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FORM 10-K
U.S. Securities and Exchange Commission
Washington, D.C. 20549
(Mark One)
[ x ] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [Fee Required]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1943 [No Fee Required]
For the transition period from __________ to _________
Commission file number: 0-21352
APPLIED INNOVATION INC.
(Name of registrant as specified in its charter)
DELAWARE 31-1177192
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
5800 INNOVATION DRIVE, DUBLIN, OHIO 43016
(Address of principal executive offices)(Zip Code)
Issuer's telephone number: 614-798-2000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value per share
(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, and (2) has been subject to the filing requirements for
at least the past 90 days. YES X NO
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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. [ X ]
Aggregate market value of voting stock held by non-affiliates of the registrant,
9,171,761 shares, based on the $5.00 closing sale price on March 2, 1997, was
$45,858,805.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: 15,772,832 shares of Common
Stock were outstanding at March 2, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Annual Report to the Stockholders for the fiscal
year ended December 31, 1996, are incorporated by reference in Part II.
Part III - Proxy Statement for 1997 Annual Meeting of Stockholders, in part, as
indicated.
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PART I
ITEM 1. BUSINESS.
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GENERAL
Applied Innovation Inc. (the "Company") develops, manufactures and markets
network mediation and network bridging products and associated services to
support the operation, maintenance, administration and provisioning of the
internal data network that is used by telecommunications companies to manage
elements in their customer service network systems. The Company's primary
emphasis is on providing hardware and software solutions to companies in the
telephone industry.
The Company's predecessor was incorporated in 1983 and engaged primarily in
development and preliminary testing activities until September 1984. At that
time, the Company began marketing the AISwitch(TM) Series 170. In 1986, the
Company began to reposition its products for use by telecommunications
companies. This effort led to the Company's current principal product, the
AISwitch(TM) Series 180, which is used to interconnect many types of
telecommunications equipment and management support systems to provide more
reliable and cost effective operations. In June 1986, the Company was formed as
a Delaware corporation and the Company's predecessor, an Ohio corporation, was
merged into the Company solely for the purpose of effecting a change in
domicile.
In 1995, the Company formed its wholly owned subsidiary Applied Innovation
International Inc., a U.S. Virgin Islands corporation, to act as a foreign sales
corporation to market the Company's products outside of the United States.
The Company's executive offices and manufacturing facilities are located at
5800 Innovation Drive, Dublin, Ohio 43016, telephone (614) 798-2000.
THE COMPANY'S MARKET
The Company's products provide the data network needed to monitor and
maintain thousands of pieces of electronic equipment used to provide
telecommunications service. Telecommunications companies continually upgrade and
expand the equipment needed to provide service to their customers. As each piece
of new equipment is installed, it is connected to a data monitoring network that
is used to report alarms, gather performance information, and to provide test
access and equipment reprogramming for establishing and maintaining customer
service. All of these new components must efficiently communicate with
computerized maintenance systems if customer calls and data transmission are to
be completed reliably. Incompatible older equipment must also be connected to
and integrated with the new components and the computerized management systems.
In a new initiative, the Company is developing a product line designed to
capture dial-up data traffic and divert it to an overlay data network. These
products would be installed in telephone central offices as close as possible to
the originating switches and would intercept data traffic and multiplex it
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on to existing high speed data network backbones. The market for the data
services access multiplexer is comprised of the same telephone companies that
the Company currently serves.
The Company is seeking to expand distribution for the AISwitch(TM) outside
the United States with agreements for representation in NAFTA and the Far East.
The Company has taken early steps to establish a local presence in China, which
is rapidly becoming the world's biggest market for telecommunications equipment.
The Company believes that countries currently building telecommunication
infrastructure will require centralized network management and the supporting
data communications capability supplied by the AISwitch(TM). The flexibility of
the AISwitch(TM) is the major benefit that customers enjoy by adopting the
central offices' products. This flexibility means that almost every data
communications protocol can be supported on the single platform.
The Company estimates that the seven Regional Bell Operating Companies
control approximately half of the estimated 20,000 telecommunications central
office locations in the United States. The remaining locations are controlled by
a few large independent firms like GTE and United Telecommunications and over
4,000 smaller independent firms. Because of their relative size, demand for
product, and importance, the Company has concentrated its marketing efforts on
the Regional Bell Operating Companies. As a result, the Company has historically
received a large percentage of its total annual revenues from Regional Bell
Operating Companies. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Each Regional Bell Operating Company has a finite number of central office
facilities which limit their total capacity for the Company's existing products.
To the extent that the Company achieves significant penetration with the
Company's existing products of any one Regional Bell Operating Company's central
office facilities, it cannot anticipate substantial additional sales of those
existing products to the Regional Bell Operating Company. Future domestic sales
growth to these customers will depend on the development of new products and new
releases of existing products. Sales growth for existing products will be
derived from additional sales to other Regional Bell Operating Companies, to
interexchange carriers and to the emerging competitive access providers. See
"Business - Business Risks - Risks Associated with Customer Concentration;
Dependence on Telecommunications Industry."
PRODUCTS
Several innovative data communications switching products are offered by
the Company for use in telecommunications company central office locations.
These switches channel several hundred communications circuits through one line,
which requires fewer dedicated lines and reduces the cost of telecommunications
networks. The importance of telecommunications companies adapting central
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offices to new computerized management systems represents a market niche for the
Company's products. The products currently available from the Company include:
PRODUCT DESCRIPTION
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AISwitch(TM)Series 180 Telco Network Bridge
AISwitch(TM)Series 130 Mini-mediator
Applied View(TM) Network Management System
AISwitch(TM) Series 180
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The AISwitch(TM) Series 180 connects multiple generations of
telecommunications network equipment to computers that monitor, control and
analyze field conditions. The AISwitch(TM) Series 180 incorporates the latest
high speed microprocessor and programmable gate array technology to bridge the
hardware and software gaps between old and new equipment. All vintages of
equipment can be integrated with support systems. The AISwitch(TM) Series 180
provides productivity gains and cost savings at both the customers' central
office and operations centers.
Within a typical telecommunications service region, there may be as many as
10,000 elements to interface with a variety of equipment using various
communications protocols. Communications protocols are standards which describe
the way in which data is transmitted between computer systems. Replacing
existing equipment and updating it to conform to newer standards takes place on
extended schedules of up to twenty years, with successive introductions of new
technologies. For this reason, many of the central office and local site
locations utilize multiple generations of equipment from different vendors, each
with unique operating conditions. The Company's products offer one of the most
comprehensive solutions available for connecting these dissimilar
telecommunications elements.
A unique capability of the AISwitch(TM) Series 180 and the Company's
technical organization is the ability to engineer custom interfaces for vendors
of telecommunications equipment and for telecommunications companies. Each
AISwitch(TM) includes a wide variety of functions and options that are
configured to fit client needs.
The key to the AISwitch(TM) Series 180 integration capability is its
flexible microprocessor controlled digital switching and protocol processing
capabilities. The AISwitch(TM) Series 180 permits the use of industry-standard,
open architecture network building blocks to more easily connect different
computers, network elements and other intelligent central office equipment with
one or more network destinations. The Company transforms a complex multi-vendor
environment into an easily managed seamless network to increase the total
efficiency of Operations, Administration, Maintenance and Provisioning systems.
A noteworthy recent development is the technology agreement with Cisco
Systems, Inc. ("Cisco") which allowed the company to integrate a Cisco router in
the AISwitch(TM). Cisco's world class routing technology is the most widely used
and allows the AISwitch(TM) to interwork smoothly with the routing technology
already in use by most of the Company's customers.
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AISwitch(TM) Series 130
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The AISwitch(TM) Series 130 is designed to provide network mediation
functions in small telecommunications company central offices and controlled
environmental vaults. Its smaller packaging provides an economic alternative
when only a few service providing elements at a remote location need to be
connected to the maintenance network.
Applied View(TM)
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Applied View(TM) is the Company's open standards management system.
AppliedView(TM) provides industry standard Simple Network Management Protocol
(SNMP) management of the OAM&P network, which connects Network Elements with
Operations Support Systems. Because AppliedView(TM) is based on Hewlett-Packard
Company's OpenView(TM) ("HP OpenView(TM)"), the same system can also monitor
other data communications networks and systems. AppliedView(TM) also provides a
platform for Telecommunications Management Network (TMN), and Element Management
Layer (EML).
Applied View(TM) utilizes a Graphical User Interface (GUI). The GUI
displays the front panel of the AISwitch chassis and status information. This
display shows the AISwitch panel as it appears at a remote location, including
all port types, port and card locations within the AISwitch, and status
indicators where they appear on the chassis panel. Additionally, connections
between AISwitches and connections between AISwitches and NES or OSSs can also
be displayed. AppliedView(TM) connection diagrams can be viewed over background
graphics, such as a geographic map of a country, showing the actual geographic
location of problems. On-screen graphics also display I/O card types.
AppliedView(TM) enables customers to make basic configuration changes to
every AISwitch in their network. Alias parameters and destination names for
every AISwitch in the network may be changed from a single location. New
additional alias parameters and destination names may be added using
AppliedView(TM).
AppliedView(TM) provides centralized configuration backup and control, and
automatically stores status, alias, destination and alarm events in the HP
OpenView(TM) database. When used to manage the AISwitch inventory
AppliedView(TM) collects information about the chassis, cards and ports.
Additionally, AppliedView(TM) provides context sensitive hypertext on-line help
screens.
MANUFACTURING AND OPERATIONS
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The printed circuit boards of the AISwitch(TM) are proprietary designs of
the Company. Printed circuit boards and power supplies used in each of the
Company's product families are manufactured by third parties on a contract basis
and standard electronic components are purchased from a variety of vendors. The
Company is not dependent upon any of these manufacturers for its printed circuit
boards or parts inventory as there are alternative sources available. Schedules
based on order backlog and favorable prices determine when and from whom
components are purchased. The Company utilizes an automated inventory control
system and a streamlined sales reporting and forecasting system.
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The printed circuit boards and components are sent to job shop assembly
firms to provide assembly and wave soldering services. Final assembly and
testing of the AISwitch(TM) is conducted in the Company's Dublin, Ohio
production facility. Although some physical and electrical inspection of the
printed circuit boards is performed at the off-site assembly houses, final
quality control is accomplished at the Company's facility.
The Company has made significant investments to attain quality assurance
consistent with stringent industry standards. The Company utilizes sophisticated
testing facilities for its products that are designed to simulate extreme
temperature and natural disaster conditions in order to validate the integrity
of these products in unforeseen circumstances so that service interruptions are
avoided. The manufacturing and quality assurance programs that the Company
utilizes are designed to be in compliance with Bellcore's Network Equipment -
Building System (NEBS) Generic Equipment Requirements and the International
Standards Organization 9001 ("ISO 9001") guidelines. On July 12, 1995, the
Company received ISO 9001 certification.
SALES AND MARKETING
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The Company's products and services are sold primarily through its own
sales force. The Company also markets its products through original equipment
manufacturers, resellers, system integrators and distributors. These alternative
distribution channels allow sales of the Company's products to markets that are
not easily accessible or not cost effective for its own sales force.
The Company's marketing staff consists of a Senior Vice President of Sales
and Marketing, a Vice President of Sales, Regional Sales Managers, Sales
Engineers and an administrative staff. Sales leads for the AISwitch(TM) are
currently generated primarily through target marketing key firms in the
telecommunications industry, direct mail and trade shows. Some media exposure
has been used and the Company plans to expand this form of marketing in the
future. Sales leads are followed up by personal contact from the Company's
marketing staff. If sufficient interest exists, an on-site visit may be
scheduled for the purpose of making a sales presentation or actual demonstration
of the product.
RESEARCH AND DEVELOPMENT
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The Company's research and development activity is now joined with product
management to create product development teams with improved focus on customer
requirements. The Data Communications Network Products (DCN) team focuses on
enhancing the AISwitch(TM) for its operations support role, while the Access
Products team focuses on creating products to help telephone companies handle
the burgeoning data traffic caused by the explosion of the Internet.
Enhancements to the AISwitch(TM) are focused on increasing its capacity and
adapting to the emerging Open Systems Interconnection (OSI) applications being
driven into Network Elements by worldwide standardization efforts. At the same
time, the AISwitch(TM) is being enhanced to accommodate older data communication
standards in order to broaden its range of application.
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The Access Products, represented by the AI 5800, are strategic new
developments which will expand the Company's technology into Asynchronous
Transfer Mode (ATM), another emerging worldwide standard for carrying all types
of communications in one protocol. The AI 5800 will require a new level of
sophistication in development capability which is being met by the establishment
of the Research and Development Center in North Carolina's Research Triangle
Park, where several world class telecommunications and data communication
centers have attracted a pool of talented hardware and software engineers.
The Company spent $7,646,796, $5,979,252 and $2,688,653 on
Company-sponsored research and development during the fiscal years ended
December 31, 1996, 1995, and 1994, respectively. Research and development
expenditures represented approximately 18.6%, 16.6% and 8.2% of total revenues
in fiscal 1996, 1995, and 1994, respectively. The Company continues to expect to
commit a substantial amount of resources and cash to its research and
development efforts during 1997. See "Business - Business Risks - New Products
and Rapid Technological Change; Need to Manage Product Transitions."
CUSTOMER SERVICE AND WARRANTY
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A program manager interfaces between the Company and the customer for
product implementation and service. The program manager is supported through
direct access to senior management of the Company and its engineering staff.
Formal review procedures are used by the Company to determine progress during
the installation phase of the process. Successful completion of milestones are
documented and reported to the customer. During the system test and shakedown
period, the program manager is also responsible for assuring that all possible
circumstances are covered prior to certification of the system for full
operation. Following installation, the program manager continues to monitor the
customer's system to ensure proper satisfaction.
The Company designs training programs to educate the customer's system
administration, operations and maintenance personnel to operate the system.
Classes are available, either on-site or at the Company's headquarters.
Additional training is also offered to the customer during system upgrades and
for new operations personnel.
The AISwitch(TM) carries a one year warranty with guaranteed overnight
factory replacement service for circuit boards or system modules in the event of
equipment failure. In addition, for an additional charge, on-site spares are
available for those customers who require immediate replacement. Non-working
units do not need to be returned to the Company until the new modules are up and
running.
The Company also provides a 24-hour Service Hotline for instant access to
the Company's field service and support departments. It also offers a toll-free
800 number.
Warranty expense represented approximately 10.2%, 1.7%, and 2.1% of total
revenues in fiscal 1996, 1995, and 1994. Warranty expense increased in 1996
because of repair costs of units which the
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Company agreed to repair to avoid future product difficulties and to demonstrate
the Company's quality assurance commitment to customers. See "Business -
Business Risks - Risk of Product Defects."
FIELD SERVICE
The Company's field service department provides custom design and
installation services for telecommunications network equipment. The Company
believes that its field service division complements and enhances the sale of
its network mediation products.
COMPETITION
There are over 40 manufacturers of data communications equipment.
Manufacturers of these products frequently specialize their products for
specific applications and could enter the Company's target market. Significant
competition exists from several well-established companies having resources
greatly superior to those of the Company as well as from relatively new but
aggressive companies.
Competition for the Company's products has traditionally come primarily
from suppliers of telecommunications switching and transmission equipment.
Lucent Technologies does have a product line, Datakit, which competes directly
with the Company's products when selling into the telecommunications industry.
Some competition also comes from other data communications suppliers, such
as Cisco Systems, Inc., Dantel, Bay Networks, and Harris Corp. and from computer
companies, like Hewlett-Packard and IBM, who primarily focus on
non-telecommunications business customers. Most of the products from these
companies are designed for use in computer centers and do not meet the standards
required for use in the telecommunications central office. In some cases, newer
products or redesigned older products from these suppliers compete with the
Company's products. See "Business - Business Risks Competition."
PERSONNEL
As of February 28, 1997, the Company had 208 full-time and part-time
employees. The Company anticipates that it will continue to increase the number
of its employees as it grows.
BUSINESS RISKS
The Company desires to take advantage of the "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995. In addition to the other
information in this report, readers should carefully consider that the following
important factors, among others, in some cases have affected, and in the future
could affect, the Company's actual results and could cause the Company's actual
consolidated results of operations for the year ended December 31, 1997, and
beyond, to differ materially from those expressed in any forward-looking
statements made by, or on behalf of, the Company.
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RISKS ASSOCIATED WITH CUSTOMER CONCENTRATION; DEPENDENCE ON
TELECOMMUNICATIONS INDUSTRY. A significant portion of the Company's revenues in
each fiscal quarter since inception has been derived from substantial orders
placed by large organizations, such as the seven Regional Bell Operating
Companies. As a result, the Company's revenues often have been concentrated
among a relatively small number of customers. In fiscal 1996, 1995, and 1994,
revenues from the Company's three, four and three largest customers represented
approximately 53%, 67%, and 63%, respectively, of the Company's total revenues.
The Company expects that it will continue to be dependent upon a limited number
of customers for a significant portion of its revenues in future periods. None
of the Company's customers is contractually obligated to license or purchase
additional products or services from the Company. As a result of this customer
concentration, the Company's business, operating results and financial condition
could be materially adversely affected by the failure of anticipated orders to
materialize and by deferrals or cancellations of orders. In addition, there can
be no assurance that revenue from customers that have accounted for significant
revenues in past periods, individually or as a group, will continue, or if
continued will reach or exceed historical levels in any future period.
Furthermore, such customers are concentrated in the telecommunications industry.
Accordingly, the Company's future success depends upon the capital spending
patterns of such customers and the continued demand by such customers for the
Company's products and services. The Company's operating results may in the
future be subject to substantial period-to-period fluctuations as a consequence
of such customer concentration and factors affecting capital spending in the
telecommunications industry.
PRODUCT CONCENTRATION. Revenue from the sale, service and support of the
Company's AISwitch(TM) family of products has accounted for substantially all of
the Company's revenues since inception. The Company believes that revenue from
the sale, service and support of AISwitch(TM) will continue to account for
substantially all of the Company's total revenue in fiscal 1997. Therefore, the
Company's future operating results, particularly in the near term, are
significantly dependent upon the continued market acceptance of AISwitch(TM),
improvements to the AISwitch(TM) framework and new and enhanced AISwitch(TM)
development tools and network operations support. There can be no assurance that
the AISwitch(TM) will continue to achieve market acceptance or that the Company
will be successful in developing, introducing or marketing improvements to the
AISwitch(TM) framework or new or enhanced AISwitch(TM) development tools and
applications. The life cycles of AISwitch(TM), including the AISwitch(TM)
development tools and applications, are difficult to estimate due in large part
to the recent emergence of many of the Company's markets, the effect of future
product enhancements and competition. A decline in the demand for the
AISwitch(TM) as a result of competition, technological change or other factors
would have a material adverse effect on the Company's business, operating
results and financial condition.
NEW PRODUCTS, RESEARCH AND DEVELOPMENT, AND RAPID TECHNOLOGICAL CHANGE;
NEED TO MANAGE PRODUCT TRANSITIONS. The market for the Company's products is
characterized by rapidly changing technologies, evolving industry standards,
frequent new product introductions and rapid changes in customer requirements.
The introduction of products embodying new technologies and the emergence of new
industry standards and practices can render existing products obsolete and
unmarketable. As a result, the life cycles of the Company's products are
difficult to estimate. The Company's future success will depend on its ability
to enhance its existing products and to develop and introduce, on a timely and
cost-effective basis, new products and product features that keep pace with
technological developments
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and emerging industry standards and address the increasingly sophisticated needs
of its customers. The Company is attempting to ensure future success by
investing heavily in its research and development effort. However, there can be
no assurance that the Company will be successful in developing and marketing new
products or product features that respond to technological change or evolving
industry standards, that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of these
new products and features, or that its new products or product features will
adequately meet the requirements of the marketplace and achieve market
acceptance. If the Company is unable, for technological or other reasons, to
develop and introduce enhancements of existing products or new products in a
timely manner, the Company's business, operating results and financial condition
will be materially adversely affected.
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 obsolete
or 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 one or
more of its competitors will not cause customers to defer purchasing existing
Company products. Such deferment of purchases could have a material adverse
effect on the Company's business, operating results and financial condition.
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS; SEASONALITY. The Company's
quarterly operating results have in the past and will in the future vary
significantly depending on factors such as the timing of significant orders and
shipments, capital spending patterns of the Company's customers, changes in
pricing policies by the Company or its competitors, the lengthy sales cycle of
the Company's products, increased competition, changes in operating expenses,
personnel changes, demand for the Company's products, the number, timing and
significance of new product and product enhancement announcements by the Company
and its competitors, the ability of the Company to develop, introduce and market
new and enhanced versions of its products on a timely basis, the mix of direct
and indirect sales and general economic factors, among others. A significant
portion of the Company's revenues have been, and will continue to be, derived
from substantial orders placed by large organizations, such as the Regional Bell
Operating Companies, and the timing of such orders and their fulfillment has
caused and will continue to cause material fluctuations in the Company's
operating results, particularly on a quarterly basis. Due to the foregoing
factors, quarterly revenue and operating results have been and will continue to
be difficult to forecast. Revenues are also difficult to forecast because the
Company's sales cycle, from initial evaluation to product shipment, varies
substantially from customer to customer. For these and other reasons, the sales
cycle associated with the purchase of the Company's products is typically
lengthy and subject to a number of significant risks, including customers'
budgetary constraints and internal acceptance reviews, over which the Company
has little or no control. The Company's expense levels are based, in part, on
its expectations as to future revenue levels. If revenue levels are below
expectations, operating results are likely to be materially adversely affected.
In particular, because only a small portion of the Company's expenses varies
with revenue, net income may be disproportionately affected by a reduction in
revenue. The Company's business has experienced and is expected to continue to
experience significant seasonality, in part due to an increase in capital
expenditures by customers in certain quarters. Based upon all of the foregoing,
the Company believes that quarterly
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revenues and operating results are likely to vary significantly in the future
and that period-to-period comparisons of its results of operations are not
necessarily meaningful and should not be relied upon as indications of future
performance. Further, it is likely that in some future quarter, the Company's
revenue or operating results will be below the expectations of public market
analysts and investors. In such event, the price of the Company's Common Stock
could be materially adversely affected.
MANAGEMENT OF GROWTH. The Company has experienced a period of rapid revenue
and customer growth and an expansion in the number of its employees, the scope
of its operating and financial systems and the geographic area of its
operations. This growth has resulted in new and increased responsibilities for
management personnel and has placed and continues to place a significant strain
upon the Company's management, operating and financial systems and resources.
Although the Company believes that there are currently no existing material
weaknesses, to accommodate recent growth and to compete effectively and manage
future growth, if any, the Company will be required to continue to implement and
improve operational, financial and management information systems, procedures
and controls on a timely basis and in such a manner as is necessary to
accommodate the increased number of transactions and customers and the increased
size of the Company's operations. Management of future growth, if any, will also
require that the Company continuously expand, train, motivate and manage its
work force. These demands will require the addition of new management personnel.
The Company's future success will depend to a significant extent on the ability
of its current and future executive officers to operate effectively, both
independently and as a group. There can be no assurance that the Company's
personnel, systems, procedures and controls will be adequate to support the
Company's existing and future operations. Any failure to implement and improve
the Company's operational, financial and management systems or to expand, train,
motivate or manage employees could have a material adverse effect on the
Company's business, operating results and financial condition.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a significant
degree upon the continuing contributions of its key management, sales,
professional services, customer support and product development personnel. In
particular, the Company would be materially adversely affected if it were to
lose the services of Gerard B. Moersdorf, Jr., Chief Executive Officer,
President, Treasurer and a director of the Company, who has provided significant
leadership and direction to the Company since its inception. The Company has
obtained key man life insurance on the life of Mr. Moersdorf in the amount of
$1,000,000 payable to the Company. The loss of key management or technical
personnel could adversely affect the Company. The Company believes that its
future success will depend in large part upon its ability to attract and retain
highly-skilled managerial, sales, professional services, customer support and
product development personnel. The Company has at times experienced and
continues to experience difficulty in recruiting qualified personnel.
Competition for qualified personnel is intense, and there can be no assurance
that the Company will be successful in attracting and retaining such personnel.
In addition, there are only a limited number of qualified professional services
and customer support engineers, and competition for such individuals is
especially intense. In addition, competitors have in the past and may in the
future attempt to recruit the Company's employees. Failure to attract and retain
key personnel could have a material adverse effect on the Company's business,
operating results and financial condition.
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FUTURE OPERATING RESULTS UNCERTAIN. Although the Company has previously
experienced significant growth in revenues and net income, the Company expects
that historical growth rates are not sustainable and such growth rates should
not be considered indicative of future growth, if any. There can be no assurance
that the Company's revenues will grow or be sustained in future periods or that
the Company will remain profitable in any future period.
COMPETITION. Most of the Company's current and potential competitors have
longer operating histories and significantly greater financial, technical,
sales, customer support, marketing and other resources, as well as greater name
recognition and a larger installed base of their products and technologies than
the Company. There can be no assurance that the Company's current or potential
competitors will not develop products comparable or superior to those developed
by the Company or adapt more quickly than the Company to new technologies,
evolving industry trends or changing customer requirements. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors or that competitive pressures faced by the Company will
not have a material adverse effect on its business, operating results and
financial condition. If the Company is unable to compete successfully against
current and future competitors, the Company's business, operating results and
financial condition will be materially and adversely affected.
RISK OF PRODUCT DEFECTS. Products as complex as those offered by the
Company may contain defects or failures when introduced or when new versions or
enhancements are released. The Company has in the past discovered defects in
certain of its products. Although the Company has remedied all known material
defects in its products, there can be no assurance that, despite testing by the
Company and its customers, errors will not be found in existing or new products
or releases, resulting in delay or loss of revenue, loss of market share or
failure to achieve market acceptance. Any such occurrence could have a material
adverse effect upon the Company's business, operating results and financial
condition.
DEPENDENCE UPON PROPRIETARY TECHNOLOGY; RISK OF THIRD PARTY CLAIMS OF
INFRINGEMENT. The Company's success and ability to compete is dependent in part
upon its proprietary software technology. The Company relies on a combination of
trade secret, copyright and trademark laws, nondisclosure and other contractual
agreements and technical measures to protect its proprietary rights. The Company
currently has no patents or patent applications pending. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's products or to obtain and use information that the
Company regards as proprietary. There can be no assurance that the steps taken
by the Company to protect its proprietary technology will prevent
misappropriation of such technology, and such protections may not preclude
competitors from developing products with functionality or features similar to
the Company's products. In addition, effective copyright and trade secret
protection may be unavailable or limited in certain foreign countries. While the
Company believes that its products and trademarks do not infringe upon the
proprietary rights of third parties, there can be no assurance that the Company
will not receive future communications from third parties asserting that the
Company's products infringe, or may infringe, the proprietary rights of third
parties. The Company expects that software product developers will be
increasingly subject to infringement claims as a number of products and
competitors in the Company's industry segment grows and the functionality of
products in different industry segments overlap. Any such claims, with or
without
-12-
<PAGE> 13
merit, could be time-consuming, result in costly litigation and diversion of
technical and management personnel, cause product shipment delays or require the
Company to develop non-infringing technology or enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to the Company or at all. In the event of a
successful claim of product infringement against the Company and failure or
inability of the Company to develop non-infringing technology or license the
infringed or similar technology, the Company's business, operating results and
financial condition could be materially adversely affected. 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 at all. Although the Company believes that
alternative software is available from other third-party suppliers, the loss of
or inability to maintain any of these software licenses or the inability of the
third parties to timely and cost-effectively enhance their products in response
to changing customer needs, industry standards or technological developments
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 would have a material adverse effect on the Company's
business, operating results and financial condition.
CONCENTRATION OF STOCK OWNERSHIP. The present directors, executive officers
and principal shareholders of the Company and their affiliates beneficially own
approximately 43.0% of the outstanding shares of Common Stock. In particular,
Gerard B. Moersdorf, Jr. and his spouse own approximately 41.5% of the
outstanding shares of Common Stock. As a result, these shareholders are able to
exercise significant influence over matters requiring shareholder approval,
including the election of directors and approval of significant corporate
transactions. Such concentration of ownership may have the effect of delaying or
preventing a change in control of the Company.
LIMITED MARKET; VOLATILITY OF STOCK PRICE. Although the Company is listed
on the Nasdaq National Market, there can be no assurance that an active or
liquid trading market in the Common Stock will continue. The market price of the
shares of Common Stock is likely to be highly volatile and may be significantly
affected by factors such as actual or anticipated fluctuations in the Company's
operating results, announcements of technological innovations, new products or
new contracts by the Company or its competitors, developments with respect to
copyrights or proprietary rights, general market conditions and other factors.
In addition, the stock market has from time to time experienced significant
price and volume fluctuations that have particularly affected the market prices
for the common stocks of technology companies. These types of broad market
fluctuations may adversely affect the market price of the Company's Common
Stock. In the past, following periods of volatility in the market price of a
company's securities, securities class action litigation has often been
initiated against such company. Such litigation could result in substantial
costs and a diversion of management's attention and resources, which could have
a material adverse effect upon the Company's business, operating results and
financial condition.
ANTI-TAKEOVER PROVISIONS; CERTAIN PROVISIONS OF DELAWARE LAW; CERTIFICATE
OF INCORPORATION AND BY-LAWS. Certain provisions of Delaware law, the Company's
Certificate of Incorporation and By-Laws could have the effect of making it more
difficult for a third party to acquire, or of discouraging
-13-
<PAGE> 14
a third party from attempting to acquire, control of the Company. The Company's
By-Laws provide for the Board of Directors to be divided into three classes of
directors serving staggered three-year terms. Such classification of the Board
of Directors expands the time required to change the composition of a majority
of directors and may tend to discourage a proxy contest or other takeover bid
for the Company. Additionally, the directors, executive officers and existing
principal stockholders of the Company and their affiliates collectively own
approximately 43.0% of the outstanding the Company's Common Stock. Such
concentration of ownership may have the effect of delaying or preventing a
change in control of the Company.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING. The Company
currently anticipates that its available cash resources will be sufficient to
meet its presently anticipated and projected working capital and capital
expenditure requirements both for the short-term and through at least December
31, 1997. See "Management's Discussion and Analysis of Financial Condition and
the Results of Operations - Liquidity and Capital Resources." The Company may
need to raise additional funds through public or private debt or equity
financings in order to take advantage of unanticipated opportunities, including
more rapid expansion or acquisitions of complementary businesses or
technologies, or to develop new or enhanced services and related products or
otherwise respond to unanticipated competitive pressures. If additional funds
are raised through the issuance of equity securities, the percentage ownership
of the then current stockholders of the Company may be reduced and such equity
securities may have rights, preferences or privileges senior to those of the
holders of the Company's Common Stock. There can be no assurance that additional
financing will be available on terms favorable to the Company, or at all. If
adequate funds are not available or are not available on acceptable terms, the
Company may not be able to take advantage of unanticipated opportunities,
develop new or enhanced services and related products or otherwise respond to
unanticipated competitive pressures and the Company's business, operating
results and financial condition could be materially adversely affected.
ITEM 2. PROPERTIES.
----------
In 1994, the Company completed construction of a new corporate office and
manufacturing facility in Dublin, Ohio. All of the Company's design,
manufacturing and administrative activities and a substantial portion of its
marketing activities are conducted at this location. This facility was expanded
in 1995 from approximately 55,000 square feet to 115,000 square feet. The
expansion was funded with cash on hand and operating cash flows. The Company
owns the building and the approximately 13 acres of land on which it is situated
and 15 acres adjacent to the facility.
The Company entered into a lease for approximately 24,000 square feet of
space in Morrisville, North Carolina. The Morrisville facility will be used by
the Company primarily for research and development activities. The lease for the
Morrisville facility has a five year term which commenced in February 1997.
ITEM 3. LEGAL PROCEEDINGS.
-----------------
Not applicable.
-14-
<PAGE> 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
---------------------------------------------------------------------
Applied Innovation Inc. common stock has been traded in the
over-the-counter market since 1986. The common stock was traded on the NASDAQ
OTC Bulletin Board until May 18, 1993. From May 18, 1993 to November 26, 1993
the common stock was traded on the NASDAQ Small Cap Market. On November 29, 1993
the common stock began trading on the NASDAQ National Market. The following
table sets forth, for the periods indicated, the high and low bid prices for
Applied Innovation Inc. common stock. The table includes values adjusted to
reflect the 2 for 1 stock split paid on August 31, 1995. The prices shown
represent quotations between dealers, without adjustment for retail markups,
markdowns or commissions and may not represent actual transactions.
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
High Low High Low High Low
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Q1 13 8 13.75 11.125 16.5 10.5
------------------------------------------------------------------------
Q2 14 8.25 25.625 12.37 15.5 9.125
------------------------------------------------------------------------
Q3 10.875 7.875 31.625 15.75 11.25 7.5
------------------------------------------------------------------------
Q4 10.125 5.75 17.50 6.875 14.375 10
------------------------------------------------------------------------
</TABLE>
At March 13, 1997, the Company had 837 stockholders of record.
The Company has not paid any cash dividends and presently anticipates that
all of its future earnings will be retained for development of its business. The
Company does not anticipate paying cash dividends on its Common Stock in the
foreseeable future. The payment of any future dividends would be at the
discretion of the Company's Board of Directors and would depend upon, among
other things, future earnings, operations, capital requirements, the general
financial condition of the Company and general business conditions. Although the
Company's ability to pay dividends is not currently restricted by any of its
financing agreements, the Company may be subject to such restrictions in the
future.
-15-
<PAGE> 16
ITEM 6. SELECTED FINANCIAL DATA.
-----------------------
<TABLE>
<CAPTION>
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Total revenue...................... $6,339,222 $16,105,474 $32,805,321 $36,013,535 $41,145,876
Net income......................... $1,540,347 $3,991,054 $7,057,916 $6,054,030 $2,154,568
Earnings per share................. $.11 $.26 $.44 $.38 $.14
Weighted average shares outstanding 14,455,672 15,530,240 15,863,174 15,953,064 15,863,653
including common stock
equivalents......................
Total assets....................... $4,302,974 $11,771,042 $23,893,615 $30,531,727 $35,662,244
Stockholders' equity............... $3,050,148 $10,376,845 $19,926,612 $27,314,930 $29,941,858
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-----------------------------------------------------------------------
OF OPERATIONS.
-------------
The information required by this item is included under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Company's Annual Report to Stockholders and is incorporated
herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
-------------------------------------------
The Company's balance sheets as of December 31, 1996 and 1995, and the
statements of income, stockholders' equity and cash flows for each of the
years in the three year period ended December 31, 1996, and the related
notes to financial statements are included in the Company's Annual Report to
Stockholders and are incorporated herein by reference.
The following table presents certain unaudited financial data for each
quarter in the Company's last two fiscal years. The Company believes that all
necessary and normal recurring adjustments have been included in order to
present the following quarterly financial information fairly and in accordance
with generally accepted accounting principles when read in conjunction with the
Company's financial statements incorporated herein by reference.
-16-
<PAGE> 17
Quarterly Financial Information
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Three
Three Three Months Months
Months Months Ended Ended
Ended Ended September December
1996 March 31 June 30 30 31
------ -------- ------- --------- --------
<S> <C> <C> <C> <C>
Total revenues............. $8,913 $11,428 $10,888 $9,918
Gross profit............... 5,746 6,089 5,378 3,529
Income before income
taxes................... 1,946 2,147 1,135 (1,818)
Net income................. 1,196 1,321 699 (1,061)
Net income per share....... $0.08 $0.08 $0.04 ($0.07)
</TABLE>
<TABLE>
<CAPTION>
Three Three
Three Three Months Months
Months Months Ended Ended
Ended Ended September December
1995 March 31 June 30 30 31
------ -------- ------- --------- --------
<S> <C> <C> <C> <C>
Total revenues............. $8,232 $10,751 $8,209 $8,821
Gross profit............... 5,349 6,877 5,304 5,773
Income before income 2,429 3,645 2,216 1,593
taxes....................
Net income................. 1,506 2,260 1,401 887
Net income per share....... $0.09 $0.14 $0.09 $0.06
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE.
--------------------
Not applicable.
-17-
<PAGE> 18
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
--------------------------------------------------
The information appearing under the caption "ELECTION OF DIRECTORS" on
pages 4 through 11 of the Company's Proxy Statement relating to the Company's
Annual Meeting of Stockholders to be held on April 24, 1997 (the "Proxy
Statement"), and the information appearing under the caption "SECTION 16(a)
BENEFICIAL OWNERSHIP REPORTING COMPLIANCE" on page 13 of the Proxy Statement is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
----------------------
The information appearing in the Proxy Statement under the caption
"ELECTION OF DIRECTORS - Executive Compensation" on pages 7 and 8 of the Proxy
Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
--------------------------------------------------------------
The information appearing in the Proxy Statement under the caption
"OWNERSHIP OF COMMON STOCK BY PRINCIPAL SHAREHOLDERS" on page 2, and under the
caption "SECURITY OWNERSHIP OF MANAGEMENT" on pages 3 and 4 of the Proxy
Statement, is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
----------------------------------------------
The information appearing in the Proxy Statement under the caption
"ELECTION OF DIRECTORS - Related Party Transactions" on pages 8 and 9 is
incorporated herein by reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
---------------------------------------------------------------
(a)(1) The following documents are filed as part of this report:
Balance Sheets as of December 31, 1996 and 1995
Statements of Income for the years ended December 31, 1996, 1995, and
1994
Statements of Stockholders' Equity for the years ended December 31,
1996, 1995, and 1994
Statements of Cash Flows for the years ended December 31, 1996, 1995,
and 1994
Notes to Financial Statements
-18-
<PAGE> 19
(a)(2) No schedules are included because of the absence of the conditions
under which they are required or because the required information is
included in the financial statements or the notes thereto.
(a)(3) Exhibits: The following exhibits are filed as part of this report:
EXHIBIT
NO. DESCRIPTION PAGE
------- ----------- ----
3.1 Certificate of Incorporation of the Company........................(1)
3.2 By-laws of the Company, as amended.................................(1)
10.1 Company's Amended and Restated 1986 Incentive Stock Option
Plan, including form of Stock Option Agreement.....................(1)*
10.2 Company's 1986 Amended and Restated Non-Statutory Stock
Option Plan, including form of Stock Option Agreement..............(1)*
10.3 Form of Confidentiality, Assignment and Non-Competition
Agreement between the Company and employee officers................(1)*
10.4 and 10.5 Omitted
10.6 Letter Agreement between the Company and
John M. Spiegel re: employment.....................................(1)*
10.7 Omitted
10.8 Form of Indemnification Agreement between the Company
and officers and directors.........................................(2)*
10.9 Schedule of Indemnification Agreements.............................(2)*
10.10 Letter Agreement between the Company and
Anthony F. Bucciero re: employment.................................(3)*
10.11 Omitted
10.12 Omitted
10.13 Company's 1996 Stock Option Plan...................................(4)*
10.14 Letter Agreement regarding employment, dated April 27, 1995,
between the Company and Lawrence H. Corbett........................(4)*
-19-
<PAGE> 20
11 Statement re: computation of earnings per share....................__
13 Portions of the Annual Report to Stockholders......................__
23.1 Consent of KPMG Peat Marwick LLP...................................__
24 Powers of Attorney .........................................__
27 Financial Data Schedule............................................__
---------------------
(1) Previously filed with the same exhibit number with the Company's Form
10-SB filed March 10, 1993 and incorporated herein by reference.
(2) Previously filed with the same exhibit number with the Company's Form
10-KSB filed March 31, 1994 and incorporated herein by reference.
(3) Previously filed with the same exhibit number with the Company's Form
10-K filed March 31, 1995 and incorporated herein by reference.
(4) Previously filed with the same exhibit number with the Company's Form
10-K filed March 31, 1996 and incorporated herein by reference.
* Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this form.
(b) No reports on Form 8-K were filed in the fourth quarter of 1996.
(c) Exhibits - The exhibits to this report begin on page __.
(d) Financial Statement Schedules - None.
-20-
<PAGE> 21
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 INNOVATION INC.
Date: March 31, 1997 By: /s/ Gerard B. Moersdorf, Jr.
------------------------------
Gerard B. Moersdorf, Jr., Chairman
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 and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Gerard B. Moersdorf, Jr. Chairman, President March 31, 1997
- ----------------------------- and Treasurer (Principal
Gerard B. Moersdorf, Jr. Executive and Financial
Officer)
*John M. Spiegel Comptroller March 31, 1997
- ----------------------------- (Principal Accounting
John M. Spiegel Officer)
*James H. Blough Director March 31, 1997
- -----------------------------
James H. Blough
*Curtis A. Loveland Director March 31, 1997
- -----------------------------
Curtis A. Loveland
*Gerard B. Moersdorf, Sr. Director March 31, 1997
- -----------------------------
Gerard B. Moersdorf, Sr.
*Richard W. Oliver Director March 31, 1997
- -----------------------------
Richard W. Oliver
*Thomas W. Huseby Director March 31, 1997
- -----------------------------
Thomas W. Huseby
*By: /s/ Gerard B. Moersdorf, Jr.
----------------------------
Gerard B. Moersdorf, Jr.
(Attorney-in-Fact)
-21-
<PAGE> 1
APPLIED INNOVATION INC.
Exhibit 11
Statement Regarding Computation of Earnings Per Share
For the years ended December 31, 1996, 1995, and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Weighted average number of common
shares outstanding 15,764,632 15,683,264 15,553,628
Add net shares issuable pursuant to stock
option plans less shares assumed
repurchased at the average market price 99,021 269,800 301,630
Add shares issuable pursuant to officer and
manager compensation plans 0 0 7,916
---------- ---------- ----------
Number of shares for computation of
primary earnings per share 15,863,653 15,953,064 15,863,174
Add net shares issuable pursuant to stock
option plans less shares assumed
repurchased at period end market price 0 0 22,582
---------- ---------- ----------
Number of shares for computation of fully
diluted earnings per share 15,863,653 15,953,064 15,885,756
========== ========== ==========
Net income for primary and fully diluted
earnings per share $2,154,568 $6,054,030 $7,057,916
========== ========== ==========
Primary earnings per share $.14 $.38 $.44
========== ========== ==========
Fully diluted earnings per share $.14 $.38 $.44
========== ========== ==========
</TABLE>
<PAGE> 1
Exhibit 13
APPLIED INNOVATION INC.
AND SUBSIDIARY
----------------
Consolidated Financial Statements
December 31, 1996 and 1995
(With Independent Auditors' Report Thereon)
<PAGE> 2
Exhibit 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
OVERVIEW
Applied Innovation Inc. develops, manufactures, and markets network mediation
and bridging products and services to the telecommunication industry. The
Company's products and services support the operation, maintenance,
administration and provisioning of the internal networks used by
telecommunications companies to manage elements in their customer service
network systems. The Company's primary emphasis is on providing hardware and
software solutions to companies in the telecommunications industry.
The Company's products provide the data network needed to monitor and maintain
thousands of pieces of electronic equipment used to deliver telecommunication
services. The telecommunications companies continually upgrade and expand the
equipment they use to provide service to their customers. As each new piece of
equipment is installed, it is connected to a data-monitoring network that is
used to report alarms, gather performance information, provide test access, and
reprogram equipment to establish and maintain customer service. All these new
components must efficiently communicate with the data-monitoring network if
customer calls and data transmission are to be completed reliably. Older
equipment must also be connected to and integrated with the new components and
the data-monitoring network. The Company's products perform this critical
bridging and mediation function.
The Company sells its products and services through it own sales force. The
Company also markets its products through original equipment manufacturers,
resellers, systems integrators, and distributors. These alternative distribution
channels enable the Company to make sales in markets that its own sales force
cannot reach easily or cost-effectively.
The Company estimates that the seven Regional Bell Operating Companies (RBOCs)
control approximately half of the estimated 20,000 communications central office
locations in the United States. The remaining locations are controlled by a few
large firms (like GTE, MCI, and Sprint United) and more than 4,000 smaller
independent firms. The Company has concentrated its marketing efforts on the
RBOCs because of their relative size, demand for product, and importance. As a
result, the Company has historically received a large percentage of its total
annual revenues from RBOCs.
Each RBOC has a finite number of central offices, which limits its total demand
for the Company's existing products. To the extent that the Company achieves
significant penetration with existing products of any one RBOC's central office
facilities, it cannot anticipate substantial additional sales of these products
to the same RBOC. Future domestic sales to these customers will depend on the
development of new products and new releases of existing products. Sales growth
for existing products will be achieved through additional sales to other RBOCs
and eventual penetration of the diverse market of independent phone companies.
<PAGE> 3
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's Consolidated
Statements of Income as a percentage of total revenue for the periods indicated.
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Revenue 100.00% 100.00% 100.00%
Cost of sales 49.59% 35.29% 37.63%
------ ------ ------
Gross profit 50.41% 64.71% 62.37%
------ ------ ------
Operating expenses:
Selling, general and
administrative 24.82% 21.81% 19.35%
Research and development 18.58% 16.60% 8.20%
------ ------ ------
43.40% 38.41% 27.55%
------ ------ ------
Income from operations 7.01% 26.30% 34.82%
------ ------ ------
Other income (expense): 1.27% 1.17% 0.43%
Interest income 0.01% (0.03%) (0.02%)
------ ------ ------
Gain (loss) on disposal of assets 1.28% 1.14% 0.41%
------ ------ ------
Income before income taxes 8.29% 27.44% 35.23%
Income taxes 3.05% 10.63% 13.72%
------ ------ ------
Net income 5.24% 16.81% 21.51%
====== ====== ======
</TABLE>
<PAGE> 4
YEAR ENDED DECEMBER 31, 1996, COMPARED TO YEAR ENDED DECEMBER 31, 1995
Total revenues rose to $41,145,876 in 1996 from $36,013,535 in 1995, an increase
of 14.3%. Most of the advance resulted from increases in unit sales of the
AISwitch(TM) Series 180. Because sales are concentrated among the large Regional
Bell Operating Companies and inter-exchange carriers, a small number of
customers have accounted for substantial portions of the Company's annual sales.
Three companies accounted for 53% of the Company's total revenue in 1996. Each
of these three customers contributed between 15% and 20% of total sales.
Cost of sales as a percentage of revenues increased to 49.6% in 1996 from 35.3%
in 1995, and gross profit decreased to 50.4% in 1996 from 64.7% in 1995. The
reduction in gross profit as a percentage of revenue was due in part to costs
incurred to support and upgrade certain installed products pending the release
of new products and selected price competition. Additionally, gross profit in
1996 was adversely impacted by increased warranty expense attributable to units
which the Company agreed to repair to avoid future product difficulties, and
demonstrate the Company's quality assurance commitment to customers. The Company
expects gross profit, as a percentage of revenues, to be higher in 1997 than in
1996.
Research and development expenses increased to $7,646,796 in 1996 from
$5,979,252 in 1995, and increased as a percentage of revenue to 18.6% in 1996
from 16.6% in 1995. A substantial portion of the increase resulted from the
hiring of additional personnel. The Company anticipates that in 1997 the actual
dollars expended for research and development will be higher than in 1996 to
support its existing product lines and to develop an Internet access product for
its telecommunications company customers.
Selling, general, and administrative expenses increased to $10,212,917 in 1996
from $7,851,747 in 1995. As a percentage of revenue, these expenses increased to
24.8% in 1996 from 21.8% in 1995. The increase is attributable to additional
administrative personnel to support current operations, increased sales,
marketing and product management personnel to support planned growth, and
completion of an addition to the Company's Dublin, Ohio facility at the
beginning of 1996. To support continued growth, the Company expects additional
increases in sales, general, and administrative personnel and related costs
during 1997 as a percentage of sales.
As a result of the above changes in revenues and expenses, income from
operations decreased by 69.6% to $2,882,608 in 1996 from $9,471,686 in 1995. As
a percentage of total revenues, income from operations was 7.0% in 1996 and
26.3% in 1995.
Net other income increased by $116,616 to $527,960 in 1996. The increase is
attributable to interest income earned on higher average cash balances.
Income before income taxes decreased in 1996 by 65.5% to $3,410,568 from
$9,883,030.
The Company's effective income tax rate was 36.8% in 1996 and 38.7% in 1995.
<PAGE> 5
YEAR ENDED DECEMBER 31, 1995, COMPARED TO YEAR ENDED DECEMBER 31, 1994
Total revenues rose to $36,013,535 in 1995 from $32,805,321 in 1994, an increase
of 9.8%. Most of this increase resulted from increases in unit sales of the
AISwitch(TM) Series 180. Because sales are concentrated among the large RBOCs
and inter-exchange carriers, a small number of customers have accounted for
substantial portions of the Company's annual revenues. Four companies accounted
for 67% of the Company's total revenue in 1995. Each of these four customers
contributed between 13% and 20% of total sales. Three customers accounted for
63% of the Company's total revenue in 1994. Each of these customers contributed
between 14% and 27% of total sales.
Cost of sales as a percentage of revenues decreased to 35.3% in 1995 from 37.6%
in 1994, and gross profit increased to 64.7% in 1995 from 62.4% in 1994. The
increase in gross profit percentage was due primarily to a sales decline in the
Company's field service division, which operates at a lower gross profit
percentage than does the manufacturing business.
Research and development expenses increased by 122.4% to $5,979,252 in 1995 from
$2,688,653 in 1994, and increased as a percentage of revenue to 16.6% in 1995
from 8.2% in 1994. A substantial portion of the increase resulted from the
hiring of additional research and development personnel.
Selling, general, and administrative expenses increased by 23.7% to $7,851,747
in 1995 from $6,348,498 in 1994. As a percentage of revenue, selling, general,
and administrative expenses increased to 21.8% in 1995 from 19.4% in 1994. The
increase is attributable to a variety of factors, including the addition of
personnel and expenses associated with the expansion of corporate facilities.
As a result of the above changes in revenues and expenses, income from
operations decreased by 17.1% to $9,471,686 in 1995 from $11,424,887 in 1994. As
a percentage of total revenues, income from operations was 26.3% in 1995 and
34.8% in 1994.
Net other income increased by 209.2% to $411,344 in 1995 from $133,029 in the
previous year. The increase is attributable to the interest income earned on
substantially higher average cash balances.
Income before income taxes decreased in 1995 by 14.5% to $9,883,030 from
$11,557,916.
The Company's effective income tax rate was 38.7% in 1995 and 38.9% in 1994.
<PAGE> 6
SELECTED QUARTERLY RESULTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
1996 Q1 Q2 Q3 Q4
- ----------------------- ------- ------- ------- -------
<S> <C> <C> <C> <C>
Total Revenues: $8,913 $11,428 $10,888 $9,918
Gross Profit: 5,746 6,089 5,378 3,529
Income Before Income Taxes: 1,946 2,147 1,135 (1,818)
Net Income: 1,196 1,321 699 (1,061)
Net Income Per Share: $0.08 $0.08 $0.04 ($0.07)
1995 Q1 Q2 Q3 Q4
- ----------------------- ------- ------- ------- -------
Total Revenues: $8,232 $10,751 $8,209 $8,821
Gross Profit: 5,349 6,877 5,304 5,773
Income Before Income Taxes: 2,429 3,645 2,216 1,593
Net Income: 1,506 2,260 1,401 887
Net Income Per Share: $0.09 $0.14 $0.09 $0.06
</TABLE>
The Company's quarterly opening results have varied significantly in the past
and will do so in the future. In 1996, quarterly revenue varied from $8.9
million in the first quarter to $11.4 million in the second quarter. In 1995,
quarterly revenue varied from $8.2 million in the first and third quarters to
$10.8 million in the second quarter. Management believes that significant
fluctuation in quarterly revenue is due in part to the timing of larger orders
placed by customers, changes in the telecommunications industry, and the timing
of releases of the Company's product enhancements and upgrades. The Company
expects that quarterly revenue will continue to vary based on these factors.
Because of the nature of its business, it is extremely difficult to predict the
number of orders and the related revenue for any given period. Thus, the Company
cannot predict whether trends will continue or whether the Company's orders and
related revenue will return to the historical growth levels previously enjoyed
by the Company.
<PAGE> 7
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities totaled $5,403,318 and $10,882,892 for
1996 and 1995, respectively. In 1996, net income plus depreciation provided
$3,579,949 of operating cash flow. In 1995, net income plus depreciation
provided $6,771,199 of operating cash flow. In 1996 and 1995, net cash provided
by operating activities included $192,000 and $1,148,000 respectively, realized
from tax benefits received on the exercise of non-qualified stock options and
the disqualifying disposition of incentive stock options. These amounts are
included in accrued expenses in the Consolidated Statements of Cash Flows.
Net working capital was $19,090,815 at December 31, 1996, compared to
$17,498,683 at December 31, 1995. Current ratios on those dates were 4.5:1 and
6.7:1 respectively. The Company had no long-term debt either year.
Capital expenditures equaled $2,531,577 and $5,409,009 in 1996 and 1995,
respectively. Net capital expenditures in 1996 included $2,342,122 for the
purchase of equipment and furniture and fixtures. Capital expenditures in 1995
included $2,444,985 for the purchase of land and construction of additional
manufacturing and development facilities. The Company opened a satellite
research and development facility in Raleigh, North Carolina in February 1997.
The new facility required initial capital expenditures of approximately $400,000
in 1997 to be fully functional.
The Company has an unsecured line of credit from a bank totaling $5,000,000.
Interest on the outstanding balance is payable monthly at the London Interbank
Offered Rate (LIBOR) plus 2 percent. Unpaid principal is due March 31, 1998. The
Company is in compliance with all related loan covenants. At December 31, 1996,
the full $5,000,000 amount of the line was available.
The Company believes that its existing cash, cash equivalents, and internally
generated funds will be sufficient to meet its presently anticipated working
capital needs and capital expenditures through December 31, 1997. To the extent
that the Company needs additional capital resources, the Company believes that
it will have access to bank financing.
<PAGE> 8
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The foregoing statements include forward-looking statements concerning future
gross margins, R&D expenses, SG&A expenses, capital expenditures, and capital
resources, all of which involve risks and uncertainties. The Company's actual
experience may differ materially from that projected above. Factors that might
cause the Company's present expectations to not materialize or to change
include, but are not limited to, the continued acceptance of the Company's
existing telecommunications network management products by Regional Bell
Operating Companies and other telecommunications carries; changes in customer
needs, demands and buying patterns for telecommunication equipment; the timely
development of new products and product upgrades and the market's acceptance of
such products; changes in product warranty experience; competitive pressures
from companies with substantially greater resources; the ability of the Company
to hire additional technical personnel for new product development; the
Company's ability to manage its planned new product development; and other
factors discussed in the Company's prior filings with the Securities and
Exchange Commission, including the Annual Report on Form 10-K for the year ended
December 31, 1996.
<PAGE> 9
INDEPENDENT AUDITORS' REPORT
The Directors and Stockholders
Applied Innovation Inc.:
We have audited the accompanying consolidated balance sheets of Applied
Innovation Inc. and subsidiary as of December 31, 1996 and 1995, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the years in the three-year period ended December 31, 1996. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Applied Innovation
Inc. and subsidiary as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1996 in conformity with generally accepted accounting
principles.
Columbus, Ohio
February 14, 1997
<PAGE> 10
APPLIED INNOVATION INC.
AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 1996 and 1995
<TABLE>
<CAPTION>
ASSETS 1996 1995
------ ---------- ----------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 12,278,092 9,176,287
Accounts receivable, net of allowance of $112,528 in 1996 and $100,000 in 1995
(note 7) 7,646,517 6,572,326
Inventory (note 2) 3,005,921 4,060,939
Prepaid expenses 270,611 228,688
Deferred income taxes 1,366,025 553,445
---------- ----------
Total current assets 24,567,166 20,591,685
---------- ----------
Property, plant and equipment:
Land 1,458,296 1,458,296
Building 4,843,165 4,795,778
Vehicles 40,143 40,143
Equipment 5,164,077 3,105,539
Furniture 1,942,545 1,658,961
---------- ----------
13,448,226 11,058,717
Less accumulated depreciation 2,470,584 1,185,940
---------- ----------
Net property, plant and equipment 10,977,642 9,872,777
Other assets 117,436 67,265
---------- ----------
$ 35,662,244 30,531,727
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable:
Trade 1,517,191 1,107,379
Construction - 549,586
Accrued expenses:
Royalties 76,036 180,290
Commissions 315,830 211,106
Real estate taxes 133,415 111,825
Payroll taxes and withholdings 65,839 78,160
Income taxes 289,612 227,990
Payroll 98,448 71,652
Profit sharing plan 218,391 211,712
Warranty 2,761,589 343,302
---------- ----------
Total current liabilities 5,476,351 3,093,002
Deferred income taxes 244,035 123,795
---------- ----------
Total liabilities 5,720,386 3,216,797
---------- ----------
Stockholders' equity:
Common stock, $.01 par value. Authorized 30,000,000 shares; issued and
outstanding 15,764,632 shares in 1996 and 15,683,264 in 1995 157,646 156,832
Additional paid-in capital 8,360,502 7,980,124
Deferred compensation (51,501) (142,669)
Retained earnings 21,475,211 19,320,643
---------- ----------
Total stockholders' equity 29,941,858 27,314,930
Commitments and contingencies (notes 12 and 13)
---------- ----------
$ 35,662,244 30,531,727
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 11
APPLIED INNOVATION INC.
AND SUBSIDIARY
Consolidated Statements of Income
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Revenue (note 7) $ 41,145,876 36,013,535 32,805,321
Cost of sales 20,403,555 12,710,850 12,343,283
---------- ---------- ----------
Gross profit 20,742,321 23,302,685 20,462,038
---------- ---------- ----------
Operating expenses:
Selling, general and administrative 10,212,917 7,851,747 6,348,498
Research and development 7,646,796 5,979,252 2,688,653
---------- ---------- ----------
17,859,713 13,830,999 9,037,151
---------- ---------- ----------
Income from operations 2,882,608 9,471,686 11,424,887
---------- ---------- ----------
Other income (expense):
Interest income 523,956 420,367 139,955
Gain (loss) on disposal of assets 4,004 (9,023) (6,926)
---------- ---------- ----------
527,960 411,344 133,029
---------- ---------- ----------
Income before income taxes 3,410,568 9,883,030 11,557,916
Income taxes (note 10) 1,256,000 3,829,000 4,500,000
---------- ---------- ----------
Net income $ 2,154,568 6,054,030 7,057,916
========== ========== ==========
Earnings per share (note 6):
Primary earnings per share $ .14 .38 .44
========== ========== ==========
Net fully diluted earnings per share $ .14 .38 .44
========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 12
APPLIED INNOVATION INC.
AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
Common stock
---------------------- Additional Deferred
Number paid-in compensation Retained
of shares Amount capital (note 11) earnings
---------- ------- --------- ------- ----------
<S> <C> <C> <C> <C> <C>
Balance--December 31, 1993 14,663,628 $ 146,636 4,012,512 - 6,208,697
Stock options exercised (note 8) 886,000 8,860 438,414 - -
Tax benefit associated with exercise
of stock options - - 2,053,577 - -
Net income - - - - 7,057,916
Restricted stock awards - - 105,900 (105,900) -
---------- ------- --------- ------- ----------
Balance--December 31, 1994 15,549,628 155,496 6,610,403 (105,900) 13,266,613
Stock options exercised (note 8) 125,000 1,250 150,853 - -
Tax benefit associated with exercise
of stock options - - 1,148,000 - -
Amortization of deferred compensation
- - - 34,185 -
Net income - - - - 6,054,030
Restricted stock awards 8,636 86 70,868 (70,954) -
---------- ------- --------- ------- ----------
Balance--December 31, 1995 15,683,264 156,832 7,980,124 (142,669) 19,320,643
Stock options exercised (note 8) 77,120 771 223,958 - -
Tax benefit associated with exercise
of stock options - - 192,000 - -
Amortization of deferred compensation
- - - 55,631 -
Net income - - - - 2,154,568
Restricted stock awards 4,248 43 (35,580) 35,537 -
---------- ------- --------- ------- ----------
Balance--December 31, 1996 15,764,632 $ 157,646 8,360,502 (51,501) 21,475,211
========== ======= ========= ======= ==========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 13
APPLIED INNOVATION INC.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,154,568 6,054,030 7,057,916
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 1,425,381 717,169 341,115
(Gain) loss on disposal of assets (4,004) 9,023 6,926
Provision for deferred compensation 55,631 34,185 -
Provision for deferred income taxes (699,000) 18,000 (554,000)
Effects of changes in operating assets and liabilities:
Accounts receivable (1,074,191) 1,676,639 (5,027,450)
Inventory 1,055,018 2,025,746 (4,047,467)
Prepaid expenses (41,923) (147,612) (26,862)
Other assets (50,171) (41,668) (12,322)
Accounts payable (139,774) 416,453 787,721
Accrued expenses 2,721,783 124,866 3,845,422
Deferred revenue - (3,939) (18,238)
---------- ---------- ---------
Net cash provided by operating activities 5,403,318 10,882,892 2,352,761
---------- ---------- ---------
Cash flows from investing activities:
Purchases of property, plant and equipment (2,531,577) (5,409,009) (3,563,934)
Proceeds from sale of property, plant and equipment 5,335 673 5,500
Purchase of marketable securities - - (23,178)
Proceeds from sale of marketable securities - 422,322 -
---------- ---------- ---------
Net cash used by investing activities (2,526,242) (4,986,014) (3,581,612)
---------- ---------- ---------
Cash flows from financing activities--
Proceeds from issuance of common stock 224,729 152,103 447,274
---------- ---------- ---------
Net cash provided by financing activities 224,729 152,103 447,274
---------- ---------- ---------
Increase (decrease) in cash and cash equivalents 3,101,805 6,048,981 (781,577)
Cash and cash equivalents--beginning of year 9,176,287 3,127,306 3,908,883
---------- ---------- ---------
Cash and cash equivalents--end of year $ 12,278,092 9,176,287 3,127,306
========== ========== =========
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Income taxes paid $ 1,558,832 3,613,032 1,875,994
========== ========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 14
APPLIED INNOVATION INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1996 and 1995
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following accounting principles and practices of Applied Innovation
Inc. and subsidiary (the Company) are set forth to facilitate the
understanding of data presented in the consolidated financial
statements:
(a) DESCRIPTION OF BUSINESS ACTIVITY
The Company is a leading provider of network solutions for
telecommunications service providers. The Dublin, Ohio, based
company designs and manufactures products for network management,
protocol conversion, mediation and data communication between
network elements and operations support systems. The Company's
products enable operations systems to manage all the elements in
multi-vendor, multi-protocol telecommunications networks. The
majority of the Company's customers are Regional Bell Operating
Companies, inter-exchange carriers and competitive access
providers.
(b) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Applied
Innovation Inc. and its wholly owned subsidiary. All significant
intercompany balances and transactions have been eliminated in
consolidation.
(c) CASH EQUIVALENTS
Cash equivalents of $6,104,874 and $5,557,759 at December 31, 1996 and
1995, respectively, consist of taxable and tax exempt bonds with
seven day put options. For purposes of the statement of cash
flows, the Company considers all highly liquid investments with
original maturities of three months or less to be cash
equivalents.
(d) REVENUE RECOGNITION
Sales revenue is recognized when products are shipped. Field service
revenue is recognized as projects are completed.
(e) INVENTORY
Inventory is stated at the lower of cost or market using the
first-in, first-out method.
(Continued)
<PAGE> 15
-2-
APPLIED INNOVATION INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(f) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation
is provided on the straight-line method over the estimated
useful lives as follows:
LIVES (IN YEARS)
----------------
Building 40
Vehicles 5
Equipment 3-5
Furniture 7
(g) WARRANTY
The Company warrants its products for one year after sale.
Additionally, the Company may agree to repair, replace or service
its products beyond the one year warranty period. Accordingly,
the Company accrues the estimated costs of such warranties and
services.
(h) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and
tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
(i) STOCK OPTION PLANS
Prior to January 1, 1996, the Company accounted for its stock option
plans in accordance with the provisions of Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. As such, compensation
expense would be recorded on the date of grant only if the
current market price of the underlying stock exceeded the
exercise price.
On January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based
Compensation (Statement 123), which permits entities to recognize
as expense over the vesting period the fair value of all
stock-based awards on the date of grant (fair-value-based
method). Alternatively, Statement 123 also allows entities to
continue to apply the provisions of APB Opinion No. 25 and
provide pro forma net income and pro forma earnings per share
disclosures for employee stock option grants made in 1995 and
future years as if the fair-value-based method defined in
Statement 123 had been applied. The Company has elected to
continue to apply the provisions of APB Opinion No. 25 and
provide the pro forma disclosure provisions of Statement 123.
(Continued)
<PAGE> 16
-3-
APPLIED INNOVATION INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(j) RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations when
incurred.
Software development costs have been accounted for in accordance with
Statement of Financial Accounting Standards No. 86, Accounting
for the Cost of Computer Software to be Sold, Leased or Otherwise
Marketed. Under the standard, capitalization of software
development costs begin upon the establishment of technological
feasibility or a working model, subject to net realizable value
considerations. As of December 31, 1996 and 1995, such
capitalizable costs were insignificant. Accordingly, the Company
has charged all such costs to research and development.
(k) GENERAL CREDIT RISK
The Company grants credit on open account to its customers,
substantially all of whom are in the telecommunications industry.
(l) USE OF ESTIMATES
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities
and the disclosure of contingent assets and liabilities to
prepare these consolidated financial statements in conformity
with generally accepted accounting principles. Actual results
could differ from those estimates.
(2) INVENTORY
Major classes of inventory at December 31, 1996 and 1995 are summarized
below:
<TABLE>
<CAPTION>
1996 1995
--------- ---------
<S> <C> <C>
Raw materials $ 1,831,708 1,947,014
Work-in-process 456,137 632,740
Finished goods 793,076 1,531,185
--------- ---------
3,080,921 4,110,939
Reserve for obsolescence (75,000) (50,000)
--------- ---------
$ 3,005,921 4,060,939
========= =========
</TABLE>
(3) FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of all financial instruments approximate carrying values
because of the short maturities of those instruments.
(Continued)
<PAGE> 17
-4-
APPLIED INNOVATION INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(4) LINE OF CREDIT
The Company has a $5 million revolving line of credit available. Effective
August 1, 1996, the line was extended and it expires on March 31,
1998. The outstanding principal bears interest at the London Interbank
Offered Rate plus 2% (7.5% at December 31, 1996). Borrowings under
this line are unsecured. No amounts were outstanding under this line
of credit at December 31, 1996 and 1995.
(5) STOCK SPLIT
On July 27, 1995 the Board of Directors declared a two for one common
stock split in the form of a 100% common stock dividend to
stockholders of record on August 17, 1995, payable August 31, 1995. On
January 25, 1994, the Board of Directors declared a two for one common
stock split in the form of a 100% common stock dividend to
stockholders of record on February 16, 1994, payable March 2, 1994.
All share and per share amounts in the accompanying consolidated
financial statements have been adjusted for the splits. In connection
with the stock splits, the par value has remained $.01 per share.
(6) EARNINGS PER SHARE
The calculations of earnings per share for the years ended December 31,
1996, 1995 and 1994 are based upon the weighted average shares
outstanding during the periods and, when applicable, those stock
options that are dilutive after giving retroactive effect for the two
for one splits on August 17, 1995 and February 16, 1994. Weighted
average common shares deemed outstanding, using the treasury stock
method, totaled 15,863,653, 15,953,064, and 15,863,174 shares for the
years ended December 31, 1996, 1995 and 1994, respectively.
(7) MAJOR CUSTOMERS
During the year ended December 31, 1996, revenues to three major customers
comprised 53% of total revenues. The revenues to these three customers
individually ranged from 15% to 20% of total revenues. At December 31,
1996, the amount due from these customers included in trade accounts
receivable was $2,306,795.
During the year ended December 31, 1995, revenues to four major customers
comprised 67% of total revenues. The revenues to these three customers
individually ranged from 13% to 20% of total revenues. At December 31,
1995, the amount due from those customers included in trade accounts
receivable was $3,044,350.
During the year ended December 31, 1994, revenues to three major customers
comprised 63% of total revenues. The revenues to these four customers
individually ranged from 14% to 27% of total revenues.
(Continued)
<PAGE> 18
-5-
APPLIED INNOVATION INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(8) STOCK OPTION PLANS
The Company's 1996 Stock Option Plan (the 1996 Plan) was adopted by the
Board of Directors on February 1, 1996 and approved by the
stockholders of the Company as of April 25, 1996. A total of 1,000,000
shares of common stock have been reserved for issuance under the 1996
Plan. Options granted under the 1996 Plan may be either incentive
stock options or non-statutory stock options, with maximum terms of
ten years. The exercise price of each incentive stock option must be
at least 100% of the fair market value per share of the Company's
common stock as determined by the Stock Option and Compensation
Committee on the date of grant.
Previously, the Company had adopted the 1986 Incentive Stock Option Plan
and the 1986 Non-statutory Stock Option Plan (the 1986 Plans). Options
granted under the 1986 Plans have maximum terms of ten years. The
exercise price of each incentive stock option must be at least 100% of
the fair market value per share of the Company's common stock as
determined by the Stock Option and Compensation Committee on the date
of grant.
Tax benefits realized by the Company for deductions in excess of
compensation expense under these plans are credited to additional
paid-in capital.
At December 31, 1996, there were 885,000 additional shares available for
grant under the 1996 Plan. The per share weighted-average fair value
of stock options granted during 1996 and 1995 was $6.33 and $6.55 on
the date of grant using the Black Scholes option-pricing model with
the following weighted-average assumptions used for grants in the
years ended December 31, 1996 and 1995, respectively: dividend yield
of 0% for both years; expected volatility of 66% and 71%; risk-free
interest rate of 6% for both years; and expected life of 4.3 and 3.1
years.
The Company applies APB Opinion No. 25 in accounting for its plans and,
accordingly, no compensation cost has been recognized for its stock
options in the financial statements. Had the Company determined
compensation cost based on the fair value at the grant date for its
stock options under Statement 123, the Company's net income and
earnings per share, net of related income tax effects, would have been
reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1996 1995
--------- ---------
<S> <C> <C>
Net income As reported $2,154,568 6,054,030
Pro forma 1,709,554 5,813,856
Primary earnings per share As reported $ .14 .38
Pro forma .11 .36
Fully diluted earnings per share As reported $ .14 .38
Pro forma .11 .36
</TABLE>
(Continued)
<PAGE> 19
-6-
APPLIED INNOVATION INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
Pro forma net income reflects only options granted in 1996 and 1995.
Therefore, the full impact of calculating compensation cost for stock
options under Statement 123 is not reflected in the pro forma net
income amounts presented above because compensation cost is reflected
over the options' vesting period and compensation cost for options
granted prior to January 1, 1995 is not considered.
Stock option activity during the periods indicated is as follows:
<TABLE>
<CAPTION>
Number of Weighted-average
shares exercise price
--------- ----------------
<S> <C> <C>
Balance at December 31, 1993 1,253,000 $ 1.07
Granted 285,000 11.49
Exercised (886,000) 0.51
Canceled/expired (32,000) 4.79
---------
Balance at December 31, 1994 620,000 $ 6.48
Granted 90,000 12.75
Exercised (125,000) 1.22
Canceled/expired (12,000) 4.79
---------
Balance at December 31, 1995 573,000 $ 8.65
Granted 265,000 11.19
Exercised (77,120) 2.91
Canceled/expired (58,480) 8.39
---------
Balance at December 31, 1996 702,400 $ 10.26
=========
</TABLE>
The following table summarizes information about options outstanding at
December 31, 1996:
<TABLE>
<CAPTION>
Options outstanding Options exercisable
-------------------------------------- ---------------------
Weighted-
average Weighted- Weighted-
remaining average average
Range of Number of contractual exercise Number of exercise
exercise prices shares life price shares price
--------------- ------- ---------- ------ ------- -----
<S> <C> <C> <C> <C> <C> <C>
$.625 - .685 48,200 1.0 $ .67 48,200 $ .67
$4.78 - 4.79 88,200 2.3 4.78 78,600 4.78
$7.72 - 9.75 119,400 5.1 8.76 39,400 8.25
$10.75 - 14.25 446,600 4.3 12.78 222,609 13.24
------- -------
702,400 4.0 10.26 388,809 9.46
======= =======
</TABLE>
(Continued)
<PAGE> 20
-7-
APPLIED INNOVATION INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
(9) DEFINED CONTRIBUTION PLAN
During 1992, the Company adopted a defined contribution 401(k) and profit
sharing plan which covers all eligible employees. In 1996, 1995, and
1994 the Company matched 25% of each participant's contribution up to
6% of that participant's compensation. The Company may also make
profit sharing contributions at the discretion of the Board of
Directors. For 1996, 1995 and 1994, the profit sharing contribution
was $200,000, $200,000, and $130,000, respectively, and the total
expense related to the plan was $259,061, $232,885, and $144,377,
respectively.
(10) INCOME TAXES
Income tax expense (benefit) consists of:
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
--------- --------- ---------
<S> <C> <C> <C>
Year ended December 31, 1996:
U.S. federal $ 1,706,000 (631,000) 1,075,000
State and local 249,000 (68,000) 181,000
--------- --------- ---------
$ 1,955,000 (699,000) 1,256,000
========= ========= =========
Year ended December 31, 1995:
U.S. federal $ 3,220,000 15,300 3,235,300
State and local 591,000 2,700 593,700
--------- --------- ---------
$ 3,811,000 18,000 3,829,000
========= ========= =========
Year ended December 31, 1994:
U.S. federal $ 3,929,000 (471,000) 3,458,000
State and local 1,125,000 (83,000) 1,042,000
--------- --------- ---------
$ 5,054,000 (554,000) 4,500,000
========= ========= =========
</TABLE>
A reconciliation of income tax expense at the expected federal statutory
rate (34%) to income tax expense at the Company's effective rates for
continuing operations is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Computed tax at the expected
federal statutory rate $ 1,159,593 3,360,230 3,929,691
State and local income taxes, net
of federal income tax effect 96,340 392,760 659,500
Other 67 76,010 (89,191)
--------- --------- ---------
$ 1,256,000 3,829,000 4,500,000
========= ========= =========
</TABLE>
(Continued)
<PAGE> 21
-8-
APPLIED INNOVATION INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1996 and 1995 are presented below:
<TABLE>
<CAPTION>
1996 1995
--------- -------
<S> <C> <C>
Deferred tax assets:
State income taxes $ - 91,200
Warranty reserve 1,063,212 137,320
Accounts receivable allowance 43,323 40,000
Inventory, principally due to additional costs
inventoried for tax purposes 259,875 284,925
Other 19,250 -
--------- -------
Total gross deferred tax assets 1,385,660 553,445
Deferred tax liabilities:
Plant and equipment, principally due to
difference in depreciation 244,035 123,795
State income taxes 19,635 -
--------- -------
Total gross deferred tax liabilities 263,670 123,795
--------- -------
Net deferred tax asset $ 1,121,990 429,650
========= =======
</TABLE>
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all
of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the utilization
of loss carrybacks or the generation of future taxable income during
the periods in which those temporary differences become deductible.
Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning
strategies in making this assessment. Based upon the level of
historical taxable income and projections for future taxable income
over the periods which the deferred tax assets are deductible,
management believes that it is more likely than not the Company will
realize the benefits of these deductible differences and, therefore,
no valuation allowance has been provided.
(11) BONUS PLAN
In 1996 and 1995, the Company offered a bonus plan to certain officers
and managers. Depending on the level of pretax, prebonus earnings
achieved, participants are entitled to specified percentages of their
base salaries as bonuses. The bonuses are payable on March 15
following the year end with 50% payable in cash and 50% payable in
restricted, forfeitable shares of common stock at specified values.
The shares vest and become nonforfeitable if the participants are
still employed by the Company three years after the payable date.
(Continued)
<PAGE> 22
-9-
APPLIED INNOVATION INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements, Continued
The deferred compensation represents a contra equity account to be
amortized over the three-year vesting period. The related shares of
common stock are included as common stock equivalents in the earnings
per share calculation.
(12) LEASE COMMITMENTS
The Company is obligated for office space in North Carolina under a five
year operating lease, with termination rights after three years upon
payment of a specified termination fee. Rental payments include
minimum base rent plus payments for taxes, insurance and certain
operating, repair and maintenance expenses of the facility. There was
no rent expense in 1996 or 1995 as the Company did not occupy the
office space until 1997.
Future minimum lease payments under the operating lease as of December 31,
1996 are:
<TABLE>
<CAPTION>
Year ending December 31:
<S> <C> <C>
1997 $ 225,170
1998 245,640
1999 245,640
2000 245,640
2001 245,640
2002 20,470
---------
Total minimum lease payments $ 1,228,200
=========
</TABLE>
(13) CONTINGENCIES
The Company is involved with various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse
effect on the Company's consolidated financial position, results of
operations or liquidity.
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors
Applied Innovation Inc.:
We consent to incorporation by reference in the registration statements (No.
33-62646, 33-94582 and 333-4432) on Form S-8 of Applied Innovation Inc. of our
report dated February 14, 1997, relating to the consolidated balance sheets of
Applied Innovation Inc. and subsidiary as of December 31, 1996 and 1995, and
the related consolidated statements of income, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1996,
which report appears in the December 31, 1996, annual report on Form 10-K of
Applied Innovation Inc.
/s/ KPMG Peat Marwick LLP
Columbus, Ohio
March 26, 1997
<PAGE> 1
POWER OF ATTORNEY
-----------------
Each of the undersigned officers and directors of Applied Innovation Inc.,
a Delaware corporation (the "Company"), hereby appoints Gerard B. Moersdorf, Jr.
and Curtis A. Loveland as his true and lawful attorneys-in-fact, or either of
them, with power to act without the other, as his true and lawful
attorney-in-fact, in his name and on his behalf, and in any and all capacities
stated below, to sign and to cause to be filed with the Securities and Exchange
Commission the Company's annual report on Form 10-K, for the year ended December
31, 1996, and any and all amendments thereto, hereby granting unto said
attorneys, and to each of them, full power and authority to do and perform in
the name and on behalf of the undersigned, in any and all such capacities, every
act and thing whatsoever necessary to be done in and about the premises as fully
as each of the undersigned could or might do in person, hereby granting to each
such attorney full power of substitution and revocation, and hereby ratifying
all that either such attorney or his substitute may do by virtue hereof.
IN WITNESS WHEREOF, the undersigned have executed this Power of Attorney in
counterparts if necessary, effective as of March 23, 1997.
/s/ Gerard B. Moersdorf, Jr.
-------------------------------------
Gerard B. Moersdorf, Jr.
Chairman, President and Treasurer
(Principal Executive and Financial Officer)
/s/ John M. Spiegel
-------------------------------------
John M. Spiegel, Comptroller
(Principal Accounting Officer)
/s/ James H. Blough
-------------------------------------
James H. Blough, Director
/s/ Curtis A. Loveland
-------------------------------------
Curtis A. Loveland, Director
/s/ Gerard B. Moersdorf, Sr.
-------------------------------------
Gerard B. Moersdorf, Sr., Director
/s/ Richard W. Oliver
-------------------------------------
Richard W. Oliver, Director
/s/ Thomas W. Huseby
-------------------------------------
Thomas W. Huseby, Director
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 12,278,092
<SECURITIES> 0
<RECEIVABLES> 7,759,045
<ALLOWANCES> 112,528
<INVENTORY> 3,005,921
<CURRENT-ASSETS> 24,567,166
<PP&E> 13,448,226
<DEPRECIATION> 2,470,584
<TOTAL-ASSETS> 35,662,244
<CURRENT-LIABILITIES> 5,476,351
<BONDS> 0
0
0
<COMMON> 157,646
<OTHER-SE> 29,784,212
<TOTAL-LIABILITY-AND-EQUITY> 35,662,244
<SALES> 41,145,876
<TOTAL-REVENUES> 41,145,876
<CGS> 20,403,555
<TOTAL-COSTS> 20,403,555
<OTHER-EXPENSES> 17,859,713
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 3,410,568
<INCOME-TAX> 1,256,000
<INCOME-CONTINUING> 2,154,568
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,154,568
<EPS-PRIMARY> 0.14
<EPS-DILUTED> 0.14
</TABLE>
