<PAGE> 1
EXHIBIT 99.1
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations," the Consolidated Financial Statements and Notes, and the unaudited
Condensed Consolidated Financial Statements and Notes included elsewhere in this
document.
FIVE-YEAR SUMMARY OF SELECTED CONSOLIDATED DATA
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------------------
1999(1) 1998 1997 1996(2) 1995
-------- -------- -------- --------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Consolidated Statements of Income
Data:
Revenues $296,611 $316,409 $267,858 $ 130,193 $ 54,287
Cost of revenues 157,911 171,843 145,933 73,950 33,469
-------- -------- -------- --------- --------
Gross profit 138,700 144,566 121,925 56,243 20,818
-------- -------- -------- --------- --------
Operating expenses:
Research and development 48,343 41,687 25,726 14,413 5,730
Selling, general and administrative 68,372 66,429 42,653 21,188 9,660
DSC litigation costs -- -- -- 18,947 1,623
-------- -------- -------- --------- --------
Total operating expenses 116,715 108,116 68,379 54,548 17,013
-------- -------- -------- --------- --------
Operating income 21,985 36,450 53,546 1,695 3,805
Other income (expense), net 385,444 4,051 4,866 2,388 (1,367)
-------- -------- -------- --------- --------
Income before income taxes 407,429 40,501 58,412 4,083 2,438
Income taxes (benefit) 158,359 14,648 21,612 (3,154) 97
-------- -------- -------- --------- --------
Net income $249,070 $ 25,853 $ 36,800 $ 7,237 $ 2,341
======== ======== ======== ========= ========
Basic net income per share (3) $ 3.20 $ 0.34 $ 0.52 $ 0.30 $ 0.27
======== ======== ======== ========= ========
Shares used in basic per share
computations 77,723 75,273 70,131 24,146 8,746
======== ======== ======== ========= ========
Diluted net income per share (3) $ 3.05 $ 0.32 $ 0.48 $ 0.11 $ 0.05
======== ======== ======== ========= ========
Shares used in diluted per share
computations 81,657 79,825 77,469 68,048 50,684
======== ======== ======== ========= ========
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
----------------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheets Data:
Cash, cash equivalents and marketable
securities $732,122 $110,866 $105,196 $108,430 $ 11,118
Working capital 583,357 208,604 193,640 145,338 18,770
Total assets 901,775 308,255 273,293 175,679 36,680
Redeemable convertible preferred stock -- -- -- -- 37,777
Stockholders' equity (deficit) 645,064 267,839 223,720 158,023 (15,765)
</TABLE>
(1) Includes a $379.3 million gain realized upon conversion of an investment
into Cisco Systems, Inc. common stock. Without this gain, our effective tax
rate would have been 30%, and net income for the year ended December 31,
1999 would have been $20.0 million.
(2) Includes a charge of $15.8 million to reflect a cash payment of $10.1
million and the issuance of 1,451,574 shares of common stock to DSC in
settlement of outstanding litigation. Without this charge, operating income
for the year ended December 31, 1996 would have been $17.5 million.
(3) See "Note 1 of Notes to Consolidated Financial Statements" for an
explanation of the determination of the number of shares used in computing
basic and diluted net income per share.
1
<PAGE> 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" in our Quarterly
Report on Form 10-Q for the period ended June 30, 2000, as filed with the
Securities and Exchange Commission (SEC), 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 of a single customer could have a significantly
adverse impact on our business.
- We may continue to 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 expose us to
fluctuations in capital spending pattern 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 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 SEC.
The following discussion should be read in conjunction with the condensed
consolidated financial statements and notes thereto, on pages 11 through 29 of
this Form 8-K.
OVERVIEW
We design and manufacture worldwide 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.
Our OmniMAX product portfolio consists of: AccessMAX(TM), a variety of broadband
multi-service access platforms including our 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
2
<PAGE> 3
customer premises; and TransMAX(TM), a Sonet/SDH optical transport system for
metro ring solutions. 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 completed the acquisition of GVN Technologies, Inc. (GVN),
of Largo, Florida, a leading developer of integrated access device equipment for
the service provider market. In the acquisition, the former stockholders of GVN
received shares of our common stock in exchange for their shares of GVN at the
rate of .088 shares of our common stock for each share of GVN common stock and
preferred stock. The acquisition was accounted for as a pooling of interests. An
aggregate of 894,306 shares of our common stock was issued pursuant to the
acquisition, and we assumed an aggregate of 209,794 options to purchase GVN
common stock.
All of our financial data presented in the consolidated financial statements and
management's discussion and analysis of financial condition and results of
operations included within this Current Report on Form 8-K have been restated to
include the historical financial information of GVN in accordance with generally
accepted accounting principles applicable after financial statements are issued
for a period which includes the date of consummation of a business combination
and pursuant to regulation S-X. Our statement of income for the year ended
December 31, 1999 has been combined with the GVN statement of income for the
year ended December 31, 1999. Our statement of income for the year ended
December 31, 1998 has been combined with the GVN statement of income for the
year ended June 30, 1998. GVN was formed in July 1997 and accordingly had no
effect on our statement of income for the year ended December 31, 1997. This
presentation is in accordance with the rules and regulations of the SEC which
require that the comparable fiscal years be combined in the consolidated
financial statements. The consolidated balance sheets at December 31, 1999 and
1998 combine the balance sheets of GVN as of December 31, 1999 and June 30,
1998, respectively.
In 1999, revenues decreased $19.8 million from 1998 and operating income
declined $14.5 million from 1998. Revenue levels were below the prior year,
primarily as a result of lower international revenues. International revenue
levels were adversely affected by certain customers reducing their capital
expenditures during 1999 in order to fully deploy their existing inventory.
Operating income as a percentage of revenue was below that of 1998 as a result
of lower revenue levels and increased investments in our research and
development activities during 1999. However, other income rose to 129.9% of
revenues in 1999, as compared with 1.3% in 1998, primarily as a result of Cisco
Systems, Inc.'s acquisition of Cerent Corporation in which we had invested. This
gain increased our 1999 net income to $249.1 million, or 84.0% of revenues, as
compared with $25.9 million, or 8.2% of revenues in 1998. Without this gain and
the related tax effects, our net income would have been $20.0 million in 1999.
Although we have achieved profitability every year beginning in 1995, there can
be no assurance that profitability will be sustained or increased in the future.
Factors which may adversely impact revenue levels include product introductions
or announcements by competitors, price competition, a decline in the demand for
our products, product obsolescence, loss of customers, and inability to
penetrate certain markets, among other reasons.
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<PAGE> 4
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage of
revenues represented by certain items reflected in our consolidated statements
of income:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Revenues 100.0% 100.0% 100.0%
Cost of revenues 53.2 54.3 54.5
------ ------ ------
Gross profit 46.8 45.7 45.5
------ ------ ------
Operating expenses:
Research and development 16.3 13.2 9.6
Selling, general and administrative 23.1 21.0 15.9
------ ------ ------
Total operating expenses 39.3 34.2 25.5
------ ------ ------
Operating income 7.4 11.5 20.0
Other income, net 129.9 1.3 1.8
------ ------ ------
Income before income taxes 137.4 12.8 21.8
Income taxes 53.4 4.6 8.1
------ ------ ------
Net income 84.0% 8.2% 13.7%
====== ====== ======
</TABLE>
1999 Compared with 1998
REVENUES. In 1999, revenues, including royalties, totaled $296.6 million, a
decrease of $19.8 million, or 6.3%, from the $316.4 million reported in 1998.
The decrease was primarily the result of lower international revenues in 1999 as
compared with 1998. International revenues decreased 61.9% to $31.3 million in
1999 from $82.0 million in 1998 and represented 10.6% of 1999 revenues compared
with 25.9% in 1998. As compared with 1998, we experienced lower international
revenue levels in 1999 from our customers in South Africa, France, China,
Brazil, and Venezuela. There were no international royalties in 1999 as compared
with the $5.4 million recorded in 1998 primarily as a result of the litigation
settlement with the Industrial Technology Research Institute in that year.
Partially offsetting the decline in international revenues was an increase in
our U.S. revenues year-over-year. U.S. revenues increased 13.2% from $234.4
million in 1998 to $265.3 million in 1999, representing 89.4% and 74.1 % of
revenues in 1999 and 1998, respectively.
The increase in U.S. revenues for 1999 was primarily the result of sales growth
in the competitive local exchange carrier and regional Bell operating company
markets and sales to Tellabs, Inc. In the quarter ended December 31, 1999,
WinStar Communications, Inc. (WinStar) accounted for 18.9% of total revenues;
North Supply Company, a subsidiary of Sprint, (Sprint), accounted for 10.5%;
Tellabs, Inc. accounted for 10.3%; and SBC Communications, Inc. accounted for
10.0%. In the quarter ended December 31, 1998, WinStar accounted for 32.9% of
total revenues. In the year ended December 31, 1999, WinStar accounted for 16.4%
of total revenues, and Sprint accounted for 11.7%. For the year ended December
31, 1998, WinStar accounted for 11.1% of total revenues and Integrators of
System Technology (Pty) Ltd. of South Africa accounted for 10.2%. No other
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 focusing on securing large accounts. There
can be no assurance that our principal customers will continue to purchase our
products at current levels, if at all. Only one of our customers has entered
into an agreement requiring it to purchase a minimum amount of product from us.
4
<PAGE> 5
GROSS PROFIT. In 1999, gross profit was $138.7 million compared with $144.6
million for 1998, and represented gross margins as a percentage of revenues of
46.8% in 1999 and 45.7% in 1998. The increase in gross profit percentage from
1998 to 1999 was due to the customer and product mix, primarily due to a greater
proportion of U.S. sales which tend to have higher margins than international
sales. Cost savings from engineering design changes and manufacturing
efficiencies also increased our gross profit. In the future, gross profits 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, 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 1999, research and development expenses increased
$6.6 million, or 15.8%, to $48.3 million compared with $41.7 million in 1998.
Research and development expenses represented 16.3% of total revenues in 1999
and 13.2% in 1998.
The increase in research and development expenses from 1998 to 1999 was
primarily due to the cost of employee hiring and relocation, compensation, and
depreciation on test equipment used to develop and test new products and
features. The number of employees in research and development was 264 as of
December 31, 1999. We believe that rapidly evolving technology and competition
in our industry necessitate the continued commitment of resources to 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. All research and development costs to date have been expensed
as incurred.
SELLING, GENERAL AND ADMINISTRATIVE. In 1999, selling, general and
administrative expenses increased 3.0%, to $68.4 million compared with $66.4
million in 1998. Selling, general and administrative expenses represented 23.1%
of total revenues in 1999 and 21.0% in 1998.
The change in selling, general and administrative expenses in 1999 as compared
with 1998 was primarily due to increases in compensation and benefits and
litigation costs, partially offset by decreases in outside consultants costs and
distributor commissions. Selling, general and administrative headcount was 319
as of December 31, 1999. We plan to continue to allocate resources to our sales,
marketing and administrative functions to remain competitive in our industry and
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 1999, other income increased $381.3 million to $385.4 million
compared with $4.1 million in 1998. The increase was primarily the result of a
$379.3 million gain recorded in November for the step-up in basis of our
investment in Cerent Corporation upon conversion to Cisco Systems, Inc. (Cisco)
common stock. The conversion to Cisco common stock was the result of Cisco's
acquisition of Cerent Corporation in 1999.
INCOME TAXES. In 1999 and 1998, we recorded income taxes at an effective rate
that approximated the combined federal and state statutory rates. The effective
tax rate increased from 36.0% in 1998 to 39.0% in 1999 primarily due to the gain
arising from the conversion of our investment in Cerent Corporation into Cisco
Systems, Inc. common stock.
1998 Compared with 1997
REVENUES. For 1998, revenues totaled $316.4 million, an increase of $48.5
million, or 18.1%, over the $267.9 million reported in 1997. The largest
increase in revenues was in the U.S. market which increased $37.4 million or
19.0% over the prior year. International revenues increased $11.1 million, or
15.7%, year-over-year and represented 25.9% of revenues in 1998 and 26.5% of
revenues in 1997.
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<PAGE> 6
The increase in U.S. revenues for 1998 was primarily the result of sales growth
in the competitive local exchange carrier market and continued sales penetration
of the independent local exchange carrier market. The growth in revenues was
partially offset by the substantial reduction in sales to GTE from 1997. The
growth in international sales was primarily due to higher sales to our customer
in South Africa, partially offset by lower sales in the Asia Pacific region. For
the year ended December 31, 1998, WinStar accounted for 11.1% of total revenues
and Integrators of System Technology (Pty) Ltd. of South Africa accounted for
10.2%. For the year ended December 31, 1997, GTE accounted for 19.2% of total
revenues. No other customer accounted for 10% or more of total revenues in
either period.
GROSS PROFIT. For 1998, gross profit was $144.6 million compared with $121.9
million for 1997, and represented gross margins as a percentage of revenues of
45.7% in 1998 and 45.5% in 1997. The increase in gross profit percentage from
1997 to 1998 was due to cost savings from engineering design changes, the
customer mix, vendor discounts, and higher royalty revenue. Gross profits may
fluctuate due to a wide variety of factors as discussed above.
RESEARCH AND DEVELOPMENT. For 1998, research and development expenses increased
$16.0 million, or 62.3%, to $41.7 million compared with $25.7 million in 1997.
Research and development expenses represented 13.2% of total revenues in 1998
and 9.6% in 1997.
The increase in research and development expenses from 1997 to 1998 was
primarily due to the addition of engineering personnel and the related increases
in salaries, benefits, hiring and relocation, facility costs, and use of outside
consultants and services. Additional expense increases were a result of material
costs and depreciation on test equipment used to develop and test new products
and features. As of December 31, 1998, the number of employees in research and
development was 309 compared with 176 at the end of 1997, an increase of 75.6%.
SELLING, GENERAL AND ADMINISTRATIVE. For 1998, selling, general and
administrative expenses increased $23.7 million, or 55.5%, to $66.4 million
compared with $42.7 million in 1997. Selling, general and administrative
expenses represented 21.0% of total revenues in 1998 and 15.9% in 1997.
The increase in general and administrative expenses for 1998, as compared with
1997, was primarily due to compensation and benefits, litigation costs, facility
costs, and depreciation on capital equipment purchases. The increases in sales
and marketing expenses for the year ended December 31, 1998 as compared with
1997 was attributable primarily to additional sales and marketing personnel and
the associated salaries and benefits, the effect of higher revenue levels on
commissions earned by the sales force and international distributors, and
increased spending on travel and outside services. Selling, general and
administrative headcount increased 29.3% to 335 as of December 31, 1998, from
259 as of the end of 1997.
INCOME TAXES. For 1998 and 1997, income taxes were recorded at an effective rate
that approximated the combined federal and state statutory rates. The effective
tax rate declined from 37.0% in 1997 to 36.0% in 1998 primarily due to tax
exempt interest income, utilization of research and development credits, and
benefits from our foreign sales corporation.
LIQUIDITY AND CAPITAL RESOURCES
Capital resources and liquidity as of December 31, 1999 and 1998 consisted of
the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1999 1998
-------- -------
<S> <C> <C>
Cash and cash equivalents $ 31,372 $20,782
Marketable securities 700,750 90,084
Working capital, excluding cash and cash equivalents
marketable securities and associated deferred tax assets
and liabilities 56,572 97,738
</TABLE>
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<PAGE> 7
As of December 31, 1999, cash, cash equivalents and marketable securities
amounted to $732.1 million compared with $110.9 million as of December 31, 1998.
At December 31, 1999, we owned $551.4 million worth of Cisco common stock as a
result of the completion of the acquisition of Cerent and resultant exchange of
our Cerent stock for Cisco's common stock. In February 2000, we entered into a
hedging transaction structured as a costless collar agreement (collar) to
minimize the impact of potential adverse market risk on the Cisco stock we own.
The collar provides us with a floor value of approximately $650.0 million for
the hedged shares, while allowing us to participate in up to approximately
$350.0 million in further appreciation above the floor value. We will also be
able to borrow against the value of a portion of the shares hedged. We plan to
hedge an additional 260,000 shares of Cisco common stock expected to be received
in April 2000, unless Cisco makes claims against such shares under the terms of
the Cerent acquisition.
Operating activities in 1999 generated net cash of $66.6 million. This was
primarily the result of operating earnings, including adjustments for non-cash
activities such as a gain on a strategic investment and deferred income taxes,
and decreases in accounts receivable and inventories. Days sales outstanding
were 68 days at the end of 1999 compared with 90 days at the end of 1998, mainly
as a result of increased collections on international sales. Net cash of $72.1
million was used in investing activities in 1999, primarily as a result of
marketable securities purchases.
We had a $50.0 million unsecured bank line with two banks at December 31, 1999.
In February 2000, we amended the line to $30.0 million; the line expires in July
2000. The bank line carries interest of LIBOR plus 1.50%. Under the bank line,
the banks may issue letters of credit up to $10.0 million on our behalf. As of
December 31, 1999, $2.7 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 covenants. At December 31,
1999, 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 open foreign
exchange contracts up to $40.0 million. There are no borrowing provisions or
financial covenants associated with these facilities. At December 31, 1999, one
foreign exchange contract of $0.2 million was outstanding, which matured on
January 28, 2000.
We also have lease lines totaling $4.6 million that were used for equipment and
furniture purchases.
We believe our existing cash and short-term investments, available credit
facilities, and cash flows from operating and financing activities are adequate
to support our financial resource needs, including working capital requirements,
capital expenditures and operating lease obligations for the next twelve months.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion and analysis of market risk 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. Actual results could differ
materially from those indicated from these forward-looking statements. Our
market risk lies in foreign currency exchange rate fluctuations, changes in
interest rates, and fluctuations in the value of our marketable securities and
related hedging arrangements.
Our foreign exchange risk arises from both revenues and expenses associated with
our international sales and operations. One of our customer contracts was
payable in French francs at December 31, 1999, and the receivable was hedged
using a forward currency exchange contract. Beginning in 2000, this customer
contract will be payable in either francs or euros, and we will hedge the
receivable using forward currency exchange contracts. The remainder of
international sales are denominated in U.S. dollars. Changes in foreign exchange
rates create risk for us and we attempt to mitigate adverse fluctuations from
impacting results of operations and cash flows. We use foreign exchange
contracts to offset gains and losses on exchange rate fluctuations against gains
and losses on assets or liabilities hedged. At December 31, 1999, one foreign
7
<PAGE> 8
exchange contract for $0.2 million was outstanding with a maturity date of
January 28, 2000. Non-U.S. dollar expenses primarily consist of operating
expenses incurred in the local currencies of our United Kingdom, Switzerland,
France, Spain, Australia, Hong Kong, and China-based sales and representative
offices. International sales offices' operating expenses generally consist of
compensation-related costs and general office expenses which are paid in a
timely manner. Operating expenses for these offices have historically been
insignificant on a consolidated basis, and changes in the U.S. dollar value of
these expenses due to fluctuations in the exchange rates are not considered
material. The introduction in 1999 of the euro currency may cause increased
competition by creating cross-border competition. We are evaluating our
marketing and pricing strategies in light of competitive factors in the European
market. As use of the euro increases and becomes mandatory in 2002, we may have
to change our billing practices in the future. Adoption of the euro has not, to
date, had a material impact on our business, results of operations or financial
condition.
Our marketable securities portfolio consists of domestic corporate equity as
well as domestic municipal debt and domestic corporate debt securities of
various issuers, types, and maturities. Approximately 37.8% of the debt
securities mature in one year or less. At December 31, 1999, the weighted
average yield on our debt securities was 4.08%, and the weighted average yield
on cash equivalents was 5.24%.
We received approximately 5.3 million shares of Cisco common stock on November
1, 1999 in exchange for our equity interest in Cerent. We recorded a gain of
approximately $379.3 million due to this acquisition which is reflected in our
results of operations for the fourth quarter of 1999. As of December 31, 1999,
the value of the Cisco shares was $551.4 million.
The marketable securities portfolio, including our Cisco common stock, is
classified as available for sale and recorded at fair value on the balance sheet
with unrealized gains and losses reported in the equity section of the balance
sheet, net of taxes. These securities are not leveraged and are held for
purposes other than trading.
We face interest rate risk exposure on our debt securities and declines in
interest rates could result in material decreases in interest earnings on those
securities. We do not undertake any specific actions to cover our exposure to
interest rate risk, and we are not a party to any interest rate risk management
transactions.
The following table shows the hypothetical changes in fair values of municipal
and corporate debt securities we held at year end which are sensitive to changes
in interest rates. The modeling technique used measures the change in fair
market values arising from hypothetical parallel shifts in the yield curve of
plus or minus 200 basis points (BPS) over an immediate time horizon.
This table estimates the fair value of our debt securities at an immediate time
horizon (in thousands):
<TABLE>
<CAPTION>
Valuation of Valuation of
Securities Given an No Change Securities Given an
Interest Rate in Interest Rate
Issuer Decrease of 200 BPS Interest Rate Increase of 200 BPS
-------------------- --------------------- ------------- ---------------------
<S> <C> <C> <C>
Municipal and
Corporate Debt
Securities $152,723 $ 149,348 $146,619
</TABLE>
We face market price volatility risk exposure on our corporate equity securities
consisting of Cisco common stock, and declines in the market price could result
in material decreases in those securities. At December 31, 1999, contractual
transfer restrictions on the sale of the stock prohibited us from undertaking
any specific actions to cover our exposure to market price volatility risk and
we were not a party to any market price volatility risk management transactions.
The following table shows the hypothetical changes in fair values of the Cisco
shares we held at year end. The modeling technique used measures the change in
fair market value arising from a hypothetical change in fair value arising from
a 20% change in the stock's price. This table estimates the fair value of our
Cisco shares at an immediate time horizon (in thousands):
8
<PAGE> 9
<TABLE>
<CAPTION>
Valuation of Valuation of
Securities Given a No Change Securities Given an
Decrease of 20% In in Stock Increase of 20% In
Issuer Stock Price Price Stock Price
------------------ --------------------- ------------ ---------------------
<S> <C> <C> <C>
Corporate Equity
Securities $ 441,122 $ 551,402 $ 661,682
</TABLE>
In February 2000, contractual transfer restrictions on the Cisco shares expired,
and we entered into a hedging transaction structured as a costless collar
agreement (collar) to minimize the impact of potential adverse market risk on
the Cisco shares we own. The collar covers approximately 5.0 million shares with
a term of approximately three years. The collar limits our exposure to, and
benefits from, price fluctuations in the underlying Cisco stock. The collar
provides us with a floor value of approximately $650.0 million for the hedged
shares, while allowing us to participate in up to approximately $350.0 million
in further appreciation above the floor value. We will record the collar at its
estimated fair market value. We will account for the collar as a hedge, and
changes in the value of the collar are anticipated to be largely offset by
changes in the value of the underlying stock which is also marked-to-market
through accumulated other comprehensive income in our balance sheet. We expect
to receive and hedge an additional 260,000 shares to be released to us in April
2000 unless Cisco makes claims against such shares under the terms of the Cerent
acquisition. In February 2000, Cisco announced a two-for-one stock split to
stockholders of record on February 22, 2000 to be distributed March 22, 2000. We
believe the split will not significantly impact our collar arrangement. For
additional information with respect to the potential impact of adverse market
price volatility on the Cisco stock we own, refer to Part I, Item 3 -
"Quantitative and Qualitative Disclosures About Market Risk on page 20 of our
Quarterly Report for the period ended June 30, 2000 as filed with the SEC.
SEASONALITY
Our customers normally install a portion of the OmniMAX system in outdoor
locations. Shipments of the system are subject to the effects of seasonality,
with fewer installation projects scheduled for the winter months. The majority
of our sales have been made to companies in the U.S., and accordingly, we
believe that over time the effect of seasonality will cause revenues in the
quarter ended March 31 to be lower than revenues in the preceding quarter ended
December 31. In particular, we currently believe that revenues in the quarter
ended March 31, 2000 may be lower than revenues in the quarter ended December
31, 1999.
YEAR 2000 READINESS
We did not experience any material disruptions to our business, results of
operations, or the OmniMAX global product family as a result of the transition
from 1999 to 2000. We plan to retain our year 2000 (Y2K) contingency plans in
case of any potential Y2K-related events that may arise in the first half of
2000, including any Y2K problems encountered by our customers and key vendors.
We believe we have taken the steps necessary to understand and resolve Y2K
issues; however, failure to adequately address all known and unknown Y2K
readiness issues could result in, among other things, product shipment delays,
unforeseen operating expenses and lower net income. We tracked external costs
incurred to remedy Y2K-affected software, hardware, and embedded technology;
however, we did not separately track internal costs incurred, such as payroll
costs for employees working on Y2K matters. Expenditures in relation to Y2K
readiness were $73,000.
Certain Accounting Pronouncements
The effective date of Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities, has been deferred,
and will be effective for AFC beginning in the first quarter of 2001. Refer to
Note 1 of "Notes to Consolidated Financial Statements" for a discussion of the
accounting treatment of derivative instruments as required by this Statement.
9
<PAGE> 10
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Advanced Fibre Communications, Inc.:
We have audited the accompanying consolidated balance sheets of Advanced Fibre
Communications, Inc. and subsidiaries as of December 31, 1999 and 1998 and the
related consolidated statements of income, stockholders' equity and other
comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 1999. Our audit also included the financial statement
schedule included herein as of and for each of the years in the three-year
period ended December 31, 1999. These consolidated financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Advanced Fibre
Communications, Inc. and subsidiaries as of December 31, 1999 and 1998, and the
results of its operations and its cash flows for each of the years in the
three-year period ended December 31, 1999, in conformity with accounting
principles generally accepted in the United States of America.
/s/ KPMG LLP
San Francisco, California
January 31, 2000, except as to notes 3 and 12a,
which are as of February 9, 2000, and note 12b,
which is as of August 4, 2000.
10
<PAGE> 11
ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1999 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 31,372 $ 20,782
Marketable securities 700,750 90,084
Accounts receivable, less allowances of $3,436 and $5,326
in 1999 and 1998, respectively 60,768 73,488
Inventories 37,946 53,060
Other current assets 6,736 9,736
--------- ---------
Total current assets 837,572 247,150
Property and equipment, net 56,914 49,418
Other assets 7,289 11,687
--------- ---------
Total assets $ 901,775 $ 308,255
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 19,868 $ 12,682
Accrued liabilities 28,818 25,864
Deferred tax liabilities 205,529 --
--------- ---------
Total current liabilities 254,215 38,546
Long-term liabilities 2,496 1,870
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 1999 and 1998; 79,077,392 and 76,191,353 shares issued
and outstanding in 1999 and 1998, respectively 790 762
Deferred stock compensation (96) (84)
Additional paid-in capital 238,074 211,392
Notes receivable from stockholders (241) (730)
Accumulated other comprehensive income 100,968 --
Retained earnings 305,569 56,499
--------- ---------
Total stockholders' equity 645,064 267,839
--------- ---------
Total liabilities and stockholders' equity $ 901,775 $ 308,255
========= =========
</TABLE>
See accompanying notes to consolidated financial statements
11
<PAGE> 12
ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Revenues $296,611 $316,409 $267,858
Cost of revenues 157,911 171,843 145,933
-------- -------- --------
Gross profit 138,700 144,566 121,925
-------- -------- --------
Operating expenses:
Research and development 48,343 41,687 25,726
Selling, general and administrative 68,372 66,429 42,653
-------- -------- --------
Total operating expenses 116,715 108,116 68,379
Operating income 21,985 36,450 53,546
Other income, net 385,444 4,051 4,866
-------- -------- --------
Income before income taxes 407,429 40,501 58,412
Income taxes 158,359 14,648 21,612
-------- -------- --------
Net income $249,070 $ 25,853 36,800
======== ======== ========
Basic net income per share $ 3.20 $ 0.34 $ 0.52
-------- -------- --------
Shares used in basic per share
computations 77,723 75,273 70,131
-------- -------- --------
Diluted net income per share $ 3.05 $ 0.32 $ 0.48
-------- -------- --------
Shares used in diluted per share
computations 81,657 79,825 77,469
-------- -------- --------
</TABLE>
See accompanying notes to supplemental consolidated financial statements
12
<PAGE> 13
ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND OTHER COMPREHENSIVE INCOME
Years Ended December 31, 1999, 1998, and 1997
(In thousands, except share data)
<TABLE>
<CAPTION>
Notes
Receivable
Common Stock Deferred Additional from Retained
------------------------- Stock Paid-in Stock- Earnings
Shares Amount Compensation Capital holders (Deficit)
---------- -------- ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balances as of
December 31, 1996 65,299,214 $ 653 $ -- $163,675 $(151) $ (6,154)
Exercise of common stock
options and warrants 6,940,978 69 -- 2,446 -- --
Secondary public offering of
common stock 400,000 4 -- 7,839 -- --
Sale of common stock for
notes receivable 25,378 3 -- 684 (684) --
Repurchase of common stock (39,200) (3) -- (10) -- --
Tax benefit from
option exercises -- -- -- 18,549 -- --
Net income -- -- -- -- -- 36,800
---------- -------- -------- -------- ----- --------
Balances as of
December 31, 1997 72,626,370 726 -- 193,183 (835) 30,646
Exercise of common stock
options and warrants 3,096,149 31 -- 6,295 -- --
Issuance of common stock 475,200 5 -- 847 -- --
Granting of stock options below
intrinsic value -- -- (125) 125 -- --
Vesting of stock options below
intrinsic value -- -- 41 -- -- --
Payment of notes receivable
from stockholder -- -- -- -- 105 --
Repurchase of common stock (6,366) -- -- (4) -- --
Tax benefit from
option exercises -- -- -- 10,946 -- --
Net income -- -- -- -- -- 25,853
---------- -------- -------- -------- ----- --------
Balances as of
December 31, 1998 76,191,353 762 (84) 211,392 (730) 56,499
Exercise of common stock
options and warrants 2,565,454 25 -- 10,858 -- --
Issuance of common stock 16,276 -- -- 3 -- --
Inclusion of GVN earnings for the
period July 1 to December 31, 1998 -- -- -- 881 -- --
Conversion of preferred stock
into common stock in pooling 239,959 2 -- 1,998 -- --
Conversion of debt and accrued
interest into common stock 106,637 1 -- 1,817 -- --
Cancellation of notes receivable
from stockholder -- -- -- -- 489 --
Granting of stock options below
intrinsic value -- -- (395) 395 -- --
Vesting of stock options below
intrinsic value -- -- 308 513 -- --
Forfeiture of stock options -- -- 75 (75) -- --
Repurchase of common stock (42,287) -- -- (11) -- --
Tax benefit from
option exercises -- -- -- 10,303 -- --
Net income -- -- -- -- -- 249,070
Other comprehensive income:
Unrealized gain on available
for sale securities(1)
---------- -------- -------- -------- ----- --------
Balances as of December 31, 1999 79,077,392 $ 790 $ (96) $238,074 $(241) $305,569
========== ======== ======== ======== ===== ========
</TABLE>
<TABLE>
<CAPTION>
Accumulated Total
Other Stock-
Comprehensive Comprehensive holders'
Income Income Equity
------------- ------------- --------
<S> <C> <C> <C>
Balances as of
December 31, 1996 $ -- $158,023
Exercise of common stock
options and warrants -- 2,515
Secondary public offering of
common stock -- 7,843
Sale of common stock for
notes receivable -- 3
Repurchase of common stock -- (13)
Tax benefit from
option exercises -- 18,549
Net income $ 36,800 -- 36,800
======== -------- --------
Balances as of
December 31, 1997 -- 223,720
Exercise of common stock
options and warrants -- 6,326
Issuance of common stock -- 852
Granting of stock options below
intrinsic value -- --
Vesting of stock options below
intrinsic value -- 41
Payment of notes receivable
from stockholder -- 105
Repurchase of common stock -- (4)
Tax benefit from
option exercises -- 10,946
Net income $ 25,853 -- 25,853
======== -------- --------
Balances as of
December 31, 1998 -- 267,839
Exercise of common stock
options and warrants -- 10,883
Issuance of common stock -- 3
Inclusion of GVN earnings for the
period July 1 to December 31, 1998 -- 881
Conversion of preferred stock
into common stock in pooling -- 2,000
Conversion of debt and accrued
interest into common stock -- 1,818
Cancellation of notes receivable
from stockholder -- 489
Granting of stock options below
intrinsic value -- --
Vesting of stock options below
intrinsic value -- 821
Forfeiture of stock options -- --
Repurchase of common stock -- (11)
Tax benefit from
option exercises -- 10,303
Net income $249,070 -- 249,070
Other comprehensive income:
Unrealized gain on available
for sale securities(1) 100,968 100,968 100,968
--------
$350,038
======== -------- --------
Balances as of
December 31, 1999 $100,968 $645,064
======== ========
</TABLE>
<TABLE>
<CAPTION>
1999 1998 1997
-------- ------ ------
<S> <C> <C> <C>
(1):
Net unrealized gain on available for sale marketable securities during period $166,178 $-- $--
Less: reclassification adjustment for net gains included in net income -- -- --
Less: deferred income taxes related to the net unrealized gain 65,210 -- --
Net unrealized gain on available for sale marketable securities $100,968 $-- $--
</TABLE>
See accompanying notes to consolidated financial statements
13
<PAGE> 14
ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 249,070 $ 25,853 $ 36,800
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred income taxes 144,853 (2,451) (826)
Depreciation and amortization 13,187 8,059 2,850
Tax benefit from option exercises 10,303 10,946 18,549
Stock based compensation 821 41 --
Allowances for uncollectible accounts and returns (1,586) 3,658 2,729
Gain on strategic investment (384,758) -- --
Changes in operating assets and liabilities:
Accounts receivable 14,306 1,952 (49,036)
Inventories 12,914 (987) (34,724)
Other current assets (1,451) (960) (1,175)
Other assets 288 (4,273) 101
Accounts payable 7,186 (5,793) 9,676
Accrued and other liabilities 1,459 (3,364) 22,232
--------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 66,592 32,681 7,176
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (491,534) (226,702) 185,834
Maturities of marketable securities 308,002 79,131 69,873
Sales of marketable securities 124,268 153,630 (268,362)
Investment in development-stage company 3,063 (2,018) (3,000)
Purchase of property and equipment (15,865) (32,272) (17,767)
--------- --------- ---------
NET CASH USED IN INVESTING ACTIVITIES (72,066) (28,231) (33,422)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of common stock options and 16,064 7,279 2,514
warrants, net
Proceeds from secondary offering of common stock -- -- 7,843
--------- --------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 16,064 7,279 10,357
--------- --------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 10,590 11,729 (15,889)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 20,782 9,053 24,942
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 31,372 $ 20,782 $ 9,053
========= ========= =========
NON-CASH FINANCING AND INVESTING ACTIVITIES:
Issuance of common stock for notes receivable $ -- $ -- $ 684
CASH PAID:
Income taxes $ 2,399 $ 7,190 $ 442
</TABLE>
See accompanying notes to consolidated financial statements
14
<PAGE> 15
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
AFC designs and manufactures worldwide 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". In 2000, we
reorganized our UMC1000(TM) product family into a broader definition, the
OmniMAX(TM), 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. 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.
FISCAL YEAR
We operate on a 13-week fiscal quarter, comprised of four, four, and five week
periods, ending on the last Saturday of the last week of the five-week period.
In the year 2000, we will operate on a 53-week fiscal year, with four, five, and
five week periods in the third quarter. We believe the effect of the additional
week is not significant to our results of operations or cash flows.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of AFC and our
subsidiaries. All significant intercompany balances and transactions have been
eliminated. An investment in a development-stage company, which is less than 20%
owned, is accounted for under the cost method.
CASH AND CASH EQUIVALENTS
We consider all highly liquid investments with original maturities of three
months or less to be cash equivalents. Cash and cash equivalents are generally
invested in money market funds.
MARKETABLE SECURITIES
All marketable securities are classified as available-for-sale and are stated at
fair value, which approximates cost.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We use foreign exchange contracts to offset gains and losses on exchange rate
fluctuations against gains and losses on assets or liabilities hedged. One of
our customer contracts was payable in French francs at December 31, 1999, and
the receivable was hedged using a forward currency exchange contract.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards (SFAS) No. 133 in June 1998, Accounting for Derivative
Instruments and Hedging Activities. The effective date has been deferred to
fiscal years beginning after June 15, 2000. 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 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. We
are currently evaluating the requirements and the impact of SFAS No. 133.
INVENTORIES
Inventories include material, labor and overhead and are valued at the lower of
first-in, first-out cost or market. A reserve for obsolescence has been
established and the balance is reviewed for adequacy on a quarterly basis.
15
<PAGE> 16
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. We compute depreciation using the
straight-line method over the estimated useful lives, generally three years for
computers and software and seven years for office and engineering equipment,
furniture, and fixtures.
LONG-LIVED ASSETS
We evaluate long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of the asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount exceeds the fair value of the assets. Assets to be disposed of are
reported at the lower of carrying values or fair values, less costs of disposal.
REVENUE RECOGNITION, ALLOWANCES AND PRODUCT WARRANTY
Revenue is generally recognized when products are shipped. An allowance for
estimated returns and an allowance for uncollectible accounts are based on
experience. A provision for estimated warranty costs is recorded at the time of
sale and periodically adjusted to reflect actual experience. We generally
warrant our products for two years.
INCOME TAXES
We account for income taxes using the asset and liability method of accounting.
Under this method, deferred tax assets and liabilities are recognized based on
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases.
EQUITY-BASED COMPENSATION PLANS
We account for equity-based compensation plans with employees using the
intrinsic value method.
NET INCOME PER SHARE
Basic net income per share is computed using the weighted average number of
shares of common stock outstanding. 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.
FOREIGN CURRENCY TRANSLATION
Operations conducted in our foreign offices are transacted in local currencies.
Assets and liabilities are translated into U.S. dollars using the translation
rate at the balance sheet date, and income and expense amounts are translated at
weighted average exchange rates during the year. Translation adjustments, if
material, are recorded to other comprehensive income in the equity section of
the balance sheet.
CONCENTRATION OF CREDIT RISK
Cash equivalents and trade accounts receivable are the primary financial
instruments potentially exposing us to credit risk. We manufacture and sell the
OmniMAX global product family principally to telecommunication companies in the
U.S. and to telecommunication companies and distributors in international
markets. To reduce credit risk, we perform ongoing credit evaluations of our
customers' financial condition. In some cases, we may require customer
prepayment, bank guarantees or letters of credit.
16
<PAGE> 17
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
We have made a number of estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from these estimates.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the current
year's presentation.
NOTE 2. MARKETABLE SECURITIES
Marketable securities are valued at fair market value, and are comprised of the
following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1999 1998
-------- -------
<S> <C> <C>
Corporate equity securities $551,402 $ --
Municipal debt securities 142,348 89,454
Corporate debt securities 7,000 630
Money market accounts 19,094 8,135
-------- -------
Total marketable securities and cash equivalents $719,844 $98,219
======== =======
</TABLE>
On November 1, 1999, we acquired approximately 5.3 million shares of Cisco
common stock as a result of the completion of Cisco's acquisition of Cerent
Networks and resultant exchange of our Cerent stock for Cisco's. We realized a
gain for the step-up in basis of $379.3 million before taxes at the acquisition
date in our Cisco stock. We also recorded an unrealized gain of $166.6 million,
before taxes, in our Cisco stock at December 31, 1999. On November 1, 1999, we
pledged 3,431 shares as a charitable donation and recorded the related
contribution of $250,000 to other income.
We recorded a $0.5 million unrealized loss in our debt securities at December
31, 1999. Unrealized gains and losses were not significant in 1998. The fair
value of securities maturing in one year or less and those maturing between one
year and five years was $56.4 million and $92.9 million, respectively, as of
December 31, 1999.
NOTE 3. SUBSEQUENT EVENT
On February 9, 2000, we entered into a hedging transaction structured as a
costless collar agreement (collar) to manage our exposure to fluctuations in the
market price of Cisco common stock we own. The collar covers approximately 5.0
million shares with a term of approximately three years. The collar limits our
exposure to, and benefits from, price fluctuations in the underlying Cisco
stock. It provides us with a floor value of approximately $650 million for the
hedged shares while allowing us to participate in up to approximately $350
million of any further appreciation in the shares above the floor value. We will
record the collar at its estimated fair market value. We will account for the
collar as a hedge, and changes in the value of the collar are anticipated to be
largely offset by changes in the value of the underlying stock which is also
marked-to-market through accumulated other comprehensive income in our balance
sheet. As part of the collar, we will be able to borrow against the value of a
portion of the hedged stock.
17
<PAGE> 18
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 4. INVENTORIES
The major components of inventories are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
------- -------
<S> <C> <C>
Raw materials $ 7,706 $16,135
Work-in-progress 1,113 566
Finished goods 29,127 36,359
------- -------
Total inventories $37,946 $53,060
======= =======
</TABLE>
NOTE 5. PROPERTY AND EQUIPMENT
A summary of property and equipment follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
------- -------
<S> <C> <C>
Furniture and fixtures $ 9,251 $ 7,837
Computer, software, and office 28,601 23,247
equipment
Engineering equipment 41,178 29,881
------- -------
79,030 60,965
Less: accumulated depreciation 22,116 11,547
------- -------
Property and equipment, net $56,914 $49,418
======= =======
</TABLE>
Engineering equipment at December 31, 1999 included a transfer of $2.2 million
worth of inventory. This transaction arose as the result of building test
fixtures and expanding research and development labs that will be used in the
future to develop products and technology.
NOTE 6. ACCRUED LIABILITIES
A summary of accrued liabilities follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
------- -------
<S> <C> <C>
Warranty $ 8,898 $ 6,563
Other 5,560 9,031
Outside services 5,328 3,219
Salaries and benefits 5,340 4,278
Income and sales taxes 3,692 2,773
------- -------
Total accrued liabilities $28,818 $25,864
======= =======
</TABLE>
18
<PAGE> 19
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7. INCOME TAXES
A summary of the components of income taxes (benefit) follows (in thousands):
<TABLE>
<CAPTION>
CHARGE
IN LIEU
OF
INCOME
CURRENT DEFERRED(1) TAXES(2) TOTAL
------- ----------- -------- --------
<S> <C> <C> <C> <C>
Year ended December 31, 1999:
Federal $2,986 $ 121,787 $ 9,175 $133,948
State 217 23,066 1,128 24,411
------ --------- ------- --------
Income taxes $3,203 $ 144,853 $10,303 $158,359
====== ========= ======= ========
Year ended December 31, 1998:
Federal $4,382 $ (1,455) $ 9,533 $ 12,460
State 1,771 (996) 1,413 2,188
------ --------- ------- --------
Income taxes (benefit) $6,153 $ (2,451) $10,946 $ 14,648
====== ========= ======= ========
Year ended December 31, 1997:
Federal $3,142 $ (1,052) $16,017 $ 18,107
State 747 226 2,532 3,505
------ --------- ------- --------
Income taxes (benefit) $3,889 $ (826) $18,549 $ 21,612
====== ========= ======= ========
</TABLE>
(1) The change in deferred taxes excludes the unrealized gains and losses on
marketable securities.
(2) The charge in lieu of income taxes results from the tax benefit of stock
option exercises.
Income taxes differ from the amounts computed by applying the U.S. federal
statutory rate of 35% in 1999, 35% in 1998, and 34% in 1997 to income before
income taxes as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1999 1998 1997
--------- -------- --------
<S> <C> <C> <C>
Income taxes at statutory rate $ 142,600 $ 14,176 $ 19,860
State taxes, net of federal benefit 16,050 1,422 2,258
Current losses and temporary
differences for which no benefit
was recognized 774 54 95
Foreign sales corporation benefit (114) (164) (179)
Utilization of credits (1,450) (735) (304)
Tax exempt interest (1,400) (1,225) (407)
Change in valuation allowance (1,667) 531 --
Other 3,566 589 289
--------- -------- --------
Income taxes $ 158,359 $ 14,648 $ 21,612
========= ======== ========
</TABLE>
19
<PAGE> 20
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7. INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and liabilities are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1999 1998
--------- --------
<S> <C> <C>
Deferred tax assets:
Allowances and accruals $ 8,464 $ 7,000
Research tax credit carry-forwards 5,087 2,597
Minimum tax credit carry-forwards 1,085 744
Net operating loss carry-forwards 1,009 531
Unrealized loss on marketable securities 192 --
Other 70 309
--------- --------
Gross deferred tax assets 15,907 11,181
Valuation allowance -- (531)
--------- --------
Net deferred tax assets 15,907 10,650
Deferred tax liabilities:
Recognized gain on marketable securities (148,839) --
Unrealized gain on marketable securities (65,402) --
Net book value over net tax basis (5,741) (4,128)
--------- --------
Gross deferred tax liabilities (219,982) (4,128)
--------- --------
Net deferred tax assets/(liabilities) $(204,075) $ 6,522
========= ========
</TABLE>
As of December 31, 1999, we had research credit carry-forwards for federal and
California income tax return purposes of approximately $3.3 million and $1.8
million, respectively. The federal and California research tax credit
carry-forwards are available to reduce future income subject to income taxes.
The federal research credit carry-forwards will expire at various dates through
the year 2019 and the California research credits will carry forward
indefinitely until utilized. We have alternative minimum tax credit
carry-forwards for federal income tax return purposes of approximately $1.1
million, which carry forward indefinitely until utilized.
NOTE 8. BANK BORROWINGS
We had a $50.0 million unsecured bank line with two banks at December 31, 1999.
In February 2000, we amended the line to $30.0 million. The line expires in July
2000. The bank line carries interest of LIBOR plus 1.50%. Under the bank line,
the banks may issue letters of credit up to $10.0 million on our behalf. As of
December 31, 1999, $2.7 million in letters of credit were outstanding, of which
$1.0 million was held as a short-term deposit on one of our leased facilities
and another $1.0 million was held as a five-year deposit on the same building.
The bank line requires us to comply with certain covenants. At December 31,
1999, 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 open foreign
exchange contracts up to $40.0 million. There are no borrowing provisions,
financial covenants, or fees associated with these facilities. At December 31,
1999, one foreign exchange contract of $0.2 million was outstanding, which
matured on January 28, 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 shares we own. We will also be able to borrow against the value of a
portion of the shares hedged.
20
<PAGE> 21
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. STOCKHOLDERS' EQUITY
SECONDARY OFFERING
In February 1997, we completed a secondary offering of 4,000,000 shares of
common stock, 3,600,000 of which were sold by certain stockholders and 400,000
of which were sold by AFC, generating approximately $7.8 million of net proceeds
to AFC.
COMMON STOCK SPLIT
In 1997, we effected a two-for-one stock split. All share, per share, and common
stock amounts herein have been restated to reflect the effect of this split.
COMMON STOCK OPTIONS
Our 1996 Stock Incentive Plan (the 1996 Plan) is the successor equity incentive
program to our 1993 Stock Option/Stock Issuance Plan (the Predecessor Plan). A
total of 21,409,663 shares of common stock were authorized for issuance under
the Predecessor Plan and 1996 Plan as of December 31, 1999, and 19,138,074 as of
December 31, 1998. The share reserve automatically increases on the first
trading day of each calendar year by an amount equal to 3% of the number of
shares of common stock outstanding on the last trading day of the immediately
preceding calendar year.
Options issued prior to 1997 generally vest 20% on the first anniversary date
and ratably over the following 48 months. Options issued subsequent to January
1, 1997 generally vest ratably over 48 months for employees with over one year
of service, and 25% on the first anniversary date and ratably over the following
36 months for new employees. The options expire ten years from the date of grant
and are normally canceled three months after termination of employment.
In August 1998, the Compensation Committee of the Board of Directors authorized
a program to offer to replace option grants made under the 1996 Plan that were
granted at exercise prices exceeding $12.49 per share. The offer was made to all
employees, 99% of whom participated, involving options to purchase 4,190,105
shares of common stock and was affected on September 14, 1998. The exercise
price of each option was re-priced at $7.88, based on the closing market price
of the stock on September 14, 1998. The re-pricing was subject to the condition
that the options were not exercised, and employment was not terminated, prior to
March 15, 1999, and September 15, 1999, for employees and officers,
respectively. Vesting of the re-priced options was suspended at September 14,
1998, and resumed on March 15, 1999 for employees, and September 15, 1999 for
officers. Any employee voluntarily terminating employment during the suspended
vesting period lost the affected options, including previously vested portions
of those options. During 1998, the option grants for two directors were
re-priced. The original exercise prices ranged from $34.00 to $40.00 per share,
and the re-pricing involved options to purchase a total of 80,000 shares of
common stock. The exercise price of each re-priced option was $8.63, based on
the closing market price of the stock on October 27, 1998. The re-pricing was
subject to the condition that the options were not exercised, and the
directorships are not terminated, prior to October 27, 1999. Vesting of the
re-priced options was suspended at October 27, 1998, and resumed on October 27,
1999.
21
<PAGE> 22
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. STOCKHOLDERS' EQUITY (Continued)
A summary of the stock option plan activity is presented below:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------
1999 1998 1997
----------------------- ------------------------ ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS SHARES PRICE SHARES PRICE SHARE PRICE
------------------------ ----------- ----------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 8,171,547 $ 6.62 8,396,625 $ 11.81 8,635,088 $ 1.66
Granted 5,148,606 21.11 7,845,550 13.13 3,689,011 27.34
Exercised (1,727,436) 4.96 (2,289,033) 1.70 (3,050,793) 0.38
Cancelled (2,405,221) 8.48 (5,781,595) 24.92 (876,681) 14.64
----------- ----------- ----------- ----------- ------------ -----------
Outstanding at end of
year 9,187,496 $ 14.53 8,171,547 $ 6.62 8,396,625 $ 11.81
Exercisable at end of
year 2,145,102 1,488,822 2,614,653
Available for grant 6,558,508 9,271,426 11,333,015
Weighted average fair
value of options
granted during the year $ 13.27 $ 8.96 $ 17.90
</TABLE>
The following table summarizes information about stock options outstanding as of
December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- ---------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF OPTION CONTRACTUAL EXERCISE EXERCISE
EXERCISE PRICES SHARES LIFE PRICE SHARES PRICE
------------------- ------------ -------------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
$0.01 - $0.75 697,563 5.4 years $ 0.47 505,172 $ 0.40
1.71 - 6.25 634,348 6.7 5.29 508,910 5.45
6.80 - 7.88 2,865,122 8.8 7.74 647,670 7.84
8.03 - 8.63 1,071,045 9.0 8.52 286,597 8.53
8.78 - 9.94 186,547 8.8 9.34 46,805 9.20
10.00 - 16.31 1,755,662 9.6 15.63 44,587 12.56
16.50 - 19.56 142,760 9.0 17.34 16,450 17.85
20.13 - 29.81 670,429 9.7 24.00 60,916 26.07
31.00 - 39.56 78,550 8.9 33.96 27,858 31.01
41.94 - 46.13 1,085,470 10.0 44.34 137 44.19
------------------- ------------ -------------- ----------- ------------ -----------
$0.01 - $46.13 9,187,496 8.8 $ 14.53 2,145,102 $ 6.64
</TABLE>
22
<PAGE> 23
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. STOCKHOLDERS' EQUITY (Continued)
EMPLOYEE STOCK PURCHASE PLAN
Under the 1996 Employee Stock Purchase Plan (the Purchase Plan) we are
authorized to issue up to three million shares of common stock to eligible
employees of AFC and participating subsidiaries. The Purchase Plan has been
implemented in a series of successive offering periods, each with a maximum
duration of 24 months. Eligible employees can enter on the start date of any
offering period or on any subsequent semi-annual entry date. Employees may have
up to 10% of their base salary withheld through payroll deductions to purchase
common stock. The purchase price of the stock is the lower of 85% of 1) the fair
market value of the common stock on the participant's entry date (strike price)
or 2) the fair market value on the semi-annual purchase date. Purchase dates are
January 31 and July 31 of each year, or the closest business day preceding those
dates when the purchase date falls on a non-business day. If the fair market
value on any purchase date during the existing offering period is less than the
strike price established at the beginning of the offering period, a new offering
period will commence. The current offering period commenced on February 2, 1999
and is scheduled to continue through January 31, 2001.
A total of 219,318 shares of common stock with a weighted average fair value of
$10.24 per share were purchased in 1999. A total of 88,222 shares with a
weighted average fair value of $10.88 were purchased on the semi-annual January
31, 2000 purchase date using contributions withheld during 1999. At December 31,
1999, 2,455,263 shares remained available for issuance.
COMMON STOCK WARRANTS
Warrants to purchase shares of common stock were issued to investors as part of
the preferred stock agreements. The warrants expire through the year 2000 and
are summarized as follows:
<TABLE>
<CAPTION>
EXERCISE
NUMBER PRICE PER
OF SHARES SHARE
---------- ------------
<S> <C> <C>
Warrants outstanding as of December 31, 1997 1,289,744 $0.01 -3.50
Exercised (608,088) 0.01 -0.58
---------- ------------
Warrants outstanding as of December 31, 1998 681,656 0.13 -3.50
Exercised (620,000) 0.13 -0.58
========== ============
Warrants outstanding as of December 31, 1999 61,656 $ 3.50
========== ============
</TABLE>
PRO FORMA FAIR VALUE INFORMATION
We apply the intrinsic value method of accounting prescribed by APB Opinion No.
25 for our stock-based compensation plans. If compensation cost for our
stock-based compensation plans had been determined in accordance with the fair
value approach set forth in SFAS No.123, Accounting for Stock-Based
Compensation, our net income and earnings per share would have been reduced to
the pro forma amounts as follows (in thousands except per share data):
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Net income:
As reported $ 249,070 $ 25,853 $ 36,800
Pro forma 223,576 2,097 26,404
Basic net income per share:
As reported $ 3.20 $ 0.34 $ 0.52
Pro forma 2.88 0.03 0.38
Diluted net income per share:
As reported $ 3.05 $ 0.32 $ 0.48
Pro forma 2.74 0.03 0.34
</TABLE>
23
<PAGE> 24
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. STOCKHOLDERS' EQUITY (Continued)
The fair value of option grants in 1999, 1998, and 1997 were estimated on the
date of grant using the Black-Scholes option-pricing model, assuming no dividend
yield, with the following weighted average assumptions:
<TABLE>
<CAPTION>
RISK-FREE
VOLATILITY INTEREST RATE EXPECTED LIFE
-------------- -------------- -----------------
<S> <C> <C> <C>
1999 90% 5.81% 4 Years
1998 85 5.54 5
1998 Re-priced 85 4.72 4
1997 71 6.23 5
</TABLE>
Pro forma compensation costs related to the Purchase Plan were recognized for
the fair value of the employees' purchase rights, as of the date of purchase
using the Black-Scholes option-pricing model. The following weighted average
assumptions were used, assuming no dividend yield:
<TABLE>
<CAPTION>
SEMI-ANNUAL RISK-FREE
PURCHASE DATES VOLATILITY INTEREST RATE EXPECTED LIFE
-------------- -------------- -----------------
<S> <C> <C> <C>
January 2000 85% 4.9% 8 Months
July 1999 85 4.9 8
January 1999 75 5.8 14
July 1998 71 5.8 14
January 1998 71 5.8 14
July 1997 71 5.8 14
January 1997 71 5.8 14
</TABLE>
NET INCOME PER SHARE
The computation of shares and net income amounts used in the calculation of
basic and diluted net income per share are as follows (in thousands, except
share data):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Net income $249,070 $ 25,853 $ 36,800
======== ======== ========
Shares used in basic per share calculations - actual weighted
average common shares outstanding for the period 77,723 75,273 70,131
Weighted average number of shares upon exercise of
dilutive options and warrants 3,934 4,552 7,338
======== ======== ========
Shares used in diluted per share calculations 81,657 79,825 77,469
======== ======== ========
Basic net income per share $ 3.20 $ 0.34 $ 0.52
======== ======== ========
Diluted net income per share $ 3.05 $ 0.32 $ 0.48
======== ======== ========
</TABLE>
24
<PAGE> 25
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 10. COMPREHENSIVE INCOME
We have adopted the provisions of SFAS No. 130, Reporting Comprehensive Income.
SFAS No. 130 requires that changes in the amounts of certain items, including
unrealized gains and losses on available-for-sale securities and foreign
currency translation adjustments be shown as components of accumulated other
comprehensive income. Our foreign currency translation adjustments were not
significant in 1999 or 1998. Our accumulated other comprehensive income is
composed of unrealized gains and losses on marketable securities.
NOTE 11. COMMITMENTS AND CONTINGENCIES
LEASES
Office space and certain equipment are leased under operating leases. Future
minimum payments under operating leases with an initial term of more than one
year as of December 31, 1999 are summarized as follows (in thousands):
<TABLE>
<S> <C>
2000 $7,833
2001 7,180
2002 6,387
2003 6,281
2004 6,155
Thereafter 43,764
--------
Total minimum lease payments $77,600
========
</TABLE>
Total rent expense for all operating leases were $6.6 million, $6.1 million, and
$5.3 million for the years ended December 31, 1999, 1998, and 1997,
respectively.
EMPLOYEE BENEFIT PLAN
We have a 401(k) plan under which employees may contribute a portion of their
compensation on a tax-deferred basis to the plan. We contributed to the plan on
a matching basis up to a maximum of $5,000 per employee during 1999. We act as
the plan administrator. During 1999 and 1998, we contributed $1.8 million and
$1.4 million respectively, to the plan.
LITIGATION
STOCKHOLDER LITIGATION - AFC and various of its current and former officers and
directors are parties to a consolidated lawsuit which purports to be a class
action filed on behalf of certain of our stockholders (excluding the defendants
and parties related to them). 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 is currently pending before the court. Limited discovery has occurred,
and only limited discovery is expected to occur pending ruling on the motion to
dismiss. 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.
25
<PAGE> 26
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12. SUBSEQUENT EVENTS
a. MARCONI/RELTEC CORPORATION In 1997, AFC filed a lawsuit against RELTEC
Corporation, now Marconi Communications, Inc., alleging trade secret
misappropriation, tortious interference with a contract, and related claims. The
case involved RELTEC's acquisition of AFC's technology through our Taiwan-based
licensee, Vidar-SMS Co., Ltd. AFC and Marconi announced a settlement of the case
on February 7, 2000. Related to the settlement, Marconi agreed to pay AFC $32.75
million, and AFC and Marconi entered into a distribution agreement under which
Marconi will distribute the UMC1000 in specific countries outside North America
over a three year period, 2000-2002. The agreement anticipates that Marconi will
purchase for resale $110 million of the UMC1000 product family during the three
year period ($30 million in 2000, $40 million in 2001, and $40 million in 2002),
and guarantees AFC specified minimum payments if Marconi's UMC1000 purchases do
not meet expectations.
b. ACQUISITION OF GVN TECHNOLOGIES, INC. On May 16, 2000, we completed the
acquisition of GVN Technologies, Inc. (GVN), of Largo, Florida, a leading
developer of integrated access device equipment for the service provider market.
In the acquisition, the former stockholders of GVN received shares of our common
stock in exchange for their shares of GVN at the rate of .088 shares of our
common stock for each share of GVN common stock and preferred stock. The
acquisition was accounted for as a pooling of interests. An aggregate of 894,306
shares of our common stock was issued pursuant to the acquisition, and we
assumed an aggregate of 209,794 options to purchase GVN common stock.
The following information presents certain income statement data of the separate
companies for the periods preceding the merger (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Net revenues
AFC $ 296,571 $ 316,409 $ 267,858
GVN 40 -- --
--------- --------- ---------
$ 296,611 $ 316,409 $ 267,858
========= ========= =========
Net Income (loss)
AFC $ 250,297 $ 27,207 $ 36,800
GVN (1,227) (1,354) --
--------- --------- ---------
$ 249,070 $ 25,853 $ 36,800
========= ========= =========
</TABLE>
There were no material transactions between AFC and GVN prior to the merger. The
effects of conforming GVN's accounting policies to those of AFC were not
material.
NOTE 13. SEGMENT INFORMATION
We operate in the access market and derive substantially all of our revenues
from sales of the OmniMAX global product family. We organize our operations
based on designing, developing, manufacturing, selling, and supporting the
OmniMAX global product family. The chief operating decision makers evaluate
performance, make operating decisions, and allocate resources based on
consolidated financial data. Gross profit, operating income, income from
operations, and income taxes are not allocated or specific to individual
departments within the organization. Subsidiaries are not considered material to
our consolidated results, and for purposes of this disclosure, are not
considered significant to ongoing operations. Accordingly, we have a single
reportable segment. As such, we are required to disclose certain information
about our product, information about geographic areas, and information about
major customers.
26
<PAGE> 27
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the year ended December 31, 1999, revenues arising from sales of the OmniMAX
global product family, excluding royalties, were $296.1 million, compared with
$310.7 million in 1998 and $266.4 million in 1997. We sell the OmniMAX global
product family in over 25 countries worldwide; sales to external customers are
categorized geographically by each customer's country of domicile. For the year
ended December 31, 1999 revenues from sales to U.S. customers, excluding
royalties, were $264.8 million, as compared to $234.2 million in 1998 and $197.0
million in 1997. For the year ended December 31, 1999, revenues from sales to
all foreign countries, excluding royalties, were $31.3 million, as compared with
$76.6 million in 1998 and $69.4 million in 1997. There were no material revenues
from a single customer in foreign countries in the year ended December 31, 1999
or 1997. Material revenues from external customers in South Africa for the year
ended December 31, 1998, were $32.4 million. For the year ended 1999, two
customers in the U.S. accounted for 16.4% and 11.7% of total revenues,
respectively. For the year ended 1998, one customer in the U.S. accounted for
11.1% and one customer in South Africa accounted for 10.2% of total revenues.
For the year ended 1997, one customer in the U.S. accounted for 19.2% of total
revenues. Long-lived assets, excluding deferred tax assets, located in the U.S.
totaled $63.2 million as of December 31, 1999 and $59.6 million as of December
31, 1998. Long-lived assets, excluding deferred tax assets, located in foreign
countries totaled $1.1 million as of December 31, 1999 and $1.4 million as of
December 31, 1998.
NOTE 14. COMPANY INFORMATION AND CERTAIN CONCENTRATIONS
We currently derive substantially all of our revenue from the OmniMAX global
product family, and we expect this concentration will continue for the
foreseeable future. As a result, any factor adversely affecting the demand for,
or pricing of, the OmniMAX global product family could lower revenues and
decrease net income. Manufacturing operations consist of the final product
assembly, system integration, and testing. Although our product designs employ
primarily industry standard hardware, certain components are only available
through limited sources of supply. Our proprietary ASICs, codec components, and
some surface mount technology components and other components are available from
limited sources. Printed circuit board assemblies and channel bank assemblies
are provided by a limited number of turnkey vendors. If essential components
cannot be obtained as required, we may be unable to meet demand for our
products, thereby adversely affecting our revenues and net income. In addition,
scarcity of such components could result in cost increases that adversely affect
our gross profit margin.
27
<PAGE> 28
ADVANCED FIBRE COMMUNICATIONS, INC.
QUARTERLY RESULTS OF OPERATIONS
Selected quarterly financial data is summarized below (unaudited)(in thousands):
<TABLE>
<CAPTION>
QUARTERS ENDED
---------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
1999 1999 1999 1999 1998 1998 1998 1998
-------- -------- -------- -------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $ 82,797 $ 76,456 $ 69,758 $ 67,600 $ 76,059 $ 67,429 $ 86,261 $ 86,660
Cost of revenues 43,259 39,870 37,569 37,213 40,792 37,185 47,494 46,372
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit 39,538 36,586 32,189 30,387 35,267 30,244 38,767 40,288
-------- -------- -------- -------- -------- -------- -------- --------
Operating expenses:
Research and development 12,645 11,736 12,149 11,813 10,981 11,603 10,610 8,493
Selling, general and administrative 17,123 17,823 17,323 16,103 16,478 16,572 18,343 15,036
-------- -------- -------- -------- -------- -------- -------- --------
Total operating expenses 29,768 29,559 29,472 27,916 27,459 28,175 28,953 23,529
-------- -------- -------- -------- -------- -------- -------- --------
Operating income 9,770 7,027 2,717 2,471 7,808 2,069 9,814 16,759
Other income, net 380,832 1,783 1,361 1,468 1,033 895 979 1,144
-------- -------- -------- -------- -------- -------- -------- --------
Income before income taxes 390,602 8,810 4,078 3,939 8,841 2,964 10,793 17,903
Income taxes 153,462 2,852 561 1,484 3,215 1,153 3,896 6,384
-------- -------- -------- -------- -------- -------- -------- --------
Net income $237,140 $ 5,958 $ 3,517 $ 2,455 $ 5,626 $ 1,811 $ 6,897 $ 11,519
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
AS A PERCENTAGE OF REVENUES
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues 52.2 52.1 53.9 55.0 53.6 55.1 55.1 53.5
----- ----- ----- ----- ----- ----- ----- -----
Gross profit 47.8 47.9 46.1 45.0 46.4 44.9 44.9 46.5
----- ----- ----- ----- ----- ----- ----- -----
Operating expenses:
Research and development 15.3 15.4 17.4 17.5 14.4 17.2 12.3 9.8
Selling, general and administrative 20.7 23.3 24.8 23.8 21.7 24.6 21.3 17.4
----- ----- ----- ----- ----- ----- ----- -----
Total operating expenses 36.0 38.7 42.2 41.3 36.1 41.8 33.6 27.2
----- ----- ----- ----- ----- ----- ----- -----
Operating income 11.8 9.2 3.9 3.7 10.3 3.1 11.4 19.3
Other income, net 460.0 2.3 2.0 2.2 1.4 1.3 1.1 1.3
----- ----- ----- ----- ----- ----- ----- -----
Income before income taxes 471.8 11.5 5.8 5.8 11.6 4.4 12.5 20.7
Income taxes 185.3 3.7 0.8 2.2 4.2 1.7 4.5 7.4
----- ----- ----- ----- ----- ----- ----- -----
Net income 286.4% 7.8% 5.0% 3.6% 7.4% 2.7% 8.0% 13.3%
===== ===== ===== ===== ===== ===== ===== =====
</TABLE>
See accompanying notes to consolidated financial statements.
28
<PAGE> 29
ADVANCED FIBRE COMMUNICATIONS, INC.
SCHEDULE II - VALUATION ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
ADDITIONS
---------------------------
BALANCE AT CHARGED TO CHARGED DEDUCTIONS BALANCE
ALLOWANCE FOR BEGINNING COSTS AND TO OTHER FROM AT END OF
RECEIVABLES OF PERIOD EXPENSES ACCOUNTS ALLOWANCE PERIOD
---------------------- ----------- ----------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Year ending
December 31, 1997 $ -- 2,729 -- -- $2,729
Year ending
December 31, 1998 2,729 3,658 -- (1,061) 5,326
Year ending
December 31, 1999 5,326 (1,586) -- (304) 3,436
</TABLE>
<TABLE>
<CAPTION>
ADDITIONS
---------------------------
BALANCE AT CHARGED TO CHARGED DEDUCTIONS BALANCE
BEGINNING COSTS AND TO OTHER FROM AT END OF
RESERVE FOR INVENTORY OF PERIOD EXPENSES ACCOUNTS ALLOWANCE PERIOD
---------------------- ----------- ----------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Year ending
December 31, 1997 614 1,971 -- (1,185) 1,400
Year ending
December 31, 1998 1,400 4,949 -- (1,398) 4,951
Year ending
December 31, 1999 4,951 7,221 (113) (4,051) 8,008
</TABLE>
<TABLE>
<CAPTION>
ADDITIONS
---------------------------
BALANCE AT CHARGED TO CHARGED DEDUCTIONS BALANCE
BEGINNING COSTS AND TO OTHER FROM AT END OF
WARRANTY RESERVE OF PERIOD EXPENSES ACCOUNTS ALLOWANCE PERIOD
---------------------- ----------- ----------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Year ending
December 31, 1997 2,551 9,171 -- (6,793) 4,929
Year ending
December 31, 1998 4,929 11,504 -- (9,870) 6,563
Year ending
December 31, 1999 6,563 8,910 -- (6,575) 8,898
</TABLE>
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