<PAGE> 1
QUARTER 3-FY 1996
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
(Mark One)
{X} QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended MAY 26, 1996
------------
OR
{ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-12622
-------
TELCO SYSTEMS, INC.
-------------------
(Exact name of registrant as specified in its charter)
Delaware 94-217877
------------------------------ ------------------------
(State or other jurisdiction (I.R.S. employer
incorporation or organization) identification no.)
63 NAHATAN STREET, NORWOOD, MASSACHUSETTS 02062
-----------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (617) 551-0300
--------------
NO CHANGE
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if change since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
---- ----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Classes Outstanding at July 2, 1996
- ----------------------------------- ---------------------------------
Common Stock, $.01 par value 10,531,275
1
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TELCO SYSTEMS, INC.
INDEX
REPORT ON FORM 10-Q
FOR QUARTER ENDED MAY 26, 1996
Page Number
-----------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
------- --------------------
Consolidated Balance Sheets
May 26, 1996 and August 27, 1995 3
Consolidated Statements of Operations
Three months and nine months ended May 26, 1996
and May 28, 1996 4
Consolidated Statements of Cash Flows
Nine months ended May 26, 1996
and May 28, 1995 5
Notes to Consolidated Financial Statements 6-7
Item 2. Management's Discussion and Analysis of
------- Financial Condition and Results of Operations 8-10
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 11
-----------------------------------------
SIGNATURE(S) 12
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
- -----------------------------
<TABLE>
TELCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<CAPTION>
May 26, 1996 August 27, 1995
------------ ---------------
<S> <C> <C>
Assets
- ------
Current assets:
Cash and equivalents ................................. $ 11,423 $18,208
Short-term investments ............................... 7,504 10,895
Accounts receivable, net ............................. 14,169 10,047
Refundable income taxes .............................. 848 1,251
Inventories, net ..................................... 18,671 18,473
Other current assets ................................. 1,871 2,585
-------- -------
Total current assets ............................. 54,486 61,459
-------- -------
Plant and equipment, at cost ........................... 46,253 41,720
Less accumulated depreciation ........................ 33,641 31,114
-------- -------
Net plant and equipment ........................... 12,612 10,606
Intangible and other assets, net ....................... 9,074 10,374
-------- -------
Total assets ...................................... $ 76,172 $82,439
======== =======
Liabilities and Shareholders' Equity
- ------------------------------------
Current liabilities:
Accounts payable ..................................... $ 9,119 $ 3,952
Payroll and related liabilities ...................... 2,297 2,628
Other accrued liabilities ............................ 8,632 4,964
-------- -------
Total current liabilities ......................... 20,048 11,544
-------- -------
Restructuring and other long-term liabilities .......... 3,939 3,490
Shareholders' Equity:
Preferred stock, $.01 par value, 5,000,000
shares authorized; no shares outstanding .......... -- --
Common stock, $.01 par value, 24,000,000
shares authorized; shares outstanding
10,482,078 at May 26, 1996;
10,230,624 at August 27, 1995 ..................... 105 102
Capital in excess of par value ....................... 73,942 71,566
Accumulated deficit .................................. (21,016) (4,263)
Unearned compensation - restricted stock ............. (846) --
-------- -------
Total shareholders' equity ........................ 52,185 67,405
-------- -------
Total liabilities and shareholders' equity ... $ 76,172 $82,439
======== =======
</TABLE>
See accompanying notes to consolidated financial statements
3
<PAGE> 4
<TABLE>
TELCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
May 26, May 28, May 26, May 28,
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Sales:
Broadband transmission products ............ $ 11,508 $ 8,631 $ 33,352 $27,665
Network access products .................... 10,360 10,811 26,983 37,704
Bandwidth optimization products ............ 1,355 1,214 3,998 4,381
-------- ------- -------- -------
23,223 20,656 64,333 69,750
-------- ------- -------- -------
Cost and expenses:
Cost of products sold ...................... 15,174 11,060 39,298 37,507
Research and development ................... 5,124 4,992 14,203 13,315
Sales, marketing and administration ........ 9,779 5,930 23,284 17,439
Restructuring costs ........................ 4,659 -- 4,659 --
Amortization of intangible assets .......... 196 196 586 582
Interest income ............................ (255) (457) (944) (1,202)
-------- ------- -------- -------
34,677 21,721 81,086 67,641
-------- ------- -------- -------
(Loss) income before income taxes ............ (11,454) (1,065) (16,753) 2,109
Income tax (benefit) provision ............... -- (125) -- 250
-------- ------- -------- -------
Net (loss) income ............................ $(11,454) $ (940) $(16,753) $ 1,859
======== ======= ======== =======
Average shares and equivalents (thousands) ... 10,408 10,098 10,316 10,329
(Loss) earnings per share .................... $ (1.10) $ (.09) $ (1.62) $ .18
</TABLE>
See accompanying notes to consolidated financial statements.
4
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<TABLE>
TELCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<CAPTION>
Nine months ended
-----------------
May 26, 1996 May 28, 1995
------------ ------------
<S> <C> <C>
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
Cash flows from operating activities:
Net (loss) income .................................... $(16,753) $ 1,859
Depreciation and amortization ........................ 4,360 4,278
Restructuring costs .................................. 4,659 --
Other non-operating items ............................ 177 --
Change in assets and liabilities:
Accounts receivable ............................... (4,122) 3,381
Refundable income tax ............................. 403 --
Inventories ....................................... (1,700) (4,112)
Other current assets .............................. 714 (570)
Intangible and other assets ....................... 24 (923)
Accounts payable and other current liabilities .... 7,234 (4,135)
Restructuring liabilities ......................... (301) --
Long-term liabilities ............................. (599) (845)
-------- --------
Net cash used in operating activities ................ (5,904) (1,067)
-------- --------
Cash flows from investing activities:
Additions to plant and equipment, net ................ (5,627) (2,011)
Purchase of short-term investments ................... (19,225) (12,567)
Maturities of short-term investments ................. 22,616 12,989
-------- --------
Net cash used in investing activities ................ (2,236) (1,589)
-------- --------
Cash flows from financing activities:
Proceeds from sale of common shares
under employee stock plans ........................ 1,355 4,514
-------- --------
Net cash provided by financing activities ............ 1,355 4,514
-------- --------
(Decrease) increase in cash and equivalents ............ (6,785) 1,858
Cash and equivalents at beginning of year .............. 18,208 15,262
-------- --------
Cash and equivalents at end of period .................. $ 11,423 $ 17,120
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
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TELCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR PERIOD ENDED MAY 26, 1996
(UNAUDITED)
Note 1 - The consolidated financial statements of Telco Systems, Inc. (the
Company) included in this report reflect all adjustments (consisting of only
normally recurring accruals) which, in the opinion of management, are necessary
for a fair presentation of the consolidated financial position at May 26, 1996
and the consolidated statements of operations and cash flows for the nine months
ended May 26, 1996 and May 28, 1995. The unaudited results of operations for the
interim periods reported are not necessarily indicative of results to be
expected for the year.
Certain notes and other information have been condensed or omitted from these
interim financial statements. The statements, therefore, should be read in
conjunction with the consolidated financial statements and related notes
included in the Telco Systems, Inc. Annual Report on Form 10-K for the year
ended August 27, 1995.
<TABLE>
<CAPTION>
Note 2 - Inventories, net (dollars in thousands) May 26, 1996 August 27, 1995
------------ ---------------
<S> <C> <C>
Raw materials .............................. $ 9,582 $ 9,101
Work-in-process ............................ 3,674 3,060
Finished goods ............................. 5,415 6,312
------- -------
$18,671 $18,473
======= =======
</TABLE>
<TABLE>
Note 3 - Shares Outstanding
<CAPTION>
Changes in shares outstanding: Nine months ended
-----------------
May 26, 1996 May 28, 1995
------------ ------------
<S> <C> <C>
Outstanding at beginning of period ......... 10,230,624 9,649,051
Options exercised ........................ 113,444 444,554
Restricted stock grants .................. 82,000 --
Employee stock purchase plan ............. 56,010 56,005
---------- ----------
Outstanding at end of period ............... 10,482,078 10,149,610
========== ==========
</TABLE>
Note 4 - Restricted Stock Grants
On February 15, 1996, 92,000 restricted shares of the Company's common stock
were granted and issued to certain key employees. Shares were awarded in the
name of each of the participants who have all the rights of other stockholders,
subject to certain restrictions and forfeiture provision. For the period ended
May 26, 1996, 10,000 shares were forfeited due to employee terminations.
Restrictions on the shares expire equally on the anniversary date of the award
over the next four years.
The market value of the shares awarded, $1,023,500, has been recorded as
unearned compensation - restricted stock and is shown as a separate component of
stockholder's equity. Unearned compensation is being amortized to expense over
the four year vesting period.
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Note 5. Restructuring Costs
In May 1996, the Company's management approved a plan to restructure its
operations. The Company recognized the following restructure charges for the
period ended May 26, 1996, as follows:
Excess facilities $2,225
Write-down of assets to net realizable value 2,039
Employee severance costs 1,034
Restructure credit relating to 1993 excess facilities costs (639)
------
$4,659
======
The Company has implemented a restructure plan in order to be able to better
respond to rapidly growing domestic and international markets. The plan included
identifying operational efficiencies while maintaining the Company's
long-standing reputation for service and quality. The primary operational
efficiency to be implemented is the consolidation and move of manufacturing
operations from the Company's Fremont, California site to the Norwood,
Massachusetts location by the end of calendar year 1996. The technology centers
of excellence will continue to be located both in Fremont and Norwood.
The reserve for excess facilities costs was established for future cash
expenditures relating to unoccupied space at the Company's Fremont facility
resulting from the manufacturing consolidation. These costs include primarily
lease payments, utilities, maintenance, property taxes and other related
expenses.
The reserve for asset write-downs includes inventory relating to management's
decision to discontinue the development of certain products and fixed asset
production tools specifically related to these product lines. Additionally, the
Company wrote off the unamortized goodwill for its Bandwidth bridge technology
because of changing technology within this product segment.
The reserve for employee severance costs includes charges relating to a staff
reduction of 28 employees resulting from cost containment measures including the
restructuring of the Engineering, Sales, Marketing and Administration
organizations as well as the decision to discontinue the development of certain
products. In addition, the reserve consists of severance costs to be paid to
approximately 50 employees at the Fremont site whose positions will be
eliminated upon the consolidation of manufacturing operations in Norwood.
The credit relating to the 1993 restructure charge represents the net cash flows
to be received from a recently entered sublease which will absorb approximately
44% of the excess facility space reserved in fiscal 1993. As of May 26, 1996,
the remaining fiscal 1993 restructure reserve of $2.5 million was solely for the
remaining excess facility costs in Norwood.
During the quarter ended May 26, 1996, the actual cash payments related to the
1996 restructure amounted to $.3 million and were related to employee
termination costs. The Company expects that the restructuring actions will be
completed by the end of calendar 1996.
7
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w
PART I. FINANCIAL INFORMATION (CONTINUED)
<TABLE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth for the period indicated (i) percentages which certain items
reflected in the financial data bear to sales of the Company and (ii) the percent change of such
items as compared to the indicated prior period. See Consolidated Statements of Income.
<CAPTION>
Percentage of Sales Percentage Increase (Decrease)
------------------- ------------------------------
Third Quarter Nine Months Third Quarter Nine Months
1996 1995 1996 1995 1996 VS. 1995 1996 VS. 1995
---- ---- ---- ---- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Sales ................................... 100.0% 100.0% 100.0% 100.0% 12.4% (7.8%)
Costs and expenses:
Costs of products sold ................ 65.3% 53.6% 61.1% 53.8% 37.2% 4.8%
Research and development .............. 22.1% 24.2% 22.1% 19.1% 2.6% 6.7%
Sales, marketing and administration ... 42.1% 28.7% 36.2% 25.0% 64.9% 33.5%
Restructuring costs ................... 20.0% -- 7.2% -- -- --
Amortization of intangible assets ..... .8% .9% .9% .8% 0% .7%
Interest income ....................... (1.0%) (2.2%) (1.5%) (1.7%) (44.2%) (21.5%)
------ ------ ------ ------ ------- -------
Total costs and expenses ................ 149.3% 105.2% 126.0% 97.0% 59.6% 19.9%
------ ------ ------ ------ ------- -------
(Loss) income before income taxes ....... (49.3%) (5.2%) (26.0%) 3.0% 975.5% (894.0%)
Income tax (benefit) provision .......... -- (.6%) -- .4% (100.0%) (100.0%)
------ ------ ------ ------ ------- -------
Net (loss) income ....................... (49.3%) (4.6%) (26.0%) 2.6% 1118.5% (1001.2%)
------ ------ ------ ------ ------- -------
</TABLE>
8
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TELCO SYSTEMS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE AND NINE MONTH PERIODS ENDED MAY 26, 1996
SALES AND NET LOSS - Sales for the third quarter of fiscal 1996 increased 12% to
$23.2 million compared with $20.7 million in the third quarter of last year. The
increase was the result of higher third quarter order levels in both the
Broadband and Network access product areas. For the first nine months of fiscal
1996, sales amounted to $64.3 million, a decrease of 8% compared with the same
period last year. The year to date decrease resulted primarily from lower
shipments of network access products due to continued competitive pressure on
sales of certain older products. Sales of Broadband products to Regional Bell
Operating Companies (RBOCs) for the third quarter of fiscal 1996 and for the
nine month period amounted to 34% of total sales. For the same periods last
year, sales to RBOCs accounted for 26% of sales and 23% of sales, respectively.
The Company has no assurance that RBOC customers will continue to place orders
at recent levels, and any significant decline would adversely impact Company
financial results.
Net loss for the quarter was ($11.4) million or ($1.10) per share compared with
a net loss of ($.9) million or ($.09) per share in the third quarter of last
year. For the nine month period of fiscal 1996, the net loss was ($16.8) million
or ($1.62) per share compared with net income of $1.9 million or $.18 per share
for the comparable nine months period of last year. The net loss for the third
quarter partially resulted from the $4.7 million restructuring charge previously
discussed in Note 5. In addition, the third quarter included non-recurring
charges resulting from the transfer of manufacturing operations to Norwood,
inventory adjustments, consulting costs and employee relocation charges. The net
loss for the first nine months of fiscal 1996 resulted primarily from the third
quarter restructuring and non-recurring charges in addition to lower sales
volume of older network access products, increased spending on research and
development projects and selling and marketing activities.
COST OF PRODUCTS SOLD - Cost of products sold represented 65% of sales in the
third quarter of fiscal 1996. In the third quarter of fiscal 1995, cost of
products sold represented 54% of sales. For the nine month period, costs of
products sold represented 61% and 54% in 1996 and 1995, respectively. In the
third quarter of fiscal 1996, gross margins were adversely affected by
non-recurring inventory adjustments and by lower product margins on the inital
production for new network access products. For the first nine months of fiscal
1996, in addition to the above items, the increase in cost of products sold are
also related to lower absorption of fixed costs resulting from the lower
operating level and increased competitive pricing pressures on older network
access products.
RESEARCH AND DEVELOPMENT - Spending on research and development for both
broadband and network access products continued at a high level in the third
quarter of fiscal 1996, increasing 3% to $5.0 million compared with the third
quarter of fiscal 1995. For the first nine months of fiscal 1996, research and
development expense was $14.2 million, an increase of 7% over the comparable
period of fiscal 1995. These increases are due to higher spending for new
product development, feature additions to existing products and product
modification for international applications.
SALES, MARKETING AND ADMINISTRATION - Sales, marketing and administration
expense was $9.8 million and $23.3 million for the third quarter and first nine
months of fiscal 1996, respectively. This represented an increase of 65% for the
third quarter compared with last year and a 34% increase compared with the nine
month period last year. These increases are primarily related to expanded
selling and marketing activities in the international marketplace and certain
non-recurring charges discussed above which were incurred during the third
quarter of fiscal 1996.
INTEREST INCOME - Interest income decreased 44% compared with the third quarter
of fiscal 1995. For the first nine months of fiscal 1996, interest income
declined 22% over the comparable period in fiscal 1995. This decrease resulted
primarily during the second and third quarters due to lower interest rates
earned on a lower level of average cash and short-term investments.
9
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PROVISION FOR INCOME TAXES - The Company provided for no taxes during the third
quarter and for the first nine months of fiscal 1996. Due to net losses through
nine months and the availability of $2.7 million of deferred tax credits to
offset future tax liabilities, no income tax provision or benefit is anticipated
for fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES - For the nine month period ended May 26, 1996,
cash and short-term investments decreased $10.2 million to $18.9 million. The
decrease reflects the net loss for the period as well as $4.1 million from
higher accounts receivable due to quarter end shipments and $5.6 million in
capital expenditures, partially offset by higher current liabilities.
The Company maintains a $10.0 million line of credit with the Bank of Boston
which is available through September 30, 1996. Under the facility, borrowings
may be made at the bank's prime rate plus one half percent. Although the Company
had no borrowing against the line in fiscal 1996, approximately $1.1 million has
been reserved to support various guarantees in effect at May 26, 1996.
Management believes that existing cash and short-term investments of $18.9
million will be adequate to satisfy operating cash requirements for the
foreseeable future.
OTHER FINANCIAL INFORMATION - New orders received during the third quarter of
fiscal 1995 were $33.2 million compared with $20.1 million during the third
quarter of last year. For the nine month period, new orders were $77.7 million
in fiscal 1996, compared with $67.7 million in fiscal 1995. At the end of the
third quarter, the backlog of unfilled customer orders shipped within one year
was $18.1 million. This represents an increase of $9.1 million compared with the
end of the second quarter, and an increase of $12.5 million compared with the
previous year end. The Company's order trend is characterized by short-customer
scheduled delivery cycles. Accordingly, a substantial portion of sales in each
fiscal quarter is derived from orders booked in the period.
10
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TELCO SYSTEMS, INC.
PART II. OTHER INFORMATION
--------------------------
Item 6. Exhibits and Reports filed on Form 8-K
- ----------------------------------------------
(b) The Company filed no reports on Form 8-K during the fiscal quarter for
which this report is filed.
11
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TELCO SYSTEMS, INC.
SIGNATURE(S)
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
TELCO SYSTEMS, INC.
By: /s/ John A. Ruggiero
--------------------------
John A. Ruggiero
Vice Chairman of the Board of Directors
Chief Financial Officer
12
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> AUG-25-1996
<PERIOD-END> MAY-26-1996
<CASH> 11,423
<SECURITIES> 7,504
<RECEIVABLES> 14,169
<ALLOWANCES> 0
<INVENTORY> 18,671
<CURRENT-ASSETS> 54,486
<PP&E> 46,253
<DEPRECIATION> 33,641
<TOTAL-ASSETS> 76,172
<CURRENT-LIABILITIES> 20,048
<BONDS> 0
0
0
<COMMON> 105
<OTHER-SE> 73,942
<TOTAL-LIABILITY-AND-EQUITY> 76,172
<SALES> 23,223
<TOTAL-REVENUES> 23,223
<CGS> 15,174
<TOTAL-COSTS> 34,677
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (11,454)
<INCOME-TAX> 0
<INCOME-CONTINUING> (11,454)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,454)
<EPS-PRIMARY> (1.10)
<EPS-DILUTED> (1.10)
</TABLE>
