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FORM 10-K FY 1997
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended AUGUST 31, 1997
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OR
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from TO
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Commission file number 0-12622
TELCO SYSTEMS, INC
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(Exact name of registrant as specified in its charter)
Delaware 94-2178777
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
63 NAHATAN STREET, NORWOOD, MASSACHUSETTS 02062
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(Address of principal executive offices)
Registrant's telephone number, including area code: (781) 551-0300
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
(Title of Class)
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 voting stock held by nonaffiliates of the
registrant was approximately $149,407,000 as of November 7, 1997.
On November 7, 1997 there were 10,884,366 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
(2) Portions of the definitive proxy statement (the "Definitive
Proxy Statement") required to be filed with Securities and
Exchange Commission relative to the Company's 1997 annual
meeting of shareholders are incorporated by reference into
Part III.
Exhibit Index is on Page 37
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Item 1. BUSINESS
GENERAL
The Company was incorporated in California on September 7, 1972, and
reincorporated in Delaware on December 17, 1986. Its principal office is located
at 63 Nahatan Street, Norwood, Massachusetts 02062 (telephone number is (781)
551-0300. Unless the context indicates otherwise, the terms "Company" and "Telco
Systems" refer to Telco Systems, Inc. The Company is a manufacturer of three
major product lines, focused on providing integrated access for network
services: the broadband transmission products, referred to as "Broadband"; the
network access products, referred to as "Access"; and the bandwidth optimization
products, referred to as "Bandwidth Optimization".
The Company's products are deployed at the edge of the service
providers' networks to provide organizations with a flexible, cost-effective
means of transmitting voice, data, video and image traffic over public or
private networks. These products are used in a wide variety of applications by
network service providers, such as long distance carriers, Bell Operating
Companies, independent and competitive local access providers, as well as
government agencies, electric utilities, wireless service operators, and major
corporations. Its products, which can be found most often in telephone company
central offices and in private communications networks, perform functions that
range from basic signaling and multiplexing of DS0 (64kbps) low speed data and
voice traffic to digital fiber optic transmission of high-speed, high-capacity
services over SONET OC-3 (155Mbps) networks.
In January 1983, the Company acquired the fiber optics transmission
business from Raytheon Company, which evolved into the Broadband product line.
Sales of broadband transmission products in fiscal year 1997 comprised
approximately 54% of the Company's total revenue. In August 1984, the Company
acquired TeleBit, Inc., a manufacturer of digital transmission systems based in
Lombard, Illinois. Later, the products from this acquisition were merged with
the Company's Voice Frequency products which together evolved into the Access
product line. In fiscal 1997, sales of access products were 41% of total sales.
In May 1992, the Company acquired Magnalink Communications Corporation, a
developer and manufacturer of high speed data compression and bandwidth
optimization products, which evolved into the Bandwidth Optimization product
line. In fiscal 1997, bandwidth optimization products represented 5% of sales.
For fiscal 1997, the Company reported sales of $117.8 million and a net
loss of $1.1 million or $.10 per share. Working capital at year end amounted to
$40.4 million, including cash and marketable securities of $12.7 million. For a
more complete discussion of the results of operations, please refer to
Management's Discussion and Analysis of Results of Operations and Financial
Condition found on page 11 of this report.
BROADBAND PRODUCTS
Primary customers of the Company's Broadband products are Bell
Operating Companies and major independent telephone companies as well as
competitive and alternate access providers. Products are sold as either complete
systems or as stand-alone equipment installed by the Company, third party
installers, or by the Company's customers. A complete system may include the
fiber optic cable, which is not manufactured by the Company but is purchased
from a number of suppliers.
The most common application of the Company's Broadband transmission
products is for cost-effective delivery of high capacity T1 (1.544Mbps) and T3
(45Mbps) services in the local loop applications between the telephone company
central office or hubbing sites and customers' business premises. These services
are delivered over both fiber optic technology, as well as copper-based
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technology. The Company believes that such local loop applications will continue
to grow due to the Telecommunications Reform Act of 1996 as the local access
market opens to competition.
Broadband transmission products currently manufactured by the
Company can be grouped into two categories: fiber optic terminals and
multiplexers; and network monitoring and control systems.
FIBER OPTIC TERMINALS AND MULTIPLEXERS: These systems typically
consist of a digital multiplexer and a fiber optic transmitter/receiver
integrated into one functional unit. The multiplexer portion of the terminal
unit combines digital inputs from multiple sources into one digital output.
Multiplexers can be combined in order to achieve higher transmission rates. The
basic function of the transmitter portion of a terminal is to convert electronic
input into a series of light pulses for transmission over optical fiber. The
receiver function of a terminal reconverts the light pulses received over the
fiber into digital electronic signals. To meet the various needs of the public
and private telephone networks, the Company offers products for transmitting at
different capacities.
The Company offers modular fiber optic terminals that enable the
customer to upgrade its system by adding modules as increased capacity is
required. The Company's terminals, depending on bit-rate and other design
configurations, can accommodate transmission over distances of up to 60
kilometers. Prices for a typical system are dependent on configuration and
accordingly can range from $5,000 to $30,000 per terminal.
The broadband transmission multiplexers support speeds ranging from
T1 (1.544Mbps) to SONET OC3 (155Mbps). These systems can connect into
asynchronous or SONET digital cross-connect systems in a service providers'
central office.
NETWORK MONITORING AND CONTROL SYSTEMS: The Company offers a
modular computer-based system management system that is used to configure the
products, monitor and control their operations, and to identify failure of
specific multiplexers or terminals in the network. It also detects and reports
system signal degradation, allowing an operator to identify potential failures
before they occur and to schedule preventative maintenance. In addition, during
FY97, the Company also added Simplified Network Management Protocol (SNMP)-proxy
agent to its HyperSPAN product line to make it manageable from any SNMP Manager
- - a key evolving requirement in the Internet Service Provider (ISP) and
Competitive Local Exchange Carrier (CLEC) marketplace.
ACCESS PRODUCTS
Primary customers of the Company's access products are long
distance service providers, competitive and alternate local access providers,
Bell Operating Companies, government agencies, electric utilities and wireless
service operators. In many cases, the products are purchased by the service
providers and are installed on customer premises or are leased to private
network users. These products comply with both North American and international
standards for specific applications, and are sold worldwide.
The Company's network access products are designed for the digital
multiplexing of voice and data traffic of up to T1 and E1 rates. The trend
towards increased use of public network services for voice, data and video
applications has created greater demand for customer premises access
multiplexers. The Company's access servers enables integration of multiple
slower-speed lines and services onto a single or multiple, high-speed, T1/E1
access facility, ultimately saving access line charges for end users. They
support interfaces for various types of telephony and data services, such as
Plain Old Telephone System (POTS), Centrex extensions, P-Phones, switched data,
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Integrated Services Digital Network (ISDN) and frame relay. In addition, the
Company provides a network management system which is designed to control its
intelligent transmission products.
Typical prices for network access equipment range from $5,000 to $15,000.
NETWORK ACCESS SERVERS: The Company's Access60 network access
servers provide highly reliable digital access to public, private and hybrid
networks. They integrate multiple business applications through cost-effective
connections to dedicated, switched and packet network services, and support
multiple networking functions such as T1/E1 add/drop multiplexing, grooming and
digital cross-connection. They also support advanced services such as ISDN and
frame relay. The products provide complete redundant architecture for fail-safe
operation, a must for service providers. Access45 was introduced during fiscal
1997, and is a smaller version of Access60 representing a lower price point. It
is designed to meet a key requirement for the CLEC marketplace, which is to
provide a high number of service ports in a very small form factor. It is
completely compatible with Access60, and uses the same interface cards to
deliver the same services.
DIGITAL MULTIPLEXER PRODUCTS: The Company's products use digital
technology and provide over 40 different plug-in printed circuit cards to
support a large variety of analog and digital voice, data, and video
applications. The products provide conversion of analog signals into digital
information, combine them with additional digital data inputs and enable them to
be processed and transmitted at high speed over copper wires. The Company
provides a full range of products from cost effective digital channel banks to
high-functionality DSU/CSU.
NETWORK MANAGEMENT AND CONTROL SYSTEM: The Company offers a
standards-based SNMP network management system for its Access45 and Access60
network access servers and Access35 network access multiplexer. It also offers a
software-based management and control system, which is designed to control the
Route-24 and network access multiplexer and DCB-24 digital channel bank. This
system remotely manages voice and data mix, bandwidth allocation, and selective
access to special services offered by T1 carriers. In addition, it can be used
to modify the network as user requirements change.
BANDWIDTH OPTIMIZATION PRODUCTS
Primary customers for the Company's bandwidth optimization products
are private network users at major corporations worldwide. These products
interconnect geographically remote local area networks (LANs) through wide area
networks (WANs), with an emphasis on optimizing the utilization of WAN links. In
LAN/WAN applications, WAN links have the lowest throughput, the highest expense,
the lowest reliability, and the least security. The bandwidth optimization
products increase the throughput of WAN links by two to six times (depending on
the type of data traffic) via data compression; reduce expense of WAN links by
enabling usage of lower-speed links at higher throughput; and offer features for
improved redundancy, fault tolerance, security and privacy. Typical units are in
the $3,000 to $9,000 price range. The Optimizer product line also supports
compression for frame relay data, and can be connected to any standard frame
relay service offering. It is approved in the leading frame relay service
offerings, such as AT&T, WorldCom and Sprint.
MARKETING AND CUSTOMERS
Telco Systems is engaged in a single business segment constituting
the development, manufacturing, marketing and service of integrated access
solutions for the telecommunications industry. Primary users of the Company's
products are the Regional Bell Operating Companies (RBOCs), independent
telephone companies, interexchange carriers, competitive and alternate
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access providers, electric utilities, wireless service operators, government
agencies and private network end users.
The Company's broadband transmission products and network access
products are generally sold to specialized common carriers and telephone
operating companies on an off-the-shelf basis. Typically, the products have been
evaluated by such customers and approved for purchase in advance. Both network
access and broadband products are manufactured by the Company based on
forecasted usage. Sales to the RBOCs accounted for 39% of sales in fiscal 1997,
37% of sales in fiscal 1996, and 29% of sales in fiscal 1995. RBOC sales include
sales to NYNEX of 33% in fiscal 1997, 31% in fiscal 1996, and 17% in fiscal
1995. NYNEX continues to be a significant customer of the Broadband Business
Unit. A material curtailment in the NYNEX order rate, if not offset by sales to
other customers, would result in insufficient gross margin to cover the current
level of operating costs and would adversely impact total company results. Other
significant customers include MCI Communications and Walker and Associates which
each represented 11% and 10% of sales in fiscal 1997, respectively. In fiscal
1996, Sprint and Walker and Associates each represented 13% and 11%,
respectively. In fiscal 1995, Sprint represented 18% of sales. During fiscal
1997, the Company also won a large bid with British Telecom, a major European
carrier, for its Access60 product. International revenue represented 7% of total
revenue in fiscal 1997 compared with 4% in fiscal 1996.
The Company markets its products through a combination of its own
sales force, value-added resellers and distributors. Installation is primarily
performed by third party providers. The Company has technical support and
applications engineering personnel and offers training of customer personnel.
ORDERS AND BACKLOG
In fiscal 1997, the Company received orders totaling $114.4
million. Of this amount, $58.5 million was for broadband transmission products,
$50.4 million was for network access products, and $5.5 million was for
bandwidth optimization products. During the first quarter of fiscal 1998, the
Company was notified by a major customer, MCI Communications, of its intention
to cancel an order for Access60 products in the amount of $6.9 million. Had this
cancellation been reflected in fiscal 1997, total orders would have been $107.5
million. Firm backlog shippable within a twelve-month period was approximately
$21.2 million at the end of fiscal 1997, compared to approximately $24.8 million
at the end of fiscal 1996. Firm backlog would have been $14.3 million if the
previously discussed cancellation occurred in fiscal 1997. Broadband
transmission products comprised 26% of the backlog for fiscal year 1997 and 44%
for fiscal 1996. Network access products represented 72% of backlog at fiscal
1997 year end and 54% of backlog at fiscal 1996 year end. The Company's order
trend is characterized by short customer-scheduled delivery cycles. Accordingly,
a substantial portion of sales in each fiscal quarter are derived from orders
received in the quarter. In the Company's experience, its backlog at a given
time is not necessarily indicative of prospective sales volume. In addition to
the short delivery cycles, customers may revise scheduled delivery dates, revise
product configuration or cancel orders.
COMPETITION
The Company competes in its markets based upon price/performance
advantages offered by a number of its products, certain product features, and
its ability to meet customer delivery requirements on a timely basis. Most of
the Company's competitors have greater financial, technological and personnel
resources than the Company. The Company's competitors in the broadband
transmission market are predominantly large, full-line, integrated manufacturers
of telecommunications equipment, such as AT&T, Fujitsu, Northern Telecom
Limited, Alcatel, NEC and ADC Telecommunications. Many of these competitors have
introduced newer SONET transmission products which the telephone operating
companies are deploying in public networks.
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The availability of such SONET products by competitors provides a distinct
product advantage for them in certain customer applications. However, the higher
cost of the SONET products, typically 20-50% more expensive than the
asynchronous transmission products, is providing a continued strong demand for
the Company's asynchronous transmission products in certain customer
applications. The Company's principal competitors with respect to the network
access product market include Premisys Communications, Verilink Corp., Newbridge
Networks, Tellabs and Coastcomm. The Company believes that it has substantially
strengthened its competitive position in this market with the availability of
new features for the Access60 product, and introduction of the new Access45
product, as well as with a stronger network of distributors. The Company also
believes that the redundancy, high-density application and the fail-safe nature
of the Access60 architecture makes the product more suitable for the service
providers market. Primary competitors for bandwidth optimization products are
Fastcom and Symplex, which focus on data compression technologies for lower data
rates in the range of 64Kbps. The Company believes that its data compression
technology has significant cost and performance advantages for higher data rates
in the range of 256Kbps and 1.544Mbps.
RESEARCH AND DEVELOPMENT
The Company maintains two technology centers for research and
development located in Norwood, Massachusetts and Fremont, California. In the
broadband transmission product area, the Company is concentrating its research
and development efforts on new products for delivering more cost-effective
solutions for DS3-based systems in the local loop distribution portion of the
telephone network. In the network access product area, development programs
continue for further enhancements and newer features for digital loop access and
data services applications for Access45 and Access60 Network Access servers. In
both areas, a significant portion of the R&D investment is going towards
development of lower-cost designs to improve gross margins of existing products.
Programs for new products are based on market analysis and estimates of customer
demand which are subject to continuing change. Therefore, there can be no
assurance that sales of such products will meet current expectations.
Spending on research and development activities of $15.4 million
represented 13% of sales in fiscal 1997. This compares with $18.0 million in
fiscal 1996 and $18.2 million in fiscal 1995 which represented 19% and 20% of
sales in each year, respectively. The Company expects to maintain the fiscal
1997 level of spending for research and development into fiscal 1998.
From time to time the Company has employed consultants to perform
research and development functions. The Company plans to continue this practice
as a means of augmenting its internal research and development capabilities.
EMPLOYEES
As of August 31, 1997, the Company had 382 employees, of whom 93
were in sales, sales support and marketing, 83 in product development, 158 in
manufacturing and 48 in administration. Competition for highly skilled
engineering, managerial, sales, marketing and product development personnel is
very intense. The Company believes that its future success will depend in large
part on its ability to attract and retain such individuals. Accordingly, the
loss of key personnel could materially and adversely affect the Company's
business, results of operations and financial condition. There can be no
assurance that the Company will be successful in attracting and retaining the
personnel required to engineer, manage, market or develop its products and
conduct its operations successfully. The Company considers its employee
relations to be excellent and is not a party to any collective bargaining
agreement.
MANUFACTURING
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The Company's manufacturing process primarily involves the assembly
of electronic components onto custom-designed printed circuit boards,
incorporating these boards into larger system packages, and testing the finished
products to assure their proper functioning in accordance with product
specifications. Most components used in the process are standard electrical,
electronic and mechanical parts available from many suppliers. The Company does,
however, currently depend on various single sources to supply certain
custom-designed components used in its products. To balance single source
dependence, the Company will maintain higher inventory levels or seek to qualify
secondary sources where appropriate.
The plan announced in the latter half of fiscal 1996 to consolidate
manufacturing operations into the Company's facility located in Norwood,
Massachusetts was completed in fiscal 1997. Please refer to note 8 to the
consolidated financial statements for further information concerning the 1996
restructuring plan. Approximately 80% of the Company's older network access
equipment is manufactured by a subcontractor at facilities in Malaysia and
Singapore. Inspection, final test and system assembly is performed at the
Company's Norwood, Massachusetts facility. Approximately 20% of the Company's
broadband transmission products is manufactured by a subcontractor in Singapore.
Inspection, final test and system assembly for these products is also performed
at the Company's Norwood, Massachusetts facility. The Company presently
maintains a favorable relationship with these vendors and does not presently
anticipate any difficulties that would prevent timely procurement of scheduled
product. As a backup to these principal sub-contractors, the Company maintains
an in-house ability to manufacture these products.
The Company maintains a non-exclusive volume purchase agreement
with a major distributor of electronic components. The benefits of this
agreement to the Company are principally discounts and product availability at
certain purchasing levels. This agreement does not contain purchase commitments.
Although the Company has not experienced significant difficulty in obtaining
desired quantities from any of its single sources or other vendors, business
could be adversely affected if components used in its products were not
available on a timely basis.
REGULATORY AND LEGISLATIVE MATTERS
Regulations of the Federal Communications Commission affect various
products of the Company. Certain regulations require that products which reside
on a customer's premises and interconnect the public switched network meet
certain standards to prevent harm to the network. Other regulations limit the
levels of electromagnetic radiation which may emanate from an electronic device
located on a customer's premise. The Company currently complies with these
regulations and believes it will be able to comply with these regulations in the
future. Changes in existing laws and regulations which govern the
telecommunications industry could affect the business of the Company.
PATENTS
The Company currently holds several patents and has patent
applications pending. Management believes, however, that timely implementation
of technological advances, responsiveness to market requirements, depth of
technical expertise and a high level of customer service and support are more
important to its success than patent rights.
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CORPORATE OFFICERS OF REGISTRANT
Following is a list of the Company's executive officers:
NAME AGE POSITION
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William B. Smith, Ph.D. 53 President and Chief Executive Officer
William J. Stuart 46 Vice President and Chief Financial Officer
Richard J. Nardone 49 Vice President, Corporate Resources
Anand S. Parikh 38 Vice President, Marketing and Business
Development
Philip D. Wilson 52 Vice President, Engineering
Dr. Smith has been Chief Executive Officer since March of 1996. He
joined the company as President and Chief Operating Officer in 1995. Prior to
that he was Senior Vice President of US West, Inc. and President of US West
Advanced Technologies since 1991. Prior to that, he was Executive Director of
AT&T Bell Laboratories since 1986.
Mr. Stuart has been Vice President and Chief Financial Officer
since joining the Company in January 1997. Prior to that he was Vice President
and Chief Financial Officer of AccessLine Technologies, a telecommunications
software company since 1992. Prior to that he was Vice President - International
with AT&T Paradyne since 1989 and Treasurer of Paradyne Corporation prior to its
acquisition by AT&T in 1989.
Mr. Nardone has been Vice President of Corporate Resources since
March of 1996 and Vice President of Human Resources since September 1995. Prior
to that he was Senior Manager of Human Resources at Ungermann-Bass Networks,
Inc. ( a manufacturer of networking systems) since 1992. Prior to that he was
Director of Human Resources at Proteon, Inc.( a manufacturer of networking
systems).
Mr. Parikh joined the Company as Vice President of Marketing and
Business Development in 1995. Prior to that he was with Lightstream Corporation
in Billerica, Massachusetts as Vice President, Strategic Business Development
since 1994 and Vice President, Marketing since 1993. Prior to that, he was
General Manager of the Broadband Networks Business Unit of Ungermann-Bass
Networks, Inc. a manufacturer of networking systems, since 1991. Prior to that,
he held various senior management positions at Digital Equipment Corp. for nine
years.
Mr. Wilson joined the Company as Vice President, Engineering in
March of 1996. Prior to that he held various senior management positions with
Racal Datacom, a manufacturer of data communications equipment since 1991, most
recently as Vice President of Engineering, LAN Products and Fiber Systems.
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Item 2. PROPERTIES
The Company's corporate offices and manufacturing operations are
located in Norwood, Massachusetts. Engineering, sales and marketing activities
are located in Norwood and Fremont, California.
The Company leases a 216,000 square foot manufacturing, research
and administration facility in Norwood, Massachusetts, that is owned by a
limited partnership in which the Company has a 50% partnership interest.
Approximately 60% of this facility is utilized by the Company. Excess costs
associated with idle portions of the facility have been included in the
restructuring charge recorded by the Company in fiscal 1993. On November 11,
1994, the Company entered into an agreement for the lease of an 118,000 square
foot manufacturing, research and administration facility in Fremont, California.
During fiscal 1996, portions of this facility were identified as excess
following the consolidation of manufacturing operations into the Norwood,
Massachusetts facility. The consolidation plan was completed during fiscal 1997.
For a more complete discussion of excess facilities, please refer to note 8 to
the consolidated financial statements.
The Company leases additional facilities, primarily for sales and
sales support in: Overland Park, Kansas; Dallas, Texas; The United Kingdom; Hong
Kong and Belgium under one to five-year leases, each facility being between 500
and 5,000 square feet. The Company believes that its present facilities are
adequate for its current level of operations.
The Company owns substantially all of its equipment except for
certain equipment purchased by the Company within the eighteen month period
prior to August 31, 1997. This equipment is leased to the Company as discussed
in Note 7 to the financial statements.
Item 3. LEGAL PROCEEDINGS
There are no material legal proceedings to which the Company is a
party or of which any of its properties is the subject.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted to a vote of security holders of the
Company during the fourth quarter of fiscal 1997.
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PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Telco Systems' common stock is quoted on the NASDAQ National Market under the
symbol "TELC." The quarterly price ranges for the Company's common stock are as
follows:
Fiscal Year
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1997 1996
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High Low High Low
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First Quarter........... 21 3/4 15 14 3/4 9 3/4
Second Quarter.......... 24 3/8 12 1/2 12 3/8 9 1/4
Third Quarter........... 17 1/4 7 3/4 16 3/8 8 3/8
Fourth Quarter.......... 13 3/4 8 7/8 18 3/8 11 3/8
The Company has never declared or paid any dividends on its common stock
and does not plan to pay cash dividends in the foreseeable future.
At August 31, 1997, the number of holders of the Company's common stock
was 393. The Company believes that many of its shares are held by individual
participants in security listing positions or "street names" and estimates there
are an additional 6,700 beneficial holders as of August 31, 1997.
Item 6. SELECTED FINANCIAL DATA
Five years ended August 31, 1997
1997 1996 1995 1994 1993
(In thousands except per share amounts)
Summary of Operations
Year-end backlog*................ $ 21,151 $ 24,815 $ 5,527 $ 7,251 $ 6,714
Sales............................ 117,843 93,954 89,070 100,470 83,222
Net income (loss)**.............. (1,078) (15,545) 628 4,770 (16,285)
Earnings (loss) per share........ $ (.10) $ (1.50) $ .06 $ .48 $ (1.75)
Average shares and
equivalents (thousands)...... 10,701 10,357 10,345 9,858 9,300
Year-end employment.............. 382 388 436 443 442
Balance Sheet
Working capital.................. $ 40,414 $ 35,917 $49,915 $ 43,210 $ 36,989
Total assets..................... 78,599 79,504 82,439 82,202 80,551
Long-term liabilities............ 1,531 3,350 3,490 4,443 7,852
Total shareholders' equity....... $ 55,756 $ 53,997 $67,405 $ 61,548 $ 54,872
*The 1997 year-end backlog includes an order for $6,919 which was canceled
during the first quarter of fiscal 1998.
**The 1997 net loss includes a $1,070 gain on the sale of an investment. The
1996 net loss includes $4,209 of restructuring costs; 1995 Net income includes
$420 of restructuring credits; 1993 net loss includes $13,605 of restructuring
costs. The Company has never declared or paid any dividends on its common
stock.
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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FISCAL 1997 COMPARED WITH FISCAL 1996
Sales in fiscal 1997 increased 25% to $117.8 million compared with
$94.0 million in fiscal 1996. Increased shipments of Access60 network access
products and broadband transmission products more than offset decreased sales of
older network access products.
In fiscal 1997, broadband transmission product sales represented 54% of
total sales reflecting an increase of 35% compared with fiscal 1996. The Company
continued to experience increased demand for asynchronous products exceeding the
30% growth rate experienced in fiscal 1996. Approximately 80% of the Company's
sales of these products are used by telephone company customers to provide high
bandwidth fiber optic services in the feeder or distribution section of the
public telephone network. Sales to one RBOC represented 60% and 61% of sales of
broadband transmission products in fiscal 1997 and fiscal 1996, respectively. As
a percent of total sales, this RBOC represented 33% and 31% in fiscal 1997 and
fiscal 1996, respectively. In fiscal 1997, access product sales represented 41%
of total sales reflecting an increase of 18% compared with fiscal 1996.
Substantially all of this growth can be attributed to sales of the Company's new
Access 60 server which increased 87% compared with fiscal 1996. The Access 60
product represented 46% of access product sales in fiscal 1997 compared with 29%
in fiscal 1996. This increase was partially offset by a decline in sales of
older low-end access products. In fiscal 1997, sales of bandwidth optimization
products represented 5% of total sales and remained substantially even with
fiscal 1996.
Total orders booked in fiscal 1997 amounted to $114.4 million, slightly
ahead of fiscal 1996 orders of $113.5 million. Backlog at the end of fiscal 1997
decreased to $21.2 million compared with $24.8 million at the end of the
previous year. During the first quarter of fiscal 1998, the Company was notified
by a major customer, MCI Communications, of its intention to cancel an order for
Access60 products in the amount of $6.9 million. Had this cancellation been
reflected in fiscal 1997, total orders would have been $107.5 million. Firm
backlog would have been $14.3 million if this order cancellation had occurred in
fiscal 1997.
The Company's major customers include telephone operating companies and
long distance carriers. Sales to RBOC and other major telephone companies
represented 43% of total sales compared with 42% in fiscal 1996. The major long
distance carriers represented 20% of sales on fiscal 1997 compared with 19% in
fiscal 1996. International revenue represented 7% of total revenue in fiscal
1997 compared with 4% in fiscal 1996.
In fiscal 1997 the Company recorded a net loss of $1.1 million or $.10
per share compared with a net loss in fiscal 1996 of $15.5 million or $1.50 per
share. The fiscal 1996 net loss included a net restructuring charge of $4.2
million or $.41 per share which is discussed in note 8 to the financial
statements. Additionally, fiscal 1996 included non-recurring charges associated
with the transfer of manufacturing operations from Fremont, California to
Norwood, Massachusetts. Increased revenues and lower operating expenses were
primarily responsible for the improved operating results compared with fiscal
1996.
Gross profit in fiscal 1997 was $42.9 million and represented 36% of
sales. In fiscal 1996, gross profit was $36.7 million or 39% of net sales. This
decrease in gross profit percentage resulted in part as the product revenue mix
shifted towards lower margin products, primarily in the access products group.
To reverse this trend, efforts are continuing into fiscal 1998 to reduce product
cost through manufacturing process improvements and product enhancements.
Research and development expense amounted to $15.4 million and
represented a decrease of 15% compared with fiscal 1996. This decrease resulted
as development efforts for certain broadband products were curtailed. Remaining
resources were focused on new product efforts in
11
12
the access products area. Research and development expense represented 13% of
sales in fiscal 1997 compared with 19% of sales in fiscal 1996.
Sales, marketing and administration expense was $29.7 million in fiscal
1997 compared with $30.4 million in fiscal 1996. Lower spending in fiscal 1997
resulted from the Company's consolidation actions which occurred in the third
quarter of fiscal 1996. This favorable spending variance was partially offset by
additional costs relating to certain selling activity realignments which
occurred in the third quarter of fiscal 1997.
During the first quarter of fiscal 1997, the Company liquidated its
equity position in an international distributor of the Company's products due to
certain changes in strategic objectives. The sale of this investment, originally
made in fiscal 1995, yielded a one-time gain of $1.1 million.
Amortization expense relates to the acquisition of the broadband family
of products in 1983, certain channel bank products in 1984 and the acquisition
of Magnalink Communications Corporation in 1992. In fiscal 1997, amortization
expense was $.7 million in fiscal 1997 compared with $.8 million in fiscal 1996.
Interest income was $.7 million and $1.1 million in fiscal 1997 and
fiscal 1996, respectively. This decrease resulted as operating requirements for
cash reduced the amounts available to generate interest income.
In fiscal 1997, the Company's operating loss did not generate currently
available tax benefits.
FISCAL 1996 COMPARED WITH FISCAL 1995
Sales for fiscal 1996 increased 5% to $94.0 million compared with sales
in fiscal 1995 of $89.1 million as increased shipments of broadband transmission
products and the Company's new Access 50/60 products more than offset a decrease
in sales of certain older low-end access products.
Sales of broadband transmission products, which represented 50% of
total sales, increased 30% in fiscal 1996 principally due to strong demand by
some Regional Bell Operating Company (RBOC) customers for the Company's
asynchronous products for use in local loop applications. Approximately 80% of
the Company's sales of these products continued to be for provision of high
bandwidth fiber optic services in the feeder or distribution section of the
public telephone network. RBOCs represented 69% and 58% of sales of broadband
transmission products in fiscal 1996 and fiscal 1995, respectively. Sales to one
RBOC of broadband products amounted to 31% and 17% of total sales in FY96 and
FY95, respectively. Sales of network access products were 44% of total sales and
decreased 12% in fiscal year 1996. This decrease was principally related to
continued competitive pressure on certain older products which was partially
offset by increased demand for the Company's new Access60 network access server
and other new products. Sales of Bandwidth Optimization products declined 3% in
fiscal 1996.
Total orders booked in fiscal 1996 amounted to $113.5 million, an
increase of 30% compared with fiscal 1995 orders of $87.3 million. Increased
customer demand for both the Company's Access60 network access server and
HyperSPAN broadband multiplexers accounted for this increase. The backlog of
unfilled orders at August 25, 1996 increased 351% to $24.8 million compared with
$5.5 million at the previous year end. The year end backlog is reflective of
increased demand for both network access products and broadband transmission
products and also included early receipt of some customer stocking orders. The
Company believes that it has sufficient manufacturing capacity to meet the
increased demand.
12
13
The Company's major customers include telephone operating companies and
interexchange carriers. Sales to RBOC customers and other major telephone
companies represented 42% of total sales in fiscal 1996 compared with 35% of
total sales in fiscal 1995. The major interexchange carriers represented 19% and
23% of sales in fiscal 1996 and fiscal 1995, respectively.
The Company recorded a net loss of $15.5 million or $1.50 per share for
fiscal 1996 compared with net income of $0.6 million or $.06 per share in fiscal
1995. The fiscal 1996 net loss included a $4.2 million restructuring charge
discussed in Note 8 to the financial statements. In addition, year end results
included non-recurring charges resulting from the transfer of manufacturing
operations from the Company's Fremont, California, facility to its facility
located in Norwood, Massachusetts, which were recorded in the third quarter. As
a result of lower operating costs experienced after these actions, a favorable
adjustment to the third quarter restructuring charge of $0.5 million and record
sales in the fourth quarter of fiscal 1996, the Company reported net income of
$1.2 million or $.11 per share on sales of $29.6 million .
Gross profit in fiscal 1996 was $36.7 million and represented 39% of
sales compared with $40.5 million or 46% of sales in fiscal 1995. Gross profit
was adversely affected by additional costs for facility consolidations and by
lower product margins on the initial production of new network access products.
In addition, the Company experienced increased competitive pricing pressures on
older network access products.
Spending for research and development in fiscal 1996 was slightly below
the fiscal 1995 level. Lower spending resulted as development efforts for
certain broadband products were curtailed in conjunction with the Company's
restructuring activities discussed in Note 8 to the financial statements.
Research and development represented 19% of sales in fiscal 1996 and 20% of
sales in fiscal 1995.
Sales, marketing and administration expense increased 33% to $30.4
million compared with $22.9 million in fiscal 1995. Increased expenses resulted
from domestic sales channel development, international selling and marketing
activities and certain non-recurring administrative charges relating to facility
consolidations. Sales, marketing and administrative expenses represented 32% of
sales in fiscal 1996 and 26% of sales in fiscal 1995.
During the third quarter of fiscal 1996, the Company's management
approved a plan to restructure its operations. As a result, the Company recorded
a restructuring charge of $4.2 million which was net of a recovery of $0.6
million associated with restructuring activities recorded in fiscal 1993. The
charge included costs associated with excess facility costs in Fremont,
California, the write-down of certain assets to net realizable value, and
employee severance costs. For a more complete discussion of the 1996
restructuring charge, please refer to Note 8 to the financial statements.
Amortization expense relates to the acquisition of the broadband family
of products in 1983, certain channel bank products in 1984, and the acquisition
of Magnalink Communications Corporation in 1992. Amortization expense was $0.8
million in both fiscal 1996 and fiscal 1995.
Interest income was $1.1 million in fiscal 1996 compared with $1.6
million in fiscal 1995. This decrease was principally related to a lower level
of average cash equivalents and short-term investments in fiscal 1996 compared
with fiscal 1995.
In fiscal 1996, the Company's operating loss did not generate currently
available tax benefits. In fiscal 1995, no tax provision was recorded due to the
availability of tax benefits relating to prior year operating losses and tax
credits not previously benefited.
13
14
LIQUIDITY AND CAPITAL RESOURCES
During fiscal 1997, cash and marketable securities decreased $2.3
million resulting in a year-end balance of $12.7 million compared with $15.0
million at the end of fiscal 1996. In order to support fiscal 1997 revenue
growth, cash of $4.1 million was consumed by operating activities. Cash was
required to fund increased inventory of $4.9 million, net payments on
liabilities of $3.2 million and increased accounts receivable of $1.6 million.
These requirements were partially funded by net income before non-cash expenses,
proceeds from the sale of an investment and an income tax refund. Capital
expenditures of $3.6 million were required to increase manufacturing capacity in
response to increased customer demand. During fiscal 1997, the Company entered
into a sale-leaseback arrangement for certain capital equipment which provided
cash of $2.6 million. Proceeds from the sale of common stock under various stock
option and purchase plans provided cash in the amount of $2.8 million.
Working capital at August 31, 1997 was $40.4 million, compared with
$35.9 million at August 25, 1996. The ratio of current assets to current
liabilities at fiscal year end was 2.9 compared with 2.6 at the end of last
year.
The Company maintains a $20.0 million secured line of credit with Fleet
Bank which is available to fund working capital requirements and is available
until May 30, 1998. In addition to this principal credit line, the Company has a
$3.5 million equipment financing line of credit with Fleet Bank which is
available until December 31, 1997. Although the Company did not utilize any of
its financing alternatives in fiscal 1997, approximately $.2 million was
reserved to cover various guarantees in effect at August 31, 1997.
Management believes that its cash and marketable securities and the
availability of its various financing arrangements will be sufficient to fund
operating cash requirements and future growth for the foreseeable future.
The Company practice has been to retain cash provided by operations to
fund future growth. Accordingly, the Company has never declared or paid a cash
dividend on its capital stock.
FACTORS THAT MAY AFFECT FUTURE FINANCIAL RESULTS
Discussions in this Form 10-K include statements concerning the Company's
future products, expenses, revenue, liquidity and cash needs as well as the
Company's future operations and financial results. These forward-looking
statements are based on current expectations. Accordingly, the Company assumes
no obligation to update this information. Numerous factors, including but not
limited to economic and competitive conditions, incoming order levels, shipment
volumes, and product margins, could cause actual results to differ from those
described in these statements. Prospective investors and stockholders should
carefully consider the foregoing factors, as well as those set forth below in
evaluating these forward-looking statements.
The Company's backlog may not be representative of actual sales for any
succeeding period because of the timing of orders, delivery intervals, customer
and product mix, the possibility of changes in delivery schedules, and additions
or cancellation of orders. Historically, a significant portion of the Company's
sales in any quarter result from orders received in the same period; thus, order
delays could have an immediate and materially adverse impact on sales and
profit. Recent merger activity among some of the Company's large customers could
adversely affect future orders as those customers reassess their strategic
direction. NYNEX, the Company's largest customer recently merged with Bell
Atlantic. Although the Company believes that its products continue to offer a
competitive advantage to NYNEX, there can be no assurance that their historic
order level will continue.
14
15
The Company operates in a highly competitive environment and in a
highly competitive industry, which include significant pricing pressures. These
competitive pressures could cause reduced demand for the Company's products. If
the Company was not successful in winning future business opportunities, there
could be insufficient revenue to cover costs and expenses incurred in
anticipation of these opportunities. Accordingly, the Company may from time to
time experience unanticipated intense competitive pressure, possibly causing
operating results to vary from those expected.
The Company's future operating results are dependent on its ability to
develop, produce and market new and innovative products and services. Critical
to the Company's growth strategy is the acceptance of the Access60 product and
certain broadband products. There are numerous risks inherent in this complex
process, including rapid technological change and the requirement that the
Company bring to market in a timely fashion new products and services which meet
customers' changing needs. The introduction of newer technologies could result
in lower demand for the Company's products and cause inventory on hand to become
obsolete. The Company experiences intense competition for skilled employees who
are in great demand. If important technical and management positions remain
unfilled, completion of product development and other programs could be delayed
causing financial results to be adversely affected.
Historically, the Company has generated a disproportionate amount of
its operating revenues toward the end of each quarter, making precise prediction
of revenues and earnings particularly difficult and resulting in risk of
variance of actual results from those forecast at any time. In addition, the
Company's operating results historically have varied from fiscal period to
fiscal period. Accordingly, the Company's financial results in any particular
fiscal period are not necessarily indicative of results for future periods.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL SCHEDULES PAGE
Report of Ernst & Young LLP Independent Auditors 16
Consolidated Statements of Operations 17
Consolidated Balance Sheets 18
Consolidated Statements of Shareholders' Equity 19
Consolidated Statements of Cash Flows 20
Notes to Consolidated Financial Statements 21
Supplementary Data (Unaudited) 30
Consolidated Financial Statement Schedules: 31
Schedule II-Valuation and Qualifying Accounts
(All other schedules for which provision is made
in Regulation S-X are not required or are
inapplicable and therefore have been omitted.)
15
16
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of Telco Systems, Inc.
We have audited the accompanying consolidated balance sheets of Telco
Systems, Inc. as of August 31, 1997 and August 25, 1996, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended August 31, 1997. Our audits also
included the financial statement schedule listed in the index at Item 14 (a).
These financial statements and schedule 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 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 consolidated financial position of
Telco Systems, Inc. at August 31, 1997, and August 25, 1996, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended August 31, 1997, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
ERNST & YOUNG LLP
Boston, Massachusetts
October 15, 1997
16
17
CONSOLIDATED STATEMENTS OF OPERATIONS Telco Systems, Inc .
Three years ended August 31, 1997 1997 1996 1995
- ------------------------------------------------------------------------------------------------
(In thousands except per share amounts)
Net sales ................................. $ 117,843 $ 93,954 $ 89,070
Costs and expenses
Cost of products sold ..................... 74,985 57,285 48,559
Research and development .................. 15,355 17,991 18,207
Sales, marketing and administration ....... 29,652 30,408 22,945
Restructuring costs (credit) .............. -- 4,209 (420)
Gain on investment ........................ (1,070) -- --
Amortization of intangible assets ......... 669 752 783
Interest income ........................... (670) (1,146) (1,632)
--------- --------- --------
118,921 109,499 88,442
--------- --------- --------
Net (loss) income ......................... $ (1,078) $ (15,545) $ 628
========= ========= ========
Average shares and equivalents ............ 10,701 10,357 10,345
Net (loss) income per share ............... $ (.10) $ (1.50) $ .06
See accompanying notes to consolidated financial statements.
17
18
CONSOLIDATED BALANCE SHEETS TELCO SYSTEMS, INC.
August 31, 1997 and August 25, 1996 1997 1996
- -----------------------------------------------------------------------------------------------------
(In thousands)
Assets
Current assets:
Cash and equivalents ........................................ $ 5,406 $ 8,461
Marketable securities ....................................... 7,302 6,581
Accounts receivable, less allowance for
doubtful accounts of $895 in 1997 ($676 in 1996) ........ 19,663 18,025
Refundable income taxes ..................................... -- 702
Inventories, net ............................................ 28,370 23,495
Other current assets ........................................ 985 810
-------- --------
Total current assets ................................... 61,726 58,074
Plant and equipment, at cost ..................................... 46,401 45,941
Less accumulated depreciation ............................... 36,712 33,411
-------- --------
Net plant and equipment ................................ 9,689 12,530
Intangible and other assets, less accumulated
amortization of $11,651 in 1997 ($10,935 in 1996) ............... 7,184 8,900
-------- --------
Total assets ................................................ $ 78,599 $ 79,504
======== ========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable ............................................ 7,292 $ 9,758
Payroll and related liabilities ............................. 3,492 3,649
Other accrued liabilities ................................... 10,528 8,750
-------- --------
Total current liabilities .............................. 21,312 22,157
Restructuring and other long-term liabilities .................... 1,531 3,350
Shareholders' equity:
Series A Participating Cumulative Preferred Stock, 200 shares -- --
authorized; no shares outstanding
Preferred stock, $.01 par value, 5,000
shares authorized; no shares outstanding .................... -- --
Common stock, $.01 par value, 24,000 shares authorized;
shares outstanding: 10,805 at August 31, 1997;
(10,520 at August 25, 1996) .................................. 108 105
Capital in excess of par value .............................. 76,602 74,267
Accumulated deficit ......................................... (20,886) (19,808)
Unearned compensation - restricted stock .................... (68) (567)
-------- --------
Total shareholders' equity ................................ 55,756 53,997
-------- --------
Total liabilities and shareholders' equity .................. $ 78,599 $ 79,504
======== ========
See accompanying notes to consolidated financial statements.
18
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CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY TELCO SYSTEMS, INC.
Three years ended August 31, 1997
- --------------------------------------------------------------------------------
Common Stock Paid-in Unearned Accumulated
Shares Amount Capital Compensation Deficit Total
------ ------ ------- ------------ ------------ -----
(In thousands)
Balance, August 28, 1994.................. 9,649 $ 96 $66,343 (4,891) 61,548
----- ------- ------- ------- ------
Net income for year....................... 628 628
Issuance of common stock:
Employee stock purchase plan............ 56 1 504 505
Exercise of stock options............... 526 5 4,719 4,724
------ ------- ------- ------- ------
Balance, August 27, 1995.................. 10,231 102 71,566 (4,263) 67,405
------ ------- ------- ------- ------
Net (loss) for year....................... (15,545) (15,545)
Issuance of common stock:
Employee stock purchase plan............ 56 514 514
Exercise of stock options............... 174 2 1,533 1,535
Restricted stock, net................... 59 1 654 $ (655)
Amortization of unearned
compensation.......................... 88 88
------ ------- ------- ------- --------- ------
Balance, August 25, 1996.................. 10,520 105 74,267 (567) (19,808) 53,997
Net (loss) for year....................... (1,078) (1,078)
Issuance (cancellations) of common stock:
Employee stock purchase plan............ 43 448 448
Exercise of stock options............... 284 3 2,360 2,363
Restricted stock, net................... (42) (473) 473 --
Amortization of unearned
compensation.......................... 26 26
------ ------- ------- ------- --------- ------
BALANCE, AUGUST 31, 1997 10,805 $ 108 $76,602 $ (68) $ (20,886) 55,756
====== ======= ======= ======= ========= ======
See accompanying notes to consolidated financial statements
19
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CONSOLIDATED STATEMENTS OF CASH FLOWS TELCO SYSTEMS, INC.
Three years ended August 31, 1997 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------
(In thousands)
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
Cash Flows from Operating Activities
Net (loss) income ................................... $ (1,078) $(15,545) $ 628
Depreciation and amortization ....................... 5,094 5,324 4,982
Restructuring costs (credit) ........................ -- 4,209 (420)
Amortization of unearned compensation ............... 26 88 --
Change in assets and liabilities
Accounts receivable, net ............................ (1,638) (7,978) 5,017
Refundable income taxes ............................. 702 549 (1,251)
Inventories, net .................................... (4,875) (6,074) (3,229)
Other current assets ................................ (175) 1,775 320
Other assets ........................................ 1,000 25 (924)
Accounts payable and other current liabilities ...... (1,512) 9,585 (4,401)
Restructuring liabilities ........................... (2,192) (1,845) (469)
Long-term liabilities ............................... 536 113 (330)
-------- -------- --------
Net cash (used in) provided by operating activities .... (4,112) (9,774) (77)
Cash Flows from Investing Activities
Additions to plant and equipment, net ............... (3,634) (6,336) (2,257)
Proceeds from sale - lease back ..................... 2,601 -- --
Purchase of marketable securities ................... (11,674) (24,350) (29,665)
Maturities of marketable securities ................. 10,953 28,664 29,716
-------- -------- --------
Net cash (used in) investing activities ............. (1,754) (2,022) (2,206)
Cash Flows from Financing Activities
Proceeds and related tax benefits from sale of common
shares under employee stock plans ................. 2,811 2,049 5,229
-------- -------- --------
Net cash provided by financing activities ........... 2,811 2,049 5,229
-------- -------- --------
(Decrease) increase in cash and equivalents ............ (3,055) (9,747) 2,946
Cash and equivalents at beginning of year .............. 8,461 18,208 15,262
-------- -------- --------
Cash and equivalents at end of year .................... $ 5,406 $ 8,461 $ 18,208
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash Paid During the Year
Income taxes ....................................... $ -- $ 89 $ 1,235
See accompanying notes to consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 1 SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION The financial statements consolidate the accounts of
Telco Systems, Inc., and its subsidiaries (the Company). Intercompany accounts
and transactions have been eliminated. The Company's fiscal year ends on the
last Sunday in August which included 53 weeks in fiscal 1997 and 52 weeks in
both fiscal 1996 and fiscal 1995. Certain amounts reported in prior years have
been reclassified to be consistent with the current year's presentation.
The Company has 50% limited partnership interests in two real estate
partnerships which are accounted for by the equity method of accounting. The
aggregate net investment in these partnerships on the accompanying balance
sheets is not material (See Note 7).
NEW ACCOUNTING STANDARDS In February 1997, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standards 128 (SFAS 128),
"Earnings Per Share" which will require adoption in the Company's second quarter
of fiscal 1998. This statement specifies the computation, presentation and
disclosure requirements of earnings per share. The Company believes that
adoption of this statement will have no material impact on its consolidated
financial statements and related disclosures.
In June 1997, the FASB issued Statement No. 130, "Reporting
Comprehensive Income" (SFAS 130). SFAS 130 establishes standards for reporting
comprehensive income and its components in a full set of general purpose
financial statements. SFAS 130 requires that items to be recorded in
comprehensive income, which include unrealized gains/losses on marketable
securities classified as available-for-sale and cumulative translation
adjustments, be displayed with the same prominence as other financial statement
items. The Company is in the process of determining the effect of adoption of
this statement on its consolidated financial statements and related disclosures.
SFAS 130 is required to be adopted in the Company's financial statements for the
year ending August 29, 1999.
In June 1997, the FASB issued Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information," (SFAS 131). SFAS 131
establishes standards for the way public business enterprises report information
about operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in interim
financial reports issued to shareholders. SFAS 131 also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. SFAS 131 is required to be adopted in the Company's financial
statements for the year ending August 29, 1999. The adoption of SFAS 131 will
have no impact on the Company's financial results or financial condition, but
may result in certain disclosures of segment information.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
REVENUE RECOGNITION In general, the Company recognizes revenue from product
sales at the time of shipment. In certain contractual situations, revenue is
recognized when the product is accepted by the customer.
21
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 1 (continued)
PRODUCT WARRANTY Expected future product warranty liability is provided for when
the product is sold.
CASH EQUIVALENTS AND MARKETABLE SECURITIES The Company classifies all of its
marketable securities as available-for-sale securities. These securities are
stated at their fair value. There are currently no unrealized holding gains and
losses. The Company considers all highly liquid investments with maturity of 91
days or less to be cash equivalents. Those instruments with maturities greater
than 91 are classified as marketable securities. Cash equivalents and marketable
securities are carried at market, and consist of U.S. Government securities,
bank certificates of deposit and corporate issues. All securities mature within
twelve months.
INVENTORIES Inventories are stated at the lower of cost or market. The cost of
products sold is based on standard costs, which approximate actual costs as
determined by the first-in, first-out method.
Inventories at fiscal year end were as follows:
1997 1996
---------- ----------
(in thousands)
Raw material.................................................................... $ 12,803 $ 12,112
Work-in-process................................................................. 5,605 5,560
Finished goods ................................................................. 9,962 5,823
---------- ----------
$ 28,370 $ 23,495
========== ==========
PLANT AND EQUIPMENT Additions to plant and equipment are recorded at cost.
Depreciation is determined by using the straight-line method over the estimated
useful lives of the assets - three to eight years. Leasehold improvements are
amortized on a straight-line basis over the shorter of their estimated useful
life or the lease term.
Plant and equipment, at cost, at fiscal year end were as follows:
1997 1996
--------- ---------
(in thousands)
Machinery and equipment......................................................... $ 33,313 $ 31,214
Furniture and leasehold improvements............................................ 13,088 14,727
--------- ---------
$ 46,401 $ 45,941
========= =========
INTANGIBLE AND OTHER ASSETS Intangible assets arising in connection with
business acquisitions were $7,122,000 and $7,791,000 at August 31, 1997 and
August 25, 1996, respectively. They are amortized over lives ranging from seven
to twenty-five years using the straight-line method, with an average remaining
life of 10.7 years. The carrying value of goodwill is reviewed periodically
based on the undiscounted cash flows of the entities acquired over the remaining
amortization period. Should this review indicate that goodwill will not be
recoverable, the carrying value will be reduced by the estimated shortfall of
undiscounted cash flows.
CONCENTRATIONS OF CREDIT RISK Financial instruments which potentially subject
the Company to concentrations of credit risk consist primarily of cash
equivalents, short-term investments, and accounts receivable. The Company's
temporary cash investments, which are principally limited to U.S. Government
securities and bank certificates of deposit, are subject to minimal risk. The
Company routinely assesses the financial strength of its customers and, as a
consequence, believes that its trade accounts receivable credit risk exposure is
limited.
22
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 1 (continued)
EARNINGS (LOSS) PER SHARE Earnings (loss) per share is based on the weighted
average number of common shares outstanding and common stock equivalents, if
dilutive. Fully diluted earnings per share did not differ significantly from
primary earnings per share in any year. Net loss per share in fiscal years 1997
and 1996 did not consider common stock equivalents as the effect would be
antidilutive.
NOTE 2 DESCRIPTION OF BUSINESS
The Company is engaged in a single business segment constituting the
development, manufacturing, and marketing of broadband transmission products,
network access products, and bandwidth optimization products for the
telecommunications industry. Regional Bell Operating Companies (RBOC),
independent telephone companies, and interexchange carriers are the primary
users of the Company's products. Sales to the RBOCs accounted for 39% of sales
in fiscal 1997, 37% of sales in fiscal 1996, and 29% of sales in fiscal 1995.
RBOC sales include sales to one RBOC of 33% in fiscal 1997, 31% in fiscal 1996,
and 17% in fiscal 1995. In fiscal 1997, two additional customers each
represented 11% and 10% of sales. In fiscal 1996, two additional customers each
represented 13% and 11% of sales. In fiscal 1995, one additional customer
represented 18% of sales.
NOTE 3 INCOME TAXES
The components of the provision (benefit) for income taxes were as follows:
Fiscal Year
-----------
1997 1996 1995
---------- --------- ------
Federal (In thousands)
Current ......................................................................... $ -- $ (1,105) $ (821)
Deferred ........................................................................ -- 1,105 821
---------- --------- ------
$ -- $ -- $ --
========== ========= ======
The provision (benefit) for income taxes differs from the amount computed using
the statutory rate as follows:
Fiscal Year
-----------
1997 1996 1995
----------- ----------- ----------
(In thousands)
Federal income taxes at statutory rate........................................... $ (366) $ (5,285) $ 214
Loss producing no current tax benefit............................................ 123 5,024
Amortization of goodwill......................................................... 243 247 267
Previously unbenefited deferred items ........................................... (566)
Other............................................................................ 14 85
----------- ----------- ----------
Income tax provision ............................................................ $ -- $ -- $ --
=========== =========== ==========
23
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 3 (continued)
The components of deferred tax assets and liabilities at fiscal year end are as
follows:
1997 1996
--------------------------
(In thousands)
DEFERRED TAX ASSETS
Restructuring costs ........................................................ $ 1,863 $ 2,942
Inventory and other reserves ............................................... 8,049 4,384
Net operating loss carryforward ............................................ 2,058 3,173
Tax credit carryforward .................................................... 4,019 3,543
Other ...................................................................... 97 187
-------- --------
16,086 14,229
Valuation reserve .......................................................... (15,009) (13,063)
-------- --------
Total deferred tax assets .................................................. 1,077 1,166
-------- --------
DEFERRED TAX LIABILITIES
Accelerated tax deduction .................................................. 1261 1,188
Amortization ............................................................... 267 287
Depreciation ............................................................... (373) (250)
Other ...................................................................... (78) (59)
-------- --------
Total deferred tax liabilities ............................................. 1,077 1,166
-------- --------
Net deferred tax assets .................................................... $ -- $ --
======== ========
SFAS 109, "Accounting for Income Taxes", requires that a valuation reserve be
established if it is "more likely than not" that realization of the tax benefits
will not occur. The valuation reserve increased by $1,946,000 in fiscal 1997.
This change is due primarily to an increase in the current year of inventory and
other reserves. These items have been fully reserved.
At August 31, 1997, the Company had net operating loss carryforwards to reduce
future taxable income of $5,000,000. To the extent not utilized, the U.S.
Federal net operating loss will expire in 2011. The Company also had unused
research and development and investment tax credit carryforwards of $4,000,000
at August 31,1997, which expire from fiscal years 1999 through 2012.
NOTE 4 ACCRUED LIABILITIES
Accrued liabilities at fiscal year end were as follows:
1997 1996
----------------------------
(In thousands)
Restructuring costs......................................................... $ 2,485 $ 2,322
Warranty and rework ........................................................ 2,027 1,173
All other accrued liabilities............................................... 6,016 5,255
----------- --------
$ 10,528 $ 8,750
=========== ========
24
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 5 LINE OF CREDIT
The Company maintains a $20.0 million secured line of credit with Fleet
Bank which is available until May 30, 1998. At August 31, 1997, $165,000 was
reserved to support various guarantees in effect at that date. Additionally, the
Company maintains a $3.5 million line of credit with Fleet Bank which is
specifically designated for the acquisition of capital equipment. This line of
credit is available until December 31, 1997.
There were no borrowings against these credit lines at August 31, 1997.
NOTE 6 LONG-TERM LIABILITIES
At August 31, 1997 and August 25, 1996, restructuring and other
long-term liabilities include $.3 million and $2.6 million, respectively, of
restructuring costs discussed in Note 8.
NOTE 7 LEASE COMMITMENTS
The Company leases a 216,000 square-foot manufacturing, research and
administration facility in Norwood, Massachusetts, from a limited partnership in
which the Company has a 50% interest. Neither the Company nor the other partners
have made or anticipate making any substantial capital contributions or advances
to the partnership. Under the partnership agreement, the Company, in addition to
its 50% interest, is entitled to a priority payment (which would proportionately
increase with an increase in the property value) out of the proceeds of any sale
or future refinancing of the property. The gross rent payable is $1.5 million
annually through January 31,1999. For the remainder of the lease term ending
January 31, 2004, gross rent payable is $1.7 million annually.
In June 1997, the Company entered into a sale-leaseback arrangement for
certain computer and other electronic equipment which provided cash of
approximately $2.6 million. The operating leases contained in the arrangement
cover periods from two to four years. All of equipment included in the
transaction was purchased by the Company within the last eighteen months.
The Company leases other facilities and certain equipment under
noncancelable operating leases expiring at various dates through 2005. The
Company is required to pay property taxes, insurance and normal maintenance
costs. Certain of the lease agreements provide for five-year renewal options,
and future lease payments could increase based on the Consumer Price Index.
Minimum annual lease commitments under non-cancelable operating leases
for facilities and equipment as of August 31, 1997 are set forth in the
following table. Amounts relating to excess facilities included herein have been
accrued as discussed in Note 8:
25
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 7 (continued)
Gross Lease Sub-lease Net Lease
Fiscal Year Payments income Payments
- --------------------------------------------------------------------------------------------------------------------------
(In thousands)
1998................................................... $ 3,570 $ 710 $ 2,860
1999................................................... 3,584 647 2,937
2000................................................... 3,256 509 2,747
2001................................................... 3,179 412 2,767
2002................................................... 2,887 69 2,818
Beyond................................................. 6,498 6,498
---------- ---------- -----------
$ 22,974 $ 2,347 $ 20,627
========== ========== ===========
Rent expense under operating leases was $3.1 million in fiscal 1997, $2.9
million in fiscal 1996, and $2.4 million in fiscal 1995.
NOTE 8 RESTRUCTURING COSTS
During fiscal 1996, the Company's management approved a plan to restructure
its operations and recognized the following charges (in thousands):
Excess Facilities...................................................... $ 2,225
Write-down of assets to net realizable value........................... 1,589
Employee severance costs............................................... 1,034
Restructuring credit relating to 1993 excess facilities costs.......... (639)
--------
$ 4,209
========
The plan included the consolidation and move of manufacturing operations from
the Company's Fremont, California facility to its facility located in Norwood,
Massachusetts. During fiscal 1997, the plan was accomplished within original
cost estimates. At August 31, 1997, the remaining reserve balance of $1,657,000
was specifically designated for excess facility costs at the Fremont, California
location.
At August 31, 1997, the remaining fiscal 1993 restructuring reserve for excess
facility costs for the Norwood, Massachusetts location was $1,098,000
NOTE 9 STOCK PLANS
Under the Company's 1980 Stock Option Plan, the 1988 Non-Qualified Stock Option
Plan, and the 1990 Stock Option Plan (the Plans), officers, directors, and key
employees have been granted options to purchase shares of the Company's common
stock at a price equal to the market value at the date of grant. Options
normally become exerciseable ratably over a 48 month period, commencing six
months from the date of grant, and expire after ten years. At August 31, 1997,
1,479,786 shares of common stock were reserved for issuance under the Plans.
26
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 9 (continued)
On May 20, 1997, the Board of Directors approved an amendment to the
Company's 1990 Stock Option Plan and reduced the exercise price of certain stock
options granted to employees between May 15, 1996 and May 13, 1997 at exercise
prices ranging from $11.50 to $20.875 per share. The exercise price was adjusted
to be equal to the current market price on that day. Stock options granted to
the Company's Board of Directors and to employees in conjunction with a general
option grant on March 5, 1997 were excluded from this action. Approximately
388,581 shares were reduced to the new exercise price of $9.625.
On February 15, 1996, 92,000 restricted shares of the Company's common
stock were granted and issued to certain key employees. Shares were awarded in
the name of each of the participants who have all the rights of other
stockholders, subject to certain restrictions and forfeiture provisions. At
August 31, 1997, 7,500 shares carried restrictions. Restrictions on the shares
expire ratably on the anniversary date of the award over the next three years.
A summary of the activity in the stock option plans for fiscal 1996,
1995, and 1994 is presented as follows:
Available Options Option Price
Stock Option Plans For Options Outstanding Per Share
----------- ----------- ------------
Balance at August 28, 1994........................ 166,936 1,248,850 $ 2.13 - $15.88
------- --------- -----------------
Grants....................................... (395,456) 395,456 $ 9.88 - $16.75
Authorized under 1990 plan................... 250,000
Exercised.................................... (525,568) $ 2.13 - $15.50
Canceled..................................... 159,439 (159,439) $ 3.38 - $16.25
Expired...................................... (1,167)
------- --------- -----------------
Balance at August 27, 1995....................... 179,752 959,299 $ 2.25 - $16.75
------- --------- -----------------
Authorized under 1990 Plan................... 350,000
Grants....................................... (572,305) 572,305 $ 9.63 - $16.38
Exercised.................................... (173,895) $ 3.00 - $16.25
Canceled..................................... 182,887 (182,887) $ 3.38 - $16.38
------- --------- -----------------
Balance at August 25, 1996........................ 140,334 1,174,822 $ 2.13 - $16.75
------- --------- -----------------
Authorized under 1990 Plan........................ 450,000
Grants....................................... (902,831) 902,831 $ 13.09 - $20.88
Exercised.................................... (284,370) $ 2.13 - $16.38
Canceled..................................... 677,297 (677,297) $ 3.00 - $20.88
Expired...................................... (1,000) $ 3.00
------- --------- -----------------
Balance at August 31, 1997........................ 363,800 1,115,986 $ 2.25 - $19.00
------- --------- -----------------
At August 31, 1997, August 25, 1996, and August 27, 1995, there were
464,589 shares, 464,767 shares, and 413,495 shares exerciseable, respectively.
27
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 9 (continued)
Under the Company's 1983 Employee Stock Purchase Plan, eligible
employees may purchase shares of common stock through payroll deductions (up to
a maximum of 10% of their salary) at a price equal to 85% of the lower of the
stock's fair market value at the beginning or at the end of each six month
offering period. There were 38,947 shares issueable under the Plan for fiscal
1997 of which 22,112 were outstanding at August 31,1997. For fiscal 1996 and
1995, 56,010 shares and 56,005 shares, respectively, were issued under the Plan.
At August 31,1997, 59,383 shares of common stock were reserved for issuance
under the Plan.
In October 1995, the Financial Accounting Standards Board issues
Statement of Financial Accounting Standard 123 (SFAS 123), "Accounting for
Stock-Based Compensation". SFAS 123 requires that companies either recognize
compensation expense for grants of stock, stock options and other equity
instruments based on fair value, or provide pro forma disclosure of net income
and earnings per share in the notes to the financial statements. The Company
adopted the disclosure-only provisions of SFAS 123 in fiscal 1997 and has
applied APB Opinion No. 25 and related interpretations in accounting for its
plans.
28
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 9 (continued)
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions:
Stock Options Employee Stock
and Awards Purchase Plans
1997 1996 1997 1996
Weighted Average fair value of shares $8.36 $10.54 $6.00 $4.16
Shares Granted 902,831 631,305 38,947 56,010
Assumptions:
Risk-free interest rate 5.9% 6.0% 5.0% 5.0%
Expected volatility 146.2% 144.4% 88.0% 87.2%
Expected life of grants: 5.5 years 5.5 years .5 years .5 years
Dividend yield None None None None
Outstanding and Exerciseable by
Price Range
As of August 31, 1997
Shares Outstanding Shares Exercisable
------------------ -------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Range of Outstanding Contractual Exercise Exerciseable Exercise
Exercise Prices at 8/31/97 Life Price at 8/31/97 Price
- -------------------------------------------------------------------------------------------------------------
STOCK OPTION PLAN
$ 2.25 - $ 8.63 125,309 5.02 $ 7.67 116,770 $ 7.61
$ 9.31 - $ 9.88 502,296 9.18 $ 9.60 96,507 $ 9.66
$10.00 - $11.38 279,025 8.19 $10.83 129,091 $10.91
$11.75 - $19.00 209,356 7.14 $14.57 122,221 $14.15
--------------- --------- ---- ------ ------- ------
$ 2.25 - $19.00 1,115,986 8.08 $10.62 464,589 $10.67
=============== ========= ==== ====== ======= ======
STOCK PURCHASE PLAN
$11.05 $ 22,112 -- $11.05 $22,112 $11.05
=============== ========= ===== ====== ======= ======
29
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 9 (continued)
Had compensation costs for the Company's stock option plans and
employee stock purchase plans been determined on the fair market value at the
grant dates for such awards, the Company's net loss and net loss per share would
approximate the pro forma amounts below:
1997 1996
Net loss:
As reported $ (1,078) $ (15,545)
Pro forma $ (4,380) $ (16,787)
Net loss per share:
As reported $ (.10) $ (1.50)
Pro forma $ (.41) $ (1.62)
The effects of applying SFAS 123 for the purpose of providing pro forma
disclosures may not be indicative of the effects on reported net income and net
income per share for future years, as the pro forma disclosures include the
effects of only those awards granted after August 27, 1995.
NOTE 10 EMPLOYEE BENEFIT PLAN
The Company maintains a defined contribution savings plan under the
provisions of Internal Revenue Code Section 401(k). Under the terms of the Plan,
the Company contributes up to 3% of base pay to a fund which is held by a
trustee. All employees are eligible to participate in the Plan and are entitled,
upon termination or retirement, to receive their vested portion of the savings
fund assets. The unvested portion remains in the Plan and is used to reduce
future Plan expense. Total Plan expense was $468,000 in fiscal 1997, $547,000 in
fiscal 1996, and $525,000 in fiscal 1995.
NOTE 11 STOCKHOLDER RIGHTS PLAN
On February 19, 1997, the Board of Directors of Telco Systems, Inc.
adopted a Stockholder Rights Plan (the "Plan") and distributed one Right for
each outstanding share of the Company's Common Stock, par value $.01 per share.
The Rights were issued to holders of record of Common Stock outstanding on
February 19, 1997. Each share of Common Stock issued after February 19, 1997
will also include one Right subject to certain limitations. Each Right when it
becomes exerciseable will initially entitle the registered holder to purchase
from the Company one one-hundredth (1/100th) of a share of Series A
Participating Cumulative Preferred Stock, par value $.01 per share ("Series A
Preferred Stock"), of the Company at a price of $50.00 (the "Exercise Price").
Currently, the Rights are attached to the Company's common stock. These
Rights are not now exerciseable and cannot be transferred separately. The Rights
become exerciseable and separately transferable when the Board learns that any
person or group (other than Kopp Investment Advisors, Inc. and its affiliates or
associates (collectively "KIA")), has acquired 15% or more of the Company's
outstanding common stock or on such date as may be designated by the Board
following the announcement of a tender or exchange offer for outstanding shares
of common stock which could result in the offeror becoming the beneficial owner
of 15% or more of the Company's outstanding common stock. Under such
circumstances, holders of the Rights will be entitled to purchase, for the
Exercise Price, that number of hundredths of a share of Series A
30
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 11 (continued)
Preferred Stock equivalent to the number of shares of the Company's common stock
(or under certain circumstances other equity securities) having a market value
of two times the Exercise Price. 15% holders (other than KIA), however, are not
entitled to exercise their Rights under such circumstances. As a result, their
voting and equity interests in the Company would be substantially diluted should
the rights ever be exercised.
The Rights expire in February 2007, but may be redeemed earlier by the
Company in accordance with the provisions of the Rights Plan at a price of $.01
per Right.
SUPPLEMENTARY DATA
QUARTERLY INFORMATION TELCO SYSTEMS, INC.
Quarterly financial information (unaudited) is as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars in thousands except per share amounts)
1997
Sales ......................... $ 31,835 $ 27,295 $ 27,411 $ 31,302
Gross profit .................. $ 12,473 $ 11,520 $ 8,293 $ 10,572
Net income (loss) ............. $ *2,274 $ 256 $ (4,017) $ 409
Net income (loss) per share ... $ .21 $ .02 $ (.37) $ .04
1996
Sales ......................... $ 20,533 $ 20,577 $ 23,223 $ 29,621
Gross profit .................. $ 8,421 $ 8,565 $ 8,049 $ 11,634
Net income .................... $ (2,620) $ (2,679) $**(11,454) $**1,208
Net income per share .......... $ (.26) $ (.26) $ (1.10) $ .11
*Fiscal 1997 net (loss) income includes a $1,070 gain on the sale of an
investment in the first quarter.
**Fiscal 1996 net (loss) income includes a restructuring charge of $4,659
in the third quarter and a restructuring credit of $450 in the fourth quarter.
31
32
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(Dollars in thousands)
Three Years Ended August 31, 1997
---------------------------------
1997 1996 1995
---- ---- ----
Allowance for Doubtful Accounts:
Balance at beginning of period........... $676 $649 $797
Charges to costs and expenses............ 292 102 63
Deductions............................... (73) (75) (211)
---- ---- ----
Balance at end of period................. $895 $676 $649
==== ==== ====
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
Incorporated by reference from the Definitive Proxy Statement, with the
exception that information regarding the executive officers of Telco
Systems, Inc. is contained in Item 1 Part I on page 8 of this report.
Item 11. EXECUTIVE COMPENSATION
Incorporated by reference from the Definitive Proxy Statement.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF TELCO
SYSTEMS, INC.
Incorporated by reference from the Definitive Proxy Statement.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the Definitive Proxy Statement.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
See index to Consolidated Financial Statements at page 15.
(a) 2. FINANCIAL STATEMENT SCHEDULES
See index to Consolidated Financial Statements at page 15.
32
33
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
(a)3. EXHIBITS
Management contracts and compensatory plans or agreements
required to be filed as exhibits pursuant to item 14(a) (3)
of Form 10-K are identified by asterisks (*).
3.1 Certificate of Incorporation of Telco Systems, Inc. (1)
3.2 Bylaws of Telco Systems, Inc., as amended. (2)
10.3 Telco Systems, Inc. Employee Stock Purchase Plan, as amended
through July, 1991 (3)*
10.4 Amendment to Telco Systems, Inc. Employee Stock Purchase Plan,
adopted August, 1991.*
10.5 Telco Systems, Inc. 1988 Non-Statutory Stock Option Plan, as
amended.*
10.8 Partnership Agreement relating to facilities of Telco Systems
Fiber Optics Corporation located at 63 Nahatan Street,
Norwood, Massachusetts, dated August 29, 1985. (7)
10.23 Lease of facilities of Telco Systems Fiber Optics Corporation
located at 63 Nahatan Street, Norwood, Massachusetts, dated
December 12, 1985. (4)
10.38 Telco Systems, Inc. 1990 Stock Option Plan, as amended.*
10.39 Lease dated May 3, 1990 between the Registrant and Pactel
Properties for facilities located at 4305 Cushing Parkway,
Fremont, California (7)
10.40 Stock Purchase Agreement between Registrant and Magnalink
Communications Corporation dated May 29, 1992. (4)
10.42 Amendment to lease of facility located at 63 Nahatan Street,
Norwood, MA dated January 1, 1994. (5)
10.44 Stock Purchase Agreement and Registration Rights Agreement
between the Registrant and Unitech Telecom, Inc. dated March
29, 1995 (6)
10.45 Amendments one and two to lease of facility in Fremont,
California between the Registrant and Riggs National Bank of
Washington D.C. as trustee of the Multi-Employer Property
Trust, (successor to Pactel Properties) dated April 12, 1995
and May 8, 1995, respectively. (6)
10.46 Agreement between the Registrant and John A. Ruggiero dated
March 26, 1996. (7)*
10.48 Agreement between the Registrant and William B. Smith dated
March 6, 1995. (6)*
33
34
10.49 Amendments three to lease of facility in Fremont, California
between the Registrant and Riggs National Bank of Washington
D.C. as trustee of the Multi-Employer Property Trust,
(successor to Pactel Properties) dated January 22, 1996. (7)
10.50 Sale Leaseback Agreement between the Registrant and G.E.
Capital Corp. dated June 6. 1997.
10.51 Agreement between the Registrant and William J. Stuart dated
August 29, 1997.*
10.52 Agreement between the Registrant and Anand S. Parikh dated
September 8, 1997.*
10.53 Agreement between the Registrant and Richard J. Nardone dated
August 29, 1997.*
10.54 Rights Agreement between the Registrant and the First National
Bank of Boston as Rights Agent dated February 19, 1997. (8)
10.55 Certificate of the Voting Powers, Preferences and Relative,
Participating, Optional and Other Special Rights,
Qualifications, Limitations or Restrictions of Series A
Participating Cumulative Preferred Stock. (9)
22.1 Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors.
27 Financial Data Schedule
Notes: (1) Incorporated by reference to Exhibit 3.1 to Appendix II of
the definitive proxy statement of the Company dated November
20, 1986 relating to the Annual Meeting of Shareholders on
December 17, 1986.
(2) Incorporated by reference to Exhibits 3.2 to the
Registrant's Report on Form 10-K for its fiscal year ended
August 30, 1987.
(3) Incorporated by reference to Exhibit 4.1 to the Registrant's
Form S-8 (File No. 33-26976).
(4) Incorporated by reference to Exhibits 10.23 and 10.40,
respectively, to the Registrant's Report on Form 10-K for
its fiscal year ended August 30, 1992.
(5) Incorporated by reference to Exhibit 10.38 and 10.42,
respectively to the Registrant's Report on Form 10-K for its
fiscal year ended August 28, 1994.
(6) Incorporated by reference to Exhibit 10.44 and 10.45,
respectively to the Registrant's Report on Form 10-K dated
August 27, 1995.
(7) Incorporated by Reference to Exhibit 10.8, 10.39, 10.46, and
10.49, respectively, to the Registrant's Report on Form 10-K
dated August 25, 1996.
34
35
(8) Incorporated by Reference to Exhibit 1 to the Registrant's
Form 8-A dated February 19, 1997.
(9) Incorporated by Reference to Exhibit 4(b) to the
Registrant's Report on Form 8-K dated February 19, 1997.
(b) Reports on Form 8-K
There were no reports filed on Form 8-K during the fourth quarter of
fiscal 1997.
35
36
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.
Dated: November 26, 1997 TELCO SYSTEMS, INC.
/s/ William B. Smith
--------------------
By William B. Smith
President and Chief Executive Officer
and Director (Principal Executive Officer)
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
registrant and in the capacities and on the date indicated.
/s/ William J. Stuart Vice President and
- --------------------- Chief Financial Officer Date: November 26,1997
William J. Stuart (Principal Financial and
Accounting Officer)
/s/ William B. Smith President and Chief Executive Date: November 26,1997
- --------------------- Officer/Director
William B. Smith
/s/
- --------------------- Director Date:
Dean C. Campbell
/s/ Sheldon Horing Director
- ---------------------
Sheldon Horing Date: November 20,1997
/s/ Steward Flaschen Director Date: November 20,1997
- ---------------------
Steward Flaschen
/s/ John A. Ruggiero Director Date: November 24,1997
- ---------------------
John A. Ruggiero
36
37
EXHIBIT INDEX
-------------
EXHIBIT PAGE
NUMBER EXHIBIT NUMBER
- -------------------------------------------------------------------------------
10.4 Amendment to Telco Systems, Inc. Employee Stock Purchase Plan, 38
Adopted August, 1991.*
10.5 Telco Systems, Inc., 1988 Non-Statutory Stock Option Plan, as 39
Amended.*
10.38 Telco Systems, Inc., 1990 Stock Option Plan, as Amended.* 47
10.50 Sale Leaseback Agreement between the Registrant and G.E. Capital 55
Corp. dated June 6, 1997.
10.51 Agreement between the Registrant and William J. Stuart dated 66
August 29, 1997.*
10.52 Agreement between the Registrant and Anand S. Parikh dated 73
September 8, 1997.*
10.53 Agreement between the Registrant and Richard J. Nardone dated 80
August 29, 1997.*
22.1 Subsidiaries of the Registrant. 87
23.1 Consent of Ernst & Young LLP, Independent Auditors 88
27 Financial Data Schedule
37