<PAGE> 1
FORM 10-K FY 1997
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended AUGUST 31, 1997
------------------------------
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 94-2178777
-------- ----------
(State or other jurisdiction of (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: (781) 551-0300
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
(Title of Class)
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant was approximately $149,407,000 as of November 7, 1997.
On November 7, 1997 there were 10,884,366 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
(2) Portions of the definitive proxy statement (the "Definitive
Proxy Statement") required to be filed with Securities and
Exchange Commission relative to the Company's 1997 annual
meeting of shareholders are incorporated by reference into
Part III.
Exhibit Index is on Page 37
<PAGE> 2
Item 1. BUSINESS
GENERAL
The Company was incorporated in California on September 7, 1972, and
reincorporated in Delaware on December 17, 1986. Its principal office is located
at 63 Nahatan Street, Norwood, Massachusetts 02062 (telephone number is (781)
551-0300. Unless the context indicates otherwise, the terms "Company" and "Telco
Systems" refer to Telco Systems, Inc. The Company is a manufacturer of three
major product lines, focused on providing integrated access for network
services: the broadband transmission products, referred to as "Broadband"; the
network access products, referred to as "Access"; and the bandwidth optimization
products, referred to as "Bandwidth Optimization".
The Company's products are deployed at the edge of the service
providers' networks to provide organizations with a flexible, cost-effective
means of transmitting voice, data, video and image traffic over public or
private networks. These products are used in a wide variety of applications by
network service providers, such as long distance carriers, Bell Operating
Companies, independent and competitive local access providers, as well as
government agencies, electric utilities, wireless service operators, and major
corporations. Its products, which can be found most often in telephone company
central offices and in private communications networks, perform functions that
range from basic signaling and multiplexing of DS0 (64kbps) low speed data and
voice traffic to digital fiber optic transmission of high-speed, high-capacity
services over SONET OC-3 (155Mbps) networks.
In January 1983, the Company acquired the fiber optics transmission
business from Raytheon Company, which evolved into the Broadband product line.
Sales of broadband transmission products in fiscal year 1997 comprised
approximately 54% of the Company's total revenue. In August 1984, the Company
acquired TeleBit, Inc., a manufacturer of digital transmission systems based in
Lombard, Illinois. Later, the products from this acquisition were merged with
the Company's Voice Frequency products which together evolved into the Access
product line. In fiscal 1997, sales of access products were 41% of total sales.
In May 1992, the Company acquired Magnalink Communications Corporation, a
developer and manufacturer of high speed data compression and bandwidth
optimization products, which evolved into the Bandwidth Optimization product
line. In fiscal 1997, bandwidth optimization products represented 5% of sales.
For fiscal 1997, the Company reported sales of $117.8 million and a net
loss of $1.1 million or $.10 per share. Working capital at year end amounted to
$40.4 million, including cash and marketable securities of $12.7 million. For a
more complete discussion of the results of operations, please refer to
Management's Discussion and Analysis of Results of Operations and Financial
Condition found on page 11 of this report.
BROADBAND PRODUCTS
Primary customers of the Company's Broadband products are Bell
Operating Companies and major independent telephone companies as well as
competitive and alternate access providers. Products are sold as either complete
systems or as stand-alone equipment installed by the Company, third party
installers, or by the Company's customers. A complete system may include the
fiber optic cable, which is not manufactured by the Company but is purchased
from a number of suppliers.
The most common application of the Company's Broadband transmission
products is for cost-effective delivery of high capacity T1 (1.544Mbps) and T3
(45Mbps) services in the local loop applications between the telephone company
central office or hubbing sites and customers' business premises. These services
are delivered over both fiber optic technology, as well as copper-based
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technology. The Company believes that such local loop applications will continue
to grow due to the Telecommunications Reform Act of 1996 as the local access
market opens to competition.
Broadband transmission products currently manufactured by the
Company can be grouped into two categories: fiber optic terminals and
multiplexers; and network monitoring and control systems.
FIBER OPTIC TERMINALS AND MULTIPLEXERS: These systems typically
consist of a digital multiplexer and a fiber optic transmitter/receiver
integrated into one functional unit. The multiplexer portion of the terminal
unit combines digital inputs from multiple sources into one digital output.
Multiplexers can be combined in order to achieve higher transmission rates. The
basic function of the transmitter portion of a terminal is to convert electronic
input into a series of light pulses for transmission over optical fiber. The
receiver function of a terminal reconverts the light pulses received over the
fiber into digital electronic signals. To meet the various needs of the public
and private telephone networks, the Company offers products for transmitting at
different capacities.
The Company offers modular fiber optic terminals that enable the
customer to upgrade its system by adding modules as increased capacity is
required. The Company's terminals, depending on bit-rate and other design
configurations, can accommodate transmission over distances of up to 60
kilometers. Prices for a typical system are dependent on configuration and
accordingly can range from $5,000 to $30,000 per terminal.
The broadband transmission multiplexers support speeds ranging from
T1 (1.544Mbps) to SONET OC3 (155Mbps). These systems can connect into
asynchronous or SONET digital cross-connect systems in a service providers'
central office.
NETWORK MONITORING AND CONTROL SYSTEMS: The Company offers a
modular computer-based system management system that is used to configure the
products, monitor and control their operations, and to identify failure of
specific multiplexers or terminals in the network. It also detects and reports
system signal degradation, allowing an operator to identify potential failures
before they occur and to schedule preventative maintenance. In addition, during
FY97, the Company also added Simplified Network Management Protocol (SNMP)-proxy
agent to its HyperSPAN product line to make it manageable from any SNMP Manager
- - a key evolving requirement in the Internet Service Provider (ISP) and
Competitive Local Exchange Carrier (CLEC) marketplace.
ACCESS PRODUCTS
Primary customers of the Company's access products are long
distance service providers, competitive and alternate local access providers,
Bell Operating Companies, government agencies, electric utilities and wireless
service operators. In many cases, the products are purchased by the service
providers and are installed on customer premises or are leased to private
network users. These products comply with both North American and international
standards for specific applications, and are sold worldwide.
The Company's network access products are designed for the digital
multiplexing of voice and data traffic of up to T1 and E1 rates. The trend
towards increased use of public network services for voice, data and video
applications has created greater demand for customer premises access
multiplexers. The Company's access servers enables integration of multiple
slower-speed lines and services onto a single or multiple, high-speed, T1/E1
access facility, ultimately saving access line charges for end users. They
support interfaces for various types of telephony and data services, such as
Plain Old Telephone System (POTS), Centrex extensions, P-Phones, switched data,
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Integrated Services Digital Network (ISDN) and frame relay. In addition, the
Company provides a network management system which is designed to control its
intelligent transmission products.
Typical prices for network access equipment range from $5,000 to $15,000.
NETWORK ACCESS SERVERS: The Company's Access60 network access
servers provide highly reliable digital access to public, private and hybrid
networks. They integrate multiple business applications through cost-effective
connections to dedicated, switched and packet network services, and support
multiple networking functions such as T1/E1 add/drop multiplexing, grooming and
digital cross-connection. They also support advanced services such as ISDN and
frame relay. The products provide complete redundant architecture for fail-safe
operation, a must for service providers. Access45 was introduced during fiscal
1997, and is a smaller version of Access60 representing a lower price point. It
is designed to meet a key requirement for the CLEC marketplace, which is to
provide a high number of service ports in a very small form factor. It is
completely compatible with Access60, and uses the same interface cards to
deliver the same services.
DIGITAL MULTIPLEXER PRODUCTS: The Company's products use digital
technology and provide over 40 different plug-in printed circuit cards to
support a large variety of analog and digital voice, data, and video
applications. The products provide conversion of analog signals into digital
information, combine them with additional digital data inputs and enable them to
be processed and transmitted at high speed over copper wires. The Company
provides a full range of products from cost effective digital channel banks to
high-functionality DSU/CSU.
NETWORK MANAGEMENT AND CONTROL SYSTEM: The Company offers a
standards-based SNMP network management system for its Access45 and Access60
network access servers and Access35 network access multiplexer. It also offers a
software-based management and control system, which is designed to control the
Route-24 and network access multiplexer and DCB-24 digital channel bank. This
system remotely manages voice and data mix, bandwidth allocation, and selective
access to special services offered by T1 carriers. In addition, it can be used
to modify the network as user requirements change.
BANDWIDTH OPTIMIZATION PRODUCTS
Primary customers for the Company's bandwidth optimization products
are private network users at major corporations worldwide. These products
interconnect geographically remote local area networks (LANs) through wide area
networks (WANs), with an emphasis on optimizing the utilization of WAN links. In
LAN/WAN applications, WAN links have the lowest throughput, the highest expense,
the lowest reliability, and the least security. The bandwidth optimization
products increase the throughput of WAN links by two to six times (depending on
the type of data traffic) via data compression; reduce expense of WAN links by
enabling usage of lower-speed links at higher throughput; and offer features for
improved redundancy, fault tolerance, security and privacy. Typical units are in
the $3,000 to $9,000 price range. The Optimizer product line also supports
compression for frame relay data, and can be connected to any standard frame
relay service offering. It is approved in the leading frame relay service
offerings, such as AT&T, WorldCom and Sprint.
MARKETING AND CUSTOMERS
Telco Systems is engaged in a single business segment constituting
the development, manufacturing, marketing and service of integrated access
solutions for the telecommunications industry. Primary users of the Company's
products are the Regional Bell Operating Companies (RBOCs), independent
telephone companies, interexchange carriers, competitive and alternate
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access providers, electric utilities, wireless service operators, government
agencies and private network end users.
The Company's broadband transmission products and network access
products are generally sold to specialized common carriers and telephone
operating companies on an off-the-shelf basis. Typically, the products have been
evaluated by such customers and approved for purchase in advance. Both network
access and broadband products are manufactured by the Company based on
forecasted usage. Sales to the RBOCs accounted for 39% of sales in fiscal 1997,
37% of sales in fiscal 1996, and 29% of sales in fiscal 1995. RBOC sales include
sales to NYNEX of 33% in fiscal 1997, 31% in fiscal 1996, and 17% in fiscal
1995. NYNEX continues to be a significant customer of the Broadband Business
Unit. A material curtailment in the NYNEX order rate, if not offset by sales to
other customers, would result in insufficient gross margin to cover the current
level of operating costs and would adversely impact total company results. Other
significant customers include MCI Communications and Walker and Associates which
each represented 11% and 10% of sales in fiscal 1997, respectively. In fiscal
1996, Sprint and Walker and Associates each represented 13% and 11%,
respectively. In fiscal 1995, Sprint represented 18% of sales. During fiscal
1997, the Company also won a large bid with British Telecom, a major European
carrier, for its Access60 product. International revenue represented 7% of total
revenue in fiscal 1997 compared with 4% in fiscal 1996.
The Company markets its products through a combination of its own
sales force, value-added resellers and distributors. Installation is primarily
performed by third party providers. The Company has technical support and
applications engineering personnel and offers training of customer personnel.
ORDERS AND BACKLOG
In fiscal 1997, the Company received orders totaling $114.4
million. Of this amount, $58.5 million was for broadband transmission products,
$50.4 million was for network access products, and $5.5 million was for
bandwidth optimization products. During the first quarter of fiscal 1998, the
Company was notified by a major customer, MCI Communications, of its intention
to cancel an order for Access60 products in the amount of $6.9 million. Had this
cancellation been reflected in fiscal 1997, total orders would have been $107.5
million. Firm backlog shippable within a twelve-month period was approximately
$21.2 million at the end of fiscal 1997, compared to approximately $24.8 million
at the end of fiscal 1996. Firm backlog would have been $14.3 million if the
previously discussed cancellation occurred in fiscal 1997. Broadband
transmission products comprised 26% of the backlog for fiscal year 1997 and 44%
for fiscal 1996. Network access products represented 72% of backlog at fiscal
1997 year end and 54% of backlog at fiscal 1996 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 are derived from orders
received in the quarter. In the Company's experience, its backlog at a given
time is not necessarily indicative of prospective sales volume. In addition to
the short delivery cycles, customers may revise scheduled delivery dates, revise
product configuration or cancel orders.
COMPETITION
The Company competes in its markets based upon price/performance
advantages offered by a number of its products, certain product features, and
its ability to meet customer delivery requirements on a timely basis. Most of
the Company's competitors have greater financial, technological and personnel
resources than the Company. The Company's competitors in the broadband
transmission market are predominantly large, full-line, integrated manufacturers
of telecommunications equipment, such as AT&T, Fujitsu, Northern Telecom
Limited, Alcatel, NEC and ADC Telecommunications. Many of these competitors have
introduced newer SONET transmission products which the telephone operating
companies are deploying in public networks.
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The availability of such SONET products by competitors provides a distinct
product advantage for them in certain customer applications. However, the higher
cost of the SONET products, typically 20-50% more expensive than the
asynchronous transmission products, is providing a continued strong demand for
the Company's asynchronous transmission products in certain customer
applications. The Company's principal competitors with respect to the network
access product market include Premisys Communications, Verilink Corp., Newbridge
Networks, Tellabs and Coastcomm. The Company believes that it has substantially
strengthened its competitive position in this market with the availability of
new features for the Access60 product, and introduction of the new Access45
product, as well as with a stronger network of distributors. The Company also
believes that the redundancy, high-density application and the fail-safe nature
of the Access60 architecture makes the product more suitable for the service
providers market. Primary competitors for bandwidth optimization products are
Fastcom and Symplex, which focus on data compression technologies for lower data
rates in the range of 64Kbps. The Company believes that its data compression
technology has significant cost and performance advantages for higher data rates
in the range of 256Kbps and 1.544Mbps.
RESEARCH AND DEVELOPMENT
The Company maintains two technology centers for research and
development located in Norwood, Massachusetts and Fremont, California. In the
broadband transmission product area, the Company is concentrating its research
and development efforts on new products for delivering more cost-effective
solutions for DS3-based systems in the local loop distribution portion of the
telephone network. In the network access product area, development programs
continue for further enhancements and newer features for digital loop access and
data services applications for Access45 and Access60 Network Access servers. In
both areas, a significant portion of the R&D investment is going towards
development of lower-cost designs to improve gross margins of existing products.
Programs for new products are based on market analysis and estimates of customer
demand which are subject to continuing change. Therefore, there can be no
assurance that sales of such products will meet current expectations.
Spending on research and development activities of $15.4 million
represented 13% of sales in fiscal 1997. This compares with $18.0 million in
fiscal 1996 and $18.2 million in fiscal 1995 which represented 19% and 20% of
sales in each year, respectively. The Company expects to maintain the fiscal
1997 level of spending for research and development into fiscal 1998.
From time to time the Company has employed consultants to perform
research and development functions. The Company plans to continue this practice
as a means of augmenting its internal research and development capabilities.
EMPLOYEES
As of August 31, 1997, the Company had 382 employees, of whom 93
were in sales, sales support and marketing, 83 in product development, 158 in
manufacturing and 48 in administration. Competition for highly skilled
engineering, managerial, sales, marketing and product development personnel is
very intense. The Company believes that its future success will depend in large
part on its ability to attract and retain such individuals. Accordingly, the
loss of key personnel could materially and adversely affect the Company's
business, results of operations and financial condition. There can be no
assurance that the Company will be successful in attracting and retaining the
personnel required to engineer, manage, market or develop its products and
conduct its operations successfully. The Company considers its employee
relations to be excellent and is not a party to any collective bargaining
agreement.
MANUFACTURING
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The Company's manufacturing process primarily involves the assembly
of electronic components onto custom-designed printed circuit boards,
incorporating these boards into larger system packages, and testing the finished
products to assure their proper functioning in accordance with product
specifications. Most components used in the process are standard electrical,
electronic and mechanical parts available from many suppliers. The Company does,
however, currently depend on various single sources to supply certain
custom-designed components used in its products. To balance single source
dependence, the Company will maintain higher inventory levels or seek to qualify
secondary sources where appropriate.
The plan announced in the latter half of fiscal 1996 to consolidate
manufacturing operations into the Company's facility located in Norwood,
Massachusetts was completed in fiscal 1997. Please refer to note 8 to the
consolidated financial statements for further information concerning the 1996
restructuring plan. Approximately 80% of the Company's older network access
equipment is manufactured by a subcontractor at facilities in Malaysia and
Singapore. Inspection, final test and system assembly is performed at the
Company's Norwood, Massachusetts facility. Approximately 20% of the Company's
broadband transmission products is manufactured by a subcontractor in Singapore.
Inspection, final test and system assembly for these products is also performed
at the Company's Norwood, Massachusetts facility. The Company presently
maintains a favorable relationship with these vendors and does not presently
anticipate any difficulties that would prevent timely procurement of scheduled
product. As a backup to these principal sub-contractors, the Company maintains
an in-house ability to manufacture these products.
The Company maintains a non-exclusive volume purchase agreement
with a major distributor of electronic components. The benefits of this
agreement to the Company are principally discounts and product availability at
certain purchasing levels. This agreement does not contain purchase commitments.
Although the Company has not experienced significant difficulty in obtaining
desired quantities from any of its single sources or other vendors, business
could be adversely affected if components used in its products were not
available on a timely basis.
REGULATORY AND LEGISLATIVE MATTERS
Regulations of the Federal Communications Commission affect various
products of the Company. Certain regulations require that products which reside
on a customer's premises and interconnect the public switched network meet
certain standards to prevent harm to the network. Other regulations limit the
levels of electromagnetic radiation which may emanate from an electronic device
located on a customer's premise. The Company currently complies with these
regulations and believes it will be able to comply with these regulations in the
future. Changes in existing laws and regulations which govern the
telecommunications industry could affect the business of the Company.
PATENTS
The Company currently holds several patents and has patent
applications pending. Management believes, however, that timely implementation
of technological advances, responsiveness to market requirements, depth of
technical expertise and a high level of customer service and support are more
important to its success than patent rights.
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CORPORATE OFFICERS OF REGISTRANT
<TABLE>
<CAPTION>
Following is a list of the Company's executive officers:
NAME AGE POSITION
---- --- --------
<S> <C> <C>
William B. Smith, Ph.D. 53 President and Chief Executive Officer
William J. Stuart 46 Vice President and Chief Financial Officer
Richard J. Nardone 49 Vice President, Corporate Resources
Anand S. Parikh 38 Vice President, Marketing and Business
Development
Philip D. Wilson 52 Vice President, Engineering
</TABLE>
Dr. Smith has been Chief Executive Officer since March of 1996. He
joined the company as President and Chief Operating Officer in 1995. Prior to
that he was Senior Vice President of US West, Inc. and President of US West
Advanced Technologies since 1991. Prior to that, he was Executive Director of
AT&T Bell Laboratories since 1986.
Mr. Stuart has been Vice President and Chief Financial Officer
since joining the Company in January 1997. Prior to that he was Vice President
and Chief Financial Officer of AccessLine Technologies, a telecommunications
software company since 1992. Prior to that he was Vice President - International
with AT&T Paradyne since 1989 and Treasurer of Paradyne Corporation prior to its
acquisition by AT&T in 1989.
Mr. Nardone has been Vice President of Corporate Resources since
March of 1996 and Vice President of Human Resources since September 1995. Prior
to that he was Senior Manager of Human Resources at Ungermann-Bass Networks,
Inc. ( a manufacturer of networking systems) since 1992. Prior to that he was
Director of Human Resources at Proteon, Inc.( a manufacturer of networking
systems).
Mr. Parikh joined the Company as Vice President of Marketing and
Business Development in 1995. Prior to that he was with Lightstream Corporation
in Billerica, Massachusetts as Vice President, Strategic Business Development
since 1994 and Vice President, Marketing since 1993. Prior to that, he was
General Manager of the Broadband Networks Business Unit of Ungermann-Bass
Networks, Inc. a manufacturer of networking systems, since 1991. Prior to that,
he held various senior management positions at Digital Equipment Corp. for nine
years.
Mr. Wilson joined the Company as Vice President, Engineering in
March of 1996. Prior to that he held various senior management positions with
Racal Datacom, a manufacturer of data communications equipment since 1991, most
recently as Vice President of Engineering, LAN Products and Fiber Systems.
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Item 2. PROPERTIES
The Company's corporate offices and manufacturing operations are
located in Norwood, Massachusetts. Engineering, sales and marketing activities
are located in Norwood and Fremont, California.
The Company leases a 216,000 square foot manufacturing, research
and administration facility in Norwood, Massachusetts, that is owned by a
limited partnership in which the Company has a 50% partnership interest.
Approximately 60% of this facility is utilized by the Company. Excess costs
associated with idle portions of the facility have been included in the
restructuring charge recorded by the Company in fiscal 1993. On November 11,
1994, the Company entered into an agreement for the lease of an 118,000 square
foot manufacturing, research and administration facility in Fremont, California.
During fiscal 1996, portions of this facility were identified as excess
following the consolidation of manufacturing operations into the Norwood,
Massachusetts facility. The consolidation plan was completed during fiscal 1997.
For a more complete discussion of excess facilities, please refer to note 8 to
the consolidated financial statements.
The Company leases additional facilities, primarily for sales and
sales support in: Overland Park, Kansas; Dallas, Texas; The United Kingdom; Hong
Kong and Belgium under one to five-year leases, each facility being between 500
and 5,000 square feet. The Company believes that its present facilities are
adequate for its current level of operations.
The Company owns substantially all of its equipment except for
certain equipment purchased by the Company within the eighteen month period
prior to August 31, 1997. This equipment is leased to the Company as discussed
in Note 7 to the financial statements.
Item 3. LEGAL PROCEEDINGS
There are no material legal proceedings to which the Company is a
party or of which any of its properties is the subject.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted to a vote of security holders of the
Company during the fourth quarter of fiscal 1997.
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PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Telco Systems' common stock is quoted on the NASDAQ National Market under the
symbol "TELC." The quarterly price ranges for the Company's common stock are as
follows:
<TABLE>
<CAPTION>
Fiscal Year
-----------
1997 1996
---- ----
High Low High Low
--------------------------------------------------
<S> <C> <C> <C> <C>
First Quarter........... 21 3/4 15 14 3/4 9 3/4
Second Quarter.......... 24 3/8 12 1/2 12 3/8 9 1/4
Third Quarter........... 17 1/4 7 3/4 16 3/8 8 3/8
Fourth Quarter.......... 13 3/4 8 7/8 18 3/8 11 3/8
</TABLE>
The Company has never declared or paid any dividends on its common stock
and does not plan to pay cash dividends in the foreseeable future.
At August 31, 1997, the number of holders of the Company's common stock
was 393. The Company believes that many of its shares are held by individual
participants in security listing positions or "street names" and estimates there
are an additional 6,700 beneficial holders as of August 31, 1997.
Item 6. SELECTED FINANCIAL DATA
Five years ended August 31, 1997
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
(In thousands except per share amounts)
Summary of Operations
<S> <C> <C> <C> <C> <C>
Year-end backlog*................ $ 21,151 $ 24,815 $ 5,527 $ 7,251 $ 6,714
Sales............................ 117,843 93,954 89,070 100,470 83,222
Net income (loss)**.............. (1,078) (15,545) 628 4,770 (16,285)
Earnings (loss) per share........ $ (.10) $ (1.50) $ .06 $ .48 $ (1.75)
Average shares and
equivalents (thousands)...... 10,701 10,357 10,345 9,858 9,300
Year-end employment.............. 382 388 436 443 442
Balance Sheet
Working capital.................. $ 40,414 $ 35,917 $49,915 $ 43,210 $ 36,989
Total assets..................... 78,599 79,504 82,439 82,202 80,551
Long-term liabilities............ 1,531 3,350 3,490 4,443 7,852
Total shareholders' equity....... $ 55,756 $ 53,997 $67,405 $ 61,548 $ 54,872
</TABLE>
*The 1997 year-end backlog includes an order for $6,919 which was canceled
during the first quarter of fiscal 1998.
**The 1997 net loss includes a $1,070 gain on the sale of an investment. The
1996 net loss includes $4,209 of restructuring costs; 1995 Net income includes
$420 of restructuring credits; 1993 net loss includes $13,605 of restructuring
costs. The Company has never declared or paid any dividends on its common
stock.
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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FISCAL 1997 COMPARED WITH FISCAL 1996
Sales in fiscal 1997 increased 25% to $117.8 million compared with
$94.0 million in fiscal 1996. Increased shipments of Access60 network access
products and broadband transmission products more than offset decreased sales of
older network access products.
In fiscal 1997, broadband transmission product sales represented 54% of
total sales reflecting an increase of 35% compared with fiscal 1996. The Company
continued to experience increased demand for asynchronous products exceeding the
30% growth rate experienced in fiscal 1996. Approximately 80% of the Company's
sales of these products are used by telephone company customers to provide high
bandwidth fiber optic services in the feeder or distribution section of the
public telephone network. Sales to one RBOC represented 60% and 61% of sales of
broadband transmission products in fiscal 1997 and fiscal 1996, respectively. As
a percent of total sales, this RBOC represented 33% and 31% in fiscal 1997 and
fiscal 1996, respectively. In fiscal 1997, access product sales represented 41%
of total sales reflecting an increase of 18% compared with fiscal 1996.
Substantially all of this growth can be attributed to sales of the Company's new
Access 60 server which increased 87% compared with fiscal 1996. The Access 60
product represented 46% of access product sales in fiscal 1997 compared with 29%
in fiscal 1996. This increase was partially offset by a decline in sales of
older low-end access products. In fiscal 1997, sales of bandwidth optimization
products represented 5% of total sales and remained substantially even with
fiscal 1996.
Total orders booked in fiscal 1997 amounted to $114.4 million, slightly
ahead of fiscal 1996 orders of $113.5 million. Backlog at the end of fiscal 1997
decreased to $21.2 million compared with $24.8 million at the end of the
previous year. During the first quarter of fiscal 1998, the Company was notified
by a major customer, MCI Communications, of its intention to cancel an order for
Access60 products in the amount of $6.9 million. Had this cancellation been
reflected in fiscal 1997, total orders would have been $107.5 million. Firm
backlog would have been $14.3 million if this order cancellation had occurred in
fiscal 1997.
The Company's major customers include telephone operating companies and
long distance carriers. Sales to RBOC and other major telephone companies
represented 43% of total sales compared with 42% in fiscal 1996. The major long
distance carriers represented 20% of sales on fiscal 1997 compared with 19% in
fiscal 1996. International revenue represented 7% of total revenue in fiscal
1997 compared with 4% in fiscal 1996.
In fiscal 1997 the Company recorded a net loss of $1.1 million or $.10
per share compared with a net loss in fiscal 1996 of $15.5 million or $1.50 per
share. The fiscal 1996 net loss included a net restructuring charge of $4.2
million or $.41 per share which is discussed in note 8 to the financial
statements. Additionally, fiscal 1996 included non-recurring charges associated
with the transfer of manufacturing operations from Fremont, California to
Norwood, Massachusetts. Increased revenues and lower operating expenses were
primarily responsible for the improved operating results compared with fiscal
1996.
Gross profit in fiscal 1997 was $42.9 million and represented 36% of
sales. In fiscal 1996, gross profit was $36.7 million or 39% of net sales. This
decrease in gross profit percentage resulted in part as the product revenue mix
shifted towards lower margin products, primarily in the access products group.
To reverse this trend, efforts are continuing into fiscal 1998 to reduce product
cost through manufacturing process improvements and product enhancements.
Research and development expense amounted to $15.4 million and
represented a decrease of 15% compared with fiscal 1996. This decrease resulted
as development efforts for certain broadband products were curtailed. Remaining
resources were focused on new product efforts in
11
<PAGE> 12
the access products area. Research and development expense represented 13% of
sales in fiscal 1997 compared with 19% of sales in fiscal 1996.
Sales, marketing and administration expense was $29.7 million in fiscal
1997 compared with $30.4 million in fiscal 1996. Lower spending in fiscal 1997
resulted from the Company's consolidation actions which occurred in the third
quarter of fiscal 1996. This favorable spending variance was partially offset by
additional costs relating to certain selling activity realignments which
occurred in the third quarter of fiscal 1997.
During the first quarter of fiscal 1997, the Company liquidated its
equity position in an international distributor of the Company's products due to
certain changes in strategic objectives. The sale of this investment, originally
made in fiscal 1995, yielded a one-time gain of $1.1 million.
Amortization expense relates to the acquisition of the broadband family
of products in 1983, certain channel bank products in 1984 and the acquisition
of Magnalink Communications Corporation in 1992. In fiscal 1997, amortization
expense was $.7 million in fiscal 1997 compared with $.8 million in fiscal 1996.
Interest income was $.7 million and $1.1 million in fiscal 1997 and
fiscal 1996, respectively. This decrease resulted as operating requirements for
cash reduced the amounts available to generate interest income.
In fiscal 1997, the Company's operating loss did not generate currently
available tax benefits.
FISCAL 1996 COMPARED WITH FISCAL 1995
Sales for fiscal 1996 increased 5% to $94.0 million compared with sales
in fiscal 1995 of $89.1 million as increased shipments of broadband transmission
products and the Company's new Access 50/60 products more than offset a decrease
in sales of certain older low-end access products.
Sales of broadband transmission products, which represented 50% of
total sales, increased 30% in fiscal 1996 principally due to strong demand by
some Regional Bell Operating Company (RBOC) customers for the Company's
asynchronous products for use in local loop applications. Approximately 80% of
the Company's sales of these products continued to be for provision of high
bandwidth fiber optic services in the feeder or distribution section of the
public telephone network. RBOCs represented 69% and 58% of sales of broadband
transmission products in fiscal 1996 and fiscal 1995, respectively. Sales to one
RBOC of broadband products amounted to 31% and 17% of total sales in FY96 and
FY95, respectively. Sales of network access products were 44% of total sales and
decreased 12% in fiscal year 1996. This decrease was principally related to
continued competitive pressure on certain older products which was partially
offset by increased demand for the Company's new Access60 network access server
and other new products. Sales of Bandwidth Optimization products declined 3% in
fiscal 1996.
Total orders booked in fiscal 1996 amounted to $113.5 million, an
increase of 30% compared with fiscal 1995 orders of $87.3 million. Increased
customer demand for both the Company's Access60 network access server and
HyperSPAN broadband multiplexers accounted for this increase. The backlog of
unfilled orders at August 25, 1996 increased 351% to $24.8 million compared with
$5.5 million at the previous year end. The year end backlog is reflective of
increased demand for both network access products and broadband transmission
products and also included early receipt of some customer stocking orders. The
Company believes that it has sufficient manufacturing capacity to meet the
increased demand.
12
<PAGE> 13
The Company's major customers include telephone operating companies and
interexchange carriers. Sales to RBOC customers and other major telephone
companies represented 42% of total sales in fiscal 1996 compared with 35% of
total sales in fiscal 1995. The major interexchange carriers represented 19% and
23% of sales in fiscal 1996 and fiscal 1995, respectively.
The Company recorded a net loss of $15.5 million or $1.50 per share for
fiscal 1996 compared with net income of $0.6 million or $.06 per share in fiscal
1995. The fiscal 1996 net loss included a $4.2 million restructuring charge
discussed in Note 8 to the financial statements. In addition, year end results
included non-recurring charges resulting from the transfer of manufacturing
operations from the Company's Fremont, California, facility to its facility
located in Norwood, Massachusetts, which were recorded in the third quarter. As
a result of lower operating costs experienced after these actions, a favorable
adjustment to the third quarter restructuring charge of $0.5 million and record
sales in the fourth quarter of fiscal 1996, the Company reported net income of
$1.2 million or $.11 per share on sales of $29.6 million .
Gross profit in fiscal 1996 was $36.7 million and represented 39% of
sales compared with $40.5 million or 46% of sales in fiscal 1995. Gross profit
was adversely affected by additional costs for facility consolidations and by
lower product margins on the initial production of new network access products.
In addition, the Company experienced increased competitive pricing pressures on
older network access products.
Spending for research and development in fiscal 1996 was slightly below
the fiscal 1995 level. Lower spending resulted as development efforts for
certain broadband products were curtailed in conjunction with the Company's
restructuring activities discussed in Note 8 to the financial statements.
Research and development represented 19% of sales in fiscal 1996 and 20% of
sales in fiscal 1995.
Sales, marketing and administration expense increased 33% to $30.4
million compared with $22.9 million in fiscal 1995. Increased expenses resulted
from domestic sales channel development, international selling and marketing
activities and certain non-recurring administrative charges relating to facility
consolidations. Sales, marketing and administrative expenses represented 32% of
sales in fiscal 1996 and 26% of sales in fiscal 1995.
During the third quarter of fiscal 1996, the Company's management
approved a plan to restructure its operations. As a result, the Company recorded
a restructuring charge of $4.2 million which was net of a recovery of $0.6
million associated with restructuring activities recorded in fiscal 1993. The
charge included costs associated with excess facility costs in Fremont,
California, the write-down of certain assets to net realizable value, and
employee severance costs. For a more complete discussion of the 1996
restructuring charge, please refer to Note 8 to the financial statements.
Amortization expense relates to the acquisition of the broadband family
of products in 1983, certain channel bank products in 1984, and the acquisition
of Magnalink Communications Corporation in 1992. Amortization expense was $0.8
million in both fiscal 1996 and fiscal 1995.
Interest income was $1.1 million in fiscal 1996 compared with $1.6
million in fiscal 1995. This decrease was principally related to a lower level
of average cash equivalents and short-term investments in fiscal 1996 compared
with fiscal 1995.
In fiscal 1996, the Company's operating loss did not generate currently
available tax benefits. In fiscal 1995, no tax provision was recorded due to the
availability of tax benefits relating to prior year operating losses and tax
credits not previously benefited.
13
<PAGE> 14
LIQUIDITY AND CAPITAL RESOURCES
During fiscal 1997, cash and marketable securities decreased $2.3
million resulting in a year-end balance of $12.7 million compared with $15.0
million at the end of fiscal 1996. In order to support fiscal 1997 revenue
growth, cash of $4.1 million was consumed by operating activities. Cash was
required to fund increased inventory of $4.9 million, net payments on
liabilities of $3.2 million and increased accounts receivable of $1.6 million.
These requirements were partially funded by net income before non-cash expenses,
proceeds from the sale of an investment and an income tax refund. Capital
expenditures of $3.6 million were required to increase manufacturing capacity in
response to increased customer demand. During fiscal 1997, the Company entered
into a sale-leaseback arrangement for certain capital equipment which provided
cash of $2.6 million. Proceeds from the sale of common stock under various stock
option and purchase plans provided cash in the amount of $2.8 million.
Working capital at August 31, 1997 was $40.4 million, compared with
$35.9 million at August 25, 1996. The ratio of current assets to current
liabilities at fiscal year end was 2.9 compared with 2.6 at the end of last
year.
The Company maintains a $20.0 million secured line of credit with Fleet
Bank which is available to fund working capital requirements and is available
until May 30, 1998. In addition to this principal credit line, the Company has a
$3.5 million equipment financing line of credit with Fleet Bank which is
available until December 31, 1997. Although the Company did not utilize any of
its financing alternatives in fiscal 1997, approximately $.2 million was
reserved to cover various guarantees in effect at August 31, 1997.
Management believes that its cash and marketable securities and the
availability of its various financing arrangements will be sufficient to fund
operating cash requirements and future growth for the foreseeable future.
The Company practice has been to retain cash provided by operations to
fund future growth. Accordingly, the Company has never declared or paid a cash
dividend on its capital stock.
FACTORS THAT MAY AFFECT FUTURE FINANCIAL RESULTS
Discussions in this Form 10-K include statements concerning the Company's
future products, expenses, revenue, liquidity and cash needs as well as the
Company's future operations and financial results. These forward-looking
statements are based on current expectations. Accordingly, the Company assumes
no obligation to update this information. Numerous factors, including but not
limited to economic and competitive conditions, incoming order levels, shipment
volumes, and product margins, could cause actual results to differ from those
described in these statements. Prospective investors and stockholders should
carefully consider the foregoing factors, as well as those set forth below in
evaluating these forward-looking statements.
The Company's backlog may not be representative of actual sales for any
succeeding period because of the timing of orders, delivery intervals, customer
and product mix, the possibility of changes in delivery schedules, and additions
or cancellation of orders. Historically, a significant portion of the Company's
sales in any quarter result from orders received in the same period; thus, order
delays could have an immediate and materially adverse impact on sales and
profit. Recent merger activity among some of the Company's large customers could
adversely affect future orders as those customers reassess their strategic
direction. NYNEX, the Company's largest customer recently merged with Bell
Atlantic. Although the Company believes that its products continue to offer a
competitive advantage to NYNEX, there can be no assurance that their historic
order level will continue.
14
<PAGE> 15
The Company operates in a highly competitive environment and in a
highly competitive industry, which include significant pricing pressures. These
competitive pressures could cause reduced demand for the Company's products. If
the Company was not successful in winning future business opportunities, there
could be insufficient revenue to cover costs and expenses incurred in
anticipation of these opportunities. Accordingly, the Company may from time to
time experience unanticipated intense competitive pressure, possibly causing
operating results to vary from those expected.
The Company's future operating results are dependent on its ability to
develop, produce and market new and innovative products and services. Critical
to the Company's growth strategy is the acceptance of the Access60 product and
certain broadband products. There are numerous risks inherent in this complex
process, including rapid technological change and the requirement that the
Company bring to market in a timely fashion new products and services which meet
customers' changing needs. The introduction of newer technologies could result
in lower demand for the Company's products and cause inventory on hand to become
obsolete. The Company experiences intense competition for skilled employees who
are in great demand. If important technical and management positions remain
unfilled, completion of product development and other programs could be delayed
causing financial results to be adversely affected.
Historically, the Company has generated a disproportionate amount of
its operating revenues toward the end of each quarter, making precise prediction
of revenues and earnings particularly difficult and resulting in risk of
variance of actual results from those forecast at any time. In addition, the
Company's operating results historically have varied from fiscal period to
fiscal period. Accordingly, the Company's financial results in any particular
fiscal period are not necessarily indicative of results for future periods.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL SCHEDULES PAGE
Report of Ernst & Young LLP Independent Auditors 16
Consolidated Statements of Operations 17
Consolidated Balance Sheets 18
Consolidated Statements of Shareholders' Equity 19
Consolidated Statements of Cash Flows 20
Notes to Consolidated Financial Statements 21
Supplementary Data (Unaudited) 30
Consolidated Financial Statement Schedules: 31
Schedule II-Valuation and Qualifying Accounts
(All other schedules for which provision is made
in Regulation S-X are not required or are
inapplicable and therefore have been omitted.)
15
<PAGE> 16
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of Telco Systems, Inc.
We have audited the accompanying consolidated balance sheets of Telco
Systems, Inc. as of August 31, 1997 and August 25, 1996, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended August 31, 1997. Our audits also
included the financial statement schedule listed in the index at Item 14 (a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Telco Systems, Inc. at August 31, 1997, and August 25, 1996, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended August 31, 1997, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
ERNST & YOUNG LLP
Boston, Massachusetts
October 15, 1997
16
<PAGE> 17
CONSOLIDATED STATEMENTS OF OPERATIONS Telco Systems, Inc .
<TABLE>
<CAPTION>
Three years ended August 31, 1997 1997 1996 1995
- ------------------------------------------------------------------------------------------------
(In thousands except per share amounts)
<S> <C> <C> <C>
Net sales ................................. $ 117,843 $ 93,954 $ 89,070
Costs and expenses
Cost of products sold ..................... 74,985 57,285 48,559
Research and development .................. 15,355 17,991 18,207
Sales, marketing and administration ....... 29,652 30,408 22,945
Restructuring costs (credit) .............. -- 4,209 (420)
Gain on investment ........................ (1,070) -- --
Amortization of intangible assets ......... 669 752 783
Interest income ........................... (670) (1,146) (1,632)
--------- --------- --------
118,921 109,499 88,442
--------- --------- --------
Net (loss) income ......................... $ (1,078) $ (15,545) $ 628
========= ========= ========
Average shares and equivalents ............ 10,701 10,357 10,345
Net (loss) income per share ............... $ (.10) $ (1.50) $ .06
</TABLE>
See accompanying notes to consolidated financial statements.
17
<PAGE> 18
CONSOLIDATED BALANCE SHEETS TELCO SYSTEMS, INC.
<TABLE>
<CAPTION>
August 31, 1997 and August 25, 1996 1997 1996
- -----------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C>
Assets
Current assets:
Cash and equivalents ........................................ $ 5,406 $ 8,461
Marketable securities ....................................... 7,302 6,581
Accounts receivable, less allowance for
doubtful accounts of $895 in 1997 ($676 in 1996) ........ 19,663 18,025
Refundable income taxes ..................................... -- 702
Inventories, net ............................................ 28,370 23,495
Other current assets ........................................ 985 810
-------- --------
Total current assets ................................... 61,726 58,074
Plant and equipment, at cost ..................................... 46,401 45,941
Less accumulated depreciation ............................... 36,712 33,411
-------- --------
Net plant and equipment ................................ 9,689 12,530
Intangible and other assets, less accumulated
amortization of $11,651 in 1997 ($10,935 in 1996) ............... 7,184 8,900
-------- --------
Total assets ................................................ $ 78,599 $ 79,504
======== ========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable ............................................ 7,292 $ 9,758
Payroll and related liabilities ............................. 3,492 3,649
Other accrued liabilities ................................... 10,528 8,750
-------- --------
Total current liabilities .............................. 21,312 22,157
Restructuring and other long-term liabilities .................... 1,531 3,350
Shareholders' equity:
Series A Participating Cumulative Preferred Stock, 200 shares -- --
authorized; no shares outstanding
Preferred stock, $.01 par value, 5,000
shares authorized; no shares outstanding .................... -- --
Common stock, $.01 par value, 24,000 shares authorized;
shares outstanding: 10,805 at August 31, 1997;
(10,520 at August 25, 1996) .................................. 108 105
Capital in excess of par value .............................. 76,602 74,267
Accumulated deficit ......................................... (20,886) (19,808)
Unearned compensation - restricted stock .................... (68) (567)
-------- --------
Total shareholders' equity ................................ 55,756 53,997
-------- --------
Total liabilities and shareholders' equity .................. $ 78,599 $ 79,504
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE> 19
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY TELCO SYSTEMS, INC.
Three years ended August 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Common Stock Paid-in Unearned Accumulated
Shares Amount Capital Compensation Deficit Total
------ ------ ------- ------------ ------------ -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance, August 28, 1994.................. 9,649 $ 96 $66,343 (4,891) 61,548
----- ------- ------- ------- ------
Net income for year....................... 628 628
Issuance of common stock:
Employee stock purchase plan............ 56 1 504 505
Exercise of stock options............... 526 5 4,719 4,724
------ ------- ------- ------- ------
Balance, August 27, 1995.................. 10,231 102 71,566 (4,263) 67,405
------ ------- ------- ------- ------
Net (loss) for year....................... (15,545) (15,545)
Issuance of common stock:
Employee stock purchase plan............ 56 514 514
Exercise of stock options............... 174 2 1,533 1,535
Restricted stock, net................... 59 1 654 $ (655)
Amortization of unearned
compensation.......................... 88 88
------ ------- ------- ------- --------- ------
Balance, August 25, 1996.................. 10,520 105 74,267 (567) (19,808) 53,997
Net (loss) for year....................... (1,078) (1,078)
Issuance (cancellations) of common stock:
Employee stock purchase plan............ 43 448 448
Exercise of stock options............... 284 3 2,360 2,363
Restricted stock, net................... (42) (473) 473 --
Amortization of unearned
compensation.......................... 26 26
------ ------- ------- ------- --------- ------
BALANCE, AUGUST 31, 1997 10,805 $ 108 $76,602 $ (68) $ (20,886) 55,756
====== ======= ======= ======= ========= ======
</TABLE>
See accompanying notes to consolidated financial statements
19
<PAGE> 20
CONSOLIDATED STATEMENTS OF CASH FLOWS TELCO SYSTEMS, INC.
<TABLE>
<CAPTION>
Three years ended August 31, 1997 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C>
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
Cash Flows from Operating Activities
Net (loss) income ................................... $ (1,078) $(15,545) $ 628
Depreciation and amortization ....................... 5,094 5,324 4,982
Restructuring costs (credit) ........................ -- 4,209 (420)
Amortization of unearned compensation ............... 26 88 --
Change in assets and liabilities
Accounts receivable, net ............................ (1,638) (7,978) 5,017
Refundable income taxes ............................. 702 549 (1,251)
Inventories, net .................................... (4,875) (6,074) (3,229)
Other current assets ................................ (175) 1,775 320
Other assets ........................................ 1,000 25 (924)
Accounts payable and other current liabilities ...... (1,512) 9,585 (4,401)
Restructuring liabilities ........................... (2,192) (1,845) (469)
Long-term liabilities ............................... 536 113 (330)
-------- -------- --------
Net cash (used in) provided by operating activities .... (4,112) (9,774) (77)
Cash Flows from Investing Activities
Additions to plant and equipment, net ............... (3,634) (6,336) (2,257)
Proceeds from sale - lease back ..................... 2,601 -- --
Purchase of marketable securities ................... (11,674) (24,350) (29,665)
Maturities of marketable securities ................. 10,953 28,664 29,716
-------- -------- --------
Net cash (used in) investing activities ............. (1,754) (2,022) (2,206)
Cash Flows from Financing Activities
Proceeds and related tax benefits from sale of common
shares under employee stock plans ................. 2,811 2,049 5,229
-------- -------- --------
Net cash provided by financing activities ........... 2,811 2,049 5,229
-------- -------- --------
(Decrease) increase in cash and equivalents ............ (3,055) (9,747) 2,946
Cash and equivalents at beginning of year .............. 8,461 18,208 15,262
-------- -------- --------
Cash and equivalents at end of year .................... $ 5,406 $ 8,461 $ 18,208
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash Paid During the Year
Income taxes ....................................... $ -- $ 89 $ 1,235
</TABLE>
See accompanying notes to consolidated financial statements.
20
<PAGE> 21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 1 SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION The financial statements consolidate the accounts of
Telco Systems, Inc., and its subsidiaries (the Company). Intercompany accounts
and transactions have been eliminated. The Company's fiscal year ends on the
last Sunday in August which included 53 weeks in fiscal 1997 and 52 weeks in
both fiscal 1996 and fiscal 1995. Certain amounts reported in prior years have
been reclassified to be consistent with the current year's presentation.
The Company has 50% limited partnership interests in two real estate
partnerships which are accounted for by the equity method of accounting. The
aggregate net investment in these partnerships on the accompanying balance
sheets is not material (See Note 7).
NEW ACCOUNTING STANDARDS In February 1997, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standards 128 (SFAS 128),
"Earnings Per Share" which will require adoption in the Company's second quarter
of fiscal 1998. This statement specifies the computation, presentation and
disclosure requirements of earnings per share. The Company believes that
adoption of this statement will have no material impact on its consolidated
financial statements and related disclosures.
In June 1997, the FASB issued Statement No. 130, "Reporting
Comprehensive Income" (SFAS 130). SFAS 130 establishes standards for reporting
comprehensive income and its components in a full set of general purpose
financial statements. SFAS 130 requires that items to be recorded in
comprehensive income, which include unrealized gains/losses on marketable
securities classified as available-for-sale and cumulative translation
adjustments, be displayed with the same prominence as other financial statement
items. The Company is in the process of determining the effect of adoption of
this statement on its consolidated financial statements and related disclosures.
SFAS 130 is required to be adopted in the Company's financial statements for the
year ending August 29, 1999.
In June 1997, the FASB issued Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information," (SFAS 131). SFAS 131
establishes standards for the way public business enterprises report information
about operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in interim
financial reports issued to shareholders. SFAS 131 also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. SFAS 131 is required to be adopted in the Company's financial
statements for the year ending August 29, 1999. The adoption of SFAS 131 will
have no impact on the Company's financial results or financial condition, but
may result in certain disclosures of segment information.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
REVENUE RECOGNITION In general, the Company recognizes revenue from product
sales at the time of shipment. In certain contractual situations, revenue is
recognized when the product is accepted by the customer.
21
<PAGE> 22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 1 (continued)
PRODUCT WARRANTY Expected future product warranty liability is provided for when
the product is sold.
CASH EQUIVALENTS AND MARKETABLE SECURITIES The Company classifies all of its
marketable securities as available-for-sale securities. These securities are
stated at their fair value. There are currently no unrealized holding gains and
losses. The Company considers all highly liquid investments with maturity of 91
days or less to be cash equivalents. Those instruments with maturities greater
than 91 are classified as marketable securities. Cash equivalents and marketable
securities are carried at market, and consist of U.S. Government securities,
bank certificates of deposit and corporate issues. All securities mature within
twelve months.
INVENTORIES Inventories are stated at the lower of cost or market. The cost of
products sold is based on standard costs, which approximate actual costs as
determined by the first-in, first-out method.
Inventories at fiscal year end were as follows:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
(in thousands)
<S> <C> <C>
Raw material.................................................................... $ 12,803 $ 12,112
Work-in-process................................................................. 5,605 5,560
Finished goods ................................................................. 9,962 5,823
---------- ----------
$ 28,370 $ 23,495
========== ==========
</TABLE>
PLANT AND EQUIPMENT Additions to plant and equipment are recorded at cost.
Depreciation is determined by using the straight-line method over the estimated
useful lives of the assets - three to eight years. Leasehold improvements are
amortized on a straight-line basis over the shorter of their estimated useful
life or the lease term.
Plant and equipment, at cost, at fiscal year end were as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(in thousands)
<S> <C> <C>
Machinery and equipment......................................................... $ 33,313 $ 31,214
Furniture and leasehold improvements............................................ 13,088 14,727
--------- ---------
$ 46,401 $ 45,941
========= =========
</TABLE>
INTANGIBLE AND OTHER ASSETS Intangible assets arising in connection with
business acquisitions were $7,122,000 and $7,791,000 at August 31, 1997 and
August 25, 1996, respectively. They are amortized over lives ranging from seven
to twenty-five years using the straight-line method, with an average remaining
life of 10.7 years. The carrying value of goodwill is reviewed periodically
based on the undiscounted cash flows of the entities acquired over the remaining
amortization period. Should this review indicate that goodwill will not be
recoverable, the carrying value will be reduced by the estimated shortfall of
undiscounted cash flows.
CONCENTRATIONS OF CREDIT RISK Financial instruments which potentially subject
the Company to concentrations of credit risk consist primarily of cash
equivalents, short-term investments, and accounts receivable. The Company's
temporary cash investments, which are principally limited to U.S. Government
securities and bank certificates of deposit, are subject to minimal risk. The
Company routinely assesses the financial strength of its customers and, as a
consequence, believes that its trade accounts receivable credit risk exposure is
limited.
22
<PAGE> 23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 1 (continued)
EARNINGS (LOSS) PER SHARE Earnings (loss) per share is based on the weighted
average number of common shares outstanding and common stock equivalents, if
dilutive. Fully diluted earnings per share did not differ significantly from
primary earnings per share in any year. Net loss per share in fiscal years 1997
and 1996 did not consider common stock equivalents as the effect would be
antidilutive.
NOTE 2 DESCRIPTION OF BUSINESS
The Company is engaged in a single business segment constituting the
development, manufacturing, and marketing of broadband transmission products,
network access products, and bandwidth optimization products for the
telecommunications industry. Regional Bell Operating Companies (RBOC),
independent telephone companies, and interexchange carriers are the primary
users of the Company's products. Sales to the RBOCs accounted for 39% of sales
in fiscal 1997, 37% of sales in fiscal 1996, and 29% of sales in fiscal 1995.
RBOC sales include sales to one RBOC of 33% in fiscal 1997, 31% in fiscal 1996,
and 17% in fiscal 1995. In fiscal 1997, two additional customers each
represented 11% and 10% of sales. In fiscal 1996, two additional customers each
represented 13% and 11% of sales. In fiscal 1995, one additional customer
represented 18% of sales.
NOTE 3 INCOME TAXES
The components of the provision (benefit) for income taxes were as follows:
<TABLE>
<CAPTION>
Fiscal Year
-----------
1997 1996 1995
---------- --------- ------
Federal (In thousands)
<S> <C> <C> <C>
Current ......................................................................... $ -- $ (1,105) $ (821)
Deferred ........................................................................ -- 1,105 821
---------- --------- ------
$ -- $ -- $ --
========== ========= ======
</TABLE>
The provision (benefit) for income taxes differs from the amount computed using
the statutory rate as follows:
<TABLE>
<CAPTION>
Fiscal Year
-----------
1997 1996 1995
----------- ----------- ----------
(In thousands)
<S> <C> <C> <C>
Federal income taxes at statutory rate........................................... $ (366) $ (5,285) $ 214
Loss producing no current tax benefit............................................ 123 5,024
Amortization of goodwill......................................................... 243 247 267
Previously unbenefited deferred items ........................................... (566)
Other............................................................................ 14 85
----------- ----------- ----------
Income tax provision ............................................................ $ -- $ -- $ --
=========== =========== ==========
</TABLE>
23
<PAGE> 24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 3 (continued)
The components of deferred tax assets and liabilities at fiscal year end are as
follows:
<TABLE>
<CAPTION>
1997 1996
--------------------------
(In thousands)
DEFERRED TAX ASSETS
<S> <C> <C>
Restructuring costs ........................................................ $ 1,863 $ 2,942
Inventory and other reserves ............................................... 8,049 4,384
Net operating loss carryforward ............................................ 2,058 3,173
Tax credit carryforward .................................................... 4,019 3,543
Other ...................................................................... 97 187
-------- --------
16,086 14,229
Valuation reserve .......................................................... (15,009) (13,063)
-------- --------
Total deferred tax assets .................................................. 1,077 1,166
-------- --------
DEFERRED TAX LIABILITIES
Accelerated tax deduction .................................................. 1261 1,188
Amortization ............................................................... 267 287
Depreciation ............................................................... (373) (250)
Other ...................................................................... (78) (59)
-------- --------
Total deferred tax liabilities ............................................. 1,077 1,166
-------- --------
Net deferred tax assets .................................................... $ -- $ --
======== ========
</TABLE>
SFAS 109, "Accounting for Income Taxes", requires that a valuation reserve be
established if it is "more likely than not" that realization of the tax benefits
will not occur. The valuation reserve increased by $1,946,000 in fiscal 1997.
This change is due primarily to an increase in the current year of inventory and
other reserves. These items have been fully reserved.
At August 31, 1997, the Company had net operating loss carryforwards to reduce
future taxable income of $5,000,000. To the extent not utilized, the U.S.
Federal net operating loss will expire in 2011. The Company also had unused
research and development and investment tax credit carryforwards of $4,000,000
at August 31,1997, which expire from fiscal years 1999 through 2012.
NOTE 4 ACCRUED LIABILITIES
Accrued liabilities at fiscal year end were as follows:
<TABLE>
<CAPTION>
1997 1996
----------------------------
(In thousands)
<S> <C> <C>
Restructuring costs......................................................... $ 2,485 $ 2,322
Warranty and rework ........................................................ 2,027 1,173
All other accrued liabilities............................................... 6,016 5,255
----------- --------
$ 10,528 $ 8,750
=========== ========
</TABLE>
24
<PAGE> 25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 5 LINE OF CREDIT
The Company maintains a $20.0 million secured line of credit with Fleet
Bank which is available until May 30, 1998. At August 31, 1997, $165,000 was
reserved to support various guarantees in effect at that date. Additionally, the
Company maintains a $3.5 million line of credit with Fleet Bank which is
specifically designated for the acquisition of capital equipment. This line of
credit is available until December 31, 1997.
There were no borrowings against these credit lines at August 31, 1997.
NOTE 6 LONG-TERM LIABILITIES
At August 31, 1997 and August 25, 1996, restructuring and other
long-term liabilities include $.3 million and $2.6 million, respectively, of
restructuring costs discussed in Note 8.
NOTE 7 LEASE COMMITMENTS
The Company leases a 216,000 square-foot manufacturing, research and
administration facility in Norwood, Massachusetts, from a limited partnership in
which the Company has a 50% interest. Neither the Company nor the other partners
have made or anticipate making any substantial capital contributions or advances
to the partnership. Under the partnership agreement, the Company, in addition to
its 50% interest, is entitled to a priority payment (which would proportionately
increase with an increase in the property value) out of the proceeds of any sale
or future refinancing of the property. The gross rent payable is $1.5 million
annually through January 31,1999. For the remainder of the lease term ending
January 31, 2004, gross rent payable is $1.7 million annually.
In June 1997, the Company entered into a sale-leaseback arrangement for
certain computer and other electronic equipment which provided cash of
approximately $2.6 million. The operating leases contained in the arrangement
cover periods from two to four years. All of equipment included in the
transaction was purchased by the Company within the last eighteen months.
The Company leases other facilities and certain equipment under
noncancelable operating leases expiring at various dates through 2005. The
Company is required to pay property taxes, insurance and normal maintenance
costs. Certain of the lease agreements provide for five-year renewal options,
and future lease payments could increase based on the Consumer Price Index.
Minimum annual lease commitments under non-cancelable operating leases
for facilities and equipment as of August 31, 1997 are set forth in the
following table. Amounts relating to excess facilities included herein have been
accrued as discussed in Note 8:
25
<PAGE> 26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 7 (continued)
<TABLE>
<CAPTION>
Gross Lease Sub-lease Net Lease
Fiscal Year Payments income Payments
- --------------------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C>
1998................................................... $ 3,570 $ 710 $ 2,860
1999................................................... 3,584 647 2,937
2000................................................... 3,256 509 2,747
2001................................................... 3,179 412 2,767
2002................................................... 2,887 69 2,818
Beyond................................................. 6,498 6,498
---------- ---------- -----------
$ 22,974 $ 2,347 $ 20,627
========== ========== ===========
</TABLE>
Rent expense under operating leases was $3.1 million in fiscal 1997, $2.9
million in fiscal 1996, and $2.4 million in fiscal 1995.
NOTE 8 RESTRUCTURING COSTS
During fiscal 1996, the Company's management approved a plan to restructure
its operations and recognized the following charges (in thousands):
<TABLE>
<S> <C>
Excess Facilities...................................................... $ 2,225
Write-down of assets to net realizable value........................... 1,589
Employee severance costs............................................... 1,034
Restructuring credit relating to 1993 excess facilities costs.......... (639)
--------
$ 4,209
========
</TABLE>
The plan included the consolidation and move of manufacturing operations from
the Company's Fremont, California facility to its facility located in Norwood,
Massachusetts. During fiscal 1997, the plan was accomplished within original
cost estimates. At August 31, 1997, the remaining reserve balance of $1,657,000
was specifically designated for excess facility costs at the Fremont, California
location.
At August 31, 1997, the remaining fiscal 1993 restructuring reserve for excess
facility costs for the Norwood, Massachusetts location was $1,098,000
NOTE 9 STOCK PLANS
Under the Company's 1980 Stock Option Plan, the 1988 Non-Qualified Stock Option
Plan, and the 1990 Stock Option Plan (the Plans), officers, directors, and key
employees have been granted options to purchase shares of the Company's common
stock at a price equal to the market value at the date of grant. Options
normally become exerciseable ratably over a 48 month period, commencing six
months from the date of grant, and expire after ten years. At August 31, 1997,
1,479,786 shares of common stock were reserved for issuance under the Plans.
26
<PAGE> 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 9 (continued)
On May 20, 1997, the Board of Directors approved an amendment to the
Company's 1990 Stock Option Plan and reduced the exercise price of certain stock
options granted to employees between May 15, 1996 and May 13, 1997 at exercise
prices ranging from $11.50 to $20.875 per share. The exercise price was adjusted
to be equal to the current market price on that day. Stock options granted to
the Company's Board of Directors and to employees in conjunction with a general
option grant on March 5, 1997 were excluded from this action. Approximately
388,581 shares were reduced to the new exercise price of $9.625.
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. At
August 31, 1997, 7,500 shares carried restrictions. Restrictions on the shares
expire ratably on the anniversary date of the award over the next three years.
A summary of the activity in the stock option plans for fiscal 1996,
1995, and 1994 is presented as follows:
<TABLE>
<CAPTION>
Available Options Option Price
Stock Option Plans For Options Outstanding Per Share
----------- ----------- ------------
<S> <C> <C> <C>
Balance at August 28, 1994........................ 166,936 1,248,850 $ 2.13 - $15.88
------- --------- -----------------
Grants....................................... (395,456) 395,456 $ 9.88 - $16.75
Authorized under 1990 plan................... 250,000
Exercised.................................... (525,568) $ 2.13 - $15.50
Canceled..................................... 159,439 (159,439) $ 3.38 - $16.25
Expired...................................... (1,167)
------- --------- -----------------
Balance at August 27, 1995....................... 179,752 959,299 $ 2.25 - $16.75
------- --------- -----------------
Authorized under 1990 Plan................... 350,000
Grants....................................... (572,305) 572,305 $ 9.63 - $16.38
Exercised.................................... (173,895) $ 3.00 - $16.25
Canceled..................................... 182,887 (182,887) $ 3.38 - $16.38
------- --------- -----------------
Balance at August 25, 1996........................ 140,334 1,174,822 $ 2.13 - $16.75
------- --------- -----------------
Authorized under 1990 Plan........................ 450,000
Grants....................................... (902,831) 902,831 $ 13.09 - $20.88
Exercised.................................... (284,370) $ 2.13 - $16.38
Canceled..................................... 677,297 (677,297) $ 3.00 - $20.88
Expired...................................... (1,000) $ 3.00
------- --------- -----------------
Balance at August 31, 1997........................ 363,800 1,115,986 $ 2.25 - $19.00
------- --------- -----------------
</TABLE>
At August 31, 1997, August 25, 1996, and August 27, 1995, there were
464,589 shares, 464,767 shares, and 413,495 shares exerciseable, respectively.
27
<PAGE> 28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 9 (continued)
Under the Company's 1983 Employee Stock Purchase Plan, eligible
employees may purchase shares of common stock through payroll deductions (up to
a maximum of 10% of their salary) at a price equal to 85% of the lower of the
stock's fair market value at the beginning or at the end of each six month
offering period. There were 38,947 shares issueable under the Plan for fiscal
1997 of which 22,112 were outstanding at August 31,1997. For fiscal 1996 and
1995, 56,010 shares and 56,005 shares, respectively, were issued under the Plan.
At August 31,1997, 59,383 shares of common stock were reserved for issuance
under the Plan.
In October 1995, the Financial Accounting Standards Board issues
Statement of Financial Accounting Standard 123 (SFAS 123), "Accounting for
Stock-Based Compensation". SFAS 123 requires that companies either recognize
compensation expense for grants of stock, stock options and other equity
instruments based on fair value, or provide pro forma disclosure of net income
and earnings per share in the notes to the financial statements. The Company
adopted the disclosure-only provisions of SFAS 123 in fiscal 1997 and has
applied APB Opinion No. 25 and related interpretations in accounting for its
plans.
28
<PAGE> 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 9 (continued)
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions:
<TABLE>
<CAPTION>
Stock Options Employee Stock
and Awards Purchase Plans
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Weighted Average fair value of shares $8.36 $10.54 $6.00 $4.16
Shares Granted 902,831 631,305 38,947 56,010
Assumptions:
Risk-free interest rate 5.9% 6.0% 5.0% 5.0%
Expected volatility 146.2% 144.4% 88.0% 87.2%
Expected life of grants: 5.5 years 5.5 years .5 years .5 years
Dividend yield None None None None
</TABLE>
Outstanding and Exerciseable by
Price Range
As of August 31, 1997
<TABLE>
<CAPTION>
Shares Outstanding Shares Exercisable
------------------ -------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Range of Outstanding Contractual Exercise Exerciseable Exercise
Exercise Prices at 8/31/97 Life Price at 8/31/97 Price
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STOCK OPTION PLAN
$ 2.25 - $ 8.63 125,309 5.02 $ 7.67 116,770 $ 7.61
$ 9.31 - $ 9.88 502,296 9.18 $ 9.60 96,507 $ 9.66
$10.00 - $11.38 279,025 8.19 $10.83 129,091 $10.91
$11.75 - $19.00 209,356 7.14 $14.57 122,221 $14.15
--------------- --------- ---- ------ ------- ------
$ 2.25 - $19.00 1,115,986 8.08 $10.62 464,589 $10.67
=============== ========= ==== ====== ======= ======
STOCK PURCHASE PLAN
$11.05 $ 22,112 -- $11.05 $22,112 $11.05
=============== ========= ===== ====== ======= ======
</TABLE>
29
<PAGE> 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 9 (continued)
Had compensation costs for the Company's stock option plans and
employee stock purchase plans been determined on the fair market value at the
grant dates for such awards, the Company's net loss and net loss per share would
approximate the pro forma amounts below:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Net loss:
As reported $ (1,078) $ (15,545)
Pro forma $ (4,380) $ (16,787)
Net loss per share:
As reported $ (.10) $ (1.50)
Pro forma $ (.41) $ (1.62)
</TABLE>
The effects of applying SFAS 123 for the purpose of providing pro forma
disclosures may not be indicative of the effects on reported net income and net
income per share for future years, as the pro forma disclosures include the
effects of only those awards granted after August 27, 1995.
NOTE 10 EMPLOYEE BENEFIT PLAN
The Company maintains a defined contribution savings plan under the
provisions of Internal Revenue Code Section 401(k). Under the terms of the Plan,
the Company contributes up to 3% of base pay to a fund which is held by a
trustee. All employees are eligible to participate in the Plan and are entitled,
upon termination or retirement, to receive their vested portion of the savings
fund assets. The unvested portion remains in the Plan and is used to reduce
future Plan expense. Total Plan expense was $468,000 in fiscal 1997, $547,000 in
fiscal 1996, and $525,000 in fiscal 1995.
NOTE 11 STOCKHOLDER RIGHTS PLAN
On February 19, 1997, the Board of Directors of Telco Systems, Inc.
adopted a Stockholder Rights Plan (the "Plan") and distributed one Right for
each outstanding share of the Company's Common Stock, par value $.01 per share.
The Rights were issued to holders of record of Common Stock outstanding on
February 19, 1997. Each share of Common Stock issued after February 19, 1997
will also include one Right subject to certain limitations. Each Right when it
becomes exerciseable will initially entitle the registered holder to purchase
from the Company one one-hundredth (1/100th) of a share of Series A
Participating Cumulative Preferred Stock, par value $.01 per share ("Series A
Preferred Stock"), of the Company at a price of $50.00 (the "Exercise Price").
Currently, the Rights are attached to the Company's common stock. These
Rights are not now exerciseable and cannot be transferred separately. The Rights
become exerciseable and separately transferable when the Board learns that any
person or group (other than Kopp Investment Advisors, Inc. and its affiliates or
associates (collectively "KIA")), has acquired 15% or more of the Company's
outstanding common stock or on such date as may be designated by the Board
following the announcement of a tender or exchange offer for outstanding shares
of common stock which could result in the offeror becoming the beneficial owner
of 15% or more of the Company's outstanding common stock. Under such
circumstances, holders of the Rights will be entitled to purchase, for the
Exercise Price, that number of hundredths of a share of Series A
30
<PAGE> 31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 11 (continued)
Preferred Stock equivalent to the number of shares of the Company's common stock
(or under certain circumstances other equity securities) having a market value
of two times the Exercise Price. 15% holders (other than KIA), however, are not
entitled to exercise their Rights under such circumstances. As a result, their
voting and equity interests in the Company would be substantially diluted should
the rights ever be exercised.
The Rights expire in February 2007, but may be redeemed earlier by the
Company in accordance with the provisions of the Rights Plan at a price of $.01
per Right.
SUPPLEMENTARY DATA
QUARTERLY INFORMATION TELCO SYSTEMS, INC.
Quarterly financial information (unaudited) is as follows:
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars in thousands except per share amounts)
<S> <C> <C> <C> <C>
1997
Sales ......................... $ 31,835 $ 27,295 $ 27,411 $ 31,302
Gross profit .................. $ 12,473 $ 11,520 $ 8,293 $ 10,572
Net income (loss) ............. $ *2,274 $ 256 $ (4,017) $ 409
Net income (loss) per share ... $ .21 $ .02 $ (.37) $ .04
1996
Sales ......................... $ 20,533 $ 20,577 $ 23,223 $ 29,621
Gross profit .................. $ 8,421 $ 8,565 $ 8,049 $ 11,634
Net income .................... $ (2,620) $ (2,679) $**(11,454) $**1,208
Net income per share .......... $ (.26) $ (.26) $ (1.10) $ .11
</TABLE>
*Fiscal 1997 net (loss) income includes a $1,070 gain on the sale of an
investment in the first quarter.
**Fiscal 1996 net (loss) income includes a restructuring charge of $4,659
in the third quarter and a restructuring credit of $450 in the fourth quarter.
31
<PAGE> 32
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Years Ended August 31, 1997
---------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Allowance for Doubtful Accounts:
Balance at beginning of period........... $676 $649 $797
Charges to costs and expenses............ 292 102 63
Deductions............................... (73) (75) (211)
---- ---- ----
Balance at end of period................. $895 $676 $649
==== ==== ====
</TABLE>
Item 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference from the Definitive Proxy Statement, with the
exception that information regarding the executive officers of Telco
Systems, Inc. is contained in Item 1 Part I on page 8 of this report.
Item 11. EXECUTIVE COMPENSATION
Incorporated by reference from the Definitive Proxy Statement.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF TELCO
SYSTEMS, INC.
Incorporated by reference from the Definitive Proxy Statement.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the Definitive Proxy Statement.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
See index to Consolidated Financial Statements at page 15.
(a) 2. FINANCIAL STATEMENT SCHEDULES
See index to Consolidated Financial Statements at page 15.
32
<PAGE> 33
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
(a)3. EXHIBITS
Management contracts and compensatory plans or agreements
required to be filed as exhibits pursuant to item 14(a) (3)
of Form 10-K are identified by asterisks (*).
3.1 Certificate of Incorporation of Telco Systems, Inc. (1)
3.2 Bylaws of Telco Systems, Inc., as amended. (2)
10.3 Telco Systems, Inc. Employee Stock Purchase Plan, as amended
through July, 1991 (3)*
10.4 Amendment to Telco Systems, Inc. Employee Stock Purchase Plan,
adopted August, 1991.*
10.5 Telco Systems, Inc. 1988 Non-Statutory Stock Option Plan, as
amended.*
10.8 Partnership Agreement relating to facilities of Telco Systems
Fiber Optics Corporation located at 63 Nahatan Street,
Norwood, Massachusetts, dated August 29, 1985. (7)
10.23 Lease of facilities of Telco Systems Fiber Optics Corporation
located at 63 Nahatan Street, Norwood, Massachusetts, dated
December 12, 1985. (4)
10.38 Telco Systems, Inc. 1990 Stock Option Plan, as amended.*
10.39 Lease dated May 3, 1990 between the Registrant and Pactel
Properties for facilities located at 4305 Cushing Parkway,
Fremont, California (7)
10.40 Stock Purchase Agreement between Registrant and Magnalink
Communications Corporation dated May 29, 1992. (4)
10.42 Amendment to lease of facility located at 63 Nahatan Street,
Norwood, MA dated January 1, 1994. (5)
10.44 Stock Purchase Agreement and Registration Rights Agreement
between the Registrant and Unitech Telecom, Inc. dated March
29, 1995 (6)
10.45 Amendments one and two to lease of facility in Fremont,
California between the Registrant and Riggs National Bank of
Washington D.C. as trustee of the Multi-Employer Property
Trust, (successor to Pactel Properties) dated April 12, 1995
and May 8, 1995, respectively. (6)
10.46 Agreement between the Registrant and John A. Ruggiero dated
March 26, 1996. (7)*
10.48 Agreement between the Registrant and William B. Smith dated
March 6, 1995. (6)*
33
<PAGE> 34
10.49 Amendments three to lease of facility in Fremont, California
between the Registrant and Riggs National Bank of Washington
D.C. as trustee of the Multi-Employer Property Trust,
(successor to Pactel Properties) dated January 22, 1996. (7)
10.50 Sale Leaseback Agreement between the Registrant and G.E.
Capital Corp. dated June 6. 1997.
10.51 Agreement between the Registrant and William J. Stuart dated
August 29, 1997.*
10.52 Agreement between the Registrant and Anand S. Parikh dated
September 8, 1997.*
10.53 Agreement between the Registrant and Richard J. Nardone dated
August 29, 1997.*
10.54 Rights Agreement between the Registrant and the First National
Bank of Boston as Rights Agent dated February 19, 1997. (8)
10.55 Certificate of the Voting Powers, Preferences and Relative,
Participating, Optional and Other Special Rights,
Qualifications, Limitations or Restrictions of Series A
Participating Cumulative Preferred Stock. (9)
22.1 Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors.
27 Financial Data Schedule
Notes: (1) Incorporated by reference to Exhibit 3.1 to Appendix II of
the definitive proxy statement of the Company dated November
20, 1986 relating to the Annual Meeting of Shareholders on
December 17, 1986.
(2) Incorporated by reference to Exhibits 3.2 to the
Registrant's Report on Form 10-K for its fiscal year ended
August 30, 1987.
(3) Incorporated by reference to Exhibit 4.1 to the Registrant's
Form S-8 (File No. 33-26976).
(4) Incorporated by reference to Exhibits 10.23 and 10.40,
respectively, to the Registrant's Report on Form 10-K for
its fiscal year ended August 30, 1992.
(5) Incorporated by reference to Exhibit 10.38 and 10.42,
respectively to the Registrant's Report on Form 10-K for its
fiscal year ended August 28, 1994.
(6) Incorporated by reference to Exhibit 10.44 and 10.45,
respectively to the Registrant's Report on Form 10-K dated
August 27, 1995.
(7) Incorporated by Reference to Exhibit 10.8, 10.39, 10.46, and
10.49, respectively, to the Registrant's Report on Form 10-K
dated August 25, 1996.
34
<PAGE> 35
(8) Incorporated by Reference to Exhibit 1 to the Registrant's
Form 8-A dated February 19, 1997.
(9) Incorporated by Reference to Exhibit 4(b) to the
Registrant's Report on Form 8-K dated February 19, 1997.
(b) Reports on Form 8-K
There were no reports filed on Form 8-K during the fourth quarter of
fiscal 1997.
35
<PAGE> 36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Dated: November 26, 1997 TELCO SYSTEMS, INC.
/s/ William B. Smith
--------------------
By William B. Smith
President and Chief Executive Officer
and Director (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
/s/ William J. Stuart Vice President and
- --------------------- Chief Financial Officer Date: November 26,1997
William J. Stuart (Principal Financial and
Accounting Officer)
/s/ William B. Smith President and Chief Executive Date: November 26,1997
- --------------------- Officer/Director
William B. Smith
/s/
- --------------------- Director Date:
Dean C. Campbell
/s/ Sheldon Horing Director
- ---------------------
Sheldon Horing Date: November 20,1997
/s/ Steward Flaschen Director Date: November 20,1997
- ---------------------
Steward Flaschen
/s/ John A. Ruggiero Director Date: November 24,1997
- ---------------------
John A. Ruggiero
36
<PAGE> 37
EXHIBIT INDEX
-------------
EXHIBIT PAGE
NUMBER EXHIBIT NUMBER
- -------------------------------------------------------------------------------
10.4 Amendment to Telco Systems, Inc. Employee Stock Purchase Plan, 38
Adopted August, 1991.*
10.5 Telco Systems, Inc., 1988 Non-Statutory Stock Option Plan, as 39
Amended.*
10.38 Telco Systems, Inc., 1990 Stock Option Plan, as Amended.* 47
10.50 Sale Leaseback Agreement between the Registrant and G.E. Capital 55
Corp. dated June 6, 1997.
10.51 Agreement between the Registrant and William J. Stuart dated 66
August 29, 1997.*
10.52 Agreement between the Registrant and Anand S. Parikh dated 73
September 8, 1997.*
10.53 Agreement between the Registrant and Richard J. Nardone dated 80
August 29, 1997.*
22.1 Subsidiaries of the Registrant. 87
23.1 Consent of Ernst & Young LLP, Independent Auditors 88
27 Financial Data Schedule
37
<PAGE> 1
EXCERPT FROM
MINUTES
BOARD OF DIRECTORS MEETING
AUGUST 19, 1991
TELCO SYSTEMS, INC.
On motions duly made and seconded, the Board also unanimously approved
the following resolutions:
VOTED: That the Corporation hereby amends paragraph 13 of its 1983
EMPLOYEE STOCK PURCHASE PLAN (relating to assignability of
rights under the Plan) by deleting the first sentence and
inserting the following new sentence:
'No rights of any employee under this Plan shall be
assignable by him or her, by operation of law, or
otherwise, except (a) to the extent that a member is
permitted to designate a beneficiary or beneficiaries as
provided above, or (b) by will or applicable laws of
descent and distribution if no such beneficiary is
designated.'
VOTED: Regarding the Corporation's 1983 EMPLOYEE STOCK PURCHASE PLAN,
that the President or the Chief Financial Officer, with the
assistance of counsel, advise in writing those persons who may
be deemed to be Directors or Officers of the Corporation
within the meaning of Section 16(b) of the Securities Exchange
Act of 1934 and the rules and regulations thereunder of the
conditions required to be satisfied under S.E.C. Rule 16b-3 so
that transactions by such persons under said Plan shall be
exempt from Section 16(b).
exhibit 10.4
38
<PAGE> 1
As amended through 11/12/91
TELCO SYSTEMS INC.
1988 NON-STATUTORY STOCK OPTION PLAN
------------------------------------
1. PURPOSE OF THE PLAN.
This 1988 Non-Statutory Stock Option Plan (the "Plan") of Telco
Systems, Inc., a Delaware corporation (the "Company"), is designed to provide
financial and investment incentives to present and future key employees of the
Company and of its subsidiaries, and to persons who are or become directors of
any such subsidiary, by affording them an opportunity to acquire or increase
their proprietary interest in the Company through the acquisition of shares of
its Common Stock. By encouraging stock ownership by such key employees and such
other persons, the Company seeks to attract and retain in its employ persons of
exceptional competence, to attract as directors persons of wide experience and a
high degree of competence, and to furnish an added incentive for all of such
persons to increase their efforts on behalf of the Company.
2. ADMINISTRATION.
The Plan shall be administered by the Board of Directors of the Company
(the "Board"). All questions of interpretation and application of the Plan, of
options granted hereunder (the "Options") and of the value of shares of Common
Stock subject to an Option, shall be subject to the determination, which shall
be final and binding, of a majority of the Board. The Board may appoint a Stock
Option Committee (the "Committee"), which shall be constituted as determined by
the Board and which, subject to the provisions of the Plan and the approval of
the Board, shall have and exercise all powers of the Board to administer the
Plan. In the event that the powers of the Board are so delegated to the
Committee, the term "Board" as used herein shall be deemed to refer to the
Committee. Notwithstanding the foregoing, the Committee shall not have the right
to amend or terminate the Plan, which right shall be reserved solely to the
Board.
3. OPTION SHARES.
The stock subject to the Options and other provisions of the Plan shall
be shares of the Company's Common Stock, $.01 par value (the "Common Stock").
The total amount of the Common Stock with respect to which Options may be
granted shall not exceed in the aggregate 350,000 shares; provided, however,
that the class and aggregate number of shares which may be subject to options
granted hereunder shall be subject to adjustment in accordance with the
provisions of paragraph 15 hereof. Such shares may be treasury shares or
authorized but unissued shares.
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<PAGE> 2
In the event that any outstanding Option for any reason shall expire or
terminate prior to exercise, the shares of Common Stock allocable to the
unexpired portion of such option may again be subject to an Option under the
Plan.
4. AUTHORITY TO GRANT OPTIONS AND AMOUNT OF GRANTS.
The Board may grant Options from time to time to such eligible persons
as it shall determine ("Optionees"). The number of shares of Common Stock to be
covered by any option shall be as determined by the Board.
5. ELIGIBILITY.
The individuals who shall be eligible to participate in the Plan shall
be such key employees and directors of any subsidiary corporation as the Board
shall determine from time to time; provided, however, that no person shall
participate in the Plan who in the opinion of the Board may be deemed to be a
director or officer of the Company within the meaning of Section 16(b) of the
Securities Exchange Act of 1934 and the rules and regulations thereunder. For
all purposes of the Plan the term "subsidiary corporation" shall mean any
corporation of which 50% or more of its outstanding voting stock is at the time
owned by the Company or by one or more subsidiary corporations.
6. OPTION PRICE.
The price at which shares may be purchased pursuant to Options shall be
specified by the Board at the time the Option is granted, and may not be less
than 85% of the fair market value of the shares of Common Stock on the date the
option is granted; provided, however, that no Option may be granted to an
individual who, at the time such Option is granted, owns more than 10% of the
total combined voting power or value of all classes of stock of the Company or
any subsidiary corporation of the Company unless such Option provides that the
purchase price per share shall not be less than 110% of the fair market value of
the Common Stock on the date the Option is granted.
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<PAGE> 3
7. DURATION OF OPTIONS.
The Board in its discretion may provide that an option shall be
exercisable during any specified period of time of not more than 10 years
commencing on the date such option is granted.
8. AMOUNT EXERCISABLE.
Each Option may be exercised, so long as it is valid and outstanding,
from time to time in part or as a whole, subject to any limitations with respect
to the number of shares for which the Option may be exercised at a particular
time and to such other conditions as the Board in its discretion may specify
upon granting the option, provided, however, that each Option shall be
exercisable as to not less than one-fifth of the shares for which it may be
exercised on the first anniversary date from the date of such grant, and not
less than an additional one-fifth of such shares on each of the second, third,
fourth and fifth anniversary dates from the date of such grant.
9. EXERCISE OF OPTIONS.
Options shall be exercised by the delivery of written notice to the
Company setting forth the number of shares with respect to which the Option is
to be exercised and the address to which certificates therefor are to be mailed,
together with (a) cash, check, bank draft or postal or express money order
payable to the order of the Company for an amount equal to the option price of
such shares, or (b) with the consent of the Board, shares of Common Stock of the
company having a fair market value equal to the option price of such shares, or
(c) with the consent of the Board, the purchaser's promissory note (secured by
collateral, which may be the shares purchased, having a value equal to the
principal amount of the note) bearing interest at such rate as the Board in its
discretion may specify upon exercise of the Option, or (d) with the consent of
the Board, a combination of (a), (b) or (c). For the purpose of the preceding
sentence, the fair market value of the shares of Common Stock so delivered to
the Company shall be the fair market value as determined in good faith by the
Board. As promptly as practicable after receipt of such written notification and
payment, the Company shall deliver to the Optionee certificates for the number
of shares with respect to which such Option has been so exercised, issued in the
Optionee's name; provided, however, that such delivery shall be deemed effected
for all purposes when a stock transfer agent of the Company shall have deposited
such certificates in the United States mail, addressed to the Optionee, at the
address referred to above.
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<PAGE> 4
10. TRANSFERABILITY OF OPTIONS.
Options shall not be transferable by an Optionee otherwise than by will
or under the laws of descent and distribution, and shall be exercisable, during
his lifetime, only by him.
11. TERMINATION OF EMPLOYMENT OR DEATH OF EMPLOYEE-OPTIONEES.
Except as may be otherwise expressly provided in any Option, Options
issued to employees of the Company or a subsidiary shall terminate on the
earlier of:
(i) the date of expiration thereof;
(ii) the date of termination of the employment relationship
between the Company and the Optionee for cause; or
(iii) 30 days after the date of termination of the employment
relationship between the Company and the Optionee without
cause, other than death or retirement in good standing from
the employ of the Company for reasons of age or disability
under the then established rules of the Company.
Whether authorized leave of absence, or absence on military or
government service, shall constitute termination of the employment relationship
between the Company and the Optionee shall be determined by the Board at the
time thereof. In the event of the death of an Optionee while in the employ of
the Company and before the date of expiration of such Option, such Option shall
terminate on the earlier of such date of expiration or 180 days following the
date of such death. After the death of such Optionee, his executors,
administrators or any person or persons to whom his Option may be transferred by
will or by the laws of descent and distribution shall have the right, at any
time prior to the expiration of such 180-day period, to exercise the Option to
the extent the Optionee was entitled to exercise such Option immediately prior
to his death. If, before the date of expiration of the Option, an Optionee shall
be retired in good standing from the employ of the Company for reasons of age or
disability under the then established rules of the Company, the Option shall
terminate on the earlier of such date of expiration or 90 days after the date of
such retirement. In the event of such retirement, the Optionee shall have the
right prior to the termination of such Option to exercise the Option to the
extent to which he was entitled to exercise such Option immediately prior to
such retirement. An employment relationship between the Company and an Optionee
shall be deemed to exist during any period in which the Optionee is employed by
the Company or by any subsidiary corporation.
12. TERMINATION OF ENGAGEMENT OR DEATH OF OTHER OPTIONEES.
Except AS may be otherwise expressly provided in any Option and except
in case of the death of the Optionee, Options issued to directors of subsidiary
corporations who are not employees of the Company or such subsidiary
corporations shall terminate on the earlier of:
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<PAGE> 5
(i) the date of expiration thereof;
(ii) the date of termination for cause of the engagement of the
Optionee as a director; or
(iii) 30 days after the date of termination, other than for cause,
of such engagement. In the event of the death of an Optionee
while engaged as a director by a subsidiary corporation, and
before the date of expiration of such Option, such Option
shall terminate on the earlier of such date of expiration or
180 days following the date of death. After the death of such
Optionee, his executors, administrators or any person or
persons to whom his option may be transferred by will or by
the laws of descent and distribution shall have the right, at
any time prior to the expiration of such 180-day period, to
exercise the Option to the extent the Optionee was entitled
to exercise such option immediately prior to his death.
13. REQUIREMENTS OF LAW.
The Company shall not be required to sell or issue any shares under any
option if the issuance of such shares shall constitute a violation by the
optionee or by the Company of any provisions of any law or regulation of any
governmental authority. In addition, in connection with the Securities Act of
1933, as amended (the "Act"), upon exercise of any Option, the Company shall not
be required to issue such shares unless such shares are registered under the Act
or the Board has received evidence satisfactory to it to the effect that the
holder of such Option will not transfer such shares except pursuant to a
registration statement in effect under the Act or unless an opinion of counsel
to the Company has been received by the Company to the effect that such
registration is not required. Without limiting the generality of the foregoing,
the Company shall not be obligated to issue any such shares if in the Company's
sole judgment to do so would cause the Company or such issue not to be in
compliance with the requirements of Rule 504 promulgated under the Act. Any
determinations in this connection by the Board shall be final, binding and
conclusive. In the event the shares issuable on exercise of an option are not
registered under the Act, the Company may imprint on the certificate or
certificates evidencing such shares the following legend or any other legend
which counsel for the Company considers necessary or advisable to comply with
the Act:
"The shares of stock represented by this certificate
have not been registered under the Securities Act of 1933 or
under the securities laws of any State and may not be sold or
transferred except upon such registration or upon receipt by
the Corporation of an opinion of counsel satisfactory to the
Corporation, in form and substance satisfactory to the
Corporation, that registration is not required for such sale
or transfer."
43
<PAGE> 6
The Company may, but shall in no event be obligated to, register any
securities covered hereby pursuant to the Act; and in the event any shares are
so registered the Company may remove any legend on certificates representing
such shares. The Company shall not be obligated to take any other affirmative
action in order to cause the exercise of an Option or the issuance of shares
pursuant thereto to comply with any law or regulation of any governmental
authority.
14. NO RIGHTS AS STOCKHOLDER.
No Optionee shall have rights as a stockholder with respect to shares
covered by his option until the date of issuance of a stock certificate for such
shares; and, except as otherwise provided in paragraph 15 hereof, no adjustment
for dividends, or otherwise, shall be made if the record date therefor is prior
to the date of issuance of such certificate.
15. EMPLOYMENT OBLIGATION.
The granting of any Option shall not impose upon the Company any
obligation to employ or continue to employ any Optionee; and the right of the
Company to terminate the employment or engagement of any officer, employee or
other Optionee shall not be diminished or affected by reason of the fact that an
option has been granted to him.
16. CHANGES IN THE COMPANY'S CAPITAL STRUCTURE.
The existence of outstanding Options shall not affect in any way the
right or power of the Company or its stockholders to make or authorize any or
all adjustments, recapitalizations, reorganizations or other changes in the
Company's capital structure or its business, or any merger or consolidation of
the Company, or any issue of bonds, debentures, preferred or prior preference
stock ahead of or affecting the Common Stock or the rights thereof, or the
dissolution or liquidation of the Company, or any sale or transfer of all or any
part of its assets or business, or any other corporate act or proceeding,
whether of a similar character or otherwise.
If the Company shall effect a subdivision or consolidation of shares or
other capital readjustment, the payment of a stock dividend, or other increase
or reduction of the number of shares of the Common Stock outstanding, without
receiving compensation therefor in money, services or property, then (i) the
number, class, and per share price of shares of stock subject to outstanding
Options hereunder shall be appropriately adjusted in such a manner as to entitle
an Optionee to receive upon exercise of an Option, for the same aggregate cash
consideration, the same total number and class of shares as he would have
received as a result of the event requiring the adjustment had he exercised his
Option in full immediately prior to such event; and (ii) the number and class of
shares with respect to which Options may be granted under the Plan shall be
adjusted by substituting for the total number of shares of Common Stock then
reserved for issuance under
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<PAGE> 7
the Plan that number and class of shares of stock that the owner of an equal
number of outstanding shares of Common Stock would own as the result of the
event requiring the adjustment.
After a merger of one or more corporations into the Company, or after a
consolidation of the Company and one or more corporations in which the Company
shall be the surviving corporation, each holder of an outstanding Option shall,
at no additional cost, be entitled upon exercise of such Option to receive
(subject to any required action by stockholders) in lieu of the number of shares
as to which such Option shall then be so exercisable, the number and class of
shares of stock or other securities to which such holder would have been
entitled pursuant to the terms of the agreement of merger or consolidation if,
immediately prior to such merger or consolidation, such holder had been the
holder of record of a number of shares of Common Stock equal to the number of
shares as to which such Option shall be so exercised.
If the Company is merged into or consolidated with another corporation under
circumstances where the Company is not the surviving corporation, or if the
Company is liquidated, or sells or otherwise disposes of substantially all its
assets to another corporation while unexercised Options remain outstanding under
the Plan, (i) subject to the provisions of clause (iii) below, after the
effective date of such merger, consolidation or sale, as the case may be, each
holder of an outstanding Option shall be entitled, upon exercise of such Option,
to receive, in lieu of shares of Common Stock, shares of such stock or other
securities, cash or property as the holders of shares of Common Stock received
pursuant to the terms of the merger, consolidation or sale; (ii) the Board may
accelerate the time for exercise of all unexercised and unexpired options to and
after a date prior to the effective date of such merger, consolidation,
liquidation or sale, as the case may be, specified by the Board; or (iii) all
outstanding Options may be cancelled by the Board as of the effective date of
any such merger, consolidation, liquidation or sale provided that (x) notice of
such cancellation shall be given to each holder of an Option and (y) each holder
of an Option shall have the right to exercise such Option to the extent that the
same is then exercisable or, if the Board shall have accelerated the time for
exercise of all unexercised and unexpired options, in full during the 30-day
period preceding the effective date of such merger, consolidation, liquidation,
sale or acquisition.
Except as hereinbefore expressly provided, the issue by the Company of
shares of stock of any class, or securities convertible into shares of stock of
any class, for cash or property, or for labor or services either upon direct
sale or upon the exercise of rights or warrants to subscribe therefor, or upon
conversion of shares or obligations of the Company convertible into such shares
or other securities, shall not affect, and no adjustment by reason thereof shall
be made with respect to, the number or price of shares of Common Stock then
subject to outstanding Options.
17. AMENDMENT OR TERMINATION OF PLAN.
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<PAGE> 8
The Board may modify, revise or terminate this Plan at any time and
from time to time.
18. WRITTEN AGREEMENT.
Each Option granted hereunder shall be embodied in a written option
agreement which shall be subject to the terms and conditions prescribed above
and shall be signed by the President, any Vice President or the Chief Financial
officer of the Company for and in the name and on behalf of the Company. Such an
option agreement shall contain such other provisions as the Board in its
discretion shall deem advisable.
19. EFFECTIVE DATE.
The Plan became effective upon its adoption by the Board on May 12,
1988. Options may not be granted under the Plan more than 10 years after said
effective date. The Plan shall terminate (i) when the total amount of the Common
Stock with respect to which Options may be granted shall have been issued upon
the exercise of Options; (ii) by action of the Board pursuant to paragraph 16
hereof; or (iii) at the close of business on May 12, 1998, whichever shall first
occur.
20. REPURCHASE RIGHTS.
The Board may in its discretion provide, upon the grant of any option
hereunder, that the Company shall have an option to repurchase ALL or any number
of shares purchased upon exercise of such option within 60 days prior to, or at
any time after, the termination of the employment, or engagement by the Company
as a director, of the Optionee to whom the Option was granted. Therepurchase
price per share payable by the Company shall be such amount or be determined by
such formula as is fixed by the Board at the time the Option for the shares
subject to repurchase was granted. In the event the Board shall grant options
subject to the Company's repurchase option, the certificate or certificates
representing the shares purchased pursuant to such Option shall carry a legend
satisfactory to counsel for the Company referring to the Company's repurchase
option.
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<PAGE> 1
TELCO SYSTEMS, INC.
1990 STOCK OPTION PLAN, AS AMENDED
(including amendments through May 20, 1997)
SECTION 1. PURPOSE
The 1990 Stock Option Plan (the "Plan") is intended to attract and
retain highly qualified and competent employees and directors, to serve as a
performance incentive for officers and employees of Telco Systems, Inc., a
Delaware corporation (the "Company"), or its Subsidiaries (as hereinafter
defined) and for certain other individuals providing services to or acting as
directors of the Company or its Subsidiaries, to encourage the persons to whom
options are granted (a "Grantee" or "Grantees") to acquire or increase a
proprietary interest in the success of the Company and to maintain and enhance
the Company's long-term performance and profitability. The Company intends that
this purpose will be effected by the granting of incentive stock options
("Incentive Options") as defined in Section 422 of the Internal Revenue Code of
1986, as amended (the "Code") and other stock options ("Non-Statutory Options")
under the Plan. The term "Subsidiaries" means any corporations in which stock
possessing 50% or more of the total combined voting power of all classes of
stock of any such corporation or corporations is owned directly or indirectly by
the Company.
SECTION 2. OPTIONS TO BE GRANTED AND ADMINISTRATION
2.1 OPTIONS TO BE GRANTED. Options granted under the Plan may be either
Incentive Options or Non-Statutory Options.
2.2 ADMINISTRATION BY AND POWERS OF THE COMMITTEE. The Plan shall be
administered by a committee (the "Committee") consisting of at least two
"Outside Directors." As used herein, the term "Outside Director" means any
director of the Company who (i) is not an officer or employee of the Company or
of an "affiliated group" (as such term is defined in Section 1504(a) of the
Code) which includes the Company (an "Affiliate"), (ii) is not a former employee
of the Company or any Affiliate who is receiving compensation for prior services
(other than benefits under a tax-qualified retirement plan) during the Company's
or any Affiliate's taxable year, (iii) has not been an officer of the Company or
any Affiliate and (iv) does not receive remuneration from the Company or any
Affiliate, either directly or indirectly, in any capacity other than as a
director. It is the intention of the Company that the Plan shall be administered
by "Non-Employee Directors" within the meaning of Rule 16b-3 under the
Securities Exchange Act of 1934 (the "Exchange Act"), but the authority and
validity of any act taken or not taken by the Committee shall not be affected if
any person administering the Plan is not a Non-Employee Director. Except as
specifically reserved to the Board under the terms of the Plan, and subject to
Section 4.2 hereof, the Committee shall have full and final authority to
operate, manage and administer the Plan on behalf of the Company. This authority
shall include, but not be limited to: (i) the power to grant options
conditionally or unconditionally; (ii) the power to prescribe the form or forms
of the instruments evidencing options granted under this Plan; (iii) the power
to interpret the Plan; (iv) the power to provide regulations for the operation
of the incentive features of the Plan, and otherwise to prescribe regulations
for interpretation, management and administration of the Plan; (v) the power to
delegate to other persons the responsibility for performing ministerial acts in
furtherance of the Plan's purpose; and (vi) the power to engage the services of
persons or organizations in furtherance of the Plan's purpose, including but not
limited to banks, insurance companies, brokerage firms and consultants.
In addition, as to each option, except for options granted pursuant to
Section 4.2, the Committee shall have full and final authority in its
discretion: (i) to determine the number of shares
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<PAGE> 2
subject to each option; (ii) to determine the time or times at which options
will be granted; (iii) to determine the price for the shares subject to each
option, which price shall be subject to the applicable requirements, if any, of
Section 5(c) hereof; and (iv) subject to the provisions of the Plan, to
determine the time or times when each option shall become exercisable and the
duration of the exercise period, which shall not exceed the limitations
specified in Section 5(a). The Committee may, in its sole and unilateral
discretion, and on either a case by case or aggregate basis, accelerate the
schedule of the time or times when an outstanding option may be exercised,
reduce the exercise price of an outstanding option, or extend the duration of an
outstanding option past the times set for in Section 5(e), other than Section
5(e)(i); provided that the Committee may not accelerate unexercised and
unexpired options pursuant to this Section 2.2 if in the opinion of the
Company's independent auditors to do so would adversely affect pooling of
interests treatment intended to be effected in connection with a Transaction, as
such term is defined in Section 8.2 hereof.
No member of the Committee shall be liable for any action or
determination made in good faith with respect to the Plan or any option granted
hereunder.
2.3 LIMITATION ON OPTION REPRICING. Notwithstanding the foregoing, it
is the intention of the Company that the discretion of the Committee with
respect to Option Repricing (as hereinafter defined) be limited as hereinafter
set forth. For purposes of this paragraph, the term "Option Repricing" shall be
deemed to refer to (i) any amendment of an outstanding option that has the
effect of reducing the exercise price of such option, or (ii) any option grant
that is by its terms contingent upon the surrender or exchange by the grantee of
an outstanding option having a higher exercise price. It is the policy of the
Company that Option Repricing is to be employed only in exceptional
circumstances, where necessary to restore the incentive value of outstanding
options and where the Committee has determined that such Option Repricing is
necessary to fulfill a legitimate corporate purpose, including the retention of
one or more key employees.
2.4 APPOINTMENT AND PROCEEDINGS OF COMMITTEE. The Board may from time
to time appoint members of the Committee in substitution for or in addition to
members previously appointed, and subject to Section 2.2 hereof may fill
vacancies, however caused, in the Committee. The Committee shall select one of
its members as its chairman and shall hold its meetings at such times and places
as it shall deem advisable. A majority of its members shall constitute a quorum,
and all actions of the Committee shall require the affirmative vote of a
majority of its members. Any action may be taken by a written instrument signed
by all of the members, and any action so taken shall be as fully effective as if
it had been taken by a vote of a majority of the members at a meeting duly
called and held.
SECTION 3. STOCK
3.1 SHARES SUBJECT TO PLAN. The stock subject to options granted under
the Plan shall be shares of the Company's common stock, $.01 par value ("Common
Stock"), either authorized but unissued or held in treasury. The total number of
shares that may be issued pursuant to options granted under the Plan shall not
exceed an aggregate of 2,300,000 shares of Common Stock, of which not more than
325,000 shares may be issued pursuant to Section 4.2 hereof. Such numbers of
shares shall be subject to adjustment in accordance with Section 7.
3.2 LAPSED OR UNEXERCISED OPTIONS. Whenever any outstanding option
under the Plan expires, is cancelled or is otherwise terminated (other than by
exercise), the shares of Common Stock allocable to the unexercised portion of
such option shall be restored to the Plan and shall again become available for
the grant of other options under the Plan.
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<PAGE> 3
SECTION 4. ELIGIBILITY
4.1 ELIGIBLE GRANTEES. Incentive Options may be granted only to
officers and other employees of the Company or its Subsidiaries, including
members of the Board who are also employees of the Company or a Subsidiary.
Non-Statutory Options may be granted to officers or other employees of the
Company or its Subsidiaries, including members of the Board or the board of
directors of any Subsidiary, and to certain other individuals providing services
to the Company or its Subsidiaries. Non-Statutory Options may be granted to
members of the Board who are not full-time employees of the Company or a
Subsidiary ("Outside Directors") only as provided in Section 4.2 hereof.
4.2 NON-DISCRETIONARY OPTION GRANTS TO OUTSIDE DIRECTORS. Any other
provision of this Plan to the contrary notwithstanding, Outside Directors shall
not be eligible to receive options under the Plan except pursuant to this
Section 4.2. On the first business day following the Company's Annual Meeting of
Stockholders or, if the Annual Meeting has not been held by the last business
day of March in any year, then on the last business day of March in such year
(the "Grant Date"), (i) any Outside Director who was elected a director by the
stockholders of the Company for the first time at the most recent annual meeting
of stockholders shall, without any action of the Committee, be granted a
Non-Qualified Option to purchase 10,000 shares of Common Stock, (ii) each
Outside Director elected prior to January 22, 1997 who holds Non-Qualified
Options to purchase fewer than 50,000 shares of Common Stock shall, without any
action of the Committee, be granted a Non-Qualified Option to purchase 10,000
shares of Common Stock, and (iii) each other Outside Director shall, without any
action of the Committee, be granted a Non-Qualified Option to purchase 5,000
shares of Common Stock. Options shall be granted pursuant to this Section 4.2
only to persons who are serving as Outside Directors on the Grant Date. No
Outside Director shall receive more than one grant pursuant to clause (i) of
this Section. The 5,000-share and 10,000-share amounts referred to in this
Section shall be subject to adjustment in accordance with Section 7 hereof. The
purchase price per share of the Common Stock under each option granted pursuant
to this Section shall be equal to the fair market value of the Common Stock on
the date the option is granted. Each such option shall expire on the tenth
anniversary of the date of grant and shall not be exercisable until after the
expiration of six months following the date of grant, becoming exercisable at
that time for a whole number of shares equal, as nearly as practicable, to
one-eighth of the total number of shares subject to such option, and becoming
exercisable ratably thereafter in monthly installments until fully exercisable
on the fourth anniversary of the date of grant.
4.3 LIMITATIONS ON 10% STOCKHOLDERS. No Incentive Option shall be
granted to an individual who, at the time the Incentive Option is granted, owns
(including ownership attributed pursuant to Section 424 of the Code) more than
l0% of the total combined voting power of all classes of stock of the Company or
any parent or Subsidiary of the Company (a "greater-than-10% stockholder"),
unless such Incentive Option provides that (i) the purchase price per share
shall not be less than 110% of the fair market value of the Common Stock at the
time such Incentive Option is granted, and (ii) such Incentive Option shall not
be exercisable to any extent after the expiration of five years from the date it
is granted.
4.4 LIMITATION ON EXERCISABLE OPTIONS. The aggregate fair market value
(determined at the time the Incentive Option is granted) of the Common Stock
with respect to which Incentive Options are exercisable for the first time by
any person during any calendar year under the Plan and under any other option
plan of the Company (or a parent or subsidiary as defined in Section 424 of the
Code) shall not exceed $100,000. Any option granted in excess of the foregoing
limitation shall be specifically designated as being a Non-Statutory Option.
4.5 LIMITATION ON GRANT OF OPTIONS. In no event may any Plan
participant be granted options with respect to more than 100,000 shares of
Common Stock in any fiscal year. The number of shares of Common Stock issuable
pursuant to an option granted to a Plan participant in a fiscal
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<PAGE> 4
year that is subsequently forfeited, canceled or otherwise terminated shall
continue to count toward the foregoing limitation in such fiscal year. In
addition, if the exercise price of an option is subsequently reduced, the
transaction shall be deemed a cancellation of the original option and the grant
of a new one so that both transactions shall count toward the maximum shares
issuable in the fiscal year of each transaction.
SECTION 5. AGREEMENTS EVIDENCING STOCK OPTIONS
Each option agreement (each, a "Plan agreement") shall contain such
provisions as the Committee shall from time to time deem appropriate. Plan
agreements need not be identical, but each such agreement by appropriate
language shall include the substance of all of the following provisions:
(a) EXPIRATION. Subject to Section 4.2 hereof, notwithstanding any
other provision of the Plan or of any Plan agreement, each option shall expire
on the date specified in the Plan agreement, which date shall not be later than
the tenth anniversary of the date on which the option was granted (fifth
anniversary in the case of an Incentive Option granted to a greater-than-10%
stockholder).
(b) EXERCISE. Subject to Sections 4.2 and 6.4 hereof, each option shall
be exercisable in full or in installments (which need not be equal) and at such
times as designated by the Committee. To the extent not exercised, installments
shall accumulate and be exercisable, in whole or in part, at any time after
becoming exercisable, but not later than the date the option expires.
(c) PURCHASE PRICE. The purchase price per share of the Common Stock
under each option shall be not less than the fair market value of the Common
Stock on the date the option is granted (110% of the fair market value in the
case of an Incentive Option granted to a greater-than-10% stockholder). For the
purpose of the Plan, the fair market value of the Common Stock shall be the
closing price per share on the date of grant of the option as reported by a
nationally recognized stock exchange, or, if the Common Stock is not listed on
such an exchange, as reported by the NASDAQ National Market System, or, if the
Common Stock is not quoted on the NASDAQ National Market System, the fair market
value as determined by the Committee.
(d) TRANSFERABILITY OF OPTIONS. Options granted under the Plan and the
rights and privileges conferred thereby may not be transferred, assigned,
pledged or hypothecated in any manner (whether by operation of law or otherwise)
other than by will or by applicable laws of descent and distribution, and shall
not be subject to execution, attachment or similar process. Upon any attempt so
to transfer, assign, pledge, hypothecate or otherwise dispose of any option
under the Plan or any right or privilege conferred hereby, contrary to the
provisions of the Plan, or (if the Committee shall so determine) upon any levy
or any attachment or similar process upon the rights and privileges conferred
hereby, such option shall thereupon terminate and become null and void.
(e) TERMINATION OF EMPLOYMENT OR DEATH OF GRANTEE. Except as may be
otherwise expressly provided in the terms and conditions of the Plan agreements,
options granted hereunder shall terminate on the earlier to occur of:
(i) the date of expiration thereof; or
(ii) other than in the case of death of the Grantee or disability of
the Grantee within the meaning of Section 22(e)(3) of the Code ("disability"),
immediately upon termination of the employment or other relationship between the
Company and the Grantee for cause as determined by the Committee, or 30 days
after termination of the employment or other relationship between the Company
and the Grantee without cause.
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An employment relationship between the Company and the Grantee shall be
deemed to exist during any period during which the Grantee is employed by the
Company or by any Subsidiary. Whether an authorized leave of absence or absence
on military government service shall constitute termination of the employment
relationship between the Company and the Grantee shall be determined by the
Committee at the time thereof.
As used herein, "cause" shall mean (x) any material breach by the
Grantee of any agreement to which the Grantee and the Company are both parties,
(y) any act or omission to act by the Grantee which may have a material and
adverse effect on the Company's business or on the Grantee's ability to perform
services for the Company, including, without limitation, the commission of any
crime (other than ordinary traffic violations), or (z) any material misconduct
or material neglect of duties by the Grantee in connection with the business or
affairs of the Company or any affiliate of the Company.
In the event of the death of a Grantee while in an employment or other
relationship with the Company and before the date of expiration of an option
held by such Grantee, such option shall terminate on the earlier of such date of
expiration or 180 days following the date of such death. After the death of the
Grantee, his executors, administrators or any person or persons to whom his
option may be transferred by will or by laws of descent and distribution shall
have the right, at any time prior to such termination, to exercise the option to
the extent the Grantee was entitled to exercise such option immediately prior to
his death.
If a Grantee's employment or other relationship with the Company
terminates because of a disability, the Grantee's option shall terminate on the
earlier of the date of expiration thereof or 12 months following the termination
of such relationship; and unless by its terms it sooner terminates and expires
during such 12-month period, the Grantee may exercise that portion of his or her
option which is exercisable at the time of termination of such relationship.
(f) RIGHTS OF GRANTEES. No Grantee shall be deemed for any
purpose to be the owner of any shares of Common Stock subject to any option
unless and until (i) the option shall have been exercised pursuant to the terms
thereof and (ii) the Company shall have issued and delivered the shares to the
Grantee.
SECTION 6. METHOD OF EXERCISE AND PAYMENT
6.1 NOTICE OF EXERCISE. Any option granted under the Plan may be
exercised by the Grantee by delivering to the Company on any business day a
written notice (the "Notice") specifying the number of shares of Common Stock
with respect to which the Grantee then desires to exercise the option,
specifying the address to which the certificates for such shares are to be
mailed and accompanied by payment for such shares.
6.2 EXERCISE OF OPTIONS. Payment for the shares of Common Stock
purchased pursuant to the exercise of an option shall be made either (i) in cash
equal to the option price for the number of shares specified in the Notice (the
"Total Option Price"), or (ii) if authorized by the applicable Plan agreement,
in shares of Common Stock having a fair market value equal to or less than the
Total Option Price, plus cash in an amount equal to the excess, if any, of the
Total Option Price over the fair market value of such shares of Common Stock.
For the purpose of the preceding sentence, the fair market value of the shares
of Common Stock so delivered to the Company shall be determined in the manner
specified in Section 5(c) hereof. As promptly as practicable after receipt of
such Notice and payment, the Company shall deliver to the Grantee certificates
for the number of shares with respect to which such option has been so
exercised, issued in the Grantee's name; provided, however, that such delivery
shall be deemed effected for all purposes when the Company
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or a stock transfer agent of the Company shall have deposited such certificates
in the United States mail, addressed to the Grantee, at the address specified
pursuant to Section 6.1.
6.3 SPECIAL LIMITS AFFECTING SECTION 16(B) GRANTEES. Options granted to
a person who in the opinion of the Committee may be deemed to be a director or
officer of the Company within the meaning of Section 16(b) of the Exchange Act
and the rules and regulations thereunder (a "Section 16(b) Grantee") shall not
be exercisable until after the expiration of six months following the date of
grant. At least six months shall elapse between the date an option is granted to
a Section 16(b) Grantee and the date of disposition of the option (other than
upon exercise) or the Common Stock subject to such option.
SECTION 7. ADJUSTMENT UPON CHANGES IN CAPITALIZATION
7.1 NO EFFECT OF OPTIONS UPON CERTAIN CORPORATE TRANSACTIONS. The
existence of outstanding options shall not affect in any way the right or power
of the Company or its stockholders to make or authorize any or all adjustments,
recapitalizations, reorganizations or other changes in the Company's capital
structure or its business, or any merger or consolidation of the Company, or any
issue of Common Stock, or any issue of bonds, debentures, preferred or prior
preference stock ahead of or affecting the Common Stock or the rights thereof,
or the dissolution or liquidation of the Company, or any sale or transfer of all
or any part of its assets or business, or any other corporate act or proceeding,
whether of a similar character or otherwise.
7.2 STOCK DIVIDENDS, RECAPITALIZATIONS, ETC. If the Company shall
effect a subdivision or consolidation of shares or other capital readjustment,
the payment of a stock dividend, or other increase or reduction of the number of
shares of the Common Stock outstanding, without receiving compensation therefor
in money, services or property, then (i) the number, class and per share price
of shares of stock subject to outstanding options hereunder shall be
appropriately adjusted in such a manner as to entitle a Grantee to receive upon
exercise of an option, for the same aggregate cash consideration, the same total
number and class of shares that the owner of an equal number of outstanding
shares of Common Stock would own as a result of the event requiring the
adjustment; and (ii) the number and class of shares that may be issued under,
and with respect to which options may be granted pursuant to, the Plan shall be
adjusted by substituting for the total number of shares of Common Stock then
reserved for issuance under, and with respect to which options may be granted
pursuant to, the Plan that number and class of shares of stock that the owner of
an equal number of outstanding shares of Common Stock would own as the result of
the event requiring the adjustment.
7.3 DETERMINATION OF ADJUSTMENTS. Adjustments under this Section 7
shall be determined by the Committee and such determinations shall be
conclusive. The Committee shall have the discretion and power in any such event
to determine and to make effective provision for acceleration of the time or
times at which any option or portion thereof shall become exercisable. No
fractional shares of Common Stock shall be issued under the Plan on account of
any adjustment specified above.
7.4 NO ADJUSTMENT IN CERTAIN CASES. Except as hereinbefore expressly
provided, the issue by the Company of shares of stock of any class, or
securities convertible into shares of stock of any class, for cash or property
or for labor or services, either upon direct sale or upon the exercise of rights
or warrants to subscribe therefor, or upon conversion of shares or obligations
of the Company convertible into such shares or other securities, shall not
affect, and no adjustment by reason thereof shall be made with respect to, the
number or price of shares of Common Stock then subject to outstanding options.
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<PAGE> 7
SECTION 8. EFFECT OF CERTAIN TRANSACTIONS
8.1 MERGER WITHOUT CHANGE OF CONTROL. After a merger of one or more
corporations into the Company, or after a consolidation of the Company and one
or more corporations, in each case as a result of which the stockholders of the
Company immediately prior to such merger or consolidation own after such merger
or consolidation shares representing at least fifty percent (50%) of the voting
power of the merged or consolidated corporations, each holder of an outstanding
option shall, at no additional cost, be entitled upon exercise of such option to
receive (subject to any required action by stockholders), in lieu of the number
of shares as to which such option shall then be so exercisable, the number and
class of shares of stock or other securities to which such holder would have
been entitled pursuant to the terms of the agreement of merger or consolidation
if, immediately prior to such merger or consolidation, such holder had been the
record holder of a number of shares of Common Stock equal to the number of
shares as to which such option was exercisable.
8.2 SALE OR MERGER WITH CHANGE OF CONTROL. If the Company is merged or
consolidated with another corporation under circumstances in which the
stockholders of the Company immediately prior to such merger or consolidation do
not own after such merger or consolidation shares representing at least fifty
percent (50%) of the voting power of the merger or consolidated corporations, or
if the Company is liquidated or sells or otherwise disposes of substantially all
of its assets (each hereinafter referred to as a "Transaction"), then in such
event, immediately prior to the effective time of the Transaction and without
any further action by the Committee or the Board of Directors, all unexercised
and unexpired options outstanding under the Plan shall automatically be
accelerated so as to be exercisable in full immediately prior to the effective
time of the Transaction. Notwithstanding the foregoing, outstanding unexercised
and unexpired options shall not be automatically accelerated if, in the opinion
of the Company's independent auditors, to do so would adversely affect pooling
of interest treatment intended to be effected in connection with the
Transaction, in which case, upon the effectiveness of the Transaction, each
holder of an outstanding option shall be entitled, upon exercise of such option,
to receive, in lieu of shares of Common Stock, shares of such stock or other
securities, cash or property as the holders of shares of Common Stock received
pursuant to the terms of the Transaction.
SECTION 9. AMENDMENT OF THE PLAN
The Board may terminate the Plan and may amend the Plan at any time,
and from time to time, subject to the limitation that, except as provided in
Sections 7 and 8 hereof, no amendment shall be effective unless approved by the
stockholders of the Company in accordance with applicable law and regulations,
at an annual or special meeting held within 12 months before or after the date
of adoption of such amendment, in any instance in which such amendment would:
(i) increase the number of shares of Common Stock that may be issued under, or
as to which options may be granted pursuant to, the Plan; or (ii) change in
substance the provisions of Section 4 hereof relating to eligibility to
participate in the Plan.
SECTION 10. NON-EXCLUSIVITY OF THE PLAN; NON-UNIFORM DETERMINATIONS
Neither the adoption of the Plan by the Board nor the approval of the
Plan by the stockholders of the Company shall be construed as creating any
limitations on the power of the Board to adopt such other incentive arrangements
as it may deem desirable, including without limitation the granting of options
otherwise than under the Plan, and such arrangements may be either applicable
generally or only in specific cases.
The Committee's determinations under the Plan need not be uniform and
may be made by it selectively among persons who receive, or are eligible to
receive, awards under the Plan (whether or not such persons are similarly
situated). Without limiting the generality of the foregoing, the Committee shall
be entitled, among other things, to make non-uniform and selective
determinations,
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<PAGE> 8
and to enter into non-uniform and selective Plan agreements, as to (i) the
persons to receive awards under the Plan, (ii) the terms and provisions of
awards under the Plan, (iii) the exercise by the Committee of its discretion in
respect of the exercise of options pursuant to the terms of the Plan, and (iv)
the treatment of leaves of absence pursuant to Section 5(e) hereof.
SECTION 11. GOVERNMENT AND OTHER REGULATIONS; TAX WITHHOLDING
The obligation of the Company to sell and deliver shares of Common
Stock with respect to options granted under the Plan shall be subject to all
applicable laws, rules and regulations, including all applicable federal and
state securities laws, and the obtaining of all such approvals by government
agencies as may be deemed necessary or appropriate by the Committee. All shares
sold under the Plan shall bear appropriate legends. The Company may, but shall
in no event be obligated to, register or qualify any securities covered hereby
under applicable federal and state securities laws; and in the event any shares
are so registered or qualified the Company may remove any legend on certificates
representing such shares. The Company shall not be obligated to take any other
affirmative action in order to cause the exercise of an option or the issuance
of shares pursuant thereto to comply with any law or regulation of any
governmental authority. The Plan shall be governed by and construed in
accordance with the laws of the State of Delaware.
Whenever under the Plan shares are to be delivered upon exercise of an
option, the Company shall be entitled to require as a condition of delivery that
the Grantee remit an amount sufficient to satisfy all federal, state and other
governmental withholding tax requirements related thereto.
SECTION 12. EFFECTIVE DATE OF PLAN
The effective date of the Plan is October 26, 1990, the date on which
it was approved by the Board. No option may be granted under the Plan after the
tenth anniversary of such effective date. Subject to the foregoing, options may
be granted under the Plan at any time subsequent to October 26, 1990; provided,
however, that (a) no such option shall be exercised or exercisable unless the
stockholders of the Company shall have approved the Plan no later than one year
from such effective date, and (b) all options issued prior to the date of such
stockholders' approval shall contain a reference to such condition.
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<PAGE> 1
Telco Systems, Inc.
Subsidiaries of the Registrant
NAME JURISDICTION INCORPORATED
- -------------------------- -------------------------
Telco Security Corporation Massachusetts
Telco Systems, Ltd. United Kingdom
Telco Systems Asia/Pacific Hong Kong
TSI Exports, Ltd. Barbados
Telco Indemnity, Ltd. Bermuda
Exhibit 22.1
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Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statements
pertaining to the Telco Systems, Inc. 1983 Employee Stock Purchase Plan (Form
S-8 No. 33-26976); the Telco Systems, Inc. 1980 Stock Option Plan (Form S-8 Nos.
2-94474, 33-2024 and 33-10548); the Telco Systems, Inc. 1988 Non-Statutory Stock
Option Plan (Form S-8 No. 33-28295) and the 1990 Stock Option Plan (Form S-8
Nos. 33-42751 and 333-00959) of our report dated October 15, 1997, with respect
to the consolidated financial statements and schedule of Telco Systems, Inc.
included in the Annual Report (Form 10-K) for the year ended August 31, 1997.
ERNST & YOUNG LLP
Boston, Massachusetts
November 26, 1997
EXHIBIT 23.1
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MASTER LEASE AGREEMENT
THIS MASTER LEASE AGREEMENT, dated as of ;June6, 1997 ("Agreement"), between
General Electric Capital Corporation, with an office at 4 North Park Drive Suite
500, Hunt Valley, MD 21030 (hereinafter called, together with its successors and
assigns. if any, "Lessor"), and Telco Systems, Inc., a corporation organized and
existing under the laws of the State of Delaware with its mailing address and
chief place of business at 63 Nahatan Street, Norwood, MA 07062 (hereinafter
called "Lessee").
WITNESSETH:
I. LEASING:
(a) Subject to the terms and conditions set forth below, Lessor agrees to
lease to LESSEE, AND LESSEE AGREE TO LEASE FROM LESSOR, THE EQUIPMENT
("EQUIPMENT") described in Annex A to any schedule hereto ("Schedule")
or, if applicable, to Section A of any Schedule. TERMS DEFINED IN A
SCHEDULE AND NOT OTHERWISE DEFINED herein shall have the meanings
ascribed to them in such Schedule.
(b) The obligation of Lessor to purchase Equipment from the manufacturer or
supplier thereof ("Supplier") and to lease the same to Lessee under any
Schedule shall be subject to receipt by Lessor, prior to the Lease
Commencement Date (with respect to such Equipment), of each of the
following documents in form and substance satisfactory to Lessor: (i) a
Schedule relating to the Equipment then to be leased hereunder, (ii) a
Purchase Order Assignment and Consent in the form of Annex B to the
applicable Schedule, unless Lessor shall have delivered its purchase
order for such Equipment, (iii) evidence of insurance which complies
with the requirements of Section X and (iv) such other documents as
Lessor may reasonably request. As a further condition to such
obligations of Lessor, Lessee shall, upon delivery of such Equipment
(but not later than the Last Delivery Date specified in the applicable
Schedule) execute and deliver to Lessor a Certificate of Acceptance
(which may be in the form of Annex C to the applicable Schedule)
covering such Equipment, and, if requested by Lessor,-deliver to Lessor
a bill of sale therefor (in form and substance satisfactory to Lessor).
Lessor hereby appoints Lessee its agent for inspection and acceptance
of the Equipment from the Supplier. Upon execution by Lessee of any
Certificate of Acceptance, the Equipment described thereon shall be
deemed to have been delivered to, and irrevocably accepted by, Lessee
for lease hereunder
II. TERM, RENT AND PAYMENT:
(a) The rent payable hereunder and Lessee's right to use the Equipment
shall commence on the date of execution by Lessee of the Certificate of
Acceptance for such Equipment ("Lease Commencement Date"). The term of
this Agreement shall be the period specified in the applicable
Schedule. If any term is extended, the word "term" shall be deemed to
refer to all extended term, and all provision of this Agreement shall
apply during any extended term, except as may be otherwise specifically
provided in writing.
(b) Rent shall be paid to Lessor at its address stated above, except as
otherwise directed by Lessor. Payments of rent shall be in the amount
set forth in, and due in accordance with, the provisions of the
applicable Schedule. If one or more Advance Rents are payable, such
Advance Rent shall be (i) set forth on the applicable Schedule, (ii)
due upon acceptance by Lessor of such Schedule, and (iii) v hen
received by Lessor, applied to the first rent payment
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<PAGE> 2
and the balance, if any, to the final rental payment(s) under such
Schedule. In no event shall any Advance Rent or any other rent payments
be refunded to Lessee. If rent is not paid within ten days of its due
date, Lessee agrees to pay a late charge of five cents ($.05) per
dollar on, and in addition to, the amount of such rent but not
exceeding the lawful maximum, if any.
III. RENT ADJUSTMENT:
(a) The periodic rent payments m each Schedule have been calculated on the
assumption (which, as between Lessor and Lessee, is mutual) that the
maximum effective corporate income tax rate (exclusive of any minimum
tax rate) for calendar-year taxpayer ("Effective Rate") will be
thirty-five percent (35%) each year during the lease term.
(b) If, solely as a result of Congressional enactment of any law
(including, without limitation, any modification of, or amendment or
addition to, the Internal Revenue Code of 1986, as amended, (the
"Code")), the Effective Rate is higher than thirty-five percent (35%)
for any year during the lease term, then Lessor shall have the right to
increase such rent payments by requiring payment of a single additional
sum equal to the product of (i) the Effective Rate (expressed as a
decimal) for such year less .35 (or, in the event that any adjustment
has been made hereunder for any previous year, the Effective Rate
(expressed as a decimal) used in calculating the next previous
adjustment) times (ii) the adjusted Termination Value, divided by (iii)
the difference between the new Effective Tax Rate (expressed as a
decimal) and one ( I ). The adjusted Termination Value shall be the
Termination Value (calculated as of the first rental due in the year
for which such adjustment is being made) less the Tax Benefits that
would be allowable under Section 168 of the Code (as of the first day
of the year for which such adjustment is being made and all subsequent
years of the lease term). Lessee shall pay to Lessor the full amount of
the additional rent payment on the later of (i) receipt of notice or
(ii) the first day of the year for which such adjustment is being made.
(c) Lessee's obligations under this Section lll shall survive any
expiration or termination of this Agreement.
IV. TAXES: Except as provided in Sections lll and XV(c), Lessee shall have
no liability for taxes imposed by the United States of America or any
State or political subdivision thereof which are on or measured by the
net income of Lessor. Lessee shall report (to the extent that it is
legally permissible) and pay promptly all other taxes, fees and
assessments due, imposed, assessed or levied against any Equipment (or
the purchase, ownership, delivery, leasing, possession, use or
operation thereof), this Agreement (or any rentals or receipts
hereunder), any Schedule, Lessor or Lessee by any foreign, federal,
state or local government or taxing authority during or related to the
term of this Agreement, including, without limitation, all license and
registration fees, and all sales, use, personal property, excise, gross
shall (i) reimburse Lessor upon receipt of written request for
reimbursement for any Taxes charged to or assessed against Lessor, (ii)
on request of Lessor, submit to Lessor written evidence of Lessee's
payment of Taxes, (iii) on all reports or returns show the ownership of
the Equipment by Lessor, and (iv) send a copy thereof to Lessor.
V. REPORTS:
(a) Lessee will notify Lessor in writing, within ten (10) days after any
tax or other lien shall attach to any Equipment, of the full
particulars thereof and of the location of such equipment on the date
of such notification .
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<PAGE> 3
(b) Lessee will within ninety (90) days of the close of each fiscal year of
Lessee, deliver to Lessor, Lessee's balance sheet and profit and loss
statement, certified by a recognized firm of certified public
accountants. Upon request Lessee will deliver to Lessor quarterly,
within ninety (90) days of the close of each fiscal quarter of Lessee,
in reasonable detail, copies of Lessee's quarterly financial report
certified by the chief financial officer of Lessee.
(c) Lessee will permit Lessor to inspect any Equipment during normal
business hours.
(d) Lessee will keep the Equipment at the Equipment Location (specified in
the applicable Schedule) and will promptly notify Lessor of any
relocation of Equipment. Upon the written request of Lessor. Lessee
will notify Lessor forthwith in writing of the location of any
Equipment as of the date of such notification.
(e) Lessee will promptly and fully report to Lessor in writing if any
Equipment is lost or damaged (where the estimated repair costs would
exceed ten percent ( 10%) of its then fair market value), or is
otherwise involved in an accident causing personal injury or property
damage.
(f) Within sixty (60) days after any request by Lessor, Lessee will furnish
a certificate of an authorized officer of Lessee stating that he has
reviewed the activities of Lessee and that, to the best of his
knowledge, there exists no default (as described in Section Xll) or
event which with notice or lapse of time (or both) would become such a
default.
VI. DELIVERY, USE AND OPERATION:
(a) All Equipment shall be shipped directly from the Supplier to Lessee.
(b) Lessee agrees that the Equipment shall be used by Lessee solely in the
conduct of its business and in a manner complying with all applicable
federal, state, and local laws and regulations.
(c) LESSEE SHALL NOT ASSIGN, MORTGAGE, SUBLET OR HYPOTHECATE ANY EQUIPMENT,
OR THE INTEREST OF LESSEE HEREUNDER. NOR SHALL LESSEE REMOVE ,ANY
EQUIPMENT FROM THE CONTINENTAL UNITED STATES. WITHOUT THE PRIOR WRITTEN
CONSENT OF THE LESSOR.
(d) Lessee will keep the Equipment free and clear of all liens and
encumbrances other than those which result from acts of Lessor
VII. SERVICE:
(a) Lessee will, at its sole expense, maintain each unit of Equipment in
good operating order, repair, condition and appearance in accordance
with manufacturer's recommendations, normal wear and tear excepted.
Lessee shall, if at any time requested by Lessor, affix in a prominent
position on each unit of Equipment plates, tags or other identifying
labels showing ownership thereof by Lessor
(b) Lessee will nor, without the prior consent of Lessor, affix or install
any accessory, equipment or device on any Equipment if such addition
will impair the originally intended function or use of such Equipment.
All additions, repairs, parts, supplies, accessories, equipment, and
devices furnished, attached or affixed to any Equipment which are not
readily removable shall be made only in compliance with applicable law,
including Internal
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Revenue Service guidelines, and shall become the property of Lessor.
Lessee will not, without the prior written consent of Lessor and
subject to such conditions as Lessor may impose for its protection,
affix or install any Equipment to or in any other personal or real
property.
(c) Any alterations or modifications to the Equipment that may, at any time
during the term of this Agreement, be required to comply with any
applicable law, rule or regulation shall be made at the expense of
Lessee.
VIII. STIPULATED LOSS VALUE: Lessee shall promptly and fully notify Lessor in
writing if any unit of Equipment shall be or become worn out, lost,
stolen, destroyed, irreparably damaged in the reasonable determination
of Lessee, or permanently rendered unfit for use from any cause
whatsoever (such occurrences being hereinafter called "Casualty
Occurrences"). On the rental payment date next succeeding a Casualty
Occurrence (the "Payment Date"), Lessee shall pay Lessor the sum of (x)
the Stipulated Loss Value of such unit calculated as of the rental next
preceding such Casualty Occurrence (-CALCULATION Date-); and (y) all
rental and other amounts which are due hereunder as of the Payment
Date. Upon payment of all sums due hereunder, the term of this lease as
to such unit shall terminate and (except in the case of the loss, theft
or complete destruction of such unit) Lessor shall be entitled to
recover possession of such unit
IX. LOSS OR DAMAGE: Lessee hereby assumes and shall bear the entire risk of
any loss, theft, damage to, or destruction of, any unit of Equipment.
X. INSURANCE: Lessee agrees, at is own expense, to keep all Equipment
insured for such amounts and against such hazards as Lessor may
require, including, but not limited to, insurance for damage to or loss
of such Equipment and liability coverage for personal injuries, death
or property damage! with Lessor named as additional insured and with a
loss payable clause in favor of Lessor, as is interest may appear,
irrespective of any breach of warranty or other act or omission of
Lessee. The insurance shall provide (i) liability coverage in an amount
equal to at least ONE MILLION U S. DOLLARS ($1,000,000.00) total
liability per occurrence, unless otherwise stated in any Schedule, and
(ii) casualty /property damage coverage in an amount equal to the
higher of the Stipulated Loss Value or the full replacement cost of the
Equipment; or at such other amounts as may be required by Lessor. All
such policies shall be with companies, and on terms, satisfactory to
Lessor. Lessee agrees to deliver to Lessor evidence of insurance
satisfactory to Lessor. No insurance shall be subject to any
co-insurance clause. Lessee hereby appoints Lessor as Lessee's
attorney-in-fact to make proof of loss and claim for insurance, and to
make adjustments with insurers and to receive payment of and execute or
endorse all documents, checks or drafts in connection with payments
made as a result of such insurance policies. Any expense of Lessor in
adjusting or collecting insurance shall be become by Lessee. Lessee
will not make adjustments with insurers except (i) with respect to
claims for damage to any unit of Equipment where the repair costs do
not exceed ten percent (10%) of such unit's fair market value, or (ii)
with Lessors written consent. Said policies shall provide that the
insurance may not be altered or canceled by the insurer until after
shiny (30) days written notice to Lessor. Lessor may, at is option,
apply proceeds of insurance, whole or in pan, to (i) repair or replace
Equipment or any portion thereof, or (ii) satisfy any obligation of
Lessee to Lessor hereunder.
XI. RETURN OF EQUIPMENT:
(a) Upon any expiration or termination of this Agreement or any Schedule,
Lessee shall promptly, at its own cost and expense: (i) perform any
testing and repairs required to place
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the affected units of Equipment in the same condition and appearance as
when received by Lessee (reasonable wear and tear excepted) and in good
working order for their originally intended purpose; (ii) if
deinstallation, disassembly or crating is required, cause such units to
be deinstalled, disassembled and crated by an authorized manufacture's
representative or such other service person as is satisfactory to
Lessor; and (iii) return such units to a location within the
continental United States as Lessor shall direct; (iv) ensure all
Lessee installed markings which are not necessary for the operation,
maintenance or repair of the Equipment are properly removed; (v)
provide that all Equipment will be cleaned and cosmetically acceptable,
and in such condition as to be immediately installed and put into use
in a similar environment for which the Equipment was originally
intended to be used; (vi) remove all waste material and fluid from the
Equipment and dispose of in accordance with then current waste disposal
laws; and (vii) obtain and pay for a policy of transit insurance for
the redelivery period in an amount equal to the replacement value of
1he equipment and name Lessor as the loss payee on all such policies of
insurance.
(b) Until Lessee has fully complied with the requirements of Section Xl(a)
above, Lessee's rent payment obligation and all other obligations under
this Agreement shall continue from month to month notwithstanding any
expiration or termination of the lease term. Lessor may terminate such
continued leasehold interest upon ten (10) days notice to Lessee.
(c) At least ninety (90) days and not more than one hundred twenty (120)
days prior to lease termination. Lessee shall: (i) provide to Lessor a
detailed inventory of all component of the Equipment including model
and serial numbers; and (ii) provide an up-to-date copy of all
documentation pertaining to the Equipment including, but not limited to
service manuals, blue pants, process flow,, diagrams, operating manuals
and maintenance records.
(d) At least one hundred twenty (120) days prior to and continuing up to
lease termination. Lessee shall, upon receiving reasonable notice from
Lessor, make the Equipment available for on-site operational
inspections by potential purchasers. Lessee shall provide personnel,
power and other requirements necessary to demonstrate electrical,
hydraulic and mechanical systems for each item of Equipment.
XII. DEFAULT:
(a) Lessor may in writing declare this Agreement in default if Lessee
breaches its obligation to pay rent or any other sum when due and fails
to cure the breach within ten ( 10) days; Lessee breaches any of its
insurance obligations under Section X; Lessee breaches any of is other
obligations and fails to cure that breach within thirty (30) days after
written notice thereof; any representation or warranty made by Lessee
in connection with this Agreement shall be false or misleading in any
material respect; Lessee becomes insolvent or ceases to do business as
a going concern; any Equipment is illegally used; or a petition is
filed by or against Lessee or any Guarantor of Lessee's obligations to
Lessor under any bankruptcy or insolvency laws. Such declaration shall
apply to all Schedules except as specifically excepted by Lessor.
(b) After default, at the request of Lessor, Lessee shall comply with the
provisions of Section Xl(a). Lessee hereby authorizes Lessor to enter,
with or without legal process, any premises where any Equipment is
believed to be and take possession thereof. Lessee shall, without
further demand, forthwith pay to Lessor (i) as liquidated damages for
loss of a bargain and not as a penalty, the Stipulated Loss Value of
the Equipment (calculated as of the rental next preceding the
declaration of default), and (ii) all rentals and other sums then due
hereunder. Lessor may, but shall not be required to, sell Equipment at
private or public sale, in bulk or in parcels, with or without notice,
and without having the Equipment
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present at the place of sale; or Lessor may, but shall not be required
to, lease, otherwise dispose of or keep idle all or part of the
Equipment; and Lessor may use Lessee's premises for any or all of the
foregoing without liability for rent. costs, damages or otherwise. The
proceeds of sale, lease or other disposition, if any, shall be applied
in the following order of priorities: (1) to pay all of Lessor's cost,
charges and expenses incurred in taking, removing, holding, repairing
and selling, leasing or otherwise disposing of Equipment; then, (2) to
the extent not previously paid by Lessee, to pay Lessor all sums due
from Lessee hereunder; then (3) to reimburse to Lessee any sums
previously paid by Lessee as liquidated damages; and (4) any surplus
shall be retained by Lessor. Lessee shall pay any deficiency in ( I )
and (2) forthwith
(c) The foregoing remedies are cumulative, and any or all thereof may be
exercised in lieu of or in addition to each other or any remedies at
law, in equity, or under statute. Lessee waives notice of sale or other
disposition (and the time and place thereof), and the manner and place
of any advertising. Lessee shall pay Lessor's annual attorney's fees
incurred in connection with the enforcement, assertion defense or
preservation of Lessor's rights and remedies hereunder, or if
prohibited by law, such lesser sum as may be permitted. Waiver of any
default shall not be a waiver of any other or subsequent default.
(d) Any default under the terms of this or any other agreement between
Lessor and Lessee may be declared by Lessor a default under this and
any such other agreement.
XIII. ASSIGNMENT: Lessor may, without the consent of Lessee, assign this
Agreement or any Schedule. Lessee agrees that if Lessee receives
written notice of an assignment from Lessor, Lessee will pay all rent
and all other amounts payable under any assigned Equipment Schedule to
such assignee or as instructed by Lessor. Lessee further agrees to
confirm in writing receipt of the notice of assignment as may be
reasonably requested by assignee. Lessee hereby waives and agrees not
to assert against any such assignee any defense, set-off, recoupment
claim or counterclaim which Lessee has or may at any time have against
Lessor for any reason whatsoever.
XIV. NET LEASE; NO SET-OFF, ETC: This Agreement is a net lease. Lessee's
obligation to pay rent and other amount due hereunder shall be absolute
and unconditional. Lessee shall not be entitled to any abatement or
reductions of, or set-offs against said rent or other amounts,
including. without limitation, those arising or allegedly arising out
of claims (present or future, alleged or annual and including claims
arising out of strict tort or negligence of Lessor) of Lessee against
Lessor under this Agreement or otherwise. Nor shall this Agreement
terminate or the obligations of Lessee be affected by reason of any
defect in or damage to, or loss of possession, use or destruction of,
any Equipment from whatsoever cause. It is the intention of the parties
that rents and other amounts due hereunder shall continue to be payable
in all events in the manner and at the times set forth herein unless
the obligation to do so shall have been terminated pursuant to the
express terms hereof
XV. INDEMNIFICATION:
(a) Lessee hereby agrees to indemnify, save and keep harmless Lessor, its
agents, employees, successors and assigns from and against any and all
losses, damages, penalties, injuries, claims, anions and suits,
including legal expenses, of whatsoever kind and nature, in contract or
tort (but excluding all losses, damages, penalties, injuries, claims,
anions and suits arising solely from willful misconduct or gross
negligence of Lessor) including, but not limited to, Lessor's strict
liability in tort, arising out of (i) the selection, manufacture,
purchase, acceptance or rejection of Equipment, the ownership of
Equipment during the term of this Agreement, and the delivery, lease,
possession, maintenance, uses, condition,
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return or operation of Equipment (including, without limitation, latent
and other defects, whether or not discoverable by Lessor or Lessee and
any claim for patent. trademark or copyright infringement or
environmental damage) or (ii) the condition of Equipment sold or
disposed of after use by Lessee any sublessee or employees of Lessee.
Lessee shall. upon request. defend any actions based on. or arising out
of any of the foregoing
(b) Lessee hereby represents, warrants and covenants that (i) on the Lease
Commencement Date for any unit of Equipment, such unit will qualify for
all of the items of deduction and credit specified in Section C of the
applicable Schedule ("Tax Benefits") in the hands of Lessor (all
references to Lessor in this Section XV include Lessor and the
consolidated taxpayer group of which Lessor is a member), and (ii) at
no time during the term of this Agreement will Lessee take or omit to
take, nor will it permit any sublessee or assignee to take or omit to
take, any action (whether or not such an or omission is otherwise
permitted by Lessor or the terms of this Agreement), which will result
in the disqualification of any Equipment for, or recapture of, all or
any portion of such Tax Benefits.
(c) If as a result of a breach of any representation, warranty or covenant
of the Lessee contained in this Agreement or any Schedule (x) tax
counsel of Lessor shall determine that Lessor is not entitled to claim
on its Federal income tax return all or any portion of the Tax Benefits
with respect to any Equipment, or (y) any such Tax Benefit claimed on
the Federal income tax return of Lessor is disallowed or adjusted by
the Internal Revenue Service, or (z) any such Tax Benefit is recomputed
or recaptured (any such determination, disallowance, adjustment,
recomputation or recapture being hereinafter called a "Loss"), then
Lessee shall pay to Lessor, as an indemnity and as additional rent,
such amount as shall, in the reasonable opinion of Lessor, cause
Lessor's after-tax economic yields and cash flows, computed on the same
assumptions, including tax rates (unless any adjustment has been made
under Section 111 hereof, in which case the Effective Rate used in the
next preceding adjustment shall be substituted), as were utilized by
Lessor in originally evaluating the transaction (such yields and flows
being hereinafter called the "NET ECONOMIC Return") to equal the Net
Economic Return that would have been realized by Lessor if such Loss
had not occurred. Such amount shall be payable upon demand accompanied
by a statement describing in reasonable detail such Loss and the
computation of such amount.
(d) All of Lessor's rights, privileges and indemnities contained in this
Section XV shall survive the expiration or other termination of this
Agreement and the rights, privileges and indemnities contained herein are
expressly made for the benefit of, and shall be enforceable by Lessor, is
successors and assigns.
XVI. DISCLAIMER: LESSEE ACKNOWLEDGES THAT TT HAS SELECTED THE EQUIPMENT
WITHOUT ANY ASSISTANCE FROM LESSOR, ITS AGENTS OR EMPLOYEES. LESSOR
DOES NOT MAKE, HAS NOT MADE, NOR SHALL BE DEEMED TO MAKE OR HAVE MADE,
ANY WARRANTY OR REPRESENTATION, EITHER EXPRESS OR IMPLIED, WRITTEN OR
ORAL, WITH RESPECT TO THE EQUIPMENT LEASED HEREUNDER OR ANY COMPONENT
THEREOF, INCLUDING, WITHOUT LIMITATION, ANY WARRANTY AS TO DESIGN,
COMPLIANCE WITH SPECIFICATIONS, QUALITY OF MATERIALS OR WORKMANSHIP,
MERCHAN'TABILITY, FITNESS FOR ANY PURPOSE, USE OR OPERATION, SAFETY,
PATENT, TRADEMARK OR COPYRIGHT INFRINGEMEN'T, OR TITLE. All such risks,
as between Lessor and Lessee, are to be borne by Lessee. Without
limiting the foregoing. Lessor shall have no responsibility or
liability to Lessee or any other person with respect to any of the
following, regardless of any negligence of Lessor (i) any liability,
loss or damage caused or alleged to be caused directly or indirectly by
any Equipment, any inadequacy thereof, any deficiency or defect (latent
or otherwise) therein, or any other circumstance in connection
therewith; (ii) the use, operation or performance of any Equipment or
any risks
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relating thereto; (iii) any interruption of service, loss of business or
anticipated profits or consequential damages; or (iv) the delivery,
operation, servicing, maintenance, repair, improvement or replacement of
any Equipment. If, and so long as, no default exists under this Lease,
Lessee shall be, and hereby is, authorized during the term of this Lease
to assert and enforce. at Lessee's sole cost and expense. from time to
time. in the name of and for the account of Lessor and or Lessee. as their
interests may
XVII. REPRESENTATIONS AND WARRANTIES OF LESSEE: Lessee hereby
represents and warrants to Lessor that on the date hereof and on the
date of execution of each Schedule
(a) Lessee has adequate power and capacity to enter into, and perform under,
this Agreement and ail related documents (together, the "DOCUMENTS") AND
IS DULY qualified to do business wherever necessary to y on its present
business and operations, including the jurisdiction(s) where the Equipment
is or is to be located.
(b) The Documents have been duly authorized, executed and delivered by Lessee
and constitute valid, legal and binding agreements, enforceable in
accordance with their terms, except to the extent that the enforcement of
remedies therein provided may be limited under applicable bankruptcy and
insolvency laws.
(c) No approval, consent or withholding of objections is required from any
governmental authority or instrumentality with respect to the entry into
or performance by Lessee of the Documents except such as have already
herein obtained
(d) The entry into and performance by Lessee of the Documents will not:
(i) violate any judgment, order, law or regulation applicable to Lessee
or any provision of Lessee's Certificate of Incorporation or by-laws;
or (ii) result in any breach of, constitute a default under or result
in the creation of any lien, charge, security interest or other
encumbrance upon any Equipment pursuant to any indenture, mortgage,
deed of trust, bank loan or credit agreement or other instrument (other
than this Agreement) to which Lessee is a party
(e) There are no suits or proceedings pending or threatened in court or before
any commission, board or other administrative agency against or affecting
Lessee, which will have a material adverse effect on the ability of Lessee
to fulfill its obligations under this Agreement.
(f) The Equipment accepted under any Certificate of Acceptance is and will
remain tangible personal property.
(g) Each Balance Sheet and Statement of Income delivered to Lessor has been
prepared in accordance with generally accepted accounting principles, and
since the date of the most recent such Balance Sheet and Statement of
Income, there has been no material adverse change.
(h) Lessee is and will be at all times validly existing and in good standing
under the laws of the State of its incorporation (specified in the first
sentence of this Agreement).
(i) The Equipment will at all times be used for commercial or business
purposes.
XVIII. EARLY TERMINATION:
(a) On or after the First Termination Date (specified in the applicable
Schedule), Lessee may, so long as no default exists hereunder, terminate
this Agreement as to all (but not less than
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all) of the Equipment on such Schedule as of a rent payment date
("Termination Date") upon at least ninety (90) days prior written notice
to Lessor.
(b) Lessee shall, and Lessor may, solicit cash bids for the Equipment on an AS
IS, WHERE IS BASIS without recourse to or warranty from Lessor, express or
implied ("AS IS BASIS"). Prior to the Termination Date, Lessee shall (i)
certify to Lessor any bids received by Lessee and (ii) pay to Lessor (A)
the Termination Value (calculated as of the rental due on the Termination
Date) for the Equipment. and (B) all rent and other sums due and unpaid as
of the Termination Date.
(c) Provided that all amounts due hereunder have been paid on the Termination
Date, Lessor shall (i) sell the Equipment on an AS IS BASIS for cash to
the highest bidder and (ii) refund the proceeds of such sale (net of any
related expenses) to Lessee up to the amount of the Termination Value. If
such sale is not consummated, no termination shall occur and Lessor shall
refund the Termination Value (less any expenses incurred by Lessor) to
Lessee.
(d) Notwithstanding the foregoing, Lessor may elect by written notice, at any
time prior to the Termination Date, not to sell the Equipment In that
event on the Termination Date Lessee shall (i) return the Equipment (in
accordance with Section XI) and (ii) pay to Lessor all amounts required
under Section XVIII(B) LESS THE amount of the highest bid certified by
Lessee to Lessor.
XIX. PURCHASE OPTION:
(a) So long as no default exists hereunder and the lease has not been earlier
terminated, Lessee may at lease expiration, upon at least one hundred
eighty ( 180) days prior written notice to Lessor, purchase all (but not
less than all) of the Equipment in any Schedule on an AS IS WHERE IS
BASIS, without recourse to or warranty from Lessor, express or implied,
for cash equal to its then Fair Market Value (plus all applicable sales
taxes).
(b) "FAIR MARKET VALUE" SHALL mean the price which a willing buyer (who is
neither a lessee in possession nor a used equipment dealer) would pay
for the Equipment in an arm's-length transaction to a willing seller
under no compulsion to sell; PROVIDED, HOWEVER, that in such
determination: (i) the Equipment shall be assumed to be in the
condition in which it is required to be maintained and resumed under
this Agreement; (ii) in the case of any installed Equipment that
Equipment shall be valued on an installed basis; and (iii) costs of
removal from current location shall not be a deduction from such
valuation. If Lessor and Lessee are unable to agree on the Fair Market
Value at least one hundred thirty-five (135) days before lease
expiration, Lessor shall appoint an independent appraiser (reasonably
acceptable to Lessee) to determine Fair Market Value, and that
determination shall be final, binding and conclusive. Lessee shall bear
all costs associated with any such appraisal.
(c) Lessee shall be deemed to have waived this option unless it provides
Lessor with written notice of its irrevocable election to exercise the
same within fifteen (15) days after Fair Market Value is determined (by
agreement or appraisal).
XX. MISCELLANEOUS:
(a) LESSEE HEREBY UNCONDITIONALLY WAIVES ITS RIGHTS TO A JURY TRIAL OF ANY
CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF, DIRECTLY OR
INDIRECTLY, TIHIS LEASE, ANY OF THE RELATED DOCUMENTS, ANY DEALINGS
BETWEEN LESSEE AND LESSOR RELATING TO THE SUBJECT MATTER
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OF THIS TRANSACTION OR ANY RELATED TRANSACTIONS, AND/OR THE RELATIONSHIP
THAT IS BEING ESTABLISHED BETWEEN LESSEE AND LESSOR. THE SCOPE OF THIS
WAIVER IS INTENDED TO BE ALL ENCOMPASSING OF ANY AND ALL DISPUTES THAT MAY
BE FILED IN ANY COURT (INCLUDING, WITHOUT LIMITATION, CONTRACT CLAIMS,
TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW AND STATUTORY
CLAIMS). THIS WAIVER IS IRREVOCABLE MEANING THAT IT MAY NOT BE MODIFIED
EITHER ORALLY OR IN WRITING, AND THE WAIVER SHALL APPLY TO ANY SUBSEQUENT
AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO THIS LEASE, ANY
RELATED DOCUMENTS, OR TO ANY OTHER DOCUMENTS OR AGREEMENTS RELATING TO
THIS TRANSACTION OR ANY RELATED TRANSACTION. IN THE EVENT OF LITIGATION,
THIS LEASE MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL BY THE COURT
(b) Unless and until Lessee exercises its rights under Section XIX above,
nothing herein contained shall give or convey to Lessee any right title
or interest in and to any Equipment except as a lessee. Any
cancellation or termination by Lessor, pursuant to the provision of
this Agreement, any Schedule, supplement or amendment hereto, or the
lease of any Equipment hereunder, shall not release Lessee from any
then outstanding obligations to Lessor hereunder. All Equipment shall
at all times remain personal property of Lessor regardless of the
degree of its annexation to any real property and shall not by reason
of any installation in, or affixation to, real or personal property
become a part thereof.
(c) Time is of the essence of this Agreement Lessor's failure at anytime to
require strict performance by Lessee of any of the provisions hereof
shall not waive or diminish Lessor's right thereafter to demand strict
compliance therewith. Lessee agrees, upon Lessor's request, to execute
any instrument necessary or expedient for filing, recording or
perfecting the interest of Lessor. All notices required to be given
hereunder shall be deemed adequately given if sent by registered or
certified mail to the addressee at its address stated herein, or at
such other place as such addressee may have designated in writing. This
Agreement and any Schedule and Annexes thereto constitute the entire
agreement of the parties with respect to the subject matter hereof NO
VARIATION OR MODIFICATION OF THIS AGREEMENT OR ANY WAIVER OF ANY OF
ITS PROVISIONS OR CONDITIONS, SHALL BE VALID UNLESS IN WRITING AND
SIGNED BY AN AUTHORIZED REPRESENTATIVE OF THE PARTIES HERETO.
(d) In case of a failure of Lessee to comply with any provision of this
Agreement, Lessor shall have the right, but shall not be obligated, to
effect such compliance, in whole or in part; and all moneys spent and
expenses and obligations incurred or assumed by Lessor in effecting
such compliance shall constitute additional rent due to Lessor within
five days after the date Lessor sends notice to Lessee requesting
payment. Lessor's effecting such compliance shall not be a waiver of
Lessee's default.
(e) Any rent or other amount not paid to Lessor when due hereunder shall bear
interest, both before and after any judgment or termination hereof, at the
lesser of eighteen percent (18%) per annum or the maximum rate allowed by
law. Any provisions in this Agreement and any Schedule which are in
conflict with any statute, law or applicable rule shall be deemed omitted
modified or altered to conform thereto.
(f) Adjustment to Capitalized Lessor's Cost Lessee hereby irrevocably
authorizes Lessor to adjust the Capitalized Lessor's Cost up or down by
no more than ten percent (10%) within each Schedule to account for
equipment change orders, equipment returns, invoicing errors, and
similar manner. Lessee acknowledges and agrees that the Rent shall be
adjusted as a
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result of such change in the Capitalized Lessor's Cost. Lessor shall send
Lessee a written notice stating the final Capitalized Lessor's Cost, if
different from that disclosed on the Schedule.
IN WITNESS WEIEREOF, Lessee and Lessor have caused this Schedule to be executed
by their duly authorized representatives as of the date first above written
LESSOR: LESSEE:
General Electric Capital Corporation Telco Systems, Inc.
By; Eric J. Staczek By: William J. Stuart
Credit Analyst VP & CFO
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SENIOR EXECUTIVE TERMINATION BENEFITS AGREEMENT
AGREEMENT, dated as of August 7, 1997 between TELCO SYSTEMS, INC., a
Delaware corporation (the "Company"), and William J. Stuart (the "Executive").
R E C I T A L S
A. The Company considers it essential to the best interests of the Company
and its stockholders that its management be encouraged to remain with the
Company and to continue to devote full attention to the Company's business in
the event that an effort is made to obtain control of the Company through a
tender offer or otherwise. In this connection, the Company recognizes that the
possibility of a change in control and the uncertainty and questions which it
may raise among management may result in the departure or distraction of
management personnel to the detriment of the Company and its stockholders.
Accordingly, the Company's board of directors (the "Board") has determined that
appropriate steps should be taken to reinforce and encourage the continued
attention and dedication of members of the Company's management to their
assigned duties without distraction in the face of the potentially disturbing
circumstances arising from the possibility of a change in control of the
Company.
B. The Executive is a key executive of the Company, and the Company
believes that the Executive has made valuable contributions to the
productivity and profitability of the Company.
C. In the event that the Company receives any proposal from a third person
concerning a possible business combination with, or acquisition of equity
securities of, the Company, the Board believes it imperative that the Company
and the Board be able to rely upon the Executive to continue in his position and
that the Company be able to receive and rely upon his advice, if so requested,
as to the best interests of the Company and its stockholders without concern
that he might be distracted by the personal uncertainties and risks created by
such a proposal.
D. Should the Company receive any such proposal, in addition to the
Executive's regular duties, he may be called upon to assist in the assessment of
such proposals, advise management and the Board as to whether such proposal
would be in the best interests of the Company and its stockholders, and to take
such other actions as the Board might determine to be appropriate.
NOW, THEREFORE, to assure the Company that it will have the continued
undivided attention and services of the Executive and the availability of his
advice and counsel notwithstanding the possibility, threat or occurrence of a
bid to take over control of the Company, and to induce the Executive to
remain in the employ of the Company, and for other good and valuable
consideration, the Company and the Executive agree as follows:
1. SERVICES DURING CERTAIN EVENTS
In the event that a third person begins a tender or exchange offer,
circulates a proxy to stockholders, or takes other steps seeking to effect a
Change in Control (as hereafter defined), the
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Executive agrees that he will not voluntarily leave the employ of the Company,
and will render the services contemplated in the recitals to this Agreement,
until the third person has abandoned or terminated his or its efforts to effect
a Change in Control or until after such a Change in Control has been effected.
2. CHANGE IN CONTROL
For purposes of this Agreement, a Change in Control of the Company shall
be deemed to have taken place if: (a) a third person, including a "group" as
defined in Section 13(d)(3) of the Securities Exchange Act of 1934, becomes the
beneficial owner of shares of any class of the Company's stock having 40% or
more of the total number of votes that may be cast for the election of directors
of the Company (excluding (i) Kopp Investment Advisors ("KIA") for so long as
KIA qualifies to report its beneficial ownership of shares of the Company's
stock on Schedule 13G under the Securities and Exchange Act of 1934 or (ii)
affiliates or associates of KIA that have acquired the Company's stock in the
ordinary course of business and, in the case of KIA, its affiliates and
associates, not with the purpose or effect of changing or influencing the
control of the Company); or (b) the stockholders of the Company approve a
definitive agreement for the sale or other disposition of all or substantially
all of the assets of the Company, the merger or other business combination of
the Company with or into another corporation pursuant to which the Company will
not survive or will survive only as a subsidiary of another corporation, in
either case with the stockholders of the Company prior to the merger or other
business combination holding less than 50% of the voting shares of the merged or
combined companies after such merger or other business combination, or any
combination of the foregoing.
3. CIRCUMSTANCES TRIGGERING RECEIPT OF SEVERANCE BENEFITS
(a) The Company shall provide the Executive with the benefits set forth in
Section 5 upon any termination of the Executive's employment by the Company
within 18 months following a Change in Control for any reason except the
following:
(i) Termination by reason of the Executive's death, provided the
Executive has not previously given a valid Notice of Termination (as
defined in Section 4) pursuant to Subsection 3(b);
(ii) Termination by reason of the Executive's disability. For the purpose
hereof, "disability" shall be defined as the Executive's inability
by reason of illness or other physical or mental disability to
perform the duties required by his employment for any consecutive
period of 180 calendar days, provided that notice of any termination
by the Company because of the Executive's disability shall have been
given to the Executive prior to the full resumption by him of the
performance of such duties;
(iii) Termination for cause. For the purposes hereof, "cause" shall be
defined as the willful and continued failure of the Executive to
perform substantially his duties or
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action by the Executive involving willful misfeasance, gross
negligence or the commission of any felonious action; provided,
however, that termination for cause based on the Executive's willful
and continued failure to substantially perform his duties shall not
be effective unless the Executive shall have received written notice
from the Board of such failure (specifying in detail the facts and
circumstances on which the Board is relying) and a demand for
substantial performance 30 days prior to such termination and the
Board determines that the Executive shall have failed during such
30-day period to resume the diligent performance of his duties.
(b) The Company shall also provide the Executive with the benefits
set forth in Section 5 upon any termination of the Executive's employment
with the Company at the option of the Executive within 18 months after a
Change in Control followed by the occurrence of any one of the following
events:
(i) Without the express written consent of the Executive, the
assignment of the Executive to any duties substantially
inconsistent with this positions, duties, responsibilities or
status with the Company immediately prior to the Change in
Control, a substantial reduction of his duties or
responsibilities or assignment of the Executive to a business
location more than 20 miles from the regular business location
of the Executive prior to the Change in Control, in each case
as determined in good faith by the Executive;
(ii) A reduction by the Company in the amount of the Executive's
salary as compared to that which was paid immediately prior to
the Change in Control, or any failure to maintain or provide
benefit plans covering the Executive providing benefits at
least substantially equivalent to the level of benefits paid
or available to the Executive under the Company's benefit
plans immediately prior to the Change in Control;
(iii) The failure of the Company to obtain the assumption of the
obligation to perform this Agreement by any successor as
required by Section 10;
(iv) Any material breach by the Company of any of the provisions of
this Agreement or any material failure by the Company to carry
out any of its obligations hereunder.
4. NOTICE OF TERMINATION
Any termination of the Executive's employment with the Company by the
Company as contemplated by Subsection 3(a) or by the Executive as contemplated
by Subsection 3(b) shall be communicated by written Notice of Termination to the
other party. Any Notice of Termination given by the Executive pursuant to
Subsection 3(b) or given by the Company in connection with a termination as to
which the Company believes it is not obligated to provide the Executive with the
benefits set forth herein shall set forth the effective date of termination (the
"Termination Date"),
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the specific provision in this Agreement relied upon and, in reasonable detail,
the facts and circumstance claimed to provide a basis for such termination.
5. TERMINATION BENEFITS
Subject to the conditions set forth in Sections 3 and 10 in the event of
termination of the Executive's employment under the circumstance described in
Section 3, the following benefits (subject to any applicable payroll or similar
taxes required to be withheld) shall be paid on a monthly basis, or in the case
of fringe benefit shall continue to be provided, for a period of 13 months after
the Termination Date to the Executive:
(a) COMPENSATION
Thirteen payments, each equal to (i) one-twelfth times the Executive's
effective annual base salary as of the Termination Date plus (ii) an amount
equal to one-twelfth times the highest annual bonus paid or payable under the
Company's Management Incentive Compensation Plan, or otherwise paid or payable
to the Executive by the Company as a bonus, with respect to any consecutive
12-month period during the three years prior to the Termination Date, will be
paid monthly during the 13 months commencing on the Termination Date. The
Executive, may by notice to the Company at any time during such 13-month period,
elect to receive his remaining compensation in a lump sum payment, subject,
however, to the provisions of Section 6 hereof.
(b) INSURANCE BENEFITS, ETC.
To the extent permitted by law or the terms of such Company plans, the
Executive's participation (including dependent coverage) in the life,
short-term, disability, health and dental insurance plans, vision care plans,
and any other fringe benefits of the Company appropriate to the Executive's
status in effect immediately prior to the Change in Control (including, but not
limited to, executive medical insurance coverage) shall be continued, or
equivalent benefits provided, by the Company, at no additional cost to the
Executive, for a period of 13 months commencing on the Termination Date.
6. STOCK OPTION VESTING AND EXERCISE
In the event that the Executive's employment with the Company is
terminated under the circumstances described in Section 3, all stock options
held by the Executive as of the Termination Date shall remain outstanding and
shall continue to vest until the earlier of (a) 13 months after the Termination
Date or (b) the date on which the Company pays the Executive the balance of his
compensation under Section 5(a) in a lump sum, as provided in the last sentence
of Section 5(a).
7. CONSULTING SERVICES
In the event that the Executive's employment with the Company is
terminated under the circumstances described in Section 3, the Executive shall
at the request of the Company provide up to a maximum of six hours per month of
consulting services during each of the 13 months following
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<PAGE> 5
the Termination Date. Such services shall be performed at such times and places
as are mutually agreeable to the Company and the Executive, and shall continue
notwithstanding payment by the Company of the lump sum compensation payment
described in the last sentence of Section 5(a). Notwithstanding the provisions
of this Section 7, the Executive shall be under no obligation to perform any
consulting services if and to the extent that the performance of such services
shall cause him to be in material breach of any contract with a subsequent
employer of the Executive or would otherwise be inconsistent with his
obligations to such an employer.
8. EFFECT OF SUBSEQUENT EMPLOYMENT
None of the benefits provided for or payable pursuant to this Agreement
shall be affected or reduced in the event that the Executive obtains other
employment after the Termination Date.
9. CONTINUING OBLIGATIONS
In order to induce the Company to enter into this Agreement, the Executive
hereby ratifies and confirms his Invention, Non-Disclosure and Non-Competition
Agreement with the Company. Without limiting the generality of the foregoing,
the Executive agrees that all documents, records, techniques, business secrets
and other information which have come into his possession from time to time
during his employment hereunder shall be deemed to be confidential and
proprietary to the Company and that he shall retain in confidence any
confidential information known to him concerning the Company and its
subsidiaries and their respective businesses so long as such information is not
publicly disclosed.
10. SUCCESSORS
(a) The Company will require any successor (whether direct or indirect, by
purchase, merger, consolidation or otherwise) to all or substantially all of the
business and/or assets of the Company expressly to assume and agree to perform
this Agreement in the same manner and to the same extent that Company would be
required to perform it if no such transaction had taken place. Failure of the
Company to obtain such agreement prior to the effective date of any such
transaction shall be a breach of this Agreement and shall entitle the Executive
to compensation from the Company in the same amount and on the same terms as the
Executive would be entitled hereunder if he were to terminate his employment
pursuant to Subsection 3(b), except that for purposes of implementing the
foregoing, the date on which any such transaction becomes effective shall be
deemed the Termination Date. As used in this Agreement, "Company" shall mean the
Company as defined herein and any successor to its business and/or assets as
aforesaid which executes and delivers that agreement provided for in this
Section 10 or which otherwise becomes bound by all the terms and provisions of
this Agreement by operation of law.
(b) This Agreement shall inure to the benefit of and be enforceable by the
Executive's personal or legal representatives, executors, administrators,
successors, heirs, distributees, devisees and legatees. If the Executive should
die or become disabled as defined in 3(a)(ii) while any
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<PAGE> 6
amounts are payable to him hereunder, all such amounts, unless otherwise
provided herein, shall be paid in accordance with the terms of this Agreement to
him or to his designee or, if there be no such designee, to his estate.
11. NOTICES
For the purposes of this Agreement, notices and all other communications
provided for herein shall be in writing and shall be deemed to have been duly
given when delivered or mailed by United States registered or certified mail,
return receipt required, postage prepaid, addressed as follows:
If to the Executive: William J. Stuart
86 Jacobs Lane
Norwell, MA 02061
If to the Company: Telco Systems, Inc.
63 Nahatan Street
Norwood, MA 02062
Attention: Corporate Secretary
or to such other address as either party may have furnished to the other in
accordance herewith, except that notices of change of address shall be effective
only upon receipt.
12. GOVERNING LAW
The validity, interpretation, construction and performance of this
Agreement shall be governed by the laws of the State of Delaware.
13. ARBITRATION
Any controversy or claim arising out of or relating to this Agreement or
the breach thereof shall be settled by arbitration to be conducted in Boston,
Massachusetts in accordance with the Commercial Arbitration Rules of the
American Arbitration Association, and judgment upon the award rendered by the
arbitrators may be entered in any court having jurisdiction thereof.
14. MISCELLANEOUS
No provisions of this Agreement may be modified, waived or discharged
unless such waiver, modification or discharge is agreed to in writing signed by
the Executive and on behalf of the Company. No waiver by either party hereto of,
or compliance with, any condition or provision of this Agreement to be performed
by such other party shall be deemed a waiver of the same or any other provisions
or conditions at any prior or subsequent time. No agreements or representations,
oral or otherwise, express or implied, with respect to the subject matter hereof
have been made by either party which are not set forth expressly in this
Agreement.
15. SEPARABILITY
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The invalidity or unenforceability of any provisions of this Agreement
shall not affect the validity or enforceability of any other provisions of this
Agreement, all of which shall remain in full force and effect.
16. NON-ASSIGNABILITY
This Agreement is personal in nature and neither of the parties hereto
shall, without the consent of the other, assign or transfer this Agreement or
any rights or obligations hereunder, except as provided in Section 10. Without
limiting the foregoing, the Executive's right to receive payments hereunder
shall not be assignable or transferable, whether by pledge, creation of a
security interest or otherwise, other than to a person or persons designated in
writing by the Executive or a transfer by his will or by the laws of descent or
distribution, and in the event of any attempted assignment or transfer contrary
to this Section the Company shall have no liability to pay any amount so
attempted to be assigned or transferred.
17. TERMINATION
The Company may terminate this Agreement at any time by 30 days written
notice of such termination given to the Executive; EXCEPT THAT such termination
shall not be made, and if made shall have no effect, (a) within eighteen months
after the Change of Control in question or (b) during any period of time when
the Company has knowledge that any third person has taken steps reasonably
calculated to effect a Change in Control until, in the opinion of the Board, the
third person has abandoned or terminated his efforts to effect a Change in
Control. Any decision by the Board that the third person has abandoned or
terminated his efforts to effect a change in control shall be conclusive and
binding on the Executive.
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed
and delivered as of the day and year set forth below.
AGREED: TELCO SYSTEMS, INC.:
/s/ William J. Stuart /s/ William B. Smith
- -------------------------------- By: ----------------------------
William J. Stuart President & Chief Executive
Officer
Date: August 7, 1997 Date: August 7, 1997
-------------------------- ---------------------------
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<PAGE> 1
SENIOR EXECUTIVE TERMINATION BENEFITS AGREEMENT
AGREEMENT, dated as of August 7, 1997 between TELCO SYSTEMS, INC., a
Delaware corporation (the "Company"), and Anand S. Parikh (the "Executive").
R E C I T A L S
A. The Company considers it essential to the best interests of the Company
and its stockholders that its management be encouraged to remain with the
Company and to continue to devote full attention to the Company's business in
the event that an effort is made to obtain control of the Company through a
tender offer or otherwise. In this connection, the Company recognizes that the
possibility of a change in control and the uncertainty and questions which it
may raise among management may result in the departure or distraction of
management personnel to the detriment of the Company and its stockholders.
Accordingly, the Company's board of directors (the "Board") has determined that
appropriate steps should be taken to reinforce and encourage the continued
attention and dedication of members of the Company's management to their
assigned duties without distraction in the face of the potentially disturbing
circumstances arising from the possibility of a change in control of the
Company.
B. The Executive is a key executive of the Company, and the Company
believes that the Executive has made valuable contributions to the productivity
and profitability of the Company.
C. In the event that the Company receives any proposal from a third person
concerning a possible business combination with, or acquisition of equity
securities of, the Company, the Board believes it imperative that the Company
and the Board be able to rely upon the Executive to continue in his position and
that the Company be able to receive and rely upon his advice, if so requested,
as to the best interests of the Company and its stockholders without concern
that he might be distracted by the personal uncertainties and risks created by
such a proposal.
D. Should the Company receive any such proposal, in addition to the
Executive's regular duties, he may be called upon to assist in the assessment of
such proposals, advise management and the Board as to whether such proposal
would be in the best interests of the Company and its stockholders, and to take
such other actions as the Board might determine to be appropriate.
NOW, THEREFORE, to assure the Company that it will have the continued
undivided attention and services of the Executive and the availability of his
advice and counsel notwithstanding the possibility, threat or occurrence of a
bid to take over control of the Company, and to induce the Executive to
remain in the employ of the Company, and for other good and valuable
consideration, the Company and the Executive agree as follows:
1. SERVICES DURING CERTAIN EVENTS
In the event that a third person begins a tender or exchange offer,
circulates a proxy to stockholders, or takes other steps seeking to effect a
Change in Control (as hereafter defined), the
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<PAGE> 2
Executive agrees that he will not voluntarily leave the employ of the Company,
and will render the services contemplated in the recitals to this Agreement,
until the third person has abandoned or terminated his or its efforts to effect
a Change in Control or until after such a Change in Control has been effected.
2. CHANGE IN CONTROL
For purposes of this Agreement, a Change in Control of the Company shall
be deemed to have taken place if: (a) a third person, including a "group" as
defined in Section 13(d)(3) of the Securities Exchange Act of 1934, becomes the
beneficial owner of shares of any class of the Company's stock having 40% or
more of the total number of votes that may be cast for the election of directors
of the Company (excluding (i) Kopp Investment Advisors ("KIA") for so long as
KIA qualifies to report its beneficial ownership of shares of the Company's
stock on Schedule 13G under the Securities and Exchange Act of 1934 or (ii)
affiliates or associates of KIA that have acquired the Company's stock in the
ordinary course of business and, in the case of KIA, its affiliates and
associates, not with the purpose or effect of changing or influencing the
control of the Company); or (b) the stockholders of the Company approve a
definitive agreement for the sale or other disposition of all or substantially
all of the assets of the Company, the merger or other business combination of
the Company with or into another corporation pursuant to which the Company will
not survive or will survive only as a subsidiary of another corporation, in
either case with the stockholders of the Company prior to the merger or other
business combination holding less than 50% of the voting shares of the merged or
combined companies after such merger or other business combination, or any
combination of the foregoing.
3. CIRCUMSTANCES TRIGGERING RECEIPT OF SEVERANCE BENEFITS
(a) The Company shall provide the Executive with the benefits set forth in
Section 5 upon any termination of the Executive's employment by the Company
within 18 months following a Change in Control for any reason except the
following:
(i) Termination by reason of the Executive's death, provided the
Executive has not previously given a valid Notice of Termination
(as defined in Section 4) pursuant to Subsection 3(b);
(ii) Termination by reason of the Executive's disability. For the
purpose hereof, "disability" shall be defined as the Executive's
inability by reason of illness or other physical or mental
disability to perform the duties required by his employment for any
consecutive period of 180 calendar days, provided that notice of
any termination by the Company because of the Executive's
disability shall have been given to the Executive prior to the full
resumption by him of the performance of such duties;
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<PAGE> 3
(iii) Termination for cause. For the purposes hereof, "cause" shall be
defined as the willful and continued failure of the Executive to
perform substantially his duties or action by the Executive
involving willful misfeasance, gross negligence or the commission
of any felonious action; provided, however, that termination for
cause based on the Executive's willful and continued failure to
substantially perform his duties shall not be effective unless the
Executive shall have received written notice from the Board of such
failure (specifying in detail the facts and circumstances on which
the Board is relying) and a demand for substantial performance 30
days prior to such termination and the Board determines that the
Executive shall have failed during such 30-day period to resume the
diligent performance of his duties.
(b) The Company shall also provide the Executive with the benefits set
forth in Section 5 upon any termination of the Executive's employment with the
Company at the option of the Executive within 18 months after a Change in
Control followed by the occurrence of any one of the following events:
(i) Without the express written consent of the Executive, the
assignment of the Executive to any duties substantially
inconsistent with this positions, duties, responsibilities or
status with the Company immediately prior to the Change in Control,
a substantial reduction of his duties or responsibilities or
assignment of the Executive to a business location more than 20
miles from the regular business location of the Executive prior to
the Change in Control, in each case as determined in good faith by
the Executive;
(ii) A reduction by the Company in the amount of the Executive's salary
as compared to that which was paid immediately prior to the Change
in Control, or any failure to maintain or provide benefit plans
covering the Executive providing benefits at least substantially
equivalent to the level of benefits paid or available to the
Executive under the Company's benefit plans immediately prior to
the Change in Control;
(iii) The failure of the Company to obtain the assumption of the
obligation to perform this Agreement by any successor as required
by Section 10;
(iv) Any material breach by the Company of any of the provisions of this
Agreement or any material failure by the Company to carry out any
of its obligations hereunder.
4. NOTICE OF TERMINATION
Any termination of the Executive's employment with the Company by the
Company as contemplated by Subsection 3(a) or by the Executive as contemplated
by Subsection 3(b) shall be communicated by written Notice of Termination to the
other party. Any Notice of Termination given by the Executive pursuant to
Subsection 3(b) or given by the Company in connection with a termination as to
which the Company believes it is not obligated to provide the Executive with the
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<PAGE> 4
benefits set forth herein shall set forth the effective date of termination (the
"Termination Date"), the specific provision in this Agreement relied upon and,
in reasonable detail, the facts and circumstance claimed to provide a basis for
such termination.
5. TERMINATION BENEFITS
Subject to the conditions set forth in Sections 3 and 10 in the event of
termination of the Executive's employment under the circumstance described in
Section 3, the following benefits (subject to any applicable payroll or similar
taxes required to be withheld) shall be paid on a monthly basis, or in the case
of fringe benefit shall continue to be provided, for a period of 13 months after
the Termination Date to the Executive:
(a) COMPENSATION
Thirteen payments, each equal to (i) one-twelfth times the Executive's
effective annual base salary as of the Termination Date plus (ii) an amount
equal to one-twelfth times the highest annual bonus paid or payable under the
Company's Management Incentive Compensation Plan, or otherwise paid or payable
to the Executive by the Company as a bonus, with respect to any consecutive
12-month period during the three years prior to the Termination Date, will be
paid monthly during the 13 months commencing on the Termination Date. The
Executive, may by notice to the Company at any time during such 13-month period,
elect to receive his remaining compensation in a lump sum payment, subject,
however, to the provisions of Section 6 hereof.
(b) INSURANCE BENEFITS, ETC.
To the extent permitted by law or the terms of such Company plans, the
Executive's participation (including dependent coverage) in the life,
short-term, disability, health and dental insurance plans, vision care plans,
and any other fringe benefits of the Company appropriate to the Executive's
status in effect immediately prior to the Change in Control (including, but not
limited to, executive medical insurance coverage) shall be continued, or
equivalent benefits provided, by the Company, at no additional cost to the
Executive, for a period of 13 months commencing on the Termination Date.
6. STOCK OPTION VESTING AND EXERCISE
In the event that the Executive's employment with the Company is
terminated under the circumstances described in Section 3, all stock options
held by the Executive as of the Termination Date shall remain outstanding and
shall continue to vest until the earlier of (a) 13 months after the Termination
Date or (b) the date on which the Company pays the Executive the balance of his
compensation under Section 5(a) in a lump sum, as provided in the last sentence
of Section 5(a).
7. CONSULTING SERVICES
In the event that the Executive's employment with the Company is
terminated under the circumstances described in Section 3, the Executive shall
at the request of the Company provide up
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<PAGE> 5
to a maximum of six hours per month of consulting services during each of the 13
months following the Termination Date. Such services shall be performed at such
times and places as are mutually agreeable to the Company and the Executive, and
shall continue notwithstanding payment by the Company of the lump sum
compensation payment described in the last sentence of Section 5(a).
Notwithstanding the provisions of this Section 7, the Executive shall be under
no obligation to perform any consulting services if and to the extent that the
performance of such services shall cause him to be in material breach of any
contract with a subsequent employer of the Executive or would otherwise be
inconsistent with his obligations to such an employer.
8. EFFECT OF SUBSEQUENT EMPLOYMENT
None of the benefits provided for or payable pursuant to this Agreement
shall be affected or reduced in the event that the Executive obtains other
employment after the Termination Date.
9. CONTINUING OBLIGATIONS
In order to induce the Company to enter into this Agreement, the Executive
hereby ratifies and confirms his Invention, Non-Disclosure and Non-Competition
Agreement with the Company. Without limiting the generality of the foregoing,
the Executive agrees that all documents, records, techniques, business secrets
and other information which have come into his possession from time to time
during his employment hereunder shall be deemed to be confidential and
proprietary to the Company and that he shall retain in confidence any
confidential information known to him concerning the Company and its
subsidiaries and their respective businesses so long as such information is not
publicly disclosed.
10. SUCCESSORS
(a) The Company will require any successor (whether direct or indirect, by
purchase, merger, consolidation or otherwise) to all or substantially all of the
business and/or assets of the Company expressly to assume and agree to perform
this Agreement in the same manner and to the same extent that Company would be
required to perform it if no such transaction had taken place. Failure of the
Company to obtain such agreement prior to the effective date of any such
transaction shall be a breach of this Agreement and shall entitle the Executive
to compensation from the Company in the same amount and on the same terms as the
Executive would be entitled hereunder if he were to terminate his employment
pursuant to Subsection 3(b), except that for purposes of implementing the
foregoing, the date on which any such transaction becomes effective shall be
deemed the Termination Date. As used in this Agreement, "Company" shall mean the
Company as defined herein and any successor to its business and/or assets as
aforesaid which executes and delivers that agreement provided for in this
Section 10 or which otherwise becomes bound by all the terms and provisions of
this Agreement by operation of law.
(b) This Agreement shall inure to the benefit of and be enforceable by the
Executive's personal or legal representatives, executors, administrators,
successors, heirs, distributees, devisees
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<PAGE> 6
and legatees. If the Executive should die or become disabled as defined in
3(a)(ii) while any amounts are payable to him hereunder, all such amounts,
unless otherwise provided herein, shall be paid in accordance with the terms of
this Agreement to him or to his designee or, if there be no such designee, to
his estate.
11. NOTICES
For the purposes of this Agreement, notices and all other communications
provided for herein shall be in writing and shall be deemed to have been duly
given when delivered or mailed by United States registered or certified mail,
return receipt required, postage prepaid, addressed as follows:
If to the Executive: Anand S. Parikh
19 Freedom Farme Road
Acton, MA 01720
If to the Company: Telco Systems, Inc.
63 Nahatan Street
Norwood, MA 02062
Attention: Corporate Secretary
or to such other address as either party may have furnished to the other in
accordance herewith, except that notices of change of address shall be effective
only upon receipt.
12. GOVERNING LAW
The validity, interpretation, construction and performance of this
Agreement shall be governed by the laws of the State of Delaware.
13. ARBITRATION
Any controversy or claim arising out of or relating to this Agreement or
the breach thereof shall be settled by arbitration to be conducted in Boston,
Massachusetts in accordance with the Commercial Arbitration Rules of the
American Arbitration Association, and judgment upon the award rendered by the
arbitrators may be entered in any court having jurisdiction thereof.
14. MISCELLANEOUS
No provisions of this Agreement may be modified, waived or discharged
unless such waiver, modification or discharge is agreed to in writing signed by
the Executive and on behalf of the Company. No waiver by either party hereto of,
or compliance with, any condition or provision of this Agreement to be performed
by such other party shall be deemed a waiver of the same or any other provisions
or conditions at any prior or subsequent time. No agreements or representations,
oral or otherwise, express or implied, with respect to the subject matter hereof
have been made by either party which are not set forth expressly in this
Agreement.
15. SEPARABILITY
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<PAGE> 7
The invalidity or unenforceability of any provisions of this Agreement
shall not affect the validity or enforceability of any other provisions of this
Agreement, all of which shall remain in full force and effect.
16. NON-ASSIGNABILITY
This Agreement is personal in nature and neither of the parties hereto
shall, without the consent of the other, assign or transfer this Agreement or
any rights or obligations hereunder, except as provided in Section 10. Without
limiting the foregoing, the Executive's right to receive payments hereunder
shall not be assignable or transferable, whether by pledge, creation of a
security interest or otherwise, other than to a person or persons designated in
writing by the Executive or a transfer by his will or by the laws of descent or
distribution, and in the event of any attempted assignment or transfer contrary
to this Section the Company shall have no liability to pay any amount so
attempted to be assigned or transferred.
17. TERMINATION
The Company may terminate this Agreement at any time by 30 days written
notice of such termination given to the Executive; EXCEPT THAT such termination
shall not be made, and if made shall have no effect, (a) within eighteen months
after the Change of Control in question or (b) during any period of time when
the Company has knowledge that any third person has taken steps reasonably
calculated to effect a Change in Control until, in the opinion of the Board, the
third person has abandoned or terminated his efforts to effect a Change in
Control. Any decision by the Board that the third person has abandoned or
terminated his efforts to effect a change in control shall be conclusive and
binding on the Executive.
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed
and delivered as of the day and year set forth below.
AGREED: TELCO SYSTEMS, INC.:
/s/ Anand S. Parikh /s/ William B. Smith
- -------------------------------- By: -----------------------------------
Anand S. Parikh President & Chief Executive Officer
Date: September 8, 1997 Date: September 8, 1997
-------------------------- ----------------------------------
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<PAGE> 1
SENIOR EXECUTIVE TERMINATION BENEFITS AGREEMENT
AGREEMENT, dated as of August 7, 1997 between TELCO SYSTEMS, INC., a
Delaware corporation (the "Company"), and Richard J. Nardone (the "Executive").
R E C I T A L S
A. The Company considers it essential to the best interests of the Company
and its stockholders that its management be encouraged to remain with the
Company and to continue to devote full attention to the Company's business in
the event that an effort is made to obtain control of the Company through a
tender offer or otherwise. In this connection, the Company recognizes that the
possibility of a change in control and the uncertainty and questions which it
may raise among management may result in the departure or distraction of
management personnel to the detriment of the Company and its stockholders.
Accordingly, the Company's board of directors (the "Board") has determined that
appropriate steps should be taken to reinforce and encourage the continued
attention and dedication of members of the Company's management to their
assigned duties without distraction in the face of the potentially disturbing
circumstances arising from the possibility of a change in control of the
Company.
B. The Executive is a key executive of the Company, and the Company
believes that the Executive has made valuable contributions to the productivity
and profitability of the Company.
C. In the event that the Company receives any proposal from a third person
concerning a possible business combination with, or acquisition of equity
securities of, the Company, the Board believes it imperative that the Company
and the Board be able to rely upon the Executive to continue in his position and
that the Company be able to receive and rely upon his advice, if so requested,
as to the best interests of the Company and its stockholders without concern
that he might be distracted by the personal uncertainties and risks created by
such a proposal.
D. Should the Company receive any such proposal, in addition to the
Executive's regular duties, he may be called upon to assist in the assessment of
such proposals, advise management and the Board as to whether such proposal
would be in the best interests of the Company and its stockholders, and to take
such other actions as the Board might determine to be appropriate.
NOW, THEREFORE, to assure the Company that it will have the continued
undivided attention and services of the Executive and the availability of his
advice and counsel notwithstanding the possibility, threat or occurrence of a
bid to take over control of the Company, and to induce the Executive to
remain in the employ of the Company, and for other good and valuable
consideration, the Company and the Executive agree as follows:
1. SERVICES DURING CERTAIN EVENTS
In the event that a third person begins a tender or exchange offer,
circulates a proxy to stockholders, or takes other steps seeking to effect a
Change in Control (as hereafter defined), the
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<PAGE> 2
Executive agrees that he will not voluntarily leave the employ of the Company,
and will render the services contemplated in the recitals to this Agreement,
until the third person has abandoned or terminated his or its efforts to effect
a Change in Control or until after such a Change in Control has been effected.
2. CHANGE IN CONTROL
For purposes of this Agreement, a Change in Control of the Company shall
be deemed to have taken place if: (a) a third person, including a "group" as
defined in Section 13(d)(3) of the Securities Exchange Act of 1934, becomes the
beneficial owner of shares of any class of the Company's stock having 40% or
more of the total number of votes that may be cast for the election of directors
of the Company (excluding (i) Kopp Investment Advisors ("KIA") for so long as
KIA qualifies to report its beneficial ownership of shares of the Company's
stock on Schedule 13G under the Securities and Exchange Act of 1934 or (ii)
affiliates or associates of KIA that have acquired the Company's stock in the
ordinary course of business and, in the case of KIA, its affiliates and
associates, not with the purpose or effect of changing or influencing the
control of the Company); or (b) the stockholders of the Company approve a
definitive agreement for the sale or other disposition of all or substantially
all of the assets of the Company, the merger or other business combination of
the Company with or into another corporation pursuant to which the Company will
not survive or will survive only as a subsidiary of another corporation, in
either case with the stockholders of the Company prior to the merger or other
business combination holding less than 50% of the voting shares of the merged or
combined companies after such merger or other business combination, or any
combination of the foregoing.
3. CIRCUMSTANCES TRIGGERING RECEIPT OF SEVERANCE BENEFITS
(a) The Company shall provide the Executive with the benefits set forth in
Section 5 upon any termination of the Executive's employment by the Company
within 18 months following a Change in Control for any reason except the
following:
(i) Termination by reason of the Executive's death, provided the
Executive has not previously given a valid Notice of Termination
(as defined in Section 4) pursuant to Subsection 3(b);
(ii) Termination by reason of the Executive's disability. For the
purpose hereof, "disability" shall be defined as the Executive's
inability by reason of illness or other physical or mental
disability to perform the duties required by his employment for
any consecutive period of 180 calendar days, provided that notice
of any termination by the Company because of the Executive's
disability shall have been given to the Executive prior to the
full resumption by him of the performance of such duties;
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<PAGE> 3
(iii) Termination for cause. For the purposes hereof, "cause" shall be
defined as the willful and continued failure of the Executive to
perform substantially his duties or action by the Executive
involving willful misfeasance, gross negligence or the commission of
any felonious action; provided, however, that termination for cause
based on the Executive's willful and continued failure to
substantially perform his duties shall not be effective unless the
Executive shall have received written notice from the Board of such
failure (specifying in detail the facts and circumstances on which
the Board is relying) and a demand for substantial performance 30
days prior to such termination and the Board determines that the
Executive shall have failed during such 30-day period to resume the
diligent performance of his duties.
(b) The Company shall also provide the Executive with the benefits set
forth in Section 5 upon any termination of the Executive's employment with the
Company at the option of the Executive within 18 months after a Change in
Control followed by the occurrence of any one of the following events:
(i) Without the express written consent of the Executive, the
assignment of the Executive to any duties substantially
inconsistent with this positions, duties, responsibilities or
status with the Company immediately prior to the Change in
Control, a substantial reduction of his duties or
responsibilities or assignment of the Executive to a business
location more than 20 miles from the regular business location of
the Executive prior to the Change in Control, in each case as
determined in good faith by the Executive;
(ii) A reduction by the Company in the amount of the Executive's salary
as compared to that which was paid immediately prior to the Change
in Control, or any failure to maintain or provide benefit plans
covering the Executive providing benefits at least substantially
equivalent to the level of benefits paid or available to the
Executive under the Company's benefit plans immediately prior to the
Change in Control;
(iii) The failure of the Company to obtain the assumption of the
obligation to perform this Agreement by any successor as required by
Section 10;
(iv) Any material breach by the Company of any of the provisions of this
Agreement or any material failure by the Company to carry out any of
its obligations hereunder.
4. NOTICE OF TERMINATION
Any termination of the Executive's employment with the Company by the
Company as contemplated by Subsection 3(a) or by the Executive as contemplated
by Subsection 3(b) shall be communicated by written Notice of Termination to the
other party. Any Notice of Termination given by the Executive pursuant to
Subsection 3(b) or given by the Company in connection with a termination as to
which the Company believes it is not obligated to provide the Executive with the
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benefits set forth herein shall set forth the effective date of termination (the
"Termination Date"), the specific provision in this Agreement relied upon and,
in reasonable detail, the facts and circumstance claimed to provide a basis for
such termination.
5. TERMINATION BENEFITS
Subject to the conditions set forth in Sections 3 and 10 in the event of
termination of the Executive's employment under the circumstance described in
Section 3, the following benefits (subject to any applicable payroll or similar
taxes required to be withheld) shall be paid on a monthly basis, or in the case
of fringe benefit shall continue to be provided, for a period of 13 months after
the Termination Date to the Executive:
(a) COMPENSATION
Thirteen payments, each equal to (i) one-twelfth times the
Executive's effective annual base salary as of the Termination Date plus (ii) an
amount equal to one-twelfth times the highest annual bonus paid or payable under
the Company's Management Incentive Compensation Plan, or otherwise paid or
payable to the Executive by the Company as a bonus, with respect to any
consecutive 12-month period during the three years prior to the Termination
Date, will be paid monthly during the 13 months commencing on the Termination
Date. The Executive, may by notice to the Company at any time during such
13-month period, elect to receive his remaining compensation in a lump sum
payment, subject, however, to the provisions of Section 6 hereof.
(b) INSURANCE BENEFITS, ETC.
To the extent permitted by law or the terms of such Company plans,
the Executive's participation (including dependent coverage) in the life,
short-term, disability, health and dental insurance plans, vision care plans,
and any other fringe benefits of the Company appropriate to the Executive's
status in effect immediately prior to the Change in Control (including, but not
limited to, executive medical insurance coverage) shall be continued, or
equivalent benefits provided, by the Company, at no additional cost to the
Executive, for a period of 13 months commencing on the Termination Date.
6. STOCK OPTION VESTING AND EXERCISE
In the event that the Executive's employment with the Company is
terminated under the circumstances described in Section 3, all stock options
held by the Executive as of the Termination Date shall remain outstanding and
shall continue to vest until the earlier of (a) 13 months after the
Termination Date or (b) the date on which the Company pays the Executive the
balance of his compensation under Section 5(a) in a lump sum, as provided in
the last sentence of Section 5(a).
7. CONSULTING SERVICES
In the event that the Executive's employment with the Company is
terminated under the circumstances described in Section 3, the Executive shall
at the request of the Company provide up
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<PAGE> 5
to a maximum of six hours per month of consulting services during each of the 13
months following the Termination Date. Such services shall be performed at such
times and places as are mutually agreeable to the Company and the Executive, and
shall continue notwithstanding payment by the Company of the lump sum
compensation payment described in the last sentence of Section 5(a).
Notwithstanding the provisions of this Section 7, the Executive shall be under
no obligation to perform any consulting services if and to the extent that the
performance of such services shall cause him to be in material breach of any
contract with a subsequent employer of the Executive or would otherwise be
inconsistent with his obligations to such an employer.
8. EFFECT OF SUBSEQUENT EMPLOYMENT
None of the benefits provided for or payable pursuant to this Agreement
shall be affected or reduced in the event that the Executive obtains other
employment after the Termination Date.
9. CONTINUING OBLIGATIONS
In order to induce the Company to enter into this Agreement, the
Executive hereby ratifies and confirms his Invention, Non-Disclosure and
Non-Competition Agreement with the Company. Without limiting the generality
of the foregoing, the Executive agrees that all documents, records,
techniques, business secrets and other information which have come into his
possession from time to time during his employment hereunder shall be deemed
to be confidential and proprietary to the Company and that he shall retain in
confidence any confidential information known to him concerning the Company
and its subsidiaries and their respective businesses so long as such
information is not publicly disclosed.
10. SUCCESSORS
(a) The Company will require any successor (whether direct or indirect, by
purchase, merger, consolidation or otherwise) to all or substantially all of the
business and/or assets of the Company expressly to assume and agree to perform
this Agreement in the same manner and to the same extent that Company would be
required to perform it if no such transaction had taken place. Failure of the
Company to obtain such agreement prior to the effective date of any such
transaction shall be a breach of this Agreement and shall entitle the Executive
to compensation from the Company in the same amount and on the same terms as the
Executive would be entitled hereunder if he were to terminate his employment
pursuant to Subsection 3(b), except that for purposes of implementing the
foregoing, the date on which any such transaction becomes effective shall be
deemed the Termination Date. As used in this Agreement, "Company" shall mean the
Company as defined herein and any successor to its business and/or assets as
aforesaid which executes and delivers that agreement provided for in this
Section 10 or which otherwise becomes bound by all the terms and provisions of
this Agreement by operation of law.
(b) This Agreement shall inure to the benefit of and be enforceable by
the Executive's personal or legal representatives, executors, administrators,
successors, heirs, distributees, devisees
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and legatees. If the Executive should die or become disabled as defined in
3(a)(ii) while any amounts are payable to him hereunder, all such amounts,
unless otherwise provided herein, shall be paid in accordance with the terms of
this Agreement to him or to his designee or, if there be no such designee, to
his estate.
11. NOTICES
For the purposes of this Agreement, notices and all other communications
provided for herein shall be in writing and shall be deemed to have been duly
given when delivered or mailed by United States registered or certified mail,
return receipt required, postage prepaid, addressed as follows:
If to the Executive: Richard J. Nardone
27 Stone Hill Road
Chelmsford, MA 01863
If to the Company: Telco Systems, Inc.
63 Nahatan Street
Norwood, MA 02062
Attention: Corporate Secretary
or to such other address as either party may have furnished to the other in
accordance herewith, except that notices of change of address shall be
effective only upon receipt.
12. GOVERNING LAW
The validity, interpretation, construction and performance of this
Agreement shall be governed by the laws of the State of Delaware.
13. ARBITRATION
Any controversy or claim arising out of or relating to this Agreement
or the breach thereof shall be settled by arbitration to be conducted in
Boston, Massachusetts in accordance with the Commercial Arbitration Rules of
the American Arbitration Association, and judgment upon the award rendered by
the arbitrators may be entered in any court having jurisdiction thereof.
14. MISCELLANEOUS
No provisions of this Agreement may be modified, waived or discharged
unless such waiver, modification or discharge is agreed to in writing signed by
the Executive and on behalf of the Company. No waiver by either party hereto of,
or compliance with, any condition or provision of this Agreement to be performed
by such other party shall be deemed a waiver of the same or any other provisions
or conditions at any prior or subsequent time. No agreements or representations,
oral or otherwise, express or implied, with respect to the subject matter hereof
have been made by either party which are not set forth expressly in this
Agreement.
15. SEPARABILITY
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<PAGE> 7
The invalidity or unenforceability of any provisions of this Agreement
shall not affect the validity or enforceability of any other provisions of this
Agreement, all of which shall remain in full force and effect.
16. NON-ASSIGNABILITY
This Agreement is personal in nature and neither of the parties hereto
shall, without the consent of the other, assign or transfer this Agreement or
any rights or obligations hereunder, except as provided in Section 10. Without
limiting the foregoing, the Executive's right to receive payments hereunder
shall not be assignable or transferable, whether by pledge, creation of a
security interest or otherwise, other than to a person or persons designated in
writing by the Executive or a transfer by his will or by the laws of descent or
distribution, and in the event of any attempted assignment or transfer contrary
to this Section the Company shall have no liability to pay any amount so
attempted to be assigned or transferred.
17. TERMINATION
The Company may terminate this Agreement at any time by 30 days written
notice of such termination given to the Executive; except that such termination
shall not be made, and if made shall have no effect, (a) within eighteen months
after the Change of Control in question or (b) during any period of time when
the Company has knowledge that any third person has taken steps reasonably
calculated to effect a Change in Control until, in the opinion of the Board, the
third person has abandoned or terminated his efforts to effect a Change in
Control. Any decision by the Board that the third person has abandoned or
terminated his efforts to effect a change in control shall be conclusive and
binding on the Executive.
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed
and delivered as of the day and year set forth below.
AGREED: TELCO SYSTEMS, INC.:
/s/ Richard J. Nardone /s/ William B. Smith
- ------------------------------- By: -----------------------------------
Richard J. Nardone President & Chief Executive Officer
Date: August 29, 1997 Date: August 29, 1997
------------------------- ---------------------------------
86
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