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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
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 0-21352
APPLIED INNOVATION INC.
(Exact name of registrant as specified in its charter)
DELAWARE 31-1177192
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification no.)
5800 INNOVATION DRIVE, DUBLIN, OHIO 43016
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (614) 798-2000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
As of August 9, 2002 there were 14,950,749 shares of common stock outstanding.
APPLIED INNOVATION INC.
Table of Contents
Page
----
Facing Page 1
Table of Contents 2
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2002 (unaudited)
and December 31, 2001 3
Consolidated Statements of Operations for the three- and six-month
periods ended June 30, 2002 and 2001 (unaudited) 4
Consolidated Statements of Cash Flows for the six-month
periods ended June 30, 2002 and 2001 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 6 - 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9 - 14
Item 3. Quantitative and Qualitative Disclosure About Market Risk 15
Part II. Other Information
Items 1 - 5 15
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits 15
(b) Reports on Form 8-K - None 15
Signatures 16
- 2 -
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPLIED INNOVATION INC.
Consolidated Balance Sheets
(Unaudited)
Assets June 30, 2002 December 31, 2001
------------- -----------------
Current assets:
Cash and cash equivalents $ 16,279,940 $ 15,698,594
Short term investments 7,807,264 6,067,770
Accounts receivable 7,573,686 7,697,003
Inventory, net 4,446,848 7,322,316
Income taxes 1,464,710 903,269
Other current assets 496,544 630,593
Deferred income taxes 2,306,500 2,678,000
------------ ------------
Total current assets 40,375,492 40,997,545
Property, plant and equipment, net 8,408,231 8,823,355
Investments 1,908,166 6,849,766
Intangible assets 446,250 551,250
Goodwill 3,455,801 3,423,201
Other assets 177,502 202,687
------------ ------------
$ 54,771,442 $ 60,847,804
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,389,736 $ 3,107,412
Accrued expenses:
Warranty 765,791 819,166
Payroll and related expenses 1,310,868 1,512,229
Other accrued expenses 391,248 379,888
Deferred revenue 3,906,837 3,375,197
------------ ------------
Total current liabilities 8,764,480 9,193,892
Note payable 750,000 750,000
------------ ------------
Total liabilities 9,514,480 9,943,892
Stockholders' equity:
Preferred stock; $.01 par value; authorized 5,000,000 shares;
none issued and outstanding -- --
Common stock; $.01 par value; authorized 55,000,000 shares; issued and
outstanding 14,954,549 shares in 2002 and 15,512,899 shares in 2001 149,545 155,129
Additional paid-in capital 5,857,192 8,659,450
Note receivable for common stock (494,871) (494,871)
Retained earnings 39,742,690 42,535,717
Accumulated other comprehensive income 2,406 48,487
------------ ------------
Total stockholders' equity 45,256,962 50,903,912
------------ ------------
$ 54,771,442 $ 60,847,804
============ ============
See accompanying notes to consolidated financial statements.
- 3 -
APPLIED INNOVATION INC.
Consolidated Statements of Operations (Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
2002 2001 2002 2001
------------ ----------- ------------ -----------
Sales:
Products and integration $ 14,412,735 $12,617,482 $ 22,214,190 $34,711,380
Services 2,038,129 4,373,131 3,719,318 7,917,949
------------ ----------- ------------ -----------
Total sales 16,450,864 16,990,613 25,933,508 42,629,329
Cost of sales:
Cost of sales - products and integration 7,940,353 5,822,281 12,224,478 18,058,079
Cost of sales - services 1,561,062 2,810,755 2,701,099 4,585,920
------------ ----------- ------------ -----------
Total cost of sales 9,501,415 8,633,036 14,925,577 22,643,999
Gross profit 6,949,449 8,357,577 11,007,931 19,985,330
Operating expenses:
Selling, general and administrative 5,375,969 5,490,025 10,659,058 11,548,326
Research and development 1,849,601 2,295,135 4,292,015 4,916,458
Restructuring charges (226,192) 292,330 407,730 292,330
------------ ----------- ------------ -----------
(Loss) income from operations (49,929) 280,087 (4,350,872) 3,228,216
Interest income and other income, net 166,145 337,213 360,845 786,079
------------ ----------- ------------ -----------
(Loss) income before income taxes 116,216 617,300 (3,990,027) 4,014,295
Income taxes 35,000 209,600 (1,197,000) 1,364,900
------------ ----------- ------------ -----------
Net (loss) income $ 81,216 $ 407,700 $ (2,793,027) $ 2,649,395
============ =========== ============ ===========
(Loss) earnings per share:
Basic (loss) earnings per share $ 0.01 $ 0.03 $ (0.18) $ 0.17
============ =========== ============ ===========
Diluted (loss) earnings per share $ 0.01 $ 0.03 $ (0.18) $ 0.16
============ =========== ============ ===========
Weighted-average shares outstanding
for basic (loss) earnings per share 15,070,116 15,905,784 15,232,485 15,893,017
============ =========== ============ ===========
Weighted-average shares outstanding
for diluted (loss) earnings per share 15,091,715 16,275,516 15,232,485 16,244,532
============ =========== ============ ===========
See accompanying notes to consolidated financial statements.
- 4 -
APPLIED INNOVATION INC.
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended June 30,
2002 2001
------------ ------------
Cash flows from operating activities:
Net (loss) income $ (2,793,027) $ 2,649,395
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation 907,055 807,760
Amortization of intangible assets 105,000 --
Loss (gain) on disposal of assets 48,773 (1,559)
Deferred income tax expense 400,000 400,000
Tax benefit of options exercised 340 32,830
Effects of changes in operating assets and liabilities:
Accounts receivable 123,317 15,389,787
Inventory 2,875,468 3,844,464
Income taxes (561,441) --
Other current assets 134,049 (182,799)
Other assets 25,185 19,638
Accounts payable (717,676) (15,306,210)
Accrued expenses (275,976) (3,430,505)
Deferred revenue 531,640 (882,406)
------------ ------------
Net cash provided by operating activities 802,707 3,340,395
------------ ------------
Cash flows from investing activities:
Purchases of property, plant and equipment (545,695) (937,074)
Purchases of investments (2,565,718) (14,522,516)
Maturities of investments 4,936,710 10,371,315
Sales of investments 756,533 3,146,459
Proceeds from sales of property, plant and equipment 4,991 6,531
------------ ------------
Net cash provided by (used in) investing activities 2,586,821 (1,935,285)
------------ ------------
Cash flows from financing activities:
Common stock repurchased (2,816,526) --
Proceeds from issuance of common stock 8,344 699,461
------------ ------------
Net cash (used in) provided by financing activities (2,808,182) 699,461
------------ ------------
Increase in cash and cash equivalents 581,346 2,104,571
Cash and cash equivalents - beginning of period 15,698,594 14,020,080
------------ ------------
Cash and cash equivalents - end of period $ 16,279,940 $ 16,124,651
============ ============
See accompanying notes to consolidated financial statements.
- 5 -
APPLIED INNOVATION INC.
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of presentation - The consolidated balance sheet as of June 30, 2002,
the consolidated statements of operations for the three- and six-month periods
ended June 30, 2002 and 2001, and the consolidated statements of cash flows for
the six-month periods ended June 30, 2002 and 2001 have been prepared by the
Company without audit. In the opinion of management, all adjustments, which
consist solely of normal recurring adjustments, necessary to present fairly, in
accordance with generally accepted accounting principles, the financial
position, results of operations and cash flows for all periods presented have
been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These consolidated financial statements should
be read in conjunction with the consolidated financial statements and notes
thereto included in the Company's December 31, 2001 Annual Report on Form 10-K.
The results of operations for the period ended June 30, 2002 are not necessarily
indicative of the results for the full year.
Certain prior year amounts have been reclassified to conform with current year
presentation.
2. Inventory - Inventory is stated at the lower of cost or market. Cost is
computed using standard cost, which approximates actual cost on a first-in,
first-out method, net of allowances for estimated obsolescence. Major classes of
inventory at June 30, 2002 and December 31, 2001 are summarized below:
June 30, 2002 December 31, 2001
------------- -----------------
Raw materials $ 3,454,419 $ 7,104,242
Work-in-process 637,104 181,552
Finished goods 1,179,877 1,806,808
----------- -----------
5,271,400 9,092,602
Reserve for obsolescence (824,552) (1,770,286)
----------- -----------
$ 4,446,848 $ 7,322,316
=========== ===========
During the three- and six-month periods ended June 30, 2002, the Company
recorded inventory charges of $1,398,000 and $1,862,000, respectively. These
amounts were charged to cost of goods sold to write down fiber optic components,
lasers and other inventory.
3. Income taxes - The Company has recorded its interim income tax provision
based on estimates of the Company's effective tax rate expected to be applicable
for the full fiscal year. Estimated effective rates recorded during interim
periods may be periodically revised, if necessary, to reflect current estimates.
- 6 -
4. Comprehensive income - Comprehensive income (loss) for the three- and
six-month periods ended June 30, 2002 was $78,236 and ($2,839,108),
respectively. The sole adjustment necessary to reconcile net income (loss) with
comprehensive income (loss) is for the net unrealized loss, net of taxes, on
investment securities, which was $2,980 for the three months ended June 30, 2002
and $46,081 for the six months ended June 30, 2002. Comprehensive income for the
three- and six-month periods ended June 30, 2001 was $508,446 and $2,638,964,
respectively. The sole adjustment necessary to reconcile net income with
comprehensive income is for the net unrealized gain (loss), net of taxes, on
investment securities, which was $100,746 for the three months ended June 30,
2001 and ($10,431) for the six months ended June 30, 2001.
5. Earnings per share - Basic (loss) earnings per share is calculated using the
weighted-average number of common shares outstanding during the periods. Diluted
earnings per share is calculated using the weighted-average number of common and
common equivalent shares outstanding during the periods. Due to the Company's
net loss, no common equivalent shares were included in the calculation of
diluted loss per share for the six months ended June 30, 2002 because their
effect would have been anti-dilutive. For the six months ended June 30, 2002,
the Company's weighted-average number of stock options which were in-the-money
and, therefore, potentially dilutive, was 239,669. For that same period, the
Company had 2,494,883 of weighted-average stock options which were
out-of-the-money.
Shares of common stock used in calculating (loss) earnings per share differed
from outstanding shares reported in the consolidated financial statements as
follows:
Three months ended Three months ended
June 30, 2002 June 30, 2001
------------- -------------
Basic earnings Diluted earnings Basic earnings Diluted earnings
per share per share per share per share
--------- --------- --------- ---------
Outstanding shares 14,954,549 14,954,549 15,910,989 15,910,989
Effect of weighting changes
in outstanding shares 115,567 115,567 (5,205) (5,205)
Stock options -- 21,599 -- 369,732
---------- ---------- ---------- ----------
Adjusted shares 15,070,116 15,091,715 15,905,784 16,275,516
========== ========== ========== ==========
Six months ended Six months ended
June 30, 2002 June 30, 2001
-------------- -------------
Basic loss Diluted loss Basic earnings Diluted earnings
per share per share per share per share
--------- --------- --------- ---------
Outstanding shares 14,954,549 14,954,549 15,910,989 15,910,989
Effect of weighting changes
in outstanding shares 277,936 277,936 (17,972) (17,972)
Stock options -- -- -- 351,515
---------- ---------- ---------- ----------
Adjusted shares 15,232,485 15,232,485 15,893,017 16,244,532
========== ========== ========== ==========
- 7 -
6. Goodwill and intangible assets - Effective January 1, 2002, the Company
adopted the provisions of Statement of Financial Accounting Standards (SFAS) No.
142, Goodwill and Other Intangible Assets. SFAS No. 142 requires that goodwill
and intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. It also requires that the Company complete a
transitional goodwill impairment test within six months from the date of
adoption and reassess the useful lives of other intangible assets within the
first interim quarter after adoption. Any impairment losses that arise due to
the initial adoption of the standard must be reported as a cumulative effect of
a change in accounting principle.
The Company had no previously recorded goodwill or other intangible assets
accounted for under standards other than SFAS No. 142. During the second quarter
of 2002, the Company completed the transitional goodwill impairment test
required by SFAS No. 142 and determined that no impairment charge was necessary.
7. Equity - On September 14, 2001, the Company's Board of Directors authorized a
stock repurchase program under which the Company may purchase up to 1,500,000
shares of common stock over the next twelve months. During the three months
ended June 30, 2002, the Company paid $789,484 to repurchase 186,500 shares
under this program. During the six months ended June 30, 2002, the Company paid
$2,816,526 to repurchase 560,350 shares under this program. Since the inception
of the repurchase program, the Company has paid $5,844,653 to repurchase
1,005,650 shares.
8. Restructuring costs - On February 5, 2002, the Company announced a reduction
in workforce of approximately 16%, or approximately 50 employees, throughout all
departments. The Company recorded a workforce reduction charge of approximately
$634,000 in the first quarter of 2002 relating primarily to severance and fringe
benefits. The Company has paid out $375,000 of such costs as of June 30, 2002
and reversed $226,000 of accrued restructuring costs in the second quarter of
2002. Due to changing business conditions and a shift in the Company's market
priorities, the Company did not fully enact the headcount reduction planned in
the first quarter. Further, certain fringe benefit costs associated with the
first quarter headcount reduction, as well as the duration of the severance
period for certain severed employees, were less than originally estimated. As of
June 30, 2002, the remaining accrued restructuring costs were $33,000. These
costs are expected to be paid out prior to December 31, 2002.
9. Employee Stock Purchase Plan - At the April 25, 2002 Annual Meeting of
Stockholders, the Applied Innovation Inc. Employee Stock Purchase Plan ("the
Plan") was approved and adopted. The Plan authorizes the sale of up to 500,000
shares of Applied Innovation Inc. common stock to eligible employees, pursuant
to the terms and conditions outlined in the Plan.
- 8 -
10. Subsequent events
On August 14, 2002, the Company announced a restructuring plan, including
management changes and a reduction in workforce of approximately 40%, or
approximately 100 employees, throughout all departments. Management changes
include Gerard B. Moersdorf, Jr., Chairman and Founder, resuming his previous
role as President and Chief Executive Officer. Robert L. Smialek will vacate
those positions, which he held since July 2000, and will no longer serve on the
Company's Board of Directors. As a result of the restructuring plan, the Company
expects to record restructuring charges of approximately $2,000,000 to
$2,400,000 during the third quarter of 2002, relating primarily to severance and
other fringe benefits for affected employees, as well as charges related to
excess equipment and leased offices. The Company expects to pay out the majority
of such costs through the remainder of 2002.
On August 7, 2002, the Company entered into an agreement with The Huntington
National Bank ("the Bank") for a credit facility. The term of the credit
facility is 364 days and provides for a line of credit up to $10,000,000, with
interest payable monthly and principal due at maturity. Borrowings on the line
will be limited to $5,000,000 on real estate, plus 75% of eligible accounts
receivable and 40% of eligible inventory, as defined in the agreement. Available
borrowings will bear interest at the London Interbank Offered Rate ("LIBOR")
plus 1.65%, or the Bank's Prime Commercial Rate less 1.00%, at the option of the
Company. Borrowings will be collateralized by the Company's receivables,
inventory, certain investments, equipment, real estate and general intangibles.
The credit facility contains certain financial covenants, including, but not
limited to, restrictions on the payment of dividends, minimum tangible net worth
and a minimum liquidity ratio.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Applied Innovation Inc. develops, manufactures, and markets network mediation
and bridging products and related services to the telecommunications industry.
The products and services support the operation, maintenance, administration and
provisioning of a variety of switching and transmission devices used by wireline
and wireless telecommunications providers to assist in the management of their
customer service networks. The Company's primary emphasis is on providing
integrated hardware, software, service and turnkey network management solutions.
The Company's largest customers are the four Regional Bell Operating Companies
("RBOCs"), as well as other large domestic and foreign phone companies. In
recent months, sales focus has increased significantly related to domestic
Independent Operating Carriers ("IOCs"), also known as Independent Local
Exchange Carriers ("ILECs"), which are operating companies in local and rural
markets.
Our order flow and product and services sales continue to be negatively impacted
by the telecommunications industry's prolonged slowdown. While we continue to
manage through this downturn and still believe that our customers are among the
stronger industry participants who will likely survive this current downturn, we
remain unable to provide revenue estimates or other guidance for the remainder
of 2002. The uptick in orders which we experienced in the first half of
- 9 -
the second quarter in 2002 proved unsustainable as we experienced a drop off in
orders in the second half of the quarter. For the second half of 2002, we expect
continued weakness in our core market as RBOCs and other large domestic service
providers continue to reduce spending. This will negatively affect domestic
demand for our core products as well as installation services. We continue to
view the international and wireless markets as areas of opportunity and will
continue the efforts which we began in those areas in 2001. We have continued to
establish international sales distributor relationships and have completed or
are pursuing numerous field trials internationally.
On August 14, 2002, the Company announced a restructuring plan, including
management changes and a reduction in workforce of approximately 40%, or
approximately 100 employees, throughout all departments. Management changes
include Gerard B. Moersdorf, Jr., Chairman and Founder, resuming his previous
role as President and Chief Executive Officer. Robert L. Smialek will vacate
those positions, which he held since July 2000, and will no longer serve on the
Company's Board of Directors. As a result of the restructuring plan, the Company
expects to record restructuring charges of approximately $2,000,000 to
$2,400,000 during the third quarter of 2002, relating primarily to severance and
other fringe benefits for affected employees, as well as charges related to
excess equipment and leased offices. The Company expects to pay out the majority
of such costs through the remainder of 2002.
RESULTS OF THE THREE-AND SIX-MONTH PERIODS ENDED JUNE 30, 2002 COMPARED TO
THREE- AND SIX-MONTH PERIODS ENDED JUNE 30, 2001
Sales for the second quarter of 2002 were $16,451,000, a 3% decrease from sales
of $16,991,000 during the second quarter of 2001. Year-to-date, sales of
$25,934,000 for 2002 decreased 39% from 2001 year-to-date sales of $42,629,000.
The 2001 year-to-date sales include $5,830,000 of integration sales from the
first quarter of 2001 which the Company identified as non-recurring in nature.
Excluding the impact of the non-recurring integration sales, year-to-date sales
decreased 30% from the previous year. The overall decrease in year-to-date sales
is largely attributable to the ongoing capital spending reductions throughout
the telecommunications industry.
Gross profit as a percentage of total sales was 42% for the second quarter of
2002, versus 49% for the second quarter of 2001. Year-to-date gross profit
percentages were 42% and 47% for 2002 and 2001, respectively. The decrease in
gross profit as a percentage of total sales is directly related to the overall
decrease in demand for both products and services. With lower product demand, it
becomes more difficult to cover certain fixed manufacturing costs. Lower
services demand results in lower utilization of service personnel and therefore
depressed services margins. In addition, the Company took additional inventory
charges in the second quarter of 2002 to further writedown certain of its
optical and other component inventory, as further discussed below.
The following table summarizes sales and gross profit for products and services:
For the Quarter Ended June 30, 2002 For the Quarter Ended June 30, 2001
----------------------------------- -----------------------------------
Products Services Total Products Services Total
-------- -------- ----- -------- -------- -----
Sales $14,413,000 $2,038,000 $16,451,000 $12,618,000 $4,373,000 $16,991,000
Gross Profit 6,472,000 477,000 6,949,000 6,796,000 1,562,000 8,358,000
Gross Profit % 45% 23% 42% 54% 36% 49%
Product sales of $14,413,000 were 88% of 2002 second quarter sales, versus
product sales of $12,618,000, or 74% of 2001 second quarter sales. This
represented a 14% increase in product sales from the second quarter of 2001,
driven primarily by sales of core products for central office applications to
two of the Company's largest customers as well as sales of third-party equipment
associated with a network management system (NMS) deployment in the quarter.
Year-to-date product sales of $22,214,000 were 86% of total sales in 2002,
versus $34,711,000 or 81% of total sales in 2001. This represented a 36%
decrease in product sales from the previous year, attributable to reduced
capital spending in the telecommunications industry. Product sales include
revenues
- 10 -
from the sales of AIswitch, AIscout, and other products, as well as third-party
hardware and software licensing revenues.
Gross profit on product sales was 45% of total product sales for the second
quarter of 2002, compared with 54% of total product sales for the same period
last year. While the sales mix in the second quarter of 2002 included a higher
proportion of high margin core products, overall gross profit on product sales
was negatively impacted by two factors. First, gross profits on third-party
equipment sales are generally lower than on the Company's core products and the
current quarter included approximately $1,500,000 of third-party equipment
associated with the NMS deployment previously mentioned. Second, $1,398,000 of
inventory charges were taken in the second quarter of 2002 that negatively
impacted product gross profits.
Because the telecommunication industry's capital spending and demand for optical
components continues to lag, the Company recorded additional inventory charges
of $1,398,000 ($0.06 per share, net of tax) in the second quarter of 2002.
Year-to-date inventory charges total $1,862,000 ($0.09 per share, net of tax).
These amounts were charged to cost of goods sold. The charges related primarily
to writing down the cost of the inventory components supporting the Company's
LuxConnect optical transmission product as well as laser components for the
Company's AIflex product. With this writedown, inventory for the LuxConnect
product line has been reduced to zero and the Company has discontinued the
product line. Excluding the effect of these inventory charges, gross profit on
product sales for the second quarter of 2002 would have been $7,870,000, or 55%
of product sales.
Services sales of $2,038,000 were 12% of 2002 second quarter sales, versus
services sales of $4,373,000, or 26% of 2001 second quarter sales. Year-to-date
services sales of $3,719,000 were 14% of total sales in 2002, compared to
$7,918,000, or 19% of total sales in 2001. Services revenue decreased 53% from
2001 in both the three- and six-month periods ending June 30, 2002. Demand for
installation services has decreased, corresponding with the overall decrease in
product sales from the previous year and consistent with the overall reduced
spending in the industry. Services sales consist of network planning and design,
installation, project management, engineering services, training and
maintenance.
Services gross profit for the three-month period ended June 30, 2002 was 23% of
services sales, versus 36% of services sales a year ago. The decrease in gross
profit on services sales was primarily attributable to decreased utilization of
services personnel during the second quarter of 2002 due to overall lower
demand.
Because of the Company's concentration of sales to RBOCs, long distance phone
companies, and one foreign service provider, a small number of customers
typically represent substantial portions of total sales. For the first six
months of 2002, sales to three companies comprised 78% of total sales. Each of
the three customers contributed between 19% and 33% of total sales.
Selling, general and administrative (SG&A) expenses decreased to $5,376,000 in
the second quarter of 2002, from $5,490,000 in the second quarter of 2001. As a
percentage of total quarterly sales, this represented 33% in 2002 and 32% in
2001. Year-to-date SG&A expenditures were
- 11 -
$10,659,000 for 2002 and $11,548,000 for 2001, which represented 41% of total
sales in 2002 and 27% in 2001. The decrease in year-to-date SG&A expenditures
from the previous year is largely attributable to lower sales commissions and
travel related expenses, consistent with overall lower sales volumes. In
addition, marketing-related spending on discretionary items such as advertising
and trade shows has been reduced and overall headcount is lower than in the
previous year. The increase in year-to-date SG&A spending as a percentage of
total sales is primarily a result of lower total sales in 2002 than in 2001. The
Company anticipates SG&A expenses for the remainder of 2002 will continue to be
less than prior year amounts due to decreased staffing and other cost-saving
measures.
Research and development (R&D) expenses decreased 19% to $1,850,000 for the
second quarter of 2002, from $2,295,000 for the same period in 2001. R&D as a
percentage of total sales decreased to 11% for the second quarter of 2002, down
from 14% for the same period in 2001. Year-to-date R&D expenses were $4,292,000
for 2002 and $4,916,000 for 2001. The decrease in R&D expenses is primarily
attributed to reduced staffing and decreased consulting costs, as well as lower
material costs. Also, the Company was continuing to invest in R&D associated
with the LuxConnect product in the previous year. The Company expects to
continue to invest in product enhancements and new product development to
support changing customer and industry needs, as well as to position itself to
capitalize on opportunities in international and wireless markets. However, the
Company expects R&D expenditures for the remainder of 2002 to be lower than
2001.
The Company recorded a non-recurring charge to operating expenses of
approximately $634,000 in the first quarter of 2002. The non-recurring charge,
relating primarily to severance and fringe benefits associated with a 16%
workforce reduction in February, was separately stated on the consolidated
statements of operations. The Company has paid out $375,000 of such costs as of
June 30, 2002 and reversed $226,000 of accrued restructuring costs in the second
quarter of 2002. Due to changing business conditions and a shift in the
Company's market priorities, the Company did not fully enact the headcount
reduction planned in the first quarter. Further, certain fringe benefit costs
associated with the first quarter headcount reduction, as well as the duration
of the severance period for certain severed employees, were less than originally
estimated. The Company expects to pay out the remaining accrued costs ($33,000
at June 30, 2002) by December 31, 2002.
As a result of the above factors, the Company recorded a loss from operations of
$50,000 in the second quarter of 2002, versus income from operations of $280,000
in the second quarter of 2001. Year-to-date loss from operations was $4,351,000,
versus income from operations of $3,228,000 in 2001. Year-to-date loss from
operations represents 17% of total sales in 2002, versus income from operations
of 8% of total sales in 2001.
The Company's effective tax rate was 30% for the three- and six-month periods
ended June 30, 2002 versus an effective rate of 34% for the same periods in
2001. The decrease in effective tax rate is due primarily to the estimated
full-year impact of research and experimentation credits.
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LIQUIDITY AND CAPITAL RESOURCES
The Company had $25,995,000 of cash and cash equivalents and short- and
long-term investments at June 30, 2002, a decrease of $2,621,000 from the
December 31, 2001 balance of $28,616,000.
For the six-month period ended June 30, 2002, operating activities provided
$803,000 of cash. Operations provided cash despite the net loss for the period
of $2,793,000, largely due to operating expenses that did not require the use of
cash, including $1,012,000 of depreciation and amortization and $1,862,000 of
inventory writedowns, as well as changes in other operating assets and
liabilities. During the same period, investing activities provided $2,587,000 of
cash primarily due to maturities and sales of investments (net of purchases) of
$3,128,000 offset by $546,000 of equipment purchases. Also during the period,
the Company used $2,817,000 to repurchase common stock.
During the six-month period ended June 30, 2001, operating activities provided
$3,340,000 in cash. During the same period, the Company purchased $937,000 of
equipment to support operations and purchased $1,005,000 of investment
securities (net of maturities and sales).
Net working capital was $31,611,000 at June 30, 2002, compared to $31,804,000 at
December 31, 2001. At June 30, 2002, the current ratio was 4.6:1 and the
Company's only debt outstanding was a $750,000 note payable issued in
conjunction with an acquisition that occurred in 2001. The note payable bears
interest at the annual rate of 8%, with interest payments due semi-annually and
principal due at maturity in August 2004.
On August 7, 2002, the Company entered into an agreement with The Huntington
National Bank ("the Bank") for a credit facility. The term of the credit
facility is 364 days and provides for a line of credit up to $10,000,000, with
interest payable monthly and principal due at maturity. Available borrowings on
the line will be limited to $5,000,000 on real estate, plus 75% of eligible
accounts receivable and 40% of eligible inventory, as defined in the agreement.
Borrowings will bear interest at the London Interbank Offered Rate ("LIBOR")
plus 1.65%, or the Bank's Prime Commercial Rate less 1.00%, at the option of the
Company. Borrowings will be collateralized by the Company's receivables,
inventory, certain investments, equipment, real estate and general intangibles.
The credit facility contains certain financial covenants, including, but not
limited to, restrictions on the payment of dividends, minimum tangible net worth
and a minimum liquidity ratio.
The Company believes that its existing cash, cash equivalents, investments, cash
to be generated from future operations and available credit facility will
provide sufficient capital to meet the business needs of the Company for the
next twelve months. However, the Company could generate additional funding
through issuance of debt or equity or through the sale of land if the Company's
working capital needs significantly increase due to circumstances such as
sustained weakness in the telecommunications industry which results in decreased
demand for the Company's products and services and operating losses; faster than
expected growth which results in increased accounts receivable and inventory;
additional investment or acquisition activity; or significant research and
development efforts.
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IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2002, the Financial Accounting Standards Board issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146
will require a company to disclose information about its exit and disposal
activities, the related costs, and changes in those costs in the notes to the
interim and annual financial statements that include the period in which an exit
or disposal activity is initiated. SFAS No. 146 requires disclosure, for each
reportable segment, of the exit or disposal activity costs incurred in the
period and the cumulative amount incurred, net of any changes in the liability,
with and explanation of the reasons for the changes. SFAS No. 146 also requires
a company to disclose the total amount of costs expected to be incurred in
connection with the exit or disposal activity. The new requirements are
effective prospectively for exit and disposal activities initiated after
December 31, 2002. The Company does not anticipate that adoption of SFAS No. 146
will have a material impact on its financial condition or results of operations.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The foregoing Management's Discussion and Analysis of Financial Condition and
Results of Operations contains certain 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, which are intended to be
covered by the safe harbors created thereby. These statements include, but may
not be limited to, all statements regarding intent, beliefs, expectations,
projections, forecasts, and plans of the Company and its management, and include
statements regarding sales growth in the year 2002 (paragraph 2), restructuring
charges (paragraph 3), future SG&A expenditures (paragraph 13), future R&D
expenditures (paragraph 14), non-recurring workforce reduction charges
(paragraph 15), and sufficiency of capital resources (paragraph 23). These
forward-looking statements involve numerous risks and uncertainties, including,
without limitation, fluctuations in demand for the Company's products and
services, the impact of competitive products and services, general economic and
business conditions, the Company's ability to develop new products as planned
and on budget, the fact that the Company may decide to substantially increase
R&D expenditures to meet the needs of its business and customers, currently
unforeseen circumstances that could require the use of capital resources,
current and future mergers of key customers and the various risks inherent in
the Company's business and other risks and uncertainties detailed from time to
time in the Company's periodic reports filed with the Securities and Exchange
Commission, including the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2001. One or more of these factors have affected, and
could in the future affect, the Company's business and financial results and
could cause actual results to differ materially from plans and projections.
Therefore, there can be no assurance that the forward-looking statements
included in this Form 10-Q will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation by the Company, or any other person, that the objectives and
plans of the Company will be achieved. All forward-looking statements are based
on information presently available to the management of the Company. The Company
assumes no obligation to update any forward-looking statements.
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Item 3. Quantitative and Qualitative Disclosure about Market Risk -
The Company does not have any material exposure to interest rate changes,
commodity price changes, foreign currency fluctuation, or similar market risks.
Furthermore, the Company has not entered into any derivative contracts. Related
to an acquisition in 2001, the Company has a $750,000 note payable, bearing
interest at a fixed rate of 8% annually and due in August 2004.
PART II. OTHER INFORMATION
Items 1 - 3. Inapplicable
Items 4. Submission of Matters to a Vote of Security Holders
(a) Applied Innovation Inc. held its Annual Meeting of Stockholders on April
25, 2002, for the purpose of electing three Class III directors and
approving the Employee Stock Purchase Plan.
(b) At the Annual Meeting of Stockholders, all directors nominated were
elected.
(c) The table shows the voting tabulation for each matter voted upon at the
Annual Meeting of Stockholders.
ACTION FOR WITHHELD
- ------ --- --------
Election of Class III Directors
Gerard B. Moersdorf, Jr. 14,143,406 362,312
Robert L. Smialek 14,134,576 371,142
Alexander B. Trevor 14,419,097 86,621
ACTION FOR AGAINST WITHHELD
- ------ --- ------- --------
Approval of the Employee Stock
Purchase Plan 13,959,575 479,699 66,444
Item 5. Inapplicable
Item 6. (a) Exhibits
Exhibit 10.1 - Employment Agreement between the Company and
John F. Petro
Exhibit 99.1 - Certification by Chief Executive Officer
Exhibit 99.2 - Certification by Chief Financial Officer
(b) Reports on Form 8-K - None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
APPLIED INNOVATION INC.
-----------------------
(Registrant)
August 14, 2002 /s/ Gerard B. Moersdorf, Jr.
- --------------- ----------------------------
Date Gerard B. Moersdorf, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
August 14, 2002 /s/ Michael P. Keegan
- ------------------ ---------------------
Date Michael P. Keegan
Vice President, Chief Financial Officer
and Treasurer
(Principal Financial Officer and Principal
Accounting Officer)
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