<PAGE> 1
QUARTER 2 - 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 February 25, 1996
-----------------
OR
--
{ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from TO
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Commission file number 0-12622
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TELCO SYSTEMS, INC
------------------
(Exact name of registrant as specified in its charter)
Delaware 94-2178777
------------------------------ ------------------
(State or other jurisdiction (I.R.S. employer
incorporation or organization) identification no.)
63 NAHATAN STREET, NORWOOD, MASSACHUSETTS 02062
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(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 April 2, 1996
- ---------------------------- ----------------------------
Common Stock, $.01 par value 10,401,980
1
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<TABLE>
TELCO SYSTEMS, INC.
INDEX
REPORT ON FORM 10-Q
FOR QUARTER ENDED FEBRUARY 25, 1996
<CAPTION>
Page Number
-----------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
----------------------------
Consolidated Balance Sheets
February 25, 1996 and August 27, 1995 3
Consolidated Statements of Operations
Three months and six months ended
February 25, 1996 and February 26, 1995 4
Consolidated Statements of Cash Flows
Six months ended February 25, 1996
and February 26, 1995 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
-------
Financial Condition and Results of Operations 7 - 9
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 10
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Item 6. Exhibits and Reports on Form 8-K 10
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SIGNATURE(S) 11
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- ------------------------------
TELCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
February 25, 1996 August 27, 1995
----------------- ---------------
Assets
- ------
<S> <C> <C>
Current assets:
Cash and equivalents...................... $11,478 $18,208
Short-term investments.................... 11,456 10,895
Accounts receivable, net.................. 12,595 10,047
Refundable income taxes................... 848 1,251
Inventories, net.......................... 18,553 18,473
Other current assets...................... 2,172 2,585
------- -------
Total current assets................ 57,102 61,459
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Plant and equipment, at cost................. 45,024 41,720
Less accumulated depreciation............. 32,945 31,114
------- -------
Net plant and equipment................ 12,079 10,606
------- -------
Intangible and other assets, net............. 9,712 10,374
------- -------
Total assets........................... $78,893 $82,439
======= =======
Liabilities and Shareholders' Equity
- ------------------------------------
Current liabilities:
Accounts payable.......................... $ 4,806 $ 3,952
Payroll and related liabilities........... 2,428 2,628
Other accrued liabilities................. 6,319 4,964
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Total current liabilities.............. 13,553 11,544
------- -------
Restructuring and other long-term
liabilities............................... 2,773 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:
10,372,281 at February 25, 1996;
10,230,624 at August 27, 1995.......... 104 102
Capital in excess of par value............ 73,038 71,566
Accumulated deficit....................... (9,562) (4,263)
Unearned compensation - restricted stock.. (1,013) --
------- -------
Total shareholders' equity............. 62,567 67,405
------- -------
Total liabilities and
shareholders' equity ............... $78,893 $82,439
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
3
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TELCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ -----------------
Feb. 25, Feb. 26, Feb. 25, Feb. 26,
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Sales:
Broadband transmission products ............ $10,918 $ 9,015 $21,844 $19,034
Network access products .................... 8,006 12,279 16,623 26,893
Bandwidth optimization products ............ 1,653 1,583 2,643 3,167
------- ------- ------- -------
20,577 22,877 41,110 49,094
======= ======= ======= =======
Costs and expenses:
Cost of products sold ...................... 12,012 12,065 24,124 26,447
Research and development ................... 4,546 4,214 9,079 8,323
Sales, marketing and administration ........ 6,821 5,500 13,505 11,509
Amortization of intangible assets .......... 195 186 390 386
Interest (income) .......................... (318) (443) (689) (745)
------- ------- ------- -------
23,256 21,522 46,409 45,920
------- ------- ------- -------
(Loss) income before income taxes. ........... (2,679) 1,355 (5,299) 3,174
Provision for income taxes ................... --- 100 --- 375
------- ------- ------- -------
Net (loss) income ............................ $(2,679) $ 1,255 $(5,299) $ 2,799
======= ======= ======= =======
Average shares and equivalents (thousands) ... 10,283 10,392 10,271 10,334
(Loss) earnings per share .................... $ (.26) $ .12 $ (.52) $ .27
</TABLE>
See accompanying notes to consolidated financial statements.
4
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TELCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Six months ended
----------------
Feb. 25, 1996 Feb. 26, 1995
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INCREASE (DECREASE) IN CASH AND EQUIVALENTS
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income ........................................ $ (5,299) $ 2,799
Depreciation and amortization ............................ 2,923 2,949
Other non-operating items ................................ 10 ---
Change in assets and liabilities:
Accounts receivable ................................... (2,548) 2,068
Refundable income taxes ............................... 403 ---
Inventories ........................................... (80) (3,093)
Other current assets .................................. 413 (168)
Intangible and other assets ........................... 24 103
Accounts payable and other current liabilities ........ 2,009 (3,028)
Long-term liabilities ................................. (717) (505)
-------- --------
Net cash (used in) provided by operating activities ...... (2,862) 1,125
-------- --------
Cash flows from investing activities:
Additions to plant and equipment, net ................... (3,758) (1,315)
Purchase of short-term investments ...................... (15,337) (13,550)
Maturities of short-term investments .................... 14,776 15,497
-------- --------
Net cash (used in) provided by investing activities ..... (4,319) 632
-------- --------
Cash flows from financing activities:
Proceeds from sale of common shares
under employee stock plans ............................... 451 3,696
-------- --------
Net cash (used in) provided by financing activities ..... 451 3,696
-------- --------
(Decrease) increase in cash and equivalents ................ (6,730) 5,453
Cash and equivalents at beginning of year .................. 18,208 15,262
-------- --------
Cash and equivalents at end of period ...................... $ 11,478 $ 20,715
======== ========
</TABLE>
5
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TELCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR PERIOD ENDED FEBRUARY 25, 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 February 25, 1996 and the consolidated
statements of operations and cash flows for the six months ended
February 25, 1996 and February 26, 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) February 25, 1995 August 27, 1995
----------------- ---------------
<S> <C> <C>
Raw materials............................ $ 9,791 $ 9,101
Work-in-process.......................... 3,066 3,060
Finished goods........................... 5,696 6,312
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$18,553 $18,473
======= =======
</TABLE>
<TABLE>
Note 3 - Shares Outstanding
<CAPTION>
Changes in shares outstanding: Six months ended
----------------
Feb. 25, 1996 Feb. 26, 1995
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<S> <C> <C>
Outstanding at beginning of period....... 10,230,624 9,649,051
Options exercised..................... 23,748 377,818
Restricted stock grants............... 92,000 ---
Employee stock purchase plan.......... 25,909 27,167
---------- ----------
Outstanding at end of period............. 10,372,281 10,054,036
========== ==========
</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 provisions. 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.
6
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PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
<TABLE>
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)
------------------- ------------------------------
Second Quarter Six Months Second Quarter Six 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% (10.1%) (16.3%)
Costs and expenses:
Costs of products sold .............. 58.4% 52.8% 58.7% 53.8% (0.4%) (8.8%)
Research and development ............ 22.1% 18.4% 22.1% 17.0% 7.9% 9.1%
Sales, marketing and
administration .................... 33.1% 24.0% 32.8% 23.4% 24.0% 17.3%
Amortization of intangible assets ... .9% .8% .9% .8% 4.8% 1.0%
Interest expense .................... -- -- -- -- -- --
Interest income ..................... (1.5%) (1.9%) (1.7%) (1.5%) (28.2%) (7.5%)
----- ----- ------ ----- ----- -----
Total costs and expenses .............. 113.0% 94.1% 112.8% 93.5% 8.1% 1.1%
----- ----- ------ ----- ----- -----
(Loss) income before income taxes ..... (13.0%) 5.9% (12.8%) 6.5% -- --
Provision for income taxes ............ -- .4% -- .8% -- --
----- ----- ------ ----- ----- -----
Net (loss) income ..................... (13.0%) 5.5% (12.8%) 5.7% -- --
===== ===== ====== ===== ===== =====
</TABLE>
7
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TELCO SYSTEMS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE AND SIX MONTH PERIODS ENDED FEBRUARY 25, 1996
SALES AND NET LOSS - Sales for the second quarter of fiscal 1996 decreased 10%
to $20.6 million compared with $22.9 million in the second quarter of last year.
For the first six months of fiscal 1996, sales amounted to $41.1 million, a
decrease of 16% compared with the same period last year. These decreases
resulted primarily from lower shipments of network access products due to
continued competitive pressure on sales of certain older products. Sales to
NYNEX, a significant customer of the Broadband Business Unit, accounted for 34%
of total sales in the second quarter of fiscal 1996 compared to 19% for the same
period in fiscal 1995. For the first six months of fiscal 1996, NYNEX sales
accounted for 31% of total sales compared to 14% for the same period last year.
Net loss for the quarter was ($2.7) million or ($.26) per share compared with
net income of $1.3 million or $.12 per share in the second quarter of last year.
For the six month period of fiscal 1996, the net loss was ($5.3) million or
($.52) per share, compared with net income of $2.8 million or $.27 per share for
the comparable six month period of last year. The net loss for the second
quarter and first half of the year resulted primarily from lower sales volume of
older network access products, increased spending on research and development
projects, and selling and marketing activities. Management is evaluating a
number of alternatives to both reduce costs and increase revenues in order to
achieve a return to profitability in the future.
COST OF PRODUCTS SOLD - Cost of products sold represented 58% of sales in the
second quarter of fiscal 1996. In the second quarter of fiscal 1995, cost of
products sold represented 53% of sales. For the six month period, costs of
products sold represented 59% and 54% in 1996 and 1995, respectively. The
increases in cost of products sold are principally 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 second
quarter of fiscal 1996, increasing 8% to $4.5 million compared with the second
quarter of fiscal 1995. For the first six months of fiscal 1996, research and
development expense was $9.0 million, an increase of 9% 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
modifications for international applications.
SALES, MARKETING AND ADMINISTRATION - Sales, marketing and administration
expense was $6.8 million and $13.5 million for the second quarter and first six
months of fiscal 1996, respectively. This represented an increase of 24% for the
second quarter compared with last year and a 17% increase compared with the six
month period last year. These increases are primarily related to expanded
selling and marketing activities in the international marketplace.
INTEREST INCOME - Interest income decreased 28% compared with the second quarter
of fiscal 1995. For the first six months of fiscal 1996, interest income
declined 8% over the comparable period in fiscal 1995. This decrease resulted
primarily during the second quarter, due to lower interest rates earned on a
lower level of average cash and short-term investments.
PROVISION FOR INCOME TAXES - The Company provided for no taxes during the second
quarter and for the first six months of fiscal 1996. Due to net losses through
six 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.
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LIQUIDITY AND CAPITAL RESOURCES - For the six month period ended February 25,
1996, cash and short-term investments decreased $6.2 million to $22.9 million.
The decrease reflects the net operating loss for the period as well as $2.5
million from higher accounts receivable due to quarter end shipments and $3.8
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 until 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 borrowings against the line in fiscal 1996, approximately $1.1 million has
been reserved to support various guarantees in effect at February 25, 1996.
Management believes that existing cash and short-term investments of $22.9
million will be adequate to satisfy operating cash requirements for the
foreseeable future.
9
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TELCO SYSTEMS, INC.
PART II. OTHER INFORMATION
--------------------------
<TABLE>
Item 4. Submission of Matters to a Vote of Security Holders
- ------- ---------------------------------------------------
The Company held its most recent Annual meeting of Shareholders on January 24,
1996. At the meeting, the stockholders elected Dean C. Campbell, Steward S.
Flaschen, John A. Ruggiero, William B. Smith and Sheldon Horing as directors of
the corporation, to hold office until the next annual shareholders' meeting, or
until such time as their successors are elected. At the meeting, 9,781,798
shares of common stock representing 95% of the total outstanding shares were
voted in the following manner:
<CAPTION>
Total Vote For Total Vote Withheld
Each Director From Each Director
------------- ------------------
<S> <C> <C>
Dean Campbell 9,656,417 125,381
Steward Flaschen 9,658,428 123,370
John Ruggiero 9,663,867 117,931
William Smith 9,663,478 118,320
Sheldon Horing 9,658,982 122,816
</TABLE>
Additionally, the stockholders approved the 1990 Stock Option Plan as
amended by a vote of 8,580,131 in favor, 1,060,338 opposed, and 141,329
abstentions and ratified the selection of Ernst and Young LLP as independent
certified public accountants for the Company by a vote of 9,695,453 in favor,
53,141 opposed, and 33,204 abstentions.
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.
10
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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/ Daniel A. DiPietro
----------------------------
Daniel A. DiPietro
Vice President and
Corporate Controller
Principal Accounting Officer
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:
----------------------------
Daniel A. DiPietro
Vice President and
Corporate Controller
Principal Accounting Officer
11
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> AUG-25-1996
<PERIOD-START> NOV-25-1996
<PERIOD-END> FEB-25-1996
<EXCHANGE-RATE> 1
<CASH> 11,478
<SECURITIES> 11,456
<RECEIVABLES> 12,595
<ALLOWANCES> 0
<INVENTORY> 18,553
<CURRENT-ASSETS> 57,102
<PP&E> 45,024
<DEPRECIATION> 32,945
<TOTAL-ASSETS> 78,893
<CURRENT-LIABILITIES> 13,553
<BONDS> 0
<COMMON> 104
0
0
<OTHER-SE> 62,463
<TOTAL-LIABILITY-AND-EQUITY> 78,893
<SALES> 20,577
<TOTAL-REVENUES> 20,577
<CGS> 12,012
<TOTAL-COSTS> 23,256
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,679)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,679)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,679)
<EPS-PRIMARY> (.26)
<EPS-DILUTED> (.26)
</TABLE>
