<PAGE> 1
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 FOR
THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT UNDER 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.
(Name of registrant as specified in its charter)
DELAWARE 31-1177192
(State or other jurisdiction (I.R.S. Employer Identification No.)
of 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
--- ---
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,
8,899,323 shares, based on the $13.00 closing sale price on March 10, 2000, was
$115,691,199.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: 15,496,852 shares of Common
Stock were outstanding at March 10, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Annual Report to the Stockholders for the fiscal
year ended December 31, 1999, are incorporated by reference in Part II.
Part III - Proxy Statement for the Annual Meeting of Stockholders to be held
April 27, 2000, in part, as indicated.
<PAGE> 2
This Annual Report on Form 10-K contains forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, and Section 26A of the Securities Act of 1933, as amended. The words
"anticipate," "believe," "expect," "estimate," and "project" and similar words
and expressions identify forward-looking statements which speak only as of the
date hereof. Investors are cautioned that such statements involve risks and
uncertainties that could cause actual results to differ materially from
historical or anticipated results due to many factors, including, but not
limited to, the factors discussed in "Business - Business Risks." The Company
undertakes no obligation to publicly update or revise any forward-looking
statements.
PART I
ITEM 1. BUSINESS.
--------
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 service providers to
manage elements in their customer service network systems.
The Company's predecessor was incorporated in 1983 and engaged
primarily in development and preliminary testing activities until September
1984. 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 MARKETS
The Company's products provide the data network used to support
Operations Support Systems needed to monitor and maintain thousands of pieces of
electronic equipment, or Network Elements, used by telecommunications service
providers. Network Elements provide the switching, connections and support
products required to transmit voice and data calls through one or more Central
Offices. Telecommunications service providers 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 the Company's 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. The Company's customers can use the Operations Support Systems
to perform a variety of tasks that include: fault management, configuration
management, performance management, security and inventory management.
-2-
<PAGE> 3
The Company is seeking to expand distribution for its products outside
the United States. The Company has taken early steps to establish a presence,
through distributors, OEM agreements, or otherwise, in Australia, Canada, China,
Mexico, the Philippines, Taiwan and South Africa. The Company believes that
countries currently building telecommunications infrastructures will require
centralized network management and the supporting data communications capability
supplied by its products.
The Company estimates that the Regional Bell Operating Companies
(RBOCs) 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 firms like GTE, Sprint, AT&T, MCIWorldcom, and over
1,000 smaller independent firms, competitive local exchange carriers (CLECs) and
long distance companies. Because of their relative size, demand for product, and
importance, the Company has concentrated its marketing efforts on the larger
telecommunications service providers. The Company has historically received a
large percentage of its annual net sales from RBOCs. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Each telecommunications service provider has a finite number of Central
Office facilities which limit their total capacity for the Company's products.
To the extent that the Company achieves significant penetration with the
Company's products into any single customer's Central Office facilities, it
cannot anticipate substantial additional sales of those existing products to the
customer. Future domestic sales growth to these customers depends on the
development and acceptance of new products and new releases of existing
products. Additional sales growth may be derived from additional sales to other
RBOCs, CLECs and long distance phone companies. See "Business - Business Risks -
Risks Associated with Customer Concentration; Dependence on Telecommunications
Industry."
PRODUCTS
AISWITCH(TM)
- ------------
The AISwitch connects multiple generations of telecommunications
network equipment to computers that monitor, control and analyze field
conditions. The AISwitch incorporates the latest high speed microprocessor and
programmable gate array technology to bridge the hardware and software gaps
between old and new equipment, providing productivity gains and cost savings at
both the customer's Central Office and the Operations Centers. Substantially all
vintages of telecommunications network equipment can be integrated with support
systems through the use of the AISwitch.
The AISwitch provides connectivity and visibility among the diverse
communication protocols and vendor equipment found in every telecommunications
network. Within a typical telecommunications service region, there may be as
many as 10,000 Network Elements to interface
-3-
<PAGE> 4
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.
A unique capability of the AISwitch and the Company's technical
organization is the ability to engineer custom interfaces for telecommunications
equipment produced by a variety of different manufacturers for
telecommunications service providers. Each AISwitch includes a wide variety of
functions and options that are configured to fit client needs.
The key to the AISwitch integration capability is its flexible
microprocessor controlled digital switching and protocol processing
capabilities. The AISwitch 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 (OAM&P) systems.
The AISwitch features NEBS Level 3 compliance, Hot Swap capability,
software download and is Simple Network Management Protocol (SNMP) manageable.
It ensures 100% connectivity, 100% reliability and 100% availability from OS
systems to Network Elements across any data communication network.
The Company has licensed technology from Cisco Systems, Inc. ("Cisco")
which allows the Company to integrate a Cisco router into the AISwitch. Cisco's
routing technology is the most widely used and allows the AISwitch to work
smoothly with the routing technology already in use by most of the Company's
customers. See "Business - Business Risks - Reliance on Suppliers."
AISCOUT(TM)
- -----------
The AIscout is a self-contained, economical, mediation and
concentration device providing versatile functionality and hardware connectivity
for data communications networks. While designed for smaller Central Offices,
Controlled Environmental Vaults and collocation sites, the AIscout offers many
features to meet a broad range of network needs. It is ideal for protocol
mediation and port concentration for transporting OAM&P data between Network
Elements and Operational Support Systems. The AIscout offers remote software
download capabilities, remote configuration, SNMP manageability, configuration
backup, download and restore and local craft access. These management features
contribute to more efficient allocation of customers' manpower. By integrating
the AIflex (Fiber LAN Extender - a WDM technology) within the AIscout, the OAM&P
traffic may use the same fiber as the payload traffic. This eliminates the need
for routers and CSU/DSUs, which in turn flatten out the network and eliminates
both the need for installing a dedicated circuit and recurring monthly dedicated
circuit costs.
-4-
<PAGE> 5
APPLIEDVIEW(TM)
- ---------------
AppliedView is an element management system which allows the people and
operations systems in a Network Operations Center to monitor the status of
AISwitch units in remote locations such as Central Offices and Controlled
Environmental Vaults. The program includes software download and configuration
backup for remote AISwitch units. AppliedView gives Network Operations Center
technicians the same view as a technician standing in front of the switch. It
provides centralized, constant and continuous surveillance and provisioning of
the AISwitch network. Through a graphical user interface, this network manager
reduces the cost and time required for upgrades and remote site maintenance.
AIFLEX(TM)
- ----------
The AIflex enables telecom companies to use existing fiber connections
from the Central Office to monitor and manage Controlled Environmental Vaults,
huts and shelters. The AIflex uses Wave Division Multiplexer (WDM) technology to
enable telecommunication providers to manage remote locations as nodes on a
Central Office-based LAN. Connecting directly to existing fiber without
interfering with existing payload, AIflex transmits management data between
remote sites and the central office without additional cost and delays
associated with extra lines or routers. Utilizing existing fiber saves money,
saves recurring circuit costs, frees a resource generating circuit and speeds
deployment time.
AIM(TM)
- -------
The Applied Innovation Mediator (AIM) is a lower-cost alternative to
the AISwitch that provides operations center management of small office network
elements in small central offices, Controlled Environmental Vaults, cell sites
and huts. It provides connectivity to virtually any network element, OS system,
or data communications network in a compact, cost-effective package. The AIM
also integrates diverse protocols and physical interfaces of network elements
for OAM&P applications.
NEWEB(TM)
- ---------
NEWEB combines the AISwitch and Web technology for simple, secure
access to Network Elements from anywhere, anytime. Using a client/server
architecture, NEWEB provides users with a simple intuitive means to locate and
connect to specific network elements through a point and click, pull-down menu
interface. NEWEB gives technicians direct access, with PCs or workstations, to
remote Network Elements. Users increase their productivity by eliminating
unnecessary field service calls. NEWEB also enables users to diagnose and repair
faults in less time while shortening their learning curve for Network Element
provisioning and troubleshooting. With a multi-level
-5-
<PAGE> 6
security system that requires a password and username, properly authorized users
can easily add new Network Elements and customize the menu commands to meet
specific user needs. As a result, one user may be granted limited access to a
single equipment type in a city, while another user may have full access to
everything in a network, nationwide.
AISPY(TM)
- ---------
AIspy is a comprehensive system for managing small telecom sites such
as Controlled Environmental Vaults, cell sites, huts, collocation sites, small
central offices and remote and unmanned facilities. AIspy provides monitoring
capabilities for the entire facility through a multitude of alarms and sensors.
AIspy is built to telephone company standards and provides the customer with
multiple management and communication path options. It has the capability to
control and record access into the monitored site through either keypad or
cellular phone (DTMF) input.
MANUFACTURING AND OPERATIONS
All of the printed circuit boards used within the Company's products
are proprietary designs of the Company. Printed circuit boards and power
supplies used in each of the Company's products are contracted out to third
party manufacturing firms for assembly. These subassemblies are then shipped to
the Company for testing and final assembly. Procurement of materials is driven
through an enterprise resource planning ("ERP") system with production forecasts
supplied to contract firms for component ordering from sources supplied and
approved by the Company. The Company maintains and controls all documentation
and process requirements for products manufactured by the contract assembly
firms. The Company utilizes multiple assembly firms and is, therefore, not
dependent on any single third party manufacturer.
The Company performs multiple inspections on its products as well as
various test procedures prior to shipment to customers. These processes are
designed to assure product performance and reliability in the environments in
which the products will be used. The Company has made and continues to make
significant investments to attain quality assurance consistent with stringent
industry standards. The Company develops and manufactures its products in
accordance with NEBS and Generic Equipment Requirements guidelines. The Company
is International Standards Organization 9001 ("ISO 9001") certified.
SALES AND MARKETING
The Company's products and services are sold primarily through its own
sales force, except for independent sales agents in Canada, South Africa,
Australia and Taiwan. The Company is exploring alternative distribution channels
to allow sales of the Company's products to markets that are not easily
accessible nor cost effective for its own sales force. In addition to the
Dublin, Ohio headquarters, the Company maintains sales offices in Atlanta,
Chicago, Dallas, Denver and New York.
-6-
<PAGE> 7
The Company's sales and marketing staff consists of a Senior Vice
President of Sales, a Director of Marketing, a Director of International
Marketing, a Director of Product Line Management, a Director of Customer
Service, Regional Sales Managers, Senior Account Managers, Account Managers,
Associate Account Managers, Sales Engineers, Product Line Managers and an
administrative staff. Sales leads are currently generated primarily through
target marketing to telecommunications service providers, direct mail and trade
shows. Sales leads are followed up by personal contact from the Company's sales
and marketing staff. If sufficient interest exists, an on-site visit may be
scheduled for the purpose of making a sales presentation, which may include a
product demonstration.
The technical complexity of the Company's products and the relative
large size of customers creates a long sales cycle for the Company's products.
The technical nature of the products and Central Office environment also
mandates a very technical sales force. The Company's sales force receives
incentive compensation based on increased levels of sales.
RESEARCH AND DEVELOPMENT
The Company's research and development ("R&D") activity is coordinated
with product management to create product development teams that focus on
customer requirements. Enhancements to the AISwitch 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 is being enhanced to accommodate older
data communication standards in order to broaden its range of application
The Company spent $7,479,496, $11,979,875 and $12,897,072, on
Company-sponsored R&D during the fiscal years ended December 31, 1999, 1998 and
1997, respectively. R&D expenditures represented approximately 15.1%, 22.3%, and
27.6% of annual net sales in fiscal 1999, 1998 and 1997, respectively. During
1998 and 1997, the Company incurred $6,263,000 and $6,536,000, respectively, in
R&D related to the terminated Access Products Group development activity. The
Company expects to commit a substantial amount of resources and cash to its
research and development efforts during 2000. See "Business - Business Risks -
New Products and Rapid Technological Change; Need to Manage Product
Transitions."
CUSTOMER SERVICE AND WARRANTY
The Company offers its customers a variety of support services such as
project management, training, detail engineering, installation and test and
turn-up. Project managers interface between the Company and customers for
installation of new products and service and upgrades of existing products. The
project manager is also responsible for assuring that all possible circumstances
are anticipated prior to certifying the system for full operation. Following
installation, the project 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 at the customer's
-7-
<PAGE> 8
site or at the Company's headquarters. Additional training is also offered to
the customer during system upgrades and for new operations personnel.
The Company's field service department provides custom design and
installation services for telecommunications network equipment. The Company
believes that its field service department complements and enhances the sale of
its products.
The Company warrants its products for a minimum of one year and up to
five years, as negotiated under contract. Customers may also purchase extended
warranty contracts with guaranteed overnight factory replacement service for
circuit boards or system modules in the event of equipment failure. Software
revisions to the Company's products are also available as part of the warranty
package. In addition, for an additional charge, on-site spares are available for
those customers who require immediate replacement. The Company also provides a
24-hour Service Hotline for instant access to its field service and support
departments. A toll-free 800 number is also offered.
Warranty expense represented approximately 2.4%, 4.5% and 3.6% of
annual net sales in 1999, 1998 and 1997, respectively. See "Business - Business
Risks - Risk of Product Defects."
COMPETITION
There are numerous manufacturers of data communications equipment.
Manufacturers of these products frequently specialize their products for
specific applications and could enter the Company's target markets. Significant
competition exists from several well-established companies having resources
superior to those of the Company and 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 has a product line, Datakit, which competes directly with
the Company's products when selling into the telecommunications industry.
Competition also comes from other data communications suppliers, such as Cisco
Systems, Inc., Dantel and Harris Corporation's Westronics division. 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 March 1, 2000, the Company had 233 full-time and part-time
employees. The Company's employees are distributed among the following
departments: Sales and Marketing (39); Research and Development (69); Customer
Service (56); Manufacturing (39); and Operations (30). The Company anticipates
that it will continue to increase the number of its employees as it grows.
-8-
<PAGE> 9
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, 2000, and beyond, to differ materially from those expressed in any
forward-looking statements made by, or on behalf of, the Company.
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 RBOCs. As a result, the Company's net
sales often have been concentrated among a relatively small number of customers.
In fiscal 1999, 1998 and 1997, net sales from the Company's two, five and five
largest customers represented approximately 42%, 75% and 76%, respectively, of
the Company's total net sales. 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 are 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 or by deferrals or
cancellations of orders. In addition, there can be no assurance that revenue
from customers that have accounted for significant net sales 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 family of products has accounted for substantially all of
the Company's net sales since inception. The Company believes that revenue from
the sale, service and support of the AISwitch will continue to account for a
significant portion of the Company's net sales in fiscal 2000. Therefore, the
Company's future operating results, particularly in the near term, are
significantly dependent upon the continued market acceptance of the AISwitch,
improvements to the AISwitch framework and new and enhanced development tools
and network operations support. There can be no assurance that the AISwitch will
continue to achieve market acceptance or that the Company will be successful in
developing, introducing or marketing improvements to the AISwitch framework or
new or enhanced development tools and applications. The life cycles of products,
including 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 as a result of competition, technological
-9-
<PAGE> 10
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 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.
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.
-10-
<PAGE> 11
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 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.
Reliance on Suppliers. The Company purchases raw material and licenses
technology from a number of domestic and foreign sources. The Company believes
that certain of currently there are acceptable alternatives to the suppliers of
raw material and technology used in its products, with the exception of network
routing products supplied by Cisco Systems, Inc. The Company currently purchases
network routing products and licenses technology regarding the same from Cisco
Systems, Inc. pursuant to a Technology Agreement. The term of the Technology
Agreement expires
-11-
<PAGE> 12
on December 31, 2000 and automatically renews for one year periods, unless
either party elects not to renew. Additionally, the Technology Agreement may be
terminated by either party for any reason upon six months notice. The Company
believes that its customers place a high value on the incorporation of network
routing products and technology from Cisco Systems, Inc. into the Company's
products. While the Company believes that it could obtain similar quality
network routing products and technology from other vendors, the termination of
the Technology Agreement could materially adversely affect the acceptance of the
Company's products, which could have a material adverse effect on the Company's
business, financial condition and results of operations.
Future Capital Needs; Uncertainty of Additional Financing. The Company
currently anticipates that its existing cash, cash equivalents, investments,
cash to be generated from future operations, and funds which may be obtained
from future financing activities will provide sufficient capital to meet the
business needs of the Company. 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.
Future Operating Results Uncertain. Although the Company has previously
experienced 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 be profitable in any future period.
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 or substantial warranty expense. Any such
occurrence could have a material adverse effect upon 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
-12-
<PAGE> 13
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 RBOCs, 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 net sales 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 net sales, net income (loss) may be disproportionately
affected by a reduction in net sales. 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 net sales 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 net sales 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.
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 Chairman 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 other 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. Furthermore, competitors have
-13-
<PAGE> 14
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.
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 Company's common stock will continue. The market
price of the shares of the Company's 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 and
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 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 beneficially own
approximately 44.9% of the outstanding shares of the Company's Common Stock.
Such concentration of ownership may have the effect of delaying or preventing a
change in control of the Company.
Concentration of Stock Ownership. The present directors, executive
officers and principal stockholders of the Company and their affiliates
beneficially own approximately 44.9% of the outstanding shares of the Company's
Common Stock. In particular, Gerard B. Moersdorf, Jr. and his spouse own
approximately 42.2% of the outstanding shares of Common Stock. As a result,
these stockholders are able to exercise significant influence over matters
requiring stockholder 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.
-14-
<PAGE> 15
ITEM 2. PROPERTIES.
----------
The Company headquarters is a 115,000 square foot modern corporate
office and manufacturing facility in Dublin, Ohio. All of the Company's
manufacturing, administrative and research and development activities and a
substantial portion of its marketing activities are conducted at this location.
The Company owns the building and the approximately 33 acres of land on which it
is situated.
ITEM 3. LEGAL PROCEEDINGS.
-----------------
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
Not applicable.
-15-
<PAGE> 16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
---------------------------------------------------------------------
The Company's 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 the Company's common
stock. The prices shown represent quotations between dealers, without adjustment
for retail markups, markdowns or commissions and may not represent actual
transactions.
<TABLE>
<CAPTION>
1999 1998
---- ----
High Low High Low
<S> <C> <C> <C> <C>
Q1 $5.19 $3.13 $8.00 $5.38
Q2 $5.75 $2.81 $11.75 $7.00
Q3 $4.94 $3.50 $11.25 $2.38
Q4 $9.00 $3.40 $4.50 $2.19
--------------------------------------------
</TABLE>
At March 10, 2000, the Company had 625 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.
ITEM 6. SELECTED FINANCIAL DATA.
-----------------------
The information required by this item is included under the caption
"Selected Consolidated Financial Data " in the Company's Annual Report to
Stockholders and is incorporated herein by reference.
-16-
<PAGE> 17
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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
----------------------------------------------------------
The Company does not have any material exposure to interest rate
changes, commodity price changes, foreign currency fluctuations, or similar
market risks. Furthermore, the Company has not entered into any derivative
contracts and the Company has no debt outstanding as of December 31, 1999.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
-------------------------------------------
The information required by this item is included under the caption
"Consolidated Financial Statements" in the Company's Annual Report to
Stockholders and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE.
--------------------
None.
-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 27, 2000 (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 through 11 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 STOCKHOLDERS" on page 2, and under the
caption "SECURITY OWNERSHIP OF MANAGEMENT" on page 3 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 9 and 10 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:
Consolidated Balance Sheets as of December 31, 1999 and 1998.
Consolidated Statements of Operations for the years ended December 31,
1999, 1998 and 1997.
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1999, 1998 and 1997.
Consolidated Statements of Cash Flows for the years ended December 31,
1999, 1998 and 1997.
Notes to Consolidated Financial Statements.
-18-
<PAGE> 19
(a)(2) Schedule II (Valuation and Qualifying Accounts)
(a)(3) Exhibits: The following exhibits are filed as part of this report:
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
<S> <C> <C>
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 Technology Agreement, dated November 12, 1996, between
the Company and Cisco Systems, Inc...........................................................(2)
10.5A Letter Agreement between the Company and William H. Largent
regarding employment.........................................................................(2)*
10.5B Employment Agreement between the Company and William H. Largent..............................(2)*
10.6 Letter Agreement between the Company and
John M. Spiegel re: employment...............................................................(1)*
10.7 Employment Agreement between the Company and
William J. Mrukowski.........................................................................(2)*
10.8 Form of Indemnification Agreement between the Company
and officers and directors...................................................................(3)*
10.9 Schedule of Indemnification Agreements.......................................................(3)*
10.10 Letter Agreement between the Company and Michael P. Keegan regarding
employment...................................................................................(4)*
10.11 Amended and Restated 1996 Stock Option Plan..................................................(4)*
</TABLE>
-19-
<PAGE> 20
<TABLE>
<CAPTION>
<S> <C> <C>
10.12 Reserved
10.13 Reserved
11 Statement re: computation of earnings per share...............................................(4)
13 Portions of the Annual Report to Stockholders.................................................(4)
23.1 Consent of KPMG LLP ..........................................................................(4)
24 Powers of Attorney ...........................................................................(4)
27 Financial Data Schedule ......................................................................(4)
99 Independent Auditors' Report .................................................................(4)
</TABLE>
- ----------
(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-K filed March 31, 1998 and incorporated
herein by reference.
(3) Previously filed with the same exhibit number with the
Company's Form 10-KSB filed March 31, 1994 and incorporated
herein by reference.
(4) Filed herewith.
* Management contract or compensatory plan or arrangement
required to be filed as an exhibit to this form.
(b) Form 8-K filed October 27, 1999, reporting that on October 22, 1999,
the Company's Board of Directors authorized the Company to repurchase
up to 1,000,000 shares of its outstanding common stock through October
31, 2000 (Item 5 and Item 7).
(c) Exhibits - The exhibits to this report follow the signature page.
(d) Financial Statement Schedules - The financial statement schedule to
this report follows the signature page and the independent auditor's
report thereon is included in Exhibit 99 to this Report on Form 10-K.
-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 30, 2000 By: /s/ Gerard B. Moersdorf, Jr.
-------------------------------
Gerard B. Moersdorf, Jr., Chairman,
President and Treasurer
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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Gerard B. Moersdorf, Jr. Chairman, President March 30, 2000
- ------------------------------ and Treasurer (Principal Executive
Gerard B. Moersdorf, Jr. Officer)
/s/ Michael P. Keegan
- ------------------------------
Michael P. Keegan Vice President, March 30, 2000
Chief Financial Officer
(Principal Financial and Accounting
Officer)
*James H. Blough
- ------------------------------
James H. Blough Director March 30, 2000
*Curtis A. Loveland
- ------------------------------
Curtis A. Loveland Director March 30, 2000
*Gerard B. Moersdorf, Sr.
- ------------------------------
Gerard B. Moersdorf, Sr. Director March 30, 2000
*Richard W. Oliver
- ------------------------------
Richard W. Oliver Director March 30, 2000
*Thomas W. Huseby
- ------------------------------
Thomas W. Huseby Director March 30, 2000
</TABLE>
-21-
<PAGE> 22
<TABLE>
<CAPTION>
<S> <C> <C>
*Alexander B. Trevor
- ------------------------------
Alexander B. Trevor Director March 30, 2000
*William H. Largent
- ------------------------------
William H. Largent Director March 30, 2000
*By: /s/ Gerard B. Moersdorf, Jr.
------------------------------
Gerard B. Moersdorf, Jr.
(Attorney-in-Fact)
</TABLE>
-22-
<PAGE> 23
Applied Innovation Inc.
Schedule II - Valuation and Qualifying Accounts
For the Years Ended December 31, 1997, 1998 and 1999
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
- -------- -------- -------- -------- --------
/---------Additions--------/
----------------------------
Balance at Charged to Charged to
beginning of costs and other Balance at
Description period expense accounts Deductions end of period
- ----------- ------ ------- -------- ---------- -------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1997:
Allowance for doubtful accounts $ 112,528 $ 756,633 -- $ 640,877 $ 228,284
Allowance for obsolete inventory 75,000 37,116 -- -- 112,116
Warranty provision 2,761,589 1,537,591 -- 2,143,855 2,155,325
YEAR ENDED DECEMBER 31, 1998:
Allowance for doubtful accounts $ 228,284 $ 147,091 -- $ 119,258 $ 256,117
Allowance for obsolete inventory 112,116 1,153,556 -- 1,105,672 160,000
Warranty provision 2,155,325 2,640,076 -- 2,150,663 2,644,738
YEAR ENDED DECEMBER 31, 1999:
Allowance for doubtful accounts $ 256,117 $ 162,103 -- $ 100,673 $ 317,547
Allowance for obsolete inventory 160,000 -- -- -- 160,000
Warranty provision 2,644,738 1,602,570 -- 2,369,577 1,877,731
</TABLE>
-23-
<PAGE> 1
Exhibit 10.10
[APPLIED INNOVATION INC. LETTERHEAD]
June 14, 1999
Mr. Michael P. Keegan
5208 Whisper Willow Drive
Fairfax, VA 22030
Dear Mike:
We are pleased to confirm our offer for, and your acceptance of, the position of
VP & Chief Financial Officer. We are excited about your joining the Company, and
we are confident you have the ability to make a major contribution to Applied's
future performance. We know that Applied will offer you challenging and
rewarding opportunities professionally and personally.
Following are the terms of your employment offer:
1. EMPLOYMENT
You will initially report to Gerard Moersdorf--President, & Chief
Executive Officer.
Your targeted start date is July 26, 1999, but this date will stay
flexible based on your needs.
2. COMPENSATION
Your base salary compensation will be at a bi-weekly salary of
$5,769.24 (26 pay periods per year), payable in accordance with the
normal payroll practices of the company. With this offer comes our
liberal benefits package on which you have already received
information.
You will also be eligible to participate in the management bonus plan.
The bonus plan will be based on corporate objectives. Your objectives
will be the same as those currently in place for the President/CEO and
the Vice President of Sales and Marketing. The objectives are primarily
relate to targeted sales and pre-tax profits, as determined by the
President's Operating Report. The bonus, if any, will be paid after
completion of the 1999 audit, which is anticipated to be in February,
2000.
<PAGE> 2
Michael P. Keegan
June 14, 1999
Page 2
3. VACATION
You will be entitled to 15 days paid vacation during each of your first
full six calendar years of your employment. After that you will receive
vacation in accordance with the Applied Innovation Inc. vacation
policy. Presently, that policy provides one additional day per year up
to a maximum of 20 days in year eleven. You will have 6 days of paid
vacation available for use during 1999.
4. RELOCATION
APPROVAL
The Chief Executive Officer will have the ultimate authority for all
decisions relating to reimbursement of relocation expenses.
GUIDELINES
A. HOUSE HUNTING TRIPS
The company will reimburse expenses for up to two trips for
the employee and spouse to select a residence at the new
location. The Company will also reimburse expenses for one of
the trips to include children of the employee and spouse,
subject to review by the Company. Typically these trips should
not exceed 3 days/2 nights, but necessary exceptions will be
considered on a case by case basis. The Company will reimburse
reasonable expenses for flights/mileage, meals and hotel.
B. TEMPORARY LIVING EXPENSES
The relocating employee is expected to make all reasonable
efforts to secure housing at the new location prior to the
sale of the current home and moving of the employee and
family, thereby eliminating the need for temporary housing and
property storage; however, the Company recognizes that there
may be circumstances beyond the employee's control relating to
the sale of the current home and/or purchase of the new home
which may result in the need for temporary housing. In these
circumstances the Company will consider providing temporary
housing (rent and utilities for furnished apartment or hotel
room selected by the Company) and property storage (van line
storage or self storage facility selected by the Company) on a
case by case basis. Such approved storage would include the
additional labor costs associated with the additional loading
and unloading of household goods.
Temporary housing and property storage should typically not
exceed 90 days and are subject to advance approval.
<PAGE> 3
Michael P. Keegan
June 14, 1999
Page 3
C. TRANSPORTATION OF HOUSEHOLD GOODS
The company will pay for reasonable costs of transporting
normal household goods, including packing, loading, hauling
and unloading of household goods (excluding cars, boats and
campers). The carrier will be selected by the Company.
D. TRANSPORTATION OF EMPLOYEE AND FAMILY
The company will pay for reasonable costs associated with
transporting you and your family to your new location.
Reasonable costs include standard mileage reimbursement (10
cents per mile) per vehicle driven, plus meals and in-transit
lodging.
E. SALE OF RESIDENCE
Payment of the following expenses incidental to the sale of
the employee's home will be considered:
1. Realtor commission/Broker fee up to 6% of sale price of home.
2. Appraisal, credit report and survey when required by law or
mortgage holder.
3. Mortgagee's title policy, abstract or title guarantee.
4. Recording of mortgage and deed.
5. Local mortgage tax.
6. Reasonable attorney fees consistent with local requirements
limited to $300.00.
7. Transfer fees up to $2.00 per thousand dollars of selling
price.
8. Title insurance up to $3.50 per thousand dollars of selling
price.
9. Deed preparation up to $35.00.
10. Gas and termite inspection up to $90.00.
11. Septic/well inspection up to $100.00.
12. Home warranty up to $300.00.
Not reimbursable:
o Full or pro-rated hazard insurance
o Property taxes/aggregate escrow reserve
o Interest charges
o Home owner association dues
<PAGE> 4
Michael P. Keegan
June 14, 1999
Page 4
F. PURCHASE OF RESIDENCE
Payment of the following expenses incidental to the purchase
of the employee's home will be considered:
o Buyer closing costs: the Company will pay for the buyer
closing costs for the purchase of the new home, providing the
selling price of the current home and purchase price of the
new home have a difference of less than 10%. If the purchase
price of your new home is more than 10% higher than the
selling price of your current home, the Company will pay for a
prorated amount of the closing costs. Reimbursable closing
costs will include the costs listed in section "E" above for
items 2 through 12.
o Mortgage related points: if the interest rate on the existing
mortgage is less than the available interest rate on the new
mortgage of comparable terms (30 year fixed to 30 year fixed,
ARM to ARM, etc.), the Company will pay the necessary points
to buy down the interest rate to the same level as the
interest rate on your existing mortgage, providing the total
length of the new mortgage is not longer than the original
length of your existing mortgage. This buy down is subject to
Company review and approval.
o The cost of standard utility hook-ups at the new residence.
G. VEHICLE LICENSING COSTS
The Company will reimburse the cost of the first 12 months of
car license plates/tags for up to two vehicles.
H. EMPLOYEE HOME VISITS WHILE IN TEMPORARY HOUSING
The Company will determine whether reimbursement for employee
home visit expenses will be allowed during the relocation
period. When authorized, all reasonable attempts should be
made to combine necessary work/business trips with such home
visits.
All of the above costs must be reasonable in amount and
subject to AI review and approval. If special conditions exist
and additional assistance is required, appropriate advance
approval is required.
I. MISCELLANEOUS ACCOUNTABLE COSTS
The Company will provide a $2000.00 accountable allowance for
other miscellaneous move related expenses. The costs must be
approved by the Company and be directly related to the
relocation event. As with all other expenses under this policy
a full accounting, included written receipts with proper
explanation, is to be provided before reimbursement occurs.
<PAGE> 5
Michael P. Keegan
June 14, 1999
Page 5
J. WHAT IS TAXABLE AND NON-TAXABLE AS INCOME
For clarification, the following items are NOT taxable income:
transportation of your household goods, 10 cents per mile for
driving personal vehicles to the new location, flights and
lodging during transport of immediate family members to the
new location. All other relocation costs listed above should
be assumed to be taxable income. Federal Internal Revenue
Service regulations require that all relocation expenses for
which an employee is reimbursed or which are being paid
directly by the Company be reported as gross income. These
expenses will be included in the gross earnings figure on the
employee's W-2 form.
The Company will gross up payments/reimbursements to cover all
payroll taxes.
All expenses reimbursable under these guidelines which are not
paid directly by the Company must be submitted on an expense
form with appropriate receipts. When submitting relocation
expenses for reimbursement, please use an expense form that
contains only relocation expenses do not mix relocation
expenses and business expenses on a single expense form.
K. REPAYMENT SCHEDULE
If the employee voluntarily resigns from employment with the
Company, or the employee's employment is terminated for any
form of gross misconduct, the employee will reimburse the
Company as follows:
0-30 days 100.00%
31-60 days 91.63%
61-90days 83.30%
91-120 days 74.97%
121-150 days 66.64%
151-180 days 58.31%
181-210 days 49.98%
211-240 days 41.65%
241-270 days 33.32%
271-300 days 24.99%
301-330 days 16.66%
331-365 days 8.33%
<PAGE> 6
Michael P. Keegan
June 14, 1999
Page 6
5. STOCK OPTIONS
Under the 1996 Stock Option Plan, options may be granted by the Board
of Directors at exercise prices not less than fair market value. In
accordance with that plan, we offer the following:
a) The compensation committee of the Board of Directors, effective
upon the start of your employment, will grant you options to
purchase 50,000 shares of common stock of the Company.
b) All of the options will be exercisable at a price equal to the
closing price (as quoted by NASDAQ) of the Company's stock on the
day prior to the start of your employment.
c) The options will be subject to the normal requirements of the Plan
(copy enclosed), and 20% of the options will vest and become
exercisable upon each annual anniversary of your employment by the
Company.
d) The options will terminate on the eighth anniversary of the date
of grant.
Your employment is "at-will employment" (may be terminated by either the Company
or yourself at any time and for any reason). If, in the future, you elect to
terminate your employment with the Company, we request that you provide a
minimum notice of fourteen days.
By accepting this offer, you represent and warrant that you are not a party to
any agreement that would prevent you from performing your duties for the Company
or which would expose the Company to a risk of suit by reason of your employment
by the Company.
In consideration of your employment, you will enter into an Employment Agreement
with the Company. A copy of this agreement is enclosed for your careful review.
Please sign the Employment Agreement and one copy of this letter, and return to
affirm acceptance of this offer. We look forward to working with you and we are
confident that your employment at Applied Innovation will be challenging and
successful.
Sincerely,
Larenda Johnson
Employment Manager
Enclosure: Employment Agreement
/s/ Michael P. Keegan June 18, 1999
- -------------------------- --------------------
Michael P. Keegan Date
<PAGE> 1
Exhibit 10.11
APPLIED INNOVATION INC.
AMENDED AND RESTATED
1996 STOCK OPTION PLAN
1. PURPOSE. This plan (the "Plan") is intended as an incentive and to
encourage stock ownership by certain key employees, officers and directors of,
and consultants and advisers who render services to, Applied Innovation Inc., a
Delaware corporation (the "Company"), and any current or future Parent or
Subsidiary thereof (the "Company Group") by the granting of stock options (the
"Options") as provided herein. By encouraging such stock ownership, the Company
seeks to attract, retain and motivate employees, officers, directors,
consultants and advisers of training, experience and ability. The Options
granted under the Plan may be either incentive stock options ("ISOs") which meet
the requirements of section 422 of the Internal Revenue Code of 1986, as amended
from time to time hereafter (the "Code"), or options which do not meet such
requirements ("Non-Statutory Options").
2. EFFECTIVE DATE. The Plan will become effective on April 25, 1996
(the "Effective Date").
3. ADMINISTRATION.
(a) The Plan will be administered by a committee (the
"Committee") appointed by the Board of Directors of the Company (the "Board")
which consists of not fewer than two members of the Board. If any class of
equity securities of the Company is registered under section 12 of the
Securities Exchange Act of 1934, as amended (the "1934 Act"), all members of the
Committee will be "non-employee directors" as defined in Rule 16b-3(b)(2)(i)
promulgated under the 1934 Act (or any successor rule of like tenor and effect)
and "outside directors" as defined in section 162(m) of the Code and the
regulations promulgated thereunder.
(b) Subject to the provisions of the Plan, the Committee is
authorized to establish, amend and rescind such rules and regulations as it
deems appropriate for its conduct and for the proper administration of the Plan,
to make all determinations under and interpretations of, and to take such
actions in connection with the Plan or the Options granted thereunder as it
deems necessary or advisable. All actions taken by the Committee under the Plan
are final and binding on all persons. No member of the Committee is liable for
any action taken or determination made relating to the Plan, except for willful
misconduct.
(c) The Company will indemnify each member of the Committee
against costs, expenses and liabilities (other than amounts paid in settlements
to which the Company does not consent, which consent will not be unreasonably
withheld) reasonably incurred by such member in connection with any action to
which he or she may be a party by reason of service as a member of the
Committee, except in relation to matters as to which he or she is adjudged in
such action to be personally guilty of negligence or willful misconduct in the
performance of his or her duties. The foregoing right to indemnification is in
addition to such other rights as the Committee member may enjoy as a matter of
law, by reason of insurance coverage of any kind, or otherwise.
4. ELIGIBILITY.
(a) The Committee may grant Options and Tax Offset Payments,
as defined in paragraph 10, to such Key Employees of (or, in the case of
Non-Statutory Options only, to directors who are not employees of and to
consultants and advisers who render services to) the Company or the Company
Group as the Committee may select from time to time (the "Optionees"). The
Committee may grant more than one Option to an individual under the Plan.
(b) [reserved].
(c) No ISO may be granted to an individual who, at the time an
ISO is granted, is considered under section 422(b)(6) of the Code as owning
stock possessing more than 10 percent of the total combined voting
<PAGE> 2
power of all classes of stock of the Company or of its Parent or any Subsidiary;
provided, however, this restriction will not apply if at the time such ISO is
granted the option price per share of such ISO is at least 110% of the Fair
Market Value of such share, and such ISO by its terms is not exercisable after
the expiration of five years from the date it is granted. This paragraph 4(c)
has no application to Options granted under the Plan as Non-Statutory Options.
(d) The aggregate Fair Market Value (determined as of the date
the ISO is granted) of shares with respect to which ISOs are exercisable for the
first time by any Optionee during any calendar year under the Plan or any other
incentive stock option plan of the Company or the Company Group may not exceed
$100,000. If an ISO which exceeds the $100,000 limitation of this paragraph 4(d)
is granted, the portion of such Option which is exercisable for Shares in excess
of the $100,000 limitation shall be treated as a Non-Statutory Option pursuant
to Section 422(d) of the Code. Except as otherwise provided in the preceding
sentence, this paragraph 4(d) has no application to Options granted under the
Plan as Non-Statutory Options.
5. STOCK SUBJECT TO PLAN. The shares subject to Options under the Plan
are the shares of common stock, $.01 par value, of the Company (the "Shares").
The Shares issued pursuant to Options granted under the Plan may be authorized
and unissued Shares, Shares purchased on the open market or in a private
transaction, or Shares held as treasury stock. The aggregate number of Shares
for which Options may be granted under the Plan may not exceed 2,000,000 shares,
subject to adjustment in accordance with the terms of paragraph 13 of the Plan.
The maximum number of Shares for which Options may be granted under the Plan
during the term of the Plan to any one individual may not exceed 750,000 shares
subject to adjustment in accordance with the terms of paragraph 13 of the Plan.
The unpurchased Shares subject to terminated or expired Options may again be
offered under the Plan. The Committee, in its sole discretion, may permit the
exercise of any Option as to full Shares or fractional Shares. Proceeds from the
sale of Shares under Options will be general funds of the Company.
6. TERMS AND CONDITIONS OF OPTIONS.
(a) At the time of grant, the Committee will determine whether
the Options granted will be ISOs or Non-Statutory Options. All Options and Tax
Offset Payments granted will be authorized by the Committee and, within a
reasonable time after the date of grant, will be evidenced by stock option
agreements in writing ("Stock Option Agreements"), in the form attached hereto
as Exhibit A, or in such other form and containing such terms and conditions not
inconsistent with the provisions of this Plan as the Committee may determine.
Any action under paragraph 13 may be reflected in an amendment to, or
restatement of, such Stock Option Agreements.
(b) The Committee may grant Options and Tax Offset Payments
having terms and provisions which vary from those specified in the Plan if such
Options or Tax Offset Payments are granted in substitution for, or in connection
with the assumption of, existing options granted by another corporation and
assumed or otherwise agreed to be provided for by the Company pursuant to or by
reason of a transaction involving a corporate merger, consolidation, acquisition
of property or stock, separation, reorganization or liquidation to which the
Company is a party.
7. PRICE. The Committee will determine the option price per Share (the
"Option Price") of each Option granted under the Plan. Notwithstanding the
foregoing, the Option Price of each ISO granted under the Plan may not be less
than the Fair Market Value of a Share on the date of grant of such Option. The
date of grant will be the date the Committee acts to grant the Option or such
later date as the Committee specifies and the Fair Market Value will be
determined in accordance with paragraph 26(c) and without regard to any
restrictions other than a restriction which, by its terms, will never lapse.
8. OPTION PERIOD. The Committee will determine the period during which
each Option may be exercised (the "Option Period"); provided, however, any ISO
granted under the Plan will have an Option Period which does not exceed 10 years
from the date of grant.
<PAGE> 3
9. NONTRANSFERABILITY OF OPTIONS. An Option will not be transferable
by the Optionee otherwise than by will or the laws of descent and distribution
and may be exercised, during the lifetime of the Optionee, only by the Optionee
or by the Optionee's guardian or legal representative. Notwithstanding the
foregoing, an Optionee may transfer a Non-Statutory Option to members of his or
her immediate family (as defined in Rule 16a-1 promulgated under the 1934 Act),
to one or more trusts for the benefit of such family members or to partnerships
in which such family members are the only partners if (a) the stock option
agreement with respect to such Non-Statutory Option as approved by the Committee
expressly so provides and (b) the Optionee does not receive any consideration
for the transfer. Non-Statutory Options held by such transferees are subject to
the same terms and conditions that applied to such Non-Statutory Options
immediately prior to transfer.
10. TAX OFFSET PAYMENTS. The Committee has the authority and discretion
under the Plan to make cash grants to Optionees to offset a portion of the taxes
which may become payable upon exercise of Non-Statutory Options or on certain
dispositions of Shares acquired under ISOs ("Tax Offset Payments"). In the case
of Non-Statutory Options, such Tax Offset Payments will be in an amount
determined by multiplying a percentage established by the Committee by the
difference between the Fair Market Value of a Share on the date of exercise and
the Option Price, and by the number of Shares as to which the Option is being
exercised. If the Tax Offset Payment is being made on account of the disposition
of Shares acquired under an ISO, such Tax Offset Payments will be in an amount
determined by multiplying a percentage established by the Committee by the
difference between the Fair Market Value of a Share on the date of disposition,
if less than the Fair Market Value on the date of exercise, and the Option
Price, and by the number of Shares acquired under an ISO of which an Optionee is
disposing. The percentage will be established, from time to time, by the
Committee at that rate which the Committee, in its sole discretion, determines
to be appropriate and in the best interest of the Company to assist Optionees in
the payment of taxes. The Company has the right to withhold and pay over to any
governmental entities (federal, state or local) all amounts under a Tax Offset
Payment for payment of any income or other taxes incurred on exercise.
11. EXERCISE OF OPTIONS.
(a) The Committee, in its sole discretion, will determine the
terms and conditions of exercise and vesting percentages of Options granted
hereunder. Notwithstanding the foregoing or the terms and conditions of any
Stock Option Agreement to the contrary, (i) if the Optionee's employment is
terminated as a result of disability or death, his or her Options will be
exercisable to the extent and for the period specified in paragraph 12(b); (ii)
if the Optionee's employment is terminated other than as a result of disability
or death or For Cause, his or her Options will be exercisable to the extent and
for the period specified in paragraph 12(a); (iii) if a merger or similar
reorganization or sale of substantially all of the Company's assets occurs, all
outstanding Options will be exercisable to the extent and for the period
specified in paragraph 13(b) or paragraph 13(c), whichever paragraph applies;
and (iv) if a Change in Control occurs, all outstanding Options will be
exercisable for the period specified in paragraph 13(d).
(b) An Option may be exercised only upon delivery of a written
notice to the Committee, any member of the Committee, or any officer of the
Company designated by the Committee to accept such notices on its behalf,
specifying the number of Shares for which it is exercised.
(c) Within five business days following the date of exercise
of an Option, the Optionee or other person exercising the Option will make full
payment of the Option Price in cash or, with the consent of the Committee, (i)
by tendering previously acquired Shares (valued at Fair Market Value, as
determined by the Committee, as of such date of tender); (ii) with a full
recourse promissory note of the Optionee for the portion of the Option Price in
excess of the par value of Shares subject to the Option, under terms and
conditions determined by the Committee; (iii) any combination of the foregoing;
or (iv) if the Shares subject to the Option have been registered under the
Securities Act of 1933, as amended (the "1933 Act"), and there is a regular
public market for the Shares, by delivering to the Company on the date of
exercise of the Option written notice of exercise together with:
<PAGE> 4
(A) written instructions to forward a copy of such
notice of exercise to a broker or dealer, as defined in section
3(a)(4) and 3(a)(5) of the 1934 Act ("Broker"), designated in
such notice and to deliver to the specified account maintained
with the Broker by the person exercising the Option a
certificate for the Shares purchased upon the exercise of the
Option, and
(B) a copy of irrevocable instructions to the Broker to
deliver promptly to the Company a sum equal to the purchase
price of the Shares purchased upon exercise of the Option and
any other sums required to be paid to the Company under
paragraph 18 of the Plan.
(d) If Tax Offset Payments sufficient to allow for withholding
of taxes are not being made at the time of exercise of an Option, the Optionee
or other person exercising such Option will pay to the Company an amount equal
to the withholding amount required to be made less any amount withheld by the
Company under paragraph 18.
12. TERMINATION OF EMPLOYMENT.
(a) Upon termination of an Optionee's employment with the
Company or the Company Group, other than (i) termination of employment by reason
of death or Disability, or (ii) termination of employment For Cause, the
Optionee will have 30 days after the date of termination (but not later than the
expiration date of the Stock Option Agreement) to exercise all Options held by
him or her to the extent the same were exercisable on the date of termination;
provided, however, if such termination is a result of the Optionee's retirement
with the consent of the Company, such Option shall then be exercisable to the
extent of 100% of the Shares subject thereto. The Committee will determine in
each case whether a termination of employment is a retirement with the consent
of the Company and, subject to applicable law, whether a leave of absence is a
termination of employment. The Committee may cancel an Option during the 30-day
period after termination of employment referred to in this paragraph if the
Optionee engages in employment or activities contrary, in the opinion of the
Committee, to the best interests of the Company.
(b) Upon termination of employment by reason of death or
Disability, the Optionee's personal representative, or the person or persons to
whom his or her rights under the Options pass by will or the laws of descent or
distribution, will have one year after the date of such termination (but not
later than the expiration date of the Stock Option Agreement) to exercise all
Options held by Optionee to the extent the same were exercisable on the date of
termination; provided, however, the Committee, in its sole discretion, may
permit the exercise of all or any portion of any Option granted to such Optionee
not otherwise exercisable.
(c) Upon termination of employment For Cause, all Options held
by such Optionee will terminate effective on the date of termination of
employment.
13. STOCK SPLITS; MERGERS; REORGANIZATIONS; CHANGE IN CONTROL.
(a) If a stock split, stock dividend, combination or exchange of
shares, exchange for other securities, reclassification, reorganization,
redesignation or other change in the Company's capitalization occurs, the
Committee will proportionately adjust or substitute the aggregate number of
Shares for which Options may be granted under this Plan, the number of Shares
subject to outstanding Options and the Option Price of the Shares subject to
outstanding Options to reflect the same. The Committee will make such other
adjustments to the Options, the provisions of the Plan and the Stock Option
Agreements as may be appropriate and equitable, which adjustments may provide
for the elimination of fractional Shares.
(b) In the event of a change of the Company's common stock, $.01
par value, resulting from a merger or similar reorganization as to which the
Company is the surviving corporation, or a merger or similar reorganization
involving only a change in the state of incorporation or an internal
reorganization not involving a
<PAGE> 5
Change in Control, the number and kind of Shares which thereafter may be
purchased pursuant to an Option under the Plan and the number and kind of Shares
then subject to Options granted hereunder and the price per Share thereof will
be appropriately adjusted in such manner as the Board may deem equitable to
prevent dilution or enlargement of the rights available or granted hereunder.
(c) Except as otherwise determined by the Board, a merger or a
similar reorganization which the Company does not survive (other than a merger
or similar reorganization involving only a change in the state of incorporation
or an internal reorganization not involving a Change in Control), or a sale of
all or substantially all of the assets of the Company, will cause every Option
hereunder to terminate, to the extent not then exercised, unless any surviving
entity agrees to assume the obligations hereunder on terms reasonably acceptable
to the Board; provided, however, that, in the case of such a merger or similar
reorganization, or such a sale of all or substantially all of the assets of the
Company, if there is no such assumption, the Board, in its sole discretion, may
provide that some or all of the unexercised portion of any one or more of the
outstanding Options will be immediately exercisable and vested as of such date
prior to such merger, similar reorganization or sale of assets as the Board
determines. If the Board makes an Option fully exercisable under this paragraph
13(c), the Board will notify the Optionee that the Option will be fully
exercisable for a period of thirty (30) days from the date of such notice, and
the Option will terminate upon the expiration of such period.
(d) If a Change in Control occurs, all outstanding Options
granted under this Plan will become immediately exercisable to the extent of
100% of the Shares subject thereto notwithstanding any contrary waiting or
vesting periods specified in this Plan or in any applicable Stock Option
Agreement.
14. SALE OF OPTION SHARES. If any class of equity securities of the
Company is registered pursuant to section 12 of the 1934 Act, any Optionee or
other person exercising the Option who is subject to section 16 of the 1934 Act
by virtue of his or her relationship to the Company shall not sell or otherwise
dispose of the Shares subject to the Option unless at least six months have
elapsed from the date of the grant of the Option.
15. RIGHTS AS SHAREHOLDER. The Optionee has no rights as a shareholder
with respect to any Shares covered by an Option until the date of issuance of a
stock certificate to the Optionee for such Shares.
16. NO CONTRACT OF EMPLOYMENT. Nothing in the Plan or in any Option or
Stock Option Agreement confers on any Optionee any right to continue in the
employment or service of the Company or any Parent or Subsidiary of the Company
or interfere with the right of the Company to terminate such Optionee's
employment or other services at any time. The establishment of the Plan will in
no way, now or hereafter, reduce, enlarge or modify the employment relationship
between the Company or any Parent or Subsidiary of the Company and the Optionee.
Options granted under the Plan will not be affected by any change of duties or
position as long as the Optionee continues to be employed by the Company or any
Parent or Subsidiary of the Company.
17. AGREEMENTS AND REPRESENTATIONS OF OPTIONEES. As a condition to the
exercise of an Option, the Committee, in its sole determination, may require the
Optionee to represent in writing that the Shares being purchased are being
purchased only for investment and without any present intent at the time of the
acquisition of such Shares to sell or otherwise dispose of the same.
18. WITHHOLDING TAXES. The Company or any Parent or Subsidiary of the
Company has the right (a) to withhold from any salary, wages, or other
compensation for services payable by the Company or any Parent or Subsidiary of
the Company to or with respect to an Optionee, or to demand payment from the
Optionee or other person to whom the Company is delivering certificates for
Shares purchased upon exercise of an Option of, amounts sufficient to satisfy
any federal, state or local withholding tax liability attributable to such
Optionee's (or any beneficiary's or personal representative's) receipt or
disposition of Shares purchased under any Option or (b) to take any such other
action as it deems necessary to enable it to satisfy any such tax withholding
obligations. The Committee, in its sole discretion, may permit an Optionee to
elect to have Shares that would be acquired upon exercise of Options (valued at
Fair Market Value as of the date of exercise) withheld by the Company in
satisfaction of such Optionee's withholding tax liabilities.
<PAGE> 6
19. EXCHANGES. The Committee may permit the voluntary surrender of all
or a portion of any Option granted under the Plan to be conditioned upon the
granting to the Optionee of a new Option for the same or a different number of
Shares as the Option surrendered, or may require such voluntary surrender as a
condition precedent to a grant of a new Option to such Optionee. Subject to the
provisions of the Plan, such new Option will be exercisable at such price,
during such period and on such other terms and conditions as are specified by
the Committee at the time the new Option is granted. Upon surrender, the Options
surrendered will be cancelled, and the Shares previously subject to them will be
available for the grant of other Options. The Committee also may grant Tax
Offset Payments to any Optionee surrendering such Option for a new Option.
20. COMPLIANCE WITH LAWS AND REGULATIONS. The Plan, the grant and
exercise of Options thereunder, and the obligation of the Company to sell and
deliver the Shares under such Options, will be subject to all applicable federal
and state laws, rules and regulations and to such approvals by any government or
regulatory agency as may be required. Options issued under this Plan are not
exercisable prior to (i) the date upon which the Company has registered the
Shares for which Options may be issued under the 1933 Act and the completion of
any registration or qualification of such Shares under state law, or any ruling
or regulation of any government body which the Company, in its sole discretion,
determines to be necessary or advisable in connection therewith, or (ii) receipt
by the Company of an opinion from counsel to the Company stating that the
exercise of such Options may be effected without registering the Shares subject
to such Options under the 1933 Act or under state or other law.
21. ASSUMPTION. The Plan may be assumed by the successors and assigns
of the Company.
22. EXPENSES. The Company will bear all expenses and costs in
connection with administration of the Plan.
23. AMENDMENT, MODIFICATION AND TERMINATION OF THE PLAN. The Board may
terminate, amend or modify the Plan at any time without further action on the
part of the shareholders of the Company; provided, however, that (a) no
amendment to the Plan may cause the ISOs granted hereunder to fail to qualify as
incentive stock options under the Code; and (b) any amendment to the Plan which
requires the approval of the shareholders of the Company under the Code, the
regulations promulgated thereunder or the rules promulgated under section 16 of
the 1934 Act will be subject to approval by the shareholders of the Company in
accordance with the Code, such regulations or such rules. No amendment,
modification or termination of the Plan may adversely affect in any manner any
Option previously granted to an Optionee under the Plan without the consent of
the Optionee or the transferee of such Option.
24. TERM OF PLAN. The Plan will become effective on the Effective Date,
subject to the approval of the Plan by the holders of a majority of the shares
of stock of the Company entitled to vote within twelve months of the date of the
Plan's adoption by the Board, and the exercise of all Options granted prior to
such approval will be subject to such approval. The Plan will terminate on the
tenth anniversary of the Effective Date, or such earlier date as may be
determined by the Board. Termination of the Plan, however, will not affect the
rights of Optionees under Options previously granted to them, and all unexpired
Options will continue in force and operation after termination of the Plan
except as they may lapse or terminate by their own terms and conditions.
25. LIMITATION OF LIABILITY. The liability of the Company under this
Plan or in connection with any exercise of an Option is limited to the
obligations expressly set forth in the Plan and in any Stock Option Agreements,
and no term or provision of this Plan or of any Stock Option Agreements will be
construed to impose any further or additional duties, obligations or costs on
the Company not expressly set forth in the Plan or the Stock Option Agreements.
<PAGE> 7
26. DEFINITIONS.
(a) Change In Control. A "Change in Control" will be deemed to
have occurred if and when (i) a person, partnership, corporation, trust or other
entity ("Person") acquires or combines with the Company, or 50 percent or more
of its assets or earning power, in one or more transactions, and after such
acquisition or combination, less than a majority of the outstanding voting
shares of the Person surviving such transaction (or the ultimate parent of the
surviving Person) is owned by the owners of the voting shares of the Company
outstanding immediately prior to such acquisition or combination, unless the
Change in Control transaction or transactions have been approved in advance by
Board members representing at least two-thirds of the Board members; or (ii)
during any period of two consecutive years during the term of this Plan,
individuals who at the beginning of such period are members of the Board
("Original Board Members") cease for any reason to constitute at least a
majority of the Board, unless the election of each Board member who was not an
Original Board Member has been approved in advance by Board members representing
at least two-thirds of the Board members then in office who were Original Board
Members.
(b) Disability. The term "Disability" means a physical or mental
condition resulting from bodily injury, disease, or mental disorder which
renders the Optionee incapable of continuing the Optionee's usual and customary
employment or service with the Company or the Company Group.
(c) Fair Market Value. If the Shares are publicly traded, the
term "Fair Market Value" as used in this Plan means (i) the closing price quoted
in the Nasdaq National Market, if the shares are so quoted, (ii) the last quote
reported by Nasdaq for small-cap issues, if the shares are so quoted, (iii) the
mean between the bid and asked prices as reported by Nasdaq, if the Shares are
so quoted, or (iv) if the Shares are listed on a securities exchange, the
closing price at which the Shares are quoted on such exchange, in each case at
the close of the date immediately before the Option is granted or, if there be
no quotation or sale on that date, the next preceding date on which the Shares
were quoted or traded. In all other cases, the Fair Market Value will be
determined in accordance with procedures established in good faith by the
Committee and with respect to ISOs, conforming to regulations issued by the
Internal Revenue Service regarding incentive stock options.
(d) Key Employees. The term "Key Employees" means those
executive, administrative, operational and managerial employees of the Company
Group who are determined by the Committee to be eligible for Options under the
Plan.
(e) Parent and Subsidiary. The terms "Parent" and "Subsidiary"
as used in the Plan have the respective meanings set forth in sections 424(e)
and (f) of the Code.
(f) Termination For Cause. Termination of Employment "For Cause"
means termination of employment for (a) the commission of an act of dishonesty,
including but not limited to misappropriation of funds or property of the
Company; (b) the engagement in activities or conduct injurious to the reputation
of the Company; (c) the conviction or entry of a guilty or no contest plea to a
misdemeanor involving an act of moral turpitude or a felony; (d) the violation
of any of the terms and conditions of any written agreement the Optionee may
have with the Company or its Parent or Subsidiary (following 30 days' written
notice from the Company specifying the violation and the employee's failure to
cure such violation within such 30-day period) or (e) any refusal to comply with
the written directives, policies or regulations established from time to time by
the Board.
<PAGE> 8
APPLIED INNOVATION INC.
By: /s/ Gerard B. Moersdorf, Jr.
-------------------------------
Gerard B. Moersdorf, Jr.
Adopted by the Board of Directors: February 1, 1996
Adopted by the Stockholders: April 25, 1996
Effective Date: April 25, 1996
Amended by the Board of Directors: February 12, 1998
Approved by the Stockholders: April 23, 1998
Amended by the Board of Directors: December 3, 1998
Amended by the Board of Directors: December 2, 1999
<PAGE> 1
EXHIBIT 11
APPLIED INNOVATION INC.
Statement Regarding Computation of Earnings Per Share
For the years ended December 31, 1999, 1998, and 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Weighted average number of common
shares outstanding - used for computation
of basic earnings (loss) per share 15,598,143 15,804,608 15,786,332
Add net shares issuable pursuant to stock
option plans less shares assumed
repurchased at the average
market price 48,907 158,238 --
------------ ------------ ------------
Number of shares for computation of
diluted earnings (loss) per share 15,647,050 15,962,846 15,786,332
============ ============ ============
Net income (loss) for basic and diluted
earnings (loss) per share $ 7,005,081 $ 2,309,652 $ (637,195)
============ ============ ============
Basic earnings (loss) per share $ 0.45 $ 0.15 $ (0.04)
============ ============ ============
Diluted earnings (loss) per share $ 0.45 $ 0.14 $ (0.04)
============ ============ ============
</TABLE>
<PAGE> 1
EXHIBIT 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
Applied Innovation Inc. ("AI") develops, manufactures, and markets network
mediation and bridging products and related services to the telecommunications
industry. AI's products and services support the operation, maintenance,
administration and provisioning of a variety of switching and transmission
devices used by telecommunications providers to assist in the management of
their customer service network. AI's primary emphasis is on providing integrated
hardware and software solutions to companies in the telecommunications industry.
Through the AISwitch(TM) 180, AIscout(TM), AIflex(TM), AIM(TM), AIspy(TM), and
NEWEB(TM) series products, AI provides the data network needed to monitor and
maintain thousands of pieces of electronic equipment used to deliver
telecommunication services. Telecommunications providers 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, maintain and improve customer
service. The new equipment, along with the immense installed base of older
equipment, must be connected and integrated to efficiently communicate with the
data-monitoring network. AI's products perform this critical bridging and
mediation function.
COMPARISON OF 1999 TO 1998
Net sales of $49,524,000 for the year ended December 31, 1999 decreased 8% from
$53,628,000 from the prior year. The decrease in sales is largely attributed to
increased competition in markets served by the Company's AI Switch 180, and to a
lesser extent, temporary postponement of orders from certain customers as they
addressed year 2000 issues within their networks. 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 AI's net sales. Two companies accounted for 42% of AI's
net sales in 1999. These two customers contributed 15% and 27% of net sales,
respectively.
Gross profit, as a percentage of net sales, was 58% in 1999, compared to 59% in
1998. The company expects 2000 gross profit, as a percentage of net sales, to be
lower than the 1999 percentage due to competitive pricing pressure in the
Company's markets. Additionally, the Company's recently introduced products have
lower selling prices and are expected to generate slightly lower gross margins
than the Company's products have historically achieved.
Research and development ("R&D") expenses decreased to $7,480,000 (15% of net
sales) in 1999 from $11,980,000 (22% of net sales) in 1998. The decrease was due
to a reduction in R&D expenses associated with Access Products Group ("APG")
development activities and related closure of the Raleigh, North Carolina
facility in September 1998. Excluding $6,263,000 of R&D related to APG
development activities in 1998, AI's R&D expenses increased in 1999 compared to
core product related expenses of $5,717,000 in 1998. This is a result of
increases in staffing to support product development and of resources allocated
to the investigation of potential new products and technologies. The Company
expects 2000 R&D as a percentage of sales to be generally consistent with the
1999 amount.
Selling, general and administrative expenses ("SG&A") decreased to $11,965,000
(24% of net sales) in 1999 from $14,428,000 (27% of net sales) in 1998. The
decrease in SG&A is primarily attributed to a reduction in selling costs and
marketing expenses, as well as rent and other costs associated with the
Company's terminated
<PAGE> 2
Access Products Group. The Company anticipates that SG&A expenses for 2000 will
be higher than 1999 due to increases in sales staff and marketing expenses.
A non-recurring charge of $3.8 million was recorded in 1998 to account for the
termination of the APG development activity. This charge is separately stated on
the Consolidated Statements of Operations and reflects all costs associated with
the termination of the APG. The charge includes $1.1 million of severance
related costs, a charge of $2.2 million to write down specific APG assets and
$0.5 million related to occupancy costs, asset moving costs and other associated
termination costs.
As a result of the above changes in sales and expenses, 1999 income from
operations increased to $9,162,000 from $1,183,000 in 1998. Income from
operations represents 19% of net sales in 1999, compared to 2% of net sales in
1998.
Other income decreased to $924,000 in 1999, versus $1,665,000 in 1998. Net other
income for 1998 included a reversal of a previously accrued third party sales
expense of $1,049,000.
Income before income taxes in 1999 was $10,086,000, compared to $2,848,000 in
1998.
The effective income tax rate was 31% in 1999 compared to 19% in 1998. Relative
to pre-tax income, the amount of tax credits for R&D activities was much higher
in 1998 than in 1999, resulting in a significantly lower effective income tax
rate in 1998 than in 1999.
Net income was $7,005,000, or $0.45 diluted earnings per share in 1999 versus
net income of $2,310,000, or $0.14 diluted earnings per share in 1998. The
diluted weighted average number of shares was 15,647,000 for 1999 compared to
15,963,000 for 1998.
COMPARISON OF 1998 TO 1997
Net sales increased to $53,628,000 for the year ended December 31, 1998 from
$46,661,000 for the year ended December 31, 1997, or an increase of 15%. Most of
the increase resulted from additional unit sales of AI's core product offering,
the AISwitch Series 180. Because sales are concentrated among the RBOCs, a small
number of customers have accounted for a substantial portion of AI's annual net
sales. Five companies accounted for 75% of AI's net sales in 1998. Each of these
five customers contributed between 11% and 21% of net sales. Net sales of the
terminated APG products were less than 1% of total net sales in 1998.
Gross profit increased to 59% in 1998 from 57% in 1997. The improved gross
profit for 1998 was due to higher production volume and cost improvement
programs implemented during 1998.
Research and development ("R&D") expenses decreased to $11,980,000 in 1998 from
$12,897,000 in 1997. The decrease was the result of a reduction in R&D
associated with AI's core product offering and the termination of the APG
development activities and related closure of the Raleigh, North Carolina
facility in September 1998. During 1998 and 1997 AI incurred $5,717,000 and
$6,361,000, respectively, in R&D expenses related to the core product offering
along with $6,263,000 and $6,536,000, respectively, in R&D expenses related to
the terminated APG development activity.
Selling, general and administrative ("SG&A") expenses decreased to $14,428,000
in 1998 from $15,091,000 in 1997. The decrease was primarily attributable to a
$740,000 expense in 1997 for accounts receivable determined to be not
collectible. This type of expense did not occur in 1998.
<PAGE> 3
A non-recurring charge of $3.8 million was taken in the third quarter of 1998 to
account for the termination of the APG development activity. This charge is
separately stated on the Consolidated Statements of Operations and reflects all
costs associated with the termination of the APG. The charge includes $1.1
million of severance related costs, a charge of $2.2 million to write down
specific APG assets and $0.5 million related to occupancy costs, asset moving
costs and other associated termination costs.
As a result of the above changes in sales and expenses, there was income from
operations of $1,183,000 in 1998 compared to a loss from operations of
$1,419,000 in 1997.
Net other income increased to $1,665,000 in 1998 compared to $401,000 in 1997.
Net other income for 1998 included a reversal of a previously accrued third
party sales expense of $1,049,000. Due to a change in the relationship regarding
how a third party is compensated for sales efforts related to AI's products,
both parties agreed that the previously recorded expense would not be paid. AI
previously expensed and accrued $746,000 in 1997 and $303,000 in 1998 related to
these sales efforts.
Income before income taxes in 1998 was $2,848,000 compared to a loss before
income taxes of $1,017,000 in 1997.
The effective income tax rate was 19% in 1998 compared to an income tax benefit
of 37% in 1997. The decrease in the effective income tax rate is the result of
AI receiving tax credits for R&D activities and job creation in the State of
Ohio.
Net income was $2,310,000, or $0.14 diluted earnings per share in 1998, compared
to a net loss of $637,000, or $0.04 diluted loss per share in 1997. The diluted
weighted average number of shares was 15,963,000 for 1998 compared to 15,786,000
for 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company had $19,071,000 of cash and cash equivalents and short- and
long-term investments at December 31, 1999 compared to $17,211,000 at December
31, 1998. During 1999, operating activities provided cash of $4,588,000.
Additionally, the Company purchased $1,193,000 of equipment to support
operations and purchased $7,162,000 of investment securities.
Net working capital was $22,928,000 at December 31, 1999 and the current ratio
was 4.1:1. AI had no debt in 1999 or 1998.
On October 21, 1999, the Board of Directors approved a one-year extension of the
Company's 1,000,000 share stock repurchase program originally adopted in October
1998. Under this program, the Company has repurchased 448,000 shares through
December 31, 1999, at an average per share price of $3.72.
AI's management believes that its current cash and equivalents and cash
generated from future operations will provide sufficient capital to meet the
business needs of AI through 2000.
<PAGE> 4
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report, including Management's Discussion and Analysis of Financial
Condition and Results of Operations as well as the Letter to Stockholders and
the discussion of AI's business contains various 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
forward-looking statements include, but may not be limited to, all statements
regarding intent, beliefs, expectations, projections, forecasts, and plans of AI
and its management, and include statements regarding future sales and other
results of operations, any statements regarding the continued historical trends,
any statements regarding the sufficiency of AI's cash balances and cash
generated from operating activities, implementation and financing of the stock
repurchase program, and any statement regarding the future of the
telecommunications industry or AI's business. These forward-looking statements
involve numerous risks and uncertainties, including, without limitation, the
fact that AI 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, and the various risks inherent in AI's
business and other risks and uncertainties detailed from time to time in AI's
periodic reports filed with the Securities and Exchange Commission, including
AI's Annual Report on Form 10-K. One or more of these factors have affected, and
could in the future affect, AI's business and financial results in future
periods and could cause actual results to differ materially from plans and
projections. Therefore, there can be no assurance that the forward-looking
statements included herein 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 AI, or any other person, that the objectives and plans of AI
will be achieved. All forward-looking statements made herein are based on
information presently available to the management of AI. AI assumes no
obligation to update any forward-looking statements.
<PAGE> 5
APPLIED INNOVATION INC.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
At December 31,
---------------
Assets 1999 1998
------ ---- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 11,928,868 $ 17,211,499
Short-term investments 1,794,581 --
Accounts receivable, net of allowance of $317,547 in 1999 and $256,117 in 1998 10,990,025 7,698,250
Inventory 3,913,432 3,620,655
Other current assets 577,091 295,923
Deferred income taxes 1,231,000 1,410,000
------------ ------------
Total current assets 30,434,997 30,236,327
------------ ------------
Property, plant and equipment:
Land 1,639,303 1,639,303
Building 4,986,714 4,875,476
Equipment 5,984,287 6,238,173
Furniture 1,974,332 1,949,575
------------ ------------
14,584,636 14,702,527
Less accumulated depreciation 5,941,568 5,276,287
------------ ------------
Property, plant and equipment, net 8,643,068 9,426,240
Investments 5,347,377 --
Other assets 168,887 107,106
------------ ------------
$ 44,594,329 $ 39,769,673
============ ============
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Accounts payable $ 2,224,460 $ 1,051,922
Accrued expenses:
Warranty 1,877,731 2,644,738
Income taxes 1,405,010 2,250,554
Payroll and related expenses 835,789 1,062,453
Royalties 177,019 272,269
Property taxes 364,361 382,315
Access Products termination charge 288,613 387,478
Deferred revenue 333,682 11,261
------------ ------------
Total current liabilities 7,506,665 8,062,990
Deferred income taxes -- 64,000
------------ ------------
Total liabilities 7,506,665 8,126,990
------------ ------------
Stockholders' equity:
Common stock, $.01 par value; authorized 30,000,000 shares; issued and outstanding
15,371,932 shares in 1999 and 15,786,132 shares in 1998 153,719 157,861
Additional paid-in capital 6,801,476 8,337,154
Retained earnings 30,152,749 23,147,668
Accumulated other comprehensive loss - net (20,280) --
------------ ------------
Total stockholders' equity 37,087,664 31,642,683
------------ ------------
$ 44,594,329 $ 39,769,673
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 6
APPLIED INNOVATION INC.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Net sales $ 49,523,619 $ 53,627,516 $ 46,661,054
Cost of sales 20,917,459 22,236,650 20,091,096
------------ ------------ ------------
Gross profit 28,606,160 31,390,866 26,569,958
------------ ------------ ------------
Operating expenses:
Selling, general and administrative 11,965,059 14,428,447 15,091,470
Research and development 7,479,496 11,979,875 12,897,072
Non-recurring charge -- 3,800,000 --
------------ ------------ ------------
Total operating expenses 19,444,555 30,208,322 27,988,542
------------ ------------ ------------
Income (loss) from operations 9,161,605 1,182,544 (1,418,584)
------------ ------------ ------------
Other income (expense):
Interest income 992,665 614,705 535,409
Other income -- 1,049,100 --
Gain (loss) on disposal of assets (68,189) 1,303 (134,020)
------------ ------------ ------------
Total other income, net 924,476 1,665,108 401,389
------------ ------------ ------------
Income (loss) before income taxes 10,086,081 2,847,652 (1,017,195)
Income taxes 3,081,000 538,000 (380,000)
------------ ------------ ------------
Net income (loss) $ 7,005,081 $ 2,309,652 $ (637,195)
============ ============ ============
Earnings (loss) per share:
Basic earnings (loss) per share $ .45 $ .15 $ (.04)
============ ============ ============
Diluted earnings (loss) per share $ .45 $ .14 $ (.04)
============ ============ ============
Weighted average shares outstanding for basic earnings
(loss) per share 15,598,143 15,804,608 15,786,332
============ ============ ============
Weighted average shares outstanding for diluted earnings
(loss) per share 15,647,050 15,962,846 15,786,332
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 7
APPLIED INNOVATION INC.
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
COMMON STOCK
----------------------
Number Additional Deferred Accumulated
of shares Paid-in Compen- Retained other compre-
outstanding Amount Capital sation Earnings hensive loss Totals
----------- ------ ------- ------ -------- ------------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance-December 31, 1996 15,764,632 $157,646 $8,360,502 $(51,501) $21,475,211 $ -- $29,941,858
Stock options exercised 26,200 262 16,863 -- -- -- 17,125
Tax benefit associated with
exercise of stock options -- -- 29,693 -- -- -- 29,693
Amortization of deferred
compensation -- -- -- 51,501 -- -- 51,501
Net loss -- -- -- -- (637,195) -- (637,195)
---------- -------- ---------- -------- ----------- ---------- -----------
Balance-December 31, 1997 15,790,832 157,908 8,407,058 -- 20,838,016 -- 29,402,982
Stock options exercised 29,100 291 49,982 -- -- -- 50,273
Tax benefit associated with
exercise of stock options -- -- 8,079 -- -- -- 8,079
Common stock repurchased (33,800) (338) (127,965) -- -- -- (128,303)
Net income -- -- -- -- 2,309,652 -- 2,309,652
---------- -------- ---------- -------- ----------- ---------- -----------
Balance-December 31, 1998 15,786,132 157,861 8,337,154 -- 23,147,668 -- 31,642,683
Comprehensive income:
Net income -- -- -- -- 7,005,081 -- 7,005,081
Unrealized loss on
investments, net -- -- -- -- -- (20,280) (20,280)
-----------
Total comprehensive income -- -- -- -- -- -- 6,984,801
Common stock repurchased (414,200) (4,142) (1,535,678) -- -- -- (1,539,820)
---------- -------- ---------- -------- ----------- ---------- -----------
Balance-December 31, 1999 15,371,932 $153,719 $6,801,476 $ -- $30,152,749 $ (20,280) $ 37,087,664
========== ======== ========== ======== =========== ========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 8
APPLIED INNOVATION INC.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 7,005,081 $ 2,309,652 $ (637,195)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation 1,883,381 2,658,968 2,448,009
(Gain) loss on disposal of assets 68,189 (1,303) 134,020
Provision for deferred compensation -- -- 51,501
Deferred income tax expense (benefit) 80,000 (477,000) 80,000
Write down of assets related to termination of
Access Products development activity -- 2,322,634 --
Effects of changes in operating assets and liabilities:
Accounts receivable (3,291,775) 4,246,442 (4,298,175)
Inventory (292,777) (861,343) (170,378)
Other current assets (281,168) 2,439 (27,751)
Other assets (26,781) 6,990 3,340
Accounts payable 1,172,538 (2,313,893) 1,848,624
Accrued expenses (2,051,284) 2,369,887 843,750
Deferred revenue 322,421 (21,570) 32,831
------------ ------------ ------------
Net cash provided by operating activities 4,587,825 10,241,903 308,576
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property, plant and equipment (1,193,200) (1,216,487) (4,453,540)
Purchases of available for sale investments (32,071,575) -- --
Maturities of available for sale investments 11,478,082 -- --
Sale of available for sale investments 13,431,255 -- --
Proceeds from sale of property, plant and equipment 24,802 60,878 15,210
------------ ------------ ------------
Net cash used by investing activities (8,330,636) (1,155,609) (4,438,330)
------------ ------------ ------------
Cash flows from financing activities:
Common stock repurchased (1,539,820) (128,303) --
Tax benefit associated with exercise of stock options -- 8,079 29,693
Proceeds from issuance of common stock -- 50,273 17,125
------------ ------------ ------------
Net cash provided (used) by financing activities (1,539,820) (69,951) 46,818
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents (5,282,631) 9,016,343 (4,082,936)
Cash and cash equivalents-beginning of year 17,211,499 8,195,156 12,278,092
------------ ------------ ------------
Cash and cash equivalents-end of year $ 11,928,868 $ 17,211,499 $ 8,195,156
============ ============ ============
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Income taxes paid $ 3,846,544 $ 1,232 $ 75,801
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 9
APPLIED INNOVATION INC.
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
(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:
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 multivendor, multiprotocol
telecommunications networks. The majority of the Company's
customers are regional bell operating companies, long distance
phone companies and competitive access providers.
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.
CASH EQUIVALENTS
Cash equivalents represent short-term investments with original
maturities of three months or less. At December 31, 1999 and
1998, cash equivalents of $10,080,163 and $11,524,611,
respectively, were invested in corporate notes and commercial
paper and taxable and tax exempt bonds with original
maturities of three months or less.
INVESTMENTS
Since the Company does not intend to hold its investments in debt
and equity securities until maturity and does not actively
trade the securities to maximize trading gains, the Company
classifies these securities as "available-for-sale" and,
accordingly, reports such securities at fair value plus
accrued interest. The fair value of debt securities is
determined from public quotations for such securities as of
the reporting date. Any temporary excess (deficiency) of fair
value over (under) the underlying cost of the investment, net
of taxes, is excluded from current period earnings and is
reported as unrealized gains (losses) as a separate component
of stockholders' equity.
REVENUE RECOGNITION
Sales revenue is recognized when products are shipped, except in
situations where the customer directs the Company to hold the
products. In such situations, revenue is recognized when all
other terms and obligations of the sale are met, including the
transfer of title and risk of loss. Field service revenue is
recognized as projects are completed. Revenue under annual
maintenance agreements is recognized straight-line over the
period of the agreement.
<PAGE> 10
INVENTORY
Inventory is stated at the lower of cost or market using the
first-in, first-out method.
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:
<TABLE>
<CAPTION>
Lives (in years)
---------------
<S> <C>
Building 40
Equipment 3-5
Furniture 7
</TABLE>
WARRANTY
The Company warrants its products for a minimum of one year after
sale and up to five years as negotiated under contract.
Additionally, the Company may agree to repair, replace or
service its products beyond the warranty period. Accordingly,
the Company accrues the estimated costs of such warranties and
services.
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.
STOCK OPTION PLANS
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting principles Board ("APB") Opinion No.
25, Accounting for Stock Issued to Employees, and related
interpretations, in accounting for its fixed plan stock
options. 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. Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based compensation," established accounting and
disclosure requirements using a fair value-based method of
accounting for stock-based employee compensation plans. As
allowed by SFAS No. 123, the Company elected to continue to
apply intrinsic value-based method of accounting described
above, and has adopted the disclosure requirements of SFAS
123.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed when incurred.
<PAGE> 11
GENERAL CREDIT RISK
The Company grants credit on open account to its customers,
substantially all of whom are in the telecommunications
industry.
USE OF ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements
and the reported amounts of revenue and expenses during the
reporting period. Estimates are used for, but not limited to,
the accounting for doubtful accounts, inventory obsolescence,
depreciation and amortization, sales returns, warranty costs,
taxes, and contingencies. Actual results could differ from
these estimates.
(2) INVENTORY
Major classes of inventory at December 31, 1999 and 1998 are summarized
below:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Raw materials $ 2,739,379 $ 2,280,652
Work-in-process 142,030 235,062
Finished goods 1,192,023 1,264,941
------------- -------------
4,073,432 3,780,655
Reserve for obsolescence (160,000) (160,000)
------------- -------------
$ 3,913,432 $ 3,620,655
============= =============
</TABLE>
(3) INVESTMENTS
The fair values of all financial instruments, excluding investments,
approximate carrying values because of short maturities of those
instruments.
The following summarizes the Company's investments in securities at
December 31, 1999. The Company had no investments at December 31,
1998.
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------- -------------- -------------- ------------
<S> <C> <C> <C> <C>
U.S. agency obligations $1,935,335 $ 50 $(45,703) $ 1,889,682
U.S. government obligations 277,064 -- (5,966) 271,098
Corporate obligations 4,171,350 44,923 (22,696) 4,981,178
---------------- -------------- -------------- ------------
Total $7,171,350 $ 44,973 $(74,365) $ 7,141,958
================ ============== ============== ============
Reported as:
Short-term investments $ 1,794,581
Investments 5,347,377
------------
Total $ 7,141,958
============
</TABLE>
<PAGE> 12
The Company's debt securities at fair market value mature as follows:
$1,794,581 in less than one year, $4,216,794 after one year but less
than five years, and $1,130,583 in five or more years.
(4) EARNINGS (LOSS) PER SHARE
The calculations of earnings (loss) per share for the years ended
December 31, 1999, 1998, and 1997 are based upon the weighted
average shares outstanding during the periods and, when applicable,
those stock options that are dilutive, using the treasury stock
method. Reconciliations of the numerators and denominators of the
basic and diluted earnings (loss) per share calculations follow:
<TABLE>
<CAPTION>
Year ended December 31, 1999
--------------------------------------------
Income Shares Per share
(numerator) (denominator) Amount
----------- ------------- ------
<S> <C> <C> <C>
Basic earnings per share-
Net income available to common stockholders $7,005,081 15,598,143 $ .45
=========
Effect of dilutive securities-
Stock options -- 48,907
----------- ----------
Dilutive earnings per share
Net income available to common stockholders
including assumed conversions $7,005,081 15,647,050 $ .45
=========== ========== =========
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31, 1998
-----------------------------------------
Income Shares Per share
(numerator) (denominator) Amount
----------- ------------- ------
<S> <C> <C> <C>
Basic earnings per share-
Net income available to common stockholders $2,309,652 15,804,608 $ .15
=========
Effect of dilutive securities-
Stock options -- 158,238
----------- ----------
Diluted earnings per share-
Net income available to common stockholders
including assumed conversions $ 2,309,652 15,962,846 $ .14
=========== ========== =========
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31, 1997
------------------------------------------
Loss Shares Per share
(numerator) (denominator) Amount
----------- ---------- ---------
<S> <C> <C> <C>
Basic and diluted loss per share $ (637,195) 15,786,332 $ (.04)
=========== ========== =========
</TABLE>
Stock options which are antidilutive under the treasury stock method
have been excluded from the above earnings (loss) per share
calculations.
(5) MAJOR CUSTOMERS
Revenues to major customers comprised 42%, 75%, and 76% of net sales for
1999, 1998 and 1997, respectively. The number of major customers
previously referred to were two, five, and five for 1999, 1998 and
1997, respectively, with trade accounts receivable balances of
$3,173,344 and $4,746,738 at December 31, 1999 and 1998,
respectively.
<PAGE> 13
(6) 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, with 1,000,000
shares of common stock reserved for issuance under the 1996 Plan.
The 1996 Plan was amended by the Board of Directors and approved by
the stockholders of the Company on April 23, 1998 to increase the
shares available for issuance under the 1996 Plan from 1,000,000 to
2,000,000. Options granted under the 1996 Plan may be either
incentive stock options or nonstatutory 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.
Effective March 1, 1997, the Company repriced all stock options
outstanding with exercise prices exceeding the fair market value per
share of the Company's common stock on that date. The stock options
were repriced at $5, the fair market value on March 1, 1997.
At December 31, 1999, there were 1,172,600 additional shares available
for grant under the 1996 Plan. The per share weighted-average fair
value of stock options granted during 1999, 1998, and 1997 was
$2.36, $4.15, and $2.35, respectively, 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, 1999, 1998, and 1997, respectively: dividend yield of
0% for all years; expected volatility of 71%, 71%, and 67%;
risk-free interest rate of 6% for all years; and expected life of
4.5, 4.5, and 4.2 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 SFAS No. 123, including the impact of the
options repriced in 1997, the Company's net income (loss) and
earnings (loss) per share, net of related income tax effects, would
have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) As reported $ 7,005,081 $ 2,309,652 $ (637,195)
Pro forma 6,519,016 1,877,467 (1,664,539)
Basic earnings (loss) per share As reported $ .45 $ .15 $ (.04)
Pro forma .42 .12 (.11)
Diluted earnings (loss) per share As reported $ .45 $ .14 $ (.04)
Pro forma .42 .12 (.11)
</TABLE>
<PAGE> 14
Pro forma net income (loss) reflects only options granted since January
1, 1995. Therefore, the full impact of calculating compensation cost
for stock options under SFAS No. 123 is not reflected in the pro
forma net income (loss) 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.
A summary of stock option activity follows:
<TABLE>
<CAPTION>
Number of Weighted-average
shares exercise price
------ -------------
<S> <C> <C>
Balance at December 31, 1996 702,400 $ 10.26
Granted 1,179,150 5.20
Exercised (26,200) .65
Canceled/expired (821,100) 9.98
---------
Balance at December 31, 1997 1,034,250 4.96
Granted 349,250 6.87
Exercised (29,100) 1.73
Canceled/expired (409,750) 5.73
---------
Balance at December 31, 1998 944,650 5.43
Granted 515,000 3.68
Exercised -- --
Canceled/expired (354,350) 4.78
---------
Balance at December 31, 1999 1,105,300 4.82
=========
</TABLE>
<PAGE> 15
The following table summarizes information about options outstanding at December
31, 1999:
<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>
$ 3.44 - 4.81 388,750 6.8 $3.64 56,700 $3.48
$ 5.00 510,800 2.5 5.00 412,320 5.00
$ 5.63 - 6.81 145,750 5.6 6.46 35,150 6.33
$ 7.00 - 7.53 60,000 4.4 7.05 55,200 7.01
---------- --------
1,105,300 4.6 4.82 559,370 5.13
========== =========
</TABLE>
(7) DEFINED CONTRIBUTION PLAN
The Company sponsors a defined contribution 401(k) and profit sharing
plan that covers all eligible employees. Since October 1, 1999, the
Company matched 50% of each participant's contribution, up to 6% on
that participant's contribution. From April 1, 1998 to October 1,
1999, the Company matched 35%, and prior to April 1, 1998, the
Company matched 25%. The Company may also make profit sharing
contributions at the discretion of the Board of Directors. For 1999,
1998, and 1997, the profit sharing contribution was $250,000,
$100,000, and $0, respectively, and the total expense related to the
plan was $475,373, $329,918, and $141,798, respectively.
(8) INCOME TAXES
Income tax expense (benefit) consists of:
<TABLE>
<CAPTION>
Current Deferred Total
----------- ----------- -----------
<S> <C> <C> <C>
Year ended December 31, 1999:
Federal $ 2,663,000 $ 74,000 $ 2,737,000
State and local 338,000 6,000 344,000
----------- ----------- -----------
$ 3,001,000 $ 80,000 $ 3,081,000
=========== =========== ===========
Year ended December 31, 1998:
Federal $ 912,000 $ (438,000) $ 474,000
State and local 103,000 (39,000) 64,000
----------- ----------- -----------
$ 1,015,000 $ (477,000) $ 538,000
=========== =========== ===========
Year ended December 31, 1997:
Federal $ (460,000) $ 36,000 $ (424,000)
State and local -- 44,000 44,000
----------- ----------- -----------
$ (460,000) $ 80,000 $ (380,000)
=========== =========== ===========
</TABLE>
<PAGE> 16
A reconciliation of income tax expense (benefit) at the expected
federal statutory rate (34%) to income tax expense (benefit) at the
Company's effective rates for continuing operations is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Computed tax at the expected federal statutory rate $ 3,429,000 $968,000 $(346,000)
State and local income taxes, net of federal income
tax effect 223,000 29,000 43,000
Meals and entertainment expenses 37,000 40,000 66,000
Research and experimentation credit (585,000) (464,000) (104,000)
Tax-exempt interest income (33,000) (36,000) (43,000)
Other 10,000 1,000 4,000
-------------- ------------- ------------
$ 3,081,000 $538,000 $(380,000)
============== ============= =============
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1999 and 1998 are presented below:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Deferred tax assets:
Warranty reserve $ 695,000 $ 979,000
Accounts receivable allowance 117,000 95,000
Inventory, principally due to additional costs inventoried for
tax purposes 189,000 189,000
Access Products termination charge 107,000 144,000
Deferred revenue 123,000 --
Property, plant and equipment, principally due to differences in
depreciation 35,000 --
Other -- 3,000
--------- ---------
Total gross deferred tax assets 1,266,000 1,410,000
--------- ---------
Deferred tax liabilities:
Property, plant and equipment, principally due to differences in
depreciation -- 64,000
--------- ---------
Total gross deferred tax liabilities -- 64,000
--------- ---------
Net deferred tax asset $1,266,000 $1,346,000
========== ==========
</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.
<PAGE> 17
(9) OTHER INCOME
In 1998, there was a change in the Company's business relationship with
a third party regarding compensation to the third party for sales
efforts related to the Company's products. The change in the
relationship resulted in both parties agreeing that certain
obligations due the third party by the Company would not be paid.
The Company previously expensed and accrued $745,875 in 1997 and
$303,225 in 1998 related to the sales efforts. As a result of the
change, the Company reversed the accrued liability and recognized
other income of $1,049,100 in the fourth quarter of 1998.
(10) LEASE COMMITMENTS
The Company is obligated for office space in Colorado, North Carolina,
and Texas under various operating leases, which expire over the next
three years. The Company's North Carolina property is sublet through
the term of the lease.
Future minimum lease payments and related sublease receipts under the
operating leases as of December 31, 1999 are:
<TABLE>
<CAPTION>
Lease Sublease
Year ending December 31: Payments Receipts
-------- --------
<S> <C> <C> <C>
2000 $ 353,862 $(249,990)
2001 360,006 (249,990)
2002 110,986 (27,082)
--------------------------
Total minimum lease payments $ 824,855 $(527,063)
==========================
</TABLE>
Total rent expense in 1999, 1998, and 1997 was $92,222, $349,889,
and $283,040, respectively. Costs associated with the Company's
North Carolina lease were accrued in 1998 as a component of the
non-recurring charge. Accordingly, such costs have been excluded
from 1999 rent expense.
(11) STOCK REPURCHASE PROGRAM
On October 21, 1999, the Company's Board of Directors approved a one
year extension of the Company's 1,000,000 share stock repurchase
program originally adopted in October 1998. Under this program, the
Company has repurchased 448,000 shares through December 31, 1999.
<PAGE> 18
(12) NON-RECURRING CHARGE
In September of 1998, the Company terminated all product development
and related activities of its Access Products Group due to an
unsuccessful search for a strategic partner The termination resulted
in a one-time non-recurring charge of $3.8 million which was
recorded in the third quarter of 1998. This charge accounted for all
costs associated with the termination of the Access Products Group,
including the closing of the Raleigh, North Carolina facility. The
charge resulted in $1.1 million of severance related costs, a charge
of $2.2 million to write down specific assets and $.5 million
related to occupancy and other associated termination costs.
(13) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
A summary of quarterly financial information follows (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
1999 Q1 Q2 Q3 Q4
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Net sales $ 10,854 $ 12,523 $ 11,779 $ 14,368
Gross profit 6,589 7,178 7,060 7,780
Income before income taxes 1,979 2,629 2,359 3,119
Net income 1,267 1,682 1,510 2,547
Net income per share $ .08 $ .11 $ .10 $ .16
</TABLE>
<TABLE>
<CAPTION>
1998 Q1 Q2 Q3 Q4
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Net sales $ 11,518 $ 14,784 $ 14,020 $ 13,306
Gross profit 6,653 8,272 8,422 8,044
Income (loss) before income taxes (176) 434 (2,101) 4,691
Net income (loss) (116) 286 (1,386) 3,526
Net income (loss) per share $ (.01) $ .02 $ (.09) $ .22
</TABLE>
<PAGE> 1
Exhibit 23.1
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 9, 2000, relating to the consolidated balance sheets of
Applied Innovation Inc. and subsidiary as of December 31, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1999,
and related schedule, which report appears in the December 31, 1999 annual
report on Form 10-K of Applied Innovation Inc.
/s/ KMPG LLP
Columbus, Ohio
March 28, 2000
<PAGE> 1
EXHIBIT 24
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 fiscal year ended
December 31, 1999, 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, 2000.
DIRECTORS/OFFICERS:
<TABLE>
<CAPTION>
Signature Title
--------- -----
<S> <C>
/s/ Gerard B. Moersdorf, Jr. Chairman, President and Treasurer
- -------------------------------------------- (Principal Executive Officer)
Gerard B. Moersdorf, Jr.
/s/ Michael P. Keegan Vice President and Chief Financial Officer
- -------------------------------------------- (Principal Financial and Accounting Officer)
Michael P. Keegan
/s/ William H. Largent Director
- --------------------------------------------
William H. Largent
/s/ James H. Blough Director
- --------------------------------------------
James H. Blough
/s/ Curtis A. Loveland Director
- --------------------------------------------
Curtis A. Loveland
/s/ Gerard B. Moersdorf, Sr. Director
- --------------------------------------------
Gerard B. Moersdorf, Sr.
/s/ Richard W. Oliver Director
- --------------------------------------------
Richard W. Oliver
/s/ Thomas W. Huseby Director
- --------------------------------------------
Thomas W. Huseby
/s/ Alexander B. Trevor Director
- --------------------------------------------
Alexander B. Trevor
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 11,928,868
<SECURITIES> 1,794,581
<RECEIVABLES> 11,307,572
<ALLOWANCES> 317,547
<INVENTORY> 3,913,432
<CURRENT-ASSETS> 30,439,997
<PP&E> 14,584,636
<DEPRECIATION> 5,941,568
<TOTAL-ASSETS> 44,594,329
<CURRENT-LIABILITIES> 7,506,665
<BONDS> 0
0
0
<COMMON> 153,719
<OTHER-SE> 36,933,945
<TOTAL-LIABILITY-AND-EQUITY> 44,594,329
<SALES> 49,523,619
<TOTAL-REVENUES> 49,523,619
<CGS> 20,917,459
<TOTAL-COSTS> 20,917,459
<OTHER-EXPENSES> 19,444,555
<LOSS-PROVISION> 130,000
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 10,086,081
<INCOME-TAX> 3,081,000
<INCOME-CONTINUING> 7,005,081
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,005,081
<EPS-BASIC> .45
<EPS-DILUTED> .45
</TABLE>
<PAGE> 1
Exhibit 99
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Applied Innovation Inc.:
We have audited the accompanying consolidated balance sheets of Applied
Innovation Inc. and subsidiary as of December 31, 1999 and 1998, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the years in the three year period ended December 31, 1999. In
connection with our audits of the consolidated financial statements, we have
also audited the financial statement schedule of valuation and qualifying
accounts. These consolidated financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
financial statement schedule 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, 1999 and 1998, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1999, in conformity with generally accepted accounting
principles. Also in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
/s/ KPMG LLP
Columbus, Ohio
February 9, 2000
