UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 27, 1997
[_] 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 0-23263
EXCEL SWITCHING CORPORATION
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(Exact name of registrant as specified in its charter)
Massachusetts 04-2992806
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
255 Independence Drive
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HYANNIS, MASSACHUSETTS 02601
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(Address of principal executive offices) (Zip code)
(508) 862-3000
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$.01 par value
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES: [X] NO: [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
The aggregate market value of the Registrant's Common Stock, $.01 par value,
held by non-affiliates of the Registrant as of March 6, 1998 was $629,092,888
based on the price of $19.25 on that date as reported on the Nasdaq National
Market. As of March 6, 1998, 32,720,200 shares of the Registrant's Common
Stock, $.01 par value, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Specified portions of the Company's Proxy Statement, which is expected to
be filed within 120 days after the end of the Company's fiscal year, are
incorporated by reference into Part III (Items 10, 11, 12 and 13) of this
Report.
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PART I
ITEM 1. BUSINESS
Information contained in this Report contains forward-looking
statements such as statements of the Company's plans, objectives, expectations
and intentions, that can be identified by the use of forward-looking
terminology, such as "may", "will", "expect", "anticipate", "believe", "plan",
"intend", "could", "estimates", "is being" or "goal" or other variations of
these terms or comparable terminology. Such statements are subject to risks and
uncertainties that could cause actual results to differ materially from those
anticipated. The cautionary statements made in this Report should be read as
being applicable to all forward-looking statements whenever they appear in this
Report. Factors that could cause or contribute to such differences include
those discussed in the risk factors set forth in Item 7 below (the "Risk
Factors") as well as those discussed elsewhere herein.
Excel Switching Corporation ("Excel" or the "Company") is a leading provider
of open switching platforms for telecommunications networks worldwide. The
Company develops, manufactures, markets and supports a family of open,
programmable, carrier-class switches that address the complex enhanced services
and wireless and wireline infrastructure needs of network providers. Excel's
products offer network providers the flexibility to address multiple market
applications and the scalability to deploy a variety of system capacities. The
Company's programmable switching platforms enable network providers to deliver
improved networking functionality at a lower cost than purchasing, upgrading or
reprogramming traditional, closed, central office switches. The Company's
products are currently deployed in telecommunications networks in almost 60
countries throughout the world.
Excel offers a family of programmable switching platforms that are designed
with distributed architecture and open software to maximize performance and
provide multiple levels of programmability and redundancy. Excel's open
switching platforms integrate with a wide variety of host computer systems,
operating systems and application development environments. The Company's
product family scales from approximately 100 to 30,720 ports. Using Excel's
patented Programmable Protocol Language ("PPL"), application developers can
customize the switching software to their unique requirements, allowing them to
introduce new services and applications rapidly. As customer requirements
evolve, the Excel platform can be upgraded without requiring extensive and
complex programming changes to the underlying software.
The Company sells to a variety of customers in the worldwide
telecommunications market. Excel's customers integrate the Company's open,
programmable switching platforms with their product offerings to address a
variety of market applications for network providers, ranging from enhanced
services such as voice messaging, one number services and prepaid debit cards,
to wireless and wireline infrastructure services such as tandem switching,
mobile switching centers and intelligent base station controllers.
INDUSTRY BACKGROUND
Global deregulation and technological advances have led to significant change
in the worldwide telecommunications market. Increased telecommunications service
demand coupled with the advent of new carriers are creating an intensely
competitive environment for network providers. In the United States, competition
exists among the Regional Bell Operating Companies ("RBOCs"), Interexchange
Carriers ("IXCs"), Local Exchange Carriers ("LECs"), Competitive Local Exchange
Carriers ("CLECs"), wireless carriers and cable television broadcasters.
Internationally, established network providers ("PTTs") are facing competition
from emerging alternative wireless and wireline carriers. Increasing competitive
pressures in the United States and internationally are forcing network providers
to lower infrastructure costs, increase network flexibility and offer new and
enhanced services. These challenges require network providers to deploy new
services rapidly and cost-effectively, while protecting their existing
infrastructure investment.
Functionality of the core telecommunications switching infrastructure has not
developed as quickly as network providers demand. Traditional telecommunications
switches are designed for specific uses, and as a result, are time-consuming and
expensive to modify for new applications. These traditional, closed switches do
not provide the scalability, flexibility or cost-effectiveness to address the
requirements of enhanced services or wireless and wireline
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infrastructure. In addition, traditional switches are not compatible among
vendors nor are they easily adaptable to different international network
signaling requirements.
Enhanced Services
The evolving telecommunications environment is increasingly forcing network
providers to differentiate their offerings. As network providers strive to
capture or maintain market share and stimulate usage, they must offer as
standard features many enhanced services that were once offered as premium
applications. Enhanced services include such diverse telephony applications as
voice messaging, one number services, paging, e-mail, fax messaging, unified
messaging, voice recognition dialing, prepaid debit cards and conference
bridging. Once deployed, enhanced services enable network providers to increase
revenues through subscription fees and greater network utilization.
Open, programmable switches address an emerging market for enhanced services
as application developers, OEMs and systems integrators increasingly are able to
develop applications that were once controlled by closed switch vendors. Systems
designed by traditional switch vendors are not easily modified for enhanced
services. Using open, programmable switching platforms, network providers are
able to implement applications cost-effectively today that can scale as customer
demand increases over time, while protecting their existing investment in legacy
switches.
Wireless Infrastructure
Deregulation, increased consumer demand, increased competition for subscribers
and price/performance improvements in service have led to rapid growth in the
wireless infrastructure market. The wireless infrastructure market includes
traditional cellular systems, emerging personal communication services ("PCS"),
wireless local loop and mobile satellite systems. Wireless infrastructure
equipment for these markets needs to address both high and low mobility wireless
networks and accommodate analog and emerging digital standards such as CDMA, GSM
and PCS-1900. Network providers are seeking solutions that will allow them to
meet today's market demands cost-effectively while scaling to meet future
requirements. Network providers also are seeking an alternative to the expensive
and traditional infrastructure of the telephone network to address the local
loop. As widespread replacement or installation of copper wireline remains
prohibitively expensive, the market for wireless systems to provide basic
telephone service has emerged.
Open, programmable switches provide the speed, scalability and cost-
effectiveness that wireless network providers are seeking. Programmable switches
enable wireless network providers to prototype, test and deploy new wireless
services in a rapid timeframe. Open, programmable switches can scale
incrementally as the wireless subscriber base expands or demands more services,
allowing wireless network providers to make cost-effective initial
infrastructure investments. In addition, open, programmable switches enable
wireless network providers to add enhanced services to their networks using the
same infrastructure platform.
Wireline Infrastructure
Traditional switching technology has not kept pace with the new applications
and service requirements generated by the rapid growth and competitive changes
within the global telecommunications markets. New entrants, such as CLECs, long
distance resellers and emerging international network providers, do not wish to
invest in or incur the high operating costs of traditional, inflexible, single-
purpose switching equipment. Many of these new network providers must initially
compete with incumbent RBOCs, LECs, IXCs and PTTs for subscribers based upon
lower prices and improved services. In addition, many existing network providers
are expanding into new markets, such as the RBOCs entering the long distance
market and the IXCs entering the local exchange market. To compete in these new
markets, incumbent providers must add cost-effective switches to their current
networking infrastructure.
Using open, programmable switching platforms, network providers can build
flexible, cost-effective wireline infrastructures which can be adapted to their
specific service requirements. With open, programmable switching platforms,
network providers can scale their networks as they add subscribers and implement
new and enhanced services
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using the same infrastructure. Open, programmable switches have recently been
implemented in tandem switching, one-plus dialing, international call-back
services and international gateway.
Initial Programmable Switching Products
Several companies market switching products aimed at addressing the
limitations of traditional, closed switches. However, the initial switching
products designed to address this opportunity have not satisfied the
requirements of network providers. Initial products positioned as open,
programmable switches have been configurable, but have lacked the
programmability, openness, flexibility and scalability needed to address a wide
range of enhanced services and wireless and wireline infrastructure
requirements. The Company believes that network providers are demanding
telecommunications switches that are truly open and programmable, thereby
enabling them rapidly and cost-effectively to meet their enhanced services and
infrastructure requirements.
THE EXCEL SOLUTION
Excel has developed open, programmable switching platforms that allow network
providers to offer cost-effective, scalable and flexible enhanced services and
wireless and wireline communications with a time-to-market advantage over
conventional switching platforms. The Company's integrated hardware and software
solutions are designed to offer the following benefits:
Open Programmability. The Company's product architecture is designed to be
open at multiple software programming levels, including the protocol, call
control, digital signal processing, resource provisioning and application
levels. Using these programmability features, network providers can rapidly
integrate applications with non-standard and international protocol variations
and offer customized services to their end-users. Excel's switching platforms
offer complete programmability, rather than configurability, from the host
computer. They are designed to be truly open, allowing customers to control
their own applications, and to have the capability to modify any function of
the software within the platform at any level, time or geographic location.
Rapid Time-to-Market. The Company's products are designed to allow
application developers to offer network providers new services more quickly
than with conventional switching platforms. Excel's open programmability
facilitates rapid deployment of these services in domestic and international
markets by integrating rapidly with various signaling protocols and global
network standards.
Flexibility. The Company's switching platforms can be programmed by a
customer to be used for a wide-range of enhanced services and wireless and
wireline infrastructure applications.
Scalability. The distributed and modular nature of Excel's switching
platforms allows network providers to expand their networks easily as the
subscriber base increases. Excel's switching platforms can scale from 512 to
2,048 ports within the individual chassis and total system capacity can be
expanded to 30,720 ports through the use of Excel's patented fiber optic
expansion network, EXNET. In addition, network providers can migrate across
the Company's product family without undertaking expensive and time consuming
modifications to the host platform.
Distributed Architecture. The Company's products are designed with
distributed architecture utilizing its patented Selective Space Switching
technology and a fiber optic expansion network. These designs increase
reliability and allow linear growth in performance as resources are added.
Cost-Effective. Excel's products offer increased capacity, performance and
functionality for a lower initial investment and reduced operational costs
than traditional, closed switches.
Redundancy and Reliability. The Company's carrier-class products are designed
to meet the high redundancy and reliability requirements demanded by network
providers. The redundant features of the Company's products ensure that
critical applications remain operational.
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PRODUCTS AND TECHNOLOGY
Excel's products and technology are contained within the framework of Open
Network Expansion Architecture ("ONE Architecture ") which was introduced in
February 1998. ONE Architecture is Excel's concept that its switching solutions
provide an open, scalable and cost-effective solution for the telecommunication
needs of network providers. ONE Architecture encompasses the existing family of
switching products and related software technologies described below.
PRODUCTS
The Company offers a family of open, programmable switching products for
application developers, OEMs and systems integrators. The Company's product
family consists of four switching products: the LNX, a 2,048 port switching
platform; the CSN, a 1,024 port switching platform; the PCX, a 512 port
switching platform; and the EXS, a 30,720 port switching system. All of the
Company's products can be used in a wide range of enhanced services and wireless
and wireline infrastructure applications.
All of Excel's products share a common software architecture, allowing any
specific application to run on any platform, and are designed with multiple
levels of redundancy. The LNX and CSN switching platforms share a set of common
card components which include network interface line cards such as T1, E1 and J1
interfaces, and service resource cards such as multi-function Digital Signal
Processors, Primary Rate ISDN, SS7 and DASS2. Excel's network interface line
cards provide direct connectivity to, and ease of integration with, a variety of
international signaling protocols. The service resource cards provide customers
with a range of common channel signaling and switching applications, offering
network providers the ability to control their applications and the flexibility
to expand to other services or signaling protocols as needed. Multiple cards can
be installed on a single chassis to manage various signaling and call control
capabilities or to provide fault tolerant configurations. In addition, the
Company offers network interface line cards and service resource cards
separately to allow customers to upgrade previously deployed switching
platforms.
EXCEL PRODUCT FAMILY
LNX
The LNX is a 2,048 port, non-blocking, open, programmable switching platform
which provides high performance and fault tolerance in a small chassis. With all
modules supporting redundant configurations, the LNX is designed for central
office environments requiring a high level of reliability and ease of
maintainability. The LNX can operate as a stand-alone switch or as a node in
Excel's patented EXS switching system, currently supporting scalability up to
30,720 non-blocking ports. The LNX consists of the 2,048 port matrix card
residing in a 20-slot chassis, a host interface and a fully configurable
combination of network interface line and service resource cards. All LNX cards
can be replaced while the system is operating ("hot-swappable"), providing
ease of maintenance and upgrading without interruption of service.
The predecessor to the LNX, the XLDX, is a 1,536 port programmable platform
first installed in a central office environment in 1988. XLDX systems are still
supported by the Company for customers with an XLDX installed base.
CSN
The CSN is a 1,024 port, non-blocking, open, programmable switching platform
that provides the same features and scalability as the LNX but in a more compact
chassis. The CSN utilizes the same common elements of network line interfaces,
service resources, common channel signaling packet engines and host interfaces
as the LNX, with the same reliability features such as hot-swappability and full
redundancy. The CSN is well suited for wireless applications where space
constraints dictate the need for carrier-class switching within a compact
chassis.
5
PCX
The PCX is a PC-based, 512 port, non-blocking, open, programmable switching
platform that supports the same programmable features and shares the same
hardware and software architecture as the LNX and CSN platforms. The PCX is
designed for the customer premises equipment marketplace to provide a total
solution in a small chassis, addressing the needs of midrange switching
applications. With its PC-based platform, the PCX can support an internal host
processor as well as internal voice processing resources. The PCX enables
application developers to combine Excel's programmable switching features with
industry-standard voice processing technology for a single, stand-alone
solution.
EXS
The EXS is an open, non-blocking system comprised of LNX and CSN programmable
switching platforms distributed across EXNET, the Company's fiber optic
expansion network. The current EXNET network can support up to 30,720 ports,
encompassing any combination of LNXs and CSNs. The patented EXS architecture is
designed to allow further expansion beyond the current 30,720 ports. Parallel
EXNET fiber networks can also be used to create fully redundant systems to
ensure maximum availability and fault tolerance.
Because each EXS node is a self-contained LNX or CSN switching platform,
processing power can scale linearly as the system is expanded. Individual LNX or
CSN nodes can be isolated and serviced without the entire system being brought
out-of-service, providing ease of maintenance. Since each node can operate and
process calls independently, total system reliability and availability is
increased.
TECHNOLOGY
Selective Space Switching Technology
A unique aspect of Excel's distributed architecture is its patented Selective
Space Switching technology which allows the platform's internal bus to switch
traffic between any input or output port, DSP, packet engine resource or EXNET
Controller without losing critical port capacity. Unlike traditional switches,
with Selective Space Switching technology, available port capacity is not
compromised as additional modules are added. When resource modules are added,
the platform's switching capacity increases, and its full non-blocking switch
port capacity is retained.
Open Software Technology
Unlike traditional, proprietary switches, Excel's programmable platforms share
a common, open, software architecture designed to be programmable by third
parties. The open programmability of Excel's switching platforms is based on its
Application Programming Interface ("API") and its patented Programmable Protocol
Language ("PPL").
The API is a message-based protocol designed for communication between the
programmable switching platform and the application software located on a host
computer. Excel's open API allows the application software to access call
processing control, configuration, maintenance and alarm reporting functions
within the switch at a level that is not currently available in competitive
products. Excel's API is compatible across the Company's product family.
Excel's PPL is a patented technology that provides an easy and convenient
mechanism for developers and operators to implement modifications at multiple
programming levels without having to write complex software code. Protocols are
developed and modified using a graphical user interface development environment,
requiring the user to have only limited software programming experience. With
PPL, support personnel can easily effect detailed changes to the switching
software on site without using expensive equipment or requiring additional
technical personnel. These benefits provide increased software maintainability
while reducing development costs and eliminating customized work for Excel and
its customers. Using its PPL technology, Excel is continually working with its
customers to provide additional domestic and international network interfaces.
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CUSTOMERS
During 1997 the Company sold its products to over 130 customers engaged in a
variety of segments of the telecommunications industry. The Company's customers
include application developers, OEMs and systems integrators. Approximately
40.6%, 36.7% and 26.0% of the Company's revenues in 1995, 1996 and 1997,
respectively, were derived from sales to Comverse Network Systems (formerly
Boston Technology, Inc.), approximately 10.2% of the Company's revenues in 1997
were derived from sales to QUALCOMM Incorporated and approximately 11.4% of the
Company's revenues in 1995 were derived from sales to Ericsson Messaging Systems
Inc.
The primary end-users of the Company's products are public network providers,
including RBOCs, IXCs, LECs, CLECs, wireless carriers and PTTs. The Company's
products also are used by a number of large corporations to satisfy specific
telecommunications requirements.
CUSTOMER SERVICE, SUPPORT AND TRAINING
The Company believes that the responsiveness and expertise of its customer
service personnel is essential to developing and maintaining long-term
relationships with its customers which require uninterrupted operation of the
Company's products.
The Company provides pre- and post-sales engineering services and has a
technical assistance center which provides support and service by telephone. The
Company offers a variety of engineering services such as customer application
design review, protocol development, product training, performance testing and
field support. The Company has a fully-equipped training facility and provides a
wide range of training courses to its customers, both on and off site. The
Company also has a fully-equipped applications lab with call traffic load
capabilities where customers can test and verify new applications or
enhancements to existing applications. The Company's technical assistance center
provides telephone support and service on a 24-hour, seven-day-a-week basis. To
ensure that the Company is providing quality support services, the Company has
instituted a formal customer satisfaction program which involves senior
management review and regularly scheduled customer support surveys. In addition,
Company personnel meet regularly with customers to discuss product quality and
customer satisfaction.
The Company provides a product warranty on its hardware products which
generally covers a period of 14 months from shipment. This warranty coverage
includes technical assistance, as well as product repair or product replacement,
depending upon the circumstances of the warranty claim. Although the Company
charges fees for certain support and services, to date, revenues from such fees
have been immaterial.
SALES AND MARKETING
The Company sells its products primarily to application developers, OEMs and
systems integrators which incorporate the Company's products into their service
and product offerings. The Company's principal marketing activities are to
identify customers which could benefit from the Company's products, identify new
markets for the Company's products and increase sales to existing customers.
The sale of the Company's products is a multi-step and interdisciplinary
process which can typically range from 12 to 24 months or more from initial
customer contact to large-scale commercialization of a customer's application or
service based on the Company's products. The initial evaluation stage, typically
three to six months, is primarily the role of the Company's sales and marketing
personnel, and members of the Company's senior management, and involves
educating potential customers on the functionality and benefits derived from
using the Company's products. The next stage, which can involve members of both
the Company's customer support and research and development organizations,
involves providing the customer with the required training and technical support
to integrate the Company's products into a new application or service. This
stage of the sales process is generally the longest and is dependent upon an
application or service provider's own internal application or service
development program.
The Company sells to its customers through its own sales force, from its
headquarters, as well as from sales offices in California, Georgia, Illinois,
Massachusetts, New York, Ohio and Texas. The Company recently hired a sales
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representative in Japan to focus on the Far East market. The Company is
currently negotiating with an individual in Belgium to act as a sales
representative focusing on the European market. The Company currently has no
other offices outside the United States, but is exploring the establishment of
foreign sales offices within the next 12 months in Europe and Asia. To date, the
Company has no firm commitments to establish such international sales offices
and there can be no assurance that the Company will actually open any foreign
offices. In addition, the Company maintains an inside sales group, located at
its headquarters, which is responsible for platform configuration and price
quotations, order administration and telephone sales activities. In order to
create awareness, market demand and sales opportunities, the Company engages in
a number of marketing activities which include exhibiting products and customer
applications at industry trade shows, advertising in selected publications aimed
at targeted markets, public relations activities with trade and business press,
publication of technical articles and the distribution of sales literature,
technical specifications and documentation.
RESEARCH AND PRODUCT DEVELOPMENT
Management believes that the Company's success will depend on its ability to
develop and introduce in a timely fashion new products and enhancements to its
existing products. The Company has in the past made, and intends to continue to
make, significant investments in product and technological development.
Extensive product development input is obtained through customers and the
Company's monitoring of end-user needs and changes in the marketplace.
The Company is focusing its development efforts on providing enhanced
functionality to its products including increased port capacity and performance,
the development of additional related software applications and tools and the
improvement of third-party application integration. The software applications
under development are being designed to enable customers to shorten their
application development cycle thereby improving time-to-market and reducing
initial investment in research and development.
There can be no assurance that the Company will not experience difficulties
that could delay or prevent the successful development, introduction or
marketing of such new products and enhancements, or that its new products and
enhancements will adequately meet the requirements of the marketplace and
achieve market acceptance. Announcements of currently planned or other new
product offerings by the Company or its competitors may cause customers to defer
or cancel the purchase of existing Company products. The Company's inability to
develop on a timely basis new products or enhancements to existing products, or
the failure of such new products or enhancements to achieve market acceptance,
could have a material adverse effect on the Company's business, financial
condition and results of operations.
The development of new, technologically advanced products is a complex and
uncertain process requiring the accurate anticipation of technological and
market trends. The introduction of new or enhanced products also requires the
Company to manage the transition from older products in order to minimize
disruption in customer ordering patterns, avoid excessive levels of older
product inventories and ensure that adequate supplies of new products can be
delivered to meet anticipated customer demand. There can be no assurance that
the Company will successfully develop, introduce or manage the transition to new
products. Furthermore, products such as those offered by the Company may contain
undetected or unresolved errors when they are first introduced or as new
versions are released. There can be no assurance that despite extensive testing
by the Company, errors will not be found in new products or upgrades after
commencement of commercial shipments, resulting in delays in or loss of market
acceptance and sales, diversion of development resources, injury to the
Company's reputation or increased service and warranty costs, any of which could
have a material adverse effect on the Company's business, financial condition
and results of operations. See Item 7. "Risk Factors--Risk of New Product
Introductions" and "Risk Factors--Rapid Technological Change."
The Company's engineering, research and development expenditures totaled
approximately $8.1 million, $11.1 million and $13.3 million in 1995, 1996 and
1997, respectively. The Company performs its research and product development
activities at its principal offices in Hyannis, Massachusetts. The Company has
achieved International Standard Organization (ISO) 9001 registration for quality
assurance in design production, installation and service.
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MANUFACTURING
The Company's manufacturing operations consist primarily of materials planning
and procurement, final assembly, testing and quality control. The Company uses
several independent manufacturers to provide certain printed circuit boards,
chassis and subassemblies. The Company's manufacturing process enables it to
configure its products to meet a wide variety of individual customer
requirements. The Company plans to strengthen manufacturing capability both in
its existing facilities and through expansion of activities with independent
manufacturers. Future growth of the Company will require extension of existing
internal and external manufacturing resources, hiring of additional technical
personnel, improved coordination of supplier relationships with the Company's
inventory ordering and management practices, and expansion of information
systems to accommodate planned growth across these areas. See Item 7. "Risk
Factors--Management of Growth and Hiring of Additional Personnel."
Although the Company generally uses standard parts and components for its
products, many critical components are purchased from sole or single source
vendors for which alternative sources may not be currently available. Some of
these components are available from only one supplier, for which there is no
substitute at this time. If supply of these components should cease, the Company
would be required to redesign its products. Although the Company works closely
with some well-established vendors, the Company has no supply commitments from
its vendors and generally purchases components on a purchase order basis as
opposed to entering into long term procurement agreements with vendors. To date,
the Company has generally been able to obtain adequate supplies in a timely
matter from its primary vendors or, when necessary to meet production needs,
from alternate vendors. The Company believes that, in most cases, alternate
vendors can be identified if current vendors are unable to fulfill needs.
However, delays or failure to identify an alternate vendor, if required, or a
reduction or interruption in supply, or a significant increase in the price of
components would materially and adversely affect the Company's business,
financial condition and results of operations and could impact customer
relationships. See Item 7. "Risk Factors--Dependence on Single and Sole Source
Suppliers."
COMPETITION
The markets in which the Company competes are characterized by intense
competition, with a large number of suppliers providing different types of
products to different segments of the markets. The Company currently competes
principally on the basis of: (i) the breadth of its products' features and
benefits; (ii) the flexibility, scalability, quality, ease of use, reliability
and cost effectiveness of its products; and (iii) the Company's reputation and
the depth of its expertise, customer service and support. While the Company
believes that it currently competes favorably overall with respect to these
factors, there can be no assurance that the Company will be able to continue to
do so.
The Company competes or may compete directly or indirectly with the following
categories of companies: (i) other manufacturers of programmable switches such
as Summa Four, Inc., Redcom Laboratories, Inc. and Harris Corporation; (ii)
large, well-established switch and telecommunications equipment manufacturers
such as Alcatel Alsthom Compagnie Generale d'Electricite SA, DSC Communications
Corporation, Lucent Technologies Inc., Northern Telecom Limited, Siemens AG and
Telefonaktiebolaget LM Ericsson; and (iii) to a lesser degree, systems
integrators and application developers whose switches are based on PC card-level
products manufactured by companies such as Aculab Inc., Dialogic Corporation and
Natural MicroSystems Corporation. In addition, several smaller companies have
begun recently to manufacture programmable switching platforms. Due to the
rapidly evolving markets in which the Company competes, additional competitors
with significant market presence and financial resources, including large
telecommunications equipment manufacturers and computer hardware and software
companies, may enter those markets, thereby further intensifying competition.
Additionally, there can be no assurance that one or more of the Company's
application developers will not begin to develop or market products in
competition with the Company.
Many of the Company's current and potential competitors have significantly
greater financial, selling and marketing, technical, manufacturing and other
resources than the Company. As a result, these competitors may be able to devote
greater resources to the development, promotion, sale and support of their
products than the Company. The Company, however, does not believe any of its
competitors are currently dominant in its industry segment. Some of the
Company's competitors currently offer financing alternatives to their customers,
a service that the Company does not provide at this time. The Company has no
current intention to offer such financing alternatives to its customers in the
9
foreseeable future. Moreover, these companies may introduce additional products
that are competitive with those of the Company or enter into strategic
relationships to offer complete solutions which the Company does not currently
offer. There can be no assurance that the Company's products would compete
effectively with such products.
The Company believes that its open, programmable switching platform, with
the Company's patented Selective Space Switching technology and Programmable
Protocol Language, offers its customers a competitive advantage for flexible,
scaleable and cost-effective switching capabilities. Although the Company
believes these technological features represent advantages over its competitors,
maintaining these advantages will require continued investment by the Company in
research and development, selling and marketing and customer service and
support. In addition, as the Company enters new markets, distribution channels,
technical requirements and levels and bases of competition may be different than
those in the Company's current markets. There can be no assurance that the
Company will be able to compete successfully against either current or potential
competitors in the future. See Item 7. "Risk Factors--Highly Competitive
Market."
INTELLECTUAL PROPERTY
The Company relies upon a combination of patent, copyright and trademark
and trade secret laws as well as confidentiality procedures and contractual
restrictions to establish and protect its proprietary rights. The Company has
also entered into confidentiality and invention assignment agreements with its
employees and consultants and enters into non-disclosure agreements with its
suppliers, distributors and customers so as to limit access to and disclosure of
its proprietary information. There can be no assurance such measures will be
adequate to deter and prevent misappropriation of the Company's technologies or
independent third-party development of similar technologies. The laws of certain
foreign countries in which the Company's products are or may be developed,
manufactured or sold may not protect the Company's products or intellectual
property rights to the same extent as do the laws of the United States and thus
make the possibility of piracy of the Company's technology and products more
likely.
As of December 27, 1997, a total of nine U.S. patents and one foreign
patent have been issued to the Company. The Company has a total of 11 U.S.
patent applications and 64 international and foreign national patent
applications pending. The U.S. issued patents cover various aspects of: (i) the
architecture and division of call processing responsibility in the Company's PCX
product; (ii) the design and internal construction of a rack-mountable chassis
used with the Company's PCX product; (iii) the architecture of certain
communications resource and I/O cards which may be used in conjunction with any
of the Company's family of programmable switching platforms relating to the
Company's Selective Space Switching technology; (iv) the PPL software which may
be used, in conjunction with any of the Company's family of programmable
switching platforms, to create or modify applications or communications
protocols; (v) a line card redundancy arrangement for use in conjunction with
the Company's LNX and CSN products; and (vi) the architecture of the Company's
fiber optic expansion network, EXNET. The U.S. patents will expire at various
times between the years 2008 and 2014. The Company also has thirteen U.S.
trademark applications pending.
The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert patent, copyright,
trademark and other intellectual property rights to technologies that are
important to the Company. Although the Company has from time to time received
communications from third parties asserting that the Company's products infringe
or may infringe proprietary rights of third parties, the Company believes that
none of such claims, if determined adversely to the Company, would have a
material adverse effect on the Company's business, financial condition or
results of operations. In its distribution agreements, the Company agrees to
indemnify its customers for any expenses or liabilities resulting from claimed
infringements of patents, trademarks or copyrights of third parties. In certain
limited instances, the amount of such indemnities may be greater than the
revenues the Company may have received from the customer. In the event of
litigation to determine the validity of any third-party claims, such litigation,
whether or not determined in favor of the Company, could result in significant
expense to the Company and divert the efforts of the Company's technical and
management personnel. In the event of an adverse ruling in such litigation, the
Company might be required to discontinue the use and sale of infringing
products, expend significant resources to develop non-infringing technology or
obtain licenses from third parties. There can be no assurance that licenses from
third parties would be available on reasonable commercial terms, if at all. In
the event of a successful claim against the Company and the failure of the
Company to develop or license a substitute technology, the Company's business,
financial
10
condition and results of operations would be materially adversely affected. The
Company changed its name from Excel Inc. to Excel Switching Corporation in
September 1997. Searches performed on the term Excel have revealed several
registrations and numerous uses of that term, and terms substantially similar to
it, alone and in combination with other terms and designs. Accordingly, there
can be no assurance that third parties will not assert trademark infringement
claims relating to the name Excel Switching Corporation in the future. See Item
7. "Risk Factors--Dependence on Proprietary Rights."
EMPLOYEES
As of December 27, 1997, the Company employed 270 persons, including 98 in
engineering, research and development, 69 in selling, marketing and customer
service and support, 59 in manufacturing and 44 in finance, administration and
management information systems. None of the Company's employees are
represented by collective bargaining arrangements, and the Company believes that
its relations with its employees are good. The Company expects to hire
additional engineering, sales and marketing personnel over the next 12 to 18
months to accommodate planned domestic and international expansion. The hiring
of additional personnel will place additional demands on management's ability to
assimilate, direct and supervise a growing work force. There can be no
assurance that the Company will be successful in assimilating this growth in
personnel. See Item 7. "Risk Factors--Management of Growth and Hiring of
Additional Personnel."
The Company's success depends to a significant degree upon the continuing
contributions of its key management, sales, engineering, customer support and
product development personnel. The loss of any of the key management or
technical personnel could have a material adverse effect on the Company. The
Company believes that its future success will depend in large part upon its
ability to attract and retain highly-skilled managerial, sales, customer support
and product development personnel. The Company has at times experienced and
continues to experience difficulty in recruiting qualified personnel.
Competition for qualified personnel in the Company's industry is intense, and
there can be no assurance that the Company will be successful in attracting and
retaining such personnel. Failure to attract and retain key personnel could
have a material adverse effect on the Company's business, financial condition
and results of operations. See Item 7. "Risk Factors--Dependence on Key
Personnel" and "Risk Factors--Management of Growth and Hiring of Additional
Personnel."
ITEM 2. PROPERTIES
The Company's headquarters total approximately 98,250 square feet and are
located in four buildings in Hyannis, Massachusetts. Two of the buildings,
totaling approximately 55,500 square feet, are owned by the Company and house
the engineering, sales, marketing and administrative functions of the Company.
The third building, approximately 25,750 square feet, is leased by the Company
and houses the manufacturing and manufacturing support functions of the Company.
The lease expires in July 2000, but contains an option for an additional five-
year term. An option to purchase this building may be exercised at any time
after August 1998. The Company intends to exercise this option and,
accordingly, has recorded this lease as a capital transaction. The fourth
building, approximately 17,000 square feet, is leased by the Company until March
31, 1998 as temporary office space for research and development activities until
construction of the new building described below is completed. Management
Company is currently negotiating with the owner of the building to become a
tenant at will through May 1998. There can be no assurance that such an
agreement will be reached nor at terms acceptable to the Company.
During 1997 the Company purchased additional property and initiated
construction of a building, expected to be completed in 1998, which will add
approximately 46,000 square feet of space for engineering activities. In
January 1998, the Company entered into a Purchase and Sale Agreement to purchase
approximately 108,000 square feet of additional land and also executed an
agreement providing Excel with an option to purchase up to an additional 274,000
square feet of land. This option does not expire until January 2000 subject to
an annual, non-refundable payment.
The Company also leases sales offices in San Jose and Sand Diego,
California; Atlanta, Georgia, Rolling Meadows, Illinois; Newton, Massachusetts;
White Plains, New York; Cleveland, Ohio; and Grapevine, Texas. The Company
intends to expand the capabilities and size of these offices and open additional
offices, both domestically and internationally, as needs arise.
11
Although the Company anticipates that it will not require additional
manufacturing space for at least the next 12 months, the Company's business,
financial condition and results of operations could be materially adversely
affected if it does not expand manufacturing capacity as required.
The Company believes that its current facilities and planned expansions are
adequate to meet its needs through the next 12 months. However, due to the
limited supply of suitable additional or alternative office and manufacturing
space in the Hyannis, Massachusetts area, there can be no assurance that the
Company will not be required in the future to invest heavily in the renovation
of space in the Hyannis vicinity or in relocating the Company's headquarters.
See Item 7. "Risk Factors--Management of Growth and Hiring of Additional
Personnel" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources."
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information - The Company's Common Stock is quoted on the Nasdaq National
Market under the symbol "XLSW". The following table sets forth the quarterly
high and low sales prices per share of Common Stock since the Company's initial
public offering on November 4, 1997, as reported by the Nasdaq National Market.
Fiscal Year Ended December 27, 1997 High Low
- ----------------------------------- ------ ------
First Quarter N/A N/A
Second Quarter N/A N/A
Third Quarter N/A N/A
Fourth Quarter (from November 4, 1997) 27 7/8 14 1/4
Number of Holders - As of March 23, 1998, there were approximately 98 holders
of record of the Company's Common Stock, including multiple beneficial holders
at depositories, banks and brokers listed as a single holder in the street name
of each respective depository, bank or broker. The Company believes there are
over 400 beneficial owners of its Common Stock.
Dividend Policy - The Company does not expect to pay cash dividends on its
Common Stock in the foreseeable future. The Company currently intends to retain
all of its future earnings, if any, for use in the operation of the business.
In addition, the Company's credit facility restricts the Company's payment of
cash dividends. See Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
Recent Sales of Unregistered Securities - The following information is furnished
with regard to all securities issued by the Registrant within fiscal 1997 which
were not registered under the Securities Act.
On December 2, 1997 options to purchase a total of 2,000 shares of Common
Stock granted to employees of the Company under the Registrant's Stock Option
Program were exercised at an exercise price of $1.00 per share, for an aggregate
purchase price of $2,000.00. On December 4, 1997 options to purchase a total of
400 shares of Common Stock granted to employees of the Company under the
Registrant's Stock Option Program were exercised at an exercise price of $1.00
per share, for an aggregate purchase price of $400.00.
12
The securities issued in such transactions were not registered under the
Securities Act, as amended, in reliance upon exemptions from registration set
forth in Section 3(b) and 4(2) of the Securities Act, relating to sales by an
issuer not involving any public offering. None of the foregoing transactions,
either individually or in the aggregate, involved a public offering.
Use of Proceeds of Initial Public Offering - On November 4, 1997 the Securities
and Exchange Commission declared effective the Company's Registration Statement
on Form S-1, Commission file number 333-35791, relating to the initial public
offering of the Company's Common Stock, $.01 par value. The offering commenced
on November 4, 1997 and all shares covered by the Registration Statement were
sold. The managing underwriters for the offering were Morgan Stanley & Co.
Incorporated, Hambrecht & Quist LLC and NationsBanc Montgomery Securities LLC.
The following sets forth certain information regarding the offering and the
Company's application of the net proceeds therefrom through December 27, 1997.
Number of shares registered 5,175,000
Number of shares sold by the Company 4,500,000
Number of shares sold by the selling stockholder 675,000
Aggregate price of the offering amount registered and sold by the Company $94,500,000
Offering Expenses:
Underwriting discounts and commissions 6,615,000
Finder's fees -
Expenses paid to or for underwriters -
Other expenses 779,000
-----------
Total expenses 7,394,000
-----------
Net offering proceeds to the Company $87,106,000
===========
Aggregate price of the offering amount registered and sold by selling $14,175,000
stockholder
Offering expenses:
Underwriting discounts and commissions 992,250
Finder's fees -
Expenses paid to underwriters -
Other expenses -
-----------
Total expenses 992,250
-----------
Net offering proceeds to the selling stockholder $13,182,750
===========
No such expenses were paid directly or indirectly to directors, officers,
general partners of the Company or their associates, to persons owning ten
percent or more of any class of equity of the Company or to affiliates of the
Company.
To date, the Company has not utilized any of the net proceeds from the IPO.
The Company has invested all such net proceeds in investment grade, interest-
bearing securities.
13
ITEM 6. SELECTED FINANCIAL DATA
The following table contains certain selected consolidated financial data
of the Company and is qualified in its entirety by the more detailed
Consolidated Financial Statements included herein. This data should be read in
conjunction with "Item 7. Management's Discussion and Analysis of Financial
Conditions and Results of Operations" and the Consolidated Financial Statements
appearing elsewhere herein.
FISCAL YEAR
------------------------------------------------------------------
1993 1994 1995 1996 1997
---------- ---------- ---------- ---------- ----------
(in thousands, except per share data)
CONSOLIDATED STATEMENTS OF INCOME DATA:
Revenues $10,033 $20,723 $36,161 $62,050 $88,727
Cost of revenues....................................... 2,945 7,074 12,100 24,312 26,631
------- ------- ------- ------- -------
Gross profit........................................ 7,088 13,649 24,061 37,738 62,096
------- ------- ------- ------- -------
Operating expenses:....................................
Engineering, research and development............... 1,862 3,301 8,117 11,121 13,260
Selling and marketing............................... 140 362 2,923 6,621 11,486
General and administrative.......................... 2,194 2,903 4,238 6,426 7,949
------- ------- ------- ------- -------
Total operating expenses......................... 4,196 6,566 15,278 24,168 32,695
------- ------- ------- ------- -------
Income from operations........................... 2,892 7,083 8,783 13,570 29,401
Other income (expense)................................. (681) (4) 38 (384) 1,392
------- ------- ------- ------- -------
Income before provision for income taxes......... 2,211 7,079 8,821 13,186 30,793
Provision for income taxes............................. 815 2,889 3,410 5,285 12,177
------- ------- ------- ------- -------
Net income............................................. $ 1,396 $ 4,190 $ 5,411 $ 7,901 $18,616
======= ======= ======= ======= =======
Basic earnings per share............................... $.05 $.15 $.19 $.28 $.65
======= ======= ======= ======= =======
Diluted earnings per share............................. $.05 $.13 $.17 $.24 $.54
======= ======= ======= ======= =======
Basic weighted average shares outstanding.............. 27,946 27,946 27,962 28,090 28,756
Diluted weighted average shares outstanding............ 30,864 31,341 31,822 32,697 34,361
Dec. 31, Dec. 31, Dec. 31, Dec. 28, Dec. 27,
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
(in thousands)
Consolidated Balance Sheet Data:
Working capital................................. $2,323 $5,906 $10,238 $14,960 $116,374
Total assets.................................... 5,483 9,973 22,683 34,772 149,694
Long-term obligations, less current maturities.. - - 3,537 3,837 108
Total stockholders' equity...................... 2,255 6,471 12,125 20,086 125,915
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Item 1. Business", "Item 6. Selected Financial Data", the Company's
Consolidated Financial Statements and Notes thereto and the information
described under the caption "Risk Factors" below.
14
OVERVIEW
Excel Switching Corporation ("Excel" or the "Company") has been profitable
since it was founded in 1988 and has financed its operations principally through
cash generated from operations. The Company has experienced significant revenue
growth resulting, in part, from the increasing acceptance of programmable
switching as a means of addressing the enhanced services and wireless and
wireline infrastructure needs of network providers. The Company designed and
shipped its first programmable switching product, the XLDX, during the fourth
quarter of 1988, to Comverse Network Systems (formerly Boston Technology, Inc.)
("Comverse"). Excel subsequently expanded its product offering to include a
family of open, programmable switching platforms. The LNX and PCX switching
platforms were introduced in 1991 and have been subsequently enhanced. The
Company introduced the EXS switching system in 1995 and the CSN switching
platform in 1996. Through December 27, 1997, the Company's revenues have been
derived from sales to application developers, OEMs and systems integrators.
During the early years of the Company's operations, revenues from Comverse
represented substantially all of the Company's annual revenues. The Company has
continued to establish customer relationships with other application developers,
OEMs and systems integrators, penetrate new markets, and improve the capacity,
functionality and features of its family of products. Currently, Excel sells its
products to over 130 customers engaged in a variety of segments of the global
telecommunications industry. During 1997, Comverse represented approximately
26.0% of the Company's revenues.
The Company's products are sold through its direct sales force primarily to
application developers, OEMs and systems integrators which incorporate the
Company's products into their service and product offerings. The Company sells
each of its switching platforms with a varying combination of network interface
line cards and service resource cards that are specified by customer and
application requirements. The Company also sells additional network interface
line cards and service resource cards that allow customers to expand capacity
and functionality and provide for redundancy of their installed systems.
Revenues from product sales are recognized upon shipment, at which time the
Company provides an estimate of anticipated post sale support, warranty costs
and sales returns. The increase in the reserve for sales returns can be
attributed to the volume increase in sales, the timing and significance of new
product introductions and the increased complexity of the uses of the Company's
equipment. In addition, the Company estimates reserves to adjust for the
realizability of accounts receivable and inventory. While the Company believes
its estimates for post sale support, warranty costs, sales returns and the
realizability of accounts receivable and inventory are adequate, actual results
could differ from those estimates.
Revenues from sales of software development tools and services such as
technical support, training and product maintenance have not been significant to
date. The Company has not capitalized any software development costs and all
research and development costs have been expensed as incurred.
The Company's profitability is influenced by a number of factors, including
pricing, cost of materials, product and technological advancements from research
and development efforts and the expansion of its operations. The Company
anticipates the addition of personnel and related infrastructure as it seeks to
increase revenues, and to meet other strategic goals such as developing new
products and technologies, broadening strategic partnerships with, and
incorporating new applications for, its customers, entering new markets and
expanding internationally. The Company anticipates that engineering, research
and development expenses will increase in absolute dollars, and may increase as
a percentage of revenues, as the Company pursues engineering efforts to provide
enhanced functionality to its products, increase port capacity and develop
additional software features.
15
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of revenues represented by certain items reflected in the Company's Consolidated
Statements of Income:
Fiscal Year
------------------------------------------------------------
1995 1996 1997
---------- ---------- ----------
Revenues.................................................... 100.0% 100.0% 100.0%
Cost of revenues............................................ 33.5 39.2 30.0
----- ----- -----
Gross profit............................................. 66.5 60.8 70.0
----- ----- -----
Operating Expenses:.........................................
Engineering, research and development.................... 22.4 17.9 14.9
Selling and marketing.................................... 8.1 10.7 13.0
General and administrative............................... 11.7 10.3 9.0
----- ----- -----
Total operating expenses.................................... 42.2 38.9 36.9
----- ----- -----
Income from operations...................................... 24.3 21.9 33.1
Other income (expense)...................................... .1 (.6) 1.6
----- ----- -----
Income before provision for income taxes.................... 24.4 21.3 34.7
Provision for income taxes.................................. 9.4 8.5 13.7
----- ----- -----
Net income.................................................. 15.0% 12.8% 21.0%
===== ===== =====
FISCAL YEAR ENDED DECEMBER 27, 1997 COMPARED TO FISCAL YEAR ENDED DECEMBER 28,
1996
Revenues. The Company's revenues consist of sales, primarily in the United
States, of its open, programmable switching platforms and related network
interface line cards and service resource cards. Revenues increased 43.0% from
$62.1 million in 1996 to $88.7 million for 1997. The increase resulted, in part,
from the Company's continuing efforts to enhance the scalability, performance,
capacity and functionality of its products through the modification and
introduction of features and products. The increase in revenues also resulted
from the introduction of new or expanded offerings by existing customers
incorporating the Company's products, the expansion of customers' existing
markets and the introduction of new applications by new and existing customers.
In addition, revenues increased due to increased market penetration resulting
from the efforts of the Company's expanded selling and marketing organizations.
Revenues from the Company's five largest customers represented approximately
57.1% and 50.9% of the Company's revenues for 1996 and 1997, respectively.
Comverse represented approximately 36.7% and 26.0% of the Company's revenues for
these same periods, respectively. Additionally, 10.2% of the Company's revenues
in 1997 were derived from QUALCOMM Incorporated. Although the Company's largest
customers have varied from period to period, the Company believes that revenues
derived from current and potential large customers will continue to represent a
significant proportion of revenues, and that its results of operations in any
given period will continue to depend to a significant extent upon sales to a
limited number of customers. There can be no assurance that the Company's
principal customers will continue to purchase product at current levels, if at
all.
Gross Profit. Cost of revenues consists primarily of the cost of purchased
components and subassemblies, contract manufacturing costs, labor and overhead
relating to material procurement, final assembly, testing and quality control,
and warranty and post sale support costs. Cost of revenues increased 9.5% from
$24.3 million in 1996 to $26.6 million for 1997. Gross margin increased from
60.8% in 1996 to 70.0% in 1997. The increase in gross margin was primarily
attributable to lower component prices, changes in product mix and increased
manufacturing efficiencies as the Company increased its production volume in
1997. In addition, gross margins for 1996 were negatively impacted by the
introduction of the EXS switching system and related technology which resulted
in valuation adjustments of certain existing inventory components.
Engineering, Research and Development. Engineering, research and
development costs consist primarily of compensation and related costs of
engineering and development personnel, materials and supplies consumed in
prototype development, related facility costs and depreciation of engineering
and test equipment. All research and
16
development costs, including software development costs, have been expensed as
incurred. Engineering, research and development costs increased 19.2% from $11.1
million in 1996 to $13.3 million for 1997. As a percentage of revenues, these
costs were 17.9% and 14.9%, respectively, in such periods. The increase in
engineering, research and development costs in absolute dollars was primarily
attributable to an increase in engineering and research personnel partially
offset by decreases in the consumption of prototype supplies and materials.
Engineering and research personnel increased from 68 employees at the end of
1996 to 98 employees at the end of 1997.
Selling and Marketing. Selling and marketing costs consist primarily of
compensation and related costs for sales, marketing and customer support
personnel, travel and advertising, trade show and other promotional activities.
Selling and marketing costs increased 73.5% from $6.6 million in 1996 to $11.5
million for 1997. As a percentage of revenues, these costs were 10.7% and 13.0%,
respectively, in such periods. The increase in selling and marketing costs in
absolute dollars was primarily attributable to an increase in sales, marketing
and customer support personnel and an increase in trade show and promotional
activities during 1997. Sales, marketing and customer support personnel
increased from 51 employees at the end of 1996 to 69 employees at the end of
1997.
General and Administrative. General and administrative costs include
compensation and related costs of management, finance, management information
systems and administrative personnel, professional services, costs to implement
and maintain manufacturing and management information systems and other general
corporate expenses. General and administrative costs increased 23.7% from $6.4
million in 1996 to $7.9 million for 1997. As a percentage of revenues, these
costs were 10.3% and 9.0%, respectively, in such periods. The increase in
general and administrative costs in absolute dollars was primarily attributable
to an increase in general and administrative personnel from 35 employees at the
end of 1996 to 44 employees at the end of 1997.
Other Income (Expense). Other income (expense), which primarily includes
interest income and interest expense, increased from ($384,000) in 1996 to $1.4
million in 1997. This increase was primarily attributable to an increase in
interest income derived from larger balances of invested cash and securities.
Provision for Income Taxes. The Company's effective rate for Federal and
state income taxes was 40.1% and 39.5% for 1996 and 1997, respectively. The
decrease in effective rates is primarily attributable to a decrease in the
effective state income tax rate and the utilization of certain tax credits.
FISCAL YEAR ENDED DECEMBER 28, 1996 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
1995
Revenues. Revenues increased from $36.2 million in 1995 to $62.1 million in
1996. The increase resulted, in part, from the Company's continuing efforts to
enhance the scalability, performance, capacity and functionality of its products
through the modification and introduction of features and products, including
the introduction of the EXS switching system in 1995 and the CSN switching
platform in 1996. The increase in revenues also resulted from the introduction
of new or expanded offerings by existing customers incorporating the Company's
products, the introduction of new applications by new and existing customers and
the expansion of the Company's selling and marketing efforts.
Revenues from the Company's five largest customers represented
approximately 70.1% and 57.1% of the Company's revenues for 1995 and 1996,
respectively. During 1995 and 1996, Comverse represented approximately 40.6% and
36.7%, respectively, of the Company's revenues. Additionally, 11.4% of the
Company's revenues in 1995 were derived from sales to Ericsson Messaging Systems
Inc.
Gross Profit. Cost of revenues increased from $12.1 million in 1995 to
$24.3 million in 1996. The gross margin decreased from 66.5% in 1995 to 60.8% in
1996. The decrease in gross margin in 1996 resulted primarily from the
introduction of the EXS switching system and related technology, which resulted
in valuation adjustments of certain existing inventory components. Increased
warranty and related support costs also contributed to the decline in gross
margin. In addition, gross margin was negatively impacted by the Company's
relocation of its manufacturing operations in November 1995, the subsequent
expansion of this facility in 1996 and increased compensation and related costs
associated with the Company's efforts to strengthen its manufacturing
infrastructure.
17
Engineering, Research and Development. Engineering, research and
development costs increased from $8.1 million in 1995 to $11.1 million in 1996.
As a percentage of revenues, engineering, research and development expenses were
22.4% and 17.9% for 1995 and 1996, respectively. The increases in engineering,
research and development costs in absolute dollars were primarily attributable
to continuing efforts to expand the Company's research and development
infrastructure. Engineering, research and development personnel increased from
38 employees at the end of 1995 and to 68 employees at the end of 1996.
Increases also resulted from the timing and amount of the consumption of
materials used for prototypes in the development process. The Company's
relocation in 1995 to a larger facility and capital investments made in 1995 and
1996 in engineering and test equipment resulted in increased occupancy costs and
depreciation expenses for both years.
Selling and Marketing. Selling and marketing costs increased from $2.9
million in 1995 to $6.6 million in 1996. As a percentage of revenues, these
costs were 8.1% and 10.7% for 1995 and 1996, respectively. The increase in
selling and marketing costs reflects the expansion of the Company's sales,
marketing and customer support personnel from 28 employees at the end of 1995
and to 51 employees at the end of 1996. During 1995 and 1996, the Company's
expanded efforts to market and promote its products through trade shows,
advertising, public relations and other promotional activities also resulted in
increased selling and marketing costs. The Company's relocation in 1995 and the
opening of four sales offices in 1996 resulted in increased occupancy costs in
1995 and 1996.
General and Administrative. General and administrative costs increased from
$4.2 million in 1995 to $6.4 million in 1996. As a percentage of revenues, these
costs were 11.7% and 10.3% for 1995 and 1996, respectively. The increase in
general and administrative costs in absolute dollars resulted primarily from an
increase in general and administrative personnel from 21 employees at the end of
1995 to 35 employees at the end of 1996. The Company's efforts to expand and
strengthen the administrative infrastructure included the additions of a Chief
Financial Officer, Chief Operating Officer and other personnel in the areas of
finance, human resources and purchasing. During 1996, the Company made
significant investments in its manufacturing and management information systems,
including the implementation of its enterprise resource planning system. The
Company's relocation to larger facilities in 1995 resulted in increased
occupancy and depreciation costs in 1995 and 1996.
Other Income (Expense). Other income (expense) was $38,000 and ($384,000)
for 1995 and 1996, respectively.
Provision for Income Taxes. The Company's effective rate for Federal and
state income taxes was 38.7% and 40.1% for 1995 and 1996, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, Excel has funded its operations primarily through cash
provided by operations. In November 1997, the Company received total net
proceeds of approximately $87.1 million from the initial public offering of its
common stock. See Item 5. "Market for Registrant's Common Equity and Related
Stockholder Matters".
At December 27, 1997, the Company's principal sources of liquidity
consisted of cash, cash equivalents and marketable securities of approximately
$114.9 million, working capital of approximately $116.4 million and $15.0
million of funds available under a bank line of credit.
During 1995, 1996 and 1997, cash provided by operating activities totaled
$1.2 million, $7.3 million and $27.2 million, respectively. The increase in 1996
was primarily attributable to increases in net income, accrued expenses and
accrued income taxes, partially offset by an increase in deferred income taxes
and a decrease in accounts payable. The increase in 1997 was primarily
attributable to an increase in profitability, accounts payable and accrued
expenses.
The Company's investing activities consumed $4.1 million, $4.1 million and
$70.4 million in 1995, 1996 and 1997, respectively. During 1997, net purchases
of marketable securities consumed approximately $67.0 million. The remaining
expenditures primarily reflect the acquisition, renovation and expansion of the
Company's facilities and the purchase of capital equipment.
18
During 1995, the Company purchased and renovated two buildings and related
land for approximately $3.2 million. These acquisitions and renovations were
financed, in part, by the proceeds from a $2.6 million secured loan from a bank.
This loan was paid in full in January 1998.
In 1995, the Company entered into a building lease which requires monthly
payments of approximately $13,000 through July 2000. The lease can be extended
through July 2005 and includes a purchase option exercisable, beginning in
August 1998, for $875,000. The Company intends to exercise this option as early
as possible, and accordingly, has reflected this lease as a capital transaction.
On June 30, 1997, the Company purchased property to be used for the
construction of an additional building. The purchase price of $575,000 and the
estimated construction costs were to be financed, in part, by a $2.1 million
Real Estate Promissory Note with a bank, of which $460,000 was advanced to the
Company during 1997. Borrowings under this note bore interest at prime plus .25%
and were secured by the property and certain other assets. Monthly payments of
interest began in July 1997. In January 1998, the Company paid in full all
outstanding balances under this note.
During 1997, the Company began construction of a 46,000 square foot
building to be used for engineering and research activities. Construction is
expected to be completed by the end of the second quarter of 1998 at an
estimated cost of approximately $3.7 million. In January 1998, the Company
executed a Purchase and Sale Agreement to purchase approximately 108,000 square
feet of additional land for approximately $324,000 and also completed an
agreement providing Excel with an option to purchase up to an additional 274,000
square feet of land at a total cost of approximately $821,000. This option does
not expire until January 2000 subject to an annual, non-refundable payment of
approximately $71,000. The total costs of the facility and land acquisition will
be funded by existing cash resources.
The Company's unsecured line of credit arrangement with a bank provides up
to $15.0 million in credit availability. Borrowings under this agreement bear
interest, at the Company's discretion, at either the bank's base rate or the
Eurodollar rate plus 2.5%. The agreement requires the Company to comply with
certain financial covenants, including a liabilities to tangible net worth
ratio, a current assets to current liabilities ratio and a minimum profitability
covenant. The agreement also restricts the Company's ability to pay cash
dividends. The Company was in compliance with these covenants as of December 27,
1997. There were no amounts outstanding under this line of credit at December
28, 1996 or December 27, 1997.
The Company does not have any other significant capital commitments and
believes that available funds and cash generated from operations, will be
sufficient to meet the Company's working capital requirements for at least the
foreseeable future. The Company plans to finance its long-term capital needs
with available funds, together with available borrowings and cash flow from
operations. To the extent that such funds are insufficient to finance the
Company's activities, the Company may have to raise working capital through the
issuance of additional equity or debt securities. There can be no assurance that
additional financing will be available on acceptable terms.
Year 2000 Compliance: Management has initiated a Company-wide program to
assess the impact of the Year 2000 issue on the Company's computer systems and
applications as well as the Company's product offerings. Management believes
that a majority of the Company's product offerings are currently Year 2000
compliant and that its primary internal information systems used to support its
operations are compatible with the Year 2000. However, the Company utilizes
other third party equipment, telecommunication products and other third party
software applications which may or may not be Year 2000 compliant. Although the
Company is currently taking steps to address the impact, if any, of the Year
2000 issue surrounding such third party products, failure of any critical third-
party products to operate properly in the Year 2000 may have a material adverse
effect on results of operations or require the Company to incur unanticipated
expenses to remedy any problems. In addition, as the Company purchases many
critical components from single or sole source suppliers, failure of any such
vendor to adequately address issues relating to the Year 2000 problem may have a
material adverse effect on the Company's business, financial condition and
results of operations.
RECENT ACCOUNTING ANNOUNCEMENT
On February 10, 1998, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin No. 98 (SAB 98). This bulletin revises the SEC's
guidance for calculating earnings per share with respect to equity securities
19
issued prior to an initial public offering and is effective for fiscal years
ending after December 15, 1997. The prior years' earnings per share have been
retroactively restated to reflect the adoption of SAB 98. As a result of this
restatement, the Company's previously reported diluted earnings per share has
been increased by $.01 in each of the fiscal years 1993, 1995 and 1996 to $.05,
$.07 and $.24, respectively.
RISK FACTORS
This Report contains statements which may be "forward-looking" statements
and are subject to risks and uncertainties that could cause actual results to
differ significantly from expectations. In particular, statements contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" which are not historical facts, including, but not limited to,
statements regarding the anticipated adequacy of cash resources to meet the
Company's working capital requirements, statements regarding the intention to
exercise a purchase option on an existing building lease and statements
regarding the anticipated proportion of revenues to be derived from a limited
number of customers, may constitute forward looking statements. Factors that
could cause or contribute to such differences include those discussed below, as
well as those discussed elsewhere in this Report.
Fluctuations in Results of Operations. The Company's results of operations
have varied significantly in the past and may vary significantly in the future,
on a quarterly and annual basis, as a result of a variety of factors, many of
which are outside the Company's control. These factors include, without
limitation: (i) the timing and size of orders which are received and can be
shipped in any particular period; (ii) the commercial success of the Company's
products; (iii) delays in the introduction of products or product enhancements
by the Company and the Company's ability to introduce new products and
technologies on a timely basis; (iv) the financial stability of the Company's
major customers; (v) the timing of new product introductions or announcements by
the Company or its competitors; (vi) the availability of adequate supplies of
key components and assemblies and the adequacy of third-party manufacturing
capabilities; (vii) the seasonality of the placement of customer orders; (viii)
the timing and nature of selling and marketing expenses such as tradeshows and
advertising campaigns; (ix) the timing of development expenditures and personnel
changes; (x) the publication of opinions about the Company and its products, or
its competitors or their products, by industry analysts; (xi) customer order
deferrals in anticipation of product enhancements or new product offerings by
the Company or its competitors; and (xii) customer cancellation of orders and
the gain or loss of significant customers, including those due to industry
combinations. Moreover, any downturn in general economic conditions could
precipitate significant reductions in corporate spending for telecommunications
infrastructure, which could result in delays or cancellations of orders for the
Company's products. The Company's expense levels are relatively fixed and are
based, in significant part, on expectations of future revenues. Consequently, if
revenue levels are below expectations, expense levels could be
disproportionately high as a percentage of revenues, and the Company's business,
financial condition and results of operations would be materially adversely
affected. The Company has historically operated with little backlog because its
products are generally shipped within 60 days of acceptance of an order by the
Company. As a result, revenues in any quarter are substantially dependent on
orders booked and shipped in that quarter and on sales by the Company's
customers to end users. See "--Concentration of Customers" and "Business--
Customers."
The Company has experienced significant fluctuations in revenues, expenses
and results from operations from quarter to quarter, and such fluctuations are
likely to continue. The Company typically receives more product orders and
generates greater revenues in the fourth quarter. During the last several years,
revenues in the first quarter have typically been lower than those recorded in
the preceding fourth quarter. The Company believes that this concentration of
order placements in specific quarterly periods is due to customer's' buying
patterns and budgeting cycles. A significant portion of the Company's revenues
have been generated from a limited number of customers and it is difficult to
predict the timing of future orders and shipments to these and other customers.
The Company anticipates that its results of operations in any given period will
continue to depend to a significant extent upon sales to a small number of
customers. See "--Concentration of Customers" and "Business--Customers."
The Company also believes that the purchase of its products generally
involves a significant commitment of a customer's capital resources. Therefore,
any downturn in any customer's business could have a material adverse effect on
the Company's revenues, business, financial condition and quarterly results of
operations. In addition, the Company historically has recognized a large portion
of its revenues from sales booked and shipped in the last month of a quarter
such that the magnitude of quarterly fluctuations may not become evident until
late in, or at the end of, a particular
20
quarter. Because a number of the Company's individual orders are for significant
amounts, the failure to ship a significant order in a particular quarter could
materially adversely affect revenues and results of operations for such quarter.
To the extent that significant sales occur earlier than expected, results of
operations for subsequent quarters may be materially adversely affected. Due to
these and other factors, the Company's quarterly revenues, expenses and results
of operations could vary significantly in the future, and period-to-period
comparisons should not be relied upon as indications of future performance.
There can be no assurance that the Company will be able to increase its revenues
in future periods or be able to sustain its level of revenues or its rate of
revenue growth on a quarterly or annual basis. See "--Length of Sales Cycle" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Due to all of the foregoing factors, it is possible that in some future
quarter, the Company's results of operations will be below the expectations of
public market analysts and investors. In such event, the market price of the
Company's Common Stock would likely be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Dependence on Relationships with Application Developers, OEMs and Systems
Integrators. The Company sells substantially all of its products to, and
maintains strategic relationships with, application developers, original
equipment manufacturers ("OEMs") and systems integrators which incorporate the
Company's products into their service and product offerings. As a result, sales
of the Company's products are dependent upon the continued market acceptance of
the service and product offerings of the Company's customers. Although the
Company maintains contractual relationships with a substantial number of its
customers, such contracts do not provide for minimum purchase requirements, nor
do they contain provisions requiring the exclusive purchase of the Company's
products. The development of an application or service for the
telecommunications market can involve a substantial amount of time and expense.
The delay or failure of a customer's application development program
incorporating the Company's products could delay or prevent expected sales of
the Company's products. The inability or cessation of customers to integrate the
Company's products into their service and product offerings, product development
delays by application developers and other customers, lack of market acceptance
of the service and product offerings of the Company's customers or a customer's
decision to market products manufactured by a competitor of the Company, or the
manufacture of such products themselves, would have a material adverse effect on
the Company's business, financial condition and results of operations.
Additionally, selling through indirect channels may limit the Company's
information concerning the volume of products sold by the Company's customers to
end users and the Company's contact with its end users. As a result, the
Company's ability to forecast revenues accurately (notwithstanding the forecasts
of its customers), evaluate end-user satisfaction and recognize emerging end-
user requirements may be hindered. See "Business--Sales and Marketing."
Length of Sales Cycle. The time between the date of initial contact with a
potential customer and large-scale commercialization of a new customer
application or system based on the Company's products is often lengthy,
typically ranging from 12 to 24 months or more, and is subject to delays over
which the Company has little or no control, including customers' budgetary
constraints, customers' internal acceptance reviews, the success and continued
internal support of customers' own development efforts, and the possibility of
cancellation of projects by customers. Although the Company attempts to develop
its products with the goal of shortening the time to market of its customers'
products, the timing of the commercialization of a new customer application or
service based on the Company's products is primarily dependent on the success
and timing of a customer's own internal development program. Delays can also be
caused by late deliveries by other vendors, changes in implementation priorities
and slower than anticipated growth in demand for the services that the Company's
products support. A delay in, or cancellation of, the sale of the Company's
products could have a material adverse effect on the Company's business,
financial condition and results of operations and cause the Company's results of
operations to vary significantly from quarter to quarter. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Concentration of Customers. Approximately 40.6%, 36.7% and 26.0% of the
Company's revenues in 1995, 1996 and 1997, respectively, were derived from sales
to Comverse Network Systems (formerly Boston Technology, Inc.), approximately
10.2% of the Company's revenues in 1997 were derived from sales to QUALCOMM
Incorporated and approximately 11.4% of the Company's revenues in 1995 were
derived from sales to Ericsson Messaging Systems, Inc.
21
In 1995, 1996 and 1997, the Company's five largest customers accounted for
approximately 70.1%, 57.1% and 50.9%, respectively, of the Company's revenues.
Although the Company's largest customers have varied from period to period, the
Company anticipates that its results of operations in any given period will
continue to depend to a significant extent upon sales to a small number of
customers. None of the Company's customers has entered into a long-term supply
agreement requiring any of them to purchase a minimum amount of product from the
Company. There can be no assurance that the Company's principal customers will
continue to purchase product from the Company at current levels, if at all, or
that the Company will be able to replace such purchases with sales to other
customers. In January 1998, Boston Technology, Inc. merged with Comverse
Technologies, Inc. In September 1997, Octel Communications Corporation, one of
the Company's five largest customers in 1996 and 1997, was acquired by Lucent
Technologies Inc. The Company cannot estimate the potential impact on its
business of these two recent transactions. The loss of one or more major
customers could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business--
Customers."
Evolving Market For Telecommunications Services. The Company's future
success will depend on continued growth in the market for telecommunications
services. The global telecommunications marketplace is evolving and it is
difficult to predict its potential size or future growth rate. There can be no
assurance that deregulation and continued improvements and expansions of
infrastructure will continue to cause this market to grow or that increased
regulation will not present barriers to the sales of existing or future
products. There can also be no assurance that telecommunications applications
and infrastructure needs will not emerge for which the Company's products are
not designed. If this market fails to grow or grows more slowly or in a
different direction than the Company currently anticipates, the Company's
business, financial condition and results of operations could be materially
adversely affected. See "Business--Industry Background."
Concentrated Product Family. The Company currently derives substantially
all of its revenues from its family of open, programmable switching platforms
and expects that this concentration will continue in the foreseeable future. As
a result, any decrease in the overall level of sales of, or the prices for,
open, programmable switching platforms due to product enhancements,
introductions or announcements by the Company's competitors, a decline in the
demand for open, programmable switches, product obsolescence, price competition,
technological change or any other reason could have a material adverse effect on
the Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Risk of New Product Introductions. The Company intends to continue to
invest in product and technology development, including increasing port capacity
and performance, the development of additional related software applications and
tools, the improvement of third-party application integration, and the continued
provision of updated product features and enhancements. There can be no
assurance that the Company will not experience difficulties that could delay or
prevent the successful development, introduction or marketing of such new
products and enhancements, or that its new products and enhancements will
adequately meet the requirements of the marketplace and achieve market
acceptance. Announcements of currently planned or other new product offerings by
the Company or its competitors may cause customers to defer or cancel the
purchase of existing Company products. The Company's inability to develop on a
timely basis new products or enhancements to existing products, or the failure
of such new products or enhancements to achieve market acceptance, could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "--Rapid Technological Change," "Business--Products
and Technology" and "Business--Research and Product Development."
The development of new, technologically advanced products is a complex and
uncertain process requiring the accurate anticipation of technological and
market trends. The introduction of new or enhanced products also requires the
Company to manage the transition from older products in order to minimize
disruption in customer ordering patterns, avoid excessive levels of older
product inventories and ensure that adequate supplies of new products can be
delivered to meet anticipated customer demand. There can be no assurance that
the Company will successfully develop, introduce or manage the transition to new
products. Furthermore, products such as those offered by the Company may contain
undetected or unresolved errors when they are first introduced or as new
versions are released. There can be no assurance that despite extensive testing
by the Company, errors will not be found in new products or upgrades after
commencement of commercial shipments, resulting in delays in or loss of market
acceptance and sales, diversion of
22
development resources, injury to the Company's reputation or increased service
and warranty costs, any of which could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business--Research and Product Development."
Rapid Technological Change. The telecommunications equipment market is
subject to rapid technological change, evolving industry standards and frequent
new product introductions and enhancements that may render existing products
obsolete. As a result, the Company's position in this market could erode rapidly
due to unforeseen changes in product features and functions of competing
products. The Company's growth and future results of operations will depend in
part on its ability to respond to these changes by enhancing its existing
products and developing and introducing, on a timely and cost-effective basis,
new products and features to meet or exceed technological advances in the
marketplace. The failure of the Company to respond to rapidly changing
technologies could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business--Industry
Background" and "Business--Research and Product Development."
Management of Growth and Hiring of Additional Personnel. The Company has
experienced growth in revenues and expansion of its operations which have placed
significant demands on the Company's management, engineering staff and
facilities. The Company has recently hired additional engineering, marketing,
accounting and finance personnel, including its Vice President of Research and
Development within the last 12 months. The Company is also implementing
additional financial and management procedures which the Company believes will
address increasing demands on resources. However, the Company believes that
further improvements in management and operational controls are needed, and will
continue to be needed, to manage any future growth. Continued growth will also
require the Company to hire more engineering, selling and marketing and
administrative personnel, expand customer support capabilities, expand
management information systems and improve its inventory management practices.
The Company has at times experienced, and continues to experience, difficulty in
recruiting qualified personnel. Recruiting qualified personnel is an intensely
competitive and time-consuming process. There can be no assurance that the
Company will be able to attract and retain the necessary personnel to accomplish
its growth strategies or that it will not experience constraints that will
adversely affect its ability to satisfy customer demand in a timely fashion or
to support satisfactorily its customers and operations. If the Company's
management is unable to manage growth effectively, the Company's business,
financial condition and results of operations could be materially adversely
affected. See "Business--Employees."
While the Company believes its current and planned facilities are adequate
to meet its needs through the next 12 months, future growth may require the
Company to obtain additional or alternative facilities. Due to the limited
supply of suitable additional or alternative office and manufacturing space in
the Cape Cod, Massachusetts area, there can be no assurance that such space can
be leased or acquired without substantial required renovations. Relocation of
any segment of the Company's operations may disrupt business and have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, the local permitting and variance procedures for the
renovation of buildings or new construction in the Cape Cod area is more onerous
than found in metropolitan areas. Accordingly, there can be no assurance that
the Company will not be required in the future to devote significant resources
to the permitting and renovation of additional facilities or in relocating some
or all of the Company's facilities. See "Item 2--Properties."
Dependence on Key Personnel. The Company's success depends to a
significant degree upon the continued contributions of its President, Chief
Executive Officer and principal stockholder, Robert P. Madonna, and its key
management, engineering, selling and marketing and manufacturing personnel, many
of whom would be difficult to replace. The Company does not have employment
contracts with its key personnel. The loss of the services of any key personnel,
the inability to attract or retain qualified personnel in the future or delays
in hiring required personnel, particularly software engineers, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Highly Competitive Market. The market for telecommunications products is
highly competitive and subject to rapid technological change. The Company
competes or may compete directly or indirectly with the following categories of
companies: (i) other manufacturers of programmable switches such as Summa Four,
Inc., Redcom Laboratories, Inc. and Harris Corporation; (ii) large, well-
established switch and telecommunications equipment manufacturers such as
23
Alcatel Alsthom Compagnie Generale d'Electricite SA, DSC Communications
Corporation, Lucent Technologies Inc., Northern Telecom Limited, Siemens AG and
Telefonaktiebolaget LM Ericsson; and (iii) to a lesser degree, systems
integrators and application developers whose switches are based on PC card-level
products manufactured by companies such as Aculab Inc., Dialogic Corporation and
Natural MicroSystems Corporation. In addition, several smaller companies have
begun to manufacture programmable switching platforms. Due to the rapidly
evolving markets in which the Company competes, additional competitors with
significant market presence and financial resources, including large
telecommunications equipment manufacturers and computer hardware and software
companies, may enter those markets, thereby further intensifying competition.
Additionally, there can be no assurance that one or more of the Company's
application developers will not begin to develop or market products in
competition with the Company. Increased competition could result in price
reductions and loss of market share which would materially adversely affect the
Company's business, financial condition and results of operations. Many of the
Company's current and potential competitors have significantly greater
financial, selling and marketing, technical, manufacturing and other resources
than the Company. Some of the Company's competitors currently offer financing
alternatives to their customers, a service that the Company does not provide.
Moreover, the Company's competitors may also foresee the course of market
developments more accurately than the Company. Although the Company believes it
has certain technological and other advantages over its competitors, realizing
and maintaining such advantages will require a continued high level of
investment by the Company in research and product development, marketing and
customer service and support. There can be no assurance that the Company will
have sufficient resources to continue to make such investments or that the
Company will be able to make the technological advances necessary to compete
successfully with its existing competitors or with new competitors. See
"Business--Competition."
Dependence on Single and Sole Source Suppliers. The Company purchases many
critical components from single or sole source vendors. The inability to develop
alternative sources for these components or to obtain sufficient quantities of
these components could result in delays or reductions in product shipments which
could materially adversely affect the Company's business, financial condition
and results of operations. In the event of a reduction or interruption of
supply, a significant amount of time, in some cases as much as three to four
months, could be required before the Company would begin receiving adequate
supplies from such alternative suppliers. Further, in such event, the Company's
business, financial condition and results of operations would be materially
adversely affected. In addition, the manufacture of certain of these single or
sole source components is extremely complex, and the Company's reliance on the
suppliers of these components exposes the Company to potential production
difficulties and quality variations, which could negatively impact cost and
timely delivery of the Company's products. Certain components are available from
only one supplier, for which there is no substitute at this time. If supply of
these components should cease, the Company would be required to redesign its
products. No assurance can be given that supply problems will not occur or, if
such problems do occur, that satisfactory solutions would be available. The
Company does not have long-term contracts with its suppliers and there can be no
assurance that these suppliers will continue to be able to produce these
components or to meet the Company's requirements. Any significant interruption
in the supply, or degradation in the quality, of any such component could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Business--Manufacturing."
Although the Company generally requires its customers to submit quarterly
forecasts of their needs, the Company's customers frequently require rapid
delivery after placement of a purchase order. Because the Company does not
maintain significant component inventories, a delay in shipment by a supplier
could lead to lost sales. Lead times for materials and components may vary
significantly and depend on factors such as specific supplier performance,
contract terms and general market demand for components. If orders vary from
forecasts, the Company may experience excess or inadequate inventory of certain
materials and components. While the Company has not experienced shortages and
allocations of these components to date, any shortages in the future, including
those occasioned by increased sales, could result in delays in fulfillment of
customer orders. Such delays, shortages and allocations could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Business--Manufacturing."
Dependence on Third-Party Manufacturers. The Company relies on a limited
number of independent manufacturers, some of which are small, privately-held
companies, to provide certain components and assemblies made to the Company's
specifications. These manufacturers substantially complete production of the
Company's products, which are then shipped to the Company for final assembly and
quality control. In the event that any of the Company's subcontractors were to
experience financial, operational, production or quality assurance difficulties
or a catastrophic
24
event that resulted in a reduction or interruption in supply to the Company, the
Company's business, financial condition and results of operations would be
materially adversely affected until the Company was able to establish sufficient
manufacturing capabilities from alternative sources. There can be no assurance
that alternative manufacturing sources will be able to meet the Company's future
requirements or that existing or alternative sources will continue to be
available to the Company at favorable prices. See "Business--Manufacturing."
Compliance with Regulations and Evolving Industry Standards. The market
for the Company's products is characterized by the need to meet a significant
number of communications regulations and standards, some of which are evolving
as new technologies are deployed. In the United States, the Company's products
must comply with various regulations including those promulgated by the Federal
Communications Commission and standards established by Underwriters Laboratories
and Bell Communications Research. Furthermore, there are regulations and
standards imposed by various foreign countries where the Company's products are
installed. The failure of the Company's products to comply, or delays in
compliance, with the various existing and evolving industry regulations and
standards could delay the introduction of the Company's products. Moreover, the
enactment by federal, state or foreign governments of new laws or regulations,
changes in the interpretation of existing laws or regulations or a reversal of
the trend toward deregulation in the telecommunications industry could
materially adversely affect the Company's customers, and thereby materially
adversely affect the Company's business, financial condition and results of
operations. See "Business--Industry Background."
Dependence on Proprietary Rights. The Company's success and its ability to
compete is dependent, in part, upon its proprietary rights. The Company relies
primarily on a combination of patent, copyright, trademark and trade secret
laws, as well as confidentiality procedures and contractual restrictions to
establish and protect its proprietary rights. There can be no assurance that
such measures will be adequate to protect the Company's proprietary rights.
Further, the Company may be subject to additional risks as it enters into
transactions in countries where intellectual property laws are not well
developed or are difficult to enforce. Legal protections of the Company's
proprietary rights may be ineffective in such countries. Litigation to defend
and enforce the Company's intellectual property rights could result in
substantial costs and diversion of resources and could have a material adverse
effect on the Company's business, financial condition and results of operations,
regardless of the final outcome of such litigation. Despite the Company's
efforts to safeguard and maintain its proprietary rights both in the United
States and abroad, there can be no assurance that the Company will be successful
in doing so or that the steps taken by the Company in this regard will be
adequate to deter misappropriation or independent third-party development of the
Company's technology or to prevent an unauthorized third party from copying or
otherwise obtaining and using the Company's products or technology. There also
can be no assurance that others will not independently develop similar
technologies or duplicate any technology developed by the Company. Any such
events could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company has entered into agreements with a small number of its
customers requiring the Company to deposit its source code and, on occasion,
manufacturing blueprints, tooling diagrams and production specifications, in
escrow with a third party. These escrow agreements typically provide that these
customers have a non-exclusive right to use such code and other materials in the
event that there is a bankruptcy proceeding by or against the Company, if the
Company ceases to conduct business or if the Company defaults on its support
obligations. The use of such agreements may increase the likelihood of
misappropriation by third parties.
As the number of entrants to the Company's markets increases and the
functionality of the Company's products increases and overlaps with the products
of other companies, the Company may become subject to claims of infringement or
misappropriation of the intellectual property rights of others. In its
distribution agreements, the Company agrees to indemnify its customers for any
expenses or liabilities resulting from claimed infringements of patents,
trademarks or copyrights of third parties. In certain limited instances, the
amount of such indemnities may be greater than the revenues the Company may have
received from the customer. There can be no assurance that third parties will
not assert infringement or misappropriation claims against the Company in the
future with respect to current or future products. Any claims or litigation,
with or without merit, could be time-consuming, result in costly litigation,
cause product shipment delays or require the Company to enter into royalty or
licensing arrangements. Such royalty or licensing arrangements, if required, may
not be available on terms acceptable to the Company, if at all, which could have
a material adverse effect on the Company's business, financial condition and
results of operations. In addition, the
25
Company changed its name from Excel Inc. to Excel Switching Corporation in
September 1997. Searches performed on the term Excel have revealed several
registrations and numerous uses of that term, and terms substantially similar to
it, alone and in combination with other terms and designs. Accordingly, there
can be no assurance that third parties will not assert trademark infringement
claims relating to the name Excel in the future. See "Business--Intellectual
Property."
Risks Associated with International Sales. In 1996 and 1997, sales to
customers located outside of the United States accounted for less than 4% and
8%, respectively, of the Company's revenues in each such period. However, the
Company sells its products to application developers, OEMs and systems
integrators located within the United States which market products and services
based on the Company's products worldwide. The Company intends to expand its
operations outside the United States and enter additional international markets,
which will require significant management attention and financial resources.
International sales are subject to a variety of risks, including difficulties in
establishing and managing international distribution channels, in servicing and
supporting products sold outside the United States and in translating products
and related materials into foreign languages. International operations are also
subject to difficulties in collecting accounts receivable, staffing and managing
personnel and enforcing intellectual property rights. Other factors that can
adversely affect international operations include fluctuations in the value of
foreign currencies and currency exchange rates, changes in import/export duties
and quotas, introduction of tariff or non-tariff barriers and economic or
political changes in international markets. Any inability to obtain foreign
regulatory approvals on a timely basis could have a material adverse effect on
the Company's business, financial condition and results of operations. If the
Company's international sales increase, its revenues may also be affected to a
greater extent by seasonal fluctuations resulting from lower levels of sales
which typically occur during the summer months in Europe and other parts of the
world. There can be no assurance that these factors will not have a material
adverse effect on the Company's future international sales and, consequently, on
the Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Risks Relating to Potential Acquisitions. The Company may, from time to
time, pursue the acquisition of other companies, assets, products and
technologies although the Company has no present commitments or agreements with
respect to any such acquisitions. Acquisitions involve a number of operating
risks that could materially adversely affect the Company's results of
operations, including the diversion of management's attention to assimilate the
operations, products and personnel of the acquired companies, the amortization
of acquired intangible assets, and the potential loss of key employees of the
acquired companies. Furthermore, acquisitions may involve businesses in which
the Company lacks experience. Because management has limited experience in
acquisitions and the Company has no experience in integrating acquired companies
or technologies into its operations, there can be no assurance that the Company
will be able to manage one or more acquisitions successfully, or that the
Company will be able to integrate the operations, products or personnel gained
through any such acquisitions without a material adverse effect on the Company's
business, financial condition and results of operations.
Control by Principal Stockholder. Robert P. Madonna, the Company's
President, Chief Executive Officer, Chairman of the Board and principal
stockholder, beneficially owns approximately 83.6% of the outstanding shares of
Common Stock of the Company. As a result, Mr. Madonna has the ability to elect
the Company's directors and to determine the outcome of corporate actions
requiring stockholder approval, irrespective of how other stockholders of the
Company may vote. This concentration of ownership may have the effect of
delaying or preventing a change in control of the Company which may be favored
by a majority of the remaining stockholders, or cause a change of control not
favored by the Company's other stockholders.
Shares Eligible for Future Sale. Sales of substantial amounts of shares of
the Company's Common Stock 180 days after the Company's initial public offering
on November 4, 1997 could adversely affect the market price of the Common Stock.
Upon expiration of lock-up agreements with the Underwriters on May 4, 1998,
approximately 27,918,400 additional shares of Common Stock will be available for
sale in the public market, subject to the provisions of Rule 144 under the
Securities Act. At December 27, 1997, approximately 7,179,990 shares of Common
Stock were issued or issuable pursuant to vested options under the Company's
stock plans, of which approximately 107,700 shares are not subject to lock-up
agreements with the Underwriters and were eligible for sale in the public market
in accordance with Rule 701 under the Securities Act beginning February 4, 1998.
The Company intends to file one or more registration statements on Form S-8
under the Securities Act on or about May 4, 1998 to register up to 11,275,840
shares of Common Stock subject to outstanding stock options granted pursuant to
the Company's Stock Option Program as of
26
December 27, 1997, of which options to purchase 7,149,990 shares of Common Stock
were vested as of December 27, 1997 and 3,625,000 shares of Common Stock
issuable pursuant to the Company's 1997 stock plans. Such registration
statements are expected to become effective upon filing. At such time,
approximately 7,327,050 shares of Common Stock issuable upon the exercise of
options granted as of December 27, 1997 and covered by these registration
statements will be vested and eligible for sale in the public market upon the
exercise of underlying options to the extent not previously sold pursuant to
Rule 701.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements and Supplementary Data of the Company
are listed under Part IV, Item 14, in this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 is hereby incorporated by
reference to the information under the headings "Elections of Directors" and
"Executive Officers" in the Company's definitive proxy statement to be filed by
the Company within 120 days after the close of its fiscal year ended December
27, 1997.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is hereby incorporated by
reference to the information under the heading "Executive Compensation" and
"Options and Stock Plans" in the Company's definitive proxy statement to be
filed by the Company within 120 days after the close of its fiscal year ended
December 27, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is hereby incorporated by
reference to the information under the heading "Security Ownership of Certain
Beneficial Owners and Management" in the definitive proxy statement to be filed
by the Company within 120 days after the close of its fiscal year ended December
27, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is hereby incorporated by
reference to the information under the heading "Certain Transactions", if any,
in the Company's definitive proxy statement to be filed by the Company within
120 days after the close of its fiscal year ended December 27, 1997.
27
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report: Page
----
(1) Financial Statements
Report of Independent Public Accountants F-1
Consolidated Balance Sheets as of December 28, 1996 and December 27, 1997 F-2
Consolidated Statements of Income for the Fiscal Years 1995, 1996 and 1997 F-3
Consolidated Statements of Stockholders' Equity for the Fiscal Years 1995,
1996 and 1997 F-4
Consolidated Statements of Cash Flows for the Fiscal Years 1995, 1996 and 1997 F-5
Notes to Consolidated Financial Statements F-6
(2) Financial Statement Schedule
Report of Independent Public Accountants
Valuation and qualifying accounts Schedule II
(3) Listing of Exhibits
28
EXHIBIT NO. REFERENCE
3.1 Restated Articles of Organization of the Company. A**
3.2 Restated By-laws of the Company. A**
4.1 Specimen certificate representing the Common Stock. A**
10.1 1997 Stock Option Plan. A**
10.2 1997 Non-Employee Director Stock Option Plan. A**
10.3 1997 Employee Stock Purchase Plan. A**
10.4 Form of Stock Option Agreement of the Company used under Stock Option Program. A**
10.5 Lease dated as of July 27, 1995 between the Company and Independence Park, Inc., A**
as amended
10.6 Purchase and Resale Agreement dated as of May 27, 1994 between the Company and A**
Boston Technology, Inc.
10.7 Credit Agreement and Promissory Note dated as of December 21, 1995 between the Filed
Company and The First National Bank of Boston, as amended. herewith
10.8 Mortgage and Security Agreement and Real Estate Promissory Note dated April 21, A**
1995 between the Company and Cape Cod Bank and Trust Company.
10.9 Loan Agreement, Real Estate Promissory Note and Security Agreement dated as of A**
June 30, 1997 between the Company and Cape Cod Bank and Trust Company.
21.1 Subsidiaries of the Company Filed
herewith
27 Financial Data Schedule Filed
herewith
- --------------------------
A Incorporated by reference to the Company's registration statement on Form
S-1 (Registration No. 333-35791). The number set forth herein is the number
of the Exhibit in said registration statement.
** In accordance with Rule 12b-32 under the Securities Exchange Act of 1934,
as amended, reference is made to the documents previously filed with the
Securities and Exchange Commission, which documents are hereby incorporated
by reference.
(b) REPORTS ON FORM 8-K
-------------------
The Company did not file any current reports on Form 8-K during the quarter
ended December 27, 1997.
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
EXCEL SWITCHING CORPORATION
Dated: March 25, 1998 By: /s/ Robert P. Madonna
----------------------
Robert P. Madonna
President, Chief Executive Officer &
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.
Signature Title Date
/s/ Robert P. Madonna Director, President, Chief Executive Officer and March 25, 1998
- ---------------------- Chairman of the Board (Principal Executive Officer)
Robert P. Madonna
/s/ Stephen S. Galliker Vice President, Finance and Administration March 25, 1998
- ------------------------ and Chief Financial Officer (Principal Financial
Stephen S. Galliker and Accounting Officer)
/s/ Christopher Stavros Director, Vice President, General Counsel March 25, 1998
- ---------------------- and Clerk
Christopher Stavros
/s/ Edward L. Breslow Director March 25, 1998
- ---------------------
Edward L. Breslow
/s/ John Loughlin Director March 25, 1998
- -----------------
John Loughlin
30
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Excel Switching Corporation:
We have audited the accompanying consolidated balance sheets of Excel Switching
Corporation (a Massachusetts corporation formerly known as Excel Inc.) and
subsidiaries as of December 28, 1996 and December 27, 1997, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 27, 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Excel Switching
Corporation and subsidiaries as of December 28, 1996 and December 27, 1997, and
the results of their operations and their cash flows for each of the three years
in the period ended December 27, 1997, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 21, 1998
F-1
EXCEL SWITCHING CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
ASSETS
December 28, December 27,
1996 1997
CURRENT ASSETS:
Cash and cash equivalents $ 4,069 $ 47,968
Marketable securities - 66,929
Accounts receivable, net of reserves of $979
and $1,350 in 1996 and 1997, respectively 10,329 12,843
Inventories 7,358 4,740
Prepaid taxes - 122
Deferred tax asset 3,761 5,626
Other current assets 292 1,298
--------- ----------
Total current assets 25,809 139,526
--------- ----------
PROPERTY AND EQUIPMENT:
Test equipment 3,400 4,015
Buildings 3,925 3,991
Office equipment, furniture and fixtures 1,836 3,460
Land 576 576
Building improvements 493 523
Assets under capital lease 489 489
Construction in progress (Note 7) - 1,129
--------- ----------
10,719 14,183
Less--Accumulated depreciation and amortization 1,756 4,015
---------- -----------
8,963 10,168
--------- ----------
$ 34,772 $ 149,694
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 499 $ 4,213
Accounts payable 1,896 4,177
Accrued expenses 5,807 11,156
Accrued income taxes 2,647 3,606
--------- ---------
Total current liabilities 10,849 23,152
--------- ---------
DEFERRED INCOME TAXES - 519
--------- ---------
LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 3,837 108
--------- ---------
COMMITMENTS (Note 7)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
Authorized--10,000,000 shares; no shares
issued and outstanding - -
Common stock, $.01 par value-
Authorized--100,000,000 shares
Issued and outstanding--28,089,600 and
32,592,000 shares at December 28, 1996 281 326
and December 27, 1997, respectively
Additional paid-in capital 647 88,134
Deferred compensation (192) (491)
Unrealized loss on investments - (20)
Retained earnings 19,350 37,966
--------- ---------
Total stockholders' equity 20,086 125,915
--------- ---------
$ 34,772 $ 149,694
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
EXCEL SWITCHING CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
-------------------Year Ended--------------------
December 31, December 28, December 27,
1995 1996 1997
REVENUES $ 36,161 $ 62,050 $ 88,727
COST OF REVENUES 12,100 24,312 26,631
---------- ---------- ----------
Gross profit 24,061 37,738 62,096
---------- ---------- ----------
OPERATING EXPENSES:
Engineering, research and development 8,117 11,121 13,260
Selling and marketing 2,923 6,621 11,486
General and administrative 4,238 6,426 7,949
---------- ---------- ----------
Total operating expenses 15,278 24,168 32,695
---------- ---------- ----------
Income from operations 8,783 13,570 29,401
OTHER INCOME (EXPENSE):
Interest income and other expense, net 110 111 1,764
Interest expense (72) (495) (372)
---------- ---------- ----------
Total other income (expense) 38 (384) 1,392
---------- ---------- ----------
Income before provision for income taxes 8,821 13,186 30,793
PROVISION FOR INCOME TAXES 3,410 5,285 12,177
---------- ---------- ----------
NET INCOME $ 5,411 $ 7,901 $ 18,616
========== ========== ==========
BASIC EARNINGS PER SHARE $ .19 $ .28 $ .65
========== ========== ==========
DILUTED EARNINGS PER SHARE $ .17 $ .24 $ .54
========== ========== ==========
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 27,962 28,090 28,756
========== ========== ==========
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 31,822 32,697 34,361
========== ========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
EXCEL SWITCHING CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share data)
Common Stock Additional Deferred Unrealized Retained
Number of $.01 Par Paid-in Compensation Loss on Earnings Total
Shares Value Capital Investments
BALANCE, DECEMBER 31, 1994 27,945,600 $ 280 $ 251 $ (99) $ -- $ 6,039 $ 6,471
Compensation expense associated with the grant of -- -- 432 (189) -- -- 243
stock options
Forfeiture of stock options with deferred -- -- (16) 16 -- -- --
compensation
Exercise of stock options 144,000 1 -- -- -- (1) --
Net income -- -- -- -- -- 5,411 5,411
---------- ----- -------- ------ ----- -------- ---------
BALANCE, DECEMBER 31, 1995 28,089,600 281 667 (272) -- 11,449 12,125
Compensation expense associated with the grant of -- -- -- 73 -- -- 73
stock options
Forfeiture of stock options with deferred -- -- (20) 7 -- -- (13)
compensation
Net income -- -- -- -- -- 7,901 7,901
---------- ----- -------- ------ ----- -------- ---------
BALANCE, DECEMBER 28, 1996 28,089,600 281 647 (192) -- 19,350 20,086
Compensation expense associated with the grant of -- -- 424 (299) -- -- 125
stock options
Exercise of stock options 2,400 -- 2 -- -- -- 2
Proceeds of initial public offering of common 4,500,000 45 87,061 -- -- -- 87,106
stock, net of approximately $7,394,000 in
issuance costs
Unrealized loss on investments -- -- -- -- (20) -- (20)
Net income -- -- -- -- -- 18,616 18,616
---------- ----- -------- ------ ----- -------- ---------
BALANCE, DECEMBER 27, 1997 32,592,000 $ 326 $ 88,134 $ (491) $ (20) $ 37,966 $ 125,915
========== ===== ======== ====== ===== ======== =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
EXCEL SWITCHING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
-------------------Year Ended---------------------
December 31, December 28, December 27,
1995 1996 1997
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 5,411 $ 7,901 $ 18,616
Adjustments to reconcile net income to net cash provided by
operating activities-
Depreciation and amortization 560 1,166 2,259
Loss on disposal of property and equipment 95 - -
Unrealized loss on investments - - 20
Deferred income taxes (487) (3,417) (1,346)
Compensation expense associated with the grant of stock 243 60 125
options, net of forfeitures
Changes in assets and liabilities-
Accounts receivable (3,928) (2,020) (2,514)
Inventories (3,760) (409) 2,618
Prepaid taxes (401) 401 (122)
Other current assets (123) (132) (1,006)
Accounts payable 2,419 (2,473) 2,281
Accrued expenses 1,198 3,877 5,349
Accrued income taxes (55) 2,350 959
--------- --------- ---------
Net cash provided by operating activities 1,172 7,304 27,239
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (4,096) (4,601) (3,464)
Proceeds from sale of property and equipment - 548 -
Purchases of marketable securities, net - - (66,969)
--------- --------- ---------
Net cash used in investing activities (4,096) (4,053) (70,433)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term obligations 2,740 649 460
Payments on long-term obligations (53) (601) (475)
Proceeds from sale of common stock - - 87,106
Proceeds from the exercise of stock options - - 2
--------- --------- ---------
Net cash provided by financing activities 2,687 48 87,093
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (237) 3,299 43,899
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,007 770 4,069
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 770 $ 4,069 $ 47,968
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for-
Interest $ 119 $ 490 $ 377
========= ========= =========
Taxes $ 4,353 $ 5,951 $ 13,271
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
Acquisition of property and equipment under capital lease $ 1,112 $ 489 $ -
obligations ========= ========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
EXCEL SWITCHING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 27, 1997
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Excel Switching Corporation (the Company), formerly known as Excel Inc.,
was incorporated in Massachusetts in January 1988 and is a leading
provider of open switching platforms for telecommunications networks
worldwide. The Company develops, manufactures, markets and supports a
family of open, programmable, carrier-class switches that address the
complex enhanced services and wireless and wireline infrastructure needs
of network providers. The Company sells to a variety of customers in the
worldwide telecommunications market, including applications developers,
original equipment manufacturers (OEMs) and system integrators.
The accompanying consolidated financial statements reflect the
application of certain accounting policies as described below and
elsewhere in these notes to consolidated financial statements.
(a) Principles of Consolidation
These consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant
intercompany transactions have been eliminated.
(b) Change in Fiscal Year-End
During 1996, the Company elected to change its fiscal year-end
from December 31 to the last Saturday in December. In the
accompanying consolidated financial statements, 1995 refers to the
year ended December 31, 1995; 1996 refers to the year ended
December 28, 1996; and 1997 refers to the year ended December 27,
1997.
(c) Management 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.
The market for telecommunications equipment in which the company
operates can be characterized as rapidly changing due to several
factors including technological advancements, the introduction of
new products and services by the Company and its competitors, and
the increasing demands placed on equipment in worldwide
telecommunications networks. Significant assets and liabilities
with reported amounts based on estimates include accounts
receivable, inventory and accrued expenses for post sale support
costs, warranty costs and sales returns. While the Company
believes its estimates are adequate, actual results could differ
from those estimates.
F-6
EXCEL SWITCHING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 27, 1997
(Continued)
(d) Revenue Recognition
Revenue from product sales is recognized at the time of shipment
to the customer at which time transfer of ownership occurs. The
Company provides for anticipated product returns, post sale
support and warranty costs at the time of product shipment.
(e) Sources of Supply and Third-Party Manufacturing Relationships
Certain components used in the manufacture of the Company's
products are currently available only from single- or sole-source
suppliers. In addition, the Company relies on a limited number of
third parties to manufacture certain other components and
subassemblies. Shortages resulting from a change in arrangements
with these suppliers and manufacturers could cause delays in
manufacturing and product shipments and possible deferral or
cancellation of customer orders.
(f) Cash, Cash Equivalents and Marketable Securities
The Company accounts for investments in accordance with Statement
of Financial Accounting Standards (SFAS) No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Under this
standard, investments for which the Company has the positive
intent and ability to hold to maturity are reported at amortized
cost, which approximates fair market value, and are classified as
held-to-maturity. The Company did not classify any investments as
held-to-maturity at December 28, 1996 or December 27, 1997.
Investments purchased to be held for indefinite periods of time
and not intended at the time of purchase to be held-to-maturity
are classified as available-for-sale and reported at fair market
value. Unrealized losses on available-for-sale securities at
December 27, 1997 were approximately $20,000. The investments that
the Company has deemed available-for-sale include certificates of
deposit, commercial paper, bankers' acceptances and corporate,
state municipality and U.S. government debt securities. Cash
equivalents are highly liquid investments with original maturities
of three months or less. Marketable securities are highly liquid
investment grade securities with original maturities of greater
than three months. To date, the Company has not recorded any
realized gains or losses.
F-7
EXCEL SWITCHING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 27, 1997
(Continued)
Cash, cash equivalents and marketable securities consist of the
following (in thousands):
1996 1997
Cash and cash equivalents-
Cash $ 4,016 $ 1,655
Time deposits 53 1,459
Money markets - 9,791
Commercial paper - 32,071
Bankers' acceptance - 2,992
------- --------
Total cash and cash equivalents $ 4,069 $ 47,968
======= ========
Marketable securities-
Time deposits $ - $ 2,004
U.S. government and agency debt securities - 31,090
Municipality debt securities - 2,000
Commercial paper - 4,900
Corporate debt securities - 26,935
------- --------
Total marketable securities $ - $ 66,929
======= ========
The following table summarizes the remaining maturity of the Company's
investments in debt securities as of December 27, 1997 (in thousands):
One year or less $ 83,343
One to five years 14,647
Variable maturity 2,000
--------
$ 99,990
========
(g) Inventories
Inventories are valued at the lower of cost (first-in, first-out) or
market. Work-in-process and finished goods consist of materials, labor
and manufacturing overhead. Inventories at December 28, 1996 and
December 27, 1997 consist of the following (in thousands):
1996 1997
Raw materials $ 3,585 $ 396
Work-in-process 2,988 3,713
Finished goods 785 631
------- -------
$ 7,358 $ 4,740
======= =======
F-8
EXCEL SWITCHING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 27, 1997
(Continued)
(h) Depreciation and Amortization
The Company provides for depreciation and amortization using both
straight-line and accelerated methods by charges to operations in
amounts that allocate the cost of the assets over their estimated
useful lives as follows:
Estimated
Description Useful Lives
Test equipment 2-5 years
Buildings 40 years
Office equipment, furniture and fixtures 2-7 years
Building improvements 7-40 years
Assets under capital lease 3 years
(i) Research and Development and Software Development Costs
Research and development costs have been charged to operations as
incurred. Capitalization of computer software costs begin upon the
establishment of technological feasibility. Because the Company
believes its current process for developing software is essentially
completed concurrently with the establishment of technological
feasibility, no costs have been capitalized to date.
(j) Concentrations of Credit Risk
Financial instruments that subject the Company to significant
concentrations of credit risk consist primarily of cash, cash
equivalents, marketable securities and trade accounts receivable. The
Company's investments are in financial instruments of high quality.
Concentration of credit risk with respect to accounts receivable is
limited to customers to whom the Company makes significant sales. One
significant customer accounted for approximately 34% and 15% of
accounts receivable at December 28, 1996 and December 27, 1997,
respectively. Another significant customer accounted for approximately
18% of accounts receivable at December 27, 1997 (see Note 9). To
control credit risk, the Company performs regular credit evaluations of
its customers' financial condition and maintains allowances for
potential credit losses.
(k) Fair Value of Financial Instruments
The carrying amounts of the Company's cash and cash equivalents,
accounts receivable and accounts payable approximate fair value due to
the short-term nature of these instruments. The carrying amounts of
debt issued pursuant to agreements with banks approximate fair value
since the interest rates on these instruments fluctuate with market
interest rates.
F-9
EXCEL SWITCHING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 27, 1997
(Continued)
(l) Earnings per Share
In March 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 128, Earnings per Share. This statement established standards
for computing and presenting earnings per share and applies to entities
with publicly traded common stock or potential common stock. This
statement is effective for fiscal years ending after December 15, 1997.
In February 1998, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin (SAB) No. 98. This bulletin revises the SEC's
guidance for calculating earnings per share with respect to equity
security issuances before an initial public offering (IPO) and is
effective for fiscal years ending after December 15, 1997. The prior
years' earnings per share have been retroactively restated to reflect
the adoption of SFAS No. 128 and SAB No. 98.
Basic earnings per share was determined by dividing net income by the
weighted average common shares outstanding during the period. Diluted
earnings per share was determined by dividing net income by diluted
weighted average shares outstanding. Diluted weighted average shares
reflects the dilutive effect, if any, of both common equivalent shares
and nominal issuances. Common equivalent shares include common stock
options to the extent their effect is dilutive, based on the treasury
stock method. Nominal issuances arise when a registrant issues common
stock, options or warrants to purchase common stock or other
potentially dilutive instruments for nominal consideration, as defined
by SAB No. 98, in the periods preceding an IPO. During the period
preceding the Company's IPO, the Company did not have any nominal
issuances.
The calculations of basic and diluted weighted average shares
outstanding are as follows (in thousands):
1995 1996 1997
Basic weighted average common shares
outstanding 27,962 28,090 28,756
Weighted average common equivalent
shares 3,860 4,607 5,605
------ ------ ------
Diluted weighted average shares
outstanding 31,822 32,697 34,361
====== ====== ======
(m) New Accounting Standards
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 requires disclosure of all components of
comprehensive income on an annual and interim basis. Comprehensive
income is defined as the change in equity of a business enterprise
during a period from transactions and other events and circumstances
from nonowner sources. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997.
F-10
EXCEL SWITCHING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 27, 1997
(Continued)
In July 1997, the FASB issued SFAS No. 131, Disclosures About Segments
of an Enterprise and Related Information. SFAS No. 131, requires
certain financial and supplementary information to be disclosed on an
annual and interim basis for each reportable segment of an enterprise.
SFAS No. 131 is effective for fiscal years beginning after December 15,
1997. Unless impracticable, companies would be required to disclose
similar prior period information upon adoption.
(2) LONG-TERM OBLIGATIONS
Long-term obligations consist of the following at December 28, 1996 and
December 27, 1997 (in thousands):
1996 1997
Mortgage and Security Agreement $ 2,485 $ 2,386
Real Estate Promissory Note - 460
Promissory note payable to a bank 435 272
Capital lease obligation--building 997 926
Capital lease obligation--equipment 419 277
------- -------
4,336 4,321
Less--Current maturities 499 4,213
------- -------
$ 3,837 $ 108
======= =======
In January 1998, the Company repaid all outstanding obligations under the
Mortgage and Security Agreement, promissory note payable and the Real
Estate Promissory Note. Accordingly, all outstanding balances as of
December 27, 1997 have been reflected as current liabilities in the
accompanying December 27, 1997 consolidated balance sheet.
On April 21, 1995, the Company entered into a $2,600,000 Mortgage and
Security Agreement with a bank to finance the purchase of two buildings and
related land. The agreement required monthly principal and interest
payments through April 2010. Interest accrued at prime (8.5% at
December 27, 1997) plus .75%. The mortgage was collateralized by the two
buildings and related land, which have a carrying value of approximately
$3,100,000 at December 27, 1997. The Company was subject to certain
restrictive covenants under this agreement.
F-11
EXCEL SWITCHING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 27, 1997
(Continued)
In June 1997, the Company purchased property to be used for the
construction of an additional building. The purchase price of $575,000 and
the construction costs were to be financed, in part, by a $2,100,000 Real
Estate Promissory Note with a bank. In connection with the purchase, the
bank advanced $460,000 under this note. Borrowings under this note bore
interest at prime (8.5% at December 27, 1997) plus .25% and were secured by
the property and a certificate of deposit in the amount of $385,000.
During 1996, the Company entered into a promissory note with a bank for
$489,000, the proceeds of which were used to fund building improvements and
to retire a previous promissory note with the same bank in the original
amount of $300,000. Borrowings under this note required monthly principal
payments plus interest at prime (8.5% at December 27, 1997) plus 1% through
August 1999.
In 1995, the Company entered into a building lease that requires monthly
payments of approximately $13,000 through July 2000. This lease includes a
purchase option exercisable beginning in August 1998 for $875,000.
Management intends to exercise this option and, accordingly, has recorded
this lease as a capital lease obligation. The present value of the
remaining lease payments and the purchase price have been recognized as the
capital lease obligation using an effective rate of 8.3%.
During 1996, the Company entered into an agreement with a leasing company,
which provided for the sale and leaseback of certain equipment that had a
net book value of approximately $474,000. Proceeds to the Company in
connection with this sale were approximately $548,000. The resulting gain
has been deferred and is being recognized ratably over the lease term.
Under the terms of the agreement, the Company is required to make thirty-
six monthly installments of approximately $16,000. The present value of the
lease payments has been recognized as a capital lease obligation using an
effective rate of 9%.
Assuming the Company exercises its purchase option in 1998 with respect to
the 1995 building lease, future maturities of the remaining capital lease
obligations are as follows (in thousands):
1998 $ 1,167
1999 112
-------
1,279
Less--Amount representing interest 76
Total long-term obligations $ 1,203
=======
F-12
EXCEL SWITCHING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 27, 1997
(Continued)
(3) LINE-OF-CREDIT ARRANGEMENT
In December 1997, the Company's unsecured line-of-credit arrangement with a
bank was amended to provide up to $15,000,000 in financing. Borrowings
under this line bear interest at either the bank's base rate (8.5% at
December 27, 1997) or the Eurodollar rate (5.7% at December 27, 1997) plus
1.75%. The Company is required to maintain certain restrictive covenants
under this agreement. This agreement expires June 30, 1999. There were no
borrowings outstanding under this agreement at December 28, 1996 or
December 27, 1997.
(4) INCOME TAXES
The Company provides for income taxes under SFAS No. 109, Accounting for
Income Taxes. Under SFAS No. 109, a deferred tax asset or liability is
determined based on the difference between the financial statement and tax
bases of assets and liabilities, as measured by the enacted tax rates
expected to be in effect when the differences reverse.
The components of the provision for income taxes are as follows (in
thousands):
1995 1996 1997
Current-
Federal $ 3,054 $ 6,731 $11,249
State 843 1,971 2,274
------- ------- -------
3,897 8,702 13,523
------- ------- -------
Deferred (prepaid)-
Federal (363) (2,904) (1,036)
State (124) (513) (310)
------- ------- -------
(487) (3,417) (1,346)
------- ------- -------
Total provision $ 3,410 $ 5,285 $12,177
======= ======= =======
A reconciliation of the federal statutory rate to the Company's effective
tax rate is as follows:
1995 1996 1997
Income tax provision at federal statutory rate 34% 34% 35%
Increase (decrease) in tax resulting from-
State tax provision, net of federal benefit 6 6 5
Research and development tax credits (1) - (2)
Other - - 2
---- ---- ----
Effective tax rate 39% 40% 40%
==== ==== ====
F-13
EXCEL SWITCHING CORPORATION
Notes To Consolidated Financial Statements
December 27, 1997
(Continued)
The approximate income tax effect of each type of temporary difference
composing the net deferred tax asset at December 28, 1996 and December 27,
1997 is as follows (in thousands):
1996 1997
Difference in inventory accounting method $ (275) $ (778)
Nondeductible reserves 1,427 2,185
Nondeductible accruals 2,674 3,736
Depreciation and amortization 137 -
Other temporary differences (202) (36)
-------- --------
Net deferred tax asset $ 3,761 $ 5,107
======== ========
(5) STOCKHOLDERS' EQUITY
(a) Initial Public Offering
In November 1997, the Company completed an IPO of 4,500,000 shares of
common stock at a per share price of $21. The Company received proceeds
of approximately $87.1 million, net of underwriting discounts and
commissions and offering expenses of approximately $7.4 million.
(b) Common Stock
On September 16, 1997, the Company restated its Articles of
Organization to provide for authorized common stock of 100,000,000
shares, with a $.01 par value, 85,000,000 of which were designated as
voting shares and 15,000,000 of which were designated as nonvoting
shares. The accompanying consolidated financial statements have been
retroactively restated for this change. Upon the effective date of the
Registration Statement relating to the Company's IPO of common stock,
all authorized and outstanding shares of nonvoting common stock were
automatically converted, on a one-for-one basis, into shares of voting
common stock.
At December 27, 1997, there were 14,840,840 shares of common stock
reserved for future issuance under the Company's stock option plans.
(c) Preferred Stock
In September 1997, the Board of Directors and sole voting stockholder
authorized 10,000,000 shares of $.01 par value preferred stock. The
Board of Directors has the authority to issue such shares in one or
more series and to fix the relative rights and preferences without
further vote or action by the stockholders. Currently, the Board of
Directors has no plans to issue any shares of preferred stock.
F-14
EXCEL SWITCHING CORPORATION
Notes to Consolidated Financial Statements
(Continued)
(d) Stock Splits
On September 19, 1996, the Company declared a three-for-one split
of the shares of common stock. On September 16, 1997, the Company
declared a two-for-one split of the shares of common stock. All
share and per share amounts for all periods presented have been
adjusted to reflect these splits.
(6) STOCK OPTION PLANS
(a) Stock Option Program
The Company has granted nonqualified stock options to purchase
shares of its common stock at exercise prices generally determined
to be at fair market value by the Company's Board of Directors on
the date of grant. Options are generally exercisable within 10
years of the original date of grant and vest over a period of up
to five years from the date of grant. In some instances, options
have been granted at exercise prices below the fair market value
on the date of grant. The difference, if any, between the fair
market value of shares of the Company's nonvoting common stock, as
determined by the Company's Board of Directors, and the exercise
price of the option is recognized as compensation expense over the
vesting term. During 1995, 1996 and 1997, the Company recognized
net compensation expense of approximately $243,000, $60,000 and
$125,000, respectively. In November 1997, this program was
terminated. There are 11,215,840 options outstanding under this
program as of December 27, 1997.
(b) 1997 Stock Option Plan
In September 1997, the Company's Board of Directors and sole
voting stockholder adopted the 1997 Stock Option Plan (1997 Plan).
Under the terms of the 1997 Plan, incentive and nonqualified stock
options may be granted to employees and consultants to purchase an
aggregate of 3,000,000 shares of common stock. Subsequent to
December 27, 1997, approximately 108,900 options were been granted
under the 1997 Plan.
F-15
EXCEL SWITCHING CORPORATION
Notes to Consolidated Financial Statements
December 27, 1997
(Continued)
(c) Director Option Plan
The Company's Non-Employee Director Stock Option Plan (Director
Option Plan) was adopted by the Board of Directors and sole voting
stockholder in September 1997. The Director Option Plan provides
for the grant of options to purchase an aggregate 225,000 shares
of common stock to nonemployee directors of the Company. Each such
director will be granted an option to purchase 30,000 shares upon
election to the Board of Directors. In addition, each such
director will be automatically granted an option to purchase
15,000 shares in each of the two years following the date such
person becomes a director. These options will vest 1/3 on grant
date, 1/3 one year from grant date and 1/3 two years from grant
date. In November of 1997, three nonemployee directors were
elected and each received 30,000 options at an exercise price of
$21 per share.
(d) 1997 Employee Stock Purchase Plan
In September 1997, the Company's Board of Directors and sole
voting stockholder approved the 1997 Employee Stock Purchase Plan,
pursuant to which a maximum of 400,000 shares of common stock may
be issued to participating employees in semiannual grants at a
price equal to 85% of fair market value, as defined. No shares
have been issued under this plan.
(e) Stock Option Activity
Stock option activity under all plans for the three years in the
period ended December 27, 1997 is as follows:
Number of Weighted
Shares Average
Exercise
Price
Outstanding, December 31, 1994 6,639,840 $ 0.025
Granted 1,491,000 0.333
Exercised (144,000) 0.002
Forfeited (96,000) 0.002
----------- -------
Outstanding, December 31, 1995 7,890,840 0.084
Granted 1,997,500 4.250
Forfeited (30,000) 0.333
----------- -------
Outstanding, December 28, 1996 9,858,340 0.927
Granted 1,574,100 9.471
Exercised (2,400) 1.000
Forfeited (124,200) 4.035
----------- -------
Outstanding, December 27, 1997 11,305,840 $ 2.083
=========== =======
F-16
EXCEL SWITCHING CORPORATION
Notes to Consolidated Financial Statements
December 27, 1997
(Continued)
The following table summarizes information about stock options
outstanding at December 27, 1997:
Range of exercise prices Number Weighted Number Weighted
Outstanding Average Exercisable Average
Remaining Exercise
Contractual Price
Life
$ 0.002 5,469,840 6.1 5,355,840 $ 0.002
0.167 930,000 6.9 687,600 0.167
0.333 1,455,600 7.7 829,800 0.333
1.00- 2.33 321,600 8.5 60,000 2.333
4.50- 6.00 2,222,300 8.9 216,750 4.777
7.00-10.50 391,300 9.3 - -
11.50-15.50 417,800 9.7 - -
18.00-21.00 97,400 9.9 30,000 21.000
----------- --------- --------
11,305,840 7,179,990 $ 0.307
=========== ========= ========
Exercisable, December 28, 1996 6,356,940 $ 0.046
========= ========
Exercisable, December 31, 1995 5,840,040 $ 0.029
========= ========
(f) Fair Value of Stock Options
In October 1995, the FASB issued SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No. 123 requires the measurement
of the fair value of stock options to be included in the
statement of income or disclosed in the notes to financial
statements. The Company has determined that it will continue to
account for stock-based compensation for employees under
Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and elect the disclosure-only alternative
under SFAS No. 123.
Had compensation cost for the Company's option plans been
determined based on the fair value at the grant dates, as
prescribed in SFAS No. 123, the Company's net income would have
been as follows:
1995 1996 1997
Net income (in thousands)-
As reported $ 5,411 $ 7,901 $ 18,616
Pro forma 5,317 7,456 16,712
Diluted earnings per share-
As reported $ .17 $ .24 $ .54
Pro forma .17 .23 .49
F-17
EXCEL SWITCHING CORPORATION
Notes to Consolidated Financial Statements
December 27, 1997
(Continued)
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following
assumptions used for grants during the applicable period:
1995 1996 1997
Dividend yield - - -
Volatility 56.6% 56.6% 56.6%
Risk-free interest rate 6.0%-6.5% 5.9%-6.8% 5.0%-6.6%
Expected option term 7.5 years 7.5 years 5.0 years
Weighted average fair value
per share of options
granted $.97 $5.64 $5.28
(7) COMMITMENTS
The Company leases certain equipment and office facilities under
noncancelable operating leases, which expire at various dates through
November 2001. Future minimum lease payments required under these leases
at December 27, 1997 are approximately as follows (in thousands):
Fiscal Year Amount
1998 $ 925
1999 600
2000 229
2001 125
--------
$ 1,879
========
Total rent expense under these agreements for 1995, 1996 and 1997 was
approximately $193,000, $1,062,000 and $1,172,000, respectively.
During 1997, the Company began construction of a new office and research
facility. As of December 31, 1997, the Company had incurred approximately
$1.1 million of acquisition and construction costs, which are classified
as construction in progress in the accompanying consolidated balance
sheets. The Company estimates total facility costs to be approximately
$3,700,000.
F-18
EXCEL SWITCHING CORPORATION
Notes To Consolidated Financial Statements
December 27, 1997
(Continued)
(8) EMPLOYEE BENEFIT PLAN
The Company has a qualified 401(k) retirement savings plan covering all
employees. Under this plan, participants may elect to defer a portion of
their compensation, subject to certain limitations. In addition, the
Company, at the discretion of the Board of Directors, may make profit
sharing contributions into the plan. For fiscal years 1995, 1996 and
1997, the Company made contributions of approximately $209,000, $534,000
and $898,000, respectively.
(9) SIGNIFICANT CUSTOMERS
Sales to significant customers as a percentage of the Company's total
revenues were as follows:
1995 1996 1997
Significant customer A 41% 37% 26%
Significant customer B - - 10
Significant customer C 11 - -
(10) ACCRUED EXPENSES
Accrued expenses at December 28, 1996 and December 27, 1997 consist of
the following (in thousands):
1996 1997
Accrued sales returns $ 1,243 $ 4,397
Accrued payroll and benefits 1,322 2,297
Accrued post-sales support and warranty 1,225 1,690
Accrued marketing 352 1,166
Accrued professional fees 624 737
Accrued other 1,041 869
---------- ----------
$ 5,807 $ 11,156
========== ==========
F-19
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Excel Switching Corporation:
We have audited, in accordance with generally accepted auditing standards, the
consolidated financial statements of Excel Switching Corporation and
subsidiaries included in this Form 10-K and have issued our report thereon dated
January 21, 1998. Our audit was made for the purpose of forming an opinion on
the basic consolidated financial statements taken as a whole. The schedule
listed in Item 14(a)(2) is the responsibility of the Company's management and is
presented for the purpose of complying with Securities and Exchange Commission's
rules and is not part of the basic consolidated financial statements. This
schedule has been subjected to the auditing procedures applied in the audit of
the basic consolidated financial statements and, in our opinion, fairly states,
in all material respects, the financial data required to be set forth therein,
in relation to the basic consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 21, 1998
SCHEDULE II
EXCEL SWITCHING CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
Allowance for Balance Charged
Doubtful Beginning to Cost Deductions Balance End of
Accounts of Period or Expense (Write-offs) Period
------------- --------- ---------- ------------ --------------
1995 266,000 387,000 0 653,000
1996 653,000 497,000 (171,000) 979,000
1997 979,000 555,000 (184,000) 1,350,000