9)
Proceeds from issuance of common stock 392 416
--------- --------
Net cash provided by financing activities 360 407
--------- --------
Net decrease in cash and cash equivalents (3,048) (1,266)
Cash and cash equivalents at beginning of period 12,513 4,400
--------- --------
Cash and cash equivalents at end of period $ 9,465 $ 3,134
--------- --------
</TABLE>
The accompanying notes
are an integral part of the financial statements.
5
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(DOLLARS IN THOUSANDS)
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 period ended June 30,
1999 are not necessarily indicative of the results that may be expected for the
year ending December 31, 1999. These financial statements should be read in
conjunction with the Company's audited financial statements and notes thereto,
together with Management's Discussion and Analysis of Financial Condition and
Results of Operations, and Risks and Uncertainties, contained in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1998 filed
with the SEC.
2. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No.
133 establishes accounting and reporting standards for derivative and hedging
activities. In accordance with SFAS No. 133 all derivatives must be recognized
as assets or liabilities and measured at fair value. This Statement will be
effective for the Company's fiscal year 2001. The Company has not yet determined
the impact of the adoption of this new accounting pronouncement on its
consolidated financial position or results of operations.
3. INVENTORY
Inventory is valued at the lower of cost (determined using the first-in,
first-out method) or market. Inventory was as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
----------- --------------
<S> <C> <C>
Inventories:
Raw materials $2,649 $3,266
Work-in-process 1,641 2,389
Finished goods 667 698
-------- --------
4,957 6,353
Less reserves (730) (674)
-------- --------
$4,227 $5,679
======== ========
</TABLE>
4. RESTRUCTURING CHARGE FOR TERMINATION OF JOINT DEVELOPMENT AGREEMENT
On March 3, 1999, the Company announced the termination of its joint development
agreement ("JDA") with Northern Telecom, Inc. ("Nortel"). The Company and Nortel
entered into the JDA in September 1997 to develop Synchronous Optical Network
("SONET") network element products for the telecommunications industry. The
intellectual property rights associated with the jointly developed technology
will become the property of the
6
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(DOLLARS IN THOUSANDS)
Company. Under the JDA, the Company and Nortel each contributed technology and
development resources to the project and shared the development costs. The
Company's development costs associated with the JDA have been expensed as
incurred.
For the six months ended June 30, 1999, the Company incurred a one-time
restructuring charge of $1,435, of which $1,335 is included as a separate
component of operating expenses and $100 is included in costs of revenue. Cash
expenditures are estimated to be $469 which consists of employee severance
costs, a facility closure in Richardson, Texas and other costs. The significant
components of the restructuring charge are:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
COMPONENT Amount Amounts incurred as of Estimated amounts to be
June 30, 1999 paid in the future
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Severance and related personnel costs $ 264 $ 264 $ 0
Capital asset writeoffs 866 866 0
Facility Closure 152 72 80
Excess inventory writedown 100 100 0
Other costs 53 10 43
-------- ------ -------
Total restructuring costs $1,435 $1,312 $123
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
Severance costs related to the termination of approximately 65 people, the
majority of which were engineers focused on the JDA. The capital asset writeoffs
related to software development tool kits acquired specifically for the JDA that
had no on-going business use. The facility in Richardson, Texas is a leased
facility which the Company has the ability to sub-lease. The Company has
estimated the costs associated with leasing the facility until a sub-lessee can
be found. The inventory write down related to excess quantities of components
used in the JDA product design that were purchased in advance. Other costs are
associated with legal services and other professional services required to
complete the termination of the JDA. The majority of the expenditures have been
concluded however, there may be costs associated with the closure of the leased
facility in Richardson, Texas that could continue in to the future.
5. PER SHARE INFORMATION
Basic EPS is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
is computed giving effect to all dilutive potential common shares that were
outstanding during the period. Dilutive potential common shares consist of the
incremental common shares issuable upon the exercise of stock options and
warrants for all periods. There are no reconciling items in the numerator and
denominator for basic and diluted EPS.
6. SEGMENTS
In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information", information regarding the Company's business segments
is reported for financial statement purposes consistently with the manner in
which these segments are evaluated for internal reporting and management's
assessment of performance. The Company evaluates the performance of its segment
and allocates resources to them based on segment earnings before allocation of
corporate costs.
The Company has two business units, Network Systems and Network Management, that
are organized around the Company's product lines. The Network Systems business
unit is formed around the Company's network test and performance monitoring
products and services, including its T3AS Test and Performance Monitoring System
("T3AS"), Centralized Test System ("CTS"), Remote Module, a network interface
unit ("NIU"), OPTIS (previously named Test OS), Network Embedded Protocol
Access System ("NEPA"), and Sectionalizer. The Network Management business unit
focuses on the Company's Operations Support System ("OSS") software products
7
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(DOLLARS IN THOUSANDS)
including .Provisioner, Traffic Data Collection and Engineering System
("TDC&E"), Fault Management System ("FMS"), and OS design services.
The table below presents information about revenues and operating loss for
reportable segments for the three and six months ended June 30:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
----------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
REVENUES:
Network Systems $ 5,821 $ 5,437 $ 10,616 $ 8,929
Network Management 3,042 3,143 5,449 4,923
----------- ------------- ------------ ------------
Consolidated totals $ 8,863 $ 8,580 $ 16,065 $ 13,852
=========== ============= ============ ============
OPERATING LOSS:
Network Systems $ (36) $ (2,342) $ (1,265) $ (5,934)
Network Management 354 861 373 164
----------- ------------- ------------- ------------
Total for reportable segments 318 (1,481) (892) (5,770)
Reconciling items (1,247) (1,303) (2,428) (2,348)
----------- ------------- ------------- ------------
Consolidated totals $ (929) $ (2,784) $ (3,320) $ (8,118)
=========== ============= ============ ============
</TABLE>
The table below presents the reconciliation of operating loss for reportable
segments to consolidated loss before income taxes for the three and six months
ended June 30:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
---------- ------------ ---------- -----------
<S> <C> <C> <C> <C>
Operating loss for reportable segments $ 318 $(1,481) $ (892) $(5,770)
Other unallocated segment expenses (1,254) (1,309) (2,436) (2,364)
Other unallocated income 134 168 254 342
--------- ---------- --------- ---------
Consolidated loss before income taxes $ (802) $(2,622) $(3,074) $(7,792)
========= ========== ========= =========
</TABLE>
Operating loss for reportable segments includes segment revenues with deductions
made for related development and selling costs and certain expenses controllable
by segment managers. Other unallocated segment expenses consist of corporate
selling, general and administrative expenses allocated to each segment based on
segment revenues. Other unallocated income consists of interest income on
investments held at the corporate level.
8
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(DOLLARS IN THOUSANDS)
The table below presents the reconciliation of total assets for reportable
segments to consolidated total assets at:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
----------- -------------
<S> <C> <C>
Total assets for reportable
Segments $12,859 $17,256
Other unallocated assets:
Cash and investments 14,332 12,513
Other 3,687 4,503
----------- ----------
Consolidated total assets $30,878 $34,272
=========== ==========
</TABLE>
Total assets for reportable segments includes amounts attributable to trade
accounts receivable, inventory and property and equipment. Other unallocated
assets principally consists of deferred taxes, intangible assets obtained in
conjunction with certain acquisitions and prepaid expenses.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE STATEMENTS CONTAINED IN THIS FORM 10-Q THAT ARE NOT PURELY HISTORICAL ARE
FORWARD LOOKING STATEMENTS. STATEMENTS WHICH USE THE WORDS "OBJECTIVE," "SEEK,"
"INTEND," "WILL," "ANTICIPATE," "CAN," "CONTINUE," "PLAN," AND "EXPECT," ARE
FORWARD LOOKING STATEMENTS. THESE FORWARD LOOKING STATEMENTS, INCLUDING
STATEMENTS REGARDING THE COMPANY'S (I) PLANS FOR DEVELOPMENT OR ACQUISITION AND
INTRODUCTION OF NEW PRODUCTS OR ENHANCEMENT OF EXISTING PRODUCTS, (II) STRATEGY,
INCLUDING ITS FOCUS ON ITS CORE BUSINESS,(III) EXPANDED MARKETING EFFORTS, (IV)
EXPECTED LEVELS OF EXPENDITURES, (V) GOAL OF MAXIMIZING THE VALUE OF TECHNOLOGY
AND (VI) THE COMPANY'S TIMING OF YEAR 2000 COMPLIANCE, ARE BASED ON INFORMATION
AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES NO
OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENT. IT IS IMPORTANT TO NOTE
THAT THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE IN SUCH
FORWARD LOOKING STATEMENTS. AMONG THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO
DIFFER MATERIALLY ARE THE FACTORS SET FORTH BELOW UNDER THE HEADING "RISKS AND
UNCERTAINTIES."
RECENT DEVELOPMENTS
On March 3, 1999, the Company announced the termination of its JDA
with Nortel. The Company and Nortel entered into the JDA in September 1997 to
develop SONET network element products for the telecommunications industry. The
intellectual property rights associated with the jointly developed technology
became the property of the Company. Under the JDA, the Company and Nortel each
contributed technology and development resources to the project and shared the
development costs. The Company's development costs associated with the JDA were
expensed as incurred. The Company has reduced expenses associated with the
development conducted under the JDA and continues to explore alternatives for
maximizing the value of the jointly developed technology. There can be no
assurance that the Company will be successful in it efforts to maximize the
value of the technology developed under the JDA or that the jointly developed
technology will provide future value to the Company.
On March 31, 1999, the Company announced a workforce reduction of
approximately 65 people. The Company determined the reduction was necessary in
order to align its current operations with the Company's objectives of focusing
on market opportunities in its core business, reducing expenses including
expenses related to its recently terminated JDA with Nortel and improving
operating results. The majority of the reduction in workforce were engineers
focused on development conducted under the JDA. As a result of the reduction in
workforce, the Company has closed its office in Richardson, Texas. In the
quarter ended March 31, 1999 the Company incurred a restructuring charge of
$1,435,000 related to the reduction in workforce, the closure of the Texas
facility, and the write-down of certain capital assets and inventory.
RESULTS OF OPERATIONS
Revenue totaled $8,863,000 for the three months ended June 30, 1999, a
3% increase from $8,580,000 for the three months ended June 30, 1998. The
increase is primarily the result of increased revenue from the sale of network
systems products partially offset by decreased revenue from the sale of network
management OSS products. Revenue generated from the sale of the Company's
network systems products and services totaled $5,821,000 for the three months
ended June 30, 1999, a 7% increase from $5,437,000 for the three months ended
June 30, 1998. The increase was primarily the result of increased licensing
revenues related to the Remote Module product line. Revenue generated from the
sale of the Company's network management OS products and services totaled
$3,042,000 for the three months ended June 30, 1999, a 3% decrease from
$3,143,000 for the three months ended June 30, 1998. The decrease was the result
of decreased sales of the Company's design services and TDC&E products largely
offset by increased revenues from the Company's FMS software product. For the
three months ended June 30, 1999, BellSouth, MCI WorldCom and Bell Atlantic
accounted for 33%, 12%, and 10% of the Company's total revenue, respectively.
For the three months ended June 30, 1998, MCI WorldCom and BellSouth accounted
for 36% and 32% of the Company's total revenue, respectively.
Revenue totaled $16,065,000 for the six months ended June 30, 1999, a
16% increase from $13,852,000 for the six months ended June 30, 1998. The
increase is primarily the result of increased revenue from the sale of network
systems products as well as increased revenue related to network management OSS
products. Revenue
10
<PAGE>
generated from the sale of the Company's network systems products and services
totaled $10,616,000 for the six months ended June 30, 1999, a 19% increase from
$8,929,000 for the six months ended June 30, 1998. The increase was primarily
the result of increased sales of the Company's T3AS and CTS products and
increased licensing revenues related to the Remote Module product line. Revenue
generated from the sale of the Company's network management OSS products and
services totaled $5,449,000 for the six months ended June 30, 1999, an 11%
increase from $4,923,000 for the six months ended June 30, 1998. The increase
was the result of increased revenue related to the Company's .Provisioner and
FMS OSS products partially offset by decreased sales of the Company's design
services.. For the six months ended June 30, 1999, BellSouth, Bell Atlantic and
MCI WorldCom accounted for 32%, 12%, and 8% of the Company's total revenue,
respectively. For the six months ended June 30, 1998, BellSouth and MCI WorldCom
accounted for 33% and 31% of the Company's total revenue, respectively.
Gross profit totaled $5,332,000 for the three months ended June 30,
1999, a 10% increase from $4,839,000 for the three months ended June 30, 1998.
Gross profit as a percent of revenue was 60% for the three months ended June 30,
1999 compared to 56% for the same period in 1998. The increase in gross profit
levels was primarily the result of improved gross profit margins on the Remote
Module product resulting from manufacturing cost reductions. Gross profit
totaled $9,640,000 for the six months ended June 30, 1999, a 50% increase from
$6,447,000 for the six months ended June 30, 1998. Gross profit as a percent of
revenue was 60% for the six months ended June 30, 1999 compared to 47% for the
same period in 1998. The increase in gross profit levels was primarily the
result of a network systems product mix weighted toward T3AS products, which
carry higher gross margins than the CTS and Remote Module product and improved
gross profit margins on the Remote Module product resulting from manufacturing
cost reductions. Additionally, the allocation of the Company's relatively fixed
manufacturing overhead costs over higher revenue levels and lower inventory
write-downs resulted in higher overall gross profit levels in the first half of
1999. There can be no assurance that the Company will be able to maintain the
current gross profit margins or gross profit as a percent of revenue levels.
Factors which may materially and adversely affect the Company's gross profit in
the future include its level of revenue, competitive pricing pressures 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 costs, disruptions in sources of supply, regulatory changes,
seasonal patterns of bookings, capital spending, and changes in general economic
conditions.
Research and development expenses totaled $2,761,000 for the three
months ended June 30, 1999, a 27% decrease from $3,777,000 for the three months
ended June 30, 1998. The decrease is primarily the result of lower personnel
expenses as a result of the termination of the JDA with Nortel and the
subsequent reduction in engineering staff. For the three months ended June 30,
1999 and June 30, 1998, the Company's net research and development expenses
include $300,000 and $1,006,000 offsets, respectively, representing Nortel's
proportionate share of development costs incurred for the project conducted
under the JDA. Research and development expenses totaled $5,946,000 for the six
months ended June 30, 1999, a 19% decrease from $7,320,000 for the six months
ended June 30, 1998. The decrease is primarily the result of lower personnel and
non-recurring development expenses as a result of the termination of the JDA
with Nortel and subsequent reduction in engineering staff. In addition, during
the first quarter of 1999, Nortel agreed to increase its proportionate share of
total development costs incurred under the JDA from 50% to 60%. As a result, a
greater portion of expenses incurred under the JDA during the first quarter of
1999 were reimbursed by Nortel, resulting in a larger offset to research and
development expenses. For the six months ended June 30, 1999 and 1998, the
Company's net research and development expenses included $2,141,000 and
$1,704,000 offsets, respectively, representing Nortel's proportionate share of
development costs incurred for the project conducted under the JDA. The Company
believes that its future success depends on its ability to maintain its
technological leadership through enhancement of its existing products and
development of innovative new products and services that meet customer needs.
Included in the results of operations for the six months ended June
30, 1999 is a restructuring charge of $1,435,000, of which $1,335,000 is
included as a separate component of operating expenses and $100,000 that is
included as part of cost of revenue (see Note 4 of the Notes to the Condensed
Consolidated Financial Statements contained herein). The restructuring charge is
a result of the Company's plan to focus its efforts on market opportunities in
its core business and the termination of the JDA with Nortel.
Also included in the results of operations for the six months ended
June 30, 1999 is a one-time credit adjustment of $1,361,000, which represents
11
<PAGE>
an increase from 50% to 60% in Nortel's proportionate share of total development
expenses incurred under the JDA through December 31, 1998.
Sales and marketing expenses totaled $2,147,000 for the three months
ended June 30, 1999, a 16% decrease from $2,551,000 for the three months ended
June 30, 1998. The decrease is primarily attributable to lower travel and
promotional expenses. Sales and marketing expenses totaled $4,426,000 for the
six months ended June 30, 1999, an 8% decrease from $4,831,000 for the six
months ended June 30, 1998. The decrease is primarily due to lower travel and
professional services expenses. The Company expects sales and marketing expenses
will increase during the second half of 1999 as it adds additional sales,
marketing and technical support personnel to support increased focus on new
customer markets and planned product introductions.
General and administrative expenses totaled $1,353,000 for the three
months ended June 30, 1999, a 4% increase from $1,295,000 for the three months
ended June 30, 1998. The increase is attributable to increased personnel costs
associated with the business unit restructuring partially offset by decreased
legal and professional services. General and administrative expenses totaled
$2,614,000 for the six months ended June 30, 1999, an 8% increase from
$2,414,000 for the six months ended June 30, 1998. The increase is attributable
to higher personnel costs associated with the business unit restructuring
partially offset by a decrease in professional services. The Company expects
that general and administrative expenses may increase in 1999 as a result of
expected administrative costs related to the termination of the JDA with Nortel
and potential increased expenses related to the Company's focus on Year 2000
issues.
Interest income totaled $134,000 for the three months ended June 30,
1999, a 20% decrease from $168,000 for the three months ended June 30, 1998.
Interest income totaled $254,000 for the six months ended June 30, 1999, a 26%
decrease from $342,000 for the six months ended June 30, 1998. The decrease for
the three and six months ended June 30 is primarily due to lower rates of return
on invested balances in 1999 compared to 1998.
For the three and the six months ended June 30, 1999 and June 30,
1998, the Company provided for income taxes related to the operations of the
Company's Canadian subsidiary, based on an effective Canadian tax rate of 50%
and 46%, respectively. At December 31, 1998, the Company had federal income
tax-loss carry-forwards of approximately $27,642,000 and California State income
tax-loss carry-forwards of approximately $5,458,000. The Company's use of
approximately $1,166,000 of its federal tax-loss carry-forwards, and $408,000 of
its federal and $105,000 of its California tax credit carry-forwards are
significantly limited as a result of ownership changes associated with equity
financing in January 1989 and March 1991. See footnote 9 to the Consolidated
Financial Statements in the December 31, 1998 Form 10-K.
As a result of the factors discussed above, the Company incurred a net
loss of $843,000 or $.06 per basic and diluted share for the three months ended
June 30, 1999 compared to net loss of $2,658,000, or $.21 per basic and diluted
share for the three months ended June 30, 1998. The Company incurred a net loss
of $3,169,000 or $.24 per basic and diluted share for the six months ended June
30, 1999 compared to net loss of $7,865,000, or $.62 per basic and diluted share
for the six months ended June 30, 1998. Excluding the one time credit adjustment
of $1,361,000 and the restructuring charge of $1,435,000, the Company would have
recorded a net loss of $3,095,000, or $.24 per basic and diluted share for the
six months ended June 30, 1999.
LIQUIDITY AND CAPITAL RESOURCES
Cash and investments totaled $14,332,000 at June 30, 1999 compared to
$12,513,000 at December 31, 1998. The increase in cash is primarily due to
reductions in trade receivables and inventory offset by a reduction in accrued
expenses and decreased operating losses for the period.
Net working capital totaled $16,483,000 at June 30, 1999 compared to
$16,756,000 at December 31, 1998. The decrease in working capital was primarily
the result of a decrease in inventory and trade receivables significantly offset
by an increase in cash and investments and a decrease in accrued expenses.
Cash provided from the Company's operating activities totaled
$1,628,000 for the six months ended June 30, 1999 compared to $216,000 for the
six months ended June 30, 1998. The cash provided for the first six month
12
<PAGE>
of 1999 was primarily the result of reductions in trade receivables and
inventory offset by a reduction in accrued expenses and lower operating losses
for the period.
Cash used for capital expenditures totaled approximately $169,000 for
the six months ended June 30, 1999 compared to $1,370,000 for the six months
ended June 30, 1998. Most of the capital additions in the first six months of
1999 were for the purchase of software development tool kits and computer
workstations. The Company expects that 1999 capital expenditures will decrease
substantially from 1998 levels due to the termination of the JDA with Nortel.
Planned expenditures will focus on upgrades to the Company's network
infrastructure and specific needs for ongoing research and development projects.
Assuming no material changes in the Company's current operating plans,
the Company believes that cash generated from operations, and the total of its
cash and investments, will be sufficient to meet its working capital and capital
expenditure requirements for at least the next twelve months. However, there can
be no assurance that the Company will not need to seek additional capital
resources to meet working capital and capital expenditure requirements.
Additionally, significant additional capital resources may be required to fund
acquisitions of complementary businesses, products or technologies that are
focused on the Company's core business. The Company may need to issue additional
shares of its capital stock or incur indebtedness in connection with any such
acquisitions or future operations. At present, the Company does not have any
agreements or commitments with respect to any such acquisitions.
The Company believes the impact of inflation on its business
activities has not been significant to date.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. Without
modification, these systems and software will be unable to appropriately
interpret or recognize dates beyond the calendar year 1999. The Year 2000
computer issue could result in system failures or miscalculations causing
disruptions in business operations worldwide (including, without limitation,
disruptions in order processing, invoicing, manufacturing and similar
functions).
The risk to ADA exists in four areas: systems used by the Company to
run its business, systems used by the Company's suppliers, potential warranty or
other claims from Company customers, and the potential reduced spending by
telecommunication service providers ("TSPs") on network performance management
products as a result of significant information systems spending on Year 2000
remediation.
The Company is continuing to conduct an assessment and analysis of its
internal information technology ("IT") systems to determine the potential costs
and scope of any Year 2000 issues. Based on a preliminary assessment, ADA has
determined that certain of its IT systems need to be upgraded or replaced to
address Year 2000 issues. The Company believes that all necessary upgrades or
replacements of its IT systems will be completed by September 30, 1999.
Validation testing will be conducted as IT systems are upgraded and replaced.
All IT systems that have been purchased in 1999 or 1998 are Year 2000 compliant.
The upgrades are generally covered by service contracts previously entered into
by the Company in the ordinary course of business and the cost of the upgrades
and remediation is not expected to be material to the Company's operating
results. If implementation of upgrades or replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.
ADA has conducted a comprehensive evaluation of its non-IT systems and
equipment (e.g., facilities, and test equipment containing microprocessors or
other similar circuitry, etc.). Based on this evaluation, ADA does not expect
Year 2000 issues to have a material adverse effect on the Company's non-IT
systems and equipment. However, Year 2000 compliance for some of the Company's
non-IT systems and equipment is dependent upon upgrades to be provided by third
party vendors. The Company expects all upgrades required from third party
vendors to complete Year 2000 compliance for non-IT systems and equipment to be
completed by September 30, 1999. There can be no assurance that third party
vendor upgrades to non-IT systems and equipment will be Year 2000 complaint or
that the upgrades will be completed prior to the end of 1999 which could
negatively impact the functionality of non-IT systems and equipment that could
have a material adverse effect on the Company's revenue, operating results and
financial condition.
13
<PAGE>
In addition, the Company has made inquiries of its third party
suppliers to determine if they have any Year 2000 issues that will materially
and adversely impact the Company. To date, the Company has not been made aware
of any material Year 2000 issues which would adversely affect ADA.
The Company believes that current versions of its products are Year
2000 compliant. The Company does not expect additional efforts, if required, to
complete Year 2000 compliance for its products will be material. Internal
validation testing was conducted as products were upgraded. An independent third
party also performed validation testing on one of the Company's test and
performance management products. However, since all customer situations cannot
be anticipated, particularly those involving third party products, the Company
may see an increase in warranty and other claims as a result of the Year 2000
transition. In addition, litigation regarding Year 2000 compliance issues is
expected to escalate. For these reasons, the impact of customer claims could
have a material adverse impact on the Company's operating results or financial
condition.
Year 2000 compliance is an issue for virtually all businesses, whose
computer systems and applications may require significant hardware and software
upgrades or modifications. TSPs have devoted a substantial portion of their
information systems' spending to fund such upgrades and modifications and have
diverted spending away from network performance management products. Such
changes in customers' spending patterns have had and could continue to have a
material adverse impact on the Company's sales, operating results or financial
condition.
The Company intends to continue the review, remediation and testing of
its Year 2000 status and, to the extent necessary, it will develop Year 2000
contingency plans for critical business purposes. In addition, there can be no
assurance that Year 2000 issues will not have a material adverse effect on the
Company if ADA and/or those with whom it conducts business are unsuccessful in
identifying or implementing timely solutions to any Year 2000 problems.
RISKS AND UNCERTAINTIES
CUSTOMER MERGERS. Many of the major TSPs currently involved in or that
have recently completed merger transactions are customers of the Company.
Several of these mergers involved companies that purchase network systems and
software products and services from the Company's competitors. Consequently,
these mergers may result in the loss of business and customers for the Company.
Additionally, the impact of capital spending constraints during the merger
transitions and thereafter has had and could continue to have a material adverse
effect on the Company's business, operating results and financial condition. In
addition, future merger transactions involving or contemplated by the Company's
current or prospective customers may cause increased concentration among some of
the Company's major customers or delays or decreases in their capital spending
decisions, any of which could have a material adverse effect on the Company's
business, operating results and financial condition.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; HISTORY OF LOSSES. The
Company has experienced significant fluctuations in bookings, revenue and
operating results from quarter to quarter due to a combination of factors and
expects such fluctuations to continue in future periods. Factors that may cause
the Company's results of operations to vary significantly from quarter to
quarter include but are not limited to the size and timing of customer orders
and subsequent shipment of systems products and implementation of OS software
products to major customers, timing and market acceptance of product
introductions or enhancements by the Company or its competitors, customer order
deferrals in anticipation of new products, technological changes in the
telecommunications industry, competitive pricing pressures, changes in the
Company's operating expenses, personnel changes, management of a changing
business, changes in the mix of products sold and licensed, disruption in
sources of supply, changes in pricing policies by the Company's suppliers,
regulatory changes, capital spending, delays of payments by customers and
general economic conditions. The Company believes that in late 1997 it began
experiencing seasonality in its product shipments and Operating System ("OS")
software licensing. Generally, TSPs place more orders for products and licenses
in the second and fourth quarters, with the orders significantly down in the
first quarter and relatively flat in the third quarter of each year. The Company
expects that revenue may begin to reflect these seasonal order cycles more
closely, which could result in quarterly fluctuations. There can be no assurance
that the TSPs will not defer or delay orders contrary to the historical seasonal
pattern or that they will not change their ordering patterns. Because of the
relatively fixed nature of most of the Company's costs, including personnel and
facilities costs, any unanticipated shortfall in revenue in any fiscal quarter
would have a proportionately greater
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impact on the Company's operating income in that quarter and may result in
fluctuations in the price of the Company's Common Stock.
As the impact of the Company's Network Management business unit on the
Company's revenue increases, the Company may be faced with greater fluctuations
in operating income. The licensing and implementation of the Company's OS
products generally involves a significant capital expenditure and a commitment
of resources by prospective customers. Accordingly, the Company is dependent on
its customers' decisions as to the timing and level of commitment and
expenditures. In addition, the Company typically realizes a significant portion
of license revenues in the last weeks or even days of a quarter. As a result,
the magnitude of quarterly fluctuations in the Network Management business unit
may not become evident until late in, or after the close of, a particular
quarter. In addition, the Company does not recognize service revenues until the
services are rendered. The time required to implement the Company's OS products
can vary significantly with the needs of its customers and is generally a
process that extends for several months. Because of their complexity, larger
implementations may take multiple quarters to complete. Additionally,
quarter-to-quarter product mix variations, customer orders tending to be placed
late in the quarter, and competitive pressures on pricing could have a
materially adverse effect on the Company's operating results in any one quarter.
The Company's expenses are based in part on the Company's expectations as to
future revenues and to a large extent are fixed in the short term. If revenues
do not meet expectations, the Company's business, operations and financial
condition are likely to be materially adversely affected.
The Company has experienced losses in the past and there can be no
assurance that the Company will not experience losses in the future.
COMPETITION. Competition in the Company's markets is intense and is
characterized by rapidly changing technologies, conformance with evolving
industry standards, frequent new product introductions and enhancements, rapid
changes in customer requirements, and price-competitive bidding. To maintain and
improve its competitive position, the Company must continue to develop and
introduce, in a timely and cost-effective manner, new products and features that
keep pace with increasing customer requirements. The Company expects competition
in its markets to increase from existing competitors and from other companies
which may enter the Company's current or future markets. The Company believes
the principal competitive factors affecting the market for its network systems
test and performance monitoring products are product features, price,
conformance with BellCore and other industry transmission standards and
specifications, performance and reliability, technical support, and the
maintenance of close working relationships with customers. The Company's network
systems products, especially CTS and Remote Module, are currently focused in
highly competitive market niches. The environment for CTS and Remote Module is
fiercely competitive with respect to price, product features, established
customer-supplier relationships and conformance with industry standards. The
Company believes the current competitors that provide partial solutions to
either performance monitoring or testing of the DS3, and the DS1 and DS0
circuits that make up the DS3 circuit, include Hekimian, TTC, Wiltron and some
of the manufacturers of large transmission equipment and digital cross-connect
test and performance monitoring equipment such as Lucent, Alcatel, Ericsson, ADC
Telecommunications, and Tellabs, Inc. The Company's Remote Module product
addresses the DS1 NIU market in which current competitors include Westell Inc.,
Teltrend Inc., and Troncom, Inc. In addition, in 1997, ANSI adopted certain of
the Company's Remote Module signaling technology as an industry standard. As a
result, the Company is obligated to grant licenses of this technology to third
parties, including competitors, on fair and equitable terms which has resulted
in competition from the licensees of its own technology. Many of these
competitors have significantly greater technical, financial, manufacturing, and
marketing resources than the Company.
The Company believes there are an increasing number of current
competitors in the network management OS market that provide network management
OS applications for circuit and services provisioning and services management,
testing and test management, fault and alarm management and surveillance,
network and circuit performance monitoring and traffic management
telecommunications functions. The OS market is characterized by a wide range of
companies that have varying degrees of market influence. The nature of the
network management OS market is such that improved technologies and tool sets
have made the barriers to entry in this market relatively small resulting in
fierce competition. The principal competitive factors affecting the Company's
network management OS products include product quality, performance, price,
customer support, corporate reputation, and product features such as
scalability, interoperability, functionality and ease of use. The Company's
existing and potential competitors offer a variety of solutions to address
network management needs. Competitors include suppliers of standard
off-the-shelf products, custom software developers, large telecommunications
equipment
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vendors that offer software applications to manage their own and other
suppliers' equipment, such as Lucent, Nortel, Fujitsu, and Ericsson, hardware
and software vendors, including IBM, Sun Microsystems and Hewlett Packard, and
providers of specific network management and OS applications, such as BellCore,
OSI, TCSI, Architel and others. Additionally, many of the Company's existing and
potential customers continuously evaluate whether they should develop their own
network management and OS applications or license them from outside vendors. The
Company expects competition in the OS market to increase significantly in the
future. Additionally, several of the Company's competitors have long-established
relationships with the Company's current and prospective customers which may
adversely affect the Company's ability to successfully compete for business with
these customers. In addition, product price reductions resulting from market
share penetration initiatives or competitive pricing pressures could have a
material and adverse effect on the Company's business, operating results, and
financial condition. There can be no assurance that the Company will have the
financial resources, technical expertise or manufacturing, marketing,
distribution and support capabilities to compete successfully in the future.
CONCENTRATION OF MAJOR CUSTOMERS; TELEPHONE COMPANY QUALIFICATION
REQUIREMENTS. The market for the Company's products and services currently
consists of the five RBOCs, IXCs, ILECs, CLECs, emerging carriers, ISPs,
enterprise networks and other TSPs. Historically, the Company's marketing
efforts focused primarily on the RBOCs, which accounted for approximately 31%,
47% and 52% of the Company's total revenue in 1997, 1998, and the six months
ended June 30, 1999, respectively. However, the Company's strategy has been to
focus its efforts on diversifying its customer base. RBOC and IXC customers
accounted for 52% and 9% of the Company's total revenue for the six months ended
June 30, 1999 and 47% and 23% for the year ended December 31, 1998,
respectively. The increased customer base is primarily a function of the
Company's acquisitions in 1996 and 1997. As a result of these acquisitions, the
Company added OS related products and services that the Company has been able to
market to a wider group of customers. In addition, the Company added a number of
TSPs that were new customers to the Company. To date, the OS customers tend to
be long distance telephone companies, CLECs, emerging carriers and enterprise
vendors who have not invested in legacy systems from BellCore. While the Company
believes its customer base diversification is beneficial to the Company, there
can be no assurances that the Company will be able to continue expanding the
distribution of its OS and system products and services to additional
prospective customers. In addition, the Company's customers are significantly
larger than the Company and may be able to exert a high degree of influence over
the Company. The loss of one or more of the Company's major customers, the
reduction of orders, a delay in deployment of the Company's products or the
cancellation, modification or non-renewal of license or maintenance agreements
could materially and adversely affect the Company's business, operating results
and financial condition. BellSouth, Ameritech, Southwestern Bell and MCI
WorldCom have entered into purchase contracts with the Company. MCI WorldCom has
also entered into license agreements with the Company. Other TSPs purchase the
Company's network system products and license OS products under standard
purchase orders. Since the RBOC and MCI WorldCom contracts may be terminated at
either the customer's or the Company's convenience, the Company believes that
the purchase contracts and license agreements are not materially different than
purchasing or licensing under purchase orders. Prior to selling products to
RBOCs and certain other TSPs, a vendor must often first undergo a product
qualification process with the TSP for its products. Although the qualification
process for a new product varies somewhat among these prospective customers, the
Company's experience is that the process often takes a year or more. Currently,
the five RBOCs, MCI WorldCom and several other customers have qualified the
Company's products, when required. Any failure on the part of any of the
Company's customers to maintain their qualification of the Company's products,
failure of any of the TSPs to deploy the Company's products, or any attempt by
any of the TSPs to seek out alternative suppliers could have a material adverse
effect on the Company's business, operating results and financial condition.
There can be no assurance that the Company's products will be qualified by new
customers, or that such qualification will not be significantly delayed.
Furthermore, work force reductions and staff reassignments by some of the
Company's customers have in the past delayed the product qualification process,
and the Company expects such reductions and reassignments to continue in the
future. There can be no assurance that such reductions and reassignments will
not have a material adverse effect on the Company's business, operating results
and financial condition.
DEPENDENCE ON TWO PRODUCT LINES. Historically, the majority of the
Company's revenue has been derived from the sale of its network systems products
and services. However, as a result of acquisitions completed in 1996 and 1997,
the Company added additional product lines and derived revenue from a product
mix of both network systems products and services and network management OS
software products and services. Revenue from network systems products and
services, including CTS, T3AS and Remote Module, generated 56% and 66% of the
Company's total revenues for the year ended December 31, 1998 and the six months
ended June 30, 1999, respectively. Revenue from network management OS products
and services, including software design services, .Provisioner, Test OS, TDC&E
and FMS, generated 44% and 34% of the Company's total revenue for the year ended
December 31, 1998 and six months ended June 30, 1999,
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respectively. However, there can be no assurance that the Company's future
revenues will not be heavily dependent on sales from only one of its primary
product lines. The Company is investing in the expansion of these two product
lines through the enhancement, development and marketing of its NIU, CTS, NEPA,
T3AS, Test OS, .Provisioner, TDC&E and FMS products. Failure by the Company to
enhance either its existing products and services or to develop new product
lines and new markets could materially and adversely affect the Company's
business, operating results and financial condition. There is no assurance that
the Company will be able to develop and market new products and technology or
otherwise diversify its source of revenue.
MANAGEMENT OF CHANGING BUSINESS. As a result of acquisitions in 1996
and 1997, the Company formed two business units around the Company's product
lines: the Network Systems business unit and the Network Management business
unit. The Network Systems business unit is built around the Company's test and
performance management products, including T3AS, CTS, Remote Module,
Sectionalizer, NEPA and PAAS products. The Network Management business unit
focuses on OS software products including. Provisioner, TDC&E, Test OS, GTA,
FMS, and OS design services. These business units operate in four separate
geographic locations. The Company continues to face significant management
challenges related to the integration of the business operations of these
business units. The acquisitions and resultant growth in the Company's
infrastructure have placed, and are expected to continue to place, a significant
strain on the Company's management, information systems and operations. The
strain experienced to date has chiefly been in management of a geographically
distributed organization, and in hiring sufficient numbers of qualified
personnel to support the expansion of the business. The Company may also make
future acquisitions where it believes it can acquire new products or otherwise
rapidly enter new or emerging markets. Mergers and 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. Additionally, as
a result of the termination of the JDA, the Company discontinued operations
conducted at its Richardson, Texas facility. There can be no assurance that the
Company will not incur significant expenses related to the closure of the Texas
facility that could have a material impact on the Company's business, operating
results and financial condition.
RAPID TECHNOLOGICAL CHANGE AND DEPENDENCE ON NEW PRODUCTS. The market
for the Company's products is characterized by rapid technological advances,
evolving industry transmission standards, changing regulatory environments,
price-competitive bidding, changes in customer requirements, and frequent new
product introductions and enhancements. The introduction of telecommunications
network performance management products involving superior technologies or the
evolution of alternative technologies or new industry transmission standards
could render the Company's existing products, as well as products currently
under development, obsolete and unmarketable. The Company believes its future
success will depend in part upon its ability, on a cost-effective and timely
basis, to continue to enhance its products, to develop and introduce new
products for the telecommunications network performance management market, to
address new industry standards and changing customer needs and to achieve broad
market acceptance for its products. In particular, the Company anticipates that
the SONET and SDH optical transmission standards will become the industry
transmission standards over the coming years for the North American and
international networks, respectively. The Company's current network circuit test
and performance monitoring systems do not address either the SONET or SDH
transmission standards. The Company intends to extend its current products and
develop new products to accommodate such new transmission standards and other
advances in technology, as they evolve. The widespread adoption of SONET and/or
SDH as industry transmission standards before the Company is able to
successfully develop products which address such transmission standards could in
the future adversely affect the sale and deployment of the Company's products.
The Company's OS products are designed to operate on a variety of
hardware and software platforms and with a variety of databases employed by its
customers in their networks. The Company must continually modify and enhance its
OS products to keep pace with changes in hardware and software platforms and
database technology. As a result, uncertainties related to the timing and nature
of new product announcements, introductions or modifications by systems vendors,
particularly, Sun Microsystems and Hewlett Packard, and by vendors of
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relational database software, particularly, Oracle Corporation, could materially
adversely impact the Company's business, operating results and financial
condition. In addition, the failure of the Company's OS products to operate
across the various existing and evolving versions of hardware and software
platforms and database environments employed by customers would have a material
adverse effect on the Company's business, operating results and financial
condition.
The introduction or announcement of products by the Company or one or
more of its competitors embodying new technologies, or changes in industry
standards or customer requirements, could render the Company's existing products
and solutions obsolete and unmarketable. The introduction of new or enhanced
versions of its products requires the Company to manage the transition from
older products in order to minimize disruption in customer ordering. There can
be no assurance that the introduction or announcement of new product offerings
by the Company or its competitors will not cause customers to defer licensing or
purchasing of existing Company products or engaging the Company's services. Any
deferral of revenues could have a material adverse effect on the Company's
business, operating results and financial condition.
Any failure by the Company to anticipate or respond on a
cost-effective and timely basis to technological developments, changes in
industry transmission standards or customer requirements, or any significant
delays in product development or introduction could have a material adverse
effect on the Company's business. There can be no assurance that the Company
will be able to successfully develop new products to meet customer requirements,
to address new industry transmission standards and technological changes or to
respond to new product announcements by others, or that such products will
achieve market acceptance.
DEPENDENCE ON SUPPLIERS AND SUBCONTRACTORS. Certain components used in
the Company's T3AS, CTS, PAAS and Remote Module products, including its VLSI
ASICs, are available from a single source and other components are available
from only a limited number of sources. The Company has few supply agreements and
generally makes its purchases with purchase orders. Further, certain components
require an order lead time of up to one year. Other components that currently
are readily available may become difficult to obtain in the future. Failure of
the Company to order sufficient quantities of these components in advance could
prevent the Company from increasing production in response to customer orders in
excess of amounts projected by the Company. In the past, the Company has
experienced delays in the receipt of certain of its key components, which have
resulted in delays in product deliveries. There can be no assurance that delays
in key component and part deliveries will not occur in the future.
The inability to obtain sufficient key components as required or to
develop alternative sources if and as required in the future could result in
delays or reductions in product shipments, which in turn could have a material
adverse effect on the Company's customer relationships and operating results.
Additionally, the Company uses third-party subcontractors for the manufacture of
its sub-assemblies. 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.
HIGH INVENTORY LEVELS AND NEED TO MAKE ADVANCE PURCHASE COMMITMENTS.
To respond to anticipated customer demand, the Company maintains high inventory
levels. Maintaining high inventory levels substantially increases the risk that
the Company's profitability and results of operations may from time to time be
materially and adversely affected by inventory obsolescence. To procure adequate
supplies of certain products or components, the Company must make advance
commitments to purchase relatively large quantities of such products or
components in a number of circumstances. A large portion of the Company's
purchase commitments consists of custom parts, some of which are sole-source
such as VLSI ASICs, for which there is no alternative use or application. In the
first quarter of 1998, the Company recorded a charge for inventory obsolescence
totaling $378,000. The inability of the Company to sell such products or
incorporate such components in its other products could have a material adverse
effect on the Company's business, operating results and financial condition.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. Without modification, these systems and software will be
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unable to appropriately interpret or recognize dates beyond the calendar year
1999. The Year 2000 computer issue could result in system failures or
miscalculations causing disruptions in business operations worldwide (including,
without limitation, disruptions in order processing, invoicing, manufacturing
and similar functions).
The risk to ADA exists in four areas: systems used by the Company to
run its business, systems used by the Company's suppliers, potential warranty or
other claims from Company customers, and the potential reduced spending by TSPs
on network performance management products as a result of significant
information systems spending on Year 2000 remediation.
The Company is continuing to conduct an assessment and analysis of its
internal information technology ("IT") systems to determine the potential costs
and scope of any Year 2000 issues. Based on a preliminary assessment, ADA has
determined that certain of its IT systems need to be upgraded or replaced to
address Year 2000 issues. The Company believes that all necessary upgrades or
replacements of its IT systems will be completed by September 30, 1999.
Validation testing will be conducted as IT systems are upgraded and replaced.
All IT systems that have been purchased in 1999 or 1998 are Year 2000 compliant.
The upgrades are generally covered by service contracts previously entered into
by the Company in the ordinary course of business and the cost of the upgrades
and remediation is not expected to be material to the Company's operating
results. If implementation of upgrades or replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.
ADA has conducted a comprehensive evaluation of its non-IT systems and
equipment (e.g., facilities, and test equipment containing microprocessors or
other similar circuitry, etc.). Based on this evaluation, ADA does not expect
Year 2000 issues to have a material adverse effect on the Company's non-IT
systems and equipment. However, Year 2000 compliance for some of the Company's
non-IT systems and equipment is dependent upon upgrades to be provided by third
party vendors. The Company expects all upgrades required from third party
vendors to complete Year 2000 compliance for non-IT systems and equipment to be
completed by September 30, 1999. There can be no assurance that third party
vendor upgrades to non-IT systems and equipment will be Year 2000 complaint or
that the upgrades will be completed prior to the end of 1999 which could
negatively impact the functionality of non-IT systems and equipment that could
have a material adverse effect on the Company's revenue, operating results and
financial condition.
In addition, the Company has made inquiries of its third party
suppliers to determine if they have any Year 2000 issues that will materially
and adversely impact the Company. To date, the Company has not been made aware
of any material Year 2000 issues which would adversely affect ADA.
The Company believes that current versions of its products are Year
2000 compliant. The Company does not expect additional efforts, if required, to
complete Year 2000 compliance for its products will be material. Internal
validation testing was conducted as products were upgraded. An independent third
party also performed validation testing on one of the Company's test and
performance management products. However, since all customer situations cannot
be anticipated, particularly those involving third party products, the Company
may see an increase in warranty and other claims as a result of the Year 2000
transition. In addition, litigation regarding Year 2000 compliance issues is
expected to escalate. For these reasons, the impact of customer claims could
have a material adverse impact on the Company's operating results or financial
condition.
Year 2000 compliance is an issue for virtually all businesses, whose
computer systems and applications may require significant hardware and software
upgrades or modifications. TSPs have devoted a substantial portion of their
information systems' spending to fund such upgrades and modifications and divert
spending away from network performance management products. Such changes in
customers' spending patterns have had and could continue to have a material
adverse impact on the Company's sales, operating results or financial condition.
The Company intends to continue the review, remediation and testing of
its Year 2000 status and, to the extent necessary, it will develop Year 2000
contingency plans for critical business purposes. In addition, there can be no
assurance that Year 2000 issues will not have a material adverse effect on the
Company if ADA and/or those with whom it conducts business are unsuccessful in
identifying or implementing timely solutions to any Year 2000 problems.
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PRODUCT RECALL AND DEFECTS. Producers of telecommunications network
performance management products such as those being marketed by the Company, are
often required to meet rigorous standards imposed by BellCore, the research and
development entity created following the divestiture of AT&T to provide ongoing
engineering support to the RBOCs. In addition, the Company must meet specialized
standards imposed by many of its customers. The Company's products are also
required to interface in a complex and changing environment with
telecommunication network equipment made by numerous other suppliers. Since many
of these suppliers are competitors of the Company, there can be no assurance
that they will cooperate with the Company. In the event there are material
deficiencies or defects in the design or manufacture of the Company's systems,
or if the Company's systems become incompatible with existing third-party
network equipment, the affected products could be subject to a recall. The
Company has experienced two significant product recalls in its history and there
can be no assurance that the Company will not experience any product recalls in
the future. The cost of any subsequent product recall and associated negative
publicity could have a material adverse effect on the Company's business,
operating results and financial condition. In addition, the Company's
development and enhancement of its complex OS products entails substantial risks
of product defects. There can be no assurance that software errors will not be
found in existing or new products or releases after commencement of commercial
licensing, which may result in delay or loss of revenue, loss of market share,
failure to achieve market acceptance, or may otherwise adversely impact the
Company's business, operating results and financial condition.
GOVERNMENT REGULATION. The majority of the Company's customers operate
within the telecommunications industry which is subject to regulation in the
United States and other countries. Most of the Company's customers must receive
regulatory approvals in conducting their businesses. Although the
telecommunications industry has recently experienced government deregulation,
there is no assurance this trend will continue.
Moreover, the federal and state courts and the FCC continue to
interpret and clarify the provisions of the 1996 Telecommunications Act. In
fact, recent regulatory rulings have affected the ability of the Company's
customers to enter new markets and deliver new services which could impact their
ability to make significant capital expenditures. The effect of judicial or
regulatory rulings by federal and state agencies on the Company's customers may
adversely impact the Company's business, operating results and financial
condition.
POTENTIAL COMPETITION FROM RBOCS. The 1996 Telecommunications Act has
generally eliminated the restrictions which had previously prohibited the RBOCs
from manufacturing telecommunications equipment (subject to first satisfying
certain conditions designed to facilitate local exchange competition and receipt
of prior approval by the FCC). These restrictions had been imposed under the
Modification of Final Judgment, which governed the structure of the 1984
divestiture by AT&T of its local operating telephone company subsidiaries. The
passage of the 1996 Telecommunications Act may have an adverse effect on the
Company because the RBOCs, which are presently the Company's principal
customers, may now become manufacturers of some or all of the products currently
manufactured and sold by the Company and, consequently, may no longer purchase
telecommunications equipment produced by the Company at the levels historically
experienced.
PROPRIETARY TECHNOLOGY. The Company relies on a combination of
technical leadership, patent, trade secret, copyright and trademark protection
and non-disclosure agreements to protect its proprietary rights. Although the
Company has pursued and intends to continue to pursue patent protection of
inventions that it considers important and for which such protection is
available, the Company believes its success will be largely dependent on its
reputation for technology, product innovation, affordability, marketing ability
and response to customers needs. Currently, the Company has fifteen U.S. patents
granted. Additionally, the Company has three pending U.S. patent applications on
file covering various circuit and system aspects of its products. There can be
no assurance that the Company will be granted additional patents or that, if any
patents are granted, they will provide the Company's products with significant
protection or will not be challenged. Additionally, should a third party
challenge any of the Company's current or future patents, there can be no
assurance that the Company will be successful in defending its patents or that
any litigation, regardless of outcome, will not result in substantial cost to
and diversion of efforts by the Company. As part of its confidentiality
procedures, the Company generally enters into non-disclosure agreements with its
employees, consultants and suppliers, and limits access to and distribution of
its proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use the Company's technology without
authorization. Accordingly, there can be no assurance that the Company will be
successful in protecting its proprietary technology or that ADA's proprietary
rights will preclude competitors from developing products or technology
equivalent or superior to that of the Company.
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The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. The Company is currently not party to any litigation regarding any
patents or other intellectual property rights. However, there can be no
assurance that third parties will not assert infringement claims against the
Company in the future or that any such assertions will not result in costly
litigation or require the Company to obtain a license to intellectual property
rights of such parties. There can be no assurance that any such licenses would
be available on terms acceptable to the Company, if at all. Further, litigation,
regardless of outcome, could result in substantial cost to and diversion of
efforts by the Company. Any infringement claims or litigation by or against the
Company could materially and adversely affect the Company's business, operating
results and financial condition. Moreover, the laws of some foreign countries do
not protect the Company's proprietary rights in the products to the same extent
as do the laws of the United States.
The Company relies on certain software that it licenses from third
parties, including software that is integrated with internally developed
software and used in the Company's products to perform key functions. There can
be no assurance that these third party software licenses will continue to be
available to the Company on commercially reasonable terms or that such licenses
will not be terminated. Although the Company believes that alternative software
is available from other third party suppliers, the loss of or inability of the
third parties to enhance their products in a timely and cost-effective manner
could result in delays or reductions in product shipments by the Company until
equivalent software could be developed internally or identified, licensed, and
integrated, which could have a material adverse effect on the Company's
business, operating results and financial condition.
DEPENDENCE ON KEY PERSONNEL. The success of the Company is dependent,
in part, on its ability to attract and retain highly qualified personnel.
Competition for such personnel is intense and the inability to attract and
retain additional key employees or the loss of one or more current key employees
could adversely affect the Company. There can be no assurance that the Company
will be successful in hiring or retaining requisite personnel.
VOLATILITY OF STOCK PRICE. The Company's future earnings and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in revenue or earnings from levels expected by public
market analysts and investors could have an immediate and significant adverse
effect on the trading price of the Company's Common Stock. Fluctuation in the
Company's stock price may also have an effect on customer decisions to purchase
the Company's products which could have a material adverse effect on the
Company's business, operating results and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required.
21
<PAGE>
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 Report, the Company is not a party to any legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on May 12, 1999. At the
meeting, the stockholders elected Gary D. Cuccio, John F. Malone,
Kenneth E. Olson, Christopher B. Paisley, Peter P. Savage and Donald
L. Strohmeyer as directors of the Company for the ensuing year and
until their respective successors are elected. The following tables
sets forth the results of voting in this election:
<TABLE>
<CAPTION>
FOR AGAINST WITHHELD
------------- ---------- -----------
<S> <C> <C> <C>
Gary D. Cuccio 11,754,981 -- 100,263
John F. Malone 11,745,881 -- 109,363
Kenneth E. Olson 11,753,051 -- 102,193
Christopher B. Paisley 11,745,565 -- 109,679
Peter P. Savage 11,693,986 -- 161,258
Donald L. Strohmeyer 11,755,722 -- 99,522
</TABLE>
In addition, the stockholders voted on the following proposals:
(a) To amend the Company's 1998 Employee Stock Purchase Plan to
increase the maximum aggregate number of shares reserved for
issuance thereunder by 300,000:
<TABLE>
<CAPTION>
FOR AGAINST WITHHELD
------------- ---------- -----------
<S> <C> <C> <C>
9,332,405 2,491,609 31,230
</TABLE>
This proposal was approved.
(b) To ratify the appointment of PricewaterhouseCoopers, LLP as the
Company's independent public accountants for the fiscal year
ending December 31, 1999:
<TABLE>
<CAPTION>
FOR AGAINST WITHHELD
------------- ---------- -----------
<S> <C> <C>
11,751,847 66,353 38,044
</TABLE>
This proposal was approved.
22
<PAGE>
ITEM 5. OTHER INFORMATION
Proposals of stockholders intended to be presented at the next Annual
Meeting of Stockholders of the Company must be received by the Company at its
offices at 9855 Scranton Road, San Diego, CA, 92121 not later than December 13,
1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT NUMBER
3.3 (1) Certificate of Incorporation of the Company
3.4 (2) Certificate of Agreement of Merger of the
Company and its California predecessor
3.5 (1) Bylaws of the Company
27.1 Financial Data Schedule
(1) Incorporated by reference to the Company's Current Report on Form 8-K
Dated December 23,1997 (File No. 0-23698)
(2) Incorporated by reference to the Company's Current Report on Form 8-K/A
Dated January 12, 1998 (File No. 0-23698)
(b) Reports on Form 8-K.
None.
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
By: /s/ Donald L. Strohmeyer President, Chief Executive August 16, 1999
----------------------------
(Donald L. Strohmeyer) Officer and Director
(Principal Executive
Officer)
By: /s/ James L. Keefe Vice President, Finance and August 16, 1999
----------------------------
(James L. Keefe) Administration, Chief
Financial Officer, Secretary
(Principal Accounting
Officer)
</TABLE>
24
<PAGE>
[ARTICLE] 5
[MULTIPLIER] 1,000
<TABLE>
<S> <C>
[PERIOD-TYPE] 6-MOS
[FISCAL-YEAR-END] JUN-30-1999
[PERIOD-START] JAN-01-1999
[PERIOD-END] JUN-30-1999
[CASH] 9,465
[SECURITIES] 4,867
[RECEIVABLES] 5,306
[ALLOWANCES] (145)
[INVENTORY] 4,227
[CURRENT-ASSETS] 25,215
[PP&E] 13,271
[DEPRECIATION] (9,799)
[TOTAL-ASSETS] 30,878
[CURRENT-LIABILITIES] 8,732
[BONDS] 0
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[COMMON] 13
[OTHER-SE] 22,133
[TOTAL-LIABILITY-AND-EQUITY] 30,878
[SALES] 16,065
[TOTAL-REVENUES] 16,065
[CGS] 6,425
[TOTAL-COSTS] 6,425
[OTHER-EXPENSES] 12,940
[LOSS-PROVISION] 20
[INTEREST-EXPENSE] (1)
[INCOME-PRETAX] (3,074)
[INCOME-TAX] 95
[INCOME-CONTINUING] (3,169)
[DISCONTINUED] 0
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] (3,169)
[EPS-BASIC] (0.24)
[EPS-DILUTED] (0.24)
</TABLE>
<PAGE>
EXHIBIT 5.0
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-3 (File Nos. 2-78465, 2-81026, 2-82260, 2-85387, 2-86457,
2-92391, 2-94757, 33-365, 33-2387, 33-5544, 33-17169, 33-24058, 33-30610 and
33-62551), on Form S-4 (File No. 333-44933) and on Form S-8 (File Nos. 2-87779,
33-10465, 33-17243, 33-42427, 33-50768, 33-57491, 33-57495, 33-16461, and
333-01639, and 333-75797) of Dynatech Corporation of our reports dated April 26,
1999 relating to the financial statements and financial statement schedule,
which appears in this Form 8-K.
PricewaterhouseCoopers LLP
Boston, Massachusetts
January 13, 2000
<PAGE>
EXHIBIT 6.0
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 333-08297 and 333-48105) of Applied Digital Access,
Inc. of our report dated January 28, 1999, except as to Note 10 which is as of
March 31, 1999, which appears in the Current Report of Form 8K of Dynatech
Corporation dated January 14, 2000.
PricewaterhouseCoopers LLP
Boston, Massachusetts
January 13, 2000
