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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to____________
Commission file number: 0-28734
ADVANCED FIBRE COMMUNICATIONS, INC.
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<S> <C>
A Delaware I.R.S. Employer
Corporation Identification No.
68-0277743
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1465 North McDowell Boulevard
Petaluma, California 94954
Telephone: (707) 794-7700
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
As of November 3, 2000, 80,653,247 shares of common stock were outstanding.
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ADVANCED FIBRE COMMUNICATIONS, INC.
REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
TABLE OF CONTENTS
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PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
September 30, 2000 and December 31, 1999................................................................2
Condensed Consolidated Statements of Income
Three and nine months ended September 30, 2000 and 1999.................................................3
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 2000 and 1999...........................................................4
Notes to Condensed Consolidated Financial Statements........................................................5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..........................8
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................................20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................................21
Item 2. Changes in Securities and Use of Proceeds.....................................................................21
Item 3. Defaults Upon Senior Securities...............................................................................21
Item 4. Submission of Matters to a Vote of Security Holders...........................................................21
Item 5. Other Information.............................................................................................21
Item 6. Exhibits and Reports on Form 8-K..............................................................................21
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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)
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<CAPTION>
September 30, December 31,
2000 1999
(Unaudited)
----------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 19,282 $ 31,372
Marketable securities 888,171 700,750
Accounts receivable, net 68,479 60,768
Inventories, net 48,986 37,946
Other current assets 11,568 6,736
----------- -----------
Total current assets 1,036,486 837,572
Property and equipment, net 66,942 56,914
Other assets 11,477 7,289
----------- -----------
TOTAL ASSETS $ 1,114,905 $ 901,775
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 18,952 $ 19,868
Accrued liabilities 32,950 28,818
Deferred tax liabilities 260,446 205,529
----------- -----------
Total current liabilities 312,348 254,215
Long-term liabilities 2,505 2,496
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares
authorized, no shares issued and outstanding -- --
Common stock, $0.01 par value; 200,000,000 shares
authorized in 2000 and 1999; 80,595,729 and 79,077,392
shares issued and outstanding in 2000 and 1999, respectively 806 790
Deferred stock compensation -- (96)
Additional paid-in capital 264,453 238,074
Notes receivable from stockholders (56) (241)
Accumulated other comprehensive income 180,287 100,968
Retained earnings 354,562 305,569
----------- -----------
Total stockholders' equity 800,052 645,064
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,114,905 $ 901,775
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements
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ADVANCED FIBRE COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
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<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $114,100 $ 76,456 $300,751 $213,814
Cost of revenues 60,355 39,870 160,264 114,652
-------- -------- -------- --------
Gross profit 53,745 36,586 140,487 99,162
-------- -------- -------- --------
Operating expenses:
Research and development 16,189 11,736 45,305 35,698
Selling, general, and
administrative 20,063 17,823 57,575 51,249
-------- -------- -------- --------
Total operating expenses 36,252 29,559 102,880 86,947
-------- -------- -------- --------
Operating income 17,493 7,027 37,607 12,215
Other income, net 2,169 1,783 39,153 4,612
-------- -------- -------- --------
Income before income taxes 19,662 8,810 76,760 16,827
Income taxes 6,685 2,852 26,099 4,897
-------- -------- -------- --------
Net income $ 12,977 $ 5,958 $ 50,661 $ 11,930
======== ======== ======== ========
Basic net income per share $ 0.16 $ 0.08 $ 0.63 $ 0.15
======== ======== ======== ========
Shares used in basic per share
computations 80,431 77,965 80,043 77,330
======== ======== ======== ========
Diluted net income per share $ 0.15 $ 0.07 $ 0.60 $ 0.15
======== ======== ======== ========
Shares used in diluted per share
computations 84,658 81,817 84,830 80,624
======== ======== ======== ========
</TABLE>
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)
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Nine Months Ended
September 30,
-----------------------------
2000 1999
--------- ---------
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 50,661 $ 11,930
Adjustments to reconcile net income to net cash provided by
operating activities:
Tax benefit from option exercises 15,390 3,911
Depreciation and amortization 9,981 9,580
Allowance for uncollectible accounts and returns 1,382 (2,233)
Deferred income taxes 2,910 (318)
Changes in operating assets and liabilities:
Accounts receivable (9,093) 20,253
Inventories (11,040) 14,419
Other current assets (5,151) (418)
Long-term assets 5,773 263
Accounts payable (915) 1,794
Other liabilities 4,140 4,707
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 64,038 63,888
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (270,193) (315,152)
Maturities of marketable securities 118,619 212,666
Sales of marketable securities 95,454 80,355
Purchases of property and equipment, net of disposals (19,867) (15,489)
Other long-term investments (10,103) (450)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (86,090) (38,070)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from other stock issuances and exercise of common stock
options and warrants 5,639 7,912
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 5,639 7,912
--------- ---------
EFFECT OF ADJUSTMENT TO CONFORM FISCAL YEAR ENDS IN POOLING
TRANSACTION 4,323 --
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (12,090) 33,730
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 31,372 20,782
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 19,282 $ 54,512
========= =========
</TABLE>
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 unaudited 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 (SEC). 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 contained in our Current Report on Form 8-K filed
September 19, 2000 which gives retroactive effect to the consolidation of GVN
Technologies, Inc. (GVN).
The unaudited condensed consolidated financial statements include Advanced Fibre
Communications, Inc. and its subsidiaries (AFC). Significant intercompany
transactions and accounts have been eliminated. Certain prior period amounts
have been reclassified to conform with the current period presentation.
We generally operate on 13-week fiscal quarters ending on the last Saturday of
each fiscal period. For presentation purposes only, the fiscal periods are shown
as ending on the last day of the month of the respective fiscal period. The
fiscal quarter ending September 30, 2000 was 14 weeks, and our fiscal year will
have 53 weeks to maintain the convention of ending the fiscal year on the last
Saturday of the calendar year. The results of operations for the three and nine
month periods ended September 30, 2000 are not necessarily indicative of the
operating results for the full year.
All historical financial information has been restated to reflect the
acquisition of GVN in the second quarter of fiscal 2000, which was accounted for
as a pooling of interests.
NOTE 2 POOLING OF INTERESTS COMBINATION
On May 16, 2000, AFC acquired GVN, a leading developer of integrated access
device equipment for the service provider market. Under the terms of the
agreement, approximately 1.1 million shares and options to purchase AFC common
stock were issued in exchange for all outstanding shares and options of GVN.
This acquisition was accounted for as a pooling of interests. All historical
financial information contained herein has been restated to include the combined
operating results, financial position and cash flows of AFC and GVN. The
combined year to date financial results presented include non-recurring costs,
primarily legal and other professional fees, of approximately $1.1 million.
Prior to the acquisition, GVN operated on a June 30 fiscal year end. There were
no conforming accounting adjustments for GVN, and there were no intercompany
transactions between the entities prior to the combination.
NOTE 3 INVENTORIES
Inventories are valued at the lower of first-in, first-out cost or market and
consisted of the following (in thousands):
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September 30, December 31,
2000 1999
(Unaudited)
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Raw materials $13,837 $ 7,706
Work-in-progress 1,758 1,113
Finished goods 33,391 29,127
------- -------
Inventories, net $48,986 $37,946
======= =======
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NOTE 4 COMPREHENSIVE INCOME
Accumulated other comprehensive income, in the stockholders' equity section of
our balance sheet, is composed primarily of unrealized gains and losses on
marketable securities. For the period from December 31, 1999 to September 30,
2000, we recorded an unrealized gain, net of taxes, of approximately $79.1
million on the shares of Cisco Systems, Inc. (Cisco) we hold, net of the change
in value of the costless collar agreement to which our Cisco shares are subject.
We recorded an unrealized gain, net of taxes, of approximately $195,000 for the
change in value of the remainder of our marketable securities portfolio during
this same time period. Our foreign currency translation adjustments were not
significant as of September 30, 2000 or 1999. The following table presents the
components of comprehensive income (in thousands):
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<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income $ 12,977 $ 5,958 $ 50,661 $ 11,930
Change in unrealized gain on investments,
net of tax 1,947 0 79,319 0
-------- -------- -------- --------
Total comprehensive income $ 14,924 $ 5,958 $129,980 $ 11,930
======== ======== ======== ========
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NOTE 5 COMMITMENTS AND CONTINGENCIES
STOCKHOLDER LITIGATION - AFC and various of its current and former officers and
directors are defendants in a consolidated lawsuit which purports to be a class
action filed on behalf of certain of our stockholders. The lawsuit alleges that
the defendants violated certain federal securities laws. The plaintiffs filed a
consolidated Amended Complaint on or about January 27, 1999. Defendants' motion
to dismiss the complaint was granted by the Court on March 24, 2000. Plaintiffs
were given leave to file an amended complaint, which they filed on June 2, 2000.
Defendants moved again to dismiss this complaint. Limited discovery has
occurred, and only limited discovery is expected to occur pending a ruling on
the motion to dismiss the most recent complaint. Based on current information,
we believe the suit to be without merit and intend to defend AFC and its
officers and directors vigorously. Although it is reasonably possible we may
incur a loss upon the conclusion of this claim, an estimate of any loss or range
of loss cannot be made. No provision for any liability that may result upon
adjudication has been made in the consolidated financial statements. In the
opinion of management, resolution of this matter is not expected to have a
material adverse effect on our financial position. However, depending on the
amount and timing, an unfavorable resolution of this matter could materially
affect our future results of operations or cash flows in a particular period. In
connection with these legal proceedings, we expect to incur substantial legal
and other expenses. Stockholder suits of this kind are highly complex and can
extend for a protracted period of time, which can substantially increase the
cost of such litigation and divert the attention of management from the
operations of AFC.
NOTE 6 OTHER INCOME
Included in other income for the year to date is $32.75 million in cash that
Marconi Communications Inc. paid to us related to the settlement of litigation
in February 2000.
NOTE 7 SEGMENT REPORTING
We derive substantially all of our revenues from sales of the OmniMAX(TM)
product family, and our company is not organized by multiple operating segments
for the purpose of making operating decisions or assessing performance.
Accordingly, we have a single reportable segment and report only certain
enterprise-wide disclosures.
For the third quarter of 2000, revenues from sales to customers, excluding
royalties, were $113.9 million, compared with $76.2 million in the same period
of 1999. For the nine months ended September 30, 2000,
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revenues from sales to customers, excluding royalties, were $300.2 million,
compared with $213.4 million in the same period of 1999. We have a single
reportable segment; thus, there is no difference between reportable income and
consolidated income. Long-lived assets, excluding deferred tax assets, located
in the U.S. increased to $77.6 million as of September 30, 2000 from $63.2
million as of December 31, 1999. Long-lived assets, excluding deferred tax
assets, located in foreign countries decreased to $0.8 million as of September
30, 2000 from $1.1 million as of December 31, 1999.
NOTE 8 NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the weighted
average number of common shares outstanding during the period. Diluted net
income per share is computed using the weighted average number of shares of
common stock on an as-if converted basis, and common equivalent shares from
options and warrants to purchase common stock using the treasury stock method,
when dilutive.
The computation of shares and net income used in the calculation of basic and
diluted net income per share for the three and nine month periods ended
September 30, 2000 and 1999 is (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income $12,977 $ 5,958 $50,661 $11,930
======= ======= ======= =======
Shares used in basic per share calculations,
actual weighted average common shares
outstanding for the period 80,431 77,965 80,043 77,330
Weighted average number of shares upon
exercise of dilutive options and warrants 4,227 3,852 4,787 3,294
------- ------- ------- -------
Shares used in diluted per share
calculations 84,658 81,817 84,830 80,624
======= ======= ======= =======
Basic net income per share $ 0.16 $ 0.08 $ 0.63 $ 0.15
======= ======= ======= =======
Diluted net income per share $ 0.15 $ 0.07 $ 0.60 $ 0.15
======= ======= ======= =======
</TABLE>
NOTE 9 CERTAIN ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and
Hedging Activities, which was amended by SFAS No. 137, Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133 - an Amendment of FASB Statement No. 133, and further amended
by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain
Hedging Activities - an Amendment of FASB Statement No. 133. SFAS No. 133 is
effective on a prospective basis for interim periods and fiscal years beginning
January 1, 2001. The statement will be effective for us beginning in the first
quarter of 2001. This standard requires that we recognize all derivatives as
either assets or liabilities in the balance sheet and that we measure those
instruments at fair value. The treatment of gains or losses resulting from
changes in the derivative will be determined depending on the type and use of
the derivative and whether it qualifies for hedge accounting. This treatment
will introduce more volatility into the company's non-operating earnings. We are
currently evaluating the requirements and the impact of SFAS No. 133, SFAS No.
137, and SFAS No. 138.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 (SAB 101),
Revenue Recognition in Financial Statements. SAB 101 summarizes certain of the
SEC's views in applying generally accepted accounting principles to revenue
recognition in financial statements. The implementation date of SAB 101
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has been extended to the fourth quarter of 2000 to allow additional time for
registrants to study forthcoming SEC guidance, but its provisions will be
applied retroactively to the beginning of 2000. We are currently evaluating the
effect of SAB 101 on our operations and financial position.
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 our intent, belief, estimates, current plans, or
expectations. Current and 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 our forward-looking statements, as set forth below in
"Certain Factors That Might Affect Future Operating Results", are:
- Our operating results will likely continue to fluctuate due to
seasonality and other factors.
- Because a limited number of customers account for a substantial portion
of our total revenues, the loss or significant reduction in sales of a
single customer could have a material adverse impact on our business.
- We may experience delays and defects in product development and product
feature releases.
- We conduct business internationally and face several risks associated
with international markets.
- We face intense competition, and the competitive landscape in our
industry changes rapidly.
- Our business and operating results will be harmed if we fail to manage
recent and potential growth.
- Our product line is concentrated within a single family of products, and
our ability to introduce new product features and to respond to rapid
technological change is subject to significant uncertainty.
- Our ability to protect our proprietary technology is limited, and we
expect to continue to be subject to third-party claims of intellectual
property infringement.
- Our customers are concentrated in a single industry which exposes us to
fluctuations in capital spending patterns and other factors affecting
demand for our products in this industry.
- We may be unable to secure necessary components and support because we
depend upon a limited number of third-party manufacturers and support
organizations, over which we have no control, and in some cases we rely
upon sole source suppliers.
- We must attract, retain, and motivate key technical and management
personnel in a competitive market.
- Recent and future acquisitions may adversely affect our operations and
financial results.
- We are party to costly and disruptive legal proceedings, the outcome of
which is unpredictable.
- Our business will suffer if our products do not comply with numerous
regulations and industry standards, which are subject to change.
- There may be other risks identified from time to time in our 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, on pages 2 through 8 of this Form 10-Q.
OVERVIEW
We design and manufacture worldwide end-to-end broadband access solutions for
the portion of the telecommunications network between the carrier's central
office and its subscribers, often referred to as the "last mile". Our
OmniMAX(TM) is a global product family consisting of multi-service access
platforms with integrated optics and intelligent customer premises equipment.
Our OmniMAX products can quickly and cost-effectively upgrade legacy networks,
ubiquitously delivering narrowband, wideband, and broadband services to
subscribers regardless of their geographic proximity to a carrier's central
office.
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Our OmniMAX product portfolio consists of: AccessMAX(TM), a variety of broadband
multi-service access platforms including AFC's flagship product, the
UMC1000(TM), that provide local loop voice, data, and broadband solutions;
PremMAX(TM), a series of integrated access devices that provide integrated voice
and data at the customer premises; TransMAX(TM), a Sonet/SDH optical transport
system for metro ring solutions; and, Panorama(TM) Element Management System,
AFC's family of end-to-end network and element management software products used
for provisioning and maintaining our equipment. We also design and manufacture
environmentally hardened outside plant cabinets and technology ranging from 48
to 2,048 lines, as well as indoor cabinets ranging from 48 to 480 lines.
On May 16, 2000, we acquired GVN Technologies, Inc. (GVN) in an acquisition
structured as a pooling of interests. All historical financial information
contained herein has been restated to include the combined operating results,
financial position, and cash flows of AFC and GVN.
RESULTS OF OPERATIONS
REVENUES. In the third quarter ended September 30, 2000, our revenues increased
49.2% to $114.1 million as compared with $76.5 million for the same period in
1999. Revenues for the first nine months of 2000 were $300.8 million, an
increase of 40.7%, compared with $213.8 million for the same period of 1999.
The increase in revenues was primarily due to higher U.S. revenues which were
$101.7 million in the third quarter of 2000 compared with $68.6 million in the
same period of 1999, an increase of 48.2%. The increase in U.S. revenues for the
period was due to increased sales to North Supply Company, a subsidiary of
Sprint (Sprint), Tellabs International, SBC Operations, Inc., and RCN Telecom
Services, Inc.
International revenues in the third quarter of 2000 totaled $12.4 million,
compared with $7.8 million for the comparable period in 1999. The increase was
primarily due to higher sales to customers in South Africa and the Caribbean
countries. International revenues for the third quarter of 2000 and 1999
represented 10.9% and 10.2% of consolidated revenues, respectively.
International revenues for the first nine months of the year totaled $33.3
million, compared with $24.7 million for the same period of 1999. The increase
was due to higher sales to customers in South Africa, Caribbean countries and
France, offset by lower sales to customers in Venezuela and Panama.
International revenues for the first nine months of 2000 and 1999 represented
11.1% and 11.6% of consolidated revenues, respectively.
The additional fourteenth week in the third quarter of 2000 also contributed to
the increase in revenues as compared with the third quarter of 1999 which had 13
weeks.
In the third quarter of 2000, Sprint accounted for 13.3% of revenues, and
WinStar Communications, Inc. (WinStar) accounted for 13.2%. For the third
quarter of 1999, WinStar accounted for 23.8%. For the first nine months of 2000,
WinStar and Sprint accounted for 19.9% and 12.8% of revenues, respectively. For
the same period of 1999, sales to WinStar accounted for 15.4% of revenues, and
Sprint accounted for 12.2%. No other customer accounted for 10% or more of
revenues in any of these periods. Although our largest customers have varied
from period to period, we anticipate that results of operations in any given
period will continue to depend to a significant extent upon sales to a small
number of customers. This dependence may increase due to our strategy of
focusing on securing large accounts. There can be no assurance that our
principal customers will continue to purchase products from us at current
levels, if at all. The loss of, or significant reduction in sales to one or more
principal customers may result in lower revenues and decreased net income.
GROSS PROFIT. In the third quarter of 2000, gross profit margin (gross profit as
a percentage of revenues) decreased to 47.1% from 47.9% in the same period of
1999. In the first nine months of 2000, gross profit margin grew to 46.7% from
46.4% in the same period of 1999.
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The decrease in gross profit margin in the third quarter of 2000 as compared
with the same period of 1999 is primarily due to changes in customer and product
mix. The overall increase in gross profit margin for the first nine months of
2000 is due to increased efficiencies resulting from a higher volume of
production.
In the future, gross profit margin may fluctuate due to a wide variety of
factors, including: our ability to introduce new products and technologies on a
timely basis, the timing of new product introductions or announcements by us or
our competitors, the mix between U.S. and international sales, the customer mix,
the product feature 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, component pricing changes due to vendor allocation,
engineering and manufacturing efficiencies, the extent of global sourcing of our
products, price competition, unit volume, royalty revenues, excess or obsolete
inventory, and changes in warranty coverage.
RESEARCH AND DEVELOPMENT. In the third quarter of 2000, research and development
expenses increased to $16.2 million, compared with $11.7 million for the same
period in 1999, and represented 14.2% and 15.3% of revenues, respectively. In
the first nine months of 2000, research and development expenses increased to
$45.3 million compared with $35.7 million for the same period in 1999 and
represented 15.1% and 16.7% of revenues, respectively.
The increase in research and development expense in both the third quarter and
the first nine months of 2000, compared with 1999, is primarily due to higher
compensation and benefits expense resulting from the addition of new personnel,
partially through our acquisition of GVN in May 2000, and the additional
fourteenth week in the third quarter. There were also greater bonuses and
incentives given to employees meeting operating goals and product development
milestones, an increase in depreciation on test equipment used to develop and
test new products and features, and an increase in direct expenses related to
product development and testing. We used more outside services for testing and
product development in the first nine months of 2000 than in the same period in
1999. We believe that rapidly evolving technology and competition in our
industry necessitate the continued commitment of resources to our product
development in order to remain competitive. We plan to continue to support the
development of new products and features as well as product cost reductions,
while seeking to carefully manage the rate of increase of such expenses through
expense controls.
SELLING, GENERAL, AND ADMINISTRATIVE. For the third quarter of 2000, selling,
general, and administrative expenses increased to $20.1 million, compared with
$17.8 million for the same period in 1999, and represented 17.6% and 23.3% of
revenues, respectively. In the first nine months of 2000, selling, general, and
administrative expenses increased to $57.6 million compared with $51.2 million
for the first nine months of 1999 and represented 19.1% and 24.0% of revenues,
respectively.
The increase in selling, general, and administrative expenses in both the third
quarter and the first nine months of 2000 compared with 1999 is primarily due to
higher compensation and benefits expense resulting from an increase in personnel
and the additional fourteenth week in the third quarter. There were also greater
bonuses and incentives for personnel meeting operating goals and increased sales
force commissions expense. For the year to date, there was an increase in
donations made to educational institutions. The selling, general, and
administrative expense increases were partially offset by a decrease in
litigation costs. We plan to continue to allocate resources to our sales,
marketing, and administrative functions to remain competitive in our industry
and to support our research and development functions. We recognize the need to
balance these costs with expense controls to carefully manage the increase of
such expenses.
OTHER INCOME. In the third quarter of 2000, other income increased to $2.2
million from $1.8 million in the same period of 1999, primarily due to an
increase in interest income. In the first nine months of 2000, other income
increased to $39.2 million from $4.6 million in the same period of 1999. The
increase is primarily a result of $32.75 million in cash received in conjunction
with the litigation settlement with Marconi in February 2000.
INCOME TAXES. For the third quarter and first nine months of 2000 and 1999, we
recorded income taxes at an effective rate that approximated the combined
federal and state statutory rates. Our effective tax rate in 2000
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is expected to be 34.0%. In the second quarter of 1999 a change in the tax law
enabled us to utilize the net operating loss carry-forward of GVN to reduce our
effective tax rate. This change in the tax law resulted in an effective tax rate
of 32.4% for the third quarter of 1999, and 29.1% for the nine months ended
September 30, 1999. The effective rate for the entire year of 1999 was 39.0%.
The higher rate for 1999 was primarily due to the gain arising from the
conversion of our investment in Cerent Corporation, Inc. into Cisco Systems,
Inc. (Cisco) common stock in November 1999. Although the tax rate in 2000 has
decreased from the rate for the entire year of 1999, the rate is higher than the
third quarter and first nine months of 1999 primarily due to the gain arising
from settlement of the Marconi litigation in February 2000.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2000, cash and cash equivalents were $19.3 million, compared
with $31.4 million at December 31, 1999. Marketable securities totaled $888.2
million at September 30, 2000, compared with $700.8 million as of December 31,
1999. The $187.4 million increase was primarily a result of the $131.3 million
unrealized gain, before taxes, for the change in value of the Cisco shares we
hold.
In February 2000, we entered into a hedging transaction structured as a costless
collar agreement, with a term of approximately three years, to minimize the
potential market risk on approximately 10 million shares of Cisco stock we own.
We have the ability to borrow against the value of a portion of the shares
hedged, which we have pledged to secure our obligations under the collar
agreement. We hedged approximately 530,000 additional shares of Cisco common
stock received in the second quarter of 2000. For additional information with
respect to the potential impact of adverse market price volatility on our Cisco
stock we own, refer to Part 1, Item 3 - "Quantitative and Qualitative
Disclosures About Market Risk" on page 20 of this Quarterly Report on Form 10-Q.
Operating activities for the nine months ended September 30, 2000 generated net
cash of $64.0 million. This was primarily the result of net income of $50.7
million and adjustments for non-cash activities including $15.4 million of tax
benefit from the exercise of employee stock options. Net cash of $86.1 million
was used in investing activities during the nine months ended September 30, 2000
primarily for marketable securities purchases offset by proceeds from the
maturities and sales of marketable securities.
We have amended our unsecured bank line agreement. The existing bank line is
through two banks and carries an interest rate of LIBOR plus 1.50%. The terms of
the existing agreement expired in July 2000, and the terms of the amended bank
line, which is in the amount of $25.0 million, are extended to July 2001. Under
the bank line, the banks may issue letters of credit up to $10.0 million on our
behalf. As of September 30, 2000, $3.7 million in letters of credit were
outstanding, of which $1.0 million was issued as a short-term deposit on one of
our leased facilities and another $1.0 million was issued as a five-year deposit
on the same building. The bank line requires us to comply with certain financial
covenants. As of September 30, 2000, no borrowings were outstanding under the
bank line, and we were in compliance with the covenants.
We also maintain bank agreements with two banks under which we may enter into
foreign exchange contracts up to $40.0 million. There are no borrowing
provisions or financial covenants associated with these facilities. As of
September 30, 2000, there were approximately $1.5 million in foreign exchange
contracts outstanding.
We believe our existing cash and marketable securities, available credit
facilities and cash flows from operating and financing activities will be
adequate to support our financial resource needs, including working capital and
capital expenditures requirements, and operating lease obligations, 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 AFC and
our business.
OUR OPERATING RESULTS WILL LIKELY CONTINUE TO FLUCTUATE DUE TO SEASONALITY AND
OTHER FACTORS.
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Our operating results have been, and will continue to be, affected by a wide
variety of factors, some of which are outside our control, that could, among
other things, lower revenues, increase operating expenses, and lower net income.
These factors include:
- U.S. and international sales mix
- Customer and distribution channel mix
- Product feature component mix
- Timing and size of orders which are received and can be shipped in a
quarter
- Availability of adequate supplies of key components and assemblies
- Component pricing changes due to vendor allocation
- Rapidly changing industry standards and customer needs
- Our ability to introduce new product features and technologies on a
timely basis
- Timing of new product feature introductions or announcements by our
competitors
- Price competition
- Unit volume
- Royalty revenue levels
- Excess or obsolete inventory
- Adequacy of manufacturing capacity
- Customers' ability to pay when due
- Expanded warranty coverage
- Integration of acquired businesses and technologies and expenses
associated with acquisitions
We sell our OmniMAX product family primarily to telecommunications companies
installing our equipment as part of their access networks. Additions to those
networks represent complex engineering projects, requiring lengthy periods from
project conceptualization to completion. Our equipment typically represents only
a portion of a given project and, therefore, the timing of product shipment and
revenue recognition is often difficult to forecast. Our customers normally
install a portion of our equipment in outdoor locations. Shipments of the system
can be subject to the effects of seasonality, with fewer installation projects
scheduled for the winter months. The majority of our sales have been made to
telecommunications companies in the U.S., and accordingly, we believe that over
time this seasonality will generally cause revenues in the quarter ended March
31 to be lower than revenues in the preceding quarter ended December 31. In
developing countries, delays and reductions in the planned project deployment
can be caused by additional factors including currency fluctuations, reductions
in capital availability due to declines in the local economy, priority changes
in governments' budgets, political environment, and delays in receiving
government approval for deployment of the OmniMAX global product family in the
last mile.
Expenditures for research and development, sales, general, and administrative
functions are based, in part, on future growth projections and in the near term
are relatively fixed. We may be unable to adjust spending in a timely manner in
response to any unanticipated failure to meet these growth projections.
Accordingly, any significant decline in demand for the OmniMAX global product
family relative to planned levels could result in, among other things, higher
operating expenses as a percentage of revenue, and lower than expected net
income in a quarter or subsequent quarters.
All of the above factors are difficult to forecast, and these or other factors
could, among other things, reduce revenues, increase operating expenses, and
reduce net income. As a result, we believe that period to period comparisons are
not necessarily meaningful and should not be relied upon as indications of
future performance. There can be no assurance that we will sustain or increase
our profitability in the future.
We have made an investment in a start-up company specializing in
telecommunication technologies. This investment is inherently risky, as the
market for the technology or products the company has under development are in
the early stages and may never materialize. We could lose our entire investment
in this company.
In February 2000, we entered into a hedging transaction structured as a costless
collar agreement to minimize the potential impact of adverse market risk on the
Cisco shares we own. We are currently evaluating the
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requirements and impact of Statement of Financial Accounting Standards (SFAS)
No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No.
133 is effective for us beginning in the first quarter of 2001, and there may be
changes in accounting for hedges under SFAS No. 133 which, combined with the
anticipated volatility in Cisco's stock price, may affect our income statement
and cause our results of operations to fluctuate. Refer to Part I, Item 3 -
"Quantitative and Qualitative Disclosures About Market Risk" on page 20 of this
Quarterly Report on Form 10-Q as it pertains to this matter.
Fluctuations in our operating results may cause volatility in the price of our
common stock. It is possible that in any given period, revenues or operating
results will be below the expectations of public market analysts and investors.
In such event, the market price of our common stock would likely be materially
adversely affected. Due to factors outside our control, there may be little or
no meaningful relationship between the resulting market price of our common
stock and the results of operations. Factors outside our control, such as market
analysts' published expectations and short traders' activities, can cause a
material fluctuation in our stock price. In addition, the stock market has
demonstrated extreme price and volume fluctuations that have affected the market
price of many technology companies in particular, and that have been unrelated
to the operating performance of those companies. The significant decline in the
market price of our common stock in mid-1998 resulted in stockholder litigation
against AFC and various officers and directors. Such litigation, or future
litigation based on fluctuations in our stock price, could result in substantial
litigation costs and a diversion of management's attention and resources from
our operations. See Note 5 - "Commitments and Contingencies" on page 6 of this
Quarterly Report on Form 10-Q as it pertains to this matter.
BECAUSE A LIMITED NUMBER OF CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR
TOTAL REVENUES, THE LOSS OR SIGNIFICANT REDUCTION IN SALES OF A SINGLE CUSTOMER
COULD HAVE A MATERIAL ADVERSE IMPACT ON OUR BUSINESS.
For the quarter ended September 30, 2000, Sprint accounted for 13.3% of total
revenues, and WinStar accounted for 13.2%. For the third quarter of 1999,
WinStar accounted for 23.8%. No other single customer accounted for 10% or more
of total revenues in any of these periods. Although our largest customers have
varied from period to period, we anticipate that results of operations in any
given period will continue to depend to a significant extent upon sales to a
small number of customers. This dependence may increase due to our strategy of
securing large accounts. There can be no assurance that significant customers
will continue to purchase products at current levels, if at all. In the event
that a significant existing customer merges with another company, there can be
no assurance that such customer will continue to purchase the OmniMAX global
product family. The loss of, or significant reduction in sales to one or more
significant customers could, among other things, decrease revenues and net
income, and increase our dependency on our remaining significant customers.
WE MAY EXPERIENCE DELAYS AND DEFECTS IN PRODUCT DEVELOPMENT AND PRODUCT FEATURE
RELEASES.
We have experienced delays in completing development and introduction of new
product variations and feature enhancements in the past, and there can be no
assurance that such delays will not continue or recur in the future. We could
incur contract penalties should we fail to meet production and delivery time
schedules on certain orders. There can be no assurance that we will be
successful in developing new product features and releasing products to the
market, or that we will be able to do so before our competitors. The OmniMAX
global product family contains a significant amount of complex hardware and
software that may contain undetected or unresolved errors that may become
apparent as product features are introduced, or as new versions are released.
Technical difficulties have been discovered in certain system installations. It
is possible that, despite significant testing, hardware or software errors will
be found in the OmniMAX global product family after commencement of shipments
resulting in delays or cancellation of customer orders, payment of contract
penalties to customers, or the loss of market acceptance. Any of these factors
could result in, among other things, decreased revenues, net income, and cash
flows.
WE CONDUCT BUSINESS INTERNATIONALLY AND FACE SEVERAL RISKS ASSOCIATED WITH
INTERNATIONAL MARKETS.
A portion of our business is conducted internationally. Operating in
international markets subjects us to certain risks including:
- Political and economic conditions
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- Tariffs or other barriers
- Longer sales and payment cycles
- Collection of accounts receivable
- Staffing and managing international operations
- Exchange and repatriation controls on foreign earnings
- Negative tax consequences
- Exchange rate fluctuations
- Changes in regulatory requirements
International sales constituted 10.9% of our total revenues in the quarter ended
September 30, 2000 and 11.1% for the first nine months of 2000. In the
corresponding periods of 1999, international sales were 10.2% and 11.6% of total
revenues, respectively. International sales have fluctuated in absolute dollars
and as a percentage of revenues and are expected to continue to fluctuate in
future periods. We continue to experience certain difficulties in international
markets, and there can be no assurance that we can expand our international
operations. Failure to meet revenue projections in the international market
could, among other things, adversely affect the future growth of consolidated
revenues, gross profit, and net income.
Many international telecommunications companies are owned or strictly regulated
by local authorities. Access to international markets is often difficult to
achieve due to trade barriers and established relationships between
government-owned or controlled telecommunications companies and traditional
indigenous equipment vendors. Many of these companies require extended payment
terms and financing options which increase the risk of nonpayment and may, among
other things, have the effect of increasing our operating expenses, lowering net
income, and decreasing cash flows. We may be required to post bid and
performance bonds for certain customers in international markets. Failure to
meet delivery schedules could also result in the loss of collateral posted for
the bonds or financial penalties, which could, among other things, increase our
operating expenses and lower net income.
We are working to enter new international markets which demand significant
management attention and financial commitment. Successful expansion of
international operations and sales in certain markets may depend on our ability
to establish and maintain productive strategic relationships. We rely on a
number of third-party distributors and sales representatives to market and sell
the OmniMAX global product family outside of the U.S. There can be no assurance
that such distributors or sales representatives will provide the support and
effort necessary to service international markets effectively. In addition, some
of our third-party and indirect distribution channels have resulted in lower
gross profit margins in the past. Increased sales through these channels may
reduce our overall gross profit margins. There can be no assurance that we 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. We may be unable to increase
international sales of the OmniMAX global product family through joint ventures
or strategic relationships. The failure to do so could significantly limit our
ability to expand international operations and could, among other things, reduce
our revenues, gross profit, and net income.
Sales activities in foreign countries may subject us to taxation in those
countries. Although we have attempted to minimize our exposure to taxation in
foreign countries, any income or other taxes imposed may increase our overall
effective tax rate and adversely impact our competitiveness in those countries.
In addition, we currently intend that the earnings of our foreign subsidiaries
remain permanently invested in these entities in order to facilitate the
potential expansion of our business. To the extent that these earnings are
actually or deemed repatriated, U.S. and state income taxes would be imposed,
and this could adversely impact our overall effective tax rate, net income, and
cash flows.
Our international sales are primarily U.S. dollar denominated. As a result, an
increase in the value of the dollar relative to foreign currencies could make
our product less competitive in international markets.
We must comply with various country-specific regulations and standards to
compete in international markets. Any inability to obtain local regulatory
approval could delay or prevent entrance into international markets,
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which could result in, among other things, delays or loss of customer orders,
decreased revenues, and lower net income.
WE FACE INTENSE COMPETITION, AND THE COMPETITIVE LANDSCAPE IN OUR INDUSTRY
CHANGES RAPIDLY.
Many of our competitors have more extensive financial, marketing, and technical
resources than we have and enjoy superior name recognition in the market. Our
primary competitors include: ADC Telecommunications, Inc., Carrier Access
Corporation, Compagnie Financiere Alcatel, Lucent Technologies, Inc., Marconi
Communications Inc., Next Level Communications, Inc., Northern Telecom Ltd., and
Siemens AG.
Marconi is a competitor in the U.S. market, but it also serves as a distributor
of our products in the international market starting this year. As a result of a
settlement and distribution agreement reached in February 2000, Marconi entered
into a minimum purchase agreement for the OmniMAX global product family and acts
as a distributor in specific international markets.
As a result of a settlement agreement and related agreements entered into in
1998 with the Industrial Technology Research Institute, certain of its member
companies have been granted certain rights to manufacture and sell the European
Telecommunications Standards Institute version of our narrowband UMC1000(TM)
product outside of North America. We currently compete with such entities in
international markets, primarily in China. Upon termination of certain
restrictions set forth in the settlement agreement in January 2005, those member
companies will gain a worldwide, non-exclusive, royalty-free, irrevocable
license to use an older version of narrowband UMC1000 technology and will be
able to compete with us worldwide.
We believe rapid technological change, continuing regulatory change and industry
consolidation will continue to cause rapid evolution in the competitive
environment of the telecommunications equipment market, the full scope and
nature of which is difficult to predict. Industry consolidation among our
competitors may provide those companies with price competition leverage and
broader product lines superior to our pricing and present technology. Moreover,
we believe that technological and regulatory change will continue to attract new
entrants to the market in which we compete. There can be no assurance that we
will be able to compete successfully in the future.
OUR BUSINESS AND OPERATING RESULTS WILL BE HARMED IF WE FAIL TO MANAGE RECENT
AND POTENTIAL GROWTH.
Historically, we have experienced periods of rapid growth, which have imposed
significant burdens on management, operations, finance, and other resources. We
must continue to recruit, train, assimilate, motivate, and retain qualified
managers and employees to manage our operations effectively. Our results of
operations could be adversely affected if revenues do not increase sufficiently
to compensate for any increase in operating expenses and facility obligations
resulting from any expansion. If we fail to effectively manage any growth in our
U.S. and international operations, including growth through acquisitions, our
business could be disrupted, and we could incur, among other things, increased
operating expenses, lower net income, and decreases in cash flow.
We have expanded our manufacturing capacity and may further expand it in the
future. There can be no assurance that we will not have excess manufacturing
capacity or that further utilization of our manufacturing and distribution
facility will continue without interruption.
OUR PRODUCT LINE IS CONCENTRATED WITHIN A SINGLE FAMILY OF PRODUCTS, AND OUR
ABILITY TO INTRODUCE NEW PRODUCT FEATURES AND RESPOND TO RAPID TECHNOLOGICAL
CHANGE IS SUBJECT TO SIGNIFICANT UNCERTAINTY.
Substantially all of our revenues are derived from the OmniMAX global product
family, and we expect this concentration will continue in the foreseeable
future. Any decrease in the level of sales of, or the prices for, the OmniMAX
global product family could result in, among other things, decreased revenues
and lower net income. Factors potentially affecting sales include price
competition, introductions or announcements by competitors, a decline in the
demand for the OmniMAX global product family, or product obsolescence, among
others.
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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. For example, the
introduction of new industry digital switch interfaces, such as GR-303, TR-08,
and V5, reduces the amount of equipment required to support each access line or
port. There can be no assurance that technological advances in the
telecommunications industry will not reduce sales of the OmniMAX global product
family, diminish market acceptance of the system or render the system obsolete
and possibly result in, among other things, loss of customer orders, decreased
revenues, and lower net income.
Our success will depend upon our ability to enhance the OmniMAX global product
family technology and to develop and introduce, on a timely basis, new products
or new product feature enhancements. Product enhancements must keep pace with
technological developments and emerging industry standards, and they must
address changing customer requirements in a cost-effective manner. There can be
no assurance that we will be successful in identifying, developing,
manufacturing, and marketing new products or product enhancements that respond
to technological change or evolving industry standards, and that achieve market
acceptance. We may be required to incur substantial costs to modify the OmniMAX
global product family, develop or acquire new products, and build our
infrastructure to accommodate these changes. In addition, if product or warranty
costs associated with our new products are greater than we have experienced
historically, our gross profit may be adversely affected. From time to time, we
or our competitors may announce new products or product enhancements, services,
or technologies that have the potential to replace or shorten the life cycle of
the OmniMAX global product family causing customers to defer purchasing our
equipment.
OUR ABILITY TO PROTECT OUR PROPRIETARY TECHNOLOGY IS LIMITED, AND WE EXPECT TO
CONTINUE TO BE SUBJECT TO THIRD-PARTY CLAIMS OF INTELLECTUAL PROPERTY
INFRINGEMENT.
We attempt to protect our technology through a combination of copyrights, trade
secret laws, contractual obligations, and patents. We do not presently hold any
patents for the OmniMAX global product family, and although four patent
applications are pending, they may not result in any issued patents. These
intellectual property protection measures may not be sufficient to prevent
wrongful misappropriation of our technology nor will they prevent competitors
from independently developing technologies that are substantially equivalent or
superior to our technology. The laws of many foreign countries do not protect
our intellectual property rights to the same extent as the laws of the U.S.
Failure to protect proprietary information could result in, among other things,
loss of our competitive advantage, loss of customer orders, decreased revenues,
and lower net income.
Like other participants in our industry, we expect that we will be increasingly
subject to infringement claims and other intellectual property disputes as
competition in our market continues to intensify. We have been subject to
several intellectual property disputes in the past.
From 1998 through January 2000, we pursued trade secret misappropriation and
related claims against RELTEC Corporation, now Marconi Communications Inc. The
case involved RELTEC's acquisition of AFC's technology through our Taiwan-based
licensee, Vidar-SMS Co., Ltd. The case settled in February 2000, when Marconi
agreed to pay us $32.75 million in cash and entered into a distribution
agreement for our UMC1000 product family that guarantees AFC minimum purchases
or specified payments over the following three years.
In 1998, we settled litigation with the Industrial Technology Research Institute
and its sub-licensee member companies, and others, involving breach of a prior
agreement, trade secret misappropriation, unfair competition, and related
claims. Under the settlement, we granted a limited license for the use of
certain proprietary technology. In September 1998, we settled litigation with
Acer Netxus, Inc. enjoining them from developing, manufacturing, and selling any
device utilizing or deriving from our UMC1000 technology.
In 1996, we settled litigation with DSC Communications, Inc. (DSC) under which
DSC had claimed proprietary rights to the UMC1000 technology. In June 1999, we
settled litigation with Alcatel USA, Inc. (formerly DSC) under a separate
proprietary rights claim to our UMC1000 technology.
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In the future, we may be subject to additional litigation and may be required to
defend against claimed infringements of the rights of others or to determine the
scope and validity of the proprietary rights of others. Litigation also may be
necessary to enforce and protect our trade secrets and other intellectual
property rights. Any such litigation could be costly and divert management's
attention from running our operations, either of which could result in, among
other things, increased operating expenses, lower net income, and failure to
remain competitive in a rapidly changing technological environment. Adverse
determinations in such litigation could result in the loss of our proprietary
rights, subject us to significant liabilities, require us to seek licenses from
third parties, or prevent us from manufacturing or selling our products.
Furthermore, there can be no assurance that any necessary licenses will be
available on reasonable terms. Any one of these results could, among other
things, decrease revenues, increase operating expenses, lower net income, and
decrease cash flows.
OUR CUSTOMERS ARE CONCENTRATED IN A SINGLE INDUSTRY WHICH EXPOSES US TO
FLUCTUATIONS IN CAPITAL SPENDING PATTERNS AND OTHER FACTORS AFFECTING DEMAND FOR
OUR PRODUCTS IN THIS INDUSTRY.
Our customers are concentrated in the public carrier telecommunications industry
and, in the U.S. include CLECs, RBOCs, NLECs, and IOCs. Accordingly, our future
success depends upon the capital spending patterns of these customers and the
continued demand by these customers for the OmniMAX global product family.
Recent problems of CLECs in particular including their ability to raise capital
to build out their networks, a slowdown in capital expenditures, and the scale
and complexity of rolling out digital subscriber line service, or similar
problems in the future, could contribute to unexpected sales slowdowns or to
slower payments on account. Our historical markets have been the U.S. and
international small to mid-line size markets. We are attempting to expand into
larger-line size markets both in the U.S. and international markets. The OmniMAX
global product family and any new products we introduce may not be met with
widespread acceptance among the telecommunications companies and other potential
customers. Existing customers and potential customers may adopt alternative
architectures or technologies that are incompatible with our technology which
could result in, among other things, delays or cancellation of customer orders,
decreased revenues, and lower net income. There can be no assurance that
telecommunications companies, foreign governments or other customers will pursue
infrastructure upgrades that will necessitate the implementation of advanced
products such as the OmniMAX global product family. Infrastructure improvements
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.
WE MAY BE UNABLE TO SECURE NECESSARY COMPONENTS AND SUPPORT BECAUSE WE DEPEND
UPON A LIMITED NUMBER OF THIRD-PARTY MANUFACTURERS AND SUPPORT ORGANIZATIONS,
OVER WHICH WE HAVE NO CONTROL, AND IN SOME CASES WE RELY UPON SOLE SOURCE
SUPPLIERS.
Certain components used in our products, including our proprietary ASICs, codec
components, lasers, certain surface mount technology components, and other
components, are only available from a single source or limited number of
vendors. A limited number of vendors manufacture the subassemblies to our
specifications for use in our systems. Some of the sole source vendors are
companies who, from time to time, allocate parts to telecommunications equipment
manufacturers due to market demand for components and equipment. Especially in
recent times in a worldwide telecommunications market expansion, many component
suppliers have placed critical components on worldwide allocation. Many of our
competitors are much larger and may be able to obtain priority allocations from
these shared vendors, thereby limiting or making unreliable the sources of
supply for these components. In addition, our current strategy includes focusing
on securing large customer accounts. These customers may require us to produce
and ship large orders within a compressed timeframe. This may absorb available
supplies of components and impair our ability to make later shipments to others.
We have experienced shortages of key components from time to time in the past,
and there can be no assurance that shortages of components will not occur in the
future or will not result in our having to pay a higher price for components. If
sufficient quantities of these or any other components cannot be obtained,
delays or reductions in manufacturing or product shipments could occur which
could result in, among other things, delays or cancellation of customer orders,
contractual penalties, and lower revenues, gross profit, net income, and cash
flows. In particular, we rely upon:
- Solectron International USA, Inc. to manufacture PCBAs
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- Infineon Technologies AG, Advanced Micro Devices, and ST Microelectronics
for PCBA components
- Paragon Electronic Systems, Inc. and Tyco Printed Circuit Group Inc. to
manufacture backplanes and channel bank assemblies
- General Cable Corporation for protector panel subassemblies
- CMOR Manufacturing and Wilco Wire Technology, Inc. for cable and wire
harnesses and various turnkey assemblies
- American Microsystems, Inc. and Texas Instruments for ASICs
- Hendry Telephone Products for fuse panels and racks
- Powersafe Standby Batteries Inc. for battery systems
- ADC Telecommunications for custom enclosures and boards
- Sonoma Metal Products, Inc., Cowden Metal San Jose, Inc., Mayville Metal
Products, and EMAR, Inc. to manufacture the external housing cabinets
- Advanced Digital Graphics, Inc. for system documentation
Our production and shipping schedules could be adversely affected if one or more
of our vendors were to experience financial, operational, production, or quality
assurance difficulties that resulted in a reduction or interruption in supply to
us or otherwise failed to meet our manufacturing requirements. We may not be
able to establish sufficient manufacturing supply from alternative sources.
Current or alternative manufacturers may not be able to meet our future
requirements and such manufacturing services may not continue to be made
available to us at favorable prices, or at all.
Various third party support organizations provide post-sales support to our U.S.
customers. There can be no assurance that these organizations will be able to
provide the level of customer support demanded by existing or potential
customers.
WE MUST ATTRACT, RETAIN, AND MOTIVATE KEY TECHNICAL AND MANAGEMENT PERSONNEL IN
A COMPETITIVE MARKET.
Our success depends to a significant extent upon key technical and management
employees. The loss of the services of any of these key employees could result
in, among other things, loss of our competitive position in a rapidly changing
technological environment, which in turn could lead to decreased revenues,
increased operating expenses to locate experienced replacements, and lower net
income. In the recent past, we have experienced an increase in our employee
turnover rate, including technical and engineering positions. Competition for
highly qualified employees is intense and the process of locating key technical
and management personnel with the required combination of skills and attributes
is often lengthy and expensive. In general, we do not have employment agreements
with, or key person life insurance for, our employees. There can be no assurance
that we will be successful in retaining our existing key personnel or in
attracting and retaining the additional employees we may require. There can be
no assurance as to the ongoing effectiveness of key personnel on our business,
financial condition and results of operations.
RECENT AND FUTURE ACQUISITIONS MAY ADVERSELY AFFECT OUR OPERATIONS AND FINANCIAL
RESULTS.
As part of our efforts to enhance our existing products, introduce new products,
and fulfill changing customer requirements, we plan to pursue acquisitions of
complementary companies, products, and technologies. On May 16, 2000, we
acquired GVN Technologies, Inc. (GVN), a privately-held developer of integrated
access devices, for approximately 1.1 million shares and options to purchase our
common stock.
Our acquisition of GVN and future acquisitions, if any, will involve numerous
risks, including the following:
- Disruption of our ongoing business and diversion of our management's time
and attention
- Exposure to unknown liabilities of acquired companies
- Potential difficulties and costs in assimilating the operations,
personnel, and technologies of the acquired businesses, such as
integrating GVN's products into the OmniMAX global product family
- Possible loss of acquired companies' employees, customers, and vendors
- Difficulties in completing the development and application of acquired
technologies
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- Potential impairment of our existing relationships with employees,
customers, distributors, and other business partners due to the addition
of new personnel, products, and technologies
- Risks associated with operating in new markets, including potentially
greater competition and additional intellectual property claims
- Additional expenses associated with amortization of goodwill or other
intangible assets arising from acquisitions
- Dilution of our existing stockholders if we pay for acquisitions with
equity securities, such as in the GVN acquisition
We cannot make assurances that the GVN acquisition, or any other acquisition
that we undertake, will not result in significant costs or business disruption,
or that we will be able to successfully integrate GVN or any other businesses,
products, technologies, or personnel that we may acquire. Our failure to do so
could seriously harm our business, financial condition, and results of
operations.
WE ARE PARTY TO COSTLY AND DISRUPTIVE LEGAL PROCEEDINGS, THE OUTCOME OF WHICH IS
UNPREDICTABLE.
We are a party to certain legal proceedings as described in Note 5 -
"Commitments and Contingencies" on page 6 of this Quarterly Report on Form 10-Q.
We are unable to predict the ultimate outcome of these proceedings or 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, these
proceedings could result in significant diversion of management's time, and
significant legal costs which could result in, among other things, increased
operating expenses and lowered net income, and failure to remain competitive in
a rapidly changing technological environment.
OUR BUSINESS WILL SUFFER IF OUR PRODUCTS DO NOT COMPLY WITH NUMEROUS REGULATIONS
AND INDUSTRY STANDARDS, WHICH ARE SUBJECT TO CHANGE.
The OmniMAX global product family must comply with a significant number of voice
and data regulations and standards, which vary between U.S. and international
markets, and may vary within specific international markets. Standards for new
services continue to evolve, and we will need to modify our products or develop
new versions to meet these standards. If our systems fail to comply with
evolving standards in U.S. and international markets on a timely basis, our
ability to sell our product would be impaired, and we could experience, among
other things, delayed or lost customer orders, decreased revenues, and lower net
income. Standards setting and compliance verification in the U.S. are determined
by the Federal Communications Commission, Underwriters Laboratories, Quality
Management Institute, Telcordia, other independent third party testing
organizations, and by independent telecommunications companies. In international
markets, our products must comply with recommendations issued by the
Consultative Committee on International Telegraph and Telephony, Industry
Canada, and individual regional carriers' network operating system requirements
and specifications. Our products must also comply with standards issued by the
European Telecommunications Standards Institute and implemented and enforced by
the Telecommunications Regulatory Authority of each European nation.
We need to continue to ensure that the OmniMAX global product family is easily
integrated with various network management systems. Telcordia testing on our
products is often required to ensure interoperability with various standards of
operations, administration, maintenance and provisioning systems. Telcordia
testing requires significant investments in time and money to achieve
compliance. Failure to maintain such compliance or to obtain it on new features
released in the future could result in, among other things, delays in or loss of
customer orders, decreased revenues, and lower net income.
We have maintained compliance with ISO 9001 since we were first certified in
1997. The ISO standard consists of all elements defining a quality system, aimed
primarily at achieving customer satisfaction by preventing non-conformity at all
stages, from design through servicing. In September 2000, we also received our
TL9000 certification for our hardware, software and services. TL9000
certification is a quality standard designed specifically for the
telecommunications industry. There can be no assurance that we will maintain
these certifications. The failure to maintain any such certification may
preclude selling the OmniMAX global
19
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product family in certain markets and could adversely affect our ability to
compete with other vendors of telecommunications equipment.
Our ability to compete with other telecommunications equipment vendors could be
adversely affected should we fail to maintain interoperability with other
companies or if we fail to ensure that the OmniMAX global product family
complies with industry standards.
In 1996, the U.S. Congress passed regulations that affect telecommunications
services, including changes to pricing, access by competitive vendors and many
other broad changes to the data and telecommunications networks and services.
These changes have had a major impact on the pricing of existing services, and
may affect the deployment of future services. These changes have caused greater
consolidation in the telecommunications industry, which in turn could disrupt
existing customer relationships, and could result in, among other things, delays
or loss of customer orders and lower revenues. There can be no assurance that
any future legislative and regulatory changes will not have a material adverse
effect on the demand for the OmniMAX global product family. Uncertainty
regarding future legislation and governmental policies combined with emerging
new competition may also affect the demand for telecommunications products such
as the OmniMAX system.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We held approximately 10.6 million shares of Cisco common stock as of September
30, 2000. We received approximately 5.3 million shares in 1999 in exchange for
our equity interest in Cerent, and the number of shares doubled as a result of
Cisco's 2-for-1 stock split in March 2000. In February 2000, we entered into a
hedging transaction structured as a costless collar agreement to minimize the
impact of potential adverse market risk on the Cisco stock we own. Assuming an
immediate decrease of 20% in Cisco's stock price from the closing price at
September 29, 2000, the last business day of our third fiscal quarter, of
$55.250 per share and the impact on the put and call feature of the collar
agreement, the hypothetical unrealized loss in accumulated other comprehensive
income related to these holdings would be approximately $17.2 million, net of
income taxes. See the additional information with respect to market risk
contained in our Current Report on Form 8-K filed September 19, 2000.
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<PAGE> 22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See discussion in Part I - "Note 5 Commitments and Contingencies" beginning on
page 6 of this Quarterly Report on Form 10-Q.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS:
(a). ISSUANCE OF UNREGISTERED SECURITIES:
Between July 1 and September 30, 2000 the Company issued and sold the
following securities which were not registered under the Securities Act
of 1933 (Securities Act): the Company issued and sold an aggregate of
55,940 shares of common stock upon the net exercise of warrants to one
entity for aggregate consideration of 4,196 shares of common stock.
The sale and issuance of securities in the transaction described above
was deemed to be exempt from registration under the Securities Act in
reliance upon Section 4(2) of the Securities Act as a transaction by an
issuer not involving any public offering.
(b). USE OF PROCEEDS: None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES:
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
None
ITEM 5. OTHER INFORMATION:
Our president and chief executive officer, John Schofield, has informed us that,
in order to diversify his investment portfolio while avoiding conflicts of
interest or the appearance of any such conflict that might arise from his
position with the company, he has established a written plan in accordance with
SEC Rule 10b5-1 for gradually liquidating a portion of his holdings of our
common stock.
In particular, we have been notified that Mr. Schofield intends to exercise
options on 6,000 shares of stock per month and to sell the resulting shares in
the public market, subject to certain contingencies relating to continuation of
employment, change of control, and prevailing stock price. The current plan runs
from January 1, 2001 through December 31, 2001.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a). EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
-------- -----------------------------------------------------------------------------
<S> <C>
27.0 Financial data schedule.
27.999 Financial data schedule, restated for the acquisition of GVN Technologies,
Inc., for the nine month period ended September 30, 1999.
(b). REPORTS ON FORM 8-K:
Form 8-K filing on September 19, 2000; Item 5 - Other Events. Filing
of consolidated financial statements for the years ended December 31,
1999, 1998 and 1997 giving retroactive effect to the acquisition of
GVN Technologies, Inc.
</TABLE>
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<PAGE> 23
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADVANCED FIBRE COMMUNICATIONS, INC.
Date: November 13, 2000 By: /s/ Keith E. Pratt
-------------------------------------
Name: Keith E. Pratt
Title: Vice President, Chief Financial
Officer, and Assistant Secretary
(Duly Authorized Signatory and
Principal Financial Officer)
22
<PAGE> 24
ADVANCED FIBRE COMMUNICATIONS, INC.
INDEX TO EXHIBITS FILED WITH THIS QUARTERLY REPORT ON FORM 10-Q:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
--------- --------------------------------------------------------------------------
<S> <C>
27.0 Financial data schedule.
27.999 Financial data schedule, restated for the acquisition of GVN Technologies,
Inc., for the nine month period ended September 30, 1999.
</TABLE>
23
