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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, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 000-23698
APPLIED DIGITAL ACCESS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 68-0132939
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
9855 SCRANTON ROAD, SAN DIEGO, CALIFORNIA 92121
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, ZIP CODE)
(619) 623-2200
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
--------------------------
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. ___
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on February
28, 1999 as reported on the Nasdaq National Market, was approximately
$18,132,185. For the purposes of this calculation, shares owned by officers,
directors and 5% shareholders known to the registrant have been deemed to be
owned by affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. There were 12,918,599 shares of the
Registrant's Common Stock, $0.001 par value, outstanding as of February 28,
1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held May 12, 1999, referred to herein as the "Proxy
Statement", are incorporated by reference as provided in Part III.
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PART I
ITEM 1. BUSINESS
THE STATEMENTS CONTAINED IN THIS FORM 10-K THAT ARE NOT PURELY
HISTORICAL ARE FORWARD LOOKING STATEMENTS. STATEMENTS WHICH USE THE WORDS
"OBJECTIVE," "SEEK," "INTEND," "WILL," "ANTICIPATE," "CAN," "CONTINUE," AND
"EXPECT," ARE FORWARD LOOKING STATEMENTS. THESE FORWARD LOOKING STATEMENTS,
INCLUDING STATEMENTS REGARDING THE COMPANY'S (I) PLANS FOR DEVELOPMENT OR
ACQUISITION OF NEW PRODUCTS OR ENHANCEMENT OF EXISTING PRODUCTS, (II)
STRATEGY, (III) EXPANDED MARKETING EFFORTS, (IV) EXPECTED LEVELS OF
EXPENDITURES, (V) GOAL OF MAXIMIZING THE VALUE OF TECHNOLOGY AND (VI) THE
COMPANY'S TIMING OF YEAR 2000 COMPLIANCE, ARE BASED ON INFORMATION AVAILABLE
TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO
UPDATE ANY SUCH FORWARD-LOOKING STATEMENT. IT IS IMPORTANT TO NOTE THAT THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD
LOOKING STATEMENTS. AMONG THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO
DIFFER MATERIALLY ARE THE FACTORS SET FORTH BELOW UNDER THE HEADING "RISKS
AND UNCERTAINTIES."
Applied Digital Access, Inc. ("ADA" or the "Company"), was incorporated
in California in August 1987, and reincorporated in Delaware in December 1997
through its merger into a newly formed Delaware corporation. Unless otherwise
indicated, as used in this report, the "Company" and "ADA" refer to Applied
Digital Access, Inc., a Delaware corporation, and it predecessor entity. The
Company's principal executive offices are located at 9855 Scranton Road, San
Diego, California, 92121.
ADA is a leading provider of network performance management products
that include systems, software, and services used to manage the quality,
performance, availability and reliability of telecommunications service
providers' ("TSPs") networks. ADA's products are designed to enable TSPs to
improve their quality of service, to increase productivity, to lower operating
expenses and to effectively deploy new services. ADA has positioned its business
to assist TSPs in addressing the rapidly increasing demand for new services,
higher bandwidth and access to the Internet. ADA's systems and software provide
network management functions such as circuit provisioning, network configuration
management, network performance management, circuit testing, and traffic
management of the public switched network. ADA has addressed the industry demand
for network management products with a three-faceted approach: (1) network
systems that provide testing and performance monitoring functions as well as
selected transport functions; (2) network management software that enables TSPs
to manage their network operations; and (3) services that are customized to meet
the evolving needs of the TSP market. The Company has formed two business units
around the company's product lines: the Network Systems business unit and the
Network Management business unit.
The Network Systems business unit is built around the Company's test
and performance management products and services, including its T3AS Test and
Performance Monitoring System ("T3AS"), Centralized Test System ("CTS"), Remote
Module, a DS1 network interface unit ("NIU"), Sectionalizer, Network Embedded
Protocol Access system ("NEPA"), and Protocol Analysis Access System ("PAAS").
The Network Management business unit focuses on the Company's
Operations Systems ("OS") software products, including .Provisioner, Traffic
Data Collection and Engineering System ("TDC&E"), Test OS, Fault Management
System ("FMS"), Graphical Test Assistant ("GTA"), and OS design services. The
formation of the Network Management business unit resulted from strategic
acquisitions made in 1996 and 1997. The Company's 1996 acquisition of certain
assets from Applied Computing Devices, Inc. ("ACD") resulted in the addition of
the Company's TDC&E and FMS product lines. The Company's 1996 acquisition of
certain assets from MPR Teltech, Ltd. and the subsequent 1997 acquisition of a
software license from Northern Telecom, Ltd. resulted in the addition of the
Company's .Provisioner product line.
The Company's products are deployed by over 50 TSPs including the five
regional bell operating companies ("RBOCs"), long-distance or interexchange
carriers ("IXCs"), competitive local exchange carriers ("CLECs"), independent
local exchange carriers ("ILECs"), emerging carriers and cable companies.
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RECENT DEVELOPMENTS
On March 3, 1999, the Company announced the termination of its joint
development agreement ("JDA") with Nortel. The Company and Nortel entered
into the agreement in September 1997 to develop SONET network element
products for the telecommunications industry. The intellectual property
rights associated with the jointly developed technology will become the
property of the Company. Under the JDA, the Company and Nortel each
contributed technology and development resources to the project conducted
under the JDA and shared the development costs. The Company's development
costs associated with the JDA have been expensed as incurred. Nortel is
obligated to continue funding its share of the development costs associated
with the JDA project through June 2, 1999. The Company expects to
substantially reduce expenses associated with the development conducted under
the JDA and will explore alternatives for maximizing the value of the jointly
developed technology. There can be no assurance that the Company will be
successful in its efforts to maximize the value of the technology developed
under the JDA or that the jointly developed technology will provide future
value to the Company. Under terms of the JDA, if the jointly developed
technology is successfully implemented into a marketable product, Nortel
retains the right to receive limited future royalties in order to recoup its
share of development costs incurred under the JDA.
On March 31, 1999 the Company announced a reduction in its workforce
of approximately 65 people, or 22% of its total workforce. Of the reduction
in workforce, 23 were temporary positions. The Company determined the
reduction was necessary in order to align its current operations with the
Company's objectives of focusing on market opportunities in its core
business, reducing expenses including expenses related to its recently
terminated JDA with Nortel and improving operating results. The majority of
the reduction in workforce were engineers focused on development conducted
under JDA. As a result of the reduction in workforce, the Company will close
its office in Richardson, Texas. The Company will incur a significant
one-time charge in the first quarter ending March 31, 1999, related to the
reduction in workforce. The Company's restructuring plan includes the
identification of the affected personnel, facility closures, asset write
downs, and lease terminations. The Company has not completed its analysis of
the total dollar amount associated with the restructuring charge, but will
complete this process prior to issuing its first quarter operating results.
BACKGROUND
The Telecommunications Deregulation Act of 1996 (the "1996
Telecommunications Act") has greatly increased the competitive nature of the
telecommunications industry and has changed traditional supplier-customer
relationships among local telephone companies and long distance providers. TSPs,
which include the RBOCs, IXCs, CLECs, ILECs, Internet service providers
("ISPs"), cable companies, and emerging carriers are entering the territories
and businesses of each other, fiercely competing to supply business customers
with highly profitable telecommunications networks and services. The competitive
climate has created significant challenges for TSPs as they strive to meet
objectives of increasing revenue and market share, while retaining current
customers and lowering operating costs.
The volume of digital information transmitted through the
telecommunication system has grown rapidly in recent years. This growth has
been driven primarily by the proliferation of personal computers and
workstations, the prevalence of networking and use of the Internet, the
adoption of client/server computing, the increase in cellular telephone and
facsimile use, and the deployment of new digital information applications
including multimedia, video conferencing, and image-processing. As a result,
TSPs have been required to rapidly deploy new high-speed data and voice
circuits operating at a 1.54 megabit-per-second rate, called DS1, or T1, and
at a 45 megabit-per-second rate, called DS3 or T3. The DS3 transmission rate
is the highest electrical telecommunication circuit transmission rate
currently available in North America.
The present structure of the telecommunications industry in the
United States is largely a result of the court-mandated divestiture of AT&T
in 1984. The AT&T divestiture resulted in the creation of the RBOCs, the
competitive IXC market, and the emergence of CLECs and emering carriers who
offer local telephone service in competition with the RBOCs and ILECs.
Regulation through competition is the philosophy that resulted in the breakup
of AT&T, and the Company believes it continues to be the philosophy of the
Federal Communications Commission ("FCC"). The passage of the 1996
Telecommunications Act allows each of these TSPs to enter the territories and
businesses of the others and has resulted in an unprecedented number of
mergers and acquisitions among TSPs. While the Company believes that the new
law will bring new opportunities for network equipment suppliers, it is too
early to assess the long-term impact of this new law on the
telecommunications industry and ADA's business. RBOCs have faced increased
competition from CLECs and emerging carriers and from the local service
competitive initiatives of the IXCs and from non-traditional providers of
telephone service such as cable television companies. The Company believes
that many of the new competitive entrants will continue to focus their
efforts on corporate and government communications networks, which are among
the most profitable market segments. Customers in these segments require
highly reliable data and voice communications circuits to enable them to
conduct their day-to-day business without interruption. These new competitors
are often able to offer higher-quality and lower-cost service than local
telephone companies, and as a result, have gained significant market share in
these segments. This increased competition has brought pressure on RBOCs to
protect their existing revenue bases by improving the quality of their
service and to reduce their costs. At the same time, the RBOCs continue to
re-engineer and downsize their organizations. The large reductions in staff
have often resulted in the loss of highly experienced and technical people,
leaving less experienced staff to operate and maintain the networks.
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Long distance data or voice circuit often involves three or more
telephone companies: the local telephone companies on each end and the IXC
providing the connection between the two local companies. Responsibility for
service in long distance high-speed data and voice networks is transferred
from one carrier to another at their network boundaries.
The Company believes that the segmentation of the telecommunications
network has made it more difficult for telephone companies to identify and
respond to problems in their networks. For example, many stock brokerage
firms communicate real-time stock quotes and buy and sell orders to and from
their brokers over high-speed data communications lines. Such firms monitor
their own circuits and can detect when data communications service begins to
degrade. When degradation in service is noted, the telecommunications manager
of the firm contacts the telephone company that manages the network -
typically the IXC. Initially, the IXC does not know where the problem is
located and must initiate three trouble reports, one in each local telephone
company and one in its own company. Each telephone company then dispatches
multiple repair crews with portable test equipment to attempt to locate the
problem. Typically, repair crews are dispatched to a number of locations,
including the network boundary between the long distance and the local
telephone company, the telephone building nearest the user, and to outside
facilities such as the cables and equipment beneath streets and on poles
between the central offices and the end-user customer. This system of
maintenance results in a number of inefficiencies. For example, the Company
believes telephone company repair crews often incur needless expense only to
report "no trouble found." Despite their best efforts, repair crews often
inadvertently interrupt or damage circuits that are working and may make
unnecessary repairs.
IXCs measure quality of service provided by the local telephone
companies in two principal ways: failure rate (customer-reported troubles per
100 circuits per month), and mean-time-to-restore (the time needed to respond
to and resolve a customer's complaint). These measures frequently influence
IXCs and end-user customer decisions about which local telephone company to
use. To date, local telephone companies' level of services measured by these
standards has often placed them at a competitive disadvantage. In order to
reduce failure rates and improve restoration times, the Company believes
telephone companies are motivated to change the traditional methods of
handling service problems as described above. They are looking for solutions
that do not require dispatching repair crews with portable test equipment
when problems occur and, instead, allow them to monitor circuits remotely
from a central management site. They are also seeking effective methods of
remotely testing and monitoring DS3 and DS1 circuits at the network boundary.
Finally, telephone companies are looking to improve their quality of service
by moving from reactive maintenance to preventive maintenance through
performance monitoring. These network quality and performance requirements
have created a need for a cost-effective solution to network performance
management.
THE APPLIED DIGITAL ACCESS SOLUTION
ADA focuses on providing network performance management solutions to
TSPs. These solutions are comprised of products that address traffic, fault,
performance, configuration, provisioning and test management. The Company has
focused its research and development activities on creating products that
provide answers, instead of data, to TSPs, and on making network management
easier.
ADA's test and monitoring systems, intelligent NIUs, and OS software,
in stand-alone applications, and in integrated solutions, help TSPs improve
performance to their business customers. The Company's products help TSPs
provide better service to their business customers by providing new services
faster, restoring service faster when circuits fail, optimizing performance on
in-service circuits, and maximizing the performance of the public switched
telephone network. When competing for profitable business customers, the
integration of network management functions are valuable assets to TSPs. Without
efficient integrated network management systems, TSPs are hard pressed to
increase market share.
The Company provides TSPs with network performance management products
to provision new circuits, test circuits, monitor telephone network building
blocks such as digital switches, digital cross-connect systems and SONET
transmission systems, monitor transmission performance on high-speed digital
circuits, and manage transmission facilities to optimize the performance of the
telecommunications network in the era of increased
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demand from Internet usage. The Company believes its network systems products
enable TSPs to greatly improve their reliability of service, reduce circuit
repair time, reduce network management expense, and proactively maintain
network quality.
STRATEGY
The Company seeks to maintain a leadership position as a supplier of
network performance management solutions for high-speed TSPs and to become a
leading provider of OS solutions for network management of telecommunications
networks:
1. DEVELOPING AND ENHANCING PRODUCTS FOR NETWORK BOUNDARY
APPLICATIONS.
The initial application for the Company's network systems products
has been at the network boundary between the IXC and the local TSP.
Installation of the T3AS system at these boundaries allows the local TSP to
quickly determine if a reported trouble is within its network. It also allows
the local TSP to continuously monitor its circuits and react to degradation
of the signal before service is affected. With the Company's Remote Module, a
DS1 NIU, the boundary between the local telephone company and the end-user
can now be monitored non-intrusively, either in a stand-alone application or
continuously monitored as part of an integrated system using the Company's
test and monitoring systems or test and monitoring capabilities in systems
from other suppliers. While the Remote Module provides valuable information
about circuit performance when used in a stand-alone mode, it provides better
information when used in conjunction with a test and monitoring system
elsewhere in the network. The Company believes the Remote Module provides the
most valuable information when used in conjunction with the Company's
Sectionalizer Software and test and monitoring systems also made by the
Company. The combination of the products' capabilities enables TSPs to
improve their ability to address the increasingly competitive business
environment.
2. FOCUSING SALES AND MARKETING EFFORTS ON A BROADER RANGE OF TSPS.
ADA's initial sales have been to the RBOCs and their affiliates, all of
whom have a compelling need to improve the quality and reduce the cost of their
services. Competitive pressures are forcing telephone companies to move toward a
centralized network management infrastructure that uses integrated test and
performance monitoring systems. The Company has broadened its target market with
applications that are appropriate for IXCs, CLECs, emerging carriers, enterprise
networks and other TSPs.
3. DEVELOPING AND ENHANCING PRODUCTS AND SERVICES TO ADDRESS DATA
PROTOCOLS.
The Company believes that there are additional applications for ADA's
product lines that extend its utility to new service offerings by its customers
that address data protocols, including frame relay, asynchronous transfer mode
("ATM") and Internet protocols. The Company's NEPA and PAAS systems currently
provide customers with testing and monitoring capabilities for broadband
networks. The Company has additional protocol monitoring and analysis products
under development.
4. DEVELOPING AND ENHANCING PRODUCTS AND SERVICES TO ADDRESS OS.
The Company is extending its current product line and market to
address selected applications within the OS function. OS are computer
software-based systems that provide operations support for telecommunications
functions. The OS market is very large and companies such as Lucent
Technologies, Inc. ("Lucent") and BellCore (recently renamed Telcordia
Technologies) have historically addressed its applications. Some of the older
products from these suppliers, called "legacy systems," are limited in their
ability to provide TSPs with the real-time information that is needed to
manage complex high-speed telecommunications networks. The market for
intelligent network management systems has become fragmented, and the Company
perceives a need for solutions that address the OS applications of
provisioning, configuration management, testing, surveillance, performance
monitoring and traffic management, among others. The Company further believes
that additional value can be provided to its TSP customers through
integration of multiple OS applications, and through integration of the
Company's OS applications with existing legacy systems.
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5. DEVELOPING PRODUCTS TO ADDRESS NEW TRANSMISSION STANDARDS.
The Company intends to extend its current products and develop new
products to accommodate new telecommunication transmission standards. The
Company anticipates that the SONET and SDH optical transmission standards
will become the industry transmission standards for the North American and
international networks, respectively. The Company's current network circuit
test and performance monitoring systems do not address either the SONET or
SDH transmission standards. The Company intends to extend its current
products and develop new products to accommodate such new transmission
standards and other advances in technology, as they evolve. See "Risks and
Uncertainties--Rapid Technological Change and Dependence on New Products."
6. EXPANDING TO OTHER APPLICATIONS.
The Company believes that there are additional applications for ADA's
product lines that extend its utility to network boundaries between TSPs and
other users, such as corporate customers, cellular telephone companies, and
cable television companies.
PRODUCTS
NETWORK SYSTEMS TEST AND PERFORMANCE MANAGEMENT PRODUCTS
CENTRALIZED TEST SYSTEM (CTS)
CTS is a sophisticated digital test system device for voice frequency
("VF"), digital data service ("DDS"), high-capacity digital service ("HCDS"),
DS3, and packet based services, such as frame relay and ATM. CTS functions as a
remote test unit ("RTU") and a test system controller for circuits transported
through digital cross-connect systems (DCS). CTS accesses DS0, DS1 and DS3
circuits carried through synchronous or asynchronous interfaces on DCS. CTS is
designed for applications with both centralized and distributed architectures.
Its modular design, scalability, test suite and integrated testing and fault
isolation functions provide an economic and flexible solution for DCS or non-DCS
based test and performance monitoring. CTS' evolutionary platform can be
reconfigured as an in-line T3AS system without obsolescence of original modules
to add new capabilities and full-time performance monitoring and non-intrusive
testing. CTS is installed where test access is highly critical and efficient use
of network resources is important.
T3AS TEST AND PERFORMANCE MONITORING SYSTEM (T3AS)
T3AS consists of digital test access units ("DTAU") that can be
co-located or placed at network boundaries between TSPs. The performance
monitoring capabilities of T3AS provide visibility to the services carried by
the network. T3AS is physically located at network boundaries between TSPs to
quickly isolate, identify and report the location of circuit troubles in
these networks. T3AS is an integrated test and performance monitoring device
that interfaces to the network at both the DS1 and DS3 transport rates while
providing visibility down to DS0, and subrate DS0, circuits. T3AS' technology
and flexible architecture enable T3AS to function either as a DTAU or RTU.
The T3AS system interfaces with the TSPs' network management OS using
industry-standard interfaces and protocols. T3AS can also function as a CTS
to interface with DCSs in the telephone network to provide additional test
capability when circuit access is provided through such systems. The T3AS
system supports up to 48 DS3 circuits, or 1,120 DS1 circuits when accessing
the network at the DS1 rate of transmission. T3AS' distributed architecture
allows individual high-speed or low-speed subsystems to be installed at
locations remote from the T3AS base system. T3AS' distributed architecture
supports applications where the number of DS3 or DS1 circuits at a particular
remote location does not warrant the cost of a full T3AS system, such as at
network boundaries with fewer than six DS3 circuits or 140 DS1 circuits
between a local telephone company and an IXC, and at network boundaries
between the local telephone company and the end-user. Users can easily
upgrade their existing T3AS systems by adding distributed system hardware
modules and software. The low-speed subsystem provides test and performance
monitoring capabilities similar to the high-speed subsystem, but for DS1
circuits. This subsystem is intended for network boundaries where circuits
cross at the DS1 rate. The low-speed subsystem units are interchangeable with
the high-speed subsystem units in the T3AS racks. Each low-speed subsystem
has a capacity of 140 DS1 circuits and can be deployed in a distributed
system to share administration and test resources with the other subsystems
of the T3AS base system.
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REMOTE MODULE
ADA's Remote Module is an intelligent DS1 NIU that non-intrusively
monitors the performance of T1 circuits. Installed at network boundaries between
the local TSP and the end-user, the Remote Module enables the TSP to determine
whether circuit troubles originated in the TSP's network or in the end-user's
network. When installed at the local TSP's network boundary at the end-user
customer premises, and in tandem with a T3AS system at the network boundary
between the long distance telephone company and the local service provider, the
Remote Module provides a unique end-to-end view of the DS1 circuit. This view of
service level performance is critical to improve service quality and reliability
and to reduce costs. Telephone network management centers can view a DS1 circuit
within their network and beyond the boundaries of their network, and can quickly
identify and isolate failures from the performance monitoring information
available. The Remote Module can provide similar, although less extensive
functionality, in a stand-alone mode, or in conjunction with DTAUs and RTUs
provided by other suppliers.
SECTIONALIZER
Sectionalizer is expert system software that non-intrusively identifies
the location of DS1 circuit troubles and provides answers in seconds rather than
hours. Sectionalizer correlates and processes extended superframe performance
monitoring data and presents that information pictorially to technicians
enabling them to isolate problems in real time to determine whether they are on
the customer's premises or other portions of the network. Hard to isolate
sporadic troubles are identified through the software's correlation of
historical circuit events. Sectionalizer complements the deployment of Remote
Module, T3AS and CTS by utilizing the equipment to rapidly identify and isolate
network troubles and take a proactive perspective in network management.
Sectionalizer is the driving force behind ADA's Network Boundary
Sectionalization application. Sectionalizer executes on T3AS, CTS, and Remote
Module platforms.
NETWORK EMBEDDED PROTOCOL ACCESS (NEPA)
NEPA is a system that provides TSPs with the ability to remotely and
non-intrusively access, analyze and monitor Frame Relay, IP, and ATM networks.
NEPA probes the network and the embedded protocols within it, providing
real-time analysis of both the physical and logical network layers, including
fault isolation and notification, circuit turn-up, and systems testing. NEPA is
an SNMP standards based system that provides on-demand, non-intrusive remote
protocol analysis and testing of data communciations networks, circuits, and
devices. NEPA's intuitive user interface utilizes web browser technology to
provide remote access and analysis of network protocols via the Internet. The
systems architecture facilitates multiple remote monitoring, analysis and access
sessions supporting concurrent users and simultaneous testing sessions. The NEPA
system collects data out in the network and transports the information to a UNIX
or NT server. NEPA software applications interactively utilize the server's
collected data to allow support personnel network analysis from anywhere in the
network via the Internet. These access locations may be at the network backbone,
or at switching devices, routers, and other network access devices.
PROTOCOL ANALYSIS ACCESS SYSTEM
The T3AS platform can be configured to provide access to broadband
circuits that are provisioned for advanced data services such as frame relay,
SMDS or ATM. Surveillance and testing capabilities in broadband networks may not
be as automated as they are in traditional telephone networks. Diagnosing
troubles within the network often requires coordination among multiple
organizations and dispatches to customer sites. PAAS provides circuit testing
and connects circuits to a protocol analyzer for more detailed troubleshooting.
T3AS PAAS provides a cost-effective method to access circuits from a centralized
network management center.
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NETWORK MANAGEMENT OS SOFTWARE PRODUCTS
.PROVISIONER
Provisioner is an OS software application that provides service
initiation and service management capability for transport networks comprised of
multiplexers, DCSs, and other transport elements. .Provisioner enables TSPs to
activate new circuits and services, and to manage transport networks from a
single user interface concentrating on end-to-end services rather than on
individual network elements. .Provisioner is a turnkey solution for multi-vendor
operations. The modular architecture and object-oriented software support
current and future applications, including management of frame relay and ATM
networks.
TRAFFIC DATA COLLECTION AND ENGINEERING ("TDC&E")
TDC&E is a traffic management OS that provides the capability to
collect traffic data from a variety of existing network elements,
predominantly central office switches, in addition to emerging network
elements such as ATM and frame relay switches. TDC&E supports all major
traffic engineering functions and provides an accurate, quantifiable
reporting mechanism for marketing and quality assurance functions.
FAULT MANAGEMENT SYSTEM ("FMS")
FMS is an alarm and network surveillance OS that is used in
combination with other OS software installed in TSP networks. This
application is designed to receive and analyze alarm messages, fault
messages, and information from managed network elements. Key features of this
system include real-time event and alarm acquisition, event processing and
correlation, and historical fault analysis and reporting. In addition,
automated reactions and responses can be programmed based upon selected event
occurrences. FMS provides operational system features to manage the state of
a multi-network-element, multi-vendor hybrid network.
TEST OS & Graphical Test Assistant ("GTA")
Test OS is a browser-based test management operating system that
provides fast test access through point-and-click graphical user interfaces
("GUI") that replace cumbersome test commands and hide distinctions in test
equipment and software to simplify ease of use. Test OS is a highly scalable,
flexible application that supports multiple users at varying access levels
for tests at DS0, DS1 and DS3 rates. GTA is a Test OS application that
functions as a graphical test front-end system to T3AS and CTS for DS0, DS1
and DS3 testing. GTA provides simple point-and-click access to all T3AS and
CTS testing functionality on a Windows NT or Windows 95 platform. While
primarily designed for TSPs without a test management OS, GTA also
complements existing test OSs by augmenting functionality.
CUSTOMERS
The Company sells its network performance management products and
services to the TSP market and several enterprise networks. Historically, the
majority of the Company's network test and performance monitoring products
have been sold to the RBOCs. The RBOCs accounted for approximately 73%, 31%
and 47% of the Company's total revenue in years 1996, 1997 and 1998,
respectively. In 1997, the Company expanded its customer base for its network
test and performance monitoring products to include the long distance, or
IXC, market with sales of these products to MCI WorldCom. In 1996 and 1997,
the Company acquired and developed several network management OS software
products. The acquisitions added over 30 new customers to the Company's
customer base. Customers for the Company's network management OS software
products and services include MCI WorldCom, British Columbia Telecom, GTE,
WinStar Communications, IntelCom Group and other TSPs and enterprise
networks. The Company has provided software design services to Nortel Network
Management Services Division, Telus, BC Tel and Bell Canada. The Company has
increased its sales and marketing efforts aimed at CLECs, IXCs, emerging
carriers and enterprise networks. There can be no assurance that these
efforts will be successful. See "Risks and Uncertainties--Competition."
The Company currently has purchase contracts with MCI WorldCom,
Ameritech, BellAtlantic, BellSouth and Southwestern Bell. MCI WorldCom has also
entered into license agreements with the Company. Other TSPs purchase the
Company's network systems products and network management OS products under
standard purchase orders and software license agreements. Since the MCI
WorldCom, BellSouth, Ameritech and Southwestern Bell
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contracts may be terminated at either the customers' or the Company's
convenience, the Company believes that these purchase and license contracts
are not materially different than purchasing or licensing under standard
purchase orders. Most of the Company's customers are significantly larger
than the Company and may be able to exert a high degree of influence over the
Company. In addition, a small number of customers have historically accounted
for substantially all of the Company's revenue in any given fiscal period. In
1998, BellSouth, MCI WorldCom and Bell Atlantic accounted for 26%, 23%, and
12% of the Company's total revenue, respectively. In 1997, Nortel, MCI
WorldCom and BellSouth accounted for 20%, 28%, and 17% of the Company's total
revenue, respectively.
Prior to selling products to RBOCs and certain IXCs and ILECs, a vendor
must often first undergo a product qualification process for its product with
these carriers. The Company typically spends from six to eighteen months or more
discussing its products with a potential customer prior to the customer agreeing
to put the product through its qualification process. Although the qualification
process for a new product varies somewhat among these prospective customers, the
Company's experience is that the process often takes a year or more and
generally consists of the following phases:
- LABORATORY EVALUATIOn. The product's function and performance are
tested against all relevant industry standards, including BellCore
standards. This process can take from two weeks to three months or
more depending on a variety of factors.
- FIELD TRIAl. A number of telephone lines are equipped with the
product for simulated operation in a field trial lasting from three
weeks to three months or more. These field trials are used to
evaluate performance, to assess the ease of installation and to
establish troubleshooting procedures. The evaluating carriers grant
conditional product approval upon successful completion of a field
trial, enabling field personnel to order limited quantities of the
product under one-time approvals.
- FIRST OFFICE APPLICATIOn. In a first office application, live
circuits are placed on the system under evaluation. The system is
then used on live circuits for periods ranging from one to six
months or more to verify functionality and operation.
- PRODUCT SELECTION AND DEPLOYMENt. Prior to product selection and
deployment which may take from one to four months or more, the
evaluating carrier develops and implements a variety of methods and
procedures that cover ordering, stocking, installation,
maintenance, returns and all other activities associated with the
use of the product.
The loss of one or more of the Company's major customers, the reduction
of orders or a delay in deployment of the Company's products could materially
and adversely affect the Company's business, operating results and financial
condition. Further, any failure on the part of any of the Company's customers to
maintain their approval of the Company's products, failure of any of the
Company's customers to deploy the Company's products or any attempt by any of
the Company's customers to seek out alternative suppliers could have a material
adverse effect on the Company's business, operating results and financial
condition. In addition, there can be no assurance that new customers will
approve the Company's products, or that such approval will not be significantly
delayed. Furthermore, work force reductions and staff reassignments by the
Company's customers have in the past delayed or indefinitely postponed the
product approval process and the Company expects such reductions and
reassignments to continue in the future. There can be no assurance that the
impact of such reductions and reassignments will not have a material adverse
effect on the Company's business, operating results and financial condition.
TECHNOLOGY
The T3AS system consists of a real-time operating system and an
extensive suite of proprietary applications software that is executed on
proprietary distributed processing hardware. The operating system implements the
distributed processing functionality of T3AS by linking, in a maximum capacity
system, more than 350 dedicated microprocessors in a real-time computing
environment. The T3AS software architecture is designed to enable new system
features and capabilities to be installed easily through field software
upgrades. Up to 145 simultaneous users can be supported by the T3AS system. All
performance monitoring parameters and telephone circuit tests have been verified
for compliance with BellCore-published technical requirements by BellCore, and
also independently verified by the Company's telephone company customers.
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The Company's software and hardware architecture facilitates important
system capabilities such as fault tolerance and hitless access. Fault tolerance
provides a one-to-one redundant circuit path that provides backup for each DS3
and DS1 circuit. DS3 and DS1 circuits may be transferred from the online main
path to the redundant standby path without disruption of the embedded data
streams. Transfers are accomplished automatically if a hardware or software
malfunction is detected in the T3AS system. Transfers can also be accomplished
manually when telephone company personnel initiate maintenance actions. "Hitless
access" is an industry term used to describe a method of obtaining access to a
low-speed circuit embedded in a high-speed circuit without affecting any other
circuit embedded in the high-speed circuit. In the T3AS system, the Company's
proprietary technology provides access to the DS3 circuit, any embedded DS1
circuit, DS0 circuit, or other subrate circuit, without affecting any other
circuit within the DS3 circuit.
The CTS contains many of the core technology building blocks present in
the T3AS. The T3AS is optimized for large cross sections of circuits and is
positioned in series with the network DS3 and DS1, or T1 traffic. CTS, by
contrast, contains DS3/T1/DS0 test resources that are shared among a cross
section of circuits that are passing through DCSs. CTS interfaces to DCS systems
to provide test capability. CTS provides firewall technology by taking in
commands from a tester in a centralized maintenance center and translating these
commands into a sequence of instructions that are sent to the DCS to configure
the circuit access appropriately. In this fashion, the risk of improper circuit
manipulation is minimized since the CTS system isolates the test technician from
the details of the access and automatically configures the DCS appropriately.
Both the in-line T3AS and the CTS systems are modularly expandable and
support distributed configurations. Subsystems can be optionally co-located in a
common rack or the individual subsystems can be located in remote locations many
miles away and connected to the base system via a packetized T1 link that is
used for transport of control information and DS0 circuits under test. This
technology provides for a virtual single network element configuration with a
single interface to the OS while at the same time allowing the flexibility to
locate modular subsystems in smaller remote locations. In addition, this
technology provides a significant cost benefit since the cost of the common
equipment located in the base location is shared among all remote subsystems.
The subsystems can then be configured in a low cost streamlined fashion since
they can rely on the shared base system to provide a significant amount of
functionality.
The Company has evolved its performance management technology,
originally focusing on the physical layer, and moving to higher levels
addressing logical layers and higher protocol layers. This technology provides
for end-to-end circuit performance management in a diverse network containing
multiple hierarchical transport protocols.
The Company's Remote Module introduces new technology that serves to
extend the performance management capabilities of the T3AS to the customer
premises boundary for use in NIU products. This capability facilitates
sectionalization of network faults on T1 circuits. This technology provides
support for T1 performance monitoring and the ability to convey performance
monitoring information into the network from the customer premises in a fashion
that is completely transparent to the customer's data. This new technology has
been offered up for standardization and the Company is working closely with the
ANSI, T1R1 and T1M1 standards bodies on incorporating this technology into the
new T1 standards. However, there can be no assurances that this new technology
will be adopted by the ANSI, T1R1 and T1M1 standards bodies as an industry
standard.
The Company's OS software products include systems that perform digital
cross-connect and add-drop multiplexer service activation, circuit provisioning,
node surveillance and switched fault management, and traffic data collection and
reporting. The products provide capabilities as stand-alone products or can be
integrated into a total solution offering with other ADA products or a TSP's
legacy or standards based service management framework. The software products
are designed using the latest object-oriented methodologies. The development
life cycle process is well documented and has been registered as ISO 9001
compliant. The enhanced products are written to support the latest in Relational
database, ODBC, JDBC, Corba compliant and client server technologies. GUI
versions of the TDC&E and .Provisioner products support JAVA web browser
enabling technology and all current versions of these products are either year
2000 compliant or have year 2000 support activities scheduled to complete in
1999. There can be no assurance that the Company will be successful in
implementing its year 2000 modifications in a cost-effective and timely manner.
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RESEARCH AND PRODUCT DEVELOPMENT
The Company believes its future success will depend in part on its
ability, on a cost-effective and timely basis, to continue to enhance its
products, to develop and introduce new products for the telecommunications
network performance management market, to address new industry standards and
changing customer needs and to achieve broad market acceptance for its products.
Product line extensions require the Company to work closely with its
current and potential customers. Using feedback received from such customers,
the Company identifies and then develops new products and enhancements to its
existing products that the Company believes will increase their usefulness or
extend their application. Examples of product extensions of the Company's
T3AS test and performance monitoring system include CTS, NEPA and PAAS. In
addition, the Company continually seeks to reduce the manufacturing costs of
its products by taking advantage of advances in hardware technology. Finally,
new technologies, such as SONET, frame relay, and ATM are the focus of
significant research and product development activity at ADA. The Company
anticipates that the SONET and SDH optical transmission standards will become
the industry standards over the coming years for the North American and
international networks, respectively. The Company's current network circuit
test and performance monitoring systems do not address either the SONET or
SDH transmission standards.
The market for the Company's products is characterized by rapid
technological advances, evolving industry transmission standards, changing
regulatory environments, price-competitive bidding, changes in customer
requirements and frequent new product introductions and enhancements. The
introduction of telecommunications network performance management products
involving superior technologies or the evolution of alternative technologies or
new industry transmission standards could render the Company's existing
products, as well as products currently under development, obsolete and
unmarketable.
In 1996, 1997, and 1998, the Company spent $7.4 million, $9.2 million
and $14.3 million, respectively, on research and development efforts. In 1997
and 1998, the Company's research and development operating expenses included
$2.2 million and $3.9 million offsets, respectively, representing Nortel's
proportionate share of development costs incurred for the initial project
conducted under the JDA. As a result of Nortel's termination of the JDA, the
Company expects to significantly reduce research and development expenses
previously associated with the JDA. Nortel is obligated to continue funding its
share of development costs associated with the JDA through June 2, 1999. The
Company cannot currently determine the impact the JDA termination will have on
the company's operating results.
MANUFACTURING AND SUPPLIERS
The Company's manufacturing operations focus on network systems
products and consist primarily of material planning and procurement, final
assembly, module testing, burn-in, final system testing and quality control.
The Company procures all components from outside manufacturers and believes
it has good relationships with its suppliers. The majority of final assembly
and tests are completed by the Company at its production facility. The
Company utilizes
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contract manufacturing (both consignment and turnkey operations) for the
assembly of certain sub-assemblies, including printed circuit board modules.
The Company also purchases sub-assemblies that have been modified to the
Company's specifications from original equipment manufacturers.
The Company is registered under the ISO 9001 standard for its
headquarters facility in San Diego, California. ISO 9001 Quality Standards
were developed by the International Organization for Standardization. It is a
quality system standard for ensuring a total quality management system in
engineering and manufacturing. The scope of the Company's registration is for
the design and manufacture of telecommunications network performance
management products, including associated software that help TSPs manage
their networks.
All products are rigorously tested prior to shipment to customers. All
printed circuit board modules are tested individually and as part of a system.
The Company's quality control program is modeled to support the BellCore
standards. To date, the Company has not experienced significant field failures.
In the event there are material deficiencies or defects in the design
or manufacture of the Company's systems or if the Company's systems become
incompatible with existing third-party network equipment, the affected products
could be subject to a recall. The Company has experienced two significant
product recalls in its history. There can be no assurance that the Company will
not experience product recalls in the future. The cost of any subsequent product
recall could have a material adverse effect on the Company's business, operating
results and financial condition. In addition, the Company could materially
suffer from the potential negative publicity associated with a recall.
Generally, the Company uses industry standard components for its
products. Some components, however, including VLSI ASICs, are custom made to the
Company's specifications. Certain components used in the Company's T3AS, CTS,
PAAS and Remote Module products, including its VLSI ASICs, are currently
available from only one source and other components are available from only a
limited number of sources. The Company has few supply agreements and generally
makes its purchases with purchase orders. Further, certain components require an
order lead time of up to one year. Other components that currently are readily
available may become difficult to obtain in the future. Failure of the Company
to order sufficient quantities of these components in advance could prevent the
Company from increasing production of products in response to customer orders in
excess of amounts projected by the Company. In the past, the Company has
experienced delays in the receipt of certain of its key components, which have
resulted in delays in product deliveries. There can be no assurance that delays
in key component and product deliveries will not occur in the future. The
inability to obtain sufficient key components as required or to develop
alternative sources if and as required in the future could result in delays or
reduction in product shipments, which in turn could have a material adverse
effect on the Company's customer relationships and operating results.
Additionally, the Company uses third-party subcontractors for the
manufacture of its sub-assemblies. This reliance on third-party subcontractors
involves several risks, including the potential absence of adequate capacity,
the unavailability or interruption of access to certain process technologies and
reduced control over product quality, delivery schedules, manufacturing yields
and costs. Shortages of raw materials or production capacity constraints at the
Company's subcontractors could negatively affect the Company's ability to meet
its production obligations and result in increased prices for affected parts. To
procure adequate supplies of certain components, the Company must make advance
commitments to purchase relatively large quantities of such components in a
number of circumstances. The Company believes, however, that by relying on a
limited number of suppliers, it is in a better position to control quality,
reduce manufacturing costs and improve product standardization.
At December 31, 1998, the Company had open noncancelable purchase
commitments of approximately $3,003,000 covering several different components. A
large portion of the Company's purchase commitments consist of custom parts,
some of which are sole source such as VLSI ASICs, for which there is no
alternative use or application. The inability of the Company to incorporate such
components in its products could have a material adverse effect on the Company's
business, operating results and financial condition.
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MARKETING, SALES AND CUSTOMER SUPPORT
The Company markets its products to TSPs through an experienced
direct sales force and strategic partnerships with third parties. Each of the
Company's sales managers operate from a site located near his or her
strategic responsibility.
The Company also provides engineering and installation services ("E&I")
for customers. These services are performed at the customer site and involve
assisting the customers with the installation of the Company's products into the
customer's network structure. These services are performed by customer support
field applications and field support engineers.
All service, repair and technical support of the Company's products are
performed in-house. The Company also provides comprehensive on-site field
support to its customers. The Company offers technical support to its customers
on a 24-hours-a-day, 7-days-a-week basis. The Company's standard hardware and
software warranties are two years and one year, respectively.
BACKLOG
At December 31, 1998, the Company had a firm backlog of approximately
$5,178,000, all of which is expected to be filled during fiscal 1999. At
December 31, 1997, backlog was approximately $2,672,000. The majority of backlog
represents orders for the Company's network management OS products. Orders for
network management OS products generally have longer lead times than network
systems products but are generally delivered within six months of the order
placement. The Company has been operating in a book and ship mode for network
systems products, a trend the Company anticipates will continue. There can be no
assurance that the current level of backlog will continue. In addition, since
orders constituting the Company's current backlog are subject to changes in
delivery schedules, the backlog is not necessarily an indication of future
revenue. In certain cases, ADA may permit orders to be canceled without penalty
where management believes it may be in the best interests of ADA to do so. To
date, cancellation of orders has not been material.
COMPETITION
Competition in the Company's markets is intense and is characterized by
rapidly changing technologies, conformance with evolving industry standards,
frequent new product introductions and enhancements, rapid change in customer
requirements, and price-competitive bidding. To maintain and improve its
competitive position, the Company must continue to develop and introduce, in a
timely and cost-effective manner, new products and features that keep pace with
increasing customer requirements. The Company expects competition in its markets
to increase from existing competitors and from other companies which may enter
the Company's current or future markets.
The Company believes the principal competitive factors affecting the
market for its network systems test and performance monitoring products are:
product features, price, conformance with BellCore and other industry
transmission standards and specifications, performance and reliability,
technical support, and the maintenance of close working relationships with
customers. The Company's network systems products, especially CTS and Remote
Module, are currently focused in highly competitive market niches. The
environment for CTS and Remote Module is fiercely competitive with respect to
price, product features, established customer-supplier relationships and
conformance with industry standards. The Company believes the current
competitors that provide partial solutions to either performance monitoring or
testing of the DS3, and the DS1 and DS0 circuits that make up the DS3 circuit,
include Hekimian Laboratories, Inc. ("Hekimian"), Telecommunications Techniques
Corporation ("TTC"), Anritsu Wiltron Corporation ("Wiltron") and some of the
manufacturers of large transmission equipment and digital cross-connect test and
performance monitoring equipment such as Lucent Technologies, Inc. ("Lucent"),
Alcatel Data Networks ("Alcatel"), Ericsson Communications Inc. ("Ericsson"),
ADC Telecommunications, and Tellabs, Inc. The Company's Remote Module product
addresses the DS1 NIU market in which current competitors include Westell Inc.,
Teltrend Inc., and Troncom, Inc. Many of these competitors have significantly
greater technical, financial, manufacturing, and marketing resources than the
Company. In addition, in 1997, ANSI adopted certain of the Company's technology
as an industry standard. As a result, the Company is obligated to grant licenses
of this technology to third parties, including competitors, on fair and
equitable terms and may also face competition from the licensees of its own
technology.
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The Company believes there are an increasing number of current
competitors in the network management OS market that provide network management
OS applications for circuit and services provisioning and services management,
testing and test management, fault and alarm management and surveillance,
network and circuit performance monitoring and traffic data collection and
management telecommunications functions. The OS market is characterized by a
wide range of companies that have varying degrees of market influence. The
nature of the network management and OS market is such that improved
technologies and tool sets have made the barriers to entry in this market
relatively small resulting in fierce competition. The principal competitive
factors affecting the Company's network management and OS products include
product quality, performance, price, customer support, corporate reputation, and
product features such as scalability, interoperability, functionality and ease
of use. The Company's existing and potential competitors offer a variety of
solutions to address network management needs. Competitors include suppliers of
standard off-the-shelf products, custom software developers, large
telecommunications equipment vendors that offer software applications to manage
their own and other suppliers' equipment, such as Lucent, Nortel, Fujitsu, and
Ericcson, hardware and software vendors, including IBM, Sun Microsystems and
Hewlett Packard, and providers of specific network management and OS
applications such as BellCore, Objective Systems Integrators ("OSI"), TCSI
Corporation ("TCSI"), Architel and others. Additionally, many of the Company's
existing and potential customers continuously evaluate whether they should
develop their own network management and OS applications or license them from
outside vendors. The Company expects competition in the OS market to increase
significantly in the future.
Additionally, several of the Company's competitors have
long-established relationships with the Company's current and prospective
customers which may adversely affect the Company's ability to successfully
compete for business with these customers. In addition, product price reductions
resulting from market share penetration initiatives or competitive pricing
pressures could have a material and adverse effect on the Company's business,
operating results, and financial condition. There can be no assurance that the
Company will have the financial resources, technical expertise or manufacturing,
marketing, distribution and support capabilities to compete successfully in the
future.
PROPRIETARY RIGHTS
ADA relies on a combination of technical leadership, trade secret,
patent, copyright and trademark protection and non-disclosure agreements to
protect its proprietary rights. Although the Company has pursued and intends
to continue to pursue patent protection of inventions that it considers
important and for which such protection is available, the Company believes
its success will be largely dependent on its reputation for technology,
product innovation, affordability, marketing ability and response to
customers needs. Currently, the Company has fifteen U.S. patents granted
(each of which has a minimum of eleven years remaining). Additionally, the
Company has three pending U.S. patent applications on file covering various
circuit and system aspects of its products. There can be no assurance that
the Company will be granted additional patents or that, if any patents are
granted, they will provide the Company's products with significant protection
or will not be challenged.
The Company believes that the rapid rate of technological change and
the relatively long development cycle for integrated circuits are also
significant factors in the protection of the Company's proprietary position. The
Company's proprietary VLSI ASICs incorporate unique system architectures and
circuit approaches that have been developed through a broad, in-depth
understanding of the telephone network. Availability of these proprietary
devices, knowledge and experience of the Company's personnel, new product
development, market recognition and product support are key factors in the
protection of the Company's proprietary position. As part of its confidentiality
procedures, the Company generally enters into non-disclosure agreements with its
employees, consultants and suppliers, and limits access to and distribution of
its proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use the Company's technology without
authorization. Accordingly, there can be no assurance that the Company will be
successful in protecting its proprietary technology or that ADA's proprietary
rights will preclude competitors from developing products or technology
equivalent or superior to that of the Company.
The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. There can be no assurance that third parties will not assert
infringement claims against the Company in the future or that any such
assertions will not result in costly litigation or
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require the Company to obtain a license to intellectual property rights of
such parties. There can be no assurance that any such licenses would be
available on terms acceptable to the Company, if at all. Further, litigation,
regardless of outcome, could result in substantial cost to and diversion of
efforts by the Company. Any infringement claims or litigation against the
Company could materially and adversely affect the Company's business, results
of operations and financial condition. Moreover, the laws of some foreign
countries do not protect the Company's proprietary rights in the products to
the same extent as do the laws of the United States.
EMPLOYEES
As of February 28, 1999, ADA had approximately 261 employees,
including 150 in engineering, 60 in sales, marketing and customer support, 21
in operations and 30 in administration and finance. The Company also employs
a number of temporary and contract employees. As of February 28, 1999, the
Company employed approximately 31 temporary and contract employees mostly in
research and development. The success of the Company is dependent, in part,
on its ability to attract and retain highly qualified personnel. Competition
for such personnel is intense and the inability to attract and retain
additional key employees or the loss of one or more current key employees
could adversely affect the Company. There can be no assurance that the
Company will be successful in hiring or retaining requisite personnel.
INDUSTRY SEGMENT AND GEOGRAPHICAL INFORMATION
The Company operates in one industry segment through two business
units focused on the Company's network systems and network management product
lines, respectively. Information with respect to the Company's operations in
its business units and geographical areas for the 1996, 1997 and 1998 fiscal
years is set forth in Note 6 on pages F-15 through F-19 of the Company's
Financial Statements and is incorporated herein by reference.
RISKS AND UNCERTAINTIES
CUSTOMER MERGERS. Many of the major TSPs currently involved in or that
have recently completed merger transactions are customers of the Company.
Several of these mergers involved companies that purchase network systems and
software products and services from the Company's competitors. Consequently,
these mergers may result in the loss of business and customers for the Company.
Additionally, the impact of capital spending constraints during the merger
transitions and thereafter has had and could continue to have a material adverse
effect on the Company's business, operating results and financial condition. In
addition, future merger transactions involving or contemplated by the Company's
current or prospective customers may cause increased concentration among some of
the Company's major customers or delays or decreases in their capital spending
decisions, any of which could have a material adverse effect on the Company's
business, operating results and financial condition.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; HISTORY OF LOSSES. The
Company has experienced significant fluctuations in bookings, revenue and
operating results from quarter to quarter due to a combination of factors and
expects such fluctuations to continue in future periods. Factors that may cause
the Company's results of operations to vary significantly from quarter to
quarter include but are not limited to the size and timing of customer orders
and subsequent shipment of systems products and implementation of OS software
products to major customers, timing and market acceptance of product
introductions or enhancements by the Company or its competitors, customer order
deferrals in anticipation of new products, technological changes in the
telecommunications industry, competitive pricing pressures, changes in the
Company's operating expenses, personnel changes, management of a changing
business, changes in the mix of products sold and licensed, disruption in
sources of supply, changes in pricing policies by the Company's suppliers,
regulatory changes, capital spending, delays of payments by customers and
general economic conditions. The Company believes that in late 1997 it began
experiencing seasonality in its product shipments and OS software licensing.
Generally, TSPs place more orders for products and licenses in the second and
fourth quarters, with the orders significantly down in the first quarter and
relatively flat in the third quarter of each year. The Company expects that
revenue may begin to reflect these seasonal order cycles more closely, which
could result in quarterly fluctuations. There can be no assurance that the TSPs
will not defer or delay orders contrary to the historical seasonal pattern or
that they will not change their ordering patterns. Because of the relatively
fixed nature of most of the Company's costs, including personnel and facilities
costs, any unanticipated shortfall in revenue in any fiscal quarter would have a
proportionately greater impact on the Company's operating income in that quarter
and may result in fluctuations in the price of the Company's Common Stock.
As the impact of the Company's Network Management business unit on
the Company's revenue increases, the Company may be faced with greater
fluctuations in operating income. The licensing and implementation of the
Company's OS products generally involves a significant capital expenditure
and a commitment of resources by prospective customers. Accordingly, the
Company is dependent on its customers' decisions as to the timing and level
of commitment and expenditures. In addition, the Company typically realizes a
significant portion of license revenues in the last weeks or even days of a
quarter. As a result, the magnitude of quarterly fluctuations in the Network
Management business unit may not become evident until late in, or after the
close of, a particular quarter. In addition, the Company does not recognize
service revenues until the services are rendered. The time required to
implement the Company's OS products can vary significantly with the needs of
its customers and is generally a process that extends for several months.
Because of their complexity, larger implementations may take multiple
quarters to complete. Additionally, quarter-to-quarter product mix
variations, customer orders tending to be placed late in the quarter, and
competitive pressures on pricing could have a materially adverse effect on
the Company's operating results in any one quarter. The Company's expenses
are based in part on the Company's expectations as to future revenues and to
a large extent are fixed in the short term. If revenues do not meet
expectations, the Company's business, operations and financial condition are
likely to be materially adversely affected. The Company has experienced
losses in the past and there can be no assurance that the Company will not
experience losses in the future.
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COMPETITION. Competition in the Company's markets is intense and is
characterized by rapidly changing technologies, conformance with evolving
industry standards, frequent new product introductions and enhancements, rapid
changes in customer requirements, and price-competitive bidding. To maintain and
improve its competitive position, the Company must continue to develop and
introduce, in a timely and cost-effective manner, new products and features that
keep pace with increasing customer requirements. The Company expects competition
in its markets to increase from existing competitors and from other companies
which may enter the Company's current or future markets. The Company believes
the principal competitive factors affecting the market for its network systems
test and performance monitoring products are product features, price,
conformance with BellCore and other industry transmission standards and
specifications, performance and reliability, technical support, and the
maintenance of close working relationships with customers. The Company's network
systems products, especially CTS and Remote Module, are currently focused in
highly competitive market niches. The environment for CTS and Remote Module is
fiercely competitive with respect to price, product features, established
customer-supplier relationships and conformance with industry standards. The
Company believes the current competitors that provide partial solutions to
either performance monitoring or testing of the DS3, and the DS1 and DS0
circuits that make up the DS3 circuit, include Hekimian, TTC, Wiltron and some
of the manufacturers of large transmission equipment and digital cross-connect
test and performance monitoring equipment such as Lucent, Alcatel, Ericsson, ADC
Telecommunications, and Tellabs, Inc. The Company's Remote Module product
addresses the DS1 NIU market in which current competitors include Westell Inc.,
Teltrend Inc., and Troncom, Inc. In addition, in 1997, ANSI adopted certain of
the Company's Remote Module signaling technology as an industry standard. As a
result, the Company is obligated to grant licenses of this technology to third
parties, including competitors, on fair and equitable terms which has resulted
in competition from the licensees of its own technology. Many of these
competitors have significantly greater technical, financial, manufacturing, and
marketing resources than the Company.
The Company believes there are an increasing number of current
competitors in the network management OS market that provide network management
OS applications for circuit and services provisioning and services management,
testing and test management, fault and alarm management and surveillance,
network and circuit performance monitoring and traffic management
telecommunications functions. The OS market is characterized by a wide range of
companies that have varying degrees of market influence. The nature of the
network management OS market is such that improved technologies and tool sets
have made the barriers to entry in this market relatively small resulting in
fierce competition. The principal competitive factors affecting the Company's
network management OS products include product quality, performance, price,
customer support, corporate reputation, and product features such as
scalability, interoperability, functionality and ease of use. The Company's
existing and potential competitors offer a variety of solutions to address
network management needs. Competitors include suppliers of standard
off-the-shelf products, custom software developers, large telecommunications
equipment vendors that offer software applications to manage their own and other
suppliers' equipment, such as Lucent, Nortel, Fujitsu, and Ericsson, hardware
and software vendors, including IBM, Sun Microsystems and Hewlett Packard, and
providers of specific network management and OS applications, such as BellCore,
OSI, TCSI, Architel and others. Additionally, many of the Company's existing and
potential customers continuously evaluate whether they should develop their own
network management and OS applications or license them from outside vendors. The
Company expects competition in the OS market to increase significantly in the
future. Additionally, several of the Company's competitors have long-established
relationships with the Company's current and prospective customers which may
adversely affect the Company's ability to successfully compete for business with
these customers. In addition, product price reductions resulting from market
share penetration initiatives or competitive pricing pressures could have a
material and adverse effect on the Company's business, operating results, and
financial condition. There can be no assurance that the Company will have the
financial resources, technical expertise or manufacturing, marketing,
distribution and support capabilities to compete successfully in the future.
16
<PAGE>
CONCENTRATION OF MAJOR CUSTOMERS; TELEPHONE COMPANY QUALIFICATION
REQUIREMENTS. The market for the Company's products and services currently
consists of the five RBOCs, IXCs, ILECs, CLECs, emerging carriers, ISPs,
enterprise networks and other TSPs. Historically, the Company's marketing
efforts focused primarily on the RBOCs, which accounted for approximately 73%,
31% and 47% of the Company's total revenue in 1996, 1997, and 1998,
respectively. However, the Company's strategy has been to focus its efforts on
diversifying its customer base. RBOCs, and IXCs customers accounted for 47%, and
23% of the Company's total revenue in 1998 and 31% and 27% in 1997,
respectively. The increased customer base is primarily a function of the
Company's acquisitions in 1996 of Applied Computing Devices, Inc. ("ACD") and
the Special Services Network ("SSN") division of MPR Teltech Inc. and the
acquisition of the DSS II license from Nortel in 1997. As a result of these
acquisitions, the Company added OS related products and services that the
Company has been able to market to a wider group of customers. In addition, the
Company added a number of TSPs that were new customers to the Company. To date,
the OS customers tend to be long distance telephone companies, CLECs, emerging
carriers and enterprise vendors who have not invested in legacy systems from
BellCore. While the Company believes its customer base diversification is
beneficial to the Company, there can be no assurances that the Company will be
able to continue expanding the distribution of its OS and system products and
services to additional prospective customers. In addition, the Company's
customers are significantly larger than the Company and may be able to exert a
high degree of influence over the Company. The loss of one or more of the
Company's major customers, the reduction of orders, a delay in deployment of the
Company's products or the cancellation, modification or non-renewal of license
or maintenance agreements could materially and adversely affect the Company's
business, operating results and financial condition. BellSouth, Ameritech,
Southwestern Bell and MCI WorldCom have entered into purchase contracts with the
Company. MCI WorldCom has also entered into license agreements with the Company.
Other TSPs purchase the Company's network system products and license OS
products under standard purchase orders. Since the RBOC and MCI WorldCom
contracts may be terminated at either the customer's or the Company's
convenience, the Company believes that the purchase contracts and license
agreements are not materially different than purchasing or licensing under
purchase orders. Prior to selling products to RBOCs and certain other TSPs, a
vendor must often first undergo a product qualification process with the TSP for
its products. Although the qualification process for a new product varies
somewhat among these prospective customers, the Company's experience is that the
process often takes a year or more. Currently, the five RBOCs, MCI WorldCom and
several other customers have qualified the Company's products, when required.
Any failure on the part of any of the Company's customers to maintain their
qualification of the Company's products, failure of any of the TSPs to deploy
the Company's products, or any attempt by any of the TSPs to seek out
alternative suppliers could have a material adverse effect on the Company's
business, operating results and financial condition. There can be no assurance
that the Company's products will be qualified by new customers, or that such
qualification will not be significantly delayed. Furthermore, work force
reductions and staff reassignments by some of the Company's customers have in
the past delayed the product qualification process, and the Company expects such
reductions and reassignments to continue in the future. There can be no
assurance that such reductions and reassignments will not have a material
adverse effect on the Company's business, operating results and financial
condition.
DEPENDENCE ON TWO PRODUCT LINES. Historically, the majority of the
Company's revenue has been derived from the sale of its network systems products
and services. However, as a result of acquisitions completed in 1996 and 1997,
the Company added additional product lines and derived revenue from a product
mix of both network systems products and services and network management OS
software products and services. Revenue from network systems products and
services, including CTS, T3AS and Remote Module, generated 50% and 56% of the
Company's total revenues in 1997 and 1998, respectively. Revenue from network
management OS products and services, including software design services,
.Provisioner, Test OS, TDC&E and FMS, generated 50% and 44% of the Company's
total revenue in 1997 and 1998, respectively. However, there can be no assurance
that the Company's future revenues will not be heavily dependent on sales from
only one of its primary product lines. The Company is investing in the expansion
of these two product lines through the enhancement, development and marketing of
its NIU, CTS, NEPA, T3AS, Test OS, .Provisioner, TDC&E and FMS products. Failure
by the
17
<PAGE>
Company to enhance either its existing products and services or to develop
new product lines and new markets could materially and adversely affect the
Company's business, operating results and financial condition. There is no
assurance that the Company will be able to develop and market new products
and technology or otherwise diversify its source of revenue.
MANAGEMENT OF CHANGING BUSINESS. As a result of acquisitions in 1996
and 1997, the Company formed two business units around the Company's product
lines: the Network Systems business unit and the Network Management business
unit. The Network Systems business unit is built around the Company's test and
performance management products, including T3AS, CTS, Remote Module,
Sectionalizer, NEPA and PAAS products. The Network Management business unit
focuses on OS software products including .Provisioner, TDC&E, Test OS, GTA,
FMS, and OS design services. These business units operate in four separate
geographic locations. The Company continues to face significant management
challenges related to the integration of the business operations of these
business units. The acquisitions and resultant growth in the Company's
infrastructure have placed, and are expected to continue to place, a significant
strain on the Company's management, information systems and operations. The
strain experienced to date has chiefly been in management of a geographically
distributed organization, and in hiring sufficient numbers of qualified
personnel to support the expansion of the business. The Company may also make
future acquisitions where it believes it can acquire new products or otherwise
rapidly enter new or emerging markets. Mergers and acquisitions of high
technology companies are inherently risky and can place significant strains on
the Company's management, information systems and operations. The Company is not
able to forecast additional strains that may be placed on the Company's
management, information systems and operations as a result of recent or future
acquisitions or in the future. The Company's potential inability to manage its
changing business effectively could have a material adverse effect on the
Company's business, operating results, and financial condition. Additionally, as
a result of the termination of the JDA, the Company expects to discontinue
operations conducted at its Richardson, Texas facility. There can be no
assurance that the Company will not incur significant expenses related to the
closure of the Texas facility that could have a material impact on the Company's
business, operating results and financial condition.
RAPID TECHNOLOGICAL CHANGE AND DEPENDENCE ON NEW PRODUCTS. The market
for the Company's products is characterized by rapid technological advances,
evolving industry transmission standards, changing regulatory environments,
price-competitive bidding, changes in customer requirements, and frequent new
product introductions and enhancements. The introduction of telecommunications
network performance management products involving superior technologies or the
evolution of alternative technologies or new industry transmission standards
could render the Company's existing products, as well as products currently
under development, obsolete and unmarketable. The Company believes its future
success will depend in part upon its ability, on a cost-effective and timely
basis, to continue to enhance its products, to develop and introduce new
products for the telecommunications network performance management market, to
address new industry standards and changing customer needs and to achieve broad
market acceptance for its products. In particular, the Company anticipates that
the SONET and SDH optical transmission standards will become the industry
transmission standards over the coming years for the North American and
international networks, respectively. The Company's current network circuit test
and performance monitoring systems do not address either the SONET or SDH
transmission standards. The Company intends to extend its current products and
develop new products to accommodate such new transmission standards and other
advances in technology, as they evolve. The widespread adoption of SONET and/or
SDH as industry transmission standards before the Company is able to
successfully develop products which address such transmission standards could in
the future adversely affect the sale and deployment of the Company's products.
The Company's OS products are designed to operate on a variety of
hardware and software platforms and with a variety of databases employed by its
customers in their networks. The Company must continually modify and enhance its
OS products to keep pace with changes in hardware and software platforms and
database technology. As a result, uncertainties related to the timing and nature
of new product announcements, introductions or modifications by systems vendors,
particularly, Sun Microsystems and Hewlett Packard, and by vendors of relational
database software, particularly, Oracle Corporation, could materially adversely
impact the Company's business, operating results and financial condition. In
addition, the failure of the Company's OS products to operate across the various
existing and evolving versions of hardware and software platforms and database
environments employed by customers would have a material adverse effect on the
Company's business, operating results and financial condition.
The introduction or announcement of products by the Company or one or
more of its competitors embodying new technologies, or changes in industry
standards or customer requirements, could render the
18
<PAGE>
Company's existing products and solutions obsolete and unmarketable. The
introduction of new or enhanced versions of its products requires the Company
to manage the transition from older products in order to minimize disruption
in customer ordering. There can be no assurance that the introduction or
announcement of new product offerings by the Company or its competitors will
not cause customers to defer licensing or purchasing of existing Company
products or engaging the Company's services. Any deferral of revenues could
have a material adverse effect on the Company's business, operating results
and financial condition.
Any failure by the Company to anticipate or respond on a cost-effective
and timely basis to technological developments, changes in industry transmission
standards or customer requirements, or any significant delays in product
development or introduction could have a material adverse effect on the
Company's business. There can be no assurance that the Company will be able to
successfully develop new products to meet customer requirements, to address new
industry transmission standards and technological changes or to respond to new
product announcements by others, or that such products will achieve market
acceptance.
DEPENDENCE ON SUPPLIERS AND SUBCONTRACTORS. Certain components used in
the Company's T3AS, CTS, PAAS and Remote Module products, including its VLSI
ASICs, are available from a single source and other components are available
from only a limited number of sources. The Company has few supply agreements and
generally makes its purchases with purchase orders. Further, certain components
require an order lead time of up to one year. Other components that currently
are readily available may become difficult to obtain in the future. Failure of
the Company to order sufficient quantities of these components in advance could
prevent the Company from increasing production in response to customer orders in
excess of amounts projected by the Company. In the past, the Company has
experienced delays in the receipt of certain of its key components, which have
resulted in delays in product deliveries. There can be no assurance that delays
in key component and part deliveries will not occur in the future.
The inability to obtain sufficient key components as required or to
develop alternative sources if and as required in the future could result in
delays or reductions in product shipments, which in turn could have a material
adverse effect on the Company's customer relationships and operating results.
Additionally, the Company uses third-party subcontractors for the manufacture of
its sub-assemblies. This reliance on third-party subcontractors involves several
risks, including the potential absence of adequate capacity, the unavailability
of or interruption in access to certain process technologies, and reduced
control over product quality, delivery schedules, manufacturing yields and
costs. Shortages of raw materials or production capacity constraints at the
Company's subcontractors could negatively affect the Company's ability to meet
its production obligations and could result in increased prices for affected
parts.
HIGH INVENTORY LEVELS AND NEED TO MAKE ADVANCE PURCHASE COMMITMENTS. To
respond to anticipated customer demand, the Company maintains high inventory
levels. Maintaining high inventory levels substantially increases the risk that
the Company's profitability and results of operations may from time to time be
materially and adversely affected by inventory obsolescence. To procure adequate
supplies of certain products or components, the Company must make advance
commitments to purchase relatively large quantities of such products or
components in a number of circumstances. A large portion of the Company's
purchase commitments consists of custom parts, some of which are sole-source
such as VLSI ASICs, for which there is no alternative use or application. In the
first quarter of 1998, the Company recorded a charge for inventory obsolescence
totaling $378,000. The inability of the Company to sell such products or
incorporate such components in its other products could have a material adverse
effect on the Company's business, operating results and financial condition.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. Without modification, these systems and software will be unable to
appropriately interpret or recognize dates beyond the calendar year 1999. The
Year 2000 computer issue could result in system failures or miscalculations
causing disruptions in business operations worldwide (including, without
limitation, disruptions in order processing, invoicing, manufacturing and
similar functions).
The risk to ADA exists in four areas: systems used by the Company to
run its business, systems used by the Company's suppliers, potential warranty or
other claims from Company customers, and the potential reduced spending by TSPs
on network performance management products as a result of significant
information systems spending on Year 2000 remediation.
19
<PAGE>
The Company is continuing to conduct an assessment and analysis of its
internal information technology ("IT") systems to determine the potential costs
and scope of any Year 2000 issues. Based on a preliminary assessment, ADA has
determined that certain of its IT systems need to be upgraded or replaced to
address Year 2000 issues. The Company believes that all necessary upgrades or
replacements of its IT systems will be completed by June 30, 1999. Validation
testing will be conducted as IT systems are upgraded and replaced. All IT
systems that have been purchased in 1999 or 1998 are Year 2000 compliant. The
upgrades are generally covered by service contracts previously entered into by
the Company in the ordinary course of business and the cost of the upgrades and
remediation is not expected to be material to the Company's operating results.
If implementation of upgrades or replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.
ADA has conducted a comprehensive evaluation of its non-IT systems
and equipment (e.g., facilities, and test equipment containing
microprocessors or other similar circuitry, etc.). Based on this evaluation,
ADA does not expect Year 2000 issues to have a material adverse effect on the
Company's non-IT systems and equipment. However, Year 2000 compliance for
some of the Company's non-IT systems and equipment is dependent upon upgrades
to be provided by third party vendors. The Company expects all upgrades
required from third party vendors to complete Year 2000 compliance for non-IT
systems and equipment to be completed by September 30, 1999. There can be no
assurance that third party vendor upgrades to non-IT systems and equipment
will be Year 2000 complaint or that the upgrades will be completed prior to
the end of 1999 which could negatively impact the functionality of non-IT
systems and equipment that could have a material adverse effect on the
Company's revenue, operating results and financial condition.
In addition, the Company has made inquiries of its third party
suppliers to determine if they have any Year 2000 issues that will materially
and adversely impact the Company. To date, the Company has not been made aware
of any material Year 2000 issues which would adversely affect ADA.
The Company believes that the majority of its current products are
Year 2000 compliant. The remaining Company products are expected to be Year
2000 compliant by June 30, 1999. The Company had originally expected this
process to be completed by December 31, 1998. The Company does not expect
additional efforts required to complete Year 2000 compliance for these
products will be material. Internal validation testing is being conducted as
products are being upgraded. An independent third party also performed
validation testing on one of the Company's test and performance management
products. However, since all customer situations cannot be anticipated,
particularly those involving third party products, the Company may see an
increase in warranty and other claims as a result of the Year 2000
transition. In addition, litigation regarding Year 2000 compliance issues is
expected to escalate. For these reasons, the impact of customer claims could
have a material adverse impact on the Company's operating results or
financial condition.
Year 2000 compliance is an issue for virtually all businesses, whose
computer systems and applications may require significant hardware and
software upgrades or modifications. TSPs have devoted a substantial portion
of their information systems' spending to fund such upgrades and
modifications and divert spending away from network performance management
products. Such changes in customers' spending patterns have had and could
continue to have a material adverse impact on the Company's sales, operating
results or financial condition.
The Company intends to continue the review, remediation and testing of
its Year 2000 status and, to the extent necessary, it will develop Year 2000
contingency plans for critical business purposes. In addition, there can be no
assurance that Year 2000 issues will not have a material adverse effect on the
Company if ADA and/or those with whom it conducts business are unsuccessful in
identifying or implementing timely solutions to any Year 2000 problems.
PRODUCT RECALL AND DEFECTS. Producers of telecommunications network
performance management products such as those being marketed by the Company, are
often required to meet rigorous standards imposed by BellCore, the research and
development entity created following the divestiture of AT&T to provide ongoing
engineering support to the RBOCs. In addition, the Company must meet specialized
standards imposed by many of its customers. The Company's products are also
required to interface in a complex and changing environment with
telecommunication network equipment made by numerous other suppliers. Since many
of these suppliers are competitors of the Company, there can be no assurance
that they will cooperate with the Company. In the event there are material
deficiencies or defects in the design or manufacture of the Company's systems,
or if the Company's systems become incompatible with existing third-party
network equipment, the affected products could be subject to a recall. The
Company has experienced two significant product recalls in its history and there
can be no assurance that the Company will not experience any product recalls in
the future. The cost of any subsequent product recall and associated negative
publicity could have a material adverse effect on the Company's business,
operating results and
20
<PAGE>
financial condition. In addition, the Company's development and enhancement
of its complex OS products entails substantial risks of product defects.
There can be no assurance that software errors will not be found in existing
or new products or releases after commencement of commercial licensing, which
may result in delay or loss of revenue, loss of market share, failure to
achieve market acceptance, or may otherwise adversely impact the Company's
business, operating results and financial condition.
GOVERNMENT REGULATION. The majority of the Company's customers operate
within the telecommunications industry which is subject to regulation in the
United States and other countries. Most of the Company's customers must receive
regulatory approvals in conducting their businesses. Although the
telecommunications industry has recently experienced government deregulation,
there is no assurance this trend will continue. Moreover, the federal and state
courts and the FCC continue to interpret and clarify the provisions of the 1996
Telecommunications Act. In fact, recent regulatory rulings have affected the
ability of the Company's customers to enter new markets and deliver new services
which could impact their ability to make significant capital expenditures. The
effect of judicial or regulatory rulings by federal and state agencies on the
Company's customers may adversely impact the Company's business, operating
results and financial condition.
POTENTIAL COMPETITION FROM RBOCS. The 1996 Telecommunications Act has
generally eliminated the restrictions which had previously prohibited the RBOCs
from manufacturing telecommunications equipment (subject to first satisfying
certain conditions designed to facilitate local exchange competition and receipt
of prior approval by the FCC). These restrictions had been imposed under the
Modification of Final Judgment, which governed the structure of the 1984
divestiture by AT&T of its local operating telephone company subsidiaries. The
passage of the 1996 Telecommunications Act may have an adverse effect on the
Company because the RBOCs, which are presently the Company's principal
customers, may now become manufacturers of some or all of the products currently
manufactured and sold by the Company and, consequently, may no longer purchase
telecommunications equipment produced by the Company at the levels historically
experienced.
PROPRIETARY TECHNOLOGY. The Company relies on a combination of
technical leadership, patent, trade secret, copyright and trademark
protection and non-disclosure agreements to protect its proprietary rights.
Although the Company has pursued and intends to continue to pursue patent
protection of inventions that it considers important and for which such
protection is available, the Company believes its success will be largely
dependent on its reputation for technology, product innovation,
affordability, marketing ability and response to customers needs. Currently,
the Company has fifteen U.S. patents granted. Additionally, the Company has
three pending U.S. patent applications on file covering various circuit and
system aspects of its products. There can be no assurance that the Company
will be granted additional patents or that, if any patents are granted, they
will provide the Company's products with significant protection or will not
be challenged. Additionally, should a third party challenge any of the
Company's current or future patents, there can be no assurance that the
Company will be successful in defending its patents or that any litigation,
regardless of outcome, will not result in substantial cost to and diversion
of efforts by the Company. As part of its confidentiality procedures, the
Company generally enters into non-disclosure agreements with its employees,
consultants and suppliers, and limits access to and distribution of its
proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use the Company's technology
without authorization. Accordingly, there can be no assurance that the
Company will be successful in protecting its proprietary technology or that
ADA's proprietary rights will preclude competitors from developing products
or technology equivalent or superior to that of the Company.
The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. The Company is currently not party to any litigation regarding any
patents or other intellectual property rights. However, there can be no
assurance that third parties will not assert infringement claims against the
Company in the future or that any such assertions will not result in costly
litigation or require the Company to obtain a license to intellectual property
rights of such parties. There can be no assurance that any such licenses would
be available on terms acceptable to the Company, if at all. Further, litigation,
regardless of outcome, could result in substantial cost to and diversion of
efforts by the Company. Any infringement claims or litigation by or against the
Company could materially and adversely affect the Company's business, operating
results and financial condition. Moreover, the laws of some foreign countries do
not protect the Company's proprietary rights in the products to the same extent
as do the laws of the United States.
21
<PAGE>
The Company relies on certain software that it licenses from third
parties, including software that is integrated with internally developed
software and used in the Company's products to perform key functions. There can
be no assurance that these third party software licenses will continue to be
available to the Company on commercially reasonable terms or that such licenses
will not be terminated. Although the Company believes that alternative software
is available from other third party suppliers, the loss of or inability of the
third parties to enhance their products in a timely and cost-effective manner
could result in delays or reductions in product shipments by the Company until
equivalent software could be developed internally or identified, licensed, and
integrated, which could have a material adverse effect on the Company's
business, operating results and financial condition.
DEPENDENCE ON KEY PERSONNEL. The success of the Company is dependent,
in part, on its ability to attract and retain highly qualified personnel.
Competition for such personnel is intense and the inability to attract and
retain additional key employees or the loss of one or more current key employees
could adversely affect the Company. There can be no assurance that the Company
will be successful in hiring or retaining requisite personnel.
VOLATILITY OF STOCK PRICE. The Company's future earnings and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in revenue or earnings from levels expected by public
market analysts and investors could have an immediate and significant adverse
effect on the trading price of the Company's Common Stock. Fluctuation in the
Company's stock price may also have an effect on customer decisions to purchase
the Company's products which could have a material adverse effect on the
Company's business, operating results and financial condition.
ITEM 2. PROPERTIES
The Company currently maintains its headquarters in a leased facility
in San Diego, California, which contains all development, engineering, assembly,
marketing and administrative functions, in 62,368 square feet of space in one
building. The lease expires in 2003. The Company has sub-leased a portion of the
San Diego facility through 2000. The Company also leases additional office
facilities in Terre Haute, Indiana, Burnaby, British Columbia and Richardson,
Texas, all of which house product development and customer support operations.
The Company leases 12,600, 25,604 and 14,750 square feet of space in Terre
Haute, Burnaby and Richardson, respectively. The Terre Haute, Burnaby and
Richardson leases expire in September 1999, December 1999 and January 2005,
respectively. The Company believes that its existing facilities will be adequate
to meets its needs through 1999.
ITEM 3. LEGAL PROCEEDINGS
From time to time, ADA may be involved in litigation relating to claims
arising out of its operations in the normal course of business. As of the date
of this Annual Report, the Company is not a party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
STOCK MARKET INFORMATION
Applied Digital Access' Common Stock is listed on the Nasdaq National
Market and is traded on the over the counter market under the symbol "ADAX". The
following table sets forth the high and low sales prices the Company's Common
Stock for the periods indicated.
<TABLE>
<CAPTION>
1998 HIGH LOW
---- ---- ---
<S> <C> <C>
First Quarter $ 10.75 $ 6.06
22
<PAGE>
Second Quarter 8.75 4.31
Third Quarter 5.94 2.38
Fourth Quarter 3.69 2.00
</TABLE>
<TABLE>
<CAPTION>
1997 HIGH LOW
---- ---- ---
<S> <C> <C>
First Quarter $ 8.50 $ 4.88
Second Quarter 9.38 3.63
Third Quarter 10.00 6.50
Fourth Quarter 11.88 5.00
</TABLE>
There were 321 shareholders of record as of February 28, 1999.
DIVIDEND POLICY
Applied Digital Access has not declared or paid any cash dividends on
its Common Stock to date. The Company currently intends to retain all earnings,
if any, to fund the development and growth of its business and therefore does
not anticipate paying any cash dividends within the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
(Dollars in thousands, except
per share data)
Revenue $ 35,597 $ 20,470 $ 24,422 $ 34,050 $ 29,217
Gross profit 20,791 11,753 11,813 18,934 15,630
Operating expenses:
Research and development 5,335 5,807 7,356 9,164 14,313
In process research and development
related to acquisitions
- - 3,286 1,578 -
Sales and marketing 3,363 4,234 6,312 7,995 9,801
General and administrative 2,337 2,985 3,576 5,252 5,079
--------- --------- -------- ------- -------
Total operating expenses 11,035 13,026 20,530 23,989 29,193
--------- --------- -------- ------ ------
Net income (loss) $ 10,620 $ 759 $ (7,120) $ (4,283) $ (13,124)
--------- --------- -------- ------- -------
--------- --------- -------- ------- -------
Net income (loss) per share, $ 1.01 $ .06 $ (.59) $ (.34) $ (1.03)
--------- --------- -------- ------- -------
--------- --------- -------- ------- -------
basic (1)
Net income (loss) per share, $ .88 $ .06 $ (.59) $ (.34) $ (1.03)
--------- --------- -------- ------- -------
--------- --------- -------- ------- -------
diluted (1)
Weighted average number of shares, 10,542 11,806 12,084 12,460 12,711
basic (1)
Weighted average number of shares, 12,091 12,848 12,084 12,460 12,711
diluted (1)
Working capital $ 26,081 $ 36,728 $ 31,229 $ 26,788 $ 16,756
Total assets 48,919 49,936 45,972 46,283 34,272
Long-term debt 82 49 33 15 -
</TABLE>
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of the number of
23
<PAGE>
shares used in computing net income per share. Amounts have been restated
for the adoption of Statement of Financial Accounting Standard No. 128
"Earnings Per Share".
24
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT DEVELOPMENTS
On March 3, 1999, the Company announced the termination of its joint
development agreement ("JDA") with Nortel. The Company and Nortel entered
into the JDA in September 1997 to develop SONET network element products for
the telecommunications industry. The intellectual property rights associated
with the jointly developed technology will become the property of the
Company. Under the JDA, the Company and Nortel each contributed technology
and development resources to the project and shared the development costs.
The Company's development costs associated with the JDA have been expensed as
incurred. Nortel is obligated to continue funding its share of the
development costs associated with the JDA project through June 2, 1999. The
Company expects to substantially reduce expenses associated with the
development conducted under the JDA and will explore alternatives for
maximizing the value of the jointly developed technology. There can be no
assurance that the Company will be successful in it efforts to maximize the
value of the technology developed under the JDA or that the jointly developed
technology will provide future value to the Company. Under terms of the JDA,
if the jointly developed technology is successfully implemented into a
marketable product, Nortel retains the right to receive limited future
royalties in order to recoup its share of development costs incurred under
the JDA.
On March 31, 1999 the Company announced a reduction in its workforce
of approximately 65 people, or 22% of its total workforce. Of the reduction in
workforce, 23 were temporary positions. The Company determined the reduction
was necessary in order to align its current operations with the Company's
objectives of focusing on market opportunities in its core business, reducing
expenses including expenses related to its recently terminated JDA with
Nortel and improving operating results. The majority of the reduction in
workforce were engineers focused on development conducted under JDA. As a
result of the reduction in workforce, the Company will close its office in
Richardson, Texas. The Company will incur a significant one-time charge in
the first quarter ending March 31, 1999, related to the reduction in
workforce. The Company's restructuring plan includes the identification of
the affected personnel, facility closures, asset write downs, and lease
terminations. The Company has not completed its analysis of the total dollar
amount associated with the restructuring charge, but will complete this
process prior to issuing its first quarter operating results.
25
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain statements of operations data as
a percent of revenue, for the years ended December 31, 1996, 1997 and 1998.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Revenue 100% 100% 100%
Cost of revenue 52% 44% 47%
----- ----- -----
Gross profit 48% 56% 53%
----- ----- -----
Operating expenses:
Research and Development 30% 27% 49%
Purchased in-process research and development
related to acquisitions 13% 5% -
Sales and marketing 26% 23% 34%
General and administrative 15% 15% 17%
----- ------ -----
Total operating expenses 84% 70% 100%
----- ----- ------
Operating loss (36)% (14)% (47)%
Other income, net 7% 3% 2%
---- ----- ----
Loss before income taxes (29)% (11)% (45)%
Provision for income taxes (1)% (1)% (1)%
------ ------ ------
Net loss (30)% (12)% (46)%
------ ------ ------
------ ------ ------
</TABLE>
1998 COMPARED WITH 1997
Revenue totaled $29,217,000 in 1998, a 14% decrease from $34,050,000
in 1997. The decrease is primarily the result of decreased revenue from the
sale of network management OS products and to a lesser extent decreased
revenue from the sale of network systems products. The Company believes the
majority of the revenue decreases resulted from decreased capital spending by
TSPs for network performance management products. Revenue generated from the
sale of the Company's network management OS services and products totaled
$12,762,000 in 1998, a 25% decrease from $16,989,000 in 1997. The decrease
was the net result of decreased OS design services revenue partially offset
by increased sales of the Company's .Provisioner and TDC&E OS software
products. The decreased revenue from OS design services and increased sales
of the Company's .Provisioner product partially resulted from the Company's
acquisition of an exclusive license to Northern Telecom Ltd.'s ("Northern
Telecom") DSS II software product in June 1997. Prior to the acquisition, the
Company provided OS design services to Northern Telecom that supported the
DSS II product. As a result of the acquisition, the Company's OS design
services business supporting DSS II shifted to a product-based business. The
Company now markets and supports the DSS II product and technology under the
new name .Provisioner. Unlike revenue from OS software design services which
is recognized as the service is performed, revenue from OS software product
sales requires the satisfaction of specific delivery and acceptance criteria
prior to revenue recognition. The timing of product acceptance can have a
material impact on revenue recognition in a particular quarter or year. As a
result, there can be significant quarterly or yearly variations in revenue
from OS product sales. Revenue generated from the sale of the Company's
network systems products and services totaled $16,455,000 in 1998, a 4%
decrease from $17,061,000 in 1997. The decrease was the net result of
decreased sales of CTS products offset by increased sales of the Company's
T3AS and Remote Module products. In 1998, BellSouth, MCI WorldCom and Bell
Atlantic accounted for 26%, 23%, and 12% of the Company's total revenue,
respectively. In 1997, MCI WorldCom, Northern Telecom and BellSouth accounted
for 28%, 20%, and 17% of the Company's total revenue, respectively.
The Company believes decreased capital spending by its customers in
1998 resulted from several factors, including, but not limited to, large-scale
merger activity, capital budget constraints, Y2K concerns, and customer
inventory reductions and tightening of inventory control. There can be no
assurance that the Company's future revenue will not be negatively impacted by
these factors which could have a material adverse effect on the company's
operating results.
26
<PAGE>
Gross profit totaled $15,630,000 in 1998, a 17% decrease from
$18,934,000 in 1997. Gross profit as a percent of revenue was 53% in 1998
compared to 56% in 1997. The decrease in gross profit and gross profit as a
percent of revenue was the result of decreased sales of the Company's OS
software products, increased sales of the Company's lower-margin Remote Module
NIU, and the impact of a $378,000 one-time inventory obsolescence charge. The
Company's OS software products typically have significantly higher gross margins
than network systems products. The highly competitive Remote Module NIU market
is subject to severe pricing pressures which have contributed to significantly
lower overall gross profits on these products. Additionally, the Company's
relatively fixed manufacturing overhead costs allocated over lower revenue
levels in 1998 resulted in lower overall gross profit levels. The net decrease
in gross profit as a percent of revenue resulted from the factors discussed
above substantially offset by the shift in the Company's OS software design
services business to an OS software product-based business. As a result of the
.Provisioner (formerly DSS II) license acquisition in 1997, a majority of
engineering design labor previously associated with OS design services revenue
shifted from the cost of revenue line to research and development operating
expenses supporting OS software product development. There can be no assurance
that the Company will be able to maintain the current gross profit margins or
gross profit as a percent of revenue levels. Factors which may materially and
adversely affect the Company's gross profit in the future include its level of
revenue, competitive pricing pressures in the telecommunication network
management market, new product introductions by the Company or its competitors,
potential inventory obsolescence and scrap, possible recalls, production or
quality problems, timing of development expenditures, changes in material costs,
disruptions in sources of supply, regulatory changes, seasonal patterns of
bookings, capital spending, and changes in general economic conditions.
Research and development expenses totaled $14,313,000 in 1998, a 56%
increase from $9,164,000 in 1997. The increase was primarily due to increased
personnel and non-recurring engineering costs associated with the Nortel JDA
and a shift in engineering labor from cost of revenue to research and
development operating expenses as a result of the .Provisioner license
acquisition in June 1997 discussed above in the gross profit analysis.
Research and development personnel expenses increased 19% compared to 1997,
mostly related to increased personnel to support the JDA. In 1998 and 1997,
the Company's net research and development expenses included $3,926,000 and
$2,190,000 offsets, respectively, representing Nortel's proportionate share
of development costs incurred for the initial project conducted under the
JDA. As a result of Nortel's termination of the JDA, the Company expects to
significantly reduce research and development expenses previously associated
with the JDA. Nortel is obligated to continue funding its share of
development costs associated with the JDA through June 2, 1999. The Company
cannot currently determine the impact the JDA termination will have on the
Company's operating results. The Company believes that its future success
depends on its ability to maintain its technological leadership through
enhancement of its existing products and development of innovative new
products and services that meet customer needs. Therefore, the Company
intends to continue to make significant investments in research and product
development in association with planned development projects. The competition
for highly qualified engineering personnel is intense. There can be no
assurance that the Company will be successful in attracting and retaining key
personnel required to develop new products which could have a material
adverse effect on the Company's future operating results.
Sales and marketing expenses totaled $9,801,000 in 1998, a 23%
increase from $7,995,000 in 1997. The majority of the increase is the result of
increased staff and travel costs in sales to support increased sales efforts and
new customer accounts and increased personnel costs in technical support and
marketing to support the shift of a majority of the Company's OS design services
business to an OS software product-based business. The Company expects to
continue to increase the level of sales, marketing and technical support
personnel in order to support increased focus on existing and new markets and
planned product introductions.
General and administrative expenses totaled $5,129,000 in 1998, a 2%
decrease from $5,252,000 in 1997. The majority decrease is primarily due to
lower consulting and recruiting costs significantly offset by increased legal
expenses and increased expenses for the amortization of goodwill and
intangible assets associated with the Nortel license acquisition. The Company
expects that general and administrative expenses may increase in 1999 as a
result of expected administrative costs related to the termination of the JDA
with Nortel and potential increased expenses related to the Company's focus
on Year 2000 issues.
Interest income totaled $675,000 in 1998, a 25% decrease from $904,000
in 1997. The decrease is the result of a decrease in cash investments during
1998 compared to 1997.
27
<PAGE>
In 1998 and 1997, the Company provided for income taxes related to the
operations of the Company's Canadian subsidiary, based on an effective Canadian
tax rate of 46%. At December 31, 1998, the Company had federal income tax-loss
carry-forwards of approximately $27,642,000 and California state income tax-loss
carry-forwards of approximately $5,458,000. The Company's use of approximately
$1,166,000 of its federal tax-loss carry-forwards, and $408,000 of its federal
and $105,000 of its California tax credit carry-forwards are significantly
limited as a result of ownership changes associated with equity financing in
January 1989 and March 1991. See Note 9 of Notes to Consolidated Financial
Statements. Management is not able to estimate levels of tax deductions which
will be generated as a result of these transactions in future periods.
As a result of the factors discussed above, the Company incurred a net
loss of $13,124,000, or $1.03 per basic and diluted share in 1998 compared to
net loss of $4,283,000, or $.34 per basic and diluted share in 1997. Excluding
$1,578,000 in one-time charges for purchased research and development costs
associated with the license acquisition from Nortel, the Company would have
recorded a net loss of $2,705,000, or $.22 per basic and diluted share in 1997.
1997 COMPARED WITH 1996
Revenue totaled $34,050,000 in 1997, a 39% increase from $24,422,000 in
1996. The increase is primarily the result of revenue generated from network
management OS software design services and products acquired through
acquisitions during 1997 and 1996. Revenue from the Company's network systems
products and services totaled $17,061,000 in 1997, a 6% decrease from
$18,144,000 in 1996. The decrease was the net result of decreased sales of the
Company's T3AS system offset by sales of the Company's CTS products to MCI
WorldCom and increased sales of the Company's Remote Module to BellSouth.
Revenue from network management OS services and products totaled $16,989,000 in
1997, a 171% increase from $6,278,000 in 1996. The majority of the increase was
the result of increased sales of software design services to Northern Telecom
and sales of the Company's .Provisioner software product to BC Tel and MCI
WorldCom. Since the Company acquired its software design services business in
July 1996, the increased revenue in 1997 was mostly the result of a full year of
software design services revenue. In June 1997, the Company acquired an
exclusive license from Nortel to its DSS II software product. The acquisition
generated a shift in the Company's Canadian operations from a software design
services business to a product business. The Company markets and supports the
DSS II product and technology under the new name .Provisioner. In 1997, MCI
WorldCom, Nortel and BellSouth accounted for 28%, 20%, and 17% of the Company's
revenue, respectively. In 1996, US WEST, NYNEX, and Nortel accounted for 31%,
23%, and 15% of the Company's revenue, respectively.
Gross profit totaled $18,934,000 in 1997, a 60% increase from
$11,813,000 in 1996. Gross profit as a percent of revenue was 56% in 1997
compared to 48% in 1996. The increases in gross profit and gross profit as a
percent of revenue resulted primarily from increased sales of higher margin
network management OS software products partially offset by decreased sales of
network systems products as well as a change in product mix for network systems
products from T3AS systems to a product mix weighted toward the Company's CTS
and Remote Module NIU products which carry lower product margins compared to the
Company's T3AS system. The highly competitive CTS and NIU markets are subject to
severe pricing pressures which have contributed to significantly lower overall
gross profits on these products. Additionally, gross profit for 1997 increased
due to the shift of a majority of engineering labor previously associated with
design services revenue from the cost of revenue line to research and
development operating expenses as a result of the transition of most of the
Company's Canadian operations from design services to product development
resulting from the license acquisition.
Research and development expenses totaled $9,164,000 in 1997, a 25%
increase from $7,356,000 in 1996. The increase was primarily due to a shift of a
majority of engineering labor previously associated with design services revenue
from the cost of revenue line to research and development operating expenses as
a result of the transition of most of the Company's Canadian operations from
design services to product development as discussed above in the gross profit
analysis, and the addition of research and development personnel as part of the
JDA with Nortel. Research and development personnel expenses increased 57%
compared to 1996, mostly related to the shift in the Company's Canadian
operations from OS design services to a product based business.
28
<PAGE>
In 1997, the Company recorded a one-time charge for purchased research
and development costs related to the acquisition of the DSS II software license
and related assets of $1,578,000. In 1996, the Company acquired certain assets
of both ACD in Terre Haute, Indiana and the SSN division of MPR Teltech, in
Vancouver, British Columbia. See Note 8 of Notes to Consolidated Financial
Statements for additional information. In conjunction with the ACD and SSN
acquisitions, the Company recorded one-time charges for purchased research and
development costs of $1,186,000 and $2,100,000, respectively.
Sales and marketing expenses totaled $7,995,000 in 1997, a 27% increase
from $6,312,000 in 1996. The increase was the result of increased personnel
costs in the network management business unit to support the shift from a design
services business to a product based business, increased personnel expenses in
1997 as a result of the acquisitions made in 1996, and increased commission
expenses.
General and administrative expenses totaled $5,252,000 in 1997, a 49%
increase from $3,529,000 in 1996. The majority of the increase was attributable
to the amortization of goodwill and intangible assets associated with the SSN
acquisition in the third quarter of 1996 and the license acquisition from Nortel
in June 1997, as well as increased personnel and infrastructure expenses
required to support the expanded operations of the Company as a result of the
1996 and 1997 acquisitions.
Interest income totaled $904,000 in 1997, a 46% decrease from
$1,673,000 in 1996. The decrease is the result of a decrease in cash investments
during 1997 compared to 1996.
In 1997 and 1996, the Company provided for income taxes related to the
operations of the Company's Canadian subsidiary, based on an effective Canadian
tax rate of 46%. At December 31, 1997, the Company had federal income tax-loss
carry-forwards of approximately $15,644,000 and California state income tax-loss
carry-forwards of approximately $7,561,000. The Company's use of approximately
$1,166,000 of its federal tax-loss carry-forwards, and $408,000 of its federal
and $105,000 of its California tax credit carry-forwards are significantly
limited as a result of ownership changes associated with equity financing in
January 1989 and March 1991.
As a result of the factors discussed above, the Company incurred a net
loss of $4,283,000, or $.34 per basic and diluted share in 1997 compared to net
loss of $7,120,000, or $.59 per basic and diluted share in 1996. Excluding
$1,578,000 in one-time charges for purchased research and development costs
associated with the license acquisition from Nortel, the Company would have
recorded a net loss of $2,705,000, or $.22 per basic and diluted share in 1997.
Excluding $3,286,000 in one-time charges for purchased research and development
costs associated with the ACD and SSN asset acquisitions, the Company would have
recorded a net loss of $3,834,000, or $.32 per basic and diluted share in 1996.
QUARTERLY RESULTS
The Company has experienced significant fluctuations in bookings,
revenue and operating results from quarter to quarter due to a combination of
factors and expects such fluctuations to continue in future periods. Factors
that may cause the Company's results of operations to vary significantly from
quarter to quarter include but are not limited to the size and timing of
customer orders and subsequent shipment of systems products and implementation
of OS software products to major customers, timing and market acceptance of
product introductions or enhancements by the Company or its competitors,
customer order deferrals in anticipation of new products, technological changes
in the telecommunications industry, competitive pricing pressures, changes in
the Company's operating expenses, personnel changes, management of a changing
business, changes in the mix of products sold and licensed, disruption in
sources of supply, changes in pricing policies by the Company's suppliers,
regulatory changes, capital spending, delays of payments by customers and
general economic conditions. The Company believes its product shipments and OS
software licensing are subject to seasonality trends. Generally, TSPs place more
orders for products and licenses in the second and fourth quarters with the
orders significantly down in the first quarter and relatively flat in the third
quarter of each year. The Company expects that revenue may begin to reflect
these seasonal order cycles more closely, which could result in quarterly
fluctuations. There can be no assurance that the TSPs will not defer or delay
orders contrary to the historical seasonal pattern or that they will not change
their ordering patterns. Because of the relatively fixed nature of most of the
Company's costs, including personnel and facilities costs, any unanticipated
shortfall in revenue in any fiscal quarter would have a proportionately greater
29
<PAGE>
impact on the Company's operating income in that quarter and may result in
fluctuations in the price of the Company's Common Stock.
As the impact of the Company's Network Management business unit on the
Company's revenue increases, the Company may be faced with greater fluctuations
in operating income. The licensing and implementation of the Company's OS
products generally involves a significant capital expenditure and a commitment
of resources by prospective customers. Accordingly, the Company is dependent on
its customers' decisions as to the timing and level of commitment and
expenditures. In addition, the Company typically realizes a significant portion
of license revenues in the last weeks or even days of a quarter. As a result,
the magnitude of quarterly fluctuations in the Network Management business unit
may not become evident until late in, or after the close of, a particular
quarter. In addition, the Company does not recognize service revenues until the
services are rendered. The time required to implement the Company's OS products
can vary significantly with the needs of its customers and is generally a
process that extends for several months. Because of their complexity, larger
implementations may take multiple quarters to complete. Additionally,
quarter-to-quarter product mix variations, customer orders tending to be placed
late in the quarter, and competitive pressures on pricing could have a
materially adverse effect on the Company's operating results in any one quarter.
The Company's expenses are based in part on the Company's expectations as to
future revenues and to a large extent are fixed in the short term. If revenues
do not meet expectations, the Company's business, operations and financial
condition are likely to be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
Cash and investments totaled $12,513,000 at December 31, 1998 and
$13,179,000 at December 31, 1997. The decrease in cash and investments is
primarily due to the net loss incurred substantially offset by cash collections
from accounts receivable and payments received from Nortel under the JDA.
Net working capital totaled $16,756,000 at December 31, 1998 and
$26,788,000 at December 31, 1997. The decrease in working capital was primarily
the result of a decrease in accounts receivable and other current assets. The
decrease in other current assets is primarily related to payments received from
Nortel for their proportionate share of the development costs incurred under the
JDA
The Company's 1998 operating activities used $91,000 in cash primarily
as a result of the net loss incurred which was offset by decreases in accounts
payable and other current assets and an increase in deferred revenue. In 1997,
the Company's operating activities used $3,528,000 in cash primarily as a result
of increased accounts receivable resulting from a majority of the Company's
fourth quarter sales occurring late in the quarter and increased operating
expenses related to internal funding of the JDA with Nortel, partially offset by
increased accounts payable and decreased inventory levels.
Cash used for capital expenditures totaled approximately $1,806,000 in
1998 and $2,432,000 in 1997. Most of the capital additions were for the purchase
of software development tool kits, computer workstations and lab equipment
associated with the Company's expanded research and development efforts
associated with the JDA and tenant improvements for the Company's Richardson,
Texas office. The Company acquired capital equipment through capital lease
arrangements totaling $43,000 and $0 in 1998 and 1997, respectively. In 1997,
the purchase cost of the DSS II license acquisition from Nortel totaled
$3,382,000, of which $2,515,000 was paid in 1997 and $867,000 in 1998. The
tangible assets acquired as part of the DSS II license acquisition consisted
mostly of computer and lab equipment. The Company expects that 1999 capital
expenditures will decrease slightly from 1998 levels. Most of the planned
expenditures are for network computer servers and software development tool kits
related to planned research and development efforts and upgrades to the
Company's network infrastructure.
Assuming no material changes in the Company's current operating plans,
the Company believes that cash generated from operations, and the total of its
cash and investments, will be sufficient to meet its working capital and capital
expenditure requirements for at least the next twelve months. However, there can
be no assurance that the Company will not need to seek additional capital
resources to meet working capital and capital expenditure requirements.
Additionally, significant additional capital resources may be required to fund
acquisitions of complementary businesses, products or technologies that are
focused on the Company's core business. The Company may need to issue additional
shares of its capital stock or incur indebtedness in connection with any such
acquisitions or future operations. At present, the Company does not have any
agreements or commitments with
30
<PAGE>
respect to any such acquisitions.
The Company believes the impact of inflation on its business activities
has not been significant to date.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. Without modification, these systems and software will be unable to
appropriately interpret or recognize dates beyond the calendar year 1999. The
Year 2000 computer issue could result in system failures or miscalculations
causing disruptions in business operations worldwide (including, without
limitation, disruptions in order processing, invoicing, manufacturing and
similar functions).
The risk to ADA exists in four areas: systems used by the Company to
run its business, systems used by the Company's suppliers, potential warranty or
other claims from Company customers, and the potential reduced spending by TSPs
on network performance management products as a result of significant
information systems spending on Year 2000 remediation.
The Company is continuing to conduct an assessment and analysis of its
internal information technology ("IT") systems to determine the potential costs
and scope of any Year 2000 issues. Based on a preliminary assessment, ADA has
determined that certain of its IT systems need to be upgraded or replaced to
address Year 2000 issues. The Company believes that all necessary upgrades or
replacements of its IT systems will be completed by June 30, 1999. Validation
testing will be conducted as IT systems are upgraded and replaced. All IT
systems that have been purchased in 1999 or 1998 are Year 2000 compliant. The
upgrades are generally covered by service contracts previously entered into by
the Company in the ordinary course of business and the cost of the upgrades and
remediation is not expected to be material to the Company's operating results.
If implementation of upgrades or replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.
ADA has conducted a comprehensive evaluation of its non-IT systems
and equipment (e.g., facilities, and test equipment containing
microprocessors or other similar circuitry, etc.). Based on this evaluation,
ADA does not expect Year 2000 issues to have a material adverse effect on the
Company's non-IT systems and equipment. However, Year 2000 compliance for
some of the Company's non-IT systems and equipment is dependent upon upgrades
to be provided by third party vendors. The Company expects all upgrades
required from third party vendors to complete Year 2000 compliance for non-IT
systems and equipment to be completed by September 30, 1999. There can be no
assurance that third party vendor upgrades to non-IT systems and equipment
will be Year 2000 complaint or that the upgrades will be completed prior to
the end of 1999 which could negatively impact the functionality of non-IT
systems and equipment that could have a material adverse effect on the
Company's revenue, operating results and financial condition.
In addition, the Company has made inquiries of its third party
suppliers to determine if they have any Year 2000 issues that will materially
and adversely impact the Company. To date, the Company has not been made aware
of any material Year 2000 issues which would adversely affect ADA.
The Company believes that the majority of its current products are
Year 2000 compliant. The remaining Company products are expected to be Year
2000 compliant by June 30, 1999. The Company had originally expected this
process to be completed by December 31, 1998. The Company does not expect
additional efforts required to complete Year 2000 compliance for these
products will be material. Internal validation testing is being conducted as
products are being upgraded. An independent third party also performed
validation testing on one of the Company's test and performance management
products. However, since all customer situations cannot be anticipated,
particularly those involving third party products, the Company may see an
increase in warranty and other claims as a result of the Year 2000
transition. In addition, litigation regarding Year 2000 compliance issues is
expected to escalate. For these reasons, the impact of customer claims could
have a material adverse impact on the Company's operating results or
financial condition.
Year 2000 compliance is an issue for virtually all businesses, whose
computer systems and applications may require significant hardware and
software upgrades or modifications. TSPs have devoted a substantial portion
of their information systems' spending to fund such upgrades and
modifications and divert spending away from network performance management
products. Such changes in customers' spending patterns have had and could
continue to have a material adverse impact on the Company's sales, operating
results or financial condition.
The Company intends to continue the review, remediation and testing of
its Year 2000 status and, to the extent necessary, it will develop Year 2000
contingency plans for critical business purposes. In addition, there can be no
assurance that Year 2000 issues will not have a material adverse effect on the
Company if ADA and/or those with whom it conducts business are unsuccessful in
identifying or implementing timely solutions to any Year 2000 problems.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS
No. 133 establishes accounting and reporting standards for derivative and
hedging activities. In accordance with SFAS No. 133 all derivatives must be
recognized as assets or liabilities and measured at fair value. This Statement
will be effective for the Company's fiscal year 2000. The Company has not yet
determined the impact of the adoption of this new accounting pronouncement on
its consolidated financial position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Required.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements are set forth on pages F-1 through F-28 of
this Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Identification of Directors. The information under the caption
"Director Nominees," appearing in the Proxy Statement, is incorporated herein by
reference.
Identification of Executive Officers. The information under the caption
"Executive Officers," appearing in the Proxy Statement, is incorporated herein
by reference.
Section 16(a) Beneficial Ownership Reporting Compliance. The
information under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance," appearing in the Proxy Statement, is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information under the caption "Executive Compensation and Other
Matters," appearing in the Proxy Statement, is incorporated herein by reference.
31
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the heading "Security Ownership of Certain
Beneficial Owners and Management," appearing in the Proxy Statement, is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the heading "Certain Transactions," appearing in
the Proxy Statement, is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The following financial statements of the Company are included on pages
F-1 through F-28 of this Annual Report on Form 10-K:
Report of Independent Accountants
Consolidated Balance Sheets at December 31, 1997 and December 31, 1998
Consolidated Statements of Operations and Comprehensive loss for the years
ended December 31, 1996, 1997 and 1998
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1997 and 1998
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
The following financial statement schedules are included in Item 14 (d):
Schedule II - Valuation and Qualifying Accounts for the years ended
December 31, 1996, 1997 and 1998
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore have
been omitted.
(b) Reports on Form 8-K
None.
(c) Exhibits
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER NUMBER
--------------- --------------
<S> <C> <C>
2.1(5) Asset Purchase Agreement between Applied Digital Access,
Inc. and Applied Computing Devices, Inc. dated February
29, 1996
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER NUMBER
--------------- --------------
<S> <C> <C>
2.2(7) Asset Purchase Agreement between Applied Digital Access,
Inc. and MPRTeltech, Ltd. dated July 16, 1996
2.3(11) Asset Purchase Agreement between the Company and
Northern Telecom Limited dated June 27, 1997 (the "Asset
Purchase Agreement") (with certain confidential portions
omitted).
3.3(13) Certificate of Incorporation of the Company
3.4(14) Certificate of Agreement of Merger of the Company
and its California predecessor.
+3.5(15) Bylaws of the Company.
10.1(1) Registration Rights Agreement by and between
the Company and certain shareholders of the
Company, dated May 22, 1992 as amended pursuant
to the Amendment to Registration Rights Agreement
dated April 9, 1993.
10.2(1) Lease for the Company's facilities at 9855 Scranton
Road, dated June 15, 1993
10.3(1) Agreement dated July 1, 1991 by and between the
Company and BellSouth Services Incorporated, as
amended (with certain confidential portions
omitted).
10.4(1) Software License Agreement dated January 16, 1992
by and between the Company and GCOM (with certain
confidential portions omitted).
10.5(1) Master Agreement for Operations Systems
Modifications for the Integration of Network
Elements, dated June 17, 1991 by and between the
Company and BellCore, as amended.
10.6(1) Addendum #1 to Master Agreement for Operations
Systems Modifications for the Integration of
Network Elements, dated June 17, 1991 by and
between the Company and BellCore dated July 10,
1991.
10.7(1) Addendum #2 to Master Agreement for Operations
Systems Modifications for the Integration of
Network Elements, dated June 17, 1991 by and
between the Company and BellCore dated November
19, 1993.
10.8(1) Addendum #3 to Master Agreement for Operations
Systems Modification for the Integration of
Network Elements dated June 17, 1991 by and
between the Company and BellCore dated December
27, 1993.
+10.9(1) Severance Agreement dated November 27, 1990 by and
between the Company and Peter P. Savage.
+10.10(1) Severance Agreement dated June 20, 1988 by and between
the Company and Paul R. Hartmann.
+10.11(1) 1994 Stock Option/Stock Issuance Plan Form of Stock
Option Agreement.
+10.12(1) 1994 Stock Option/Stock Issuance Plan Form of Stock
Issuance Agreement.
+10.13(1) 1994 Employee Stock Purchase Plan Form of Stock Purchase
Agreement.
+10.14(1) Form of Employee Proprietary Information Agreement.
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER NUMBER
--------------- --------------
<S> <C> <C>
10.15(1) Binary Software License Agreement dated March 7,
1989 between the Company and Software Components
Group, Inc., as amended.
10.16(2) Reinstatement Agreement dated September 22, 1994
between the Company and BellSouth
Telecommunications Incorporated (with certain
confidential portions omitted) (Exhibit 10.2).
10.17(2) Purchase Agreement for Telecommunications Products and
Related Services between Ameritech Services, Inc. (with
certain confidential portions omitted) (Exhibit 10.3).
10.18(3) First Amendment to Office Lease dated September 23, 1994
between the Company and Sorrento Tech Associates.
10.19(4) Purchase Agreement for Telecommunications Products and
Related Services between Southwestern Bell Telephone
Company and the Company, dated September 8, 1995 (with
certain confidential portions omitted)
+10.20(6) Applied Digital Access, Inc. 1994 Stock Option/Stock
Issuance Plan, as amended
10.21(8) Master Agreement between Northern Telecom, Ltd. and
Applied Digital Access, Inc. dated July 16, 1996.
10.22(8) Stock Purchase Agreement between Applied Digital Access,
Inc. and MPR Teltech, Ltd. dated July 16, 1996.
10.23(8) License Agreement between Northern Telecom, Ltd. and
Applied Digital Access, Inc. dated July 16, 1996
10.24(8) Second Amendment to Lease between Sorrento Tech
Associates and Applied Digital Access, Inc. dated August
8, 1996.
10.25(8) Lease Agreement between Rose Hulman Institute of
Technology, through its authorized leasing agent, Ragle
and Company, and Applied Digital Access, Inc. dated
September 15, 1996.
10.26(9) Sublease agreement between the Company and ENOVA
Corporation dated December 9, 1996
10.27(9) First Amendment to Sublease between the Company
and ENOVA Corporation dated January 24, 1997.
10.28(9) Office Lease Agreement between 2725321 Canada Inc. and
Applied Digital Access - Canada, Inc. dated January 1,
1997.
10.29(10) License Agreement between Northern Telecom, Ltd. and the
Company dated as of January 24, 1997 (with certain
confidential portions omitted).
10.30(11) License Agreement between Northern Telecom, Ltd. and the
Company dated as of June 27, 1997 (with certain
confidential portions omitted).
10.31(11) Applied Digital Access, Inc. 1997 Registration Rights
Agreement between the Company and Northern Telecom, Ltd.
dated as of June 27, 1997.
10.32(11) Stock and Warrant Purchase Agreement between the Company
and Northern Telecom, Ltd. dated as of June 27, 1997.
10.33(11) Master Purchase Agreement between MCI Telecommunications
Corporation and the Company dated June 16, 1997 (with
certain confidential portions omitted).
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER NUMBER
--------------- --------------
<S> <C> <C>
10.34(11) Master Agreement between Northern Telecom, Ltd. and the
Company dated as of June 26, 1997 (with certain
confidential portions omitted).
10.35(12) Joint Development Agreement between Northern Telecom,
Inc. and the Company dated September 30, 1997 (with
certain confidential portions omitted).
+10.36(15) Applied Digital Access, Inc. Amended and Restated 1996
Non-qualified Stock Option Plan
+10.37(15) Amended and Restated 1996 Non-qualified Stock Option
Plan Form of Stock Option Agreement.
+10.38(16) Severance Agreement dated March 24, 1995 by and between
the Company and Donald J. O'Connor.
+10.39(16) Severance Agreement dated March 12, 1997 by and between
the Company and Steven F.X. Murphy.
10.40(16) Lease Agreement between Campbell Creek, Ltd. and the
Company dated as of October 1, 1997.
10.41(16) First Amendment to Lease Agreement between Campbell
Creek, Ltd. and the Company dated as of January 22,
1998.
10.42(16) Second Amendment to Sublease between the Company and
ENOVA Corporation dated December 31, 1997.
+10.43(16) Form of Indemnification Agreements between the Company
and each of its directors.
+10.44(16) Form of Indemnification Agreements between the Company
and each of its officers.
+10.45(16) Applied Digital Access, Inc. 1994 Employee Stock
Purchase Plan, as amended.
+10.46(16) Management Team Incentive Compensation Plan, as amended.
10.47(16) Agreement between Telesector Resources Group, Inc.
("Bell Atlantic") and Applied Digital Access, Inc.
executed July 15, 1998 (with certain confidential
portions omitted). (Exhibit 10.1)
+10.48 Form of Executive Officer Retention Agreement between
Applied Digital Access and the following Executive
Officers: Donald L. Strohmeyer, Paul R. Hartmann, James
L. Keefe, Wayne M. Lettiere, Donald J. O'Connor, and
Kevin T. Pope.
+10.49 President and Chief Executive Officer Retention
Agreement between Applied Digital Access and Peter P.
Savage dated November 3, 1998.
+10.50 Confidential Separation Agreement between Stephen F.X.
Murphy and Applied Digital Access, Inc. dated January
25, 1999.
23.1 Consent of Independent Accountants.
27.1 Financial Data Schedule.
+ Management contract or compensatory plan.
</TABLE>
(1) Incorporated by reference to the Company's Registration
Statement on Form S-1
35
<PAGE>
(No. 33-75258), as amended.
(2) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1994 (File No.0-23698).
(3) Incorporated by reference to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1995
(File No. 0-23698).
(4) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1995 (File No.0-23698).
(5) Incorporated by reference to the Company's Current
Report on Form 8-K dated March 15, 1996 (File No.
0-23698).
(6) Incorporated by reference to the Company's Registration
Statement on Form S-8 (No. 333-08297), as amended
(7) Incorporated by reference to the Company's Current
Report on Form 8-K dated July 31, 1996 (File No.
0-23698).
(8) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1995 (File No. 0-23698).
(9) Incorporated by reference to the Company's Annual Report
on Form 10-K for the year ended December 31, 1996 (File
No. 0-23698).
(10) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1997
(File No. 0-23698).
(11) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1997
(File No. 0-23698).
(12) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1997 (File No. 0-23698).
(13) Incorporated by reference to the Company's Current
Report on Form 8-K dated December 23, 1997 (File No.
0-23698).
(14) Incorporated by reference to the Company's Current
Report on Form 8-K/A dated January 12, 1998 (File No.
0-23698).
(15) Incorporated by reference to the Company's Registration
Statement on Form S-8 (File No. 333- 48105).
(16) Incorporated by reference to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997
(File No. 0-23698).
(17) Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998
(File No. 0-23698).
36
<PAGE>
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.
APPLIED DIGITAL ACCESS, INC.
Date: March 31, 1999 By: /s/ Donald L. Strohmeyer
---------------------------
Donald L. Strohmeyer
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
By: /s/ Donald L. Strohmeyer President, Chief Executive March 31, 1999
--------------------------------- Officer and Director
(Donald L. Strohmeyer) (Principal Executive Officer)
By: /s/ James L. Keefe Vice President, Finance March 31, 1999
--------------------------------- and Administration, Chief
(James L. Keefe) Financial Officer, Secretary
(Principal Accounting Officer)
By: /s/ Gary D. Cuccio Director March 31, 1999
---------------------------------
(Gary D. Cuccio)
By: /s/ John F. Malone Director March 31, 1999
---------------------------------
(John F. Malone)
By: /s/ Kenneth E. Olson Director March 31, 1999
---------------------------------
(Kenneth E. Olson)
By: /s/ Christopher B. Paisley Director March 31, 1999
---------------------------------
(Christopher B. Paisley)
By: /s/ Peter P. Savage Director March 31, 1999
---------------------------------
(Peter P. Savage)
</TABLE>
37
<PAGE>
APPLIED DIGITAL ACCESS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
<S> <C>
1. CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Accountants F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 F-3
Consolidated Statements of Operations and Comprehensive Loss
for the Years Ended December 31, 1996, 1997 and 1998 F-4
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1996, 1997 and 1998 F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1997 and 1998 F-6
Notes to Consolidated Financial Statements F-7
2. FINANCIAL STATEMENT SCHEDULE:
Schedule II - Valuation and Qualifying Accounts for the
Years Ended December 31, 1996, 1997 and 1998 F-28
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Applied Digital Access, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 32 present fairly, in all material
respects, the financial position of Applied Digital Access, Inc. and its
subsidiary at December 31, 1997 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles. In
addition, in our opinion, the financial statement schedule listed in the
index appearing under Item 14(a)(2) on page 32 presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial
statements and financial statement schedule are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits.
We conducted our audits of these statements in accordance with generally
accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
January 28, 1999, except as to Note 10
which is as of March 31, 1999
F-2
<PAGE>
APPLIED DIGITAL ACCESS, INC.
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
- -----------------------------------------------------------------------------------------------------------------
DECEMBER 31,
1997 1998
(DOLLARS IN THOUSANDS,
except per share data)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,400 $ 12,513
Investments 8,779 -
Trade accounts receivable, net 12,981 6,111
Inventory, net 5,859 5,679
Deferred income taxes 130 130
Prepaid expenses and other current assets 3,775 1,700
--------- ---------
Total current assets 35,924 26,133
Property and equipment, net 6,165 5,466
Intangible assets, net 2,822 1,247
Deferred income taxes 1,372 1,426
--------- ---------
Total assets $ 46,283 $ 34,272
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,478 $ 2,922
Accrued expenses 2,846 2,333
Accrued warranty expense 1,323 1,264
Current portion of capital lease obligations 18 41
Deferred revenue 1,471 2,817
--------- ---------
Total current liabilities 9,136 9,377
Capital lease obligations, net of current portion 15 -
--------- ---------
Total liabilities 9,151 9,377
--------- ---------
Commitments and contingencies (Note 4)
Shareholders' equity:
Preferred stock, no par value; 7,500,000 shares authorized;
no shares issued - -
Common stock, $.001 par value; 30,000,000 shares authorized;
12,605,082 and 12,909,315 shares issued and outstanding at
December 31, 1997 and 1998, respectively 13 13
Additional paid-in capital 54,089 54,897
Accumulated other comprehensive income 84 163
Accumulated deficit (17,054) (30,178)
--------- ---------
Total shareholders' equity 37,132 24,895
--------- ---------
--------- ---------
Total liabilities and shareholders' equity $ 46,283 $ 34,272
--------- ---------
--------- ---------
</TABLE>
The accompanying notes are an integral part
of these financial statements.
F-3
<PAGE>
APPLIED DIGITAL ACCESS, INC.
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
- ------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
1996 1997 1998
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Revenue $ 24,422 $ 34,050 $ 29,217
Cost of revenue 12,609 15,116 13,587
------------ ------------ ------------
Gross profit 11,813 18,934 15,630
------------ ------------ ------------
Operating expenses:
Research and development 7,356 9,164 14,313
In-process research and development related
to acquisitions 3,286 1,578 -
Sales and marketing 6,312 7,995 9,801
General and administrative 3,529 5,252 5,129
------------ ------------ ------------
Total operating expenses 20,483 23,989 29,243
------------ ------------ ------------
Operating loss (8,670) (5,055) (13,613)
Interest income 1,673 904 675
------------ ------------ ------------
Loss before income taxes (6,997) (4,151) (12,938)
------------ ------------ ------------
Provision for income taxes 123 132 186
------------ ------------ ------------
Net loss (7,120) (4,283) (13,124)
Other comprehensive income (loss)
Foreign currency translation adjustments (1) 68 91
Unrealized gains (losses) on securities (121) (9) (12)
------------ ------------ ------------
Other comprehensive income (loss) (122) 59 79
------------ ------------ ------------
Comprehensive loss $ (7,242) $ (4,224) $ (13,045)
------------ ------------ ------------
------------ ------------ ------------
Net loss per share, basic and diluted $ (.59) $ (.34) $ (1.03)
------------ ------------ ------------
------------ ------------ ------------
Shares used in per share computations 12,084,242 12,459,511 12,711,203
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part
of these financial statements.
F-4
<PAGE>
APPLIED DIGITAL ACCESS, INC.
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- ---------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
---------------------- PAID-IN DEFERRED COMPREHENSIVE ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION INCOME (LOSS) DEFICIT TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 11,899,216 $ 12 $ 51,480 $ (101) $ 147 $ (5,651) $ 45,887
---------- ---------- ---------- ---------- ----------- ----------- ----------
Net loss - - - - - (7,120) (7,120)
Foreign currency
translation adjustment - - - - (1) - (1)
Unrealized loss on
investments - - - - (121) - (121)
Amortization of deferred
compensation for stock options - - - 51 - - 51
Issuance of common stock upon
exercise of stock options 149,261 - 115 - - - 115
Issuance of common stock
under stock purchase plan 56,857 - 428 - - - 428
Issuance of common stock in
connection with acquisition 150,000 - 1,088 - - - 1,088
---------- ---------- ---------- ---------- ----------- ----------- ----------
Balance, December 31, 1996 12,255,334 12 53,111 (50) 25 (12,771) 40,327
Net loss - - - - - (4,283) (4,283)
Foreign currency
translation adjustment - - - - 68 - 68
Unrealized loss on
investments - - - - (9) - (9)
Amortization of deferred
compensation for stock options - - - 50 - - 50
Issuance of common stock upon
exercise of stock options 221,235 1 380 - - - 381
Issuance of common stock
under stock purchase plan 128,513 - 598 - - - 598
---------- ---------- ---------- ---------- ----------- ----------- ----------
Balance, December 31, 1997 12,605,082 13 54,089 - 84 (17,054) 37,132
Net loss - - - - - (13,124) (13,124)
Foreign currency
translation adjustment - - - - 91 - 91
Unrealized loss on
investments - - - - (12) - (12)
Issuance of common stock upon
exercise of stock options 91,649 - 192 - - - 192
Issuance of common stock
under stock purchase plan 212,584 - 616 - - - 616
---------- ---------- ---------- ---------- ----------- ----------- ----------
Balance, December 31, 1998 12,909,315 $ 13 $ 54,897 $ - $ 163 $ (30,178) $ 24,895
---------- ---------- ---------- ---------- ----------- ----------- ----------
---------- ---------- ---------- ---------- ----------- ----------- ----------
</TABLE>
The accompanying notes are an integral part
of these financial statements.
F-5
<PAGE>
APPLIED DIGITAL ACCESS, INC.
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ----------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
1996 1997 1998
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (7,120) $ (4,283) $ (13,124)
Adjustments to reconcile net loss to net cash used
by operating activities:
Depreciation and amortization 1,819 3,089 3,703
Amortization of discount (accretion of premium) on investments 95 (119) 41
Amortization of deferred compensation 51 50 -
Acquired in-process research and development 3,286 1,578 -
Change in inventory reserves (68) 101 104
Changes in operating assets and liabilities:
Trade accounts receivable (1,440) (6,183) 6,870
Inventory (723) 1,403 76
Deferred taxes - - (54)
Prepaid expenses and other current assets 207 (2,686) 2,075
Accounts payable 300 1,358 (556)
Accrued expenses 648 1,355 (513)
Accrued warranty expense 93 (75) (59)
Deferred revenue 587 884 1,346
---------- ---------- ----------
Net cash used by operating activities (2,265) (3,528) (91)
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (20,923) (18,517) (10,903)
Maturities of investments 30,923 29,792 19,640
Purchases of property and equipment (1,709) (2,432) (1,806)
Purchase costs related to asset acquisitions (6,356) (3,382) -
Reimbursement of costs related to acquisition - - 500
Purchase of license agreement (350) - -
---------- ---------- ----------
Net cash provided by investing activities 1,585 5,461 7,431
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations (32) (16) (35)
Proceeds from exercise of stock options and warrants 115 381 192
Proceeds from issuance of common stock 428 598 616
---------- ---------- ----------
Net cash provided by financing activities 511 963 773
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents (169) 2,896 8,113
Cash and cash equivalents at beginning of year 1,673 1,504 4,400
---------- ---------- ----------
Cash and cash equivalents at end of year $ 1,504 $ 4,400 $ 12,513
---------- ---------- ----------
---------- ---------- ----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 7 $ 4 $ 2
Cash paid during the year for income taxes - 229 104
Noncash investing and financing activities:
Issuance of common stock in connection with acquisition 1,088 - -
Assets acquired under capital lease - - 43
</TABLE>
The accompanying notes are an integral part
of these financial statements.
F-6
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Applied Digital Access, Inc. (the "Company") designs, engineers and
manufactures network test and performance monitoring systems and software
and provides services for the management and testing of
telecommunications circuits. The Company has two core business segments:
Network Systems and Network Management. The Network Systems business unit
provides test and performance management products and services whereas
the Network Management business unit focuses on the design and
manufacture of operations systems software.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary, Applied Digital Access Canada ("ADA
Canada"). All significant intercompany transactions and balances have
been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts 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 estimates.
SEGMENT REPORTING
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 131 DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION during the year ended December 31, 1998. This Statement
establishes standards for reporting information about operating segments
in annual financial statements and requires selected information about
operating segments in interim financial reports issued to shareholders.
Under SFAS 131, operating segments are to be determined consistent with
the way that management organizes and evaluates financial information
internally for making operating decisions and assessing performance.
Disclosures required under this Statement include information about
products and services, geographic areas and major customers. The
presentation of segment information in prior periods has been
reclassified to conform to the current year presentation.
REVENUE RECOGNITION
The Company's revenues are primarily derived from hardware product sales,
software product sales and perpetual license fees. In addition, the
Company also derives revenues from installation and implementation
services, maintenance agreement sales and software royalties.
F-7
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Revenue from sales of hardware and software products is generally
recognized upon shipment. For shipments of products involving significant
acceptance requirements, revenue is recognized when the Company has met
substantially all its performance requirements and acceptance criteria
have been met.
Revenue from perpetual license arrangements is recognized upon delivery
of the related software and customer acceptance when the Company has no
significant continuing obligations and collection is probable.
Revenue from installation and implementation services is recognized as
the services are performed while revenue from maintenance contracts is
recognized ratably over the related contract terms.
Royalty revenue is generally recognized as earned in accordance with the
terms of respective license agreements. For certain of the Company's
license agreements, royalty revenue is recognized when reasonable
estimates of such amounts can be made.
Amounts received on uncompleted contracts in excess of incurred costs are
classified depending upon the nature of the contract as either deferred
revenue or payments in excess of billings on contracts.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and short-term investments with
original maturities of 90 days or less when purchased. At December 31,
1998, cash in excess of daily requirements was invested in marketable
securities consisting of obligations of the U.S. Government and
commercial paper with original maturities of less than 90 days.
INVESTMENTS
The Company determines the appropriate classification of its debt
securities at the time of purchase and assesses such designations at each
balance sheet date. Realized gains and losses are determined using the
specific identification method and are included in other income. Gross
unrealized holding gains or losses are excluded from earnings and
reported, net of the related tax effect, as a separate component of
shareholders' equity. The amortized cost of debt securities is adjusted
for the amortization of premiums and accretion of discounts to maturity.
Such amortization is included in interest income. Fair value is
determined based on quoted market prices.
INVENTORY
Inventory is stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.
F-8
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Significant renewals and
improvements are capitalized while maintenance and repairs are expensed
as incurred. Depreciation is computed over estimated useful lives using
the straight-line method.
Useful lives for property and equipment are as follows:
Computer equipment 3 - 6 years
Machinery and equipment 3 - 6 years
Office furniture and equipment 3 - 7 years
Purchased computer software 3 - 6 years
Leasehold improvements are amortized using the straight-line method over
the shorter of the lease term or the estimated useful lives of such
improvements.
Upon retirement or other disposition, the cost and related accumulated
depreciation or amortization are removed from the accounts and any
resulting gain or loss is reflected in income.
INTANGIBLE ASSETS
Intangible assets consist of goodwill, purchased technology, customer
contracts and license agreement fees. Goodwill represents the excess of
the purchase price over net assets of businesses acquired. Purchased
technology, customer contracts and license agreement fees are stated at
cost. Intangible assets are amortized on a straight-line basis over
periods of three to five years.
The carrying value of intangible assets is periodically reviewed by the
Company and impairment recognized if events indicate that the expected
future cash flows from such intangibles are less than their carrying
value. The Company did not recognize any impairment on its intangible
assets during the years ended December 31, 1996, 1997, and 1998.
During the year ended December 31, 1998, the Company received amounts
determined to be contingent consideration related to an acquisition in
the prior period. Accordingly, goodwill related to the acquisition was
decreased by the amount of $500 representing contingent consideration
received.
ADVERTISING
Advertising costs are expensed as incurred. Advertising expense was
approximately $217, $250 and $302 for the years ended December 31, 1996,
1997 and 1998, respectively.
F-9
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
STOCK-BASED COMPENSATION
The Company measures compensation cost for its stock-based employee and
non-employee director compensation plans using the intrinsic value
method. Pro forma disclosures of net loss and net loss per common share
are provided as if the fair value method had been applied in measuring
compensation expense.
FOREIGN CURRENCY TRANSLATION
The local currency is the functional currency for ADA Canada. Assets and
liabilities are translated at the exchange rate on the balance sheet date
while revenues and expenses are translated at average rates of exchange
prevailing during the year. Adjustments resulting from translating ADA
Canada's financial statements into U.S. dollars are reported as a
separate component of shareholders' equity and classified as other
comprehensive income (loss). For the years ended December 31, 1996,
1997 and 1998, the effect of exchange rate changes on cash has not been
significant.
CONCENTRATIONS
The market for the Company's products is characterized by rapid
technological advances, evolving industry transmission standards, changes
in customer requirements and frequent new product introductions and
enhancements. The introduction of telephone network test and performance
monitoring products involving superior technologies or the evolution of
alternative technologies or new industry transmission standards could
render the Company's existing products, as well as products currently
under development, obsolete and unmarketable.
The Company operates in an environment significantly affected by recent
merger and acquisition activity among its customers. Such activity may
substantially reduce the number of customers for the Company's products
and may have a material and adverse effect upon the Company's results of
operations and financial position.
A significant portion of the Company's revenues and trade receivables are
concentrated with a limited number of telecommunications service
providers or affiliated companies in the United States and Canada.
The Company's customers consist primarily of Regional Bell Operating
Companies, long distance carriers, local exchange carriers and
independent telephone companies. Sales are typically made on credit with
varying terms depending upon the customer and nature of the product. The
Company does not hold collateral to secure payment as the Company
considers its customers to be large companies with substantial financial
resources. Although the Company deems its reserve for uncollectible
receivables to be adequate, a default on payment of a significant
customer receivable could materially and adversely affect the Company's
operating results and financial position.
From time to time, the Company may have cash in excess of federally
insured limits held at certain banks. The Company has not experienced any
losses on its cash or cash equivalents to date.
F-10
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
All the Company's investments at December 31, 1997 consisted of
obligations of the U.S. Government and its agencies.
The Company currently buys certain key components of its products from a
limited number of suppliers. Although there are a limited number of
suppliers of the components, management believes that other suppliers
could provide similar key components on comparable terms. A change in
suppliers, however, could cause a delay in manufacturing and a possible
loss of sales, which would adversely affect operating results.
INCOME TAXES
The Company's current income tax expense is the amount of income taxes
expected to be payable for the current year. Deferred income taxes are
recognized for the tax consequences in future years for differences
between the tax basis of assets and liabilities ("temporary differences")
and their financial reporting amounts at each year end based on enacted
tax laws and statutory rates applicable to the periods in which the
temporary differences are expected to affect taxable income. Valuation
allowances are established when necessary to reduce deferred tax assets
to the amount expected to be realized.
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per common share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding during
the period. Diluted earnings (loss) per common share is computed by
dividing net income (loss) by the weighted average number of common
shares and potential common shares outstanding during the period using
the treasury stock method. For the years ended December 31, 1996, 1997,
and 1998, the weighted average number of common shares outstanding for
both basic and diluted earnings (loss) per common share is comparable as
the inclusion of potential common shares for diluted earnings (loss) per
share would have been antidilutive due to the Company's losses from
continuing operations. There are no reconciling items in calculating the
numerator and denominator for basic and diluted earnings (loss) per share
for any periods presented.
COMPREHENSIVE INCOME
The Company adopted SFAS No. 130, REPORTING COMPREHENSIVE INCOME during
the year ended December 31, 1998. This Statement requires the Company to
report all changes in equity from non-owner sources, including unrealized
gains and losses on certain investments in debt and equity securities and
foreign currency translation adjustments, as components of other
comprehensive income. Such amounts are presented as a separate component
of equity entitled "Accumulated Other Comprehensive Income" in the
statement of financial position. The individual components of other
comprehensive income are also reported with net income (loss) as
"Comprehensive Income" in the results of operations. The income tax
expense (benefit) related to items of other comprehensive income is not
significant for the years ended December 31, 1996, 1997, and 1998.
Financial statements for earlier periods have been reclassified for
comparative purposes.
F-11
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES. This Statement establishes accounting and reporting standards
for derivatives and hedging activities. In accordance with this
Statement, all derivatives must be recognized as assets or liabilities
and measured at fair value. This Statement will be effective for the
Company's fiscal year 2000. The Company has not yet determined the impact
of the adoption of this new accounting pronouncement on its consolidated
financial position or results of operations.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year financial
statements to conform to the current year presentation.
2. INVESTMENTS
At December 31, 1997, all marketable debt securities consisted of
obligations of the U.S. Government and its agencies and were classified
as available-for-sale. The estimated fair value of such investments
approximated its amortized cost and, therefore, there were no significant
unrealized gains or losses.
3. COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------
1997 1998
<S> <C> <C>
Inventories:
Raw materials $ 3,419 $ 3,266
Work-in-process 2,223 2,389
Finished goods 787 698
----------- ------------
6,429 6,353
Less reserves (570) (674)
----------- ------------
$ 5,859 $ 5,679
----------- ------------
----------- ------------
Property and equipment:
Computer equipment $ 5,655 $ 6,031
Machinery and equipment 2,967 4,062
Office furniture and equipment 1,815 1,166
Purchased computer software 1,371 2,136
Leasehold improvements 911 1,129
----------- ------------
12,719 14,524
Less accumulated depreciation and amortization (6,554) (9,058)
----------- ------------
$ 6,165 $ 5,466
----------- ------------
----------- ------------
</TABLE>
F-12
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Depreciation expense was $1,368, $1,904 and $2,629 for the years ended
December 31, 1996, 1997 and 1998, respectively. Of these amounts, $140,
$194 and $412 related to amortization of purchased software costs for the
years ended December 31, 1996, 1997 and 1998, respectively.
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------
1997 1998
<S> <C> <C>
Intangible Assets:
Goodwill $ 3,619 $ 3,119
Technology and customer contracts 337 337
Licenses 350 350
----------- ------------
4,306 3,806
Less accumulated amortization (1,484) (2,559)
----------- ------------
$ 2,822 $ 1,247
----------- ------------
----------- ------------
Accrued expenses:
Accrued payroll and related costs $ 902 $ 287
Accrued vacation 583 773
Accrued income taxes 388 425
Accrued contract costs - 448
Payments in excess of billings on contracts - 250
Acquisition costs payable 867 -
Other accrued liabilities 106 150
----------- ------------
$ 2,846 $ 2,333
----------- ------------
----------- ------------
</TABLE>
4. COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
The Company had unconditional purchase obligations under contracts for
inventory purchases. The portion of such obligations not completed at
year end represent unrecorded commitments of approximately $2,500 and
$3,003 at December 31, 1997 and 1998, respectively.
LEASES
The Company leases certain facilities and equipment under both operating
and capital leases.
F-13
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Commitments for minimum lease payments under non-cancelable leases with
the initial or remaining terms greater than twelve months as of
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
YEAR ENDING DECEMBER 31, LEASES LEASES
<S> <C> <C>
1999 $ 43 $ 1,203
2000 - 897
2001 - 789
2002 - 1,047
2003 - 859
Thereafter 269
--------------- ----------------
43 $ 5,064
----------------
Less amounts representing interest (2) ----------------
---------------
Present value of net minimum lease
payments $ 41
---------------
---------------
</TABLE>
Property and equipment includes the following amounts for capitalized
leases:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------
1997 1998
<S> <C> <C>
Machinery and equipment $ - $ 43
Office furniture and equipment 67 67
Leasehold improvements 149 149
----------- ------------
216 259
Less accumulated amortization (140) (182)
----------- ------------
$ 76 $ 77
----------- ------------
----------- ------------
</TABLE>
Capital lease agreements of certain equipment contain bargain purchase
options whereby the Company has the option to purchase the equipment for
a nominal amount at the end of the lease term.
Certain of the Company's operating leases contain purchase options and
renewal options. Rent expense incurred under such leases was
approximately $613, $673 and $1,259 for the years ended December 31,
1996, 1997 and 1998, respectively.
LITIGATION
Various claims arising in the ordinary course of business, seeking
monetary damages and other relief, are pending. The amount of the
liability, if any, from such claims cannot be determined with certainty.
F-14
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
5. COMMON STOCK WARRANTS
In conjunction with an acquisition in June 1997, the Company issued three
year warrants to purchase 150,000 shares of common stock at $12 per
share.
6. SEGMENT REPORTING
In accordance with SFAS No. 131, information regarding the Company's
business segments is reported for financial statement purposes
consistently with the manner in which these segments are evaluated for
internal reporting and management's assessment of performance. The
Company evaluates the performance of its segment and allocates resources
to them based on segment earnings before allocation of corporate costs.
The Company is organized primarily on the basis of products which are
broken down into Network Systems and Network Management. Network Systems
products include T3AS products and services, including CTS and PAAS, as
well as the Remote Module product. Network Management products focus on
Operating System ("OS") software products which include .Provisioner,
TDC&E, FMS and OS design services.
The table below presents information about revenues, operating income
(loss) and total assets for reportable segments for the years ended
December 31:
<TABLE>
<CAPTION>
OPERATING
INCOME TOTAL
REVENUES (LOSS) ASSETS
<S> <C> <C> <C>
1996:
Network Systems $ 18,144 $ (782) $ 14,565
Network Management 6,278 (2,603) 4,533
---------------- --------------- ----------------
Total for reportable segments 24,422 (3,385) 19,098
Reconciling items - (5,285) 26,874
---------------- --------------- ----------------
Consolidated totals $ 24,422 $ (8,670) $ 45,972
---------------- --------------- ----------------
---------------- --------------- ----------------
1997:
Network Systems $ 17,061 $ (3,209) $ 18,573
Network Management 16,989 4,961 6,432
---------------- --------------- ----------------
Total for reportable segments 34,050 1,752 25,005
Reconciling items - (6,807) 21,278
---------------- --------------- ----------------
Consolidated totals $ 34,050 $ (5,055) $ 46,283
---------------- --------------- ----------------
---------------- --------------- ----------------
</TABLE>
F-15
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING
INCOME TOTAL
REVENUES (LOSS) ASSETS
<S> <C> <C> <C>
1998:
Network Systems $ 16,455 $ (7,186) $ 13,312
Network Management 12,762 1,556 3,944
---------------- --------------- ----------------
Total for reportable segments 29,217 (5,630) 17,256
Reconciling items - (7,983) 17,016
---------------- --------------- ----------------
Consolidated totals $ 29,217 $ (13,613) $ 34,272
---------------- --------------- ----------------
---------------- --------------- ----------------
</TABLE>
The table below presents the reconciliation of operating income (loss)
for reportable segments to consolidated loss before income taxes for the
years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Operating income (loss) for reportable
segments $ (3,385) $ 1,752 $ (5,630)
Other segment expenses (5,285) (6,807) (7,983)
Other unallocated income 1,673 904 675
---------------- --------------- ----------------
Consolidated loss before
income taxes $ (6,997) $ (4,151) $ (12,938)
---------------- --------------- ----------------
---------------- --------------- ----------------
</TABLE>
Operating income (loss) for reportable segments includes segment revenues
with deductions made for related selling costs and certain expenses
controllable by segment managers. Other segment expenses consist of
corporate selling, general and administrative expenses allocated to each
segment based on segment revenues. Other unallocated income consists
of interest income on investments held at the corporate level.
F-16
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
The table below presents the reconciliation of total assets for
reportable segments to consolidated total assets at December 31:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Total assets for reportable
segments $ 19,098 $ 25,005 $ 17,256
Other segment assets 3,525 6,492 2,925
Other unallocated assets:
Cash 1,504 4,400 12,513
Investments 19,956 8,779 -
Other 1,889 1,607 1,578
---------------- ---------------- ----------------
Consolidated total assets $ 45,972 $ 46,283 $ 34,272
---------------- ---------------- ----------------
---------------- ---------------- ----------------
</TABLE>
Total assets for reportable segments includes amounts attributable to
trade accounts receivable, inventory and property and equipment. Other
segment assets consist primarily of intangible assets obtained in
conjunction with certain acquisitions. Other unallocated assets consists
principally of deferred taxes and prepaid expenses
The table below presents information about other significant items
included in segment operating income and segment assets as of and for the
years ended December 31:
<TABLE>
<CAPTION>
DEPRECIATION EXPENDITURES
AND FOR ADDITIONS
AMORTIZATION TO LONG-LIVED
EXPENSE ASSETS
<S> <C> <C>
1996:
Network Systems $ 1,024 $ 1,239
Network Management 344 374
Reconciling items 451 96
---------------- ---------------
Consolidated totals $ 1,819 $ 1,709
---------------- ---------------
---------------- ---------------
1997:
Network Systems $ 1,131 $ 1,573
Network Management 773 694
Reconciling items 1,185 165
---------------- ---------------
Consolidated totals $ 3,089 $ 2,432
---------------- ---------------
---------------- ---------------
</TABLE>
F-17
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DEPRECIATION EXPENDITURES
AND FOR ADDITIONS
AMORTIZATION TO LONG-LIVED
EXPENSE ASSETS
<S> <C> <C>
1998:
Network Systems $ 1,595 $ 1,449
Network Management 1,033 284
Reconciling items 1,075 73
---------------- ---------------
Consolidated totals $ 3,703 $ 1,806
---------------- ---------------
---------------- ---------------
</TABLE>
Depreciation expense on segment property and equipment included as a
component of total segment assets utilized by management in assessing
segment operating performance is included in operating income for
reportable segments. For each of the years ended December 31, 1996, 1997,
and 1998, the reconciling item to arrive at consolidated depreciation and
amortization expense consists of amortization expense related to
intangible assets.
The table below presents information about revenue and long-lived assets
by geographic area as of and for the years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Revenues:
United States $ 20,071 $ 24,189 $ 25,571
Canada 4,351 9,861 3,646
---------------- ---------------- ----------------
Consolidated totals $ 24,422 $ 34,050 $ 29,217
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Long-lived assets:
United States $ 4,109 $ 4,515 $ 4,156
Canada 827 1,650 1,310
---------------- ---------------- ----------------
Consolidated totals $ 4,936 $ 6,165 $ 5,466
---------------- ---------------- ----------------
---------------- ---------------- ----------------
</TABLE>
F-18
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
The table below presents information about segment revenues from major
customers as a percentage of total revenues for the years ended
December 31:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Network Systems:
US WEST 31% 4% 3%
Bell Atlantic (NYNEX) 23% 8% 12%
BellSouth 7% 17% 26%
MCI WorldCom - 18% 7%
Network Management:
Northern Telecom, Inc. 15% 20% -
MCI WorldCom - 10% 16%
</TABLE>
7. EMPLOYEE BENEFIT PLANS
EMPLOYEE SAVINGS AND RETIREMENT PLAN
The Company has a 401(k) defined contribution plan that allows eligible
employees who have been employed by the Company for a minimum of one
month to contribute up to 15% of their salary, subject to annual limits.
The Company may also elect to make discretionary contributions to the
accounts of employees who have completed 1,000 hours of service during
the plan year. Such discretionary employer contributions vest ratably
over a four year period. The Company did not make any contributions
related to this Plan for the years ended December 31, 1996, 1997, or
1998.
PROFIT SHARING PLAN
The Company has a profit sharing plan available to all employees which
provides compensation to employees when the Company exceeds certain
targeted performance objectives. Employees are eligible to participate in
the first full quarter after their employment with the Company begins.
The Compensation Committee of the Board of Directors determines the
annual amount allocable to the Plan and such amount expensed was $418 for
the year ended December 31, 1997. No amounts were expensed under the Plan
for either of the years ended December 31, 1996 or 1998.
STOCK OPTION PLANS
Options to purchase common stock of the Company have been granted to
employees and non-employee Directors under the 1994 Stock Option/Stock
Issuance Plan, as amended (the "1994 Plan"), and to non-officer,
non-director employees and consultants under the 1996 Non-Qualified Stock
Option Plan, as amended (the "1996 Plan"), which collectively comprise
the "Stock Option Plans." A description of each plan follows.
- The 1994 Plan superceded and consolidated the 1988 Stock Option Plan
and Restricted Stock Purchase Plan (the "1988 Plan"). Outstanding
stock options and unvested share issuances under the 1988 Plan were
incorporated into and assumed in the 1994 Plan.
F-19
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
The 1994 Plan authorizes up to 4,100,000 shares to be granted no
later than February 2004. The 1994 Plan provides for the grant of
both incentive and non-qualified stock options which are exercisable
for up to ten years from the grant date. The 1994 Plan has three
components as follows:
- The Discretionary Option Grant Program for selected employees and
consultants has both incentive and non-qualified components.
Non-qualified options granted under the Discretionary Option
Grant Program may be purchased at not less than 85% of fair
market value of the stock at the date of grant whereas incentive
options may be purchased at fair market value. Such options
generally vest over a period not exceeding five years.
- The Automatic Option Grant Program provides for non-qualified
stock options to be granted to non-employee directors at fair
market value. Options generally vest over a period not exceeding
five years.
- The Stock Issuance Program provides for the issuance of shares of
common stock which may be purchased by eligible employees and
certain other qualified individuals at a price not less than 85%
of fair market value. Such options may be immediately exercisable
or may vest over a period not exceeding five years.
- The 1996 Plan authorizes up to 1,450,000 shares to be granted no
later than September 2008. Under terms of the 1996 Plan, the
Company may grant options to selected non-officer non-director
employees and consultants. The options are generally exercisable
at not less than 85% of fair market value. Options generally vest
over periods not exceeding five years and have a maximum term of
ten years.
- Additionally, a fully-exercisable non qualified option to purchase
17,087 shares of common stock at an exercise price of $0.14 was
outstanding at December 31, 1995, 1996, 1997, and 1998. This
option was not issued pursuant to any of the Company's stock
option plans. This option expires in May 2001.
In September 1998, the Compensation Committee of the Company's Board
of Directors authorized a program to cancel and regrant option grants
made under the 1994 and 1996 Plans that were granted at exercise
prices exceeding the fair market value of common stock as of the
effective date of the program, October 23, 1998. The exercise price of
each regranted option was $2.75, based on the closing market price of
the Company's common stock on October 23, 1998. Each optionee holding
such an option had the opportunity to (i) elect to retain the old
option or (ii) accept a new option with an exercise price equal to the
fair market value of the Company's common stock on the effective date
and cancel the older, higher-priced option. Each regranted option
covered the same number of shares subject to the higher-priced option
at the time of cancellation and maintained the same vesting period as
the previously cancelled option. The regranted option is subject to
the condition that the options cannot be exercised, and employment is
not terminated, prior to April 23, 1999. Any employee voluntarily
leaving the Company during the suspended vesting period will lose the
affected options, including previously vested portions of those
options.
In October 1998, the Compensation Committee of the Company's Board of
Directors authorized a program to cancel and regrant option grants
made under the 1994 Plan to officer employees of the Company that were
granted at exercise prices exceeding the fair market value of common
stock as of the effective date of the program, November 3, 1998. The
exercise price of each regranted option was $2.75, based on the
closing market price of the Company's common stock on November 3,
1998. Each optionee holding such an option had the opportunity to (i)
elect to retain the old option or (ii) accept new options with
exercise prices equal to the fair market value of the Company's common
stock on the effective date and cancel the older, higher-priced
option. Each regranted option covered one half the number of shares
subject to the higher-priced option at the time of cancellation. One
of the regranted options maintained the same vesting period as the
previously cancelled option. The other regranted option vests in equal
monthly installments over a 48 month period beginning on the effective
date of the program. The regranted options are subject to the
condition that the options cannot be exercised, and employment is not
terminated, prior to May 3, 1999. Any officer employee voluntarily
leaving the Company during the suspended vesting period will lose the
affected options, including previously vested portions of those
options.
F-20
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
A summary of stock option transactions for the 1994 and 1996 Plans
described above is as follows:
<TABLE>
<CAPTION>
1994 AND 1996 STOCK OPTION PLANS
-------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------- -------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE
--------------- ------------ --------------- ------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995 1,671,309 $ 5.63 787,291 $ 2.17
Options granted 874,887 9.01
Options exercised (149,261) .77
Options canceled (598,732) 18.30
--------------- ------------ --------------- ------------
Balance at December 31, 1996 1,798,203 5.54 813,939 2.49
Options granted 1,404,976 6.58
Options exercised (252,337) 6.34
Options canceled (299,984) 7.65
--------------- ------------ --------------- ------------
Balance at December 31, 1997 2,650,858 6.20 1,185,372 5.02
Options granted 2,990,941 3.49
Options exercised (91,649) 5.23
Options canceled (2,571,217) 7.32
--------------- ------------ --------------- ------------
December 31, 1998 2,978,933 $ 2.60 675,253 $ 1.52
--------------- ------------ --------------- ------------
--------------- ------------ --------------- ------------
</TABLE>
The following table summarizes information about all stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
------------------------------ ------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------ ------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OF SHARES LIFE PRICE OF SHARES PRICE
----------------------------------- -------------- ------------ --------------- -----------
<S> <C> <C> <C> <C> <C>
$0.14 to $2.69 496,526 3.77 $ 0.36 475,713 $ 0.27
$2.75 2,295,415 8.71 2.75 142,525 2.75
$3.00 to $16.13 204,079 9.00 6.34 57,015 8.81
------------- -------------- ------------ --------------- -----------
2,996,020 7.91 $ 2.60 675,253 $ 1.52
------------- -------------- ------------ --------------- -----------
------------- -------------- ------------ --------------- -----------
</TABLE>
EMPLOYEE STOCK PURCHASE PLANS
The Company has three Employee Stock Purchase Plans which provide
eligible employees the opportunity to purchase the Company's common
stock through payroll deductions. The Company's employees in the
United States are eligible to participate in the 1994 Employee Stock
Purchase Plan, as amended and the 1998 Employee Stock Purchase Plan
whereas the Company's Canadian employees are eligible to participate
in a separate 1998 Employee Stock Purchase Plan. Each of the Plans has
substantially identical terms. Under the terms of the Plans, employees
qualify if they have
F-21
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
been employed at least 20 hours per week for more than five months.
After three months of service, qualifying employees are eligible to
participate in the Plans in the quarter following the period in which
the eligibility requirement is fulfilled. Employees may elect to have
up to 15% of their regular compensation withheld through regular
payroll deductions. At each quarter-end, amounts accumulated in the
participant's account are used to purchase shares of the Company's
common stock at the lower of 85% of the fair market value of the stock
at either the date of the participant's entry into the Plan or the
last day of the quarter. The initial option period for each of the
Plans is generally twelve to twenty-four months with subsequent option
periods covering one twelve month period. Each Plan terminates either
at the end of the respective option periods or when the maximum number
of shares available for issuance under the Plan have been issued.
Under these Plans, 56,857, 128,513, and 212,584 shares of common stock
were issued during the years ended December 31, 1996, 1997, and 1998,
respectively. At December 31, 1998, 218,443 shares of common stock
were available for future purchases. No shares remained available for
future purchases under the 1994 Employee Stock Purchase Plan, as
amended.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation plans in accordance
with Accounting Principles Board ("APB") Opinion No. 25 ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES and related Interpretations. Under the
provisions of APB 25, the Company measures compensation cost using the
intrinsic value method rather than the fair value method prescribed by
SFAS No. 123 ACCOUNTING FOR STOCK-BASED COMPENSATION. Accordingly, no
compensation cost has been recognized in the Company's results of
operations. The Company has adopted the disclosure-only provisions of
SFAS No. 123 which require the presentation of pro forma information
related to net income (loss) and net income (loss) per share as if the
Company accounted for its stock-based compensation plans using the fair
value method. Such pro forma information is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1996 1997 1998
<S> <C> <C> <C>
Net loss:
As reported $(7,120) $(4,283) $(13,124)
Pro forma (8,352) (6,830) (15,979)
Net loss per common share:
As reported, basic and diluted $(.59) $(.34) $(1.03)
Pro forma, basic and diluted $(.69) $(.55) $(1.26)
</TABLE>
F-22
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
The fair value of options granted under the Stock Option Plans and shares
issued under the Employee Stock Purchase Plans reported below have been
estimated at the date of grant using the Black-Scholes option-pricing
model based on the following weighted-average assumptions:
<TABLE>
<CAPTION>
STOCK OPTION PLANS EMPLOYEE STOCK PURCHASE PLANS
-------------------------------------- ---------------------------------------
1996 1997 1998 1996 1997 1998
<S> <C> <C> <C> <C> <C> <C>
Risk-free interest rate 6.21% 6.17% 5.10% 6.21% 6.17% 4.69%
Dividend yield 0% 0% 0% 0% 0% 0%
Expected volatility 65.09% 69.76% 74.17% 65.09% 69.76% 74.17%
Expected life (in years) 5 5 5 .25 .25 .25
</TABLE>
The estimated fair value of options granted under the Stock Option Plans
at December 31, 1996, 1997 and 1998 was $4.22, $3.40, and $2.33 per
share, respectively. The estimated fair value of shares issued under the
Employee Stock Purchase Plans at December 31, 1996, 1997, and 1998 was
$9.56, $6.58, and $1.05 per share, respectively.
8. ACQUISITIONS
In February 1996, the Company acquired certain assets of Applied
Computing Devices, Inc. ("ACD"), a company that developed and marketed
operations systems software used primarily by independent telephone
companies to manage certain functions in their networks. The customer set
and products of ACD complement those of the Company and the Company
intends to continue to market and enhance these products. The Company
acquired the assets for $1,700 in cash and incurred approximately $200 in
related costs. The assets were acquired at an auction held in Federal
Bankruptcy Court, Southern District of Indiana. The transaction, which
was accounted for as a purchase, included the acquisition of in-process
research and development valued at approximately $1,200, property and
equipment valued at approximately $377 and purchased technology valued at
approximately $337. The Company recorded a one-time charge in the first
quarter of 1996 for approximately $1,186 associated with purchased
research and development costs.
In July 1996, the Company acquired certain assets of MPR Teltech, a
subsidiary of British Columbia Telecom, Inc. The assets acquired were
part of MPR Teltech's operating unit commonly known as the Special
Services Network division ("SSN"). The Company and its Canadian
subsidiary, ADA Canada, acquired the assets for $4,200 in cash, 150,000
shares of the Company's common stock and incurred approximately $200 in
related costs. SSN was an operations systems software development group
with expertise in the development of network management systems for
public carriers. SSN developed operations systems software primarily for
Northern Telecom ("Nortel"). SSN has become part of ADA Canada and will
develop network performance management operations systems software
products for the Company and its customers, including Nortel. The
transaction, which was
F-23
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
accounted for as a purchase, included the acquisition of in-process
research and development valued at approximately $2,100, property and
equipment valued at approximately $900 and goodwill and know-how valued
at approximately $2,588. The Company recorded a one-time charge in the
third quarter of 1996 for the $2,100 associated with purchased research
and development costs.
In June 1997, the Company acquired an exclusive worldwide license to
Nortel's Digital Support System II-TM- ("DSSII") operations system
software product, subject to certain residual rights retained by Nortel.
The Company acquired the license and certain assets related to the DSSII
product for a purchase price of $3,100. Of this amount, $3,100 was paid
in cash. The Company recorded a charge of approximately $1,578 for
purchased research and development associated with the acquisition of
the license and the assets. As part of the transaction, the Company also
issued Nortel three-year warrants to purchase 150,000 shares of the
Company common stock at an exercise price of $12 per share.
The following condensed pro forma results of operations information has
been presented to give effect to the acquisitions as if such transactions
had occurred at the beginning of each of the periods presented. The
historical results of operations have been adjusted to reflect additional
depreciation and amortization expense based upon the value allocated to
assets acquired in the purchases. The pro forma results of operations
information is presented for information purposes only and is not
necessarily indicative of the operating results that would have occurred
had the acquisitions been consummated as of the beginning of the periods
presented, nor is it necessarily indicative of future operating results.
<TABLE>
<CAPTION>
CONDENSED PRO FORMA RESULTS OF OPERATIONS
(UNAUDITED)
YEAR ENDED DECEMBER 31
---------------------------
1996 1997
<S> <C> <C>
Revenue $29,660 $34,050
Net loss (7,474) (4,283)
Net loss per share, basic and diluted (.61) (.34)
Weighted average shares used in computation 12,165 12,605
</TABLE>
F-24
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
9. INCOME TAXES
The provision for income taxes for the years ended December 31, 1996,
1997 and 1998 consists of current taxes for foreign operations.
Differences between the statutory rate and the effective tax rate for the
year ended December 31, 1996, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Taxes at federal statutory rate (34.0%) (34.0%) (34.0%)
Foreign income taxes 1.8% 3.2% 1.4%
Net operating loss carryforwards and research and
development tax credits (utilized) not utilized 33.0% 33.0% 33.0%
Other 1.0% 1.0% 1.0%
--- --- ---
Provision for income taxes 1.8% 3.2% 1.4%
--- --- ---
--- --- ---
</TABLE>
The components of the deferred tax assets at December 31, 1997 and 1998
are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
---------------------------------
1997 1998
<S> <C> <C>
Allowances and reserves $ 780 $ 818
Vacation accrual 178 250
Capitalized research and development 2,577 2,982
Net operating loss carryforwards 5,908 10,383
Tax credits 1,991 2,691
Accelerated depreciation (287) (145)
Other 10 10
--------------- ---------------
Total gross deferred tax asset 11,157 16,989
Less valuation allowance (9,655) (15,433)
--------------- ---------------
$ 1,502 $ 1,556
--------------- ---------------
--------------- ---------------
</TABLE>
F-25
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Realizability of the deferred tax asset is dependent on the Company
generating sufficient taxable income or utilizing tax planning
strategies available to the Company prior to expiration of the net
operating loss carryforwards. Although realization is not assured,
management believes it is more likely than not that the net deferred tax
asset will be realized. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of
future taxable income during the carryforward period are reduced.
At December 31, 1998, the Company has net operating loss carryforwards
for federal income tax purposes of approximately $27,642, of which $5,458
is attributable to disqualifying dispositions of stock options. The
Company also has net operating loss carryforwards for California tax
purposes of approximately $13,796 at December 31, 1998, of which $2,804
is attributable to disqualifying dispositions of stock options. The
amount attributable to the disposition of stock options will not impact
the Company's effective tax rate in future periods as the impact will be
reflected as a component of equity when recognized.
The Company also has research and development tax credit carryforwards of
approximately $2,162 for federal and $802 for California tax purposes at
December 31, 1998. These carryforwards will begin expiring, if unused, in
2003.
The Internal Revenue Code imposes limits on the availability of net
operating loss carryforwards and certain tax credits that arose prior to
certain cumulative changes in a corporation's ownership resulting in a
change of control of the Company. The Company's use of approximately
$1,166 of its federal net operating loss carryforwards and $408 of its
federal and $105 of its California tax credit carryforwards are
significantly limited because the Company underwent "ownership-changes"
in January 1989 and March 1991. In each year following the change, the
Company will be able to offset taxable income by a limited amount of the
pre-ownership change carryforwards. This limitation is determined by the
value of the Company immediately prior to the ownership change multiplied
by the long-term tax-exempt rate. Net operating losses and tax credits
that are unavailable in any year as a consequence of this limitation may
be carried forward for future use subject to certain restrictions.
F-26
<PAGE>
APPLIED DIGITAL ACCESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
10. SUBSEQUENT EVENTS
TERMINATION OF JOINT DEVELOPMENT AGREEMENT
On March 3, 1999, the Company's Joint Development Agreement (the
"Agreement") with Nortel was terminated. The Agreement, dated September
29, 1997, was for the development of SONET network element products for
the telecommunications industry. Under the terms of the Agreement, the
Company and Nortel each contributed technology and resources and shared
development costs related to the project. Nortel is obligated to continue
providing funding for the project for three months after the termination
date. While the Company has retained the intellectual property rights
associated with the jointly developed technology, Nortel has the right to
receive royalties to recover its portion of development costs paid to the
Company should the Company sell products utilizing the jointly developed
technology. The amount potentially reimbursable to Nortel was $6,117 at
December 31, 1998.
On March 31, 1999 the Company announced a reduction in its workforce of
approximately 65 people, or 22% of its total workforce. Of the reduction
in workforce, 23 were temporary positions. The Company determined the
reduction was necessary in order to align its current operations with
the Company's objectives of focusing on market opportunities in its
core business, reducing expenses including expenses related to its
recently terminated JDA with Nortel and improving operating results.
The majority of the reduction in workforce were engineers focused on
development conducted under JDA. As a result of the reduction in
workforce, the Company will close its office in Richardson, Texas.
The Company will incur a significant one-time charge in the first
quarter ending March 31, 1999, related to the reduction in workforce.
The Company's restructuring plan includes the identification of
the affected personnel, facility closures, asset write downs, and lease
terminations. The Company has not completed its analysis of the total
dollar amount associated with the restructuring charge, but will complete
this process prior to issuing its first quarter operating results.
F-27
<PAGE>
APPLIED DIGITAL ACCESS, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS
BEGINNING CHARGED TO BALANCE AT
DESCRIPTION YEAR OF YEAR EXPENSES WRITEOFFS END OF YEAR
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts 1996 $50 $ - $ - $50
1997 50 - - 50
1998 50 50 100
Inventory reserve 1996 537 - (68) 469
1997 469 312 (211) 570
1998 570 757 (653) 674
</TABLE>
F-28
<PAGE>
EXHIBIT 10.48
EXECUTIVE OFFICER
RETENTION AGREEMENT
This Executive Officer Retention Agreement (the "Agreement") is made
and entered into as of November 3, 1998 (the "Effective Date"), by and between
Applied Digital Access, Inc., a Delaware corporation (the "Company") and
___________________________ ("Executive").
RECITALS
The Company recognizes that the possibility of a Change of Control may
change the nature and structure of the Company and that uncertainty regarding
the consequences of such events may adversely affect the Company's ability to
retain its executives and other key employees. The Company also recognizes that
Executive possesses an intimate and essential knowledge of the Company upon
which the Company may need to draw for objective advice and continued services
in connection with any Change of Control that is potentially advantageous to the
Company's stockholders. The Company believes that the existence of this
Agreement will serve as an incentive to Executive to remain in the employ of the
Company and will enhance its ability to call on and rely upon Executive in
connection with a Change of Control.
The Company and Executive desire to enter into this Agreement in order
to provide additional compensation and benefits to Executive upon a Covered
Termination and to encourage Executive to continue to devote full attention and
dedication to the Company and to continue employment with the Company.
1. DEFINITIONS. As used in this Agreement, unless the context
requires a different meaning, the following terms shall have the meanings set
forth herein:
(a) "BASE SALARY" means the Executive's then current annual
base salary.
(b) "BOARD" means the Board of Directors of the Company or
any successor corporation thereto.
(c) "CAUSE" means:
(i) a proven willful act or failure to act including
theft, a material act of dishonesty, fraud, or the intentional falsification of
any employment or Company records which substantially impairs Executive's
ability to perform his duties under this Agreement;
(ii) willful improper disclosure of the Company's
confidential, business or proprietary information by Executive;
(iii) willful failure to substantially perform, or gross
neglect of, Executive's duties, including the refusal to perform any reasonable
act requested by the Board; provided such condition(s) remain(s) in effect
twenty (20) days after written notice is delivered by the Board to Executive of
such condition(s);
1
<PAGE>
(iv) any willful and intentional failure by Executive
to take or prevent any action which, in the reasonable determination of the
Board, hinders the possibility of, or process surrounding, any possible Change
in Control, or
(v) the Executive's conviction (including any plea of
guilty or nolo contendere) for a felony causing material harm to the reputation
and standing of the Company.
No act or failure shall be considered willful unless committed without good
faith and without a reasonable belief that the act or omission was in the best
interests of the Company.
Notwithstanding the foregoing, Executive shall not have been deemed to been
terminated for Cause without an opportunity for Executive, together with counsel
(if any) to be heard before the Board.
(d) "CHANGE OF CONTROL" means:
(i) any "person" (as such term is used in Sections
13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act")), other than a trustee or other fiduciary holding securities of
the Company under an employee benefit plan of the Company, becomes the
"beneficial owner" (as defined in Rule 13d-3 promulgated under the Exchange
Act), directly or indirectly, of securities of the Company representing fifty
percent (50%) or more of (A) the outstanding shares of common stock of the
Company or (B) the combined voting power of the Company's then-outstanding
securities;
(ii) the Company is party to a merger or consolidation
which results in the holders of voting securities of the Company outstanding
immediately prior thereto failing to continue to represent (either by remaining
outstanding or by being converted into voting securities of the surviving
entity) at least fifty percent (50%) of the combined voting power of the voting
securities of the Company or such surviving entity outstanding immediately after
such merger or consolidation;
(iii) there occurs a change in the Board within a
two-year period, as a result of which fewer than a majority of the Directors are
Incumbent Directors. For purposes of this Agreement, an Incumbent Director is
any director who is either:
(A) a director of the Company as of the
Effective Date; or
(B) a director who is elected or nominated for
election to the Board with the affirmative votes of at least a majority of the
Incumbent Directors at the time of such election or nomination (but shall not
include an individual whose election or nomination is in connection with an
actual or threatened proxy contest relating to the election of directors to the
Company);
(iv) the sale or disposition of all or substantially
all of the Company's assets (or any transaction having similar effect is
consummated); or
(v) the dissolution or liquidation of the Company.
2
<PAGE>
Notwithstanding any other provision herein to the contrary, for purposes of this
Agreement no Change of Control shall be deemed to have occurred as a result of
any ownership change which may occur as a result of an underwritten public
offering or private placement of the Company's stock.
(e) "COVERED TERMINATION" means:
(i) any termination of Executive's employment by the
Company without Cause within twelve (12) months after the date of a Change of
Control; or
(ii) any resignation by Executive for Good Reason
within twelve (12) months after the date of a Change of Control.
"Covered Termination" shall not include any termination of
Executive's employment (a) by the Company for Cause; (b) by the Company as a
result of the Permanent Disability of Executive; (c) as a result of the death of
Executive; or (d) as a result of Executive's voluntary termination of employment
for any reason other than Good Reason.
(f) "GOOD REASON" means the occurrence of any of the
following conditions, without Executive's written consent, which condition(s)
remain(s) in effect twenty (20) days after written notice is delivered by
Executive to the Board of such condition(s):
(i) a demotion which results in Executive no longer
holding a substantially similar position as an executive officer of the Company
with substantially similar pay. Any such determination under this subsection
shall be made by the Company; provided, however, that any decrease greater than
five percent (5%) in Executive's Base Salary following a Change of Control shall
not be deemed substantially similar pay;
(ii) the relocation of Executive's work place to a
location more than fifty (50) miles from the location of Executive's work place
prior to the Change of Control; or
(iii) any material breach of this Agreement by the
Company.
(g) "PERMANENT DISABILITY" means that:
(i) Executive has been incapacitated by bodily injury
or disease so as to be prevented thereby from engaging in the performance of
duties on behalf of the Company;
(ii) such total incapacity has continued for a period
of six (6) consecutive months; and
(iii) such incapacity will, in the opinion of a
qualified physician selected by the Company, be permanent and continuous during
the remainder of Executive's life.
2. POSITION AND DUTIES. Executive shall continue to be an at-will
employee of the Company employed in his current position at his current salary
rate. Executive shall also be entitled to continue to participate in and to
receive benefits on the same basis as other similarity-situated employees under
any and all of the Company's employee benefit plans as in effect from time to
time. In addition, Executive shall be entitled to the benefits afforded to other
similarly-
3
<PAGE>
situated employees under the Company's vacation, holiday and business
expense reimbursement policies. Executive agrees to devote Executive's full
business time, energy and skill to the duties of the Company. These duties shall
include, but not be limited to, any duties consistent with Executive's position
which may be assigned to Executive from time to time.
3. NO BENEFITS PAYABLE UNLESS A COVERED TERMINATION. This Agreement
is intended to address the benefits payable to Executive upon a Covered
Termination. As such, upon any termination of Executive which is not a Covered
Termination, Executive shall be entitled to only that compensation and those
benefits from the Company which have been earned under Section 2 above through
the date of such termination. PROVIDED, HOWEVER, that, pursuant to the terms of
one or more other written agreements, Executive may be entitled to benefits upon
a termination which is not a Covered Termination.
4. COVERED TERMINATION.
(a) SEVERANCE BENEFITS. In the event of a Covered
Termination, Executive shall be entitled to the following separation benefits:
(i) all accrued salary and accrued but unused vacation
earned through the date of Executive's termination;
(ii) twelve (12) months of Base Salary, paid in
accordance with the Company's then-existing payroll practices; provided,
however, that during such twelve (12) month-period (the "Consulting Period")
Executive shall be deemed to be a consultant of the Company, including for tax
purposes. Accordingly, Executive shall be liable for all income and employment
taxes;
(iii) continued vesting of Executive's then outstanding
stock options during the Consulting Period;
(iv) reimbursement for all expenses reasonably and
necessarily incurred by the Executive in connection with the business of the
Company prior to Executive's termination of employment; provided Executive
remits to the Company, within fourteen (14) days following the Covered
Termination, a proper and complete expense report;
(v) provided Executive elects continued medical
insurance coverage in accordance with the applicable provisions of federal law
(commonly referred to as "COBRA"), the payment by Company of Executive's COBRA
premiums for the duration of such Consulting Period; provided, further, if
Executive's medical coverage immediately prior to the date of the Covered
Termination included Executive's dependents, the Company-paid COBRA premiums
shall include such dependents. Notwithstanding the above, in the event Executive
becomes covered under another employer's group health plan (other than a plan
which imposes a preexisting condition exclusion, unless the preexisting
condition exclusion does not apply) during the Consulting Period, the Company
shall cease payment of the COBRA premiums; and
(vi) all benefits, if any, under the Company's 401(k)
Plan and other Company benefit plans to which Executive may be entitled pursuant
to the terms of such plan(s).
4
<PAGE>
5. CONFLICT OF INTEREST. During the Consulting Period, Executive
agrees not to compete with the Company, either directly or indirectly, without
the prior written consent of the Company, which shall not be unreasonably
withheld. Executive also agrees that during the Consulting Period, Executive
will not, directly or indirectly, solicit the services of or in any other manner
persuade employees or customers of the Company to discontinue that person's or
entity's relationship with or to the Company as an employee or customer, as the
case may be.
6. PAYMENT OF TAXES. All payments made to Executive under this
Agreement shall be subject to all applicable federal, state and local income,
employment and payroll taxes.
7. PARACHUTE PAYMENT. If the benefits provided under this Agreement
result in Executive being subject to any excise tax due to characterization of
any amounts payable hereunder as "excess parachute payments" (pursuant to
Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code")),
the Company agrees to offer the Executive the option of (i) receiving the full
parachute payment subject to the excise tax, or (ii) receiving a reduced
parachute payment that would not subject Executive to the excise tax (which in
some circumstances may maximize the net benefit to Executive). Unless the
Company and Executive otherwise agree in writing, any calculation required under
this Section shall be made in writing by independent public accountants agreed
to by the Company and Executive (the "Accountants"), whose calculation shall be
conclusive and binding upon Executive and the Company for all purposes. For
purposes of this Section, the Accountants may rely on reasonable, good faith
interpretations concerning the application of Sections 280G and 4999 of the
Code. The Company and Executive shall furnish to the Accountants such
information and documents as the Accountants may reasonably request in order to
make a determination. The Company shall bear all costs the Accountants may
reasonably incur in connection with any calculations contemplated by this
Section.
8. EXCLUSIVE REMEDY. The payments and benefits provided for in
Section 4 shall constitute the Executive's sole and exclusive remedy for any
alleged injury or other damages arising out of the cessation of Executive's
employment relationship with the Company in connection with a Covered
Termination. To the extent Executive is entitled to severance or other benefits
upon termination of employment under this Agreement and any other agreement, the
benefits payable under this Agreement shall be reduced by the amounts paid to
Executive under any other such agreement. However, this Agreement is not
intended to and shall not affect, limit or terminate (i) any plans, programs, or
arrangements of the Company that are regularly made available to a significant
number of employees of the Company, (ii) any agreement or arrangement with
Executive that has been reduced to writing and which does not relate to the
subject matter hereof, or (iii) any agreements or arrangements hereafter entered
into by the parties in writing, except as otherwise expressly provided herein.
9. PROPRIETARY AND CONFIDENTIAL INFORMATION. The Executive agrees to
continue to abide by the terms and conditions of any confidentiality and/or
proprietary rights agreement previously entered into by the Executive and the
Company.
10. ARBITRATION. Any claim, dispute or controversy arising out of
this Agreement, the interpretation, validity or enforceability of this Agreement
or the alleged breach thereof shall be submitted by the parties to binding
arbitration by the American Arbitration Association in San Diego County,
California or elsewhere by mutual agreement. The selection of the arbitrator and
5
<PAGE>
the arbitration procedure shall be governed by the Commercial Arbitration Rules
of the American Arbitration Association. All costs and expenses of arbitration
(or litigation to enforce such arbitration), including but not limited to
attorneys fees and other costs reasonably incurred by Executive, shall be paid
by party which does not prevail. Judgment may be entered on the award of the
arbitration in any court having jurisdiction.
11. INTERPRETATION. The Company and Executive agree that this
Agreement shall be interpreted in accordance with and governed by the laws of
the State of California, without regard to such state's conflict of laws rules.
12. RELEASE OF CLAIMS. No severance benefits shall be paid to
Executive under this Agreement unless and until Executive shall, in
consideration of the payment of such severance benefit, execute a release of
claims in a form attached hereto; provided, however, that such release shall not
apply to any right of Executive may have to be indemnified by the Company.
13. SUCCESSORS AND ASSIGNS.
(a) SUCCESSORS OF THE COMPANY. The Company will require any
successor or assign (whether direct or indirect, by purchase, merger,
consolidation or otherwise) to all or substantially all of the business and/or
assets of the Company, expressly, absolutely and unconditionally to assume and
agree to perform this Agreement in the same manner and to the same extent that
the Company would be required to perform it if no such succession or assignment
had taken place. Failure of the Company to obtain such agreement prior to the
effectiveness of any such succession transaction shall be a breach of this
Agreement which entitles Executive to terminate employment with the Company for
Good Reason and receive the benefits provided under Section 4 of this Agreement.
As used in this Agreement, "Company" shall mean the Company and any successor or
assign to the Company's business and/or assets as aforesaid which executes and
delivers the agreement provided for in this Section 13 or which otherwise
becomes bound by all the terms and provisions of this Agreement by operation of
law.
(b) HEIRS OF EXECUTIVE. This Agreement shall inure to the
benefit of and be enforceable by the Executive's personal and legal
representatives, executors, administrators, successors, heirs, distributees,
devisees and legatees.
14. NOTICES. For purposes of this Agreement, notices and all other
communications provided for in the Agreement shall be in writing and shall be
deemed to have been duly given when delivered or mailed by United States
registered mail, return receipt requested, postage prepaid, as follows:
if to the Company: Applied Digital Access, Inc.
9855 Scranton Road
San Diego, CA 92121
Attn: Compensation Committee of the Board
and if to the Executive at the address specified below Executive's signature.
Notice may also be given at such other address as either party may furnish to
the other in writing in accordance herewith, except that notices of change of
address shall be effective only upon receipt.
6
<PAGE>
15. VALIDITY. If any one or more of the provisions (or any part
thereof) of this Agreement shall be held invalid, illegal or unenforceable in
any respect, the validity, legality and enforceability of the remaining
provisions (or any part thereof) shall not in any way be affected or impaired
thereby.
16. MODIFICATION. This Agreement may only be modified or amended by a
written agreement signed by Executive and the Company.
17. COUNTERPARTS. This Agreement may be executed in counterparts,
each of which shall be deemed an original.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
Effective Date.
APPLIED DIGITAL ACCESS, INC.
By:
-------------------------------
Title:
-------------------------------
EXECUTIVE:
-------------------------------------
Address for Notice:
-------------------------------------
-------------------------------------
-------------------------------------
7
<PAGE>
EXHIBIT A: RELEASE OF CLAIMS
In consideration for the benefits to be received under that Retention
Agreement to which this Release is attached as EXHIBIT A, Executive and his
successors release the Company and all affiliated companies, and their
shareholders, investors, directors, officers, employees, agents, attorneys,
legal successors and assigns of and from any and all claims, actions and causes
of action, whether now known or unknown, which Executive now has, or at any
other time had, or shall or may have against the released parties based upon or
arising out of any matter, cause, fact, thing, act or omission whatsoever
occurring or existing at any time up to and including the date on which this
Release becomes effective, including, but not limited to, any claims of breach
of contract, wrongful termination, fraud, defamation, infliction of emotional
distress or national origin, race, age, sex, sexual orientation, disability or
other discrimination or harassment under the Civil Rights Act of 1964, the Age
Discrimination In Employment Act of 1967, the Americans With Disabilities Act,
the Fair Employment and Housing Act or any other applicable law.
Notwithstanding the foregoing, Executive does not release any claim for
any additional benefits pursuant to the Agreement which Executive is entitled to
receive following the date on which this Release is executed. In addition,
Executive shall continue to be entitled to all of the rights and benefits set
forth in any indemnification agreement between Executive and the Company.
Further, notwithstanding anything in this Release, Executive shall continue to
be indemnified to the full extent permitted by law for any event or occurrence
related to Executive's status as an employee, director, officer, agent or
fiduciary of the Company or any affiliate thereof or by reason of any action or
inaction on the part of Executive while serving in such capacity.
Executive acknowledges that he has read Section 1542 of the Civil Code
of the State of California, which states in full:
A general release does not extend to claims which the creditor
does not know or suspect to exist in his favor at the time of
executing the release, which if known by him must have materially
affected his settlement with the debtor.
Executive waives any rights that he has or may have under Section 1542
to the full extent that he may lawfully waive such rights pertaining to this
release of claims, and affirms that he is releasing all known and unknown claims
that he has or may have against the parties listed above.
Executive understands that Executive should consult with an attorney
prior to signing this Release and that Executive is giving up any legal claims
Executive has against the parties released above by signing this Release.
Executive acknowledges that Executive is signing this Release knowingly,
willingly and voluntarily in exchange for the benefits described herein.
Executive further understands that, IF AND ONLY IF EXECUTIVE IS AGE 40 OR OLDER,
Executive has up to 21 days to consider this Release, that Executive may revoke
it at any time during the 7 days after the date it is signed, and that it shall
not become effective until that 7-day period has passed.
Signature: Date:
------------------------------ --------------------
8
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EXHIBIT 10.49
PRESIDENT AND CHIEF EXECUTIVE OFFICER
RETENTION AGREEMENT
This Executive Officer Retention Agreement (the "Agreement") is made
and entered into as of November 3, 1998 (the "Effective Date"), by and between
Applied Digital Access, Inc., a Delaware corporation (the "Company") and Peter
P. Savage ("Executive").
RECITALS
The Company recognizes that the possibility of a Change of Control may
change the nature and structure of the Company and that uncertainty regarding
the consequences of such events may adversely affect the Company's ability to
retain its executives and other key employees. The Company also recognizes that
Executive possesses an intimate and essential knowledge of the Company upon
which the Company may need to draw for objective advice and continued services
in connection with any Change of Control that is potentially advantageous to the
Company's stockholders. The Company believes that the existence of this
Agreement will serve as an incentive to Executive to remain in the employ of the
Company and will enhance its ability to call on and rely upon Executive in
connection with a Change of Control.
The Company and Executive desire to enter into this Agreement in order
to provide additional compensation and benefits to Executive upon a Covered
Termination and to encourage Executive to continue to devote full attention and
dedication to the Company and to continue employment with the Company.
1. DEFINITIONS. As used in this Agreement, unless the context
requires a different meaning, the following terms shall have the meanings set
forth herein:
(a) "BASE SALARY" means the Executive's then current annual
base salary.
(b) "BOARD" means the Board of Directors of the Company or any
successor corporation thereto.
(c) "CAUSE" means:
(i) a proven willful act or failure to act including
theft, a material act of dishonesty, fraud, or the intentional falsification of
any employment or Company records which substantially impairs Executive's
ability to perform his duties under this Agreement;
(ii) willful improper disclosure of the Company's
confidential, business or proprietary information by Executive;
(iii) willful failure to substantially perform, or gross
neglect of, Executive's duties, including the refusal to perform any reasonable
act requested by the Board; provided such condition(s) remain(s) in effect
twenty (20) days after written notice is delivered by the Board to Executive of
such condition(s);
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(iv) any willful and intentional failure by Executive
to take or prevent any action which, in the reasonable determination of the
Board, hinders the possibility of, or process surrounding, any possible Change
in Control, or
(v) the Executive's conviction (including any plea of
guilty or nolo contendere) for a felony causing material harm to the reputation
and standing of the Company.
No act or failure shall be considered willful unless committed without good
faith and without a reasonable belief that the act or omission was in the best
interests of the Company.
Notwithstanding the foregoing, Executive shall not have been deemed to been
terminated for Cause without an opportunity for Executive, together with counsel
(if any) to be heard before the Board.
(d) "CHANGE OF CONTROL" means:
(i) any "person" (as such term is used in Sections
13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act")), other than a trustee or other fiduciary holding securities of
the Company under an employee benefit plan of the Company, becomes the
"beneficial owner" (as defined in Rule 13d-3 promulgated under the Exchange
Act), directly or indirectly, of securities of the Company representing fifty
percent (50%) or more of (A) the outstanding shares of common stock of the
Company or (B) the combined voting power of the Company's then-outstanding
securities;
(ii) the Company is party to a merger or consolidation
which results in the holders of voting securities of the Company outstanding
immediately prior thereto failing to continue to represent (either by remaining
outstanding or by being converted into voting securities of the surviving
entity) at least fifty percent (50%) of the combined voting power of the voting
securities of the Company or such surviving entity outstanding immediately after
such merger or consolidation;
(iii) there occurs a change in the Board within a
two-year period, as a result of which fewer than a majority of the Directors are
Incumbent Directors. For purposes of this Agreement, an Incumbent Director is
any director who is either:
(A) a director of the Company as of the
Effective Date; or
(B) a director who is elected or nominated for
election to the Board with the affirmative votes of at least a majority of the
Incumbent Directors at the time of such election or nomination (but shall not
include an individual whose election or nomination is in connection with an
actual or threatened proxy contest relating to the election of directors to the
Company);
(iv) the sale or disposition of all or substantially
all of the Company's assets (or any transaction having similar effect is
consummated); or
(v) the dissolution or liquidation of the Company.
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Notwithstanding any other provision herein to the contrary, for purposes of this
Agreement no Change of Control shall be deemed to have occurred as a result of
any ownership change which may occur as a result of an underwritten public
offering or private placement of the Company's stock.
(e) "COVERED TERMINATION" means:
(i) any termination of Executive's employment by the
Company without Cause within twelve (12) months after the date of a Change of
Control; or
(ii) any resignation by Executive for Good Reason
within twelve (12) months after the date of a Change of Control.
"COVERED TERMINATION" shall not include any termination of
Executive's employment (a) by the Company for Cause; (b) by the Company as a
result of the Permanent Disability of Executive; (c) as a result of the death of
Executive; or (d) as a result of Executive's voluntary termination of employment
for any reason other than Good Reason.
(f) "GOOD REASON" means the occurrence of any of the following
conditions, without Executive's written consent, which condition(s) remain(s) in
effect twenty (20) days after written notice is delivered by Executive to the
Board of such condition(s):
(i) a demotion which results in Executive no longer
holding a substantially similar position as an executive officer of the Company
with substantially similar pay. Any such determination under this subsection
shall be made by the Company; provided, however, that any decrease greater than
five percent (5%) in Executive's Base Salary following a Change of Control shall
not be deemed substantially similar pay;
(ii) the relocation of Executive's work place to a
location more than fifty (50) miles from the location of Executive's work place
prior to the Change of Control; or
(iii) any material breach of this Agreement by the
Company.
(g) "PERMANENT DISABILITY" means that:
(i) Executive has been incapacitated by bodily injury
or disease so as to be prevented thereby from engaging in the performance of
duties on behalf of the Company;
(ii) such total incapacity has continued for a period
of six (6) consecutive months; and
(iii) such incapacity will, in the opinion of a
qualified physician selected by the Company, be permanent and continuous during
the remainder of Executive's life.
2. POSITION AND DUTIES. Executive shall continue to be an at-will
employee of the Company employed in his current position at his current salary
rate. Executive shall also be entitled to continue to participate in and to
receive benefits on the same basis as other similarity-situated employees under
any and all of the Company's employee benefit plans as in effect from
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time to time. In addition, Executive shall be entitled to the benefits
afforded to other similarly-situated employees under the Company's vacation,
holiday and business expense reimbursement policies. Executive agrees to
devote Executive's full business time, energy and skill to the duties of the
Company. These duties shall include, but not be limited to, any duties
consistent with Executive's position which may be assigned to Executive from
time to time.
3. NO BENEFITS PAYABLE UNLESS A COVERED TERMINATION. This Agreement
is intended to address the benefits payable to Executive upon a Covered
Termination. As such, upon any termination of Executive which is not a Covered
Termination, Executive shall be entitled to only that compensation and those
benefits from the Company which have been earned under Section 2 above through
the date of such termination. PROVIDED, HOWEVER, that, pursuant to the terms of
one or more other written agreements, Executive may be entitled to benefits upon
a termination which is not a Covered Termination.
4. COVERED TERMINATION.
(a) SEVERANCE BENEFITS. In the event of a Covered Termination,
Executive shall be entitled to the following separation benefits:
(i) all accrued salary and accrued but unused vacation
earned through the date of Executive's termination;
(ii) eighteen (18) months of Base Salary, paid in
accordance with the Company's then-existing payroll practices; provided,
however, that during such eighteen (18) month-period (the "Consulting Period")
Executive shall be deemed to be a consultant of the Company, including for tax
purposes. Accordingly, Executive shall be liable for all income and employment
taxes;
(iii) continued vesting of Executive's then outstanding
stock options during the Consulting Period;
(iv) reimbursement for all expenses reasonably and
necessarily incurred by the Executive in connection with the business of the
Company prior to Executive's termination of employment; provided Executive
remits to the Company, within fourteen (14) days following the Covered
Termination, a proper and complete expense report; (v) provided Executive elects
continued medical insurance coverage in accordance with the applicable
provisions of federal law (commonly referred to as "COBRA"), the payment by
Company of Executive's COBRA premiums for the duration of such Consulting
Period; provided, further, if Executive's medical coverage immediately prior to
the date of the Covered Termination included Executive's dependents, the
Company-paid COBRA premiums shall include such dependents. Notwithstanding the
above, in the event Executive becomes covered under another employer's group
health plan (other than a plan which imposes a preexisting condition exclusion,
unless the preexisting condition exclusion does not apply) during the Consulting
Period, the Company shall cease payment of the COBRA premiums; and
(vi) all benefits, if any, under the Company's 401(k)
Plan and other Company benefit plans to which Executive may be entitled pursuant
to the terms of such plan(s).
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5. CONFLICT OF INTEREST. During the Consulting Period, Executive
agrees not to compete with the Company, either directly or indirectly, without
the prior written consent of the Company, which shall not be unreasonably
withheld. Executive also agrees that during the Consulting Period, Executive
will not, directly or indirectly, solicit the services of or in any other manner
persuade employees or customers of the Company to discontinue that person's or
entity's relationship with or to the Company as an employee or customer, as the
case may be.
6. PAYMENT OF TAXES. All payments made to Executive under this
Agreement shall be subject to all applicable federal, state and local income,
employment and payroll taxes.
7. PARACHUTE PAYMENT. If the benefits provided under this Agreement
result in Executive being subject to any excise tax due to characterization of
any amounts payable hereunder as "excess parachute payments" (pursuant to
Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code")), the
Company agrees to offer the Executive the option of (i) receiving the full
parachute payment subject to the excise tax, or (ii) receiving a reduced
parachute payment that would not subject Executive to the excise tax (which in
some circumstances may maximize the net benefit to Executive). Unless the
Company and Executive otherwise agree in writing, any calculation required under
this Section shall be made in writing by independent public accountants agreed
to by the Company and Executive (the "Accountants"), whose calculation shall be
conclusive and binding upon Executive and the Company for all purposes. For
purposes of this Section, the Accountants may rely on reasonable, good faith
interpretations concerning the application of Sections 280G and 4999 of the
Code. The Company and Executive shall furnish to the Accountants such
information and documents as the Accountants may reasonably request in order to
make a determination. The Company shall bear all costs the Accountants may
reasonably incur in connection with any calculations contemplated by this
Section.
8. EXCLUSIVE REMEDY. The payments and benefits provided for in
Section 4 shall constitute the Executive's sole and exclusive remedy for any
alleged injury or other damages arising out of the cessation of Executive's
employment relationship with the Company in connection with a Covered
Termination. To the extent Executive is entitled to severance or other benefits
upon termination of employment under this Agreement and any other agreement,
the benefits payable under this Agreement shall be reduced by the amounts paid
to Executive under any other such agreement. However, this Agreement is not
intended to and shall not affect, limit or terminate (i) any plans, programs, or
arrangements of the Company that are regularly made available to a significant
number of employees of the Company, (ii) any agreement or arrangement with
Executive that has been reduced to writing and which does not relate to the
subject matter hereof, or (iii) any agreements or arrangements hereafter entered
into by the parties in writing, except as otherwise expressly provided herein.
9. PROPRIETARY AND CONFIDENTIAL INFORMATION. The Executive agrees to
continue to abide by the terms and conditions of any confidentiality and/or
proprietary rights agreement previously entered into by the Executive and the
Company.
10. ARBITRATION. Any claim, dispute or controversy arising out of
this Agreement, the interpretation, validity or enforceability of this Agreement
or the alleged breach thereof shall be submitted by the parties to binding
arbitration by the American Arbitration Association in San
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Diego County, California or elsewhere by mutual agreement. The selection of
the arbitrator and the arbitration procedure shall be governed by the
Commercial Arbitration Rules of the American Arbitration Association. All
costs and expenses of arbitration (or litigation to enforce such
arbitration), including but not limited to attorneys fees and other costs
reasonably incurred by Executive, shall be paid by party which does not
prevail. Judgment may be entered on the award of the arbitration in any court
having jurisdiction.
11. INTERPRETATION. The Company and Executive agree that this
Agreement shall be interpreted in accordance with and governed by the laws of
the State of California, without regard to such state's conflict of laws rules.
12. RELEASE OF CLAIMS. No severance benefits shall be paid to
Executive under this Agreement unless and until Executive shall, in
consideration of the payment of such severance benefit, execute a release of
claims in a form attached hereto; provided, however, that such release shall not
apply to any right of Executive may have to be indemnified by the Company.
13. SUCCESSORS AND ASSIGNS.
(a) SUCCESSORS OF THE COMPANY. The Company will require any
successor or assign (whether direct or indirect, by purchase, merger,
consolidation or otherwise) to all or substantially all of the business and/or
assets of the Company, expressly, absolutely and unconditionally to assume and
agree to perform this Agreement in the same manner and to the same extent that
the Company would be required to perform it if no such succession or assignment
had taken place. Failure of the Company to obtain such agreement prior to the
effectiveness of any such succession transaction shall be a breach of this
Agreement which entitles Executive to terminate employment with the Company for
Good Reason and receive the benefits provided under Section 4 of this Agreement.
As used in this Agreement, "Company" shall mean the Company and any successor or
assign to the Company's business and/or assets as aforesaid which executes and
delivers the agreement provided for in this Section 13 or which otherwise
becomes bound by all the terms and provisions of this Agreement by operation of
law.
(b) HEIRS OF EXECUTIVE. This Agreement shall inure to the
benefit of and be enforceable by the Executive's personal and legal
representatives, executors, administrators, successors, heirs, distributees,
devisees and legatees.
14. NOTICES. For purposes of this Agreement, notices and all other
communications provided for in the Agreement shall be in writing and shall be
deemed to have been duly given when delivered or mailed by United States
registered mail, return receipt requested, postage prepaid, as follows:
if to the Company: Applied Digital Access, Inc.
9855 Scranton Road
San Diego, CA 92121
Attn: Compensation Committee of the Board
and if to the Executive at the address specified below Executive's signature.
Notice may also be given at such other address as either party may furnish to
the other in writing in accordance herewith, except that notices of change of
address shall be effective only upon receipt.
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15. VALIDITY. If any one or more of the provisions (or any part
thereof) of this Agreement shall be held invalid, illegal or unenforceable in
any respect, the validity, legality and enforceability of the remaining
provisions (or any part thereof) shall not in any way be affected or impaired
thereby.
16. MODIFICATION. This Agreement may only be modified or amended by a
written agreement signed by Executive and the Company.
17. COUNTERPARTS. This Agreement may be executed in counterparts,
each of which shall be deemed an original.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
Effective Date.
APPLIED DIGITAL ACCESS, INC.
By:
------------------------------
Title:
------------------------------
EXECUTIVE:
James Keefe
------------------------------------
Address for Notice:
------------------------------------
------------------------------------
------------------------------------
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EXHIBIT A: RELEASE OF CLAIMS
In consideration for the benefits to be received under that Retention
Agreement to which this Release is attached as EXHIBIT A, Executive and his
successors release the Company and all affiliated companies, and their
shareholders, investors, directors, officers, employees, agents, attorneys,
legal successors and assigns of and from any and all claims, actions and causes
of action, whether now known or unknown, which Executive now has, or at any
other time had, or shall or may have against the released parties based upon or
arising out of any matter, cause, fact, thing, act or omission whatsoever
occurring or existing at any time up to and including the date on which this
Release becomes effective, including, but not limited to, any claims of breach
of contract, wrongful termination, fraud, defamation, infliction of emotional
distress or national origin, race, age, sex, sexual orientation, disability or
other discrimination or harassment under the Civil Rights Act of 1964, the Age
Discrimination In Employment Act of 1967, the Americans With Disabilities Act,
the Fair Employment and Housing Act or any other applicable law.
Notwithstanding the foregoing, Executive does not release any claim for
any additional benefits pursuant to the Agreement which Executive is entitled to
receive following the date on which this Release is executed. In addition,
Executive shall continue to be entitled to all of the rights and benefits set
forth in any indemnification agreement between Executive and the Company.
Further, notwithstanding anything in this Release, Executive shall continue to
be indemnified to the full extent permitted by law for any event or occurrence
related to Executive's status as an employee, director, officer, agent or
fiduciary of the Company or any affiliate thereof or by reason of any action or
inaction on the part of Executive while serving in such capacity.
Executive acknowledges that he has read Section 1542 of the Civil Code
of the State of California, which states in full:
A general release does not extend to claims which the creditor
does not know or suspect to exist in his favor at the time of
executing the release, which if known by him must have materially
affected his settlement with the debtor.
Executive waives any rights that he has or may have under Section 1542
to the full extent that he may lawfully waive such rights pertaining to this
release of claims, and affirms that he is releasing all known and unknown claims
that he has or may have against the parties listed above.
Executive understands that Executive should consult with an attorney
prior to signing this Release and that Executive is giving up any legal claims
Executive has against the parties released above by signing this Release.
Executive acknowledges that Executive is signing this Release knowingly,
willingly and voluntarily in exchange for the benefits described herein.
Executive further understands that, IF AND ONLY IF EXECUTIVE IS AGE 40 OR OLDER,
Executive has up to 21 days to consider this Release, that Executive may revoke
it at any time during the 7 days after the date it is signed, and that it shall
not become effective until that 7-day period has passed.
Signature: Date:
------------------------------ -----------------------
<PAGE>
EXHIBIT 10.50
CONFIDENTIAL SEPARATION AGREEMENT
This Confidential Separation Agreement ("Agreement") is entered into as
of January 25, 1999 (hereinafter the "Effective Date"), by and between Steven F.
X. Murphy ("Murphy") and Applied Digital Access, Inc. (the "Company") with
respect to the following facts:
RECITALS
A. Murphy is currently an officer of the Company and holds the title
of Vice President of Sales and Marketing.
B. Pursuant to the terms of this Agreement, Murphy's employment with
the Company will terminate, and Murphy will be deemed to have resigned from his
employment with the Company.
AGREEMENT
WHEREFORE, the parties to this Agreement agree as follows:
1. TERMINATION OF EMPLOYMENT. On the Effective Date of this
Agreement, Murphy's employment with the Company will terminate, and he will be
deemed to have resigned from his employment.
2. SEVERANCE PAYMENTS TO MURPHY.
(a) In exchange for the valuable consideration described in
this Agreement, the Company agrees to pay Murphy severance pay in the total
amount of One Hundred Thousand Dollars ($100,000), less withholdings and
applicable taxes, a sum to which Murphy is not otherwise entitled.
(b) This severance pay will be paid to Murphy monthly in six
(6) equal monthly installments. The first payment of $16,666.67 will be made
immediately upon Murphy's execution of this Agreement, and the remaining five
payments will be made monthly on the 15th of each month from February 15, 1999
through June 15, 1999 by automatic deposit into an account to be designated by
Murphy. The time period from the Effective Date of this Agreement through the
date of the final severance payment will hereinafter be referred to as the
"Severance Period."
(c) The Company further agrees that, on or before January 29,
1999, it will reimburse Murphy for any remaining reasonable business expenses
Murphy has submitted to the Company for reimbursement. The Company further
agrees that, during the Severance Period, it will pay Murphy's COBRA premiums
unless and until Murphy obtains employment benefits from another employer during
the Severance Period. The Company further agrees that Murphy will be allowed to
exercise all stock options held by Murphy that have vested as of the Effective
Date of this Agreement. The Company further agrees that, during the Severance
Period, Murphy will be allowed to use the personal computer belonging to the
Company that is currently in
<PAGE>
Murphy's possession, provided the Company is first allowed the opportunity to
erase the hard drive of that computer. The computer will be returned by
Murphy to the Company at the end of the Severance Period.
(d) Murphy acknowledges and agrees that, other than the
compensation and benefits described in this paragraph, Murphy has received all
the compensation from the Company to which he is entitled, and he acknowledges
and agrees that he is not entitled to any additional employee benefits,
incentive compensation, vacation pay, stock option vesting, bonuses, profit
sharing, or any other compensation or benefits of any kind or character from the
Company.
3. RELEASE BY MURPHY. In exchange for the valuable consideration
described in this Agreement, Murphy unconditionally, irrevocably and absolutely
releases and discharges the Company and any related or subsidiary corporations
or organizations, as well as all present and former employees, officers,
directors, agents, successors and assigns of the Company (hereinafter
collectively "Releasees"), from any and all claims related in any way to the
transactions, affairs or occurrences between them to date, including but not
limited to Murphy's employment with the Company, the termination of his
employment, and all losses, liabilities, claims, charges, demands and causes of
action, known or unknown, suspected or unsuspected, arising directly or
indirectly out of or in any way connected with the termination of Murphy's
employment with the Company. This release is intended to have the broadest
possible application and includes but is not limited to any claim for unpaid
salary or employee benefits, incentive compensation, commissions, bonuses,
profit sharing, breach of contract, wrongful termination, tortious discharge,
defamation, false imprisonment, fraud, infliction of emotional distress or
employment discrimination arising under federal, state or local law, including
but not limited to the California Fair Employment and Housing Act, Title VII of
the Civil Rights Act of 1964 and the Employee Retirement Income Security Act,
but excludes claims under the Age Discrimination in Employment Act of 1967.
4. WAIVER OF UNKNOWN CLAIMS. Murphy expressly acknowledges and
agrees that the release set forth above is binding notwithstanding any facts he
later becomes aware of, any change in the law that might have affected his
decision to enter into this Agreement, or any discovery by him that the facts or
the law relative to the matters released herein are different from what he
understood them to be at the time of signing this Agreement. Murphy expressly
waives all of the benefits and rights granted to him pursuant to Civil Code
Section 1542, which provides and reads as follows:
A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR
DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF
EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY
AFFECTED HIS SETTLEMENT WITH THE DEBTOR.
5. PROMISE NOT TO PROSECUTE. The parties to this Agreement, for
themselves, their heirs, successors and assigns, agree that they will not
prosecute or allow to be prosecuted on their behalf, in any administrative
agency or court, whether state or federal, any claim or demand of any type
related to the matters released above. It is the intention of the parties that
with the
<PAGE>
execution of this Agreement, the Company and its officers, directors,
employees (past or present), agents, successors or assigns, and all
subsidiary and affiliated corporations will be absolutely, unconditionally
and forever discharged of and from all obligations to or on behalf of Murphy
related in any way to the matters discharged herein.
6. NONSOLICITATION OF COMPANY'S EMPLOYEES. Murphy further agrees
that for one year following the Effective Date of this Agreement, he will not,
either directly or indirectly, separately or in association with others, solicit
any of the Company's employees, encourage others to solicit any of the Company's
employees, or encourage any of the Company's employees to discontinue their
employment with the Company. Further, Murphy will not solicit any consultants
that have consulting agreements or consulting arrangements with the Company,
encourage any of the Company's consultants to discontinue their relationships
with the Company, or assist others in soliciting or encouraging any of the
Company's consultants to discontinue their relationships with the Company.
7. NONDISPARAGEMENT/PUBLIC STATEMENTS. Murphy agrees that he will
hereafter conduct himself in a manner that tends to increase the value of the
Company to its shareholders. To that end, Murphy agrees that he will not at any
time make any statements, written or verbal, that defame, disparage or denigrate
the personal and/or professional reputations of the Company and/or its officers,
directors, managers, employees, or anyone affiliated with the Company. Murphy
further agrees that, if questioned by anyone about the Company, he will take
affirmative steps to publicly support the Company, those affiliated with the
Company, and the Company's decisions and stated directions, and will encourage
employees of the Company to remain employed at the Company and work for its
success. The Company and its officers and directors agree that they will not at
any time make any public statements, written or verbal, that defame, disparage
or denigrate the personal and/or professional reputation of Murphy.
8. CONFIDENTIALITY. Murphy agrees that the terms and conditions of
this Agreement shall remain strictly confidential and shall not be disclosed to
any other person or entity except as provided below:
(a) Murphy may disclose the terms of this Agreement deemed in
good faith to be necessary to the California Franchise Tax Board, the United
States Internal Revenue Service, his spouse, his immediate family, his tax or
financial advisers and his legal counsel.
(b) Except as provided in Paragraph 7 above, Murphy will
respond to or in any way participate in or contribute to any public discussion,
notice or other publicity concerning or in any way related to the transaction or
events that are the subject of this Agreement or the execution of this
Agreement.
(c) Without limiting the generality of the foregoing, Murphy
agrees that he will not disclose any information regarding this Agreement to any
current, former or future employee of the Company or any attorney or other
representative thereof.
<PAGE>
9. ACKNOWLEDGMENT OF EMPLOYEE PROPRIETARY INFORMATION AGREEMENT.
(a) Murphy acknowledges and affirms his obligations as set
forth in the Applied Digital Access Employee Proprietary Information Agreement
("EPIA") he executed on or about April 1, 1997, and Murphy specifically
acknowledges and agrees that the EPIA remains in full force and effect
notwithstanding any provision of this Agreement.
(b) Murphy further certifies and agrees that, pursuant to the
"Release of Assets" form attached as Exhibit B to the EPIA, he will preserve as
confidential all trade secrets, confidential knowledge, data or other
proprietary information relating to products, processes, know-how, designs,
formulas, development or experimental work, computer lists, business plans,
financial information or other subject matter pertaining to any business of the
Company or any of its clients, consultants or licensees.
(c) Murphy further certifies and agrees that, pursuant to the
"Release of Assets" form attached as Exhibit B to the EPIA, he does not have in
his possession, nor has he failed to return, any devices, records, data, notes,
proposals, lists, correspondence, specifications, drawings, blueprints,
sketches, materials, equipment, other documents or property, or reproductions of
any of the aforementioned items belonging to the Company, other than the
personal computer referenced in Paragraph 2 above.
10. REMEDIES FOR BREACH.
(a) The parties to this Agreement agree that, if Murphy or any
of his agents breach any of the terms of this Agreement during the Severance
Period, Murphy will forfeit his right to receive any remaining severance
payments described in this Agreement, to the extent those payments have not yet
been made.
(b) The parties further agree that if the Company fails to
make any of the payments described in Paragraph 1, other than for the reasons
set forth in this paragraph, the remaining payments to Murphy will become
immediately due and owing to Murphy, and Murphy will be entitled to interest at
the legal rate for the period during which the Company fails to make such
payment.
(c) The parties further agree that a breach of any of the
terms of this Agreement by Murphy or any of his agents will be deemed to cause
irreparable harm to the Company, such that the Company's remedy at law is
recognized to be inadequate to redress the harm to the Company. With this
understanding, the parties agree that, upon a breach of any of the terms of this
Agreement by Murphy or any of his agents, the Company may apply for immediate
injunctive relief in any court of competent jurisdiction to enforce the terms of
this Agreement, as well as for money damages, including punitive damages, for
breach of any of the terms of this Agreement. If the Company's application for
injunctive or other relief is denied by the court or is otherwise unsuccessful,
the parties understand and agree that no res judicata effect and no effect on
the Company's right to apply for any future relief shall flow therefrom.
(d) The parties further agree that, in the event of any
litigation concerning any controversy, claim or dispute between the parties
arising out of or relating to this Agreement or the breach hereof, or the
interpretation hereof, the prevailing party shall be entitled to recover
<PAGE>
from the losing party reasonable expenses, attorneys' fees, and costs
incurred therein or in the enforcement or collection of any judgment or award
rendered therein. The "prevailing party" means the party determined by the
court to have most nearly prevailed, even if such party did not prevail in
all matters.
(e) The parties further agree that the remedies expressed in
this paragraph are in addition to all other remedies at law or in equity that
may be available to the Company upon a breach of this Agreement.
(f) The parties further agree that, before seeking any of the
remedies set forth in this paragraph against the other party to this Agreement,
the party seeking said remedy will notify the other party in writing of that
party's alleged breach of the terms of this Agreement and allow for a 20-day
opportunity to cure the alleged breach. If the breaching party fails to cure the
alleged breach with said 20-day period to the reasonable satisfaction of the
party alleging the breach, that party may seek to enforce any and all remedies
set forth in this paragraph.
11. VOLUNTARY AGREEMENT. Murphy acknowledges that he has executed
this Agreement after independent investigation and without coercion, duress,
fraud or undue influence. Murphy also acknowledges that he has read and
understands the terms of this Agreement. Murphy also agrees that he has been
given a full opportunity to consult with, and has consulted with, an attorney
regarding this Agreement and its terms. By signing this Agreement, Murphy
acknowledges that he does so freely, knowingly and voluntarily.
12. MISCELLANEOUS PROVISIONS.
(a) ENTIRE AGREEMENT. With the exception of the EPIA discussed
in Paragraph 9 above, this Agreement contains the entire agreement between the
parties with respect to the subject matter hereof. It is agreed that there are
no collateral agreements or representations, written or oral, that are not
contained in this Agreement. This Agreement may be amended only by a written
instrument executed by all parties hereto.
(b) SEVERABILITY. Should it be determined by a court that any
term of this Agreement is unenforceable, that term shall be deemed to be
deleted. However, the validity and enforceability of the remaining terms shall
not be affected by the deletion of the unenforceable term. Furthermore, in the
event of a breach of any provision of this Agreement, all other provisions of
this Agreement shall remain in full force and effect.
(c) APPLICABLE LAW. The validity, interpretation and
performance of this Agreement shall be construed and interpreted according to
the laws of the State of California.
(d) BINDING ON SUCCESSORS. The parties agree that this
Agreement shall be binding on and inure to the benefit of the successors, heirs
and assigns of the Company and Murphy.
(e) INTERPRETATION; CONSTRUCTION. The headings set forth in
this Agreement are for convenience only and shall not be used in interpreting
this Agreement. This Agreement has been drafted by legal counsel representing
the Company, but Murphy has participated in the negotiation of its terms.
Furthermore, Murphy acknowledges that he has had an opportunity to
<PAGE>
read, review and discuss each term of this Agreement with legal counsel, and
therefore the normal rule of construction to the effect that any ambiguities
are to be resolved against the drafting party shall not be employed in the
interpretation of this Agreement.
(f) SIGNATORIES' REPRESENTATIONS. The parties affixing their
signatures hereto represent and warrant that they have the authority to enter
into this Agreement on their own behalf and/or on behalf of their employer and
to bind all persons or entities who may claim through them; that they have
neither filed nor caused to be filed any claims or actions against any other
party to this Agreement that are not the subject of the release set forth above;
and that the claims released by this Agreement have not been assigned to any
other person or entity.
(g) COUNTERPARTS. This Agreement may be executed in identical
counterparts. The Agreement will be binding and enforceable when all parties
have signed an original counterpart of this Agreement.
* * *
REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK
<PAGE>
The parties have read the foregoing Agreement and fully understand each
and every provision contained herein and have been given the opportunity to
consult with counsel regarding this Agreement.
WHEREFORE, the parties have executed this Agreement on the dates shown
below.
APPLIED DIGITAL ACCESS, INC.
Dated: By:
---------------------------- ----------------------------------
By:
Its:
Dated:
---------------------------- -------------------------------------
Steven F. X. Murphy
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 12,513
<SECURITIES> 0
<RECEIVABLES> 6,211
<ALLOWANCES> (100)
<INVENTORY> 5,679
<CURRENT-ASSETS> 26,133
<PP&E> 14,524
<DEPRECIATION> (9,058)
<TOTAL-ASSETS> 34,272
<CURRENT-LIABILITIES> 9,377
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 24,882
<TOTAL-LIABILITY-AND-EQUITY> 34,272
<SALES> 29,217
<TOTAL-REVENUES> 29,217
<CGS> 13,587
<TOTAL-COSTS> 13,587
<OTHER-EXPENSES> 29,191
<LOSS-PROVISION> 50
<INTEREST-EXPENSE> 2
<INCOME-PRETAX> (12,938)
<INCOME-TAX> 186
<INCOME-CONTINUING> (13,124)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,124)
<EPS-PRIMARY> (1.03)
<EPS-DILUTED> (1.03)
</TABLE>
