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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
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NUMBER: 0-28734
ADVANCED FIBRE COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 68-0277743
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
ONE WILLOW BROOK COURT
PETALUMA, CALIFORNIA 94954
(707) 794-7700
(ADDRESS, INCLUDING ZIP CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES
AND 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, $0.01
PAR VALUE
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 15, 1999, 76,624,882 shares of Advanced Fibre Communications,
Inc. Common Stock, $0.01 par value, were outstanding, and the aggregate market
price of the shares held by non-affiliates was $577,597,854. (Solely for the
purposes of calculating the preceding amount, all directors and officers of the
registrant are deemed to be affiliates.)
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Company's Annual Report to Stockholders for the
year ended December 31, 1998 and the Company's definitive Proxy Statement issued
in connection with the 1999 Annual Meeting of Stockholders to be held on May 25,
1999, are incorporated by reference in Parts II and III of this report.
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ADVANCED FIBRE COMMUNICATIONS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
PAGE
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PART I.
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 17
Item 3. Legal Proceedings........................................... 17
Item 4. Submission of Matters to a Vote of Security Holders......... 19
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 20
Item 6. Selected Consolidated Financial Data........................ 21
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of
Operations.................................................. 21
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 21
Item 8. Financial Statements and Supplementary Data................. 22
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial
Disclosure.................................................. 22
PART III.
Item 10. Directors, Executive Officers and Key Employees of the
Registrant.................................................. 23
Item 11. Executive Compensation...................................... 26
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 26
Item 13. Certain Relationships and Related Transactions.............. 26
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 26
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PART I.
Except for the historical financial information contained herein, the
following discussion may contain "forward-looking statements" that have been
made pursuant to the provisions of the Private Securities Litigation Reform Act
of 1995. Such statements include declarations regarding the intent, belief or
current expectations of the Company and its management. Any such forward-looking
statements are not guarantees of future performance and involve a number of
risks and uncertainties. Actual results could differ materially from those
indicated by such forward-looking statements. Among the important factors that
could cause actual results to differ materially from those indicated by such
forward-looking statements are those set forth beginning on page 8 in "Certain
Factors That Might Affect Future Operating Results," as well as those noted in
the documents incorporated herein by reference. Unless required by law, the
Company undertakes no obligations to update publicly any forward-looking
statements, whether as a result of new information, future events or otherwise.
However, readers should carefully review the risk factors set forth in other
reports or documents the Company files from time to time with the Securities and
Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any
current reports on Form 8-K.
ITEM 1. BUSINESS
OVERVIEW
Advanced Fibre Communications, Inc. ("the Company" or "AFC") designs,
develops, manufactures, markets and supports the Universal Modular Carrier
1000(TM) ("UMC 1000"), a cost-effective, multi-service digital loop carrier
system developed to serve small to mid line size markets. The UMC 1000 is
designed to enable telecommunications companies and other service providers to
connect subscribers to the central office switch for voice and data
communications. The UMC 1000 meets the service needs of domestic and
international subscribers, including analog services such as plain old telephone
service ("POTS"), high speed digital data service, and Integrated Services
Digital Network compatibility.
The UMC 1000 can provide narrowband and broadband services in a single
platform, from POTS to all types of digital subscriber lines ("xDSL") over
copper wire, fiber optic cable or wireless transport media. The 6.2 Gbps
backplane architecture allows the UMC 1000 to transition between time division
multiplexing ("TDM"), Frame Relay, and Asynchronous Transfer Mode ("ATM")
networks. Designed with distributed common control, the system is economically
scalable from two to 2,000 lines, and can transition from a narrowband to
broadband access system. The UMC 1000 can be installed in a variety of network
configurations to support the varying geographic distribution of subscriber
bases. Thus, the UMC 1000 offers a cost-effective solution to the small to mid
line size market with a wide variety of features and advanced services.
There are more than 12,000 UMC 1000 systems installed in 23 countries
serving approximately 2.5 million access lines. In the U.S., Sprint, WinStar,
and Pac Bell, among others, deploy the UMC 1000 system. The UMC 1000 system has
been deployed in South Africa, France, Canada, Mexico, Puerto Rico, Venezuela,
Brazil, Panama, China, Hong Kong, Japan, and the Philippines, among others. The
UMC 1000 is distributed and serviced worldwide through a direct sales force in
the United States and through direct sales, distributors and sales
representatives in international markets.
AFC was incorporated in California in May 1992 and reincorporated in
Delaware in September 1995. The Company completed an initial public offering on
October 4, 1996 and a secondary offering on February 12, 1997. Principal
executive offices are located at One Willow Brook Court, Petaluma, California
94954, and the telephone number at that address is (707) 794-7700.
AFC operates on a 13-week fiscal quarter, comprised of four, four and five
week months ending on the last Saturday of the last week of the five-week month.
For presentation purposes only, the first three fiscal quarters are shown as
ending on March 31, June 30, and September 30, and the fourth fiscal quarter and
fiscal year are shown as ending on December 31. As used in this report, 1998,
1997, and 1996 refer to the fiscal years ending December 31, 1998, 1997 and
1996, respectively, unless the context otherwise indicates.
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INDUSTRY BACKGROUND
Over the past twenty years, the telecommunications industry has experienced
significant advances technologically and architecturally. These changes have
been prompted by the demand for new and expanded services, increased competition
among telecom providers, and the need to leverage existing networks and reduce
operating costs.
The Telecommunications Act of 1996 opened up the telecom markets to new
entrants and created an environment in which telecom providers began offering
expanded crossover services. Growth in the Internet, electronic commerce, and
telecommuting increased pressure on telecom providers to supply a broader range
of voice and data services over faster networks. Today, over 7,500 registered
Internet Service Providers in the U.S. have helped drive the demand for faster
transmission and higher broadband capacity. Subscriber demand has created a need
by telecom providers for flexible, cost efficient local loop system upgrades
from current voice-optimized networks to networks optimized for packet data, or
statistical multiplexing. Packet data provides a more efficient method of
sending data and is rapidly replacing traditional TDM. However, in general, the
broadband capacity of the access network has not kept pace with these
developments, particularly in the local loop portion between the central office
and the subscriber. For the most part, standard analog modems have reached the
data-carrying capacity of the existing local loop network and telecom providers
have sought solutions to ease the congestion in this portion of the network.
BRIDGING THE VOICE AND DATA EVOLUTION
The UMC 1000 provides cost-effective, multi-service local loop systems for
the small to mid line size market, incorporating a modular architecture
supporting copper, fiber, and wireless and the evolution from one transmission
media to another. The system was developed to expand local loop capacity by
using more of the available frequency spectrum of copper lines to provide
symmetric or asymmetric data service. AFC delivers a platform that supports
narrowband and wideband services. The addition of high speed SONET/SDH
capabilities, and ATM, the leading protocol capable of managing a wide diversity
of services in the access network are in development. The UMC 1000 is easily
scalable from two to 2,000 lines through the addition of modular components and
plug-in cards.
Utilizing a single platform and a variety of line cards supporting specific
services, the UMC 1000 system is capable of providing a range of voice and data
services. The system's ability to provide xDSL technology from any slot in any
shelf, without the loss of POTS density, allows telecom providers to deploy high
speed data services more quickly and cost effectively.
The UMC 1000 was designed to require a minimum number of common control
units to support transmission over a variety of media and the delivery of more
advanced services and features by telecom providers. In addition, the system can
be installed in a variety of network configurations to support the varying
geographic distribution of subscriber bases. With the UMC 1000, the Company is a
leading provider of cost effective and flexible solutions for the local access
market.
RECENT DEVELOPMENTS
In 1998, AFC released a new 24 lowline size product, Element Management
System, and the V6.1 software and hardware package for the UMC 1000 adding
Asymmetric Digital Subscriber Line ("ADSL") capabilities, 24 line fiber to the
curb, and expanding the system to serve up to 2,000 lines. In early 1999, the
Company released an ADSL card that fully integrates ADSL and POTS on a single
card, making high speed Internet access available to subscribers served over
digital loop carriers.
AFC has introduced the UMC 1000 Third Generation Digital Loop Carrier(TM)
("3GDLC"). This enhanced version of the UMC 1000 is designed to accommodate the
bandwidth and connectivity requirements of current and future local loop
applications. The 3GDLC has the capability to connect simultaneously to TDM,
cell (ATM and Frame Relay), and high speed SONET/SDH network architectures. It
delivers voice or data access from 64 Kbps to 155 Mbps to any subscriber from a
single channel bank assembly. The 3GDLC was designed to support 6.2 Gbps
bandwidth, making it capable of delivering broadband and narrowband
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technology and services anywhere in the local loop from a single platform. The
GR-303 interface capability has been added to the 3GDLC and allows a remote DLC
terminal to connect directly to a telecommunications company switch.
The Company seeks to enhance its products and technology by forming
strategic alliances with other technology leaders whose products leverage and
integrate with the UMC 1000 system. AFC has product and technology alliances
with ADTRAN, Inc. and Pairgain Technologies, Inc. to collaborate on high speed
digital subscriber line solutions. A joint marketing agreement with VINA
Technologies combines VINA's Multiservice T1 Integrator(R) and the UMC 1000 with
a GR-303 interface, integrating voice and data traffic into a single T1 line.
The Company has entered into alliances with 3Com Corporation, Aware, Inc.,
Cayman Systems, Centillium Technology Corporation, Efficient Networks, Inc., and
Redback Networks, Inc. concentrating on ADSL technology.
In the latter portion of 1998, AFC joined a strategic alliance with
Sourcenet Corporation, Efficient Networks, Inc., Minerva Systems, Newbridge
Networks, nCUBE, and Stellar One Corporation to develop and produce a complete
end to end advanced telecommunications services solution called On Demand
Network(TM) ("ODN"). ODN uses ATM packet switching over DSL to provide high
speed "always on" Internet access, data transport, true video on demand,
multichannel broadcast video, pay per view, and voice service over a single
copper pair connection to the home. ODN is compatible with existing telephones,
televisions and personal computers, and the service is affordable from a total
cost of ownership perspective.
AFC is a member of the Universal ADSL Work Group ("UAWG"), a group of
leading telecommunications, networking industry, and personal computer companies
working to create a universal ADSL standard and facilitate interoperability of
devices. The stated goal of UAWG is to propose an open, interoperable
International Telecommunications Union Standard of ADSL which will deliver high
speed communications up to 25 times the speed of current high speed analog modem
technology.
MARKETS AND CUSTOMERS
The largest portion of the Company's customer base consists of the
independent telecommunications companies serving the U.S. rural and suburban
markets. The UMC 1000 system is deployed by National Local Exchange Carriers
("NLECs"), Competitive Local Exchange Carriers ("CLECs"), Independent Local
Exchange Carriers ("ILECs"), Regional Bell Operating Companies ("RBOCs") and
international telecommunications service providers.
Domestic Small to Mid Line Size Markets. The domestic small to mid line
size markets for telecommunications services are generally located in rural and
suburban areas and are served by approximately 1,200 independent
telecommunications companies and the five RBOCs. The independent
telecommunications companies range from rural companies with as few as 125
subscribers to NLECs such as Sprint with approximately 7.7 million subscribers.
The Company has divided the domestic telecommunications company market into the
following markets:
- small independents using consultant/engineering firms to provide network
design for service expansion and modernization
- medium size independents performing network design internally
- CLECs requiring cost-effective platforms with a wide range of
copper-based services
- NLECs whose requirements include testing and equipment modifications to
meet specific network requirements
- RBOCs requiring cost-effective solutions to their small to mid line size
requirements.
During 1998, AFC extended supply contracts with among others, TDS Telecom,
and distribution agreements with Sprint North Supply, and ALLTEL Supply, among
others. The Company also entered into a five year contract with the U.S.
Government's General Services Administration. Under the terms of this
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contract, the UMC 1000 was added to the government's supply catalog, providing a
designated purchasing path for government agencies, contractors and other
authorized organizations to purchase the system.
In 1998, AFC expanded its sales force to specifically pursue orders from
CLECs, focusing on approximately 130 potential customers in 1999. During the
third and fourth quarters of 1998, AFC shipped the largest single purchase order
in the Company's history to a leading CLEC.
International Markets. The international telecommunications market can be
divided into two general categories of service need requirements. Basic
services, such as POTS, fulfill the immediate service needs of developing
countries with little or no telecommunications infrastructure. Developed
countries generally require more advanced telecommunication services, often
coupled with unique standards or network specifications. In many of these
international markets, deregulation and privatization of the incumbent
telecommunications companies are prompting service providers to optimize
existing facilities, typically consisting of copper, for a growing subscriber
base. Simultaneously, these companies are installing technology offering the
opportunity in the future for advanced services. The UMC 1000 can be used to
cost-effectively deliver basic service over existing copper or to develop a
fiber or wireless network where no facilities exist. As service demand grows,
the telecommunications companies can incrementally add more sophisticated high
bandwidth services within the UMC 1000 configuration. The Company is pursuing
selected opportunities to develop these international markets primarily through
its direct sales force, local distributors and strategic relationships.
In 1998, AFC's international revenues grew 15.7%. During the year, the
Company extended existing contracts with Integrators of System Technology (Pty)
to sell to South Africa's main telephony provider (Telkom South Africa), France
Telecom, and Hongkong Telecommunications. The Company continued to supply
product under contracts to customers in Canada, Venezuela, Brazil, and Panama.
SALES, MARKETING AND CUSTOMER SUPPORT
The UMC 1000 is marketed worldwide directly to telecommunications companies
and indirectly through original equipment manufacturers, distributors, and sales
representatives. AFC's sales force consists of two groups, one of which focuses
on U.S. and Canadian telecommunications companies, and the second focusing on
international markets.
The North American sales force focuses on developing relationships,
understanding network deployment strategies, and cost requirements of ILECs,
NLECs, CLECs, and RBOCs in the U.S. and telecommunications companies in Canada.
As of December 31, 1998, the North American sales organization consisted of 33
direct salespeople and one domestic sales vice president.
AFC's sales personnel are dedicated to specific customer accounts. In
addition to direct calls on telecommunications companies, sales to customers
often involve marketing through consulting engineers who are retained by small
independent telecommunications companies for engineering, specifications and
installation services.
In international markets, a direct sales force is employed consisting of
thirteen salespersons and one vice president. The primary tasks of the
International sales force include marketing the UMC 1000 directly to
international telecommunications companies and selecting, training and managing
local distributors. Sales to international customers are primarily fulfilled
through the Company's distributors and sales representatives. AFC has
international sales or representative offices in Hong Kong, Shanghai, Singapore,
New Delhi, London, Warsaw, and Coral Gables, Florida. The organizational
infrastructure has dedicated international business development, product
management, customer support personnel, and distribution channel management in
all major international regions.
The North American and International sales organizations receive support
from AFC's marketing department for, among other things, product marketing,
advertising and marketing communications. The marketing department works closely
with telecommunications companies' planning and engineering departments on
specific network configurations in order to provide product proposals that are
optimal in terms of both performance and cost.
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AFC's customer support organization is responsible for servicing products
and assisting sales personnel. In addition to its own field technical service
engineers, AFC also relies on various third party support organizations to
provide post sales support to domestic customers. International customer support
is provided directly or through authorized distributors. Training curriculums
and materials are made available to customers either through student training or
train-the-trainer programs. The UMC 1000 generally has a 24-month warranty
period.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts have been focused on
developing local loop products with advanced features for small line size and
mid line size markets. The UMC 1000 was designed with a modular software and
hardware platform that can be configured and adapted to particular customer
requirements. Development efforts include extensive attention to ease of
installation and use by the customer as evidenced in the menu driven software
approach as well as the compact and efficient hardware design demonstrated in
its printed circuit board assemblies. Research and development personnel work
closely with sales and marketing personnel to ensure development efforts are
targeted to customer needs. Recent development efforts have focused on
developing enhancements to the UMC 1000 system, such as a new fiber to the curb
capability, single-pair digital subscriber line service, the first production
version of an ADSL card, wireless local loop, video/PSTN connections, survivable
span, ATM broadband capabilities, a 24 line cabinet, and larger line size
products. In international markets, efforts have been focused on the V5.2 switch
interface, element management system, and numerous country-specific
customizations.
The industry in which the Company operates is characterized by rapidly
changing technological and market conditions which may shorten product life
cycles. AFC's future competitive position will depend not only upon successful
production and sales of the UMC 1000, but also upon its ability to develop and
produce, on a timely basis, new features and services to meet existing and
anticipated industry demands. The Company is currently engaged in the
development of several new features for the UMC 1000. During the product
development process, a substantial amount of resources is invested in products
that often require extensive field testing and evaluation prior to introduction
to the market.
Research and development costs charged to expense were $41.0 million in
1998, $25.7 million in 1997, and $14.4 million in 1996. As a percentage of total
revenues, research and development costs represented 13.1% in 1998, 9.6% in
1997, and 11.1% in 1996. AFC considers its research and development efforts
vital to its future success and plans to continue to support the development of
new products, features and product cost reductions. As of December 31, 1998, the
research and development staff had grown to 288 employees from 176 employees at
the end of 1997.
MANUFACTURING
Manufacturing, system integration and certain testing operations are
performed at AFC's headquarters in Petaluma, California. The Company's
manufacturing operations consist primarily of the final assembly and testing of
product, primarily printed circuit boards purchased from third parties, and
cabinet assembly. Quality is monitored at each stage of the production and
supply process, including the selection of component suppliers, warehouse
procedures, the assembly of finished goods and final testing, packaging and
shipping. Functional, environmental and systems testing and other quality
assurance related activities are performed on the subassemblies incorporated
into the UMC 1000. In February 1998, the domestic manufacturing and distribution
operations were moved into a new facility, doubling capacity. See Part I, Item 1
- -- "Certain Factors That Might Affect Future Operating Results" as it pertains
to these matters on pages 12 and 13 of this Annual Report on Form 10-K.
AFC relies on a limited number of independent contractors to manufacture
the subassemblies to strict specifications for use in the Company's products. In
particular, AFC relies on:
- Flextronics International Ltd. and Solectron International USA, Inc. to
manufacture printed circuit board assemblies ("PCBA")
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- Siemens Microelectronics, Inc. for PCBA components
- Paragon Electronic Systems, Inc., and Tyco Printed Circuit Group Inc. to
manufacture backplanes and channel bank assemblies
- Celestica, Inc. for channel bank assemblies and protector panel
subassemblies
- General Cable Corporation for protector panel subassemblies
- CMOR Manufacturing and Wilco Wire Technology, Inc. for cable and wire
harnesses and various turnkey assemblies
- American Microsystems, Inc. for application specific integrated circuits
- Hendry Telephone Products for fuse panels and racks
- Powersafe Standby Batteries Inc. for battery systems
- LeeMah Electronics Inc. for fully integrated cabinets
- Pairgain Technologies Inc. for custom enclosures and boards
- Sonoma Metal Products, Inc., Cowden Metal San Jose, Inc., Mayville Metal
Products, and EMAR Inc. to manufacture the external housing cabinets
- Advanced Digital Graphics, Inc. for system documentation
Certain components used in the UMC 1000 are only available from a single
source or limited number of suppliers. Some of AFC's sole source suppliers are
companies which from time to time allocate parts to telecommunications equipment
manufacturers due to market demand for components and equipment. Many of AFC's
competitors are much larger and may be able to obtain priority allocations from
these shared suppliers, resulting in limited or unreliable sources of supply for
these components. See Part I, Item 1 -- "Certain Factors That Might Affect
Future Operating Results" as it pertains to these matters on page 13 of this
Annual Report on Form 10-K.
COMPETITION
AFC's competitors range from small companies, both domestic and
international, to large multinational corporations. The Company's principal
competitors include: ADC Telecommunications, Inc., Alcatel
Alsthom Compagnie, Ericsson Inc., Fujitsu America, Inc., Hitron Technology,
Inc., Huawei Technologies Co. Ltd., Lucent Technologies, Inc., NEC America,
Inc., Nokia Telecommunications, Northern Telecom Ltd., Opnet Technologies Co.
Ltd., RELTEC Corporation, Shenzhen Zhongxing Telecom Corporation, Ltd., UT
Starcom, Inc. and Vidar-SMS Co. Ltd.
Many of these competitors have more extensive financial, marketing and
technical resources than AFC and enjoy superior name recognition in the market.
In addition, pursuant to the Settlement Agreement and related agreements entered
into with the Industrial Technology Research Institute ("ITRI"), certain of its
member companies have been granted certain rights to manufacture and sell the
European Telecommunications Standards Institute ("ETSI") version of the UMC 1000
outside of North America. These companies currently compete with AFC in
international markets, primarily in China. Upon termination of certain
restrictions set forth in such agreements, in January 2005, such companies will
have a worldwide, non-exclusive, royalty-free, irrevocable license to use
certain UMC 1000 technology and will be able to compete with the Company
worldwide at such time. See Part I, Item 3 -- "Legal Proceedings" as it pertains
to this matter on page 17 of this Annual Report on Form 10-K.
The Company believes rapid technological change, continuing regulatory
change and industry consolidation will continue to cause rapid evolution in the
competitive environment of the telecommunications equipment market, the full
scope and nature of which is difficult to predict. Moreover, AFC believes that
technological and regulatory change will continue to attract new entrants to the
market in which the Company competes.
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COMPLIANCE WITH REGULATORY AND INDUSTRY STANDARDS
The UMC 1000 is required to comply with a large number of voice and data
regulations and standards, which vary between domestic and international
markets, and may vary by specific international markets. Standards setting and
compliance verification in the U.S. are determined by the Federal Communications
Commission ("FCC"), Underwriters Laboratories, Quality Management Institute,
Telcordia Technologies, Inc. ("Telcordia") formerly known as "Bellcore", other
independent third party testing organizations, and by independent
telecommunications companies. In international markets, the Company's products
must comply with recommendations issued by Industry Canada, the Consultative
Committee on International Telegraph and Telephony, and individual regional
carriers' network operating system requirements and specifications. In addition,
the Company's products must comply with standards issued by ETSI and implemented
and enforced by the Telecommunications Regulatory Authority of each European
nation. Standards for new services continue to evolve, and AFC will be required
to modify the UMC 1000 or develop and support new versions to meet these
standards.
Telcordia testing on the UMC 1000 is often required to ensure
interoperability with various standards of operations, administration,
maintenance and provisioning systems. Telcordia testing requires significant
investments in time and money to achieve compliance. Some UMC 1000 features must
pass Telcordia testing prior to field release. See Part I, Item 1 -- "Certain
Factors That Might Affect Future Operating Results" as it pertains to these
matters beginning on page 16 of this Annual Report on Form 10-K.
AFC has successfully completed the Telcordia Operations Systems
Modifications for the Integration of Network Elements process on LFACS, TIRKS,
SWITCH, and NMA interoperability. LFACS and TIRKS are operational support
systems ("OSS") which allow RBOCs' operations systems to identify the UMC 1000's
bandwidth and equipment type and capabilities. SWITCH is an OSS designed to
inventory and assign telecommunications equipment. NMA adds the ability to
retrieve UMC 1000 alarms through the RBOCs' operating systems and generate
trouble tickets online. Switch compliance testing has been completed on GR-303
with Lucent Technologies on the Lucent 5ESS switch, and with Northern Telecom on
the DMS-100 switch. GR-303 compliance testing with Telcordia is currently in
process. The UMC 1000 is currently undergoing testing with Telcordia for
integration with OPS/INE allowing provisioning through Telcordia operating
systems.
In 1998, both the FCC and Industry Canada approved the use, deployment, and
commercial sale of the UMC 1000 Spread Spectrum Radio System ("SSR") in the U.S.
and Canada. SSR is a point to point digital microwave radio transport using
spread spectrum technology for license-free digital communication links and
offers up to 30 DSO channels per dish over 2.4 Gigahertz and up to 60 DSO over
5.7 Gigahertz transport frequencies with full voice and data capacity.
In October 1997, Underwriters Laboratories officially registered the
Company as ANSI/ISO/ASQC Q9001-1994 ("ISO") compliant which assures quality in
design, development, production, installation and servicing. The ISO standard
consists of all elements defining a quality system aimed primarily at achieving
customer satisfaction by preventing nonconformity at all stages from design
through servicing. In November 1998, Quality Management Institute completed an
annual audit and certified the Company's ongoing ISO standard compliance.
During 1998, France Telecom completed validation of the UMC 1000 and
officially endorsed the technology for deployment throughout France. France
Telecom continues to evaluate newly introduced UMC 1000 features for use in
France; however, validation must be completed prior to deployment.
In 1996, the U.S. Congress passed regulations that affect
telecommunications services, including changes to pricing, access by competitive
suppliers and many other broad changes to the data and telecommunications
networks and services. These changes will have a major impact on the pricing of
existing services, and may affect the deployment of future services. These risks
are discussed in Part I, Item 1 -- "Certain Factors That Might Affect Future
Operating Results" beginning on page 16 of this Annual Report on Form 10-K.
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ENVIRONMENTAL MATTERS
The Company's operations and manufacturing processes are subject to certain
federal, state, local and foreign environmental protection laws and regulations.
These laws and regulations relate to the use, handling, storage, discharge and
disposal of certain hazardous materials and wastes, the pre-treatment and
discharge of process waste waters and the control of process air pollutants. AFC
believes that it is in compliance in all material respects with applicable
environmental regulations.
If those laws and regulations become more stringent over time, the Company
may not be able to comply in a timely manner, or comply at all. Compliance with
new laws and regulations could create significant compliance expenses, result in
production suspension and delay, restrictions on expansion at present locations,
and require the acquisition of costly equipment. Non-compliance with laws and
regulations could result in penalties and suspension of operations.
PROPRIETARY RIGHTS AND LICENSES
AFC attempts to protect its technology through a combination of copyrights,
trade secret laws, contractual obligations and patents. No patents are currently
held for existing UMC 1000 product, but two patent applications are pending.
There can be no assurance that AFC's intellectual property protection measures
will be sufficient to prevent misappropriation of the Company's technology. See
Part I, Item 1 -- "Certain Factors That Might Affect Future Operating Results"
as it pertains to this matter on page 14 of this Annual Report on Form 10-K. The
laws of many foreign countries do not protect AFC's intellectual property rights
to the same extent as the laws of the U.S. See Part I, Item 3 -- "Legal
Proceedings" as it pertains to this matter on page 17 of this Annual Report on
Form 10-K.
Frequent litigation, based on allegations of patent and other intellectual
property infringement, has resulted from the telecommunications industry's
dependence on proprietary technology. In 1996, AFC settled litigation with DSC
Communications Corporation ("DSC") under which DSC had claimed proprietary
rights in the UMC 1000 technology. In addition, DSC filed a lawsuit in January
1998 that includes allegations of patent infringement by AFC. This pending
litigation with DSC is discussed in Part I, Item 3 -- "Legal Proceedings"
beginning on page 17 of this Annual Report on Form 10-K.
In March 1998, AFC settled litigation with ITRI, ITRI's sub-licensee Member
Companies, and others, including Acer Netxus, Inc. ("Acer") involving breach of
a prior agreement, trade secret misappropriation, unfair competition and related
claims. In September 1998, AFC settled litigation with Acer enjoining them from
the development, manufacture, and selling of any device utilizing or deriving
from AFC's UMC 1000 technology. See Part I, Item 1 -- "Certain Factors That
Might Affect Future Operating Results" as it pertains to both of these cases
beginning on page 11 and Part I, Item 3 -- "Legal Proceedings" on page 17 of
this Annual Report on Form 10-K.
EMPLOYEES
As of December 31, 1998, 815 people were employed at AFC. None of the
employees are covered by collective bargaining agreements, and AFC has never
experienced a work stoppage, strike or labor dispute. The Company believes
relations with its employees are good.
CERTAIN FACTORS THAT MIGHT AFFECT FUTURE OPERATING RESULTS
In addition to the other information in this Annual Report on Form 10-K,
the following are important factors that should be considered in evaluating the
Company and its business.
Potential Fluctuations in Future Operating Results and Seasonality. AFC's
operating results have been, and will continue to be, affected by a wide variety
of factors, some of which are outside of its control, that
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could have a material adverse effect on revenues and results of operations
during any particular period. These factors include:
- Domestic and International sales mix
- Customer mix
- Product mix
- Timing and size of orders which are received and can be shipped in a
quarter
- Availability of adequate supplies of key components and assemblies
- Ability to introduce new products and technologies on a timely basis
- Timing of new product introductions or announcements by the Company or
its competitors
- Price competition
- Unit volume
- Royalty revenue levels
- Excess or obsolete inventory
- Adequacy of manufacturing capacity
- Customers' ability to pay when due
- Expanded warranty coverage
The UMC 1000 is sold primarily to telecommunications companies installing
the UMC 1000 as part of their access networks. Additions to those networks
represent complex engineering projects, requiring lengthy periods from project
conceptualization to completion. The UMC 1000 typically represents only a
portion of a given project and, therefore, the timing of product shipment and
revenue recognition is often difficult to forecast. The Company's customers
normally install a portion of the UMC 1000 in outdoor locations. Shipments of
the system are subject to the effects of seasonality, with fewer installation
projects scheduled for the winter months. The majority of the Company's sales
are to telecommunications companies in the North American region, and
accordingly, the Company believes that over time this seasonality will cause
revenues in the quarter ended March 31 to be lower than revenues in the
preceding quarter ended December 31. In particular, AFC believes that revenues
for the quarter ended March 31, 1999 will be lower than the revenues in the
quarter ended December 31, 1998. In developing countries, delays and reductions
in the planned project deployment can be caused by additional factors, including
currency fluctuations, reductions in capital availability due to declines in the
local economy, priority changes in the governments' budgets, political
environment and delays in receiving government approval for deployment of the
UMC 1000 system in the local loop.
AFC's expenditures for research and development, marketing and sales, and
general and administrative functions are based in part on future growth
projections and in the near term are relatively fixed. The Company may be unable
to adjust spending in a timely manner in response to any unanticipated failure
to meet these growth projections. Accordingly, any significant decline in demand
for the UMC 1000 relative to planned levels could have a material adverse effect
on the Company's business, financial condition and results of operations in that
quarter or subsequent quarters.
All of the above factors are difficult to forecast, and these or other
factors could have a material adverse effect on the Company's business,
financial condition and results of operations. As a result, AFC believes that
period to period comparisons are not necessarily meaningful and should not be
relied upon as indications of future performance. There can be no assurance that
the Company will sustain or increase its profitability in the future.
Fluctuations in AFC's operating results may cause volatility in the price
of its Common Stock. It is likely that in some future quarter, revenues or
operating results will be below the expectations of public market
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analysts and investors. In such event, the market price of AFC's Common Stock
would likely be materially adversely affected. AFC attempts, through timely
press releases and announcements, to disclose significant factors impacting, or
expected to impact, the business, financial condition and results of operations.
However, due to factors outside the Company's control, there may be little or no
meaningful relationship between the resulting market price of AFC's Common Stock
and results of operations. Factors outside of the Company's control, such as
market analysts' published expectations and short traders' activities can cause
a material fluctuation in the stock price. Recent periods of volatility in the
market price of AFC's Common Stock resulted in stockholder litigation against
the Company and various officers and directors. Such litigation could result in
substantial costs and a diversion of management's attention and resources, which
could have a material adverse effect on the operating results and financial
condition of the Company. See Part I, Item 3 -- "Legal Proceedings" as it
pertains to this matter on page 18 of this Annual Report on Form 10-K.
Customer Concentration. For the year ended December 31, 1998, approximately
11.2% of total revenues were derived from sales to WinStar Communications, Inc.,
and 10.4% to Integrators of System Technology (Pty) Ltd. in South Africa. For
the year ended December 31, 1997, GTE accounted for 19.2% of total revenues. No
other single customer accounted for 10% or more of total revenues in either
period. The Company's five largest customers accounted for 41.9% of revenues in
the year ended 1998, and 38.2% of revenues in the year ended 1997. Although
AFC's largest customers have varied from period to period, the Company
anticipates that its results of operations in any given period will continue to
depend to a significant extent upon sales to a small number of customers. None
of AFC's customers have entered into agreements requiring them to purchase a
minimum amount of product from the Company. There can be no assurance that
principal customers will continue to purchase product at current levels, if at
all. In the event that a significant existing customer merged with another
telecommunications company, there can be no assurance that such customer will
continue to purchase AFC's products. The loss of one or more major customers
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Risks Associated with International Markets. International sales
constituted 26.2% of total revenues in the year ended December 31, 1998 and
26.5% in the year ended December 31, 1997. International sales have fluctuated
in absolute dollars and as a percentage of revenues, and are expected to
continue to fluctuate in future periods. The Company relies on a number of third
party distributors and sales representatives to market and sell the UMC 1000
outside of North America. There can be no assurance that such distributors or
sales representatives will provide the support and effort necessary to service
international markets effectively. AFC is entering new international markets,
which demand significant management attention and financial commitment. The
Company's management has limited experience in international operations, and
there can be no assurance that the Company will successfully expand its
international operations. Successful expansion of international operations and
sales in certain markets may depend on AFC's ability to establish and maintain
productive strategic relationships. There can be no assurance that the Company
will be able to identify suitable parties for joint ventures or strategic
relationships or, even if such parties are identified, that successful joint
ventures or strategic relationships will result. There can be no assurance that
AFC will be able to increase international sales of the UMC 1000 through
strategic relationships or joint ventures. The failure to do so could
significantly limit the ability to expand international operations and could
adversely affect AFC's business, financial condition and results of operations.
International telecommunications companies are in many cases owned or
strictly regulated by local authorities. Access to such markets is often
difficult to obtain due to trade barriers and established relationships between
a government owned or controlled telecommunications company and its traditional
indigenous equipment suppliers. Many of these companies require extended payment
terms and financing options which increase the risk of nonpayment and may have a
material adverse effect on the Company's cash flows. In addition, customers in
certain international markets require AFC to post bid and performance bonds. The
Company could incur contract penalties should it fail to meet production and
delivery time schedules on large orders. Failure to meet these schedules could
also result in the loss of collateral posted for the bonds or financial
penalties, which could adversely affect the Company's business, financial
condition and results of operations.
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International sales are currently primarily U.S. dollar denominated. As a
result, an increase in the value of the U.S. dollar relative to foreign
currencies could make AFC's products less competitive in international markets.
Failure to meet revenue projections in the international market could adversely
affect the Company's business, financial condition and results of operations.
See Part II, Item 7A -- "Quantitative and Qualitative Disclosures About Market
Risk" as it pertains to this matter on page 21 of this Annual Report on Form
10-K.
Operating in international markets subjects AFC to certain additional
risks, including:
- Changes in regulatory requirements
- Political and economic conditions
- Tariffs or other barriers
- Staffing and managing international operations
- Exchange rate fluctuations
- Exchange and repatriation controls on foreign earnings
- Negative tax consequences
- Longer sales and payment cycles
- Collection of accounts receivable
The economies in some of the Asia Pacific and Central and Latin America
regions have deteriorated resulting in the devaluation of currencies in certain
of the countries of these regions. There can be no assurance that adverse
economic conditions in foreign countries or foreign currency exchange rates will
not have a material adverse effect on AFC's business, financial condition or
results of operations.
Compliance with various country-specific regulations and standards must be
attained to compete in international markets. Any inability to obtain local
regulatory approval could delay or prevent entrance into international markets,
which could materially impact the Company's business, financial condition and
results of operations.
Competition. Many of AFC's competitors have more extensive financial,
marketing and technical resources than the Company and enjoy superior name
recognition in the market. Primary competitors include: ADC Telecommunications,
Inc., Alcatel Alsthom Compagnie, Ericsson Inc., Fujitsu America, Inc., Hitron
Technology, Inc., Huawei Technologies Co. Ltd., Lucent Technologies, Inc., NEC
America, Inc., Nokia Telecommunications, Northern Telecom Ltd., Opnet
Technologies Co. Ltd., RELTEC Corporation, Shenzhen Zhongxing Telecom
Corporation, Ltd., UT Starcom, Inc. and Vidar-SMS Co. Ltd.
As a result of the Settlement Agreement and related agreements entered into
with ITRI, certain of its Member Companies have been granted certain rights to
manufacture and sell the ETSI version of the UMC 1000 outside of North America.
Such entities currently compete with AFC in international markets, primarily in
China. Upon termination of certain restrictions set forth in such agreements, in
January 2005, such Member Companies will have a worldwide, non-exclusive,
royalty-free, irrevocable license to use certain UMC 1000 technology and,
consequently, such Member Companies will be able to compete with the Company
worldwide at such time. The Company has successfully settled its litigation
against Acer Netxus, Inc. Among other things, the Settlement Agreement and a
related Federal Court judgment permanently enjoin Acer Netxus, Inc. from
developing, manufacturing, or selling any product that uses or derives from the
UMC 1000(TM) technology. See Part I, Item 3 -- "Legal Proceedings" as it
pertains to this matter on page 17 of this Annual report on Form 10-K.
The Company believes rapid technological change, continuing regulatory
change and industry consolidation will continue to cause rapid evolution in the
competitive environment of the telecommunications equipment market, the full
scope and nature of which is difficult to predict.
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Moreover, the Company believes that technological and regulatory change
will continue to attract new entrants to the market in which the Company
competes. There can be no assurance that AFC will be able to compete
successfully in the future.
Risk of Failure to Manage Expanding Operations. A period of rapid company
growth has occurred, which has placed and could continue to place, a significant
strain on AFC's management, operational, financial and other resources. The
members of the management team have limited experience in managing rapidly
growing companies. AFC needs to continue to recruit, train, assimilate, motivate
and retain qualified managers and employees to effectively manage the growth and
any future growth. The Company's results of operations could be adversely
affected if revenues do not increase sufficiently to compensate for the increase
in operating expenses and facility obligations resulting from any expansion. Any
business disruption or other system transition difficulties could have a
material adverse effect on the Company's business, financial condition and
results of operations. The failure of the Company to effectively manage its
domestic and international operations or any current or future growth could have
a material adverse effect on the Company's business, financial condition and
results of operations.
In February 1998, AFC moved its domestic manufacturing and distribution
operations into a new facility which doubled capacity. Although the operational
capacity was expanded, there can be no assurance that the Company will not have
excess capacity or that the transition and further utilization of the new
facility will continue without interruption, or that any such interruption will
not have a material adverse effect on the Company's business, manufacturing and
distribution functions.
The Company's facility obligations and commitments are based in part on
anticipated growth projections, and in the near term are relatively fixed. Based
on existing commitments for additional office space, AFC will have excess office
space in the future. AFC's results of operations could be adversely affected if
it is unable, in a timely manner, to sublease the excess facility space at rents
comparable to the Company's obligations.
Concentrated Product Line, New Products and Rapid Technological
Change. Substantially all of AFC's revenues are derived from the UMC 1000 and
the Company expects this concentration will continue in the foreseeable future.
Any decrease in the overall level of sales of, or the prices for the UMC 1000
could have a material adverse effect on the Company's business, financial
condition and results of operations. Factors include price competition,
introductions or announcements by competitors, a decline in the demand for the
UMC 1000, or product obsolescence, among others.
The telecommunications equipment market is characterized by rapidly
changing technology, evolving industry standards, changes in end-user
requirements, and frequent new product introductions and enhancements. The
introduction of products embodying new technologies or the emergence of new
industry standards can render existing products obsolete or unmarketable. AFC's
success will depend upon its ability to enhance the UMC 1000 technology and to
develop and introduce, on a timely basis, new products and feature enhancements.
International sales in 1998 in the Asia Pacific region were affected in part by
the delay in certain technological developments designed for international
markets. New feature enhancements must keep pace with technological developments
and emerging industry standards, and address changing customer requirements in a
cost-effective manner. There can be no assurance that AFC will be successful in
identifying, developing, manufacturing, and marketing new products or product
enhancements that respond to technological change or evolving industry
standards. There can be no assurance that the Company will overcome difficulties
that could delay or prevent the successful development, introduction and
marketing of these products and enhancements, or that its new products or
enhancements will adequately meet the requirements of the marketplace and
achieve market acceptance. Substantial costs may be incurred to modify the UMC
1000 and build AFC's infrastructure to accommodate these changes. From time to
time, the Company may announce new products or enhancements, services or
technologies that have the potential to replace or shorten the life cycle of the
UMC 1000 and that may cause customers to defer purchasing the UMC 1000. The
introduction of new industry switch interfaces, such as GR-303, reduces the
amount of equipment required to support each access line or port. There can be
no assurance that technological advances in the telecommunications industry will
not reduce sales of the UMC 1000, diminish market acceptance of the
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system or render the system obsolete and, thereby, materially adversely affect
the Company's business, financial condition and results of operations.
AFC has experienced delays in completing development and introduction of
new products, product variations and feature enhancements, and there can be no
assurance that such delays will not continue or recur in the future. The UMC
1000 contains a significant amount of complex hardware and software that may
contain undetected or unresolved errors that may become apparent as products are
introduced, or as new versions are released. Technical difficulties have been
discovered in certain system installations. There can be no assurance that
despite significant testing, hardware or software errors will not be found in
the UMC 1000 after commencement of shipments, resulting in delays in, or
cancellation of, customer orders or in the loss of market acceptance, any of
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence on Telecommunications Industry and Small to Mid Line Size
Market. AFC's customers are concentrated in the public carrier
telecommunications industry and, in the U.S. market include CLECs, NLECs, ILECs,
and the RBOCs. Accordingly, AFC's future success depends upon the capital
spending patterns of such customers and the continued demand by such customers
for the UMC 1000. The target markets for the systems are the U.S. and
international small to mid line size markets. Historically, these markets have
had little access to the advanced services that can be made available through
the UMC 1000 and there can be no assurance that potential customers will
consider the near term value of these advanced services to be sufficient to
influence their purchase decisions. The system may not be met with widespread
acceptance among the telecommunications companies and other potential customers
in small to mid line size markets. Existing customers and potential customers
may adopt alternative architectures or technologies that are incompatible with
the UMC 1000 technology which could have a material adverse effect on the
Company's business, financial condition and results of operations. There can be
no assurance that telecommunications companies, foreign governments or other
customers will pursue infrastructure upgrades that will necessitate the
implementation of advanced products such as the UMC 1000. Infrastructure
improvements requiring the Company's technology may be delayed or prevented by a
variety of factors, including cost, regulatory obstacles, the lack of consumer
demand for advanced telecommunications services and alternative approaches to
service delivery.
Dependence on Sole Source and Limited Number of Third Party Manufacturers
and Support Organizations. Certain components used in the Company's products,
including the Company's proprietary application specific integrated circuits
("ASICs"), codec components, certain surface mount technology components and
other components, are only available from a single source or limited number of
suppliers. A limited number of independent contractors manufacture the
subassemblies to AFC's specifications for use in the Company's products. Some of
the sole source suppliers are companies who, from time to time, allocate parts
to telecommunications equipment manufacturers due to market demand for
components and equipment. Many of the Company's competitors are much larger and
may be able to obtain priority allocations from these shared suppliers, thereby
limiting or making unreliable the sources of supply for these components. There
can be no assurance that shortages of components will not occur in the future or
will not result in the Company having to pay a higher price for components. If
sufficient quantities of these or any other components cannot be obtained,
delays or reductions in manufacturing or product shipments could occur which
could have a material adverse effect on AFC's business, financial condition and
results of operations. In particular, the Company relies upon:
- Flextronics International Ltd. and Solectron International USA, Inc. to
manufacture printed circuit board assemblies ("PCBA")
- Siemens Microelectronics, Inc. for PCBA components
- Paragon Electronic Systems, Inc., and Tyco Printed Circuit Group Inc. to
manufacture backplanes and channel bank assemblies
- Celestica, Inc. for channel bank assemblies and protector panel
subassemblies
- General Cable Corporation for protector panel subassemblies
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- CMOR Manufacturing and Wilco Wire Technology, Inc. for cable and wire
harnesses and various turnkey assemblies
- American Microsystems, Inc. for ASICs
- Hendry Telephone Products for fuse panels and racks
- Powersafe Standby Batteries Inc. for battery systems
- LeeMah Electronics Inc. for fully integrated cabinets
- Pairgain Technologies Inc. for custom enclosures and boards
- Sonoma Metal Products, Inc., Cowden Metal San Jose, Inc., Mayville Metal
Products, and EMAR Inc. to manufacture the external housing cabinets
- Advanced Digital Graphics, Inc. for system documentation
The Company's business, financial condition and results of operations could
be adversely affected if its subcontractors were to experience financial,
operational, production, or quality assurance difficulties that resulted in a
reduction or interruption in supply to the Company or otherwise failed to meet
the Company's manufacturing requirements. The Company may not be able to
establish sufficient manufacturing supply from alternative sources. Current or
alternative manufacturers may not be able to meet the Company's future
requirements and such manufacturing services may not continue to be made
available to the Company at favorable prices, or at all.
Various third party support organizations provide post sales support to
AFC's domestic sales customers. There can be no assurance that these
organizations will be able to provide the level of customer support demanded by
existing or potential customers.
Risks Associated with Pending Litigation. AFC is a party to certain legal
proceedings as described in Part I, Item 3 -- "Legal Proceedings" beginning on
page 17 of this Annual Report on Form 10-K. The Company is unable to predict the
ultimate outcome of these proceedings or determine the total expense or possible
loss, if any, that may ultimately be incurred in the resolution of these
proceedings. Regardless of the ultimate outcome, these proceedings could result
in significant diversion of management's time.
Limited Protection of Proprietary Technology; Risk of Third Party Claims of
Infringement. AFC attempts to protect its technology through a combination of
copyrights, trade secret laws, contractual obligations, and patents. AFC does
not presently hold any patents for the UMC 1000 product, but two patent
applications are pending. These intellectual property protection measures may
not be sufficient to prevent misappropriation of AFC's technology nor will they
prevent competitors from independently developing technologies that are
substantially equivalent or superior to AFC's technology. The laws of many
foreign countries do not protect AFC's intellectual property rights to the same
extent as the laws of the U.S. Failure to protect proprietary information could
have a material adverse effect on AFC's business, financial condition and
results of operations. The Company is currently involved in a dispute with
RELTEC Corporation regarding, among other things, alleged trade secret
misappropriation. See Part I, Item 3 -- "Legal Proceedings" as it pertains to
this matter on page 18 of this Annual Report on Form 10-K.
In June 1996, AFC settled litigation with DSC Communications, Inc. ("DSC")
under which DSC had claimed proprietary rights to the UMC 1000 technology. In
January 1998, DSC filed a lawsuit against the Company alleging, among other
things, that the Company's 3GDLC product infringes a DSC patent. See Part I,
Item 3 -- "Legal Proceedings" beginning on page 18 of this Annual Report on Form
10-K.
In March 1998, AFC settled litigation with ITRI, ITRI's sub-licensee Member
Companies, and others, including Acer Netxus, Inc. ("Acer") involving breach of
a prior agreement, trade secret misappropriation, unfair competition and related
claims. In September 1998, AFC settled litigation with Acer enjoining them from
the development, manufacture, and selling of any device utilizing or deriving
from AFC's UMC 1000 technology. See Part I, Item 3 -- "Legal Proceedings" as it
pertains to both of these cases beginning on page 17 of this Annual Report on
Form 10-K.
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In the future, the Company may be subject to additional litigation to
defend against claimed infringements of the rights of others or to determine the
scope and validity of the proprietary rights of others. Future litigation also
may be necessary to enforce and protect trade secrets and other intellectual
property rights owned by AFC. Any such litigation could be costly and cause
diversion of management's attention, either of which could have a material
adverse effect on the Company's business, financial condition and results of
operations. Adverse determinations in such litigation could result in the loss
of the Company's proprietary rights, subject the Company to significant
liabilities, require the Company to seek licenses from third parties, or prevent
the Company from manufacturing or selling its products, any one of which could
have a material adverse effect on the Company's business, financial condition
and results of operations. Furthermore, there can be no assurance that any
necessary licenses will be available on reasonable terms.
Dependence on Key Personnel. AFC's success depends to a significant extent
upon key technical and management employees. The loss of the services of any of
these key employees could have a material adverse effect on AFC's business,
financial condition and results of operations. The Company does not have
employment agreements with, or key person life insurance for, any of its
employees. Competition for highly qualified employees is intense and the process
of locating key technical and management personnel with the required combination
of skills and attributes is often lengthy. There can be no assurance that AFC
will be successful in retaining its existing key personnel or in attracting and
retaining the additional employees it may require.
In June 1998, the Company's President and Chief Executive Officer, Carl
Grivner, resigned and the Company's Chairman and founder, Don Green, assumed the
role of President and Chief Executive Officer on an interim basis. The Company
is currently engaged in a search for a new President and Chief Executive
Officer. There can be no assurance that the Company will be successful in
identifying and hiring a new President and Chief Executive Officer on a timely
basis. There can be no assurance as to the effect that this management
transition may have on AFC's business, financial condition and results of
operations.
Year 2000. AFC has formed a Year 2000 Committee to understand and address
the year 2000 ("Y2K") issue as it affects the Company's infrastructure,
operations, and the UMC 1000 product. Representatives from each functional area
of the Company are responsible for identifying and assessing organizational
readiness, preparing remediation steps, testing, and applying new standards and
contingency plans.
AFC has identified and assessed a majority of the potential Y2K-affected
hardware, software, and facility equipment, and vendors in its organizational
structure. For the most part, AFC's systems and software have been found to be
Y2K compliant, or have been upgraded to compliance through manufacturers'
upgrades.
The Company is currently in the process of surveying and testing its
vendors' Y2K readiness and developing its own contingency plans in case of
vendors' failures. Contingency plans for vendor Y2K failures include
pre-qualifying alternative vendor suppliers, maintaining multiple vendor sources
for critical components and assemblies, and maintaining adequate supplies of key
components on hand. However, there can be no assurance that AFC will be able to
obtain sufficient manufacturing supply from alternative sources. Current or
alternative manufacturers may not be able to meet the Company's supply
requirements and such supplies may not continue to be made available at
favorable prices, or at all.
A survey is currently underway of AFC's leased properties and facilities,
including operational vendors providing power, local and long distance
telecommunications, water, heating and cooling, and various services to
determine the status of embedded technology equipment that could affect AFC's
operations. The Company plans to test and validate its internal operations,
complete the vendor surveys, and finalize and implement contingency plans by
mid-1999. Failure of the Company to adequately address all known and unknown Y2K
compliance issues could have a material adverse affect on AFC's business,
financial condition and results of operations.
The UMC 1000 was originally designed and developed to be Y2K compliant. AFC
utilizes operating systems and software applications that were designed and
developed to properly reflect the year 2000 and subsequent years' data. Although
AFC believes that its product and operating systems are Y2K compliant, the
Company's manufacturing suppliers may utilize equipment or software that is not
compliant. The failure on
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the part of any vendor to adequately address its own Y2K compliance issues could
lead to delays on the part of the vendor in the delivery of subassemblies for
use in the Company's products, or disruption of services provided by a vendor,
any of which could have a material adverse effect on the Company's business,
financial condition and results of operations. The remaining Y2K compliance
activities are not expected to result in significant incremental operating
expenses; the Company estimates it will not exceed $200,000 to complete its Y2K
readiness and contingency plans. Expenditures to date in relation to Y2K
readiness have been immaterial.
Compliance with Regulations and Industry Standards. The UMC 1000 is
required to comply with a large number of voice and data regulations and
standards, which vary between domestic and international markets, and may vary
within specific international markets. Standards for new services continue to
evolve, and the UMC 1000 will need to be modified or new versions developed to
meet these standards. Failure of the system to comply with, or delays in meeting
compliance of evolving standards both in domestic and international markets,
could have a material adverse effect on the Company's business, financial
condition and results of operations. Standards setting and compliance
verification in the U.S. are determined by the Federal Communications
Commission, Underwriters Laboratories, QMI, Telcordia Technologies, Inc.
("Telcordia") formerly known as "Bellcore", other independent third party
testing organizations, and by independent telecommunications companies. In
international markets, the Company's products must comply with recommendations
issued by the Consultative Committee on International Telegraph and Telephony,
Industry Canada, and individual regional carriers' network operating system
requirements and specifications. In addition, AFC's products must comply with
standards issued by the European Telecommunications Standards Institute and
implemented and enforced by the Telecommunications Regulatory Authority of each
European nation.
The Company needs to continue to ensure that the UMC 1000 is easily
integrated with various network management systems. Telcordia testing on the UMC
1000 is often required to ensure interoperability with various standards of
operations, administration, maintenance and provisioning systems. Telcordia
testing requires significant investments in time and money to achieve
compliance. Some UMC 1000 features must pass Telcordia testing prior to field
release. Failure to maintain such compliance or to obtain it on new features
released in the future could have a material adverse effect on the Company's
business, financial condition and results of operations.
In October 1997, Underwriters Laboratories officially registered AFC as
ANSI/ISO/ASQC Q9001-1994 ("ISO") compliant, which assures quality in design,
development, production, installation and servicing. The ISO standard consists
of all elements which define a quality system aimed primarily at achieving
customer satisfaction by preventing nonconformity at all stages from design
through servicing. In November 1998, Quality Management Institute certified the
Company's annual ISO standard. There can be no assurance that AFC will maintain
such certification. The failure to maintain such certification may preclude
selling the UMC 1000 in certain markets and could materially adversely affect
the Company's ability to compete with other suppliers of telecommunications
equipment.
Failure to maintain interoperability with other companies or adopt or
maintain industry standards in the UMC 1000 could have a material adverse effect
on the Company's ability to compete with other telecommunications equipment
suppliers, and could materially adversely affect its business, financial
condition and results of operations.
In 1996, the U.S. Congress passed regulations that affect
telecommunications services, including changes to pricing, access by competitive
suppliers and many other broad changes to the data and telecommunications
networks and services. These changes will have a major impact on the pricing of
existing services, and may affect the deployment of future services. These
changes could cause greater consolidation in the telecommunications industry,
which in turn could disrupt existing customer relationships and have a material
adverse effect on the Company's business, financial condition and results of
operations. There can be no assurance that any regulatory changes will not have
a material adverse effect on the demand for the UMC 1000. Uncertainty regarding
future policies combined with emerging new competition may also affect the
demand for telecommunications products such as the UMC 1000 system.
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ITEM 2. PROPERTIES
AFC leases five buildings in Petaluma, California where the following
functions reside: administration and principal executive offices, sales,
marketing, product development, manufacturing and distribution. In addition to
its Petaluma headquarters, properties are leased at the following locations:
Fremont, California (research and design), Buffalo Grove, Illinois (research and
design), Overland Park, Kansas (sales), Coral Gables, Florida (sales and
marketing), Miramar, Florida (research and design), Shanghai (sales support),
Hong Kong (sales), Singapore (sales and marketing), New Delhi (sales support).
These buildings are suitable to AFC's operational use and these facilities are
substantially utilized while still allowing room for expansion needs in the next
12 months.
The Company has signed lease agreements commencing in 1999 for two
additional buildings in Petaluma to house anticipated growth in research and
design and headquarters. The Company's facility obligations are based in part on
future growth projections, and in the near term are relatively fixed. Based on
existing commitments for additional office space, the Company will have excess
capacity and may encounter difficulty in fully utilizing these two additional
buildings as a result of any unanticipated failure to meet growth projections.
See Part I, Item 1 "Certain Factors That Might Affect Future Operating Results"
as it pertains to this matter on page 12 of this Annual Report on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
ITRI/Acer Netxus, Inc. In September 1992, AFC entered into agreements (the
"ITRI Agreements") with the Industrial Technology Research Institute ("ITRI"), a
Taiwanese government-sponsored research and development organization, that
granted to ITRI certain license rights to the European Telecommunications
Standards Institute ("ETSI") version of the UMC 1000. In July 1996, the Company
became involved in litigation and arbitration proceedings with ITRI, certain of
ITRI's sub-licensee "Member Companies", and others, including Acer Netxus, Inc.
("Acer"). These legal proceedings involved claims for breach of the ITRI
Agreements, trade secret misappropriation, unfair competition, and related
claims.
In March 1998, the Company, ITRI, the Member Companies and other parties
entered into a definitive Settlement Agreement that resolved all claims among
such parties, except Acer. Under the Settlement Agreement, all claims involved
in the proceedings between such parties were dismissed with prejudice. The
Settlement Agreement provides that the Member Companies will pay an aggregate of
$6.3 million to the Company over a five year period, and will pay the Company
royalties on the purchase of certain ASICs by the Member Companies. Under the
Settlement Agreement, the Company granted a limited license to the Member
Companies to certain of the Company's technology, agreed to sell certain ASICs
to the Member Companies, and agreed to pay $500,000 to ITRI over a three year
period for legal fees incurred by ITRI in the proceedings. The Settlement
Agreement does not grant to the Member Companies any rights to the Company's UMC
1000 Third Generation Digital Loop Carrier(TM) ("3GDLC") technology or products.
This Settlement Agreement did not affect the Company's claims against Acer.
In September 1998, AFC favorably resolved its litigation with Acer.
Pursuant to a settlement agreement dated September 18, 1998, and a Permanent
Injunction And Final Judgment entered by the United States District Court,
Northern District of California, on September 22, 1998, Acer is enjoined from
selling any digital loop carrier system for at least one year, and from
developing, manufacturing, or selling any device that uses or derives from UMC
1000 technology or that is otherwise not the product of strict clean room
development or based on licensed third party technology. In addition, the
injunction requires that Acer destroy all work product and inventory related to
its two systems that competed with the UMC 1000, and subjects Acer to a $500,000
penalty for any and each violation of the injunction.
Alcatel USA/DSC. On December 22, 1997, AFC filed a lawsuit in Sonoma County
Superior Court in California against DSC Communications Corporation ("DSC")
related to its hiring of a former employee of DSC, to become the Company's Vice
President, Product Planning. In September 1998, DSC was acquired by Alcatel
Alsthom Compagnie and is now a part of Alcatel USA, Inc. For purposes of this
footnote, reference is made only to DSC. The Company's complaint responded to
DSC's litigation threats, and sought a declaratory judgment that its hiring of
the former DSC employee was lawful. In April 1998, DSC filed a cross-complaint
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against AFC that alleged "inevitable" trade secret misappropriation and related
claims, and sought unspecified damages, and injunctive relief relating to the
alleged misappropriation, attorneys' fees and other relief. During September
1998, the Court struck all material misappropriation allegations from DSC's
Cross-Complaint. DSC filed a First Amended Cross-Complaint on October 2, 1998,
alleging "threatened" trade secret misappropriation and related claims. The
Amended Cross-Complaint sought the same relief as the original Cross-Complaint.
On January 19, 1999, the Court sustained the Company's demurrers to all but two
causes of action of the Amended Cross-Complaint, with prejudice. Thereafter, DSC
agreed to dismiss the entire action with prejudice, and in early February 1999,
the Company and DSC filed a joint Request For Dismissal of the entire action
with the Court.
On January 22, 1998, DSC filed a lawsuit against AFC and the former DSC
employee in the United States District Court, Eastern District of Texas,
alleging "inevitable" trade secret misappropriation and related claims. DSC also
asserted a separate claim against the Company for patent infringement alleging
that AFC's 3GDLC product infringes a DSC patent. DSC's complaint sought
unspecified damages and injunctive relief relating to the alleged
misappropriation and patent infringement, attorneys' fees and other relief. On
February 5, 1998, the United States District Court, Eastern District of Texas
granted AFC's motion to dismiss all non-patent claims in this lawsuit. In May
1998, the Company filed a counterclaim against DSC in the Texas patent action
alleging federal antitrust violations, unfair competition, breach of a prior
settlement agreement and other related claims. Between April and August 1998,
certain discovery occurred, and the parties filed various motions, including
cross-motions for summary judgment on the Company's defense that a prior
Settlement Agreement between AFC and DSC barred DSC's patent claims. By a Report
And Recommendation filed October 2, 1998, the United States Magistrate Judge
recommended that the District Court grant summary judgment in the Company's
favor on the patent claim based on the Settlement Agreement. DSC filed an
Objection to this ruling with the District Court on October 16, 1998, and the
matter remains pending.
Based on reviews of the patent claim, the Company believes that AFC's 3GDLC
product does not infringe the DSC patent, and that the Company has meritorious
defenses to such claim. The Company intends to vigorously defend the litigation
against DSC and prosecute its claims against DSC. However, the ultimate outcome
of these lawsuits cannot be predicted. In addition, patent litigation is highly
complex and can extend for a protracted period of time, which can divert the
attention of management and technical personnel and require the Company to incur
substantial costs and expenses. If the patent claim were to be resolved against
AFC, this could have a material adverse effect on the Company's business,
results of operations and financial condition.
RELTEC Corporation. On November 26, 1997, AFC filed a lawsuit in Sonoma
County Superior Court in California against RELTEC Corporation, alleging trade
secret misappropriation, tortious interference with a contract, and related
claims. The case involves RELTEC's alleged acquisition of AFC's technology
through the Company's Taiwan-based licensee, Vidar-SMS Co., Ltd. Discovery is
ongoing, and trial is scheduled to start on April 12, 1999.
Stockholder Litigation. The Company and various of its current and former
officers and directors are parties to a number of related lawsuits which purport
to be class actions, filed on behalf of certain of AFC's stockholders (excluding
the defendants and parties related to them). The lawsuits, which are
substantially identical, allege that the defendants violated certain federal
securities laws. The cases have been consolidated in the United States District
Court, Northern District of California. The plaintiffs filed a consolidated
Amended Complaint on or about January 27, 1999. A hearing on defendants' motion
to dismiss the complaint is scheduled for May 24, 1999. No discovery has
occurred, and only limited discovery is expected to occur pending ruling on the
motion to dismiss.
All of these actions are in the early stages of proceedings and the Company
is currently investigating the allegations. Based on its current information,
the Company believes the suits to be without merit and intends to defend itself
and its officers and directors vigorously. Although it is reasonably possible
the Company may incur a loss upon the conclusion of these claims, an estimate of
any loss or range of loss cannot be made.
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No provision for any liability that may result upon adjudication has been
made in the Company's consolidated financial statements. In the opinion of
management, resolution of this matter is not expected to have a material adverse
effect on the financial position of AFC. However, depending on the amount and
timing, an unfavorable resolution of this matter could materially affect the
Company's future results of operations or cash flows in a particular period. In
connection with these legal proceedings, the Company expects to incur
substantial legal and other expenses. Stockholder suits of this kind are highly
complex and can extend for a protracted period of time, which can substantially
increase the cost of such litigation and divert the attention of the Company's
management.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1998, no matters were submitted to a vote of
stockholders through the solicitation of proxies or otherwise.
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PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market using
the symbol "AFCI". The Company's Common Stock prices are listed daily in the
Wall Street Journal and other publications under the Nasdaq National Market
listing with the abbreviation "AdvFibComm".
In September 1997, AFC's stockholders approved an increase in the number of
authorized shares of common stock from 100,000,000 to 200,000,000. On September
22, 1997, the Company effected a two-for-one stock split to stockholders of
record as of August 29, 1997. All share, per share and common stock amounts
herein have been restated to reflect the effect of this split.
The following table lists the high and low closing sales prices for the
Company's Common Stock as reported by the Nasdaq National Market for each full
quarterly period of the two most recent fiscal years:
HIGH LOW
------ ------
FISCAL 1998:
First Quarter (through March 28)......................... $40.13 $25.25
Second Quarter (through June 27)......................... 44.50 34.00
Third Quarter (through September 26)..................... 41.06 6.00
Fourth Quarter (through December 26)..................... 11.88 4.44
FISCAL 1997:
First Quarter (through March 29)......................... $27.81 $14.50
Second Quarter (through June 28)......................... 30.44 14.50
Third Quarter (through September 27)..................... 38.00 29.88
Fourth Quarter (through December 27)..................... 42.50 23.88
On March 15, 1999, the last reported sale price of the Company's Common
Stock on the Nasdaq National Market was $8.53 per share. As of December 31,
1998, there were approximately 442 stockholders of record holding the Company's
Common Stock.
DIVIDEND POLICY
The Company has never declared or paid cash dividends on its capital stock.
The Company currently intends to utilize all of its earnings, if any, for use in
its business and does not anticipate the payment of cash dividends in the
foreseeable future. In addition, the Company's line of credit agreement requires
consent from the banks prior to payment of dividends.
ISSUANCE OF UNREGISTERED SECURITIES
None.
USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
AFC completed its initial public offering in October 1996, in which it
issued and sold 10,350,000 shares of Common Stock for aggregate proceeds to the
Company of $120.3 million. The Registration Statement Commission File No.
333-8921 for the offering was effective for October 1, 1996, and the offering
terminated on October 4, 1996. The managing underwriters for the offering were:
Morgan Stanley & Co. Incorporated, Merrill Lynch & Co., Cowen & Company and
Hambrecht & Quist. Of the aggregate proceeds received in the offering, $2.2
million was used to defray costs and expenses related to the offering, resulting
in net proceeds of approximately $118.1 million. Of the net proceeds, $14.8
million was used to reduce debt. The remainder is invested in cash equivalents
and marketable securities.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The information required by this item is set forth on page 18 of AFC's 1998
Annual Report to Stockholders, which is incorporated by reference and filed as
Exhibit 13.1.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this item is set forth on pages 19 - 25 of
AFC's 1998 Annual Report to Stockholders, which is incorporated by reference and
filed as Exhibit 13.2.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion and analysis about market risk disclosures may
contain "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. Such statements include declarations regarding the
intent, belief or current expectations of the Company and its management. AFC's
market risk lies in foreign currency exchange rate fluctuations and changes in
interest rates.
The Company's foreign exchange risk arises from both revenues and expenses
associated with its international sales and operations. AFC has one customer
contract that is payable in French francs. The receivable is hedged using
forward currency exchange contracts. The remainder of international sales are
denominated in U.S. dollars. Changes in foreign exchange rates create risk for
AFC as it attempts to mitigate adverse fluctuations from impacting results of
operations and cash flows. The Company uses foreign exchange contracts to offset
gains and losses on exchange rate fluctuations against gains and losses on
assets, liabilities and transactions hedged. At December 31, 1998, one foreign
exchange contract in the amount of $1,146,000 was outstanding with a maturity
date of January 14, 1999. Expenses primarily consist of operating expenses
incurred in the local currencies of the Company's China, Hong Kong, Singapore,
India, Poland and U.K.-based sales and representative offices. Operating
expenses generally consist of compensation-related costs, and general office
expenses which are paid in a timely manner. Operating expenses for these offices
have historically been immaterial to the Company on a consolidated basis, and
fluctuations in the exchange rates are not considered material. The introduction
in 1999 of the "Euro" currency may cause increased competition among European
companies which in turn may cause the value of the Euro to materially fluctuate
relative to the U.S. dollar. As use of the Euro increases and becomes mandatory
in 2002, the Company may have to change its billing practices in the future.
Adoption of the Euro is not expected to have a material impact on AFC's
business, results of operations or financial condition.
Changes in domestic interest rates create risk for AFC and may cause
adverse fluctuations of its marketable securities portfolio, results of
operations and cash flows. The Company may be affected by changes in the
short-term U.S. Prime Rate and the resulting interest rate on amounts borrowed
under its line of credit. AFC's marketable securities portfolio consists of
domestic municipal debt and domestic corporate debt, of which approximately 62%
mature in one year or less. At December 31, 1998, the weighted average yield on
the Company's marketable securities was 3.71%, and the weighted average yield on
cash equivalents was 4.56%. Changes in short-term U.S. interest rates affect the
market value of those marketable securities. Because of the short-term nature of
its investment portfolio, the Company believes its exposure to these market
fluctuations is immaterial. If, at December 31, 1998, interest rates had
increased immediately by two full percentage points, the Company believes its
marketable securities portfolio would not have declined by a material amount.
The marketable securities portfolio is treated as available-for-sale under
Financial Accounting Standards Board No. 115.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is set forth on pages 26 - 42 of
AFC's 1998 Annual Report to Stockholders, which is incorporated by reference and
filed as Exhibit 13.3.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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PART III.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES OF THE REGISTRANT
Executive officers are selected annually and serve at the discretion of the
Board of Directors. No family relationships exist between any of the executive
officers or directors of AFC. The following table sets forth certain information
with respect to each person who is an executive officer, key employee or
director of the Company.
NAME AGE POSITION
---- --- --------
EXECUTIVE OFFICERS
President, Chief Executive Officer, Chairman of the
Donald Green(3) 67 Board
Gregory S. Steele 37 Vice President, Chief Operating Officer
Vice President, Chief Financial Officer, Treasurer and
Peter A. Darbee 46 Secretary
Vice President, Corporate Controller and Assistant
Karen L. Godfrey 44 Secretary
James T. Hoeck 37 Vice President, Chief Technical Officer
Catherine Millet 46 Vice President, Development Engineering
Gregory A. Peters 37 Vice President, International Operations
Richard L. Stanfield 42 Vice President, Domestic Sales
John W. Webley 40 Vice President, Marketing
KEY EMPLOYEES
Richard J. Johnston 37 Vice President, Customer Service
Dennis Omanoff 43 Vice President, Quality Assurance
Pete S. Patel 47 Vice President, Operations
Amy M. Paul 30 Vice President, General Counsel
OUTSIDE DIRECTORS
Herbert M. Dwight, Jr.(2)(4) 68 Director
Ruann F. Ernst(1)(3)(4) 51 Director
Clifford H. Higgerson(2) 59 Director
Dan Rasdal(1)(3) 65 Director
Alex Sozonoff(1)(2) 60 Director
- ---------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
(3) Member of the Nominating Committee
(4) Member of the Governance Committee
DONALD GREEN is a co-founder of AFC and has served as the Company's
Chairman of the Board since May 1992. Mr. Green has served as Chief Executive
Officer since June 1998, a position he held previously from May 1992 to June
1997. Mr. Green is also a director of TCSI Corporation, Larscom, Inc., two
private organizations, and a private non-profit foundation.
GREGORY S. STEELE was named Chief Operating Officer in December 1998. From
June through December of 1998, Mr. Steele served as Vice President, Marketing,
and from April 1995 through May 1998, he held the position of Vice President,
Operations. Mr. Steele joined AFC in November 1994 and served as the Director of
Operations until his promotion in March 1995. Prior to joining the Company, from
1990 to 1994, Mr. Steele held various positions at DSC Communications
Corporation, including Director of Account Marketing and Senior Manager of
Manufacturing.
PETER A. DARBEE has served as Vice President, Chief Financial Officer,
Treasurer and Secretary since joining the Company in June 1997. Prior to joining
AFC, Mr. Darbee was the Vice President, Chief Financial Officer and Controller
of Pacific Bell, an RBOC, from 1994 through June 1997. From 1989 through 1994,
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Mr. Darbee was Vice President and co-head of Goldman Sachs' Global Energy and
Telecommunications Group.
KAREN L. GODFREY has been Corporate Controller since joining the Company in
May 1994 and Assistant Secretary since February 1995. Ms. Godfrey was made a
Vice President in May 1997. From 1992 to 1994, Ms. Godfrey was self-employed as
a financial management consultant.
JAMES T. HOECK is a co-founder of AFC and currently serves as Chief
Technical Officer. Mr. Hoeck served as Vice President and Corporate
Technologist, Advanced Research & Development from November 1997 until his
promotion in February 1999. From February 1995 through November 1997, Mr. Hoeck
served as Vice President, Advanced Development. From the inception of the
Company in May 1992 and continuing through January 1995, Mr. Hoeck served as
Vice President, Engineering.
CATHERINE MILLET has served as Vice President, Development Engineering
since June 1998. Ms. Millet joined the Company in December 1997 and served as
Vice President, Product Planning through May 1998. Prior to joining AFC, Ms.
Millet was Vice President, Advanced Planning and Senior Director, Systems
Engineering with DSC Communications Corporation from September 1994 to December
1997. From 1993 through August 1994, Ms. Millet was the Senior Director,
Engineering with Alcatel Network Systems.
GREGORY A. PETERS served as Vice President, International Operations from
June 1997 through February 1999 when Mr. Peters left the Company to pursue other
opportunities. Prior to joining the Company, Mr. Peters was the Vice President,
International Operations of ADTRAN Inc., from 1996 to June 1997. From 1993 to
1996, Mr. Peters served as Executive Vice President of Connell Communications
Company.
RICHARD L. STANFIELD has served as Vice President, Domestic Sales since
joining AFC in December 1994. Prior to joining AFC, from 1986 through December
1994, Mr. Stanfield held various management positions with Stratus Computer,
Inc., including Western Region Director of Sales.
JOHN W. WEBLEY is a co-founder of the Company and currently serves as Vice
President, Marketing. Previously, Mr. Webley served as Vice President and
Corporate Technologist, Advanced Research & Development from November 1997
through his promotion in February 1999. From February 1995 through November
1997, Mr. Webley served as Vice President, Advanced Development. From the
inception of AFC in May 1992 and continuing through January 1995, Mr. Webley
served as Vice President, Engineering.
RICHARD J. JOHNSTON was named Vice President, Customer Service in November
1998. Mr. Johnston joined AFC in April 1993 and served as Director, Customer
Service until his promotion in 1998. Prior to joining AFC, from 1988 to 1993,
Mr. Johnston served as Manager of the Technical Service Engineering department
at Optilink Corporation, which was later purchased by DSC.
DENNIS OMANOFF was hired as Vice President, Quality in April 1998. Previous
to joining AFC, Mr. Omanoff served as Senior Director of Quality, Reliability
and Engineering Services at Fore Systems from 1996 to 1998. From 1995 to 1996,
Mr. Omanoff was Chief Quality Officer at StrataCom Communications, and from 1990
to 1995, he served as Director, Quality at SynOptics.
PETE S. PATEL was named Vice President, Operations in May 1998. Previously,
Mr. Patel served as Director of Operations from June 1997 to May 1998 and as
Director of Design Verification and Test Engineering from May 1996 through June
1997. Mr. Patel joined AFC in August 1995 and served in the capacity of Senior
Test Engineering Manager until his promotion in 1997. Prior to joining AFC, from
1988 to 1995, Mr. Patel held various senior manager positions at Optilink, which
was later purchased by DSC.
AMY M. PAUL was promoted to Vice President and General Counsel in February
1999. Previously, Ms. Paul served as Director, Contracts and Legal Affairs, from
December 1995 until her promotion in 1999. Prior to joining AFC, Ms. Paul served
as an associate in the Business and Technology Group at Brobeck Phleger &
Harrison LLP from 1993 to December 1995.
HERBERT M. DWIGHT, JR. has served as a Director since May 1998. Mr. Dwight
has served as Chairman of the Board of Optical Coating Laboratory, Inc.
("OCLI"), an optical coating and specialty ink
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manufacturer, since 1991. From 1991 to April 1998, Mr. Dwight also served as
Chief Executive Officer of OCLI and from 1991 to 1997, he served as President of
OCLI. Mr. Dwight is also a director of Applied Magnetics, Inc. and Applied
Materials, Inc.
RUANN F. ERNST has served as a Director since May 1998. Ms. Ernst has
served as President and Chief Executive Officer of Digital Island, Inc., a
telecom service provider, since June 1998. From 1994 to 1998 she served as
General Manager, Financial Services Business Unit for Hewlett-Packard Company,
an electronics equipment and computer company, and from 1993 to 1994 she was
Worldwide Financial Services Marketing Manager for Hewlett-Packard. Ms. Ernst is
also a director of Phoenix International Corporation and two private
organizations.
CLIFFORD H. HIGGERSON has served as a Director since January 1993. Mr.
Higgerson has served as a General Partner of Communications Ventures, a venture
capital firm, since 1987 and a General Partner of Vanguard Venture Partners, a
venture capital firm and a stockholder of the Company, since July 1991. Mr.
Higgerson is also a Director of Digital Microwave Corporation, Ciena Corporation
and eleven private companies.
DAN RASDAL has served as a Director since February 1993. Mr. Rasdal has
served as a director of Symmetricom, Inc. ("Symmetricom"), a telecommunications
company, since 1985. From 1988 to July 1998, Mr. Rasdal was Chairman of the
Board and Chief Executive Officer of Symmetricom. From 1985 to July 1998, he
served as President and Chief Executive Officer of Symmetricomm. Mr. Rasdal is
also a director of Celeritek, Inc.
ALEX SOZONOFF has been a Director since October 1997. Mr. Sozonoff has
served as Vice President of Customer Advocacy for Hewlett-Packard Company, an
electronics equipment and computer company, since 1998. From 1994 to 1998, he
was Vice President of Marketing for Hewlett-Packard.
Messrs. Green and Rasdal were elected as a result of the terms of the
Company's certificate of incorporation and a voting agreement among certain
stockholders of the Company. The stockholders owning the Company's Series A and
Series B Preferred Stock had the right to elect three directors and agreed to
vote for directors designated in accordance with a voting agreement. Upon
closing of the initial public offering in October 1996, all Preferred Stock was
converted into shares of Common Stock and the Preferred Stock arrangements
ended.
The certificate of incorporation calls for a Board of Directors composed of
seven directors. The terms of the office of the Board of Directors are divided
into three classes:
- Clifford H. Higgerson and Alex Sozonoff are Class I Directors, and their
terms will expire at the annual meeting of the stockholders to be held
in 2000.
- Herbert M. Dwight, Jr. and Ruann F. Ernst are Class II Directors, and
their terms will expire at the annual meeting of the stockholders to be
held in 2001.
- Donald Green and Dan Rasdal are Class III Directors, and their terms
will expire at the annual meeting of the stockholders to be held in
1999.
At each annual meeting of stockholders, the newly elected directors' terms
begin on the date of election and qualification and continue for three years
through the third annual meeting following election. Terms may differ in the
case where a director resigns, is removed from office, or until the time when a
successor director is elected and qualified.
If the need arises to increase the number of directors, additional
directorships will be distributed equally among the three classes so that, as
nearly as possible, each class is equally weighted and represented.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
AFC's directors and executive officers and individuals owning more than ten
percent of the Company's Common Stock are required to file initial reports of
ownership and changes in ownership with the Securities and Exchange Commission
under Section 16(a) of the Securities Exchange Act of 1934, as amended. The
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Securities and Exchange Commission regulations also require those persons to
provide copies of all filed Section 16(a) reports to the Company. AFC has
reviewed the report copies filed in 1998, and based also on written
representations from those persons, the Company believes that there was
compliance with Section 16(a) filing requirements for 1998, except that Mr.
Green inadvertently filed one Form 4 late reporting three transactions.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth in AFC's definitive 1999
Proxy Statement to be filed within 120 days from the Company's fiscal year end.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is set forth in AFC's definitive 1999
Proxy Statement to be filed within 120 days from the Company's fiscal year end.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth in AFC's definitive 1999
Proxy Statement to be filed within 120 days from the Company's fiscal year end.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following is a list of the consolidated financial statements and the
financial statement schedules which are included in this Form 10-K or which are
incorporated herein by reference:
1. FINANCIAL STATEMENTS:
As of December 31, 1998 and 1997:
-- Consolidated Balance Sheets
For the Years Ended December 31, 1998, 1997, and 1996:
-- Consolidated Statements of Operations
-- Consolidated Statements of Redeemable Convertible Preferred Stock
and Stockholders' Equity (Deficit)
-- Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Independent Auditors' Report
Quarterly Results of Operations (Unaudited)
2. FINANCIAL STATEMENT SCHEDULE:
-- Schedule II -- Valuation Accounts
All other financial statements and financial statement schedules have been
omitted because they are not applicable, or the required information is included
in the consolidated financial statements or notes thereto.
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3(A). EXHIBITS:
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
------- --------------------
3.3.1 Fifth Amended and Restated Certificate of Incorporation of
the Registrant.(3)
3.3.2 Certificate of Designation of Series A Junior Participating
Preferred Stock.(5)
3.5 Amended and Restated Bylaws of the Registrant.(2)
4.1 Specimen Certificate of Common Stock.(1)
4.2 Series E Preferred Stock Purchase Agreement, dated September
29, 1995, between the Registrant and certain purchasers of
the Registrant's Series E Preferred Stock.(1)
4.3 Certificate of Incorporation of the Registrant (included in
Exhibit 3.3.1).
4.4 Rights Agreement dated as of May 13, 1998, between the
Registrant and BankBoston, N.A.(5)
4.5 Amendment to Rights Agreement dated as of October 19, 1998,
between the Registrant and BankBoston, N.A.(7)
10.3 Form of Warrant Issued in Connection with the Sale of the
Registrant's Series C Preferred Stock on March 16, 1994.(1)
10.4 Form of Performance Warrant Issued in Connection with the
Sale of the Registrant's Series C Preferred Stock on March
16, 1994 and May 4, 1994.(1)
10.4.1 Form of Amendment to Warrants and Performance Warrants.(1)
10.5 Warrant Issued in Connection with the Sale of the
Registrant's Series E Preferred Stock on September 29,
1995.(1)
10.6 Restricted Stock Issuance Agreement, dated May 19, 1995,
between the Registrant, Donald Green and Maureen Green.(1)
10.7 Compensation Agreement, dated May 19, 1995, between the
Registrant and Donald Green.(1)
10.8 Promissory Note Secured by Pledge Agreement, dated May 31,
1995, by Donald Green in favor of the Registrant.(1)
10.9 Stock Pledge Agreement, dated June 16, 1995, between the
Registrant and Donald Green.(1)
10.11 Hangzhou Aftek Communication Registrant Ltd. Contract, dated
June 18, 1994, between Advanced Fibre Technology
Communication (Hong Kong) Limited and Hangzhou Communication
Equipment Factory of the MPT., HuaTong Branch.(1)+
10.12 1445 & 1455 McDowell Boulevard North Net Lease, dated
February 1, 1993, between the Registrant and G & W/Redwood
Associates Joint Venture, for the premises located at 1445
McDowell Boulevard North.(1)
10.14 Redwood Business Park Net Lease, dated July 10, 1995,
between the Registrant and G & W/Redwood Associates Joint
Venture, for the premises located at 1440 McDowell Boulevard
North.(1)
10.15 Redwood Business Park Net Lease, dated June 3, 1996, between
the Registrant and G & W/Redwood Associates Joint Venture,
for the premises located at Buildings 1 & 9 of Willow Brook
Court.(1)
10.17 Form of Indemnification Agreement for Executive Officers and
Directors of the Registrant.(1)
10.18 The Registrant's 1993 Stock Option/Stock Issuance Plan, as
amended (the "1993 Plan").(1)
10.19 Form of Stock Option Agreement pertaining to the 1993
Plan.(1)
27
30
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
------- --------------------
10.20 Form of Notice of Grant of Stock Option pertaining to the
1993 Plan.(1)
10.21 Form of Stock Purchase Agreement pertaining to the 1993
Plan.(1)
10.22 The Registrant's 1996 Stock Incentive Plan (the "1996
Plan").(1)
10.23 Form of Stock Option Agreement pertaining to the 1996
Plan.(1)
10.23.1 Form of Automatic Stock Option Agreement pertaining to the
1996 Plan.(1)
10.24 Form of Notice of Grant of Stock Option pertaining to the
1996 Plan.(1)
10.24.1 Form of Notice of Grant of Non-Employee Director Automatic
Stock Option pertaining to the 1996 Plan.(1)
10.25 Form of Stock Issuance Agreement pertaining to the 1996
Plan.(1)
10.26 The Registrant's Employee Stock Purchase Plan.(1)
10.27 Stock Issuance Agreement, dated June 30, 1997, between the
Registrant and Peter A. Darbee.(2)
10.28 Note secured by Stock Pledge Agreement, dated June 30, 1997,
by Peter A. Darbee in favor of the Registrant.(2)
10.29 Stock Pledge Agreement, dated June 30, 1997, between the
Registrant and Peter A. Darbee.(2)
10.30 Consulting Agreement, dated May 19, 1997, between the
Registrant and Peter A. Darbee.(2)
10.31 Cypress Center Net Lease, dated October 9, 1997, between the
Registrant and RNM Lakeville L.P., for the premises located
at 2210 South McDowell Boulevard.(4)
10.32 Redwood Business Park Net Lease, dated August 4, 1997,
between the Registrant and G & W/Copley Redwood Business
Park, L.P., for the premises located at 1435 McDowell
Boulevard North.
10.33 Redwood Business Park Net Lease, dated October 23, 1997,
between the Registrant and G & W/Copley Redwood Business
Park, L.P., for the premises located at 1465 McDowell
Boulevard North.
10.34 Revolving Credit Agreement, dated July 30, 1998, between the
Registrant and Banque Nationale De Paris and Bank of America
National Trust and Savings Association.(6)
10.35 Redwood Business Park Net Lease, dated July 10, 1998,
between the Registrant and G & W/Copley Redwood Business
Park, L.P., for the premises located at 1347 Redwood Way.
13.1 Selected Consolidated Financial Data from the 1998 Annual
Report to Stockholders.
13.2 Management's Discussion and Analysis of Financial Condition
and Results of Operations from the 1998 Annual Report to
Stockholders.
13.3 Financial Statements and Supplementary Data from the 1998
Annual Report to Stockholders.
21.1 Subsidiaries of the Registrant.(1)
23.1 Report on Schedule and Consent of KPMG LLP.
27.1 Financial data schedule.
27.1296 Financial data schedule (restated) for the year ended
December 31, 1996.
27.1297 Financial data schedule (restated) for the year ended
December 31, 1997.
- ---------------
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (no. 333-8921) filed with the Securities and Exchange Commission on
July 26, 1996, as amended, and declared effective September 30, 1996.
28
31
(2) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997, filed with the Securities and
Exchange Commission on August 8, 1997.
(3) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997, filed with the Securities and
Exchange Commission on November 7, 1997.
(4) Incorporated by reference from the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997, filed with the Securities and Exchange
Commission on March 23, 1998.
(5) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Securities and Exchange Commission on May 19, 1998.
(6) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1998, filed with the Securities and
Exchange Commission on August 10, 1998.
(7) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Securities and Exchange Commission on October 29, 1998.
+ Portions of this Exhibit have been granted Confidential Treatment.
3(B). REPORTS ON FORM 8-K
The Company filed one report on Form 8-K during the fourth quarter ended
December 31, 1998. The report was filed on October 29, 1998, reporting an
amendment to the Company's Stockholder Rights Plan.
29
32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ADVANCED FIBRE COMMUNICATIONS, INC.
(Registrant)
March 24, 1999 By: /s/ DONALD GREEN
------------------------------------
Donald Green
President, Chief Executive Officer
and
Chairman of the Board
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ DONALD GREEN President, Chief Executive March 24, 1999
- ----------------------------------------------------- Officer and Chairman of the
Donald Green Board
/s/ HERBERT M. DWIGHT, JR. Director March 24, 1999
- -----------------------------------------------------
Herbert M. Dwight, Jr.
/s/ RUANN F. ERNST Director March 24, 1999
- -----------------------------------------------------
Ruann F. Ernst
/s/ CLIFFORD H. HIGGERSON Director March 24, 1999
- -----------------------------------------------------
Clifford H. Higgerson
/s/ DAN RASDAL Director March 24, 1999
- -----------------------------------------------------
Dan Rasdal
/s/ ALEX SOZONOFF Director March 24, 1999
- -----------------------------------------------------
Alex Sozonoff
/s/ PETER A. DARBEE Vice President, Chief Financial March 24, 1999
- ----------------------------------------------------- Officer, Treasurer and
Peter A. Darbee Secretary (Duly Authorized
Signatory and Principal
Financial Officer)
/s/ KAREN L. GODFREY Vice President, Corporate March 24, 1999
- ----------------------------------------------------- Controller and Assistant
Karen L. Godfrey Secretary (Duly Authorized
Signatory and Principal
Accounting Officer)
30