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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, 2004
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of August 9, 2004 there were 15,085,495 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, 2004 (unaudited) and December 31, 2003 3
Consolidated Statements of Operations for the three- and six-month periods ended
June 30, 2004 and 2003 (unaudited) 4
Consolidated Statements of Cash Flows for the six-month periods ended June 30,
2004 and 2003 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 6 - 9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 10 - 16
Item 3. Quantitative and Qualitative Disclosure About Market Risk 16
Item 4. Controls and Procedures 16
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders 16 - 17
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits 17
(b) Reports on Form 8-K 17
Signatures 18
-2-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPLIED INNOVATION INC.
Consolidated Balance Sheets
(Unaudited)
June 30, 2004 December 31, 2003
------------- -----------------
Assets
Current assets:
Cash and cash equivalents $ 9,368,625 $ 12,030,638
Short term investments 6,784,363 5,582,325
Accounts receivable, net 2,354,566 3,449,052
Inventory, net 4,167,598 2,814,442
Income taxes receivable 472,014 268,287
Other current assets 548,572 1,255,700
Deferred income taxes 1,656,000 1,963,000
------------ ------------
Total current assets 25,351,738 27,363,444
Property, plant and equipment, net 6,926,426 7,060,034
Investments 9,365,917 10,360,075
Intangible assets, net 26,250 131,250
Goodwill 3,525,801 3,525,801
Deferred income taxes 1,643,000 127,000
Other assets 1,340,726 1,315,275
------------ ------------
$ 48,179,858 $ 49,882,879
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 962,101 $ 790,037
Accrued expenses:
Warranty 381,925 479,062
Payroll and related expenses 783,933 787,819
Restructuring 190,795 43,825
Taxes, other than income taxes 298,589 563,252
Other accrued expenses 744,572 723,249
Deferred revenue 2,822,499 2,268,999
Note payable 750,000 750,000
------------ ------------
Total current liabilities 6,934,414 6,406,243
------------ ------------
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 15,071,547 shares in 2004 and 15,033,409 in 2003 150,715 150,334
Additional paid-in capital 6,298,856 6,140,540
Retained earnings 34,819,597 37,145,452
Accumulated other comprehensive (loss) gain, net (23,724) 40,310
------------ ------------
Total stockholders' equity 41,245,444 43,476,636
------------ ------------
$ 48,179,858 $ 49,882,879
============ ============
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,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Sales:
Products $ 4,220,954 $ 7,866,350 $ 8,662,702 $ 12,256,300
Services 1,495,560 1,645,964 2,902,130 2,864,756
------------ ------------ ------------ ------------
Total sales 5,716,514 9,512,314 11,564,832 15,121,056
Cost of sales:
Cost of sales - products 2,136,632 3,415,092 4,286,979 5,837,973
Cost of sales - services 642,957 937,673 1,382,388 1,767,521
------------ ------------ ------------ ------------
Total cost of sales 2,779,589 4,352,765 5,669,367 7,605,494
Gross profit 2,936,925 5,159,549 5,895,465 7,515,562
Operating expenses:
Selling, general and administrative 3,372,842 3,613,414 6,797,302 7,199,513
Research and development 1,293,845 1,396,136 2,685,035 2,796,253
Restructuring charges 227,690 (32,237) 227,690 (32,237)
------------ ------------ ------------ ------------
(Loss) income from operations (1,957,452) 182,236 (3,814,562) (2,447,967)
Interest and other income, net 94,500 76,290 179,707 186,667
------------ ------------ ------------ ------------
(Loss) income before income taxes (1,862,952) 258,526 (3,634,855) (2,261,300)
Income taxes (671,000) 52,000 (1,309,000) (452,000)
------------ ------------ ------------ ------------
Net (loss) income $ (1,191,952) $ 206,526 $ (2,325,855) $ (1,809,300)
============ ============ ============ ============
Basic (loss) earnings per share $ (0.08) $ 0.01 $ (0.15) $ (0.12)
============ ============ ============ ============
Diluted (loss) earnings per share $ (0.08) $ 0.01 $ (0.15) $ (0.12)
============ ============ ============ ============
Weighted-average shares outstanding
for basic (loss) earnings per share 15,067,259 14,975,067 15,065,091 14,975,067
============ ============ ============ ============
Weighted-average shares outstanding
for diluted (loss) earnings per share 15,067,259 14,980,853 15,065,091 14,975,067
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
-4-
APPLIED INNOVATION INC.
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended June 30,
2004 2003
------------ ------------
Cash flows from operating activities:
Net loss $ (2,325,855) $ (1,809,300)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Depreciation 583,084 620,562
Amortization of intangible assets 105,000 105,000
Loss on disposal of assets 57,543 28
Tax benefit of options exercised 16,329 -
Provision for deferred income taxes (1,169,000) -
Effects of changes in operating assets and liabilities:
Accounts receivable 1,094,486 (814,689)
Inventory (1,353,156) 379,882
Income taxes (203,727) 3,186,781
Other current assets 707,128 357,005
Other assets (25,451) -
Accounts payable 172,064 200,806
Accrued expenses (197,393) 414,513
Deferred revenue 553,500 1,120,718
------------ ------------
Net cash (used in) provided by operating activities (1,985,448) 3,761,306
------------ ------------
Cash flows from investing activities:
Purchases of property, plant and equipment (522,809) (245,638)
Proceeds from sales of property, plant and equipment 15,790 15,967
Purchases of investments (5,268,816) (10,057,962)
Proceeds from maturities of investments 4,273,856 9,950,727
Proceeds from sales of investments 683,046 200,816
------------ ------------
Net cash used in investing activities (818,933) (136,090)
------------ ------------
Cash flows from financing activities -
Proceeds from issuance of common stock 142,368 66,314
------------ ------------
Net cash provided by financing activities 142,368 66,314
------------ ------------
(Decrease) increase in cash and cash equivalents (2,662,013) 3,691,530
Cash and cash equivalents - beginning of period 12,030,638 8,986,292
------------ ------------
Cash and cash equivalents - end of period $ 9,368,625 $ 12,677,822
============ ============
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, 2004,
the consolidated statements of operations for the three- and six-month periods
ended June 30, 2004 and 2003, and the consolidated statements of cash flows for
the six-month periods ended June 30, 2004 and 2003 have been prepared by the
Company without audit. In the opinion of management, all adjustments necessary
to present fairly, in accordance with generally accepted accounting principles
in the United States of America, 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, 2003 Annual Report on Form 10-K.
Certain amounts in the prior year financial statements have been reclassified to
conform with current year presentation. The results of operations for the period
ended June 30, 2004 are not necessarily indicative of the results for the full
year.
2. Stock-based compensation plans - The Company accounts for stock option grants
under its stock option plans and for stock purchases under its employee stock
purchase plan in accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations.
Accordingly, no compensation cost has been recognized in the consolidated
financial statements for stock option grants or for shares purchased under the
employee stock purchase plan.
The following table illustrates the effect on net income (loss) and earnings
(loss) per share if the Company had applied the fair value recognition
provisions of Statement of Financial Accounting Standards ("SFAS") No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation
using the Black-Scholes model:
Three months ended June 30, Six months ended June 30,
2004 2003 2004 2003
------------ ----------- ------------- ------------
Net income (loss), as reported $(1,191,952) $ 206,526 $ (2,325,855) $(1,809,300)
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (400,233) (346,130) (815,219) (684,525)
----------- ---------- ------------ -----------
Pro forma net loss $(1,592,185) $ (139,604) $ (3,141,074) $(2,493,825)
=========== ========== ============ ===========
Earnings (loss) per share:
Basic - as reported $ (0.08) $ 0.01 $ (0.15) $ (0.12)
Basic - pro forma $ (0.11) $ (0.01) $ (0.21) $ (0.17)
Diluted - as reported $ (0.08) $ 0.01 $ (0.15) $ (0.12)
Diluted - pro forma $ (0.11) $ (0.01) $ (0.21) $ (0.17)
-6-
3. 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, 2004 and December 31, 2003 are summarized below:
June 30, 2004 December 31, 2003
------------- -----------------
Raw materials $ 2,668,962 $ 1,516,034
Work-in-process 12,492 134,874
Finished goods 1,661,144 1,597,534
----------- -----------
4,342,598 3,248,442
Reserve for obsolescence (175,000) (434,000)
----------- ----------
$ 4,167,598 $ 2,814,442
=========== ===========
4. Warranty - The Company's warranty activity for the three- and six-month
periods ended June 30, 2004 and 2003 is summarized below:
Three months ended June 30, Six months ended June 30,
2004 2003 2004 2003
---------- --------- --------- ---------
Beginning balance $ 431,925 $ 863,228 $ 479,062 $ 542,651
Warranty provision 102,533 171,813 267,087 642,056
Warranty costs incurred (152,533) (349,195) (364,224) (498,861)
--------- --------- --------- ---------
Ending balance $ 381,925 $ 685,846 $ 381,925 $ 685,846
========= ========= ========= =========
5. Income taxes - The Company has recorded its interim income tax provision
based on estimates of the Company's effective tax rate and income tax credits
expected to be applicable for the full fiscal year. Estimated taxes and credits
recorded during interim periods may be periodically revised, if necessary, to
reflect revised estimates for the full fiscal year.
6. Comprehensive income (loss) - Comprehensive loss for the three- and six-month
periods ended June 30, 2004 was $1,272,685 and $2,389,889, respectively. The
sole adjustment necessary to reconcile net loss with comprehensive loss is the
net unrealized loss, net of taxes, on investment securities, which was $80,733
for the three months ended June 30, 2004 and $64,034 for the six months ended
June 30, 2004.
Comprehensive income (loss) for the three- and six-month periods ended June 30,
2003 was $225,165 and ($1,783,009), respectively. The sole adjustment necessary
to reconcile net income (loss) with comprehensive income (loss) is the net
unrealized gain, net of taxes, on investment securities, which was $18,639 for
the three months ended June 30, 2003 and $26,291 for the six months ended June
30, 2003.
7. Earnings (loss) per share - Basic earnings (loss) 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 for the three-month period ended
-7-
June 30, 2004 and six-month periods ended June 30, 2004 and 2003, no common
equivalent shares were included in the calculation of diluted loss per share for
these periods because their effect would have been anti-dilutive. The Company's
weighted-average number of stock options which were in-the-money and, therefore,
potentially dilutive for the three months ended June 30, 2004 were 514,788. The
Company's weighted-average number of stock options which were in-the-money and,
therefore, potentially dilutive for the six months ended June 30, 2004 and 2003
were 928,561 and 384,551, respectively.
Stock options which were out-of-the money and, therefore, anti-dilutive under
the treasury stock method have also been excluded from the calculation of
diluted loss per share. The Company's stock options outstanding at June 30, 2004
and 2003 which were excluded because they were out-of-the-money were 1,141,650
and 1,493,820, respectively.
Shares of common stock used in calculating earnings (loss) per share differed
from outstanding shares reported in the consolidated financial statements as
follows:
Three months ended Three months ended
June 30, 2004 June 30, 2003
-------------- -------------
Basic loss Diluted loss Basic earnings Diluted earnings
per share per share per share per share
---------- ------------ -------------- ----------------
Outstanding shares 15,071,547 15,071,547 14,975,067 14,975,067
Effect of weighting changes
in outstanding shares (4,288) (4,288) - - - -
Dilutive effect of stock options - - - - - - 5,786
---------- ---------- ---------- ----------
Adjusted shares 15,067,259 15,067,259 14,975,067 14,980,853
========== ========== ========== ==========
Six months ended Six months ended
June 30, 2004 June 30, 2003
------------- -------------
Basic loss Diluted loss Basic loss Diluted loss
per share per share per share per share
---------- ------------ ---------- ------------
Outstanding shares 15,071,547 15,071,547 14,975,067 14,975,067
Effect of weighting changes
in outstanding shares (6,456) (6,456) - - - -
---------- ---------- ---------- ----------
Adjusted shares 15,065,091 15,065,091 14,975,067 14,975,067
========== ========== ========== ==========
8. Restructuring costs - During the quarter ended June 30, 2004, the Company
enacted a restructuring plan resulting in charges of $227,690 related to
severance benefits for workforce reductions in sales, services and
administration. As of June 30, 2004, the remaining restructuring accrual was
$190,795, consisting of employee separation costs of $151,972 and lease
commitments of $38,823 remaining from an August 2002 restructuring event. The
employee separation costs are scheduled to be paid in 2004, while the lease
payments (net of estimated sublease receipts) will extend into 2005.
-8-
Lease
commitments, Employee
net of sublease separations Total
--------------- ----------- -------
Restructuring accrual - December 31, 2003 $ 43,825 $ -- $ 43,825
=========== ======== ========
Restructuring event - May, 2004 -- 227,690 227,690
Cash deductions (5,002) (75,718) (80,720)
----------- -------- --------
Restructuring accrual - June 30, 2004 $ 38,823 $151,972 $190,795
=========== ======== ========
9. Major customers and geographic data - Because of the Company's concentration
of sales to the Regional Bell Operating Companies, wireless service providers
and one foreign service provider, a small number of customers typically
represent substantial portions of total sales. For the first six months of 2004,
sales to four companies comprised 71% of total sales. Each of these customers
contributed between 11% and 23% of total sales. For the first six months of
2003, sales to two companies comprised 65% of total sales. One customer
contributed 36% and the other customer contributed 29% of total sales.
The Company's sales by geographic areas for the three- and six-month periods
ended June 30, 2004 and 2003 are summarized below:
Three months ended June 30, Six months ended June 30,
2004 2003 2004 2003
----------- ---------- ----------- -----------
United States $ 5,495,630 $9,388,040 $ 9,961,291 $14,595,462
International 220,884 124,274 1,603,541 525,594
----------- ---------- ----------- -----------
$ 5,716,514 $9,512,314 $11,564,832 $15,121,056
=========== ========== =========== ===========
10. Employee Stock Purchase Plan - The Applied Innovation Inc. Employee Stock
Purchase Plan ("ESPP") was approved and adopted by the stockholders on April 25,
2002. The ESPP authorizes the Company to issue up to 500,000 shares of common
stock to eligible employees. The ESPP has semi-annual offering periods
commencing January 1 and July 1 during which eligible employees may purchase
shares at a price equal to 90% of fair market value on the first or last
business day of the offering period, whichever is lower.
On January 2, 2004, the Company issued 14,766 shares of common stock at a price
of $3.02 per share based on employee payroll deductions for the six-month
offering period ended December 31, 2003. On July 2, 2004, the Company issued
13,948 shares of common stock at a price of $3.61 per share based on employee
payroll deductions for the six-month offering period ended June 30, 2004. Since
the inception of the ESPP, 73,474 shares have been issued to eligible employees.
11. Stock repurchase program - On April 22, 2004, the Board of Directors
authorized a twelve month stock repurchase program under which the Company may
purchase up to 1,000,000 shares of common stock through April 21, 2005. As of
June 30, 2004, the Company had not purchased any shares of stock through the
program.
-9-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Applied Innovation Inc. (Applied Innovation, AI, and the Company) is a network
management solutions company that simplifies and enhances the operation of
complex, distributed voice and data networks. Building on a deep knowledge of
network architecture, elements and management, AI delivers unique hardware,
software and service solutions that provide greater connectivity, visibility and
control of network elements and the systems that support them. By providing
solutions in the areas of network mediation, aggregation and adaptation, the
Company enables its customers to more effectively and efficiently manage their
large, complex networks.
Applied Innovation's products and services help its customers to improve network
quality and uptime and, at the same time, reduce network maintenance and repair
costs. By leveraging its extensive knowledge of network infrastructure, its
vendor-neutral methodology and its customer-centric approach, AI provides
solutions which help customers better manage and control both their capital
expenditures and their operating expenditures. The Company targets three primary
markets in the U.S. and abroad: 1) telecommunications companies using wireline
networks; 2) telecommunications companies using wireless networks; and 3)
government networks. Its largest customers in those markets are the four
Regional Bell Operating Companies (RBOCs), domestic wireless service providers
and other large domestic and foreign phone companies.
Results for the second quarter of 2004 were below expectations and were
negatively impacted by continued delayed orders from the Company's key domestic
wireline customers. The Company remains committed to the wireline market and
believes that its products will continue to help carriers automate their network
management functions and operate their networks more efficiently. Automation and
efficiency improvements are particularly important to the carriers due to
decreased capital spending and headcount reductions by many in the industry in
recent years. Despite limited visibility into wireline carrier spending for the
balance of the year, the Company expects improvement in wireline order flow in
the second half of 2004 as compared to the first half. That expectation is based
in part on improvements in the regulatory environment for the RBOCs and the
continued momentum of new technologies such as DSL, VoIP and extended fiber
networks. Additionally, the Company expects that orders delayed by certain
customers in the first six months of the year will be booked in the second half
of the year.
The Company has continued its market diversification efforts, focusing on the
expansion of its wireless and international customer bases and the ongoing
business development in the government market. These efforts have resulted in
increased sales in the wireless and international markets as combined wireless
and international sales for the second quarter of 2004 grew by more than 140%
compared to a year ago and accounted for over 30% of total quarterly sales
versus less than 10% last year. The Company expects continued strength in
wireless and international sales for the balance of 2004 and will continue
extending its presence to further penetrate the government sector.
-10-
RESULTS OF THE THREE- AND SIX-MONTH PERIODS ENDED JUNE 30, 2004 COMPARED TO THE
THREE- AND SIX-MONTH PERIODS ENDED JUNE 30, 2003
TOTAL SALES AND GROSS PROFIT
Sales for the second quarter of 2004 were $5,717,000, a 40% decrease from sales
of $9,512,000 during the same period in 2003. Year-to-date sales decreased 23%
to $11,565,000 in 2004 from $15,121,000 in 2003. The overall decrease in
quarterly and year-to-date sales was largely attributable to continued order
delays at the Company's key domestic wireline customers. For the three- and
six-month periods ended June 30, 2004, sales to these customers were $3,807,000
and $6,672,000, respectively, compared to sales in the comparable periods of the
prior year of $8,650,000 and $13,474,000, respectively.
The sharp decline in wireline sales was partially offset by growth in the
wireless and international markets. Further penetration into the wireless market
resulted in wireless sales of $1,632,000 for the quarter ended June 30, 2004, an
increase of 157% from $635,000 in last year's comparable quarter. For the
six-month periods ended June 30, 2004 and 2003, wireless sales were $3,230,000
and $657,000, respectively. Additionally, improved order flow from the Company's
largest international customer led to an increase in international sales during
the current year. For the quarters ended June 30, 2004 and 2003, international
sales were $221,000 and $124,000, respectively, while year-to-date international
sales were $1,604,000 and $526,000 for 2004 and 2003, respectively.
Because of the Company's concentration of sales to the RBOCs, wireless service
providers and one foreign service provider, a small number of customers
typically represent substantial portions of total sales. For the first six
months of 2004, sales to four companies comprised 71% of total sales. Each of
these customers contributed between 11% and 23% of total sales. For the first
six months of 2003, sales to two companies comprised 65% of total sales. One
customer contributed 36% and the other customer contributed 29% of total sales.
Gross profit as a percentage of total sales was 51% for the second quarter of
2004, versus 54% for the second quarter of 2003. Gross profit for the current
year quarter compared to the same quarter a year ago was negatively impacted by
reduced coverage of fixed manufacturing costs at lower sales volumes.
Year-to-date gross profit percentages were 51% and 50% for 2004 and 2003,
respectively. For the first six months of 2003, charges totaling $550,000 for
product recall and inventory obsolescence negatively impacted gross profit.
Although no such charges were incurred in the first six months of 2004,
year-to-date gross profit in 2004 was negatively impacted by decreased coverage
of fixed manufacturing costs as a result of lower sales volume.
The following table summarizes sales and gross profit for products and services:
-11-
For the Quarter Ended June 30, 2004 For the Quarter Ended June 30, 2003
---------------------------------------- ----------------------------------------
Products Services Total Products Services Total
------------ ---------- ----------- ----------- ----------- ----------
Sales $ 4,221,000 $1,496,000 $ 5,717,000 $ 7,866,000 $ 1,646,000 $9,512,000
Gross Profit 2,084,000 853,000 2,937,000 4,451,000 709,000 5,160,000
Gross Profit % 49% 57% 51% 57% 43% 54%
PRODUCT SALES AND GROSS PROFIT
Product sales of $4,221,000 were 74% of 2004 second quarter sales, versus
product sales of $7,866,000, or 83% of 2003 second quarter sales. This
represented a 46% decrease in product sales from the comparable quarter in the
prior year. Year-to-date product sales of $8,663,000 were 75% of total sales in
2004, versus $12,256,000 or 81% of total sales in 2003. This represented a 29%
decrease in product sales from the previous year. As noted above, 2004 product
sales were impacted by postponed orders from the Company's domestic wireline
customers.
Product sales include revenues from the sales of the Company's hardware
products, as well as third-party hardware and software licensing revenues.
Gross profit on product sales was 49% of total product sales for the second
quarter of 2004, compared with 57% of total product sales for the same period
last year. The decrease in gross profit in 2004 was primarily attributable to
fewer product sales to cover certain fixed manufacturing costs.
SERVICES SALES AND GROSS PROFIT
Services sales of $1,496,000 were 26% of 2004 second quarter sales, versus
services sales of $1,646,000, or 17% of 2003 second quarter sales. Year-to-date
services sales of $2,902,000 were 25% of total sales in 2004, compared to
$2,865,000, or 19% of total sales in 2003. The 9% decrease in services sales in
the second quarter of 2004 compared to the same quarter last year was primarily
attributable to lower revenue from maintenance agreements and fewer installation
services sales.
Services sales consist of network planning and design, installation services,
project management, engineering services, training and maintenance.
Services gross profit for the quarter ended June 30, 2004 was 57% of services
sales, versus 43% of services sales for the comparable quarter a year ago. The
increase in gross profit on services sales was primarily attributable to
headcount reductions, increased utilization of services personnel and decreased
utilization of contract labor during the second quarter of 2004.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative ("SG&A") expenses decreased to $3,373,000 in
the second quarter of 2004, from $3,613,000 in the second quarter of 2003.
Year-to-date SG&A expenditures were $6,797,000 in 2004 and $7,200,000 in 2003.
The three-and six-month reductions of $240,000
-12-
and $403,000, respectively, in SG&A expenditures were largely attributable to
headcount reductions in sales and other administrative functions, reductions in
variable compensation expenses, lower personal property taxes and reduced
spending on insurance and outside consultants. The Company anticipates SG&A
expenses for the remainder of 2004 to be generally consistent with those in the
first two quarters, although certain SG&A expenses such as commissions and other
variable compensation are expected to vary proportionately with changes in sales
volumes.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development ("R&D") expenses decreased to $1,294,000 for the second
quarter of 2004, versus $1,396,000 for the same period in 2003. Year-to-date R&D
expenses were $2,685,000 for 2004 and $2,796,000 for 2003. The slight reduction
in R&D expenses was primarily a result of postponing compliance testing in the
second quarter of 2004 until the third quarter when simultaneous compliance
tests could be run on multiple products to lower the cost. The Company continues
to invest in product enhancements and new product development to support
changing customer and industry needs and product introductions. The Company
anticipates R&D expenditures for the remaining quarters in 2004 to be generally
consistent with those in the first two quarters.
RESTRUCTURING CHARGES
During the quarter ended June 30, 2004, the Company realigned certain resources
in response to shifting market conditions and Company priorities. As part of the
realignment to focus additional resources on wireless, government and outside
plant opportunities within the wireline carriers, nine employees were terminated
in sales, services and administration. The Company recorded restructuring
charges of $228,000 related to severance and other fringe benefits associated
with the terminated personnel. These employee separation costs are expected to
be fully paid in 2004. The Company expects to reduce future annual operating
expenses by at least $900,000 as a result of these actions.
INTEREST AND OTHER INCOME, NET
Interest income and other income, net increased to $95,000 in the second quarter
of 2004 from $76,000 in the comparable quarter last year. The increase was
primarily attributable to gains on sales of investments in the second quarter of
2004. Year-to-date interest income and other income, net was $180,000 in 2004
consistent with the $187,000 in the prior year. Despite the second quarter gains
on sales of investments, the year-to-date decrease is largely due to lower
average cash and investment balances and overall lower yields on those balances.
INCOME TAXES
The Company's effective income tax benefit rate was 36% for the three- and
six-month periods ended June 30, 2004 versus an effective benefit rate of 20%
for the same periods in 2003. Although the Company expects to generate fewer
research and experimentation credits in 2004, the higher
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effective benefit rate results from the estimated full-year impact of those
credits and their impact in relation to estimated taxable income or loss for the
year.
NET LOSS AND LOSS PER SHARE
As a result of the above factors, the Company recorded a net loss $1,192,000, or
$0.08 per share, in the second quarter of 2004, versus net income of $207,000,
or $0.01 per share, in the second quarter of 2003. Year-to-date net loss was
$2,326,000, or $0.15 per share, in 2004, versus net loss of $1,809,000, or $0.12
per share in 2003.
LIQUIDITY AND CAPITAL RESOURCES
Net working capital was $18,417,000 at June 30, 2004, compared to $20,957,000 at
December 31, 2003. At June 30, 2004, the current ratio was 3.7:1 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.
The Company had $25,519,000 of cash and cash equivalents and short- and
long-term investments at June 30, 2004, a decrease of $2,454,000 from the
December 31, 2003 balance of $27,973,000.
OPERATING ACTIVITIES
For the six-month period ended June 30, 2004, operating activities used
$1,985,000 of cash, primarily as a result of the $2,326,000 net loss for the
period. Another component of operating cash flows requiring the use of cash was
the $1,353,000 increase in inventory as a result of planned increases in
inventory levels in anticipation of customer orders that were subsequently
postponed. Additionally, the Company's income tax benefit of $1,309,000 for the
period did not provide cash. Other significant non-cash operating expenses and
working capital changes included: depreciation and amortization expenses of
$688,000; decreased accounts receivable of $1,094,000 resulting from continued
collections efforts and lower sales; decreased other current assets of $707,000
as a result of the receipt of insurance and other refunds; and increased
deferred revenue of $554,000 due to normal maintenance agreements invoiced in
the first quarter.
INVESTING ACTIVITIES
During the six-months ended June 30, 2004, investing activities used cash
totaling $819,000. The Company purchased $523,000 of property, plant and
equipment primarily related to information technology infrastructure and
engineering test equipment. Purchases of investments, net of maturities and
sales used cash of $312,000.
FINANCING ACTIVITIES
Common stock issued for stock option exercises and purchases under the Employee
Stock Option Plan provided cash of $142,000 during the first six months of 2004.
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The Company believes that its existing cash, cash equivalents, investments and
cash to be generated from future operations will provide sufficient capital to
meet the business needs of the Company for the next twelve months. In addition,
the Company believes it 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 resulting in decreased demand for the Company's
products and services and operating losses; faster than expected growth
resulting in increased accounts receivable and inventory; additional investment
or acquisition activity; or significant research and development efforts.
However, there can be no assurance that additional financing will be available
on terms favorable to the Company or at all.
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 forward-looking 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 any statements regarding the belief that the Company's
products will continue to help carriers automate their network management
functions and operate their networks more efficiently (paragraph 3); improved
wireline order flow in the second half of 2004 (paragraph 3); improvements in
the regulatory environment for the RBOCs (paragraph 3); the continued momentum
of new technologies (paragraph 3); booking delayed orders in the second half of
2004 (paragraph 3); continued strength in wireless and international sales for
the balance of 2004 (paragraph 4); further penetration of the government sector
(paragraph 4); future SG&A expenditures (paragraph 16); future R&D expenditures
(paragraph 17); payment of employee separation costs (paragraph 18); savings of
$900,000 resulting from employee terminations (paragraph 18); research and
experimentation credits in 2004 and resulting effective tax rates (paragraph
20); and sufficiency of capital resources (paragraph 27). 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, 2003. 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
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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.
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.
The Company invests in various debt obligations, primarily U.S. government and
agency obligations and high quality commercial paper, with maturities generally
less than three years. Although the yields on such investments are subject to
changes in interest rates, the potential impact to the Company and its future
earnings as a result of customary interest rate fluctuations is immaterial.
Furthermore, the Company has not entered into any derivative contracts. Related
to an acquisition in 2001, the Company has a $750,000 note payable due in August
2004, bearing interest at a fixed rate of 8% annually.
Item 4. Controls and Procedures
As of the end of the period covered by this report, the Company's management
carried out an evaluation, with the participation of the Company's principal
executive officer and principal financial officer, of the effectiveness of the
Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) promulgated under the Securities Exchange Act of 1934). Based upon
that evaluation, the Company's principal executive officer and principal
financial officer concluded that the Company's disclosure controls and
procedures were effective as of the end of the period covered by this report. It
should be noted that the design of any system of controls is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions, regardless of how remote.
There were no changes in the Company's internal controls over financial
reporting that occurred during the Company's most recent fiscal quarter that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II. OTHER INFORMATION
Items 1 - 3. Inapplicable
Item 4. Submission of Matters to a Vote of Security Holders
Applied Innovation Inc. held its Annual Meeting of Stockholders on April 22,
2004, for the purpose of electing two Class II directors. At the Company's
Annual Meeting of Stockholders, both incumbent nominees for director were
elected. The following table shows the voting
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tabulation for the sole matter voted on at the 2004 Annual Meeting of
Stockholders, the election of two Class II directors:
ACTION FOR WITHHOLD AUTHORITY
- ------ --- ------------------
Election of Class II Directors
Thomas W. Huseby 13,168,001 1,126,250
Curtis A. Loveland 12,680,242 1,614,009
Item 5. Inapplicable
Item 6. (a) Exhibits
Exhibit 31.1 - Rule 13a-14(a) Certification of Principal Executive
Officer
Exhibit 31.2 - Rule 13a-14(a) Certification of Principal Financial
Officer
Exhibit 32.1 - Section 1350 Certification of Principal Executive
Officer
Exhibit 32.2 - Section 1350 Certification of Principal Financial
Officer
(b) Reports on Form 8-K
On April 27, 2004, the Company filed a Current Report on Form 8-K
(Items 5 and 7), dated April 26, 2004, regarding the announcement
that the Company's Board of Directors authorized the Company to
repurchase up to one million shares of its outstanding common stock
through April 21, 2005.
On April 28, 2004, the Company furnished a Current Report on Form
8-K (Items 7 and 12), dated April 21, 2004, regarding its financial
results for the first quarter ended March 31, 2004.
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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 13, 2004 /s/ Gerard B. Moersdorf, Jr.
- ------------------ -----------------------------
Date Gerard B. Moersdorf, Jr.
Chairman, President and Chief Executive Officer
(Principal Executive Officer)
August 13, 2004 /s/ Michael P. Keegan
- ------------------ ----------------------
Date Michael P. Keegan
Executive Vice President and Chief Operating
Officer
August 13, 2004 /s/ Andrew J. Dosch
- ------------------ --------------------
Date Andrew J. Dosch
Vice President, Chief Financial Officer
and Treasurer
(Principal Financial Officer and Principal
Accounting Officer)
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