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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 March 31, 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.
A Delaware I.R.S. Employer
Corporation Identification No.
68-0277743
One Willow Brook Court
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 April 28, 2000, 79,101,266 shares of common stock were outstanding.
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ADVANCED FIBRE COMMUNICATIONS, INC.
REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
TABLE OF CONTENTS
<TABLE>
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PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
March 31, 2000 and December 31, 1999...................................................2
Condensed Consolidated Statements of Income
Three months ended March 31, 2000 and 1999.............................................3
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 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................................19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................20
Item 2. Changes in Securities and Use of Proceeds....................................................20
Item 3. Defaults Upon Senior Securities..............................................................20
Item 4. Submission of Matters to a Vote of Security Holders..........................................20
Item 5. Other Information............................................................................20
Item 6. Exhibits and Reports on Form 8-K.............................................................20
</TABLE>
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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)
(Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
----------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 30,499 $ 30,261
Marketable securities 908,597 700,750
Accounts receivable, net 62,963 60,737
Inventories, net 42,551 36,717
Other current assets 5,758 5,068
----------- ---------
Total current assets 1,050,368 833,533
Property and equipment, net 59,023 56,798
Other assets 8,938 7,093
----------- ---------
TOTAL ASSETS $ 1,118,329 $ 897,424
=========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 21,791 $ 19,092
Accrued liabilities 30,338 28,578
Deferred tax liabilities 255,740 205,529
----------- ---------
Total current liabilities 307,869 253,199
Long-term liabilities 2,440 2,483
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; 79,032,411 and 78,239,326 shares
issued and outstanding in 2000 and 1999, respectively 790 782
Additional paid-in capital 246,469 232,083
Notes receivable from stockholders (97) (241)
Accumulated other comprehensive income 223,764 100,968
Retained earnings 337,094 308,150
----------- ---------
Total stockholders' equity 808,020 641,742
----------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,118,329 $ 897,424
=========== =========
</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)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
2000 1999
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<S> <C> <C>
Revenues $85,079 $67,590
Cost of revenues 45,766 37,186
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Gross profit 39,313 30,404
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Operating expenses:
Research and development 14,177 11,606
Selling, general, and administrative 16,226 15,796
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Total operating expenses 30,403 27,402
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Operating income 8,910 3,002
Other income, net 34,945 1,494
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Income before income taxes 43,855 4,496
Income taxes 14,911 1,484
------- -------
Net income $28,944 $ 3,012
======= =======
Basic net income per share $ 0.37 $ 0.04
======= =======
Shares used in basic per share computations 78,747 76,098
======= =======
Diluted net income per share $ 0.34 $ 0.04
======= =======
Shares used in diluted per share computations 83,958 79,442
======= =======
</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)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------
2000 1999
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 28,944 $ 3,012
Adjustments to reconcile net income to net cash provided by
operating activities:
Tax benefit from option exercises 9,390 1,916
Depreciation and amortization 2,948 2,780
Allowance for uncollectible accounts and returns (469) 92
Deferred income taxes (6,517) 333
Changes in operating assets and liabilities:
Accounts receivable (1,757) 10,202
Inventories (5,834) 5,866
Other assets 2,887 897
Accounts payable 2,699 610
Other liabilities 1,707 2,430
--------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES 33,998 28,138
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales of marketable securities 27,130 17,578
Maturities of marketable securities 76,189 50,912
Purchases of marketable securities (144,305) (69,838)
Purchase of property and equipment (5,126) (5,908)
Investment in development-stage company (5,468) 0
--------- --------
NET CASH USED IN INVESTING ACTIVITIES (51,580) (7,256)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of common stock options and warrants 17,820 1,644
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NET CASH PROVIDED BY FINANCING ACTIVITIES 17,820 1,644
--------- --------
INCREASE IN CASH AND CASH EQUIVALENTS 238 22,526
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 30,261 20,669
--------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 30,499 $ 43,195
========= ========
</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. 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 Annual Report on Form 10-K, for the year
ended December 31, 1999.
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
results of operations for the three month period ended March 31, 2000 are not
necessarily indicative of the operating results for the full year.
NOTE 2 INVENTORIES
Inventories are valued at the lower of first-in, first-out cost or market and
consisted of the following (in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
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<S> <C> <C>
Raw materials $ 7,933 $ 6,907
Work-in-progress 1,049 818
Finished goods 33,569 28,992
-------- --------
Inventories, net $ 42,551 $ 36,717
======== ========
</TABLE>
NOTE 3 COMPREHENSIVE INCOME
Accumulated other comprehensive income, in the equity section of our balance
sheet, is composed primarily of unrealized gains and losses on marketable
securities. We recorded an unrealized gain, net of taxes, of approximately
$110.1 million for the change in value between December 31, 1999 and March 31,
2000 in the Cisco shares we hold. We recorded an unrealized loss, net of taxes,
of approximately $5,900 for the change in value in the remainder of our
marketable securities portfolio during this same time period. Our foreign
currency translation adjustments were not significant as of March 31, 2000 or
1999. We have total comprehensive income of $110.1 million and $0,
respectively, for the quarters ended March 31, 2000 and 1999, primarily as a
result of the Cisco unrealized gain.
NOTE 4 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. If an amended complaint is filed,
it is probable that defendants will again move to dismiss. Limited discovery has
occurred, and only limited discovery is expected to occur pending filing of a
further amended complaint and a ruling on
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the motion to dismiss that 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 5 OTHER INCOME
Included in other income is $32.75 million in cash that Marconi Communications
Inc. (Marconi) paid to us related to the settlement of litigation in February
2000.
NOTE 6 SEGMENT REPORTING
We derive substantially all of our revenues from sales of the UMC1000 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 first quarter of 2000, revenues from sales to customers, excluding
royalties, were $84.9 million, compared with $67.5 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 $67.0 million as of March 31, 2000
from $62.9 million as of December 31, 1999. Long-lived assets, excluding
deferred tax assets, located in foreign countries decreased to $0.9 million as
of March 31, 2000 from $1.1 million as of December 31, 1999.
NOTE 7 POOLING OF INTERESTS COMBINATION
In April 2000, we announced a definitive agreement to acquire privately-held GVN
Technologies, Inc. (GVN), a developer of Integrated Access Device equipment for
the service provider market. Under terms of the agreement, approximately 1.1
million shares and options to purchase AFC common stock will be exchanged for
all outstanding shares and options of GVN. This acquisition will be accounted
for as a pooling of interests and is expected to be completed in the second
quarter of 2000, subject to various closing conditions.
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.
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The computation of shares and net income used in the calculation of basic and
diluted net income per share for the three month periods ended March 31, 2000
and 1999 (in thousands, except per share data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
2000 1999
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<S> <C> <C>
Net income $28,944 $ 3,012
======= =======
Shares used in basic per share calculations,
actual weighted average common shares
outstanding for the period 78,747 76,098
Weighted average number of shares upon
exercise of dilutive options and warrants 5,211 3,344
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Shares used in diluted per share calculations 83,958 79,442
======= =======
Basic net income per share $ 0.37 $ 0.04
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Diluted net income per share $ 0.34 $ 0.04
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</TABLE>
NOTE 9 CERTAIN ACCOUNTING PRONOUNCEMENTS
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 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. We are currently evaluating the requirements and the impact of SFAS
No. 133.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Except for the historical financial information contained herein, the following
discussion and analysis may contain "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Such statements include
declarations regarding 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:
- - Potential Fluctuations in Future Operating Results and Seasonality
- - Customer Concentration
- - Delays and Defects in Product Development and Product Feature Releases
- - Risks Associated with International Markets
- - Competition
- - Risk of Failure to Manage Expanding Operations
- - Concentrated Product Line, Uncertainties Associated with New Product
Features and Rapid Technological Change
- - Limited Protection of Proprietary Technology and Risk of Third-Party Claims
of Infringement
- - Dependence on the Telecommunications Industry
- - Dependence on Sole Source and Limited Number of Third-Party Manufacturers
and Support Organizations
- - Dependence on Key Personnel
- - Risks of Acquisitions Adversely Affecting Our Operations
and Financial Results
- - Risks Associated with Pending Litigation
- - Compliance with Regulations and Industry Standards
- - Year 2000 Readiness
- - 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 7 of this Form 10-Q.
OVERVIEW
AFC designs and manufactures end-to-end distributed Multi-Service Access
Solutions for the local loop. The UMC1000 is a global product family consisting
of a variety of Multi-Service Access Platforms with integrated optics and
intelligent customer premises equipment. The platform utilizes a hybrid ATM/TDM
architecture which provides a variety of loop interfaces for POTS, ISDN,
T-1/E-1, HDSL, and ADSL services over various feeder transmission options,
including copper, fiber, and wireless. We also design and manufacture
environmentally hardened outside plant cabinets and technology ranging from 48
to 2,000 lines, as well as indoor cabinets ranging from 48 to 480 lines.
RESULTS OF OPERATIONS
REVENUES. In the first quarter ended March 31, 2000, our revenues increased
$17.5 million, or 25.9%, to $85.1 million as compared with $67.6 million for the
same period in 1999.
The increase in revenues was primarily due to higher U.S. revenues.
U.S. revenues in the first quarter of 2000 were $76.1 million compared with
$58.9 million in the first quarter of 1999, an increase of 29.2%. The
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increase in U.S. revenues for the period was mainly due to increased sales to
competitive local exchange carriers, regional Bell operating companies, and
Tellabs, Inc.
International revenues totaled $9.0 million in the first quarter of 2000,
compared with $8.7 million for the comparable period in 1999. The increase in
international revenues was primarily due to higher sales to customers in France,
the Caribbean, and Japan. International revenues represented 10.6% and 12.9% of
total consolidated revenues, respectively.
In the first quarter of 2000, WinStar Communications, Inc. (WinStar) accounted
for 24.9% of total revenues and Sprint North Supply, a subsidiary of Sprint
(Sprint), accounted for 11.4%. For the quarter ended March 31, 1999, WinStar
accounted for 13.6% of total revenues, and Sprint accounted for 13.0%. 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
product from us at current levels, if at all. Marconi is our only customer who
has entered into an agreement requiring it to purchase a minimum amount of
product from us. The loss of one or more principal customers may result in lower
revenues and decreased net income.
GROSS PROFIT. In the first quarter of 2000, gross profit as a percentage of
revenues grew to 46.2% from 45.0% in the same period in 1999.
The increase in gross profit in the first quarter of 2000 as compared with 1999
was primarily due to the gross profit associated with the product mix sold to
particular customers and the higher proportion of sales to U.S. customers, which
tend to have higher gross profit margins.
In the future, gross profit 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 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 first quarter of 2000, research and development
expenses increased $2.6 million to $14.2 million compared with $11.6 million for
the same period in 1999 and represented 16.7% and 17.2% of total revenues,
respectively.
The increase in research and development expenses for the first three months of
2000, as compared with the same period in 1999, was primarily due to increased
usage of outside services for testing and product development, hiring and
relocation costs, and depreciation on test equipment used to develop and test
new products and features. 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. All research and development costs to date
have been expensed as incurred.
SELLING, GENERAL, AND ADMINISTRATIVE. For the first quarter of 2000, selling,
general, and administrative expenses increased $0.4 million to $16.2 million
compared with $15.8 million for the same period in 1999 and represented 19.0%
and 23.4% of total revenues, respectively.
The increase in selling, general, and administrative expenses in the first
quarter of 2000, as compared with 1999, is primarily due to higher compensation
and benefits, donations for educational purposes, increased travel-related
expenses, and higher usage of outside services, partially offset by decreases in
litigation and legal costs. We plan to continue to allocate resources to our
sales, marketing, and administrative functions to
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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 first quarter of 2000, other income increased $33.4 million
from $1.5 million in the first quarter of 1999 to $34.9 million. The increase
was 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 first quarter of 2000 and 1999, we recorded income taxes
at an effective rate that approximated the combined federal and state statutory
rates. The effective tax rate for the first quarter of 1999 was 33.0%; however,
the effective rate for the entire year of 1999 was 39.0%. The increase in the
tax rate during 1999 was primarily due to the gain arising from the conversion
of our investment in Cerent Corporation, Inc. into Cisco Systems, Inc. common
stock in November 1999. Our effective tax rate in 2000 is 34.0%. Although the
tax rate in 2000 has decreased from the rate for the entire year of 1999, the
rate is higher than the first quarter of 1999 primarily due to the gain arising
from settlement of the Marconi litigation in February 2000.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2000, cash and cash equivalents were $30.5 million, compared
with $30.3 million as of December 31, 1999. Marketable securities totaled $908.6
million as of March 31, 2000, compared with $700.8 million as of December 31,
1999. The $207.8 million increase between periods was primarily a result of the
$166.9 million unrealized gain, before taxes, for the change in value of the
Cisco shares we hold.
Operating activities for the first three months of 2000 generated net cash of
$34.0 million. This was primarily the result of net income, which included a
$32.75 million litigation settlement, and adjustments for non-cash activities
such as tax benefits from option exercises. Net cash of $51.6 million was used
in investing activities in the first three months of 2000, primarily as a result
of purchases of marketable securities.
We have a $30.0 million unsecured bank line with two banks, which 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 March 31, 2000, $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 financial
covenants. As of March 31, 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 March
31, 2000, there were approximately $3.1 million in foreign exchange contracts
outstanding.
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 (post-split) 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 plan to hedge approximately 530,000 (post-split) additional
shares of Cisco common stock expected to be received in our second quarter 2000,
unless Cisco makes claims against such shares under the terms of their November
1, 1999 acquisition of Cerent Corporation, Inc.
We have lease lines totaling $4.6 million that were used for equipment and
furniture purchases.
We believe that our existing cash and short-term investments, available credit
facilities and cash flows from operating and financing activities will be
adequate to support our financial resource needs, including working capital
requirements, capital expenditures, and operating lease obligations, for the
next twelve months.
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SEASONALITY
Many of our customers install a portion of the UMC1000 system in outdoor
locations. Because of this, shipments of the UMC1000 product family are subject
to the effects of seasonality, with fewer installation projects scheduled for
the winter months. The majority of our sales are to companies in the U.S., and,
accordingly, we believe the effect of seasonality will generally cause our
revenues in the quarter ended March 31 to be lower than revenues in the
preceding quarter ended December 31. Revenues in the first quarter of 2000 were
higher than the preceding quarter due, in part, to higher international revenue
levels.
YEAR 2000 READINESS DISCLOSURE
We did not experience any material disruptions to our business, results of
operations, or the UMC1000 product family as a result of the transition from
1999 to 2000. We have retained 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 suppliers. 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 have not incurred any expenses in
relation to Y2K readiness beyond the $73,000 we spent through 1999.
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.
POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS AND SEASONALITY. Our
operating results have been, and will continue to be, affected by a wide variety
of factors, some of which are outside of 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 due to vendor allocation
- - Rapidly changing industry standards and customer needs
- - Ability to introduce new product features and technologies on a timely
basis
- - Timing of new product feature introductions or announcements by us or 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 the UMC1000 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
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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 UMC1000 product family in the local loop.
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 UMC1000 product family
relative to planned levels could result in, among other things, higher operating
expenses and lower 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 venture 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 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" as it pertains to this matter on page 19 of this
Quarterly Report on Form 10-Q.
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 of 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 4 - "Commitments and Contingencies" as it pertains to
this matter on page 5 of this Quarterly Report on Form 10-Q.
CUSTOMER CONCENTRATION. For the quarter ended March 31, 2000, WinStar accounted
for 24.9% of total revenues, and Sprint accounted for 11.4%. For the quarter
ended March 31, 1999, WinStar accounted for 13.6% of total revenues, and Sprint
accounted for 13.0%. No other single customer accounted for 10% or more of total
revenues in either 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. Marconi is our only customer who has entered into an
agreement requiring it to purchase a minimum amount of product from us. No other
customer has a minimum purchase agreement with us. There can be no assurance
that significant customers will continue to purchase product at current levels,
if at all. In the event that a significant existing customer merges with another
company, there can be no
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<PAGE> 14
assurance that such customer will continue to purchase the UMC1000 product
family. The loss of one or more significant customers could, among other things,
decrease revenues and net income, and increase our dependency on our remaining
significant customers.
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, 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 UMC1000 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 UMC1000
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.
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
- - 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 10.6% of our total revenues in the quarter ended
March 31, 2000 and 12.9% in the comparable period of 1999. 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 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
obtain 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 UMC1000 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
13
<PAGE> 15
successful joint ventures or strategic relationships will result. We may be
unable to increase international sales of the UMC1000 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, which could
result in, among other things, delays or loss of customer orders, decreased
revenues, and lower net income.
COMPETITION. Many of our competitors have more extensive financial, marketing
and technical resources than AFC and enjoy superior name recognition in the
market. Our primary competitors include: ADC Telecommunications, Inc., Carrier
Access Corporation, Cisco Systems, Inc., 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 will also serve 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 UMC1000 product family line and will
act 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 ETSI
version of the narrowband UMC1000 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, those
member companies will gain a worldwide, non-exclusive, royalty-free, irrevocable
license to use an older version of narrowband UMC1000 technology in January
2005, 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.
RISK OF FAILURE TO MANAGE EXPANDING OPERATIONS. 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.
14
<PAGE> 16
We recently 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.
CONCENTRATED PRODUCT LINE, UNCERTAINTIES ASSOCIATED WITH NEW PRODUCT FEATURES
AND RAPID TECHNOLOGICAL CHANGE. Substantially all of our revenues are derived
from the UMC1000 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 UMC1000 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 UMC1000 product family, or product obsolescence, among others.
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 UMC1000 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 UMC1000 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 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 UMC1000 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 UMC1000 product family,
causing customers to defer purchasing our equipment.
LIMITED PROTECTION OF PROPRIETARY TECHNOLOGY AND RISK OF THIRD-PARTY CLAIMS OF
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 UMC1000 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 the UMC1000 product family that guarantees AFC minimum purchases
or specified payments over the next three years.
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<PAGE> 17
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.
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.
DEPENDENCE ON THE TELECOMMUNICATIONS 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 UMC1000 product family. 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 UMC1000
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 UMC1000 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.
DEPENDENCE ON SOLE SOURCE AND LIMITED NUMBER OF THIRD-PARTY MANUFACTURERS AND
SUPPORT ORGANIZATIONS. Certain components used in our products, including our
proprietary ASICs, codec components, 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. 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, lower revenues, gross profit, net income, and cash flows.
In particular, we rely upon:
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- - Flextronics International Ltd. and Solectron International USA, Inc. to
manufacture PCBAs
- - Siemens Microelectronics, Inc. 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
- - PairGain Technologies, Inc. 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.
DEPENDENCE ON KEY PERSONNEL. 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 effect of key
personnel on our business, financial condition and results of operations.
RISK OF ACQUISITIONS ADVERSELY AFFECTING 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. In April
2000, we agreed to acquire GVN Technologies, Inc., a privately-held developer
of Integrated Access Devices, for approximately 1.1 million shares of our
common stock, including shares issuable pursuant to our assumption of GVN's
stock options. We plan to complete this acquisition in the second quarter of
2000. Despite the substantial resources we have expended in researching and
negotiating this acquisition, it is subject to several closing conditions, and
there cannot be any assurance that it will occur.
Our acquisition of GVN and any future acquisitions 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 UMC1000 product family
- - Possible loss of acquired companies' employees, customers, and vendors
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<PAGE> 19
- - Difficulties in completing the development and application of acquired
technologies
- - 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, if completed, 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.
RISKS ASSOCIATED WITH PENDING LITIGATION. We are a party to certain legal
proceedings as described in Note 4 - "Commitments and Contingencies" on page 5
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.
COMPLIANCE WITH REGULATIONS AND INDUSTRY STANDARDS. The UMC1000 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 UMC1000 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 (ISO) 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. There can be no assurance that we
will maintain such certification. The failure to maintain such certification may
preclude selling the UMC1000 product family in certain markets and could
adversely affect our ability to compete with other vendors of telecommunications
equipment.
We are currently working to achieve compliance and certification to TL9000, a
quality standard designed specifically for the telecommunications industry.
There can be no assurance that we will attain certification.
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Our ability to compete with other telecommunications equipment vendors could be
adversely affected should we fail to maintain interoperability with other
companies or adopt or maintain industry standards in the UMC1000 product family.
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 UMC1000 product family. Uncertainty regarding
future policies combined with emerging new competition may also affect the
demand for telecommunications products such as the UMC1000 system.
YEAR 2000 READINESS. We did not experience any material disruptions to our
business, results of operations, or the UMC1000 product family as a result of
the transition from 1999 to 2000. We have retained our year 2000 (Y2K)
contingency plans in case of any potential Y2K-related events that may arise in
the first half of 2000. 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We held approximately 10.6 million shares of Cisco common stock as of March 31,
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 (collar), 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 March 24, 2000, the last day of our first fiscal quarter, of $79.375
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 $25.8 million, net of income
taxes. See the additional information with respect to market risk set forth
under Item 7A of our 1999 Annual Report of Form 10-K.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See discussion in Part I - "Note 4 Commitments and Contingencies" beginning on
page 5 of this Quarterly Report on Form 10-Q.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS:
(a). CHANGES IN SECURITIES: None
(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:
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a). EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------- --------------------------------------------------------------------
<S> <C>
27.0 Financial data schedule.
27.399 Financial data schedule (restated) for the three month period ended
March 31, 1999.
</TABLE>
(b). REPORTS ON FORM 8-K:
Form 8-K dated February 9, 2000, regarding the Registrant's
execution of a hedging transaction with respect to shares of
Cisco Systems, Inc. common stock owned by the Registrant.
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<PAGE> 22
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: May 5, 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)
21
<PAGE> 23
ADVANCED FIBRE COMMUNICATIONS, INC.
INDEX TO EXHIBITS FILED WITH THIS CURRENT QUARTERLY REPORT ON FORM 10-Q:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------- --------------------------------------------------------------------
<S> <C>
27.0 Financial data schedule.
27.399 Financial data schedule (restated) for the three month period ended
March 31, 1999.
</TABLE>
22
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 30,499
<SECURITIES> 908,597
<RECEIVABLES> 65,930
<ALLOWANCES> (2,967)
<INVENTORY> 42,551
<CURRENT-ASSETS> 1,050,368
<PP&E> 84,344
<DEPRECIATION> (25,321)
<TOTAL-ASSETS> 1,118,329
<CURRENT-LIABILITIES> 307,869
<BONDS> 0
0
0
<COMMON> 790
<OTHER-SE> 807,230
<TOTAL-LIABILITY-AND-EQUITY> 1,118,329
<SALES> 84,899
<TOTAL-REVENUES> 85,079
<CGS> 43,123
<TOTAL-COSTS> 45,766
<OTHER-EXPENSES> 30,403
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (2,238)
<INCOME-PRETAX> 43,855
<INCOME-TAX> 14,911
<INCOME-CONTINUING> 28,944
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 28,944
<EPS-BASIC> 0.37
<EPS-DILUTED> 0.34
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 43,195
<SECURITIES> 91,432
<RECEIVABLES> 68,612
<ALLOWANCES> (5,418)
<INVENTORY> 47,194
<CURRENT-ASSETS> 254,321
<PP&E> 66,735
<DEPRECIATION> (14,116)
<TOTAL-ASSETS> 317,496
<CURRENT-LIABILITIES> 40,432
<BONDS> 0
0
0
<COMMON> 766
<OTHER-SE> 274,127
<TOTAL-LIABILITY-AND-EQUITY> 317,496
<SALES> 67,489
<TOTAL-REVENUES> 67,590
<CGS> 35,195
<TOTAL-COSTS> 37,186
<OTHER-EXPENSES> 27,402
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (1,298)
<INCOME-PRETAX> 4,496
<INCOME-TAX> 1,484
<INCOME-CONTINUING> 3,012
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,012
<EPS-BASIC> 0.04
<EPS-DILUTED> 0.04
</TABLE>
