REPORT OF INDEPENDENT AUDITORS
TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF TELTREND INC., We have audited
the accompanying consolidated balance sheets of Teltrend Inc. and subsidiaries
as of July 31, 1999 and July 25, 1998, and the related consolidated statements
of income, changes in stockholders' equity and cash flows for the years ended
July 31, 1999, July 25, 1998, and July 26, 1997. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Teltrend Inc.
and subsidiaries as of July 31, 1999, and July 25, 1998, and the results of
their operations and their cash flows for each of the years ended July 31,
1999, July 25, 1998, and July 26, 1997, in conformity with generally accepted
accounting principles.
Ernst & Young LLP
Ernst & Young LLP
Chicago, Illinois
August 24, 1999
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
YEAR ENDED
--------------------
JULY 31, JULY 25,
ASSETS 1999 1998
CURRENT ASSETS:
Cash and cash equivalents $25,915 $22,994
Marketable securities - 1,951
Trade accounts receivable, net of allowance for
doubtful accounts of $207 and $287 13,758 12,899
Inventories 9,466 10,656
Deferred income taxes 2,267 1,325
Prepaid expenses and other current assets 3,301 4,367
54,707 54,192
Land and buildings 3,310 3,422
Machinery and equipment 19,240 18,076
Leasehold improvements 1,264 1,310
Accumulated depreciation (13,937) (12,080)
9,877 10,728
Deferred income taxes 329 -
Intangible assets, less accumulated amortization
of $769 and $380 1,479 4,830
Other assets, less accumulated amortization
of $254 and $138 591 166
$66,983 $69,916
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,774 $ 6,194
Accrued expenses 10,260 9,099
INCOME TAXES PAYABLE 710 690
15,744 15,983
Deferred income taxes - 629
Commitments and contingencies -
Stockholders' equity:
Common stock, $0.01 par value, 15,000,000 shares
authorized and 6,512,537 and 6,462,046 issued and
5,792,537 and 6,361,046 outstanding, respectively 65 64
Additional paid-in capital 100,120 99,520
Treasury stock (11,425) (1,733)
Accumulated deficit (37,556) (44,718)
Accumulated other comprehensive income 35 171
51,239 53,304
$66,983 $69,916
The accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
YEAR ENDED
-------------------------------
JULY 31, JULY 25, JULY 26,
1999 1998 1997
Net sales $ 107,031 $ 96,762 $ 81,243
Cost of sales 58,337 52,125 45,296
Gross profit 48,694 44,637 35,947
Operating expenses:
Dales and marketing 13,119 13,166 7,333
Research and development 15,474 14,307 9,686
General and administrative 8,153 7,253 4,495
Purchased in-process research and development - 3,995 -
Loss on disposal of product line 1,300 - -
38,046 38,721 21,514
Income from operations 10,648 5,916 14,433
Other income (expense):
Interest 1,147 1,339 1,468
Other - net (256) (737) (31)
891 602 1,437
Income before income tax provision 11,539 6,518 15,870
Provision for income taxes 4,377 4,279 6,242
Net income $ 7,126 $ 2,239 $ 9,628
Net income per share of common stock $ 1.20 $ 0.35 $ 1.50
Average common shares outstanding 5,965 6,434 6,430
Net income per share of common stock -
assuming dilution $ 1.18 $ 0.34 $ 1.45
Average common shares outstanding -
assuming dilution 6,071 6,503 6,654
The accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share data)
ACCUMU- TOTAL
COMMON ADDITIONAL ACCUMU- LATED OTHER STOCK
STOCK PAID-IN TREASURY LATED COMPREHEN- HOLDERS'
PAR $0.01 CAPITAL STOCK DEFICIT SIVE INCOME EQUITY
Balance, July 27, 1996 $ 64 $ 99,166 - $(56,585) - $42,645
Net income - - - 9,628 - 9,628
Options exercised - 18 - - - 18
Tax benefit from
exercise of
stock options - 144 - - - 144
Balance, July 26, 1997 64 99,328 - (46,957) - 52,435
Net income - - - 2,239 - 2,239
Other comprehensive
income, net of tax;
Adjustment for
foreign currency
translation - - - - 171 171
Comprehensive income
for the year - - - - - 2,410
Options exercised - 77 - - - 77
Tax benefit from
exercise of
stock options - 115 - - - 115
Purchase of
101,000 shares - - (1,733) - - (1,733)
Balance, July 25, 1998 64 99,520 (1,733) (44,718) 171 53,304
Net income - - - 7,162 - 7,162
Other comprehensive
income, net of tax;
Adjustment for
foreign currency
translation - - - - (136) (136)
Comprehensive income
for the year - - - - - 7,026
Options exercised 1 426 - - - 427
Tax benefit from
exercise of
- stock options - 174 - - - 174
Purchase of
619,000 shares - - (9,692) - - (9,692)
Balance, July 31, 1999 $ 65 $100,120 $(11,425) $(37,556) $ 35 $51,239
The accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended
---------------------------------
July 31, July 25, July 26,
0PERATING ACTIVITIES 1999 1998 1997
Net income $ 7,162 $ 2,239 $ 9,628
Adjustments to reconcile net income to net cash
provided by operating activities:
Purchased in-process research and development - 3,995 -
Loss on disposal of product line 1,300 - -
Depreciation 2,953 2,899 2,028
Amortization 499 394 -
Loss (gain) on sale of equipment 121 6 (14)
Deferred income taxes (1,900) 1,309 989
Changes in certain assets and liabilities:
Accounts receivable 1,030 (2,926) 4,107
Inventories (249) 2,589 1,301
Prepaid expenses and other current assets (300) (610) 170
Accounts payable (1,326) 1,115 (2,574)
Income taxes payable 20 641 49
Accrued expenses 245 325 (1,718)
Other assets and liabilities 198 54 -
Net cash provided by operating activities 9,753 12,030 13,966
FINANCING ACTIVITIES
Exercise of common stock options
(including tax benefit) 601 192 162
Purchase of treasury stock (9,692) (1,733) -
Net cash provided by (used for) financing activities (9,091) (1,541) 162
INVESTING ACTIVITIES
Proceeds from sale of Packet Switched line,
net of cash sold 3,140 -
Capital expenditures (2,961) (4,049) (4,192)
Acquisition of business, net of cash acquired - (14,394)
Purchase of marketable securities (10,750) (1,951) (40,745)
Proceeds from sale of marketable securities 12,701 20,930 19,815
Proceeds from sale of equipment 139 143 32
Other investing activities (35) (7) (90)
Net cash provided by (used for) investing activities 2,234 672 (25,180)
Effect of exchange rate changes on cash 25 (4)
Net increase (decrease) in cash and
cash equivalents 2,921 11,157 (11,052)
Cash and cash equivalents, beginning of period 22,994 11,837 22,889
Cash and cash equivalents, end of period $ 25,915 $ 22,994 $ 11,837
The accompanying notes are an integral part of these consolidated financial
statements.
NOTES TO FINANCIAL STATEMENTS
1 BASIS OF PRESENTATION
ACQUISITION OF TELTREND LIMITED
On September 18, 1997 (the "Acquisition Date"), Teltrend purchased the
outstanding shares of Securicor 3net Limited of Basingstoke, England (with
operations in the United Kingdom, New Zealand and China) and its U.S.
affiliate Securicor 3net Inc. (together "Teltrend Limited") for total
acquisition costs of approximately $14.5 million. Teltrend Limited is a
telecommunication equipment and software company having annualized revenues in
excess of $15 million. The transaction was accounted for as a purchase and
therefore the results of Teltrend Limited since the Acquisition Date are,
included with the results of Teltrend. The purchase price was allocated to
identifiable tangible and intangible assets, including purchased in-process
research and development, on the basis of fair values as determined by an
independent appraisal. All references in these notes to "Teltrend" or the
"Company" refer to Teltrend Inc. and its wholly owned subsidiaries,
collectively, which includes Teltrend Limited (and its wholly owned
subsidiaries) from and after the Acquisition Date.
The following table summarizes, on an unaudited pro forma basis, the
combined results of operations as if the above described acquisition had taken
place on July 28, 1996. Purchased in-process research and development assets
of approximately $4 million were written off in the fiscal 1998 Consolidated
Statement of Income, and this is reflected in the fiscal 1997 pro forma
results presented below.
PRO FORMA INFORMATION
(in thousands, except per share data) FOR THE FISCAL YEAR ENDED
-------------------------
JULY 25, JULY 26,
1998 1997
Net sales $97,975 $ 99,444
Net income (loss) $ 1,797 $ (1,593)
Net income (loss) per share - assuming dilution $ 0.28 $ (0.24)
NOTES TO FINANCIAL STATEMENTS (continued)
The value of in-process research and development purchased in the Teltrend
Limited acquisition was determined by estimating the projected net cash flows
relating to products under development and discounting such cash flows to
their net present values. The four significant projects acquired by the
Company were: (1) the PAC+DPM API; (2) the SS7/Q931 for Lucent Definity: Phase
3; (3) the Interchange iQ5OOO PRI/BRI; and (4) the Interchange '97/98. These
projects represent approximately 88% of the acquired purchased research and
development fair value. The following table summarizes the nature of each of
these significant research and development projects as well as their
respective fair values at the Acquisition Date.
FAIR VALUE
PROJECT NATURE OF PROJECT (000'S)
PAC+DMP The Application Programming Interface (API) for the NiQ router $ 440
API software that enables third parties to develop and integrate,
within the NiQ router, their own special or custom
communications software.
SS7/Q931 Phase 3 added an updated processor and common board for $1,329
for Lucent all protocol applications to Phase 2. For SS7 application, it
Definity: provides dual board resilience, added maintenance features and
Phase 3 features for enhanced call center solutions.
Interchange The 5000 concentrates up to 16 Basic Rate ISDN lines and $1,098
iQ5000 converts these onto a single Primary Rate ISDN line. Used by
PRI/BRI service providers and campus networks to deploy Basic Rate
ISDN services remote from the ISDN switch.
Interchange A combination of channel grooming, address translation and $ 643
'97/98 traffic concentration features added to the Interchange software.
The most significant and uncertain assumptions that affected the Company's
valuation of the purchased in-process research and development projects
include: (i) the period of time over which economic benefits were expected to
commence; (ii) their expected income or cash flow generating ability; and
(iii) the risk adjusted discount rate. The cash flows from the significant
research and development projects were forecast to begin upon the completion
of the development process, peak two to three years thereafter, and be
followed by a steady decline. The following table summarizes, for each
significant in-process project acquired, the original estimated completion
date, the projected peak year of sales for the related product and the
projected average after-tax cash flow decline for the related product after
its sales peak.
ORIG. EST. PEAK YEAR AVERAGE ANNUAL
COMPLETION OF SALES AFTER-TAX CASH
PROJECT DATE FLOW DECLINE
PAC+DMP API June 98 2000 -41%
SS7/Q931 for Lucent Definity: Phase 3 Feb 98 2001 -42%
Interchange iQ5000 PRI/BRI Dec 97 2002 -39%
Interchange '97/98 July 98 2000 -38%
The assumed income generating ability of the various projects was based on
the sales and profit potential of the related product, as well as the
allocation of product income to the in-process technologies relative to
existing developed and post acquisition yet-to-be-defined
NOTES TO FINANCIAL STATEMENTS (continued)
technologies expected to ultimately support the product upon project
completion. Sales estimates were based on targeted market share, historical
pricing trends and expected product life cycles. Projects PAC+DPM API,
SS7/Q931 for Lucent Definity: Phase 3, Interchange iQ5000 PRI/BRI and
Interchange '97/98 were projected to have gross margins of 40%, 70%, 70% and
60%, respectively. This is compared to historical gross margins for the fully
developed products acquired in the Teltrend Limited purchase that were greater
than 65% on average. Other operating expenses, which included selling and
marketing and general and administrative expenses, were estimated at
approximately 30% of sales. In addition, the discount rate utilized for all
acquired in-process technologies was estimated at 30% in consideration of
Teltrend Limited's 15% estimated Weighted Average Cost of Capital ("WACC") and
the fact that the in-process technology had not yet reached technological
feasibility as of the date of valuation. In utilizing a discount rate greater
than Teltrend Limited's WACC, management reflected the risk premium associated
with achieving the timing and estimated cash flows associated with these
projects. Management is responsible for the integrity of the financial
information utilized in the valuation of the acquired research and
development.
2 DISPOSITION OF PRODUCT LINE
On May 28, 1999, the Company sold substantially all of the assets of its
Packet Switched product line to Centrecorn Systems Limited of England for
approximately $3.1 million. The loss is composed largely of the write-off of
intangible assets associated with the Packet Switched product line.
3 DESCRIPTION OF BUSINESS
The Company designs, manufactures and markets a broad range of products, such
as channel units, repeaters and termination units, that are used by telephone
companies to provide voice and data services over the existing telephone
network, primarily in the Local Loop, as well as a range of products which
provide ISDN and protocol interworking solutions. The Company's fiscal
year-end is the last Saturday in July.
4 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts and transactions of
the Company and its wholly owned subsidiaries. Intercompany amounts and
transactions have been eliminated in consolidation. Exchange rate fluctuations
from translating the financial statements of subsidiaries located outside the
United States into U.S. dollars are recorded in a separate component of
stockholders' equity. All other foreign exchange gains and losses
(approximately a $0.1 million loss and a $0.7 million loss in fiscal 1999 and
fiscal 1998, respectively) are included on the income statement under the
caption "Other-net."
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
NOTES TO FINANCIAL STATEMENTS (continued)
MARKETABLE SECURITIES
The Company invests in debt instruments from time to time with a maturity of
greater than three months and less than or equal to one year. Such securities
are classified as held-to-maturity, as the Company has the intent and the
ability to hold these securities until maturity. These securities are carried
at amortized cost, which approximates fair value.
INVENTORIES
Inventories are stated at the lower of cost, as determined by the first in,
first out method, or market value.
REVENUE RECOGNITION
The Company recognizes revenue upon shipment of goods and transfer of title to
customers.
INCOME TAXES
The Company accounts for income taxes using the liability method as required
by Financial Accounting Standards Board ("FASB"), Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes".
PROPERTY, PLANT, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Land, buildings, equipment and leasehold improvements are recorded at cost.
The Company uses the straightline method of computing provisions for
depreciation and amortization of property, equipment and leasehold
improvements. Service lives for principal assets are 35 to 39 years for
buildings and three to ten years for equipment and leasehold improvements.
INTANGIBLE ASSETS
Intangible assets represent the excess of purchase price over net assets
acquired in acquisitions accounted for as a purchase. At each balance sheet
date, the Company evaluates for recognition of potential impairment its
recorded intangible assets against its projected undiscounted cash flows. If
the evaluation would indicate such an impairment, the Company would measure
the impairment loss using discounted cash flows. Intangible assets are
principally being amortized over 15 years.
Intangible assets reflect the fiscal 1999 disposition of those intangible
assets related to the Packet Switched product line. In addition, the valuation
allowance related to net deferred tax assets acquired in the acquisition of
Teltrend Limited were reversed in fiscal 1999 with the offset representing a
reduction of recorded intangibles.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed when incurred. Purchased
in-process research and development is recognized in purchase business
combinations for the portion of the purchase price allocated to the appraised
value of in-process technologies. The portion assigned to in-process
technologies excludes the value of core and developed technologies, which are
recognized as intangible assets.
ADVERTISING
All costs associated with advertising and promoting products are expensed in
the period incurred. Total advertising expenses were approximately $253,000,
$260,000 and $116,000 in fiscal 1999, fiscal 1998 and fiscal 1997,
respectively.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from these estimates.
EARNINGS PER SHARE
In January 1998, the Company adopted SFAS No. 128, "Earnings Per Share,"
requiring dual presentation of basic and diluted income per share ("EPS") on
the face of the income statement. Basic EPS is computed by dividing net income
by the weighted average number of common shares outstanding during the period.
Diluted EPS reflects the potential dilution from the exercise or conversion of
securities, such as stock options into common stock. EPS amounts for all
periods have been presented, and where necessary, restated to conform to SFAS
No. 128 requirements.
The following table sets forth the computation of basic and diluted income
per share (in thousands of dollars, except per share data).
Year Ended
----------------------------------------
July 31, July 25, July 26,
1999 1998 1997
Numerator:
Net income $ 7,162 $ 2,239 $ 9,628
Denominator:
Weighted average shares outstanding 5,965 6,434 6,430
Effect of dilutive stock options 106 69 224
Weighted average shares outstanding -
assuming dilution 6,071 6,503 6,654
Net income per share $ 1.20 $ 0.35 $ 1.50
Net income per share - assuming dilution $ 1.18 $ 0.34 $ 1.45
STOCK OPTIONS
Stock options are accounted for in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB #25"). Under
APB #25, no compensation expense is recognized when the exercise price of the
option equals the fair value of the underlying stock on the grant date.
COMPREHENSIVE INCOME
In fiscal 1999, the Company adopted FASB Statement No. 130, "Reporting
Comprehensive Income." Statement 130 establishes new rules for the reporting
and displaying of comprehensive income and its components; however, the
adoption of this Statement had no impact on the Company's net income or
equity. Statement 130 requires foreign currency translation adjustments to be
included in accumulated other comprehensive income, which prior to adoption
were reported separately in stockholders' equity. Prior year financial
statements have been reclassified to conform to the requirements of Statement
130.
NOTES TO FINANCIAL STATEMENTS (continued)
NEW PRONOUNCEMENTS
In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The Statement is not required to be
adopted until fiscal years beginning after June 15, 2000. Statement 133 will
require the Company to recognize all derivatives on the consolidated balance
sheet at fair value. The Company does not anticipate that the adoption of
Statement 133 will have a significant impact on its results of operations or
financial position.
RECLASSIFICATION
Certain amounts in the fiscal 1998 and 1997 consolidated financial statements
have been reclassified to conform to fiscal 1999 presentations.
5 RETIREMENT INVESTMENT PLAN
The Company has a defined-contribution plan covering full- and part-time
personnel in the United States, who have a minimum of one-half year of service
and have attained the age of 21. Participants may contribute between 1% and
15% of their annual compensation. The Company also has a defined-contribution
plan covering all permanent employees in the United Kingdom who have completed
three months of service and are under the age of 65. Participants contribute
4% of their annual compensation, and the Company contribution is determined on
a scale basis, which is dependent on the age of the participant. Company
contributions to its defined-contribution plans were $789,000; $620,000; and
$349,000 for the years ended July 31, 1999, July 25, 1998, and July 26, 1997,
respectively.
6 INVENTORIES
Inventories at July 31, 1999 and July 25, 1998 were as follows:
(Dollars in thousands) 1999 1998
Raw materials $ 5,124 $ 6,052
Work-in-process 1,252 1,795
Finished goods 3,090 2,809
$ 9,466 $10,656
7 ACCRUED EXPENSES
Accrued expenses at July 31, 1999 and July 25, 1998 consisted of
(Dollars in thousands) 1999 1998
Salaries, wages, and bonuses $ 4,594 $ 3,258
Warranty 1,254 1,404
Other 4,412 4,437
$10,260 $ 9,099
NOTES TO FINANCIAL STATEMENTS (continued)
8 CREDIT FACILITY
In 1995, the Company entered into a credit facility (the "Bank Facility")
which provides, subject to certain restrictions, up to $15 million on an
unsecured basis for working capital financing. As amended, the Bank Facility
will expire on July 31, 2001 and, as of July 31, 1999, no amounts were
outstanding. Under the Bank Facility agreement, dividends on the Company's
Common Stock are restricted so as not to exceed 50% of the Company's net
income for the immediately preceding fiscal year.
9 COMMON STOCK OPTIONS
The Company has a stock option plan (the "Plan") which provided for the grant
of both incentive stock options and nonqualified stock options to purchase
shares of the class of Class A Common Stock of the Company existing prior to
the recapitalization of the Company in fiscal 1995 (the "Old Class A Stock").
Unless the applicable agreement expressly provided otherwise, each option
granted under the Plan was exercisable as to 20% of the shares covered thereby
immediately upon grant and as to an additional 20% of such shares on each of
the next four anniversaries of the date of grant.
In fiscal 1994, the Board of Directors approved a resolution to decrease
the exercise price of all options outstanding to the then-estimated value of
$.1643 per share from $4.1077 per share. All options outstanding under the
Plan to purchase Old Class A Stock were converted into options to purchase
shares of Common Stock, and the Company's Board of Directors amended the Plan
to provide that no additional options could be granted thereunder in the
future. As of July 31, 1999, there were 30,816 options outstanding under the
Plan.
During June 1995, the Company adopted the Teltrend Inc. 1995 Stock Option
Plan (the "1995 Stock Option Plan") which provides for the grant of both
incentive stock options in accordance with Section 422A of the Internal
Revenue Code and nonqualified stock options. A maximum of 440,000 shares of
Common Stock may be issued in the aggregate to key employees of the Company.
The Compensation Committee of the Company's Board of Directors, which
administers the 1995 Stock Option Plan, will determine when and to whom
options will be granted. Unless the applicable agreement expressly provides
otherwise, options shall become exercisable as to 25% of the shares covered
thereby on the first anniversary of the date of grant and as to an additional
25% of such shares on each of the next three anniversaries of the date of
grant. As of July 31, 1999, there were 310,600 options outstanding under the
1995 Stock Option Plan, all with an exercise price of $16 per share.
During September 1996, the Company adopted the Teltrend Inc. 1996 Stock
Option Plan (the "1996 Stock Option Plan") which provides for the grant of
both incentive stock options in accordance with Section 422A of the Internal
Revenue Code and nonqualified stock options. A maximum of 700,000 shares of
Common Stock may be issued in the aggregate to key employees of the Company.
The Compensation Committee of the Company's Board of Directors, which
administers the 1996 Stock Option Plan, will determine when and to whom
options will be granted. Unless the applicable agreement expressly provides
otherwise, options shall become exercisable as to 25% of the shares covered
thereby on the first anniversary of the date of grant and as to an additional
25% of such shares on each of the next three anniversaries of the date of
grant. As of July 31, 1999, there were 420,671 options outstanding under the
1996 Stock Option Plan with a range of exercise prices of $12.25 to $26.25 per
share.
TELTREND INC. 1999 ANNUAL REPORT
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
During October 1997, the Company adopted the Teltrend Inc. 1997
Non-Employee Director Stock Option Plan (the "1997 Director Option Plan"),
which provides for the grant of nonqualified stock options. A maximum of
250,000 shares of Common Stock may be issued to nonemployee directors of the
Company.
Each individual elected as a director of the Company at the December 11,
1997 Annual Meeting who qualified as a non-employee director was granted an
option (an "Initial Option") to purchase UP TO 6,000 shares of Common Stock on
the date of the Annual Meeting. Thereafter, each non-employee director who has
not previously been granted an option under the 1997 Director Option Plan will
receive an Initial Option to purchase up to 6,000 shares of Common Stock on
the date of his or her initial election to the Board. Additionally, each
continuing non-employee director will be granted an additional option (an
"Annual Option") to purchase up to 1,500 shares of Common Stock on each
anniversary of the date his or her Initial Option was granted. Initial Options
will generally vest and become exercisable as to 25% of the shares of Common
Stock subject thereto on the first anniversary of the date of grant and as to
an additional 25% of such Common Stock subject thereto on each of the next
three anniversaries of the date of grant. All Annual Options granted under the
1997 Director Option Plan will generally vest and become exercisable on the
first anniversary of the date of grant thereof. As of July 31, 1999, 45,000
options were outstanding under the 1997 Director Option Plan, with a range of
exercise prices of $17.62 to $21.75.
Transactions involving stock options granted under the Plan, the 1995 Stock
Option Plan, the 1996 Stock Option Plan and the 1997 Director Option Plan are
summarized as follows:
NUMBER OF OPTIONS EXERCISE PRICE
Outstanding, July 27, 1996 555,754 $19.10
Granted 273,600 17.50 to 46.25
Exercised (13,725) .16 to 16.00
Canceled (162,108) .16 to 47.00
Outstanding, July 26, 1997 653,521 $17.59
Granted 417,500 13.25 to 21.125
Exercised (25,725) .16 to 16.00
Canceled (151,500) 16.00 to 20.00
Outstanding, July 25, 1998 893,796 $15.89
Granted 187,371 12.25 to 26.25
Exercised (50,491) .16 to 20.00
Canceled (223,589) .16 to 21.125
Outstanding July 31, 1999 807,087 $16.60
The weighted average remaining contractual life of the options outstanding
is 7.3 years. Of the 807,087 stock options outstanding at July 31, 1999,
449,941 are currently exercisable with a weighted average exercise price of
$15.45.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, "Accounting for Stock-Based Compensation," and has
been determined as if the Company had accounted for its employee stock options
under the fair value method of that Statement. The fair value of these options
was estimated at the date of grant using a BlackScholes option pricing model
with the following weighted-average assumptions for fiscal 1999,
NOTES TO FINANCIAL STATEMENTS (continued)
fiscal 1998 and fiscal 1997: risk-free interest rate of 6.0 percent; dividend
yields of 0.0 percent; volatility factors of the expected market price of the
Company's Common stock of 0.59, 0.34, and 0.25, respectively; and a
weighted-average expected life of the option of 6 years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock options.
The weighted-average fair value of options was $11.08 for options granted
in fiscal 1999, $5.06 for options granted in fiscal 1998 and $7.04 for options
granted in fiscal 1997.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows (in thousands except for earnings per share
information):
FISCAL YEAR ENDED JULY
------------------------------
1999 1998 1997
Net earnings - as reported $ 7,162 $ 2,239 $ 9,628
Net earnings - pro forma $ 6,221 $ 836 $ 8,723
Diluted earnings per share - as reported $ 1.18 $ 0.34 $ 1.45
Diluted earnings per share - pro forma $ 1.02 $ 0.13 $ 1.31
The pro forma effect on net income for fiscal 1999, fiscal 1998 and fiscal
1997 is not representative of the pro forma effect on net income in future years
because it does not take into consideration pro forma compensation expense
related to grants made prior to fiscal 1997.
10 LEASE COMMITMENTS
The Company has operating leases in effect for vehicles, equipment and
facilities. Lease expense for the fiscal years ended July 31, 1999, July 25,
1998, and July 26, 1997 totaled $1,332,000; $1,072,000; and $540,000
respectively.
The Company's current lease agreement for its domestic main facility
continues through September 30, 2000. As of July 31, 1999, the Company is
negotiating to extend this lease through September 30, 2002. The expected
financial impact of the lease extension upon the future minimum annual lease
payments shown below would be $0, $456,000 and $565,000 for fiscal years 2000,
2001 and 2002 respectively.
Future minimum annual rental payments required under the leases are
$1,637,000 as follows:
(Dollars in thousands)
Fiscal Year 2000 $ 932
Fiscal Year 2001 433
Fiscal Year 2002 272
$ 1,637
NOTES TO FINANCIAL STATEMENTS (continued)
11 INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
Company's deferred taxes are as follows:
FISCAL YEAR ENDED
-------------------
JULY 31, JULY 25,
(Dollars in thousands) 1999 1998
Deferred tax assets (liabilities):
Product warranty accruals $ 483 $ 496
Inventory reserves 588 316
Vacation accrual 506 437
Medical reserve 271 240
Purchased in-process research and development 1,406 1,473
Accrued license fee 286 -
Other 133 (15)
Intangible Packet Switched assets disposed 774 -
Capital loss 3,814 -
Tax over book depreciation 76 (397)
Total deferred tax assets 8,337 2,550
Valuation allowance (5,741) (1,854)
Net recorded deferred tax assets 2,596 $ 696
Recognized in balance sheet:
Net deferred tax assets - current 2,267 $ 1,325
Net deferred tax assets - noncurrent 329 -
Net deferred tax liabilities - noncurrent - (629)
Net deferred tax assets $ 2,596 $ 696
The capital loss was generated on the disposition of the Company's Packet
Switched product line. The carryforward will expire in fiscal 2004. Due to the
uncertainty of the Company's ability to utilize the capital loss within the
carryforward period, a valuation allowance has been provided.
Significant components of the provision (benefit) for income taxes are as
follows:
FISCAL YEAR ENDED JULY
-------------------------------
(Dollars in thousands) 1999 1998 1997
Current provision
Federal $ 5,544 $ 2,369 $ 4,103
State 733 601 1,150
6,277 2,970 5,253
Deferred provision
Federal (1,683) 1,044 772
State (217) 265 217
(1,900) 1,309 989
Provision for income taxes $ 4,377 $ 4,279 $ 6,242
Income taxes paid in fiscal years 1999, 1998 and 1997 totaled $3,884,000;
$3,874,000 AND $4,826,000, respectively.
NOTES TO FINANCIAL STATEMENTS (continued)
Total income tax provision for each year varied from the amount computed by
applying the statutory U.S. federal income tax rate to income before taxes for
the reasons set forth in the following reconciliation.
FISCAL YEAR ENDED JULY
-------------------------------
(Dollars in thousands) 1999 1998 1997
Income tax provision at the statutory rate $ 4,039 $ 2,281 $ 5,555
Increase (reduction) resulting from:
State income taxes, net of federal tax benefit 516 362 794
Valuation allowance for non-United States
net operating losses 152 1,980 -
Research and development tax credits (450) (533) -
Other, net 120 189 (107)
Actual income tax provision $ 4,377 $ 4,279 $ 6,242
In fiscal 1999, foreign losses before income taxes of $1.0 million reduced
consolidated income before income taxes to $11.5 million. In fiscal 1998,
foreign losses before income taxes of $8.1 million reduced consolidated income
before income taxes to $6.5 million.
12 COMMITMENTS AND CONTINGENT LIABILITIES
Under purchase contracts with various vendors the Company has commitments to
purchase raw materials totaling approximately $5,530,000 at July 31, 1999 and
$8,986,000 at July 25, 1998.
13 SIGNIFICANT CUSTOMERS
Five customers represented: 23.7%, 19.2%, 14.9%, 10.7% and 7.1% of consolidated
net sales in 1999; 30.1%, 16.8%, 13.8%, 10.8% and 10.3% in fiscal 1998; and
30.5%, 26.0%, 15.1%, 13.4% and 10.8% in fiscal 1997.
At July 31, 1999, five customers represented 16.3%, 13.5%, 8.3%, 8.2% and
6.9% of consolidated accounts receivable, and at July 25, 1998, five customers
represented 21.8%, 18.6%, 8.9%, 8.1 % and 6.7% of consolidated accounts
receivable.
During fiscal 1998 there were two mergers involving significant customers
of the Company. Pacific Telesis Group merged with SBC Communications, Inc. and
NYNEX merged with Bell Atlantic Corp. The above percentages relating to the
Company's net sales and accounts receivable were computed, for consistency, as
if these mergers had been in effect for each of the years specified.
NOTES TO FINANCIAL STATEMENTS (continued)
14 QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
FISCAL 1999 - QUARTER ENDED
--------------------------------------------------------
OCTOBER 31, JANUARY 30, May 1, JULY 31,
1998 1999 1999(1) 1999
Net sales $ 30,198 $ 24,436 $ 26,403 $ 25,994
Gross profit 13,927 11,202 11,599 11,966
Net income $ 2,531 $ 1,110 $ 1,000 $ 2,521
Net income per common share -
assuming dilution $ 0.41 $ 0.18 $ 0.17 $ 0.42
FISCAL 1998 - QUARTER ENDED
--------------------------------------------------------
OCTOBER 25, JANUARY 24, APRIL 25, JULY 25,
1997(2) 1998 1998 1998
Net sales $ 21,677 $ 22,817 $ 25,271 $ 26,998
Gross profit 9,386 10,369 11,860 13,022
Net income (loss) $ (2,511) $ 863 $ 1,737 $ 2,149
Net income (loss) per common
share - assuming dilution $ (0.38) $ 0.13 $ 0.27 $ 0.33
(1) In the third quarter of fiscal 1999 the Company recorded a $1.3 million
charge to recognize the impairment of the Packet Switched product line
assets acquired in the acquisition of Teltrend Limited. This charge reduced
the carrying value of the assets to be disposed of to fair value less cost
to sell.
(2) As required by generally accepted accounting principles, the Company
recorded a $4.0 million charge immediately after the acquisition of
Teltrend Limited to write off the portion of the purchase price allocated
to in-process research and development.
15 SEGMENT INFORMATION
The Company has adopted SFAS No. 131, "Disclosures about Segments and Related
Information." The Company is managed in two operating segments: (i) the United
States; and (ii) Europe and the Far East. Operations in Europe and the Far East
were acquired in the first quarter of fiscal 1998 as disclosed more fully in
Note 1, "Basis of Presentation." Therefore, segment disclosures are not
applicable for fiscal year 1997.
The accounting policies of the operating segments are the same as those
described in Note 3, "Summary of Significant Accounting Policies." Intersegment
sales are not significant. Revenues are attributed to geographic areas based
upon the location of the areas producing the revenues.
FISCAL 1999
---------------------------------------------------------------------
NET SALES INCOME NET IDENTI- CAPITAL DEPRE-
(LOSS) INCOME FIABLE EXPEND- CIATION
BEFORE (LOSS) ASSETS ITURES AND
TAXES AMORTI-
(Dollars in thousands) ZATION
United States $ 89,962 $12,569 $ 8,132 $57,816 $ 2,610 $ 2,516
Europe, Far East 17,069 (1,030) (970) 9,167 351 936
Total $ 107,031 $11,539 $ 7,162 $66,983 $ 2,961 $ 3,452
NOTES TO FINANCIAL STATEMENTS (continued)
FISCAL 1998
---------------------------------------------------------------------
NET SALES INCOME NET IDENTI- CAPITAL DEPRE-
(LOSS) INCOME FIABLE EXPEND- CIATION
BEFORE (LOSS) ASSETS ITURES AND
TAXES AMORTI-
(Dollars in thousands) ZATION
United States $ 83,984 $14,636 $ 9,268 $63,520 $ 3,781 $ 2,198
Europe, Far East 12,778 (8,118) (7,029) 8,250 268 5,090
Total $ 96,762 $ 6,518 $ 2,239 $71,770 $ 4,049 $ 7,288
Operations listed in Europe, and the Far East are comprised of operations
in the United Kingdom, New Zealand and China. Included in income (loss) before
taxes in the Europe and the Far East segment for fiscal 1999 is a $1.3 million
charge for the loss on the disposition of the Company's Packet Switched product
line. See Note 2, "Disposition of Product Line." In fiscal 1998, income (loss)
before income taxes and amortization and depreciation for the Europe and Far
East segment includes a $4 million charge for the write-off of acquired
in-process research and development costs. Interest income is earned principally
within the United States operating segment.
16 RIGHTS PLAN
On January 16, 1997, the Board of Directors of the Company declared a dividend
of one preferred share purchase right (a "Right") for each outstanding share of
Common Stock of the Company. The dividend was payable on January 27, 1997 to the
holders of record of the Common Stock as of the close of business on that date.
Each Right entitles the registered holder to purchase from the Company, under
certain circumstances involving the acquisition or the announcement of the
intent to acquire 20% or more of the Company's Common Stock, one one-hundredth
of a share of Series A Junior Participating Preferred Stock, par value $.01 per
share, of the Company (the "Preferred Stock") at a price of $160.00 per one
one-hundredth of a share of Preferred Stock, subject to adjustment. The
description and terms of the Rights are set forth in a Rights Agreement dated
January 16, 1997, as amended on June 1, 1998, and as the same may be further
amended from time to time, between the Company and LaSalle National Bank, as
Rights Agent.
NOTES TO FINANCIAL STATEMENTS (continued)
MARKET FOR COMPANY'S SECURITIES AND RELATED MATTERS
The Common Stock, $.01 par value per share (the "Common Stock"), of the Company
is quoted on the Nasdaq National Market under the symbol "TLTN." There are no
shares of the Company's Class A Common Stock, $.01 par value per share,
outstanding (and hence no established public trading market therefor). The
following table sets forth the high and low closing sale prices for the Common
Stock for the periods indicated as reported on the Nasdaq National Market:
PRICE RANGE
OF COMMON STOCK
----------------------
FISCAL 1998 High Low
First Quarter (from July 27, 1997 through October 25, 1997) $ 21 1/4 $14 7/8
Second Quarter (from October 26, 1997 through
January 24, 1998) $ 18 13/16 $14 1/8
Third Quarter (from January 25, 1998 through April 25, 1998) $ 16 7/8 $12 1/4
Fourth Quarter (from April 26, 1998 through July 25, 1998) $ 18 5/8 $14 3/4
FISCAL 1999
First Quarter (from July 26, 1998 through October 31, 1998) $ 16 1/2 $11 7/8
Second Quarter (from November 1, 1998 through
January 30, 1999) $ 25 1/16 $13 1/8
Third Quarter (from January 31, 1999 through May 1, 1999) $ 26 1/4 $14 5/8
Fourth Quarter (from May 2, 1999 through July 31, 1999) $ 22 3/8 $17 1/2
FISCAL 2000
First Quarter (partial)
(from August 1, 1999 through September 24, 1999) $ 23 3/4 $16 13/16
On September 24, 1999, the last reported sale price of the Common Stock as
reported on the Nasdaq National Market was $18-5/8 per share. On that same date,
there were 95 registered holders of record of the Common Stock.
The Company has not paid any cash dividends since 1988. The terms of the
Bank Facility prohibit the Company from declaring and paying in any fiscal year
dividends which exceed, in the aggregate, 50% of the Company's net income for
the immediately preceding fiscal year. Otherwise, the declaration and payment of
dividends will be at the sole discretion of the Board of Directors of the
Company and subject to certain limitations under the General Corporation Law of
the State of Delaware. The timing, amount and form of dividends, if any, will
depend, among other things, on the Company's results of operations, financial
condition, cash requirements, plans for expansion and other factors deemed
relevant by the Board of Directors. The Company does not anticipate paying any
cash dividends in the foreseeable future.