SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________ to ________________________
Commission file number 000-22017
NACT TELECOMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0378662
(State or Other Jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
191 West 5200 North, Provo, Utah 84604
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (801) 802-3000
Securities registered pursuant to Section 12(b) of the Act: None
Name of each exchange
Title of each class on which registered
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the 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. /X/
The aggregate market value at December 23, 1997 of the Registrant's Common
Stock, $0.01 par value (based upon the closing price of $15.00 per share of such
Shares on the Nasdaq Stock Market), held by non-affiliates of the Company was
approximately $45,226,275.00. Solely for the purposes of this calculation,
shares held by directors and officers of the Registrant have been excluded. Such
exclusion should not be deemed a determination or an admission by the registrant
that such individuals are, in fact, affiliates of the Registrant.
At December 23, 1997, there were outstanding 8,128,797 shares of the
registrant's Common Stock, $0.01 par value.
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DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's definitive proxy statement to be filed not
later than January 28, 1998 pursuant to Regulation 14A are incorporated by
reference in Items 10 through 13 of Part III of this Annual Report on Form 10-K.
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TABLE OF CONTENTS
PAGE NO.
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PART I
Item 1 Business 3
Item 2 Properties 15
Item 3 Legal Proceedings 15
Item 4 Submission of Matters to a vote of Security Holders 16
PART II
Item 5 Market for Registrant's Common Equity and
Related Stockholder Matters 16
Item 6 Selected Financial Data 17
Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations 19
Item 7A Quantitative and Qualitative Disclosures about Market Risk 23
Item 8 Financial Statements and Supplementary Data 23
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures 46
PART III
Item 10 Directors and Executive Officers of the Registrant 46
Item 11 Executive Compensation 46
Item 12 Security Ownership of Certain Beneficial Owners
and Management 46
Item 13 Certain Relationships and Related Transactions 46
PART IV
Item 14 Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 46
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FORWARD-LOOKING STATEMENTS
This Form 10K contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1993, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, which are intended to be covered by
the safe harbors created thereby. Although the Company believes that the
assumptions underlying the forward-looking statements contained herein are
reasonable, any of the assumptions could be inaccurate, and therefore, there can
be no assurance that the forward-looking statements included in this Form 10-K
will prove to be accurate. Factors that could cause actual results to differ
from the results discussed in the forward-looking statements include, but are
not limited to, the Company's dependence on recently introduced products and
products under development, competition and the impact of technological change
on the Company's products. In light of the significant uncertainties inherent in
the forward -looking statements included herein, the inclusion of such
information should not be regarded as a representation by the Company or any
other person that the objectives and plans of the Company will be achieved.
PART I
ITEM 1 - BUSINESS
General
NACT Telecommunications, Inc. (the "Company") was incorporated in the State of
Utah in January 1982. The Company reincorporated in Delaware in February 1997.
The Company's address is 191 West 5200 North, Provo, Utah 84604 and its
telephone number is (801) 802-3000.
The Company provides advanced telecommunication switching platforms with
integrated applications software and network telemanagement capabilities. The
Company designs, develops and manufactures all hardware and software elements
necessary for a complete fully integrated, turnkey telecommunications switching
solution. Its customers do not require the multiple suppliers of hardware and
value added resellers of software that would otherwise be necessary to provide a
wide range of services and applications. The Company's customers include
national and international long distance carriers, prepaid debit card and
prepaid cellular network operators, international call back/reorigination
providers and other specialty telecommunications service providers.
The Company's products and services include the STX application switching
platform, the NTS telemanagement and billing system (the "NTS"), facilities
management services, and selling and servicing LCXs. The STX (the "STX") is an
integrated digital tandem switching system that currently supports up to 1,344
ports per switch and can be combined with two additional STXs to provide a total
capacity of 4,032 ports per system. The STX includes proprietary systems
software that enables standard applications such as 1+ and optional advanced
applications such as international call back/reorigination, prepaid debit card
and prepaid cellular. The Company has targeted the STX, with its enhanced
features and scaleable capacity, to an expanded group of customers, including
independent telephone companies, CAPs/CLECs, shared tenant service providers,
Fortune 1000 corporations and local telephone companies within and outside the
United States. The NTS performs call rating, accounting, switch management,
invoicing and traffic engineering for multiple switches that may either be NACT
switches or a number of other industry switches. In conjunction with the sale of
a system, the Company offers a facilities management service whereby the Company
will operate and maintain a customer's switch for a fee. In providing this
service, the Company enables its customers to direct their attention toward
marketing their products rather than initially focusing on the technical aspects
of operating a switch.
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CURRENT YEAR'S DEVELOPMENTS
The Company completed an initial public offering ("IPO") of its common stock in
March 1997. A total of 3,000,000 shares of Common Stock were sold; 2,000,000
shares by the Company and 1,000,000 shares by GST USA, Inc., the Company's
parent ("Selling Shareholder" or "GST USA"). The selling price per share was
$10.00. The Company and the Selling Shareholder received gross proceeds of
$20,000,000 and $10,000,000, respectively. The net proceeds to the Company from
the sale, after deducting underwriting discounts and offering expenses, was
approximately $18,067,000. The Company did not receive any proceeds from the
sale of Common Stock by the Selling shareholder.
On July 1, 1997 the Company completed the planned move of its corporate
headquarters and manufacturing facilities from Orem, Utah to Provo, Utah. The
new building was paid for from the proceeds of the IPO. The new facility has
increased the Company's manufacturing capabilities by approximately 300%. The
Company's former corporate headquarters and manufacturing facility was being
leased on a month to month basis.
In Fiscal 1997, the Company opened new sales and technical support offices in
Florida, New York, New Jersey and in the United Kingdom. Also, the Company made
its first international sales of its STX and NTS products in the fiscal fourth
quarter of 1997.
INDUSTRY BACKGROUND
Deregulation of long distance phone service in 1984 opened competition in the
telecommunications market to companies such as MCI Communications, Inc. ("MCI"),
Sprint Corporation ("Sprint"), WorldCom Inc. ("WorldCom"), and many smaller
specialty services providers. Today, there are over 450 long distance companies
in the United States according to the FCC. In addition to basic long distance
calling (1+), many of these companies are providing high value added, specialty
long distance products such as international call back/reorigination, prepaid
debit card and prepaid cellular to differentiate their services from each other
and to generate higher margin revenue than basic long distance phone services
can provide.
International call back/reorigination, International call back/reorigination
companies provide least cost long distance calling services from one foreign
country to another through the use of a switch located in the United States that
takes advantage of the lower rate per call charged in the United States.
According to M.J. Scheele and Associates ("M.J, Scheele"), the international
call back/ reorigination market increased from $300 million in 1994 to $485
million in 1995, with estimated growth in 1996 to over $750 million and over
$1.1 billion by 1997. M.J. Scheele also estimates that growth in the number of
call back reorigination providers will continue as well from 103 by the end of
1995 to 144 by the end of 1996 and 188 by the end of 1997. The Company believes
that as deregulation takes place in specific countries, international call
back/reorigination providers will be positioned for additional opportunities to
provide direct dial international calling by virtue of their established
customer base.
Prepaid debit cards/Prepaid cellular. Prepaid debit cards allow users to make
long distance calls from any touch tone phone based on a given number of minutes
that have been credited to the card. Prepaid debit card applications include
promotional campaigns, fund raising for charitable organizations and budgeted
out-of-town calling for travelling employees. In addition, prepaid debit cards
allow long distance companies to generate revenues from a base of customers who
would otherwise not have the opportunity to take advantage of long distance
services due to credit and other considerations. The United States prepaid debit
card market is expected to grow from $12.0 million in 1992 to approximately $1.1
billion in 1996 to over $2.0 billion in 2000, according to MultiMedia Publishing
Company ("MultiMedia"). An emerging application in the prepaid market is prepaid
cellular, a service whereby cellular phone users can limit their monthly dollar
usage automatically in the same manner that a prepaid debit card limits the time
a user can call. The Company believes that the potential prepaid cellular market
is not currently being effectively addressed in the United States. The potential
market, which, according to MultiMedia, is approximately $1.5 billion and is
expected to exceed $3.0 billion by 2000, consists of a large number of potential
users who either are denied traditional cellular service due to lack of credit
or need to limit the usage of cellular service. Prepaid cellular offers a way to
capture revenue from these potential subscribers.
1+. One plus is a dialing method that enables equal access to telephone networks
by all service providers offering direct dial long distance, whether inside or
outside of a caller's own area code. This protocol also enables the introduction
of telephone exchanges with the same three digits as area codes. The 1+ market
is comprised of both large global companies including MCI, Sprint, AT&T and
WorldCom and smaller, entrepreneurial long distance providers that are either
facilities based or switchless. Historically, these smaller specialty services
providers have competed exclusively based on price. However, the Company
believes that these companies are competing increasingly based on their ability
to provide enhanced services as well as on price. According to Frost & Sullivan,
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revenues in the United States 1+ market are predicted to exceed $70.0 billion by
1998. The share of total long distance revenues related to international
services rose from 16.0% in 1994 to 17.0% in 1995 and is likely to exceed 20.0%
by 1999. Additionally, Frost & Sullivan estimates that the international market
is growing over two times as fast as the domestic market.
As long distance service providers have increasingly offered enhanced services
to their customers, demand for these services has also increased in the local
exchange market. Competitors such as Competitive Access Provider ("CAPS"),
Competitive Local Exchange Carrier ("CLECs"), cellular and Personal
Communications Services Providers ("PCS"), specialized mobile radio companies
and, more recently, cable television providers have begun rapidly deploying
enhanced services and providing cost effective interfaces to long distance
carriers. In addition, the Telecommunications Act of 1996 allows CLECs to
compete with the incumbent Local Exchange Carrier ("LEC") (generally, the
Regional Bell Operating Company or GTE) for basic local telephone service.
NationsBanc Capital Markets, Inc., in 1996, estimated that the business and
institutional market for telecommunications services totals approximately $72.0
billion, all of which is addressable by CLECs. Additionally, demand for enhanced
services is expected to increase internationally as new service opportunities
result from the combination of privatization of previously government-owned
telecommunications systems, competition created in these international markets
and the creation of services in developing countries with typically low
densities of telephones.
The Company believes that companies competing in this new environment require
switching platform systems that are flexible to meet the diverse requirements of
an expanding array of applications. These systems must be compatible with the
variety of transmission technologies utilized by telephone companies and must be
capable of processing multiple concurrent services. In order to provide enhanced
services to end users, a provider must purchase (i) one or more applications
switch platforms, (ii) software applications to run the switches and provide
system functionality and (iii) a billing system. Historically, an entrepreneur
interested in entering the international call back/ reorigination, prepaid debit
card and prepaid cellular markets had to purchase each of these components from
a separate vendor. Customers who purchase components from different sources
must, either on their own or through the services of a consultant, configure the
disparate components and provide for the system's maintenance and upgrading.
This requires a significant expenditure of time and money, limits
interoperability and technology upgrading, and diverts company resources. The
Company believes that in today's market environment its customers require
solutions that allow quick, easy entry into the market, flexibility to add new
services and additional capacity, high reliability and low cost.
THE NACT SOLUTION
The Company provides its customers with a complete, integrated package
consisting of both the application platform hardware and the operations
application software necessary to provide a full array of intelligent network
services. The Company offers a switching solution that includes essentially all
of the key elements necessary to enable a customer to offer enhanced services
such as; the installation of the switch, the training of the customer for the
use of the switch, available applications, a billing system, consulting
services, and ongoing customer support. The Company believes that it is the only
provider of a system that integrates all of these components into one
comprehensive package that includes a broad range of applications, competitive
pricing, interoperability and scaleable port capacity. The Company sells its
products to long distance carriers, international call back/reorigination
providers, prepaid debit card and prepaid cellular network operators and other
specialty telecommunications service providers.
The Company offers a turnkey system, integrated with customer support that can
be quickly implemented and upgraded to meet evolving market requirements. The
Company makes available to its customers a full array of technical and
commercial support on a 24-hour-a-day, seven-day-a-week basis. The Company also
offers to manage and operate a customer's application platform and provide
competitively priced network services. Further, the Company continually develops
enhancements to its software applications in an effort to enable its customers
to utilize the latest technologies and most efficient systems available. The
Company strives to address its customers' specific needs and regularly enhances
its products to meet such needs. The Company believes its products enable its
customers to enter the marketplace and expand their businesses with increased
switching capacity and software applications as the need arises.
THE NACT STRATEGY
The Company's objective is to be a leading manufacturer and supplier of turnkey
solutions to providers of enhanced telecommunications services on a worldwide
basis. Key elements of the Company's strategy are to:
o Provide a Complete Integrated Switch Solution. The Company's product
strategy is to offer a switching platform consisting of both the
hardware and software necessary to provide intelligent network
services, thus offering a single source solution to its customers. The
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Company provides its customers with a switching solution that includes
essentially all of the key elements a customer needs to offer enhanced
telephone services. The Company's package also includes installation
and training with respect to the use of the switch and the
applications. The Company offers facilities management services to
operate and maintain a customer's switch. In addition, the Company
offers long distance carrier services to its facilities management
services customers. Currently, this long distance carrier service is
provided to customers with operations primarily in Brazil and Eastern
Europe.
o Focus on Growth-Oriented Telecommunications Providers. The Company
focuses on emerging providers of enhanced long distance and local
telecommunications services that are entering existing service markets
recently opened to competition. The Company expects to capitalize on
the opportunities created by the deregulation of the telecommunications
industry worldwide and the resulting increased demand for advanced,
integrated telecommunications switching equipment by offering enhanced
services and network management and billing systems. The Company
believes that as the telecommunications industry continues to evolve,
individual providers will offer more diverse services and, as a result,
will require intelligent switches with application software and
flexible billing systems.
o Build Direct Sales Organization. The Company believes that a direct
sales organization that understands and can solve complex switching and
network management and billing system requirements will enable the
Company to increase product sales to specialty telecommunications
network service providers. The Company has an established sales
presence in Utah, New York and Florida. The Company is currently
establishing a sales presence in the United Kingdom and intends to
further expand its sales organization both domestically and
internationally.
o Target Customers with Large Capacity Requirements. Historically, the
Company has focused its sales and marketing efforts on small,
entrepreneurial telecommunications service providers for which 480 port
integrated switching systems were adequate to serve their customer
base. With the introduction of the STX and its enhanced, interoperable
feature set and capacity to provide 4,032 ports, the Company is capable
of addressing the port requirements of larger customers. This customer
base consists of larger IXCs and LECs, rural independent telephone
companies, CLECs, organizations with large volumes of
telecommunications traffic (especially multinational corporations) and
manufacturers of large port capacity switches that do not have
integrated capabilities to provide enhanced telephony services.
o Expand into International Markets. The Company believes that the
international markets for competitive services present significant
opportunities for its products. To facilitate the implementation of its
international strategy, the Company is developing and adapting its
existing products to meet international standards such as international
dialing plans, E-1 and R-2 signaling. The Company intends to build its
international presence by forming relationships with distributors,
service providers and large telecommunications equipment manufacturers
and by creating an international sales force.
o Maintain a High Level of Customer Satisfaction. The Company's customers
operate in an environment in which reliability and availability of
technical support are increasingly critical factors. The Company's
manufacturing and technical support operations are intended to achieve
high reliability of its products and services. The Company's technical
support staff provides business consulting as well as trouble-shooting
services to its customers. The Company believes that its research and
development efforts contribute materially to ongoing customer
satisfaction by providing product features requested by customers. The
Company makes a significant number of sales as a result of repeat sales
and referrals from its existing customers. The Company also believes
that significant investments in research and development will be
important in maintaining and building its customer base. During the
year, the Company opened new technical support offices in Florida, New
Jersey and the United Kingdom.
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PRODUCTS
The Company's product line consists of the STX Switching System, the NTS billing
system and the LCX switching platforms.
THE STX SWITCHING SYSTEM
The Company's STX Switching System consists of an integrated application
switching platform and a suite of applications software. The Company sells an
optional companion Master Control Unit ("MCU") to integrate and service multiple
STXs and to add redundancy to the network. The Company has targeted the STX to
an expanded group of customers, including larger enhanced long distance
providers, independent telephone companies, CAPs/CLECs, shared tenant service
providers, Fortune 1000 corporations and local telephone companies in other
countries. The Company believes that its STX switching platform meets or exceeds
the scaleability, performance, interoperability and reliability standards of
this expanded customer base. The Company believes that the STX offers value
added features and capacity at price points typically below those offered by its
competitors.
The STX application switching platform was designed as a hardware platform for
the enhanced service features that are delivered by the Company's own suite of
applications software. The STX platform consists of a digital tandem switch that
currently supports up to 1,344 ports per switch. It is a single chassis design
with dual disk drives or RAID mass storage, digital audiotape (DAT) or digital
linear tape (DLT) back-up, console and dual modems. The simplicity of its design
makes it a reliable hardware platform to which enhanced telecommunications
service features can easily be added by software. The STX platform has also been
designed so that users can easily replace boards by hotswapping them, a process
that does not require the user to shut down or temporarily disable the switching
system.
The STX applications switching platform has a cost-effective design
incorporating only three types of boards, CPU, T-1 and DSP, and a chassis with a
backplane that supports 2,048 time slots. The current CPU board is powered by a
33 MHz Motorola 68040 processor and contains 64 or 128 megabytes of RAM, a
SCSI-2 peripheral interface, two ARCnet LAN controllers (backplane and external
for communication with the MCU and other STX switches), eight RS-232 serial
ports and alarm LEDs and external relays. The T-1 board is powered by a Motorola
processor and has two megabytes of RAM, an ARCnet LAN controller, and eight T-1
interface controllers that handle 192 ports. The DSP board uses a Motorola
processor with eight megabytes of RAM, an ARCnet controller, three DSP
processors (96 or 120 channels of tone decoding or encoding) and a 64-channel
audio device for the playback of integrated audio messages or the temporary
recording of audio. Each DSP board may cache up to seven megabytes of
frequently-used audio phrases, regardless of language. All boards have been
designed with low-cost components.
The STX hardware platform can operate on a standalone basis with a port capacity
of 1,344. The Company's optional MCU can link up to three STXs , which can be
served by a common database for a total system capacity of 4,032 ports. The STX
is also designed to work seamlessly with the Company's NTS 1000 and future NTS
2000 billing systems.
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APPLICATIONS SOFTWARE
The Company's suite of STX applications software consists of over one million
lines of code. This software supports major application features that are fully
integrated and interoperable. The major applications features include: equal
access calling (1+), automated operator (0+), live operator service provider
support (0-), real-time validation of credit card and billing numbers, prepaid
debit cards, prepaid cellular, international call back, phone centers, real-time
rating, fraud minimization, external computer application programming
interfaces, call re-origination, and integrated audio with twenty two languages.
Interoperability enables several applications packages to be used in conjunction
with each other. For example, a prepaid, international call back call can be
assisted by a live operator and rated as a prepaid, operator-assisted,
international call back call. Almost all features are implemented in software,
allowing unlimited capability for enhancement and customization.
MASTER CONTROL UNIT
The Master Control Unit allows interconnectivity between multiple NACT STX
platforms and permits database information to become centralized by connecting
co-located NACT systems. Interconnectivity permits expanded carrier call
routing. With more ports available due to the MCU, the likelihood of a caller
receiving a "system busy" signal is essentially eliminated. Downtime of a single
switch has minimal caller impact when proper carrier management is used.
THE COMPANY'S STX SWITCHING APPLICATIONS PLATFORM
Scaleability. The STX architecture allows configurations from 24 to 1,344 ports
in a single chassis. The MCU allows up to three STX platforms to use a single,
common database and to appear as a single applications system of up to 4,032
ports with common control of required features such as concurrency checking and
fraud minimization. This performance is achieved using the current Motorola
68040 CPU board. With a new CPU board under development by the Company,
incorporating a Motorola 68060 microprocessor, the STX and MCU systems will
achieve the full capacity of their architectures of 2,048 and 8,192 ports,
respectively.
Performance. The STX applications platform with the Motorola 68040 CPU board can
process seven to eight million call minutes per month in a 1,024 port nonblocked
configuration. The Motorola 68060 processor will increase capacity to 15 million
call minutes in a 2,048 port nonblocked configuration. By linking four STXs with
the MCU, capacity will be increased to up to 60 million call minutes per month
using the Motorola 68060 CPU board.
Interoperability. The STX applications platform has been developed to allow
multiple application packages to run simultaneously and in a seamless fashion.
An example would be a client wishing to use international call
back/reorigination, with the assistance of an operator to place the call, and
the cost of the call being debited from the client's prepaid calling account.
Virtually all features are implemented in the software allowing unlimited
capability for enhancement and customization.
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Reliability. The STX applications platform is designed using digital components
and is capable of running on single or redundant power supplies. When multiple
STX platforms are placed under the control of an MCU, the failure of a single
STX platform is handled through carrier routing of calls into the remaining STX
systems. With the introduction of the redundant MCU feature, the failure of a
single STX will not compromise the routing of calls through the system.
NTS BILLING SYSTEM
The NTS 1000 is a call rating, accounting, switch management, invoicing and
traffic engineering system designed to process the day-to-day operations of a
small-to-medium sized long distance company. The NTS 1000 can collect calls from
most major switching platforms including the STX and LCX application platforms
and can rate all types of call traffic and, using a sophisticated rating engine,
provides the owner with a highly flexible and completely customized rating
capability. The accounting system handles all of the required information for
managing a long distance customer base including configuration of authorization
codes, ANIs, accounts receivable, and management of delinquent accounts. A major
feature of the NTS 1000 is its switch management capability. When coupled with
the STX and LCX application platforms, information that has been entered into
the NTS 1000 can be electronically transferred into these systems, thereby
minimizing data entry needs. This integrated communication between the NTS 1000
and the LCX and STX also allows for automatic disabling of authorization codes
or ANIs when credit limits are exceeded. The NTS 1000 also has complete
international call back/reorigination and prepaid debit card management support,
as well as a complete invoicing package that supports multiple invoice styles
and options for summary reports. It has a sophisticated traffic engineering
reporting package that provides the ability to generate over 20 types of reports
with a user specified beginning and ending time range.
The NTS 1000 system uses high performance Pentium, Pentium Pro or Pentium II
servers using RAID and error correcting code (ECC) memory with the option of
adding additional processors. It uses SCO's latest Unix offering, 5.0, which
supports multiple processors and has full LAN support and enhanced Unix
graphical user interface (GUI) system administration tools. The NTS 1000 uses
Unify's relational database management system (RDBMS) for storage of information
and for screen entry and reports. Access to the application can be either
through a LAN using a terminal emulation package on PCs or using terminals
connected directly through RS-232 ports.
The NTS 2000 is the Company's next generation billing system. This system is a
state-of-the-art product incorporating leading edge technology and data
processing techniques. This new product integrates the popular features and
functionality of our existing NTS 1000 billing system with the following major
enhancements: real time data processing including call collection and call
rating, user friendly graphical user interface (GUI), open system connectivity
which allows integration with other information systems, enhanced security and
audit trails of user activity. This new system utilizes Informix's industry
standard On-Line Dynamic Server RDBMS, which provides for expanded growth and
also takes advantage of multiprocessor configurations. The new GUI screens
provide an advanced user interface, which dramatically increases user
productivity by consolidating operational, and management needs and providing an
environment that is user friendly and intuitive. The NTS 2000 has additional
functionality including: support of 250 digit authorization code numbers,
complete support of international rating, real time credit limit checks, and
real-time customer support management.
The NTS 2000 was released to a customer on an alpha test basis during the fiscal
fourth quarter of 1997 and is projected to be released for general sale during
the second quarter of fiscal 1998.
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LCX Switching System. Prior to introducing the STX, the Company's principal
product was the LCX applications platform, which has a maximum capacity of 480
ports in a single cabinet configuration. While the Company continues to sell
refurbished LCXs and support users of LCXs, the Company does not plan to
manufacture additional LCXs or develop ongoing enhancements for the LCX. The
versatility of the LCX, which was designed to operate in an unattended
environment, enables it to provide, in an integrated fashion, the following
applications: long distance, pay phone or courtesy phone network management,
international call back/reorigination and prepaid debit card. During the
introduction of the STX, the Company offered an option to customers of the LCX
to return their LCX system in exchange for a discount on their purchase of an
STX system. The Company refurbishes and resells the returned LCX systems, which
are attractive to customers with lower capacity and feature requirements. The
reliability of the LCX enables the system to be easily refurbished by general
cleaning and functional testing procedures. The system is then upgraded to the
latest LCX configuration, including both hardware and software, and made ready
for shipment to customers. Refurbished LCXs are currently being sold with any
two applications and five languages and is targeted to smaller customers who are
considering buying a PC-based switch without an integrated billing system for
essentially the same price.
Services. The Company offers facilities management services to its customers who
do not have or plan to hire technical operators. This service allows the
customer to concentrate on marketing its products while the Company operates and
maintains its switch for a fee. The Company offers facilities management
services to facilitate sales of its switches. The Company also provides
competitively priced domestic and international network services to its
customers, thereby facilitating their smooth entry into the communications
business. Through the aggregation of customer traffic, the Company has
negotiated favorable carrier rates from the major interexchange carriers.
Currently, the switch room that houses a customer's equipment is located at the
Company's headquarters in Provo, Utah.
Customers. The Company's applications platforms and billing systems have been
accepted in a variety of segments of the telecommunications industry and serve a
broad array of domestic and international applications. To date, the Company
estimates that it has installed over 500 application switching and billing
systems. See note 11 of Notes to Financial Statements, included in Part II of
this Form 10K filing, for listing of significant customers.
The Company's customers are diverse and represent many different aspects of the
telecommunications industry. These customers have implemented a wide variety of
features on the STX switching platform and NTS billing system including: prepaid
debit card, international call back, operator services, prepaid cellular, and
other applications for specialty markets.
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SALES AND MARKETING
The Company primarily sells its products through a direct sales force located at
the Company's headquarters in Provo, Utah and through remote sales offices in
New York and Florida. The Company's marketing strategy is to generate leads
through attendance at trade shows, advertising in industry periodicals and
referrals from existing customers. The Company convenes annual two-day round
table discussions for its customers. The Company invites its customers and their
competitors to meet in an environment of cooperation and collaboration to
discuss their experiences with the Company's products, providing significant
consideration for future NACT product development and enhancement.
The Company has established a sales presence in the United Kingdom and plans to
establish sales presence in other countries it believes to be strategically
advantageous. The Company believes that a sales organization that understands
and can solve complex switching and network management and billing systems
requirements is necessary to sell its products to specialty telecommunications
network service providers and corporate end users. The Company intends to invest
significantly to enlarge its sales organization in order to expand its customer
base and to be more geographically proactive.
The Company expects that its technical support organization and customer
referrals will continue to be an important factor in the Company's sales. In
attempting to broaden its customer base, the Company will be marketing its
products and services to larger telephony providers whose procurement processes
are generally more protracted and may be expected to require additional effort
on the Company's part.
To date, the Company has made approximately $750,000 of direct sales to
international customers. The Company believes that the international market for
its products represents growth potential in the future, particularly in the
developing countries and in countries in which the telecommunications industry
is being deregulated. The Company intends to address these opportunities by
creating an international sales force and by marketing its products through
international partners directly involved in telecommunications equipment sales.
TECHNICAL SUPPORT
The Company's technical support staff provides business consulting as well as
trouble-shooting services to its customers. The Company's customers operate in
an environment in which reliability and availability of technical support are
increasingly critical factors. Such value-added services have resulted in a
recurring stream of revenues for the Company.
11
<PAGE>
The Company's technical support department installs and supports systems sold by
the Company and provides ongoing services that include training, business
consultations, trouble-shooting and upgrades. Since the Company sells a single
switching solution that includes essentially all of the key elements a customer
needs to offer enhanced services, a customer need not look beyond the Company,
its "single source," for its technical switching solutions.
The technical support department is involved with a customer as soon as a sale
has been finalized. A detailed pre-installation checklist is completed with the
customer prior to installation. A technical support engineer installs the
equipment at the customer's location, configures software for the specific
applications to be utilized and brings up the telephone circuits. Typically, a
system is operational shortly after it is delivered.
After the equipment is installed, the Company's technical support department
works with the customer to keep the equipment functioning reliably. Modem access
to all customer equipment enables the Company's technical support personnel to
perform diagnostics, trouble-shoot equipment, perform software upgrades,
transmit programs and configure hardware from a remote location. In addition,
technical support provides consulting services on network issues and additional
applications.
To quickly and efficiently resolve customer issues, the technical support
department uses an automated tracking system that contains the complete
installed customer database, software and hardware configuration, site
addresses, contacts and modem phone numbers. An incoming customer call is
monitored on this system, and the status of the resolution of the customer
problem and the mean-time to repair are updated and maintained for reporting
back to the customer. An incident escalation procedure ensures that all customer
problems receive appropriate visibility until a solution has been achieved. The
technical support department maintains 24 hour, 7-day-a-week emergency service
coverage. The Company's equipment is warrantied for one year, after which the
customer pays an annual fee for factory support. Factory support includes toll
free telephone support, as well as all operating system software upgrades and
free board repair. These upgrades allow the Company's customers to take
advantage of software enhancements offered by the Company.
The Company's main technical support operations are located at the Company's
headquarters in Utah. The Company has also established technical support
satellite offices in New Jersey, Florida and the United Kingdom. The Company
plans to expand the department into several key locations in conjunction with
the opening of additional sales offices.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts are focused on the development of
new products and the addition of new features and capabilities to its existing
products. The research and development department continually works to improve
the quality of the Company's products and to ensure that such products meet
industry standards and government regulations. In addition, the Company is
working toward the successful development of new products that will enable it to
offer additional intelligence to a customer's existing network. During the past
16 years, the Company's engineers have introduced seven hardware platforms, 10
software applications, 20 international language software packages and numerous
enhancements to such products.
The Company is working to increase the port capacity of the STX and to improve
and supplement its enhanced services and its billing system platform. The
Company is incorporating the Motorola 68060 CPU board into the STX application
platform to enable the STX to support 2,048 ports per chassis or 8,192 ports per
integrated MCU system. With the Motorola 68060 processor, the STX is expected to
process up to 15 million call minutes per month in a 2,048 port nonblocked
configuration or can be combined with three additional STXs to provide up to 60
million call minutes per month.
12
<PAGE>
The Company is currently developing an improved billing system, the NTS 2000,
which is being designed for real time transaction processing and will use a
graphic user interface and improved call reports and will allow for greater
customization of invoices, bills and reports. The Company expects that the NTS
2000 will be available for use with its applications platform switches in the
second quarter of fiscal 1998 and will be available for use with non-NACT
switches in the future. The "server" side of the NTS 2000 will use one or more
Pentium Pro PC-server systems with the SCO UNIX operating system and an Informix
database management system. The "client" side will use a PC computer with the
Windows 95 operating system. All processing will be based upon real time
transaction processing. The NTS 2000 will allow for the customization of reports
and customer invoices on "client" PC computers while providing standard features
on the "server" computers.
The telecommunications equipment market is characterized by rapidly changing
technologies and frequent new product introductions. The rapid development of
new technologies increases the risk that current or new competitors could
develop products that would reduce the competitiveness of the Company's
products. The Company's success will depend to a substantial degree upon its
ability to respond to changes in technology and customer requirements. This will
require the timely selection, development and marketing of new products and
enhancements on a cost-effective basis. The development of new, technologically
advanced products is a complex and uncertain process, requiring high levels of
innovation. Further, the telecommunications industry is characterized by the
need to design products that meet industry standards for safety, emissions and
network interconnection. With new and emerging technologies, such standards are
often changing or unavailable. As a result, there is a potential for product
development delay due to the need for compliance with new or modified standards.
The introduction of new and enhanced products also requires that the Company
manage transitions from older products in order to minimize disruptions in
customer orders, avoid excess inventory of old products and ensure that adequate
supplies of new products can be delivered to meet customer orders.
As of September 30, 1997, approximately 23 full-time employees were engaged in
research and development. The Company spent approximately $1,183,000, $1,352,000
and $2,385,000, on research and development during the fiscal years ended
September 30, 1995, 1996 and 1997, respectively. The Company expects that it
will continue to expend significant resources for product research and
development.
MANUFACTURING AND QUALITY ASSURANCE
The Company's manufacturing operations consist primarily of material
requirements planning, material procurement and final assembly, test and quality
control of subassemblies and completed systems. The Company outsources its
printed circuit board assembly. The Company believes that by outsourcing its
printed circuit board assembly, the Company gains flexibility in the
manufacturing process and achieves lower direct labor and overhead costs. The
Company currently conducts its manufacturing operations in its new manufacturing
facility in Provo, Utah in a space of approximately 10,000 square feet.
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<PAGE>
The Company utilizes an annual planning forecast, which is modified monthly, to
determine its material and outsourcing requirements. The Company orders
materials with differing lead times, generally 30 to 180 days in advance. The
Company uses "just-in-time" ordering of materials that are readily available to
minimize inventory carrying costs. The Company's systems are manufactured to a
standard configuration that allows for better production planning, lower direct
labor and overhead costs and shorter order-to-shipment times.
The Company tests its systems in accordance with Company-designed quality
control specifications that are consistent with ISO 9000 requirements. ISO 9000
is an international quality certification process, developed in the European
Common Market and adopted in the United States as the method by which companies
can demonstrate the functionality of their quality control system.
ISO 9000 certification is a three step process: writing a "quality manual" in
accordance with the ISO 9000 requirements; documenting the processes and
procedures used to design, build, sell and finance products; and being audited
by an offcial ISO 9000 registrar. The Company has completed the "quality
manual," is currently documenting the processes and procedures and has selected
an ISO 9000 registrar to conduct the certification audit. In conjunction with
ISO 9000 certification, the Company presently has an in-house quality inspection
program where it tests all products prior to shipment to ensure the highest
standard of quality.
The Company primarily uses standard parts and components for its products,
procured from multiple vendors. Certain integrated circuits, card cage chassis
and billing system database software are presently available only from a limited
source of supply. To date, the Company has been able to obtain adequate supplies
of these components in a timely manner.
COMPETITION
The market for switching equipment and network management and billing systems is
highly competitive, and the Company expects competition to increase in the
future. The market is subject to rapid technological change, regulatory
developments in the telecommunications industry and emerging industry standards.
The Company believes that the primary competitive factors in the market for
switching equipment and network telemanagement and billing systems are the
development and rapid introduction of new product features, price/performance,
reliability and quality of customer support.
THE COMPANY BELIEVES THAT IT COMPETES ACROSS THREE CATEGORIES:
PC Based Switch Platforms. A PC-based switch platform is a personal computer,
usually with high capacity, that contains generic telephony boards for
interfacing with the public network. A typical platform provides a single
application such as debit card or international call back/reorigination, which
are software applications that can be brought to market rapidly. Leading
providers of these types of switches are CPDI, ITP, and PCS Telecom. The users
of this equipment generally tend to be start-up operations that are concerned
about initial equipment costs and that are generally able to bring software
solutions to the market rapidly. While these users may feel that PC-based
solutions are relatively low cost, as their business grows, it becomes apparent
that these systems are costly to expand on a cost per port basis and offer few
features that are standard with switch-based platforms. Additionally, PC-based
systems are not regarded as a viable solution for larger users due to their
reliability concerns.
Open Architecture (Programmable) Hardware Platforms. A programmable hardware
platform generally consists of proprietary switch hardware, together with the
necessary software to provide a programming application interface (API) that
allows other computers executing third-party application software to control the
calls within the switch hardware. Leading providers of these types of switches
are Summa Four, Excel and Redcom and the value added software providers that
support this type of hardware, such as Magellan, Boston Technology and Open
Development. The users of this type of equipment tend to be companies that have
the ability and desire to write their own applications code or are willing to
purchase their applications code from a specialized third party developer.
14
<PAGE>
Application Switch Platforms. An application switching platform is an integrated
hardware/software switching system that contains software applications that
perform basic 1+ and operator assisted services over the public network. To
provide intelligent functionality, an adjunct switch must be connected to the
application switch platform. Leading providers of application switch platforms
are Harris and Siemens Stromberg Carlson. The major users are companies that are
established in their telephony business such as 1+ providers that now need to
expand their offerings to their customers to remain competitive in the
marketplace. Enhanced services are particularly attractive to these customers
and play a large part in their decision making process.
As the Company's business develops and it seeks to market its switches to a
broader customer base, the Company's competitors may include larger switch and
telecommunications equipment manufacturers such as Lucent Technologies Inc.,
Harris, Siemens AG, Alcatel Alsthom Compagnie, Generale D'Electricite,
Telefonaktiebolaget, L.M. Ericcson and Northern Telecom Ltd. Many of the
Company's current and potential competitors have substantially greater
technical, financial, manufacturing and marketing resources than the Company.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company's success is dependent in part on intellectual property rights,
including information technology, some of which is proprietary to the Company.
The Company relies on a combination of copyright, trade secret, and trademark
law, confidentiality procedures and other contractual restrictions to establish
and protect proprietary rights in its products and technologies. As part of
these confidentiality procedures, the Company generally enters into
confidentiality and non-disclosure agreements with its employees and limits
access to and distribution of its proprietary information. The Company has
received federal trademark applications for the marks STX and NTS 2000 and is
currently conducting a review of its products to determine for which products it
will seek patent, trademark or copyright registration protection. The Company
currently licenses certain technology from third parties and plans to do so in
the future.
EMPLOYEES
At September 30, 1997, the Company had 93 full-time employees, of whom 23 were
engaged in research and development, 17 in manufacturing and quality control, 12
in sales and marketing, 21 in technical support, 6 in operations and management
information systems, and 14 in administration and finance. None of the Company's
employees is represented by a collective bargaining agreement nor has the
Company experienced any work stoppage. The Company considers its relations with
its employees to be good.
ITEM 2 - PROPERTIES
The Company's headquarters and manufacturing facility is located in Provo, Utah.
The Utah facility is a newly constructed building that the Company moved into on
July 1, 1997. The Utah facility was constructed for a cost of about $4.1 million
and was paid for from the proceeds of the Company's IPO.
The Company also has sales and technical support offices located in New York,
New Jersey, Florida and London, England. These offices are leased by the Company
under leases that expire at various dates through 1998. Annual lease payments of
these offices aggregate approximately $30,000.
With the exception of the office furnishings held under an operating lease
(approximately $900,000 net book value at September 30, 1997), the Company owns
the equipment and furnishings located in all of its facilities.
The Company considers all of its properties, both owned and leased, together
with the related equipment and furnishings contained therein, to be well
maintained, in good operating condition, and suitable for its present and
forseeable future needs.
ITEM 3 - LEGAL PROCEEDINGS
On August 24, 1995, Aerotel, Ltd. And Aerotel U.S.A., Inc. (collectively,
"Aerotel") commenced an action against the Company and a customer of the Company
in the United States District Court, Southern District of New York, alleging
that telephone systems manufactured and sold by the Company incorporating
prepaid debit card features infringe upon Aerotel's patent which was issued in
November 1987 (the "Aerotel Patent"). The initial complaint further alleged
defamation and unfair competition as a result of a Special Report disseminated
by the Company to its customers and tortious interference with prospective
business relations, alleging that the Company induced third parties to abandon
licensing negotiations with Aerotel. Aerotel sought injunctive relief, damages
in an unspecified amount, damages of up to three times the damages found for
willful infringement of the Aerotel Patent and an order requiring the Company to
publish a written apology to Aerotel. The Company filed an answer and
Counterclaim in which it denied infringement of the Aerotel Patent and sought
judgment that the Aerotel patent is invalid and unenforceable and that Aerotel
has misused its patent in violation of antitrust laws. The Company has denied
that it has committed defamation, unfair competition
15
<PAGE>
and tortious interference with prospective business relations. On May 3, 1996,
the Company served its motion for summary judgment. The Court has indicated it
will deny such motion, although the actual ruling has not yet been received. In
August 1997, Aerotel amended its complaint to include as defendants GST
Telecommunications, Inc., the parent of GST USA ("GST"), and GST USA as well as
Kyle Love, the former President of the Company and Dr. Thomas E. Sawyer, a
director of GST and the Company and the former Chairman and Chief Executive
Officer of the Company. The amended pleadings seek in excess of $18.7 million in
damages and allege that GST and GST USA have infringed the Aerotel patent, aided
and abetted infringment by others, including the Company, and participated in,
and aided and abetted alleged tortious conduct by the Company. GST, GST USA, Dr.
Sawyer and Mr. Love have served answers denying all material allegations and
intend to defend vigorously. Pretrail discovery has commenced and is scheduled
to be completed in 1998. The case is not expected to be tried until late 1998 at
the earliest. The Company's patent counsel believes that the Company has valid
defenses to the Aerotel claims. If upheld, these defenses would also be valid
for all defendants. An unfavorable decision in this action could have a material
adverse effect on the Company.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
Part II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded over the counter on the NASDAQ National
Market System under the symbol NACT. The following table presents the quarterly
high and low bid quotations in the over the counter market, as quoted by NASDAQ.
These quotations reflect the inter-dealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.
Prior to the second fiscal quarter of 1997, the Company's common stock was not
publicly traded.
1997 (Fiscal) High Low
------------- ---- ---
Second Quarter 9 - 1/2 5 - 7/8
Third Quarter 10 - 3/8 4 - 3/4
Fourth Quarter 17 - 5/8 8 - 3/8
The Company believes that there are in excess of 1,000 beneficial owners of the
Company's common stock at November 30, 1997.
The Company has never declared or paid cash dividends on its shares of capital
stock and does not intend to pay cash dividends in the foreseeable future.
Moreover, the indentures governing certain outstanding indebtedness of GST and
GST USA restrict the Company's ability to declare or pay cash dividends, and,
for the foreseeable future, effectively prohibit such payments or declarations.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
Use of Proceeds of Initial Public Offering
(1) Effective date: February 25, 1997.
(2) Offering date: February 26, 1997.
(3) Not applicable.
(4) (i) The offering terminated on March 3, 1997.
(ii) Managing Underwriter: Hambrecht & Quist and
Montgomery Securities.
(iii) Title of Securities Registered: Common Stock,
$.01 par value
per share.
(iv) Amount Registered: 2,000,000 shares.
Aggregate Offering Price: $20,000,000.
Amount Sold: 2,000,000 shares.
Aggregate Offering Price of Amount Sold to Date:
$20,000,000.
(v) A reasonable estimate of the expenses incurred during
the period from the effective date of the Securities Act
registration statement (February 25, 1997) and ending on
the ending date of the reporting period (September 30,
1997) is $1.9 million.
(vi) The net proceeds to the Company after deducting the
total expenses described in (v) above is $18.1 million.
(vii) Approximately $4.1 million of net offering proceeds were
used for the purchase of land and a building for the
Company's headquarters from GST Realco, Inc., a
subsidiary of GST Telecommunications, Inc., a holder of
more than 10% of the Company's common stock, and for
construction costs to complete the building.
(viii) Not applicable.
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ITEM 6 - SELECTED FINANCIAL DATA
The following selected financial data of the Company are qualified by reference
to and should be read in conjunction with the financial statements and the notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this filing. The statement of
operations data for the fiscal years ended September 30, 1995, 1996 and 1997 and
the balance sheet data as of September 30, 1996 and 1997 are derived from, and
are qualified by reference to, the Company's financial statements audited by
KPMG Peat Marwick LLP, independent certified public accountants included
elsewhere in this filing. The Statement of Operations data for the fiscal years
ended December 31, 1992, September 30, 1993 and September 30, 1994 and the
balance sheet data as of December 31, 1992, September 30, 1993, 1994 and 1995
are derived from the Company's financial statements audited by Squire & Co.,
independent certified public accountants, not included herein.
17
<PAGE>
<TABLE>
<CAPTION>
Fiscal year Nine months
ended ended
December 31, September 30, Fiscal year ended September 30,
------------ ------------- ------ -------------------------------------------
1992 1993(1) 1994 1995 1996 1997
---- ------- ---- ---- ---- ----
(in thousands, except per share data)
-------------------------------------
Statement of Operations Data:
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Product sales $1,860 $,2422 $5,479 $7,604 $9,930 $21,982
Network carrier sales - - - 2,782 3,783 5,716
Wins sales - - - 1,098 2,572 -
------ --------- ------- ------- ----------- ------------
Total revenues 1,860 2,422 5,479 11,484 16,285 27,698
Cost of goods sold:
Product 813 788 1,845 2,645 3,942 7,141
Network carrier usage - - - 2,731 3,382 5,486
Wins - - - 787 2,572 -
Amortization of
Acquired intangibles - 15 185 443 362 362
------ --------- ------- ---------- -------------- ------------
Total cost of goods sold 813 803 2,030 6,606 10,258 12,989
------ --------- ------- ---------- -------------- ------------
Gross profit 1,047 1,619 3,449 4,878 6,027 14,709
Operating expenses:
Research and development 374 275 677 1,183 1,352 2,385
Selling and marketing 124 178 457 925 954 2,504
General and administrative 624 561 1,353 2,153 3,024 3,472
Amortization of
Acquired intangibles - 20 257 520 573 573
------ --------- ------- ---------- -------------- ------------
Total operating expenses 1,122 1,034 2,744 4,781 5,903 8,934
------ --------- ------- ---------- -------------- ------------
Income (loss) from operations (75) 585 705 97 124 5,775
Other income net 87 31 81 189 148 517
------ --------- ------- ---------- -------------- ------------
Income before income taxes 12 616 286 272 6,292
786
Income taxes (benefit) (5) 157 293 206 78 2,476
Cumulative effect of prior year
Accounting change 162 - - - - -
====== ========= ======= ========== ============== ============
Net income $179 $459 $493 $80 $194 $3,816
====== ========= ======= ========== ============== ============
Net income per share - primary $0.06 $0.12 $0.08 $0.01 $0.03 $0.52
====== ========= ======= ========== ============== ============
Net income per share - fully diluted $0.06 $0.12 $0.08 $0.01 $0.03 $0.50
====== ========= ======= ========== ============== ============
Weighted average shares outstanding 2,870 3,847 5,998 6,114 6,114 7,351
====== ========= ======= ========== ============== ============
</TABLE>
<TABLE>
<CAPTION>
September 30,
December 31, ---------------
1992 1993 1994 1995 1996 1997
------------ --------------------------------------------------------------------
(in thousands, except per share data)
-------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents $208 $352 $1,186 $1,122 $694 $9,947
Working capital 35 3,131 3,280 4,145 4,245 21,189
Total assets 884 8,474 9,072 13,178 14,685 39,755
Long-term debt, net of current portion 150 387 - 85 58 -
Total stockholders equity 128 6,094 6,969 9,630 10,210 33,004
</TABLE>
(1) The Company changed its fiscal year-end to September 30th, effective
with the fiscal year ended September 30, 1993. Accordingly, the fiscal
year ended September 30, 1993 was a nine-month period.
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ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion should be read in conjunction with the Company's
financial statements contained herein under Item 8 of this report.
Overview
The Company provides advanced telecommunications switching platforms with
integrated applications software and network telemanagement capabilities. During
the period from 1987 through 1989, the Company developed and began selling its
LCX 120C switch application product and NTS 1000 billing system. During the
period from 1990 through 1995, the Company developed enhancements to the LCX,
including T-1 capability, enhancement of its prepaid debit card services,
automated operator, international call back and call reorigination. During the
same period, the Company also developed the Master Control Unit. In May 1996,
the Company completed development of and began selling the STX, an integrated
digital tandem switching system that includes proprietary systems software that
enables standard applications such as 1+ and optional advanced applications such
as international call back/reorigination, prepaid debit card and prepaid
cellular.
The Company sells its products in the United States to enhanced
telecommunications network service providers through a direct sales force.
During the fourth quarter of fiscal 1997, the Company sold its first STX
switching and NTS billing systems outside the United States. The Company intends
to continue to expand the marketing of its products both domestically and
internationally. Currently, the Company also provides long distance network
carrier service to facilities management customers with operations primarily in
Brazil and Eastern Europe.
In response to customer demand, in fiscal 1995, the Company began offering
facilities management and network carrier services. Facilities management
services enable a customer to concentrate on marketing its products while the
Company maintains such customer's switch(es) in the Company's facilities for a
fee. Such services can include network carrier usage in addition to the
management of a switch. The Company provides network carrier usage at
competitively priced domestic and international rates. Revenues associated with
such facilities management services, including network carrier usage, are
presented in the Company's financial statements as network carrier sales. The
gross profits associated with such sales are substantially lower than those
associated with product sales. In addition, given the small number of customers
and the high volume of revenues generated from an individual customer through
network carrier sales, the loss or gain of one or more customers could cause a
significant fluctuation in the Company's quarterly revenues.
In 1995, the Company formed Wins, a wholly-owned subsidiary, to provide
specialized long distance services (e.g. prepaid debit card, international call
back/reorigination) to potential switching system customers who wanted to enter
the specialized long distance service market before making a major capital
investment in switching equipment. The Company's financial statements for the
fiscal year ended September 30, 1995 include the accounts of the Company and
Wins. On September 30, 1995, the Company transferred ownership and operation of
Wins to GST USA in the form of a dividend accounted for at historical cost. From
October 1, 1995 through September 30, 1996, the Company provided carrier
services to GST USA for the Wins operation. The Company ceased providing carrier
services to Wins on September 30, 1996. Therefore, no revenue is recognized by
the Company from the Wins operation after September 30, 1996.
GST USA acquired a 100% interest in the Company's Common Stock through a series
of purchases of newly issued shares and shares owned by former stockholders of
the Company from September 1993 through September 30, 1995. GST USA accounted
for the acquisition using the purchase method of accounting. The excess of the
purchase price over the fair value of the assets acquired was accounted for by
GST USA as product support contracts, software development costs, and goodwill.
In accordance with the requirements of the Securities and Exchange Commission,
the Company's financial statements reflect these intangible assets on its
balance sheet, with related amortization recorded in cost of goods sold and
other operating expense in the respective years. Product support contracts and
software development costs are being amortized over a five-year straight-line
period and goodwill is being amortized over a 20-year straight-line period.
19
<PAGE>
In the second quarter of fiscal 1997, the Company completed an initial public
offering of its common stock, pursuant to which the Company and its parent
company, GST, sold two million and one million shares, respectively, of the
Company's common stock, resulting in net proceeds to the Company and GST of
approximately $18.1 million and $10.0 million, respectively. As a result of this
initial public offering, GST's interest in the Company has been reduced to
approximately 63%. On September 30, 1997, GST announced that it had retained
Hambrecht and Quist LLC to explore alternatives for monetizing its 63% interest
in the Company, including a potential sale of some or all of GST's shares of the
Company's capital stock to one or more strategic investors.
The Company is subject to certain financial restrictions by reason of its status
as a "Restricted Subsidiary" of GST and GST USA under indentures relating to
certain outstanding indebtedness of GST and GST USA. Such restrictions
significantly limit or prohibit the ability of GST and its Restricted
Subsidiaries to incur additional indebtedness or to create liens of their
assets. Effectively, the ability of the Company to incur indebtedness is limited
by the amount of indebtedness that GST and its Restricted Subsidiaries are
permitted to incur pursuant to the terms of the indentures.
FISCAL 1997 COMPARED TO FISCAL 1996
Revenues. Revenues increased by 70.1% from $16.3 million in fiscal 1996 to $27.7
million in fiscal 1997. Product sales increased by 121.4% from $9.9 million in
fiscal 1996 to $22.0 million in fiscal 1997 primarily due to sales of the STX
switching systems, which the Company began selling in May 1996. Network carrier
sales increased by 51.1% from $3.8 million in fiscal 1996 to $5.7 million in
fiscal 1997 due to increased carrier usage volumes from existing network carrier
customers. The Company generated $2.6 million in revenues from sales of network
carrier usage to Wins in 1996. On October 1, 1996, the Company discontinued
providing network carrier usage to Wins.
GROSS PROFIT
Product Sales. Gross profit on product sales increased 147.8% from $6.0 million
in fiscal 1996 to $14.8 million in fiscal 1997 due to increases in sales volumes
and gross profit per unit from the sale of larger port capacity STX switching
systems. Gross profit on product sales as a percentage of product sales
increased from 60.3% in fiscal 1996 to 67.5% in fiscal 1997 primarily due to
sales of larger port capacity STX switching systems, which have higher gross
profit margins, in fiscal 1997 and due to lower margins on STX switching systems
in fiscal 1996 as a result of special pricing on its initial sales of STX
switching systems and the discounting of LCX systems prior to the release of the
STX system in May 1996.
Network Carrier Sales. Gross profit on network carrier sales decreased 42.6%
from $0.4 million in fiscal 1996 to $0.2 million in fiscal 1997 due to a
decrease in the prices charged for international carrier traffic to the
Company's network carrier customers and due to the non recognition of profit on
network carrier sales during the fourth quarter of fiscal 1997 to Overseas
Telecom (a network carrier customer).
Wins. In fiscal 1997, there were no sales to GST USA for the Wins operations. In
fiscal 1996, the Company provided network carrier services at cost to GST USA
for the Wins operations.
Overall. Gross profit increased 144.0% from $6.0 million in fiscal 1996 to $14.7
million in fiscal 1997 primarily due to increases in sales volumes and gross
profit per unit from the sale of larger port capacity STX switching systems.
Gross profit as a percentage of net revenues increased from 37.0% in fiscal 1996
to 53.1% in fiscal 1997 primarily due to sales of larger port capacity STX
switching systems, which have higher gross profit margins, in fiscal 1997 and
due to lower margins on STX switching systems in fiscal 1996 as a result of
special pricing on its initial sales of STX switching systems and the
discounting of LCX systems prior to the release of the STX system in May 1996.
Research and Development. Research and development expenses increased by 76.4%
from $1.4 million in fiscal 1996 to $2.4 million in fiscal 1997 primarily due to
the expansion of the Company's engineering staff and an increase in expenditures
for planning and implementation of several hardware and software research and
development projects designed to enhance the STX switching and NTS billing
systems. Capitalized software development costs were $0.4 million and $0.8
million in fiscal 1996 and 1997, respectively.
20
<PAGE>
Selling and Marketing. Selling and marketing expenses increased by 162.7% from
$1.0 million in fiscal 1996 to $2.5 million in fiscal 1997 due to the hiring of
additional senior sales personnel, the opening of new domestic sales offices,
increased advertising and trade show expenditures, and increased commissions
paid to sales personnel as a result of the increase in the Company's product
sales.
General and Administrative. General and administrative expenses increased 14.8%
from $3.0 million in fiscal 1996 to $3.5 million in fiscal 1997 primarily due to
the hiring of new personnel in the Company's technical support, training,
finance, and administrative departments to support the Company's increased
sales, shipments, and installations of STX switching and NTS billing systems.
Also, in fiscal 1997, additional expenses were incurred by the Company as a
result of the construction of and move into the Company's new
headquarters/manufacturing facility on July 1, 1997.
Amortization of Acquired Intangibles. The Company has included amortization of
acquired intangibles as a component of both cost of sales and operating
expenses. These intangibles arose as a result of the acquisition of the Company
by GST USA. GST USA accounted for the acquisition using the purchase method of
accounting. The excess of the purchase price over the fair value of the assets
acquired was assigned by GST USA as product support contracts, software
development costs and goodwill, and, in accordance with requirements of the
Commission, has been included in the balance sheets of the Company with related
amortization recorded in cost of goods sold and other operating expenses.
Product support contracts and software development costs are being amortized
over a five-year straight-line period and goodwill is being amortized over a
20-year straight-line period.
Other Income and Expense. Other income, net of $0.1 million in fiscal 1996
increased to $0.5 million in fiscal 1997 due to an increase in interest income
during fiscal 1997 resulting from investing the cash proceeds received from the
IPO completed in March of 1997.
Income Taxes. The Company recorded provisions for income taxes with effective
rates of 28.8% and 39.4% of income before taxes for fiscal 1996 and 1997,
respectively. The increase in the effective tax rate in 1997 is primarily a
result of increased profitability. Future effective tax rates are expected to be
in excess of statutory rates during the amortization period of the acquired
goodwill from GST USA, as the goodwill is not deductible for tax purposes.
FISCAL 1996 COMPARED TO FISCAL 1995
Revenues. Revenues increased by 41.8% from $11.5 million in fiscal 1995 to $16.3
million in fiscal 1996. Product sales increased by 30.6% from $7.6 million in
fiscal 1995 to $9.9 million in fiscal 1996 primarily due to the introduction of
the Company's new STX switching system in May 1996. Network carrier sales
increased by 36.0% from $2.8 million in fiscal 1995 to $3.8 million in fiscal
1996 due to increased carrier usage volumes from existing network carrier
customers. Wins generated $1.1 million in revenues in fiscal 1995 Revenues
generated from Wins network carrier sales in fiscal 1996 were $2.6 million.
GROSS PROFIT.
Product Sales. Gross profit on product sales increased 20.8% from $5.0 million
in fiscal 1995 to $6.0 million in fiscal 1996 due to an increase in product
sales resulting from the introduction of the STX in May 1996. Gross profit on
product sales as a percentage of product sales decreased from 65.2% in fiscal
1995 to 60.3% in fiscal 1996 primarily due to lower margins resulting from an
emphasis on promoting the STX. Margins on initial STX sales were lower due to
special STX upgrade pricing provided to the Company's current customers through
June 1, 1996.
Network Carrier Sales. Gross profit on network carrier sales increased from $0.1
million in fiscal 1995 to $0.4 million in fiscal 1996 due to increased network
carrier sales volume. Gross profit on network carrier sales as a percentage of
network carrier sales increased from 1.8% in fiscal 1995 to 10.6% in fiscal 1996
due to increased volume discounts received from the underlying carriers as a
result of increased network carrier usage. The Company began its network carrier
operations in fiscal 1995.
Wins. Wins generated $0.3 million of gross profit in fiscal 1995 or 28.3% of
Wins sales. The Company transferred ownership and operations of Wins to GST USA
on October 1, 1995 and provided carrier services at cost to GST USA for the Wins
operations in fiscal 1996.
Overall. Gross profit increased 23.6% from $4.9 million in fiscal 1995 to $6.0
million in fiscal 1996 due to an increase in both product and network carrier
sales volume. Gross profit as a percentage of net revenues decreased from 42.5%
in fiscal 1995 to 37.0% in fiscal 1996 primarily due to lower margins resulting
from an emphasis on the STX switching system and lower margins on initial sales
of the STX switching systems.
21
<PAGE>
Research and Development. Research and development expenses increased by 14.3%
from $1.2 million in fiscal 1995 to $1.4 million in fiscal 1996 primarily due to
the move to more rapidly develop the STX switching system and to maintain
ongoing research and development of the Company's existing hardware and software
product lines. The Company's capitalized software development costs were $0.2
million and $0.4 million in fiscal 1995 and 1996, respectively.
Selling and Marketing. Selling and marketing expenses increased 3.1% from $0.9
million in fiscal 1995 to $1.0 million in fiscal 1996 primarily due to continued
expansion of the Company's sales and marketing staff. Fiscal 1996 selling and
marketing expenses were offset by the transfer of certain salary and fringe
benefit expenses to general and administrative when the Director of Sales and
Marketing was promoted to Executive Vice President and then to President and
Chief Executive Officer.
General and Administrative. General and administrative expenses increased by
40.5% from $2.2 million in fiscal 1995 to $3.0 million in fiscal 1996 primarily
due to an increase in the provision for bad debt, continued expansion of the
manufacturing and technical support departments, the expansion of the finance
department and implementation of a Company-wide quality assurance program. The
increase in the provision for bad debt was a result of increased sales volume
and the addition of a $310,000 reserve for accounts receivable due from Overseas
Telecom (a network carrier customer), which was transferred to a note
receivable.
Income Taxes. The Company recorded provisions for income taxes with effective
rates of 71.9% and 28.8% of income before taxes for fiscal 1995 and 1996,
respectively. The decrease in the effective tax rate is a result of additional
amortization of goodwill, which is not deductible for income tax purposes.
Future effective tax rates are expected to be in excess of statutory rates
during the amortization period of the acquired goodwill from GST USA, as the
goodwill is not deductible for tax purposes.
Liquidity and Capital Resources. The primary source of financing for the Company
in fiscal 1995 and 1996 was from operations and proceeds of $2.6 million
received from the sale of securities in fiscal 1993 and 1994. The primary source
of financing for the Company in fiscal 1997 was from operations and the net
proceeds of approximately $18.1 million received from the Company's Initial
Public Offering in March 1997. Net cash provided by operating activities in
fiscal 1995 and 1997 was $0.4 million and $0.2 million, respectively. Net cash
used by operating activities in fiscal 1996 was $0.1 million.
The Company has made capital expenditures of $0.3 million, $0.3 million, and
$5.2 million in fiscal 1995, 1996, and 1997, respectively. The capital
expenditures in fiscal 1995 and 1996 were primarily for the purchase of
computers and testing equipment. The capital expenditures in fiscal 1997 were
primarily for the purchase of land, the costs of construction, and the
furnishing of the Company's new corporate offices and manufacturing building and
for additional computers and research and development equipment. In fiscal 1997,
the Company also paid $0.3 million for the purchase of the source code for the
development of SS7 capability in the STX. The Company had principal commitments
as of September 30, 1997 for approximately $0.9 million for contract completion,
and purchase of the first 100 boards, of the new 68060 CPU processor for the
STX.
As of September 30, 1997, the Company had cash, cash equivalents and marketable
securities totaling $13.2 million an increase of $12.2 million from September
30, 1996. This increase is primarily due to the cash proceeds received from the
sale of common stock from the Company's initial public offering in March 1997.
The Company maintains an unsecured bank line of credit expiring in February 1998
that provides borrowings up to $.8 million at the bank's prime rate plus one
point. There was no outstanding balance under this line of credit at September
30, 1997.
As of September 30, 1997, the Company was contingently liable under lease
repurchase agreements for a maximum of $3.5 million to Zions Credit Corporation
(Zions). Zions provides lease financing to the Company's customers on a recourse
basis. The Company maintains a $6.0 million unrestricted cash balance in
accordance with conditions of the repurchase agreement.
The Company has sold carrier services to Overseas Telecom ("Overseas") since
1994. Overseas is located in Brazil and provides international call
back/reorigination services to companies and individuals primarily in Brazil and
Eastern Europe. During the year ended September 30, 1996, Overseas became
delinquent on certain of its payments. In fiscal 1997, the Company entered into
22
<PAGE>
a note receivable agreement with Overseas which provided for the repayment of
the non-current outstanding amount (approximately $0.93 million) bearing
interest at 12 percent. The note provided for payments in the amount of 6
percent of Overseas' monthly gross revenues. Additionally, 25 percent of
Overseas net income, with a minimum payment in the amount of $2,500, was also
allocated to the payment of the note. The note was secured by Overseas' accounts
receivable, customer list and certain assets. In the fourth quarter of fiscal
1997, the Company exercised its call privileges under the note and took
possession of the underlying collateral - the customer lists. There were two
separate and distinct customer lists, one from Brazil and one from Eastern
Europe. The customer list related to the Brazilian operations was sold to
Intertoll Communications Network Corp. (ICN), an existing customer of the
Company with operations in Argentina and Brazil for $1,000,000 payable in 100
monthly payments of $10,000. The related payments have been discounted at 20
percent with the related unpaid amount of approximately $485,000 classified as
notes receivable in the accompanying balance sheet.
The customer list related to the Eastern European operations was recorded on the
Company's books at the lower of fair value or cost. Fair value was estimated by
an independent third party appraiser using generally accepted valuation
standards. Accordingly, a customer list of approximately $964,000 has been
recorded as an intangible asset and will be amortized over a three-year period.
The Company currently sells the NTS 1000 billing system which will require
upgrading by the year 2000 due to its existing limitation of using only two
digits to identify the year in the date field. The Company is planning release
of its new billing system, the NTS 2000 in the first calendar quarter of 1998
which overcomes the two digit limitation currently experienced on the NTS 1000.
The company anticipates the majority of customers will upgrade to the NTS 2000.
No assurance can be made that any of the Company's customers will upgrade to the
NTS 2000. In the event that a significant number of the Company's customers do
not upgrade to the NTS 2000, the Company may incur expenses and potential loss
of ongoing service revenues.
The Company believes that the cash proceeds from the Company's initial public
offering, anticipated cash flows from operations and its line of credit will
satisfy the Company's working capital and capital expenditures requirements for
at least the next twelve months. However, there can be no assurance that the
Company will not be required to seek additional capital sooner or, if so
required, that adequate capital will be available on terms acceptable to the
Company, or at all.
Forward-looking statements: This report contains both historical facts and
forward-looking statements. Any forward-looking statements involve risks and
uncertainties, including but not limited to risk of product demand, market
acceptance, economic conditions, competitive products and pricing, difficulties
in product development, commercialization, and technology, and other risks
detailed in this filing. Although the Company believes it has the product
offerings and resources for continuing success, future revenue and margin trends
cannot be reliably predicted. Factors external to the Company can result in
volatility of the Company's common stock price. Because of the foregoing
factors, recent trends are not necessarily reliable indicators of future stock
prices or financial performance.
ITEM 7A - QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following constitutes a list of Financial Statements included in Part II of
this report:
o Independent Auditors' Report
o Balance Sheets - September 30, 1997 and 1996
o Statements of Income Years ended - September 30, 1997, 1996 and 1995
o Statements of Stockholders' Equity Years ended - September 30, 1997,
1996 and 1995
o Statements of Cash Flows Years ended - September 30, 1997, 1996 and
1995
o Notes to Financial Statements Years ended - September 30, 1997, 1996,
and 1995
23
<PAGE>
The following constitutes a list of Financial Statement Schedules included in
Part IV of this report:
o Schedule II - Valuation and Qualifying Accounts
Schedules other than those listed above are omitted because of the absence of
conditions under which they are required or because the required information is
presented in the Financial statements or notes thereto.
<PAGE>
Independent Auditors' Report
The Board of Directors and Stockholders
NACT Telecommunications, Inc.:
We have audited the accompanying balance sheets of NACT Telecommunications, Inc.
as listed in the accompanying index. In connection with our audits of the
financial statements, we also have audited the financial statement schedule as
listed in the accompanying index. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of NACT Telecommunications, Inc.
as of September 30, 1997 and 1996, and the results of its operations and its
cash flows for each of the years in the three-year period ended September 30,
1997, in conformity with generally accepted accounting principles. Also in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
/S/ KPMG Peat Marwick LLP
-------------------------
KPMG Peat Marwick LLP
Salt Lake City, Utah
December 4, 1997
24
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Balance Sheets
September 30, 1997 and 1996
<TABLE>
<CAPTION>
Assets 1997 1996
------
-------------- -------------
Current assets:
<S> <C> <C>
Cash and cash equivalents (notes 11 and 12) $ 9,946,621 694,359
Marketable investment securities (note 3) 3,247,296 250,000
Trade accounts receivable, less allowance for doubtful accounts of
$380,819 in 1997 and $100,000 in 1996 6,840,958 3,171,180
Notes receivable, less allowance for doubtful notes of $250,000
in 1997 and $310,000 in 1996 (note 4) 3,252,170 561,396
Inventories (note 2) 2,780,467 2,406,399
Prepaid expenses and other 197,659 16,338
Deferred tax assets (note 8) 587,199 418,449
-------------- -----------
Total current assets 26,852,370 7,518,121
-------------- -----------
Property and equipment, net (note 5) 5,783,157 717,804
Notes receivable, less current installments (note 4) 966,868 1,179,750
Inventories-long term (note 2) 225,000 -
Intangibles, net (notes 4 and 6) 5,775,673 5,075,366
Other assets 152,043 193,709
-------------- -----------
$ 39,755,111 14,684,750
============== ===========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 1,432,922 2,251,800
Accrued expenses 963,034 266,451
Income taxes payable (note 8) 1,353,371 199,557
Deferred revenue 466,859 350,439
Current installments of obligation under capital lease - 21,848
Payable to GST USA 1,446,891 183,176
-------------- -----------
Total current liabilities 5,663,077 3,273,271
Obligation under capital lease, less current installments - 58,221
Deferred compensation (note 13) 157,819 157,819
Deferred tax liabilities (note 8) 929,984 985,508
-------------- -----------
Total long-term liabilities 1,087,803 1,201,548
-------------- -----------
Commitments and contingencies (notes 9, 12 and 13)
Stockholders' equity:
Preferred stock, $.01 par value. Authorized 10,000,000 shares; none
issued and outstanding in 1997 and 1996 - -
Common stock, $.01 par value in 1997 and no par value in 1996.
Authorized 25,000,000 and 10,000,000 shares in
1997 and 1996, respectively; issued and outstanding
8,113,712 shares in
1997 and 6,113,712 shares 1996
81,137 9,244,847
Additional paid-in-capital 28,130,161 -
Retained earnings 4,780,760 965,255
Net unrealized gain (loss) on marketable investment
securities (note 3) 12,173 (171)
-------------- -----------
Total stockholders' equity 33,004,231 10,209,931
-------------- -----------
$ 39,755,111 14,684,750
============== ===========
</TABLE>
See accompanying notes to financial statements.
25
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Statements of Income
Years ended September 30, 1997, 1996, and 1995
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
Revenues:
Product sales $ 21,981,854 9,929,702 7,604,071
Network carrier sales 5,716,406 3,783,445 2,781,761
Wins (note 1(b)) - 2,571,731 1,097,950
------------- ------------- -------------
Total revenues 27,698,260 16,284,878 11,483,782
------------- ------------- -------------
Cost of goods sold (note 6):
Products 7,140,914 3,941,529 2,645,646
Network carrier usage (note 13) 5,485,671 3,381,716 2,731,295
Wins (note 1(b)) - 2,571,731 786,699
Amortization of acquired intangibles 362,424 362,428 442,734
------------- ------------- -------------
Total cost of goods sold 12,989,009 10,257,404 6,606,374
------------- ------------- -------------
------------- -------------
Gross profit 14,709,251 6,027,474 4,877,408
Operating expenses (note 6):
Research and development 2,385,243 1,352,138 1,183,422
Selling and marketing 2,504,420 953,486 924,542
General and administrative 3,472,069 3,024,361 2,152,898
Amortization of acquired intangibles 573,060 573,058 519,780
------------- ------------- -------------
Total operating expenses 8,934,792 5,903,043 4,780,642
------------- ------------- -------------
Income from operations 5,774,459 124,431 96,766
------------- ------------- -------------
Other income (expense):
Interest income 543,410 127,043 155,949
Interest expense (30,456) (14,202) (1,514)
Miscellaneous income 4,439 34,670 34,635
------------- ------------- -------------
Total other income 517,393 147,511 189,070
------------- ------------- -------------
Income before income taxes 6,291,852 271,942 285,836
Income taxes (note 8) 2,476,347 78,184 205,517
------------- ------------- -------------
Net income $ 3,815,505 193,758 80,319
============= ============= =============
Earnings per common and common equivalent share:
Primary $0.52 $0.03 $0.01
Fully diluted $0.50 $0.03 $0.01
</TABLE>
See accompanying notes to financial statements.
26
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Statements of Stockholders' Equity
Years ended September 30, 1997, 1996, and 1995
<TABLE>
<CAPTION>
Net
unrealized
gain (loss) on
Common stock Additional marketable
-------------------------------- paid-in Retained investment
Shares Amount capital earnings securities Total
------------- -------------- ----------- ---------- ------------ ---------
<S> <C> <C> <C> <C> <C>
Balances at September 30, 1994 6,113,712 $ 6,277,572 - 691,178 - 6,968,750
Capital contribution by parent company
(note 1(l))
- 414,981 - - - 414,981
Addition to capital arising from
push down accounting - 2,162,384 - - - 2,162,384
Net unrealized gain on marketable
investment securities - - - - 3,605 3,605
Net income - - - 80,319 - 80,319
----------- -------------- ---------- ---------- -------- ------------
Balances at September 30, 1995 6,113,712 8,854,937 - 771,497 3,605 9,630,039
Capital contribution by parent company
(note 1(l))
- 389,910 - - - 389,910
Net unrealized loss on marketable
investment securities - - - - (3,776) (3,776)
Net income - - - 193,758 - 193,758
----------- -------------- ---------- ---------- -------- ------------
Balances at September 30, 1996 6,113,712 9,244,847 - 965,255 (171) 10,209,931
Capital contribution by parent company
(note 1(l))
- - 899,799 - - 899,799
Issuance of common stock for cash, net of
expenses of $1,933,348 2,000,000 20,000 18,046,652 - - 18,066,652
Net unrealized gain on marketable
investment securities - - - - 12,344 12,344
Reclass of common stock to additional paid-
in capital resulting from establishing a
par value on common stock - (9,183,710) 9,183,710 - - -
Net income - - - 3,815,505 - 3,815,505
=========== ============ =========- ========== ======== =============
Balances at September 30, 1997 8,113,712 $ 81,137 28,130,161 4,780,760 12,173 33,004,231
=========== ============== ========= ========== ======== =============
</TABLE>
See accompanying notes to financial statements.
27
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Statements of Cash Flows
Years ended September 30, 1997, 1996, and 1995
<TABLE>
<CAPTION>
1997 1996 1995
------------- ----------- -------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income $ 3,815,505 193,758 80,319
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 1,431,226 1,165,885 1,212,039
Provision for loss on accounts, notes receivable, and recourse obligation 1,385,734 942,785 229,342
Loss (gain) on sale of marketable investment securities and equipment 45,699 (4,399) (34,635)
Capital contribution by parent company 899,799 389,910 414,981
Provision for loss on inventories 111,000 - -
Deferred taxes (224,274) (374,127) (271,762)
Decrease (increase) in operating assets:
Trade accounts and notes receivable (8,374,533) (1,980,342) (2,266,741)
Inventories (920,068) (2,019,310) 19,873
Prepaid expenses (181,321) 89,441 (94,484)
Other assets 41,666 58,360 (227,882)
Increase (decrease) in operating liabilities:
Accounts payable (818,878) 888,670 1,210,516
Accrued expenses 496,583 45,287 148,411
Income taxes payable 1,153,814 60,578 (208,468)
Deferred revenue and deferred compensation 116,420 193,475 180,844
Payable to GST USA 1,263,715 243,176 -
------------- ----------- -------------
Net cash provided by (used in)
operating activities 242,087 (106,853) 392,353
------------- ----------- -------------
Cash flows from investing activities:
Purchase of land, plant, and equipment (5,169,888) (304,614) (326,796)
Proceeds from sale of equipment - - 34,635
Proceeds from sale of available-for-sale securities 250,000 596,836 -
Purchase of available-for-sale securities (3,234,952) - -
Capitalization of software development costs (821,568) (419,154) (162,025)
Cash included in transfer of Wins to parent (note 1) - (173,718) -
------------- ----------- -------------
Net cash used in investing activities (8,976,408) (300,650) (454,186)
------------- ----------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock 18,066,652 - -
Principal payments on capital lease obligations (80,069) (19,868) (2,271)
------------- ----------- -------------
Net cash provided by (used in)
financing activities 17,986,583 (19,868) (2,271)
------------- ----------- -------------
Net increase (decrease) in cash and cash equivalents 9,252,262 (427,371) (64,104)
Cash and cash equivalents at beginning of year 694,359 1,121,730 1,185,834
------------- ----------- -------------
Cash and cash equivalents at end of year $ 9,946,621 694,359 1,121,730
============= =========== =============
</TABLE>
28
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Statements of Cash Flows (continued)
Years ended September 30, 1997, 1996, and 1995
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- --------------
Supplemental Schedule of Noncash Investing and Financing Activities
<S> <C> <C> <C>
Reclass of common stock to additional paid-in capital resulting from
establishing a par value on common stock $ 9,183,170 - -
Disposition of fully depreciated asset - 132,270 -
Repossession of equipment in settlement of accounts and notes
receivable
76,922 45,000 128,936
Property purchased under capitalized leases - - 102,208
Transfer of inventory to property, plant, and equipment 210,000 - -
Intangibles capitalized as a result of push down - - 2,162,384
Disposition of equipment - 47,366 -
Sale of equipment to Wins on note receivable - 60,000 -
Transfer of notes receivable to other assets (note 4) 964,207 - -
Change in net unrealized gain (loss) on marketable
investment securities
12,344 (171) -
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for interest $ 30,457 17,707 1,145
Cash paid during the year for income taxes 638,287 - 263,735
Supplemental Disclosure of the Assets and Liabilities
Transferred to GST (note 1(b))
Cash $ - (173,718) -
Trade accounts receivable - (68,705) -
Prepaid expenses - (751) -
Property and equipment, net - (46,020) -
Other assets - (14,036) -
Accounts payable - 150,898 -
Accrued expenses - 152,332 -
</TABLE>
See accompanying notes to financial statements.
29
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
September 30, 1997, 1996, and 1995
(1) Summary of Significant Accounting Policies
(a) Organization and Description of Business
NACT Telecommunications, Inc. (the "Company") designs,
develops and manufactures advanced telecommunications
switching platforms with integrated applications software and
network telemanagement capabilities. The Company's customers
include long distance carriers, prepaid debit (calling) card
and prepaid cellular network operators, international call
back/reorigination providers and other specialty
telecommunications service providers.
From September 1993 through September 30, 1995, GST USA, Inc.
("GST USA") acquired all of the issued and outstanding common
stock of the Company. This acquisition was accomplished
through a series of purchases of newly issued shares and the
shares of principal stockholders of the Company. As a result
of these transactions, the Company became a wholly owned
subsidiary of GST USA. GST USA accounted for the acquisition
using the purchase method of accounting. The excess of the
purchase price over the fair value of the assets acquired
totaled $6,912,322 and was assigned by GST USA as product
support contracts, software development costs, and goodwill.
These amounts are included in the accompanying balance sheet
as intangible assets.
In February 1997, the Company closed an initial public
offering (IPO) of 3,000,000 shares of common stock with
2,000,000 sold by the Company and 1,000,000 sold by GST USA.
Upon completion of the offering, GST USA ownership was reduced
to approximately 63 percent of the outstanding common stock of
the Company and, as such, GST USA continues to control the
Company. In connection with the IPO, the Company established a
par value of $.01 for common stock, increased the number of
common shares authorized to 25,000,000, and authorized
10,000,000, $.01 par value preferred shares.
On September 30, 1997, GST USA announced that it had retained
Hambrecht and Quist LLC to explore alternatives for monetizing
its 63 percent interest in the Company, including a potential
sale of some or all of the Company's capital stock to one or
more strategic investors.
(b) Wasatch International Network Services
The 1995 financial statements include the accounts of the
Company and its wholly-owned subsidiary Wasatch International
Network Services, Inc. ("Wins"), which commenced operations in
fiscal 1995 and had total assets, revenues, and net loss of
$316,455, $1,097,950 and $2,361, respectively, as of and for
the year ended September 30, 1995. All significant
intercompany transactions and balances were eliminated in
consolidation. On October 1, 1995, the Company transferred
ownership and operations of Wins to GST USA in the form of a
dividend at historical cost. From October 1, 1995 through
September 30, 1996, the Company provided carrier services to
GST USA for the Wins operation for which it received
$2,571,731. GST USA began providing its own carrier services
for Wins on October 1, 1996.
30
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(c) Cash and Cash Equivalents
The Company considers all highly liquid financial instruments
purchased with an original maturity to the Company of three
months or less to be cash equivalents. Cash equivalents
consist of money market accounts of $8,472,637 at September
30, 1997 and $125,785 at September 30, 1996.
(d) Inventories
Raw materials are valued at the lower of cost (first-in,
first-out) or market. Work-in-process and finished goods are
stated on the basis of accumulated manufacturing costs, but
not in excess of market (net realizable value). Refurbished
inventory is stated at the estimated selling price less
refurbishing costs, selling costs and a normal profit margin.
Management periodically reviews the selling price of the
refurbished inventory and records adjustments to the carrying
value, if any, in the period in which they occur.
Long-term inventory consists of component parts held in order
to provide support on existing customer equipment beyond one
year.
(e) Notes Receivable
Notes receivable are recorded at the principal amount
outstanding, net of an allowance for doubtful notes. The
allowance is an amount that management believes will be
adequate to absorb possible losses based on evaluations of
collectibility and prior loss experience. The evaluation takes
into consideration such factors specific problem loans, past
payment history, and current and anticipated economic
conditions that may affect the customers' ability to pay.
While management uses available information to recognize
losses on notes, changing economic conditions and the economic
prospects of the borrowers might necessitate future additions
to the allowance.
(f) Impaired Notes
Management, considers a note to be impaired when it is
probable that the Company will be unable to collect all
amounts due according to the contractual terms of the note
agreement. When a note is considered to be impaired, the
amount of the impairment is measured based on the present
value of expected future cash flows discounted at the note's
effective interest rate. Impairment losses are included in the
allowance for doubtful accounts through a charge to bad debt
expense. Cash receipts on impaired notes receivable are
applied to reduce the principal amount of such notes until the
principal has been recovered and are recognized as interest
income thereafter.
31
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(g) Property and Equipment
Property and equipment are stated at cost. Depreciation is
computed using the straight-line method for financial
reporting purposes. Depreciation is based upon the estimated
useful lives of individual classes of assets. The estimated
useful lives of the individual classes of assets are as
follows:
Building 35 years
Furniture and equipment 7-10 years
Computer equipment 3-7 years
Switch and testing equipment 3-7 years
(h) Intangibles
Intangibles include goodwill, software development costs,
customer lists, and product support contracts and are being
amortized on a straight-line basis over the estimated useful
lives of the respective assets.
(i) Software Development Costs
Software development costs are capitalized upon the
establishment of technological feasibility of the product.
Capitalization is discontinued when the product is available
for general release to customers. The Company capitalized
software development costs of $821,568, $419,154, and $162,025
in 1997, 1996, and 1995, respectively.
(j) Stock-Based Compensation
Effective October 1, 1996, the Company adopted the footnote
disclosure provisions of Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation
(SFAS 123). SFAS 123 encourages entities to adopt the fair
value based method of accounting for stock options or similar
equity instruments. However, it also allows an entity to
continue measuring compensation cost for stock-based
compensation using the intrinsic-value method of accounting
prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25). The Company
has elected to continue to apply the provisions of APB 25 and
provide pro forma footnote disclosures required by SFAS 123.
(k) Revenue Recognition and Deferred Revenue
Revenue from product sales is recognized when the product is
shipped and the Company has no significant performance
obligations. Revenue from network carrier sales is recognized
as the related service is provided. Deferred revenue consists
of warranty payments billed or received in advance and
deposits related to future product sales. Warranty payments
are amortized over the period of the warranty agreement which
is typically one year.
32
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(l) Income Taxes
Through February 26, 1997, the Company was a member of a
controlled group which elected for federal income tax purposes
to file a consolidated tax return with GST USA. In accordance
with the tax sharing arrangement with GST USA, the Company
recorded the estimated income tax expense as if the Company
filed a tax return on a separate company basis using the asset
and liability method. GST USA agreed to make a capital
contribution to the Company in an amount that approximates the
Company's current federal income tax expense through February
26, 1997 in lieu of an intercompany payment for such taxes.
Pursuant to the tax sharing arrangement between the Company
and GST USA, the adjustment recorded to reconcile the
intercompany and equity accounts with regard to differences
between the estimated tax determined at year-end and the final
tax amount are recognized in income tax expense in the period
determined.
The Company uses the asset and liability method of accounting
for income taxes. Under the asset and liability method,
deferred tax assets and deferred liabilities are recognized
for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and
operating loss and tax credit carryforwards. Deferred tax
assets and deferred liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered
or settled.
After the IPO on February 26, 1997, GST USA's ownership was
reduced to 63 percent. As a result, the entities no longer
meet the affiliated group test defined in Internal Revenue
Code Section 1504(a) and the Company will file stand-alone
returns for periods subsequent to February 26, 1997.
(m) Marketable Investment Securities
The Company classifies all of its marketable investment
securities as available-for-sale which are recorded at fair
market value. Unrealized holding gains and losses are excluded
from earnings and are reported, net of tax, as a separate
component of stockholders' equity until realized. A decline in
the market value of any available-for-sale security below cost
that is deemed other than temporary is charged to earnings
resulting in the establishment of a new cost basis for the
security. Dividend income is recognized when earned. Realized
gains and losses are included in earnings and are derived
using the specific-identification method for securities sold.
33
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(n) Earnings Per Common and Common Equivalent Share
Earnings per common and common equivalent share are computed
based on the weighted-average number of common shares and as
appropriate, dilutive common stock equivalents outstanding
during the period. Stock options are considered to be common
stock equivalents. The number of shares used to compute
primary earnings per common and common equivalent share were
7,350,623, 6,113,712, and 6,113,712, shares in 1997, 1996, and
1995, respectively. The number of shares used to compute
fully-diluted earnings per share reflect additional dilution
related to stock options and warrants using the market price
at the end of the period when higher than the average price
for the period. The number of shares used to compute
fully-diluted earnings per share were 7,602,156, 6,113,712,
and 6,113,712, shares in 1997, 1996, and 1995, respectively.
(o) Fair Value Disclosure
At September 30, 1997 and 1996, the book value of the
Companyis financial instruments approximates fair value.
(p) Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and
liabilities and the 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 these estimates.
(2) Inventories
Inventories consisted of the following:
1997 1996
-------------- -------------
Raw materials $ 1,065,113 377,734
Work-in-process 498,525 346,273
Finished goods 302,829 317,392
Refurbished inventory held for sale 914,000 1,365,000
-------------- -----------
$ 2,780,467 2,406,399
============== ===========
Inventory - long-term $ 225,000 -
============== ===========
34
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(3) Marketable Investment Securities
The amortized cost, gross unrealized holding gains, gross unrealized
holding losses, and fair value for available-for-sale securities by
major security type and class of security at September 30, 1997 and
1996, are as follows:
<TABLE>
<CAPTION>
Gross Gross
unrealized unrealized
Amortized cost holding holding Fair
cost gains losses value
-------------- --------------- --------------- -------------
<S> <C> <C> <C> <C>
At September 30, 1997:
U.S. government securities -
Maturing in one year or less $ 2,237,009 10,287 - 2,247,296
Certificate of deposit -
Maturing in one year or less 998,114 1,886 - 1,000,000
--------------- --------------- -------------
==============
$ 3,235,123 12,173 - 3,247,296
============== =============== =============== =============
At September 30, 1996:
U.S. government securities -
Maturing in one year or less $ 250,171 - 171 250,000
-------------- --------------- --------------- -------------
$ 250,171 - 171 250,000
============== =============== =============== =============
</TABLE>
(4) Notes Receivable
Notes receivable at September 30, 1997 and 1996 include amounts due
from product sales of approximately $4,065,638 and $1,047,500,
respectively. Interest rates on the notes range from 9 percent to 14
percent with lives ranging from six months to five years.
The Company's recorded investment in notes receivable for which an
impairment has been recognized was $137,032 and $928,210, and the
related allowance for doubtful accounts was $137,032 and $310,000 at
September 30, 1997 and 1996, respectively. The average recorded
investment in impaired notes receivable during 1997 and 1996, was
$532,261 and $548,331, respectively. There was no interest income
recognized on impaired notes receivable during 1997 and 1996.
35
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(4) Notes Receivable (continued)
The Company has sold carrier services to Overseas Telecom (iOverseasi)
since 1994. Overseas is located in Brazil and provides international
call back/reorigination services to companies and individuals primarily
in Brazil and Eastern Europe. During the year ended September 30, 1996,
Overseas became delinquent on certain of its payments. In fiscal 1997,
the Company entered into a note receivable agreement with Overseas
which provided for the repayment of the noncurrent outstanding amount
(approximately $0.93 million) bearing interest at 12 percent. The note
was secured primarily by Overseasi customer lists. In the fourth
quarter of fiscal 1997, the Company exercised its call privileges under
the note and took possession of the underlying collateral - the
customer lists. There were two separate and distinct customer lists,
one from Brazil and one from Eastern Europe. The customer list related
to the Brazilian operations was sold to Intertoll Communications
Network Corp. (iICN"), an existing customer of the Company with
operations in Argentina and Brazil for $1,000,000 payable in 100
monthly payments of $10,000. The related payments have been discounted
at 20 percent with the unpaid amount of approximately $485,000
classified as notes receivable in the accompanying balance sheet as of
September 30, 1997.
The customer list related to the Eastern European operations was
recorded on the Companyis books at the lower of fair value or cost.
Fair value was estimated by an independent third party appraiser using
generally accepted valuation standards. Accordingly, a customer list of
approximately $964,000 has been recorded as an intangible asset and
will be amortized over a three-year period.
(5) Property and Equipment
Property and equipment are as follows:
<TABLE>
<CAPTION>
1997 1996
--------------- --------------
<S> <C> <C>
Land $ 563,309 -
Building 3,626,891 -
Furniture and equipment 279,908 212,525
Computer equipment 784,521 440,827
Switch and testing equipment 1,082,217 492,052
--------------- --------------
6,336,846 1,145,404
Less accumulated depreciation and amortization 553,689 427,600
=============== ==============
$ 5,783,157 717,804
=============== ==============
</TABLE>
36
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(6) Intangibles
Intangible assets are summarized as follows:
<TABLE>
<CAPTION>
Amortization
1997 1996 period
--------------- ---------------- ----------------
<S> <C> <C> <C>
Goodwill $ 2,863,766 2,863,766 20 years
Software development costs 3,305,127 2,483,559 3-5 years
Product support contracts 2,146,176 2,146,176 5 years
Customer list 964,207 - 3 years
--------------- ----------------
9,279,276 7,493,501
Less amortization 3,503,603 2,418,135
=============== ================
$ 5,775,673 5,075,366
=============== ================
</TABLE>
On an ongoing basis, management reviews the valuation and amortization
of intangible assets to determine possible impairment by comparing the
carrying value of the asset to its undiscounted estimated future cash
flows.
Amortization expense relating to these assets was $1,085,468, $978,813,
and $962,514 for 1997, 1996, and 1995, respectively. Of these amounts,
$512,409, $405,755, and $442,734, for 1997, 1996, and 1995,
respectively, was recorded as a component of cost of goods sold.
(7) Stock Options
In November 1996, the Company adopted the 1996 Stock Option Plan ("1996
Plan") which was approved by the board of directors and GST USA. The
Company has reserved 1,250,000 shares for issuance under the 1996 Plan,
of which options to purchase 935,250 shares of common stock at an
exercise price of $9.35 per share were granted. All options granted
during the year expire on November 25, 2001. The Company may grant
incentive stock options and nonqualified stock options to employees,
officers, directors, independent contractors, and consultants. The
exercise price of options must be greater than or equal to the
estimated fair market value of the stock at the date of grant. The
board of directors or the compensation committee thereof determines
which eligible individuals are granted options, terms of the options,
exercise price, number of shares subject to the option, vesting and
exercisability. The 1996 Plan expires on November 25, 2006.
37
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(7) Stock Options (continued)
A summary of activity follows:
<TABLE>
<CAPTION>
Year ended
September 30, 1997
-------------------------------------------
Weighted-average
exercise
Number of shares price
------------------ ------------------
<S> <C> <C>
Options outstanding at beginning of year -
Plus options granted 935,250 $ 9.35
Less options exercised -
==================
Options outstanding at end of year 935,250 $ 9.35
==================
Options exercisable at end of year 289,688 $ 9.35
Weighted-average fair value of options granted
during the year $ 3.03
</TABLE>
The following table summarizes information about fixed stock options
outstanding at September 30, 1997:
<TABLE>
<CAPTION>
Options outstanding Options exercisable
---------------------------------------------------------------- ----------------------------------------
Weighted-average
Number remaining Weighted-average Number Weighted-average
Range of exercise outstanding at contractual exercise exercisable at exercise
prices September 30, life price September 30, price
1997 1997
------------------ ------------------ ---------------- ------------------ ------------------- ------------------
<S> <C> <C> <C> <C> <C>
$ 9.35 935,250 4.15 9.35 289,688 9.35
</TABLE>
The Company accounts for these plans under APB 25, under which no
compensation cost has been recognized. Had compensation cost for these
plans been determined consistent with SFAS 123, the Company's net
earnings and earnings per share would have been changed to the
following pro forma amount:
1997
------------------
Net income As reported $ 3,815,505
Pro Forma 2,784,147
Primary earnings per share: As reported $ 0.52
Pro Forma 0.38
Fully-diluted earnings per share As reported $ 0.50
Pro Forma 0.37
Pro forma net earnings reflects only options granted in fiscal 1997.
Therefore, the effect that calculating compensation cost for
stock-based compensation under SFAS 123 has on the pro forma net
earnings as shown above may not be representative of the effects on
reported net earnings for future years.
38
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(7) Stock Options (continued)
The fair value of each option grant is estimated on the date of the
grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in fiscal 1997: risk-free
interest rate of 6.0 percent; expected dividend yield of 0 percent;
expected life of 3.4 years; and expected volatility of 82 percent.
(8) Income Taxes
Income tax expense consists of:
<TABLE>
<CAPTION>
Current Deferred Total
-------------- --------------- ---------------
<S> <C> <C> <C>
Year ended September 30, 1997:
U.S. federal $ 2,336,145 (194,210) 2,141,935
State 364,476 (30,064) 334,412
============== =============== ===============
$ 2,700,621 (224,274) 2,476,347
============== =============== ===============
Year ended September 30, 1996:
U.S. federal $ 389,910 (322,207) 67,703
State 60,358 (49,877) 10,481
-------------- --------------- ---------------
$ 450,268 (372,084) 78,184
============== =============== ===============
Year ended September 30, 1995:
U.S. federal $ 414,981 (237,014) 177,967
State 64,239 (36,689) 27,550
-------------- --------------- ---------------
===============
$ 479,220 (273,703) 205,517
============== =============== ===============
</TABLE>
Income tax expense differs from the amounts computed by applying the
U.S. federal income tax rate of 34 percent to pretax income from
continuing operations as a result of the following:
<TABLE>
<CAPTION>
1997 1996 1995
-------------- --------------- ---------------
<S> <C> <C> <C>
Computed "expected" tax expense $ 2,139,230 92,460 97,184
Increase (reduction) in income taxes resulting from:
Amortization of goodwill 48,899 48,899 48,899
State and local income taxes, net of federal
income tax benefit 222,862 2,297 18,183
Meals and entertainment 5,796 3,631 4,060
Adjustment of tax provision to actual (1) - (70,040) 36,214
Other, net 59,560 937 977
--------------- --------------- ---------------
$ 2,476,347 78,184 205,517
============== =============== ===============
</TABLE>
(1) Represents management's adjustment to the Company's income tax
liability based on a current assessment of its related obligations.
39
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(8) Income Taxes (continued)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
September 30, 1997 and 1996, are presented below:
<TABLE>
<CAPTION>
1997 1996
------------------ --------------
<S> <C> <C>
Net current deferred tax assets:
Accounts and notes receivable principally due to allowance for doubtful
accounts $ 309,895 152,930
Unearned product warranty 125,422 47,074
Accrued vacation payable 55,386 37,327
Unearned sales deposits - 83,640
Inventory principally due to uniform capitalization and reserves
96,496 97,478
------------------ --------------
Total gross deferred tax assets 587,199 418,449
------------------ --------------
Net long-term deferred tax liabilities:
Deferred compensation 58,866 58,866
Plant and equipment, principally due to differences in depreciation and
capitalized interest
(77,155) (87,588)
Capitalized software (450,716) (200,619)
Push down intangibles (460,979) (756,269)
Unrealized (gain) loss on investments - 102
------------------ --------------
Total gross deferred tax liabilities (929,984) (985,508)
------------------ --------------
Net deferred tax liability $ (342,785) (567,059)
================== ==============
</TABLE>
Management believes that existing taxable temporary differences will
more likely than not reverse within the applicable carryforward periods
to allow future realization of existing deferred tax assets.
(9) Leases
The Company has operating leases for office furnishings, various office
equipment and two sales offices. Future minimum lease payments as of
September 30, 1997 are as follows:
Year ending September 30:
1998 $ 194,378
1999 180,240
2000 180,240
2001 180,240
2002 160,454
=================
Total minimum lease payments $ 895,552
=================
40
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(9) Leases (continued)
These leases generally require the Company to pay all executory costs
such as maintenance and insurance. Rental expenses for all operating
leases for 1997, 1996, and 1995, were $123,462, $100,299, and $116,944,
respectively.
(10) Profit Sharing Plans
The Company sponsors a defined contribution 401(k) plan (the "Plan")
for employees who have completed one year of service and attained the
age of 21. Participants may defer up to 15 percent of eligible
compensation. The Company, at its discretion, may match 50 percent of
participant contributions up to 7.5 percent of participant
compensation. Employer contributions made to the Plan were $88,361,
$59,881, and $51,863, for the years ended September 30, 1997, 1996, and
1995, respectively.
Through September 30, 1996, the Company established a discretionary
profit sharing program for full time employees who had completed one
full year of employment. Under the plan, 10 percent of the increase in
profits based on the Company's previous highest retained earnings
balance were allocated among employees determined on length of
employment and salary level at the discretion of the board of
directors. Contributions to the program were $132,450 and $171,483 for
the years ended September 30, 1996 and 1995, respectively. The program
was terminated on September 30, 1996.
(11) Major Customers, Concentration of Credit Risk and Network Carrier Sales
Sales to individual customers exceeding 10 percent of total revenues or
total trade accounts and notes receivable as of and for the years ended
September 30, 1997, 1996, and 1995, were as follows:
<TABLE>
<CAPTION>
Percentage of total revenues
----------------------------------------------------
Customer 1997 1996 1995
-------------------------------------------------------- -------------- -------------- -------------
<S> <C> <C> <C>
J.D. Services, Inc. 8% - -
Caribbean Telephone and Telegraph, Inc. - - 16%
Intertoll Communications Network Corp. 9 12% 8
Overseas Telecom 5 13 7
</TABLE>
<TABLE>
<CAPTION>
Percentage of total notes and accounts receivable
----------------------------------------------------
Customer 1997 1996 1995
-------------------------------------------------------- -------------- -------------- -------------
<S> <C> <C> <C>
J.D. Services, Inc. 15% - -
Caribbean Telephone and Telegraph, Inc. - - 7%
Intertoll Communications Network Corp. 4 6% 7
Overseas Telecom 3 22 7
</TABLE>
41
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(11) Major Customers, Concentration of Credit Risk and Network Carrier Sales
(continued)
The Company's customers consist of business entities geographically
dispersed primarily throughout the United States. However, the Company
also sells products and/or services to customers in the United Kingdom,
Bosnia, Serbia, Bulgaria, Saudi Arabia, and Brazil. The Company
maintains a security interest in the telecommunications systems it
sells until the related account balances are paid in full.
The Company had deposits with financial institutions in excess of the
federally insured amount of $100,000 in the amount of $9,691,380 and
$467,737 for the years ended September 30, 1997 and 1996, respectively.
Network carrier sales originating from countries outside the United
States aggregated approximately $3,180,000 and $2,105,000 for the years
ended September 30, 1997 and 1996, respectively. These sales are
payable in U.S. dollars.
(12) Commitments and Contingencies
The Company acted as a guarantor for financing transactions executed
under repurchase agreements with a financial institution for $3,482,182
and $1,035,032 at September 30, 1997 and 1996, respectively. This
results from the financial institution providing lease financing to the
Company's customers to enable them to purchase product from the
Company. At September 30, 1997, the Company had established a reserve
of $200,000 for its estimated obligation under the recourse provisions
and maintains a security interest in the equipment financed under the
repurchase agreement. No such reserve was recorded as of September 30,
1996. In addition to other covenants, the repurchase agreement requires
the Company to maintain an unrestricted cash account of $6,000,000. The
Company has also established a $750,000 revolving line of credit with
this same financial institution. No balances were outstanding under
this line of credit at September 30, 1997.
On October 1, 1996, the Company entered into employment agreements with
various employees which specify the individual's salary, benefits, and
restrictions. All agreements expire on September 30, 2001.
42
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(12) Commitments and Contingencies (continued)
On August 24, 1995, Aerotel, Ltd. and Aerotel U.S.A., Inc.,
(collectively, "Aerotel") filed a patent infringement suit against the
Company alleging that telephone systems manufactured and sold by the
Company incorporating prepaid calling features infringe upon a patent
which was issued to Aerotel in November 1987. The complaint further
alleges defamation and unfair competition by the Company and seeks
various damages. Aerotel seeks injunctive relief, damages of $18.7
million for willful infringement of its patent and an order requiring
the Company to publish a written apology to Aerotel. The Company has
filed an Answer and Counterclaim denying patent infringement,
defamation or unfair competition and seeking judgment that the Aerotel
patent is invalid and that Aerotel has misused its patent in violation
of antitrust laws. Based on information currently available, an
estimate of potential loss cannot be made. However, management is of
the opinion that there will be no material impact of the Company's
financial position, results of operations or liquidity as a result of
this suit. Accordingly, no provision for loss has been provided in the
accompanying financial statements. An unfavorable decision could have a
material adverse effect on the business, financial condition, and
results of operations of the Company.
In addition to the above, the Company has various legal claims and
other contingent matters, incurred in the normal course of business.
Although the final outcome of such matters cannot be predicted, the
Company believes the ultimate disposition of these matters will not
have a material adverse effect on the Company's financial condition,
liquidity, or results of operations.
As of September 30, 1997, the Company had capital expenditure purchase
commitments outstanding of approximately $900,000.
(13) Related Party Transactions
In June 1997, and under contract with the Company, GST Realco, Inc.
("GST Realco"), a subsidiary of GST USA, completed construction of a
40,000 square foot office building in Provo, Utah. The Company
purchased the land and a portion of the building construction from GST
Realco for $563,309 and $1,293,072, respectively, and currently
occupies the property as its corporate and manufacturing facility.
During the year ended September 30, 1996, GST USA borrowed $250,000
from the Company on short-term notes bearing interest at 11 percent.
The note was repaid by September 30, 1996. The Company recorded
interest income of $2,602 relating to this note during the year ended
September 30, 1996. There were no borrowings during fiscal 1997.
Also, during the years ended September 30, 1997 and 1996, respectively,
the Company sold $32,788 and $356,000 of application platform switching
products and $-0- and $2,571,731 of wholesale carrier usage to GST USA
or subsidiaries and purchased $4,466,907 and $361,000 of wholesale
carrier usage from GST USA.
From April 1996 through May 1997 a member of the Company's board was
compensated by GST USA for services rendered to GST USA and its
subsidiaries.
43
<PAGE>
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Notes to Financial Statements
(13) Related Party Transactions (continued)
The Company has entered into a Deferred Compensation Trust Agreement
(the Trust) with the chairman of the Company whereby the Company funded
the trust in the amount of $144,000. The principal and related interest
thereon are payable to the chairman based on a defined payment
schedule. The Company, at its sole discretion, may at any time make
additional contributions to the Trust. The Trust is subject to claims
of the Company's creditors in the event of the Company's insolvency.
(14) Accounting Standards Issued Not Yet Adopted
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, Earnings per Share
(SFAS 128). SFAS 128 establishes a different method of computing
earnings per share than is currently required under the provisions of
Accounting Principles Board Opinion No. 15. Under SFAS 128, the Company
will be required to present both basic earnings per share and diluted
earnings per share. Basic and diluted earnings per share are expected
to be comparable to the currently presented earnings per share. SFAS
128 is effective for the consolidated financial statements for interim
and annual periods ending after December 15, 1997. Accordingly, the
Company plans to adopt SFAS 128 in the first quarter of its 1998 fiscal
year and at that time all historical earnings per share data presented
will be restated to conform with the provisions of SFAS 128.
In 1997, the FASB also issued Statement No. 130, Reporting
Comprehensive Income, and Statement No. 131, Disclosures About Segments
of an Enterprise and Related Information. These statements which are
effective for periods beginning after December 15, 1997, expand or
modify disclosures and accordingly, will have no impact on the
Company's reported financial position, results of operations or cash
flows.
44
<PAGE>
Schedule II
NACT TELECOMMUNICATIONS, INC.
(A Majority Owned Subsidiary of GST USA)
Valuation and Qualifying Accounts
Years ended September 30, 1997, 1996, and 1995
<TABLE>
<CAPTION>
Balance at beginning Additions charged to Write offs against Balance at
Allowance for doubtful accounts of year bad debts allowance end of year
---------------------- ------------------------ ------------------------- ----------------
<S> <C> <C> <C> <C>
Year ended September 30, 1997 $ 100,000 $ 872,427 $ 591,608 $ 380,819
============= ============= ============== ==============
Year ended September 30, 1996 $ 116,410 $ 672,785 $ 689,195 $ 100,000
============= ============= ============== ==============
Year ended September 30, 1995 $ - $ 189,342 $ 72,932 $ 116,410
============= ============= ============== ==============
Balance at beginning Additions charged to Write offs against
Allowance for doubtful notes of year bad debts allowance year Balance at end of
---------------------- ------------------------ --------------------- -------------------
Year ended September 30, 1997 $ 310,000 $ 313,307 $ 373,307 $ 250,000
============= ============== ============= ==============
Year ended September 30, 1996 $ 40,000 $ 270,000 $ - $ 310,000
============= ============== ============= ==============
Year ended September 30, 1995 $ - $ 40,000 $ - $ 40,000
============= ============== ============= ==============
Balance at Charges
Recourse Obligation Reserve beginning of Additions and against Balance at end of
Recourse Obligation Reserve year adjustments allowance year
----------------------------------------------- ----------------------- -----------------
Year ended September 30, 1997 $ - $ 200,000 $ - $ 200,000
============= ============== ============= ==============
</TABLE>
45
<PAGE>
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed not later than January 28, 1998
pursuant to Regulation 14A of the General Rules and Regulations under the
Securities Exchange Act of 1934 ("Regulation 14A").
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed not later than January 28, 1998
pursuant to Regulation 14A.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed not later than January 28, 1998
pursuant to Regulation 14A.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed not later than January 28, 1998
pursuant to Regulation 14A.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K
(a) The following documents constitute a list of financial
statements, financial statement schedules and exhibits
required to be included in this report:
1. Financial Statements. Included in Part II, Item 8 of this report:
Independent Auditors' Report
Balance Sheets - September 30, 1997 and 1996
Statements of Income - Years ended September 30, 1997, 1996, and 1995
Statement of Stockholders' Equity - Years ended September 30, 1997,
1996 and 1995
Statements of Cash Flows - Years ended September 30, 1997, 1996, and
1995
Notes to Financial Statements - Years ended September 30, 1997, 1996
and 1995
46
<PAGE>
2. Financial Statement Schedules. Included in Part II of this report.
Schedule II - Valuation and Qualifying Accounts
Schedules not listed above have been omitted because they are not applicable or
are not required or the information required to be set forth therein is included
in the Financial Statements or notes thereto.
3. Exhibit
Number
3.1 Certificate of Incorporation of the Company, incorporated by
reference to Exhibit 3.1 of the Company's Registration Statement
on Form S-1 (Registration No. 333-17735) (the "Form S-1")
3.2 By-laws of the Company, incorporated by reference to Exhibit 3.2
of the Form S-1.
4.1 Specimen Certificate of the Company's Common Stock, incorporated
by reference to Exhibit 4.1 of the Form S-1.
4.2 Amended and Restated 1996 Stock Option Plan, incorporated by
reference to Exhibit 4.2 of the Form S-1.
10.1 Employment Agreement dated as of October 1, 1996 by and between
the Company and A. Lindsay Wallace, incorporated by reference to
Exhibit 10.1 of the Form S-1.
10.2 Employment Agreement dated as of October 1, 1996 by and between
the Company and Eric F. Gurr, incorporated by reference to Exhibit
10.2 of the Form S-1.
10.3 Employment Agreement dated as of October 1, 1996 by and between
the Company and Gary Brown, incorporated by reference to Exhibit
10.3 of the Form S-1.
10.4 Employment Agreement dated as of October 1, 1996 by and between
the Company and Geoffrey Shupe, incorporated by reference to
Exhibit 10.4 of the Form S-1.
10.5 Revolving Line of Credit Agreement dated February 6, 1996 by and
between the Company and Zions Credit Corporation, incorporated by
reference to Exhibit 10.5 of the Form S-1.
10.6 Form of Recourse Lease Financing Agreement by and between the
Company and Zions Credit Corporation, incorporated by reference to
Exhibit 10.6 of the Form S-1.
10.7 Lease Agreement dated October 20, 1994, by and between the Company
and Busch-Provo, LTD, incorporated by reference to Exhibit 10.7 of
the Form S-1.
10.8 Lease Extension Agreement dated May 15, 1996, by and between the
Company and Busch-Provo, LTD, incorporated by reference to Exhibit
10.8 of the Form S-1.
47
<PAGE>
*23.1 Consent to the incorporation by reference in the Company's
registration Statement on Form S-8 of the report of KPMG Peat
Marwick LLP included herein.
*24.1 Power of Attorney (included on the signature page of this Form
10K).
*27.1 Financial Data Schedule
- ------------------
* Filed herewith.
(b) Reports on Form 8-K. None
48
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the city of
Provo, State of Utah, on the 26th day of December, 1997.
NACT Telecommunications, Inc.
By: /S/ A. Lindsay Wallace
---------------------
A. Lindsay Wallace
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints A. Lindsay Wallace and Eric F. Gurr his true and lawful
attorney-in-fact, each acting alone, with full power of substitution and
resubstitution for him and in his name, place and stead, in any and all
capacities to sign any and all amendments to this report, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
said attorneys-in-fact or their substitutes, each acting alone, may lawfully do
or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this report has been duly signed by the following persons in the capacities and
on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/S/ A. Lindsay Wallace Chief Executive Officer (Principal December 26, 1997
- ------------------------ Executive Officer) and Director
(A. Lindsay Wallace)
/S/ Eric F. Gurr Chief Financial Officer (Principal December 26, 1997
- ------------------------- Financial & Accounting Officer)
(Eric F. Gurr)
/S/ Thomas E. Sawyer Director December 26, 1997
- ------------------------
(Thomas E. Sawyer)
/S/ Ronald Eliason Director December 26, 1997
- ------------------------
(Ronald Eliason)
</TABLE>
49
<PAGE>
Signature Title Date
--------- ----- ----
/S/ W. Gordon Blankstein Director December 26, 1997
- ------------------------
(W. Gordon Blankstein)
/S/ Robert Olson Director December 26, 1997
- ------------------------
(Robert Olson)
/S/ Clifford V. Sander Director December 26, 1997
- ------------------------
(Clifford V. Sander)
/S/ Stephen Irwin Director December 26, 1997
- ------------------------
(Stephen Irwin)
50
Exhibit 23.1
Independent Auditor's Consent
The Board of Directors
NACT Telecommunications, Inc.:
We consent to incorporation by reference in the Registration Statement (No.
333-36899) on Form S-8 of NACT Telecommunications, Inc. of our report dated
December 4, 1997, relating to the balance sheets of NACT Telecommunications,
Inc. as of September 30, 1997 and 1996, and the related statements of income,
stockholders' equity, and cash flows for each of the years in the three year
period ended September 30, 1997, and related schedule, which report appears in
the September 30, 1997 Form 10K of NACT Telecommunications, Inc.
/S/ KPMG PEAT MARWICK LLP
- -------------------------
KPMG PEAT MARWICK LLP
Salt Lake City, Utah
December 24, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-END> SEP-30-1997
<CASH> 9,946,621
<SECURITIES> 3,247,296
<RECEIVABLES> 11,690,815
<ALLOWANCES> (630,819)
<INVENTORY> 3,005,467
<CURRENT-ASSETS> 26,852,370
<PP&E> 6,336,846
<DEPRECIATION> (553,689)
<TOTAL-ASSETS> 39,755,111
<CURRENT-LIABILITIES> 5,663,077
<BONDS> 0
<COMMON> 81,137
0
0
<OTHER-SE> 32,923,094
<TOTAL-LIABILITY-AND-EQUITY> 39,755,111
<SALES> 27,698,260
<TOTAL-REVENUES> 27,698,260
<CGS> 12,989,009
<TOTAL-COSTS> 8,934,792
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,317,334
<INTEREST-EXPENSE> 30,456
<INCOME-PRETAX> 6,291,852
<INCOME-TAX> 2,476,347
<INCOME-CONTINUING> 3,815,505
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,815,505
<EPS-PRIMARY> 0.52
<EPS-DILUTED> 0.50
</TABLE>
