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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 March 31, 2005
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 April 29, 2005, there were 15,169,909 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 March 31, 2005 (unaudited)
and December 31, 2004 3
Consolidated Statements of Operations for the three months
ended March 31, 2005 and 2004 (unaudited) 4
Consolidated Statements of Cash Flows for the three months
ended March 31, 2005 and 2004 (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 - 15
Item 3. Quantitative and Qualitative Disclosure About Market Risk 15
Item 4. Controls and Procedures 16
Part II. Other Information
Items 1 - 5. 16
Item 6. Exhibits 16
Signatures 17
-2-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPLIED INNOVATION INC.
Consolidated Balance Sheets
(Unaudited)
March 31, 2005 December 31, 2004
-------------- -----------------
Assets
Current assets:
Cash and cash equivalents $ 11,144,902 $ 9,773,586
Short term investments 6,588,496 6,921,644
Accounts receivable, net of allowance of $115,000 in 2005 and 2004 4,713,578 4,657,914
Inventory, net 2,497,333 2,392,379
Other current assets 457,963 571,426
Deferred income taxes 941,000 919,000
------------ ------------
Total current assets 26,343,272 25,235,949
Property, plant and equipment, net of accumulated depreciation
of $9,945,773 in 2005 and $9,844,802 in 2004 6,301,968 6,540,850
Investments 9,139,897 9,002,404
Goodwill 3,525,801 3,525,801
Deferred income taxes 1,758,000 1,758,000
Other assets 1,347,461 1,334,918
------------ ------------
$ 48,416,399 $ 47,397,922
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 887,544 $ 853,440
Accrued expenses:
Warranty 400,000 425,000
Payroll and related expenses 784,317 810,608
Restructuring 687,817 139,020
Income taxes payable 131,772 360,917
Taxes, other than income taxes 329,156 398,974
Other accrued expenses 1,037,227 568,917
Deferred revenue 1,330,962 901,251
------------ ------------
Total current liabilities 5,588,795 4,458,127
------------ ------------
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 15,169,909 shares in 2005 and 15,107,367 in 2004 151,699 151,074
Additional paid-in capital 6,628,376 6,424,655
Retained earnings 36,071,246 36,352,868
Accumulated other comprehensive (loss) gain, net (23,717) 11,198
------------ ------------
Total stockholders' equity 42,827,604 42,939,795
------------ ------------
$ 48,416,399 $ 47,397,922
============ ============
See accompanying notes to consolidated financial statements.
-3-
APPLIED INNOVATION INC.
Consolidated Statements of Operations (Unaudited)
Three Months Ended March 31,
2005 2004
------------ ------------
Sales:
Products $ 5,593,114 $ 4,514,283
Services 1,339,405 1,334,035
------------ ------------
Total sales 6,932,519 5,848,318
Cost of sales:
Cost of sales - products 2,435,327 2,158,265
Cost of sales - services 441,770 731,513
------------ ------------
Total cost of sales 2,877,097 2,889,778
Gross profit 4,055,422 2,958,540
Operating expenses:
Selling, general and administrative 2,557,222 3,424,460
Research and development 1,153,965 1,391,190
Restructuring charges 924,805 --
------------ ------------
Total operating expenses 4,635,992 4,815,650
Loss from operations (580,570) (1,857,110)
Interest and other income, net 133,948 85,207
------------ ------------
Loss before income taxes (446,622) (1,771,903)
Income tax benefit (165,000) (638,000)
------------ ------------
Net loss $ (281,622) $ (1,133,903)
============ ============
Basic and diluted loss per share $ (0.02) $ (0.08)
============ ============
Weighted-average shares outstanding
for basic and diluted loss per share 15,146,608 15,060,852
============ ============
See accompanying notes to consolidated financial statements.
-4-
APPLIED INNOVATION INC.
Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended March 31,
2005 2004
------------ ------------
Cash flows from operating activities:
Net loss $ (281,622) $ (1,133,903)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation 211,989 290,210
Amortization of intangible assets - 52,500
Loss on disposal of assets 8,434 57,543
Stock issued to non-employees 8,000 -
Tax benefit of options exercised 5,073 14,398
Effects of changes in operating assets and liabilities:
Accounts receivable (55,664) 1,324,638
Inventory (104,954) (1,053,109)
Other current assets 113,463 625,691
Other assets (12,543) (12,663)
Accounts payable 34,104 531,925
Income taxes (229,145) (716,790)
Accrued expenses 895,998 149,286
Deferred revenue 429,711 820,721
------------ ------------
Net cash provided by operating activities 1,022,844 950,447
------------ ------------
Cash flows from investing activities:
Purchases of property, plant and equipment - (361,336)
Proceeds from sales of property, plant and equipment 18,459 15,640
Purchases of investments (3,086,302) (3,252,262)
Proceeds from maturities of investments 3,112,958 2,911,085
Proceeds from sales of investments 112,084 604,253
------------ ------------
Net cash provided by (used in) investing activities 157,199 (82,620)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common stock 191,273 111,644
------------ ------------
Net cash provided by financing activities 191,273 111,644
------------ ------------
Increase in cash and cash equivalents 1,371,316 979,471
Cash and cash equivalents - beginning of period 9,773,586 12,030,638
------------ ------------
Cash and cash equivalents - end of period $ 11,144,902 $ 13,010,109
============ ============
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 March 31, 2005,
and the consolidated statements of operations and cash flows for the three
months ended March 31, 2005 and 2004, 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, 2004 Annual Report on Form 10-K.
Certain amounts in the prior year financial statements have been reclassified to
conform to current year presentation. The results of operations for the three
months ended March 31, 2005 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 Company accounts for stock grants to non-employees in accordance with
Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments
That are Issued to Other Than Employees for Acquiring, or in Conjunction With
Selling, Goods or Services. Accordingly, the Company recognized expense for
stock grants to non-employees of $8,000 and $0 for the three months ended March
31, 2005 and 2004, respectively.
The following table illustrates the effect on net loss and 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:
-6-
Three months ended March 31,
2005 2004
----------- -----------
Net loss, as reported $ (281,622) $(1,133,903)
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (195,001) (414,986)
----------- -----------
Pro forma net loss $ (476,623) $(1,548,889)
=========== ===========
Loss per share:
Basic and diluted - as reported $ (0.02) $ (0.08)
Basic and diluted - pro forma $ (0.03) $ (0.10)
3. Inventory - Inventory is stated at the lower of cost or market. Cost is
computed using standard cost, which approximates actual cost on the first-in,
first-out basis, net of allowances for estimated obsolescence. Major classes of
inventory at March 31, 2005 and December 31, 2004 are summarized below:
March 31, 2005 December 31, 2004
-------------- -----------------
Raw materials $ 2,088,227 $ 2,098,741
Work-in-process 24,889 1,461
Finished goods 577,217 455,177
----------- -----------
2,690,333 2,555,379
Reserve for obsolescence (193,000) (163,000)
----------- -----------
$ 2,497,333 $ 2,392,379
=========== ===========
4. Warranty - The Company's warranty activity for the three months ended March
31, 2005 and 2004 is summarized below:
2005 2004
--------- ---------
Beginning balance $ 425,000 $ 479,062
Warranty provision 69,513 164,554
Warranty costs incurred (94,513) (211,691)
--------- ---------
Ending balance $ 400,000 $ 431,925
========= =========
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 loss - Comprehensive loss for the three months ended March 31,
2005 and 2004 was $316,537 and $1,117,204, respectively. The sole adjustment
necessary to reconcile net loss with comprehensive loss is for the net
unrealized gain (loss), net of taxes, on available-for-sale securities, which
was $(34,915) and $16,699 for the three months ended March 31, 2005 and 2004,
respectively.
-7-
7. Loss per share - Basic loss per share is calculated using the
weighted-average number of common shares outstanding during the periods. Diluted
loss 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 months ended March 31, 2005 and 2004, no common
equivalent shares were included in the calculation of diluted loss per share for
either period because their effect would have been anti-dilutive. The Company's
weighted-average number of options which were in-the-money and, therefore,
potentially dilutive for the three months ended March 31, 2005 and 2004 were
391,165 and 1,033,980, respectively.
Stock options which were out-of-the-money and, therefore, were 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 March 31,
2005 and 2004 which were excluded because they were out-of-the-money were
1,056,450 and 1,020,750, respectively.
Shares of common stock used in calculating loss per share differed from
outstanding shares reported in the consolidated financial statements as follows:
Three months ended Three months ended
March 31, 2005 March 31, 2004
---------------------------- ----------------------------
Basic loss Diluted loss Basic loss Diluted loss
per share per share per share per share
----------- ----------- ----------- ----------
Outstanding shares 15,169,909 15,169,909 15,062,775 15,062,775
Effect of weighting changes
in outstanding shares (23,301) (23,301) (1,923) (1,923)
----------- ----------- ----------- -----------
Adjusted shares 15,146,608 15,146,608 15,060,852 15,060,852
=========== =========== =========== ===========
8. Restructuring costs - During the quarter ended March 31, 2005, the Company
enacted two restructuring events. In January 2005, the Company announced
management changes resulting in the election of William H. Largent as President
and Chief Executive Officer. Former President and Chief Executive Officer,
Gerard B. Moersdorf, Jr. resigned those positions while retaining his position
as Chairman of the Board of Directors. At the same time, Michael P. Keegan
resigned his position as Executive Vice President and Chief Operating Officer.
In February 2005, the Company enacted a restructuring event affecting employees
in sales, engineering, operations, services and administration. As a result of
these actions, the Company incurred restructuring charges of $965,481,
consisting of severance and other benefit costs.
Certain adjustments totaling $40,676 were recorded during the quarter ended
March 31, 2005 to decrease the restructuring accrual related to prior
restructuring events. The accrual related to an October 2004 restructuring event
was reduced by $28,585 because certain benefit costs were less than originally
estimated. Additionally, adjustments of $12,091 were recorded to the lease
commitment accrual from an August 2002 restructuring event because sublease
receipts were higher than originally estimated.
Employee separation costs associated with the 2004 and 2005 restructuring events
are scheduled to be paid through the first quarter of 2006, while the lease
payments (net of estimated sublease receipts) will be completed in the second
quarter of 2005.
-8-
Activity in the restructuring accrual for the three months ended March 31, 2005
is summarized below:
Lease Employee Employee
commitments, separations, separations,
net of sublease 2004 2005 Total
--------------- --------------- ------------ ---------------
Restructuring accrual - December 31, 2004 $ 25,469 $ 113,551 $ -- $ 139,020
============== =============== ============ =============
Restructuring events - First quarter 2005 -- -- 965,481 965,481
Cash deductions (13,378) (77,619) (285,011) (376,008)
Non-cash adjustments (12,091) (28,585) -- (40,676)
-------------- --------------- ------------ -------------
Restructuring accrual - March 31, 2005 $ -- $ 7,347 $ 680,470 $ 687,817
============== =============== ============ =============
9. Major customers and geographic data - Because of the Company's concentration
of sales to a limited customer base, a small number of customers typically
represent substantial portions of total sales. For the three months ended March
31, 2005, sales to two companies comprised 73% of total sales. One customer
contributed 39% and the other customer contributed 34% of total sales. For the
first three months of 2004, sales to four companies comprised 81% of total
sales. Each of these four customers contributed between 11% and 27% of total
sales.
The Company's sales by geographic areas for the three months ended March 31,
2005 and 2004 are summarized below:
Three months ended March 31,
----------------------------
2005 2004
---------- ----------
United States $6,480,837 $4,465,661
International 451,682 1,382,657
---------- ----------
$6,932,519 $5,848,318
========== ==========
10. Employee Stock Purchase Plan - The Applied Innovation Inc. Employee Stock
Purchase Plan (ESPP), approved and adopted by the stockholders on April 25,
2002, authorizes the Company to issue up to 500,000 shares of common stock to
eligible employees, as defined. 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, 2005, the Company issued 16,856 shares of common stock at a price
of $3.12 per share based on employee payroll deductions for the six-month
offering period ended December 31, 2004. Since the inception of the ESPP, 90,330
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
March 31, 2005, 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's solutions are
targeted to four primary markets in the U.S. and abroad: 1) telecommunications
companies using wireline networks; 2) telecommunications companies using
wireless networks; 3) government networks; and 4) international
telecommunications service providers who address both wireline and wireless
services in their respective territories. Its largest customers in those markets
are the Regional Bell Operating Companies (RBOCs), domestic wireless service
providers and other large domestic and foreign phone companies.
During the first quarter of 2005, the Company experienced sales growth of 19%
over the comparable period of the prior year. First quarter 2005 growth was led
by strong sales in the domestic wireline market. Additionally, demand was solid
across all markets as the Company continued to focus on market diversification
efforts to strengthen its business in the wireless, government and international
markets. Increased demand in the wireline market was largely attributable to
accelerated customer demand for products associated with fiber-to-the-premises
initiatives at the Company's largest wireline customers. This included a mix of
both traditional products and new products focused on IP networking and network
security.
With sales at the level achieved during the first quarter of 2005, continued
cost reductions and strong profit margins, the Company believes that it has made
significant progress in developing a business model to profitably execute the
business while maintaining its commitment to innovation. The Company expects
that the market balance and year-over-year sales growth experienced during the
first quarter of 2005 will continue into the second quarter.
RESULTS OF THE THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THE THREE MONTHS
ENDED MARCH 31, 2004
TOTAL SALES AND GROSS PROFIT
Sales for the first quarter of 2005 totaled $6,933,000 compared to $5,848,000
for the same period last year, an increase of 19%.
-10-
Because of the Company's concentration of sales to a limited customer base, a
small number of customers typically represent substantial portions of total
sales. For the three months ended March 31, 2005, sales to two companies
comprised 73% of total sales. One customer contributed 39% and the other
customer contributed 34% of total sales. For the first three months of 2004,
sales to four companies comprised 81% of total sales. Each of the four customers
contributed between 11% and 27% of total sales.
Overall gross profit for the first quarter of 2005 was $4,055,000 compared to
$2,959,000 for the first quarter of 2004. As a percentage of sales, gross profit
improved to 58% in 2005 from 51% in 2004. The increase in gross profit resulted
primarily from a more favorable mix of higher margin products and services in
2005 as compared to 2004.
The following table summarizes revenues and gross profit for products and
services:
For the Quarter Ended March 31, 2005 For the Quarter Ended March 31, 2004
------------------------------------------ ------------------------------------------
Products Services Total Products Services Total
---------- ---------- ---------- ---------- ---------- ----------
Sales $5,593,000 $1,340,000 $6,933,000 $4,514,000 $1,334,000 $5,848,000
Gross Profit 3,158,000 897,000 4,055,000 2,356,000 603,000 2,959,000
Gross Profit % 56% 67% 58% 52% 45% 51%
PRODUCT SALES AND GROSS PROFIT
Product sales of $5,593,000 represented 81% of total sales in the first quarter
of 2005, versus product sales of $4,514,000, or 77% of total sales in the first
quarter of 2004. As noted above, demand in the domestic wireline market was
particularly strong, as the Company's two largest wireline customers ordered
product for their fiber-to-the-premises applications.
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 56% of total product sales for the first
quarter of 2005, compared with 52% of total product sales for the same period
last year. The increase in gross margin over the prior year period was due to a
favorable product mix, reductions in certain fixed manufacturing costs,
including personnel, and greater coverage of those fixed costs based on
increased sales levels.
SERVICES SALES AND GROSS PROFIT
In the first quarter of 2005, services sales remained generally consistent with
services sales during the same period in 2004. Services sales were $1,340,000,
or 19% of total first quarter sales in 2005, compared to $1,334,000, or 23% of
total first quarter sales in 2004.
Services sales consist primarily of network planning and design, installation
services, project management, engineering services, training and maintenance.
-11-
Gross profit on services sales was 67% during the first quarter of 2005,
compared with 45% for the same period last year. Gross margin rose primarily due
to reduced personnel costs resulting from headcount reductions during the past
two quarters. In addition, gross margin increased due to higher margin
maintenance contracts comprising a slightly larger proportion of total services
sales in the first quarter of 2005 as compared to 2004.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative ("SG&A") expenses decreased to $2,557,000 in
the first quarter of 2005, from $3,424,000 in the first quarter of 2004. As a
percentage of total quarterly sales, this represented 37% in 2005 and 59% in
2004. The decrease in SG&A spending is primarily attributable to recent
headcount reductions and cost containment measures. Specifically, reductions in
travel expenses and other discretionary spending during the quarter contributed
to lower SG&A costs. For the remaining quarters in 2005, SG&A expenses are
expected to be generally consistent with the first quarter.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development ("R&D") expenses decreased to $1,154,000 for the first
quarter of 2005 from $1,391,000 in the first quarter of 2004, a 17% reduction.
As a percentage of total quarterly sales, this represented 17% in 2005 and 24%
in 2004. The reduction in R&D expense is primarily due to headcount reductions
during the last two quarters and increased focus on cost containment. The
Company continues to invest in product enhancements and developments in response
to customer and market opportunities. Quarterly R&D expenses for the remainder
of 2005 are expected to be slightly less than those in the first quarter as a
result of the headcount reductions as well as lower compliance testing expenses.
RESTRUCTURING CHARGES
During the quarter ended March 31, 2005, the Company enacted two restructuring
events. In January 2005, the Company announced management changes resulting in
the election of William H. Largent as President and Chief Executive Officer.
Former President and Chief Executive Officer, Gerard B. Moersdorf, Jr. resigned
those positions while retaining his position as Chairman of the Board of
Directors. At the same time, Michael P. Keegan resigned his position as
Executive Vice President and Chief Operating Officer. In February 2005, the
Company enacted a restructuring event affecting employees in sales, engineering,
operations, services and administration. As a result of these actions, the
Company incurred restructuring charges of $965,000, consisting of severance and
other benefit costs. The Company expects to save approximately $2,500,000 on an
annual basis as a result of these actions.
Certain adjustments totaling $41,000 were recorded during the quarter ended
March 31, 2005 to decrease the restructuring accrual related to prior
restructuring events. The accrual related to an October 2004 restructuring event
was reduced by $29,000 because certain benefit costs were less than originally
estimated. Additionally, adjustments of $12,000 were recorded to the lease
-12-
commitment accrual from an August 2002 restructuring event because sublease
receipts were higher than originally estimated.
INTEREST AND OTHER INCOME, NET
Interest and other income, net increased to $134,000 in the first quarter of
2005 versus $85,000 in the comparable quarter last year. The overall increase
resulted primarily from higher interest income due to overall higher yields on
cash and investment balances. In addition, interest and other income, net in the
first quarter of 2004 included interest expense totaling $15,000. No such
interest charges were incurred in the first quarter of 2005.
INCOME TAXES
The Company's effective income tax benefit rate was 37% for the current quarter,
comparable to 36% for the same period in 2004.
NET LOSS AND LOSS PER SHARE
As a result of the above factors, the Company recorded a net loss of $282,000 in
the first quarter of 2005, or $0.02 per share, compared to a net loss of
$1,134,000, or $0.08 per share, during the same period last year.
LIQUIDITY AND CAPITAL RESOURCES
Net working capital was $20,754,000 at March 31, 2005, compared to $20,778,000
at December 31, 2004. At March 31, 2005, the current ratio was 4.7:1 and the
Company had no debt outstanding.
The Company had $26,873,000 of cash and cash equivalents and short- and
long-term investments at March 31, 2005, an increase of $1,175,000 from the
total December 31, 2004 balance of $25,698,000.
OPERATING ACTIVITIES
Despite the net loss of $282,000 during the first quarter of 2005, operating
activities provided cash of $1,023,000. Significant components of cash flows
from operations included: non-cash depreciation expense of $212,000; increased
accrued expenses of $896,000 resulting from unpaid severance benefits and the
receipt of customer deposits in the first quarter; and increased deferred
revenue of $430,000 resulting from annual maintenance agreements invoiced in the
first three months of the year.
INVESTING ACTIVITIES
During the first quarter of 2005, investing activities provided cash totaling
$157,000. Maturities and sales of investments, net of investment purchases,
provided $139,000 and proceeds from the sales of property, plant and equipment
provided $18,000.
-13-
FINANCING ACTIVITIES
Common stock issued for stock option exercises and purchases under the Employee
Stock Purchase Plan provided cash of $191,000 during the first quarter of 2005.
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement No. 151, "Inventory Costs," an amendment to Accounting Research
Bulletin No. 43, Chapter 4, "Inventory Pricing." This statement clarifies that
abnormal amounts of idle facility expense, freight, handling costs and wasted
material should be recognized as current period charges. The provisions of this
statement become effective for fiscal years beginning after June 15, 2005. The
Statement is not expected to have a material effect on the Company's financial
position, results of operations or cash flows.
In December 2004, the FASB issued Statement No. 123R, "Share Based Payment," a
revision of Statement No. 123, "Accounting for Stock Based Compensation" and
superseding APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Statement 123R requires the Company to expense grants made under the stock
option and employee stock purchase plans. Statement 123R is effective for fiscal
years commencing on or after June 15, 2005. Consistent with the provisions of
the new standard, the Company intends to adopt Statement 123R in the first
quarter of 2006. Upon adoption of Statement 123R, amounts previously disclosed
under Statement No. 123 will be recorded in the consolidated statement of
operations. The Company currently measures compensation costs related to its
share-based awards under APB 25, as allowed by Statement 123. Information about
the fair value of stock options under the Black-Scholes model and its pro forma
impact on the Company's net loss and loss per share can be found in Note 2 to
the consolidated financial statements.
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-
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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 progress in developing
a business model to profitably execute the business while maintaining its
commitment to innovation (paragraph 4); market balance and year-over-year sales
growth experienced during the first quarter of 2005 continuing into the second
quarter (paragraph 4); SG&A expenses for the remaining quarters in 2005
remaining generally consistent with the first quarter (paragraph 15); R&D
expenses for the remaining quarters in 2005 decreasing slightly from those in
the first quarter (paragraph 16); annual savings of $2,500,000 expected as a
result of the restructuring events during the quarter (paragraph 17);
sufficiency of capital resources (paragraph 27); the expectation that FASB
Statement No. 151 will not have a material effect on the Company's financial
position, results of operations or cash flows (paragraph 28); and the adoption
of Statement 123R in the first quarter of 2006 (paragraph 29). These
forward-looking statements involve numerous risks and uncertainties, including,
without limitation, fluctuations in demand for the Company's product and
services, competition, economic conditions, the fact that Applied Innovation may
decide to substantially increase research and development 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,
2004. 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.
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 fluctuations, 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.
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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 - 5. Inapplicable
Item 6. 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
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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)
May 6, 2005 /s/ William H. Largent
Date ----------------------
William H. Largent
President and Chief Executive
Officer
(Principal Executive Officer)
May 6, 2005 /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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