<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 27, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number 0-23263
EXCEL SWITCHING CORPORATION
---------------------------
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2992806
------------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
255 INDEPENDENCE DRIVE
----------------------
HYANNIS, MASSACHUSETTS 02601
-------------------------------
(Address of principal executive offices) (Zip code)
(508) 862-3000
--------------
(Registrant's telephone number, including area code)
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: [ ]
As of August 3, 1998, there were 33,267,048 shares of the Registrant's
Common Stock, $.01 par value, outstanding.
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EXCEL SWITCHING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
PART I. - FINANCIAL INFORMATION PAGE
ITEM 1. Consolidated Condensed Financial Statements
Consolidated Condensed Balance Sheets as of December 27,
1997 and June 27, 1998 3
Consolidated Condensed Statements of Income for the
three and six months ended June 28, 1997 and June 27, 1998 4
Consolidated Condensed Statements of Cash Flows for
the six months ended June 28, 1997 and June 27, 1998 5
Notes to Consolidated Condensed Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 17
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 18
ITEM 2. Changes in Securities and Use of Proceeds 18
ITEM 3. Defaults Upon Senior Securities 19
ITEM 4. Submission of Matters to a Vote of Security Holders 19
ITEM 5. Other Information 20
ITEM 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
EXHIBIT INDEX 22
2
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EXCEL SWITCHING CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
ASSETS
DECEMBER 27, JUNE 27,
1997 1998
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 47,968 $ 75,428
Marketable securities 66,929 44,461
Accounts receivable, net of reserves 12,843 15,910
Inventories 4,740 5,995
Prepaid taxes 122 -
Deferred tax asset 5,626 6,261
Other current assets 1,298 1,860
-------- --------
Total current assets 139,526 149,915
PROPERTY AND EQUIPMENT, NET 10,168 15,731
-------- --------
$149,694 $165,646
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 4,213 $ 1,060
Accounts payable 4,177 4,529
Accrued expenses 11,156 15,174
Accrued income taxes 3,606 2,432
-------- --------
Total current liabilities 23,152 23,195
-------- --------
DEFERRED INCOME TAXES 519 249
-------- --------
LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 108 18
-------- --------
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value
Authorized--10,000,000 shares; no shares outstanding - -
Common Stock, $.01 par value
Authorized--100,000,000 shares
issued and outstanding--32,592,000 and 33,167,160
shares at December 27, 1997 and June 27, 1998 326 332
Additional paid-in capital 88,134 92,696
Deferred compensation (491) (627)
Unrealized gain (loss) on investments (20) 7
Retained earnings 37,966 49,776
-------- --------
Total stockholders' equity 125,915 142,184
-------- --------
$149,694 $165,646
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
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EXCEL SWITCHING CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 28, JUNE 27, JUNE 28, JUNE 27,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
REVENUES $20,537 $28,739 $39,055 $54,295
COST OF REVENUES 6,173 8,508 12,033 16,088
------- ------- ------- -------
Gross profit 14,364 20,231 27,022 38,207
------- ------- ------- -------
Operating Expenses:
Engineering, research and development 3,075 5,017 6,017 9,743
Selling and marketing 2,585 3,762 4,882 7,682
General and administrative 1,892 2,576 3,851 4,994
------- ------- ------- -------
Total operating expenses 7,552 11,355 14,750 22,419
------- ------- ------- -------
Income from operations 6,812 8,876 12,272 15,788
OTHER INCOME, NET 50 1,459 94 3,107
------- ------- ------- -------
Income before provision
for income taxes 6,862 10,335 12,366 18,895
PROVISION FOR INCOME TAXES 2,745 3,876 4,946 7,086
------- ------- ------- -------
NET INCOME $ 4,117 $ 6,459 $ 7,420 $11,809
======= ======= ======= =======
BASIC EARNINGS PER SHARE $.15 $.20 $.26 $.36
======= ======= ======= =======
DILUTED EARNINGS PER SHARE $.12 $.17 $.22 $.30
======= ======= ======= =======
BASIC SHARES OUTSTANDING 28,090 32,988 28,090 32,817
DILUTED SHARES OUTSTANDING 33,591 39,083 33,396 39,008
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
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EXCEL SWITCHING CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 28, JUNE 27,
1997 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,420 $11,809
Adjustments to reconcile net income to net cash provided by
operating activities--
Depreciation and amortization 1,008 1,482
Unrealized gain on investments - 27
Deferred income taxes (1,058) (905)
Compensation expense associated with the grant of stock
options, net of forfeitures 35 89
Changes in assets and liabilities--
Accounts receivable (2,010) (3,067)
Inventories 1,644 (1,255)
Prepaid taxes - 122
Other current assets 154 (562)
Accounts payable 1,241 352
Accrued expenses 2,558 4,018
Accrued income taxes (1,337) 2,961
------- -------
Net cash provided by operating activities 9,655 15,071
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (1,255) (7,045)
Purchases of marketable securities, net (3,001) 22,468
------- -------
Net cash used in investing activities (4,256) 15,423
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term obligations (243) (3,243)
Proceeds from the exercise of stock options - 209
------- -------
Net cash used in financing activities (243) (3,034)
------- -------
NET iNCREASE IN CASH AND CASH EQUIVALENTS 5,156 27,460
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 4,069 47,968
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 9,225 $75,428
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for
Interest $ 187 $ 45
======= =======
Taxes $ 7,286 $ 4,908
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
5
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EXCEL SWITCHING CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Note 1--Interim Consolidated Condensed Financial Statements
The accompanying unaudited interim consolidated condensed financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission for reporting on
Form 10-Q. Accordingly, certain information and footnote disclosure required for
complete financial statements are not included herein. It is recommended that
these financial statements be read in conjunction with the consolidated
financial statements and related notes of Excel Switching Corporation (the
"Company") for the year ended December 27, 1997 as reported in the Company's
Annual Report on Form 10-K. In the opinion of management, all adjustments
(consisting of normal, recurring adjustments) considered necessary for a fair
presentation of financial position, results of operations and cash flows at the
dates and for the periods presented have been included. The consolidated
condensed balance sheet presented as of December 27, 1997 has been derived from
the consolidated financial statements that have been audited by the Company's
independent public accountants. The results of operations for the period ended
June 27, 1998 may not be indicative of the results that may be expected for the
year ended December 26, 1998, or for any other period.
Note 2--Earnings Per Share
In March 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 128, Earnings Per Share. This statement established standards for computing
and presenting earnings per share and applies to entities with publicly traded
common stock or potential common stock. This statement is effective for fiscal
years ending after December 15, 1997. In February 1998, the Securities and
Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 98. This
bulletin revises the SEC's guidance for calculating earnings per share with
respect to equity security issuances before an initial public offering (IPO) and
is effective for fiscal years ending after December 15, 1997. The prior periods'
earnings per share have been retroactively restated to reflect the adoption of
SFAS No. 128 and SAB No. 98.
Basic earnings per share was determined by dividing net income by the
weighted average common shares outstanding during the period. Diluted earnings
per share was determined by dividing net income by diluted weighted average
shares outstanding. Diluted weighted average shares reflect the dilutive effect,
if any, of common stock options based on the treasury stock method.
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The calculations of basic and diluted weighted average shares outstanding
are as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 28, JUNE 27, JUNE 28, JUNE 27,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
Basic weighted average common
shares outstanding 28,090 32,988 28,090 32,817
Weighted average common
equivalent shares 5,501 6,095 5,306 6,191
------ ------ ------ ------
Diluted weighted average
shares outstanding 33,591 39,083 33,396 39,008
====== ====== ====== ======
</TABLE>
Note 3--Comprehensive Income
Comprehensive income for the three and six month periods ended June 27,
1998 is approximately $6,465 and $11,826, respectively. The difference between
comprehensive income and net income relates to unrealized gains on marketable
securities. There were no differences between comprehensive income and net
income for the three and six month periods ended June 28, 1997.
Note 4--Significant Customers
Sales to significant customers as a percentage of the Company's total
revenues were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 28, JUNE 27, JUNE 28, JUNE 27,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
Significant Customer A * 32% * 27%
Significant Customer B 31% * 33% *
</TABLE>
* Sales derived from these customers were less than 10% of the Company's total
revenues for the period.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussions contain statements which may be "forward-looking"
statements and are subject to risks and uncertainties that could cause actual
results to differ significantly from expectations. In particular, statements
contained in this "Management's Discussion and Analysis of Financial Condition
and Results of Operations" which are not historical facts, including, but not
limited to, statements regarding the anticipated adequacy of cash resources to
meet the Company's working capital and facility construction requirements and
statements regarding the anticipated proportion of revenues to be derived from a
limited number of customers, may constitute forward-looking statements. Factors
that might cause such a difference include those relating to: fluctuations in
quarterly results of operations; dependence on and concentration of
relationships with application developers, original equipment manufacturers
(OEMs) and systems integrators; length of sales cycle; concentration of
customers; dependence on single and sole source suppliers; dependence on third-
party manufacturers; and management of growth and hiring of additional
personnel. Other factors may include, but are not limited to, those relating to
the evolving market for telecommunication services; concentrated product family;
risk of new product introductions; rapid technological change; dependence on key
personnel; highly competitive market; and compliance with regulations and
evolving industry standards; dependence on proprietary rights; risks associated
with international sales; and other risks identified in the Company's Securities
and Exchange Commission filings including those risks identified in the section
entitled "Risk Factors" of the Company's Annual Report for the fiscal year ended
December 27, 1997 on Form 10-K.
OVERVIEW
Excel Switching Corporation (the "Company" or "Excel"), is a leading
provider of open switching platforms for telecommunications networks worldwide.
The Company develops, manufactures, markets and supports a family of open,
programmable, carrier-class switches that address the complex enhanced services
and wireless and wireline infrastructure needs of network providers. Excel's
products offer network providers the flexibility to address multiple market
applications and the scalability to deploy a variety of system capacities. The
Company's programmable switching platforms enable network providers to deliver
improved networking functionality at a lower cost than purchasing, upgrading or
reprogramming traditional, closed, central office switches. The Company sells
to a variety of customers in the worldwide telecommunications market, including
application developers, original equipment manufacturers ("OEMs") and systems
integrators.
Excel offers a family of programmable switching platforms that are designed
with distributed architecture and open software to maximize performance and
provide multiple levels of programmability and redundancy. Excel's open
switching platforms integrate with a wide variety of host computer systems,
operating systems and application development environments. The Company's
product family scales from approximately 100 to 30,720 ports.
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Using Excel's patented Programmable Protocol Language ("PPL"), application
developers can customize the switching software to their unique requirements,
allowing them to introduce new services and applications rapidly. As customer
requirements evolve, the Excel platform can be upgraded without requiring
extensive and complex programming changes to the underlying software.
Excel's customers integrate the Company's open, programmable switching
platforms with their product offerings to address a variety of market
applications for network providers, ranging from enhanced services such as voice
messaging, one number services and prepaid debit cards, to wireless and wireline
infrastructure services such as tandem switching, mobile switching centers and
intelligent base station controllers.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
percentage of revenues represented by certain items reflected in the Company's
Consolidated Condensed Statements of Income:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 28, JUNE 27, JUNE 28, JUNE 27,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 30.1 29.6 30.8 29.6
----- ----- ----- -----
Gross profit 69.9 70.4 69.2 70.4
----- ----- ----- -----
Operating expenses:
Engineering, research and
development 15.0 17.5 15.4 17.9
Selling and marketing 12.5 13.1 12.5 14.2
General and administrative 9.2 8.9 9.9 9.2
----- ----- ----- -----
Total operating expenses 36.7 39.5 37.8 41.3
----- ----- ----- -----
Income from operations 33.2 30.9 31.4 29.1
Other income, net .2 5.1 .2 5.7
----- ----- ----- -----
Income before provision for
income taxes 33.4 36.0 31.6 34.8
Provision for income taxes 13.4 13.5 12.6 13.0
----- ----- ----- -----
Net income 20.0% 22.5% 19.0% 21.8%
===== ===== ===== =====
</TABLE>
THREE MONTHS ENDED JUNE 28, 1997 AND JUNE 27, 1998
Revenues. The Company's revenues consist of sales, primarily in the United
States, of its open, programmable switching platforms and related components.
Revenues increased 40% from $20.5 million in the three months ended June 28,
1997 to $28.7 million for the comparable period in 1998. This increase resulted
from the introduction of new or expanded
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offerings by existing customers incorporating the Company's products, the
expansion of customers' existing markets and the introduction of applications by
new and existing customers. In addition, revenues increased due to increased
market penetration resulting from the efforts of the Company's expanded selling
and marketing organizations.
Revenues from the Company's five largest customers represented
approximately 59% and 52% of the Company's revenues for the second quarters of
1997 and 1998, respectively. During the 1998 period Qualcomm Incorporated
represented approximately 32% of the Company's revenue. During the 1997 period
Comverse Network Systems (Comverse) (formerly Boston Technology, Inc.)
represented approximately 31% of the Company's revenue. Although the Company's
largest customers have varied from period to period, the Company believes that
revenues derived from current and potential large customers will continue to
represent a significant portion of revenues, and that its results of operations
in any given period will continue to depend to a significant extent upon sales
to a limited number of customers. There can be no assurance that the Company's
principal customers will continue to purchase products at current levels, if at
all.
Gross Profit. Cost of revenues consists primarily of the cost of purchased
components and subassemblies, contract manufacturing costs, labor and overhead
relating to material procurement, final assembly, testing and quality control,
and warranty and post sale support costs. Cost of revenues increased 38% from
$6.2 million in the three months ended June 28, 1997 to $8.5 million for the
comparable period in 1998. Gross margin increased from 69.9% in the second
quarter of 1997 to 70.4% in the comparable period of 1998. The increase in
gross margins is primarily attributable to lower component prices and changes in
product mix.
Engineering, Research and Development. Engineering, research and
development costs consist primarily of compensation and related costs of
engineering and development personnel, materials and supplies consumed in
prototype development and related facility and equipment costs. Engineering,
research and development costs increased 63% from $3.1 million in the second
quarter of 1997 to $5.0 million for the comparable period in 1998. As a
percentage of revenues, these costs were 15.0% and 17.5%, respectively, in such
periods. The increase in engineering, research and development costs in
absolute dollars was primarily attributable to an increase in engineering and
research personnel.
Selling and Marketing. Selling and marketing costs consist primarily of
compensation and related costs for sales, marketing and customer support
personnel, travel and advertising, trade show and other promotional activities.
Selling and marketing costs increased 46% from $2.6 million in the second
quarter of 1997 to $3.8 million for the comparable period of 1998. As a
percentage of revenues, these costs were 12.5% and 13.1%, respectively, in such
periods. The increase in selling and marketing costs in absolute dollars was
primarily attributable to an increase in sales, marketing and customer support
personnel as well as trade show and promotional activities during 1998.
General and Administrative. General and administrative costs include
compensation and related costs of management, finance and administrative
personnel, professional
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services, costs to maintain manufacturing and management information systems and
other general corporate expenses. General and administrative costs increased 36%
from $1.9 million in the second quarter of 1997 to $2.6 million for the
comparable period in 1998. As a percentage of revenues, these costs were 9.2%
and 8.9%, respectively, in such periods. The increase in general and
administrative costs in absolute dollars was primarily attributable to increases
in administrative, finance and information technology personnel as well as
increases in corporate professional expenses.
Other Income. Other income is primarily composed of interest income.
Other income increased 2,818% from $50,000 in the second quarter of 1997 to $1.5
million for the comparable period in 1998. This increase was primarily
attributable to the interest income derived from the net proceeds of
approximately $87.1 million received from the Company's initial public offering
in November 1997.
Provision For Income Taxes. The Company's effective rate for Federal and
state income taxes was approximately 40.0% and 37.5% for the second quarters of
1997 and 1998, respectively. The decrease in effective tax rates is primarily
attributable to a decrease in the effective state income tax rate and the
utilization of certain tax credits.
SIX MONTHS ENDED JUNE 28, 1997 AND JUNE 27, 1998
Revenues. Revenues increased 39% from $39.1 million in the six months
ended June 28, 1997 to $54.3 million for the comparable period in 1998. This
increase resulted from the introduction of new or expanded offerings by existing
customers incorporating the Company's products, the expansion of customers'
existing markets and the introduction of applications by new and existing
customers. In addition, revenues increased due to increased market penetration
resulting from the efforts of the Company's expanded selling and marketing
organizations.
Revenues from the Company's five largest customers represented
approximately 60% and 57% of the Company's revenues for the first six months of
1997 and 1998, respectively. During the 1998 period Qualcomm Incorporated
represented approximately 27% of the Company's revenue. During the 1997 period
Comverse represented approximately 33% of the Company's revenue. Although the
Company's largest customers have varied from period to period, the Company
believes that revenues derived from current and potential large customers will
continue to represent a significant portion of revenues, and that its results of
operations in any given period will continue to depend to a significant extent
upon sales to a limited number of customers. There can be no assurance that the
Company's principal customers will continue to purchase products at current
levels, if at all.
Gross Profit. Cost of revenues increased 34% from $12.0 million in the six
months ended June 28, 1997 to $16.1 million for the comparable period in 1998.
Gross margin increased from 69.2% in the first half of 1997 to 70.4% in the
comparable period of 1998. The increase in gross margins is primarily
attributable to lower component prices and changes in product mix.
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Engineering, Research and Development. Engineering, research and
development costs increased 62% from $6.0 million in the first half of 1997 to
$9.7 million for the comparable period in 1998. As a percentage of revenues,
these costs were 15.4% and 17.9%, respectively, in such periods. The increase
in engineering, research and development costs in absolute dollars was primarily
attributable to an increase in engineering and research personnel.
Selling and Marketing. Selling and marketing costs increased 57% from $4.9
million in the first half of 1997 to $7.7 million for the comparable period of
1998. As a percentage of revenues, these costs were 12.5% and 14.2%,
respectively, in such periods. The increase in selling and marketing costs in
absolute dollars was primarily attributable to an increase in sales, marketing
and customer support personnel as well as trade show and promotional activities
during 1998.
General and Administrative. General and administrative costs increased 30%
from $3.9 million in the first half of 1997 to $5.0 million for the comparable
period in 1998. As a percentage of revenues, these costs were 9.9% and 9.2%,
respectively, in such periods. The increase in general and administrative costs
in absolute dollars was primarily attributable to increases in administrative,
finance and information technology personnel as well as increases in corporate
professional expenses.
Other Income. Other income increased 3,205% from $94,000 in the first half
of 1997 to $3.1 million for the comparable period in 1998. This increase was
primarily attributable to the interest income derived from the net proceeds of
approximately $87.1 million received from the Company's initial public offering
in November 1997.
Provision For Income Taxes. The Company's effective rate for Federal and
state income taxes was approximately 40.0% and 37.5% for the first half of 1997
and 1998, respectively. The decrease in effective tax rates is primarily
attributable to a decrease in the effective state income tax rate and the
utilization of certain tax credits.
LIQUIDITY AND CAPITAL RESOURCES
At June 27, 1998, the Company's principal sources of liquidity consisted of
cash, cash equivalents and marketable securities of approximately $119.9
million, working capital of approximately $126.7 million and $15.0 million of
funds available under a bank line of credit. At December 27, 1997, the Company
had $114.9 million invested in cash, cash equivalents and marketable securities.
During the period ended June 27, 1998, the Company completed
construction of a new building for research and engineering activities.
Building construction costs of approximately $3.7 million were financed through
available cash resources and working capital.
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The Company believes that available cash and investments and cash funds
generated from operations will be sufficient to meet the Company's anticipated
cash requirements for working capital and capital expenditures for at least the
next twelve months.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Statements contained in this Quarterly Report on Form 10-Q that are not
historical fact may constitute forward-looking statements and are made under the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
The Company's actual results of operations and financial condition may in the
future vary significantly from those stated in any forward-looking statements.
Factors that may cause such differences include, but are not limited to, the
risks, uncertainties and other information discussed within this Quarterly
Report on Form 10-Q and other risks identified in the Company's Securities and
Exchange Commission filings, including those risks identified in the Company's
Annual Report for the fiscal year ended December 27, 1997 on Form 10-K.
The following discussion of the Company's risk factors should be read in
conjunction with the consolidated financial statements and related notes thereto
set forth elsewhere in this report and in the Company's Annual Report for the
fiscal year ended December 27, 1997 on Form 10-K. The following factors, among
others, could cause actual results to differ materially from those set forth in
forward-looking statements contained or incorporated by reference in this report
and presented by management from time to time. Such factors, among others, may
have a material adverse effect upon the Company's business, results of
operations and financial condition:
Fluctuations in Results of Operations. The Company's results of operations
have varied significantly in the past and may vary significantly in the future,
on a quarterly and annual basis, as a result of a variety of factors, many of
which are outside the Company's control. These factors include, without
limitation: (i) the timing and size of orders which are received and can be
shipped in any particular period; (ii) the commercial success of the Company's
products; (iii) delays in the introduction of products or product enhancements
by the Company and the Company's ability to introduce new products and
technologies on a timely basis; (iv) the financial stability of the Company's
major customers; (v) the timing of new product introductions or announcements by
the Company or its competitors; (vi) the availability of adequate supplies of
key components and assemblies and the adequacy of third-party manufacturing
capabilities; (vii) the seasonality of the placement of customer orders;
(viii) the timing and nature of selling and marketing expenses such as
tradeshows and advertising campaigns; (ix) the timing of development
expenditures and personnel changes; (x) the publications of opinions about the
Company and its products, or its competitors or their products, by industry
analysts; (xi) customer order deferrals in anticipation of product enhancements
or new product offerings by the Company or its competitors; and (xii) customer
cancellation of orders and the gain or loss of significant customers, including
those due to industry combinations. Moreover, any downturn in general economic
conditions could precipitate significant reductions in corporate spending for
telecommunications infrastructure, which could result in delays or cancellations
of orders for the Company's products. The
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Company's expense levels have been relatively fixed and are based, in
significant part, on expectations of future revenues. Consequently, if revenue
levels are below expectations, expense levels could be disproportionately high
as a percentage of revenues, and the Company's business, financial condition and
results of operations would be materially adversely affected. The Company has
historically operated with little backlog because its products are generally
shipped within 60 days of acceptance of an order. As a result, revenues in any
quarter are substantially dependent on orders booked and shipped in that quarter
and on sales by the Company's customers to end users.
The Company also believes that the purchase of its own products generally
involves a significant commitment of a customer's capital resources. Therefore,
any downturn in any customer's business could have a material adverse effect on
the Company's revenues, business, financial condition and quarterly results of
operations. In addition, the Company historically has recognized a large portion
of its revenues from sales booked and shipped in the last month of a quarter
such that the magnitude of quarterly fluctuations may not become evident until
late in, or at the end of, a particular quarter. Because a number of the
Company's individual orders are for significant amounts, the failure to ship a
significant order in a particular quarter could materially adversely affect
revenues and results of operations for such quarter. To the extent that
significant sales occur earlier than expected, results of operations for
subsequent quarters may be materially adversely affected. Due to these and other
factors, the Company's quarterly revenues, expenses and results of operations
could vary significantly in the future, and period-to-period comparisons should
not be relied upon as indications of future performance. There can be no
assurance that the Company will be able to increase its revenues in future
periods or be able to sustain its level of revenues or its rate of growth on a
quarterly or annual basis.
Due to all the foregoing factors, it is possible that in some future
quarter, the Company's results of operations will be below the expectations of
public market analysts and investors. In such event, the market price of the
Company's Common Stock would likely be materially adversely affected.
Dependence on Relationships with Application Developers, OEMs and Systems
Integrators. The Company sells substantially all of its products to, and
maintains strategic relationships with, application developers, original
equipment manufacturers ("OEMs") and systems integrators which incorporate the
Company's products into their service and product offerings. As a result, sales
of the Company's products are dependent upon the continued market acceptance of
the service and product offerings of the Company's customers. Although the
Company maintains contractual relationships with a substantial number of its
customers, such contracts do not provide for minimum purchase requirements, nor
do they contain provisions requiring the exclusive purchase of the Company's
products. The development of an application or service for the
telecommunications market can involve a substantial amount of time and expense.
The delay or failure of a customer's application development program
incorporating the Company's products could delay or prevent expected sales of
the Company's products. The inability or cessation of customers to integrate
the Company's products into their service and product offerings, product
development delays by
14
<PAGE>
application developers and other customers, lack of market acceptance of the
service and product offerings of the Company's customers or a customer's
decision to market products manufactured by a competitor of the Company, or the
manufacture of such products themselves, would have a material adverse effect on
the Company's business, financial condition and results of operations.
Additionally, selling through indirect channels may limit the Company's
information concerning the volume of products sold by the Company's customers to
end users and the Company's contact with its end users. As a result, the
Company's ability to forecast revenues accurately (notwithstanding the forecasts
of its customers), elevate end-user satisfaction and recognize emerging end-user
requirements may be hindered.
Length of Sales Cycle. The time between the date of initial contact with a
potential customer and large-scale commercialization of a new customer
application or system based on the Company's products is often lengthy,
typically ranging from 12 to 24 months or more, and is subject to delays over
which the Company has little or no control, including customers' budgetary
constraints, acceptance reviews, and the possibility of cancellation of projects
by customers. Although the Company attempts to develop its products with the
goal of shortening the time to market of its customers' products, the timing of
the commercialization of a new customer application or service based on the
Company's products is primarily dependent on the success and timing of a
customer's own internal development program. Delays can also be caused by late
deliveries by other vendors, changes in implementation priorities and slower
than anticipated growth in demand for services that the Company's products
support. A delay in, or cancellation of, the sale of the Company's products
could have a material adverse effect on the Company's business, financial
condition and results of operations and cause the Company's results of operation
to vary significantly from quarter to quarter.
Concentration of Customers. During the three and six month periods ended
June 27, 1998 Qualcomm Incorporated represented approximately 32% and 27%,
respectively, of the Company's revenue. In this same period, the Company's five
largest customers accounted for approximately 57% of the Company's revenues.
Although the Company's largest customers have varied from period to period, the
Company anticipates that its results of operations in any given period will
continue to depend to a significant extent upon sales to a small number of
customers. None of the Company's customers has entered into a long-term supply
agreement requiring any of them to purchase a minimum amount of product from the
Company. There can be no assurance that the Company's principal customers will
continue to purchase product from the Company at current levels, if at all, or
that the Company will be able to replace such purchases with sales to other
customers. The loss of one or more major customers could have a material adverse
effect on the Company's business, financial condition and results of operations.
Dependence on Single and Sole Source Suppliers. The Company purchases many
critical components from single or sole source vendors. The inability to develop
alternative sources for these components or to obtain sufficient quantities of
these components could
15
<PAGE>
result in delays or reductions in product shipments which could materially
adversely affect the Company's business, financial condition and results of
operations. In the event of a reduction or interruption of supply, a significant
amount of time, in some cases as much as three to four months, could be required
before the Company would begin receiving adequate supplies from such alternative
suppliers. Further, in such event, the Company's business, financial condition
and results of operations would be materially adversely affected. In addition,
the manufacture of certain of these single or sole source components is
extremely complex, and the Company's reliance on the suppliers of these
components exposes the Company to potential production difficulties and quality
variations, which could negatively impact cost and timely delivery of the
Company's products. Certain components are available from only one supplier, for
which there is no substitute at this time. If supply of these components should
cease, the Company would be required to redesign its products. No assurance can
be given that supply problems will not occur or, if such problems do occur, that
satisfactory solutions would be available. The Company does not have long-term
contracts with its suppliers and there can be no assurance that these suppliers
will continue to be able to produce these components or to meet the Company's
requirements. Any significant interruption in the supply, or degradation in the
quality, of any such component could have a material adverse effect on the
Company's business, financial condition and results of operations.
Although the Company generally requires its customers to submit quarterly
forecasts of their needs, the Company's customers frequently require rapid
delivery after placement of a purchase order. Because the Company does not
maintain significant component inventories, a delay in shipment by a supplier
could lead to lost sales. Lead times for materials and components may vary
significantly and depend on factors such as specific supplier performance,
contract terms and general market demand for components. If orders vary from
forecasts, the Company may experience excess or inadequate inventory of certain
materials and components. While the Company has not experienced shortages and
allocations of these components to date, any shortages in the future, including
those occasioned by increased sales, could result in delays in fulfillment of
customer orders. Such delays, shortages and allocations could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Dependence on Third-Party Manufacturers. The Company relies on a limited
number of independent manufacturers, some of which are small, privately held
companies, to provide certain components and assemblies made to the Company's
specifications. These manufacturers substantially complete production of the
Company's products, which are then shipped to the Company for final assembly and
quality control. In the event that any of the Company's subcontractors were to
experience financial, operational, production or quality assurance difficulties
or a catastrophic event that resulted in a reduction or interruption in supply
to the Company, the Company's business, financial condition and results of
operations would be materially adversely affected until the Company was able to
establish sufficient manufacturing capabilities from alternative sources. There
can be no assurance that alternative manufacturing sources will be able to meet
the Company's future requirements or that existing or alternative sources will
continue to be available to the Company at favorable prices.
16
<PAGE>
Management Growth and Hiring of Additional Personnel. The Company has
experienced growth in revenues and expansion of its operations which have placed
significant demands on the Company's management, engineering and administration
staff and facilities. The Company has recently hired additional engineering,
sales and other personnel. The Company is also implementing additional financial
and management procedures which the Company believes will address increasing
demands on resources. However, the Company believes that further improvements in
management and operational controls are needed, and will continue to be needed,
to manage any future growth. Continued growth will also require the Company to
hire more engineering, selling and marketing and administrative personnel,
expand customer support capabilities, expand management information systems and
improve its inventory management practices. The Company has at times
experienced, and continues to experience, difficulty in recruiting qualified
personnel. Recruiting qualified personnel is an intensely competitive and time-
consuming process. There can be no assurance that the Company will be able to
attract and retain the necessary personnel to accomplish its growth strategies
or that it will not experience constraints that will adversely affect its
ability to satisfy customer demand in a timely fashion or to support
satisfactorily its customers and operations. If the Company's management is
unable to manage growth effectively, the Company's business, financial condition
and results of operations could be materially adversely affected.
While the Company believes its current and planned facilities are adequate
to meet its needs through the next 12 months, future growth may require the
Company to obtain additional or alternative facilities. Due to the limited
supply of suitable additional or alternative office and manufacturing space in
the Cape Cod, Massachusetts area, there can be no assurance that such space can
be leased or acquired without substantial required renovations. Relocation of
any segment of the Company's operations may disrupt business and have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, the local permitting and variance procedures for the
renovation of buildings or new construction in the Cape Cod area are more
onerous than found in metropolitan areas. Accordingly, there can be no
assurance that the Company will not be required in the future to devote
significant resources to the permitting and renovation of additional facilities
or in relocating some or all of the Company's facilities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
17
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 22, 1998, the Company filed suit in the U.S. District Court for the
District of Massachusetts alleging certain of Summa Four, Inc.'s ("Summa Four")
telecommunication equipment infringes three patents owned by the Company and
seeking a finding of infringement of each of the three patents, an injunction
against further infringement, and monetary damages. Summa Four has filed a
counterclaim asserting the breach of a certain confidentiality agreement, and
seeking unspecified damages. The Company has filed an answer specifically
denying the allegations and raising several defenses to the claims raised in the
counterclaim and has filed a motion for summary judgment on such claims. The
case is in the early stages of litigation and the Company believes that
resolution thereof will not have a material adverse effect on the financial
position, results of operations or business of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Recent Sales of Unregistered Securities
The following information is furnished with regard to all securities issued
by the Registrant during the period ended June 27, 1998 that were not registered
under the Securities Act of 1993, as amended (the "Securities Act").
During the three months ended June 27, 1998 options granted to employees of
the Company under the Registrant's Stock Option Program were exercised for
common stock, $.01 par value per share, as follows:
<TABLE>
<CAPTION>
Aggregate
Number of Exercise Purchase
Date Shares Price Price
- ------------------------- ---------- ------------ --------------
<S> <C> <C> <C>
April 27, 1998 5,200 $0.33335 $1,733.42
April 29, 1998 2,000 $0.33335 $ 666.70
April 30, 1998 1,000 $0.33335 $ 333.35
</TABLE>
All such issuances were made in reliance upon Rule 701 promulgated under the
Securities Act
(d) Use of Proceeds
The Company has invested the net proceeds from the initial public offering
in November 1997 in investment grade, interest-bearing securities.
18
<PAGE>
To date, the Company has utilized the net proceeds from the initial public
offering as follows:
<TABLE>
<S> <C>
Remaining offering proceeds, March 28, 1998 $81,074,000
Purchases of property and equipment (4,192,000)
-----------
Remaining offering proceeds, June 27, 1998 $76,882,000
===========
</TABLE>
None of the net proceeds from the IPO were used to pay, directly or
indirectly, directors, officers, persons owning ten percent or more of the
Company's equity securities, or affiliates of the Company.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) On May 8, 1998, the Company held its 1998 Annual Meeting of
Stockholders.
(b) At such meeting, the following nominees and current board members,
Robert P. Madonna, Christopher Stavros, Edward L. Breslow and John
Loughlin, were re-elected to the Board of Directors to hold office
until the next Annual Meeting of Stockholders or until their
successors have been duly elected and qualified or until their
earlier resignation or removal.
(c) At the meeting, the stockholders of the Company voted:
(1) To fix the number of directors at four (4) and to elect a Board
of Directors to serve for the ensuing year or until their
respective successors are elected and qualified or until their
earlier resignation or removal. The votes cast were as follows:
<TABLE>
<CAPTION>
Votes Votes Votes Votes Broker
----------- ---------- ----------- ----------- -----------
For Against Withheld Abstained Non-votes
----------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Robert P. Madonna 28,122,554 N/A 5,344 N/A N/A
Christopher Stavros 28,123,454 N/A 4,444 N/A N/A
Edward L Breslow 28,123,454 N/A 4,444 N/A N/A
John Loughlin 28,123,454 N/A 4,444 N/A N/A
</TABLE>
(2) To ratify the selection of Arthur Andersen LLP, as independent
auditors for the fiscal year ending December 26, 1998. The
votes cast were as follows:
<TABLE>
<CAPTION>
Votes Votes Votes Votes Broker
----------- ---------- ----------- ----------- -----------
For Against Withheld Abstained Non-votes
----------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Arthur Andersen LLP 28,120,283 4,755 N/A 2,860 N/A
Ratification
</TABLE>
19
<PAGE>
(3) To transact such other business as may properly come before the
meeting or any postponements or adjournments thereof. The votes
cast were as follows:
<TABLE>
<CAPTION>
Votes Votes Votes Votes Broker
----------- ---------- ----------- ----------- -----------
For Against Withheld Abstained Non-votes
----------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Excel Switching Corp. 26,882,868 951,450 N/A 293,550 N/A
Transact Business
</TABLE>
(d) No information provided due to inapplicability of item.
ITEM 5. OTHER INFORMATION
Proposals of stockholders intended for inclusion in the proxy statement to
be furnished to all stockholders entitled to vote at the next annual meeting of
stockholders of the Company must be received at the Company's principal
executive offices not later than December 4, 1998. The deadline for providing
timely notice to the Company of matters that stockholders otherwise desire to
introduce at the next annual meeting of stockholders of the Company is
February 17, 1999. In order to curtail any controversy as to the date on which
the Company received a proposal, it is suggested that proponents submit their
proposals by Certified Mail, Return Receipt Requested.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K
None
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Excel Switching Corporation
(Registrant)
Dated: August 11, 1998 /s/ Robert P. Madonna
------------------------------------------------
Robert P. Madonna
President, Chief Executive Officer and
Chairman of the Board of Directors (Principal
Executive Officer)
Dated: August 11, 1998 /s/ Stephen S. Galliker
------------------------------------------------
Stephen S. Galliker
Vice President, Finance and Administration and
Chief Financial Officer (Principal Financial and
Accounting Officer)
21
<PAGE>
EXHIBIT INDEX
-------------
Exhibit No. Description
----------- -----------
27 Financial Data Schedule (EDGAR)
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE JUNE 27,
1998 CONSOLIDATED CONDENSED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-26-1998 DEC-26-1998
<PERIOD-START> MAR-29-1998 DEC-28-1997
<PERIOD-END> JUN-27-1998 JUN-27-1998
<CASH> 75,428 75,428
<SECURITIES> 44,461 44,461
<RECEIVABLES> 15,910 15,910
<ALLOWANCES> 1,450 1,450
<INVENTORY> 5,995 5,995
<CURRENT-ASSETS> 149,915 149,915
<PP&E> 15,731 15,731
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 165,646 165,646
<CURRENT-LIABILITIES> 23,195 23,195
<BONDS> 0 0
0 0
0 0
<COMMON> 332 332
<OTHER-SE> 141,852 141,852
<TOTAL-LIABILITY-AND-EQUITY> 165,646 165,646
<SALES> 28,739 54,295
<TOTAL-REVENUES> 28,739 54,295
<CGS> 8,508 16,088
<TOTAL-COSTS> 8,508 16,088
<OTHER-EXPENSES> 20,231 22,419
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> (1,459) (3,107)
<INCOME-PRETAX> 10,335 18,895
<INCOME-TAX> 3,876 7,086
<INCOME-CONTINUING> 6,459 11,809
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 6,459 11,809
<EPS-PRIMARY> .20 .36
<EPS-DILUTED> .17 .30
</TABLE>
