<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
AMENDMENT NO. 1
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (DATE OF EARLIEST EVENT REPORTED) May 10, 1999
EXCEL SWITCHING CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MASSACHUSETTS
----------------------------------------------
(STATE OR OTHER JURISDICTION OF INCORPORATION)
0-23263 04-2992806
- ------------------------- --------------------------------
(COMMISSION FILE NUMBER) (IRS EMPLOYER IDENTIFICATION NO.)
255 INDEPENDENCE DRIVE
HYANNIS, MASSACHUSETTS 02601
-----------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
Registrant's telephone number, including area code:
(508) 862-3000
--------------
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ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
On May 10, 1999, Racepoint Acquisition Corp. ("Racepoint"), a wholly-owned
subsidiary of Excel Switching Corporation ("Excel"), merged (the "Merger") with
and into RAScom, Inc. ("RAScom"). The Merger was approved by the Board of
Directors of Excel, Racepoint and RAScom, and in addition, by the shareholders
of RAScom. As a result of the Merger, RAScom became a wholly-owned subsidiary
of Excel.
RAScom's assets consist primarily of its open remote access server
technology including the RAServer product line which concurrently supports
access over both the public switched telephony networks and the Internet. Prior
to the Merger, RAScom designed and manufactured a remote access solution based
on open platforms for enterprise networks, carriers and Internet Service
Providers ("ISPs"). Excel intends to integrate RAScom's remote access server
technology with Excel's programmable switching technology for the enhanced
services and wireless and infrastructure markets, as well as for small and
medium sized ISPs. The acquisition of RAScom is expected to expand Excel's
addressable markets by adding data capabilities to Excel's existing programmable
switching products for the ISP and Competitive Local Exchange ("CLEC") markets.
Pursuant to the terms of the Merger, an aggregate of 1,099,940 shares of
Excel's common stock (the "Common Stock") were issued in exchange for all of the
outstanding capital stock and options to purchase capital stock of RAScom. The
shareholders of RAScom received, in the aggregate, 1,021,187 shares of Excel's
Common Stock in exchange for their shares of RAScom capital stock. In addition,
the option holders of RAScom received, in the aggregate, options to purchase
78,753 shares of Excel's Common Stock in exchange for their options to purchase
capital stock of RAScom. The source of the consideration for this acquisition
came from the authorized capital stock of Excel, and to the extent that cash was
paid for fractional shares, from Excel's cash on hand.
The terms of this transaction and the consideration received by RAScom
shareholders and option holders were the result of arm's length negotiations
between management of Excel, management of RAScom and the shareholders of
RAScom. The terms of this transaction and the exchange of RAScom securities for
the Common Stock are more fully described in the Agreement and Plan of Merger
and Reorganization (the "Merger Agreement"), dated as of April 15, 1999, as
amended, among Excel, Racepoint, RAScom, the shareholders of RAScom and Mark B.
Galvin as Indemnification Representative (previously attached as Exhibit 2.1 to
the original report on Form 8-K, dated May 10, 1999 and filed with the
Commission on May 25, 1999 and hereby incorporated by reference). Additional
terms are also provided in Amendment No. 1 to the Merger Agreement ("Amendment
No. 1 to the Merger Agreement"), dated as of May 7, 1999, among Excel,
Racepoint, RAScom, those shareholders of RAScom that are signatories thereto,
and Mark B. Galvin as Indemnification Representative (previously attached as
Exhibit 2.2 to the original report on Form 8-K, dated May 10, 1999 and filed
with the Commission on May 25, 1999 and hereby incorporated by reference).
Of the 1,021,187 shares of Common Stock issued in the Merger to the RAScom
shareholders, 102,122 shares were placed in escrow pursuant to the terms of an
Escrow Agreement (the "Escrow Agreement"), dated as of May 10, 1999, by and
among Excel, Racepoint, RAScom, State Street Bank and Trust Company ("State
Street"), the shareholders of RAScom, and Mark B. Galvin as Indemnification
Representative (previously attached as Exhibit 4.1 to the original report on
Form 8-K, dated May 10, 1999 and filed with the Commission on May 25, 1999 and
hereby incorporated by reference). Additional terms related to the escrow of
Excel Common Stock issued in the Merger is also provided in a Side Letter
Agreement (the "Side Letter Agreement"), dated as of May 10, 1999 by and among
Excel, Racepoint, RAScom, State Street and Mark B. Galvin as Indemnification
Representative (previously attached as Exhibit 4.2 to the original report on
Form 8-K, dated May 10, 1999 and filed with the Commission on May 25, 1999 and
hereby incorporated by reference).
Shareholders of RAScom that obtained Common Stock of Excel in the Merger
are also entitled to certain registration rights as detailed in the Registration
Rights Agreement (the "Registration Rights Agreement"), dated as of May 10,
1999, between the various shareholders of RAScom and Excel (previously attached
as Exhibit 4.3 to the original report on Form 8-K, dated May 10, 1999 and filed
with the Commission on May 25, 1999 and hereby incorporated by reference).
The information contained in the press release of Excel, dated May 11,
1999, announcing the consummation of the Merger, and which was attached as
Exhibit 99.1 to the original report on Form 8-K, dated May 10, 1999 and filed
with the Commission on May 25, 1999, is also hereby incorporated by reference.
The information contained in the press
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release of Excel, dated April 15, 1999, announcing the acquisition of RAScom
by Excel, and reported on a Form 8-K filed with the Commission on April 23,
1999, is also hereby incorporated by reference.
Excel intends to account for the acquisition of RAScom under the
"pooling-of-interests" accounting method. Generally accepted accounting
principles preclude Excel from restating its historical Consolidated Financial
Statements to reflect the combined operations of Excel and RAScom until Excel
has announced results of operations reflecting post-acquisition combined
operations. Excel has included in this report on Form 8-K/A Supplemental
Consolidated Financial Statements, which reflect the combined operations of
Excel and RAScom as if the two entities had operated as one entity since
inception (see Note 1 of Notes to Supplemental Consolidated Financial
Statements). Excel has also included in this report on Form 8-K/A the
Consolidated Financial Statements of RAScom, Inc. as of December 31, 1998 and
March 31, 1999. Both the Supplemental Consolidated Financial Statements of Excel
and the Consolidated Financial Statements of RAScom are provided pursuant to
Item 7 of this report on Form 8-K/A. Excel's historical consolidated financial
statements which reflect the operations of Excel without RAScom can be found in
Excel's Annual Report for the year ended December 31, 1998 on Form 10-K filed
with the Commission on March 31, 1999.
THE PRECEDING DISCUSSION IS ONLY A SUMMARY AND IS QUALIFIED IN ITS ENTIRITY
BY REFERENCE TO THE MERGER AGREEMENT, AMENDMENT NO. 1 TO THE MERGER AGREEMENT,
THE ESCROW AGREEMENT, THE SIDE LETTER AGREEMENT AND THE REGISTRATION RIGHTS
AGREEMENT, ALL OF WHICH ARE INCORPORATED AS EXHIBITS TO THIS REPORT ON
FORM 8-K/A.
Excel is providing information regarding the combined historical operations
because Excel deems this information to be of importance to holders of Common
Stock. Unless otherwise indicated, the information below gives retroactive
effect to Excel's acquisition of RAScom on May 10, 1999.
The following is a table of contents for the information included in this
Item 2:
<TABLE>
<CAPTION>
PAGE
<S> <C>
Factors That May Affect Future Operating Results 3
Selected Supplemental Consolidated Financial Data 4
Management's Discussion and Analysis of Supplemental Consolidated
Financial Condition and Results of Operations 6
Business 16
Risk Factors 24
Financial Statements, Pro Forma Financial Information and Exhibits 33
</TABLE>
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Statements contained in this Report on Form 8-K/A 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. These
statements are subject to risks and uncertainties that could cause actual
results to differ significantly from expectations. In particular, statements
contained in "Management's Discussion and Analysis of Supplemental Consolidated
Financial Condition and Results of Operations" which are not historical facts
include but are not limited to, statements regarding: the anticipated adequacy
of cash resources to meet the Company's working capital requirements;
anticipated requirements for the accrual for sales returns and allowances;
anticipated payment terms relating to account receivables; the anticipated
proportion of revenues to be derived from a limited number of customers;
anticipated expenditures and completion dates with respect to research and
development and the expansion of marketing and selling efforts; statements
regarding the Company's recourse obligation under its lease program;
unanticipated costs and difficulties associated with integrating the operations,
products and personnel of acquired businesses, including RAScom; anticipated
extension of the bank line of credit agreement; statements regarding the size of
the expected one-time charge
3
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for acquisition-related expenses and statements regarding the Company's
readiness for Y2K are forward looking statements. Factors that could cause or
contribute to such differences include, among others, those relating to
fluctuations in results of operations, dependence on and concentration of
relationships with application developers, OEMs and systems integrators,
risks relating to acquisitions and the integration of RAScom and other risks
identified in the Company's SEC filings including those contained in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1998 and these contained in the Company's quarterly report on Form 10-Q for
the three months ended March 31, 1999.
SELECTED SUPPLEMENTAL CONSOLIDATED FINANCIAL DATA
The following tables contain certain selected supplemental consolidated
financial data of the Company and are qualified in its entirety by the more
detailed Supplemental Consolidated Financial Statements included herein. This
data should be read in conjunction with "Management's Discussion and Analysis of
Supplemental Consolidated Financial Conditions and Results of Operations" and
the Supplemental Consolidated Financial Statements appearing elsewhere herein.
<TABLE>
<CAPTION>
FISCAL YEAR
--------------------------------------------------------------
1994 1995 1996 1997 1998
------- -------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF
INCOME DATA (1):
Revenues $20,723 $36,161 $62,265 $91,623 $129,339
Cost of revenues 7,074 12,100 24,552 29,043 41,754
------- ------- ------- ------- --------
Gross profit 13,649 24,061 37,713 62,580 87,585
------- ------- ------- ------- --------
Operating expenses
Engineering, research and development 3,301 8,117 12,346 16,061 26,363
Selling and marketing 362 2,923 7,939 14,797 20,872
General and administrative 2,903 4,238 6,967 9,139 12,755
Acquired in-process research and development -- -- -- -- 7,459
------- ------- ------- ------- --------
Total operating expenses 6,566 15,278 27,252 39,997 67,449
------- ------- ------- ------- --------
Income from operations 7,083 8,783 10,461 22,583 20,136
Other income (expense) (4) 38 (294) 1,576 6,252
------- ------- ------- ------- --------
Income before provision for income taxes 7,079 8,821 10,167 24,159 26,388
Provision for income taxes 2,889 3,410 4,077 9,425 11,214
------- ------- ------- ------- --------
Net income $ 4,190 $ 5,411 $ 6,090 $14,734 $ 15,174
------- ------- ------- ------- --------
------- ------- ------- ------- --------
Preferred stock dividends -- -- 263 903 1,518
------- ------- ------- ------- --------
Net income available to common stockholders $ 4,190 $ 5,411 $ 5,827 $13,831 $ 13,656
------- ------- ------- ------- --------
------- ------- ------- ------- --------
Basic earnings per share $ .15 $ .19 $ .21 $ .48 $ .41
------- ------- ------- ------- --------
------- -------- ------- ------- --------
Diluted earnings per share $ .13 $ .17 $ .18 $ .42 $ .38
------- -------- ------- ------- --------
------- -------- ------- ------- --------
Basic weighted average shares outstanding 27,946 27,962 28,253 28,939 33,406
Diluted weighted average shares outstanding 31,341 31,822 33,025 35,101 40,313
</TABLE>
4
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<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------
MAR. 28, MAR. 31,
1998 1999
---- ----
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME DATA (1): (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C>
Revenues $27,105 $37,340
Cost of revenues 9,122 12,217
------- -------
Gross profit 17,983 25,123
------- -------
Operating expenses
Engineering, research and Development 5,540 8,522
Selling and marketing 5,041 5,696
General and administrative 2,908 3,508
------- -------
Total operating expenses 13,489 17,726
------- -------
Income from operations 4,494 7,397
Other income (expense) 1,717 1,208
------- -------
Income before provision for income taxes 6,211 8,605
Provision for income taxes 2,341 3,135
------- -------
Net income $ 3,870 $ 5,470
------- -------
------- -------
Preferred stock dividends 379 404
Net income available to common stockholders $ 3,491 $ 5,066
------- -------
------- -------
Basic earnings per share $ .11 $ .15
------- -------
------- -------
Diluted earnings per share $ .10 $ .13
------- -------
------- -------
Basic weighted average shares outstanding 32,832 34,476
Diluted weighted average shares outstanding 38,983 41,118
</TABLE>
<TABLE>
<CAPTION>
DEC. 31, DEC. 31, DEC. 28, DEC. 27, DEC. 31, MAR. 31,
1994 1995 1996 1997 1998 1999
--------- --------- --------- --------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
SUPPLEMENTAL CONSOLIDATED BALANCE
SHEET DATA:
Working capital $5,906 $10,238 $19,664 $124,175 $133,976 $136,833
Total assets 9,973 22,683 41,963 163,821 207,403 230,722
Long-term obligations, less current
maturities -- 3,537 4,253 307 4,858 3,958
Total stockholders' equity 6,471 12,125 18,016 119,060 146,666 156,214
</TABLE>
- -----------
(1) On May 10, 1999, the Company acquired all of the outstanding capital
stock and options of RAScom, Inc. in exchange for 1,099,940 shares of Common
Stock. The selected supplemental consolidated financial data gives effect to the
acquisition and reflects the combined operations of Excel and RAScom as if the
two entities had operated as one entity since inception. The Company intends to
account for the acquisition under the "pooling-of-interests" accounting method.
See Note 1 of Notes to Supplemental Consolidated Financial Statements.
5
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF SUPPLEMENTAL FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH
"BUSINESS," "SELECTED SUPPLEMENTAL CONSOLIDATED FINANCIAL DATA," THE
COMPANY'S SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO
AND THE INFORMATION DESCRIBED UNDER THE CAPTION "RISK FACTORS". EXCEL IS
PROVIDING THIS INFORMATION TO REFLECT CHANGES IN THE COMPANY'S FINANCIAL
CONDITION AND RESULTS OF OPERATIONS DUE TO THE ACQUISITION OF RASCOM. THE
INFORMATION CONTAINED IN THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF
SUPPLEMENTAL CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ASSUMES THAT THE COMPANY AND RASCOM HAVE OPERATED AS ONE ENTITY SINCE
INCEPTION.
OVERVIEW
Excel Switching Corporation 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.
Since its beginning in 1988, Excel has continued to penetrate new markets
and broaden its customer base, establishing customer relationships with
application developers, OEMs, systems integrators and network service providers.
With an emphasis on product development, the Company has continued to improve
the capacity, functionality and features of its switching products. The Company
has experienced significant revenue growth resulting from increased acceptance
of open programmable switching as a means of addressing the enhanced services
and wireless and wireline infrastructure needs of network providers. Excel has
been profitable since inception and has financed its operations principally
through cash generated from operations as well as proceeds from its initial
public offering in November 1997.
On May 10, 1999, the Company acquired RAScom, Inc., a company founded in
1996 that developed, manufactured, marketed and supported a comprehensive line
of open system remote access servers. The Company exchanged 1,099,940 shares of
its Common Stock for all the outstanding capital stock and options to purchase
capital stock of RAScom. The Company placed 102,122 of these shares into escrow
as security for indemnification obligations of the shareholders of RAScom
relating to certain representations, warranties and tax matters. Excel intends
to integrate RAScom's remote access server technology with Excel's programmable
switching technology for the enhanced services, wireline and wireless
infrastructure markets as well as for small and medium sized Internet Service
Providers ("ISPs"). This acquisition is expected to expand Excel's addressable
markets by adding data capabilities to Excel's existing programmable switching
products for the ISP and Competitive Local Exchange ("CLEC") markets. This
acquisition will be accounted for as a pooling-of-interests. The Company has
incurred approximately $2.0 million of acquisition related costs, which will be
included in the consolidated statement of income for the three months ended
June 30, 1999.
On September 30, 1998, the Company acquired all the outstanding capital
stock of XNT Systems, Inc. and Quantum Telecom Solutions, Inc, both former Excel
customers. These transactions have been accounted for as purchases and,
accordingly, Excel's results of operations include the results for these two
entities only for periods subsequent to the date of acquisition. Prior to the
acquisition, XNT supplied network service providers with intelligent switch
control and comprehensive call-processing and control software applications that
managed the underlying Excel switch platform. This acquisition enhanced Excel's
ability to offer network service providers a turnkey infrastructure switching
solution. Prior to the acquisition, Quantum provided its customers with software
to configure and manage Excel switching platforms for use in networks. Both of
these acquisitions provided Excel with switch-related technology and
applications that increased both the functionality and the ease of
programmability of the Excel switching platforms. Effective December 31, 1998,
XNT and Quantum were merged into the Company and are no longer incorporated
entities.
During 1998, Excel sold its products to more than 238 customers engaged in
a variety of areas of the global telecommunications industry. The Company's
products are sold through its direct sales force to application developers,
6
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OEMs and systems integrators, which incorporate the Company's products into
their service and product offerings. In addition, the Company's products are
sold directly to end-users, particularly network service providers. The
Company sells each of its switching platforms with a varying combination of
network interface line cards and service resource cards that are specified by
customer and application requirements. The Company also sells additional
network interface line cards and service resource cards that allow customers
to expand capacity and functionality and provide for redundancy of their
installed systems.
Revenue is generally recognized when all significant contractual
obligations have been satisfied and collection of the resulting receivable is
reasonably assured. Revenue from product sales is recognized at the time of
delivery and acceptance, and after consideration of all the terms and conditions
of the customer contract. Revenue from sales-type leases is recognized at the
date of shipment, net of reserves for uncollectable amounts. Revenue from
operating leases or leases for which the collection of the lease payments is not
predictable is recognized ratably over the lease term, and the related equipment
is depreciated using the straight-line method over its estimated useful life.
Revenue from providing services and post-sale support is recognized at the time
of performance. Revenues from sales of software development tools and services
such as technical support, training and product maintenance have not been
significant to date. The Company has not capitalized any software and
development costs and all research and development costs have been expensed as
incurred.
The Company provides reserves for anticipated product returns and warranty
costs at the time of revenue recognition. In addition, the Company provides
reserves for the realizability of accounts receivable and inventory. While the
Company believes its estimates for post-sale support, warranty costs, sales
returns and the realizability of accounts receivable and inventory are adequate,
actual results could differ from those estimates.
The Company determines its requirements for its accrual for sales returns
and allowances based upon a number of factors including the Company's historical
sales credit activity, anticipated concessions on current sales, estimated
product failures and sales trends. The accrual for sales returns and allowances
was approximately $1.2 million, $4.8 million and $4.8 million at the end of
fiscal years 1996, 1997 and 1998, respectively and $4.6 million as of March 31,
1999. The increase in the accrual for sales returns and allowances from 1996 to
1997 can be attributed to the volume increase in sales, the timing and
significance of new product introductions and the increased complexity of the
uses of the Company's equipment. During the first quarter of 1997, the amount of
credits issued increased significantly, primarily as a result of the
introduction of the EXS switching system and related technology. As a result of
this increase in credit activity and in light of increasing sales volumes,
management estimated that future claim volumes would be similar. During 1997,
the provision for sales returns and allowances as a percentage of revenue
averaged approximately 5.7%. In subsequent periods, as actual credits
materialized at a lower than expected volume, the sales credit provision as a
percentage of revenue declined. During 1998 and the first quarter of 1999, this
provision averaged 2.8% and 2.1%, respectively, of revenues. Management does not
anticipate a significant change in its requirements for its accrual for sales
returns and allowances in the near term. However, new product introductions,
sales trends and other activity will continue to influence management's
estimates for such requirements.
The Company's profitability is influenced by a number of factors, including
pricing, cost of materials, product and technological advancements from research
and development efforts and the expansion of its operations. The Company
anticipates the addition of personnel and related infrastructure as it seeks to
increase revenues, and to meet other strategic goals such as developing new
products and technologies, broadening strategic partnerships with, and
incorporating new applications for, its customers, entering new markets and
expanding internationally. The Company anticipates that engineering, research
and development expenses will increase in absolute dollars, and may increase as
a percentage of revenues, as the Company pursues engineering efforts to provide
enhanced functionality to its products, increase port capacity and develop
additional software features. The Company also anticipates that selling and
marketing expenses will increase in a similar fashion as the Company enters new
markets and expands internationally.
During 1998, the Company elected to change its fiscal year-end from the
last Saturday in December to December 31 to better synchronize its fiscal
periods with the majority of its customers and suppliers.
7
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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
Supplemental Consolidated Statements of Income:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------
FISCAL YEAR MAR. 28, MAR. 31,
----------------------------------- --------- ---------
1996 1997 1998 1998 1999
-------- -------- -------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues.......................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues.................................. 39.4 31.7 32.3 33.7 32.7
------ ----- ----- ----- -----
Gross profit................................. 60.6 68.3 67.7 66.3 67.3
------ ----- ----- ----- -----
Operating Expenses:...............................
Engineering, research and development........ 19.8 17.5 20.4 20.4 22.9
Selling and marketing........................ 12.8 16.1 16.1 18.6 15.2
General and administrative................... 11.2 10.0 9.8 10.7 9.4
Acquired in-process research and development -- -- 5.8 -- --
------ ----- ----- ----- -----
Total operating expenses.......................... 43.8 43.6 52.1 49.7 47.5
------ ----- ----- ----- -----
Income from operations............................ 16.8 24.7 15.6 16.6 19.8
Other income (expense)............................ (.5) 1.7 4.8 6.3 3.2
------ ----- ----- ----- -----
Income before provision for income taxes.......... 16.3 26.4 20.4 22.9 23.0
Provision for income taxes........................ 6.5 10.3 8.7 8.6 8.4
------ ----- ----- ----- -----
Net income........................................ 9.8% 16.1% 11.7% 14.3% 14.6%
------ ----- ----- ----- -----
------ ----- ----- ----- -----
</TABLE>
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 28, 1998
REVENUES. The Company's revenues consist of sales of its open, programmable
switching platforms and related network interface line cards and service
resource cards. Revenues increased 37.8% from $27.1 million in the three months
ended March 31, 1998 to $37.3 million for the same period of 1999. The Company
believes that the increase resulted from a number of factors. The Company's
efforts to enhance the scalability, performance, capacity and functionality of
its products has contributed to an increased interest in Excel's programmable
switching platforms as a means of addressing the evolving needs of the
telecommunications industry. This includes enhancements in the areas of switch
management, PPL and SS7 as well as in infrastructure solution offerings. Over
the past several years, the Company's customer base has also broadened,
resulting in increased sales from a larger number of sources. The introduction
of new or enhanced offerings by this growing customer base as well as the
expansion of their markets resulted in an increased demand for Excel's products.
Excel also increased its efforts to assist customers with designing, planning
and testing of new customer applications. The Company expanded or established
relationships with a growing number of network service providers, resulting in
an increased amount of direct sales to end-users. Revenues also benefited by the
expansion of the selling and marketing organizations, including the
establishment of two international sales organizations in 1998, and one in late
1997.
Revenues from the Company's five largest customers represented
approximately 52% and 29% of the Company's revenues for the first quarter of
1998 and 1999, respectively. QUALCOMM Incorporated represented approximately 21%
of the Company's revenues for 1998 period. No other customer represented greater
than 10% of the Company's revenues for these periods. Although the Company's
largest customers have varied from period to period, the Company believes that
revenues derived from current and potential large customers will continue to
represent a significant proportion of revenues, and that its results of
operations in any given period will continue to depend to a significant extent
upon sales to a limited number of customers. The volume level of future
purchases, if any, by the Company's principal customers cannot be estimated
based upon historical purchasing trends. Revenues from the Company's largest
customers may significantly fluctuate period to period on both an absolute
dollar basis and as a percentage of sales.
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 33.9% from
$9.1 million in the first quarter of 1998 to $12.2 million for the same period
of 1999. Gross margin increased from 66.3% in the 1998 period to 67.3% in
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the 1999 period. The increase in gross margin in absolute dollars was
primarily attributable to the increase in sales. During the first quarter of
1998, margins were also negatively impacted by inventory obsolescence and
warranty and support charges relating to RAScom's remote access server
products.
ENGINEERING, RESEARCH AND DEVELOPMENT. Engineering, research and
development costs consist primarily of compensation and benefit related costs of
engineering and development personnel; materials and supplies consumed in
prototype development; and related facility and equipment costs. All research
and development costs, including software development costs, have been expensed
as incurred. Engineering, research and development costs increased 53.8% from
$5.5 million in the first quarter of 1998 to $8.5 million for the same period of
1999. As a percentage of revenues, these costs were 20.4% and 22.9%,
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 and, to a lesser extent, by increases in
the consumption of prototype supplies and materials. Engineering and research
personnel increased from 126 employees at the end of the first quarter of 1998
to 180 employees at the end of the same period of 1999.
SELLING AND MARKETING. Selling and marketing costs consist primarily of
compensation and benefit related costs for sales, marketing and customer support
personnel; travel, advertising, trade show and other promotional activities; and
related facility and office costs. Selling and marketing costs increased 13.0%
from $5.0 million in the first quarter of 1998 to $5.7 million for the same
period of 1999. As a percentage of revenues, these costs were 18.6% and 15.2%,
respectively in such periods. The increase in selling and marketing costs in
absolute dollars was primarily attributable to increases in sales, marketing and
customer support personnel and facility related costs. Sales, marketing and
customer support personnel increased from 83 employees at the end of the first
quarter of 1998 to 94 employees at the end of the first quarter of 1999.
GENERAL AND ADMINISTRATIVE. General and administrative costs include
compensation and benefit related costs of management, finance, management
information systems and administrative personnel; legal, accounting and other
professional services; costs to maintain manufacturing and management
information systems; and other general corporate expenses. General and
administrative costs increased 20.6% from $2.9 million in the first quarter of
1998 to $3.5 million for the same period in 1999. As a percentage of revenues,
these costs were 10.7% and 9.4%, respectively, in such periods. The increase in
general and administrative costs in absolute dollars was primarily attributable
to increases in bad debt expense and amortization of intangible assets as well
as professional fees associated with recruiting, acquisition activities and
litigation. In addition, increases in administrative, finance and information
technology personnel contributed to the overall increase in general and
administrative costs. General and administrative personnel increased from 55
employees at the end of the first quarter of 1998 to 67 employees at the end of
the first quarter of 1999.
OTHER INCOME (EXPENSE). Other income (expense), which primarily includes
interest income and interest expense, decreased 29.6% from $1.7 million in the
first quarter of 1998 to $1.2 million in the first quarter of 1999. This
decrease was attributable to the additional interest expense associated with
$8.2 million of acquisition related debt obligations issued in 1998. In
addition, interest income decreased from the prior period as a result of
decreases in the prevailing market interest rates available for the Company's
invested cash and securities.
PROVISION FOR INCOME TAXES. The Company's effective rate for Federal and
state income taxes was 37.7% and 36.4% for the first quarters of 1998 and 1999,
respectively. The decrease in the overall effective rate is primarily
attributable to a decrease in the effective state income tax rate and the
utilization of certain tax credits.
FISCAL YEAR ENDED DECEMBER 31, 1998 COMPARED TO FISCAL YEAR ENDED
DECEMBER 27, 1997
REVENUES. Revenues increased 41.2% from $91.6 million in 1997 to $129.3
million for 1998. The Company believes that the increase resulted from a number
of factors. The Company's efforts to enhance the scalability, performance,
capacity and functionality of its products has contributed to an increased
interest in Excel's programmable switching platforms as a means of addressing
the evolving needs of the telecommunications industry. This includes
enhancements in the areas of switch management, PPL and SS7 as well as in
infrastructure solution offerings. Over the past several years, the Company's
customer base has also broadened, resulting in increased sales from a larger
number of sources. The introduction of new or enhanced offerings by this growing
customer base as well as the expansion of their markets resulted in an increased
demand for Excel's products. Excel also increased its efforts to assist
customers in designing, planning and testing of new customer applications. The
Company expanded or established relationships with
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a growing number of network service providers, resulting in an increased
amount of direct sales to end-users. Revenues also benefited by the expansion
of the selling and marketing organizations, including the establishment of
two international sales organizations.
Revenues from the Company's five largest customers represented
approximately 49% and 43% of the Company's revenues for 1997 and 1998,
respectively. QUALCOMM Incorporated represented approximately 19% of the
Company's revenues 1998, respectively. Additionally, 25% of the Company's
revenues in 1997 were derived from Comverse Network Systems. No other customer
represented greater than 10% of the Company's revenues for these periods.
Although the Company's largest customers have varied from period to period, the
Company believes that revenues derived from current and potential large
customers will continue to represent a significant proportion of revenues, and
that its results of operations in any given period will continue to depend to a
significant extent upon sales to a limited number of customers. The volume level
of future purchases, if any, by the Company's principal customers cannot be
estimated based upon historical purchasing trends. Revenues from the Company's
largest customers may significantly fluctuate period to period on both an
absolute dollar basis and as a percentage of sales.
GROSS PROFIT. Cost of revenues increased 43.8% from $29.0 million in 1997
to $41.8 million for 1998. Gross margin percentage decreased from 68.3% in 1997
to 67.7% in 1998. The decrease in gross margin percentage was primarily
attributable to inventory obsolescence and warranty and support charges relating
to RAScom's remote access servers. This decrease was offset by the impact of
lower component prices, changes in the product mix, particularly in the number
of line and resource cards shipped, and increased manufacturing efficiencies as
the Company increased its production volume in 1998.
ENGINEERING, RESEARCH AND DEVELOPMENT. Engineering, research and
development costs increased 64.1% from $16.1 million in 1997 to $26.4 million
for 1998. As a percentage of revenues, these costs were 17.5% and 20.4%,
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 and, to a lesser extent, by increases in
the consumption of prototype supplies and materials. Engineering and research
personnel increased from 120 employees at the end of 1997 to 181 employees at
the end of 1998.
SELLING AND MARKETING. Selling and marketing costs increased 41.1% from
$14.8 million in 1997 to $20.9 million for 1998. As a percentage of revenues,
these costs were 16.1% in both periods. The increase in selling and marketing
costs in absolute dollars was primarily attributable to an increase in sales,
marketing and customer support personnel. In addition, increases during 1998 in
trade show and promotional activities as well as facility-related costs
contributed to the overall increase in selling and marketing activities. Sales,
marketing and customer support personnel increased from 91 employees at the end
of 1997 to 98 employees at the end of 1998.
GENERAL AND ADMINISTRATIVE. General and administrative costs increased
39.6% from $9.1 million in 1997 to $12.8 million for 1998. As a percentage of
revenues, these costs were 10.0% and 9.8%, respectively, in such periods. The
increase in general and administrative costs in absolute dollars was primarily
attributable to an increase in professional fees associated with recruiting
activities and legal and accounting activities, including those related to
acquisition investigations, international expansion and litigation. In addition,
increases in administrative, finance and information technology personnel
contributed to the overall general and administrative costs. General and
administrative personnel increased from 54 employees at the end of 1997 to 64
employees at the end of 1998.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. In connection with the
purchase of XNT in the fourth quarter of 1998, the Company allocated
approximately $3.5 million of the $8.8 million purchase price to in-process
research and development projects. In connection with the purchase of Quantum,
also in the fourth quarter of 1998, the Company allocated approximately $4.0
million of the $8.9 million purchase price to in-process research and
development projects. These allocations represent the estimated fair value
related to the incomplete research and development projects. The estimated fair
values were determined by an independent third party appraisal based upon
risk-adjusted cash flow methodologies. These costs were expensed as
non-recurring charges to operations as of the acquisition dates as the projects
had not yet reached technological feasibility and had no alternative future use.
XNT's primary projects in progress at the time of acquisition involved
designing a technology and application platform for a next-generation ADS, XNT's
core switch-control and call-processing control system. Overall, these projects
were approximately 70% complete at the time of acquisition. The estimated
revenues for the in-process technologies assumed compound annual growth rates of
60% in the five years following introduction, assuming the
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successful completion and market acceptance of the major research and
development projects. These estimated revenues are expected to peak within
five years of acquisition and then decline sharply as other new products and
technologies enter the market. The cost of remaining efforts to complete the
projects is estimated at approximately $583,000. It is expected that the
remaining development work will be completed by the end of the third quarter
of 1999.
Quantum's critical in-process projects related to the SwitchKit toolkit
which is a core switch control and application development toolkit. Overall,
these projects were approximately 55% complete at the time of acquisition. The
estimated revenues for the in-process technologies assumed compound annual
growth rates of 32% in the three years following introduction, assuming the
successful completion and market acceptance of the major research and
development projects. These estimated revenues are expected to peak within three
years of acquisition and then decline sharply as other new products and
technologies enter the market. The cost of remaining efforts to complete the
projects is estimated at approximately $1.2 million. It is expected that the
remaining development work will be completed by the end of the third quarter of
1999.
The nature of the efforts required to develop the acquired in-process
technology into commercially viable products principally relate to the
completion of all planning, designing and testing activities necessary to
establish that the product can be produced to meet its design requirements
including functionality, features and technical performance requirements.
Although the Company currently expects that the acquired in-process technology
will be successfully developed, it is possible that commercial or technical
viability of these products will not be achieved. Furthermore, future
developments in the telecommunications industry, changes in programmable
switching technology, changes in other product offerings, changes in technology
requirements of telecom service providers or other developments may cause the
Company to alter or abandon these plans.
The value assigned to acquired in-process technology was determined by
estimating the completion percentage of research and development efforts at the
acquisition date, forecasting risk-adjusted revenues considering the completion
percentage, estimating the resulting net cash flows from the projects and
discounting the net cash flows to their present values. The completion
percentages were estimated based on cost incurred to date, the importance of the
completed development tasks and the elapsed portion of the total project time.
The revenue projection used to value the in-process research and development is
based upon management's estimate of the software component contributions of the
respective software technologies intended to be integrated with the Excel
switching products. Net cash flow estimates include selling, marketing and
general administrative expenses as well as research and development expenses.
Operating expenses were estimated based on historical results and management's
estimates regarding possible profit margin improvements. Due to purchasing power
increases and general economies of scale, estimated operating expenses as a
percentage of revenues were expected to decrease within two years following the
acquisition.
In addition, net cash flow estimates were adjusted to allow for fair return
on working capital and fixed assets, charges for core technology leverage and a
return on goodwill and other intangibles. An appropriate risk-adjusted discount
rate was selected to discount the net cash flows back to their present value.
The discount rates selected for developed and in-process technology were 15% and
20%, respectively. These rates were calculated based upon an estimate of the
cost of capital and the required rates of returns typical for companies at a
similar stage of development. In the selection of these discount rates,
consideration was given to the Weighted Average Cost of Capital ("WACC"), which
was determined, in part, by using the Capital Asset Pricing Model. The discount
rate utilized for the in-process technology was higher than Excel's WACC due to
the risk of realizing cash flows from products that had yet to reach
technological feasibility. The remaining identified intangibles will be
amortized on a straight-line basis over four to ten years based upon the
expected useful lives of developed technologies, retention of workforce and
other intangible assets. If these projects are not developed, the Company may
not realize the value assigned to the in-process research and development
projects. In addition, the value of other acquired intangible assets may also
become impaired.
OTHER INCOME (EXPENSE). Other income (expense), which primarily includes
interest income and interest expense, increased from $1.6 million in 1997 to
$6.3 million in 1998. This increase was primarily derived from a larger average
balance of invested cash and securities during 1998. In November 1997, the
Company received approximately $87.1 million in net proceeds from an initial
public offering of common stock.
PROVISION FOR INCOME TAXES. The Company's effective rate for Federal and
state income taxes was 39.0% and 42.5% for 1997 and 1998, respectively. The
increase in the overall effective rate is primarily attributable to the effect
of non-deductible goodwill, acquired in-process research and development related
to the acquisition of XNT and a decrease in the effective state income tax rate
provision.
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FISCAL YEAR ENDED DECEMBER 27, 1997 COMPARED TO FISCAL YEAR ENDED DECEMBER 28,
1996
REVENUES. Revenues increased 47.2% from $62.3 million in 1996 to $91.6
million for 1997. The increase resulted, in part, from the Company's continuing
efforts to enhance the scalability, performance, capacity and functionality of
its products through the modification and introduction of features and products.
The increase in revenues also resulted from the introduction of new or expanded
offerings by existing customers incorporating the Company's products, the
expansion of customers' existing markets and the introduction of new
applications by new and existing customers. In addition, revenues increased due
to increased market penetration resulting from the efforts of the Company's
expanded selling and marketing organizations.
Revenues from the Company's five largest customers represented
approximately 57% and 49% of the Company's revenues for 1996 and 1997,
respectively. Comverse represented approximately 37% and 25% of the Company's
revenues for these same periods, respectively.
GROSS PROFIT. Cost of revenues increased 18.3% from $24.6 million in 1996
to $29.0 million for 1997. Gross margin increased from 60.6% in 1996 to 68.3% in
1997. The increase in gross margin was primarily attributable to lower component
prices, changes in product mix and increased manufacturing efficiencies as the
Company increased its production volume in 1997, all of which the Company
estimates represents approximately four to five gross margin percentage points
in 1997. In addition, gross margins for 1996 were negatively impacted by the
introduction of the EXS switching system and related technology which resulted
in valuation adjustments of certain existing inventory components, which the
Company estimates represents approximately four of five gross margin percentage
points in 1996.
ENGINEERING, RESEARCH AND DEVELOPMENT. Engineering, research and
development costs increased 30.1% from $12.3 million in 1996 to $16.1 million
for 1997. As a percentage of revenues, these costs were 19.8% 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 partially offset by decreases in the
consumption of prototype supplies and materials. Engineering and research
personnel increased from 81 employees at the end of 1996 to 120 employees at the
end of 1997.
SELLING AND MARKETING. Selling and marketing costs increased 86.4% from
$7.9 million in 1996 to $14.8 million for 1997. As a percentage of revenues,
these costs were 12.8% and 16.1%, 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 and an increase in
trade show and promotional activities during 1997. Sales, marketing and customer
support personnel increased from 61 employees at the end of 1996 to 91 employees
at the end of 1997.
GENERAL AND ADMINISTRATIVE. General and administrative costs increased
31.2% from $7.0 million in 1996 to $9.1 million for 1997. As a percentage of
revenues, these costs were 11.2% and 10.0%, respectively, in such periods. The
increase in general and administrative costs in absolute dollars was primarily
attributable to an increase in general and administrative personnel from 40
employees at the end of 1996 to 54 employees at the end of 1997.
OTHER INCOME (EXPENSE). Other income (expense) increased from ($294,000) in
1996 to $1.6 million in 1997. This increase was primarily attributable to an
increase in interest income derived from larger balances of invested cash and
securities.
PROVISION FOR INCOME TAXES. The Company's effective rate for Federal and
state income taxes was 40.1% and 39.0% for 1996 and 1997, respectively. The
decrease in effective rates is primarily attributable to the utilization of
certain tax credits and a decrease in the effective state income tax rate.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999, the Company's principal sources of liquidity consisted
of its working capital of approximately $136.8 million, including cash, cash
equivalents and marketable securities of approximately $126.4 million, and $15.0
million of funds available under a bank line of credit. On December 31, 1998,
the Company had working capital of approximately $134.0 million and $120.5
million in cash, cash equivalents and marketable securities.
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Net cash provided by operations for the three months ended March 28,
1998 and March 31, 1999 totaled $5.0 million and $795,000, respectively. The
decrease in 1999 was primarily the result of increases in accounts receivable
and inventories. This decrease was offset by increases in profitability and
the tax benefits associated with the exercise on non-qualified stock options.
During the first quarter of 1999, the Company's accounts receivable
increased $5.2 million from December 31, 1998. At December 31, 1998 accounts
receivable increased $17.0 million from December 28, 1997. Management believes
these increases are due to a number of factors including an increasing quarterly
sales volume; the timing of order placements and shipments within the quarter;
and an increase in sales to international customers and to network providers and
other end-users. Sales to such customers typically result in longer payment
terms than the Company historically has extended to its established customer
base. During the first quarter of 1999, inventories increased approximately $3.8
million from December 31, 1998. During 1999, the Company introduced several
component cards necessitating an increase in required inventory levels. In
addition, the timing of the purchase and receipt of inventory components, prior
to the end of the quarter, contributed to this increase in inventory. The
Company expects these trends to continue as it seeks to increase revenues and
further expand its business internationally and with network service providers.
During 1996, 1997 and 1998, cash provided by operating activities totaled
$4.8 million, $20.5 million and $21.0 million, respectively. The increase in
1997 was primarily attributable to increases in profitability, accounts payable
and accrued expenses. The increase in 1998 was primarily attributable to $11.6
million tax benefit resulting from the exercise of common stock options and an
increase in profitability. This increase was offset by an $16.6 million increase
in accounts receivable.
Net cash consumed in investing activities for the three months ended March
28, 1998 and March 31,1999 totaled $3.5 million and $15.3 million, respectively.
The increase in the first quarter of 1999 primarily relates to an increase in
the dollar amount of investments purchased in 1999 with maturity dates of
ninety-one days or greater.
The Company's investing activities consumed $4.5 million, $71.2 million and
$9.0 million in 1996, 1997 and 1998, respectively. The increase in 1997 was
primarily attributable to the net $66.9 million purchases of marketable
securities largely due to the net proceeds received from the Company's initial
public offering in November 1997. The decrease in 1998 was primarily
attributable to the net proceeds of approximately $11.4 million received from
the sale or maturity of marketable securities during 1998 as opposed to the net
purchases of $66.9 million in marketable securities in 1997. Other significant
contributing factors to this decrease included: an increase in expenditures
totaling approximately $12.1 million related to the acquisition of property and
equipment and the construction of a new building; and the $7.4 million paid, net
of cash received, in connection with the acquisitions of XNT and Quantum.
In October 1998, the Company initiated construction of an addition to
connect two existing buildings. Construction is scheduled for completion by the
end of the third quarter of 1999 at an estimated cost of approximately $7.0
million. Management anticipates that available cash resources will fund this
construction.
The Company's financing activities consumed $3.1 million in the three
months ended March 28, 1998 and provided $9.1 million in the three months ended
March 31, 1999. The increase during the 1999 period is primarily the result of
proceeds received in connection with the Company's lease financing program. In
addition, the 1998 period reflects the final payment of $3.1 million of bank
loan obligations.
The Company's financing activities provided $8.3 million and $96.9 million
in 1996 and 1997 and consumed $2.8 million in 1998. During 1997, the Company
received net proceeds of approximately $87.1 million from an initial public
offering of common stock. During 1998, payments of $4.6 million on long-term
debt obligations were offset by proceeds from the exercise of stock options of
$1.6 million. In January 1998, the Company repaid all existing bank obligations
totaling approximately $3.1 million under a Mortgage and Security Agreement, a
promissory note payable and a Real Estate Promissory Note. In September 1998,
the Company exercised an option for $875,000 to purchase a building under an
existing capital lease arrangement. In connection with the acquisition of XNT
and Quantum, the Company paid approximately $7.8 million and issued promissory
notes totaling approximately $8.2 million. Such notes bear interest of 10% per
annum and are payable at various dates through September 2001. Upon the
occurrence of certain events, maturity of principal amounts may be accelerated
or decelerated.
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In March 1999, the Company entered into an arrangement with a leasing
company to enable the Company's customers to finance the purchase of Excel
equipment. Under the terms of this arrangement, as amended, the Company has a
recourse obligation in the amount of the greater of $1,000,000 or 20% of the
aggregate net book value of annual equipment sales financed. In addition, the
Company has a 100% recourse obligation for contracts funded for customers
with certain credit ratings, as determined by the leasing company. During the
first quarter of 1999, the Company sold approximately $7.9 million of
equipment under this agreement to the leasing company. In addition, the
Company sold to this leasing company an existing receivable of approximately
$1.0 million. The Company's total recourse obligation at March 31, 1999 is
approximately $8.5 million.
In July 1999, the Company completed the acquisition of certain technology
and assets. This technology included host-computer based software applications
for the Excel programmable switching platforms. Consideration included cash
payments of approximately $4.0 million, the issuance of promissory notes
totaling approximately $7.4 million and the assumption of certain liabilities.
Such notes bear interest of 8% per annum and are payable at various dates
through January 2001. The Company will account for this acquisition as a
purchase transaction and, accordingly, will allocate the purchase price to the
fair value of assets acquired and liabilities assumed. Principal assets acquired
include contract rights, property and equipment, existing technology and
in-process research and development for which the Company will record a one-time
charge in the third quarter. The Company is in the process of completing a
valuation of the assets acquired in this transaction for purposes of purchase
accounting with the assistance of an independent valuation consultant.
The Company's unsecured line of credit arrangement with a bank provides up
to $15.0 million in credit availability. Borrowings under this agreement bear
interest, at the Company's discretion, at either the bank's base rate or the
Eurodollar rate plus 1.75%. The agreement requires the Company to comply with
certain financial covenants, including maintaining a ratio of liabilities to
tangible net worth, a ratio of current assets to current liabilities and a
minimum profitability covenant. The agreement also restricts the Company's
ability to pay cash dividends. The Company was in compliance with these
covenants as of March 31, 1999. The Company has not utilized funds under this
line of credit since 1996. In June 1999, the bank extended the agreement's
expiration date by 90 days to September 30, 1999. Prior to its expiration, the
Company anticipates entering into a similar new or amended agreement.
The Company does not have any other significant capital commitments and
believes that available funds and cash generated from operations will be
sufficient to meet the Company's working capital requirements for at least the
next eighteen months. The Company plans to finance its long-term capital needs
with available funds, together with available borrowings and cash flow from
operations. To the extent that such funds are insufficient to finance the
Company's activities, the Company may have to raise working capital through the
issuance of additional equity or debt securities. However, such additional
financial alternatives may not be available at such time or on acceptable terms.
YEAR 2000 READINESS DISCLOSURE STATEMENT
Many currently installed computer systems and software products are
designed to accept only two-digit entries in the date code field. As a result,
they may have problems properly recognizing 1/1/00 as January 1, 2000. In less
than a year, computer systems and/or software used by many companies may need to
be upgraded to comply with such "Year 2000" or "Y2K" requirements. Significant
uncertainty exists in the computer software, hardware and telecommunications
industries concerning the potential effects associated with the Year 2000 issue.
The Company has instituted a program to review the Y2K compliance status of
the Company's product offerings and the software and systems used in its
internal business processes. Suppliers of the components that make up Excel's
products, as well as service providers, are being contacted as part of the
Company's Y2K assessment. In July 1998, Excel received ITAA*2000 certification
from the Information Technology Association of America ("ITAA"). ITAA's review
examined eleven discrete process areas deemed necessary for a successful Y2K
conversion. ITAA's certification indicates that Excel meets the information
technology's best software development practices for addressing the Year 2000
issue.
The Company has integrated Y2K testing into the development process for all
of its products. The Company has reviewed its entire EXS family of products,
which includes the EXS, and the products formerly named the LNX and CSN. The
Company believes that its entire EXS family of products is generally Y2K
compliant. Accordingly, the use or occurrence of dates on or after January 1,
2000 and the occurrence of leap years will not affect the performance of the
Company's products with respect to the ability of such products to correctly
create, store, process and output information related to such date data. Excel's
programmable switches are controlled by a host computer owned and operated
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generally by a customer or end user, and are typically integrated into
telecommunication applications by application developers, original equipment
manufacturers and system integrators or other third parties. Excel's switch
software is embedded, real time software. By design, date values are rarely
used in Excel's products. The Company found no discrepancies with Y2K or leap
year date processing during its internal testing. Excel believes that the PCX
product line will also function properly with a host computer using DOS
version 6.22 and beyond. This belief is based on an engineering review and
internal test results of the PCX product line.
The Company has also reviewed the product offerings resulting from the
acquisitions of XNT and Quantum for Y2K compliance and believes they are
generally Y2K compliant. Prior to being acquired by Excel, both XNT and Quantum
performed their own Y2K assessment. Quantum's products use a 4-digit date code
and, therefore, have no known Y2K problems. Excel received test reports from XNT
indicating that XNT's NT-based ADS software (from version 5.14.98 forward) had
passed their internal Y2K testing. The testing of DOS-based ADS software was
completed during the second quarter of 1999. Minor issues were identified, and
customers affected are being notified.
Prior to the RAScom acquisition, an internal assessment at RAScom
identified that the majority of their products have no calendar or date
functions and therefore have no Y2K exposure. The remaining RAScom products
represent the integration of third party components. RAScom has received Y2K
compliance statements for all but the high-density digital modems, which, to the
best of RAScom's knowledge, have no date or calendar functions. RAScom has also
run Y2K BIOS check programs against their RAServer 2100 and 2600 products, and
again identified no Y2K issues. RAScom products and their related product
development processes are currently being integrated into Excel's existing,
ITAA-approved process for the development, test and release of products.
Through discussions with suppliers and or reviews of publicly disclosed
information, Excel also believes that its primary internal information systems
used to support its operations (specifically, its ERP system and common office
applications) are Y2K compatible. A Norton Y2K utility has been purchased and is
being used to verify that all common office and desktop applications are Y2K
complaint. The Company is in the process of upgrading non-Y2K compliant servers
and workstations. This upgrade process is expected to be completed during the
third quarter of 1999.
The Company is in the process of contacting its major customers and
critical suppliers of components, equipment and services to determine whether
products and services obtained by the Company from such vendors or sold by the
customer to third parties are Y2K compliant. The Company's suppliers and
customers are under no contractual obligation to provide such information to the
Company. The Company intends to continue its efforts to monitor the Y2K
compliance of suppliers and major customers.
Based on the information available to date, the Company believes it will be
able to complete its Y2K compliance review and make modifications, if necessary,
prior to the end of 1999. The Company is prioritizing its efforts to focus on
Y2K discrepancies that would significantly impact operations. Nevertheless, to
the extent the Company is relying on vendors or suppliers to notify Excel or
resolve Y2K issues within their own products, the Company may experience delays
in implementing such changes. If key systems, or a significant number of systems
were to fail as a result of Y2K problems, the Company could incur substantial
costs and disruption of its business, which would potentially have a material
adverse effect on the Company's business and results of operations. In addition,
because the Company purchases many critical components from single or
sole-source suppliers, failure of any such supplier to adequately address issues
relating to the Y2K problem in its own products or internal systems may have a
material adverse effect on the Company's business, financial condition and
results of operations.
Because a majority of the Company's products have been sold through
application developers, original equipment manufacturers and system integrators
or other third parties, users of the Company's products may experience Y2K
problems as a result of the integration of the Company's Y2K compliant products
with non-compliant Y2K products of third party suppliers. In certain
circumstances, the Company has warranted to customers that the use or occurrence
of dates on or after January 1, 2000 will not adversely affect the performance
of the Company's products with respect to the ability to create, store, process
and output information related to such date data. If any of these customers
experience Y2K problems, such customers could assert claims for damages against
the Company.
To date, the Company has not required a complete and separate budget for
investigating and remedying issues related to Y2K compliance of the Company's
own products or the software underlying systems used in its internal operations.
The costs of Excel's Y2K initiative have been incorporated into existing
workloads and budgets within the quality, engineering and information technology
departments, and are not expected to be material to the Company's
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results of operations or financial position. Management will develop a
contingency plan in the third quarter of 1999 based upon the results of
Excel's supplier and customer readiness reviews. To the extent the Company
has not adequately assessed its Y2K compliance, additional or significant
Company resources may be spent on investigating and remedying Y2K issues and
the expenditure of such resources may have a material adverse effect on the
Company's business, financial condition and results of operations in the
future.
BUSINESS
INFORMATION CONTAINED IN THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS
SUCH AS STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND
INTENTIONS, THAT CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY,
SUCH AS "MAY," "WILL" "EXPECT," "ANTICIPATE," "BELIEVE," "PLAN," "INTEND,"
"COULD," "ESTIMATES," "IS BEING" OR "GOAL" OR OTHER VARIATIONS OF THESE TERMS OR
COMPARABLE TERMINOLOGY. SUCH STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES
THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED. THE
CAUTIONARY STATEMENTS MADE IN THIS REPORT SHOULD BE READ AS BEING APPLICABLE TO
ALL FORWARD-LOOKING STATEMENTS WHENEVER THEY APPEAR IN THIS REPORT. FACTORS THAT
COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED IN THE
RISK FACTORS SET FORTH UNDER "RISK FACTORS" AS WELL AS THOSE DISCUSSED ELSEWHERE
HEREIN.
Excel Switching Corporation 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.
Excel offers a family of programmable switching platforms that are designed
with distributed architecture and open software to maximize performance and
provide multiple levels of programmability and redundancy. Excel's open
switching platforms integrate with a wide variety of host computer systems,
operating systems and application development environments. The Company's
product family scales from approximately 100 to 30,720 ports. Using Excel's
patented Programmable Protocol Language ("PPL"), application developers can
customize the switching software to their unique requirements, allowing them to
introduce new services and applications rapidly. As customer requirements
evolve, the Excel platform can be upgraded without requiring extensive and
complex programming changes to the underlying software.
The Company sells to a variety of customers in the worldwide
telecommunications market. Excel's customers integrate the Company's open,
programmable switching platforms with their product offerings to address a
variety of market applications for network providers, ranging from enhanced
services such as voice messaging, one number services and prepaid debit cards,
to wireless and wireline infrastructure services such as tandem, end-office,
mobile switching centers, intelligent base station controllers and wireless
local loop.
On May 10, 1999, the Company acquired RAScom, Inc., a company founded in
1996, that developed, manufactured markets and supported a comprehensive line of
open system remote access servers. The Company's management believes that the
acquisition will expand Excel's addressable market by adding access and data
capabilities to the Expandable Switching System (EXS) product line for the
Internet Service Provider (ISP) and Competitive Local Exchange Carrier (CLEC)
markets. Excel intends to integrate RAScom's remote access server technology
with Excel's programmable switching technology. The introduction of an
integrated solution is expected to make it possible for ISPs and CLECs to deploy
an economical solution that meets their voice, signaling and data requirements.
The integrated product is expected to give access providers the ability to
offer reliable packet-oriented data services with circuit-based telecom
services. This product is expected to eliminate the need for separate switching,
SS7 gateways, packet routing and remote access systems, collapsing them all into
a single, cost effective NEBS compliant platform. In addition, as part of
Excel's ONE Architecture, Excel Partners will now be able to offer data services
along with other enhanced services. The integration of RAScom personnel is
expected to bring technical expertise to Excel in the areas of access, LAN
routing, VPN and other emerging data technologies.
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Excel's products and technology are contained within the framework of
Open Network Expansion Architecture ("ONE Architecture(TM)") which was
introduced in February 1998. ONE Architecture is Excel's concept that its
switching solutions provide an open, scalable and cost-effective solution for
the telecommunication needs of network providers. ONE Architecture
encompasses the existing family of switching products and related embedded
software technologies described below.
EXCEL PRODUCT FAMILY
The Company offers a family of open, programmable switching products for
application developers, OEMs, systems integrators and network service providers.
The Company's product family includes the EXS-2000 (formerly referred to as the
LNX), a 2,048 port switching platform and the EXS-1000 (formerly referred to as
the CSN), a 1,024 port switching platform. Multiple nodes of EXS-2000s or
EXS-1000s can be easily linked to form an EXS system of up to 30,720 ports. The
LNX and CSN product names have been changed to EXS-2000 and EXS-1000,
respectively, to better reflect the continuity and common architecture shared
across the entire EXS product line. All of the Company's EXS products can be
used in a wide range of enhanced services and wireless and wireline
infrastructure applications.
All of Excel's switching products share a common embedded software
architecture, allowing specific applications to run on any EXS platform, and are
designed with multiple levels of redundancy. All EXS switching platforms share a
set of common card components which include network interface line cards such as
T1, E1 and J1 interfaces, and service resource cards such as multi-function
Digital Signal Processors, Primary Rate ISDN, SS7, DASS2 and DPNSS. Excel's
network interface line cards provide direct connectivity to, and ease of
integration with, a variety of international signaling protocols. The service
resource cards provide customers with a range of common channel signaling and
switching applications, offering network providers the ability to control their
applications and the flexibility to expand to other services or signaling
protocols as needed. Multiple cards can be installed on a single chassis to
manage various signaling and call control capabilities or to provide fault
tolerant configurations. In addition, the Company offers network interface line
cards and service resource cards separately to allow customers to upgrade or
enhance previously deployed switching platforms.
The EXS-2000 is a 2,048 port, non-blocking, open, programmable switching
platform that provides high performance and fault tolerance in a small chassis.
With all modules supporting redundant configurations, the EXS-2000 is designed
for central office environments requiring a high level of reliability and ease
of maintainability. The EXS-2000 can operate as a stand-alone switch or as a
node in Excel's EXS switching system, currently supporting scalability up to
30,720 non-blocking ports. The EXS-2000 consists of the 2,048 port matrix card
residing in a 20-slot chassis, a host interface and a fully configurable
combination of network interface line and service resource cards. All EXS-2000
cards can be replaced while the system is operating ("hot-swappable"), providing
ease of maintenance and upgrading without interruption of sThe predecessor to
the EXS-2000, the XLDX, is a 1,536 port programmable platform first installed in
a central office environment in 1988. XLDX systems are still supported by the
Company for customers with an XLDX installed base.
The EXS-1000 is a 1,024 port, non-blocking, open, programmable switching
platform that provides the same features and scalability as the EXS-2000 but in
a more compact chassis. The EXS-1000 utilizes the same common cards for network
line interfaces and service resources as well as utilizes common channel
signaling packet engines and host interfaces as the EXS-2000, with the same
reliability features such as hot-swap ability and full redundancy. The EXS-1000
is suited for wireless and other applications where space constraints dictate
the need for carrier-class switching within a compact chassis.
The EXS system is an open, non-blocking system comprised of multiple
EXS-2000 and or EXS-1000 programmable switching platforms distributed across
EXNET, the Company's fiber optic expansion network. The current EXNET network
can support up to 30,720 ports, encompassing combinations of EXS-2000s and or
EXS-1000s. The patented EXS architecture is designed to allow further expansion
beyond the current 30,720 ports. Parallel EXNET fiber networks can also be used
to create fully redundant systems to ensure maximum availability and fault
tolerance. Because each EXS node is a self-contained EXS-2000 or EXS-1000
switching platform, processing power can scale linearly as the system is
expanded. Individual EXS-2000 or EXS-1000 nodes can be isolated and serviced
without the entire system being brought out-of-service, providing ease of
maintenance. Since each node can operate and process calls independently, total
system reliability and availability is increased.
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The Company also offers another switching product, the PCX, which is
designed for the customer premise equipment marketplace. The PCX is designed
to provide a total solution in a small chassis and address the needs of
midrange switching applications. The PCX is a PC-based, 512 port,
non-blocking, open, programmable switching platform that supports the same
programmable features and shares the same hardware and software architecture
as the EXS-2000 and EXS-1000 platforms. With its PC-based platform, the PCX
can support an internal host processor as well as internal voice processing
resources. The PCX enables application developers to combine Excel's
programmable switching features with industry-standard voice processing
technology for a single, stand-alone solution. Although, sales of the PCX
product were not significant in 1998 or 1999, the Company continues to supply
PCX components and support the existing installed customer base.
A unique aspect of Excel's distributed architecture is its embedded
patented Selective Space Switching technology which allows the platform's
internal bus to switch traffic between any input or output port, DSP, packet
engine resource or EXNET Controller without losing critical port capacity.
Unlike traditional switches, with Selective Space Switching technology,
available port capacity is not compromised as additional modules are added. When
resource modules are added, the platform's switching capacity increases, and its
full non-blocking switch port capacity is retained.
Unlike traditional, proprietary switches, Excel's programmable platforms
share a common, open, embedded software architecture designed to be programmable
by third parties. The open programmability of Excel's switching platforms is
based on its Application Programming Interface ("API") and its patented
Programmable Protocol Language ("PPL"). The API is a message-based protocol
designed for communication between the programmable switching platform and the
application software located on a host computer. Excel's open API allows the
application software to access call processing control, configuration,
maintenance and alarm reporting functions within the switch at a level that is
not currently available in competitive products. The API also allows multiple
host computers to attach to the EXS platform to provide multiple applications on
a single platform or application load sharing architectures. Excel's API is
embedded within the Company's switching product family.
Excel's PPL is a patented technology that provides an easy and convenient
mechanism for developers and operators to implement modifications without having
to write complex software code. PPL provides a development environment at
multiple programmable levels including the signaling protocol, call control and
the supplementary service layers of the system software. PPL provides the
customer greater control over their development of competitive custom service
offerings and an ability to independently customize the switching platform to
add functionality. Software, including protocols, is developed and modified
using a graphical user interface development environment, requiring the user to
have only limited software programming experience. PPL can be leveraged in the
call control layer to customize the EXS API to match external application
requirements. This allows developers to create their own host-to-switch API to
optimize their applications and services. With PPL, support personnel can
implement detailed changes to the switching software on site without using
expensive equipment or requiring additional technical personnel. These benefits
provide increased software maintainability while reducing development costs and
eliminating customized work for Excel and its customers.
Excel's EXS programmable switching platforms supports the worldwide
telecommunications industry's Signaling System 7 ("SS7") requirements. All phone
systems require signaling to supervise or monitor the circuit, alert for
incoming calls and transmit routing and destination signals over the network.
Excel's products are also used in the Intelligent Network (IN), via its SS7
products. Excel's SS7 provides a robust, high-reliability, scalable SS7 solution
that supports multiple layers of the SS7 model. Because it uses PPL technology,
Excel's SS7 is highly programmable. With Excel's SS7, developers can build
custom IN services, enabling service providers to offer a wide variety of
competitive services to their subscribers. Excel's SS7 products support both
domestic and international standards, and enable the Excel switch to operate
either as an Intelligent Peripheral (IP) or a Service Switching Point (SSP) in
the Intelligent Network.
The Company's PPL, API and Selective Space Switching software technology
are embedded within the system software of the switching products. The Company
also sells certain separate software tools and applications including a PPL
toolkit which assists in the development of custom protocols and services,
independent of the switch architecture.
In September 1998, Excel acquired XNT Systems, Inc, a former Excel
customer. Prior to the acquisition, XNT supplied network service providers with
intelligent switch-control and comprehensive call-processing and control
software applications that managed the underlying Excel switch platform. The
acquired XNT technology enhances Excel's ability to offer its network service
providers a turnkey infrastructure switching solution containing such service
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capabilities as tandem and end-office switching. In September 1998, the
Company also acquired Quantum Telecom Solutions, Inc., a former Excel
customer. Prior to the acquisition, Quantum provided its customers with
software to configure and manage Excel switching platforms for use in
networks. Both of these acquisitions provided Excel with switch-related
technology and applications that increased both the functionality and the
ease of programmability of the Excel switching platforms. On December 31,
1998, both acquired entities were merged into the Company.
The RAScom family of products include open, remote access servers targeted
to enterprise customers, Internet Service Providers (ISPs) and OEMs. Management
believes these solutions provide the reliability and ease-of-use required for
evolving remote access applications. Customers can leverage existing investments
to deploy these solutions to minimize training, simplify administration and
provide the flexibility to support emerging technology standards and business
applications.
The RAServer 2000 series addresses the need for reliable and scalable
remote access servers for the enterprise networks and for ISPs. Enterprise
customers can deploy network access to telecommuters, contractors, remote office
workers and branch office installations by providing cost-effective
consolidation of both analog and high-speed digital circuits. ISPs can deploy
remote access and Virtual Private Network (VPN) services that leverage existing
expertise in Windows NT and the PC platform. RAServers support concurrent access
over both the Public Switched Telephone Network (PSTN) and the Internet. The
RAServer family is scalable and provides support from as few as sixteen to up to
120 concurrent remote users in a single chassis. Since each RAServer runs on the
Windows NT Server platform, they can serve as an open systems platform for
integrating a combination of communications services, including routing,
firewall, web caching, fax-out, dial-out and VoIP.
Prior to the acquisition, both companies were engaged in a joint
development project to integrate RAScom's remote access server technology with
Excel's programmable switching technology. Management believes that this newly
integrated voice and data solution can provide emerging and established carriers
and access providers a multi-service access switching system to provide
customers the ability to offer packed-oriented data services with circuit-based
telecom services.
CUSTOMERS
During 1998, the Company sold its products to more than 238 customers
engaged in a variety of areas of the telecommunications industry. The Company's
customers include application developers, OEMs, systems integrators and service
providers. Approximately 19% of the Company's revenues in 1998 were derived from
sales to QUALCOMM Incorporated and approximately 25% of the Company's revenues
in 1997 were derived from sales to Comverse Network Systems (formerly Boston
Technology, Inc.). No other customer accounted for greater than 10% of the
Company's revenues for these periods. The primary end-users of the Company's
products are public network providers, including LECs, IXCs, CLECs, wireless
carriers, ISPs and PTTs. The Company's products also are used by a number of
large corporations to satisfy specific telecommunications requirements.
CUSTOMER SERVICE, SUPPORT AND TRAINING
The Company provides pre- and post-sales engineering services and has a
technical assistance center that provides support and service by telephone. The
Company offers a variety of engineering services such as customer application
design review, protocol development, product training, performance testing and
field support. The Company has a fully equipped training facility and provides a
wide range of training courses to its customers, both on- and off-site. The
Company also has a fully equipped applications lab with call traffic load
capabilities where customers can test and verify new applications or
enhancements to existing applications. The Company's technical assistance center
provides telephone support and service on a 24-hour, seven-day-a-week basis. To
ensure that the Company is providing quality support services, the Company has a
formal customer satisfaction program which involves senior management review and
regularly scheduled customer support surveys. In addition, Company personnel
meet regularly with customers to discuss product quality and customer
satisfaction.
The Company provides a product warranty on its hardware products, which
generally covers a period of 14 months from shipment. This warranty coverage
includes technical assistance, as well as product repair or product replacement,
depending upon the circumstances of the warranty claim. In late 1998, Excel
began to offer a warranty on the software embedded within its products. This
warranty covers a period of 90 days and provides that the Excel embedded
software shall be free from certain defects. In addition, Excel began to offer
its customers an option to purchase service and
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support contract covering post-sales support. These post-sales support
agreements provide additional technical support and professional services
such as training, application planning, design consultation and
implementation assistance. Under these agreements, customers generally will
be charged an annual fee based upon the level of support requested.
SALES AND MARKETING
The Company has historically sold its products primarily to application
developers, OEMs and systems integrators which incorporated the Company's
products into their service and product offerings. During 1998, the Company
began selling more of its products directly to service providers. The Company's
principal marketing activities are to identify customers that could benefit from
the Company's products, identify new markets for the Company's products and
increase sales to existing customers.
The sale of the Company's switching products is a multi-step and
interdisciplinary process which can typically range from 12 to 24 months or more
from initial customer contact to large-scale commercialization of a customer's
application or service based on the Company's products. The initial evaluation
stage, typically three to six months, is primarily the role of the Company's
sales, marketing and engineering personnel, and members of the Company's senior
management. The sales process involves educating potential customers on the
functionality and benefits derived from using the Company's products. The next
stage, which can involve members of both the Company's customer support and
research and development organizations, involves providing the customer with the
required training and technical support to integrate the Company's products into
a new application or service. This stage of the sales process is generally the
longest and is dependent upon an application or service provider's own internal
application or service development program.
The Company sells to its customers through its own sales force, from its
headquarters, as well as from sales offices in California, Florida, Georgia,
Illinois, Massachusetts, New Hampshire, Ohio and Texas. In addition, the Company
has home-based sales representatives in Connecticut, Colorado and Maryland. The
Company has foreign sales offices in Brussels, Belgium; Dortmund, Germany; and
Tokyo, Japan. The Company currently has no other offices outside the United
States, but is exploring the establishment of additional foreign sales offices
in Europe and Asia. To date, the Company has no firm commitments to establish
such international sales offices and there can be no assurance that the Company
will actually open any foreign offices. In addition, the Company maintains an
inside sales group, located at its headquarters, which is responsible for
platform configuration and price quotations, order administration and telephone
sales activities. In order to create awareness, market demand and sales
opportunities, the Company engages in a number of marketing activities which
include exhibiting products and customer applications at industry trade shows,
advertising in selected publications aimed at targeted markets, public relations
activities with trade and business press, publication of technical articles and
the distribution of sales literature, technical specifications and
documentation.
RESEARCH AND PRODUCT DEVELOPMENT
Management believes that the Company's success will depend on its ability
to develop and introduce in a timely fashion new products and enhancements to
its existing products. The Company has in the past made, and intends to continue
to make, significant investments in product and technological development.
Extensive product development input is obtained through customers and the
Company's monitoring of end-user needs and changes in the marketplace.
The Company is focusing its development efforts on: providing enhanced
functionality to its products including increased port capacity, reliability and
performance; the development of network switching software; the integration of
RAScom technology within the EXS; the improvement of third-party application
integration including packet data technology such as VoIP, RAS and other
protocols; and enhancement of development tools. These research and development
projects are being designed to: enhance the Company's turnkey switching solution
for use by network service providers; enhance the ability to integrate voice,
data and media resources onto a single switching platform; and to enable
customers to shorten their application development cycle thereby improving
time-to-market and reducing initial investment in research and development.
The Company may experience difficulties that could delay or prevent the
successful development, introduction or marketing of such new products and
enhancements. It is possible that new products and enhancements may not
adequately meet the requirements of the marketplace and achieve market
acceptance. Announcements of currently planned or other new product offerings by
the Company or its competitors may cause customers to defer or cancel the
purchase of existing Company products. The Company's inability to develop on a
timely basis new products or
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enhancements to existing products, or the failure of such new products or
enhancements to achieve market acceptance, could have a material adverse
effect on the Company's business, financial condition and results of
operations.
The development of new, technologically advanced products is a complex and
uncertain process requiring the accurate anticipation of technological and
market trends. The introduction of new or enhanced products also requires the
Company to manage the transition from older products in order to minimize
disruption in customer ordering patterns, avoid excessive levels of older
product inventories and ensure that adequate supplies of new products can be
delivered to meet anticipated customer demand. There can be no assurance that
the Company will successfully develop, introduce or manage the transition to new
products. Furthermore, products such as those offered by the Company may contain
undetected or unresolved errors when they are first introduced or as new
versions are released. Despite extensive testing by the Company, errors may be
found in new products or upgrades after commencement of commercial shipments,
resulting in delays in or loss of market acceptance and sales, diversion of
development resources, injury to the Company's reputation or increased service
and warranty costs, any of which could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company's engineering, research and development expenditures totaled
approximately $12.3 million, $16.1 million, $26.4 million and $8.5 million
during 1996, 1997 1998, and in the first quarter of 1999, respectively. During
1998, Excel incurred one-time charges totaling approximately $7.5 million for
acquired in-process research and development relating to the acquisitions of XNT
Systems, Inc. and Quantum Telecom Solutions, Inc. See "Management's Discussion
and Analysis of Financial Condition" and "Notes to Supplemental Consolidated
Financial Statements" for more detailed disclosures relating to these
acquisitions.
The Company performs most of its research and product development
activities at its principal offices in Hyannis, Massachusetts. In addition, the
Company performs research and product development activities in offices located
in New Jersey and New Hampshire. The Company has maintained International
Standard Organization (ISO) 9001 registration for quality assurance in design,
production, installation and service since originally receiving ISO 9002
certification in 1996 and ISO 9001 certification in 1997.
MANUFACTURING
The Company's manufacturing operations consist primarily of materials
planning and procurement, final assembly, testing and quality control. The
Company uses several independent manufacturers to provide certain printed
circuit boards, chassis and subassemblies. The Company's manufacturing process
enables it to configure its products to meet a wide variety of individual
customer requirements. The Company plans to strengthen manufacturing capability
both in its existing facilities and through expansion of activities with
independent manufacturers. Future growth of the Company will require extension
of existing internal and external manufacturing resources, hiring of additional
technical personnel, improved coordination of supplier relationships with the
Company's inventory ordering and management practices, and expansion of
information systems to accommodate planned growth across these areas.
Although the Company generally uses standard parts and components for its
products, many critical components are purchased from sole or single source
vendors for which alternative sources may not be currently available. Some of
these components are available from only one supplier, for which there is no
substitute at this time. Also, from time to time, Excel provides or resells
various third party applications for use with its switching products. If supply
of these components or third party applications should cease or become
unavailable, the Company would be required to redesign its products or stop
providing such applications with its products. Although the Company works
closely with well-established vendors, the Company has no supply commitments
from its vendors and generally purchases components on a purchase order basis as
opposed to entering into long term procurement agreements with vendors. With
respect to third party applications, the Company intends to enter into supply
contracts to assure availability. To date, the Company has generally been able
to obtain adequate supplies in a timely matter from its primary vendors or, when
necessary to meet production needs, from alternate vendors. In addition, the
Company has been able to maintain relationships with application developers who
provide third party applications. The Company believes that, in most cases,
alternate vendors can be identified if current vendors are unable to fulfill
needs. However certain applications may be only available from a single
developer. Delays or failure to identify an alternate vendor, if required, a
reduction or interruption in supply, a significant increase in the price of
components or the inability to maintain a relationship with a particular
application developer would materially and adversely affect the Company's
business, financial condition, results of operations and customer relationships.
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COMPETITION
The markets in which the Company competes are characterized by intense
competition, with a large number of suppliers providing different types of
products to different segments of such markets. The telecom industry has also
been subject to rapid consolidation of equipment suppliers by larger telecom
and data network service providers.
The Company currently competes principally on the basis of: (i) the breadth
of its products' features and benefits; (ii) the flexibility, scalability,
quality, ease of use, reliability and cost effectiveness of its products; and
(iii) the Company's reputation and the depth of its expertise, customer service
and support. While the Company believes that overall, it currently competes
favorably with respect to these factors, there can be no assurance that the
Company will be able to continue to do so.
The Company competes or may compete directly or indirectly with the
following categories of companies: (i) other manufacturers of programmable
switches such as Cisco Systems, Inc. (primarily through its 1998 acquisition of
Summa Four, Inc.), Redcom Laboratories, Inc. and Harris Corporation; (ii) large,
well-established switch and telecommunications equipment manufacturers such as
Alcatel Alsthom Compagnie Generale d'Electricite SA, Lucent Technologies Inc.,
Northern Telecom Limited, Siemens AG and Telefonaktiebolaget LM Ericsson; and
(iii) to a lesser degree, systems integrators and application developers whose
switches are based on PC card-level products manufactured by companies such as
Aculab Inc., Dialogic Corporation (to be acquired by Intel Corporation) and
Natural MicroSystems Corporation. In addition, several smaller companies have
begun recently to manufacture programmable switching platforms. Through the
RAScom subsidiary, the Company competes or may compete directly or indirectly
with the following categories of companies engaged in data communications: (1)
large, well-established telecommunications equipment manufacturers such as 3Com
Corporation, Cisco Systems, Inc. and Lucent Technologies Inc.; and (ii) several
smaller manufacturers or remote access servers. Due to the rapidly evolving
markets in which the Company competes, additional competitors with significant
market presence and financial resources, including large telecommunications
equipment manufacturers and computer hardware and software companies, may enter
those markets, thereby further intensifying competition. Additionally, there can
be no assurance that one or more of the Company's application developers will
not begin to develop or market products in competition with the Company.
Many of the Company's current and potential competitors have significantly
greater financial, selling and marketing, technical, manufacturing and other
resources than the Company. As a result, these competitors may be able to devote
greater resources to the development, promotion, sale and support of their
products than the Company. The Company, however, does not believe any of its
competitors are currently dominant in its industry segment. Some of the
Company's competitors currently offer financing alternatives to their customers.
The Company has recently established a relationship with an independent leasing
company to offer a financing alternative to some or all of Excel's customers. It
is not certain that the financing alternative provided by this relationship will
be on terms that are competitive with the financial offerings of the Company's
competitors. It is not certain that the Company will be able to maintain such a
relationship or offer such financing alternatives in the future. Moreover, these
companies may introduce additional products that are competitive with those of
the Company or enter into strategic relationships to offer complete solutions
which the Company does not currently offer. It is unknown whether the Company's
products would compete effectively with such products.
The Company believes that its open, programmable switching platform, with
the Company's patented Selective Space Switching technology and Programmable
Protocol Language, offers its customers a competitive advantage for flexible,
scaleable and cost-effective switching capabilities. Although the Company
believes these technological features represent advantages over its competitors,
maintaining these advantages will require continued investment by the Company in
research and development, selling and marketing and customer service and
support. In addition, as the Company enters new markets, distribution channels,
technical requirements and levels and bases of competition may be different than
those in the Company's current markets. Accordingly, it is uncertain whether the
Company will be able to compete successfully against either current or potential
competitors in the future.
INTELLECTUAL PROPERTY
The Company relies upon a combination of patent, copyright and trademark
and trade secret laws as well as confidentiality procedures and contractual
restrictions to establish and protect its proprietary rights. The company has
also entered into confidentiality and invention assignment agreements with its
employees and consultants and enters into
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non-disclosure agreements with its suppliers, distributors and customers so
as to limit access to and disclosure of its proprietary information. There
can be no assurance such measures will be adequate to deter and prevent
misappropriation of the Company's technologies or independent third-party
development of similar technologies. The laws of certain foreign countries in
which the Company's products are or may be developed, manufactured or sold
may not protect the Company's products or intellectual property rights to the
same extent as do the laws of the United States and thus make the possibility
of piracy of the Company's technology and products more likely.
As of June 30, 1999, a total of 14 U.S. patents and 11 foreign patents have
been issued to the Company. The Company has a total of 26 U.S. patent
applications and 76 international and foreign national patent applications
pending. The U.S. issued patents relate to various aspects of: (i) the
architecture and division of call processing responsibility in the Company's PCX
product; (ii) the design and internal construction of a rack-mountable chassis
used with the Company's PCX product; (iii) the architecture of certain
communications resource and I/O cards which may be used in conjunction with any
of the Company's family of programmable switching platforms relating to the
Company's Selective Space Switching technology; (iv) the PPL software which may
be used, in conjunction with any of the Company's family of programmable
switching platforms, to create or modify applications or communications
protocols; (v) a line card redundancy arrangement for use in conjunction with
the Company's EXS-2000 and EXS-1000 products; (vi) the architecture of and
communication methods used with the Company's fiber optic expansion network,
EXNET; and (vii) a universal application programming interface (API) used in the
Company's products. The U.S. patents will expire at various times between the
years 2008 and 2017. The Company also has two U.S. trademark registrations; six
foreign trademark registrations; eight U.S. trademark applications; and 18
foreign trademark applications.
The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert patent, copyright,
trademark and other intellectual property rights to technologies that are
important to the Company. The Company is presently involved in litigation with
Cisco Systems, Inc. ("Cisco") where the Company has alleged infringement of
certain of its patents and Cisco has filed counterclaims alleging breach of a
confidentiality agreement and infringement of one of its patents. There can be
no assurance that this litigation will be resolved in the Company's favor or on
terms that are favorable to the Company. Cisco's counterclaims, if determined
adversely to the Company, could have a material adverse effect on the Company's
business, financial condition or results of operations (see "Risk Factors -
Risks Associated with Litigation"). The Company has also from time to time
received communications from other third parties asserting that the Company's
products infringe or may infringe proprietary rights of such third parties. The
Company generally believes that such claims, if determined adversely to the
Company, would not have a material adverse effect on the Company's business,
financial condition or results of operations.
In its distribution agreements, the Company agrees to indemnify its
customers for any expenses or liabilities resulting from claimed infringements
of patents, trademarks or copyrights of third parties. In certain limited
instances, the amount of such indemnities may be greater than the revenues the
Company may have received from the customer. In the event of litigation to
determine the validity of any third-party claims, such litigation, whether or
not determined in favor of the Company, could result in significant expense to
the Company and divert the efforts of the Company's technical and management
personnel. In the event of an adverse ruling in such litigation, the Company
might be required to discontinue the use and sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses
from third parties. There can be no assurance that licenses from third parties
would be available on reasonable commercial terms, if at all. In the event of a
successful claim against the Company and the failure of the Company to develop
or license a substitute technology, the Company's business, financial condition
and results of operations would be materially adversely affected. The Company
changed its name from Excel Inc. to Excel Switching Corporation in September
1997. Searches performed on the term Excel have revealed several registrations
and numerous uses of that term, and terms substantially similar to it, alone and
in combination with other terms and designs. Accordingly, there can be no
assurance that third parties will not assert trademark infringement claims
relating to the name Excel Switching Corporation in the future.
EMPLOYEES
As of March 31, 1999, the Company employed 456 persons, including 180 in
engineering, research and development, 94 in selling and marketing, 115 in
manufacturing and customer service and support and 67 in finance, administration
and management information systems. None of the Company's employees are
represented by collective bargaining arrangements, and the Company believes that
its relations with its employees are good. The Company expects to hire
additional management, engineering, finance, sales and marketing personnel over
the next 12 to 18
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months to accommodate anticipated domestic and international expansion. The
hiring of additional personnel will place additional demands on management's
ability to assimilate, direct and supervise a growing work force.
Accordingly, it is uncertain whether the Company will be successful in
assimilating this growth in personnel.
The Company's success depends to a significant degree upon the continuing
contributions of its key management, sales, engineering, customer support and
product development personnel. The loss of any of the key management or
technical personnel could have a material adverse effect on the Company. The
Company believes that its future success will depend in large part upon its
ability to attract and retain highly-skilled managerial, sales, customer support
and product development personnel. The Company has at times experienced and
continues to experience difficulty in recruiting qualified personnel.
Competition for qualified personnel in the Company's industry is intense, and
there can be no assurance that the Company will be successful in attracting and
retaining such personnel. Failure to attract and retain key personnel could have
a material adverse effect on the Company's business, financial condition and
results of operations.
RISK FACTORS
THIS REPORT CONTAINS STATEMENTS THAT ARE "FORWARD-LOOKING" STATEMENTS AND
ARE SUBJECT TO RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
SIGNIFICANTLY FROM EXPECTATIONS. IN PARTICULAR, STATEMENTS CONTAINED IN
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF SUPPLEMENTAL CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" WHICH ARE NOT HISTORICAL FACTS, INCLUDING,
BUT NOT LIMITED TO, STATEMENTS REGARDING: THE ANTICIPATED ADEQUACY OF CASH
RESOURCES TO MEET THE COMPANY'S WORKING CAPITAL REQUIREMENTS; ANTICIPATED
REQUIREMENTS FOR THE ACCRUAL FOR SALES RETURNS AND ALLOWANCES; ANTICIPATED
PAYMENT TERMS RELATING TO ACCOUNT RECEIVABLES; THE ANTICIPATED PROPORTION OF
REVENUES TO BE DERIVED FROM A LIMITED NUMBER OF CUSTOMERS; ANTICIPATED
EXPENDITURES AND COMPLETION DATES WITH RESPECT TO RESEARCH AND DEVELOPMENT AND
THE EXPANSION OF MARKETING AND SELLING EFFORTS; STATEMENTS REGARDING THE
COMPANY'S RECOURSE OBLIGATION UNDER ITS LEASE PROGRAM; UNANTICIPATED COSTS AND
DIFFICULTIES ASSOCIATED WITH INTEGRATING THE OPERATIONS, PRODUCTS AND PERSONNEL
OF ACQUIRED BUSINESSES, INCLUDING RASCOM; ANTICIPATED EXTENSION OF THE BANK LINE
OF CREDIT AGREEMENT; STATEMENTS REGARDING THE SIZE OF THE EXPECTED ONE-TIME
CHARGE FOR ACQUISITION-RELATED EXPENSES AND STATEMENTS REGARDING THE COMPANY'S
READINESS FOR Y2K ARE FORWARD LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, AMONG OTHERS, THOSE RELATING TO
FLUCTUATIONS IN RESULTS OF OPERATIONS, DEPENDENCE ON AND CONCENTRATION OF
RELATIONSHIPS WITH APPLICATION DEVELOPERS, OEMS AND SYSTEMS INTEGRATORS, RISKS
RELATING TO ACQUISITIONS AND THE INTEGRATION OF RASCOM AND OTHER RISKS
IDENTIFIED IN THE COMPANY'S SEC FILINGS INCLUDING THOSE CONTAINED IN THE
COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
AND THOSE CONTAINED IN THE COMPANY'S QUARTERLY REPORT ON FORM 10-Q FOR THE THREE
MONTHS ENDED MARCH 31, 1999.
FLUCTUATIONS IN RESULTS OF OPERATIONS. The Company's results of operations have
varied significantly in the past and may vary significantly in the future, on a
quarterly and annual basis, as a result of a variety of factors, many of which
are outside the Company's control. These factors include, without limitation:
(i) the timing and size of orders which are received and can be shipped in any
particular period; (ii) the commercial success of the Company's products; (iii)
delays in the introduction of products or product enhancements by the Company
and the Company's ability to introduce new products and technologies on a timely
basis; (iv) the financial stability of the Company's major customers; (v) the
timing of new product introductions or announcements by the Company or its
competitors; (vi) the availability of adequate supplies of key components and
assemblies and the adequacy of third-party manufacturing capabilities; (vii) the
seasonality of the placement of customer orders; (viii) the timing and nature of
selling and marketing expenses such as tradeshows and advertising campaigns;
(ix) the timing of development expenditures and personnel changes; (x) the
publication of opinions about the Company and its products, or its competitors
or their products, by industry analysts; (xi) customer order deferrals in
anticipation of product enhancements or new product offerings by the Company or
its competitors; and (xii) customer cancellation of orders and the gain or loss
of significant customers, including those due to industry combinations.
Moreover, any downturn in general economic conditions could precipitate
significant reductions in corporate spending for telecommunications
infrastructure, which could result in delays or cancellations of orders for the
Company's products. The Company's expense levels are relatively fixed and are
based, in significant part, on expectations of future revenues. Consequently, if
revenue levels are below expectations, expense levels could be
disproportionately high as a percentage of revenues, and the Company's business,
financial condition and results of operations would be materially adversely
affected. The Company has historically operated with little backlog because the
Company generally ships its products within 60 days of acceptance of an order.
As a result, revenues in any quarter
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are substantially dependent on orders booked and shipped in that quarter and
on sales by the Company's customers to end users.
The Company has experienced significant fluctuations in revenues,
expenses and results from operations from quarter to quarter, and such
fluctuations are likely to continue. The Company typically receives more
product orders and generates greater revenues in the fourth quarter. During
the last several years, revenues in the first quarter have typically been
lower than those recorded in the preceding fourth quarter. The Company
believes that this concentration of order placements in specific quarterly
periods is due to customers' buying patterns and budgeting cycles. A
significant portion of the Company's revenues have been generated from a
limited number of customers and it is difficult to predict the timing of
future orders and shipments to these and other customers. The Company
anticipates that its results of operations in any given period will continue
to depend to a significant extent upon sales to a small number of customers.
The Company also believes that the purchase of its products generally
involves a significant commitment of a customer's capital resources.
Therefore, any downturn in any customer's business could have a material
adverse effect on the Company's revenues, business, financial condition and
quarterly results of operations. In addition, the Company historically has
recognized a large portion of its revenues from sales booked and shipped in
the last month of a quarter such that the magnitude of quarterly fluctuations
may not become evident until late in, or at the end of, a particular 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. The Company's ability to increase its revenues in future
periods, sustain its level of revenues in future periods or sustain its rate
of revenue growth on a quarterly or annual basis cannot be assured.
Due to all of the foregoing factors, it is possible that in some future
quarter, the Company's results of operations will be below the expectations of
public market analysts and investors. In such event, the market price of the
Company's Common Stock would likely be materially adversely affected.
RISKS RELATING TO ACQUISITIONS. In May 1999, the Company acquired RAScom, Inc.
During the fourth quarter of 1998, the Company acquired Quantum Telecom
Solutions, Inc. and XNT Systems, Inc. The Company may also, from time to time,
pursue the acquisition of other companies, assets, products and technologies.
Acquisitions involve a number of operating risks that could materially adversely
affect the Company's results of operations, including the diversion of
management's attention to assimilate the operations, products and personnel of
the acquired companies, the acquired company's existing customer and support
obligations, the amortization of acquired intangible assets and the potential
loss of key employees of the acquired companies. Furthermore, acquisitions may
involve businesses in which the Company lacks experience. Because management and
the Company have limited experience in acquisitions and integrating acquired
companies or technologies into its operations, it is not certain that the
Company will be able to manage present and future acquisitions successfully, or
that the Company will be able to integrate the operations, products or personnel
gained through any such acquisitions without a material adverse effect on the
Company's business, financial condition and results of operations.
DIFFICULTY OF INTEGRATING TWO COMPANIES. In connection with the Company's recent
acquisition of RAScom, Inc., the successful integration of the operations,
personnel and product lines of the two companies is important to the future
financial performance of the combined enterprise. The anticipated benefits of
the acquisition may not be achieved unless, among other things, the operations
of RAScom are successfully combined with those of the Company in a timely
manner. The diversion of the attention of management, and any difficulties
encountered in the transition process, could have an adverse impact on the
revenues, financial condition and results of operations of the combined
enterprise. Excel may not be able to successfully integrate RAScom and its
services and products into the Company's operations. The inability of management
to successfully integrate the operations of the companies could have a material
adverse effect upon the business, financial condition and results of operations
of the Company.
DIFFICULTY OF INTEGRATING RASCOM PRODUCT LINES. As part of its product plans
following the acquisition of RAScom, Excel expects to be integrating RAScom's
remote access technology with Excel's programmable switching technology for the
enhanced services and wireless and infrastructure markets, as well as for small-
and medium-sized Internet Service Providers. The integration by Excel of
RAScom's product offerings may be costly, and result in unanticipated
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delays or difficulties with product integration, and require further
development expenses and further expenditures for sales and marketing
campaigns associated with advertising the new, complementary product
offerings. There is no assuranc that the RAScom research and development team
can be successfully assimilated with Excel's engineering personnel, or that
the RAScom engineering personnel will continue to remain at Excel following
the acquisition. Excel has no assurance that its existing customers will
purchase the new RAScom product lines, once integrated, or that Excel will be
able to attract new customers wit the added RAScom product capabilities.
While management believes that RAScom's technology enhances Excel's existing
product offerings and expands its addressable markets, delays or difficulties
associated with this product integration or the loss of RAScom engineering
personnel could have a material adverse effect on Excel's business, financial
condition and results of operations.
UNCERTAINTIES RELATING TO INTEGRATION OF OPERATIONS. The Company believes that
the acquisition of RAScom will result in long-term strategic benefits. However,
the realization of these benefits will depend on whether management can
integrate the operations of the Company and RAScom in an efficient and effective
manner. Among other things, the Company must integrate the respective companies'
products, technologies, distribution channels and key personnel. Furthermore,
the Company must coordinate the sales, marketing and engineering, research and
development efforts of RAScom. The difficulties of integrating RAScom may be
increased by the need to coordinate organizations with distinct cultures and
widely dispersed operations. The effective integration of the various operations
will depend on the ability of the Company to attract and retain key management,
sales, marketing and engineering, research and development personnel. The
integration of operations following the acquisition will require significant
attention of management and thus may distract attention from other day-to-day
operations of the Company.
NEED TO INTEGRATE AND RETAIN KEY EMPLOYEES OF RASCOM. The successful integration
of RAScom, Inc. is dependent on the retention and integration of the key
management, sales, marketing, engineering and other technical employees of
RAScom. Competition for qualified personnel in the industries in which the
Company and RAScom compete is very intense, and competitors may use aggressive
tactics to recruit key employees of the Company and RAScom during the
integration phase following the acquisition which could result in the loss of
key employees. The loss of these key personnel could have a material adverse
effect on the Company's business, financial condition and results of operations.
NEED TO ATTRACT AND RETAIN QUALIFIED PERSONNEL TO REPLACE THE ATTRITION OF
RASCOM PERSONNEL. In the period since the completion of the RAScom acquisition,
some key personnel of RAScom have left. The successful integration of RAScom and
its products and services depends in part on the Company's ability to attract
and retain qualified individuals to replace such personnel. Competition for
qualified personnel in the industries in which the Company and RAScom compete is
very intense. Competitors can offer compensation packages that include equity
compensation and other incentives that make it difficult for the Company to
compete in hiring and retaining qualified replacement personnel. There can be no
guarantee that the Company will be able to compete successfully in hiring and
retaining qualified replacement personnel that will allow for the successful
integration of the products, services and personnel of the two companies.
Failure to hire and retain such qualified replacement personnel could have a
material adverse effect on the Company's business, financial condition and
results of operations.
CONCENTRATION OF CUSTOMERS. During the three months ended March 31, 1999, the
Company's five largest customers accounted for approximately 29% of the
Company's revenues. During 1998's first quarter and fiscal 1998, the Company's
five largest customers accounted for approximately 52% and 43.0%, respectively,
of the Company's revenues. Although the Company's largest customers have varied
from period to period and the customer base continues to broaden, 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 have entered into a long-term supply agreement
requiring any of them to purchase a minimum amount of product from the Company.
Revenues from the Company's largest customers may significantly fluctuate period
to period on both an absolute dollar basis and as a percentage of sales. The
Company anticipates that revenues in 1999 from the Company's largest customer of
1998, QUALCOMM Incorporated, will decrease from the previous two fiscal years on
both an absolute dollar and percentage of sales basis. It is unknown whether the
Company's principal customers will continue to purchase product from the Company
at current levels, if at all, or whether 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.
HIGHLY COMPETITIVE MARKET. The market for telecommunications products is highly
competitive and subject to rapid technological change. The telecom industry has
also been subject to rapid consolidation of equipment and suppliers by larger
telecom and data network service providers. The Company competes or may compete
directly or indirectly with
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the following categories of companies: (i) other manufacturers of
programmable switches such as Cisco Systems, Inc. (primarily through its
recent acquisition of Summa Four, Inc.), Redcom Laboratories, Inc. and Harris
Corporation; (ii) large, well-established switch and telecommunications
equipment manufacturers such as Alcatel Alsthom Compagnie Generale
d'Electricite SA, Lucent Technologies Inc., Northern Telecom Limited, Siemens
AG and Telefonaktiebolaget LM Ericsson; and (iii) to a lesser degree, systems
integrators and application developers whose switches are based on PC
card-level products manufactured by companies such as Aculab Inc., Dialogic
Corporation and Natural MicroSystems Corporation. In addition, the Company
may be subject to competition from several smaller companies that have begun
to manufacture programmable switching platforms as well as from emerging data
communications equipment manufacturers. Due to the rapidly evolving markets
in which the Company competes, additional competitors with significant market
presence and financial resources, including large telecommunications
equipment manufacturers and computer hardware and software companies, may
enter those markets, thereby further intensifying competition. Additionally,
one or more of the Company's application developers may begin to develop or
market products in competition with the Company. Increased competition could
result in price reductions and loss of market share which would materially
adversely affect the Company's business, financial condition and results of
operations. Many of the Company's current and potential competitors have
significantly greater financial, selling and marketing, technical,
manufacturing and other resources than the Company. Some of the Company's
competitors currently offer financing alternatives to their customers. The
Company has recently established a relationship with an independent leasing
company to offer a financing alternative to some or all of Excel's customers.
It is not certain that financing alternative provided by this relationship
will be on terms that are competitive with the financial offerings of the
Company's competitors. It is not certain the Company will continue to offer
such financing alternatives in the future. Moreover, the Company's
competitors may also foresee the course of market developments more
accurately than the Company. Although the Company believes it has certain
technological and other advantages over its competitors, realizing and
maintaining such advantages will require a continued high level of investment
by the Company in research and product development, marketing and customer
service and support. It is not certain that the Company will have sufficient
resources to continue to make such investments or that the Company will be
able to make the technological advances necessary to compete successfully
with its existing competitors or with new competitors.
YEAR 2000 COMPLIANCE. The Company has implemented a Year 2000 compliance
program designed to ensure that the Company's computer systems and
applications will function properly beyond 1999. The Company believes that
adequate resources have been allocated for this purpose and expects the
Company's Year 2000 date conversion programs to be completed on a timely
basis. The Company does not expect to incur significant expenditures to
address this issue. However, there can be no assurance that the Company will
identify all Year 2000 problems in its computer and other systems in advance
of their occurrence or that the Company will be able to successfully remedy
any problems that are discovered. The expenses of the Company's efforts to
address such problems, or the expenses or liabilities to which the Company
may become subject as a result of such problems, could have a material
adverse effect on the Company's business, results of operations and financial
condition. In addition, the revenue stream and financial stability of
existing customers may be adversely impacted by Year 2000 problems, which
could cause fluctuations in the Company's revenues and operating
profitability and which could have a material adverse effect on the Company's
business, results of operations and financial condition.
If key systems, or a significant number of systems were to fail as a result
of Y2K problems, the Company could incur substantial costs and disruption of its
business, which would potentially have a material adverse effect on the
Company's business and results of operations. In addition, because the Company
purchases many critical components from single or sole-source suppliers, failure
of any such supplier to adequately address issues relating to the Y2K problem in
its own products or internal systems may have a material adverse effect on the
Company's business, financial condition and results of operations. In certain
circumstances, the Company has warranted to customers that the use or occurrence
of dates on or after January 1, 2000 will not adversely affect the performance
of the Company's products with respect to the ability to create, store, process
and output information related to such date data. If any of these customers
experience Y2K problems, such customers could assert claims for damages against
the Company. To the extent the Company has not adequately assessed its Y2K
compliance, additional or significant Company resources may be spent on
investigating and remedying Y2K issues and the expenditure of such resources may
have a material adverse effect on the Company's business, financial condition
and results of operations in the future.
DEPENDENCE ON RELATIONSHIPS WITH APPLICATION DEVELOPERS, OEMS AND SYSTEMS
INTEGRATORS. The Company sells a significant amount of its products to, and
maintains strategic relationships with, application developers, original
equipment manufacturers 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
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the service and product offerings of the Company's customers. Although the
Company maintains contractual relationships with a substantial number of its
customers, such contracts do not provide for minimum purchase requirements,
nor do they contain provisions requiring the exclusive purchase of the
Company's products. The development of an application or service for the
telecommunications market can involve a substantial amount of time and
expense. The delay or failure of a customer's application development program
incorporating the Company's products could delay or prevent expected sales of
the Company's products. The inability or cessation of customers to integrate
the Company's products into their service and product offerings, product
development delays by application developers and other customers, lack of
market acceptance of the service and product offerings of the Company's
customers or a customer's decision to market products manufactured by a
competitor of the Company, or the manufacture of such products themselves,
would have a material adverse effect on the Company's business, financial
condition and results of operations.
Additionally, selling through indirect channels may limit the Company's
information concerning the volume of products sold by the Company's customers to
end users and the Company's contact with its end users. As a result, the
Company's ability to forecast revenues accurately (notwithstanding the forecasts
of its customers), evaluate end-user satisfaction and recognize emerging
end-user requirements may be hindered.
RISKS RELATED TO LEASE FINANCING. In March 1999, the Company entered into an
arrangement with a leasing company to enable the Company's customers to finance
the purchase of Excel equipment. Under the terms of this arrangement, as
amended, the Company has a recourse obligation in the amount of the greater of
$1,000,000 or 20% of the aggregate net book value of annual equipment sales
financed. In addition, the Company has a 100% recourse obligation for contracts
funded for customers with certain credit ratings, as determined by the leasing
company. It is not certain that the financing alternative provided by this
relationship will be on terms that are competitive with the financial offerings
of the Company's competitors. It is not certain the Company will continue to
offer such financing alternatives in the future. Since Excel is obligated to
guarantee certain payments to the leasing company, the default by one or more
customers of their payment obligations to the leasing company under this program
may have a material adverse impact on the Company's business, financial
condition and results of operations. In addition, such default may have an
adverse impact on the Company's ability to continue to offer such alternative
financing to its customers.
DEPENDENCE ON SINGLE AND SOLE SOURCE SUPPLIERS AND THIRD-PARTY MANUFACTURERS.
The Company purchases many critical component from single or sole source vendors
and relies upon 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. In addition, from time to time Company
relies upon certain third-party software application vendors to supply certain
software applications used with the Company's switching products. The inability
to develop alternative sources for these products or to obtain sufficient
quantities of these products could result in delays or reductions in product
shipments which could materially adversely affect the Company's business,
financial condition and results of operations. In the event of a reduction or
interruption of supply, a significant amount of time, in some cases as much as
three to four months, could be required before the Company would begin receiving
adequate supplies from such alternative suppliers. Further, in such event, the
Company's business, financial condition and results of operations would be
materially adversely affected. In addition, the manufacture of certain of these
single or sole source components is extremely complex, and the Company's
reliance on the suppliers of these components exposes the Company to potential
production difficulties and quality variations, which could negatively impact
cost and timely delivery of the Company's products. Certain components and
applications 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 or stop providing such applications
with its products. It is not certain 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 therefore it is
not certain 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
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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.
EVOLVING MARKET FOR TELECOMMUNICATIONS SERVICES AND RAPID TECHNOLOGICAL CHANGE.
The Company's future success will depend on continued growth in the market for
telecommunications services. The global telecommunications marketplace is
evolving and it is difficult to predict its potential size or future growth
rate. It is not known whether deregulation and continued improvements and
expansions of infrastructure will continue to cause this market to grow or that
increased regulation will not present barriers to the sales of existing or
future products. In addition, telecommunications applications and infrastructure
needs may emerge for which the Company's products are not designed. If this
market fails to grow or grows more slowly or in a different direction than the
Company currently anticipates, the Company's business, financial condition and
results of operations could be materially adversely affected.
The telecommunications equipment market is also subject to rapid technological
change, evolving industry standards and frequent new product introductions and
enhancements that may render existing products obsolete. As a result, the
Company's position in this market could erode rapidly due to unforeseen changes
in product features and functions of competing products. The Company's growth
and future results of operations will depend in part on its ability to respond
to these changes by enhancing its existing products and developing and
introducing, on a timely and cost-effective basis, new products and features to
meet or exceed technological advances in the marketplace. The failure of the
Company to respond to rapidly changing technologies could have a material
adverse effect on the Company's business, financial condition and results of
operations.
RISKS RELATED TO SALES TO END-USERS. The Company intends to increase the volume
of sales to end-users over the next several periods. Although the Company's
products have been distributed through indirect channels to end-users, the
Company has limited experience in distributing directly to and directly
supporting end-users. Sales to end-users are subject to a variety of risks,
including increased costs to promote and market the products; to install and
integrate products and support the customer base; increased warranty obligations
and a longer sales cycle. Sales to end-users may also involve significant
acceptance, performance and other milestone criteria, which may impact the
timing of the revenue recognition. The installation of a complete system
involves the integration of the Company's product with various third-party
equipment and applications. Difficulties or delays in integration may result in
delays in market acceptance and sales, diversion of development and management
resources, injury to the Company's reputation or increased service and warranty
costs, any of which could have a material adverse affect on the Company's
business, financial condition and results of operations.
Sales to end-users may require the Company to provide additional
third-party components and software applications. The inability to obtain
sufficient supplies of these components and applications could result in delays
or reductions in product shipments which could materially adversely affect the
Company's business, financial condition and results of operations. In order to
meet the needs of network providers, the Company may be required to further
develop or enhance its existing product offerings or acquire additional products
and technologies from third parties. Such new products or enhancements may
require the Company to obtain additional technical certification in telecom
networks. Delays in product development and certification could materially
adversely affect the Company's business, financial condition and results of
operations.
CONCENTRATED PRODUCT FAMILY AND RISK OF NEW PRODUCT INTRODUCTIONS. The Company
currently derives substantially all of its revenues from its family of open,
programmable switching platforms and expects that this concentration will
continue in the foreseeable future. As a result, any decrease in the overall
level of sales of, or the prices for, open, programmable switching platforms due
to product enhancements, introductions or announcements by the Company's
competitors, a decline in the demand for open, programmable switches, product
obsolescence, price competition, technological change or any other reason could
have a material adverse effect on the Company's business, financial condition
and results of operations.
In addition, the Company intends to continue to invest in product and
technology development, including increasing port capacity and performance, the
development of additional related software applications and tools, the
improvement of third-party application integration and the continued provision
of updated product features and enhancements. The Company may experience
difficulties that could delay or prevent the successful development,
introduction or marketing of such new products and enhancements. It is not known
whether the Company's new products and enhancements will adequately meet the
requirements of the marketplace and achieve market acceptance. Announcements of
currently
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planned or other new product offerings by the Company or its competitors may
cause customers to defer or cancel the purchase of existing Company products.
The Company's inability to develop on a timely basis new products or
enhancements to existing products, or the failure of such new products or
enhancements to achieve market acceptance, could have a material adverse
effect on the Company's business, financial condition and results of
operations.
The development of new, technologically advanced products is a complex and
uncertain process requiring the accurate anticipation of technological and
market trends. The introduction of new or enhanced products also requires the
Company to manage the transition from older products in order to minimize
disruption in customer ordering patterns, avoid excessive levels of older
product inventories and ensure that adequate supplies of new products can be
delivered to meet anticipated customer demand. It is not certain that the
Company will successfully develop, introduce or manage the transition to new
products. Furthermore, products such as those offered by the Company may contain
undetected or unresolved errors when they are first introduced or as new
versions are released. Despite extensive testing by the Company, errors may be
found in new products or upgrades after commencement of commercial shipments,
resulting in delays in or loss of market acceptance and sales, diversion of
development resources, injury to the Company's reputation or increased service
and warranty costs, any of which could have a material adverse effect on the
Company's business, financial condition and results of operations.
MANAGEMENT OF GROWTH, HIRING OF ADDITIONAL PERSONNEL AND DEPENDENCE ON KEY
PERSONNEL. The Company has experienced growth in revenues and expansion of its
operations. During the previous eighteen months, the Company has established
operations internationally and has completed four acquisitions of existing
companies and/or assets. During this time, the number of the Company personnel
has significantly increased. All of these activities have placed significant
demands on the Company's management, engineering and administrative staff and
facilities. The Company continues to implement additional financial and
management procedures that 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 the infrastructure of its
international operations, 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. It is not certain whether 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 or construction of buildings in the Cape Cod area is more onerous
than found in metropolitan areas. Accordingly, the Company may be required to
devote significant resources in the future to the permitting and renovation of
additional facilities or in relocating some or all of the Company's facilities.
The Company's success depends to a significant degree upon the continued
contributions of its President, Chief Executive Officer and principal
stockholder, Robert P. Madonna, and its key management, engineering, selling and
marketing and manufacturing personnel, many of whom would be difficult to
replace. The Company does not have employment contracts with its key personnel.
The loss of the services of any key personnel, the inability to attract or
retain qualified personnel in the future or delays in hiring required personnel,
particularly software engineers, could have a material adverse effect on the
Company's business, financial condition and results of operations.
RISKS ASSOCIATED WITH INTERNATIONAL SALES. In the first quarter of 1999, direct
sales to customers located outside of the United States accounted for
approximately 30% of the Company's revenues. However, the Company sells a
significant amount of its products to application developers, OEMs and systems
integrators located within the United States which market products and services
based on the Company's products worldwide. The Company intends to further expand
its operations outside the United States and enter additional international
markets, which will require significant
30
<PAGE>
management attention and financial resources. International sales are subject
to a variety of risks, including difficulties in establishing and managing
international distribution channels, in servicing and supporting products
sold outside the United States and in translating products and related
materials into foreign languages. International operations are also subject
to difficulties in collecting accounts receivable, staffing and managing
personnel and enforcing intellectual property rights. Other factors that can
adversely affect international operations include fluctuations in the value
of foreign currencies and currency exchange rates, changes in import/export
duties and quotas, introduction of tariff or non-tariff barriers and economic
or political changes in international markets. Any inability to obtain
foreign regulatory approvals on a timely basis could have a material adverse
effect on the Company's business, financial condition and results of
operations. If the Company's international sales increase, its revenues may
also be affected to a greater extent by seasonal fluctuations resulting from
lower levels of sales which typically occur during the summer months in
Europe and other parts of the world. It is not certain that these factors
will not have a material adverse effect on the Company's future international
sales and, consequently, on the Company's business, financial condition and
results of operations.
RISKS ASSOCIATED WITH LITIGATION. The Company is currently involved in
litigation with Cisco Systems, Inc. ("Cisco") where the Company has alleged
infringement of certain of its patents and Cisco has filed counterclaims
alleging breach of a certain confidentiality agreement and infringement of one
of its patents. The litigation is in the early stages of discovery. There can be
no assurance that this litigation will ultimately be resolved in favor of the
Company or on terms that are favorable to the Company. The Company could incur
substantial costs, product shipment delays or restrictions, and diversion of
management resources in defending, pursuing and resolving these claims and
counterclaims. Cisco has substantially greater financial resources to underwrite
the cost of litigation and is in a better position to underwrite protracted
litigation. The Company might also be subject to injunctive or other equitable
relief preventing it from selling or delivering its product, or it might be
required to pay substantial damages awards or enter into licensing or royalty
arrangements to resolve these claims and counterclaims. Any of the foregoing
could have a material adverse effect on the Company's business, results of
operations and financial condition.
LENGTH OF SALES CYCLE. The time between the date of initial contact with a
potential customer and large-scale commercialization of a new customer
application or system based on the Company's products is often lengthy,
typically ranging from 12 to 24 months or more, and is subject to delays over
which the Company has little or no control, including customers' budgetary
constraints, customers' internal acceptance reviews, the success and continued
internal support of customers' own development efforts, and the possibility of
cancellation of projects by customers. Although the Company attempts to develop
its products with the goal of shortening the time to market of its customers'
products, the timing of the commercialization of a new customer application or
service based on the Company's products is primarily dependent on the success
and timing of a customer's own internal development program. Delays can also be
caused by late deliveries by other vendors, changes in implementation priorities
and slower than anticipated growth in demand for the services that the Company's
products support. A delay in, or cancellation of, the sale of the Company's
products could have a material adverse effect on the Company's business,
financial condition and results of operations and cause the Company's results of
operations to vary significantly from quarter to quarter.
DEPENDENCE ON PROPRIETARY RIGHTS. The Company's success and its ability to
compete are dependent, in part, upon its proprietary rights. The Company relies
primarily on a combination of patent, copyright, trademark and trade secret
laws, as well as confidentiality procedures and contractual restrictions to
establish and protect its proprietary rights. It is not known whether such
measures will be adequate to protect the Company's proprietary rights. Further,
the Company may be subject to additional risks as it enters into transactions in
countries where intellectual property laws are not well developed or are
difficult to enforce. Legal protections of the Company's proprietary rights may
be ineffective in such countries. Litigation to defend and enforce the Company's
intellectual property rights could result in substantial costs and diversion of
resources and could have a material adverse effect on the Company's business,
financial condition and results of operations, regardless of the final outcome
of such litigation. Despite the Company's efforts to safeguard and maintain its
proprietary rights both in the United States and abroad, it is not known whether
the Company will be successful in doing so or that the steps taken by the
Company in this regard will be adequate to deter misappropriation or independent
third-party development of the Company's technology or to prevent an
unauthorized third party from copying or otherwise obtaining and using the
Company's products or technology. There also can be no guarantees that others
will not independently develop similar technologies or duplicate any technology
developed by the Company. Any such events could have a material adverse effect
on the Company's business, financial condition and results of operations.
The Company has entered into agreements with a small number of its
customers requiring the Company to deposit its source code and, on occasion,
manufacturing blueprints, tooling diagrams and production specifications, in
escrow
31
<PAGE>
with a third party. These escrow agreements typically provide that these
customers have a non-exclusive, limited right to use such code and other
materials in the event that there is a bankruptcy proceeding by or against
the Company, if the Company ceases to conduct business or if the Company
defaults on its support obligations. The use of such agreements may increase
the likelihood of misappropriation by third parties.
As the number of entrants to the Company's markets increases and the
functionality of the Company's products increases and overlaps with the products
of other companies, the Company may become subject to claims of infringement or
misappropriation of the intellectual property rights of others. In its
distribution agreements, the Company agrees to indemnify its customers for any
expenses or liabilities resulting from claimed infringements of patents,
trademarks or copyrights of third parties. In certain limited instances, the
amount of such indemnities may be greater than the revenues the Company may have
received from the customer. There can be no guarantee that third parties will
not assert infringement or misappropriation claims against the Company in the
future with respect to current or future products. Any claims or litigation,
with or without merit, could be time-consuming, result in costly litigation,
cause product shipment delays or require the Company to enter into royalty or
licensing arrangements. Such royalty or licensing arrangements, if required, may
not be available on terms acceptable to the Company, if at all, which could have
a material adverse effect on the Company's business, financial condition and
results of operations. In addition, the Company changed its name from Excel Inc.
to Excel Switching Corporation in September 1997. Searches performed on the term
Excel have revealed several registrations and numerous uses of that term, and
terms substantially similar to it, alone and in combination with other terms and
designs. Accordingly, there can be no guarantee that third parties will not
assert trademark infringement claims relating to the name Excel in the future.
COMPLIANCE WITH REGULATIONS AND EVOLVING INDUSTRY STANDARDS. The market for the
Company's products is characterized by the need to meet a significant number of
communications regulations and standards, some of which are evolving as new
technologies are deployed. In the United States, the Company's products must
comply with various regulations including those promulgated by the Federal
Communications Commission and standards established by Underwriters Laboratories
and Bell Communications Research. Furthermore, there are regulations and
standards imposed by various foreign countries where the Company's products are
installed. The failure of the Company's products to comply, or delays in
compliance, with the various existing and evolving industry regulations and
standards could delay the introduction of the Company's products. Moreover, the
enactment by federal, state or foreign governments of new laws or regulations,
changes in the interpretation of existing laws or regulations or a reversal of
the trend toward deregulation in the telecommunications industry could
materially adversely affect the Company's customers, and thereby materially
adversely affect the Company's business, financial condition and results of
operations.
32
<PAGE>
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(A) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED. The financial statements
required in response to this item are the Consolidated Financial
Statements of RAScom, Inc. and Subsidiary as of December 31, 1998 and
the unaudited Consolidated Financial Statements of RAScom, Inc. and
Subsidiary as of March 31, 1999, attached as Exhibit 99.3 to this
report on Form 8-K/A and herein incorporated by reference.
(B) PRO FORMA FINANCIAL INFORMATION. The financial statements required in
response to this item are the Supplemental Consolidated Financial
Statements of Excel Switching Corporation as of December 27, 1997 and
December 31, 1998 and the unaudited Supplemental Consolidated Financial
Statements of Excel Switching Corporation as of March 31, 1999,
attached as Exhibit 99.4 to this report on Form 8-K/A and herein
incorporated by reference.
(c) EXHIBITS.
NO. DESCRIPTION
--- -----------
2.1 Agreement and Plan of Merger and Reorganization dated as of
April 15, 1999, by and among Excel Switching Corporation,
Racepoint Acquisition Corp., RAScom, Inc., the shareholders
of RAScom, Inc. and Mark B. Galvin as Indemnification
Representative (filed as Exhibit 2.1 to the original Report
on Form 8-K dated May 10, 1999 and filed with the Commission
on May 25, 1999 and hereby incorporated by reference).
2.2 Amendment No. 1 to the Agreement and Plan of Merger and
Reorganization dated as of May 7, 1999, by and among Excel
Switching Corporation, Racepoint Acquisition Corp., RAScom,
Inc., those shareholders of RAScom, Inc. that are signatories
thereto, and Mark B. Galvin as Indemnification Representative
(filed as Exhibit 2.2 to the original Report on Form 8-K
dated May 10, 1999 and filed with the Commission on May 25,
1999 and hereby incorporated by reference).
4.1 Escrow Agreement dated as of May 10, 1999, by and among Excel
Switching Corporation, Racepoint Acquisition Corp., RAScom,
Inc., State Street Bank and Trust Company, the shareholders
of RAScom, Inc. and Mark B. Galvin as Indemnification
Representative (filed as Exhibit 4.1 to the original Report
on Form 8-K dated May 10, 1999 and filed with the Commission
on May 25, 1999 and hereby incorporated by reference).
4.2 Side Letter Agreement dated as of May 10, 1999 by and among
Excel Switching Corporation, Racepoint Acquisition Corp.,
RAScom, Inc., State Street Bank and Trust Company and Mark B.
Galvin as Indemnification Representative (filed as Exhibit 4.2
to the original Report on Form 8-K dated May 10, 1999 and filed
with the Commission on May 25, 1999 and hereby incorporated by
reference).
4.3 Registration Rights Agreement, dated as of May 10, 1999,
between the shareholders of RAScom that are signatories
thereto and Excel Switching Corporation (filed as Exhibit 4.3
to the original Report on Form 8-K dated May 10, 1999 and
filed with the Commission on May 25, 1999 and hereby
incorporated by reference).
23.1 Consent of Arthur Andersen LLP (filed herewith).
27.1 Restated Financial Data Schedule for the fiscal years 1996,
1997 and 1998 and for the three months ended March 28, 1998 and
March 31, 1999 (filed herewith).
99.1 Press Release of Excel Switching Corporation, dated May 11,
1999, announcing the consummation of the Merger (filed as
Exhibit 99.1 to the original Report on Form 8-K dated May 10,
1999 and filed with the Commission on May 25, 1999 and hereby
incorporated by reference).
99.2 Press Release of Excel Switching Corporation dated April 15,
1999 announcing the acquisition of RAScom, Inc. by Excel
Switching Corporation (filed as Exhibit 99.1 to the Report on
Form 8-K, dated April 15, 1999 and filed with the Commission
on April 23, 1999).
99.3 Consolidated Financial Statements of RAScom, Inc. and Subsidiary
as of December 31, 1998 and the unaudited the Consolidated
Financial Statements of RAScom, Inc. and Subsidiary as of
March 31, 1999 (filed herewith).
99.4 Supplemental Consolidated Financial Statements of Excel
Switching Corporation as of December 27, 1997 and December
31, 1998 and the unaudited Supplemental Consolidated
Financial Statements of Excel Switching Corporation as of
March 31, 1999 (filed herewith).
33
<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
Dated: July 23, 1999 By: /s/ Christopher Stavros
-----------------------------
Christopher Stavros
Vice President and General Counsel
34
<PAGE>
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
---- -----------
2.1 Agreement and Plan of Merger and Reorganization dated as of April
15, 1999, by and among Excel Switching Corporation, Racepoint
Acquisition Corp., RAScom, Inc., the shareholders of RAScom, Inc.
and Mark B. Galvin as Indemnification Representative (filed as
Exhibit 2.1 to the original Report on Form 8-K dated May 10, 1999
and filed with the Commission on May 25, 1999 and hereby
incorporated by reference).
2.2 Amendment No. 1 to the Agreement and Plan of Merger and
Reorganization dated as of May 7, 1999, by and among Excel
Switching Corporation, Racepoint Acquisition Corp., RAScom, Inc.,
those shareholders of RAScom, Inc. that are signatories thereto,
and Mark B. Galvin as Indemnification Representative (filed as
Exhibit 2.2 to the original Report on Form 8-K dated May 10, 1999
and filed with the Commission on May 25, 1999 and hereby
incorporated by reference).
4.1 Escrow Agreement dated as of May 10, 1999, by and among Excel
Switching Corporation, Racepoint Acquisition Corp., RAScom, Inc.,
State Street Bank and Trust Company, the shareholders of RAScom,
Inc. and Mark B. Galvin as Indemnification Representative (filed
as Exhibit 4.1 to the original Report on Form 8-K dated May 10,
1999 and filed with the Commission on May 25, 1999 and hereby
incorporated by reference).
4.2 Side Letter Agreement dated as of May 10, 1999 by and among Excel
Switching Corporation, Racepoint Acquisition Corp., RAScom, Inc.,
State Street Bank and Trust Company and Mark B. Galvin as
Indemnification Representative (filed as Exhibit 4.2 to the
original Report on Form 8-K dated May 10, 1999 and filed with the
Commission on May 25, 1999 and hereby incorporated by reference).
4.3 Registration Rights Agreement, dated as of May 10, 1999, between
the shareholders of RAScom that are signatories thereto and Excel
Switching Corporation (filed as Exhibit 4.3 to the original
Report on Form 8-K dated May 10, 1999 and filed with the
Commission on May 25, 1999 and hereby incorporated by reference).
23.1 Consent of Arthur Andersen LLP (filed herewith).
27.1 Restated Financial Data Schedule for the fiscal years 1996,
1997 and 1998 and for the three months ended March 28, 1998 and
March 31, 1999 (filed herewith).
99.1 Press Release of Excel Switching Corporation, dated May 11, 1999,
announcing the consummation of the Merger (filed as Exhibit 99.1
to the original Report on Form 8-K dated May 10, 1999 and filed
with the Commission on May 25, 1999 and hereby incorporated by
reference).
99.2 Press Release of Excel Switching Corporation dated April 15, 1999
announcing the acquisition of RAScom, Inc. by Excel Switching
Corporation (filed as Exhibit 99.1 to the Report on Form 8-K,
dated April 15, 1999 and filed with the Commission on April 23,
1999).
99.3 Consolidated Financial Statements of RAScom, Inc. and
Subsidiary as of December 31, 1998 and the unaudited the
Consolidated Financial Statements of RAScom, Inc. and
Subsidiary as of March 31, 1999 (filed herewith).
99.4 Supplemental Consolidated Financial Statements of Excel Switching
Corporation as of December 27, 1997 and December 31, 1998 and the
unaudited Supplemental Consolidated Financial Statements of Excel
Switching Corporation as of March 31, 1999 (filed herewith).
35
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation of our reports dated May 24, 1999, included in this Form 8-K/A,
into the Company's previously filed Registration Statements File No.'s
333-83587, 333-79197, 333-51711 and 333-35791.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Boston, Massachusetts
July 23, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS FILED WITH THIS
FORM 8 K/A AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-28-1996 DEC-27-1997 DEC-31-1998 DEC-31-1998 DEC-31-1999
<PERIOD-START> JAN-01-1995 DEC-29-1996 DEC-28-1997 DEC-28-1997 JAN-01-1999
<PERIOD-END> DEC-28-1996 DEC-27-1997 DEC-31-1998 MAR-28-1998 MAR-31-1999
<CASH> 0 55499 64877 0 59447
<SECURITIES> 0 66929 55579 0 66965
<RECEIVABLES> 0 14454 31425 0 36608
<ALLOWANCES> 0 (1420) (2228) 0 (2728)
<INVENTORY> 0 5285 6800 0 10565
<CURRENT-ASSETS> 0 149832 169540 0 186664
<PP&E> 0 15446 28040 0 31214
<DEPRECIATION> 0 (4383) (8287) 0 (9217)
<TOTAL-ASSETS> 0 163821 207403 0 230722
<CURRENT-LIABILITIES> 0 25657 35564 0 49831
<BONDS> 0 0 0 0 0
0 0 0 0 0
0 18797 20315 0 20719
<COMMON> 0 328 342 0 347
<OTHER-SE> 0 118732 146324 0 155867
<TOTAL-LIABILITY-AND-EQUITY> 0 163821 146666 0 230722
<SALES> 62265 91623 129339 27105 37340
<TOTAL-REVENUES> 62265 91623 129339 27105 37340
<CGS> 24552 29043 41754 9122 25123
<TOTAL-COSTS> 24552 29043 41754 9122 25123
<OTHER-EXPENSES> 27252 39997 67449 13489 17726
<LOSS-PROVISION> 0 0 0 0 0
<INTEREST-EXPENSE> (294) 1576 6252 1717 1208
<INCOME-PRETAX> 10167 24159 26388 6211 8605
<INCOME-TAX> 4077 9425 11214 2341 3135
<INCOME-CONTINUING> 6090 14734 15174 3870 5470
<DISCONTINUED> 0 0 0 0 0
<EXTRAORDINARY> 0 0 0 0 0
<CHANGES> 0 0 0 0 0
<NET-INCOME> 6090 14734 15174 3870 5470
<EPS-BASIC> .21 .48 .41 .11 .15
<EPS-DILUTED> .18 .42 .38 .10 .13
</TABLE>
<PAGE>
Exhibit 99.3
RASCOM, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1998
TOGETHER WITH AUDITORS' REPORT
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To RAScom, Inc. and Subsidiary:
We have audited the accompanying consolidated balance sheet of RAScom, Inc. and
subsidiary (a Delaware corporation) as of December 31, 1998, and the related
consolidated statements of operations, redeemable preferred stock, stockholders'
deficit and comprehensive loss and cash flows for the year then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit 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 audit provides 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 RAScom, Inc. and subsidiary as
of December 31, 1998, and the results of their operations and their cash flows
for the year then ended, in conformity with generally accepted accounting
principles.
Boston, Massachusetts
May 24, 1999
F-1
<PAGE>
RASCOM, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31, MARCH 31,
1998 1999
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,360 $ 709
Accounts receivable, net of reserves of approximately $228 at December 31, 1998
and March 31, 1999 1,068 652
Inventories 1,396 1,089
Prepaid and other current assets 412 218
-------- --------
Total current assets 5,236 2,668
PROPERTY AND EQUIPMENT, NET 1,315 1,323
-------- --------
$ 6,551 $ 3,991
======== ========
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable $ 1,595 $ 806
Accrued expenses 2,141 3,553
-------- --------
Total current liabilities 3,736 4,359
LONG-TERM DEBT (Note 4) 5,000 5,000
COMMITMENTS (Note 9)
REDEEMABLE CONVERTIBLE PREFERRED STOCK, AT REDEMPTION VALUE:
Authorized, issued and outstanding--10,696,402 shares (Series A 2,892,744,
Series B 2,847,543, Series C 4,956,115) at December 31, 1998 and March 31, 1999 20,315 20,720
STOCKHOLDERS' DEFICIT:
Common stock, $.001 par value-
Authorized--20,000,000 shares
Issued and outstanding--4,455,402 shares at December 31, 1998 and 4,490,132
shares at March 31, 1999 4 4
Additional paid-in capital 299 305
Deferred compensation (221) (221)
Accumulated other comprehensive income 36 (63)
Accumulated deficit (22,618) (26,113)
-------- --------
Total stockholders' deficit (22,500) (26,088)
-------- --------
$ 6,551 $ 3,991
-------- --------
-------- --------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-2
<PAGE>
RASCOM, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
(UNAUDITED)
<S> <C> <C>
REVENUES $ 6,514 $ 725
COST OF REVENUES 6,294 1,432
-------- --------
Gross profit (loss) 220 (707)
-------- --------
OPERATING EXPENSES:
Selling and marketing 4,966 946
Research and development 3,974 939
General and administrative 1,686 357
-------- --------
Total operating expenses 10,626 2,242
-------- --------
Loss from operations (10,406) (2,949)
OTHER INCOME (EXPENSE):
Interest income and other expense, net 254 (7)
Interest expense (129) (134)
-------- --------
Total other income 125 (141)
-------- --------
NET LOSS $(10,281) $ (3,090)
-------- --------
-------- --------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-3
<PAGE>
RASCOM, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF REDEEMABLE PREFERRED STOCK,
STOCKHOLDERS' DEFICIT AND COMPREHENSIVE LOSS
(In thousands, except share data)
<TABLE>
<CAPTION>
REDEEMABLE CONVERTIBLE
PREFERRED STOCK COMMON STOCK
NUMBER OF REDEMPTION NUMBER OF PAR
SHARES AMOUNT SHARES VALUE
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997 10,696,402 $ 18,798 4,172,978 $ 4
Issuance of common stock upon exercise of stock
options -- -- 282,424 --
Accretion of cumulative preferred stock dividends -- 1,517 -- --
Foreign currency translation adjustment -- -- -- --
Compensation related to the grant of stock options -- -- -- --
Net loss -- -- -- --
---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1998 10,696,402 20,315 4,455,402 4
Issuance of common stock upon exercise of stock
options -- -- 34,730 --
Accretion of cumulative preferred stock dividends -- 405 -- --
Foreign currency translation adjustment -- -- -- --
Net loss -- -- -- --
---------- ---------- ---------- ----------
BALANCE, MARCH 31, 1999 (UNAUDITED) 10,696,402 $ 20,720 4,490,132 $ 4
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-4
<PAGE>
RASCOM, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF REDEEMABLE PREFERRED STOCK,
STOCKHOLDERS' DEFICIT AND COMPREHENSIVE LOSS
(In thousands, except share data)
(Continued)
<TABLE>
<CAPTION>
ACCUMULATED TOTAL
ADDITIONAL OTHER STOCKHOLDERS'
PAID-IN DEFERRED COMPREHENSIVE ACCUMULATED EQUITY COMPREHENSIVE
CAPITAL COMPENSATION INCOME DEFICIT (DEFICIT) INCOME
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997 $ 18 $ -- $ (18) $(10,820) $(10,816) $ --
Issuance of common stock upon
exercise of stock options 39 -- -- -- 39 --
Accretion of cumulative preferred
stock dividends -- -- -- (1,517) (1,517) --
Foreign currency translation
adjustment -- -- 54 -- 54 54
Compensation related to the grant
of stock options 242 (221) -- -- 21 --
Net loss -- -- -- (10,281) (10,281) (10,281)
-------- -------- -------- -------- -------- --------
Comprehensive income--1998 $(10,227)
--------
--------
BALANCE, DECEMBER 31, 1998 299 (221) 36 (22,618) (22,500) --
Issuance of common stock upon
exercise of stock options 6 -- -- -- 6 --
Accretion of cumulative preferred
stock dividends -- -- -- (405) (405) --
Foreign currency translation
adjustment -- -- (99) -- (99) (99)
Net loss -- -- -- (3,090) (3,090) (3,090)
-------- -------- -------- -------- -------- --------
Comprehensive income--Mar. 31, 1999 $ (3,189)
--------
--------
BALANCE, MARCH 31, 1999 (UNAUDITED) $ 305 $ (221) $ (63) $(26,113) $(26,088)
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-5
<PAGE>
RASCOM, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(10,281) $(3,090)
Adjustments to reconcile net income to net cash used in operating activities-
Depreciation and amortization 686 38
Compensation expense associated with stock options 21 --
Changes in assets and liabilities, net of acquisitions-
Accounts receivable 543 416
Inventories (851) 307
Prepaid taxes and other current assets (308) 195
Accounts payable 892 (790)
Accrued expenses 538 1,412
-------- -------
Net cash used in operating activities (8,760) (1,512)
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (1,106) (46)
-------- -------
Net cash used in investing activities (1,106) (46)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt (398) --
Proceeds from issuance of long-term debt 5,000 --
Proceeds from the exercise of stock options 39 6
-------- -------
Net cash provided by financing activities 4,641 6
-------- -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 54 (99)
-------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS (5,171) (1,651)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 7,531 2,360
-------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,360 $ 709
-------- -------
-------- -------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for-
Interest $ 29 $ 134
-------- -------
-------- -------
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITY:
Accretion of preferred stock $ 1,517 $ 405
-------- -------
-------- -------
Deferred compensation associated with stock option grants $ 242 $ --
-------- -------
-------- -------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-6
<PAGE>
RASCOM, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
RAScom, Inc. (the Company) is a leading provider of NT-based remote
access systems for telecommunications networks worldwide. The Company
develops, manufactures, markets and supports a family of servers that
address the complex enhanced services and wireless and wireline
infrastructure needs of network providers. The Company sells to a variety
of customers in the worldwide telecommunications market, including
applications developers, original equipment manufacturers (OEMs), system
integrators and network service providers.
On May 10, 1999, the Company exchanged all of the outstanding shares and
options for 1,099,940 shares of common stock of Excel Switching
Corporation (Excel), a company that develops, manufactures, markets and
supports a family of open, programmable, carrier-class switches. 102,122
of these shares were placed into escrow as security for indemnification
obligations of the Company relating to representations, warranties and
tax matters. The merger will be accounted for as a pooling of interests.
The accompanying consolidated financial statements reflect the
application of certain accounting policies as described below and
elsewhere in the notes to consolidated financial statements.
(a) PRINCIPLES OF CONSOLIDATION
These consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary. All significant
intercompany transactions have been eliminated.
(b) INTERIM FINANCIAL STATEMENTS
The accompanying supplemental consolidated financial statements as
of March 31, 1999 and for the three months ended March 31, 1999
are unaudited, but in the opinion of management, include all
adjustments, consisting only of normal recurring adjustments
necessary for a fair presentation of results for the interim
periods. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with
generally accepted accounting principles have been omitted with
respect to these unaudited financial statements, although the
Company believes that the disclosures included are adequate to
make the information presented not misleading. Results for the
three months ended March 31, 1999 are not necessarily indicative
of the results that may be expected for the year ending December
31, 1999.
F-7
<PAGE>
(c) MANAGEMENT'S ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes.
The market for telecommunications equipment in which the Company
operates can be characterized as rapidly changing due to several
factors including technological advancements, the introduction of
new products and services by the Company and its competitors, and
the increasing demands placed on equipment in worldwide
telecommunications networks. Significant assets and liabilities
with reported amounts based on estimates include accounts
receivable, inventory and accrued expenses for post-sale support
costs, warranty costs and sales returns and allowances. While the
Company believes its estimates are adequate, actual results could
differ from those estimates.
(d) REVENUE RECOGNITION
Revenue is generally recognized when all significant contractual
obligations have been satisfied and collection of the resulting
receivable is reasonably assured. Revenue from product sales of
hardware and software is recognized at time of delivery and
acceptance, and after consideration of all the terms and
conditions of the customer contract. Revenue from providing
services and post-sale support are recognized at time of
performance. The Company provides for anticipated product returns
and warranty costs at the time of revenue recognition.
(e) SOURCES OF SUPPLY AND THIRD-PARTY MANUFACTURING RELATIONSHIPS
Certain components used in the manufacture of the Company's
products are currently available only from single- or sole-source
suppliers. In addition, the Company relies on a limited number of
third parties to manufacture certain other components and
subassemblies. Shortages resulting from a change in arrangements
with these suppliers and manufacturers could cause delays in
manufacturing and product shipments and possible deferral or
cancellation of customer orders.
(f) RESEARCH AND DEVELOPMENT AND SOFTWARE DEVELOPMENT COSTS
Research and development costs have been charged to operations as
incurred. The Company believes its current process for developing
software is essentially completed concurrently with the
establishment of technological feasibility. Accordingly, no
software development costs have been capitalized to date.
F-8
<PAGE>
(g) CONCENTRATIONS OF CREDIT RISK
Financial instruments that subject the Company to significant
concentrations of credit risk consist primarily of cash, cash
equivalents, and trade accounts receivable. The Company's
investments are in financial instruments of high quality.
Concentration of credit risk with respect to accounts receivable
is limited to customers to whom the Company makes significant
sales. One significant customer accounted for approximately 66% of
accounts receivable at December 31, 1998. To control credit risk,
the Company performs regular credit evaluations of its customers'
financial condition and maintains allowances for potential credit
losses.
(h) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's cash and cash equivalents,
accounts receivable and accounts payable approximate fair value
due to the short-term nature of these instruments.
(i) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original
maturities of less than 90 days to be cash equivalents. Cash
equivalents consist of money market accounts at December 31, 1998
and are reported at cost, which approximates market value.
(j) COMPREHENSIVE INCOME
Comprehensive income represents the change in equity of a business
enterprise resulting from transactions and other events and
circumstances from nonowner sources. For 1998, the only difference
between comprehensive income and net income relates to the foreign
currency translation adjustment.
(2) INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or
market. Work-in-process and finished goods consist of materials, labor
and manufacturing overhead. Inventories consist of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
<S> <C> <C>
Raw materials $ 807 $ 822
Work-in-process 261 238
Finished goods 328 29
--------- ---------
$ 1,396 $ 1,089
--------- ---------
--------- ---------
</TABLE>
(3) PROPERTY AND EQUIPMENT
The Company provides for depreciation and amortization using the
straight-line method by charges to operations in amounts that allocate
the cost of the assets over their estimated useful lives.
F-9
<PAGE>
Property and equipment consists of the following at December 31, 1998 (in
thousands):
<TABLE>
<CAPTION>
ESTIMATED
1998 USEFUL LIVES
<S> <C> <C>
Computer and test equipment $ 1,236 2-5 years
Office equipment, furniture and fixtures 981 2-7 years
Leasehold improvements 152 7-40 years
-----------
2,369
Less--Accumulated depreciation and amortization 1,054
-----------
$ 1,315
-----------
-----------
</TABLE>
(4) LONG-TERM DEBT
In October 1998, the Company entered into a promissory note with a
customer that provided for an advance of $5 million to the Company. The
note bears interest at the prime rate plus 3% per annum (10.75% at
December 31, 1998). Interest is payable quarterly in arrears. Principal
due under the note is payable in twelve equal quarterly payments
beginning in October 2000. Upon the occurrence of certain events, as
defined, the maturity of principal amounts outstanding under the note may
be accelerated or decelerated.
Future maturities of the remaining long-term obligations are as follows:
<TABLE>
<S> <C>
1999 $ --
2000 417
2001 1,667
2002 1,667
2003 1,249
----------
$ 5,000
----------
----------
</TABLE>
(5) INCOME TAXES
Deferred tax assets or liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities,
as measured by the enacted tax rates expected to be in effect when the
differences reverse. A valuation allowance is recorded if it is more
likely than not that all or a portion of any deferred tax assets will not
be realized.
F-10
<PAGE>
The approximate income tax effect of each type of temporary difference
composing the net deferred tax assets at December 31, 1998 is as follows
(in thousands):
<TABLE>
<S> <C>
Net operating loss carryforwards $ 6,526
Nondeductible accruals 245
Nondeductible reserves 828
Credit carryforwards 126
Valuation allowance (7,725)
----------
Net deferred tax asset $ --
----------
----------
</TABLE>
At December 31, 1998, the Company had net operating loss carryforwards
for federal and state income tax purposes of approximately $17,034. The
net operating loss carryforwards expire through 2018 and are subject to
review and possible adjustment by the Internal Revenue Service (IRS). The
Tax Reform Act of 1986 contains provisions that may limit the net
operating loss carryforwards available to be used in any given year in
the event of significant changes in ownership interest, as defined.
(6) STOCKHOLDERS' EQUITY
(a) COMMON STOCK
The Company has 20,000,000 shares of common stock, par value of
$.001 per share authorized. At December 31, 1998, there were
2,194,597 shares of common stock reserved for future issuance
under the Company's stock plans.
(b) REDEEMABLE CONVERTIBLE PREFERRED STOCK
At December 31, 1998, the Company has authorized, issued and
outstanding 10,696,402 shares of redeemable convertible preferred
stock, of which 2,892,744 shares have been designated Series A
redeemable convertible preferred stock (Series A), 2,847,543
shares have been designated Series B redeemable convertible
preferred stock (Series B) and 4,956,115 shares have been
designated Series C redeemable convertible preferred stock (Series
C) (collectively, the preferred stock). The preferred stock
possesses the following rights and privileges:
VOTING
Preferred stockholders are entitled to a number of votes equal
to the number of shares of common stock into which the
preferred stock are then convertible.
CONVERSION AND REDEMPTION
The preferred stock is convertible into common stock at the
option of the stockholder. Each preferred share is convertible
into common stock on a one-for-one basis, subject to certain
adjustments. The preferred stock will automatically convert
into common stock in the event of a public offering of the
Company's common stock resulting in proceeds of at least
$15,000,000 and a price of at least three times the weighted
average purchase price per share of all preferred stock.
F-11
<PAGE>
On or after February 15, 2002, the preferred stockholders have
the right to require the Company to redeem the Series A,
Series B and Series C preferred stock at a price equal to the
higher of (i) the existing fair market value, as defined or
(ii) the original purchase price plus a cumulative dividend
accruing at 8% per annum per share.
DIVIDENDS
Preferred stockholders are entitled to a cumulative dividend
of 8% per annum per share if and when declared by the Board of
Directors. For any other dividends or distributions, preferred
stockholders are entitled to dividends on an as-converted
basis. No dividends have been declared to date.
LIQUIDATION
In the event of voluntary or involuntary liquidation of the
Company, the preferred stockholders have preference in
distribution and the Series A, Series B and Series C
stockholders shall be entitled to receive the greater of (i)
the original purchase price paid for their stock plus any
unpaid cumulative dividends plus any other declared but unpaid
dividends thereon or (ii) the amount they would have received
if all Series A, Series B and Series C preferred stock were
converted to common stock.
(7) STOCK OPTION PLANS
In 1996, the Board of Directors adopted and the stockholders subsequently
approved the Company's 1996 stock option plan (the 1996 Plan), which
provides for the issuance of incentive stock options and nonqualified
stock options to eligible employees, directors and consultants to the
Company. The options can be granted for periods up to ten years and
generally vest ratably over a four-year period with initial vesting
occurring on the first anniversary from the grant date and then monthly
thereafter. At December 31, 1998, 2,650,000 shares were authorized for
issuance under the 1996 Plan.
The option price for stock options granted under the 1996 Plan is
determined by a Compensation Committee consisting of two or more members
of the Company's Board of Directors. The option price for incentive stock
options shall be the fair value at the time the option is granted. In
some instances, options have been granted at exercise prices below the
fair market value on the date of grant. The difference, if any, between
the fair market value of shares of the Company's common stock and the
exercise price of the option is recognized as compensation expense over
the vesting term. During 1998, the Company granted options with exercise
prices less than fair market value. The total difference between fair
market value and the strike prices was approximately $242,000. This
difference will be recognized as compensation expense over the related
option vesting period. During 1998, the Company recognized net
compensation expense of approximately $21,000 related to these options.
F-12
<PAGE>
Stock option activity under the option plan for the year ended December
31, 1998 is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
<S> <C> <C>
Outstanding, December 27, 1997 1,677,812 $ .15
Granted 897,250 .24
Exercised (282,424) .14
Forfeited (265,228) .18
---------
Outstanding, December 31, 1998 2,027,410 $ .19
--------- --------
--------- --------
</TABLE>
The following table summarizes information about stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
NUMBER CONTRACTUAL NUMBER EXERCISE
EXERCISE PRICE OUTSTANDING LIFE EXERCISABLE PRICE
<S> <C> <C> <C> <C>
$ .10 428,958 7.53 213,058 $ .10
.18 556,555 8.20 201,576 .18
.20 632,647 9.07 80,662 .20
.22 75,000 9.24 -- .22
.30 334,250 9.64 -- --
--------- -------
2,027,410 495,296 $ .15
--------- ------- --------
--------- ------- --------
</TABLE>
Statement of Financial Accounting Standards (SFAS) No. 123, ACCOUNTING
FOR STOCK-BASED COMPENSATION, requires the measurement of the fair value
of stock options to be included in the statement of income or disclosed
in the notes to financial statements. The Company has determined that it
will continue to account for stock-based compensation for employees under
Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES, and elect the disclosure-only alternative under SFAS No.
123.
Had compensation cost for the Company's option plans been determined
based on the fair value at the grant dates, as prescribed in SFAS No.
123, the Company's net income for the year ended December 31, 1998 would
have been as follows (in thousands):
<TABLE>
<S> <C>
Net loss-
As reported $ (10,281)
Pro forma (10,312)
</TABLE>
F-13
<PAGE>
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following
assumptions used for grants during the year ended December 31, 1998:
<TABLE>
<S> <C>
Dividend yield 0%
Volatility 0%
Risk-free interest rate 5.5%
Expected option term 7 years
Weighted average fair value per
share of options granted $ 0.30
</TABLE>
(8) SEGMENT AND ENTERPRISE-WIDE REPORTING
The Company currently operates in one operating segment as a provider of
NT-based remote access systems. This segment derives its revenues from
the sale and support of a family of products that address the complex
enhanced services and wireless and wireline infrastructure needs of
network providers.
The Company derives substantially all of its revenue from the sale and
support of one group of similar products. Substantially all of the
Company's assets are located within the United States. During 1998, the
Company derived its revenues from the following geographic regions (in
thousands):
<TABLE>
<CAPTION>
1998
<S> <C>
United States $ 5,810
Other 704
--------
$ 6,514
--------
--------
</TABLE>
During 1998, the Company derived a portion of its revenues from sales to
a single customer that exceeded 10 percent of total revenues, as follows:
<TABLE>
1998
<S> <C>
Significant customer A 52%
</TABLE>
F-14
<PAGE>
(9) COMMITMENTS
(a) LEASE OBLIGATION
The Company leases certain equipment and office facilities
under noncancelable operating leases, which expire at various
dates through November 2001. Future minimum lease payments
required under these leases at December 31, 1998 are
approximately as follows (in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR AMOUNT
<S> <C>
1999 $ 406
2000 389
2001 320
2002 321
---------
$ 1,436
---------
---------
</TABLE>
Total rent expense under these agreements for 1998 and for the
three months ended March 31, 1999 was approximately $294,000.
(b) PURCHASE COMMITMENTS
In the normal course of business, the Company routinely enters
into purchase commitments for the purchase of inventory.
During the quarter ended March 31, 1999, the Company
identified a purchase commitment in excess of the anticipated
inventory usage and recorded a charge of approximately $650
against cost of sales.
(10) EMPLOYEE BENEFIT PLAN
The Company has a qualified 401(k) retirement savings plan covering all
employees. Under this plan, participants may elect to defer a portion of
their compensation, subject to certain limitations. In addition, the
Company, at the discretion of the Board of Directors, may make profit
sharing contributions into the plan. For 1998, the Company did not make
contributions to the plan.
(11) ACCRUED EXPENSES
Accrued expenses at December 31, 1998 consists of the following (in
thousands):
<TABLE>
<CAPTION>
1998
<S> <C>
Sales returns and allowances $ 113
Payroll and benefits 590
Post-sales support and warranty 455
Marketing 40
Professional fees 83
Other 860
--------
$ 2,141
--------
--------
</TABLE>
F-15
<PAGE>
Exhibit 99.4
EXCEL SWITCHING CORPORATION
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 27, 1997 AND DECEMBER 31, 1998
TOGETHER WITH AUDITORS' REPORT
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
To Excel Switching Corporation:
We have audited the accompanying supplemental consolidated balance sheets of
Excel Switching Corporation (a Massachusetts corporation) and subsidiaries as of
December 27, 1997 and December 31, 1998, and the related supplemental
consolidated statements of income, stockholders' equity and comprehensive income
and cash flows for each of the three years in the period then ended. The
supplemental consolidated financial statements give retroactive effect to the
merger with RAScom, Inc. and subsidiary (RAScom) on May 10, 1999, which has been
accounted for as a pooling of interests, as described in Note 1. These
supplemental financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these supplemental
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the supplemental financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the supplemental 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 supplemental consolidated financial statements referred to
above present fairly, in all material respects, the financial position of Excel
Switching Corporation and subsidiaries as of December 27, 1997 and December 31,
1998, and the results of their operations and their cash flows for each of the
three years in the period then ended, after giving retroactive effect to the
merger with RAScom, as described in Note 1, all in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
May 24, 1999
F-1
<PAGE>
EXCEL SWITCHING CORPORATION
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 27, DECEMBER 31, MARCH 31,
1997 1998 1999
(UNAUDITED)
<S> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 55,499 $ 64,877 $ 59,447
Marketable securities 66,929 55,579 66,965
Accounts receivable, net of reserves of $1,420, $2,228 and
$2,728 in 1997, 1998 and 1999, respectively 14,454 31,425 36,608
Inventories 5,285 6,800 10,565
Prepaid taxes 122 -- --
Deferred tax asset 6,141 8,534 8,503
Other current assets 1,402 2,325 4,576
--------- --------- ---------
Total current assets 149,832 169,540 186,664
PROPERTY AND EQUIPMENT, NET 11,063 19,753 21,997
DEFERRED TAX ASSET 2,926 7,642 11,221
INTANGIBLE ASSETS, NET OF ACCUMULATED AMORTIZATION -- 9,702 9,360
OTHER ASSETS -- 766 1,480
--------- --------- ---------
$ 163,821 $ 207,403 $ 230,722
--------- --------- ---------
--------- --------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 4,412 $ 3,408 $ 4,262
Accounts payable 4,881 4,922 9,969
Accrued expenses 12,758 20,135 17,401
Accrued income taxes 3,606 6,052 8,223
Deferred revenue -- 1,047 1,481
Recourse obligation related to lease financing program -- -- 8,495
--------- --------- ---------
Total current liabilities 25,657 35,564 49,831
DEFERRED INCOME TAXES -- -- --
LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 307 4,858 3,958
COMMITMENTS (Note 13)
REDEEMABLE CONVERTIBLE PREFERRED STOCK, AT REDEMPTION VALUE-
Authorized--10,696,402 shares
Issued and outstanding--10,696,402 shares at December 27,
1997, December 31, 1998 and March 31, 1999 18,797 20,315 20,719
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
Authorized--10,000,000 shares; no shares issued and
outstanding -- -- --
Common stock, $.01 par value-
Authorized--100,000,000 shares
Issued and outstanding--32,777,698, 34,218,309 and
34,665,766 shares at December 27, 1997, December 31, 1998
and March 31, 1999, respectively 328 342 347
Additional paid-in capital 88,154 102,165 106,750
Deferred compensation (491) (747) (700)
Accumulated other comprehensive income (38) 143 (12)
Retained earnings 31,107 44,763 49,829
--------- --------- ---------
Total stockholders' equity 119,060 146,666 156,214
--------- --------- ---------
$ 163,821 $ 207,403 $ 230,722
--------- --------- ---------
--------- --------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE SUPPLEMENTAL
CONSOLIDATED FINANCIAL STATEMENTS.
F-2
<PAGE>
EXCEL SWITCHING CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
<TABLE>
<CAPTION>
FISCAL YEARS ENDED THREE MONTHS ENDED
DECEMBER 28, DECEMBER 27, DECEMBER 31, MARCH 28, MARCH 31,
1996 1997 1998 1998 1999
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES $ 62,265 $ 91,623 $ 129,339 $ 27,105 $ 37,340
COST OF REVENUES 24,552 29,043 41,754 9,122 12,217
--------- --------- --------- --------- ---------
Gross profit 37,713 62,580 87,585 17,983 25,123
--------- --------- --------- --------- ---------
OPERATING EXPENSES:
Engineering, research and
development 12,346 16,061 26,363 5,540 8,522
Selling and marketing 7,939 14,797 20,872 5,041 5,696
General and administrative 6,967 9,139 12,755 2,908 3,508
Acquired in-process research
and development -- -- 7,459 -- --
--------- --------- --------- --------- ---------
Total operating expenses 27,252 39,997 67,449 13,489 17,726
--------- --------- --------- --------- ---------
Income from operations 10,461 22,583 20,136 4,494 7,397
OTHER INCOME (EXPENSE):
Interest income and other
expense, net 223 2,040 6,576 1,728 1,342
Interest expense (517) (464) (324) (11) (134)
--------- --------- --------- --------- ---------
Total other income
(expense) (294) 1,576 6,252 1,717 1,208
--------- --------- --------- --------- ---------
Income before provision
for income taxes 10,167 24,159 26,388 6,211 8,605
PROVISION FOR INCOME TAXES 4,077 9,425 11,214 2,341 3,135
--------- --------- --------- --------- ---------
NET INCOME $ 6,090 $ 14,734 $ 15,174 $ 3,870 $ 5,470
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
PREFERRED STOCK DIVIDENDS $ 263 $ 903 $ 1,518 $ 379 $ 404
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
NET INCOME AVAILABLE TO COMMON
STOCKHOLDERS $ 5,827 $ 13,831 $ 13,656 $ 3,491 $ 5,066
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
BASIC EARNINGS PER SHARE $ .21 $ .48 $ .41 $ .11 $ .15
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
DILUTED EARNINGS PER SHARE $ .18 $ .42 $ .38 $ .10 $ .13
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
BASIC WEIGHTED AVERAGE SHARES
OUTSTANDING 28,253 28,939 33,406 32,832 34,476
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
DILUTED WEIGHTED AVERAGE SHARES
OUTSTANDING 33,025 35,101 40,313 39,983 41,118
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE SUPPLEMENTAL
CONSOLIDATED FINANCIAL STATEMENTS.
F-3
<PAGE>
EXCEL SWITCHING CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK,
STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(in thousands, except share data)
<TABLE>
<CAPTION>
REDEEMABLE CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL
NUMBER OF REDEMPTION NUMBER OF $.01 PAR PAID-IN
SHARES AMOUNT SHARES VALUE CAPITAL
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 -- $ -- 28,089,600 $281 $ 667
Issuance of common stock -- -- 178,000 2 2
Issuance of preferred stock, net of issuance
costs of approximately $99 5,740,287 7,676 -- -- --
Compensation expense associated with stock
options -- -- -- -- --
Forfeiture of stock options with deferred
compensation -- -- -- -- (20)
Accretion of preferred stock dividends -- 263 -- -- --
Net income -- -- -- -- --
---------- ------ ---------- ---- --------
Comprehensive income--1996
BALANCE, DECEMBER 28, 1996 5,740,287 7,939 28,267,600 283 649
Compensation expense associated with stock
options -- -- -- -- 424
Exercise of stock options -- -- 10,098 -- 20
Proceeds of initial public offering of common
stock, net of approximately $7,394 in issuance
costs -- -- 4,500,000 45 87,061
Issuance of preferred stock, net of issuance
costs of approximately $44 4,956,115 9,955 -- -- --
Accretion of preferred stock dividends -- 903 -- -- --
Unrealized loss on investments, net of $33 of
taxes -- -- -- -- --
Foreign currency translation adjustment -- -- -- -- --
Net income -- -- -- -- --
---------- ------ ---------- ---- --------
Comprehensive income--1997
BALANCE, DECEMBER 27, 1997 10,696,402 18,797 32,777,698 328 88,154
Compensation expense associated with stock
options -- -- -- -- 466
Exercise of stock options -- -- 1,420,373 14 1,558
Issuance of common stock under employee stock
purchase plan -- -- 20,238 -- 361
Tax benefit from exercise of stock options -- -- -- -- 11,626
Accretion of preferred stock dividends -- 1,518 -- -- --
Foreign currency translation adjustment -- -- -- -- --
Unrealized gain on investments, net of $51 of
taxes -- -- -- -- --
Net income -- -- -- -- --
---------- ------ ---------- ---- --------
Comprehensive income--1998
BALANCE, DECEMBER 31, 1998 10,696,402 20,315 34,218,309 342 102,165
Compensation expense associated with stock
options -- -- -- -- 51
Exercise of stock options -- -- 437,400 5 480
Issuance of common stock under employee stock
purchase plan -- -- 10,057 -- 214
Tax benefit from exercise of stock options -- -- -- -- 3,840
Accretion of preferred stock dividends -- 404 -- -- --
Foreign currency translation adjustment -- -- -- -- --
Unrealized gain on investments, net of $93 of
taxes -- -- -- -- --
Net income -- -- -- -- --
---------- ------ ---------- ---- --------
Comprehensive income--March 31, 1999
BALANCE, MARCH 31, 1999 (UNAUDITED) 10,696,402 $20,719 34,665,766 $347 $106,750
---------- ------ ---------- ---- --------
---------- ------ ---------- ---- --------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE SUPPLEMENTAL
CONSOLIDATED FINANCIAL STATEMENTS.
F-4
<PAGE>
EXCEL SWITCHING CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK,
STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(in thousands, except share data)
(Continued)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
DEFERRED COMPREHENSIVE RETAINED COMPREHENSIVE
COMPENSATION INCOME EARNINGS TOTAL INCOME
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 $(272) $ -- $11,449 $ 12,125 $ --
Issuance of common stock -- -- -- 4 --
Issuance of preferred stock, net of issuance
costs of approximately $99 -- -- -- -- --
Compensation expense associated with stock
options 73 -- -- 73 --
Forfeiture of stock options with deferred
compensation 7 -- -- (13) --
Accretion of preferred stock dividends -- -- (263) (263) --
Net income -- -- 6,090 6,090 6,090
----- ------ ------- ------- -------
Comprehensive income--1996 $ 6,090
-------
-------
BALANCE, DECEMBER 28, 1996 (192) -- 17,276 18,016
Compensation expense associated with stock
options (299) -- -- 125 --
Exercise of stock options -- -- -- 20 --
Proceeds of initial public offering of common
stock, net of approximately $7,394 in issuance
costs -- -- -- 87,106 --
Issuance of preferred stock, net of issuance
costs of approximately $44 -- -- -- -- --
Accretion of preferred stock dividends -- -- (903) (903) --
Unrealized loss on investments, net of $33 of
taxes -- (20) -- (20) (20)
Foreign currency translation adjustment -- (18) -- (18) (18)
Net income -- -- 14,734 14,734 14,734
----- ------ ------- ------- -------
Comprehensive income--1997 $14,696
-------
-------
BALANCE, DECEMBER 27, 1997 (491) (38) 31,107 119,060
Compensation expense associated with stock
options (256) -- -- 210 --
Exercise of stock options -- -- -- 1,572 --
Issuance of common stock under employee stock
purchase plan -- -- -- 361 --
Tax benefit from exercise of stock options -- -- -- 11,626 --
Accretion of preferred stock dividends -- -- (1,518) (1,518) --
Foreign currency translation adjustment -- 54 -- 54 54
Unrealized gain on investments, net of $51 of
taxes -- 127 -- 127 127
Net income -- -- 15,174 15,174 15,174
----- ------ ------- ------- -------
Comprehensive income--1998 $15,355
-------
-------
BALANCE, DECEMBER 31, 1998 (747) 143 44,763 146,666
Compensation expense associated with stock
options 47 -- -- 98 --
Exercise of stock options -- -- -- 485 --
Issuance of common stock under employee stock
purchase plan -- -- -- 214 --
Tax benefit from exercise of stock options -- -- -- 3,840 --
Accretion of preferred stock dividends -- -- (404) (404) --
Foreign currency translation adjustment -- (99) -- (99) (99)
Unrealized gain on investments, net of $93 of
taxes -- (56) -- (56) (56)
Net income -- -- 5,470 5,470 5,470
----- ------ ------- ------- -------
Comprehensive income--March 31, 1999 $ 5,315
-------
-------
BALANCE, MARCH 31, 1999 (UNAUDITED) $(700) $(12) $49,829 $ 156,214
----- ------ ------- -------
----- ------ ------- -------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE SUPPLEMENTAL
CONSOLIDATED FINANCIAL STATEMENTS.
F-5
<PAGE>
EXCEL SWITCHING CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
FISCAL YEARS ENDED THREE MONTHS ENDED
DECEMBER 28, DECEMBER 27, DECEMBER 31, MARCH 28, MARCH 31,
1996 1997 1998 1998 1999
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 6,090 $ 14,734 $ 15,174 $ 3,870 $ 5,470
Adjustments to reconcile net income to net cash
provided by operating activities-
Acquired in-process research and development -- -- 7,459
Depreciation and amortization 1,251 2,543 4,261 815 1,272
Unrealized (loss) gain on investments -- (20) 127 18 (56)
Deferred income taxes (4,463) (4,098) (7,553) (1,339) (3,548)
Deferred revenue -- -- 1,000 -- 434
Compensation expense associated with stock
options 60 125 210 39 98
Changes in assets and liabilities, net of
acquisitions-
Accounts receivable (2,210) (3,935) (16,639) (1,163) (5,183)
Inventories (409) 2,180 (1,394) (947) (3,765)
Prepaid taxes 401 (122) 122 122 --
Other current assets (259) (1,089) (925) (619) (2,251)
Accounts payable (2,163) 2,676 (702) 786 5,047
Accrued expenses 4,129 6,536 6,020 2,377 (2,734)
Accrued income taxes 2,350 959 13,792 1,005 6,011
-------- -------- -------- -------- --------
Net cash provided by operating activities 4,777 20,489 20,952 4,964 795
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (4,520) (4,260) (12,109) (3,028) (3,174)
Purchases of marketable securities, net -- (66,929) 11,350 (430) (11,386)
Change in other assets (8) 8 (754) -- (714)
Cash paid for acquisitions, net of cash acquired -- -- (7,437) -- --
-------- -------- -------- -------- --------
Net cash used in investing activities (4,528) (71,181) (8,950) (3,458) (15,274)
-------- -------- -------- -------- --------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE SUPPLEMENTAL
CONSOLIDATED FINANCIAL STATEMENTS.
F-6
<PAGE>
EXCEL SWITCHING CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Continued)
<TABLE>
<CAPTION>
FISCAL YEARS ENDED THREE MONTHS ENDED
DECEMBER 28, DECEMBER 27, DECEMBER 31, MARCH 28, MARCH 31,
1996 1997 1998 1998 1999
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Lease program recourse obligation -- -- -- -- 8,495
Proceeds from issuance of long-term obligations 1,246 459 -- -- --
Payments on long-term obligations (601) (674) (4,611) (3,229) (46)
Proceeds from issuance of preferred stock 7,676 9,955 -- -- --
Proceeds from issuance of common stock 4 87,106 -- -- --
Proceeds from exercise of stock options -- 20 1,572 70 485
Issuance of common stock under employee stock
purchase plan -- -- 361 -- 214
------ ------- ------- ------- ------
Net cash provided by financing activities 8,325 96,866 (2,678) (3,159) 9,148
------ ------- ------- ------- ------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS -- (18) 54 21 (99)
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 8,574 46,156 9,378 (1,632) (5,430)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 770 9,343 55,499 55,499 64,877
------ ------- ------- ------- ------
CASH AND CASH EQUIVALENTS, END OF PERIOD $9,344 $55,499 $64,877 $53,867 $59,447
------ ------- ------- ------- ------
------ ------- ------- ------- ------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for-
Interest $ 490 $ 424 $ 324 $ 31 $ 356
------ ------- ------- ------- ------
------ ------- ------- ------- ------
Taxes $5,951 $13,271 $ 4,131 $ 2,545 $ 612
------ ------- ------- ------- ------
------ ------- ------- ------- ------
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Accretion of preferred stock dividends $ 263 $ 903 $ 1,518 $ 379 $ 404
------ ------- ------- ------- ------
------ ------- ------- ------- ------
Acquisition of property and equipment under
capital lease obligations $ 489 $ -- $ -- $ -- $ --
------ ------- ------- ------- ------
------ ------- ------- ------- ------
During 1998, the Company acquired Quantum
Telecom Solutions, Inc. and XNT Systems,
Inc., as described in Note 2. These
acquisitions are summarized as follows:
Fair value of assets acquired, excluding cash $18,470
Cash paid, net of cash acquired (7,437)
-------
Liabilities assumed and promissory notes
issued $11,033
-------
-------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE SUPPLEMENTAL
CONSOLIDATED FINANCIAL STATEMENTS.
F-7
EXCEL SWITCHING CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Excel Switching Corporation (Excel) is a leading provider of open
switching platforms for telecommunications networks worldwide. Excel
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 sells to a variety of customers in the worldwide
telecommunications market, including applications developers, original
equipment manufacturers (OEMs), system integrators and network service
providers.
On May 10, 1999, Excel acquired RAScom, Inc. and subsidiary (RAScom), a
company that develops, manufactures, markets and supports a comprehensive
line of open system, remote access servers. Excel exchanged 1,021,187
shares of common stock of all the outstanding shares of RAScom common
stock, and exchanged options to purchase 78,753 shares of Excel for all
the outstanding options of RAScom; 102,122 of the shares issued were
placed into escrow as security for indemnification obligations of RAScom
relating to representations, warranties and tax matters. This merger will
be accounted for as a pooling of interests. Generally accepted accounting
principles do not allow for restatement of historical financial
statements for a pooling of interests transaction until results that
include post-merger activity have been issued. These accompanying
supplemental financial statements have been retroactively restated to
reflect the transaction as if Excel and RAScom (the Company) had operated
as one entity since inception. The Company has incurred approximately
$1.8 million of merger-related costs, which will be included in the 1999
consolidated statement of income during the period in which the merger
was completed.
The accompanying supplemental consolidated financial statements reflect
the application of certain accounting policies, as described below and
elsewhere in these notes to supplemental consolidated financial
statements.
(a) PRINCIPLES OF CONSOLIDATION
These supplemental consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All
significant intercompany transactions have been eliminated in
consolidation.
(b) INTERIM FINANCIAL STATEMENTS
The accompanying supplemental consolidated financial statements as
of March 31, 1999 and for the three months ended March 28, 1998
and March 31, 1999 are unaudited, but in the opinion of
management, include all adjustments, consisting only of normal
recurring adjustments necessary for a fair presentation of results
for the interim periods. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally
F-8
<PAGE>
accepted accounting principles have been omitted with respect to
these unaudited financial statements, although the Company
believes that the disclosures included are adequate to make the
information presented not misleading. Results for the three months
ended March 31, 1999 are not necessarily indicative of the results
that may be expected for the year ended December 31, 1999.
(c) CHANGE IN FISCAL YEAR-END
During 1998, the Company elected to change its fiscal year-end
from the last Saturday in December to December 31 to better
synchronize its fiscal periods with the majority of its customers
and suppliers. RAScom's fiscal year has always ended on December
31. In the accompanying supplemental consolidated financial
statements, 1996 refers to the fiscal year ended December 28, 1996
for Excel and December 31, 1996 for RAScom; 1997 refers to the
fiscal year ended December 27, 1997 for Excel and December 31,
1997 for RAScom; and 1998 refers to the fiscal year ended December
31, 1998 for both Excel and RAScom.
(d) MANAGEMENT ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes.
The market for telecommunications equipment in which the Company
operates can be characterized as rapidly changing because of
several factors including technological advancements, the
introduction of new products and services by the Company and its
competitors, and the increasing demands placed on equipment in
worldwide telecommunications networks. Significant assets and
liabilities with reported amounts based on estimates include
accounts receivable, inventory, intangible assets and accrued
expenses for post sale support costs, warranty costs and sales
returns and allowances. While the Company believes its estimates
are adequate, actual results could differ from those estimates.
(e) REVENUE RECOGNITION
Revenue is generally recognized when all significant contractual
obligations have been satisfied and collection of the resulting
receivable is reasonably assured. Revenue from product sales is
recognized at time of delivery and acceptance, and after
consideration of all the terms and conditions of the customer
contract. Revenue from sales-type leases is recognized at the date
of shipment, net of reserves for uncollectable amounts. Revenue
from operating leases or leases for which the collection of the
lease payments is not predicable is recognized ratably over the
lease term, and the related equipment is depreciated using the
straight-line method over its estimated useful life (see Note 6).
Revenue from providing services and post-sale support are
recognized at time of performance. The Company provides for
anticipated product returns and warranty costs at the time of
revenue recognition.
F-9
<PAGE>
(f) SOURCES OF SUPPLY AND THIRD-PARTY MANUFACTURING RELATIONSHIPS
Certain components used in the manufacture of the Company's
products are currently available only from single- or sole-source
suppliers. In addition, the Company relies on a limited number of
third parties to manufacture certain other components and
subassemblies. Shortages resulting from a change in arrangements
with these suppliers and manufacturers could cause delays in
manufacturing and product shipments and possible deferral or
cancellation of customer orders.
(g) RESEARCH AND DEVELOPMENT AND SOFTWARE DEVELOPMENT COSTS
Research and development costs have been charged to operations as
incurred. The Company believes its current process for developing
software is essentially completed concurrently with the
establishment of technological feasibility. Accordingly, no
software development costs have been capitalized to date.
(h) CONCENTRATIONS OF CREDIT RISK
Financial instruments that subject the Company to significant
concentrations of credit risk consist primarily of cash, cash
equivalents, marketable securities and trade accounts receivable.
The Company's investments are in financial instruments of high
quality. Concentration of credit risk with respect to trade
accounts receivable is limited to customers to whom the Company
makes significant sales. Two customers accounted for approximately
14% and 12%, respectively, of accounts receivable at December 27,
1997. Another customer accounted for approximately 11% of accounts
receivable at December 31, 1998 (see Note 12). To control credit
risk, the Company performs regular credit evaluations of its
customers' financial condition and maintains allowances for
potential credit losses.
(i) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's cash and cash equivalents,
marketable securities, accounts receivable and accounts payable
approximate fair value because of the short-term nature of these
instruments. Based on the borrowing rates currently available to
the Company, the carrying amounts of debt issued during 1998 in
connection with acquisitions approximate fair value.
(j) EARNINGS PER SHARE
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
shares outstanding reflects the dilutive effect, if any, of common
stock options based on the treasury stock method and Redeemable
Convertible Preferred Stock on an as-if-converted basis. The
calculations of diluted weighted average shares outstanding
exclude 459,800 and 141,600 common stock options in 1997 and 1998,
respectively, and 126,400 and 27,700 common stock options for the
three months ended March 28, 1998 and March 31, 1999,
respectively, as their effect would be antidilutive. There were no
antidilutive common stock options in 1996.
F-10
<PAGE>
The calculations of basic and diluted weighted average shares
outstanding are as follows (in thousands):
<TABLE>
<CAPTION>
FISCAL YEARS THREE MONTHS
1996 1997 1998 1998 1999
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Basic weighted average common shares
outstanding 28,253 28,939 33,406 32,832 34,476
Weighted average common equivalent
shares from stock options 4,607 5,619 6,085 6,329 5,820
Weighted average common equivalent
shares from preferred stock 165 543 822 822 822
------ ------ ------ ------ ------
Diluted weighted average shares
outstanding 33,025 35,101 40,313 39,983 41,118
------ ------ ------ ------ ------
------ ------ ------ ------ ------
</TABLE>
(k) COMPREHENSIVE INCOME
Comprehensive income represents the change in equity of a business
enterprise resulting from transactions and other events and
circumstances from nonowner sources. For fiscal years 1997 and
1998, and for the three months ended March 28, 1998 and March 31,
1999, the only differences between comprehensive income and net
income relate to unrealized gains and losses on marketable
securities, net of the related tax effect, and foreign currency
translation adjustments.
The following is a rollforward of accumulated comprehensive income
to March 31, 1999 (unaudited):
<TABLE>
<CAPTION>
ACCUMULATED
FOREIGN UNREALIZED OTHER
CURRENCY GAINS ON COMPREHENSIVE
TRANSLATION INVESTMENTS INCOME
<S> <C> <C> <C>
Beginning balance $ 36 $ 107 $ 143
Current-period change (99) (56) (155)
------- ------- ---------
Ending balance $ (63) $ 51 $ (12)
------- ------- ---------
------- ------- ---------
</TABLE>
(2) ACQUISITIONS
On September 30, 1998 the Company acquired all of the outstanding capital
stock of Quantum Telecom Solutions, Inc. (Quantum), a New Jersey based
provider of switch-configuration software. The total consideration of
$8.9 million consisted of approximately $5.4 million of cash plus the
issuance of promissory notes totaling $3.5 million. On September 30,
1998, the Company also acquired all of the outstanding capital stock of
XNT Systems, Inc. (XNT), a supplier of intelligent switch control and
comprehensive call-processing and control software based in New
Hampshire. The total consideration
F-11
<PAGE>
of $8.8 million consisted of cash payments of approximately $2.3 million
plus the issuance of promissory notes totaling $4.7 million and the
assumption of certain liabilities of XNT totaling approximately $1.8
million.
These acquisitions were accounted for under the purchase method of
accounting, and accordingly, the results of operations from the date of
acquisition are included in the Company's supplemental consolidated
statements of income. The fair market value of assets acquired and
liabilities assumed was based on an independent appraisal. The portion of
the purchase price allocated to in-process research and development was
based on a risk-adjusted cash flow appraisal method and represents
projects that had not yet reached technological feasibility and had no
alternative future use. This portion of the purchase price was expensed
upon consummation of the acquisitions.
Based on the independent appraisal, the Company has allocated a portion
of the purchase price to certain intangible assets. Intangible assets
consist of the following at December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
ESTIMATED
USEFUL LIFE
<S> <C> <C>
Developed technology 4 years $ 2,190
Assembled workforce 5 years 350
Goodwill 10 years 7,519
-----------
10,059
Less--accumulated amortization 357
-----------
$ 9,702
-----------
-----------
</TABLE>
The Company periodically reviews the realizability of its intangible
assets and has not recorded any impairment of these assets to date. The
following unaudited pro forma summary information presents the combined
results of operations of the Company, Quantum and XNT as if the
acquisitions had occurred at the beginning of 1997. This unaudited pro
forma financial information is presented for informational purposes only
and may not be indicative of the results of operations as they would have
been if the Company, Quantum and XNT had been a single entity, nor is it
necessarily indicative of the results of operations that may be expected
in the future. Anticipated efficiencies from the consolidation of the
Company, Quantum and XNT and the effects of the acquired in process
research and development have been excluded from the amounts presented
below (in thousands, except per share data).
<TABLE>
<CAPTION>
FISCAL YEARS THREE MONTHS
1997 1998 1998 1999
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues $ 96,370 $ 132,403 $ 27,998 $ 37,340
Net income 15,612 21,495 3,410 5,882
Earnings per share-
Basic $ 0.51 $ 0.60 $ .09 $ .16
Diluted 0.44 0.53 .09 .14
</TABLE>
F-12
<PAGE>
(3) CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
Cash equivalents are highly liquid investments with original maturities
of three months or less. Marketable securities are highly liquid
investment grade securities with original maturities of greater than
three months. Investments purchased to be held for indefinite periods of
time and not intended at the time of purchase to be held-to-maturity are
classified as available-for-sale and reported at fair market value. At
December 27, 1997, December 31, 1998 and March 31, 1999, the Company has
classified all investments as available-for-sale. The unrealized gain on
available-for-sale securities at December 31, 1998 was approximately
$107,000, which has been recorded as other comprehensive income in
stockholders' equity. During fiscal years 1997 and 1998, and during the
three months ended March 28, 1998 and March 31, 1999, the Company
realized net gains of $55,000, $3,000, $0 and $0, respectively, using the
specific-identification method. No gains were realized during 1996. The
Company's investments include time deposits, commercial paper, bankers'
acceptances and corporate, state municipality and U.S.
government debt and equity securities.
Cash, cash equivalents and marketable securities consist of the following
(in thousands):
<TABLE>
<CAPTION>
DECEMBER 27, DECEMBER 31, MARCH 31,
1997 1998 1999
(UNAUDITED)
<S> <C> <C> <C>
Cash and cash equivalents-
Cash $ 2,286 $ 2,532 $ 13,157
Money markets 16,691 15,189 9,520
Time deposits 1,459 - -
Corporate debt securities - 4,000 2,700
Commercial paper 32,071 38,156 26,570
State/municipal securities - - 2,500
Bankers' acceptance 2,992 - -
Corporate equity securities - 5,000 5,000
--------- ----------- -----------
Total cash and cash equivalents $ 55,499 $ 64,877 $ 59,447
--------- ----------- -----------
--------- ----------- -----------
Marketable securities-
Corporate debt securities $ 26,935 $ 23,334 $ 34,710
Time deposits 2,004 - -
U.S. government and agency debt securities 31,090 505 503
Municipality debt securities 2,000 27,134 1,548
Commercial paper 4,900 4,606 30,204
--------- ----------- -----------
Total marketable securities $ 66,929 $ 55,579 $ 66,965
--------- ----------- -----------
--------- ----------- -----------
</TABLE>
The following table summarizes the remaining maturity of the Company's
investments in debt securities as of December 31, 1998 (in thousands):
<TABLE>
<S> <C>
One year or less $ 46,761
One to five years 25,648
Variable maturity 25,326
---------
$ 97,735
---------
---------
</TABLE>
F-13
<PAGE>
(4) INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or
market. Work-in-process and finished goods consist of materials, labor
and manufacturing overhead. Inventories consist of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 27, DECEMBER 31, MARCH 31,
1997 1998 1999
(UNAUDITED)
<S> <C> <C> <C>
Raw materials $ 708 $ 3,373 $ 4,966
Work-in-process 3,780 2,291 4,528
Finished goods 797 1,136 1,071
---------- ---------- ---------
$ 5,285 $ 6,800 $ 10,565
---------- ---------- ---------
---------- ---------- ---------
</TABLE>
(5) PROPERTY AND EQUIPMENT
The Company provides for depreciation and amortization using both
straight-line and accelerated methods by charges to operations in amounts
that allocate the cost of the assets over their estimated useful lives.
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 27, DECEMBER 31, MARCH 31, ESTIMATED USEFUL
1997 1998 1999 LIVES
(UNAUDITED)
<S> <C> <C> <C> <C>
Land $ 576 $ 1,250 $ 2,409 N/A
Test equipment 4,561 8,776 9,668 2-5 years
Office equipment, furniture and
fixtures 4,077 8,045 8,323 2-7 years
Buildings 3,991 7,763 7,414 40 years
Building improvements 573 680 1,029 7-40 years
Assets under capital lease 489 489 489 3 years
Construction in progress (Note 13) 1,179 1,037 1,882 N/A
---------- ----------- -----------
15,446 28,040 31,214
Less--Accumulated depreciation and
amortization 4,383 8,287 9,217
---------- ----------- -----------
$ 11,063 $ 19,753 $ 21,997
---------- ----------- -----------
---------- ----------- -----------
</TABLE>
(6) LEASE FINANCING PROGRAM
In March 1999, the Company entered into an arrangement with a leasing
company to enable the Company's customers to finance the purchase of
Excel equipment. Under the terms of this arrangement, as amended, the
Company has a recourse obligation in the amount of the greater of
$1,000,000 or 20% of the aggregate net book value of annual equipment
sales financed. In addition,
F-14
<PAGE>
the Company has a 100% recourse obligation for contracts funded for
customers with certain credit ratings, as determined by the leasing
company.
During the first quarter of 1999, the Company sold approximately $7.9
million of equipment under this agreement to the leasing company. The
leasing company leased this equipment to certain customers. In addition,
the Company sold the leasing company an existing receivable of
approximately $1.0 million. The Company's recourse obligation at March
31, 1999 is approximately $8.5 million, for which it has recorded a
reserve of $8.5 million. Because of the credit ratings of certain of
these customers and the related recourse obligations, the Company
determined it would record the related $7.5 million of revenue ratably as
the lease payments are received for the term of the lease or until such
time as collection of the underlying lease payments can be reasonably
assured.
(7) LONG-TERM OBLIGATIONS
Long-term obligations consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 27, DECEMBER 31, MARCH 31,
1997 1998 1999
(UNAUDITED)
<S> <C> <C> <C>
Promissory notes payable--XNT $ - $ 4,702 $ 4,702
Promissory notes payable--Quantum - 3,456 3,456
Mortgage and Security Agreement 2,386 - -
Capital lease obligation--Building 926 - -
Real Estate Promissory Note 460 - -
Promissory note payable to a bank 670 - -
Other 277 108 62
--------- ----------- ----------
4,719 8,266 8,220
Less--Current maturities 4,412 3,408 4,262
--------- ----------- ----------
$ 307 $ 4,858 $ 3,958
--------- ----------- ----------
--------- ----------- ----------
</TABLE>
In connection with the 1998 acquisition of XNT (see Note 2), the Company
issued promissory notes in the amount of $4.7 million. Interest at a rate
of 10% per annum is payable annually in arrears. The notes mature as
follows: $1.5 million in September 1999 and $1.6 million each in
September 2000 and 2001. Upon the occurrence of certain events, as
defined, the maturity of principal amounts outstanding under the notes
may be accelerated or decelerated.
In connection with the 1998 acquisition of Quantum (see Note 2), the
Company issued promissory notes in the amount of $3.5 million. Interest
at a rate of 10% per annum is payable quarterly in arrears. The notes
mature as follows: $1.8 million in September 1999, $900,000 in March 2000
and $756,000 in September 2000. Upon the occurrence of certain events, as
defined, the maturity of principal amounts outstanding under the notes
may be accelerated or decelerated.
In 1995, the Company entered into a building capital lease obligation
that included a purchase option exercisable beginning in August 1998 for
$875,000. During 1998, the Company exercised this option.
F-15
<PAGE>
In January 1998, the Company repaid all outstanding obligations under the
Mortgage and Security Agreement, promissory note payable and the Real
Estate Promissory Note. Accordingly, all outstanding balances as of
December 27, 1997 have been reflected as current liabilities in the
accompanying December 27, 1997 supplemental consolidated balance sheet.
Future maturities of the remaining long-term obligations as of December
31, 1998 are as follows (in thousands):
<TABLE>
<S> <C> <C>
1999 $ 3,408
2000 3,257
2001 1,601
----------
$ 8,266
----------
----------
</TABLE>
(8) LINE-OF-CREDIT ARRANGEMENT
The Company has an unsecured line-of-credit arrangement with a bank to
provide up to $15.0 million in financing. Borrowings under this line bear
interest at either the bank's base rate (7.75% at December 31, 1998) or
the Eurodollar rate (5.07% at December 31, 1998) plus 1.75%. The Company
is required to maintain certain restrictive covenants under this
agreement. This agreement expires September 30, 1999. There have been no
borrowings outstanding under this agreement since the fiscal year ended
1996.
(9) INCOME TAXES
Deferred tax assets or liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities,
as measured by the enacted tax rates expected to be in effect when the
differences reverse. The provision for income tax is based on pretax
financial income.
The components of the provision for income taxes are as follows (in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR
1996 1997 1998
<S> <C> <C> <C>
Current-
Federal $ 6,731 $ 11,249 $ 15,397
State 1,971 2,274 3,370
----------- ------------ -----------
8,702 13,523 18,767
----------- ------------ -----------
Deferred (prepaid)-
Federal (4,112) (3,788) (6,059)
State (513) (310) (1,494)
----------- ------------ -----------
(4,625) (4,098) (7,553)
----------- ------------ -----------
Total provision $ 4,077 $ 9,425 $ 11,214
----------- ------------ -----------
----------- ------------ -----------
</TABLE>
F-16
<PAGE>
A reconciliation of the federal statutory rate to the Company's effective tax
rate is as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
1996 1997 1998
<S> <C> <C> <C>
Income tax provision at federal statutory rate 34 % 35 % 35 %
Increase (decrease) in tax resulting from-
State tax provision, net of federal benefit 6 5 3
Research and development tax credits - (2) (3)
Nondeductible acquired in-process research and
development - - 4
Other - 1 3
-- -- --
Effective tax rate 40 % 39 % 42 %
-- -- --
-- -- --
</TABLE>
The approximate income tax effect of each type of temporary difference
composing the net deferred tax asset at December 27, 1997 and December
31, 1998 is as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 27, DECEMBER 31,
1997 1998
<S> <C> <C>
Difference in inventory accounting method $ (778) $ (512)
Nondeductible reserves 4,035 4,268
Nondeductible accruals 2,401 3,372
Depreciation and amortization - 1,392
Credit carryforwards 126 995
Net operating loss carryforwards 3,319 6,526
Other temporary differences (36) 135
----------- -----------
Net deferred tax asset $ 9,067 $ 16,176
----------- -----------
----------- -----------
</TABLE>
At December 31, 1998, the Company had net operating loss carryforwards
for federal and state income tax purposes of approximately $17,034,000.
The net operating loss carryforwards expire through 2018 and are subject
to review and possible adjustment by the Internal Revenue Service (IRS).
The Tax Reform Act of 1986 contains provisions that may limit the net
operating loss carryforwards available to be used in any given year in
the event of significant changes in ownership interest, as defined.
(10) STOCKHOLDERS' EQUITY
(a) COMMON STOCK
The Company has authorized 100,000,000 shares of common stock, par
value of $.01 per share. At December 31, 1998, there were
13,155,674 shares of common stock reserved for future issuance
under the Company's stock plans.
In November 1997, the Company completed an initial public offering
of 4,500,000 shares of common stock at a per share price of $21.
The Company received proceeds of approximately $87.1 million, net
of underwriting discounts and commissions and offering expenses of
approximately $7.4 million.
F-17
<PAGE>
(b) PREFERRED STOCK
The Company has 10,000,000 shares of $.01 par value preferred
stock authorized. The Board of Directors has the authority to
issue such shares in one or more series and to fix the relative
rights and preferences without further vote or action by the
stockholders. Currently, the Board of Directors has no plans to
issue any shares of preferred stock.
(c) REDEEMABLE CONVERTIBLE PREFERRED STOCK
Prior to the merger between the two companies, RAScom had
10,696,402 shares of redeemable convertible preferred stock
authorized and outstanding, of which 2,892,744 shares were
designated Series A Redeemable Convertible Preferred Stock (Series
A), 2,847,543 shares were designated Series B Redeemable
Convertible Preferred Stock (Series B) and 4,956,115 shares were
designated Series C Redeemable Convertible Preferred Stock (Series
C). The Series A, B and C preferred stock are entitled to certain
rights and preferences, including voting, cumulative dividends,
liquidation, redemption and conversion, as defined in the Amended
and Restated Articles of Incorporation of RAScom. Upon approval of
the merger on May 10, 1999, all outstanding shares of redeemable
convertible preferred stock plus cumulative dividends were
converted to approximately 822,000 shares of Excel common stock.
(11) STOCK OPTION PLANS
Stock options are generally exercisable within 10 years of the original
date of grant and vest over a period of up to five years from the date of
grant. In some instances, options have been granted at exercise prices
below the fair market value on the date of grant. The difference, if any,
between the fair market value of shares of the Company's common stock and
the exercise price of the option is recognized as compensation expense
over the vesting term. During fiscal years 1996, 1997 and 1998, and
during the three months ended March 28, 1998 and March 31, 1999, the
Company recognized net compensation expense of approximately $60,000,
$125,000, $189,000, $39,000 and $97,000, respectively.
The Company has the following stock option and stock purchase plans:
(a) STOCK OPTION PROGRAM
The Company has granted nonqualified stock options to purchase
shares of its common stock at exercise prices generally determined
to be at fair market value by the Company's Board of Directors on
the date of grant. In November 1997, this program was terminated.
There are 9,472,545 options outstanding under this program as of
December 31, 1998.
(b) 1997 STOCK OPTION PLAN
Under the terms of the 1997 Stock Option Plan (1997 Plan),
incentive and nonqualified stock options may be granted to
employees consultants and directors to purchase an aggregate of
5,000,000 shares of common stock. During 1998, the Company granted
1,567,200 options under the 1997 Plan, of which 1,557,800 options
were outstanding at December 31, 1998.
F-18
<PAGE>
(c) DIRECTOR OPTION PLAN
The Company's Non-Employee Director Stock Option Plan (Director
Option Plan) provides for the grant of options to purchase an
aggregate 225,000 shares of common stock to nonemployee directors
of the Company. Each such director will be granted an option to
purchase 30,000 shares upon election to the Board of Directors. In
addition, each such director will be automatically granted an
option to purchase 15,000 shares in each of the two years
following the date such person becomes a director. These options
will vest 1/3 on grant date, 1/3 one year from grant date and 1/3
two years from grant date. The Plan was amended in May 1999 to
terminate the initial grant of options to purchase 30,000 shares
and the grant of 15,000 additional shares at each of the next two
anniversary dates. Commencing January 1, 2000, each nonemployee
director will be automatically granted fully vested options to
purchase 1,250 shares of common stock once each quarter provided
that the director has been a member of the Board for at least one
year. During 1997 and 1998, the Company granted a total of 120,000
options under the Director Option Plan, of which 100,000 options
were outstanding at December 31, 1998.
(d) 1996 RASCOM STOCK OPTION PLAN
In connection with the merger of RAScom and Excel, the Company
adopted RAScom's 1996 Stock Option Plan. Under the terms of the
Company's 1996 Stock Option Plan (1996 Plan), incentive stock
options were granted to employees of RAScom, Inc. During 1997 and
1998 and the three month ended March 31, 1999, the Company granted
45,159, 47,250 and 39,920 options, respectively, of which 90,203
options were outstanding as of December 31, 1998. The Company does
not intend to issue additional grants under this Plan.
(e) STOCK OPTION ACTIVITY
Stock option activity under all option plans for the three years
in the period ended December 31, 1998 and for the three months
ended March 31, 1999 is as follows:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
<S> <C> <C>
Outstanding, December 31, 1995 7,890,840 $ 0.084
Granted 2,042,659 4.211
Forfeited (33,025) 0.508
----------
Outstanding, December 28, 1996 9,900,474 0.934
Granted 1,621,350 9.313
Exercised (10,098) 1.951
Forfeited (131,239) 3.987
----------
Outstanding, December 27, 1997 11,380,487 2.093
Granted 1,637,120 19.470
Exercised (1,420,372) 1.107
Forfeited (376,690) 8.270
----------
Outstanding, December 31, 1998 11,220,545 4.544
Granted 84,295 23.392
Exercised (437,400) 1.110
Forfeited (90,799) 10.386
----------
Outstanding, March 31, 1999 (unaudited) 10,776,641 $ 4.786
---------- ----------
---------- ----------
</TABLE>
F-19
<PAGE>
The following table summarizes information about stock options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
NUMBER CONTRACTUAL NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE EXERCISABLE PRICE
<S> <C> <C> <C> <C> <C> <C>
$ 0.002 - $0.002 4,814,005 5.2 4,814,005 $ 0.002
0.167 - 0.167 562,770 5.9 471,570 0.167
0.333 - 0.333 1,201,250 6.7 795,050 0.333
1.000 - 2.340 333,085 7.5 124,279 2.326
4.500 - 6.000 1,984,177 7.8 416,267 4.978
6.706 - 10.500 387,798 8.4 61,647 7.351
11.500 - 17.250 314,760 8.8 55,980 14.192
18.000 - 27.000 1,598,000 9.7 54,440 20.986
38.000 - 38.000 24,700 10.0 - -
---------- --------- ---------
11,220,545 6,793,238 $ 0.752
---------- --------- ---------
---------- --------- ---------
Exercisable, December 27, 1997 7,189,808 $ 0.310
--------- ---------
--------- ---------
Exercisable, December 28, 1996 6,356,940 $ 0.046
--------- ---------
--------- ---------
</TABLE>
(f) FAIR VALUE OF STOCK OPTIONS
Statement of Financial Accounting Standards (SFAS) No. 123,
ACCOUNTING FOR STOCK-BASED Compensation, requires the measurement
of the fair value of stock options to be included in the statement
of income or disclosed in the notes to financial statements. The
Company has determined that it will continue to account for
stock-based compensation for employees under Accounting Principles
Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES,
and elect the disclosure-only alternative under SFAS No. 123.
Had compensation cost for the Company's option plans been
determined based on the fair value at the grant dates, as
prescribed in SFAS No. 123, the Company's net income would have
been as follows:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Net income (in thousands)-
As reported $ 6,090 $ 14,734 $ 15,174
Pro forma 5,635 12,802 12,588
Diluted earnings per share-
As reported $ .18 $ .42 $ .38
Pro forma .17 .36 .31
</TABLE>
F-20
<PAGE>
The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the
following assumptions used for grants during the applicable
period:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Dividend yield - - -
Volatility 56.6% 56.6% 70.5%
Risk-free interest rate 5.9%-6.8% 5.0%-6.6% 4.5%-5.6%
Expected option term 7.5 years 5.0 years 5.0 years
Weighted average fair value per
share of options granted $ 5.53 $ 5.17 $12.41
</TABLE>
(g) 1998 EMPLOYEE STOCK PURCHASE PLAN
The 1997 Employee Stock Purchase Plan provides for the sale of up
to 400,000 shares of common stock to participating employees
semiannually. The purchase price is equal to 85% of the fair
market value at either the beginning or the end of the semiannual
period, as defined. During 1998, 20,238 shares of common stock
were issued under this plan.
(12) SEGMENT AND ENTERPRISE-WIDE REPORTING
The Company currently operates in one operating segment as a provider of
programmable switches. This segment derives its revenues from the sale
and support of a family of open, programmable, carrier-class switches
that address the complex enhanced services and wireless and wireline
infrastructure needs of network providers.
The Company derives substantially all of its revenue from the sale and
support of one group of similar products and services. Substantially all
of the Company's assets are located within the United States. During
fiscal years 1996, 1997 and 1998 and during the three months ended March
28, 1998 and March 31, 1999, the Company derived its revenues from the
following geographic regions (in thousands):
<TABLE>
<CAPTION>
FISCAL YEARS THREE MONTHS ENDED
1996 1997 1998 1998 1999
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
United States $ 60,423 $ 84,420 $ 114,870 $ 24,981 $ 25,809
Other 1,842 7,203 14,469 2,124 11,531
$ 62,265 $ 91,623 $ 129,339 $ 27,105 $ 37,340
------------ ---------- ----------- ---------- -----------
------------ ---------- ----------- ---------- -----------
</TABLE>
F-21
<PAGE>
During fiscal years 1996, 1997 and 1998 and during the three months ended
March 28, 1998 and March 31, 1999, the Company derived a portion of its
revenues from sales to single customers that exceeded 10% of total
revenues, as follows:
<TABLE>
<CAPTION>
FISCAL YEARS THREE MONTHS ENDED
1996 1997 1998 1998 1999
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Significant customer A * 10% 19% 21% *
Significant customer B 37% 25% * * *
</TABLE>
*Revenue derived from this customer was less than 10% of the Company's total
revenue during the period.
(13) COMMITMENTS
(a) LEASE OBLIGATION
The Company leases certain equipment and office facilities under
noncancelable operating leases, which expire at various dates
through November 2001. Future minimum lease payments required
under these leases at December 31, 1998 are approximately as
follows (in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR AMOUNT
<S> <C>
1999 $ 1,504
2000 866
2001 687
2002 321
----------
$ 3,378
----------
----------
</TABLE>
Total rent expense under these agreements for fiscal years 1996,
1997 and 1998 was approximately $1.1 million, $1.4 million and
$1.4 million, respectively.
During 1998, the Company began construction of a $7.0 million
building addition. As of December 31, 1998, the Company had
incurred approximately $1.0 million of land acquisition and
construction costs related to this building addition.
(b) PURCHASE COMMITMENTS
In the normal course of business, the Company routinely enters
into purchase commitments for the purchase of inventory. During
the quarter ended March 31, 1999, the Company identified a
purchase commitment in excess of the anticipated inventory usage
and recorded a change of approximately $650,000 against cost of
sales.
F-22
<PAGE>
(14) EMPLOYEE BENEFIT PLAN
The Company has a qualified 401(k) retirement savings plan covering all
employees. Under this plan, participants may elect to defer a portion of
their compensation, subject to certain limitations. In addition, the
Company, at the discretion of the Board of Directors, may make profit
sharing contributions into the plan. For fiscal years 1996, 1997 and
1998, the Company made contributions of approximately $534,000, $898,000
and $1,180,000, respectively.
(15) ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 27, DECEMBER 31, MARCH 31,
1997 1998 1999
(UNAUDITED)
<S> <C> <C> <C>
Accrued sales returns and allowances $ 4,846 $ 4,821 $ 4,601
Accrued payroll and benefits 2,637 7,479 5,532
Accrued post-sales support and warranty 1,938 2,925 2,598
Accrued marketing 1,215 743 1,060
Accrued purchase commitments - - 650
Accrued professional fees 796 1,006 591
Accrued other 1,326 3,161 2,369
----------- --------- ----------
$ 12,758 $ 20,135 $ 17,401
----------- --------- ----------
----------- --------- ----------
</TABLE>
F-23
