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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_____________________
FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarter ended March 31, 1997
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from ____ to____
Commission file number:
0-28734
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.)
One Willow Brook Court
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 X No
------ ------
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 April 25, 1997
----------------------------- ---------------
Common Stock, $0.01 par value 33,762,917
- -------------------------------------------------------------------------------
This report on Form 10-Q, including all exhibits, contains 26 pages. The exhibit
index is located on page 23.
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ADVANCED FIBRE COMMUNICATIONS, INC.
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1997
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
March 31, 1997 and December 31, 1996............... 3
Condensed Consolidated Statements of Operations
Three months ended March 31, 1997 and 1996......... 4
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 1997 and 1996......... 5
Notes to Condensed Consolidated Financial Statements. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................ 18
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........................................ 20
Item 6. Exhibits and Reports on Form 8-K......................... 20
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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)
March 31, December 31,
1997 1996
--------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 17,144 $ 24,942
Marketable securities 97,581 83,488
Accounts receivable 42,081 32,779
Inventories, net 19,672 17,349
Other current assets 3,794 3,631
--------- ---------
Total current assets 180,272 162,189
--------- ---------
Property and equipment, net 13,888 9,589
Other assets 3,900 3,901
--------- ---------
TOTAL ASSETS $ 198,060 $ 175,679
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 12,624 $ 8,799
Accrued liabilities 12,730 8,052
--------- ---------
Total current liabilities 25,354 16,851
--------- ---------
Long-term liabilities 897 805
Stockholders' equity:
Preferred stock, $0.01 par value;
5,000,000 shares authorized in 1997
and 1996; no shares issued and
outstanding - -
Common stock, $0.01 par value; 100,000,000
shares authorized in 1997 and 1996,
33,541,676 and 32,649,607 shares issued
and outstanding in 1997 and 1996,
respectively 335 326
Additional paid-in capital 172,881 164,002
Notes receivable from stockholders (151) (151)
Accumulated deficit (1,256) (6,154)
--------- ---------
Total stockholders' equity 171,809 158,023
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $ 198,060 $ 175,679
--------- ---------
--------- ---------
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)
(Unaudited)
Three Months Ended
March 31,
---------------------------
1997 1996
--------- ----------
Revenues $ 44,405 $ 24,121
Cost of revenues 24,977 14,101
--------- ---------
Gross profit 19,428 10,020
--------- ---------
Operating expenses:
Research and development 4,850 2,619
Selling, general, and administrative 7,798 3,545
DSC litigation costs - 691
--------- ---------
Total operating expenses 12,648 6,855
--------- ---------
Operating income 6,780 3,165
Other income (expense), net 996 (83)
--------- ---------
Income before income taxes 7,776 3,082
Income taxes 2,877 910
--------- ---------
Net income $ 4,899 $ 2,172
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--------- ---------
Net income per share $ 0.13 $ 0.08
--------- ---------
--------- ---------
Shares used in per share computations 39,104 28,871
--------- ---------
--------- ---------
See accompanying notes to condensed consolidated financial statements
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ADVANCED FIBRE COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended
March 31,
---------------------------
1997 1996
--------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,899 $ 2,172
Adjustments to reconcile net income to net
cash provided (used) in operating activities:
Depreciation and amortization 494 116
Changes in operating assets and liabilities:
Accounts receivable (9,298) (6,320)
Inventories (2,323) (3,748)
Accounts payable 3,825 1,332
Other, including other current assets
and liabilities 4,603 2,828
--------- ---------
NET CASH PROVIDED (USED) IN OPERATING
ACTIVITIES 2,200 (3,620)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of marketable securities (14,093) -
Purchase of property and equipment (4,793) (616)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (18,886) (616)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from secondary offering of common
stock 8,272 -
Proceeds from other stock issuances and
exercise of options and warrants 616 49
--------- ---------
NET CASH PROVIDED BY FINANCING
ACTIVITIES 8,888 49
DECREASE IN CASH AND CASH EQUIVALENTS (7,798) (4,187)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 24,942 11,118
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 17,144 $ 6,931
--------- ---------
--------- ---------
See accompanying notes to condensed consolidated financial statements
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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, 1996, contained in the Company's annual report on Form
10K.
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 months ended March 31, 1997 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):
March 31, December 31,
1997 1996
--------- ------------
Raw materials $ 7,991 $ 7,631
Work-in-progress 779 155
Finished goods 10,902 9,563
--------- ---------
$ 19,672 $ 17,349
--------- ---------
--------- ---------
NOTE 3 STOCKHOLDERS' EQUITY
In February 1997, the Company completed a secondary offering of 2,000,000
shares of common stock, 1,800,000 of which were sold by certain
stockholders and 200,000 of which were issued and sold by the Company.
NOTE 4 COMMITMENTS AND CONTINGENCIES
ITRI
In September, 1992, the Company entered into agreements (the ITRI
Agreements) with the Industrial Technology Research Institute ("ITRI"), a
Taiwanese government-sponsored research and development organization, that
granted to ITRI certain license rights to the ETSI version of the UMC. See
"Item 2
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Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Certain Factors that Might Affect Future Operating
Results -- Competition." In 1995, a dispute arose among the Company, 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 under the ITRI Agreements. In
reliance upon certain provisions of 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.
Pursuant to agreements with ITRI reached in 1994, the 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. Discovery in the case has been
ongoing since October, 1996. No trial date is currently set.
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 has 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 supplied the Member Companies with a
specified number of ASICs 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. 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 parties conducted discovery with respect to the royalty and ASIC supply
issues during September and October, 1996. A hearing on ITRI's motion for
a preliminary injunction to require the Company to continue supplying ASICs
and ITRI's motion to compel arbitration was held on November 22, 1996. On
January 23, 1997, the Court granted the ITRI parties' motion to compel
arbitration, and granted, in part, the Member Companies' motion for a
preliminary injunction. Under the Court's Order, the case was directed to
arbitration under the auspices of the American Arbitration Association, the
litigation was stayed, and the Company was
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directed to continue supplying ASICs to the Member Companies as under the
prior temporary restraining order.
On or about April 8, 1997, ITRI and the Member Companies filed amended
demands for arbitration with the American Arbitration Association. On
April 28, 1997, the Company filed an answer and counterclaim in the
arbitration proceeding against ITRI, the Member Companies, and Acer Netxus,
Inc., a Taiwanese company to which ITRI purportedly assigned member company
rights under the ITRI Agreements without the Company's consent. To date,
there has been no discovery or other proceedings in the arbitration, and no
hearing date is set.
The Company believes that it has meritorious defenses to the claims
asserted by the trustee, ITRI and the Member Companies and it intends to
defend the litigation vigorously. Moreover, the Company believes that the
damages claims of the trustee, ITRI, and the Member Companies are without
merit. The Company further believes that its claims against the trustee,
ITRI, the Member Companies, and Acer Netxus 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 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.
DESAI
On June 20, 1995, two investment limited partnerships, Equity-Linked
Investors, L.P. and Equity-Linked Investors, L.P. II (the "Plaintiffs")
filed a complaint against the Company in the United States District Court
for the Southern District of New York. The Plaintiffs' complaint contains
claims for breach of contract, promissory estoppel, and specific
performance related to an alleged subordinated debt financing agreement.
The Plaintiffs are affiliated with Desai Capital Management Incorporated
("Desai"). From March to June, 1995, the Company was involved in
negotiations with Desai regarding a proposed subordinated debt financing of
the Company. On June 13, 1995, the Company's Board of Directors
disapproved the proposed transaction. According to the Plaintiff's
complaint, the Company had a binding commitment to proceed with the
proposed financing. The complaint alleges that the Company committed to
accept a $10 million to $15 million loan from the Plaintiffs in exchange
for interest payments and warrants to purchase 350,000 shares of the
Company's Series E Preferred Stock at $12.50 per share (not taking into
account a two-for-one stock split in September, 1995 and the further
two-for-one stock split effected in August 1996). The complaint alleges
damages of "at least the difference between their exercisable $12.50 per
share price on 350,000 shares and the per share price of stock sold in any
initial public offering."
On July 12, 1995, and September 8, 1995, the Company filed motions to
dismiss the case for lack of federal jurisdiction and failure to state
a claim. The motions remained pending, with no discovery or other
proceedings in the case, through April, 1997. In April, 1997, the
parties entered into a settlement agreement to terminate the
litigation. Under the terms of the settlement agreement, and as
provided in the original Summary Of Proposed Terms for this
transaction, a $100,000 commitment fee that had been in an escrow
account since March, 1995 was released to the Plaintiffs and the
accrued interest was released to the Company. Pursuant to the
settlement, stipulated dismissals with prejudice of all related
litigation are to be filed before or during the week of May 5, 1997.
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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 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 $20.3 million, or 84%, from $24.1 million for
the three months ended March 31, 1996 to $44.4 million for the comparable
period of 1997. This increase was primarily the result of expansion of the
Company's customer base, higher international revenues and the introduction
of new features in the UMC system. International revenues increased $9.1
million or 198%, from $4.6 million for the first quarter of 1996 to $13.7
million for the three months ended March 31, 1997, and represented 19.1% and
30.9% of total revenues during the respective periods.
In the first quarter of 1997, GTE accounted for 13% of revenues. In the
first quarter of 1996, ALLTEL Supply, Inc., an affiliate of ALLTELL, an
independent domestic telephone company, and Hong Kong Telephone Company
Limited, accounted for 12.3% and 11.9% of revenues, respectively. No other
single 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 large 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.
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GROSS PROFIT. Gross profit is comprised of revenues less the cost of
materials, manufacturing and warranty costs. Gross profit increased $9.4
million, or 94%, from $10.0 million in the first quarter of 1996 to $19.4
million for the comparable period of 1997, and represented gross margins (as
a percentage of revenues) of 41.5% and 43.8%, respectively. The improvement
in gross margins was due to lower product costs resulting from engineering
design improvements and greater efficiencies achieved in the purchasing and
manufacturing activities related to the product as associated with higher
unit volumes. Gross margins were negatively impacted in the first quarter of
1997 by the increased level of sales in China which generally have a lower
gross margin due to the higher costs of distribution and price sensitivity as
compared with other markets. In the future, gross margins may fluctuate due
to a wide variety of factors, including: the mix between domestic and
international sales; the customer mix; 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; and unit volume.
RESEARCH AND DEVELOPMENT. Research and development expenses increased $2.2
million, or 85%, from $2.6 million for the three months ended March 31, 1996
to $4.9 million for the comparable period of 1997. The increase in research
and development expenses resulted primarily from the hiring of additional
personnel and higher costs for material and test equipment used to develop
and test new products and features. Research and development expenses
represented 10.9% of revenues in the first quarter of both 1997 and 1996.
The Company expects that research and development expenditures generally will
continue to increase in absolute dollars to support the continued development
of new features and product cost reduction efforts. All research and
development costs have been expensed as incurred.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased $4.3 million, or 120%, from $3.5 million for the three
months ended March 31, 1996 to $7.8 million for the comparable period of
1997. As a percentage of revenues, selling, general and administrative
expenses increased from 14.7% of revenues for the three months ended March
31, 1996 to 17.6% of revenues in the comparable period of 1997. The increase
in sales and marketing expenses was due to employee costs reflecting the
hiring of new employees, commissions earned by the Company's sales force and
outside international sales representatives as a result of higher revenue
levels, increased advertising and trade show participation in 1997 and higher
travel and entertainment costs. General and administrative expenses increased
for the three months ended March 31, 1997 as compared with the same period in
1996 due to an expansion of the Company's administrative staff, the legal
costs incurred for the ITRI litigation and higher facilities costs.
DSC LITIGATION COSTS. Litigation expenses in connection with the DSC
litigation were $691,000 in the first quarter of 1996 and none in 1997. This
litigation was settled in the second quarter of 1996.
INCOME TAXES. For the first quarter ended March 31, 1997 and 1996, the
Company recorded income taxes at effective rates that approximate the
combined federal and state statutory rates.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1997, the Company's cash and marketable security balances
totaled $114.7 million compared with $108.4 million at December 31, 1996.
In February 1997, the Company completed a secondary offering of 2,000,000
shares of Common Stock, 1,800,000 of which were sold by certain stockholders
and 200,000 of which were issued and sold by the Company, generating
approximately $8.3 million of net proceeds to the Company.
Net cash provided by operations in the first quarter of 1997 totaled $2.2
million. Investing activities during the quarter included additions to
property and equipment of $4.8 million. The Company continues to invest in
capital equipment to support its employee and facility growth and its
research and development and manufacturing activities.
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The Company has a $12.0 million bank line with an interest rate of prime plus
0.5%. The line of credit expired on November 15, 1996, but automatically
renews for successive thirty day periods until terminated by written
agreement. 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 March 31, 1997, and December 31, 1996 no borrowings were
outstanding under the bank line, and the Company was in compliance with the
covenants contained in the agreement. At March 31, 1997, $1.3 million was
reserved under the line for letters of credit and foreign exchange contracts.
The Company also has lease lines totaling $5.2 million that were used for
equipment and furniture purchases. There were no amounts left available
under the lease lines as of March 31, 1997.
The Company believes that its existing cash and short-term investments and
available credit facilities will be adequate to support the Company's
financial resource needs, including working capital requirements, capital
expenditures, operating lease obligations and debt payments for the next
twelve months.
CERTAIN FACTORS THAT MIGHT AFFECT FUTURE OPERATING RESULTS
In addition to the other information in this Quarterly Report on 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 Communications Corporation ("DSC") which
was settled in June 1996, the Company had an accumulated deficit of $1.3
million as of March 31, 1997. 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 mix
between domestic and international sales; the customer mix; 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; and unit volume.
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
11
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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. Fluctuations in the
Company's operating results may cause volatility in the price of the
Company's Common Stock. Further, it is likely that in some future quarter the
Company's revenues or operating results will be below the expectations of
public market analysts or investors. In such event, the market price of the
Company's Common Stock would likely be materially adversely affected.
The Company's customers normally install a portion of the UMC system in
outdoor locations. Shipments of the UMC system are subject to the effects of
seasonality, with fewer installation projects scheduled for the winter
months. Accordingly, the Company believes that over time this seasonality
will cause its revenues in the quarter ended March 31 to be lower than
revenues in the preceding quarter ended December 31.
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 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 and feature
enhancements 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.
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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 feature enhancements, 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 hardware
and 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 technical difficulties in certain UMC system installations. There
can be no assurance that despite significant testing by the Company, hardware
or software errors will not be found in the UMC system after commencement of
shipments, resulting in delays in, or cancellation of, customer orders or in
the loss of market acceptance, any 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 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., UT Starcom, Inc. and Vidar-SMS Co. Ltd. Many of these
competitors
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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 to new
member companies and whether AFC has terminated or may terminate such
agreements and the rights, if any, of the member companies thereunder.
Depending on the outcome of this dispute, the Company may face competition
from new member companies for 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 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. In June 1996, the
Company 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.
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RISK OF FAILURE TO MANAGE EXPANDING OPERATIONS. The Company has 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.
In connection with the Company's recent growth, management evaluated and
purchased a new management and accounting system in the first quarter of 1997
and has begun implementation of such system. There can be no assurance that
the Company will complete such implementation on a timely basis. 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 three months ended March 31, 1997,
approximately 13.0% of the Company's revenues were derived from sales to GTE.
For the three months ended March 31, 1996, ALLTEL Supply, Inc., and Hong Kong
Telephone Company Limited accounted for 12.3% and 11.9% of the Company's
revenues, respectively. For the first three months ended March 31,1997 and
1996, the Company's five largest customers accounted for approximately 41%
and 38% 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.
RISKS ASSOCIATED WITH INTERNATIONAL MARKETS. International sales constituted
30.9% and 19.1% of the Company's total revenues for the three months ended
March 31,1997 and 1996, 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 adversely affect 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
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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 adversely affect 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.
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. Standards setting and compliance verification in the United States
are determined by the Federal Communications Commission ("FCC"), by
Underwriters Laboratories, by independent telephone companies, by Bell
Communications Research ("Bellcore") and by other independent third-party
testing organizations. 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 must 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 completed a Bellcore technical audit and was found to meet
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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 has initiated the formal
process of applying for ISO-9001 certification and expects to complete the
audit process during 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 September, 1992, the Company entered into agreements (the ITRI Agreements)
with the Industrial Technology Research Institute ("ITRI"), a Taiwanese
government-sponsored research and development organization, that granted to
ITRI certain license rights to the ETSI version of the UMC. See "Item 2
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors that Might Affect Future Operating Results
- --Competition." In 1995, a dispute arose among the Company, 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 under the ITRI Agreements. In reliance
upon certain provisions of 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.
Pursuant to agreements with ITRI reached in 1994, the 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.
Discovery in the case has been ongoing since October, 1996. No trial date is
currently set.
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 has 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 supplied the Member Companies with a specified number of
ASICs 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. 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.
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The parties conducted discovery with respect to the royalty and ASIC supply
issues during September and October, 1996. A hearing on ITRI's motion for a
preliminary injunction to require the Company to continue supplying ASICs and
ITRI's motion to compel arbitration was held on November 22, 1996. On
January 23, 1997, the Court granted the ITRI parties' motion to compel
arbitration, and granted, in part, the Member Companies' motion for a
preliminary injunction. Under the Court's Order, the case was directed to
arbitration under the auspices of the American Arbitration Association, the
litigation was stayed, and the Company was directed to continue supplying
ASICs to the Member Companies as under the prior temporary restraining order.
On or about April 8, 1997, ITRI and the Member Companies filed amended
demands for arbitration with the American Arbitration Association. On April
28, 1997, the Company filed an answer and counterclaim in the arbitration
proceeding against ITRI, the Member Companies, and Acer Netxus, Inc., a
Taiwanese company to which ITRI purportedly assigned member company rights
under the ITRI Agreements without the Company's consent. To date, there has
been no discovery or other proceedings in the arbitration, and no hearing
date is set.
The Company believes that it has meritorious defenses to the claims asserted
by the trustee, ITRI and the Member Companies and it intends to defend the
litigation vigorously. Moreover, the Company believes that the damages
claims of the trustee, ITRI, and the Member Companies are without merit. The
Company further believes that its claims against the trustee, ITRI, the
Member Companies, and Acer Netxus 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 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.
DESAI
On June 20, 1995, two investment limited partnerships, Equity-Linked
Investors, L.P. and Equity-Linked Investors, L.P. II (the "Plaintiffs") filed
a complaint against the Company in the United States District Court for the
Southern District of New York. The Plaintiffs' complaint contains claims for
breach of contract, promissory estoppel, and specific performance related to
an alleged subordinated debt financing agreement. The Plaintiffs are
affiliated with Desai Capital Management Incorporated ("Desai"). From March
to June, 1995, the Company was involved in negotiations with Desai regarding
a proposed subordinated debt financing of the Company. On June 13, 1995, the
Company's Board of Directors disapproved the proposed transaction. According
to the Plaintiff's complaint, the Company had a binding commitment to proceed
with the proposed financing. The complaint alleges that the Company
committed to accept a $10 million to $15 million loan from the Plaintiffs in
exchange for interest payments and warrants to purchase 350,000 shares of the
Company's Series E Preferred Stock at $12.50 per share (not taking into
account a two-for-one stock split in September, 1995 and the further
two-for-one stock split effected in August 1996). The complaint alleges
damages of "at least the difference between their exercisable $12.50 per
share price on 350,000 shares and the per share price of stock sold in any
initial public offering."
On July 12, 1995, and September 8, 1995, the Company filed motions to dismiss
the case for lack of federal jurisdiction and failure to state a claim. The
motions remained pending, with no discovery or other proceedings in the case,
through April, 1997. In April, 1997, the parties entered into a settlement
agreement to terminate the litigation. Under the terms of the settlement
agreement, and as provided in the original Summary Of Proposed Terms for this
transaction, a $100,000 commitment fee that had been in an escrow account
since March, 1995 was released to the Plaintiffs and the accrued interest was
released to the Company. Pursuant to the settlement, stipulated dismissals
with prejudice of all related litigation are to be filed before or during the
week of May 5, 1997.
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ITEM 2. CHANGES IN SECURITIES:
Between January 1, 1997 and March 31, 1997 the Company issued and sold the
following securities which were not registered under the Securities Act of
1933 ("Securities Act"): (i) the Company granted stock options to its
employees under its 1996 Stock Incentive Plan, covering an aggregate of
615,735 shares of the Company's Common Stock, at exercise prices ranging from
$29.50 to $53.25 per share and (ii) the Company issued and sold an aggregate
of 342,493 shares of Common Stock upon exercise of warrants to 5 persons or
entities for aggregate consideration of $384,000.
The sales and issuances of securities in the transactions described above
were deemed to be exempt from registration under the Securities Act in
reliance upon Section 4(2) of the Securities Act, or Regulation D promulgated
thereunder, or Rule 701 promulgated under Section 3(b) of the Securities Act,
as transactions by an issuer not involving any public offering or
transactions pursuant to compensatory benefit plans and contracts relating to
compensations as provided under Rule 701. The recipients of securities in
each such transaction represented their intentions to acquire the securities
for investments only and not with a view to or for sale in connection with
any distribution thereof and appropriate legends were affixed to the
securities issued in such transactions. All recipients had adequate access,
through their relationships with the Company, to information about the
Company.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES: None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS: None
ITEM 5. OTHER INFORMATION: None
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
20
<PAGE>
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 1445 McDowell Boulevard North.*
10.16 Redwood Business Park Net Lease, dated July 9, 1995, between the
Registrant and 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 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.*
10.30 Termination Agreement of Joint Venture and Partnership Agreement,
dated December 23, 1996, between the Registrant and Tellabs
Operations, Inc.**
10.31 License and Marketing Agreement, dated December 23, 1996, between the
Registrant and Tellabs Operations, Inc.**
10.32 OEM Agreement, dated December 23, 1996, between the Registrant and
Tellabs Operations, Inc.**
11.1 Schedule re: computation of net income per share.
21.1 Subsidiaries of the Registrant.*
27.1 Financial data schedule.
* Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (no. 333-8921) filed with the Securities and Exchange Commission on
July 26, 1996, as amended, and declared effective September 30, 1996.
** Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (no. 333-20369) filed with the Securities and Exchange Commission on
January 24, 1997, as amended, and declared effective February 12, 1997.
+ Portions of this Exhibit have been granted Confidential Treatment.
(b) REPORTS ON FORM 8-K: None
21
<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: May 9, 1997 By: /s/ Dan E. Steimle
------------------------------------------
Name: Dan E. Steimle
Title: Vice President, Chief Financial
Officer, Treasurer and Secretary
22
<PAGE>
ADVANCED FIBRE COMMUNICATIONS, INC.
EXHIBIT INDEX
Exhibit
Number Document Description
- -------- --------------------
11.1 Schedule re: computation of net income per share.
27.1 Financial data schedule.
23
<PAGE>
EXHIBIT 11.1
ADVANCED FIBRE COMMUNICATIONS, INC.
SCHEDULE RE: COMPUTATION OF NET INCOME PER SHARE
(In thousands, except per share data)
Three Months Ended
March 31,
------------------------
1997 1996
---------- ---------
Net income $ 4,899 $ 2,172
---------- ---------
Weighted average common shares outstanding 33,172 5,095
Redeemable convertible preferred stock, on an
as-if converted basis 18,497
Common stock equivalents - stock options and 5,932 4,908
warrants
Staff Accounting Bulletin No. 83 issuances
and grants - stock options - 371
---------- ---------
Shares used in per share computations 39,104 28,871
---------- ---------
Net income per share $ 0.13 $ 0.08
---------- ---------
---------- ---------
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 17,144
<SECURITIES> 97,581
<RECEIVABLES> 42,081
<ALLOWANCES> 0
<INVENTORY> 19,672
<CURRENT-ASSETS> 180,272
<PP&E> 15,873
<DEPRECIATION> 1,985
<TOTAL-ASSETS> 198,060
<CURRENT-LIABILITIES> 25,354
<BONDS> 0
0
0
<COMMON> 335
<OTHER-SE> 171,474
<TOTAL-LIABILITY-AND-EQUITY> 198,060
<SALES> 43,808
<TOTAL-REVENUES> 44,405
<CGS> 23,709
<TOTAL-COSTS> 24,977
<OTHER-EXPENSES> 12,638
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (986)
<INCOME-PRETAX> 7,776
<INCOME-TAX> 2,877
<INCOME-CONTINUING> 4,899
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,899
<EPS-PRIMARY> 0.13
<EPS-DILUTED> 0.13
</TABLE>
