<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
------------------------
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
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.
<TABLE>
<S> <C>
A DELAWARE I.R.S. EMPLOYER
CORPORATION IDENTIFICATION NO.
68-0277743
</TABLE>
ONE WILLOW BROOK COURT
PETALUMA, CALIFORNIA 94954
TELEPHONE: (707) 794-7700
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 13, 2000, 78,999,803 shares of Advanced Fibre Communications,
Inc. common stock were outstanding, and the aggregate market price of shares
held by non-affiliates was approximately $5,414,727,109. (Solely for the purpose
of calculating the preceding amount, all directors and officers of the
registrant are deemed to be affiliates.)
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Annual Report to Stockholders for the year ended
December 31, 1999 and the Proxy Statement issued in connection with the 2000
Annual Meeting of Stockholders to be held on May 25, 2000, are incorporated by
reference in Parts II and III of this report.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
ADVANCED FIBRE COMMUNICATIONS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I.
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 18
Item 3. Legal Proceedings........................................... 19
Item 4. Submission of Matters to a Vote of Security Holders......... 19
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 20
Item 6. Selected Consolidated Financial Data........................ 20
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 20
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 20
Item 8. Financial Statements and Supplementary Data................. 21
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 21
PART III.
Item 10. Directors, Executive Officers and Key Employees of the
Registrant.................................................. 22
Item 11. Executive Compensation...................................... 25
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 25
Item 13. Certain Relationships and Related Transactions.............. 25
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 26
</TABLE>
i
<PAGE> 3
PART I.
Except for the historical financial information contained herein, the
following discussion may contain "forward-looking statements" that have been
made pursuant to the provisions of the Private Securities Litigation Reform Act
of 1995. Such statements include declarations regarding the intent, belief,
estimates, current plans, or expectations of Advanced Fibre Communications, Inc.
(AFC) and its management. Any such forward-looking statements are not guarantees
of future performance and involve a number of risks and uncertainties. Actual
results could differ materially from those indicated by such forward-looking
statements. Among the important factors that could cause actual results to
differ materially from those indicated by such forward-looking statements are
those set forth beginning on page 10 in "Certain Factors That Might Affect
Future Operating Results," as well as those noted in the documents incorporated
herein by reference. Unless required by law, we undertake no obligations to
update publicly any forward-looking statements, whether as a result of new
information, future events or otherwise. However, readers should carefully
review the risk factors set forth in other reports or documents we file from
time to time with the Securities and Exchange Commission, particularly the
Quarterly Reports on Form 10-Q and any current reports on Form 8-K.
ITEM 1. BUSINESS
OVERVIEW
AFC designs and manufactures end-to-end distributed multi-service access
solutions for the portion of the telecommunications network between the
carrier's central office and its subscribers, often referred to as the "local
loop." Our Universal Modular Carrier 1000(TM) (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 asynchronous transfer mode/time division multiplexing (ATM/TDM)
architecture which provides a variety of loop interfaces for narrowband analog
and digital services including plain old telephone service (POTS), integrated
services digital network (ISDN), 1.544/2.048 million bits per second
point-to-point dedicated digital circuit (T-1/E-1), high bit rate digital
subscriber line (HDSL/HDSL2), and asymmetric digital subscriber line (ADSL)
services. This platform also enables the delivery of broadband digital
subscriber line (DSL) technologies including discrete multitone (G.DMT), ADSL,
G.Lite, HDSL, HDSL2, symmetrical digital subscriber line (SDSL), and very high
data rate digital subscriber line (VDSL) (collectively referred to as "xDSL")
services to end users not served directly from a central office. These services
are supported over various feeder transmission technologies 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. We believe we were the first
vendor to ship ADSL modules that integrate ADSL circuits, POTS circuits, and
splitters onto a single ADSL x+y(TM) line card for environmentally hardened
multi-service access systems.
Telephone companies, cable TV operators, wireless network providers and
other communications service providers are building the infrastructure required
to offer high-speed Internet access, data, video, telephony, and other
interactive multimedia services to residential and business customers. The last
mile, or local loop, of the communications network has been forecasted to be the
fastest growing area for future communications equipment spending by
communications service providers. We develop, market, and support products that
enable telecommunications companies and other service providers to connect
subscribers to the central office switch for voice and data communications.
We have deployed more than 3 million POTS/POTS equivalent access lines and
over 4.5 million DS0 equivalents in over 25 countries worldwide. DS0 is a
worldwide standard speed of 64,000 bps for digitizing voice conversation using
pulse code modulation. In the United States, Sprint, WinStar, and SBC, among
others, deploy the UMC1000 product family. The UMC1000 product family has also
been deployed in South Africa, France, Canada, Venezuela, Mexico, Brazil,
Panama, the Caribbean, China, Hong Kong, and Japan, among other countries. The
UMC1000 product family is distributed and serviced through a direct sales force,
and to a lesser extent distributors, in the United States, and through direct
sales, distributors and sales representatives in international markets. This
multiple-channel distribution approach allows customers to
1
<PAGE> 4
select the channel that best addresses their specific needs and provides AFC
with broad coverage of global markets.
AFC was incorporated in California in May 1992 and reincorporated in
Delaware in September 1995. We completed an initial public offering on October
1, 1996 and a secondary offering on February 12, 1997. Our principal executive
offices are located at One Willow Brook Court, Petaluma, California 94954, and
the telephone number at that address is (707) 794-7700. We can also be reached
through our world wide web site at http://www.afc.com. Information on our
website is not part of this report.
We operate on a 13-week fiscal quarter, comprised of four, four and five
week months ending on the last Saturday of the last week of the five-week month.
For presentation purposes only, the first three fiscal quarters are shown as
ending on March 31, June 30, and September 30, and the fourth fiscal quarter and
fiscal year are shown as ending on December 31. As used in this report, 1999,
1998, and 1997 refer to the fiscal years ending December 31, 1999, 1998 and
1997, respectively, unless the context indicates otherwise.
INDUSTRY BACKGROUND
Over the past twenty years, the telecommunications industry has experienced
significant advances both technologically and architecturally. These changes
have been prompted by the demand for new and expanded services, increased
competition among telecom providers, and the need to leverage existing networks
and reduce operating costs.
The Telecommunications Act of 1996 opened the telecom markets to new
entrants and created an environment in which telecom providers began offering
expanded services. Growth in the Internet, electronic commerce, and
telecommuting increased pressure on telecom providers to supply a broader range
of voice and data services over faster networks. Today, over 7,500 registered
Internet service providers (ISPs) in the U.S. have helped drive the demand for
faster transmission and higher broadband capacity. Networks are increasingly
required to transmit large volumes of data and video for communicating
information, conducting business, and delivering entertainment.
In addition, both public and private network customers are requesting the
convergence of voice, Internet/ data and video traffic into integrated
multimedia services transmitted over one network. These demands have prompted
the development and use of broadband networks, which feature the improved
reliability and increased speed of transmission generally required for data and
video service over the network.
Specifically, the industry term "broadband" refers to all transmission
speeds of T-1 and higher. Growth in broadband network applications has resulted
in increased infrastructure investment by network operators in order to expand
network capacity and provide new applications and services to meet users' needs.
However, the broadband capacity of the access network has not kept pace with the
growth in broadband network applications, particularly in the local loop portion
between the central office and the subscriber. For the most part, standard
analog modems have reached their data-carrying capacity in the existing local
loop network and telecom providers are seeking solutions to ease the congestion
in this portion of the network.
E.VOLVING ACCESS SOLUTIONS
We use the term "e.volving" to describe the evolutionary process occurring
in today's networks and the need to adapt to the capabilities and requirements
of tomorrow's networks.
The UMC1000 product family provides both narrowband and broadband services
to customers. In 1996, in response to the predicted growth in demand for
high-speed Internet access and other broadband services, we engineered a next
generation digital loop carrier with a chassis equipped with a three-bus
backplane architecture consisting of a TDM bus, a 520 Mbps ATM high speed cell
bus, and a 5.3 Gbps synchronous optical network/synchronous digital hierarchy
bus (SONET/SDH). This system began shipping in the first quarter of 1997.
This hybrid voice and data architecture allows the UMC1000 product family
to transition between TDM, Frame Relay, and ATM networks. We believe the system
is economically scalable up to 2,000 lines and can
2
<PAGE> 5
transition from a narrowband to broadband access system. Because of this
flexibility, the UMC1000 product family offers a cost-effective multi-access
service solution with a wide variety of features and advanced services that can
be added or changed as a customer's network grows.
We have invested extensive engineering resources in the development of
custom ASICs, such as the narrowband gate array and broadband gate array. We
have finalized the design and testing of the Cellennia(TM) Cell Bus Gate Array.
This custom ASIC consists of over 1.5 million gates and is the largest ASIC AFC
has ever designed. Cellennia is the key technology that activates the high-speed
cell bus, providing a fully distributed broadband architecture. This distributed
broadband architecture allows AFC to continue to offer its "pay as you grow"
philosophy into the deployment of broadband services. Cellennia allows traffic
to move smoothly between the TDM domain and the ATM Cell domain, and integrates
ATM/TDM internetworking, cell switching, cell bus arbitration, cell mapping, and
baseline quality of service onto a single chip. The integration of these
functions substantially reduces power consumption, and we anticipate will cut
the cost by more than 50% over that of a discrete chip design.
EXPANDING PRODUCT PORTFOLIO
Our product platform consists of a wide range of products:
THE UMC1000 MULTI-SERVICE ACCESS PLATFORM
The UMC1000 product family consists of the UMC1000 120-line unit and the
UMC1048 48-line unit. Both units can be installed in a variety of network
configurations to support the varying geographic distribution of subscriber
bases. The units can be linked together to form a range of larger line systems
up to 2,000 lines. Both units provide narrowband and broadband services in a
single platform, from POTS to xDSL over copper wire, fiber optic cable or
wireless transport media.
OUTSIDE PLANT CABINETS
For remote applications requiring an outdoor housing, we offer a wide
variety of cabinets to provide the most cost-effective solution for each
application. From 48 to 2,000 lines, our cabinets incorporate an integrated
platform to save space and power. All outdoor cabinets are environmentally
controlled, easy to install, and fully compatible with the UMC1000 platform and
its feature set.
INDOOR CABINETS
Universities, hospitals, banks, ISPs, and business centers require POTS and
high speed data services such as xDSL, fractional or full T-1/E-1, and ISDN. In
order to reduce cost, telecommunications companies can deliver these services
from low-cost, secure indoor cabinets that support rapid installation in
stairwells, closets, or basements, occupying minimal valuable floor space. Our
indoor cabinets meet these needs with 48 to 480 lines, helping
telecommunications companies minimize their capital outlay while extending new
and existing fiber and copper plant.
EMS1000(TM) ELEMENT MANAGEMENT SYSTEM
The convergence of voice and data communications, and the
Telecommunications Act of 1996, have focused the telecommunications environment
on advanced services that provide reliable, high-performance communications
networks. Providers now need element management system (EMS) solutions that
integrate seamlessly into the various network management systems and operation
support systems (OSS) of yesterday, today and tomorrow. Our EMS is a valuable
element of the UMC1000 product line, which already provides a local craft user
interface and support for legacy Telcordia or industry standard OSSs via a
simple network management protocol. The EMS provides a centralized graphic user
interface for point-and-click UMC1000 network management. The EMS's flexible
telecommunications management network architecture, centralized management
capabilities, and customized applications integrate with external network
management systems to greatly enhance the service provider's ability to manage
UMC1000 networks.
3
<PAGE> 6
INTEGRATED ADSL
In 1999, we introduced the ADSL x+y family of ADSL cards that covers a wide
range of integrated ADSL-plus-POTS line cards. This family will include an
International Telecommunications Union-compliant ADSL G.Lite version in 2000.
With a patent pending for our integrated ADSL technology, the ADSL x+y product
portfolio is designed for cost effective, widespread deployment of high-speed
data services with optional derived voice for residential and business markets.
The ATM-enabled ADSL x+y product family of line cards offers a combination of
"x" ADSL circuits and optional "y" life-line POTS circuits with central office
band splitters integrated on single line cards that plug into the UMC1000
multi-service access platform. The new G.Lite, ADSL 6+6, and ATM based ADSL 2+6
card expand our product family from the original full-rate ADSL 2+6.
EMAX(TM) -- EQUIPMENT MAXIMIZATION SYSTEM
In September 1999, we announced EMAX, a product designed for revitalizing
existing outside plant housings with higher density and more advanced services
capability for third-party housing equipment. The self-contained EMAX kit fits
into most legacy digital loop carrier (DLC) cabinets, eliminating the need for
additional right-of-way, easements, and permits. Outside plant labor, such as
engineering, construction, equipment installation, and splicing, is minimized by
re-using the existing network infrastructure. EMAX can be installed in as little
as four hours, and at a fraction of the cost of the original first generation
DLC system. EMAX can easily fit into the space of a typical non-AFC DLC channel
bank. EMAX increases the capacity and density of the legacy infrastructure,
often more than doubling the capacity of the cabinet and offering the same range
of narrowband and broadband services available in any UMC1000 system. This added
density enables carriers to meet demand for second and third line POTS services
in areas where standard twisted copper pair phones lines are exhausted.
CNX1024(TM) -- CURBSIDE NETWORK ACCESS SYSTEM AND
FIBREMAX1440(TM) -- HYBRID FIBRE/POWER NODE
Also in September 1999, we introduced the Curbside Network Access System
CNX1024 and the FibreMAX1440 Hybrid Fibre/PowerNode, for a full end-to-end
fiber-to-the-curb (FTTC) system with head-end FTTC powering and fiber
distribution node. This system allows carriers to provide On-Demand Multi-
Band(TM), such as advanced broadband services, closer to the edge of the network
and closer to the customer. The CNX1024 system utilizes proven UMC1000
multi-service technology, enabling carriers to cost-effectively add
revenue-generating services.
ONX1012(TM) -- OPTICAL NETWORK ACCESS SYSTEM AND OCX103(TM) -- OPTICAL
CUSTOMER ACCESS SYSTEM
In November 1999, we introduced the ONX1012 Optical Network Access System
and the OCX103 Optical Customer Access System. These products are packet-aware
SONET/SDH add-drop optical systems that support TDM, packet, and cell services,
and are targeted to deliver high-value services to business subscribers. The
ONX1012 creates a fully integrated optical access solution that can improve the
economics for carrier networks, saving up to 75% in overall network costs.
ONX1012 can deliver services from TDM private line to ATM, to transparent local
area network service, and broadband Internet services. The OCX103 resides at the
customer premise, connecting the subscriber's voice and data to ONX1012 nodes or
to any other ATM-compliant network element. The OCX103 provides the customer
with familiar data/telephony interfaces, such as T-1/E-1, and Ethernet, and also
adds embedded software that lets carriers quickly set up value-added voice and
data services.
INDUSTRY ALLIANCES
We seek to enhance our products and technology by forming strategic
alliances with other technology leaders for mutual product leverage and
integration with the UMC1000 system. In 1999, we formed a strategic alliance
with Atmosphere Networks, a leader in packet-aware optical transmission
networks. The agreement includes joint development and interoperability, and
enlists Atmosphere Networks to provide next-generation ATM-based SONET/SDH
solutions to further expand AFC's end-to-end access product portfolio. In
4
<PAGE> 7
February 2000, we signed an agreement with Fujitsu Telecommunications Europe
Ltd. that will incorporate our next generation digital loop carrier products
into Fujitsu's multi-service access portfolio with both parties contributing
expertise to develop broadband solutions for Europe.
We have product and technology alliances with ADTRAN, Inc. and PairGain
Technologies, Inc. to collaborate on high speed digital subscriber line
solutions. We also have a joint marketing agreement with VINA Technologies which
combines VINA's Multiservice T-1 Integrator(R) and the UMC1000 with a GR-303
interface, integrating voice and data traffic into a single T-1 line. We have
entered into alliances with 3Com Corporation, Aware, Inc., Cayman Systems,
Centillium Technology Corporation, Efficient Networks, Inc., and Redback
Networks, Inc., to enable end-to-end broadband/ADSL network solutions for our
customers.
In 1999, we continued our strategic alliances with Sourcenet Corporation,
which has enlisted Efficient Networks, Inc., Minerva Systems, Newbridge
Networks, nCUBE, and Stellar One Corporation to develop and produce a complete
end-to-end advanced telecommunications services solution called On Demand
Network(TM) (ODN). ODN uses ATM packet switching over DSL to provide high speed
"always on" Internet access, data transport, true video on demand, multichannel
broadcast video, pay per view, and voice service over a single copper pair
connection to the home. ODN is compatible with existing telephones, televisions,
and personal computers, and the service is affordable from a total cost of
ownership perspective.
MARKETS AND CUSTOMERS
In recent years, traditional voice services in the U.S. and Canada have
grown at approximately 3% per year, with two-thirds of subscribers served
directly from telephone central offices. Remote access devices, such as remote
switching units or DLCs, serve the remaining one-third of the subscriber market.
However, the proportion of subscribers served by remote carrier systems is
growing rapidly, and is expected to reach 50% by mid-2001.
An estimated 30 million personal computers are connected to the Internet,
mostly with traditional dial-up modem technology over a TDM network. As the
number of computers connected to the Internet approaches 50 million in North
America, we believe that the limitations associated with a TDM infrastructure
will manifest and severely limit the growth and functionality of the network.
Growing market demand for high bandwidth services is forcing telecom providers
to reevaluate their network planning models and create new ones. Network
planners and engineers responsible for this emerging network face a complex
problem: how to effectively implement a network that optimizes diverse services
today such as voice, video, and data through overlay networks and discrete
network elements, while maintaining the design requirements for tomorrow's
network.
The solution from AFC's perspective is an integrated multi-service access
platform that provides today's foundation for multi-service deployment, with an
evolutionary path to networks of the future.
Our products are sold in the U.S. and international marketplaces to a
customer base that includes regional Bell operating companies (RBOCs), national
local exchange carriers (NLECs), competitive local exchange carriers (CLECs),
independent operating companies (IOCs), international telephone companies,
alternative carriers, system integrators and original equipment manufacturers
(OEMs). Historically, the largest revenue-producing segments of our customer
base have been the NLECs, IOCs, CLECs, and international telephone companies. In
1999, we sold our products to a wider variety of customer types and we plan to
continue to diversify our customer base among the market segments described
above. During 1999, we derived a lower percentage of our revenues from
international markets. However, we are currently attempting to expand our
presence in international markets and we are focusing our efforts on operators
who are making investments in broadband access infrastructures. Deregulation and
privatization of international incumbent telecommunications companies are
prompting service providers to upgrade and expand existing facilities to improve
their positions in an increasingly competitive marketplace. Simultaneously,
these telecommunications companies are installing technology to enable future
advanced services.
5
<PAGE> 8
During 1999, WinStar Communications, Inc. (WinStar) accounted for 15.7% of
our total revenues and North Supply Company, a subsidiary of Sprint, accounted
for 11.9%. In 1998, WinStar accounted for 11.2% of our total revenues, and
Integrators of System Technology (Pty) Ltd of South Africa accounted for 10.4%.
For 1997, GTE accounted for 19.2% of our total revenues. U.S. revenues,
including royalties, represented 89.3%, 73.8%, and 73.5% of total revenues in
1999, 1998, and 1997, respectively. International revenues, including royalties,
declined to 10.7% in 1999 as compared with 26.2% in 1998 and 26.5% in 1997.
BACKLOG
At December 31, 1999 and 1998, backlogs were approximately $35.3 million
and $10.8 million, respectively. All of the December 31, 1999 backlog is
expected to be shipped in 2000. We consider backlog to be an indicator, but not
the sole predictor, of future sales.
SALES, MARKETING, AND CUSTOMER SUPPORT
Our products are marketed worldwide directly to telecommunications
companies and indirectly through original equipment manufacturers, distributors,
and sales representatives.
Our U.S. sales group conducts sales activities from our corporate
headquarters, regional sales offices in Kansas and Illinois, and throughout the
U.S., including California, Colorado, Texas, Virginia, North Carolina, and
Minnesota, among others. Our U.S. sales personnel are dedicated to specific
customer accounts, segmented by our U.S. customer base. In addition to direct
calls on telecommunications companies, sales to customers often involve
marketing through consulting engineers who are retained by independent
telecommunications companies for engineering, specifications and installation
services. We host an annual technology conference for telecommunication
engineering consultants, consisting of specific product training as well as more
generic technology training in areas such as ADSL, broadband, and multi-service
access. Our U.S. sales group consists of approximately 45 direct salespeople,
technical, engineering, and support personnel located throughout the U.S.
Our international sales channels include both direct sales to end-user
clients and indirect sales through global regional and country OEMs,
integrators, distributors and agents. Our international sales group consists of
approximately 21 direct salespeople, technical, engineering, and support
personnel located in the U.S., Canada, the United Kingdom, Switzerland, Spain,
France, Australia, Hong Kong, and China.
The U.S. and international sales organizations receive support from our
product marketing organization for product commercialization, advertising and
marketing communications. Our product marketing organization consists of
approximately 54 employees and is closely aligned with our customer market base
to assess, capture, and deliver technical value propositions, product strategy
applications, and technical marketing collateral.
We maintain a customer support organization of approximately 85 employees
providing our customers with high-quality technical and administrative product
support. In addition to providing service during our products' standard 24-month
warranty period, our customer support department provides post-sales technical
support, technical and operational training to customers, and technical
pre-sales assistance to AFC's sales representatives and distributors. In
addition to our own field technical service engineers, we also rely on various
third party organizations to provide post-sales support to North American
customers. We provide international customer support directly or through our
authorized distributors. Training courses and materials are made available to
customers either through student training or train-the-trainer programs.
RESEARCH AND DEVELOPMENT
Our research and development efforts are focused on developing local loop
products with advanced features for global telecommunications markets. The
UMC1000 is designed as a modular software and hardware platform that can be
configured and adapted to particular customer requirements. Development efforts
include extensive attention to ease of installation and use by the customer.
Research and development personnel work closely with sales and marketing
personnel to ensure development efforts are targeted to
6
<PAGE> 9
customer needs. Recent development efforts have focused on enhancements to the
UMC1000 product family, such as new fiber-to-the-curb capability, ATM/ADSL
service cards, ATM broadband infrastructure, and larger line size products. For
international markets, efforts have been focused on the V5.1/V5.2 switch
interfaces, element management system, and numerous country-specific
customizations.
Our industry is characterized by rapidly changing technological and market
conditions which may shorten product life cycles. Our future competitive
position depends not only upon successful production and sales of the UMC1000
product family, but also upon our ability to develop and produce, on a timely
basis, new features and services to meet existing and anticipated industry
demands. We are currently engaged in developing several new features for the
UMC1000 product family. We have also reassessed our internal processes for
developing technology, and we have implemented new procedures for bringing new
products to market. During the product development process, we invest
substantial resources in products that often require extensive field testing and
evaluation before their introduction to the market. We have invested extensive
engineering resources in the development of the Cellennia Cell Bus Gate Array,
and custom ASICs, such as the narrow band gate array and the wide band gate
array.
Research and development costs charged to expense were $47.5 million in
1999, $41.0 million in 1998, and $25.7 million in 1997. As a percentage of total
revenues, research and development costs represented 16.3% in 1999, 13.1% in
1998, and 9.6% in 1997. We consider our research and development efforts vital
to our future success and we plan to continue to support the development of new
products, features and product cost reductions. We have research and development
offices in Petaluma, California; Buffalo Grove, Illinois; and Miramar, Florida.
As of December 31, 1999, the research and development staff consisted of 249
employees.
MANUFACTURING
Manufacturing, system integration, and testing operations are performed at
our headquarters in Petaluma, California. Manufacturing operations consist
primarily of final product assembly and testing. Quality is monitored at each
stage of the production and supply process, including the selection of component
vendors, receiving, assembly, final testing, packaging, and shipping.
Functional, environmental, and systems testing and other quality
assurance-related activities are performed on the subassemblies incorporated
into the UMC1000 product family.
We rely on a limited number of vendors to manufacture subassemblies to
strict specifications for use in our products. In particular, we rely on:
- Flextronics International Ltd. and Solectron International USA, Inc. to
manufacture printed circuit board assemblies (PCBA)
- 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
- LeeMah Electronics Inc. for fully integrated cabinets
- PairGain Technologies Inc. for custom enclosures and boards
7
<PAGE> 10
- 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
Certain components used in the UMC1000 product family are only available
from a single source or limited number of vendors. Some of our sole source
vendors are companies which, 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, resulting in limited or
unreliable sources of supply for these components. See Part I, Item 1 --
"Certain Factors That Might Affect Future Operating Results" as it pertains to
these matters on page 16 of this Annual Report on Form 10-K.
COMPETITION
Our competitors range from small companies, both U.S. and international, to
large multinational corporations. Principal competitors include: ADC
Telecommunications, Inc., Cisco Systems, Inc., Compagnie Financiere Alcatel,
Lucent Technologies, Inc., Marconi Communications, Inc., Next Level
Communications, Inc., Northern Telecom Ltd., and Siemens AG.
Many of these competitors have more extensive financial, marketing, and
technical resources than we do and enjoy superior name recognition in the
market.
Marconi Communications, Inc. (Marconi) is a competitor in the U.S. market,
but they will also serve as a distributor of our products in certain
international markets starting in 2000. 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 and will act as a distributor
in specific international markets.
In addition, pursuant to a settlement agreement and related agreements
entered into with the Industrial Technology Research Institute, certain of its
member companies have been granted certain rights to manufacture and sell the
European Telecommunications Standards Institute (ETSI) version of the narrowband
UMC1000 outside of North America. These companies currently compete with us in
international markets, primarily in China. Upon termination of certain
restrictions set forth in such agreements, in January 2005, such companies will
have a worldwide, non-exclusive, royalty-free, irrevocable license to use a
certain older version of narrowband UMC1000 technology and will be able to
compete with us worldwide at such time.
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. Moreover, we believe that technological
and regulatory change will continue to attract new entrants to the market in
which we compete.
TELECOMMUNICATIONS AND TECHNOLOGY INVESTMENTS
We have made investments in two start-up ventures specializing in
telecommunication technologies, Cerent Corporation and Turin Networks. On
November 1, 1999, Cerent was acquired by Cisco Systems, Inc. (Cisco) and our
investment was converted into approximately 5.3 million shares of Cisco common
stock, resulting in a non-operating gain of approximately $379.3 million. We
recorded an unrealized gain of $166.6 million in our Cisco stock at December 31,
1999 for the change in fair value between November 1 and December 31, 1999. 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 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 recorded the
collar at its estimated fair market value. We 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-
8
<PAGE> 11
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.
COMPLIANCE WITH REGULATORY AND INDUSTRY STANDARDS
The UMC1000 product family must comply with a large number of voice and
data regulations and standards, which vary between U.S. and international
markets, and may vary by specific international markets. Standards setting and
compliance verification in the U.S. are determined by the Federal Communications
Commission (FCC), Underwriters Laboratories, Quality Management Institute (QMI),
Telcordia Technologies, Inc. (Telcordia), other independent third party testing
organizations, and by independent telecommunications companies. In international
markets, our products must comply with recommendations issued by Industry
Canada, the International Telecommunications Union, and individual regional
carriers' network operating system requirements and specifications. In addition,
our product must comply with standards issued by ETSI and implemented and
enforced by the telecommunications regulatory authorities of each nation.
Standards for new services continue to evolve, and we will be required to modify
the UMC1000 or develop and support new versions to meet these standards.
Telcordia testing on the UMC1000 product family 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. Some UMC1000 product family
features must pass Telcordia testing prior to field release. See Part I, Item
1 -- "Certain Factors That Might Affect Future Operating Results" as it pertains
to these matters, beginning on page 17 of this Annual Report on Form 10-K.
We have successfully completed the Telcordia Operations Systems
Modifications for the Integration of Network Elements process on LFACS, TIRKS,
SWITCH, and NMA interoperability. LFACS and TIRKS are OSSs which allow RBOCs'
operations systems to identify the UMC1000's bandwidth and equipment type and
capabilities. SWITCH is an OSS designed to inventory and assign
telecommunications equipment. NMA adds the ability to retrieve UMC1000 alarms
through the RBOCs' operations systems and to generate trouble tickets online.
Switch compliance testing has been completed on GR-303 with Lucent Technologies
on the Lucent 5ESS switch, with Northern Telecom on the DMS-100 switch and with
Siemens on the EWSD switch. The UMC1000 is currently undergoing testing with
Telcordia for integration with OPS/INE allowing provisioning through Telcordia
operating systems.
In 1997, Underwriters Laboratories officially registered AFC as
ANSI/ISO/ASQC Q9001-1994 (ISO) compliant which signifies a standard of quality
in design, development, production, installation and servicing. In 1998, we
transitioned to QMI as our ISO 9000 registrar. We continue to maintain ISO
certification. The ISO standard consists of all elements defining a quality
system, aimed primarily at achieving customer satisfaction by preventing
nonconformity at all stages, from design through servicing. We are currently
working to achieve compliance and subsequent certification to TL9000, a quality
standard designed specifically for the telecommunications industry.
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 have affected the deployment of future services. These risks are
discussed in Part I, Item 1 -- "Certain Factors That Might Affect Future
Operating Results" beginning on page 10 of this Annual Report on Form 10-K.
ENVIRONMENTAL MATTERS
Our operations and manufacturing processes are subject to federal, state,
local and foreign environmental protection laws and regulations. These laws and
regulations relate to the use, handling, storage, discharge and disposal of
certain hazardous materials and wastes, the pre-treatment and discharge of
process waste waters and the control of process air pollutants. We believe that
we are in compliance in all material respects with applicable environmental
regulations.
9
<PAGE> 12
If those laws and regulations become more stringent over time, we may not
be able to comply in a timely manner, or comply at all. Compliance with new laws
and regulations could create significant compliance expenses, result in
production suspension and delay, restrict expansion at present locations, and
require the acquisition of costly equipment. Non-compliance with laws and
regulations could result in penalties and suspension of operations.
PROPRIETARY RIGHTS AND LICENSES
We attempt to protect our technology through a combination of copyrights,
trade secret laws, contractual obligations and patents. No patents are currently
held for the UMC1000 product family, but four patent applications are pending.
There can be no assurance that our intellectual property protection measures
will be sufficient to prevent misappropriation of our technology. See Part I,
Item 1 -- "Certain Factors That Might Affect Future Operating Results" as it
pertains to this matter on page 15 of this Annual Report on Form 10-K. The laws
of many foreign countries do not protect our intellectual property rights to the
same extent as the laws of the U.S. See Part I, Item 3 -- "Legal Proceedings" as
it pertains to this matter on page 19 of this Annual Report on Form 10-K.
Frequent litigation, based on allegations of patent and other intellectual
property infringement, has resulted from the telecommunications industry's
dependence on proprietary technology. In February 2000, we settled litigation
with Marconi under which we claimed trade secret misappropriation, tortious
interference with contract, and related claims against RELTEC Corporation, which
was acquired by Marconi. This settlement involves Marconi paying a $32.75
million cash payment to us and entering into a distribution agreement for the
UMC1000 product family. 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. This settlement involved our granting a limited
license to certain of our proprietary technology. Also in 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 Corporation (DSC) under
which DSC had claimed proprietary rights in the UMC1000 technology. In June
1999, we settled litigation with Alcatel USA, Inc. (formerly DSC) under a
separate proprietary rights claims against our UMC1000 technology.
EMPLOYEES
As of December 31, 1999, we employed 722 people. None of our employees are
covered by collective bargaining agreements, and we have never experienced a
work stoppage, strike, or labor dispute. We believe relations with our employees
are good.
CERTAIN FACTORS THAT MIGHT AFFECT FUTURE OPERATING RESULTS
In addition to the other information in this Annual Report on Form 10-K,
the following are important factors that should be considered in evaluating 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 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
- Ability to introduce new product features and technologies on a timely
basis
10
<PAGE> 13
- 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
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 U.S., and accordingly, we
believe that over time this 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 believe that revenues for the quarter ended March 31, 2000 may
be lower than our revenues in the quarter ended December 31, 1999. 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 potential 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 may affect our income
statement. Refer to Part II, Item 7A -- "Quantitative and Qualitative
Disclosures About Market Risk" as it pertains to this matter on pages 23-25 of
our Annual Report to Stockholders, which information is incorporated by
reference and filed as Exhibit 13.2.
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
11
<PAGE> 14
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 Part I, Item 3 -- "Legal
Proceedings" as it pertains to this matter on page 19 of this Annual Report on
Form 10-K.
Customer Concentration. In the year ended December 31, 1999, WinStar
accounted for 15.7% of our total revenues, and Sprint accounted for 11.9%. For
the year ended December 31, 1998, 11.2% of our total revenues were derived from
sales to WinStar and 10.4% to Integrators of System Technology (Pty) Ltd. in
South Africa. No other single customer accounted for 10% or more of total
revenues in either of these periods. Our five largest customers accounted for
46.3% of total revenues in the year ended 1999 and 41.9% in the year ended 1998.
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 that 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 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
12
<PAGE> 15
- Exchange rate fluctuations
- Changes in regulatory requirements
International sales constituted 10.7% of our total revenues in the year
ended 1999 and 26.2% in the year ended 1998. International sales have fluctuated
in absolute dollars and as a percentage of revenues and are expected to continue
to fluctuate in future periods. Sales to customers in South Africa, France,
China, Brazil, and Venezuela declined in 1999 compared with 1998. 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. There can be no
assurance that we will be able to identify suitable parties for joint ventures
or strategic relationships or, even if such parties are identified, that
successful joint ventures or strategic relationships will result. We may be
unable to increase international sales of the 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.
The economies in some Central and Latin American countries have
deteriorated, resulting in the devaluation of currencies in certain of these
countries. These conditions may persist or intensify. These conditions have
contributed to a decline in our international sales. We expect that adverse
economic conditions in foreign countries or foreign currency exchange rates
could result in, among other things, delays or cancellation of customer orders,
decreased revenues, and lower net income.
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. Refer to Part II, Item
7A -- "Quantitative and Qualitative Disclosures About Market Risk" as set forth
on pages 23-25 of our Annual Report to Stockholders, which information is
incorporated by reference and filed as Exhibit 13.2.
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
13
<PAGE> 16
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.,
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 in 2000. 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 a certain 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 a period of growth, which has imposed significant burdens on
management, operations, finance, and other resources. We need to 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, our business could be disrupted, and we could incur,
among other things, increased operating expenses, lower net income, and
decreases in cash flow.
There can be no assurance that we will not have excess manufacturing
capacity or that further utilization of our manufacturing and distribution
facility will continue without interruption.
Our facility obligations and commitments are based in part on anticipated
growth projections, and, in the near-term, are relatively fixed. Based on
existing commitments for additional office space, we may have excess office
space in the future. If we do have excess facilities, we will pursue subleasing
or restructuring our commitments on any excess space. Our operating expenses and
cash flows could be adversely affected if we are unable to, in a timely manner,
restructure our existing commitments or sublease any excess facility space at
rents comparable to our obligations.
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.
14
<PAGE> 17
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. There can be no assurance that we will overcome
difficulties that could delay or prevent the successful development,
introduction and marketing of these products and enhancements, or that new
products or enhancements will achieve market acceptance. We may be required to
incur substantial costs to modify the UMC1000 product family, develop new
products, and build our infrastructure to accommodate these changes. 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; 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 international 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.
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.
15
<PAGE> 18
In the future, we may be subject to additional litigation to defend against
claimed infringements of the rights of others or to determine the scope and
validity of the proprietary rights of others. 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, lower revenues, gross profit, net income, and
cash flows. In particular, we rely upon:
- 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
16
<PAGE> 19
- Hendry Telephone Products for fuse panels and racks
- Powersafe Standby Batteries Inc. for battery systems
- LeeMah Electronics Inc. for fully integrated cabinets
- 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. Recently, we have experienced an increase in
our employee turnover rate, including technical and engineering positions.
During the course of 1999, we experienced significant changes in our executive
officers and key employees, including our President and CFO 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.
Risks Associated with Pending Litigation. We are a party to certain legal
proceedings as described in Part I, Item 3 -- "Legal Proceedings" beginning on
page 19 of this Annual Report on Form 10-K. 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, QMI, 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
17
<PAGE> 20
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.
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 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. 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. 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.
ITEM 2. PROPERTIES
We lease four buildings in Petaluma, California where the following
functions reside: administration and principal executive offices, sales,
marketing, product development, manufacturing and distribution. In addition to
our Petaluma headquarters, we lease properties at the following locations:
Buffalo Grove, Illinois (research and development); Itasca, Illinois (sales);
Overland Park, Kansas (sales); Coral Gables, Florida (sales and sales support);
Miramar, Florida (research and development); Shanghai, China (sales support);
Hong Kong (sales); London, England (sales and sales support); and Fribourg,
Switzerland (sales support). These buildings are suitable for our operational
use.
Our facility obligations and commitments are based in part on anticipated
growth projections, and, in the near-term, are relatively fixed. Based on
existing commitments for additional office space, we will have excess office
space in the near future. We have sublet a portion of the excess office space
and we are actively pursuing subletting additional space that will become
available in the future. Our operating expenses and cash flows
18
<PAGE> 21
could be adversely affected if we are unable to, in a timely manner, restructure
our existing commitments or sublease the excess facility space at rents
comparable to our obligations.
ITEM 3. LEGAL PROCEEDINGS
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 product family in specific countries outside
the U.S. over a three year period, 2000 - 2002. The agreement anticipates that
Marconi will purchase for resale a minimum of $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 product family purchases do not meet expectations.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1999, no matters were submitted to a vote of
stockholders through the solicitation of proxies or otherwise.
19
<PAGE> 22
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market using the symbol
AFCI. Our common stock price is listed daily in the Wall Street Journal and
other publications under the Nasdaq National Market listing with the
abbreviation AdvFibComm.
In 1997, we effected a two-for-one stock split and all share, per share and
common stock amounts disclosed have been restated to reflect the effect of this
split.
The following table lists the high and low closing sales prices of our
common stock as reported by the Nasdaq National Market for each full quarterly
period of the two most recent fiscal years:
<TABLE>
<CAPTION>
HIGH LOW
FISCAL 1999: ------ ------
<S> <C> <C>
First Quarter (through March 27)........................... $13.75 $ 7.38
Second Quarter (through June 26)........................... 15.25 7.09
Third Quarter (through September 25)....................... 20.94 13.13
Fourth Quarter (through December 25)....................... 44.38 19.00
</TABLE>
<TABLE>
<CAPTION>
HIGH LOW
FISCAL 1998: ------ ------
<S> <C> <C>
First Quarter (through March 28)........................... $40.13 $25.25
Second Quarter (through June 27)........................... 44.50 34.00
Third Quarter (through September 26)....................... 41.06 6.00
Fourth Quarter (through December 26)....................... 11.88 4.44
</TABLE>
On March 13, 2000, the last reported sale price of our common stock on the
Nasdaq National Market was $80.25 per share. As of December 31, 1999, there were
approximately 427 record holders, or brokerage firms, holding our common stock.
DIVIDEND POLICY
We have never declared or paid cash dividends on our capital stock. We
currently intend to utilize all of our earnings, if any, for use in our
operations and do not anticipate the payment of cash dividends in the
foreseeable future. In addition, our line of credit agreement requires consent
from the banks prior to payment of dividends.
ISSUANCE OF UNREGISTERED SECURITIES
None.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The information required by this item is set forth on page 18 of our 1999
Annual Report to Stockholders, which information is incorporated by reference
and filed as Exhibit 13.1.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this item is set forth on pages 19-23 and 25 of
our 1999 Annual Report to Stockholders, which information is incorporated by
reference and filed as Exhibit 13.2.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is set forth on pages 23-25 of our
1999 Annual Report to Stockholders, which information is incorporated by
reference and filed as Exhibit 13.2.
20
<PAGE> 23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is set forth on pages 26-42 of our
1999 Annual Report to Stockholders, which information is incorporated by
reference and filed as Exhibit 13.3.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
21
<PAGE> 24
PART III.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES OF THE REGISTRANT
Executive officers are selected annually and serve at the discretion of the
board of directors. No family relationships exist between any of the executive
officers or directors. The following table sets forth certain information with
respect to each person who is an executive officer, key employee or director.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
EXECUTIVE OFFICERS
John A. Schofield(3)........... 51 President, Chief Executive Officer and Director
Gregory S. Steele.............. 38 Senior Vice President, Chief Operating Officer and acting Vice
President, Operations
Keith E. Pratt................. 37 Vice President, Chief Financial Officer, and Assistant Secretary
Jude S. Radeski................ 38 Corporate Controller
Mehmet N. Balos................ 44 Vice President, Global Marketing and North American Sales
Jorge A. Valdes................ 38 Vice President, Engineering
Robert G. Yates................ 57 Vice President, International Sales
KEY EMPLOYEES
Charles C. Geiger.............. 35 Vice President, Customer Service
Ron D. Longo................... 38 Vice President, Technical Marketing and Communications
Amy M. Paul.................... 31 Vice President, General Counsel and Secretary
Victoria L. Perrault........... 46 Vice President, Administrative Services
Doak K. Smailer................ 42 Vice President, Quality
OUTSIDE DIRECTORS
Donald Green(3)................ 68 Chairman of the Board
Herbert M. Dwight, Jr.(2)(4)... 69 Director
Ruann F. Ernst(1)(3)(4)........ 53 Director
Clifford H. Higgerson(2)....... 60 Director
Dan Rasdal(1)(3)............... 66 Director
Alex Sozonoff(1)(2)............ 61 Director
</TABLE>
- ---------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
(3) Member of the Nominating Committee
(4) Member of the Governance Committee
John A. Schofield joined AFC in March 1999 as President and Chief Executive
Officer, and was appointed to the Board of Directors in May 1999. Prior to
joining AFC, Mr. Schofield was employed with ADC Telecommunications, Inc. from
1992 through 1999. He held several positions at ADC, including Senior Vice
President, President of the Integrated Solutions Group, and Managing Director of
Asia Pacific/Latin America. In July 1995, Mr. Schofield joined DSC
Communications Corporation where he held the position of Vice President,
International Sales and Marketing, until his return to ADC in October 1995.
Gregory S. Steele was named Chief Operating Officer in December 1998 and
was promoted to Senior Vice President in December 1999. From June through
December of 1998, Mr. Steele served as Vice President, Marketing, and from April
1995 through May 1998, he held the position of Vice President, Operations. Mr.
Steele joined AFC in November 1994 and served as the Director of Operations
until his promotion in March 1995. Prior to joining AFC, Mr. Steele held various
positions at DSC Communications
22
<PAGE> 25
Corporation from 1990 to 1994, including Director of Account Marketing and
Senior Manager of Manufacturing.
Keith E. Pratt was promoted to Vice President, Chief Financial Officer, and
Assistant Secretary in December 1999. Mr. Pratt joined AFC in September 1997 as
Director of Corporate Development and served in this position until his
promotion in 1999. Prior to joining AFC, Mr. Pratt was Director of the Strategy
and Business Development Group with Pacific Telesis from 1995 to 1997. From 1990
through 1994, Mr. Pratt held the position of Senior Associate with Booz, Allen &
Hamilton.
Jude S. Radeski was promoted to Corporate Controller in December 1999. Mr.
Radeski joined AFC in February 1996 and served as Senior Accounting Manager
until December 1999. Prior to joining AFC, Mr. Radeski held the position of
controller with Truckee-Tahoe Lumber Company from 1992 to 1996.
Mehmet N. Balos joined AFC in July 1999 as Vice President of Global
Marketing and was appointed to Vice President of North American Sales in
addition to his marketing responsibilities in October 1999. Prior to joining
AFC, Mr. Balos was employed with Ericsson LM Telephone Company from 1997 to 1999
where he was Vice President of Access Marketing, Sales and Services worldwide.
Mr. Balos was General Manager for Pirelli Telecom Systems Group from 1995 to
1997, after heading up Corporate Marketing and Services as Vice President at ADC
Telecommunications, Inc. from 1991 to 1995.
Jorge A. Valdes has served as Vice President, Engineering since July 1999.
Mr. Valdes joined AFC in March 1998 and served as Director of Engineering in the
Florida development office through July 1999. Prior to joining AFC, Mr. Valdes
served in various management positions with Racal-Datacom from 1990 through
1998, including Engineering Director of Bandwidth Engineering and Access
Engineering as well as Senior Product Marketing Manager.
Robert G. Yates joined AFC in May 1999 as Vice President, International
Sales. Prior to joining AFC, Mr. Yates was employed with ADC Telecommunications,
Inc., from 1992 through 1999, where he held various positions including Vice
President, Asia Pacific, International Business Development Director and
Managing Director Australia and New Zealand.
Charles C. Geiger was appointed as the Vice President of Global Customer
Service in July 1999. Mr. Geiger joined AFC in November 1998 as Regional Vice
President of International Operations, where he served until his promotion in
1999. Prior to joining AFC, Mr. Geiger was employed with DSC Communications
Corporation from 1996 through 1998. He held several senior marketing and sales
positions in DSC and was based out of DSC's Denmark and UK facilities. Prior to
1996, Mr. Geiger held several positions in the U.S. and abroad at AT&T Bell
Laboratories and AT&T Network Systems as part of the international engineering,
marketing, and sales functions.
Ron D. Longo was appointed Vice President of Technical Marketing and
Communications in December 1999. Prior to his promotion, Mr. Longo held the
positions of Director of Global Marketing from February 1999 to December 1999
and Regional Vice President of International Operations from September 1997
through September 1998. Mr. Longo previously held the position of Director of
Worldwide Technical Support and Professional Services at ADTRAN, Inc. from
September 1998 through February 1999. Prior to this, Mr. Longo held various
technical and management positions at ADTRAN, Inc. from May 1994 through
September 1997, and BellSouth Telecommunications from December 1987 through May
1994.
Amy M. Paul was promoted to Vice President and General Counsel in February
1999. Ms. Paul was named Secretary of the Board in September 1999. Previously,
Ms. Paul served as Director, Contracts and Legal Affairs, from 1995 until 1999.
Prior to joining AFC, Ms. Paul served as an associate in the Business and
Technology Group of Brobeck Phleger & Harrison LLP from 1993 to 1995.
Victoria L. Perrault was promoted to Vice President of Administrative
Services in December 1999. Ms. Perrault joined AFC in March 1996, as the Human
Resource Manager and was promoted to Director of Human Resources in August 1996.
Prior to joining AFC, Ms. Perrault was the Director of Human Resources for the
Advanced Products Division of Aegon USA from 1993 to 1995.
23
<PAGE> 26
Doak K. Smailer was promoted to Vice President, Quality in February 2000.
Mr. Smailer joined AFC in November 1998 as Director, Domestic Quality and was
promoted to Director, Quality in May 1999. Prior to joining AFC, Mr. Smailer was
employed with DSC Communications Corporation from 1990 through 1998, where he
held the positions of Manager of Corporate Quality and Director of Corporate
Quality.
Donald Green is a co-founder of AFC and has served as Chairman of the Board
since 1992. Mr. Green served as Chief Executive Officer from June 1998 to March
1999 and from May 1992 to June 1997. Mr. Green is also a director of TCSI
Corporation, and three private organizations.
Herbert M. Dwight, Jr. has served as a Director since 1998. Mr. Dwight is
the retired Chairman of the Board of Optical Coating Laboratory, Inc. (OCLI), an
optical coating and specialty ink manufacturer. Mr. Dwight served in this
position from 1991 to February 2000. From 1991 to April 1998, Mr. Dwight also
served as Chief Executive Officer of OCLI and from 1991 to 1997, he served as
President of OCLI. Mr. Dwight has also served as Chairman of the Board of
Vicinity Corporation since October 1999 and as a director of Applied Magnetics,
Inc. and Applied Materials, Inc.
Ruann F. Ernst has served as a Director since 1998. Ms. Ernst has served as
Chief Executive Officer of Digital Island, Inc., an e-business delivery network,
since June 1998 and has been Chairman of the Board of Digital Island since
December 1999. From June 1998 through December 1999, Ms. Ernst also served as
President of Digital Island. From 1994 to 1998, Ms. Ernst served as General
Manager, Financial Services Business Unit for Hewlett-Packard Company, an
electronics equipment and computer company. Prior to that, Ms. Ernst served in
various management positions at Hewlett-Packard and General Electric. Ms. Ernst
is also a director of Phoenix International Corporation and two private
organizations.
Clifford H. Higgerson has served as a Director since 1993. Mr. Higgerson
has served as a General Partner of Communications Ventures, a venture capital
firm, since 1987 and a General Partner of Vanguard Venture Partners, a venture
capital firm and a stockholder of AFC, since July 1991. Mr. Higgerson is also a
Director of Digital Island, Inc., Tut Systems, Inc. and twelve private
companies.
Dan Rasdal has served as a Director since 1993. Mr. Rasdal has served as a
director of Symmetricom, Inc. (Symmetricom), a telecommunications company, since
1985. From 1985 to July 1998, Mr. Rasdal was Chairman of the Board, President,
and Chief Executive Officer of Symmetricom. Mr. Rasdal is also a director of
Celeritek, Inc.
Alex Sozonoff has been a Director since 1997. Mr. Sozonoff has served as
Vice President of Customer Advocacy for Hewlett-Packard Company, an electronics
equipment and computer company, since 1998. From 1994 to 1998, he was Vice
President of Marketing for Hewlett-Packard.
Our certificate of incorporation calls for a board of directors composed of
seven directors. The terms of office of the board of directors are divided into
three classes:
- Clifford H. Higgerson, John Schofield, and Alex Sozonoff are Class I
Directors, and their terms will expire at the annual meeting of the
stockholders to be held in 2000.
- Herbert M. Dwight, Jr. and Ruann F. Ernst are Class II Directors, and
their terms will expire at the annual meeting of the stockholders to be
held in 2001.
- Donald Green and Dan Rasdal are Class III Directors, and their terms will
expire at the annual meeting of the stockholders to be held in 2002.
At each annual meeting of stockholders, the newly elected directors' terms
begin on the date of election and qualification and continue for three years
through the third annual meeting following election. Terms may differ in the
case where a director resigns, is removed from office, or until the time when a
successor director is elected and qualified.
If the need arises to increase the number of directors, additional
directorships will be distributed equally among the three classes so that, as
nearly as possible, each class is equally weighted and represented.
24
<PAGE> 27
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Directors, executive officers, and individuals owning more than ten percent
of our common stock are required to file initial reports of ownership and
changes in ownership with the Securities and Exchange Commission under Section
16(a) of the Securities Exchange Act of 1934, as amended. The Securities and
Exchange Commission regulations also require those persons to provide copies of
all filed Section 16(a) reports to us. We have reviewed the report copies filed
in 1999, and based also on written representations from those persons, we
believe that there was compliance with Section 16(a) filing requirements for
1999, except that Mr. Valdes inadvertently filed certain holdings late on Form
5.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth in our 2000 Proxy
Statement to be filed within 120 days from our fiscal year end.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is set forth in our 2000 Proxy
Statement to be filed within 120 days from our fiscal year end.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth in our 2000 Proxy
Statement to be filed within 120 days from our fiscal year end.
25
<PAGE> 28
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following is a list of the consolidated financial statements and the
financial statement schedules which are included in this Form 10-K or which are
incorporated herein by reference:
1. FINANCIAL STATEMENTS:
As of December 31, 1999 and 1998:
- Consolidated Balance Sheets
For the Years Ended December 31, 1999, 1998, and 1997:
- Consolidated Statements of Income
- Consolidated Statements of Stockholders' Equity and Other
Comprehensive Income
- Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Independent Auditors' Report
Quarterly Results of Operations (Unaudited)
2. FINANCIAL STATEMENT SCHEDULE:
- Schedule II -- Valuation Accounts
All other financial statements and financial statement schedules have been
omitted because they are not applicable, or the required information is included
in the consolidated financial statements or notes thereto.
3(a). EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------- --------------------
<S> <C>
3.3.1 Fifth Amended and Restated Certificate of Incorporation of
the Registrant.(3)
3.3.2 Certificate of Designation of Series A Junior Participating
Preferred Stock.(5)
3.5 Amended and Restated Bylaws of the Registrant.(2)
4.1 Specimen Certificate of Common Stock.(1)
4.3 Certificate of Incorporation of the Registrant (included in
Exhibit 3.3.1).
4.4 Rights Agreement dated as of May 13, 1998, between the
Registrant and BankBoston, N.A.(5)
4.5 Amendment to Rights Agreement dated as of October 19, 1998
between the Registrant and BankBoston, N.A.(7)
10.4.1 Form of Amendment to Warrants and Performance Warrants.(1)
10.5 Warrant Issued in Connection with the Sale of the
Registrant's Series E Preferred Stock on September 29,
1995.(1)
10.8 Promissory Note Secured by Pledge Agreement, dated May 31,
1995 by Donald Green in favor of the Registrant.(1)
10.9 Stock Pledge Agreement, dated June 16, 1995 between the
Registrant and Donald Green.(1)
10.10 Compensation Agreement, dated March 23, 1999 between the
Registrant and John A. Schofield.(8)
10.11 Hangzhou Aftek Communication Registrant Ltd. Contract, dated
June 18, 1994 between Advanced Fibre Technology
Communication (Hong Kong) Limited and Hangzhou Communication
Equipment Factory of the MPT., HuaTong Branch.(1)+
</TABLE>
26
<PAGE> 29
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------- --------------------
<S> <C>
10.15 Redwood Business Park Net Lease, dated June 3, 1996 between
the Registrant and G & W/ Redwood Associates Joint Venture,
for the premises located at Buildings 1 & 9 of Willow Brook
Court.(1)
10.17 Form of Indemnification Agreement for Executive Officers and
Directors of the Registrant.(1)
10.18 The Registrant's 1993 Stock Option/Stock Issuance Plan, as
amended (1993 Plan).(1)
10.19 Form of Stock Option Agreement pertaining to the 1993
Plan.(1)
10.20 Form of Notice of Grant of Stock Option pertaining to the
1993 Plan.(1)
10.21 Form of Stock Purchase Agreement pertaining to the 1993
Plan.(1)
10.22 The Registrant's 1996 Stock Incentive Plan (1996 Plan).(1)
10.23 Form of Stock Option Agreement pertaining to the 1996
Plan.(1)
10.23.1 Form of Automatic Stock Option Agreement pertaining to the
1996 Plan.(1)
10.24 Form of Notice of Grant of Stock Option pertaining to the
1996 Plan.(1)
10.24.1 Form of Notice of Grant of Non-Employee Director Automatic
Stock Option pertaining to the 1996 Plan.(1)
10.25 Form of Stock Issuance Agreement pertaining to the 1996
Plan.(1)
10.26 The Registrant's Employee Stock Purchase Plan.(1)
10.31 Cypress Center Net Lease, dated October 9, 1997 between the
Registrant and RNM Lakeville L.P., for the premises located
at 2210 South McDowell Boulevard.(4)
10.33.1 Redwood Business Park Net Lease, dated September 22, 1999
between the Registrant and 99 AF Petaluma, L.L.C., for the
premises located at 1465 McDowell Boulevard North.(9)
10.34.2 First Amendment to Amended and Restated Revolving Credit
Agreement, dated February 1, 2000 between the Registrant and
Banque Nationale De Paris and Bank of America, N.A.
10.35 Master Stock Purchase Agreement and Pledge Agreement
Specialized Term Appreciation Retention Sale (STARS) dated
February 9, 2000 between the Registrant and Bank of America,
N.A.++
13.1 Selected Consolidated Financial Data from the 1999 Annual
Report to Stockholders.
13.2 Management's Discussion and Analysis of Financial Condition
and Results of Operations from the 1999 Annual Report to
Stockholders.
13.3 Financial Statements and Supplementary Data from the 1999
Annual Report to Stockholders.
21.1 Subsidiaries of the Registrant.(1)
23.1 Report on Schedule and Consent of KPMG LLP.
27.0 Financial data schedule.
</TABLE>
- ---------------
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (File No. 333-8921) filed with the Securities and Exchange
Commission on July 26, 1996, as amended, and declared effective September
30, 1996.
(2) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1997, filed with the Securities
and Exchange Commission on August 8, 1997.
(3) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1997, filed with the
Securities and Exchange Commission on November 7, 1997.
(4) Incorporated by reference from the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997, filed with the Securities and Exchange
Commission on March 23, 1998.
(5) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Securities and Exchange Commission on May 19, 1998.
27
<PAGE> 30
(6) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1998, filed with the Securities
and Exchange Commission on August 10, 1998.
(7) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Securities and Exchange Commission on October 29, 1998.
(8) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 1999, filed with the
Securities and Exchange Commission on May 7, 1999.
(9) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended September 31, 1999, filed with the
Securities and Exchange Commission on November 8, 1999.
+ Portions of this Exhibit have been granted Confidential Treatment.
++ Confidential Treatment has been requested for portions of this exhibit.
3(b).REPORTS OF FORM 8-K:
We filed one report on Form 8-K dated February 9, 2000 on February 11,
2000, announcing the press release with respect to a hedging
transaction involving shares of Cisco Systems, Inc. common stock owned
by AFC.
28
<PAGE> 31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
(Registrant)
By: /s/ JOHN A. SCHOFIELD
------------------------------------
John A. Schofield
President and Chief Executive
Officer
March 21, 2000
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE AND TITLE DATE
------------------- ----
<S> <C>
/s/ DONALD GREEN March 21, 2000
- -----------------------------------------------------
Donald Green
Chairman of the Board
/s/ HERBERT M. DWIGHT, JR. March 21, 2000
- -----------------------------------------------------
Herbert M. Dwight, Jr.
Director
/s/ RUANN F. ERNST March 21, 2000
- -----------------------------------------------------
Ruann F. Ernst
Director
/s/ CLIFFORD H. HIGGERSON March 21, 2000
- -----------------------------------------------------
Clifford H. Higgerson
Director
/s/ DAN RASDAL March 21, 2000
- -----------------------------------------------------
Dan Rasdal
Director
/s/ JOHN A. SCHOFIELD March 21, 2000
- -----------------------------------------------------
John A. Schofield
Director
/s/ ALEX SOZONOFF March 21, 2000
- -----------------------------------------------------
Alex Sozonoff
Director
/s/ KEITH E. PRATT March 21, 2000
- -----------------------------------------------------
Keith E. Pratt
Vice President, Chief Financial Officer,
and Assistant Secretary
(Duly Authorized Signatory and
Principal Financial Officer)
/s/ JUDE S. RADESKI March 21, 2000
- -----------------------------------------------------
Jude S. Radeski
Corporate Controller
(Duly Authorized Signatory and
Principal Accounting Officer)
</TABLE>
29
<PAGE> 32
ADVANCED FIBRE COMMUNICATIONS, INC.
INDEX TO EXHIBITS FILED WITH THIS ANNUAL REPORT ON FORM 10-K:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
------- --------------------
<S> <C>
10.34.2 First Amendment to Amended and Restated Revolving Credit
Agreement, dated February 1, 2000 between the Registrant and
Banque Nationale De Paris and Bank of America, N.A.
10.35 Master Stock Purchase Agreement and Pledge Agreement
Specialized Term Appreciation Retention Sale (STARS) dated
February 9, 2000 between the Registrant and Bank of America,
N.A.++
13.1 Selected Consolidated Financial Data from the 1999 Annual
Report to Stockholders.
13.2 Management's Discussion and Analysis of Financial Condition
and Results of Operations from the 1999 Annual Report to
Stockholders.
13.3 Financial Statements and Supplementary Data from the 1999
Annual Report to Stockholders.
23.1 Report on Schedule and Consent of KPMG LLP.
27.0 Financial data schedule.
</TABLE>
<PAGE> 33
ADVANCED FIBRE COMMUNICATIONS, INC.
SCHEDULE II - VALUATION ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
ADDITIONS
---------------------
BALANCE CHARGED
AT TO COSTS CHARGED DEDUCTIONS BALANCE
ALLOWANCE FOR BEGINNING 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 CHARGED DEDUCTIONS BALANCE
BEGINNING TO COSTS TO OTHER FROM AT END OF
RESERVE FOR INVENTORY OF PERIOD AND EXPENSES ACCOUNTS RESERVE 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 CHARGED DEDUCTIONS BALANCE
BEGINNING TO COSTS TO OTHER FROM AT END OF
WARRANTY RESERVE OF PERIOD AND EXPENSES ACCOUNTS RESERVE 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>
<PAGE> 1
Exhibit 10.34.2
FIRST AMENDMENT TO
AMENDED AND RESTATED
REVOLVING CREDIT AGREEMENT
This FIRST AMENDMENT TO AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT
AND WAIVER (this "First Amendment") is made as of February 1, 2000, by and among
ADVANCED FIBRE COMMUNICATIONS, INC., a Delaware corporation (with its successors
and permitted assigns, the "Borrower"), the LENDERS from time to time parties
hereto (including their Assignees), BANQUE NATIONALE DE PARIS, a French banking
association, as arranger and administrative agent (the "Administrative Agent"),
and BANK OF AMERICA, N.A. (formerly known as Bank of America National Trust and
Savings Association), a national banking association, as syndication agent (the
"Syndication Agent").
WHEREAS, the Borrower, the Lenders, the Administrative Agent and the
Syndication Agent are parties to that certain AMENDED AND RESTATED REVOLVING
CREDIT AGREEMENT, dated as of July 29, 1999 (as amended, modified or otherwise
supplemented prior to the date hereof, the "Agreement"); and
WHEREAS, the parties desire to amend the Agreement as hereinafter set
forth;
NOW, THEREFORE, in consideration of the premises and mutual covenants
herein contained, the parties hereby agree as follows:
SECTION 1. DEFINED TERMS. Capitalized terms that are used in this First
Amendment without definition shall have the same meanings herein as in the
Agreement.
SECTION 2. CHANGE IN AGGREGATE REVOLVING CREDIT COMMITMENT. Effective from
and after February 1, 2000, the Aggregate Revolving Credit Commitment
(representing the amount available for borrowing under the Agreement, subject to
the terms and conditions of the Agreement) shall be reduced from $50,000,000 to
$30,000,000; and the definition of "Aggregate Revolving Credit Commitment"
contained in Exhibit A to the Agreement shall be changed accordingly. Also
effective from and after February 1, 2000, the Revolving Credit Commitment for
each of Banque Nationale de Paris and Bank of America N.A. shall be reduced from
$25,000,000 to $15,000,000. The preceding reductions are subject to the
condition that as of the close of business (New York time) on January 31, 2000,
the aggregate Available Revolving Credit Commitment (after reduction for any
then pending requests for Loans or for issuance of Letters of Credit) shall be
not less than $20,000,000.
SECTION 3. AMENDMENT TO SUBSECTION 3.1(b). Subsection 3.1(b) of the
Agreement shall be amended to read in its entirety as follows:
(b) Unless otherwise approved by the Issuing Lenders with respect to
a Letter of Credit, each Letter of Credit shall (i) be denominated in
Dollars; (ii) be in a minimum dollar amount of $100,000; (iii) if a
-1-
<PAGE> 2
Standby Letter of Credit, be issued to support obligations of the Borrower
or any of its Subsidiaries, contingent or otherwise, or to finance the
working capital and business needs of the Borrower or any of its
Subsidiaries in the ordinary course of business; (iv) if a Standby Letter
of Credit, expire no later than two years after the date of its issuance;
and (v) if a Commercial Letter of Credit, expire no later than ninety days
after the date of its issuance.
SECTION 4. CASH COLLATERALIZED LETTERS OF CREDIT. Except as otherwise
provided in part (c) below, the Borrower may, at its option, provide cash
collateral in the form of assignment of a time deposit of funds (as more fully
set forth below) for any Letter of Credit hereafter issued on its account by an
Issuing Lender pursuant to Article 3 of the Agreement. Fees in connection with
any Letter of Credit arrangement which satisfies the cash collateral
requirements of Section 4 of this First Amendment shall be as provided in part
(e) below.
(a) Notice. The Borrower shall irrevocably notify the Issuing Lender
of its intent to provide cash collateral for a requested Letter of Credit at the
time that the Borrower submits its Application for such Letter of Credit.
(b) Form of Deposit, Term of Deposit, Interest Rate. Not later than
the date on which a Letter of Credit that is to be cash collateralized is
issued, the Borrower shall deposit with the Issuing Bank an amount of Dollars
(in available funds) equal to the maximum amount available under such Letter of
Credit. Such deposit shall be in the form of an irrevocable time deposit for a
term equal to the term of such Letter of Credit plus 30 days. The amount on
deposit shall bear interest at the CD Rate (as defined below) from the day
immediately following the date of the deposit until the day on which the deposit
is terminated as provided in part (f) below. The term "CD Rate" shall mean, for
each CD Interest Period (as defined below), the annual rate of interest equal to
(i) the LIBO Rate for a one month period determined by the Issuing Lender on the
first day of each CD Interest Period (ii) minus 0.125 percent (the "CD Rate").
The term "CD Interest Periods" shall mean, with respect to each deposit, the
approximately one month period beginning on the date of the deposit and ending
on the same date of the succeeding month (or, if the succeeding month does not
have such a date, then on the last day of the succeeding month), and thereafter
the approximately one month periods from the day after the previous CD Interest
Period to the same date of the succeeding month (or, if the succeeding month
does not have such a date, then on the last day of the succeeding month),
provided, that the final CD Interest Period shall end on the termination date
for the applicable deposit as provided in part (f) below. Interest earned on a
deposit shall be paid by the Issuing Lender to the Borrower immediately
following the last day of each CD Interest Period; and the obligation to pay
interest with respect to a deposit shall be solely the obligation of the Issuing
Lender holding such deposit of not of any other Lender.
(c) Non-Dollar Denominated Letters of Credit. The Issuing Lenders
shall not be required to accept a cash deposit in connection with a Letter of
Credit denominated in a currency other than United States Dollars. An Issuing
Lender may condition its acceptance of a cash deposit in connection with a
non-Dollar denominated Letter of Credit upon such terms as it deems appropriate,
including, without limitation, (i) maintenance of a deposit in Dollars equal to
some percentage greater than 100 percent of the maximum Letter of Credit amount
as converted
-2-
<PAGE> 3
at current exchange rates into Dollars, (ii) application of a different interest
rate (which may be 0 percent) than the CD Rate to such deposit, and (iii)
application of an administrative fee.
(d) Security Interest. The Borrower hereby irrevocably grants to the
Issuing Lender, for the equal and ratable benefit of all the L/C Participants, a
security interest in each deposit (including the cash deposited, accrued
interest, the deposit account and all proceeds thereof) made hereunder in
connection with the issuance of a Letter of Credit, in any instrument, document
or other evidence of such deposit (whether certificated or otherwise), and in
the products and proceeds thereof, which security interest shall secure all
obligations (both payment and performance obligations) of the Borrower to the
Lenders under this Agreement, including, without limitation, the obligation of
the Borrower to reimburse the Issuing Lender for any payment made by the Issuing
Lender in connection with the Letter of Credit issued upon the delivery of such
deposit. The Borrower shall take such additional actions as the Issuing Lender
or the Administrative Agent may require to evidence, perfect or maintain a first
priority interest in such security interest. The Issuing Lender shall also have
such lien in and against the deposited funds and the deposit account as are
provided by statute. Upon any payment by the Issuing Lender upon the Letter of
Credit for which a deposit was made, which payment is not reimbursed on the date
of such payment the Issuing Lender may (and, at the request of the
Administrative Agent, shall), without prior notice to the Borrower or other
action on the part of the Issuing Lender, apply the deposit to reimbursement of
such payment (or to reimbursement of the L/C Participants if the L/C
Participants have advanced funds to reimburse the Issuing Lender). Upon the
occurrence and during the continuation of any Event of Default the Issuing
Lender may (and, at the request of the Administrative Agent, shall) apply the
deposit as provided in Article 8 of the Agreement.
(e) Fees. For all L/C Obligations which are secured by a cash
deposit as provided in this Section 4 of this First Amendment (hereafter, the
"Secured L/C Obligations"), the Borrower shall pay to the Administrative Agent
for the ratable account of the Issuing Lender and the L/C Participants a letter
of credit fee equal to 0.50 percent (rather than equal to the Applicable Margin
for LIBO Loan, which at present is 1.50 percent) on the average daily
outstanding Secured L/C Obligations during each applicable calculation period.
All other fees, charges and expenses with respect to Secured L/C Obligations,
including issuance fees payable to the Issuing Bank, shall be identical to fees,
charges and expenses applicable to other L/C Obligations.
(f) Termination of Deposit. A deposit with respect to any Letter of
Credit, together with the security interest in such deposit, shall terminate and
the amount of the deposit together with any accrued and unpaid interest thereon
shall be paid by the Issuing Lender to the Borrower upon the earlier of (A) (i)
payment in full of the amount of any payment by the Issuing Lender with respect
to such Letter of Credit, (ii) and termination of any additional obligations of
the Issuing Lender with respect to such Letter of Credit, and (iii)
reimbursement to the Issuing Lender (and to the L/C Participants to the extent
that the L/C Participants have advanced funds to the Issuing Lender) of all
amounts reimbursable by the Borrower with respect to such Letter of Credit, or
(B) thirty days following expiration of such Letter of Credit without any
payment having been made thereunder by or on behalf of the Issuing Bank;
provided, however, that no deposit shall terminate, no security interest shall
terminate, and no deposited funds shall be returned to the Borrower if a Default
or an Event of Default has occurred and is continuing.
-3-
<PAGE> 4
Unless otherwise required by applicable law, no penalty or other charge shall be
payable by the Borrower in connection with termination of a deposit prior to its
initial term.
(g) Default. Upon the occurrence and during the continuation of an
Event of Default, any deposit or deposit account existing under this Section 4
of this First Amendment shall, from and after the date on which the Borrower
receives written notice of the Event of Default from the Administrative Agent,
be deemed to be deposits under the second paragraph of Article 8 of the
Agreement, and interest shall no longer be payable with respect to such
deposits.
(h) Post-Termination Date Letters of Credit. Any cash-collateralized
Letter of Credit having an expiration date later than the Termination Date
shall, from and after the Termination Date, be governed by the terms of Section
3.9 of the Agreement and not by Section 4 of this First Amendment.
SECTION 5. REPRESENTATIONS AND WARRANTIES. The Borrower hereby represents
to the Lenders, the Administrative Agent and the Syndication Agent that:
(a) Representations and Warranties. Its representations and
warranties contained in Article VIII to the Agreement are true and correct as of
the date hereof (unless stated to relate solely to an earlier date, in which
case such representations and warranties are true and correct as of such earlier
date).
(b) Enforceability. The execution and delivery by this First
Amendment, and the performance of its obligations under this First Amendment and
the Agreement, as amended hereby, are within its corporate powers and have been
duly authorized by all necessary corporate action on its part. This First
Amendment and the Agreement, as amended hereby, are its valid and legally
binding obligations, enforceable in accordance with their terms, except as
enforceability may be limited by bankruptcy, insolvency, reorganization or other
similar laws affecting the enforcement of creditors' rights generally and by
general principles of equity, regardless of whether such enforceability is
considered in a proceeding in equity or at law.
(c) No Default. No Default or Event of Default has occurred and is
continuing.
SECTION 6. EFFECT OF AMENDMENT. Except as expressly amended and modified
by this First Amendment, all provisions of the Agreement shall remain in full
force and effect. After this First Amendment becomes effective, all references
in the Agreement (or in any other Credit Document) to "this Agreement",
"hereof", "herein" or words of similar effect referring to the Agreement shall
be deemed to be references to the Agreement as amended by this First Amendment.
This First Amendment shall not be deemed to expressly or impliedly waive, amend
or supplement any provision of the Agreement other than as set forth herein.
SECTION 7. EFFECTIVENESS. This First Amendment shall become effective as
of the date hereof upon receipt by the Administrative Agent of counterparts of
this First Amendment (whether by facsimile or otherwise) executed by each of the
other parties hereto.
-4-
<PAGE> 5
SECTION 8. GOVERNING LAW. This First Amendment shall be governed by, and
construed in accordance with, the internal laws of the State of California
without regard to any otherwise applicable principles of conflicts of law.
SECTION 9. COUNTERPARTS. This First Amendment may be executed in any
number of counterparts and by different parties on separate counterparts, and
each counterpart shall be deemed to be an original, and all such counterparts
shall together constitute but one and the same instrument.
SECTION 10. SECTION HEADINGS. The various headings and sub-headings of
this First Amendment are inserted for convenience only and shall not affect the
meaning or interpretation of this First Amendment or the Agreement or any
provision hereof or thereof.
IN WITNESS WHEREOF, the parties hereto have caused this First Amendment to
be duly executed and delivered by their proper and duly authorized officers as
of the day and year first above written.
Advanced Fibre Communications, Inc., Bank of America, N.A.,
as Borrower as Lender and Syndication Agent
/s/ Keith E.Pratt /s/ Ronald J. Drobny
- ---------------------------------- ----------------------------------------
By: Keith E. Pratt By: Ronald J. Drobny
Title: Vice President & CFO Title: Vice President
Banque Nationale de Paris,
as Lender and Administrative Agent
/s/ Jennifer Cho
- ----------------------------------
By: Jennifer Cho
Title: Vice President
/s/ Michael McCorriston
- ----------------------------------
By: Michael McCorriston
Title: Vice President
-5-
<PAGE> 1
EXHIBIT 10.35
Confidential Treatment requested. Confidential portions of this document have
been redacted and have been separately filed with the Commission.
<PAGE> 2
EXHIBIT 10.35
[BANK OF AMERICA LOGO]
EQUITY FINANCIAL PRODUCTS GROUP
MASTER STOCK PURCHASE AGREEMENT
SPECIALIZED TERM APPRECIATION RETENTION SALE (STARS)
TABLE OF CONTENTS
ARTICLE 1
DEFINITIONS
SECTION 1.01. Definitions
ARTICLE 2
TRANSACTIONS
SECTION 2.01. Transaction Confirmations
ARTICLE 3
SALE AND PURCHASE
SECTION 3.01. Sale and Purchase
SECTION 3.02. Payment for and Delivery of Shares
ARTICLE 4
REPRESENTATIONS AND WARRANTIES OF SELLER
SECTION 4.01. Representations and Warranties of Seller
ARTICLE 5
CONDITIONS TO BUYER'S OBLIGATIONS
SECTION 5.01. Conditions
ARTICLE 6
COVENANTS
SECTION 6.01. Taxes
SECTION 6.02. Forward Contract
SECTION 6.03. Notices
SECTION 6.04. Further Assurances
SECTION 6.05. Securities Contract
SECTION 6.06. Indemnity
ARTICLE 7
ADJUSTMENTS
SECTION 7.01. Dilution Adjustments
SECTION 7.02. Merger Events
SECTION 7.03. Nationalization and Insolvency
SECTION 7.04. Termination and Payment
ARTICLE 8
ACCELERATION
SECTION 8.01. Acceleration
ARTICLE 9
MISCELLANEOUS
SECTION 9.01. Notices
SECTION 9.02. Governing Law; Severability; Submission to Jurisdiction; Waiver
of Jury Trial
SECTION 9.03. Confidentiality
SECTION 9.04. Entire Agreement
SECTION 9.05. Amendments, Waivers
SECTION 9.06. No Third Party Rights, Successors and Assigns
SECTION 9.07. Counterparts
SECTION 9.08. Early Termination
SECTION 9.09. Agreements
THIS AGREEMENT is made as of the date stated on the last page hereof among
the counterparty name on the last page hereof and any successor to such
counterparty
<PAGE> 3
("SELLER") and BANK OF AMERICA, N.A. ("BUYER").
WHEREAS, Seller owns or may own from time to time shares of common stock
of one or more issuers, or security entitlements in respect thereof;
WHEREAS, Seller has agreed, pursuant to the Pledge Agreement (as defined
herein), to grant Buyer a security interest in certain Common Stock to secure
the obligations of Seller hereunder;
WHEREAS, Seller and Buyer may wish to sell and purchase shares of such
common stock, or security entitlements in respect thereof, from time to time and
on the terms set forth herein and in certain confirmations hereunder;
NOW, THEREFORE, in consideration of their mutual covenants herein
contained, the parties hereto, intending to be legally bound, hereby mutually
covenant and agree as follows:
ARTICLE 1
DEFINITIONS
SECTION 1.01. Definitions. As used herein, the following words and phrases
shall have the following meanings:
"ACCELERATION AMOUNT" has the meaning provided in Section 8.01.
"ACCELERATION AMOUNT NOTICE" has the meaning provided in Section 8.01.
"ACCELERATION DATE" has the meaning provided in Section 8.01.
"ACCELERATION VALUE" has the meaning provided in Section 8.01.
"BANKRUPTCY CODE" has the meaning provided in Section 6.05.
"BASE AMOUNT" means, with respect to any Maturity Date for any
Transaction, the number of shares of Common Stock designated as such in the
applicable Transaction Confirmation.
"BUSINESS DAY" means any day on which commercial banks are open for
business in New York City and the New York Stock Exchange is not closed.
"CALCULATION AGENT" means Bank of America, N.A.
"CLOSING PRICE" means, with respect to any security on any Trading Day
(the "VALUATION DATE"), the arithmetic mean of the closing bid price and the
closing offer price (or, if no closing bid price or closing offer price is
reported, the last quoted bid price or offer price for such security on the
Exchange on the Valuation Date), or if such security is not so reported, the
last quoted bid price or offer price in the over-the-counter market as reported
by the National Quotation Bureau or similar organization or, if such bid price
or offer price is not available, the market value of such security on the
Valuation Date as determined by the Calculation Agent in a commercially
reasonable manner; provided that if there is a Market Disruption Event on any
Valuation Date, then the Valuation Date shall be the first succeeding Business
Day on which there is no Market Disruption Event, unless there is a Market
Disruption Event on each of the five Business Days immediately following the
original date that, but for the Market Disruption Event, would have been the
Valuation Date, in which case (i) that fifth Business Day shall be deemed to be
the Valuation Date, notwithstanding the Market Disruption Event and (ii) the
Calculation Agent shall, in a commercially reasonable manner, determine the
Closing Price as of that fifth Business Day.
"COLLATERAL AGENT" has the meaning provided in the Pledge Agreement.
"COMMON STOCK" means, for any Transaction, the class of common stock that
is the subject of such transaction, as identified in the applicable Transaction
Confirmation.
"COMPANY" means, for any Transaction, the issuer of the Common Stock that
is the subject of such Transaction, as identified in the applicable Transaction
Confirmation.
<PAGE> 4
"DOWNSIDE PROTECTION THRESHOLD PRICE" means, for any Transaction, the
price specified as the Downside Protection Threshold Price in the applicable
Transaction Confirmation.
"EVENT OF DEFAULT" has the meaning provided in Section 8.01.
"EXCHANGE" means, for any Transaction at any time, the principal national
securities exchange or automated quotation system, if any, on which the Common
Stock that is the subject of such Transaction is listed or quoted at such time.
"EXTRAORDINARY DIVIDEND" means, for any Transaction, any distribution or
dividend made or paid with respect to the Common Stock that is the subject of
such Transaction that meets the definition of Extraordinary Dividend set forth
in the applicable Transaction Confirmation.
"FREE SHARES" means shares of Common Stock (or security entitlements in
respect thereof) that are not subject to any Transfer Restrictions in the hands
of Seller immediately prior to delivery to an affiliate of Buyer designated by
Buyer hereunder and would not be subject to any Transfer Restrictions in the
hands of such affiliate of Buyer upon delivery to such affiliate of Buyer.
"FUNDED AMOUNT" means with respect to any Funded Portion for any Payment
Date, the present value on such Payment Date of a payment on the Interest
Calculation End Date for the relevant Transaction of such Funded Portion
(determined by the Calculation Agent using a discount rate equal to the
Interpolated LIBOR Rate for the period from such Payment Date to such Interest
Calculation End Date, plus the Spread).
"FUNDED PORTION" has the meaning provided in Section 3.02(a).
"FUNDED PURCHASE PRICE" means, as of any date for any Transaction, the
excess, if any, of (i) the sum of the Funded Portions for such Transaction for
all Payments Dates for such Transaction occurring prior to such date over (ii)
the sum of the Refunded Portions for such Transaction for all Refund Dates for
such Transaction occurring prior to such date.
"FUNDED SHARE AMOUNT" means, for any Maturity Date for any Transaction,
the amount obtained by subtracting the Unfunded Share Amount for such Maturity
Date for such Transaction from the Base Amount with respect to such Maturity
Date for such Transaction.
"INSOLVENCY" has the meaning provided in Section 7.03.
"INTEREST CALCULATION END DATE" means, for any Transaction, the date
specified as such in the applicable Transaction Confirmation.
"INTERPOLATED LIBOR RATE" means, for any period of less than 12 months,
the rate determined by the Calculation Agent using linear interpolation between
USD-LIBOR-BBA for the Designated Maturity (as such terms are defined in the 1991
ISDA Definitions published by the International Swaps and Derivatives
Association, Inc.) that corresponds most closely to, but is longer than, such
period, and USD-LIBOR-BBA for the Designated Maturity that corresponds most
closely to, but is shorter than, such period, or, for any period of more than 12
months, the rate determined by the Calculation Agent using linear interpolation
between the "offer side" U.S. Dollar Swap rate posted on Bloomberg Financial
Markets ("Bloomberg") Page "SWYC23 " (or any successor or replacement page) for
the Designated Maturity that corresponds most closely to, but is longer than,
such period, and the "offer side" U.S. Dollar Swap rate posted on Bloomberg Page
"SWYC23" for the Designated Maturity that corresponds most closely to, but is
shorter than, such period; provided that, in either case, the Calculation Agent
shall make such adjustments to such rates as are appropriate to reflect
continuous compounding (and not semi-annual, or other method of, compounding)
over such period.
"LIEN" means any lien, mortgage, security interest, pledge, charge or
encumbrance of any kind.
"MARKET DISRUPTION EVENT" means, for any Transaction, the occurrence or
the existence at any time on any day of any
<PAGE> 5
suspension of or limitation in trading in the Common Stock that is the subject
of such Transaction or in listed options on such Common Stock, if any, (by
reason of movements in price exceeding limits permitted by the Exchange or
otherwise), if, in the determination of the Calculation Agent, such suspension
or limitation is material.
"MARKET VALUE" means, as of any date with respect to any share of Common
Stock, the Closing Price per share of Common Stock for the Trading Day prior to
such date.
"MATURITY DATE" means, for any Transaction, each date specified as such in
the applicable Transaction Confirmation.
"MERGER DATE" has the meaning provided in Section 7.02.
"MERGER EVENT" has the meaning provided in Section 7.02.
"NATIONALIZATION" has the meaning provided in Section 7.03.
"PAYMENT DATE" has the meaning provided in Section 3.02(a).
"PLEDGE AGREEMENT" means the Pledge Agreement dated as of the date hereof
among Seller, Buyer and the Collateral Agent, as amended from time to time.
"POTENTIAL ADJUSTMENT EVENT" has the meaning provided in Section 7.01.
"PURCHASE PRICE" means, for any Transaction, the amount specified as the
Purchase Price in applicable Transaction Confirmation.
"REFUNDED AMOUNT" means with respect to any Refunded Portion for any
Refund Date, the present value on such Refund Date of a payment on the Interest
Calculation End Date for the relevant Transaction of such Refunded Portion
(determined by the Calculation Agent using a discount rate equal to the
Interpolated LIBOR Rate for the period from such Refund Date to such Interest
Calculation End Date, plus the Spread).
"REFUND DATE" has the meaning provided in Section 3.02(a).
"REFUNDED PORTION" has the meaning provided in Section 3.02(a).
"SECURITIES ACT" means the Securities Act of 1933, as amended.
"SETTLEMENT DATE" means, with respect to any Maturity Date, the third
Trading Day immediately following such Maturity Date.
"SETTLEMENT PRICE" means, for any Settlement Date, the Closing Price per
share of the relevant Common Stock on the Maturity Date with respect to such
Settlement Date.
"SETTLEMENT RATIO" means, for any Settlement Date for any Transaction, the
ratio determined in the manner set forth in the applicable Transaction
Confirmation.
"SPREAD" means, for any Transaction, the spread specified in the
applicable Transaction Confirmation.
"TERMINATION VALUE" has the meaning provided in Section 7.04.
"TERMINATION VALUE NOTICE" has the meaning provided in Section 7.04.
"TERMINATION DATE" has the meaning provided in Section 7.04.
"THRESHOLD APPRECIATION PRICE" means, for any Transaction, the price
specified as the Threshold Appreciation Price in the applicable Transaction
Confirmation.
"TRADING DAY" means, with respect to any security, a day on which the
Exchange is open for trading or quotation.
"TRANSACTION" has the meaning provided in Section 2.01.
"TRANSACTION CONFIRMATION" has the meaning provided in Section 2.01.
"TRANSFER RESTRICTION" means, with respect to any share of Common Stock
(or security entitlements in respect thereof) or other item of collateral
pledged under the Pledge Agreement, any condition to or
<PAGE> 6
restriction on the ability of the holder thereof to sell, assign or otherwise
transfer such share of Common Stock (or security entitlements in respect
thereof) or other item of collateral or to enforce the provisions thereof or of
any document related thereto whether set forth in such item of Collateral itself
or in any document related thereto, including, without limitation, (i) any
requirement that any sale, assignment or other transfer or enforcement of such
share of Common Stock (or security entitlements in respect thereof) or other
item of collateral be consented to or approved by any person, including, without
limitation, the issuer thereof or any other obligor thereon, (ii) any
limitations on the type or status, financial or otherwise, of any purchaser,
pledgee, assignee or transferee of such share of Common Stock (or security
entitlements in respect thereof) or other item of collateral, (iii) any
requirement of the delivery of any certificate, consent, agreement, opinion of
counsel, notice or any other document of any person to the issuer of, any other
obligor on or any registrar or transfer agent for, such share of Common Stock
(or security entitlements in respect thereof) or other item of collateral, prior
to the sale, pledge, assignment or other transfer or enforcement of such share
of Common Stock (or security entitlements in respect thereof) or other item of
collateral and (iv) any registration or qualification requirement or prospectus
delivery requirement for such share of Common Stock (or security entitlements in
respect thereof) or other item of collateral pursuant to any federal, state or
foreign securities law (including, without limitation, any such requirement
arising as a result of Rule 144 or Rule 145 under the Securities Act); provided
that the required delivery of any assignment, instruction or entitlement order
from the seller, pledgor, assignor or transferor of such share of Common Stock
(or security entitlements in respect thereof) or other item of collateral,
together with any evidence of the corporate or other authority of such Person,
shall not constitute a "TRANSFER RESTRICTION".
"UNFUNDED PURCHASE PRICE" means, as of any date for any Transaction, the
excess, if any, of the Purchase Price for such Transaction over the Funded
Purchase Price for such Transaction as of such date.
"UNFUNDED SHARE AMOUNT" means, for any Maturity Date for any Transaction,
the product of the Base Amount with respect to such Maturity Date and a
fraction, the numerator of which is the Unfunded Purchase Price for such
Transaction as of such Maturity Date and the denominator of which is the
Purchase Price for such Transaction.
ARTICLE 2
TRANSACTIONS
SECTION 2.01. Transaction Confirmations. At any time and from time to
time, Seller and Buyer may execute a transaction confirmation agreement
substantially in the form of Exhibit A hereto (a "TRANSACTION CONFIRMATION")
pursuant to which Seller and Buyer shall enter into a forward purchase and sale
transaction (a "TRANSACTION") on the terms set forth herein and in such
Transaction Confirmation.
ARTICLE 3
SALE AND PURCHASE
SECTION 3.01. Sale and Purchase. Upon the terms and subject to the
conditions of this Agreement and the Transaction Confirmation relating to each
Transaction, Seller agrees to sell to Buyer, and Buyer agrees to purchase and
acquire from Seller, a number of shares of the Common Stock that is the subject
of such Transaction (or security entitlements in respect thereof) determined in
accordance with Section 3.02.
SECTION 3.02. Payment for and Delivery of Shares. (a) Upon the terms and
subject to the conditions of this Agreement and the Transaction Confirmation
relating to each Transaction, Buyer and Seller shall make a payment or payments
to the other party under this Agreement and the relevant Transaction
Confirmation at the time and in the manner provided below, in each case in
immediately available funds by wire transfer to an account designated by the
payee. Seller shall have the right with respect to any Transaction, upon five
Business Days' prior
<PAGE> 7
written notice to Buyer, to demand payment on any date (a "PAYMENT DATE" for
such Transaction) during the period beginning on the Closing Date and ending on
the date five Business Days prior to the first Maturity Date for such
Transaction of the Funded Amount as of such Payment Date of all or any portion
(the "FUNDED PORTION") of the Unfunded Purchase Price as of such Payment Date,
provided that the Funded Portion shall be equal to or greater than the lesser of
(i) 2% of the Purchase Price for such Transaction and (ii) the Unfunded Purchase
Price on such Payment Date for such Transaction. Following any such payment to
Seller, Seller shall have the right, upon five Business Days' prior written
notice to Buyer, to refund on any date (a "REFUND DATE" for such Transaction) on
or prior to the date five Business Days prior to the first Maturity Date for
such Transaction all or any portion (the "REFUNDED PORTION") of the Funded
Purchase Price as of such Refund Date by paying to Buyer on such Refund Date the
Refunded Amount as of such Refund Date of such Refunded Portion, provided that
the Refunded Portion shall be equal to or greater than the lesser of (i) 2% of
the Purchase Price for such Transaction and (ii) the Funded Purchase Price on
such Refund Date for such Transaction.
(b) On each Settlement Date for such Transaction, Seller agrees to deliver
to an affiliate of Buyer designated by Buyer a number of Free Shares of the
relevant Common Stock (the "CONTRACT SHARES") equal to the sum of (i) the
product of (A) the Funded Share Amount for the Maturity Date with respect to
such Settlement Date and (B) the Settlement Ratio for such Settlement Date, plus
(ii) if the Settlement Price for such Settlement Date is greater than or equal
to the Threshold Appreciation Price for such Transaction or less than or equal
to the Downside Protection Threshold Price for such Transaction, the Unfunded
Share Amount for the Maturity Date with respect to such Settlement Date, such
sum rounded down to the nearest whole number, and cash in an amount equal to the
value (based on the Settlement Price for such Settlement Date) of any fractional
share not delivered as a result of such rounding. If (x) by 10:00 A.M., New York
City time on each Settlement Date, Seller has not otherwise effected such
delivery of Common Stock (or security entitlements in respect thereof) and (y)
the Collateral Agent then holds as collateral under the Pledge Agreement in
respect of such Transaction a number of Free Shares of the relevant Common Stock
at least equal to the number thereof required to be so delivered on such
Settlement Date, then the delivery provided by this Section 3.02(b) shall be
effected by delivery by the Collateral Agent to an affiliate of Buyer designated
by Buyer of a number of Free Shares of such Common Stock then held by the
Collateral Agent as collateral under the Pledge Agreement in respect of such
Transaction equal to the number thereof required to be delivered by Seller to an
affiliate of Buyer designated by Buyer pursuant to this Section 3.02(b) on such
Settlement Date.
(c) On each Settlement Date for such Transaction, if the Settlement
Price for such Settlement Date is greater than or equal to the Threshold
Appreciation Price for such Transaction, Buyer shall pay to Seller, in
immediately available funds by wire transfer to an account designated by Seller,
an amount of cash equal to the product of (i) the Unfunded Share Amount for the
Maturity Date with respect to such Settlement Date and (ii) the Threshold
Appreciation Price for such Transaction. On each Settlement Date for such
Transaction, if the Settlement Price for such Settlement Date is less than or
equal to the Downside Protection Threshold Price for such Transaction, Buyer
shall pay to Seller, in immediately available funds by wire transfer to an
account designated by Seller, an amount of cash equal the product of (i) the
Unfunded Share Amount for the Maturity Date with respect to such Settlement Date
and (ii) the Downside Protection Threshold Price for such Transaction.
ARTICLE 4
REPRESENTATIONS AND WARRANTIES OF SELLER
SECTION 4.01. Representations and Warranties of Seller. Seller represents
and warrants to Buyer that:
(a) Seller has been duly incorporated and is validly existing as a
corporation in good standing
<PAGE> 8
under the laws of its jurisdiction of incorporation.
(b) Seller has all corporate power to enter into this Agreement, each
Transaction Confirmation and the Pledge Agreement and each other document
relating hereto and thereto and to consummate the transactions
contemplated hereby and thereby. Each of this Agreement, each Transaction
Confirmation and the Pledge Agreement and each other document relating
hereto and thereto has been duly authorized and validly executed and
delivered by Seller and constitutes a valid and legally binding obligation
of Seller enforceable in accordance with its terms, subject to applicable
bankruptcy, insolvency and similar laws affecting creditors' rights
generally and to general equitable principles.
(c) The execution and delivery by Seller of, and the compliance by
Seller with all of the provisions of, this Agreement, each Transaction
Confirmation and the Pledge Agreement and the consummation of the
transactions herein and therein contemplated will not (i) conflict with or
result in a breach of any of the terms or provisions of, or constitute a
default under, any indenture, mortgage, deed of trust, loan agreement or
any other agreement or instrument to which Seller or any of its
subsidiaries is a party or by which Seller or any of its subsidiaries is
bound or to which any of the property or assets of Seller or any of its
subsidiaries is subject, nor will such action result in any violation of
the provisions of the Certificate of Incorporation or By-laws or other
constitutive documents of Seller or any statute or any order, rule or
regulation of any court or governmental agency or body having jurisdiction
over Seller or any of its subsidiaries or any of their respective
properties or (ii) require any consent, approval, authorization or order
of, or filing or qualification with, any governmental body, agency,
official, self-regulatory organization or court or other tribunal, whether
foreign or domestic.
(d) Seller is acting for its own account, and has made its own
independent decision to enter into this Agreement, each Transaction
Confirmation and the Pledge Agreement and as to whether this Agreement,
any Transaction Confirmation and the Pledge Agreement are appropriate or
proper for it based upon its own judgment and upon advice of such advisors
as it deems necessary. Seller acknowledges and agrees that it is not
relying, and has not relied, upon any communication (written or oral) of
Buyer or any affiliate of Buyer with respect to the legal, accounting, tax
or other implications of this Agreement, any Transaction Confirmation and
the Pledge Agreement and that it has conducted its own analyses of the
legal, accounting, tax and other implications hereof and thereof; it being
understood that information and explanations related to the terms and
conditions of this Agreement, any Transaction Confirmation or the Pledge
Agreement shall not be considered investment advice or a recommendation to
enter into this Agreement, any Transaction Confirmation or the Pledge
Agreement.
(e) Seller is entering into this Agreement and each Transaction
Confirmation with a full understanding of all of the terms and risks
hereof (economic and otherwise) and is capable of evaluating and
understanding (on its own behalf or through independent professional
advice), and understands and accepts, the terms, conditions and risks.
Seller is also capable of assuming (financially and otherwise), and
assumes, those risks.
<PAGE> 9
(f) Seller acknowledges that neither Buyer nor any affiliate of Buyer
is acting as a fiduciary for or an advisor to Seller in respect of this
Agreement, any Transaction Confirmation or the Pledge Agreement.
(g) Seller has a valid business purpose for entering into this
Agreement, and each Transaction Confirmation, and the transactions
contemplated hereby and thereby are consistent with Seller's overall
investment strategy
ARTICLE 5
CONDITIONS TO BUYER'S OBLIGATIONS
SECTION 5.01. Conditions. The obligation of Buyer to deliver (i) the
Funded Amount of the Funded Portion any Payment Date and (ii) the Unfunded
Purchase Price on the Settlement Date for each Transaction, in either case, is
subject to the satisfaction of the following conditions:
(a) The representations and warranties of Seller contained in Article
4, in the relevant Transaction Confirmation and in the Pledge Agreement
shall be true and correct as of such Payment Date or the Settlement Date,
as the case may be.
(b) The Pledge Agreement shall have been executed by the parties
thereto, and Seller shall have delivered to the Collateral Agent in
accordance therewith the collateral required to be delivered pursuant to
Section 1(b) thereof in connection with such Transaction.
(c) Seller shall have performed all of the covenants and obligations
to be performed by it hereunder and under the Pledge Agreement on or prior
to such Payment Date or the Settlement Date, as the case may be.
ARTICLE 6
COVENANTS
SECTION 6.01. Taxes. Seller shall pay any and all documentary, stamp,
transfer or similar taxes and charges that may be payable in respect of the
entry into this Agreement and each Transaction Confirmation and the transfer and
delivery of any Common Stock (or security entitlements in respect thereof)
pursuant hereto and thereto. Seller further agrees to make all payments in
respect of this Agreement and each Transaction Confirmation free and clear of,
and without withholding or deduction for or on account of, any present or future
taxes, duties, fines, penalties, assessments or other governmental charges of
whatsoever nature (or interest on any taxes, duties, fines, penalties,
assessments or other governmental charges of whatsoever nature) imposed, levied,
collected, withheld or assessed by, within or on behalf of (a) the United States
or any political subdivision or governmental authority thereof or therein having
power to tax or (b) any jurisdiction from or through which payment on the
Agreement and each Transaction Confirmation is made by the Seller, or any
political subdivision or governmental authority thereof or therein having power
to tax. In the event such withholding or deduction is imposed, Seller agrees to
indemnify the Buyer for the full amount of such withholding or deduction, as
well as any liability (including penalties, interest and expenses) arising
therefrom or with respect thereto.
SECTION 6.02. Forward Contract. Seller hereby agrees that: (i) it will not
treat this Agreement or any Transaction Confirmation, any portion of this
Agreement or any Transaction Confirmation, or any obligation hereunder as giving
rise to any interest income or other inclusions of ordinary income; (ii) it will
not treat the delivery of any portion of the shares of Common Stock (or security
entitlements in respect thereof) to be delivered pursuant to this Agreement or
any Transaction Confirmation as the payment of interest or ordinary income;
(iii) it will treat this Agreement as supplemented by each Transaction
Confirmation relating to a particular Transaction in its entirety as a forward
contract for the delivery of such
<PAGE> 10
shares of Common Stock (or security entitlements in respect thereof) that are
the subject of such Transaction; and (iv) it will not take any action (including
filing any tax return or form or taking any position in any tax proceeding) that
is inconsistent with the obligations contained in (i) through (iii).
Notwithstanding the preceding sentence, Seller may take any action or position
required by law, provided that Seller delivers to Buyer an unqualified opinion
of counsel, nationally recognized as expert in Federal tax matters and
acceptable to Buyer, to the effect that such action or position is required by a
statutory change or a Treasury regulation or applicable court decision published
after the date of this Agreement.
SECTION 6.03. Notices. Seller will cause to be delivered to Buyer:
(a) Immediately upon the occurrence of any Event of Default hereunder
or under the Pledge Agreement, or upon any officer of Seller obtaining
knowledge that any of the conditions or events described in paragraph
8.01(a) or 8.01(b) shall have occurred with respect to the Company, notice
of such occurrence; and
(b) In case at any time Seller receives notice, or any officer of
Seller obtains knowledge, that any event requiring that an adjustment be
calculated pursuant to Section 7.01 or 7.02 hereof or any Nationalization
or Insolvency with respect to any Company that is the issuer of the Common
Stock that is the subject of any Transaction shall have occurred or be
pending, then Seller shall promptly cause to be delivered to Buyer a
notice identifying such event and stating, if known to Seller, the date on
which such event occurred or is to occur and, if applicable, the record
date relating to such event. Seller shall cause further notices to be
delivered to Buyer if Seller shall subsequently receive notice, or any
officer of Seller shall obtain knowledge, of any further or revised
information regarding the terms or timing of such event or any record date
relating thereto.
SECTION 6.04. Further Assurances. From time to time, each of the parties
hereto shall use its reasonable best efforts to take, or cause to be taken, all
actions and to do, or cause to be done, all things necessary, proper and
advisable to consummate and make effective as promptly as practicable the
transactions contemplated by this Agreement and each Transaction Confirmation in
accordance with the terms and conditions hereof and thereof, including (i) using
reasonable best efforts to remove any legal impediment to the consummation of
such transactions and (ii) the execution and delivery of all such deeds,
agreements, assignments and further instruments of transfer and conveyance
necessary, proper or advisable to consummate and make effective the transactions
contemplated by this Agreement and each Transaction Confirmation in accordance
with the terms and conditions hereof and thereof.
SECTION 6.05. Securities Contract. The parties hereto recognize that the
Buyer is a financial institution within the meaning of Section 101(22) of Title
11 of the United States Code (the "BANKRUPTCY CODE"). The parties hereto further
recognize that this Agreement as supplemented by each Transaction Confirmation
is a securities contract, as such term is defined in Section 741(7) of the
Bankruptcy Code, entitled to the protection of Section 555 of the Bankruptcy
Code.
SECTION 6.06. Indemnity. In the event that Buyer or any of its affiliates
becomes involved in any capacity in any action, proceeding or investigation
brought by or against any person in connection with any matter referred to in
this Agreement, the Seller shall reimburse Buyer or such affiliate for its
reasonable legal and other out-of-pocket expenses (including the cost of any
investigation and preparation) incurred in connection therewith within 30 days
of receipt of notice of such expenses, and shall indemnify and hold Buyer or
such affiliate harmless on an after-tax basis against any losses, claims,
damages or liabilities to which Buyer or such affiliate may become subject in
connection with any such action, proceeding or investigation. The reimbursement
and
<PAGE> 11
indemnity obligations of the Seller under this Section shall be in addition to
any liability that the Seller may otherwise have, shall extend upon the same
terms and conditions to the partners, directors, officers, agents, employees and
controlling persons (if any), as the case may be, of Buyer and its affiliates
and shall be binding upon and inure to the benefit of any successors, assigns,
heirs and personal representatives of the Seller, Buyer, any such affiliate and
any such person. The Seller also agrees that neither Buyer nor any of such
affiliates, partners, directors, officers, agents, employees or controlling
persons shall have any liability to the Seller for or in connection with any
matter referred to in this Agreement except to the extent that any losses,
claims, damages, liabilities or expenses incurred by the Seller result from the
willful misconduct, gross negligence or bad faith of Buyer or a breach by Buyer
of any of its covenants or obligations hereunder. The foregoing provisions shall
survive any termination or completion of this Agreement.
ARTICLE 7
ADJUSTMENTS
SECTION 7.01. Dilution Adjustments. (a) Following the declaration by any
Company that is the issuer of the Common Stock that is the subject of any
Transaction hereunder of the terms of any Potential Adjustment Event, the
Calculation Agent will determine whether such Potential Adjustment Event has a
diluting or concentrative effect on the theoretical value of such Common Stock
and, if so, will (i) make the corresponding adjustment, if any, to any one or
more of each Base Amount, each Settlement Ratio, the Threshold Appreciation
Price, the Downside Protection Threshold Price, any Closing Price and any other
variable relevant to the exercise, settlement or payment terms of each such
Transaction contemplated hereby as the Calculation Agent determines appropriate
to account for that diluting or concentrative effect and (ii) determine the
effective date of the adjustment. The Calculation Agent may (but need not)
determine the appropriate adjustment by reference to the adjustment in respect
of such Potential Adjustment Event made by an options exchange to options on the
Common Stock traded on that options exchange.
(b) For these purposes, "POTENTIAL ADJUSTMENT EVENT" means any of
the following:
(i) a subdivision, consolidation or reclassification of shares of
such Common Stock (which does not constitute a Merger Event), or a free
distribution or dividend of any shares of such Common Stock to existing
holders of such Common Stock by way of bonus, capitalization or similar
issue;
(ii) a distribution or dividend to existing holders of such Common
Stock of (i) shares of such Common Stock, or (ii) other share capital or
securities granting the right to payment of dividends and/or the proceeds
of such liquidation of such Company equally or proportionately with such
payments to holders of such Common Stock, or (iii) other type of
securities, rights or warrants or other assets, in any case for payment
(cash or other) at less than the prevailing market price as determined by
the Calculation Agent;
(iii) an Extraordinary Dividend;
(iv) a call by such Company in respect of shares of such Common
Stock that are not fully paid;
(v) a repurchase by such Company of shares of such Common Stock,
whether out of profits or capital and whether the consideration for such
repurchase is cash, securities or otherwise; or
(vi) any other similar event that may have a diluting or
concentrative effect on the theoretical value of such Common Stock.
SECTION 7.02 Merger Events. (a) Buyer shall have the right, upon becoming
<PAGE> 12
aware of the occurrence of any Share-for-Share Merger Event (as defined below),
to notify Seller that the number of New Shares (as defined below) to which a
holder of shares of the Common Stock that is the subject of any Transaction
equal to each Base Amount with respect to such Transaction would be entitled
upon consummation of the Share-for-Share Merger Event will be deemed such "Base
Amount" and the New Shares and their issuer will be deemed the "Common Stock"
and the "Company" for such Transaction, respectively, and that the Calculation
Agent will make corresponding adjustments, if any, to any one or more of each
Base Amount, each Settlement Ratio, the Threshold Appreciation Price, the
Downside Protection Threshold Price, any Closing Price and any other variable
relevant to the exercise, settlement or payment terms of each such Transaction.
Notwithstanding the above, the Calculation Agent will determine if any such
Merger Event adjustment affects the theoretical value of any such Transaction,
and if so, may in its sole discretion make an adjustment to any one or more of
the Base Amount, the Settlement Ratio, the Threshold Appreciation Price, the
Downside Protection Threshold Price, any Closing Price, and any other variable
relevant to the exercise, settlement or payment terms of such Transaction to
reflect the characteristics (including, without limitation, the volatility,
dividend practice and policy and liquidity) of the New Shares. Any adjustment
made pursuant to this paragraph will be effective as of the date determined by
the Calculation Agent.
(b) Buyer shall have the right, upon becoming aware of the occurrence
of any Merger Event (as defined below) which does not constitute a
Share-for-Share Merger Event, to notify Seller of such event and terminate the
relevant Transaction Confirmation, following which Seller shall make a payment
to Buyer as provided in Section 7.04.
(c) "MERGER EVENT" means, in respect of any Common Stock, any (A)
reclassification or change of such Common Stock that results in a transfer of or
an irrevocable commitment to transfer 10% or more of the outstanding shares of
such Common Stock, (B) consolidation, amalgamation or merger of the Company that
is the issuer of such Common Stock with or into another entity (other than a
consolidation, amalgamation or merger in which such Company is the continuing
entity and which results in reclassification or change of less than 10% of the
outstanding shares of such Common Stock), or (C) other takeover offer for shares
of such Common Stock that results in a transfer of or an irrevocable commitment
to transfer 10% or more of the shares of such Common Stock (other than such
shares of such Common Stock owned or controlled by the offeror), in each case if
the Merger Date is on or before the final Settlement Date for the relevant
Transaction. "MERGER DATE" means, in respect of any Merger Event, the date upon
which holders of the necessary number of shares of such Common Stock (other
than, in the case of a takeover offer, shares of such Common Stock owned or
controlled by the offeror) have agreed or have irrevocably become obligated to
transfer their shares of such Common Stock. In respect of each Merger Event, the
following terms have the meanings given below:
(i) "SHARE-FOR-SHARE" means, in respect of a Merger Event, that the
consideration for such Common Stock consists (or, at the option of the
holder of such Common Stock, may consist) solely of New Shares; and
(ii) "NEW SHARES" means shares of common stock (whether of the
offeror or a third party) received in connection with a Merger Event.
SECTION 7.03. Nationalization and Insolvency. If, prior to the final
Settlement Date for any Transaction, all the shares of any Common Stock that is
the subject of such Transaction hereunder or all the assets or substantially all
the assets of the Company that is the issuer of such Common Stock are
nationalized, expropriated or are otherwise required to be transferred to any
governmental agency, authority or entity (a "NATIONALIZATION"); or by reason of
the voluntary or involuntary liquidation, bankruptcy or insolvency of or any
analogous proceeding affecting the Company, (A) all the shares of such Common
Stock are required to be transferred to a trustee, liquidator or other similar
official or (B) holders of the shares of
<PAGE> 13
such Common Stock become legally prohibited from transferring them (an
"INSOLVENCY"), then, in any such event, Buyer shall have the right, upon
becoming aware of the occurrence of a Nationalization or Insolvency, to notify
Seller of such event and terminate each such Transaction the related Transaction
Confirmation as of the date set forth in such notice following which Seller
shall make payment to Buyer as provided in Section 7.04.
SECTION 7.04. Termination and Payment. Following termination of any
Transaction as a result of any Merger Event, Nationalization or Insolvency, the
Calculation Agent shall determine the value (the "TERMINATION VALUE") equal to
the Acceleration Value for such Transaction (calculated, for purposes of this
Section 7.04, as if the Termination Date were the Acceleration Date, calculated
on the basis of, in addition to the factors indicated in Section 8.01, a value
ascribed to the relevant Common Stock equal to the consideration, if any, paid
in respect of such Common Stock at the time of the Merger Event, Nationalization
or Insolvency, as the case may be, and representing a value to Buyer (which
value may be negative) of an agreement with terms that would preserve for Buyer
the economic equivalent of the payments and deliveries that Buyer and its
affiliates would, but for the occurrence of the Merger Event, Nationalization or
Insolvency, as the case may be, have been obligated to make and entitled to
receive after the Termination Date) in settlement of such Transaction and the
related Transaction Confirmation. As promptly as reasonably practicable after
calculation of the Acceleration Value, the Calculation Agent shall deliver to
Buyer and Seller a notice (the "TERMINATION VALUE NOTICE") specifying the
Termination Value. Not later than three Business Days following delivery of a
Termination Value Notice, if the Termination Value is positive, Seller shall
make a cash payment to Buyer, or, if the Termination Value is negative, Buyer
shall make a cash payment to Seller, in either case, by wire transfer of
immediately available funds to an account designated by the payee, in an amount
equal to the absolute value of the Termination Value.
"TERMINATION DATE" means (i) in respect of a Merger Event, the Merger
Date, (ii) in respect of a Nationalization, the date of the first public
announcement of a firm intention to nationalize and (iii) in respect of an
Insolvency, the earlier of the date the shares of the relevant Common Stock are
required to be transferred to a trustee, liquidator or other similar official
and the date the holders of shares of such Common Stock become legally
prohibited from transferring such Common Stock that, in the case of a
Nationalization or an Insolvency (whether or not amended or on the terms
originally announced), leads to the Nationalization or the Insolvency, as the
case may be, in each case as determined by Buyer.
ARTICLE 8
ACCELERATION
SECTION 8.01. Acceleration. If one or more of the following events (each
an "EVENT OF DEFAULT") shall occur:
(a) any legal proceeding shall have been instituted that if adversely
decided, in Buyer's reasonable judgment would have a material adverse effect on
the Seller's ability to perform Seller's obligations hereunder or under the
Pledge Agreement or any Transaction Confirmation, or that calls into question
the validity or binding effect of any agreement of Seller hereunder or under the
Pledge Agreement or any Transaction Confirmation;
(b) Seller makes an assignment for the benefit of creditors, files a
petition in bankruptcy, is adjudicated insolvent or bankrupt, petitions or
applies to any tribunal for any receiver of or any trustee for Seller or any
substantial part of Seller's property, commences any proceeding relating to
Seller under any reorganization, arrangement, readjustment of debt, dissolution
or liquidation law or statute of any jurisdiction, whether now or hereafter in
effect, or there is commenced against or with respect to Seller or any
substantial portion of its property any such proceeding and an order for relief
is issued or such proceeding remains undismissed for a period of 60 days;
<PAGE> 14
(c) at any time, any representation made or repeated or deemed to have
been made or repeated by Seller under this Agreement, any Transaction
Confirmation or the Pledge Agreement or any certificate delivered pursuant
hereto or thereto would be incorrect or misleading in any material respect if
made or repeated as of such time;
(d) Seller fails to fulfill or discharge when due any of its
obligations, covenants or agreements under or relating to this Agreement, any
Transaction Confirmation or the Pledge Agreement, including Seller's obligations
to deliver shares of Common Stock (or security entitlements in respect thereof)
on each Settlement Date relating to each Transaction entered into hereunder;
(e) due to the adoption of, or any change in, any applicable law after
the date hereof, or due to the promulgation of, or any change in, the
interpretation by any court, tribunal or regulatory authority with competent
jurisdiction of any applicable law after the date hereof, it becomes unlawful
for Seller to perform any absolute or contingent obligation to make payment or
delivery hereunder or to comply with any other material provision of this
Agreement, any Transaction Confirmation or the Pledge Agreement;
(f) any inability (which shall include an increase in costs) of Buyer,
due to market illiquidity, illegality or lack of availability of hedging
transaction market participants or otherwise, to establish, re-establish or
maintain any hedging transaction or transactions necessary in the normal course
of Buyer's business of hedging the price and market risk of entering into and
performing under this Agreement or any Transaction hereunder;
(g) Seller fails to make any payment on the date due with respect to
any financial obligation of whatever kind or description now or hereafter
incurred by Seller (whether present or future), provided that the amount of such
financial obligation is at least equal to ++;
(h) Seller fails to make any payment on the date due with respect to
any financial obligation of whatever kind or description now or hereafter
incurred by Seller (whether present or future), provided that (i) the amount of
such financial obligation is less than ++ and (ii) in the reasonable
determination of Buyer, failure to make such payment indicates a material
deterioration of the financial condition of Seller; or
(i) a Collateral Event of Default within the meaning of the Pledge
Agreement shall occur;
then, upon notice to Seller from Buyer at any time following an Event of
Default, an "ACCELERATION DATE" shall occur, and the Calculation Agent shall
determine the Acceleration Value. If the Acceleration Value is positive, Seller
shall become obligated to deliver to an affiliate of Buyer designated by Buyer
immediately upon receipt of the Acceleration Amount Notice (as defined below) a
number of Free Shares of each Common Stock that is the subject of a Transaction
hereunder equal to the Acceleration Amount for such Common Stock; provided that
if the Collateral Agent proceeds to realize upon any collateral pledged under
the Pledge Agreement and to apply the proceeds of such realization as provided
in paragraph second of Section 8(d) thereof, then, to the extent of such
application of proceeds, Seller's obligation to deliver Common Stock pursuant to
this paragraph shall be deemed to be an obligation to deliver an amount of cash
equal to the aggregate Market Value of such Free Stock on the Acceleration Date.
The "ACCELERATION AMOUNT" of any Common Stock means the quotient obtained by
dividing: (i) the aggregate Acceleration Value, as defined below, for all
Transactions hereunder of which such Common Stock is the subject, by (ii) the
Market Value per share of such Common Stock on the Acceleration Date. If the
Acceleration Value is negative, Buyer shall make a cash payment to Seller, by
wire transfer of immediately available funds to an account designated by Seller,
on the fifth Business Day following the Acceleration Date in an amount equal to
the absolute value of the Acceleration Value.
The "ACCELERATION VALUE" means, for any Transaction hereunder, an amount
determined by the Calculation Agent in a
++ Confidential material redacted and filed separately with the Commission.
<PAGE> 15
commercially reasonable manner representing the net fair value (which value may
be negative) to Buyer and its affiliates of an agreement with terms that would
preserve for Buyer the economic equivalent of the aggregate payments and
deliveries in respect of such Transaction that Buyer and its affiliates would,
but for the occurrence of the Acceleration Date, have been obligated to make and
entitled to receive after the Acceleration Date under Article 3 (taking into
account any adjustments pursuant to Section 7.01 that may have been calculated
on or prior to the Acceleration Date). The Calculation Agent shall calculate
such amount based on the following factors (and such other factors as it deems
appropriate): (i) the volatility of the Common Stock that is the subject of such
Transaction, (ii) dividends on such Common Stock and (iii) prevailing interest
rates.
As promptly as reasonably practicable after calculation of the
Acceleration Value, the Calculation Agent shall deliver to Seller and Buyer a
notice (the "ACCELERATION VALUE NOTICE") specifying the Acceleration Value, and,
if the Acceleration Value is positive, the Acceleration Amount of shares of
Common Stock (or security entitlements in respect thereof) required to be
delivered by Seller.
ARTICLE 9
MISCELLANEOUS
SECTION 9.01. Notices. All notices and other communications hereunder
shall be in writing and shall be deemed to have been duly given if mailed or
transmitted by any standard forms of telecommunication. Notices to Buyer shall
be directed to it care of Banc of America Securities LLC, 9 West 57th Street,
New York, New York 10019, Telecopy No. 212-583-8569, Attention: Robert Dilworth;
notices to Seller shall be directed to it at the address as specified on the
last page hereof.
SECTION 9.02. Governing Law; Severability; Submission to Jurisdiction;
Waiver of Jury Trial. (a) This Agreement shall be governed by and construed in
accordance with the laws of the State of New York (without reference to choice
of law doctrine).
(b) To the extent permitted by law, the unenforceability or invalidity
of any provision or provisions of this Agreement shall not render any other
provision or provisions herein contained unenforceable or invalid.
(c) Seller and Buyer hereby irrevocably and unconditionally submit to
the non-exclusive jurisdiction of the Federal and state courts located in the
Borough of Manhattan, in the City of New York in any suit or proceeding arising
out of or relating to this Agreement or the transactions contemplated hereby.
(d) Seller and Buyer hereby irrevocably and unconditionally waive any
and all right to trial by jury in any legal proceeding arising out of or related
to this Agreement or the transactions contemplated hereby.
(e) Service of Process. Seller irrevocably appoints the party as
specified on the last page hereof, and Buyer appoints Banc of America Securities
LLC, as process agent to receive for it and on its behalf, service of process in
any action, suit or other proceeding arising out of this Agreement or any
transaction contemplated hereby. If for any reason the party as specified on the
last page hereof is unable to act as such, Seller will promptly notify Buyer and
within 30 days appoint a substitute process agent acceptable to Buyer. The
parties irrevocably consent to service of process given in the manner provided
for notices in Section 9.01. Nothing in this Agreement will affect the right of
either party to serve process in any other manner permitted by law.
SECTION 9.03. Confidentiality. Except as required by law or judicial or
administrative process, or as requested by a regulatory authority or
self-regulatory organization, each party hereto agrees to keep this Agreement,
each Transaction Confirmation and the Pledge Agreement and the transactions
contemplated hereby and thereby confidential. In the event disclosure is
permitted pursuant to the preceding sentence, the disclosing party shall (i)
provide prior notice of such disclosure to the other party, (ii)
<PAGE> 16
use its best efforts to minimize the extent of such disclosure and (iii) comply
with all reasonable requests of the other party to minimize the extent of such
disclosure. This Section 9.03 shall not prevent Seller or Buyer from disclosing
information as necessary to third-party advisors in connection with the
transactions contemplated hereby or in any Transaction Confirmation or the
Pledge Agreement; provided that such advisors agree in writing to be bound by
this Section 9.03 as if a party hereto.
SECTION 9.04. Entire Agreement. Except as expressly set forth herein and
in each Transaction Confirmation, this Agreement (as supplemented by each
Transaction Confirmation) constitutes the entire agreement and understanding
among the parties with respect to its subject matter hereof and supersedes all
oral communications and prior writings with respect thereto.
SECTION 9.05. Amendments, Waivers. Any provision of this Agreement or any
Transaction Confirmation may be amended or waived if, and only if, such
amendment or waiver is in writing and signed, in the case of an amendment, by
Buyer and Seller or, in the case of a waiver, by the party against whom the
waiver is to be effective. No failure or delay by either party in exercising any
right, power or privilege hereunder or thereunder shall operate as a waiver
thereof nor shall any single or partial exercise thereof preclude any other or
further exercise thereof or the exercise of any other right, power or privilege.
The rights and remedies herein provided shall be cumulative and not exclusive of
any rights or remedies provided by law.
SECTION 9.06. No Third Party Rights, Successors and Assigns. This
Agreement (as supplemented by each Transaction Confirmation) is not intended and
shall not be construed to create any rights in any person other than Seller,
Buyer, an affiliate of Buyer designated hereunder to receive Free Shares and
their respective successors and assigns and no other person shall assert any
rights as third party beneficiary hereunder. Whenever any of the parties hereto
is referred to, such reference shall be deemed to include the successors and
assigns of such party. All the covenants and agreements herein contained by or
on behalf of the Seller and Buyer shall bind, and inure to the benefit of, their
respective successors and assigns whether so expressed or not, and shall be
enforceable by and inure to the benefit of Buyer and its successors and assigns.
Seller shall have the right to assign its rights and obligations under this
Agreement (including each Transaction Confirmation hereunder), the Pledge
Agreement and the Common Stock pledged pursuant to the Pledge Agreement to a
broker or a dealer or an affiliate of a broker or a dealer (as such terms are
defined in the Securities Exchange Act of 1934, as amended, and the rules
thereunder), provided that (i) all such rights and obligations shall be assigned
to the same assignee, (ii) that such assignee shall be reasonably acceptable to
Buyer and (iii) Seller and such assignee shall execute documentation reasonably
acceptable to Buyer.
SECTION 9.07. Counterparts. This Agreement may be executed in any
number of counterparts, and all such counterparts taken together shall be
deemed to constitute one and the same agreement.
SECTION 9.08. Early Termination. Seller may request to terminate any
Transaction prior to the first Settlement Date for such Transaction (any such
termination, an "Early Termination") by providing written notice to Buyer at
least ten (10) Business Days prior to such Settlement Date, provided that no
Event of Default has occurred or is continuing. Upon such written request to
Buyer, the parties agree to negotiate in good faith the early termination amount
to be made in respect of such Early Termination.
SECTION 9.09. Agreements. This Agreement and the Pledge Agreement shall be
null and void in the event that the parties do not enter into any Transactions
pursuant to this Agreement.
*************
Date of Agreement: February 9, 2000
Seller: Advanced Fibre Communications, Inc.,
a corporation
Seller's Address for Notices:
One Willow Brook Ct.
<PAGE> 17
Petaluma, CA 94954
Phone No.: 707-792-4163
Telecopy No.: 707-792-7275
Attn: Peter M. Donahower, Treasurer
Service of Process: Seller hereby appoints the party specified below to
serve as process agent pursuant to Section 9.02(e):
Advanced Fibre Communications, Inc.
Attn: Amy Paul, Vice President and General Counsel
One Willow Brook Ct.
Petaluma, CA 94954
Phone No.: 707-792-4163
Telecopy No.: 707-792-7275
**************
IN WITNESS WHEREOF, the parties have signed this Agreement as of the date
and year first above written.
SELLER:
ADVANCED FIBRE COMMUNICATIONS, INC.
By: /s/ Keith E. Pratt
---------------------------------
Name: Keith E. Pratt
Title: Vice President and CFO
ADVANCED FIBRE COMMUNICATIONS, INC.
By: /s/ Peter Donahower
---------------------------------
Name: Peter Donahower
Title: Director, Treasury
BUYER:
BANK OF AMERICA, N.A.
By: /s/ William Caccamise
---------------------------------
Name: William Caccamise
Title: Managing Director
<PAGE> 18
Exhibit A
to
Master Stock Purchase Agreement
TRANSACTION CONFIRMATION
The purpose of this agreement (this "CONFIRMATION") is to confirm the
terms and conditions of the transaction entered into between Advanced Fibre
Communications, Inc. ("SELLER") and Bank of America, N.A., ("BUYER"), on the
Trade Date specified below (the "TRANSACTION"). This Confirmation constitutes a
Transaction Confirmation as referred to in the Master Stock Purchase Agreement
(as amended or supplemented from time to time, the "MASTER STOCK PURCHASE
AGREEMENT") dated as of February 9, 2000 between Seller and Buyer. This
Confirmation supplements, forms a part of, and is subject to, the Master Stock
Purchase Agreement. All provisions contained in the Master Stock Purchase
Agreement govern this Confirmation except as expressly modified below. Seller,
Buyer and Banc of America Securities LLC, as collateral agent, are parties to a
Pledge Agreement (the "PLEDGE AGREEMENT") dated as of the date of the Master
Stock Purchase Agreement. Capitalized terms used and not otherwise defined
herein shall have the meanings ascribed to them in the Master Stock Purchase
Agreement and the Pledge Agreement.
1. The terms of the particular Transaction to which this Confirmation
relates are as follows:
Trade Date: February 9, 2000
Common Stock and Company: Common stock, $0.001 par value per share of
Cisco Systems, Inc. ("CSCO")
Purchase Price: U.S. $656,166,699.50
Closing Date: February 14, 2000
Threshold Appreciation Price: U.S. ++
Downside Protection Threshold Price: U.S. ++
<TABLE>
<CAPTION>
MATURITY DATE BASE AMOUNT
- ------------- -----------
<S> <C>
++ , 2003 ++ shares
++ , 2003 ++ shares
++ , 2003 ++ shares
++ , 2003 ++ shares
++ , 2003 ++ shares
++ , 2003 ++ shares
++ , 2003 ++ shares
++ , 2003 ++ shares
++ , 2003 ++ shares
++ , 2003 ++ shares
</TABLE>
Settlement Ratio: For any Settlement Date, (i) if the Settlement Price for such
Settlement Date is less than the Threshold Appreciation Price but greater than
the Downside Protection Threshold Price, the Settlement Ratio shall be a ratio
equal to the Downside Protection Threshold Price divided by the Settlement
Price, (ii) if the Settlement Price for such Settlement Date is equal to or
greater than the Threshold Appreciation Price, the Settlement Ratio shall be a
ratio equal to one (1) minus a fraction the numerator of which is the excess of
the Threshold Appreciation Price over the Downside Protection Threshold Price
and the denominator of which is the Settlement Price, and (iii) if the
Settlement Price for such Settlement Date is equal to or less than the Downside
Protection Threshold Price, the Settlement Ratio shall be one (1), and in each
calculation described in clause (i) or (ii) above, the Settlement Ratio shall be
rounded upward or downward to the nearest 1/10,000th or, if there is not a
nearest 1/10,000th, to the next lower 1/10,000th.
Interest Calculation End Date:
February 21, 2003
Extraordinary Dividend: Any cash dividend that is paid on the Common Stock,
other than those described in Section 7.01(b)(i) or (ii) of the Master Stock
Purchase Agreement, shall be considered an extraordinary dividend (it being
understood that because there is no dividend currently paid on the Common Stock
all such dividends shall be extraordinary dividends).
++ Confidential material redacted and filed separately with the Commission.
<PAGE> 19
Spread: ++
Other Provisions:
2. The parties hereto affirm their respective representations and
warranties set forth in the Master Stock Purchase Agreement and the Pledge
Agreement as if made on the Trade Date. In addition, Seller represents and
warrants to Buyer and to the Collateral Agent that:
(a) Seller is not an "affiliate", within the meaning of Rule 144 under
the Securities Act, of the Company.
(b) Delivery of shares of Common Stock (or security entitlements in
respect thereof) by Seller pursuant to the Master Stock Purchase Agreement and
this Confirmation will pass to Buyer title to such shares (or security
entitlements) free and clear of any Liens, except for those created pursuant to
the Pledge Agreement.
(c) Seller (i) owns and, at all times prior to the release of the
Collateral pledged in respect of the Transaction to which this Confirmation
relates pursuant to the terms of the Pledge Agreement, will own such Collateral
free and clear of any Liens (other than the Security Interests) or Transfer
Restrictions and (ii) is not and will not become a party to or otherwise bound
by any agreement, other than the Pledge Agreement and this Confirmation, that
(x) restricts in any manner the rights of any present or future owner of such
Collateral with respect thereto or (y) provides any person other than Seller,
the Collateral Agent, Buyer or any securities intermediary through whom any such
Collateral is held (but, in the case of any such securities intermediary, only
in respect of Collateral held through it) with control (as defined in Section
8-106 of the UCC) with respect to any such Collateral.
3. In addition to the covenants contained in Article 6 of the Master
Stock Purchase Agreement, Seller agrees that Seller shall notify Buyer
immediately of its intention to (i) purchase Common Stock (or security
entitlements in respect thereof) or any other equity security of the Company in
an amount that would cause Seller to become the beneficial owner, directly or
indirectly, of more than three percent of the outstanding shares of any equity
security of the Company, (ii) accept a position as an officer or director of the
Company, (iii) take any action that would cause Seller to possess, directly or
indirectly, the power to direct or cause the direction of the management and
policies of the Company, whether by ownership of voting securities, by contract
or otherwise, or (iv) take any other action that could reasonably be expected to
result in Seller becoming an "affiliate", within the meaning of Rule 144 under
the Securities Act, of the Company. Seller shall not take any such action unless
a period of fifteen Business Days shall have elapsed after receipt of such
notice by Buyer and Buyer shall not have objected in writing to such action
during such period.
IN WITNESS WHEREOF, the parties have signed this Confirmation as of this
9th day of February, 2000.
SELLER:
ADVANCED FIBRE COMMUNICATIONS, INC.
By: /s/ Keith E. Pratt
---------------------------------
Name: Keith E. Pratt
Title: Vice President and CFO
ADVANCED FIBRE COMMUNICATIONS, INC.
By: /s/ Peter Donahower
---------------------------------
Name: Peter Donahower
Title: Director, Treasury
BUYER:
++ Confidential material redacted and filed separately with the Commission.
<PAGE> 20
BANK OF AMERICA, N.A.
By: /s/ William Caccamise
---------------------------------
Name: William Caccamise
Title: Managing Director
<PAGE> 21
[BANK OF AMERICA LOGO]
EQUITY FINANCIAL PRODUCTS GROUP
PLEDGE AGREEMENT -
SPECIALIZED TERM APPRECIATION RETENTION SALE (STARS)
TABLE OF CONTENTS
SECTION 1. The Security Interests
SECTION 2. Definitions
SECTION 3. Representations and Warranties of Pledgor
SECTION 4. Representations, Warranties and Agreements of the Collateral Agent
SECTION 5. Certain Covenants of Pledgor
SECTION 6. Administration of the Collateral and Valuation of the Securities
SECTION 7. Income and Voting Rights in Collateral
SECTION 8. Remedies upon Events of Default
SECTION 9. The Collateral Agent
SECTION 10. Miscellaneous
SECTION 11. Termination of Pledge Agreement
THIS AGREEMENT is made as of the date stated on the last page hereof among
the counterparty name on the last page hereof ("PLEDGOR"), BANC OF AMERICA
SECURITIES LLC, as collateral agent (the "COLLATERAL AGENT") hereunder for the
benefit of BANK OF AMERICA, N.A. ("SECURED PARTY").
WHEREAS, pursuant to the Master Stock Purchase Agreement (as amended from
time to time, the "MASTER STOCK PURCHASE AGREEMENT") dated as of the date hereof
between Pledgor and Secured Party, from time to time Pledgor may agree to sell
and Secured Party may agree to purchase shares of common stock of one or more
issuers (or security entitlements in respect thereof), subject to the terms and
conditions of the Master Stock Purchase Agreement and certain confirmations
thereunder;
WHEREAS, it is a condition to the obligations of Secured Party under the
Master Stock Purchase Agreement that Pledgor, the Collateral Agent and Secured
Party enter into this Agreement and that Pledgor grant the pledge provided for
herein;
NOW, THEREFORE, in consideration of their mutual covenants contained
herein and to secure the performance by Pledgor of its obligations under the
Master Stock Purchase Agreement and any Transaction Confirmation (as defined in
the Master Stock Purchase Agreement) and the observance and performance of the
covenants and agreements contained herein and in the Master Stock Purchase
Agreement, the parties hereto, intending to be legally bound, hereby
mutually covenant and agree as follows:
SECTION 1. The Security Interests. In order to secure the full and
punctual observance and performance of the covenants and agreements contained
herein and in the Master Stock Purchase Agreement and each Transaction
Confirmation:
(a) Pledgor hereby assigns and pledges to the Collateral Agent, as agent
of and for the benefit of Secured Party, and grants to the Collateral Agent, as
agent of and for the benefit of Secured Party, security interests in and to, and
a lien upon and right of set-off against, and transfers to the Collateral Agent,
as agent of and for the benefit of Secured Party, as and by way of a security
interest having priority over all other security interests, with power of sale,
all of its right, title and interest in and to (i) the Pledged Items described
in paragraph (b); (ii) all additions to and substitutions for such Pledged Items
(including, without limitation, any securities, instruments or other property
delivered or pledged pursuant to Section 5(a) or 6(b)); (iii) all income,
proceeds and collections received or to be received, or derived or to be
derived, now or any time hereafter (whether before or after the commencement of
any proceeding under applicable bankruptcy, insolvency or similar law, by or
against Pledgor, with respect to Pledgor) from or in connection with the Pledged
Items (including, without limitation, any shares of capital stock issued by the
Company in respect of any Common Stock (or security entitlements in respect
thereof) constituting Collateral or any cash, securities or other property
distributed in respect of or exchanged for any Common Stock (or security
entitlements in respect thereof) constituting Collateral,
<PAGE> 22
or into which any such Common Stock (or security entitlements in respect
thereof) is converted, in connection with any Merger Event, and any security
entitlements in respect of any of the foregoing); and (iv) all powers and rights
now owned or hereafter acquired under or with respect to the Pledged Items (such
Pledged Items, additions, substitutions, proceeds, collections, powers and
rights being herein collectively called the ("COLLATERAL"). The Collateral Agent
shall have all of the rights, remedies and recourses with respect to the
Collateral afforded a secured party by the UCC, in addition to, and not in
limitation of, the other rights, remedies and recourses afforded to the
Collateral Agent by this Agreement.
(b) On or prior to the Closing Date for each Transaction entered into
pursuant to the Master Stock Purchase Agreement, Pledgor shall deliver to the
Collateral Agent in pledge hereunder Eligible Collateral for such Transaction
consisting of a number of shares of the relevant Common Stock (or security
entitlements in respect thereof) equal to the sum of the Base Amounts for such
Transaction, in the manner provided in Section 6(c).
(c) In the event that the Company at any time issues to Pledgor in respect
of any Common Stock (or security entitlements in respect thereof) constituting
Collateral hereunder any additional or substitute shares of capital stock of any
class (or any security entitlements in respect thereof), Pledgor shall
immediately pledge and deliver to the Collateral Agent in accordance with
Section 6(c) all such shares and security entitlements as additional Collateral
hereunder.
(d) The Security Interests are granted as security only and shall not
subject the Collateral Agent or Secured Party to, or transfer or in any way
affect or modify, any obligation or liability of Pledgor or any Company that is
the issuer of Common Stock that is the subject of any Transaction under the
Master Stock Purchase Agreement with respect to any of the Collateral or any
transaction in connection therewith.
SECTION 2. Definitions. Capitalized terms used and not otherwise defined
herein shall have the meanings ascribed to them in the Master Stock Purchase
Agreement. As used herein, the following words and phrases shall have the
following meanings:
"AUTHORIZED OFFICER" of Pledgor means any officer as to whom Pledgor shall
have delivered notice to the Collateral Agent that such officer is authorized to
act hereunder on behalf of Pledgor.
"COLLATERAL" has the meaning provided in Section 1(a).
"COLLATERAL AGENT" means the financial institution identified as such in
the preliminary paragraph hereof, or any successor appointed in accordance with
Section 9.
"COLLATERAL EVENT OF DEFAULT" means, at any time, the occurrence of either
of the following: (A) failure of the Collateral in respect of each Transaction
under the Master Stock Purchase Agreement to include, as Eligible Collateral, at
least the Maximum Deliverable Number for such Transaction of shares of the
relevant Common Stock or (B) failure at any time of the Security Interests to
constitute valid and perfected security interests in all of the Collateral,
subject to no prior or equal Lien, or assertion of such by Pledgor in writing.
"DEFAULT SETTLEMENT DATE" has the meaning provided in Section 8(a).
"ELIGIBLE COLLATERAL" means, for any Transaction, shares of the Common
Stock that is the subject of such Transaction (or security entitlements in
respect thereof) provided that Pledgor has good and marketable title thereto,
free of all Liens (other than the Security Interests) and Transfer Restrictions
(and that the Collateral Agent has a valid, first priority perfected security
interest therein, a first lien thereon and control with respect thereto, and
provided further that to the extent the number of shares of Common Stock or
security entitlements in respect thereof pledged hereunder in respect of any
Transaction exceeds at any time the Maximum Deliverable Number thereof, such
excess shares shall not be Eligible Collateral.
"EXISTING TRANSFER RESTRICTIONS" means, with respect to any shares of
Common Stock or security entitlements in respect thereof pledged as Collateral
hereunder in connection with any Transaction, the Existing Transfer Restrictions
identified in the applicable Transaction Confirmation.
"LOCATION" means, with respect to any party, the place such party is
deemed located within the meaning of Section 9-103(3)(d) of the UCC.
2
<PAGE> 23
"MAXIMUM DELIVERABLE NUMBER" means, on any date for any Transaction, a
number of shares of Common Stock or security entitlements in respect thereof
equal to the sum of the Base Amounts for such Transaction for which settlement
under the Master Stock Purchase Agreement and the Transaction Confirmation with
respect to such Transaction has not been fully made multiplied successively by
each adjustment that shall have been calculated on or prior to such date
pursuant to Section 7.01 of the Master Stock Purchase Agreement.
"PERSON" means an individual, a corporation, a partnership, an
association, a trust or any other entity or organization, including a government
or political subdivision or an agency or instrumentality thereof.
"PLEDGED ITEMS" means, as of any date, any and all securities and
instruments delivered by Pledgor to be held by the Collateral Agent under this
Agreement as Collateral.
"SECURITY INTERESTS" means the security interests in the Collateral
created hereby.
"UCC" means the Uniform Commercial Code as in effect in the State of New
York.
SECTION 3. Representations and Warranties of Pledgor. Pledgor hereby
represents and warrants to the Collateral Agent and Secured Party that:
(a) Other than financing statements or other similar or equivalent
documents or instruments with respect to the Security Interests, no financing
statement, security agreement or similar or equivalent document or instrument
covering all or any part of the Collateral is on file or of record in any
jurisdiction in which such filing or recording would be effective to perfect a
lien, security interest or other encumbrance of any kind on such Collateral.
(b) All shares of Common Stock at any time pledged hereunder (or in
respect of which security entitlements are pledged hereunder) are and will be
issued by an issuer organized under the laws of the United States, any State
thereof or the District of Columbia and (i) certificated (and the certificate or
certificates in respect of such shares of Common Stock are and will be located
in the United States) and registered in the name of Pledgor or held through a
securities intermediary whose securities intermediary's jurisdiction (within the
meaning of Section 8-110(e) of the UCC) is located in the United States or (ii)
uncertificated and either registered in the name of Pledgor or held through a
securities intermediary whose securities intermediary's jurisdiction (within the
meaning of Section 8-110(e) of the UCC) is located in the United States.
(c) (i) Upon the delivery of certificates evidencing any Common Stock to
the Collateral Agent in accordance with Section 6(c)(A) or the registration of
uncertificated Common Stock in the name of the Collateral Agent or its nominee
in accordance with Section 6(c)(B), the Collateral Agent will have, for the
benefit of Secured Party, a valid and, as long as the Collateral Agent retains
possession of such certificates or such uncertificated Common Stock remains so
registered, perfected security interest therein, in respect of which the
Collateral Agent will have control, subject to no prior Lien and (ii) upon the
crediting of any Common Stock to a securities account of the Collateral Agent in
accordance with Section 6(c)(C), the Collateral Agent will have, for the benefit
of Secured Party, a valid and, so long as such Common Stock continues to be
credited to the account of the Collateral Agent with the applicable securities
intermediary, perfected security interest in a securities entitlement in respect
thereof, in respect of which the Collateral Agent will have control subject to
no prior Lien.
(d) No registration, recordation or filing with any governmental body,
agency or official is required in connection with the execution and delivery of
this Agreement or any Transaction Confirmation or necessary for the validity or
enforceability hereof or thereof or for the perfection or enforcement of the
Security Interests.
(e) Pledgor has not performed and will not perform any acts that might
prevent the Collateral Agent from enforcing any of the terms of this Agreement
or that might limit the Collateral Agent in any such enforcement.
(f) The Location of Pledgor is the address set forth in Section 10(d), and
under the Uniform Commercial Code as in effect in such Location, no local filing
is required to perfect a security interest in collateral consisting of general
intangibles.
(g) Any shares of Common Stock pledged hereunder were acquired by the
Seller in a transaction
3
<PAGE> 24
exempt from the registration requirements under the Securities Act pursuant to
Section 3(a)(10) of the Securities Act.
SECTION 4. Representations, Warranties and Agreements of the Collateral
Agent. The Collateral Agent represents and warrants to, and agrees with, Pledgor
and Secured Party that:
(a) The Collateral Agent is a limited liability company, duly formed,
validly existing and in good standing under the laws of the jurisdiction of its
formation, and has all powers and all material governmental licenses,
authorizations, consents and approvals required to enter into, and perform its
obligations under, this Agreement.
(b) The execution, delivery and performance by the Collateral Agent of
this Agreement have been duly authorized by all necessary action on the part of
the Collateral Agent (no action by the members of the Collateral Agent being
required) and do not and will not violate, contravene or constitute a default
under any provision of applicable law or regulation or of the certificate of
formation or by-laws of the Collateral Agent or of any material agreement,
judgment, injunction, order, decree or other instrument binding upon the
Collateral Agent.
(c) This Agreement constitutes a valid and binding agreement of the
Collateral Agent enforceable against the Collateral Agent in accordance with its
terms.
(d) The Collateral Agent has not and will not enter into any agreement
pursuant to which any person other than the Pledgor, the Collateral Agent, the
Secured Party or any securities intermediary through whom any Collateral is held
(but in the case of any such securities intermediary only in respect of
Collateral held through it) has or will have control (within the meaning of
Section 8-106 of the UCC) with respect to any Collateral.
(e) The Collateral Agent hereby agrees that all liens, pledges and other
security interests of any kind or nature held by it (other than liens, pledges
and security interests arising hereunder) in any of the Collateral securing any
obligation to the Collateral Agent (either in such capacity or in any other
capacity) (collectively, "OTHER LIENS") shall be subordinate and junior to the
liens, pledges and security interests in the Collateral arising hereunder and
that the Collateral Agent will take no action to enforce any Other Liens so long
as any obligation under the Master Stock Purchase Agreement or hereunder
(whether or not then due) should remain unsatisfied.
SECTION 5. Certain Covenants of Pledgor. Pledgor agrees that, so long as
any of its obligations under the Master Stock Purchase Agreement remain
outstanding:
(a) Pledgor shall ensure at all times that a Collateral Event of Default
shall not occur, and shall pledge additional Collateral in the manner described
in Sections 6(b) and 6(c) as necessary to cause such requirement to be met.
(b) Pledgor shall, at the expense of Pledgor and in such manner and form
as Secured Party or the Collateral Agent may require, give, execute, deliver,
file and record any financing statement, notice, instrument, document, agreement
or other papers that may be necessary or desirable in order to create, preserve,
perfect, substantiate or validate any security interest granted pursuant hereto
or to enable the Collateral Agent to exercise and enforce its rights and the
rights of Secured Party hereunder with respect to such security interest. To the
extent permitted by applicable law, Pledgor hereby authorizes the Collateral
Agent to execute and file, in the name of Pledgor or otherwise, UCC financing or
continuation statements (which may be carbon, photographic, photostatic or other
reproductions of this Agreement or of a financing statement relating to this
Agreement) that the Collateral Agent in its sole discretion may deem necessary
or appropriate to further perfect, or maintain the perfection of, the Security
Interests.
(c) Pledgor shall warrant and defend its title to the Collateral, subject
to the rights of the Collateral Agent and Secured Party, against the claims and
demands of all persons. The Collateral Agent and Secured Party (or, as they may
agree, one of them) may elect, but without an obligation to do so, to discharge
any Lien of any third party on any of the Collateral.
(d) Pledgor agrees that it shall not change (1) its name, identity
corporate structure in any manner or (2) its Location, unless in either case (A)
it shall have given the Collateral Agent not less than 30 days' prior notice
thereof and (B) such change shall not
4
<PAGE> 25
cause any of the Security Interests to become unperfected or subject any
Collateral to any other Lien.
(e) Pledgor agrees that it shall not (1) create or permit to exist any
Lien (other than the Security Interests) or any Transfer Restriction ( upon or
with respect to the Collateral, (2) sell or otherwise dispose of, or grant any
option with respect to, any of the Collateral or (3) enter into or consent to
any agreement pursuant to which any person other than the Pledgor, the
Collateral Agent, the Secured Party and any securities intermediary through whom
any of the Collateral is held (but in the case of any such securities
intermediary only in respect of Collateral held through it) has or will have
control (within the meaning of Section 8-106 of the UCC) in respect of any
Collateral.
SECTION 6. Administration of the Collateral and Valuation of the
Securities.
(a) The Collateral Agent shall determine on each Business Day whether a
Collateral Event of Default shall have occurred.
(b) Pledgor may pledge additional Collateral hereunder at any time.
Concurrently with the delivery of any additional Eligible Collateral, Pledgor
shall deliver to the Collateral Agent a certificate of an Authorized Officer of
Pledgor substantially in the form of Exhibit A hereto and dated the date of such
delivery, (A) identifying the additional items of Eligible Collateral being
pledged, (B) identifying the Transaction Confirmation relating to the
Transaction in respect of which such Eligible Collateral is being pledged, and
(C) certifying that with respect to such items of additional Eligible Collateral
the representations and warranties contained in paragraphs (a), (b), (c) and (d)
of Section 3 and paragraph (c) of Section 2 of such Transaction Confirmation are
true and correct with respect to such Eligible Collateral on and as of the date
thereof. Pledgor hereby covenants and agrees to take all actions required under
Section 6(c) and any other actions necessary to create for the benefit of the
Collateral Agent a valid, first priority, perfected security interest in, and a
first lien upon, such additional Eligible Collateral.
(c) Any delivery of Common Stock (or security entitlement in respect
thereof) as Collateral to the Collateral Agent by Pledgor shall be effected (A)
in the case of Collateral consisting of certificated Common Stock registered in
the name of Pledgor, by delivery of certificates representing such Common Stock
to the Collateral Agent, accompanied by any required transfer tax stamps, and in
suitable form for transfer by delivery or accompanied by duly executed
instruments of transfer or assignment in blank, with signatures appropriately
guaranteed, all in form and substance satisfactory to the Collateral Agent, (B)
in the case of Collateral consisting of uncertificated Common Stock registered
in the name of Pledgor, by transmission by Pledgor of an instruction to the
issuer of such Common Stock instructing such issuer to register such Common
Stock in the name of the Collateral Agent or its nominee, accompanied by any
required transfer tax stamps, and the issuer's compliance with such instructions
or (C) in the case of Common Stock in respect of which security entitlements are
held by Pledgor through a securities intermediary, by the crediting of such
Common Stock, accompanied by any required transfer tax stamps, to a securities
account of the Collateral Agent at such securities intermediary or, at the
option of the Collateral Agent, at another securities intermediary satisfactory
to the Collateral Agent. Upon delivery of any such Pledged Item under this
Agreement, the Collateral Agent shall examine such Pledged Item and any
certificates delivered pursuant to Section 6(b) or otherwise pursuant to the
terms hereof in connection therewith to determine that they comply as to form
with the requirements for Eligible Collateral.
(d) If on any Business Day the Collateral Agent determines that a
Collateral Event of Default shall have occurred, the Collateral Agent shall
promptly notify Pledgor of such determination by telephone call to an Authorized
Officer of Pledgor followed by a written confirmation of such call.
(e) If on any Business Day the Collateral Agent determines that no Event
of Default or failure by Pledgor to meet any of its obligations under Sections 5
or 6 hereof has occurred and is continuing, Pledgor may obtain the release from
the Security Interests of any Collateral upon delivery to the Collateral Agent
of a written notice from an Authorized Officer of Pledgor indicating the items
of Collateral to be released so long as, after such release, no Collateral Event
of Default shall have occurred.
(f) On each Settlement Date for each Transaction under the Master Stock
Purchase Agreement, unless (i) Seller shall have otherwise effected the
deliveries required by Section 3.02(b) of
5
<PAGE> 26
the Master Stock Purchase Agreement on each Settlement Date in respect of such
Transaction or (ii) the shares of Common Stock (or security entitlements in
respect thereof) then held by the Collateral Agent hereunder in respect of such
Transaction are not Free Shares, the Collateral Agent shall deliver (and Pledgor
hereby irrevocably instructs the Collateral Agent to deliver, in whole or
partial, as the case may be, satisfaction of Pledgor's obligations to deliver
shares of such Common Stock (or security entitlements in respect thereof) to an
affiliate of Secured Party designated by Secured Party on such Settlement Date
pursuant to the Master Stock Purchase Agreement) to an affiliate of Secured
Party designated by Secured Party shares of such Common Stock (or security
entitlements in respect thereof) then held by it hereunder in respect of such
Transaction representing the number of shares of such Common Stock (or security
entitlements in respect thereof) required to be delivered under the Master Stock
Purchase Agreement on such Settlement Date. Upon any such delivery, such
affiliate of Secured Party shall hold such shares of such Common Stock (or
security entitlements in respect thereof) absolutely and free from any claim or
right whatsoever (including, without limitation, any claim or right of Pledgor).
(g) The Collateral Agent may at any time or from time to time, in its sole
discretion, cause any or all of the Common Stock pledged hereunder (or in
respect of which security entitlements are pledged hereunder) registered in the
name of Pledgor or its nominee to be transferred of record into the name of the
Collateral Agent or its nominee. Pledgor shall promptly give to the Collateral
Agent copies of any notices or other communications received by Pledgor with
respect to Common Stock (or security entitlements in respect thereof) pledged
hereunder registered, or held through a securities intermediary, in the name of
Pledgor or its nominee and the Collateral Agent shall promptly give to Pledgor
copies of any notices and communications received by the Collateral Agent with
respect to Common Stock (or security entitlements in respect thereof) pledged
hereunder registered, or held through a securities intermediary, in the name of
the Collateral Agent or its nominee.
(h) Pledgor agrees that it shall forthwith upon demand pay to the
Collateral Agent:
(i) the amount of any taxes that the Collateral Agent or Secured
Party may have been required to pay by reason of the Security Interests or
to free any of the Collateral from any Lien thereon, and
(ii) the amount of any and all out-of-pocket expenses, including the
reasonable fees and disbursements of counsel and of any other experts,
that the Collateral Agent or Secured Party may incur in connection with
(A) the enforcement of this Agreement, including such expenses as are
incurred to preserve the value of the Collateral and the validity,
perfection, rank and value of the Security Interests, (B) the collection,
sale or other disposition of any of the Collateral, (C) the exercise by
the Collateral Agent of any of the rights conferred upon it hereunder or
(D) any Event of Default.
Any such amount not paid on demand shall bear interest (computed on the basis of
a year of 360 days and payable for the actual number of days elapsed) at a rate
per annum equal to 5% plus the prime rate as published in The Wall Street
Journal, Eastern Edition in effect from time to time during the period from the
date hereof to the date of the termination of this Agreement.
(i) Without limiting the rights and obligations of the parties under this
Agreement, the Collateral Agent agrees that, so long as an Event of Default has
not occurred, it shall not sell, lend, pledge, rehypothecate, assign or invest
in its business any of the Collateral it holds.
SECTION 7. Income and Voting Rights in Collateral.
(a) The Collateral Agent shall have the right to receive and retain as
Collateral hereunder all proceeds of the Collateral , and Pledgor shall take all
such action as the Collateral Agent shall deem necessary or appropriate to give
effect to such right. All such proceeds including, without limitation, all
dividends and other payments and distributions that are received by Pledgor
shall be received in trust for the benefit of the Collateral Agent and Secured
Party and, if the Collateral Agent so directs, shall be segregated from other
funds of Pledgor and shall, forthwith upon demand by the Collateral Agent be
paid over to the Collateral Agent as Collateral in the same form as received
(with any necessary endorsement).
6
<PAGE> 27
(b) Unless an Event of Default shall have occurred and be continuing,
Pledgor shall have the right, from time to time, to vote and to give consents,
ratifications and waivers with respect to the Collateral, and the Collateral
Agent shall, upon receiving a written request from Pledgor accompanied by a
certificate of an Authorized Officer of Pledgor stating that no Event of Default
has occurred and is continuing, deliver to Pledgor or as specified in such
request such proxies, powers of attorney, consents, ratifications and waivers in
respect of any of the Collateral that is registered, or held through a
securities intermediary, in the name of the Collateral Agent or its nominee as
shall be specified in such request and shall be in form and substance
satisfactory to the Collateral Agent.
(c) If an Event of Default shall have occurred and be continuing, the
Collateral Agent shall have the right, to the extent permitted by law, and
Pledgor shall take all such action as may be necessary or appropriate to give
effect to such right, to vote and to give consents, ratifications and waivers,
and to take any other action with respect to any or all of the Collateral with
the same force and effect as if the Collateral Agent were the absolute and sole
owner thereof.
SECTION 8. Remedies upon Events of Default.
(a) If any Event of Default shall have occurred and be continuing, the
Collateral Agent may exercise on behalf of Secured Party all the rights of a
secured party under the Uniform Commercial Code (whether or not in effect in the
jurisdiction where such rights are exercised) and, in addition, without being
required to give any notice, except as herein provided or as may be required by
mandatory provisions of law, shall: (i) deliver all Collateral consisting of
shares of Common Stock (or security entitlements in respect thereof) (but not in
excess of the number thereof deliverable under the Master Stock Purchase
Agreement at such time) to an affiliate of Secured Party designated by Secured
Party on the date of the Acceleration Amount Notice relating to such Event of
Default (the "DEFAULT SETTLEMENT DATE") in satisfaction of Pledgor's obligations
to deliver Common Stock (or security entitlements in respect thereof) under the
Master Stock Purchase Agreement, whereupon Secured Party shall hold such shares
of Common Stock (or security entitlements in respect thereof) absolutely free
from any claim or right of whatsoever kind, including any equity or right of
redemption of Pledgor that may be waived or any other right or claim of Pledgor,
and Pledgor, to the extent permitted by law, hereby specifically waives all
rights of redemption, stay or appraisal that it has or may have under any law
now existing or hereafter adopted; and (ii) if such delivery shall be
insufficient to satisfy in full all of the obligations of Pledgor under the
Master Stock Purchase Agreement or hereunder, sell all of the remaining
Collateral, or such lesser portion thereof as may be necessary to generate
proceeds sufficient to satisfy in full all of the obligations of Pledgor under
the Master Stock Purchase Agreement or hereunder, at public or private sale or
at any broker's board or on any securities exchange, for cash, upon credit or
for future delivery, and at such price or prices as the Collateral Agent may
deem satisfactory. Pledgor covenants and agrees that it will execute and deliver
such documents and take such other action as the Collateral Agent deems
necessary or advisable in order that any such sale may be made in compliance
with law. Upon any such sale the Collateral Agent shall have the right to
deliver, assign and transfer to the buyer thereof the Collateral so sold. Each
buyer at any such sale shall hold the Collateral so sold absolutely and free
from any claim or right of whatsoever kind, including any equity or right of
redemption of Pledgor that may be waived or any other right or claim of Pledgor,
and Pledgor, to the extent permitted by law, hereby specifically waives all
rights of redemption, stay or appraisal that it has or may have under any law
now existing or hereafter adopted. The notice (if any) of such sale required by
Section 9-504 of the UCC shall (1) in case of a public sale, state the time and
place fixed for such sale, (2) in case of sale at a broker's board or on a
securities exchange, state the board or exchange at which such sale is to be
made and the day on which the Collateral, or the portion thereof so being sold,
will first be offered for sale at such board or exchange, and (3) in the case of
a private sale, state the day after which such sale may be consummated. Any such
public sale shall be held at such time or times within ordinary business hours
and at such place or places as the Collateral Agent may fix in the notice of
such sale. At any such sale the Collateral may be sold in one lot as an entirety
or in separate parcels, as the Collateral Agent may determine. The Collateral
Agent shall not be obligated to make any such sale pursuant to any such notice.
The Collateral Agent may, without notice or publication, adjourn any public or
private sale or cause the same to be adjourned from time to time by announcement
at the time and place fixed for the sale, and such sale may be made at any time
or place to which the same may be so adjourned. In case of any sale of all or
any part of the Collateral on credit or for
7
<PAGE> 28
future delivery, the Collateral so sold may be retained by the Collateral Agent
until the selling price is paid by the buyer thereof, but the Collateral Agent
shall not incur any liability in case of the failure of such buyer to take up
and pay for the Collateral so sold and, in case of any such failure, such
Collateral may again be sold upon like notice. The Collateral Agent, instead of
exercising the power of sale herein conferred upon it, may proceed by a suit or
suits at law or in equity to foreclose the Security Interests and sell the
Collateral, or any portion thereof, under a judgment or decree of a court or
courts of competent jurisdiction.
(b) Pledgor hereby irrevocably appoints the Collateral Agent its true and
lawful attorney, with full power of substitution, in the name of Pledgor, the
Collateral Agent or Secured Party or otherwise, for the sole use and benefit of
the Collateral Agent and Secured Party, but at the expense of Pledgor, to the
extent permitted by law, to exercise, at any time and from time to time while an
Event of Default has occurred and is continuing, all or any of the following
powers with respect to all or any of the Collateral:
(i) to demand, sue for, collect, receive and give acquittance for
any and all monies due or to become due upon or by virtue thereof,
(ii) to settle, compromise, compound, prosecute or defend any action
or proceeding with respect thereto,
(iii) to sell, transfer, assign or otherwise deal in or with the
same or the proceeds or avails thereof, as fully and effectually as if the
Collateral Agent were the absolute owner thereof (including, without
limitation, the giving of instructions and entitlement orders in respect
thereof), and
(iv) to extend the time of payment of any or all thereof and to make
any allowance and other adjustments with reference thereto;
provided that the Collateral Agent shall give Pledgor not less than one day's
prior written notice of the time and place of any sale or other intended
disposition of any of the Collateral, except any Collateral that threatens to
decline speedily in value, including, without limitation, equity securities, or
is of a type customarily sold on a recognized market. The Collateral Agent and
Pledgor agree that such notice constitutes reasonable notification within the
meaning of Section 9-504(3) of the UCC.
(c) Upon any delivery or sale of all or any part of any Collateral made
either under the power of delivery or sale given hereunder or under judgment or
decree in any judicial proceedings for foreclosure or otherwise for the
enforcement of this Agreement, the Collateral Agent is hereby irrevocably
appointed the true and lawful attorney of Pledgor, in the name and stead of
Pledgor, to make all necessary deeds, bills of sale, instruments of assignment,
transfer or conveyance of the property, and all instructions and entitlement
orders in respect of the property, thus delivered or sold. For that purpose the
Collateral Agent may execute all such documents, instruments, instructions and
entitlement orders. This power of attorney shall be deemed coupled with an
interest, and Pledgor hereby ratifies and confirms that which its attorney
acting under such power, or such attorney's successors or agents, shall lawfully
do by virtue of this Agreement. If so requested by the Collateral Agent, by
Secured Party or by any buyer of the Collateral or a portion thereof, Pledgor
shall further ratify and confirm any such delivery or sale by executing and
delivering to the Collateral Agent, to Secured Party or to such buyer or buyers
at the expense of Pledgor all proper deeds, bills of sale, instruments of
assignment, conveyance or transfer, releases, instructions and entitlement
orders as may be designated in any such request.
(d) In the case of an Event of Default, the Collateral Agent may proceed
to realize upon the security interest in the Collateral against any one or more
of the types of Collateral, at any time, as the Collateral Agent shall determine
in its sole discretion subject to the foregoing provisions of this Section 8.
The proceeds of any sale of, or other realization upon, or other receipt from,
any of the Collateral shall be applied by the Collateral Agent in the following
order of priorities:
first, to the payment to the Collateral Agent of the expenses of
such sale or other realization, including reasonable compensation to the
Collateral Agent and its agents and counsel, and all expenses, liabilities
and advances incurred or made by the Collateral Agent in connection
therewith, including brokerage fees in connection with
8
<PAGE> 29
the sale by the Collateral Agent of any Collateral;
second, to the payment to Secured Party of an amount in respect of
each Transaction under the Master Stock Purchase Agreement equal to the
aggregate Market Value of a number of shares of the relevant Common Stock
equal to (i) the number of shares of such Common Stock (or security
entitlements in respect thereof) that would be required to be delivered
under Section 8.01 of the Master Stock Purchase Agreement on the Default
Settlement Date in respect of such Transaction without giving effect to
the proviso therein minus (ii) the number of shares of such Common Stock
(or security entitlements in respect thereof) delivered by the Collateral
Agent to Secured Party on the Default Settlement Date in respect of such
Transaction as described in Section 8(a);
finally, if all of the obligations of Pledgor hereunder and under
the Master Stock Purchase Agreement have been fully discharged or
sufficient funds have been set aside by the Collateral Agent at the
request of Pledgor for the discharge thereof, any remaining proceeds shall
be released to Pledgor.
SECTION 9. The Collateral Agent.
(a) Secured Party hereby irrevocably appoints and authorizes the
Collateral Agent to take such action as agent on its behalf and to exercise such
powers under this Agreement as are delegated to the Collateral Agent by the
terms hereof, together with all such powers as are reasonably incidental
thereto.
(b) The obligations of the Collateral Agent hereunder are only those
expressly set forth in this Agreement.
(c) The Collateral Agent may consult with legal counsel, independent
public accountants and other experts selected by it and shall not be liable for
any action taken or omitted to be taken by it in good faith in accordance with
the advice of such counsel, accountants or experts.
(d) Neither the Collateral Agent nor any of its directors, officers,
agents or employees shall be liable for any action taken or not taken by it in
connection with this Agreement (1) with the consent or at the request of Secured
Party or (2) in the absence of its own gross negligence or willful misconduct.
The Collateral Agent shall not incur any liability by acting in reliance upon
any notice, consent, certificate, statement, or other writing (which may be a
bank wire, telex or similar writing) believed by it to be genuine or to be
signed by the proper party or parties.
(e) Pledgor shall indemnify the Collateral Agent against any cost, expense
(including counsel fees and disbursements), claim, demand, action, loss or
liability (except such as result from the Collateral Agent's gross negligence or
willful misconduct) that the Collateral Agent may suffer or incur in connection
with this Agreement or any action taken or omitted by the Collateral Agent
hereunder.
(f) Beyond the exercise of reasonable care in the custody thereof, the
Collateral Agent shall have no duty as to any Collateral in its possession or
control or in the possession or control of any agent, bailee, clearing
corporation or securities intermediary or any income thereon or as to the
preservation of rights against prior parties or any other rights pertaining
thereto. The Collateral Agent shall be deemed to have exercised reasonable care
in the custody and preservation of the Collateral if the Collateral is accorded
treatment substantially equal to that which it accords its own property, and
shall not be liable or responsible for any loss or damage to any of the
Collateral, or for any diminution in the value thereof, by reason of the act or
omission of any agent, bailee, clearing corporation or securities intermediary
selected by the Collateral Agent in good faith (or selected by an agent, bailee,
clearing corporation or securities intermediary so selected by the Collateral
Agent or by any agent, bailee, clearing corporation or securities intermediary
selected in accordance with this parenthetical phrase).
(g) Any corporation or association into which the Collateral Agent may be
converted or merged, or with which it may be consolidated, or to which it may
sell or transfer its agency business and assets as a whole or substantially as a
whole, or any corporation or association resulting from any such conversion,
sale, merger, consolidation or transfer to which it is a party, shall, subject
to the prior written
9
<PAGE> 30
consent of Secured Party, be and become a successor Collateral Agent hereunder
and vested with all of the title to the Collateral and all of the powers,
discretions, immunities, privileges and other matters as was its predecessor
without, except as provided above, the execution or filing of any instrument or
any further act, deed or conveyance on the part of any of the parties hereto,
anything herein to the contrary notwithstanding.
SECTION 10. Miscellaneous.
(a) Whenever any of the parties hereto is referred to, such reference
shall be deemed to include the successors and assigns of such party. All the
covenants and agreements herein contained by or on behalf of Pledgor and the
Collateral Agent shall bind, and inure to the benefit of, their respective
successors and assigns whether so expressed or not, and shall be enforceable by
and inure to the benefit of Secured Party and its successors and assigns.
(b) To the extent permitted by law, the unenforceability or invalidity of
any provision or provisions of this Agreement shall not render any other
provision or provisions herein contained unenforceable or invalid.
(c) Any provision of this Agreement may be amended or waived if, and only
if, such amendment or waiver is in writing and signed, in the case of an
amendment, by Pledgor, the Collateral Agent and Secured Party or, in the case of
a waiver, by the party against whom the waiver is to be effective. No failure or
delay by either party in exercising any right, power or privilege hereunder
shall operate as a waiver thereof nor shall any single or partial exercise
thereof preclude any other or further exercise thereof or the exercise of any
other right, power or privilege. The rights and remedies herein provided shall
be cumulative and not exclusive of any rights or remedies provided by law.
(d) All notices and other communications hereunder shall be in writing and
shall be deemed to have been duly given if mailed or transmitted by any standard
forms of telecommunication. Notices to Pledgor shall be directed to it at the
address specified on the last page hereof; notices to the Collateral Agent shall
be directed to it at Banc of America Securities LLC, 9 West 57th Street, New
York, New York 10019, Telecopy No. 212-583-8569, Attention: Deidre Hicks;
notices to Secured Party shall be directed to it care of Banc of America
Securities LLC, 9 West 57th Street, New York, New York 10019, Telecopy No.
212-583-8569, Attention: Deidre Hicks.
(e) This Agreement shall in all respects be construed in accordance with
and governed by the laws of the State of New York (without reference to choice
of law doctrine); provided that as to Pledged Items located in any jurisdiction
other than the State of New York, the Collateral Agent on behalf of Secured
Party shall have, in addition to any rights under the laws of the State of New
York, all of the rights to which a secured party is entitled under the laws of
such other jurisdiction. The parties hereto hereby agree that the Collateral
Agent's jurisdiction, within the meaning of Section 8-110(e) of the UCC, insofar
as it acts as a securities intermediary hereunder or in respect hereof, is the
State of New York. To the extent permitted by law, the unenforceability or
invalidity of any provision or provisions of this Agreement shall not render any
other provision or provisions herein contained unenforceable or invalid.
(F) EACH PARTY HEREBY IRREVOCABLY AND UNCONDITIONALLY SUBMITS TO THE
NON-EXCLUSIVE JURISDICTION OF THE FEDERAL AND STATE COURTS LOCATED IN THE
BOROUGH OF MANHATTAN, IN THE CITY OF NEW YORK IN ANY SUIT OR PROCEEDING ARISING
OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY.
(G) EACH PARTY HEREBY IRREVOCABLY AND UNCONDITIONALLY WAIVES ANY AND ALL
RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATED TO THIS
AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY.
(h) This Agreement may be executed, acknowledged and delivered in any
number of counterparts and all such counterparts taken together shall be deemed
to constitute one and the same agreement.
SECTION 11. Termination of Pledge Agreement. This Agreement and the rights
hereby granted by Pledgor in the Collateral shall cease, terminate and be void
upon fulfillment of all of the obligations of Pledgor under the Master Stock
Purchase Agreement, under each Transaction Confirmation and hereunder. Any
Collateral remaining at the time of such termination shall be fully released and
discharged from the Security Interests and delivered to Pledgor by
10
<PAGE> 31
the Collateral Agent, all at the request and expense of Pledgor.
*************
Date of Agreement: February 9, 2000
Pledgor: Advanced Fibre Communications, Inc.
a corporation
Pledgor's Address for Notices:
One Willow Brook Ct.
Petaluma, CA 94954
Phone No.: 707-792-4163
Telecopy No.: 707-792-7275
Attn: Peter M. Donahower, Treasurer
*************
IN WITNESS WHEREOF, the parties have signed this Agreement as of the date
and year first above written.
PLEDGOR:
ADVANCED FIBRE COMMUNICATIONS, INC.
By: /s/ Keith E. Pratt
-------------------------------
Name: Keith E. Pratt
Title: Vice President and CFO
ADVANCED FIBRE COMMUNICATIONS, INC.
By: /s/ Peter Donahower
-------------------------------
Name: Peter Donahower
Title: Director, Treasury
BANC OF AMERICA SECURITIES LLC,
as Collateral Agent
By: /s/ William Caccamise
-------------------------------
Name: William Caccamise
Title: Managing Director
SECURED PARTY:
BANK OF AMERICA, N.A.
By: /s/ William Caccamise
-------------------------------
Name: William Caccamise
Title: Managing Director
11
<PAGE> 32
Exhibit A
to
Pledge Agreement
CERTIFICATE FOR ADDITIONAL COLLATERAL
The undersigned, an officer of Advanced Fibre Communications, Inc.
("PLEDGOR"), hereby certifies, pursuant to Section 6(b) of the Pledge Agreement,
dated as of February 9, 2000, among Pledgor, Banc of America Securities LLC, as
Collateral Agent, and Bank of America, N.A. (the "PLEDGE AGREEMENT"; terms
defined in the Pledge Agreement being used herein as defined therein), that:
1. Pledgor is delivering, or causing to be delivered in accordance
with Section 6(c) of the Pledge Agreement, the following securities (or
security entitlements in respect thereof) to the Collateral Agent to be
held by the Collateral Agent as additional Collateral (the "ADDITIONAL
COLLATERAL"):
2. The Transaction in respect of which the Additional Collateral is
being pledged is described in the Transaction Confirmation with a Trade
Date of ___________ __, 2000.
3. Pledgor hereby represents and warrants to the Collateral Agent
that the Additional Collateral is Eligible Collateral and that the
representations and warranties contained in paragraphs (a), (b), (c) and
(d) of Section 3 of the Pledge Agreement and paragraph (c) of Section 2 of
such Transaction Confirmation are true and correct with respect to the
Additional Collateral on and as of the date hereof.
This Certificate may be relied upon by Secured Party as fully and to the
same extent as if this Certificate had been specifically addressed to Secured
Party.
IN WITNESS WHEREOF, the undersigned has executed this Certificate this ___
day of __________, 2000.
ADVANCED FIBRE COMMUNICATIONS, INC.
By:
---------------------------------
Name:
Title:
12
<PAGE> 1
EXHIBIT 13.1
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 $ 291,568 $ 312,745 $ 267,858 $ 130,193 $ 54,287
Cost of revenues 153,743 168,654 145,933 73,950 33,469
--------- --------- --------- --------- ---------
Gross profit 137,825 144,091 121,925 56,243 20,818
--------- --------- --------- --------- ---------
Operating expenses:
Research and development 47,515 40,963 25,726 14,413 5,730
Selling, general and administrative 65,533 65,328 42,653 21,188 9,660
DSC litigation costs - - - 18,947 1,623
--------- --------- --------- --------- ---------
Total operating expenses 113,048 106,291 68,379 54,548 17,013
--------- --------- --------- --------- ---------
Operating income 24,777 37,800 53,546 1,695 3,805
Other income (expense), net 385,547 4,055 4,866 2,388 (1,367)
--------- --------- --------- --------- ---------
Income before income taxes 410,324 41,855 58,412 4,083 2,438
Income taxes (benefit) 160,027 14,648 21,612 (3,154) 97
--------- --------- --------- --------- ---------
Net income $ 250,297 $ 27,207 $ 36,800 $ 7,237 $ 2,341
========= ========= ========= ========= =========
Basic net income per share (3) $ 3.25 $ 0.36 $ 0.52 $ 0.30 $ 0.27
========= ========= ========= ========= =========
Shares used in basic per share
computations 77,048 74,788 70,131 24,146 8,746
========= ========= ========= ========= =========
Diluted net income per share (3) $ 3.07 $ 0.34 $ 0.48 $ 0.11 $ 0.05
========= ========= ========= ========= =========
Shares used in diluted per share
computations 81,424 79,511 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 $731,011 $110,753 $105,196 $108,430 $ 11,118
Working capital 580,334 209,324 193,640 145,338 18,770
Total assets 897,424 307,883 273,293 175,679 36,680
Redeemable convertible preferred stock - - - - 37,777
Stockholders' equity (deficit) 641,742 268,300 223,720 158,023 (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 33%, and net income for the year ended December
31, 1999 would have been $20.8 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.
<PAGE> 1
EXHIBIT 13.2
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 in Part I,
Item 1 - "Certain Factors That Might Affect Future Operating Results" of this
Annual Report on Form 10-K 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; 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 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 our financial
statements and related notes included elsewhere in this report.
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.
In 1999, revenues decreased $21.1 million from 1998 and operating income
declined $13.0 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 132.2% 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
<PAGE> 2
$250.3 million, or 85.8% of revenues, as compared with $27.2 million, or 8.7% of
revenues in 1998. Without this gain and the related tax effects, our net income
would have been $20.8 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.
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 52.7 53.9 54.5
------ ------ ------
Gross profit 47.3 46.1 45.5
------ ------ ------
Operating expenses:
Research and development 16.3 13.1 9.6
Selling, general and administrative 22.5 20.9 15.9
------ ------ ------
Total operating expenses 38.8 34.0 25.5
------ ------ ------
Operating income 8.5 12.1 20.0
Other income, net 132.2 1.3 1.8
------ ------ ------
Income before income taxes 140.7 13.4 21.8
Income taxes 54.9 4.7 8.1
------ ------ ------
Net income 85.8% 8.7% 13.7%
====== ====== ======
</TABLE>
1999 COMPARED WITH 1998
REVENUES. In 1999, revenues, including royalties, totaled $291.6 million, a
decrease of $21.1 million, or 6.7%, from the $312.7 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 10.7% of 1999 revenues compared
with 26.2% 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 12.8% from $230.7
million in 1998 to $260.3 million in 1999, representing 89.3% and 73.8% 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 10.6%;
Tellabs, Inc. accounted for 10.4%; and SBC Communications, Inc. accounted for
10.1%. In the quarter ended December 31, 1998, WinStar accounted for 33.3% of
total revenues. In the year ended December 31, 1999, WinStar accounted for 15.7%
of total revenues, and Sprint accounted for 11.9%. For the year ended December
31, 1998, WinStar accounted for 11.2% of total revenues and Integrators of
System Technology (Pty) Ltd. of South Africa accounted for 10.4%. No other
customer accounted for 10% or more of total revenues in any of
<PAGE> 3
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.
GROSS PROFIT. In 1999, gross profit was $137.8 million compared with $144.1
million for 1998, and represented gross margins as a percentage of revenues of
47.3% in 1999 and 46.1% 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
$6.5 million, or 15.9%, to $47.5 million compared with $41.0 million in 1998.
Research and development expenses represented 16.3% of total revenues in 1999
and 13.1% 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 249 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 0.3%, to $65.5 million compared with $65.3
million in 1998. Selling, general and administrative expenses represented 22.5%
of total revenues in 1999 and 20.9% 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 306
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 $381.4 million to $385.5 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 35.0% 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.
<PAGE> 4
1998 COMPARED WITH 1997
REVENUES. For 1998, revenues totaled $312.7 million, an increase of $44.8
million, or 16.7%, over the $267.9 million reported in 1997. The largest
increase in revenues was in the U.S. market which increased $33.8 million or
17.1% over the prior year. International revenues increased $11.1 million, or
15.7%, year-over-year and represented 26.2% of revenues in 1998 and 26.5% of
revenues in 1997.
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 11.2% of total revenues
and Integrators of System Technology (Pty) Ltd. of South Africa accounted for
10.4%. 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 $144.1 million compared with $121.9
million for 1997, and represented gross margins as a percentage of revenues of
46.1% 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
$15.3 million, or 59.5%, to $41.0 million compared with $25.7 million in 1997.
Research and development expenses represented 13.1% 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 288 compared with 176 at the end of 1997, an increase of 63.6%.
SELLING, GENERAL AND ADMINISTRATIVE. For 1998, selling, general and
administrative expenses increased $22.6 million, or 52.9%, to $65.3 million
compared with $42.7 million in 1997. Selling, general and administrative
expenses represented 20.9% 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 27.0% to 329 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 35.0% in 1998 primarily due to tax
exempt interest income, utilization of research and development credits, and
benefits from our foreign sales corporation.
<PAGE> 5
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 $ 30,261 $ 20,669
Marketable securities 700,750 90,084
Working capital, excluding cash and cash equivalents,
marketable securities and associated deferred tax assets
and liabilities 54,660 98,571
</TABLE>
As of December 31, 1999, cash, cash equivalents and marketable securities
amounted to $731.0 million compared with $110.8 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 $70.2 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 $72.0
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
<PAGE> 6
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
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.
<PAGE> 7
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
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 hypothetical change in fair value arising from a
hypothetical 20% change in the stock's price. This table estimates the fair
value of our Cisco shares at an immediate time horizon (in thousands):
<TABLE>
<CAPTION>
Valuation of Valuation of
Securities Given a No Change Securities Given an
Decrease of 20% In in Stock Increase of 20% In
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.
SEASONALITY
Our customers normally install a portion of the UMC1000 system in outdoor
locations. 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 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.
<PAGE> 8
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 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 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 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.
<PAGE> 1
EXHIBIT 13.3
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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 $ 30,261 $ 20,669
Marketable securities 700,750 90,084
Accounts receivable, less allowances of $3,436 and $5,326
in 1999 and 1998, respectively 62,747 74,967
Inventories 36,717 53,060
Other current assets 3,058 8,257
--------- ---------
Total current assets 833,533 247,037
Property and equipment, net 56,798 49,315
Other assets 7,093 11,531
--------- ---------
Total assets $ 897,424 $ 307,883
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 19,092 $ 12,573
Accrued liabilities 28,578 25,140
Deferred tax liabilities 205,529 -
--------- ---------
Total current liabilities 253,199 37,713
Long-term liabilities 2,483 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; 78,239,326 and 75,716,153 shares issued
and outstanding in 1999 and 1998, respectively 782 757
Additional paid-in capital 232,083 210,420
Notes receivable from stockholders (241) (730)
Accumulated other comprehensive income 100,968 -
Retained earnings 308,150 57,853
--------- ---------
Total stockholders' equity 641,742 268,300
--------- ---------
Total liabilities and stockholders' equity $ 897,424 $ 307,883
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 2
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 $291,568 $312,745 $267,858
Cost of revenues 153,743 168,654 145,933
-------- -------- --------
Gross profit 137,825 144,091 121,925
-------- -------- --------
Operating expenses:
Research and development 47,515 40,963 25,726
Selling, general and administrative 65,533 65,328 42,653
-------- -------- --------
Total operating expenses 113,048 106,291 68,379
Operating income 24,777 37,800 53,546
Other income, net 385,547 4,055 4,866
-------- -------- --------
Income before income taxes 410,324 41,855 58,412
Income taxes 160,027 14,648 21,612
-------- -------- --------
Net income $250,297 $ 27,207 $ 36,800
======== ======== ========
Basic net income per share $ 3.25 $ 0.36 $ 0.52
-------- -------- --------
Shares used in basic per share computations 77,048 74,788 70,131
-------- -------- --------
Diluted net income per share $ 3.07 $ 0.34 $ 0.48
-------- -------- --------
Shares used in diluted per share computations 81,424 79,511 77,469
-------- -------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 3
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 Additional from
------------------------ Paid-in Stock-
Shares Amount Capital holders
---------- --------- ---------- -------
<S> <C> <C> <C> <C>
Balances as of
December 31, 1996 65,299,214 $ 653 $ 163,675 $(151)
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 - - - -
---------- --------- --------- -----
Balances as of
December 31, 1997 72,626,370 726 193,183 (835)
Exercise of common stock
options and warrants 3,096,149 31 6,295 -
Payment of notes receivable
from stockholder - - - 105
Repurchase of common stock (6,366) - (4) -
Tax benefit from
option exercises - - 10,946 -
Net income - - - -
---------- --------- --------- -----
Balances as of
December 31, 1998 75,716,153 757 210,420 (730)
Exercise of common stock
options and warrants 2,565,460 25 11,371 -
Cancellation of notes receivable
from stockholder - - - 489
Repurchase of common stock (42,287) - (11) -
Tax benefit from
option exercises - - 10,303 -
Net income - - - -
Other comprehensive income:
Unrealized gain on available
for sale securities(1) - - - -
Balances as of ---------- --------- --------- -----
December 31, 1999 78,239,326 $ 782 $ 232,083 $(241)
========== ========= ========= =====
</TABLE>
<TABLE>
<CAPTION>
Accumulated
Other Total
Retained Compre- Compre- Stock-
Earnings hensive hensive holders'
(Deficit) Income Income Equity
---------- ------- ----------- --------
<S> <C> <C> <C> <C>
Balances as of
December 31, 1996 $ (6,154) $ - $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 - 36,800
--------- ======== --------- --------
Balances as of
December 31, 1997 30,646 - 223,720
Exercise of common stock
options and warrants - - 6,326
Payment of notes receivable
from stockholder - - 105
Repurchase of common stock - - (4)
Tax benefit from
option exercises - - 10,946
Net income 27,207 $27,207 - 27,207
--------- ======== --------- --------
Balances as of
December 31, 1998 57,853 - 268,300
Exercise of common stock
options and warrants - - 11,396
Cancellation of notes receivable
from stockholder - - 489
Repurchase of common stock - - (11)
Tax benefit from
option exercises - - 10,303
Net income 250,297 250,297 - 250,297
Other comprehensive income:
Unrealized gain on available
for sale securities(1) - 100,968 100,968 100,968
--------
$351,265
========
Balances as of --------- --------- --------
December 31, 1999 $ 308,150 $ 100,968 $641,742
========= ========= ========
</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.
<PAGE> 4
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 $ 250,297 $ 27,207 $ 36,800
Adjustments to reconcile net income to net cash provided by
operating activities:
Deferred income taxes 146,521 (2,451) (826)
Depreciation and amortization 13,109 8,026 2,850
Tax benefit from option exercises 10,303 10,946 18,549
Stock based compensation 513 - -
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 13,806 473 (49,036)
Inventories 14,143 (987) (34,724)
Other current assets (920) 519 (1,175)
Other assets 346 (4,110) 101
Accounts payable 6,519 (5,902) 9,676
Accrued liabilities 1,317 (5,202) 22,289
Other liabilities 613 1,114 (57)
--------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 70,223 33,291 7,176
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales of marketable securities 124,268 153,630 185,834
Maturities of marketable securities 308,002 79,131 69,873
Purchases of marketable securities (491,534) (226,702) (268,362)
Investments in development-stage companies 3,063 (2,018) (3,000)
Purchase of property and equipment (15,792) (32,143) (17,767)
--------- --------- ---------
NET CASH USED IN INVESTING ACTIVITIES (71,993) (28,102) (33,422)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of common stock options and 11,362 6,427 2,514
warrants, net
Proceeds from secondary offering of common stock - - 7,843
--------- --------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 11,362 6,427 10,357
--------- --------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 9,592 11,616 (15,889)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 20,669 9,053 24,942
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 30,261 $ 20,669 $ 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.
<PAGE> 5
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
AFC designs and manufactures end-to-end distributed multi-service access
solutions for the local loop. Our 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 are also a leading designer and
manufacturer of 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.
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, four, and
six week periods in the third quarter. We believe the effect of the sixth 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 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.
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.
<PAGE> 6
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
UMC1000 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.
<PAGE> 7
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 HEDGING TRANSACTION
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.
<PAGE> 8
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 $ 6,907 $16,135
Work-in-progress 818 566
Finished goods 28,992 36,359
------- -------
Total inventories $36,717 $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 $ 9,241 $ 7,831
Computer, software, and office 28,441 23,145
equipment
Engineering equipment 41,145 29,860
------- -------
78,827 60,836
Less: accumulated depreciation 22,029 11,521
------- -------
Property and equipment, net $56,798 $49,315
======= =======
</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 5,424 8,336
Outside services 5,308 3,219
Salaries and benefits 5,256 4,249
Income and sales taxes 3,692 2,773
------- -------
Total accrued liabilities $28,578 $25,140
======= =======
</TABLE>
<PAGE> 9
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 $ 123,247 $ 9,175 $135,408
State 217 23,274 1,128 24,619
------ --------- ------- --------
Income taxes $3,203 $ 146,521 $10,303 $160,027
====== ========= ======= ========
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 $ 143,614 $ 14,649 $ 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)
Other 2,553 647 289
--------- -------- --------
Income taxes $ 160,027 $ 14,648 $ 21,612
========= ======== ========
</TABLE>
<PAGE> 10
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 $ 8,371 $ 7,000
Research tax credit carry-forwards 5,087 2,597
Minimum tax credit carry-forwards 1,085 744
Unrealized loss on marketable securities 192 -
Other 37 309
--------- --------
Gross deferred tax assets 14,772 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) $(205,210) $ 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 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,
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.
<PAGE> 11
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 effected 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.
<PAGE> 12
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 SHARES PRICE
---------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 8,053,443 $ 6.67 8,303,260 $ 11.92 8,627,088 $ 1.66
Granted 5,111,229 21.21 7,820,811 13.14 3,603,646 27.42
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 9,032,015 $ 14.74 8,053,443 $ 6.67 8,303,260 $ 11.92
Exercisable at end of year 2,035,575 1,417,297 2,611,424
Available for grant 4,366,703 4,770,655 6,807,505
Weighted average fair
value of options
granted during the year $ 13.35 $ 5.32 $ 17.29
</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 $ 0.47 505,485 $ 0.40
2.35-7.50 1,397,373 8.3 6.86 457,487 6.13
7.63-7.88 2,001,659 8.6 7.86 621,438 7.88
8.03-8.63 1,071,045 9.0 8.52 286,619 8.53
8.78-15.94 625,062 9.3 12.83 59,671 11.76
16.13-19.56 1,391,050 9.7 16.40 16,002 17.88
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
44.38-44.38 1,099,284 10.0 44.38 99 44.38
</TABLE>
<PAGE> 13
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>
NUMBER EXERCISE
OF SHARES PRICE PER 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 $ 250,297 $ 27,207 $ 36,800
Pro forma 226,718 5,030 26,404
Basic net income per share:
As reported $ 3.25 $ 0.36 $ 0.52
Pro forma 2.94 0.07 0.38
Diluted net income per share:
As reported $ 3.07 $ 0.34 $ 0.48
Pro forma 2.78 0.06 0.34
</TABLE>
<PAGE> 14
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 $250,297 $ 27,207 $ 36,800
======== ======== ========
Shares used in basic per share calculations - actual
weighted average common shares outstanding for the period 77,048 74,788 70,131
Weighted average number of shares upon exercise of
dilutive options and warrants 4,376 4,723 7,338
-------- -------- --------
Shares used in diluted per share calculations 81,424 79,511 77,469
======== ======== ========
Basic net income per share $ 3.25 $ 0.36 $ 0.52
======== ======== ========
Diluted net income per share $ 3.07 $ 0.34 $ 0.48
======== ======== ========
</TABLE>
<PAGE> 15
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 $7,758
2001 7,180
2002 6,387
2003 6,281
2004 6,155
Thereafter 43,764
-------
Total minimum lease payments $77,525
=======
</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.
<PAGE> 16
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 11. COMMITMENTS AND CONTINGENCIES (Continued)
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 12.SUBSEQUENT LITIGATION SETTLEMENT
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 product family in specific countries outside
the U.S. 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 product family purchases do not meet expectations.
NOTE 13. SEGMENT INFORMATION
We operate in the access market and derive substantially all of our revenues
from sales of the UMC1000 product family. We organize our operations based on
designing, developing, manufacturing, selling, and supporting the UMC1000
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.
For the year ended December 31, 1999, revenues arising from sales of the UMC1000
product family, excluding royalties, were $291.1 million, compared with $307.1
million in 1998, and $266.4 million in 1997. We sell the UMC1000 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 $259.7 million, as compared to $230.5 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 years 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 15.7% and 11.9% of total revenues,
respectively. For the year ended 1998, one customer in the U.S. accounted for
11.2% and one customer in South Africa accounted for 10.4% 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 $62.9 million as of December 31, 1999 and $59.4 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.
<PAGE> 17
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. COMPANY INFORMATION AND CERTAIN CONCENTRATIONS
We currently derive substantially all of our revenue from the UMC1000 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 UMC1000 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 suppliers. 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.
<PAGE> 18
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. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 generally accepted
accounting principles.
KPMG LLP
San Francisco, California
January 31, 2000, except
as to Notes 3 and 12, which
are as of February 9, 2000
<PAGE> 19
QUARTERLY RESULTS OF OPERATIONS
Selected quarterly financial data is summarized below (unaudited):
<TABLE>
<CAPTION>
QUARTERS ENDED
-----------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
1999 1999 1999 1999
-----------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C>
Revenues $ 81,870 $ 75,900 $ 68,832 $ 64,966
Cost of revenues 42,243 39,086 36,932 35,482
---------- ---------- ---------- ----------
Gross profit 39,627 36,814 31,900 29,484
---------- ---------- ---------- ----------
Operating expenses:
Research and development 12,438 11,529 11,942 11,606
Selling, general and administrative 16,553 17,394 16,710 14,876
---------- ---------- ---------- ----------
Total operating expenses 28,991 28,923 28,652 26,482
---------- ---------- ---------- ----------
Operating income 10,636 7,891 3,248 3,002
Other income, net 380,857 1,809 1,387 1,494
---------- ---------- ---------- ----------
Income before income taxes 391,493 9,700 4,635 4,496
Income taxes 153,812 3,201 1,530 1,484
---------- ---------- ---------- ----------
Net income $ 237,681 $ 6,499 $ 3,105 $ 3,012
========== ========== ========== ==========
AS A PERCENTAGE OF REVENUES
-----------------------------------------------------------
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 51.6 51.5 53.7 54.6
---------- ---------- ---------- ----------
Gross profit 48.4 48.5 46.3 45.4
---------- ---------- ---------- ----------
Operating expenses:
Research and development 15.2 15.2 17.3 17.9
Selling, general and administrative 20.2 22.9 24.3 22.9
---------- ---------- ---------- ----------
Total operating expenses 35.4 38.1 41.6 40.8
---------- ---------- ---------- ----------
Operating income 13.0 10.4 4.7 4.6
Other income, net 465.2 2.4 2.0 2.3
---------- ---------- ---------- ----------
Income before income taxes 478.2 12.8 6.7 6.9
Income taxes 187.9 4.2 2.2 2.3
---------- ---------- ---------- ----------
Net income 290.3% 8.6% 4.5% 4.6%
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
QUARTERS ENDED
----------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
1998 1998 1998 1998
----------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C>
Revenues $ 75,143 $ 66,513 $ 85,345 $ 85,744
Cost of revenues 39,995 36,388 46,696 45,575
---------- ---------- ---------- ----------
Gross profit 35,148 30,125 38,649 40,169
---------- ---------- ---------- ----------
Operating expenses:
Research and development 10,800 11,422 10,429 8,312
Selling, general and administrative 16,202 16,297 18,068 14,761
---------- ---------- ---------- ----------
Total operating expenses 27,002 27,719 28,497 23,073
---------- ---------- ---------- ----------
Operating income 8,146 2,406 10,152 17,096
Other income, net 1,034 896 980 1,145
---------- ---------- ---------- ----------
Income before income taxes 9,180 3,302 11,132 18,241
Income taxes 3,215 1,153 3,896 6,384
---------- ---------- ---------- ----------
Net income $ 5,965 $ 2,149 $ 7,236 $ 11,857
========== ========== ========== ==========
AS A PERCENTAGE OF REVENUES
----------------------------------------------------------
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 53.2 54.7 54.7 53.2
---------- ---------- ---------- ----------
Gross profit 46.8 45.3 45.3 46.8
---------- ---------- ---------- ----------
Operating expenses:
Research and development 14.4 17.2 12.2 9.7
Selling, general and administrative 21.6 24.5 21.2 17.2
---------- ---------- ---------- ----------
Total operating expenses 35.9 41.7 33.4 26.9
---------- ---------- ---------- ----------
Operating income 10.8 3.6 11.9 19.9
Other income, net 1.4 1.3 1.1 1.3
---------- ---------- ---------- ----------
Income before income taxes 12.2 4.9 13.0 21.2
Income taxes 4.3 1.7 4.5 7.4
---------- ---------- ---------- ----------
Net income 7.9% 3.2% 8.5% 13.8%
========== ========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 1
EXHIBIT 23.1
REPORT ON SCHEDULE
AND
CONSENT OF KPMG LLP
The audits referred to in our report dated January 31, 2000, except as to Notes
3 and 12, which are as of February 9, 2000, included the related financial
statement schedule as of December 31, 1999 and for each of the years in the
three-year period ended December 31, 1999, included in the annual report on Form
10-K of Advanced Fibre Communications, Inc. This financial statement schedule is
the responsibility of the Company's management. Our responsibility is to express
an opinion on this financial statement schedule based on our audits. In our
opinion, such financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
We consent to incorporation by reference in the registration statements (Nos.
333-44645 and 333-15651) on Form S-8 of Advanced Fibre Communications, Inc. of
our reports dated January 31, 2000, relating to the consolidated balance sheets
of Advanced Fibre Communications, Inc. 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, and the related schedule, which reports appear,
or are incorporated by reference, in the December 31, 1999 annual report on Form
10-K of Advanced Fibre Communications, Inc.
/s/ KPMG LLP
San Francisco, California
March 21, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 30,261
<SECURITIES> 700,750
<RECEIVABLES> 66,183
<ALLOWANCES> (3,436)
<INVENTORY> 36,717
<CURRENT-ASSETS> 833,533
<PP&E> 78,828
<DEPRECIATION> (22,030)
<TOTAL-ASSETS> 897,424
<CURRENT-LIABILITIES> 253,199
<BONDS> 0
0
0
<COMMON> 782
<OTHER-SE> 640,960
<TOTAL-LIABILITY-AND-EQUITY> 897,424
<SALES> 291,051
<TOTAL-REVENUES> 291,568
<CGS> 144,833
<TOTAL-COSTS> 153,743
<OTHER-EXPENSES> 113,048
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (6,017)
<INCOME-PRETAX> 410,324
<INCOME-TAX> 160,027
<INCOME-CONTINUING> 250,297
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 250,297
<EPS-BASIC> 3.25
<EPS-DILUTED> 3.07
</TABLE>
