<PAGE> 1
QUARTER 2 - FY 1997
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
(Mark One)
{X} QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended FEBRUARY 23, 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
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TELCO SYSTEMS, INC
------------------
(Exact name of registrant as specified in its charter)
Delaware 94-2178777
------------------------------ -------------------
(State or other jurisdiction (I.R.S. employer
incorporation or organization) identification no.)
63 NAHATAN STREET, NORWOOD, MASSACHUSETTS 02062
-----------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (617) 551-0300
--------------
NO CHANGE
----------------------------------------------------
(Former name, former address and former fiscal year,
if change since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Classes Outstanding at April 2, 1997
- ---------------------------- ----------------------------
Common Stock, $.01 par value 10,759,527
1
<PAGE> 2
TELCO SYSTEMS, INC.
INDEX
REPORT ON FORM 10-Q
FOR QUARTER ENDED FEBRUARY 23, 1997
Page Number
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
------- --------------------
Consolidated Balance Sheets
February 23,1997 and August 25,1996 3
Consolidated Statements of Operations
Three and six months ended February 23,1997
and February 25,1996 4
Consolidated Statements of Cash Flows
Three and six months ended February 23,1997
and February 25,1996 5
Notes to Consolidated Financial Statements 6 - 7
Item 2. Management's Discussion and Analysis of
------- Financial Condition and Results of Operations 8 - 10
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holder 11
------- --------------------------------------------------
Item 6. Exhibits and Reports on Form 8-K 11
------- --------------------------------
SIGNATURE(S) 12
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------
<TABLE>
TELCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<CAPTION>
February 23, 1997 August 25, 1996
----------------- ---------------
<S> <C> <C>
Assets
Current assets:
Cash and equivalents.................................... $ 8,437 $ 8,461
Short-term investments.................................. 3,926 6,581
Accounts receivable, net................................ 19,870 18,025
Refundable income taxes................................. 702 702
Inventories, net........................................ 27,631 23,495
Other current assets.................................... 998 810
------- --------
Total current assets................................ 61,564 58,074
------- --------
Fixed Assets ............................................... 47,240 45,941
Less accumulated depreciation........................... 35,811 33,411
------- --------
Net fixed assets.................................... 11,429 12,530
------- --------
Intangible and other assets, net............................. 7,544 8,900
------- --------
Total assets........................................ $80,537 $ 79,504
======= ========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable........................................ $ 7,848 $ 11,243
Payroll and related liabilities......................... 1,587 1,917
Other accrued liabilities............................... 11,051 8,997
------- --------
Total current liabilities........................... 20,486 22,157
------- --------
Restructuring and other long-term liabilities................ 1,482 3,350
Shareholders' Equity:
Preferred stock, $.01 par value, 5,000,000
shares authorized; no shares outstanding............ ---- ----
Common stock, $.01 par value, 24,000,000
shares authorized; shares outstanding:
10,742,692 at February 23, 1997;
10,519,529 at August 25, 1996....................... 107 105
Capital in excess of par value.......................... 76,036 74,267
Deferred Compensation............................... (296) (567)
Accumulated deficit ................................ 17,278) (19,808)
------ --------
Total shareholders' equity..................... 58,569 53,997
------- --------
Total liabilities and shareholders' equity..... $80,537 $ 79,504
======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
<TABLE>
TELCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
Feb. 23, Feb. 25, Feb. 23, Feb. 25,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales ................................... $27,295 $20,577 $59,130 $41,110
Costs and expenses:
Cost of products sold ....................... 15,775 12,012 35,137 24,124
Research and development .................... 3,857 4,546 7,738 9,079
Sales, marketing and administration ......... 7,424 6,821 14,805
13,505
(Gain) on sale of investment ................ ---- ---- (1,070) ----
Amortization of intangible assets ........... 166 195 333 390
Interest (income) ........................... (183) (318) (343) (689)
------- ------- ------- -------
27,039 23,256 56,600 46,409
Income (loss) before income taxes ........... 256 (2,679) 2,530 (5,299)
Provision for income taxes .................. ---- ---- ---- -----
Net income (loss) ........................... $ 256 $(2,679) $ 2,530 $(5,299)
Average shares and equivalent (thousands) ... 11,076 10,283 11,060 10,271
Earnings (loss) per share ................... $ .02 (.26) $ .23 $ (.52)
</TABLE>
See accompanying notes to consolidated financial statements.
4
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<TABLE>
TELCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<CAPTION>
Six months ended
----------------
Feb. 23, 1997 Feb. 25, 1996
------------- -------------
<S> <C> <C>
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
Cash flows from operating activities:
Net income (loss) ...................................... $ 2,530 $ (5,299)
Depreciation and amortization .......................... 2,749 2,923
Amortization of unearned compensation .................. 15 10
Change in assets and liabilities:
Accounts receivable ................................ (1,845) (2,548)
Refundable income taxes ............................ ---- 403
Inventories ........................................ (4,136) (80)
Other current assets ............................... (188) 413
Intangible and other assets ....................... 1,000 24
Accounts payable and other current liabilities .... (2,749) 2,009
Restructuring liabilities ......................... (1,155) ----
Long-term liabilities ............................. 365 (717)
Net cash (used in) provided by operating activities (3,414) (2,862)
------- --------
Cash flows from investing activities:
Additions to plant and equipment, net .................. (1,292) (3,758)
Purchase of short-term investments ..................... (5,110) (15,337)
Maturities of short-term investments ................... 7,765 14,776
------- --------
Net cash (used in) provided by investing activities .... 1,363 (4,319)
------- --------
Cash flows from financing activities:
Proceeds from sale of common shares
under employee stock plans ........................... 2,027 451
------- --------
Net cash (used in) provided by financing activities .... 2,027 451
------- --------
(Decrease) increase in cash and equivalents ................ (24) (6,730)
Cash and equivalents at beginning of year .................. 8,461 18,208
------- --------
Cash and equivalents at end of period ...................... $ 8,437 $ 11,478
======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
TELCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED FEBRUARY 23, 1997
(UNAUDITED)
Note 1 - The consolidated financial statements of Telco Systems, Inc.
(the Company) included in this report reflect all adjustments
(consisting of only normally recurring accruals) which, in the opinion
of management, are necessary for a fair presentation of the
consolidated financial position at February 23, 1997 and the
consolidated statements of operations and cash flows for the six
months ended February 23, 1997 and February 25,1996. The unaudited
results of operations for the interim periods reported are not
necessarily indicative of results to be expected for the year.
Certain notes and other information have been condensed or omitted
from these interim financial statements. The statements, therefore,
should be read in conjunction with the consolidated financial
statements and related notes included in the Telco Systems, Inc.
Annual Report on Form 10-K for the year ended August 25, 1996.
<TABLE>
Note 2 - Inventories (dollars in thousands) February 23, August 25,
1997 1996
------- -------
<S> <C> <C>
Raw materials.............................. $ 9,493 $12,112
Work-in-process............................ 6,546 5,560
Finished goods............................. 11,592 5,823
------- -------
$27,631 $23,495
======= =======
</TABLE>
<TABLE>
Note 3 - Shares Outstanding
<CAPTION>
Changes in shares outstanding: Six months ended
----------------
February 23, August 25,
1997 1996
------- -------
<S> <C> <C>
Outstanding at beginning of period......... 10,519,529 10,230,624
Options exercised........................ 219,887 23,748
Restricted stock grants (retirements).... (23,000) 92,000
Employee stock purchase plan............. 26,276 25,909
---------- ----------
Outstanding at end of period............... 10,742,692 10,372,281
========== ==========
</TABLE>
6
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Note 4 - 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 exercisable
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 exercisable and cannot be transferred
separately. The Rights become exercisable 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 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.
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PART I. FINANCIAL INFORMATION (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
<TABLE>
The following table sets forth for the period indicated (i)
percentages which certain items reflected in the financial data bear
to sales of the Company and (ii) the percent change of such items as
compared to the indicated prior period. See Consolidated Statements of
Operations.
<CAPTION>
PERCENT CHANGE
--------------
PERCENT OF SALES SECOND SIX
SECOND QUARTER SIX MONTHS QTR MONTHS
-------------- --------------- -------- --------
1997 1996 1997 1996 97 vs 96 97 vs 96
---- ---- ----- ----- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Sales ................................. 100.0% 100.0% 100.0% 100.0% 32.6% 43.8%
Cost of sales ......................... 57.8% 58.4% 59.4% 58.7% 31.3% 45.7%
Expenses:
Research and development .......... 14.1% 22.1% 13.1% 22.1% (15.2%) (14.8%)
Sales, marketing and administration 27.2% 33.1% 25.0% 32.8% 8.8% 9.6%
(Gain) on sale of investment ...... -- -- (1.8%) -- NA NA
Amortization of intangible assets . 0.6% 0.9% 0.6% 0.9% (14.9%) (14.6%)
Interest (income) ................. (0.6%) (1.5%) (0.6%) (1.7%) (42.5%) (50.2%)
Total ............................ 99.1% 113.0% 95.7% ll2.8% 16.3% 22.0%
Pretax income (loss) .................. 0.9% (13.0%) 4.3% (12.8%) (109.6%) (147.7%)
Provision for income taxes ............ 0.0% 0.0% 0.0% 0.0% NA NA
Net income (loss) ..................... 0.9% (13.0%) 4.3% (12.8%) (109.6%) (147.7%)
</TABLE>
8
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
SALES AND NET INCOME - Sales for the second quarter of fiscal 1997 increased 33%
to $27.3 million compared with $20.6 million in the second quarter of last year.
For the six month period, sales increased 44% to $59.1 million compared with
$41.1 million for the first six months of fiscal 1996. Increased shipments of
Broadband products and Access products were partially offset by decreased
shipments of Bandwidth Optimization products.
Broadband products were in greater demand during the second quarter and first
six months of fiscal 1997 resulting in an increase of 39% and 48%, respectively,
over the comparable periods of last year. Telephone company customers continued
to be the major users of these products for use in local loop applications. As a
percent of total sales, Broadband products represented 56% and 55% in the second
quarter and first six months of fiscal 1997, respectively, compared with 53% in
both periods of last year.
Shipments of access products increased 33% and 45% during the second quarter and
first six months of fiscal 1997, respectively, compared with last year. This
increase reflected greater acceptance of the Company's Access60 network access
server which is increasingly being used in voice, data and wireless
applications. Access products represented approximately 40% of total sales in
all periods presented.
COST OF PRODUCT SOLD For the second quarter of fiscal 1997, cost of sales
represented 58% of total sales and was unchanged from the comparable period of
last year. For the six month periods, cost of sales was 59% of sales in both
years. During the second quarter of fiscal 1997, cost reduction activities
continued in an effort to offset lower gross margins associated with the initial
production of new products and competitive pricing pressures.
RESEARCH AND DEVELOPMENT Spending on research and development programs decreased
by 15% in both the second quarter and first six months of fiscal 1997 compared
with the same periods of last year. During the latter part of fiscal 1996,
spending on certain broadband product development programs was curtailed in
accordance with the Company's 1996 restructuring program. The success of
products presently under development continues to be dependent on the Company's
ability to attract and retain skilled employees. As a percent of sales, research
and development represented 14% and 13% in the second quarter and first six
months of fiscal 1997, respectively. Research and development represented 22% of
sales in both comparable periods of last year.
SALES, MARKETING AND ADMINISTRATION Sales, marketing and administration expense
increased 9% and 10% for the second quarter and first six months of fiscal 1996,
respectively. Increased product marketing activities and sales channel
development accounted for these increases.
GAIN ON SALE OF INVESTMENT 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. This investment, which
occurred in fiscal 1995, yielded a one-time gain of $1.1 million.
9
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AMORTIZATION OF INTANGIBLE ASSETS 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 $.2 million for the second quarter of fiscal 1997
and $.3 million for the year to date period.
INTEREST INCOME Interest income related to the Company's cash equivalents and
short-term investments decreased 43% and 50% during the second quarter and first
six months of fiscal 1997 compared with last year. This decrease was primarily
related to a lower balance of average cash equivalents and short-term
investments in fiscal 1997 compared with fiscal 1996.
PROVISION FOR INCOME TAX No provision for income tax was recorded during the
first half of fiscal 1997 since tax benefits relating to prior periods were
sufficient to offset net income generated during the first six months of fiscal
1997. No income tax benefit was available from the net loss reported for the
first six months of fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES For the six months ended February 23, 1997, cash
and short-term investments decreased $2.7 million to $12.4 million. During the
first six months of fiscal 1997, a higher level of operating activities consumed
$3.4 million of cash. Increased cash requirements for inventory, accounts
receivable and accounts payable were partially offset by net income before
non-cash expenses. Additionally, sales of common stock under various employee
stock purchase plans generated $2.0 million.
The Company maintains a $10.0 million line of credit with the Bank of Boston
which expires on September 30, 1997. Although the Company has made no borrowings
against the line in fiscal 1997, approximately $1.1 million has been reserved to
support various guarantees in effect at February 23, 1997.
Management believes that cash, short-term investments and the availability of
its line of credit will be adequate to support operating cash requirements for
the foreseeable future.
FORWARD-LOOKING INFORMATION The Private Securities Litigation Reform Act of 1995
("the Act") provides a new "safe harbor" for forward-looking statements so long
as those statements are identified as forward-looking and are accompanied by
meaningful cautionary statements identifying important factors that could cause
actual results to differ materially from those discussed in the statement. The
Company desires to take advantage of the new "safe harbor" provisions of the
Act. Certain information contained herein, particularly certain information
appearing in this section is forward-looking. Information regarding certain
important factors that could cause actual results of operations or outcomes of
other events to differ materially from any such forward-looking statement appear
together with such statement, and/or elsewhere herein. This information should
be read in conjunction with the Company's annual report on Form 10-K for the
year ended August 25, 1996, particularly the information appearing under the
heading "Factors That May Affect Future Financial Results" in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
section of the report.
10
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TELCO SYSTEMS, INC.
PART II. OTHER INFORMATION
--------------------------
Item 4 Submission of Matters to a Vote of Security Holder
- ------ --------------------------------------------------
<TABLE>
The company held its most recent Annual meeting of Shareholders on January 22,
1997. At the meeting, the stockholders elected Dean C. Campbell, Steward
S.Flashen, John A. Ruggiero, William B. Smith and Sheldon Horing as directors of
the corporation, to hold office until the next annual shareholders' meeting, or
until such time as their successors are elected. At the meeting, 10,079,741
shares of common stock representing 94% of the total outstanding shares were
voted in the following manner:
<CAPTION>
Total Vote For Total Vote Withheld
Each Director From Each Director
------------- ------------------
<S> <C> <C>
Dean Campbell........................... 9,361,260 719,560
Steward S. Flaschen..................... 9,361,255 719,560
Sheldon Horing.......................... 9,361,671 719,560
John A. Ruggiero........................ 9,354,632 719,560
William B. Smith........................ 9,362,086 719,560
</TABLE>
Additionally, the stockholders approved the 1990 Stock Option Plan as
amended by a vote of 8,086,421 in favor, 1,800,234 opposed, and 158,442
abstentions and ratified the selection of Ernst and Young LLP as independent
certified public accountants for the Company by a vote of 9,987,159 in favor,
12,059 opposed, and 80,523 abstentions.
Item 6. Exhibits and Reports filed on Form 8-K
- ------- --------------------------------------
(b) On February 20, 1997, the Company filed Form 8-K to report the
adoption of a Stockholder Rights Plan and the distribution of one
right for each outstanding share of the Company's Common Stock.
11
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TELCO SYSTEMS, INC.
SIGNATURE(S)
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
TELCO SYSTEMS, INC.
By: William J. Stuart
-----------------
William J. Stuart
Vice President and
Chief Financial Officer
Principal Accounting Officer
12
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-END> FEB-23-1997
<EXCHANGE-RATE> 1
<CASH> 8,437
<SECURITIES> 3,926
<RECEIVABLES> 19,870
<ALLOWANCES> 665
<INVENTORY> 27,631
<CURRENT-ASSETS> 61,564
<PP&E> 47,240
<DEPRECIATION> 35,811
<TOTAL-ASSETS> 80,537
<CURRENT-LIABILITIES> 20,486
<BONDS> 0
0
0
<COMMON> 107
<OTHER-SE> 58,462
<TOTAL-LIABILITY-AND-EQUITY> 80,537
<SALES> 27,295
<TOTAL-REVENUES> 27,295
<CGS> 15,775
<TOTAL-COSTS> 27,039
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 256
<INCOME-TAX> 0
<INCOME-CONTINUING> 256
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 256
<EPS-PRIMARY> 0.02
<EPS-DILUTED> 0.02
</TABLE>
