1 QUARTER 1 - FY 1996 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------- (Mark One) {X} QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended NOVEMBER 26, 1995 ----------------- OR -- { } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from TO ---------- ---------- Commission file number 0-12622 ------- TELCO SYSTEMS, INC ------------------ (Exact name of registrant as specified in its charter) Delaware 94-2178777 ------------------------------ ------------------- (State or other jurisdiction (I.R.S. employer incorporation or organization) identification no.) 63 NAHATAN STREET, NORWOOD, MASSACHUSETTS 02062 ------------------------------------------------ (Address of principal executive offices) Registrant's telephone number, including area code: (617) 551-0300 -------------- NO CHANGE ------------------------------------------------------------------------- (Former name, former address and former fiscal year, if change since last report) 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Classes Outstanding at January 3, 1996 - ----------------------------- ------------------------------ Common Stock, $.01 par value 10,269,866 1 2 TELCO SYSTEMS, INC. INDEX REPORT ON FORM 10-Q FOR QUARTER ENDED NOVEMBER 26, 1995 Page Number ----------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements ------- -------------------- Consolidated Balance Sheets November 26, 1995 and August 27, 1995 3 Consolidated Statements of Income Three months ended November 26, 1995 and November 27, 1994 4 Consolidated Statements of Cash Flows Three months ended November 26, 1995 and November 27, 1994 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of ------ Financial Condition and Results of Operations 7-8 PART III. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 9 ------- -------------------------------- SIGNATURE(S) 10 2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS - ------------------------------ TELCO SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (UNAUDITED) (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) November 26, 1995 August 27, 1995 ----------------- --------------- Assets ------ Current assets: Cash and equivalents . . . . . . . . . . . . . . . $17,347 $18,208 Short-term investments . . . . . . . . . . . . . . 10,174 10,895 Accounts receivable, net . . . . . . . . . . . . . 11,032 10,047 Refundable income taxes . . . . . . . . . . . . . 1,251 1,251 Inventories, net . . . . . . . . . . . . . . . . . 17,609 18,473 Other current assets . . . . . . . . . . . . . . . 2,265 2,585 ------- ------- Total current assets . . . . . . . . . . . . . 59,678 61,459 ------- ------- Plant and equipment, at cost . . . . . . . . . . . . 42,713 41,720 Less accumulated depreciation . . . . . . . . . . 32,140 31,114 ------- ------- Net plant and equipment . . . . . . . . . . . . 10,573 10,606 ------- ------- Intangible and other assets, net . . . . . . . . . . 10,058 10,374 ------- ------- Total assets . . . . . . . . . . . . . . . . . $80,309 $82,439 ======= ======= Liabilities and Shareholders' Equity ------------------------------------ Current liabilities: Accounts payable . . . . . . . . . . . . . . . . . $ 3,677 $ 3,952 Payroll and related liabilities . . . . . . . . . 1,843 2,628 Other accrued liabilities . . . . . . . . . . . . 6,518 4,964 ------- ------- Total current liabilities . . . . . . . . . . . 12,038 11,544 ------- ------- Restructuring and other long-term liabilities . . . . 3,152 3,490 Shareholders' Equity: Preferred stock, $.01 par value, 5,000,000 shares authorized; no shares outstanding . . . -- -- Common stock, $.01 par value, 24,000,000 shares authorized; shares outstanding: 10,266,048 at November 26, 1995; 10,230,624 at August 27, 1995 . . . . . . . . . 103 102 Capital in excess of par value . . . . . . . . . . 71,899 71,566 Accumulated deficit . . . . . . . . . . . . . . . (6,883) (4,263) ------- ------- Total shareholders' equity . . . . . . . . . 65,119 67,405 ------- ------- Total liabilities and shareholders' equity . $80,309 $82,439 ======= ======= See accompanying notes to consolidated financial statements. 3 4 TELCO SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) Three Months Ended ------------------ Nov. 26, 1995 Nov. 27, 1994 ------------- ------------- Sales: Broadband transmission products . . . . . . . . . $10,926 $10,019 Network access products . . . . . . . . . . . . . 8,617 14,614 Bandwidth optimization products . . . . . . . . . 990 1,584 ------- ------- 20,533 26,217 ------- ------- Costs and expenses: Cost of products sold . . . . . . . . . . . . . . 12,112 14,382 Research and development . . . . . . . . . . . . . 4,533 4,109 Sales, marketing and administration . . . . . . . 6,684 6,009 Amortization of intangible assets . . . . . . . . 195 200 Interest (income) . . . . . . . . . . . . . . . . (371) (302) ------- ------- 23,153 24,398 ------- ------- (Loss) income before income taxes . . . . . . . . . . (2,620) 1,819 Provision for income taxes . . . . . . . . . . . . . - 275 ------- ------- Net (loss) income . . . . . . . . . . . . . . . . . . $(2,620) $ 1,544 ======= ======= Average number of shares and equivalents (thousands) 10,266 10,273 (Loss) earnings per share . . . . . . . . . . . . . . $ (.26) $ 0.15 See accompanying notes to consolidated financial statements. 4 5 TELCO SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (DOLLARS IN THOUSANDS) Three months ended ------------------ Nov. 26, 1995 Nov. 27, 1994 ------------- ------------- INCREASE (DECREASE) IN CASH AND EQUIVALENTS Cash flows from operating activities: Net (loss) income . . . . . . . . . . . . . . . . . . . . . $(2,620) $ 1,544 Depreciation and amortization . . . . . . . . . . . . . . . 1,348 1,469 Change in assets and liabilities: Accounts receivable . . . . . . . . . . . . . . . . . . . (985) 1,032 Inventories . . . . . . . . . . . . . . . . . . . . . . 864 (1,770) Other current assets . . . . . . . . . . . . . . . . . . 320 495 Intangible and other assets . . . . . . . . . . . . . . . -- 103 Accounts payable and other current liabilities . . . . . 494 (1,577) Long-term liabilities . . . . . . . . . . . . . . . . . . (338) (361) ------- ------- Net cash (used in) provided by operating activities . . . . (917) 935 ------- ------- Cash flows from investing activities: Additions to plant and equipment, net . . . . . . . . . . . (999) (624) Purchase of short-term investments . . . . . . . . . . . . (7,039) (5,758) Maturities of short-term investments . . . . . . . . . . . 7,760 4,631 ------- ------- Net cash (used in) investing activities . . . . . . . . . . (278) (1,751) ------- ------- Cash flows from financing activities: Proceeds from sale of common shares under employee stock plans . . . . . . . . . . . . . . . 334 2,390 ------- ------- Net cash provided by financing activities . . . . . . . . . 334 2,390 ------- ------- (Decrease) increase in cash and equivalents . . . . . . . . . (861) 1,574 Cash and equivalents at beginning of quarter . . . . . . . . . 18,208 15,262 ------- ------- Cash and equivalents at end of quarter . . . . . . . . . . . $17,347 $16,836 ======= ======= See accompanying notes to consolidated financial statements. 5 6 TELCO SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For Quarter Ended November 26, 1995 (Unaudited) Note 1 - The consolidated financial statements of Telco Systems, Inc. (the Company) included in this report reflect all adjustments (consisting of only normally recurring accruals) which, in the opinion of management, are necessary for a fair presentation of the consolidated financial position at November 26, 1995 and the consolidated statements of operations and cash flows for the three months ended November 26, 1995 and November 27, 1994. The unaudited results of operations for the interim periods reported are not necessarily indicative of results to be expected for the year. Certain notes and other information have been condensed or omitted from these interim financial statements. The statements, therefore, should be read in conjunction with the consolidated financial statements and related notes included in the Telco Systems, Inc. Annual Report on Form 10-K for the year ended August 27, 1995. Note 2 - Inventories, net (dollars in thousands) November 26, August 27, 1995 1995 ------------ ---------- Raw materials . . . . . . . . . . . . $ 9,703 $ 9,101 Work-in-process . . . . . . . . . . . 2,688 3,060 Finished goods . . . . . . . . . . . . 5,218 6,312 ------- ------- $17,609 $18,473 ======= ======= Note 3 - Shares Outstanding Changes in shares outstanding: Three months ended ------------------ November 26, November 27, 1995 1994 ---- ---- Outstanding at beginning of period . . 10,230,624 9,649,051 Options exercised . . . . . . . . . 9,515 277,219 Employee stock purchase plan . . . 25,909 27,167 ---------- --------- Outstanding at end of period . . . . . 10,266,048 9,953,437 ========== ========= 6 7 PART I. FINANCIAL INFORMATION (Continued) Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table sets forth for the period indicated (i) percentages which certain items reflected in the financial data bear to sales of the Company and (ii) the percent change of such items as compared to the indicated prior period. See Consolidated Statements of Operations. PERCENT OF SALES PERCENT FIRST QUARTER INCREASE (DECREASE) ------------- ------------------- 1995 1994 1995 VS. 1994 ---- ---- ---- --- ---- Net sales . . . . . . . . . . . . . . . . 100.0% 100.0% (21.7)% Costs and expenses: Cost of products sold . . . . . . . . 59.0 54.9 (15.8) Research and development . . . . . . . 22.1 15.7 10.3 Sales, marketing and administration . . 32.6 22.9 11.2 Amortization of intangible assets . . . 0.9 0.8 (2.5) Interest income . . . . . . . . . . . (1.8) (1.2) 22.8 ----- ----- ------ Total costs and expenses . . . . . . . . 112.8 93.1 (5.1) ----- ----- ------ (Loss) income before income taxes . . . . (12.8) 6.9 -- Provision for income taxes . . . . . . . -- 1.0 (100.0) ----- ----- ------ Net (loss) income . . . . . . . . . . . . (12.8)% 5.9% -- 7 8 TELCO SYSTEMS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION FOR QUARTER ENDED NOVEMBER 26, 1995 SALES AND NET LOSS - Sales for the first quarter of fiscal 1996 decreased 22% to $20.5 million compared with $26.2 million in the first quarter of last year. This decrease resulted primarily from lower shipments of network access products due to continued competitive pressure on sales of certain older products. Net loss for the quarter was ($2.6) million or ($.26) per share compared with net income of $1.5 million or $.15 per share in the first quarter of last year. The net loss resulted from the lower sales volume and increased spending on both research and development projects and increased selling and marketing activities. COST OF PRODUCTS SOLD - Cost of products sold represented 59% of sales in the first quarter of fiscal 1996. In the first quarter of fiscal 1995, cost of products sold represented 55% of sales. This decrease in gross margin percent was principally related to lower absorption of fixed costs resulting from the lower operating level. RESEARCH AND DEVELOPMENT - Spending on research and development continued at a high level in the first quarter of fiscal 1996, increasing 10% to $4.5 million compared with the first quarter of fiscal 1995. The increase was due to higher spending for ATM/SONET products, feature additions to existing products and product modifications for international applications. SALES, MARKETING AND ADMINISTRATION - Sales, marketing and administration expense increased 11% to $6.7 million compared with $6.0 million in the first quarter of fiscal 1995. This increase was primarily related to expanded selling and marketing activities in the international marketplace. INTEREST INCOME - Interest income increased 23% compared with the first quarter of fiscal 1995. This increase resulted from higher interest rates earned on a higher level of average cash and short-term investments. PROVISION FOR INCOME TAXES - The Company provided for no taxes during the first quarter of fiscal 1996. Based on anticipated income for the year and factoring in available net operating loss carryforwards, the Company anticipates that it will not need to provide for income taxes this year. LIQUIDITY AND CAPITAL RESOURCES - For the three month period ended November 26, 1995, cash and short-term investments decreased $1.6 million to $27.5 million. The decrease reflects the net operating loss for the period as well as $1.0 million from higher accounts receivable due to quarter end shipments and $1.0 million in capital expenditures, partially offset by lower inventories and higher current liabilities. The Company maintains a $10.0 million line of credit with the Bank of Boston which is available until September 30, 1996. Under the facility, borrowings may be made at the bank's prime rate plus one half percent. Although the Company had no borrowings against the line in fiscal 1995, approximately $1.1 million has been reserved to support various guarantees in effect at November 26, 1995. Management believes that cash and short-term investments of $27.5 million and funds provided by continuing operations will be adequate to satisfy operating cash requirements for the foreseeable future. 8 9 TELCO SYSTEMS, INC. PART II. OTHER INFORMATION ---------------------------- Item 6. Exhibits and Reports filed on Form 8-K - ------- -------------------------------------- (b) The Company filed no reports on Form 8-K during the fiscal quarter for which this report is filed. 9 10 TELCO SYSTEMS, INC. SIGNATURE(S) Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TELCO SYSTEMS, INC. By:/s/ Daniel A. DiPietro ---------------------------- Daniel A. DiPietro Vice President and Corporate Controller Principal Accounting Officer 10