<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number 0-23263
EXCEL SWITCHING CORPORATION
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(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2992806
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
255 INDEPENDENCE DRIVE
HYANNIS, MASSACHUSETTS 02601
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(Address of principal executive offices) (Zip code)
(508) 862-3000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES: [X] NO: [ ]
As of August 11, 1999, there were 36,797,516 shares of the Registrant's
Common Stock, $.01 par value, outstanding.
1
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EXCEL SWITCHING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Condensed Financial Statements
Consolidated Condensed Balance Sheets 3
Consolidated Condensed Statements of Income 4
Consolidated Condensed Statements of Cash Flows 6
Notes to Consolidated Condensed Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 31
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 32
ITEM 2. Changes in Securities and Use of Proceeds 32
ITEM 3. Defaults Upon Senior Securities 33
ITEM 4. Submission of Matters to a Vote of Security Holders 33
ITEM 5. Other Information 34
ITEM 6. Exhibits and Reports on Form 8-K 34
SIGNATURES 37
EXHIBIT INDEX 38
</TABLE>
2
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EXCEL SWITCHING CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1999
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(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 64,877 $ 32,940
Marketable securities 55,579 81,716
Accounts receivable, net of reserves of $2,228 and $2,728 31,425 47,749
Inventories 6,800 12,822
Deferred tax asset 8,534 7,608
Other current assets 2,325 5,004
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Total current assets 169,540 187,839
PROPERTY AND EQUIPMENT, NET 19,753 24,747
DEFERRED TAX ASSET 7,642 7,781
INTANGIBLE ASSETS, NET 9,702 8,992
OTHER ASSETS 766 1,223
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$ 207,403 $ 230,582
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 3,408 $ 4,213
Accounts payable 4,922 8,187
Accrued expenses 20,135 17,361
Accrued income taxes 6,052 5,160
Deferred revenue 1,047 2,174
Recourse obligation -- 5,771
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Total current liabilities 35,564 42,866
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LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 4,858 3 ,958
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REDEEMABLE CONVERTIBLE PREFERRED STOCK, AT REDEMPTION VALUE-
Issued and outstanding--10,696,402 and no shares at
December 31, 1998 and June 30, 1999, respectively 20,315 --
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STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-none issued -- --
Common stock, $.01 par value-
Issued and outstanding--34,218,309 and 36,642,704 shares
at December 31, 1998 and June 30, 1999, respectively 342 366
Additional paid-in capital 102,165 130,097
Deferred compensation (747) (654)
Accumulated other comprehensive income 143 (18)
Retained earnings 44,763 53,967
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Total stockholders' equity 146,666 183,758
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$ 207,403 $ 230,582
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</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
3
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EXCEL SWITCHING CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 27, JUNE 30,
1998 1999
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<S> <C> <C>
REVENUES $30,807 $43,218
COST OF REVENUES 9,881 13,689
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Gross profit 20,926 29,529
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OPERATING EXPENSES:
Engineering, research and development 5,904 9,590
Selling and marketing 4,923 6,398
General and administrative 2,949 4,791
Merger related costs -- 2,075
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Total operating expenses 13,776 22,854
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Income from operations 7,150 6,675
OTHER INCOME, NET 1,482 1,306
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Income before provision for income taxes 8,632 7,981
PROVISION FOR INCOME TAXES 3,246 3,661
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NET INCOME $ 5,386 $ 4,320
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PREFERRED STOCK DIVIDENDS $ 379 $ 182
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NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 5,007 $ 4,138
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BASIC EARNINGS PER SHARE $ .15 $ .12
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DILUTED EARNINGS PER SHARE $ .13 $ .10
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BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 33,178 35,620
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 40,139 41,202
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
4
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EXCEL SWITCHING CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 27, JUNE 30,
1998 1999
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<S> <C> <C>
REVENUES $57,912 $80,558
COST OF REVENUES 19,003 25,906
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Gross profit 38,909 54,652
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OPERATING EXPENSES:
Engineering, research and development 11,444 18,112
Selling and marketing 9,964 12,094
General and administrative 5,857 8,299
Merger related costs -- 2,075
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Total operating expenses 27,265 40,580
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Income from operations 11,644 14,072
OTHER INCOME, NET 3,199 2,514
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Income before provision for income taxes 14,843 16,586
PROVISION FOR INCOME TAXES 5,587 6,796
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NET INCOME $ 9,256 $ 9,790
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PREFERRED STOCK DIVIDENDS $ 758 $ 586
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NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 8,498 $ 9,204
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BASIC EARNINGS PER SHARE $ .26 $ .26
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DILUTED EARNINGS PER SHARE $ .23 $ .24
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BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 33,005 35,454
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 40,151 41,158
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
5
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EXCEL SWITCHING CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 27, JUNE 30,
1998 1999
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 9,256 $ 9,790
Adjustments to reconcile net income to net cash
provided by operating activities-
Depreciation and amortization 1,335 2,875
Unrealized gain (loss) on investments 27 (161)
Deferred income taxes (2,404) 787
Compensation expense associated with the grant
of stock options, net of forfeitures 89 144
Changes in assets and liabilities-
Accounts receivable (4,235) (16,324)
Inventories (1,329) (6,022)
Prepaid taxes 122 --
Other current assets (770) (2,679)
Accounts payable 1,320 3,265
Accrued expenses 5,113 (2,549)
Accrued income taxes 2,961 5,004
Deferred revenue -- 1,127
Recourse obligation -- 5,546
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Net cash provided by operating activities 11,485 803
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (7,045) (7,159)
Purchases of marketable securities, net 22,468 (26,137)
Increase in other assets -- (457)
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Net cash provided by (used in) investing
activities 15,423 (33,753)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term obligations (3,342) (95)
Issuance of stock under employee stock
purchase plan -- 214
Proceeds from the exercise of stock options 218 894
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Net cash provided by (used in) financing
activities (3,124) 1,013
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NET INCREASE IN CASH AND CASH EQUIVALENTS 23,784 (31,937)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 55,499 64,877
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 79,283 $ 32,940
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for-
Interest $ 45 $ 225
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-------- --------
Taxes $ 4,908 $ 737
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</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
6
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EXCEL SWITCHING CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Note 1 - Interim Consolidated Condensed Financial Statements
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 Company has accounted for the acquisition under the "pooling-of-interests"
accounting method. Accordingly, the financial statements for the periods ending
June 27, 1998 have been restated as if the two entities had operated as one
entity since inception. During the second quarter of 1999, the Company recorded
a one-time charge for acquisition related expenses of approximately $2.1
million.
The accompanying unaudited interim consolidated condensed financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission for reporting on Form
10-Q. Accordingly, certain information and footnote disclosure required for
complete financial statements are not included herein. It is recommended that
these financial statements be read in conjunction with the consolidated
financial statements and related notes of Excel Switching Corporation (the
"Company") for the year ended December 31, 1998 as reported in the Company's
Form 8-K/A filed with the Commission on July 23, 1999. In the opinion of
management, all adjustments (consisting of normal, recurring adjustments)
considered necessary for a fair presentation of financial position, results of
operations and cash flows at the dates and for the periods presented have been
included. The consolidated condensed balance sheet presented as of December 31,
1998 has been derived from the consolidated financial statements that have been
audited by the Company's independent public accountants. The results of
operations for the three months ended June 30, 1999 may not be indicative of the
results that may be expected for the year ended December 31, 1999, or for any
other period.
Note 2 - 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 average shares reflect 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 basic and diluted weighted average shares outstanding are as
follows (in thousands):
7
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<TABLE>
<CAPTION>
THREE MONTHS ENDED
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JUNE 27, 1998 JUNE 30, 1999
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<S> <C> <C>
Basic weighted average common shares outstanding 33,178 35,620
Weighted average common equivalent shares from stock options 6,139 5,117
Weighted average common equivalent shares from preferred stock 822 465
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Diluted weighted average shares outstanding 40,139 41,202
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</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED
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JUNE 27, 1998 JUNE 30, 1999
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<S> <C> <C>
Basic weighted average common shares outstanding 33,005 35,454
Weighted average common equivalent shares from stock options 6,324 5,470
Weighted average common equivalent shares from preferred stock 822 234
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Diluted weighted average shares outstanding 40,151 41,158
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</TABLE>
Note 3 - Comprehensive Income
Comprehensive income for the three and six month periods ended June 30,
1999 does not significantly differ from reported net income. The differences
between comprehensive income and net income relates to unrealized gains and
losses on marketable securities, net of the related tax effect, and foreign
currency translation adjustments. There was a net period decrease in accumulated
comprehensive income for the three and six month periods ended June 30, 1999 of
approximately $6,000 and $161,000, respectively.
Note 4 - Significant Customers
Sales to significant customers as a percentage of the Company's total
revenues were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
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JUNE 27, 1998 JUNE 30, 1999
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<S> <C> <C>
Significant Customer A * 13%
Significant Customer B * 12%
Significant Customer C 30% *
</TABLE>
8
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<TABLE>
<CAPTION>
SIX MONTHS ENDED
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JUNE 27, 1998 JUNE 30, 1999
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<S> <C> <C>
Significant Customer A * *
Significant Customer B * *
Significant Customer C 25% *
</TABLE>
* Sales derived from this customer represented less than 10% of the Company's
total revenue for the period.
Note 5 - Vendor Lease 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 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. The Company defers revenue
recognition on sales involving recourse obligation until such time as the
obligation is eliminated.
During the second quarter of 1999, approximately $1.2 million of equipment
sales were financed through this program. The Company's total recourse
obligation at June 30, 1999 is approximately $5.8 million.
During the quarter, the leasing company sold an existing 100% recourse
lease contract that originated in the first quarter of 1999 to another leasing
company. As a result of this transaction, Company's recourse obligation was
eliminated. Accordingly, the Company recognized approximately $2.7 million of
net revenue.
Note 6 - Recent Acquisition
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.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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; 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, the Company's quarterly report on Form 10-Q
for the three months ended March 31, 1999, the Company's report on Form 8-K,
dated May 10, 1999 and filed with the Commission on May 25, 1999 and as amended
by the Company's Report on Form 8-K/A, dated May 10, 1999 and filed with the
Commission on July 23, 1999.
OVERVIEW
Excel Switching Corporation (the "Company") 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.
10
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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.
Excel's products and technology are contained within the framework of Open
Network Expansion Architecture ("ONE Architecture-TM-"). ONE Architecture is
Excel's concept that its switching systems provide an open, scalable and
cost-effective solution for the telecommunication needs of network providers.
ONE Architecture encompasses a family of switching products and related embedded
software technologies.
RECENT ACQUISITIONS
On May 10, 1999, the Company completed an acquisition of RAScom, Inc., a
provider of open remote access server technology. Management anticipates that
the acquisition of RAScom will expand Excel's addressable market by adding data
capabilities to the EXS product line. Under terms of the agreement, Excel
acquired all outstanding capital stock and options of RAScom in exchange for the
right to receive up to 1,099,940 shares of Excel common stock. The transaction
has been accounted for under the pooling-of-interests method. Accordingly, the
Company's financial statements for the period ended June 30, 1999 reflect the
combined results of both entities. In addition, financial results for previous
periods have been restated to reflect the combined operations for both entities
since inception. During the second quarter of 1999, the Company recorded a
one-time charge for acquisition related expenses of approximately $2.1 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.
11
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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 Consolidated
Condensed Statements of Income:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
JUNE 27, JUNE 30, JUNE 27, JUNE 30,
1998 1999 1998 1999
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<S> <C> <C> <C> <C>
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 32.1 31.7 32.8 32.2
----- ----- ----- -----
Gross profit 67.9 68.3 67.2 67.8
----- ----- ----- -----
Operating expenses:
Engineering, research and development 19.1 22.2 19.8 22.4
Selling and marketing 16.0 14.8 17.2 15.0
General and administrative 9.6 11.1 10.1 10.3
Merger related costs -- 4.8 -- 2.6
----- ----- ----- -----
Total operating expenses 44.7 52.9 47.1 50.3
----- ----- ----- -----
Income from operations 23.2 15.4 20.1 17.5
Other income, net 4.8 3.0 5.5 3.1
----- ----- ----- -----
Income before provision for income taxes 28.0 18.5 25.6 20.6
Provision for income taxes 10.5 8.5 9.6 8.4
----- ----- ----- -----
Net income 17.5% 10.0% 16.0% 12.2%
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
THREE MONTHS ENDED JUNE 28, 1998 AND JUNE 30, 1999
REVENUES. The Company's revenues consist of sales of its open, programmable
switching platforms and related components. Revenues increased 40% from $30.8
million in the three months ended June 27, 1998 to $43.2 million for the
comparable period in 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 offices in
1998 and one in late 1997.
Revenues from the Company's five largest customers represented
approximately 49% and 32% of the Company's revenues for the second quarters of
1998 and 1999, respectively. In
12
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the second quarter of 1999 Comverse Network Systems represented 13% and Cignal
Global Communications, Inc. represented 12%, including amounts financed through
third party lessors on behalf of Cignal. During the comparable 1998 period,
Qualcomm Incorporated represented approximately 30% of the Company's total
revenue. Although the Company's largest customers have varied from period to
period and the customer base continues to broaden, 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 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 39% from
$9.9 million in the three months ended June 27, 1998 to $13.7 million for the
comparable period in 1999. Gross margin increased from 67.9% in the second
quarter of 1998 to 68.3% in the comparable period of 1999. The increase in cost
of revenues and gross margin is primarily attributable to the increase in sales
volume.
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. Engineering,
research and development costs increased 62% from $5.9 million in the second
quarter of 1998 to $9.6 million for the comparable period in 1999. As a
percentage of revenues, these costs were 19.1% and 22.2%, 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 supplies
and materials used in development activities.
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 30%
from $4.9 million in the second quarter of 1998 to $6.4 million for the
comparable period of 1999. As a percentage of revenues, these costs were 16.0%
and 14.8%, respectively, in such periods. The increase in selling and marketing
costs in absolute dollars was primarily attributable to promotional activities
and costs related to the international offices established in 1998 and 1997.
GENERAL AND ADMINISTRATIVE. General and administrative costs include
compensation and benefit related costs of management, finance, information
technology and administrative personnel; legal, accounting and other
professional services; costs to maintain manufacturing and management
information systems; goodwill amortization; and other general corporate
expenses. General and administrative costs increased 62% from $2.9 million in
the second quarter of 1998 to $4.8 million for the comparable period in 1999. As
a percentage of revenues, these costs were 9.6% and 11.1%, respectively, in such
periods. The increase in general and administrative costs in absolute dollars
was primarily attributable to an increase of approximately $1.0 million in
expenses related to the Company's patent infringement lawsuit against Cisco
Systems, Inc. (See
13
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Part II, Item 1, Legal Proceedings). In addition, the increase resulted from
expenses related to bad debt expense and amortization of goodwill, as well as
professional fees associated with recruiting and acquisition activities.
MERGER RELATED COSTS. During the second quarter of 1999, the Company
incurred one-time charges for merger related costs of approximately $2.1 million
in connection with the acquisition of RAScom, Inc. Merger related costs
primarily relate to professional services expenses incurred in connection with
the acquisition including approximately $1.0 million for investment banking
advisory services and approximately $730,000 for legal and accounting fees.
OTHER INCOME. Other income is primarily composed of interest income, offset
by interest expense. Other income decreased 12% from $1.5 million in the second
quarter of 1998 to $1.3 million for the comparable period in 1999. This decrease
was primarily attributable to the interest expense associated with $8.2 million
of acquisition-related, debt obligations issued in the fourth quarter 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 approximately 37.6% and 45.9% for the second quarters of
1998 and 1999, respectively. The increase in effective tax rates is primarily
attributable to non-deductible merger related costs of approximately $2.1
million incurred during the quarter.
SIX MONTHS ENDED JUNE 27, 1998 AND JUNE 30, 1999
REVENUES. Revenues increased 39% from $57.9 million in the six months ended
June 27, 1998 to $80.6 million for the comparable period in 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 offices in 1998 and one in late 1997.
Revenues from the Company's five largest customers represented
approximately 53% and 26% of the Company's revenues for the first half of 1998
and 1999, respectively. In the second quarter of 1999, no single customer
represented greater than 10% of the Company's total revenue. During the
comparable 1998 period, Qualcomm Incorporated represented approximately 25% of
the Company's total revenue. Although the Company's largest customers have
varied from period to period and the customer base continues to broaden, 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
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period will continue to depend to a significant extent upon sales to a limited
number of customers. The volume 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 36% from $19.0 million in the six
months ended June 27, 1998 to $25.9 million for the comparable period in 1999.
Gross margin increased from 67.2% in the first half of 1998 to 67.8% in the
comparable period of 1999. The increase in cost of revenues is attributable to
the increase in sales volume.
ENGINEERING, RESEARCH AND DEVELOPMENT. Engineering, research and
development costs increased 58% from $11.4 million in the first half of 1998 to
$18.1 million for the comparable period in 1999. As a percentage of revenues,
these costs were 19.8% and 22.4%, 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
lessor extent, by increases in the consumption of prototype supplies and
materials.
SELLING AND MARKETING. Selling and marketing costs increased 21% from $10.0
million in the first half of 1998 to $12.1 million for the comparable period of
1999. As a percentage of revenues, these costs were 17.2% and 15.0%,
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, promotional activities and facility and office costs
related to the international offices established in 1998 and 1997.
GENERAL AND ADMINISTRATIVE. General and administrative costs increased 42%
from $5.9 million in the first half of 1998 to $8.3 million for the comparable
period in 1999. As a percentage of revenues, these costs were 10.1% and 10.3%,
respectively, in such periods. The increase in general and administrative costs
in absolute dollars was primarily attributable to an increase of approximately
$1.0 million in expenses related to the Company's patent infringement lawsuit
against Cisco Systems, Inc. (See Part II, Item 1, Legal Proceedings). In
addition the increase resulted from expenses related to bad debt expense and
amortization of goodwill as well as professional fees associated with recruiting
and acquisition activities
MERGER RELATED COSTS. During the second quarter of 1999, the Company
incurred one-time charges for merger related costs of approximately $2.1 million
in connection with the acquisition of RAScom, Inc. Merger related costs
primarily relate to professional services expenses incurred in connection with
the acquisition including approximately $1.0 million for investment banking
advisory services and approximately $730,000 for legal and accounting fees.
OTHER INCOME. Other income decreased 21% from $3.2 million in the first
half of 1998 to $2.5 million for the comparable period in 1999. This decrease
was primarily attributable to the interest expense associated with $8.2 million
of acquisition-related debt issued in 1998. In addition, interest income
decreased from the prior period as a result of decreases in the previous 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 approximately 37.6 % and 41.0 % for the first half of
1998 and 1999, respectively.
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The increase is effective tax rates is primarily attributable to non-deductible
merger related costs incurred during the quarter.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1999, the Company's principal sources of liquidity consisted
its working capital of approximately $145.0 million, including cash, cash
equivalents and marketable securities of approximately $114.7 million, and $15.0
million of funds available under a bank line of credit. At March 31, 1999, the
Company had working capital of approximately $136.8 million and $126.4 million
invested in cash, cash equivalents and marketable securities.
Net cash provided by operations for the six months ended June 27, 1998 and
June 30, 1999 totaled $11.5 million and $803,000, 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 of non-qualified stock options.
During the first half of 1999, the Company's accounts receivable increased
$16.3 million from December 31, 1998. Management believes this increase is 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 require longer payment terms than the Company
historically has extended to its established customer base. During the first six
months of 1999, the Company introduced several component cards and began
providing additional peripheral host-computer equipment which necessitated an
increase in required inventory levels. In addition, the timing of the purchase
and receipts of materials to meet expected demand contributed to this increase.
The Company expects these trends to continue as it seeks to increase revenues
and further expand its business internationally and with network service
providers.
Net cash provided by investing activities totaled $15.4 million for the six
months ended June 27, 1998 as compared to a net use of $33.8 million for the six
months ended June 30, 1999. The decrease primarily relates to an increase in the
dollar amount of investments purchased in 1999 with maturity dates of ninety-one
days or greater.
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 existing unsecured bank line of credit arrangement was
amended to extend the expiration date by 90 days to September 30, 1999. Prior to
its expiration,
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management anticipates entering into a similar new or amended agreement.
Management is presently negotiating a possible extension of this agreement and
believes that such an extension will be finalized prior to the expiration of the
credit agreement.
The Company believes that available cash and investments and cash funds
generated from operations will be sufficient to meet the Company's anticipated
cash requirements for working capital and capital expenditures for at least the
next eighteen months.
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. 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. The
Company found no discrepancies with Y2K or leap year date processing during its
internal testing. Excel also 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
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was completed during the second quarter of 1999. Minor issues were identified
and communicated to affected customers. DOS-based ADS customers have been
encouraged to migrate to the NT-based version of ADS.
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.
Excel's programmable switches are controlled by a host computer and are
typically integrated into telecommunication applications by application
developers, original equipment manufacturers and system integrators or other
third parties. Excel makes no representation regarding the Y2K compliance of any
host equipment or application not provided by Excel.
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
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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 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.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Statements contained in this Quarterly Report on Form 10-Q that are not
historical fact may constitute forward-looking statements and are made under the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
The Company's actual results of operations and financial condition may in the
future vary significantly from those stated in any forward-looking statements.
Factors that may cause such differences include, but are not limited to, the
risks, uncertainties and other information discussed within this Quarterly
Report on Form 10-Q and other risks identified in the Company's Securities and
Exchange Commission filings, including those risks identified in the Company's
Annual Report for the fiscal year ended December 31, 1998 on Form 10-K, the
Company's quarterly report on Form 10-Q for the three months ended March 31,
1999, the Company's report on Form 8-K, dated May 10, 1999 and filed with the
Commission on May 25, 1999 and as amended by the Company's Report on Form 8-K/A,
dated May 10, 1999 and filed with the Commission on July 23, 1999, and as
further amended by the Company's Report on Form 8-K/A dated May 10, 1999 and
filed with the Commission on July 29, 1999.
The following discussion of the Company's risk factors should be read in
conjunction with the consolidated financial statements and related notes thereto
set forth elsewhere in this report and in the Company's Report on Form 8-K/A,
dated May 10, 1999 and filed with the Commission on July 23, 1999 and as further
amended by the Company's Report on Form 8-K/A dated May 10, 1999 and filed with
the Commission on July 29, 1999. The following factors, among others, could
cause actual results to differ materially from those set forth in
forward-looking statements contained or incorporated by reference in this report
and presented by management from time to time. Such factors, among others, may
have a material adverse effect upon the Company's business, results of
operations and financial condition:
FLUCTUATIONS IN RESULTS OF OPERATIONS. The Company's results of operations have
varied significantly in the past and may vary significantly in the future, on a
quarterly and annual basis, as a result of a variety of factors, many of which
are outside the Company's control. These factors include, without limitation:
(i) the timing and size of orders which are received and can be shipped in any
particular period; (ii) the commercial success of the Company's products; (iii)
delays in the introduction of products or product enhancements by the Company
and the
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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
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.
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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 July 1999, Excel acquired certain technology
and assets. 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 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 assurance 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 with 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.
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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 and six months ended June 30, 1999,
the Company's five largest customers accounted for approximately 32% and 26%,
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. 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
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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 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
23
<PAGE>
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 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 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.
24
<PAGE>
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
25
<PAGE>
Company has not experienced shortages and allocations of these components to
date, any shortages in the future, including those occasioned by increased
sales, could result in delays in fulfillment of customer orders. Such delays,
shortages and allocations could have a material adverse effect on the Company's
business, financial condition and results of operations.
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
26
<PAGE>
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 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
27
<PAGE>
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. During 1999, direct sales to
customers located outside of the United States accounted for approximately 10%
to 30% of the Company's quarterly 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 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
28
<PAGE>
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
29
<PAGE>
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 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
30
<PAGE>
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Reference is also being made to the disclosure in Part II, Item 7A, entitled
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK of the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1998 and the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1999.
The Company, in the normal course of business, is subject to the risks
associated with fluctuations in interest rates and changes in foreign currency
exchange rates.
INTEREST AND MARKET RISK. The Company maintains a portfolio of marketable,
primarily fixed income, available-for-sale securities of various issuers, types
and maturities. The Company has not used derivative financial instruments in its
investment portfolio. The Company attempts to limits its exposure to interest
rate and credit risk by placing its investments with high-quality financial
institutions and has established investment guidelines relative to
diversification and maturities designed to maintain safety and liquidation.
Investments in both fixed rate and floating rate interest earning
instruments carry a degree of interest rate risk. Fixed rate securities may have
their fair market value adversely impacted due to a rise in interest rates,
while floating rate securities may produce less income than expected if interest
rates decline. Due in part to these factors, the Company's future investment
income may fall short of expectations due to changes in interest rates or the
Company may suffer losses in principal if forced to sell securities which have
seen a decline in market value due to changes in interest rates. The fair market
value of investment securities held at June 30, 1999 was $112.0 million,
including unrealized losses of approximately $53,000. The Company's investment
portfolio has not changed significantly since December 31, 1998. The weighted
average interest rate of the investment portfolio at December 31, 1998 and
June 30, 1999 was approximately 5.1%.
The Company's existing debt obligations are at fixed interest rates and
therefore will not be affected by changes in market interest rates. Under the
Company's line-of-credit arrangement with a bank, borrowings may bear interest
at either the bank's base rate or the Eurodollar rate plus 1.75%. At June 30,
1998, no amounts were outstanding under this line. Any interest which may in the
future become payable on the line-of-credit will be based upon variable interest
rates and will therefore be affected by changes in market interest rates.
FOREIGN CURRENCY RISK. To date, the Company's exposure to foreign currency
fluctuations has been minimal. Significantly all sales transactions are
denominated in US dollars. Letters of credit are utilized when warranted. The
Company funds its international operations from US dollar bank accounts on an
as-needed basis and, accordingly, does not maintain a significant amount of
funds in foreign currencies. Presently, the Company does not hedge foreign
currency exposure for its non-US dollar denominated operating expenses as such
amounts have not been material in relation to the Company's domestic operating
expenses.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See the disclosure contained in Part II, Item 1 entitled "Legal
Proceedings" in the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999 as filed with the Commission on May 18, 1999.
ITEM 3. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) None.
(b) None.
(c) On May 10, 1999, the Company acquired all of the outstanding capital stock
of RAScom, Inc., a Delaware corporation. In connection with this
acquisition, an aggregate of 1,099,940 shares of Excel's common stock, $.01
par value, (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 (the "Shares") 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 (the
"Option Shares") in exchange for their options to purchase capital stock of
RAScom.
The Shares were issued in reliance upon an exemption from the registration
provisions of the Securities Act of 1933, as amended (the "Act"), set
forth in Section 4(2) thereof and Rule 506 of Regulation D of the General
Rules and Regulations under the Act promulgated by the Securities and
Exchange Commission ("Regulation D"). After distribution and review of
an investor questionnaire, the Company reasonably believes that there were
less than 35 purchasers of the Shares calculated in accordance with Rules
501(e) and 502(a) of Regulation D. In connection with the issuances of the
Shares, the former stockholders of RAScom made certain representations to
the Company as to their investment intent and possessed a sufficient level
of sophistication and access to information. The Shares are subject to
restrictions on transfer absent registration under the Act or exemption
therefrom.
The Company received no proceeds from the issuance of the Shares.
Option Shares amounting to, in the aggregate, 68,501 were registered with
the Commission pursuant to a Form S-8 filed with the Commission on May 24,
1999 and a Form S-8 filed with the Commission on July 23, 1999.
For the three month period ended June 30, 1999, Option Shares amounting
to, in the aggregate, 4,759 were exercised prior to their registration.
Net proceeds to the Company from such exercise, amounted to, in the
aggregate approximately $17,683. The exercise price for the Option Shares
ranged from $2.24 to $6.74 per share of Common Stock. The Company intends
on registering these shares on a Form S-3.
The remaining Option Shares are unregistered, and unless cancelled, upon
their exercise will be converted into unregistered stock of the
Registrant.
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(d) None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) On May 14, 1999, the Company held its 1999 Annual Meeting of Stockholders.
(b) At such meeting, the following nominees and current board members, Robert
P. Madonna, Christopher Stavros, Edward L. Breslow and John Loughlin, were
re-elected to the Board of Directors to hold office until the next Annual
Meeting of Stockholders and until their successors have been duly elected and
qualified or until their earlier resignation or removal.
(c) At the meeting, the stockholders of the Company voted:
(1) To fix the number of directors at four (4) and to elect a Board of
Directors to serve for the ensuing year or until their respective
successors are elected and qualified or until their earlier resignation or
removal. The votes cast were as follows:
<TABLE>
<CAPTION>
BROKER
VOTES VOTES VOTES VOTES NON-
FOR AGAINST WITHHELD ABSTAINED VOTES
----- ------- -------- --------- ------
<S> <C> <C> <C> <C> <C>
Edward L. Breslow 33,950,459 N/A 30,239 N/A N/A
John Loughlin 33,951,059 N/A 29,639 N/A N/A
Robert P. Madonna 33,925,959 N/A 54,739 N/A N/A
Christopher Stavros 33,925,659 N/A 55,039 N/A N/A
</TABLE>
(2) To approve and ratify the Company's Amended and Restated 1997 Stock
Option Plan (the "1997 Plan") which, among other things, (a) increases the
number of shares of Common Stock available under the 1997 Plan from
3,000,000 to 5,000,000 shares, and (b) provides the opportunity for
non-employee directors to participate in the 1997 Plan. The votes cast were
as follows:
<TABLE>
<CAPTION>
BROKER
VOTES VOTES VOTES VOTES NON-
FOR AGAINST WITHHELD ABSTAINED VOTES
----- ------- -------- --------- ------
<S> <C> <C> <C> <C> <C>
Amended and Restated
1997 Stock Option Plan 28,184,590 5,085,734 N/A 9,060 701,314
Ratification
</TABLE>
(3) To approve and ratify the Company's Amended and Restated 1997
Non-Employee Director Stock Option Plan (the "Director Plan") which, among
other things, (a) provides
33
<PAGE>
for the immediate termination of both the initial grant of options to
purchase 30,000 shares of Common Stock upon joining the Board of Directors
and the automatic grant of options to purchase an additional 15,000 shares
of Common Stock on each of the following two anniversary dates thereof, and
(b) commencing January 1, 2000, provides for the automatic grant to each
non-employee director of fully vested options to purchase 1,250 shares of
Common Stock once each quarter provided that such director has been a
member of the Board for at least one year. The votes cast were as follows:
<TABLE>
<CAPTION>
BROKER
VOTES VOTES VOTES VOTES NON-
FOR AGAINST WITHHELD ABSTAINED VOTES
----- ------- -------- --------- ------
<S> <C> <C> <C> <C> <C>
Amended and Restated
1997 Non-Employee
Director Stock Option 33,696,420 272,708 N/A 11,570 N/A
Plan Ratification
</TABLE>
(4) To ratify the selection of Arthur Andersen LLP, as independent auditors
for the fiscal year ending December 31, 1999. The votes cast were as
follows:
<TABLE>
<CAPTION>
BROKER
VOTES VOTES VOTES VOTES NON-
FOR AGAINST WITHHELD ABSTAINED VOTES
----- ------- -------- --------- ------
<S> <C> <C> <C> <C> <C>
Arthur Andersen LLP 33,965,677 11,651 N/A 3,370 N/A
Ratification
</TABLE>
(d) N/A
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) 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).
34
<PAGE>
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).
3.1 Restated Articles of Organization of the Registrant (previously filed
as Exhibit 3.1 to the Registrant's Registration Statement on Form
S-1 (Registration No. 333-35791) and incorporated herein by
reference).
3.2 Restated By-Laws of the Registrant (previously filed as Exhibit 3.2 to
the Registrant's Annual Report on Form 10-K on March 31, 1999 and
incorporated herein 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 (previously 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 (previously 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 (previously 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).
10.9 Amendment No. 2 to Loan Agreement with BankBoston, N.A. dated June 29,
1999 (filed herewith).
10.10 Amendment No. 1 dated as of July 9, 1999 to Vendor Program Agreement
dated as of March 30, 1999 with NationsCredit Commercial Corporation
(filed herewith).
27 Financial Data Schedule (EDGAR) (filed herewith).
35
<PAGE>
(b) Reports on Form 8-K
1) Current Report on Form 8-K dated May 10, 1999 and filed with the
Commission on May 25, 1999 which details the acquisition of RAScom, Inc.
completed on May 10, 1999.
2) Amendment No. 1 to the Current Report on Form 8-K dated May 10, 1999
and filed with the Commission on Form 8-K/A on July 23, 1999. This report
contains the Consolidated Financial Statements of RAScom, Inc. and
Subsidiary as of December 31, 1998; the unaudited the Consolidated
Financial Statements of RAScom, Inc. and Subsidiary as of March 31, 1999;
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. These Supplemental Consolidated
Financial Statements of Excel reflect the combined operations of Excel
and RAScom as if the two entities had operated as one since inception.
3) Amendment No. 2 to the Current Report on Form 8-K dated May 10, 1999
and filed with the Commission on Form 8-K/A on July 29, 1999. This report
contains the Unaudited Supplemental Quarterly Consolidated Statements of
Income for Excel Switching Corporation for each of the four fiscal quarters
for the fiscal year ended December 31, 1998. These unaudited Quarterly
Consolidated Statements of Income reflect the combined operations of
Excel and RAScom as if the two entities had operated as one since
inception.
36
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Excel Switching Corporation
(Registrant)
Dated: August 16, 1999 /S/ ROBERT P. MADONNA
---------------------
Robert P. Madonna
President, Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
Dated: August 16, 1999 /S/ STEPHEN S. GALLIKER
-----------------------
Stephen S. Galliker
Vice President, Finance and Administration
and Chief Financial Officer (Principal
Financial and Accounting Officer)
37
<PAGE>
EXHIBIT INDEX
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).
3.1 Restated Articles of Organization of the Registrant (previously filed
as Exhibit 3.1 to the Registrant's Registration Statement on Form
S-1 (Registration No. 333-35791) and incorporated herein by
reference).
3.2 Restated By-Laws of the Registrant (previously filed as Exhibit 3.2 to
the Registrant's Annual Report on Form 10-K on March 31, 1999 and
incorporated herein 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 (previously 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 (previously 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 (previously 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).
10.9 Amendment No. 2 to Loan Agreement with BankBoston, N.A. dated June 29,
1999 (filed herewith).
10.10 Amendment No. 1 dated as of July 9, 1999 to Vendor Program Agreement
dated as of March 30, 1999 with NationsCredit Commercial Corporation
(filed herewith).
27 Financial Data Schedule (EDGAR) (filed herewith).
38
<PAGE>
Exhibit 10.9
EXCEL SWITCHING CORPORATION (f/k/a Excel, Inc.)
255 Independence Drive
Hyannis, Massachusetts 02601
Dated as of: June 29, 1999
BankBoston, N.A.,
(f/k/a The First National Bank of Boston)
100 Federal Street
Boston, Massachusetts 02110
Re: AMENDMENT NO. 2 TO LOAN AGREEMENT
Ladies and Gentlemen:
We refer to the Loan Agreement, dated as of December 21, 1995 (as amended,
the "Agreement"), between Excel Switching Corporation (f/k/a Excel, Inc.), a
Massachusetts corporation (the "Borrower"), and BankBoston, N.A. (f/k/a The
First National Bank of Boston), a national banking association (the "Lender").
Terms used in this letter of agreement (this "Amendment") which are not
defined herein, but which are defined in the Agreement, shall have the same
respective meanings herein as therein.
We have requested that you make certain amendments to the Agreement. You
have advised us that you are prepared and would be pleased to make the
amendments so requested by us on the condition that we join with you in this
Amendment.
Accordingly, in consideration of these premises, the promises, mutual
covenants and agreements contained in this Amendment, and fully intending to be
legally bound by this Amendment, we hereby agree with you as follows:
ARTICLE I
AMENDMENTS TO AGREEMENT
Effective June 29, 1999, the Agreement is amended as follows:
(a) The definition of "Revolving Credit Termination Date" in Section 1.1
of the Agreement is amended to read in its entirety as follows:
-1-
<PAGE>
"Revolving Credit Termination Date: September 30, 1999".
(b) Section 2.4(a) of the Agreement is amended by deleting the reference
to "June 30, 1999" contained therein, and by inserting in place thereof the
following:
"September 30, 1999".
(c) Section 2.3 of the Agreement is amended to read in its entirety as
follows:
"2.3 FACILITY FEE. The Company shall pay to the Bank during the
Revolving Credit Period an annual facility fee, payable quarterly in
advance on the first Business Day of each quarter, equal to 1/5% per
annum of the Commitment Amount then in effect."
ARTICLE II
AMENDMENT TO NOTE
Effective June 29, 1999, the Note is amended by deleting each reference to
the maturity date of "June 30, 1999" contained therein and by inserting a
reference to "September 30, 1999" in place thereof.
ARTICLE III
REPRESENTATIONS AND WARRANTIES
The Borrower represents and warrants to you as follows:
(a) REPRESENTATIONS IN AGREEMENT. Each of the representations and
warranties made by the Borrower to you in the Agreement was true, correct and
complete when made and is true, correct and complete on and as of the date
hereof with the same full force and effect as if each of such representations
and warranties had been made by the Borrower on the date hereof and in this
Amendment.
(b) NO DEFAULTS OR EVENTS OF DEFAULT. No default or Event of Default
exists on the date of this Amendment (after giving effect to all of the
arrangements and transactions contemplated by this Amendment).
(c) BINDING EFFECT OF DOCUMENTS. This Amendment has been duly authorized,
executed and delivered to you by the Borrower and is in full force and effect as
of the date hereof, and the agreements and obligations of the Borrower contained
herein constitute legal, valid and binding obligations of the Borrower
enforceable against the Borrower in accordance with its terms.
-2-
<PAGE>
ARTICLE IV
MISCELLANEOUS
This Amendment may be executed in any number of counterparts, each of which
when executed and delivered shall be deemed an original, but all of which
together shall constitute one instrument. In making proof of this Amendment, it
shall not be necessary to produce or account for more than one counterpart
thereof signed by each of the parties hereto. Except to the extent specifically
amended and supplemented hereby, all of the terms, conditions and the provisions
of the Agreement, the Note and each of the other documents and agreements
executed in connection therewith shall remain unmodified, and the Agreement, the
Note and each of the other documents, as amended and supplemented by this
Amendment, are confirmed as being in full force and effect.
If you are in agreement with the foregoing, please sign the form of
acceptance on the enclosed counterpart of this Amendment and return such
counterpart to the undersigned, whereupon this Amendment, as so accepted by you,
shall become a binding agreement between you and the undersigned.
Very truly yours,
EXCEL SWITCHING CORPORATION
(f/k/a EXCEL, INC.)
By: /S/ CHRISTOPHER STAVROS
-----------------------
Title: Vice President/General Counsel
The foregoing Amendment is hereby accepted by the undersigned as of June
29, 1999.
BANKBOSTON, N.A.,
(f/k/a THE FIRST NATIONAL BANK OF BOSTON)
By: /S/BRADFORD P. EGAN
-------------------
Title: Vice President
-3-
<PAGE>
EXHIBIT 10.10
AMENDMENT NO.1 TO
VENDOR PROGRAM AGREEMENT
(EXCEL)
This AMENDMENT NO. 1 ("Amendment") TO VENDOR PROGRAM AGREEMENT dated as of
March 30, 1999 is entered into as of July 9, 1999 between NATIONSCREDIT
COMMERCIAL CORPORATION ("NCC"), a Delaware corporation with its principal office
at 1355 Windward Concourse, Alpharetta, Georgia 30005, and EXCEL SWITCHING
CORPORATION ("Client"), a Delaware corporation, with its principal office at 255
Independence Drive, Hyannis, Massachusetts 03601.
RECITALS
A. Client and NCC executed and delivered a certain Vendor Program Agreement
dated as of March ___, 1999 hereinafter referred to as the "Program Agreement",
which provides for the financing by NCC of certain Contracts, Equipment and
Payments upon the terms and conditions contained therein.
B. Client has requested that NCC amend the Program Agreement to clarify certain
sections of the Program Agreement dealing with loss pools, repurchase of
equipment and remarketing].
C. Client and NCC each desire to amend the Program Agreement as provided herein.
NOW THEREFORE, in consideration of the mutual covenants contained herein, the
parties hereby agree as follows:
ARTICLE 1 - AMENDMENTS
The Program Agreement is hereby amended as follows:
1.1 Add a new definition to the Definitions Section of the Program Agreement as
follows:
"FULL RECOURSE CONTRACT" has the meaning set forth in Section 8(e).
1.2 Section 8 of the Program Agreement is hereby amended and restated to read in
full as follows:
8. ULTIMATE NET. LOSS LIMIT; FULL RECOURSE CONTRACTS.
<PAGE>
(a) The aggregate Net Loss incurred by Client pursuant to Section 7 with
respect to Contracts funded by NCC on any date of calculation shall not exceed
an amount ("Ultimate Net Loss Limit") equal to the greater of (A) $1,000,000 or
(B) 20% of the aggregate outstanding Net Book Value of all other Contracts
funded by NCC through such date, excluding from such calculations, however, any
Contracts designated as Full Recourse Contras as defined in Section 8(e) below.
(b) As used herein, "NET LOSS" means, with respect to any Contract, the sum
of (i) all payments made by Client to NCC to repurchase such Contract, plus (ii)
any cure payments made by Client to NCC with respect to such Contract, minus
(iii) the total amount realized by Client (net of reasonable expenses) upon the
liquidation or disposition of such Contract and the related Equipment, including
recoveries from any Customer and from the sale, lease or other disposition of
the Equipment. In computing Net Loss, amounts paid by Client with respect to a
Contract may only be included if Client shall have Remarketed the related
Equipment within 180 days following the date on which NCC requested repurchase
of the Contract.
(c) Client shall keep records with respect to each Contract that it
repurchases from NCC, showing amounts paid by Client to NCC with respect to such
Contract, amounts realized by it from the liquidation of Equipment, amounts
otherwise recovered and costs of recovery. Upon request, Client will furnish a
written report to NCC, within 10 days after the request, showing such amounts
for any or all Contracts. NCC shall be entitled, on reasonable notice and at
reasonable times, to audit such records of Client.
(d) Client may not, without the prior written consent of NCC (which shall
not be unreasonably withheld and subject to Section 10(e) hereof), sell any
Equipment for a price less than the Net Book Value of such Contract, or
compromise or settle the amount owing on any repurchased Contract for an amount
less than the Net Book Value thereof.
(e) Certain Contracts proposed for funding under this Agreement which do
not meet NCC's credit criteria may nevertheless be approved by NCC if so
requested by Client in an Application, and if so designated by NCC in its sole
discretion in its approval of the Application, with full recourse to Client
("Full Recourse Contracts"); provided that the total aggregate Funded Amount for
all Full Recourse Contracts outstanding at any one time shall not exceed
$___________. NCC and Client agree that NCC will periodically review this amount
and that NCC may change such limit effective upon notice to Client. If a Full
Recourse Contract sustains any default or event of default, Client agrees to pay
NCC its Net Book Value applicable to such Contract within 10 Business Days after
NCC makes demand therefor.
1.2 Section 9 of the Program Agreement is hereby amended and restated to read in
full as follows:
(c) If (i) Client breaches any representation, warranty or covenant or
fails to perform its obligations in this Agreement, or any related instrument or
agreement, (ii) any Customer returns or fails to accept any Equipment for any
reason, (iii) any Customer fails to make its first rental payment following
NCC's funding of a Contract, or (iv) any
<PAGE>
Customer fails to make payments under any Contract alleging action or inaction
(including breach of any agreement or warranty) on the part of Client, then NCC
may require that Client repurchase the affected Contract(s) and NCC's rights
respecting the applicable Equipment for the Net Book Value thereof; PROVIDED
THAT if a Customer claims a breach of warranty by Client, Client will notify NCC
of such claim, Client and NCC will investigate such claim for a period not to
exceed 90 days to determine whether in fact a breach of warranty has occurred
and NCC will not make a demand for repurchase on such grounds until the earlier
of the expiration of the 90-day period or the date on which the investigation is
completed and determines that such claim is justified. Subject to the proviso in
the previous sentence, any repurchase under this shall occur within 10 Business
Days after NCC makes demand therefor.
1.3 Section 10(a) of the Program Agreement is hereby amended and restated to
read in full as follows:
(a) Client will, at the request of NCC, assist NCC in Remarketing any
Equipment returned to or repossessed by NCC, whether due to expiration of a
Lease, default under a Contract, early or scheduled termination of a Lease,
voluntary return of Equipment, or otherwise (such Equipment being "OFF-LEASE").
Remarketing shall be performed as provided below. Client shall not discriminate
against (but shall not be required to give priority to) Equipment being
Remarketed hereunder in favor or to the detriment of any other used equipment
owned, managed, sold or remarketed by Client.
1.4 Section 10(e) of the Program Agreement is hereby amended and restated to
read in full as follows:
(e) In establishing rental or sales rates for the Remarketing of any
Equipment, Client shall apply rates that, in its best commercial judgment, are
the most favorable rates obtainable for equipment of such types. Client shall
not offer credits or discounts without NCC's prior approval. Client will
promptly identify to NCC any prospective lessees or purchasers of any Equipment,
and will promptly transmit any proposed lease, renewal, extension or sales
contract relating to Equipment and any related materials. Client shall use its
best efforts to provide NCC with such credit information as NCC may request with
respect to any prospective lessee or purchaser, but it is understood that such
information is provided without warranty by Client as to accuracy or
completeness. NCC may approve the Customer, price, terms and conditions of any
Remarketing transaction in NCC's sole discretion, and Client will not consummate
any transaction unless it is approved; PROVIDED THAT after Client has presented
and NCC has rejected two bona fide offers to purchase particular Equipment, NCC
may not thereafter unreasonably withhold its approval of any subsequent bona
fide offers to purchase such Equipment. "Bona fide offer" as used in this
subsection (e) means any offer in writing from a third party unaffiliated with
Client consistent with past sales of like kind equipment, if any. If NCC
approves of a transaction it will notify Client in writing of the approval.
NCC's failure to notify Client of approval within five Business Days after
receipt of complete credit and other information will constitute rejection. NCC
will, concurrently, use its reasonable efforts to remarket any Off-Lease
Equipment.
<PAGE>
ARTICLE 2 - REPRESENTATIONS AND WARRANTIES
2.1 Client and NCC each hereby represent and warrant to one another that the
execution and delivery of this Amendment and compliance by Client and NCC,
respectively, with all of the provisions of this Amendment (a) are within the
powers and purposes of such corporation; (b) have been duly authorized or
approved by such corporation; and (c) when executed and delivered by or on
behalf of Client and NCC, respectively, will constitute valid and binding
obligations of each, enforceable in accordance with its terms. Client and NCC
each reaffirms all of its obligations under the Program Agreement, amended to
date and by this Amendment.
ARTICLE 3 - GENERAL PROVISIONS
3.1 Except as specifically modified by this Amendment, all terms and
provisions of the Program Agreement shall remain unmodified and in full force
and effect. Nothing contained in this Amendment shall in any way impair the
validity or enforceability of the Program Agreement, as modified hereby, or
alter, waive, annul, vary, affect, or impair any provision, condition, or
covenant therein or any rights, power, or remedy granted therein.
3.2 Each party hereto has cooperated in the drafting and preparation of
this Amendment, and, as a result, this Amendment shall not be construed against
any party. This Amendment may be amended or modified only by a written agreement
signed by the parties hereto. This Amendment may be executed in counterparts.
3.3 Unless specifically defined herein, all capitalized terms shall be
defined in accordance with the Program Agreement.
3.4 To the extent that any provision of this Amendment is not enforceable
under applicable law, such provision shall be deemed null and void and shall
have no effect on the remaining portions of the Amendment or Program Agreement.
3.5 This Amendment, and all other agreements referred to herein or
delivered in connection herewith, shall constitute the entire agreement between
the parties relating to the subject matter hereof, and shall rescind all prior
agreements and understandings between the parties hereto relating to the subject
matters hereof.
IN WITNESS WHEREOF, the parties have executed this Amendment as of the date
first written above.
EXCEL SWITCHING CORPORATION NATIONSCREDIT COMMERCIAL
CORPORATION
By /s/ Stephen S. Galliker By /s/ William P. Gmaz
---------------------------- ----------------------------
Its Chief Financial Officer Its Senior Vice President
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Excel Switching Corporation's Consolidated Condensed Financial Statements
for the periods ending June 30, 1999 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1999
<PERIOD-START> APR-01-1999 JAN-01-1999
<PERIOD-END> JUN-30-1999 JUN-30-1999
<CASH> 32940 0
<SECURITIES> 81716 0
<RECEIVABLES> 47749 0
<ALLOWANCES> (2728) 0
<INVENTORY> 12822 0
<CURRENT-ASSETS> 187839 0
<PP&E> 24747 0
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 230582 0
<CURRENT-LIABILITIES> 42866 0
<BONDS> 3958 0
0 0
0 0
<COMMON> 366 0
<OTHER-SE> 183392 0
<TOTAL-LIABILITY-AND-EQUITY> 230752 0
<SALES> 43218 80558
<TOTAL-REVENUES> 43218 80558
<CGS> 13689 25906
<TOTAL-COSTS> 13689 25906
<OTHER-EXPENSES> 22854 40580
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> (1306) (2514)
<INCOME-PRETAX> 7981 14072
<INCOME-TAX> 3661 6796
<INCOME-CONTINUING> 4320 9790
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 4320 9790
<EPS-BASIC> .12 .26
<EPS-DILUTED> .10 .24
</TABLE>
