<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 0-21352
APPLIED INNOVATION INC.
(Exact name of registrant as specified in its charter)
DELAWARE 31-1177192
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification no.)
5800 INNOVATION DRIVE, DUBLIN, OHIO 43016
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (614)-798-2000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
As of August 6, 1999 there were 15,540,732 shares of common stock outstanding.
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<TABLE>
APPLIED INNOVATION INC.
Table of Contents
<CAPTION>
Page
----
<S> <C>
Facing Page 1
Table of Contents 2
Part I. Financial Information
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Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
June 30, 1999 (Unaudited) and December 31, 1998 3
Condensed Consolidated Statements of Operations for the
three and six months ended June 30, 1999 and 1998 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 1999 and 1998 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6 - 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8 - 12
Item 3. Quantitative and Qualitative Disclosure About Market Risk 12
Part II.Other Information
- -------------------------
Items 1 - 5 12
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits 13
(b) Reports on Form 8-K - None
Signatures 14
</TABLE>
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Part 1. Financial Information
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Item 1. Financial Statements
<TABLE>
APPLIED INNOVATION INC.
Condensed Consolidated Balance Sheets
<CAPTION>
Assets
------
(Unaudited)
June 30, 1999 December 31, 1998
------------- -----------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $16,355,375 $17,211,499
Short-term investments 174,618 --
Accounts receivable, net of allowance 7,472,389 7,698,250
Inventory 3,040,156 3,620,655
Prepaid expenses 175,594 295,923
Deferred income taxes 1,450,000 1,410,000
----------- -----------
Total current assets 28,668,132 30,236,327
Property, plant and equipment - net 8,758,192 9,426,240
Investments 3,077,717 --
Other assets 48,257 107,106
----------- -----------
Total Assets $40,552,298 $39,769,673
=========== ===========
<CAPTION>
Liabilities and Stockholders' Equity
------------------------------------
(Unaudited)
June 30, 1999 December 31, 1998
------------- -----------------
<S> <C> <C>
Current liabilities:
Accounts payable $ 1,532,777 $ 1,051,922
Accrued expenses 2,463,366 4,355,069
Accrued warranty expenses 2,298,185 2,644,738
Deferred revenue 533,325 11,261
----------- -----------
Total current liabilities 6,827,653 8,062,990
----------- -----------
Deferred income taxes 50,000 64,000
----------- -----------
Stockholders' equity:
Common stock; $.01 par value; 30,000,000 shares
authorized; 15,540,732 shares issued and outstanding
in June, 1999; 15,786,132 shares issued and
outstanding in December, 1998 155,407 157,861
Additional paid-in capital 7,452,284 8,337,154
Retained earnings 26,095,453 23,147,668
Accumulated other comprehensive loss - net
unrealized loss on investment securities (28,499) --
----------- -----------
33,674,645 31,642,683
----------- -----------
Total Liabilities and Stockholders' Equity $40,552,298 $39,769,673
=========== ===========
</TABLE>
See accompanying note to condensed consolidated financial statements.
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<TABLE>
APPLIED INNOVATION INC.
Condensed Consolidated Statements of Operations (Unaudited)
<CAPTION>
Three months ended June 30, Six months ended June 30,
--------------------------- ---------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales $12,522,529 $14,783,826 $23,376,631 $26,301,575
Cost of sales 5,344,836 6,512,403 9,610,363 11,376,770
----------- ----------- ----------- -----------
Gross profit 7,177,693 8,271,423 13,766,268 14,924,805
Operating expenses:
Research and development 1,781,652 3,948,475 3,401,541 7,287,485
Selling, general, and administrative 2,936,369 4,053,012 6,138,603 7,651,797
----------- ----------- ----------- -----------
Income (loss) from operations 2,459,672 269,936 4,226,124 (14,477)
Other income, net 169,158 164,353 381,661 272,300
----------- ----------- ----------- -----------
Income before income taxes 2,628,830 434,289 4,607,785 257,823
Income taxes 947,000 148,000 1,660,000 88,000
----------- ----------- ----------- -----------
Net income $ 1,681,830 $ 286,289 $ 2,947,785 $ 169,823
=========== =========== =========== ===========
Basic earnings per share $ 0.11 $ 0.02 $ 0.19 $ 0.01
=========== =========== =========== ===========
Diluted earnings per share $ 0.11 $ 0.02 $ 0.19 $ 0.01
=========== =========== =========== ===========
Weighted average shares outstanding
for basic earnings per share 15,663,296 15,802,357 15,722,931 15,796,595
=========== =========== =========== ===========
Weighted average shares outstanding
for diluted earnings per share 15,695,590 16,212,409 15,758,668 16,038,542
=========== =========== =========== ===========
</TABLE>
See accompanying note to condensed consolidated financial statements.
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<TABLE>
APPLIED INNOVATION INC.
Condensed Consolidated Statements of Cash Flows (Unaudited)
<CAPTION>
Six Months Ended June 30,
-----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,947,785 $ 169,823
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 992,843 1,478,552
Loss(gain) on sale of assets 68,057 (7,368)
Provision for deferred income taxes (54,000) (155,000)
Effects of change in operating assets and liabilities:
Accounts receivable 225,861 2,246,884
Inventory 580,499 (182,370)
Prepaid expenses 120,329 194,823
Other assets 58,849 (8,322)
Accounts payable 480,855 (664,970)
Accrued expenses (2,238,256) 420,610
Deferred revenue 522,064 --
----------- -----------
Net cash provided by operating activities 3,704,886 3,492,662
----------- -----------
Cash flows from investing activities:
Purchases of short-term available for sale investments (203,117) --
Purchases of available for sale investments (3,077,717) --
Purchases of property and equipment (416,286) (700,511)
Proceeds from sale of assets 23,434 28,910
----------- -----------
Net cash used by investing activities (3,673,686) (671,601)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock -- 20,024
Tax benefit associated with exercise of stock options -- 714
Common stock repurchased (887,324) --
----------- -----------
Net cash provided (used) by financing activities (887,324) 20,738
----------- -----------
Increase(decrease) in cash and cash equivalents (856,124) 2,841,799
Cash and cash equivalents - beginning of period 17,211,499 8,195,156
----------- -----------
Cash and cash equivalents - end of period $16,355,375 $11,036,955
=========== ===========
</TABLE>
See accompanying note to condensed consolidated financial statements.
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APPLIED INNOVATION INC.
Notes to Condensed Consolidated Financial Statements
June 30, 1999 and 1998
(Unaudited)
1. Basis of presentation - The condensed consolidated balance sheet as of June
30, 1999, the condensed consolidated statements of operations for the three and
six months ended June 30, 1999 and 1998, the condensed consolidated statement of
stockholders' equity for the six months ended June 30, 1999 and 1998, and the
condensed consolidated statements of cash flows for the six month periods then
ended have been prepared by the Company without audit. In the opinion of
management, all adjustments, which consist solely of normal recurring
adjustments, necessary to present fairly, in accordance with generally accepted
accounting principles, the financial position, results of operations and changes
in cash flows for all periods presented have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These condensed consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's December 31, 1998 Annual
Report on Form 10-K. The results of operations for the period ended June 30,
1999 are not necessarily indicative of the results for the full year.
2. Inventory - Inventory is stated at the lower of cost or market using the
first-in, first-out method, net of allowances for estimated obsolescence. Major
classes of inventory at June 30, 1999 and December 31, 1998 are summarized
below:
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
------------- -----------------
<S> <C> <C>
Raw materials $2,095,712 $2,280,652
Work-in-process 294,473 235,062
Finished goods 869,971 1,264,941
---------- ----------
3,260,156 3,780,655
Reserve for obsolescence (220,000) (160,000)
---------- ----------
$3,040,156 $3,620,655
========== ==========
</TABLE>
3. Investments - During the six month period ended June 30, 1999, the company
invested $3,281,000 in securities and Treasury notes. Those investments
scheduled to mature in more than one year have been classified as non-current
investments. All investments at June 30, 1999 are considered available-for-sale
and, accordingly, are recorded at fair value. The difference between historical
cost (purchase price) and fair value has been recorded as a reduction to
stockholders' equity.
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4. Income taxes - The Company has recorded its interim income tax provision
based on estimates of the Company's effective tax rate expected to be applicable
for the full fiscal year. Estimated effective rates recorded during interim
periods may be periodically revised, if necessary, to reflect current estimates.
5. Comprehensive income - Comprehensive income for the three and six months
ended June 30, 1999 was $1,653,331 and $2,919,286, respectively. Comprehensive
income for the three and six months ended June 30, 1998 was $286,289 and
$169,823, respectively. The adjustment necessary to reconcile net income with
comprehensive income is for the net unrealized loss on investment securities.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF THE SECOND QUARTER AND SIX MONTHS ENDED JUNE 30, 1999 VS. SECOND
QUARTER AND SIX MONTHS ENDED JUNE 30, 1998
Net sales for the second quarter of 1999 were $12,523,000, a decrease of 15%
from net sales of $14,784,000 for the second quarter of 1998. Year-to-date, net
sales for 1999 are down 11% over 1998. This decrease is attributable to a lower
number of systems sold. Because of the Company's concentration of sales to
Regional Bell Operating Companies (RBOC's) and long distance phone companies, a
small number of customers have represented substantial portions of net sales.
For the first six months of 1999, sales to three companies comprised 58% of net
sales. Each of the three customers contributed between 11% and 31% of net sales.
The Company sells to all of the RBOC's.
Gross profit as a percentage of net sales was 57% for the second quarter of 1999
versus 56% for the same period in 1998. Year-to-date gross profit percentages
were 59% and 57% for 1999 and 1998, respectively. The Company anticipates that
gross profit as a percentage of net sales will decrease over the remainder of
1999 due to the Company's new aggressive pricing strategy to address increased
competition.
Research and development (R&D) expenses decreased 55% to $1,782,000 for the
second quarter of 1999 from $3,948,000 for the same period in 1998. R&D
decreased as a percentage of net sales to 14% for the second quarter of 1999
from 27% for the same period in 1998. Year-to-date R&D expenses were $3,402,000
for 1999 and $7,287,000 for 1998. As a percentage of net sales, this represents
15% for 1999 and 28% for 1998. The decrease in R&D expenses was attributable to
the termination of the Access Products Group on September 14, 1998. R&D expenses
for the Access Products Group were $4,630,000 for the first six months of 1998.
The Company anticipates that R&D expenses in the third quarter of 1999 will be
lower than in 1998 due to the termination of the Access Products Group.
Selling, general and administrative expenses (SG&A) decreased to $2,936,000 in
the second quarter of 1999 from $4,053,000 in 1998. As a percentage of net
sales, this represents 23% in 1999 and 27% in 1998. Year-to-date SG&A was
$6,139,000 for 1999 and $7,652,000 for 1998 and represented 26% of net sales in
1999 and 29% in 1998. The significant decrease in SG&A is primarily due to a
reduction in administrative staffing and decreased use of consulting services.
The Company expects additional decreases in SG&A during the remainder of 1999
due to the termination of the Access Products Group and other cost improvement
programs.
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<PAGE> 9
As a result of the above factors, income from operations increased to $2,460,000
in the second quarter of 1999 from $270,000 in the second quarter of 1998.
Second quarter income from operations represents 20% and 2% of net sales in 1999
and 1998, respectively. Year-to-date income from operations was $4,226,000 for
1999 versus a loss from operations of $14,000 in 1998. Year-to-date income from
operations represents 18% of net sales in 1999 versus a loss from operations of
less than 1% in 1998.
The Company's effective income tax rate was 36% for the current quarter versus
an effective rate of 34% for the same period in 1998.
LIQUIDITY AND CAPITAL RESOURCES
Cash decreased by $856,000 during the first six months of 1999 to $16,355,000 at
June 30, 1999. However, the Company invested approximately $3,281,000 in short
and long term investments during the period. Operating activities produced
$3,705,000 in cash. During the same period in 1998, cash increased by $2,842,000
to $11,037,000 at June 30, 1998.
Net working capital was $21,840,000 at June 30, 1999 compared to $22,173,000 at
December 31, 1998. Current ratios on those dates were 4.2:1 and 3.8:1,
respectively. The Company had no long-term debt at June 30, 1999 or December 31,
1998.
Net capital expenditures were $416,000 for the first half of 1999 and $701,000
for the same period in 1998. Cash used for investing activities also included
$3,281,000 for the net purchases of short and long-term investments.
On October 23, 1998, the Company's Board of Directors approved a stock
repurchase program which allows the Company to repurchase up to one million
shares of its Common Stock, $.01 par value, through October 22, 1999. As of June
30, 1999, 279,200 shares had been purchased under this program. The Company
intends to finance any additional stock purchases under the program using
existing cash reserves.
The Company believes that its existing cash, cash equivalents, investments, and
cash to be generated from future operations will provide sufficient capital to
meet the business needs of the Company through the end of 1999.
-9-
<PAGE> 10
YEAR 2000
The Company faces year 2000 compliance issues similar to those faced by other
companies which design, manufacture, and sell equipment used in the
telecommunications industry. Year 2000 compliance issues typically arise with
respect to computer software systems and programs that use only two digits,
rather than four digits, to represent a particular year. Consequently, these
systems and programs may not process dates properly beyond the year 1999 and may
result in miscalculation or system failures causing disruptions of business
operations.
The Company's product development processes currently contain steps to include
year 2000 compliance verification for all current and future products. Most of
the Company's products are currently year 2000 compliant, and the Company
believes that compliance for all of its products will be achieved prior to
January 1, 2000. Customers may upgrade non-compliant products to existing
compliant products. Although the products currently offered by the Company have
been tested for year 2000 compliance, any failure of the Company's products to
perform, including the failure to process dates beyond the year 1999, could have
a material adverse effect on the Company's business, financial condition, and
results of operations. The Company's future net sales could be impacted if
customers divert portions of their capital expenditure budgets toward the year
2000 issue and away from programs that include purchases of the Company's
products.
The Company has completed its initial assessment of its internal computer
information systems and non-computer systems, which contain embedded computer
technology, to determine if such systems are year 2000 compliant. Non-compliant
systems have been categorized by their importance to the Company's operations as
critical, moderate, and non-critical. The Company is currently correcting known
non-compliant systems and presently believes that the amount of remediation work
required to address year 2000 problems is not extensive. The Company has
replaced certain financial and operational systems in the last several years,
and management believes that the new equipment and software substantially
address year 2000 issues.
The Company currently estimates that the total cost of addressing year 2000
issues will be approximately $700,000. The Company has already incurred
approximately $385,000 through June 30, 1999 in addressing year 2000 evaluation
and remediation work. All costs related to year 2000 evaluation and compliance
are being expensed by the Company as incurred, except for long-lived assets,
which will be capitalized in accordance with the Company's capitalization
policies.
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<PAGE> 11
The Company has not determined whether year 2000 issues affecting key suppliers,
significant customers, or critical service providers will materially impact the
Company's cash flows or operating results. A reasonably likely worst case
scenario of the year 2000 issue could include: isolated performance problems
with engineering, financial and administrative systems; isolated interruption of
deliveries from critical suppliers; product liability or warranty issues; and
the temporary inability of key customers to pay amounts due us. However, the
Company believes that the potential impact of a failure of its products in its
customers' telecommunications networks would be minimal due to the function that
its products serve. The Company's products assist customers in managing their
telecommunications networks but do not carry customer telecommunications
traffic.
Contingency plans are being prepared, and will be implemented if necessary,
including having sufficient liquidity available to sustain a temporary
interruption of cash receipts during early 2000 and the identification of
alternative suppliers for critical components. There can be no assurance that we
have identified, or will identify, all year 2000 affected systems, suppliers,
customers, and service providers, or that our corrective action plan will be
timely and successful.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The foregoing Management's Discussion and Analysis of Financial Condition and
Results of Operations contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, which are intended to be
covered by the safe harbors created thereby. These statements include, but may
not be limited to, all statements regarding intent, beliefs, expectations,
projections, forecasts, and plans of the Company and its management, and include
statements regarding future gross profit margins (paragraph 2), future R&D
expenditures (paragraph 3), future SG&A expenditures (paragraph 4),
implementation and financing of the stock repurchase program (paragraph 10),
sufficiency of capital resources (paragraph 11) and preparedness and compliance
with year 2000 issues (paragraphs 12 through 16). These forward-looking
statements involve numerous risks and uncertainties, including, without
limitation, the Company's ability to develop new products as planned and on
budget, the impact of competitive products and services, the fact that the
Company may decide to substantially increase R&D expenditures to meet the needs
of its business and customers, currently unforeseen circumstances could require
the use of capital resources, year 2000 issues are not fully determined and
resolved and could require additional efforts and expenditures and could impose
additional and unknown risks, and the various risks inherent in the Company's
business and other risks and uncertainties detailed from time to time in the
Company's periodic reports filed with the Securities and Exchange Commission,
including, the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1998. One or more of these factors have affected, and could in the
future affect, the Company's business and financial results and could cause
actual results to differ materially from
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<PAGE> 12
plans and projections. Therefore, there can be no assurance that the
forward-looking statements included in this press release will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as a representation by the Company, or any other person,
that the objectives and plans of the Company will be achieved. All
forward-looking statements are based on information presently available to the
management of the Company. The Company assumes no obligation to update any
forward-looking statements.
Item 3. Quantitative and Qualitative Disclosure about Market Risk -
The Company does not have any material exposure to interest rate changes,
commodity price changes, foreign currency fluctuation, or similar market risks.
Furthermore, the Company has not entered into any derivative contracts and the
Company has no debt outstanding as of June 30, 1999.
Part II. Other Information
- ---------------------------
Items 1 - 3. Inapplicable
Item 4. Submission of Matters to a Vote of Security Holders
(a) Applied Innovation Inc. held its annual meeting of stockholders on
April 22, 1999, for the purpose of electing two Class III directors.
(b) At the annual meeting of stockholders, all directors nominated were
elected.
(c) The table shows the voting tabulation for each matter voted upon at the
annual meeting of stockholders.
<TABLE>
<CAPTION>
ACTION FOR WITHHELD
- ------ --- --------
<S> <C> <C> <C>
Election of Class II Directors:
Gerard B. Moersdorf, Jr. 14,505,121 469,503
Alexander B. Trevor 14,502,921 471,703
</TABLE>
Item 5. Inapplicable
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<PAGE> 13
Part II. Other Information
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
APPLIED INNOVATION INC.
Exhibit 11
Statement Regarding Computation of Earnings Per Share For
the six months ended June 30, 1999 and 1998
<CAPTION>
1999 1998
(Unaudited) (Unaudited)
----------- -----------
<S> <C> <C>
Weighted average number of common
shares outstanding - used for
computation of basic earnings
per share 15,722,931 15,796,595
Add net shares issuable pursuant to stock
option plans less shares assumed
repurchased at the average market price 35,737 241,947
---------- ----------
Number of shares for computation of
diluted earnings per share 15,758,668 16,038,542
========== ==========
Net income for basic and diluted
earnings per share $2,947,785 $ 169,823
========== ==========
Basic earnings per share $ .19 $ .01
========== ==========
Diluted earnings per share $ .19 $ .01
========== ==========
</TABLE>
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K - None
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<PAGE> 14
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
APPLIED INNOVATION INC.
-----------------------
(Registrant)
August 13, 1999 /s/ Gerard B. Moersdorf, Jr.
- --------------- ------------------------------------------
Date Gerard B. Moersdorf, Jr.
Chairman of the Board, President,
Chief Executive Officer and Treasurer
(Principal Executive Officer)
August 13, 1999 /s/ Michael P. Keegan
- --------------- ------------------------------------------
Date Michael P. Keegan
Vice President and Chief Financial Officer
(Chief Financial Officer)
August 13, 1999 /s/ John M. Spiegel
- --------------- ------------------------------------------
Date John M. Spiegel
Controller
(Principal Accounting Officer)
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<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000798399
<NAME> APPLIED INNOVATION INC.
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 16,355,375
<SECURITIES> 174,618
<RECEIVABLES> 7,745,342
<ALLOWANCES> 272,953
<INVENTORY> 3,040,156
<CURRENT-ASSETS> 28,668,132
<PP&E> 13,809,822
<DEPRECIATION> 5,051,630
<TOTAL-ASSETS> 40,552,298
<CURRENT-LIABILITIES> 6,827,653
<BONDS> 0
0
0
<COMMON> 155,407
<OTHER-SE> 33,519,238
<TOTAL-LIABILITY-AND-EQUITY> 40,552,298
<SALES> 23,376,631
<TOTAL-REVENUES> 23,376,631
<CGS> 9,610,363
<TOTAL-COSTS> 9,610,363
<OTHER-EXPENSES> 9,470,144
<LOSS-PROVISION> 70,000
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 4,607,785
<INCOME-TAX> 1,660,000
<INCOME-CONTINUING> 2,947,785
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,947,785
<EPS-BASIC> .19
<EPS-DILUTED> .19
</TABLE>
