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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarter ended September 30, 1996
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from ____ to____
Commission file number:
0000898805
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ADVANCED FIBRE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 68-0277743
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1445 McDowell Boulevard North
Petaluma, California 94954
(707) 794-7700
(Address, including zip code, of Registrant's principal
executive offices and telephone number, including area code)
----------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes No _X_
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class November 5, 1996
---------------------------- ----------------
Common Stock, $0.01 par value 32,599,364
- --------------------------------------------------------------------------------
This report on Form 10-Q, including all exhibits, contains 28 pages. The exhibit
index is located on page 22.
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ADVANCED FIBRE COMMUNICATIONS, INC.
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1996
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
September 30, 1996 and December 31, 1995.................. 3
Condensed Consolidated Statements of Operations
Three months and nine months ended September 30,
1996 and 1995........................................... 4
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 1996 and 1995............. 5
Notes to Condensed Consolidated Financial Statements.......... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................19
Item 2. Changes in Securities..............................................20
Item 3. Defaults upon Senior Securities....................................20
Item 4. Submission of Matters to a Vote of Security Holders................20
Item 5. Other Information..................................................21
Item 6. Exhibits and Reports on Form 8-K...................................22
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ADVANCED FIBRE COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents, including restricted cash $ 6,737 $ 11,118
of $150 and $1,730, respectively
Accounts receivable, net 23,593 10,993
Inventories, net 18,073 10,149
Deferred income taxes 5,970 -
Other current assets 587 132
------------ ------------
Total current assets 54,960 32,392
Property and equipment, net 6,104 1,828
Other assets 4,059 2,460
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TOTAL ASSETS $ 65,123 36,680
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------------ ------------
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Bank Borrowings $ 14,806 $ -
Accounts payable 8,308 7,121
Accrued liabilities 7,065 6,501
------------ ------------
Total current liabilities 30,179 13,622
Long-term liabilities 646 1,046
Redeemable convertible preferred stock 39,317 37,777
Commitments and contingencies
Stockholders' equity (deficit):
Common stock, $0.01 par value; 100,000,000 and 84,654,184
shares authorized in 1996 and 1995, respectively;
6,194,852 and 5,015,168 shares issued and outstanding
in 1996 and 1995, respectively 62 50
Additional paid-in capital 6,823 (2,248)
Notes receivable from stockholders (176) (176)
Accumulated deficit (11,728) (13,391)
------------ ------------
Total Stockholders' (deficit) (5,019) (15,765)
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TOTAL LIABILITIES, REDEEMABLE CONVERTIBLE
PREFERRED STOCK, AND STOCKHOLDERS'
EQUITY (DEFICIT) $ 65,123 $36,680
------------ ------------
------------ ------------
</TABLE>
See Accompanying Notes to Condensed Consolidated Financial Statements
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ADVANCED FIBRE COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
1996 1995 1996 1995
---------- ---------- ---------- ----------
<S> <C> <S> <S> <S>
Revenues $ 35,012 $ 15,548 $ 88,784 $ 34,793
Cost of revenues 19,737 9,837 50,794 21,758
---------- ---------- ---------- ----------
Gross profit 15,275 5,711 37,989 13,035
---------- ---------- ---------- ----------
Operating expenses:
Research and development 4,141 1,406 10,035 3,670
Selling, general, and administrative 5,608 2,471 13,509 6,433
DSC litigation costs - 324 18,947 1,074
---------- ---------- ---------- ----------
Total operating expenses 9,749 4,201 42,491 11,177
---------- ---------- ---------- ----------
Operating income (loss) 5,526 1,510 (4,502) 1,858
Other income (expense):
Equity in loss of joint venture - (526) (167) (1,068)
Other income, net (338) (4) (272) 37
---------- ---------- ---------- ----------
Income (loss) before income taxes 5,188 980 (4,941) 827
Income taxes (benefit) 1,984 39 (6,604) 41
---------- ---------- ---------- ----------
Net Income $ 3,204 $ 941 $ 1,663 786
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Pro forma net income per share $ 0.10 $ 0.03 $ 0.06 $ 0.03
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Shares used in per share computations 30,533 28,024 30,058 26,723
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
See Accompanying Notes to Condensed Financial Statements
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ADVANCED FIBRE COMMUNICATIONS
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------
1996 1995
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 1,663 $ 786
Adjustments to reconcile net income to net cash
used in operating activities:
Noncash portion of litigation settlement 12,807 -
Deferred income taxes (6,760) -
Depreciation and amortization 583 211
Equity in loss of joint venture 392 1,068
Changes in operating assets and liabilities:
Accounts receivable (12,132) (5,510)
Inventories (6,435) (3,899)
Accounts payable 1,111 4,322
Other, including other current assets and liabilities 2,063 1,816
---------- ----------
NET CASH USED IN OPERATING ACTIVITIES (6,708) (1,206)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of technology license - (1,000)
Purchase of property and equipment (4,555) (489)
Advances to joint venture (167) (1,068)
Business acquisition, net of cash acquired (783) -
---------- ----------
NET CASH USED IN INVESTING ACTIVITIES (5,505) (2,557)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings, net 14,806 -
Prepayment of long-term portion of litigation settlement (7,064) -
Proceeds from issuance of redeemable convertible preferred stock - 14,539
Proceeds from exercise of common stock options and warrants 90 1,448
---------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 7,832 15,987
---------- ----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (4,381) 12,224
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 11,118 3,858
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 6,737 $ 16,082
---------- ----------
---------- ----------
NONCASH FINANCING AND INVESTING ACTIVITIES:
Issuance of preferred stock for business acquisition 1,540 -
Issuance of common stock for notes receivable - 176
Deferred portion of technology license fee - 1,500
</TABLE>
See Accompanying Notes to Condensed Financial Statements
5
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ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and pursuant to the rules and regulations of
the Securities and Exchange Commission. While these financial statements
reflect all adjustments of a normal and recurring nature which are, in the
opinion of management, necessary to present fairly the results of the
interim period, they do not include all information and footnotes required
by generally accepted accounting principles for complete financial
statements. These financial statements and notes should be read in
conjunction with the financial statements and notes thereto, for the period
ended December 31, 1995, contained in the Company's registration statement
on Form S-1.
The consolidated financial statements include Advanced Fibre
Communications, Inc., and its wholly owned subsidiaries (the "Company").
Significant intercompany transactions and accounts have been eliminated.
The Company operates on 13-week fiscal quarters ending on the last Saturday
of each fiscal period. For presentation purposes only, its fiscal periods
are shown as ending on the last day of the month of the respective fiscal
period. The results for the three and nine months ended September 30,
1996 are not necessarily indicative of the operating results for the year.
NOTE 2 INVENTORIES
Inventories are valued at the lower of first-in, first-out cost or market
and consisted of the following (in thousands):
September 30, December 31,
1996 1995
------------- ------------
Raw materials $ 6,275 $ 5,155
Work-in-progress 620 899
Finished goods 11,178 4,095
------- -------
$ 18,073 $ 10,149
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NOTE 3 JOINT VENTURES
ADVANCED ACCESS LABS
During fiscal 1994, the Company entered into a joint venture partnership,
Advanced Access Labs, with a stockholder. The joint venture designed and
developed a product to allow telephone services to be provided over
existing cable TV coaxial systems as well as other transmission media. The
Company contributed the right to use its technology in exchange for a 50%
ownership in the joint venture partnership. In the second quarter of 1995,
the Company loaned $1,000,000 to the joint venture, and in 1995 and 1996,
the Company made other net advances to the joint venture. The Company has
recorded its proportionate share of the joint venture's losses to the
extent of the Company's loans and advances therein. As a consequence, the
Company's loans and advances to the joint venture have been reduced to
zero. During the first quarter of 1996, the Company and the joint venture
partner entered into discussions to dissolve the joint venture. The joint
venture partner would receive a development license and certain market
rights, principally in the cable television market, in exchange for which
the Company would receive royalties and reimbursement of all loans and
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advances made to the joint venture to date, which totaled $1,683,000 as of
September 30, 1996. If a definitive agreement is signed on these proposed
terms, the Company will record the reimbursement of loans and advances as a
gain.
Condensed financial information of Advanced Access Labs is summarized below
(in thousands):
September 30, December 31,
1996 1995
------------- ------------
Total current assets $ 635 $ 800
Noncurrent assets 1,601 1,791
Current liabilities 5,616 4,646
Partners' (deficit) (3,380) (2,055)
Net loss - three months ended - -
Net loss - nine months ended 1,325 -
AFTEK HONG KONG
On April 11, 1996, the Company acquired all of the outstanding shares of
AFTEK Hong Kong, of which the Company had previously been a 49%
stockholder. AFTEK Hong Kong is a holding company that owns 60% of a joint
venture, AFTEK Hangzhou, that is licensed to manufacture and sell the
Company's telecommunications equipment in China. Total consideration
consisted of the following (in thousands):
Issuance of Series F preferred stock $ 1,540
Cash paid to retire note payable 939
Acquisition costs incurred 79
---------
$ 2,558
---------
The acquisition has been accounted for using the purchase method of
accounting, and, accordingly, the purchase price has been allocated to the
assets purchased and the liabilities assumed based upon their fair values
at the date of acquisition. The excess of the purchase price over the fair
values of the net assets acquired was $932,000 and has been recorded as
goodwill, which is being amortized on a straight-line basis over 5 years.
On August 10, 1996, AFTEK Hong Kong and its joint venture partner agreed to
liquidate AFTEK Hangzhou. The partners appointed a liquidation committee
to facilitate the liquidation procedures and to ensure that the liquidation
is completed in accordance with the relevant stipulations contained in the
joint venture agreement. A provision of $225,000 reflecting a reduction in
the net realizable value of AFTEK Hong Kong's interest in the joint
venture's net assets to be distributed upon liquidation was recorded in the
third quarter.
NOTE 4 BANK BORROWINGS
The Company has a revolving line of credit with a bank providing for
borrowings up to $12,000,000 at an interest rate of prime plus 0.5%.
Borrowings under the line are secured by the Company's accounts receivable.
The line of credit expires on November 15, 1996. The line of credit
contains covenants that require the Company to maintain certain financial
ratios. The borrowings outstanding as of September 30, 1996 of $7,700,000
were repaid in October 1996 with a portion of the proceeds from the
Company's initial public offering.
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In July 1996, the Company borrowed approximately $7,106,000 under a
six-month term loan. The proceeds from the loan were used to pay the
remaining obligations under the DSC litigation settlement (See Note 6).
The loan bears interest at 5.75% and has a $4.0 million compensating
balance requirement. The loan was repaid in October 1996 with a portion of
the Company's initial public offering.
NOTE 5 REDEEMABLE CONVERTIBLE PREFERRED STOCK
As of September 30, 1996, the Company had outstanding a total of 17,231,204
shares of redeemable convertible preferred stock. On October 4, 1996, upon
the consummation of the initial public offering of the Company's common
stock, all shares of redeemable convertible preferred stock were converted
into a total of 18,717,463 shares of common stock.
NOTE 6 COMMITMENTS AND CONTINGENCIES
DSC
From July 1993 until June 1996 the Company was involved in litigation with
DSC Communications Corporation ("DSC"). DSC alleged, among other things,
that the Company's Universal Modular Carrier 1000-TM- ("UMC") technology
contained or was derived from trade secrets and other proprietary
technology of DSC. The parties entered into a Settlement Agreement and
Mutual Releases dated as of June 24, 1996 (the "Settlement Agreement")
pursuant to which the litigation was terminated. Under the terms of the
Settlement Agreement, the Company paid DSC $3,000,000 in June 1996 and
$7,106,000 in July 1996, and issued 719,424 shares of common stock to DSC.
The settlement amount was recorded during the first six months of 1996 as a
charge of $15,807,000. Under the terms of the Settlement Agreement, AFC
maintains all rights to the UMC technology free and clear of any claim by
DSC.
ITRI
In 1995, a dispute arose among the Company, the Industrial Technology
Research Institute ("ITRI"), a Taiwanese government-sponsored research and
development organization in the telecommunications field, and certain of
ITRI's member companies (the "Member Companies") in which the Company
claimed that ITRI and the Member Companies were, among other things,
failing to pay royalties when due. Relying on certain provisions of the
agreements entered into in September 1992 between the Company and ITRI to
jointly develop products based upon the European Telecommunications
Standards Institute ("ETSI") version of the UMC system (the "ITRI
Agreements"), in April 1996, the Company ceased delivering to the Member
Companies certain proprietary application specific integrated circuits
("ASICs") used in manufacturing the UMC system.
On July 9, 1996, the trustee custodian of the trust account containing the
design documentation of the ASICs filed suit against the Company alleging,
among other things, the wrongful discontinuance of the sale of ASICs as
required by joint development agreements entered into by the parties in
1992. The trustee custodian seeks unspecified damages and the release of
ASICs that were held in escrow.
On July 30, 1996, the Company filed suit against ITRI and others alleging,
among other things, breach of contract. The Company seeks damages,
punitive damages and declaratory and injunctive relief. The Member
Companies, in turn, filed counter suit on August 27, 1996 seeking, among
other things, an injunction requiring further sale of the ASICs.
On September 6, 1996, the court granted a temporary restraining order
whereby the Company will be required to supply ASICs to ITRI during the
ensuing months before the next hearing.
The Company believes that it has meritorious defenses to the claims
asserted by ITRI and the Member Companies and it intends to defend the
litigation vigorously. The Company further believes that its claims
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against ITRI and the Member Companies are meritorious and the Company
intends to vigorously pursue such claims. However, due to the nature of
the claims and because the proceedings are in the discovery stage, the
Company cannot determine the total expense or possible loss, if any, that
may ultimately be incurred.
The Company is also party to other routine legal proceedings incidental to
its business. The Company does not believe the ultimate resolution of the
above pending litigation will have a material adverse effect on its
consolidated financial position.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for the historical financial information contained herein, the
following discussion and analysis may contain "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. Such
statements include declarations regarding the intent, belief or current
expectations of the Company and its management. Prospective investors are
cautioned that any such forward-looking statements are not guarantees of
future performance and involve a number of risks and uncertainties; actual
results could differ materially from those indicated by such forward-looking
statements. Among the important factors that could cause actual results to
differ materially from those indicated by such forward-looking statements, as
set forth below under "Certain Factors That Might Affect Future Operating
Results," are: (i) the limited history of operations and profitability of the
Company, (ii) potential fluctuations in future operating results and
seasonality, (iii) dependence on the telecommunications industry and small
line-size market, (iv) risks associated with a concentrated product line, new
products and rapid technological change, (v) dependence on sole-source and
other key suppliers, (vi) dependence on a limited number of third party
manufacturers and support organizations, (vii) risks associated with
competition, (viii) risks associated with pending litigation, (ix) risks
associated with limited protection of proprietary technology and risk of
third-party claims of infringement, (x) risk of failure to manage expanding
operations, (xi) customer concentration, (xii) risks associated with
international markets, (xiii) dependence on key personnel, (xiv) compliance
with regulations and industry standards and (xv) other risks identified from
time to time in the Company's reports and registration statements filed with
the Securities and Exchange Commission.
The following discussion should be read in conjunction with the Financial
Statements and Notes thereto.
GENERAL
AFC designs, develops, manufactures, markets and supports the UMC system, a
cost-effective, multi-feature digital loop carrier system developed to serve low
density markets. The Company's UMC system is designed to enable telephone
companies, cable companies and other service providers to connect subscribers to
the central office switch for voice and data communications over copper, fiber,
coaxial cable and analog radio networks. The Company was incorporated in May
1992 and was in the initial startup and development phase through December 1993.
The Company began shipping the UMC in January 1994. The Company sells its
product worldwide, primarily through its direct sales force in the domestic
market, and through joint ventures, distributors and agents in international
markets.
RESULTS OF OPERATIONS
REVENUES. Revenues increased $19.5 million, or 125%, from $15.5 million for the
three months ended September 30, 1995 to $35.0 million for the comparable period
of 1996. This increase was primarily the result of expansion of the Company's
customer base and the introduction of new features in the UMC system.
International revenues increased $3.8 million or 264.1%, from $1.4 million for
the three months ended September 30, 1995 to $5.2 million for the comparable
period of 1996, and represented 9.1% and 14.7% of total revenues during the
respective periods.
For the nine months ended September 30, 1996, revenues increased $54.0 million,
or 155%, from $34.8 million for 1995 to $88.8 million for 1996. As noted above,
this increase was primarily the result of expansion of the Company's customer
base and the introduction of new features in the UMC system. International
revenues increased $6.9 million, or 137.5% from $5.0 million in the nine months
ended September 30, 1995, to $11.9 million for the comparable period of 1996,
and represented 14.4% and 13.4% of total revenues during the respective periods.
ALLTEL Supply, Inc., an affiliate of ALLTEL, a major independent domestic
telephone company, accounted for 20.4% and 10.9% of revenues in the first three
quarters of 1995 and 1996, respectively. No other customer accounted for 10% or
more of revenues in either period. Although the Company's largest customers
have varied from period to period, the Company anticipates that its results of
operations in any given period will continue to depend to a significant extent
upon sales to a small number of customers. There can be no assurance that the
Company's principal customers will continue to purchase product from the Company
at current levels, if at all. The loss of one or more major customers could
have a material adverse effect on the Company's business, financial condition
and results of operations.
GROSS PROFIT. Gross profit is comprised of revenues less the cost of materials,
manufacturing and warranty. Gross profit increased $9.6 million, or 167%, from
$5.7 million for the three months ended September 30, 1995 to $15.3 million in
the comparable period of 1996, and represented gross margins (as a percent of
revenues) of 36.7% and 43.6% in such periods. For the nine months ended
September 30, 1996, gross profit increased $25.0 million, or 191%, from $13.0
million for 1995 to $38.0 million in 1996, and represented gross margins of
37.5% and 42.8% in such periods. The improvement in gross margins from the
three month and nine month periods in 1995 to 1996 was due to lower product
costs resulting from engineering design improvements and greater efficiencies
achieved in purchasing and manufacturing activities associated with higher unit
volumes.
RESEARCH AND DEVELOPMENT. Research and development expenses increased $2.7
million, or 195%, from $1.4 million for the three months ended September 30,
1995 to $4.1 million in the same period in 1996. As a percentage of
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revenues, research and development expenses increased from 9.0% for the three
months ended September 30, 1995 to 11.8% in the comparable period of 1996. The
increase resulted primarily from the hiring of additional personnel and the use
of outside services for certain development efforts during 1996. The increase
in research and development expenses was also attributable to higher costs for
material and test equipment used to develop and test new products and features.
For the nine months ended September 30, 1996, research and development expenses
increased $6.3 million, or 173%, from $3.7 million for the comparable period in
1995 to $10.0 million in 1996. As a percentage of revenues, research and
development expenses increased from 10.5% for the nine months ended September
30, 1995 to 11.3% in the comparable period of 1996. The increase resulted from
the hiring of additional personnel, the use of outside consultants for certain
development efforts, facilities costs and material and test equipment for the
development and testing of new products. The number of employees in research
and development increased from 56 as of September 30, 1995 to 117 as of
September 30, 1996.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased $3.1 million, or 127%, from $2.5 million for the three months
ended September 30, 1995 to $5.6 million in the comparable period in 1996. As a
percentage of revenues, selling, general and administrative expenses increased
from 15.9% of revenues for the three months ended September 30, 1995 to 16.0% of
revenues in the comparable period of 1996. Employee costs in the sales and
marketing area increased from period to period reflecting the hiring of new
employees and commissions earned by the Company's sales force as a result of
higher revenue levels. Outside service costs also increased in 1996 due to
costs of the third-party support organization that provides first-line technical
assistance and post-sales support to the Company's customers and commissions
paid to international sales representatives. The Company also increased its
advertising and trade show participation in 1996. General and administrative
expenses increased from the three months ended September 30, 1995 as compared
with the same period in 1996 due to increases in the Company's administrative
staff.
For the nine months ended September 30, 1996, selling, general and
administrative expenses increased $7.1 million, or 110%, from $6.4 million for
1995 to $13.5 million in 1996. As a percentage of revenues, selling, general
and administrative expenses decreased from 18.5% of revenues for the nine months
ended September 30, 1995 to 15.2% of revenues in the comparable period of 1996.
The increases in absolute dollars are attributed to increases in employee costs,
commissions, outside services, travel and entertainment, facilities and
advertising and trade shows.
DSC LITIGATION COSTS. Litigation expenses incurred in connection with the DSC
litigation increased $17.8 million from $1.1 million for the nine months ended
September 30, 1995 to $18.9 million in the comparable period of 1996. The
increase was primarily attributable to the $15.8 million charge recorded in the
second quarter of 1996 in connection with final settlement of the DSC litigation
in such period. See Note 6 of Notes to Condensed Consolidated Financial
statements.
EQUITY IN LOSS OF JOINT VENTURE. During each of the first three quarters of
1995 and the first quarter of 1996, the Company made advances to a joint venture
in which the Company had a 50% ownership interest. In April 1995, the Company
made a loan of $1.0 million to the joint venture. During the nine months ended
September 30, 1995 and the first quarter of 1996, the Company recorded its
proportionate share of the joint venture's losses to the extent of the loan and
advances. As a result, the loan and intercompany receivables were reduced to
zero on the Company's balance sheets as of December 31, 1995 and September 30,
1996. In the first quarter of 1996, the Company and the joint venture partner
entered into discussions to dissolve the joint venture. Under the present draft
of the agreement to dissolve the joint venture, the joint venture partner would
receive a development license and certain market rights, principally in the
cable television market, in exchange for which the Company would receive
royalties, OEM revenues on certain products, and reimbursement of all loans and
advances made to the joint venture, which totaled approximately $1.7 million at
September 30, 1996. If a definitive agreement is signed on these proposed
terms, the Company will record the reimbursement of loans and advances as a gain
in the period in which the agreement is signed.
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INCOME TAXES (BENEFIT). An income tax benefit of $6.6 million was recorded for
the nine months ended September 30, 1996 to reflect the benefit of the DSC
litigation settlement and the decrease in the valuation allowance recorded
against the Company's deferred tax assets. As of September 30, 1996, the
Company has recorded no valuation allowance against its deferred tax assets
because management believes such assets are realizable. For the third quarter
of 1996, the Company recorded income taxes at an effective rate that
approximates the combined federal and state statutory rates.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents at September 30, 1996 were $6.7 million.
Included in cash and cash equivalents was approximately $150,000 held as
collateral for bonds on certain contracts. In October 1996, the Company issued
5,175,000 shares of its common stock pursuant to an underwritten initial public
offering, which generated approximately $119.1 million of net proceeds to the
Company.
For the nine months ended, the Company used cash for operating activities of
$6.7 million as receivables and inventories growth exceeded earnings before
depreciation and amortization. Receivables were higher by $12.1 million in 1996
as a result of increased revenues. The $6.4 million growth in inventories is to
support expected additional customer requirements.
Investing activities during the nine months ended September 30, 1996 included
additions to property and equipment of $4.6 million. The Company continues to
invest in capital equipment to support its employee growth and its research and
development activities.
In April 1996, the Company purchased all of the stock outstanding in a 49%-owned
subsidiary that had not previously been owned by the Company in exchange for
220,000 shares of the Company's Series F Preferred Stock and approximately
$939,000 in cash. Such shares of Series F Preferred Stock were converted into
220,000 shares of the Company's common stock upon the consummation of the
initial public offering on October 4, 1996.
In June 1996, as part of the DSC litigation settlement, the Company paid $3.0
million in cash and issued 719,424 shares of Common Stock to DSC. In July 1996,
the Company borrowed approximately $7.1 million under a six-month term loan with
a bank. The proceeds from the loan were used to pay the remaining obligations
under the DSC litigation settlement. The loan bears interest at a rate of 5.75%
and has a $4.0 million compensating balance requirement. The loan was repaid in
October 1996 with a portion of the proceeds from the initial public offering.
In December 1995, the Company's bank line was increased from $5.0 million to
$12.0 million. The bank line expires in November 1996. Under this line, the
Company is able to borrow up to $12.0 million at an interest rate of prime
plus 0.5%. The amount available to the Company for borrowing under the line
is based upon the balance of eligible domestic accounts receivable at the
time of borrowing. As part of the bank line, the bank may issue letters of
credit up to $10.0 million and foreign exchange contracts up to $5.0 million.
The bank line requires the Company to comply with certain financial
covenants. As of December 31, 1995, no borrowings were outstanding under the
bank line. As of September 30, 1996, a total of $7.7 million was outstanding
under the line, and $0.6 million was reserved for forward exchange contracts
and letters of credit supporting bid and performance bonds on certain
international transactions. The bank line was paid down in October 1996 with
a portion of the proceeds from the initial public offering. The Company also
has lease lines totaling $5.1 million that were used for equipment and
furniture purchases. There were no amounts left available under the lease
lines as of September 30, 1996.
The Company believes that the proceeds generated by the initial public offering,
together with existing sources of liquidity and cash anticipated to be provided
by operations, will satisfy the Company's working capital requirements for the
next twelve months.
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CERTAIN FACTORS THAT MIGHT AFFECT FUTURE OPERATING RESULTS
In addition to the other information in this Form 10-Q, the following are
important factors that should be considered in evaluating the Company and its
business.
LIMITED HISTORY OF OPERATIONS AND PROFITABILITY. The Company was
incorporated in May 1992 and was in the initial startup and development phase
through December 1993. The Company began shipping the UMC in January 1994
and, accordingly, has a limited operating history. The Company has incurred
substantial expenditures related to the development, manufacturing startup
and marketing of the UMC system. As a result of these expenditures, combined
with $25.9 million of expenses and settlement amounts recorded in connection
with certain litigation with DSC which was settled in June 1996, the Company
had an accumulated deficit of $5.1 million as of September 30, 1996.
Although the Company first achieved profitability in the second quarter of
1995, it recorded a net loss in the second quarter of 1996 due to charges
associated with the settlement of litigation with DSC, and there can be no
assurance that the Company will sustain or increase its profitability in the
future.
POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS; SEASONALITY. The Company's
operating results have been, and will continue to be, affected by a wide variety
of factors, some of which are outside of the Company's control, that could have
a material adverse effect on revenues and results of operations during any
particular period. These factors include: the timing and size of orders which
are received and can be shipped in a quarter; the availability of adequate
supplies of key components and assemblies and the adequacy of manufacturing
capacity; the Company's ability to introduce new products and technologies on a
timely basis; the timing of new product introductions or announcements by the
Company or its competitors; price competition; unit volume; customer mix; and
the mix between domestic and international sales.
The UMC system is sold primarily to telephone companies that install the UMC
system as part of their access networks. Additions to those networks represent
complex engineering projects which can require from three to twelve months from
project conceptualization to completion. The UMC system typically represents
only a portion of a given project and, therefore, the timing of product shipment
and revenue recognition is often difficult to forecast. In developing
countries, delays and reductions in the planned project deployment can be caused
by additional factors, including reductions in capital availability due to
declines in the local economy, currency fluctuations, priority changes in the
government's budget and delays in receiving government approval for deployment
of the UMC system in the local loop. The Company's expenditures for research
and development, marketing and sales, and general and administrative functions
are based in part on future revenue projections and in the near term are
relatively fixed. The Company may be unable to adjust spending in a timely
manner in response to any unanticipated declines in revenues. Accordingly, any
significant decline in demand for the UMC system relative to planned levels
could have a material adverse effect on the Company's business, financial
condition and results of operations in that quarter or subsequent quarters. All
of the above factors are difficult to forecast, and these or other factors could
materially adversely affect the Company's business, financial condition and
results of operations. As a result, the Company believes that period-to-period
comparisons are not necessarily meaningful and should not be relied upon as
indications of future performance.
The Company's customers normally install the equipment in outdoor locations.
Shipments of the UMC system are subject to the effects of seasonality, with
fewer installation projects scheduled for the winter months
DEPENDENCE ON TELECOMMUNICATIONS INDUSTRY AND SMALL LINE-SIZE MARKET. The
Company's customers are concentrated in the public carrier 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 UMC system. The target markets for the UMC system are the small line
size markets of the United States and developing countries. Historically, these
markets have had little access to the advanced services that can be made
available through the UMC
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system and, accordingly, there can be no assurance that potential customers will
consider the near term value of these advanced services to be sufficient to
influence their purchase decisions. Furthermore, there can be no assurance that
the UMC system will find widespread acceptance among the telephone companies and
other potential customers in small line-size markets or that such customers and
potential customers will not adopt alternative architectures or technologies
that are incompatible with the UMC technology, which would have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, there can be no assurance that telephone companies,
foreign governments or other customers will pursue infrastructure upgrades that
will necessitate the implementation of advanced products such as the UMC system.
Infrastructure improvements requiring the Company's or similar technology may be
delayed or prevented by a variety of factors, including cost, regulatory
obstacles, the lack of consumer demand for advanced telecommunications services
and alternative approaches to service delivery.
CONCENTRATED PRODUCT LINE, NEW PRODUCTS AND RAPID TECHNOLOGICAL CHANGE. The
Company currently derives substantially all of its revenues from the UMC system
and expects that this concentration will continue in the foreseeable future. As
a result, any decrease in the overall level of sales of, or the prices for, the
UMC system due to product enhancements, introductions or announcements by the
Company's competitors, a decline in the demand for the UMC system, product
obsolescence or any other reason could have a material adverse effect on the
Company's business, financial condition and results of operations.
The telecommunications equipment market is characterized by rapidly changing
technology, evolving industry standards, changes in end-user requirements, and
frequent new product introductions and enhancements. The introduction of
products embodying new technologies or the emergence of new industry standards
can render existing products obsolete or unmarketable. The Company's success
will depend upon its ability to enhance the UMC technology and to develop and
introduce, on a timely basis, new products that keep pace with technological
developments and emerging industry standards and address changing customer
requirements in a cost-effective manner. There can be no assurance that the
Company will be successful in identifying, developing, manufacturing, and
marketing product enhancements or new products 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 products, or that its new products and
product enhancements will adequately meet the requirements of the marketplace
and achieve market acceptance. Furthermore, from time to time, the Company may
announce new products or product enhancements, services or technologies that
have the potential to replace or shorten the life cycle of the UMC system and
that may cause customers to defer purchasing the UMC system. There can be no
assurance that future technological advances in the telecommunications industry
will not diminish market acceptance of the UMC system or render the UMC system
obsolete and, thereby, materially adversely affect the Company's business,
financial condition and results of operations.
The Company has experienced delays in completing development and introduction of
new products, product variations and features, and there can be no assurance
that such delays will not continue or recur in the future. Furthermore, the UMC
system contains a significant amount of complex software that may contain
undetected or unresolved errors as products are introduced or as new versions
are released. The Company has in the past discovered software errors in certain
UMC system installations. There can be no assurance that despite significant
testing by the Company, software errors will not be found in new enhancements of
the UMC system after commencement of shipments, resulting in delays in or loss
of market acceptance, either of which could have a material adverse effect on
the Company's business, financial condition and results of operations.
DEPENDENCE ON SOLE-SOURCE AND OTHER KEY SUPPLIERS. Certain components used in
the Company's products, including the Company's proprietary application specific
integrated circuits ("ASICs"), codecs, certain surface mount technology
components and other components, are only available from a single source or
limited number of suppliers. Some of the Company's sole-source suppliers are
companies which from time to time allocate parts to telephone equipment
manufacturers due to market demand for telecommunications equipment. Many of
the Company's competitors are much larger and may be able to obtain priority
allocations from these shared suppliers, thereby limiting or making unreliable
the sources of supply for these components. The Company encountered supply
delays for codecs in the second quarter
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of 1994 which resulted in delayed shipments of the UMC system, and there can be
no assurance that similar shortages will not occur in the future or will not
result in the Company having to pay a higher price for components. If the
Company is unable to obtain sufficient quantities of these or any other
components, delays or reductions in manufacturing or product shipments could
occur which would have a material adverse effect on the Company's business,
financial condition and results of operations.
DEPENDENCE ON LIMITED NUMBER OF THIRD PARTY MANUFACTURERS AND SUPPORT
ORGANIZATIONS. The Company relies on a limited number of independent
contractors that manufacture the subassemblies to the Company's specifications
for use in the Company's products. In particular, the Company relies on: (i)
Flextronics International Ltd. and Tanon Manufacturing, Inc. (a division of
Electronic Associates, Inc.) to manufacture the Company's printed circuit board
assemblies; (ii) Paragon, Inc. to manufacture backplanes and channel bank
assemblies and (iii) Sonoma Metal Products, Inc. and Cowden Metal San Jose, Inc.
to manufacture the outside cabinets. In the event that the Company's
subcontractors were to experience financial, operational, production, or quality
assurance difficulties that resulted in a reduction or interruption in supply to
the Company or otherwise failed to meet the Company's manufacturing
requirements, the Company's business, financial condition and results of
operations would be adversely affected until the Company established sufficient
manufacturing supply from alternative sources. There can be no assurance that
the Company's current or alternative manufacturers will be able to meet the
Company's future requirements or that such manufacturing services will continue
to be available to the Company at favorable prices, or at all.
The Company also relies on Point-to-Point Communications, Inc.
("Point-to-Point"), a third-party support organization, to provide first line
technical assistance and post-sales support to AFC customers. There can be no
assurance that Point-to-Point will be able to provide the level of customer
support demanded by the Company's existing or potential customers.
COMPETITION. The market for equipment for local telecommunications networks
is extremely competitive. The Company's competitors range from small
companies, both domestic and international, to large multinational
corporations. The Company's competitors include Alcatel Alsthom Compagnie
Generale d'Electricite, DSC, ECI Telecom, Inc., E/O Networks, Fujitsu
America, Inc. Hitron Technology, Inc., Lucent Technologies, Inc., NEC
America, Inc., Northern Telecom Ltd., Opnet Technologies Co. Ltd., RELTEC
Corporation, Seiscor Technologies Inc., Siemens Corporation, Teledata
Communications Ltd. and Vidar-SMS Co. Ltd. Many of these competitors have
more extensive financial, marketing and technical resources than the Company
and enjoy superior name recognition in the market. In addition, the Company
has entered into agreements with the Industrial Technology Research Institute
("ITRI") to jointly develop products based on the UMC system. ITRI is a
Taiwanese government-sponsored research and development organization in the
telecommunications field. Such agreements grant ITRI and certain of its
member companies certain rights to manufacture and sell the European
Telecommunications Standards Institute ("ETSI") version of the UMC system
outside of North America. Such entities currently compete with the Company
in international markets, primarily in China. In addition, upon termination
of the agreements with ITRI in 2002, ITRI will have a worldwide,
non-exclusive, royalty-free, irrevocable license to use the ETSI version of
the UMC technology and, consequently, such member companies will be able to
compete with the Company worldwide at such time. There is an ongoing dispute
subject to litigation between the Company and ITRI and such member companies
as to, among other things, whether ITRI possesses the right to grant such
rights to manufacture and sell the ETSI version of the UMC system . Such
companies may possess substantially greater financial, marketing and
technical resources than the Company. The Company may also face competition
from new market entrants. There can be no assurance that the Company will be
able to compete successfully in the future.
RISKS ASSOCIATED WITH PENDING LITIGATION. The Company is a party to certain
legal proceedings including the litigation between the Company and ITRI and
certain of its member companies arising primarily out of a dispute regarding the
payment of royalties and the supply of ASICs under the agreements between the
Company and ITRI. The Company is unable to determine the total expense or
possible loss, if any, that may ultimately be incurred in the resolution of
these proceedings. Regardless of the ultimate outcome of these proceedings,
they could result in significant diversion of time by the Company's management.
After consideration of the nature of the claims and the facts relating to these
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proceedings, the Company believes that the resolution of these proceedings will
not have a material adverse effect on the Company's business, financial
condition and results of operations; however, the results of these proceedings,
including any potential settlements, are uncertain and there can be no assurance
to that effect.
LIMITED PROTECTION OF PROPRIETARY TECHNOLOGY; RISK OF THIRD-PARTY CLAIMS OF
INFRINGEMENT. The Company attempts to protect its technology through a
combination of copyrights, trade secret laws and contractual obligations. The
Company does not presently hold any patents for its existing products and has no
patent applications pending. There can be no assurance that the Company's
intellectual property protection measures will be sufficient to prevent
misappropriation of the Company's technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. In addition, the laws of many foreign
countries do not protect the Company's intellectual property rights to the same
extent as the laws of the United States. The failure of the Company to protect
its proprietary information could have a material adverse effect on the
Company's business, financial condition and results of operations.
The increasing dependence of the telecommunications industry on proprietary
technology has resulted in frequent litigation based on allegations of the
infringement of patents and other intellectual property. The Company recently
settled litigation with DSC under which DSC had claimed proprietary rights to
the UMC technology. In the future the Company may be subject to additional
litigation to defend against claimed infringements of the rights of others or to
determine the scope and validity of the proprietary rights of others. Future
litigation also may be necessary to enforce and protect trade secrets and other
intellectual property rights owned by the Company. Any such litigation could be
costly and cause diversion of management's attention, either of which could have
a material adverse effect on the Company's business, financial condition and
results of operations. Adverse determinations in such litigation could result
in the loss of the Company's proprietary rights, subject the Company to
significant liabilities, require the Company to seek licenses from third
parties, or prevent the Company from manufacturing or selling its products, any
one of which could have a material adverse effect on the Company's business,
financial condition and results of operations. Furthermore, there can be no
assurance that any necessary licenses will be available on reasonable terms.
RISK OF FAILURE TO MANAGE EXPANDING OPERATIONS. The Company has recently
experienced a period of rapid growth, which has placed and could continue to
place, a significant strain on the Company's management, operational, financial
and other resources. The members of the Company's management team have limited
experience in the management of rapidly growing companies. To effectively
manage the recent growth as well as any future growth, the Company will need to
recruit, train, assimilate, motivate and retain qualified managers and
employees. Management of future growth, if such growth occurs, may require the
Company to implement expanded or new management and accounting systems.
Information systems expansion or replacement can be a complex, costly and
time-consuming process, and there can be no assurance that any such activities
can be accomplished without disruption of the Company's business. Any business
disruption or other system transition difficulties could have a material adverse
effect on the Company's business, financial condition and results of operations.
The failure of the Company to effectively manage its domestic and international
operations or any current or future growth could have a material adverse effect
on the Company's business, financial condition and results of operations. The
Company's results of operations will be adversely affected if revenues do not
increase sufficiently to compensate for the increase in operating expenses
resulting from any expansion.
CUSTOMER CONCENTRATION. For the nine months ended September 30, 1996 and
1995, approximately 10.9% and 20.4% of the Company's revenues respectively,
were derived from sales to ALLTEL Supply, Inc. For the first nine months of
1996 and 1995, the Company's five largest customers accounted for
approximately 32.0% and 43.6% of revenues, respectively. Although the
Company's largest customers have varied from period to period, the Company
anticipates that its results of operations in any given period will continue
to depend to a significant extent upon sales to a small number of customers.
None of the Company's customers has entered into an agreement requiring it to
purchase a minimum amount of product from the Company. There can be no
assurance that the Company's principal customers will continue to purchase
product from the Company at current levels, if at all. The loss of one or
more major customers could have a material adverse effect on the Company's
business, financial condition and results of operations.
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RISKS ASSOCIATED WITH INTERNATIONAL MARKETS International sales constituted
13.4% and 14.4% of the Company's total revenues for the nine months ended
September 30, 1996 and 1995, respectively. International sales have fluctuated
in absolute dollars and as a percentage of revenues, and are expected to
continue to fluctuate in future periods. The Company relies on a number of
third-party distributors and agents to market and sell the UMC system outside of
North America. There can be no assurance that such distributors or agents will
provide the support and effort necessary to service international markets
effectively. The Company intends to expand its existing international
operations and enter new international markets, which will demand significant
management attention and financial commitment. The Company's management has
limited experience in international operations, and there can be no assurance
that the Company will successfully expand its international operations. In
addition, a successful expansion by the Company of its international operations
and sales in certain markets may depend on the Company's ability to establish
and maintain productive strategic relationships. To date, the Company has
formed three joint ventures to pursue international markets, two of which have
been or are in the process of being terminated or liquidated due to differences
with the joint venture partners. There can be no assurance that the Company
will be able to identify suitable parties for joint ventures or strategic
relationships or, even if such parties are identified, that successful joint
ventures or strategic relationships will result. Moreover, there can be no
assurance that the Company will be able to increase international sales of the
UMC system through strategic relationships or joint ventures. The failure to do
so could significantly limit the Company's ability to expand its international
operations and could have a material adverse effect on the Company's business,
financial condition and results of operations.
International telephone companies are in many cases owned or strictly regulated
by local regulatory authorities. Access to such markets is often difficult due
to the established relationships between a government owned or controlled
telephone company and its traditional indigenous suppliers of telecommunications
equipment. In addition, the Company's bids for business in certain
international markets typically will require the Company to post bid and
performance bonds and to incur contract penalties should the Company fail to
meet production and delivery time schedules on large orders. The failure of the
Company to meet these schedules could result in the loss of collateral posted
for the bonds or financial penalties which could have a material adverse effect
on the Company's business, financial condition and results of operations.
The Company's international sales currently are primarily U.S.
dollar-denominated. As a result, an increase in the value of the U.S. dollar
relative to foreign currencies could make the Company's products less
competitive in international markets. For example, increases in the value of
the U.S. dollar relative to the Mexican peso in late 1994 resulted in a
significant decrease in sales of the UMC system to Telefonos de Mexico for 1995.
Furthermore, operating in international markets subjects the Company to certain
additional risks, including unexpected changes in regulatory requirements,
political and economic conditions, tariffs or other barriers, difficulties in
staffing and managing international operations, exchange rate fluctuations,
potential exchange and repatriation controls on foreign earnings, potentially
negative tax consequences, longer sales and payment cycles and difficulty in
accounts receivable collection. In addition, any inability to obtain local
regulatory approval could delay or prevent entrance into international markets,
which could materially impact the Company's business, financial condition and
results of operations. In order to compete in international markets, the
Company will need to comply with various regulations and standards.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a significant
extent upon a number of key technical and management employees. In particular,
the Company's success depends in large part on the knowledge, expertise and
services of its co-founders: Donald Green, Chairman of the Board and Chief
Executive Officer; James T. Hoeck, Vice President, Advanced Development; and
John W. Webley, Vice President, Advanced Development. The loss of the services
of any of these persons or other key employees of the Company could have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company does not have employment agreements with, or
key person life insurance for, any of its employees. Competition for highly
qualified employees is intense and the process of locating key technical and
management personnel with the combination of skills and attributes required to
execute the Company's strategy is often lengthy. There can be no assurance that
the Company will be successful in retaining its existing key personnel or in
attracting and retaining the additional employees it may require.
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COMPLIANCE WITH REGULATIONS AND INDUSTRY STANDARDS. The UMC system is required
to comply with a large number of voice and data regulations and standards, which
vary between domestic and international markets, and may vary by the specific
international market into which the Company sells its products. The standards
in the United States are determined by the Federal Communications Commission
("FCC"), by Underwriters Laboratories, by independent telephone companies and by
Bell Communications Research ("Bellcore"). In international markets, the
Company's products must comply with recommendations issued by the Consultative
Committee on International Telegraph and Telephony and with requirements
established by the individual regional carriers which specify how equipment that
is connected to their local networks operate. In addition, the Company's
products must comply with standards issued by the European Telecommunications
Standards Institute. These standards are implemented and enforced by the
Telecommunications Regulatory Authority of each European nation. Standards for
new services continue to evolve, and the Company will be required to modify its
products or develop and support new versions of its products to meet these
standards. The failure of the Company's products to comply, or delays in
meeting compliance, with the evolving standards both in its domestic and
international markets could have a material adverse effect on the Company's
business, financial condition and results of operations.
In addition, the Company will need to ensure that its products are easily
integrated with the carriers' network management systems. The Regional Bell
Operating Companies ("RBOCs"), which represent a large segment of the U.S.
telecommunications market, in many cases require that equipment integrated into
their networks be tested by Bellcore, indicating that the products are
interoperable with the operations, administration, maintenance and provisioning
systems used by the RBOCs to manage their networks. Bellcore testing requires
significant investments in resources to achieve compliance. The UMC system
recently completed a Bellcore technical audit and was found to meet applicable
requirements. The failure to maintain such compliance or to obtain it on new
features released in the future could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company has not received ISO certification, which certifies that design and
manufacturing processes adhere to certain established standards. Many
telecommunications service providers, particularly in international markets,
will not purchase products from suppliers that have not received ISO
certification. Accordingly, until it is able to obtain ISO certification, the
Company may be precluded from selling its products to these service providers
and its ability to compete with other suppliers of communications equipment may
be adversely affected. The Company intends to initiate the formal process of
applying for ISO-9001 certification during the first quarter of 1997. ISO-9001
addresses quality assurance in design, development, production, installation and
service. There can be no assurance as to when or if the Company will receive
such certification. The failure to obtain such certification may preclude the
Company from selling the UMC system in certain markets.
The U.S. Congress recently passed new regulations that affect telecommunications
services, including changes to pricing, access by competitive suppliers and many
other broad changes to the data and telecommunications networks and services.
These changes will have a major impact on the pricing of existing services, and
may affect the deployment of future services. These changes could cause greater
consolidation in the telecommunications industry, which in turn could disrupt
existing customer relationships and have a material adverse effect on the
Company's business, financial condition and results of operations. There can be
no assurance that any regulatory changes will not have a material adverse effect
on the demand for the UMC system . Uncertainty regarding future policies
combined with emerging new competition may also affect the demand for
telecommunications products such as the UMC system.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITRI
In 1995, a dispute arose among the Company, the Industrial Technology Research
Institute ("ITRI") and certain of ITRI's member companies (the "Member
Companies") in which the Company claimed that ITRI and the Member Companies
were, among other things, failing to pay royalties when due. In reliance upon
certain provisions of the ITRI Agreements, in April 1996, the Company ceased
delivering to the Member Companies certain proprietary ASICs used in the
manufacture of the UMC system . Pursuant to agreements with ITRI reached in
1994, design documentation for these ASICs are held in a trust account, with
directions that the designs can be made available to ITRI on the occurrence of
specified conditions. On July 9, 1996, the trustee-custodian of the ASIC
designs filed suit against the Company in the United States District Court,
Eastern District of New York, alleging that the Company had wrongfully
discontinued the sale of the ASICs to the Member Companies. Among other things,
the complaint seeks unspecified damages on behalf of the trustee, and a
determination that the trustee can release the ASIC designs to ITRI. On July
31, 1996, the Company filed a counterclaim against the trustee claiming, among
other things, that the trustee improperly disclosed the design documentation to
third parties.
On July 30, 1996, the Company filed suit against ITRI and others in the United
States District Court, Northern District of California, for breach of the ITRI
Agreements, breach of covenants of good faith, trade secret misappropriation,
tortious interference, and related claims. The complaint alleges that ITRI
breached the ITRI Agreements, among other things, by failing to collect
royalties owed to the Company, by developing UMC-based products not shared with
the Company, by transferring UMC technology to an unauthorized company, and by
misappropriating the Company's trade secrets and that the ITRI Agreements have
been terminated. The Company seeks damages, punitive damages, and declaratory
and injunctive relief. On September 13, 1996, ITRI filed a demand for
arbitration of the dispute and claimed, among other things, that the Company
breached the ITRI Agreements and is liable for unspecified royalties and
punitive damages, and claiming proprietary rights in certain UMC technology. On
September 30, 1996, the Company amended the complaint in its suit against ITRI
to add the Member Companies and another company as parties to the suit.
On August 27, 1996, the Member Companies filed suit against the Company in
United States District Court, Northern District of California, alleging breach
of contract and unfair competition based on the Company's discontinuation of
ASIC sales to the Member Companies. The complaint filed by the Member Companies
alleges that the Company lacked justification to discontinue the sale of ASICs
and that its failure to sell ASICs to the Member Companies constituted unfair
competition. The Complaint seeks court-ordered arbitration, unspecified
damages, punitive damages and an injunction requiring further sales of the ASICs
to the Member Companies. On September 6, 1996, the court granted a temporary
restraining order pursuant to which the Company will be required to supply the
Member Companies with a specified number of ASICs during the ensuing two month
period on the terms and conditions set forth in the ITRI Agreements. The
court's order was granted as an interim measure to preserve the status quo
pending adjudication on the merits. The Company believes that compliance with
the court's order will not have a material adverse effect on the Company's
business, financial condition and results of operations. On September 16, 1996,
the Company filed counterclaims seeking declaratory and injunctive relief and
damages against Member Companies for, among other things, breach of contract,
fraud and misappropriation of trade secrets. On September 23, 1996, the Member
Companies filed a demand for arbitration of the dispute and claimed, among other
things, actual damages in excess of $60 million, legal fees and expenses and
punitive damages.
The Company believes that it has meritorious defenses to the claims asserted by
ITRI and the Member Companies and it intends to defend the litigation
vigorously. Moreover, the Company believes that the Member Companies' damages
claim is without merit. The Company further believes that its claims against
ITRI and the Member Companies are meritorious and the Company intends to
vigorously pursue such claims. However, due to the nature of the claims and
because the proceedings are in the discovery stage, the Company cannot determine
the total expense or possible loss, if
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any, that may ultimately be incurred either in the context of a trial,
arbitration or as a result of a negotiated settlement. Regardless of the
ultimate outcome of the proceedings, it could result in significant diversion of
time by the Company's management. After consideration of the nature of the
claims and the facts relating to the proceedings, the Company believes that the
resolution of this matter will not have a material adverse effect on the
Company's business, financial condition and results of operations; however, the
results of these proceedings, including any potential settlement, are uncertain
and there can be no assurance to that effect.
ITEM 2. CHANGES IN SECURITIES: None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES: None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On or about July 29, 1996, the Registrant distributed a Stockholder
Information Statement and solicited a Written Consent from all of its
stockholders of record as of July 26, 1996. The following matters were voted
upon and duly approved by the Registrant's stockholders by the number of
votes set forth below cast as of August 14, 1996 (in each case, the number of
votes cast is presented as of August 14, 1996, which is prior to (i) a
two-for-one stock split of each share of the Company's Capital Stock
outstanding as of August 15, 1996, and (ii) the conversion of all the Company's
Preferred Stock into Common Stock upon the consummation of the initial public
offering of the Company's Common Stock on October 4, 1996. No votes were
withheld and there were no abstentions or broker non-votes as to any matter):
1. Approval for amending the Fifth Amended and Restated Indemnity Agreement
entered into between the Registrant and Donald Green, dated September 29,
1995 (the "Indemnity Agreement"), to provide for one final adjustment to the
Conversion Prices of the Series A Preferred Stock, Series B Preferred Stock,
Series C Preferred Stock, Series D Preferred Stock, and Series E Preferred
Stock of the Registrant and for terminating the Indemnity Agreement, and
approval for amending the Conversion Prices of the Company's Preferred Stock
in the Company's Third Amended and Restated Certificate of Incorporation to
effect the amendment to the Indemnity Agreement.
CLASS FOR AGAINST
--------------------------- ----------- -------
Common Stock 2,998,771 0
Series A Preferred Stock 3,055,247 0
Series B Preferred Stock 914,806 0
Series C Preferred Stock 1,393,930 0
Series D Preferred Stock 912,950 0
Series E Preferred Stock 739,628 0
2. Approval of the adoption and filing of the Company's Third Amended and
Restated Certificate of Incorporation which increases the total number of shares
of Common Stock the Company is authorized to issue to 100,000,000.
CLASS FOR AGAINST
--------------------------- ----------- -------
Common Stock 2,998,771 0
Series A Preferred Stock 3,055,247 0
Series B Preferred Stock 914,806 0
Series C Preferred Stock 1,393,930 0
Series D Preferred Stock 912,950 0
Series E Preferred Stock 739,628 0
Series F Preferred Stock 110,000 0
20
<PAGE>
3. Approval of the adoption and filing of the Company's Fourth Amended and
Restated Certificate of Incorporation and the adoption of the Restated Bylaws of
the Company upon the consummation of the initial public offering of the
Company's Common Stock.
CLASS FOR AGAINST
--------------------------- ----------- --------
Common Stock 2,995,931 2,840
Series A Preferred Stock 3,055,247 0
Series B Preferred Stock 914,806 0
Series C Preferred Stock 1,393,930 0
Series D Preferred Stock 912,950 0
Series E Preferred Stock 739,628 0
Series F Preferred Stock 0 110,000
4. Approval of the adoption of the Company's 1996 Stock Incentive Plan.
CLASS FOR AGAINST
--------------------------- ----------- --------
Common Stock 2,998,771 0
Series A Preferred Stock 3,055,247 0
Series B Preferred Stock 914,806 0
Series C Preferred Stock 1,393,930 0
Series D Preferred Stock 912,950 0
Series E Preferred Stock 739,628 0
Series F Preferred Stock 110,000 0
5. Approval of the adoption of the Company's Employee Stock Purchase Plan.
CLASS FOR AGAINST
--------------------------- ----------- --------
Common Stock 2,998,771 0
Series A Preferred Stock 3,055,247 0
Series B Preferred Stock 914,806 0
Series C Preferred Stock 1,393,930 0
Series D Preferred Stock 912,950 0
Series E Preferred Stock 739,628 0
Series F Preferred Stock 110,000 0
ITEM 5. OTHER INFORMATION: None
21
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
Exhibit
Number Document Description
-------- --------------------
3.3 Fourth Amended and Restated Certificate of Incorporation of
the Registrant.*
3.5 Amended and Restated Bylaws of the Registrant.*
4.1 Specimen Certificate of Common Stock.*
4.2 Series E Preferred Stock Purchase Agreement, dated
September 29, 1995, between the Registrant and certain
purchasers of the Registrant's Series E Preferred Stock.*
4.3 Certificate of Incorporation of the Registrant (included in
Exhibit 3.3).*
10.1 Form of Warrant Issued In Connection with the Sale of the
Registrant's Series A Preferred Stock on January 6, 1993.*
10.2 Form of Warrant Issued In Connection with the Sale of the
Registrant's Series B Preferred Stock on October 5, 1993.*
10.3 Form of Warrant Issued In Connection with the Sale of the
Registrant's Series C Preferred Stock on March 16, 1994.*
10.4 Form of Performance Warrant Issued in Connection with the
Sale of the Registrant's Series C Preferred Stock on
March 16, 1994 and May 4, 1994.*
10.4.1 Form of Amendment to Warrants and Performance Warrants.*
10.5 Warrant Issued in Connection with the Sale of the
Registrant's Series E Preferred Stock on September 29, 1995.*
10.6 Restricted Stock Issuance Agreement, dated May 19, 1995,
between the Registrant, Donald Green and Maureen Green.*
10.7 Compensation Agreement, dated May 19, 1995, between the
Registrant and Donald Green.*
10.8 Promissory Note Secured by Pledge Agreement, dated May 31,
1995, by Donald Green in favor of the Registrant.*
10.9 Stock Pledge Agreement, dated June 16, 1995, between the
Registrant and Donald Green.*
10.10 Promissory Note issued by Carl Grivner, dated October 5,
1995, in favor of the Registrant.*
10.11 Shareholder and Joint Venture Agreement, dated December 28,
1995, between the Registrant and Harris Corporation, acting
for the purposes of the agreement through its Digital
Telephone Systems Division.*
10.12 Joint Venture & Partnership Agreement, dated April 11, 1994,
between the Registrant and Tellabs Operations, Inc.*
10.13 License, Joint Development, Supply and Authorized
Manufacturing Agreement, dated September 25, 1992, between
the Registrant and Industrial Technology Research Institute
of the Republic of China.*
10.14 Hangzhou Aftek Communication Registrant Ltd. Contract, dated
June 18, 1994, between Advanced Fibre Technology
Communication (Hong Kong) Limited and Hangzhou Communication
Equipment Factory of the MPT., HuaTong Branch.*
10.15 1445 & 1455 McDowell Boulevard North Net Lease, dated
February 1, 1993, between the Registrant and G& W/Redwood
Associates Joint Venture, for the premises located at 1455
McDowell Boulevard North.*
10.16 Redwood Business Park Net Lease, dated July 9, 1995, between
the Registrant and
22
<PAGE>
G& W/Redwood Associates Joint Venture, for the premises
located at 1455 McDowell Boulevard North.*
10.17 Redwood Business Park Net Lease, dated July 10, 1995, between
the Registrant and G& W/Redwood Associates Joint Venture,
for the premises located at 1440 McDowell Boulevard North.*
10.18 Redwood Business Park Net Lease, dated June 3, 1996, between
the Registrant and G& W/Redwood Associates Joint Venture,
for the premises located at Buildings 1& 9 of Willowbrook
Court.*
10.19 Second Amended and Restated Loan and Security Agreement,
dated December 7, 1995, between the Registrant and the Bank
of the West.*
10.20 Form of Indemnification Agreement for Executive Officers and
Directors of the Registrant.*
10.21 The Registrant's 1993 Stock Option/Stock Issuance Plan as
amended (the "1993 Plan").*
10.22 Form of Stock Option Agreement pertaining to the 1993 Plan.*
10.23 Form of Notice of Grant of Stock Option pertaining to the
1993 Plan.*
10.24 Form of Stock Purchase Agreement pertaining to the 1993
Plan.*
10.25 The Registrant's 1996 Stock Incentive Plan (the "1996
Plan").*
10.26 Form of Stock Option Agreement pertaining to the 1996 Plan.*
10.26.1 Form of Automatic Stock Option Agreement pertaining to the
1996 Plan.*
10.27 Form of Notice of Grant of Stock Option pertaining to the
1996 Plan.*
10.27.1 Form of Notice of Grant of Non-Employee Director Automatic
Stock Option pertaining to the 1996 Plan.*
10.28 Form of Stock Issuance Agreement pertaining to the 1996
Plan.*
10.29 The Registrant's Employee Stock Purchase Plan.*
11 Schedule of computation of pro forma net income per share
27 Financial Data Schedule.
- -------------------------
* Incorporated by reference to the Registrant's Registration
Statement on Form S-1 (File No. 333-8921).
(b) REPORTS ON FORM 8-K: NONE.
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant had duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADVANCED FIBRE COMMUNICATIONS, INC.
(Registrant)
Dated: November 14, 1996 By: /s/ Dan E. Steimle
----------------------------------------
Name: Dan E. Steimle
Title: Vice President, Chief
Financial Officer, Treasurer
and Secretary
24
<PAGE>
ADVANCED FIBRE COMMUNICATIONS, INC.
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
11 Schedule of computation of pro
forma net income per share.
27 Financial Data Schedule.
<PAGE>
Exhibit 11
ADVANCED FIBRE COMMUNICATIONS, INC.
SCHEDULE OF COMPUTATION OF PRO FORMA NET INCOME PER SHARE
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
1996 1995 1996 1995
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income $ 3,204 $ 941 $ 1,663 $ 786
-------- -------- -------- -------
Weighted average commmon shares
outstanding 5,531 5,009 5,461 4,160
Redeemable convertible preferred
stock, on an as-if converted
basis 18,497 17,448 18,644 17,098
Common stock equivalents-stock
options and warrants 6,505 3,190 5,648 2,947
Staff Accounting Bulletin No. 83
issuances and grants:
Stock options . 1,178 253 1,201
Redeemable convertible
preferred stock issued . 1,199 52 1,317
-------- -------- -------- --------
Shares issued in per share
computations 30,533 28,024 30,058 26,723
-------- -------- -------- --------
Pro forma net income per share $ 0.10 $ 0.03 $ 0.06 $ 0.03
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 6,737
<SECURITIES> 0
<RECEIVABLES> 23,593
<ALLOWANCES> 0
<INVENTORY> 18,073
<CURRENT-ASSETS> 54,960
<PP&E> 7,268
<DEPRECIATION> 1,164
<TOTAL-ASSETS> 65,123
<CURRENT-LIABILITIES> 30,179
<BONDS> 0
39,317
0
<COMMON> 62
<OTHER-SE> (5,081)
<TOTAL-LIABILITY-AND-EQUITY> 65,123
<SALES> 88,282
<TOTAL-REVENUES> 88,784
<CGS> 47,670
<TOTAL-COSTS> 50,795
<OTHER-EXPENSES> 42,762
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 168
<INCOME-PRETAX> (4,941)
<INCOME-TAX> (6,604)
<INCOME-CONTINUING> 1,663
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,663
<EPS-PRIMARY> 0.06
<EPS-DILUTED> 0.06
</TABLE>
