<PAGE> 1
QUARTER 3 - 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 MAY 25, 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 July 1, 1997
- ---------------------------- ---------------------------
Common Stock, $.01 par value 10,805,944
1
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TELCO SYSTEMS, INC.
INDEX
REPORT ON FORM 10-Q
FOR QUARTER ENDED MAY 25, 1997
Page Number
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
------ --------------------
Consolidated Balance Sheets
May 25, 1997 and August 25, 1996 3
Consolidated Statements of Operations
Three and nine months ended May 25, 1997
and May 26, 1996 4
Consolidated Statements of Cash Flows
Three and nine months ended May 25, 1997
and May 26, 1996 5
Notes to Consolidated Financial Statements 6 - 7
Item 2. Management's Discussion and Analysis of
------ ---------------------------------------
Financial Condition and Results of Operations 8 - 11
---------------------------------------------
Item 3. Quantitative and Qualitative Disclosures about
------ ----------------------------------------------
Market Risk 12
-----------
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 12
------ --------------------------------
SIGNATURE(S) 13
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------
TELCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
May 25, 1997 August 25, 1996
------------ ---------------
<S> <C> <C>
Assets
- ------
Current assets:
Cash and equivalents.................................. $11,791 $ 8,461
Short-term investments................................ 978 6,581
Accounts receivable, net.............................. 17,525 18,025
Refundable income taxes............................... 702 702
Inventories, net...................................... 26,146 23,495
Other current assets.................................. 962 810
------- -------
Total current assets............................... 58,104 58,074
------- -------
Fixed assets............................................. 47,940 45,941
Less accumulated depreciation......................... 36,201 33,411
------- -------
Net fixed assets................................... 11,739 12,530
------- -------
Intangible and other assets, net ........................ 7,366 8,900
------- -------
Total assets....................................... $77,209 $79,504
======= =======
Liabilities and Shareholders' Equity
- ------------------------------------
Current liabilities:
Accounts payable...................................... $ 6,701 $11,243
Payroll and related liabilities....................... 2,250 1,917
Other accrued liabilities............................. 12,010 8,997
------- -------
Total current liabilities.......................... 20,961 22,157
------- -------
Restructuring and other long-term liabilities............ 1,198 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:
10,786,287 at May 25, 1997;
10,519,529 at August 25, 1996...................... 108 105
Capital in excess of par value........................ 76,508 74,267
Deferred compensation............................. (271) (567)
Accumulated deficit .............................. (21,295) (19,808)
------- -------
Total shareholders' equity...................... 55,050 53,997
------- -------
Total liabilities and shareholders' equity $77.209 $79,504
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
TELCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(ALL AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
May 25, May 26, May 25, May 26,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales .............................. $27,411 $ 23,223 $86,541 $ 64,333
Costs and expenses:
Cost of products sold .................. 19,118 15,174 54,255 39,298
Research and development ............... 3,598 5,124 11,336 14,203
Sales, marketing and administration .... 8,705 9,779 23,510 23,284
Restructuring costs .................... -- 4,659 -- 4,659
(Gain) on sale of investment ........... -- -- (1,070) --
Amortization of intangible assets ...... 168 196 501 586
Interest (income) ...................... (161) (255) (504) (944)
------- -------- ------- --------
31,428 34,677 88,028 81,086
------- -------- ------- --------
(Loss) before income taxes ............. (4,017) (11,454) (1,487) (16,753)
Provision for income taxes ............. -- -- -- --
------- -------- ------- --------
Net (loss) ............................. $(4,017) $(11,454) $(1,487) $(16,753)
======= ======== ======= ========
Average shares and equivalents ......... 10,764 10,408 10,690 10,316
Net (loss) per share ................... $ (0.37) $ (1.10) $ (0.14) $ (1.62)
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
TELCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Nine months ended
-----------------
May 25, 1997 May 26, 1996
------------ ------------
<S> <C> <C>
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
Cash flows from operating activities:
Net (loss) ............................................. $ (1,487) $(16,753)
Depreciation and amortization .......................... 4,043 4,360
Restructuring costs .................................... -- 4,659
Amortization of unearned compensation .................. 40 177
Change in assets and liabilities:
Accounts receivable ................................ 500 (4,122)
Refundable income taxes ............................ -- 403
Inventories ........................................ (2,651) (1,700)
Other current assets ............................... (152) 714
Intangible and other assets ........................ 1,000 24
Accounts payable and other current liabilities ..... (1,994) 7,234
Restructuring liabilities .......................... (1,712) (301)
Long-term liabilities .............................. 358 (599)
-------- --------
Net cash (used in) operating activities ............ (2,055) (5,904)
-------- --------
Cash flows from investing activities:
Additions to plant and equipment, net .................. (2,718) (5,627)
Purchase of short-term investments ..................... (5,110) (19,225)
Maturities of short-term investments ................... 10,713 22,616
-------- --------
Net cash (used in) provided by investing activities .... 2,885 (2,236)
-------- --------
Cash flows from financing activities:
Proceeds from sale of common shares
under employee stock plans ........................... 2,500 1,355
-------- --------
Net cash provided by financing activities ............. 2,500 1,355
-------- --------
Increase (decrease) in cash and equivalents ............... 3,330 (6,785)
Cash and equivalents at beginning of year ................. 8,461 18,208
-------- --------
Cash and equivalents at end of period ..................... $ 11,791 $ 11,423
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
TELCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED MAY 25, 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 May 25, 1997 and the consolidated statements of
operations and cash flows for the nine months ended May 25, 1997 and
May 26,1996. 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 has 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>
<CAPTION>
Note 2 - Inventories (dollars in thousands) May 25, August 25,
1997 1996
------ ---------
<S> <C> <C>
Raw materials.................................. $12,590 $12,112
Work-in-process................................ 6,564 5,560
Finished goods................................. 6,992 5,823
------- -------
$26,146 $23,495
======= =======
<CAPTION>
Note 3 - Shares Outstanding
Changes in shares outstanding: Nine months ended
------------------
May 25, May 26,
1997 1996
------ ------
<S> <C> <C>
Outstanding at beginning of period............. 10,519,529 10,230,624
Options exercised............................ 246,647 113,444
Restricted stock grants (retirements)........ (23,000) 82,000
Employee stock purchase plan................. 43,111 56,010
---------- ----------
Outstanding at end of period................... 10,786,287 10,482,078
========== ==========
</TABLE>
6
<PAGE> 7
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.
7
<PAGE> 8
PART I. FINANCIAL INFORMATION (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following table sets forth for the period indicated (i) percentages
which certain items reflected in the financial data bear to sales of
the Company and (ii) the percent change of such items as compared to
the indicated prior period. See Consolidated Statements of Operations.
<TABLE>
<CAPTION>
PERCENT CHANGE
--------------
PERCENT OF SALES THIRD NINE
---------------- ----- ----
THIRD QUARTER NINE 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% 18.0% 34.5%
Cost of sales .............................. 69.8% 65.3% 62.7% 61.1% 26.0% 38.1%
Expenses:
Research and development ................ 13.1% 22.1% 13.1% 22.1% (29.8%) (20.2%)
Sales, marketing and administration ..... 31.8% 42.1% 27.1% 36.2% (11.0%) 1.0%
Restructuring costs ..................... -- 20.0% -- 7.2% N/A N/A
(Gain) on sale of investment ............ -- -- (1.2%) -- N/A N/A
Amortization of intangible assets ....... 0.6% 0.8% 0.6% 0.9% (14.3%) (14.5%)
Interest (income) ....................... (0.6%) (1.0%) (0.6%) (1.5%) (36.9%) (46.6%)
Total ................................... 114.7% 149.3% 101.7% l26.0% (9.4%) 8.6%
Pretax (loss) .............................. (14.7%) (49.3%) (1.7%) (26.0%) (64.9%) (91.1%)
Provision for income taxes ................. -- -- -- -- N/A N/A
Net (loss) ................................. (14.7%) (49.3%) (1.7%) (26.0%) (64.9%) (91.1%)
</TABLE>
8
<PAGE> 9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
SALES AND NET LOSS - Sales for the third quarter of fiscal 1997 increased 18% to
$27.4 million compared with sales of $23.2 million in the third quarter of last
year. For the nine month period, sales were $86.5 million, reflecting an
increase of 35% compared with sales of $64.3 million in the same period of last
year. Increased sales were recorded across all product areas with the most
significant gains in the broadband products area.
Increased demand for broadband products for use in local loop applications
resulted in increased shipments in both the third quarter and first nine months
of fiscal 1997 of 22% and 39%, respectively. As a percent of net sales in fiscal
1997, broadband products represented 51% in the third quarter and 54% in the
first nine months. For the third quarter and first nine months of fiscal 1996,
broadband products represented 50% and 52% of sales, respectively. Sales to
NYNEX represented 30% of net sales for the third quarter and 31% of net sales
for the first nine months of fiscal 1997. For the comparable periods of last
year, sales to NYNEX accounted for approximately 31% of net sales in both
periods. Although the Company has recently been selected as NYNEX's supplier of
choice for certain asynchronous products, there can be no assurance that orders
will continue at the level experienced in the recent past. Accordingly, the loss
of this customer would have a materially adverse affect on the Company' s
financial results.
Access product sales represented 42% and 41% of net sales in the third quarter
and first nine months of fiscal 1997, respectively, and increased 12% in the
third quarter and 32% in the year to date period compared with last year. These
increases resulted as the Company's Access60 network access server continues to
be deployed at an increasing rate for use in voice, data and wireless
applications.
Net loss for the third quarter and first nine months of fiscal 1997 was $4.0
million and $1.5 million, respectively, compared with $11.5 million and $16.8
million in the same periods of last year. The fiscal 1997 net loss resulted as
gross margins were adversely affected by strong competitive pressure and
increased period costs including charges associated with selling and marketing
expense reductions. Fiscal 1996 operating results included a restructuring
charge of $4.7 million and other charges associated with the transfer of
manufacturing operations from the Company's Fremont, California facility to its
facility located in Norwood, Massachusetts. The physical move of operations was
completed during the second quarter of fiscal 1997.
COST OF PRODUCTS SOLD - Cost of sales represented 70% and 63% of net sales for
the third quarter and first nine months of fiscal 1997, respectively. For the
same periods of last year, cost of sales was 65% and 61% of net sales,
respectively. During the third quarter of fiscal 1997, gross margins were
adversely affected by shipments of a proportionally higher level of lower margin
products and increased period costs associated with reserves for certain
inventory items. The Company is presently implementing initiatives to reduce
product cost through manufacturing process improvements and material procurement
cost savings.
RESEARCH AND DEVELOPMENT - Spending on research and development decreased 30% in
the third quarter of fiscal 1997 compared with the third quarter of last year
and decreased 20% in the nine month period compared with last year. Lower
spending continued into fiscal 1997 after certain broadband product development
programs were curtailed in conjunction with the Company's restructuring
activities which began in the third quarter of fiscal 1996. Research and
development expense was 13% of sales in both the third quarter and first nine
months of fiscal 1997 compared with 22% in both comparable periods of fiscal
1996.
9
<PAGE> 10
SALES, MARKETING AND ADMINISTRATION - Sales, marketing and administration
expense decreased 11% in the third quarter of fiscal 1997 compared with the
third quarter of last year. For the nine month period of this year, spending for
sales, marketing and administration was even with last year. Lower spending in
the third quarter of fiscal 1997 was partially offset by one-time costs
associated with the realignment of certain selling and marketing activities. The
third quarter of fiscal 1996 included costs associated with the relocation of
information systems and customer administration activities from the Company's
Fremont, California facility to its facility located in Norwood, Massachusetts.
RESTRUCTURING COSTS - During the third quarter of fiscal 1996, the Company's
management approved a plan to restructure its operations and recognized a charge
of $4.7 million. This charge included provisions for excess facilities, asset
write-downs and employee severance costs.
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.
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. In fiscal 1997, amortization expense was $.2 million for the third quarter
and $.5 million for the year to date period.
INTEREST INCOME - Interest income decreased 37% and 47% in the third quarter and
first nine months of fiscal 1997, respectively. This decrease resulted from a
lower level of average cash and short-term investments available for investment.
INCOME TAX PROVISION(BENEFIT) - No provision for income tax was recorded during
the first nine months of fiscal 1997 due primarily to the net loss incurred
during the period. In addition, no income tax benefits were available from the
either the fiscal 1997 or the fiscal 1996 net losses.
LIQUIDITY AND CAPITAL RESOURCES - For the nine month period ended May 25, 1997,
cash and equivalents increased $3.3 million and short-term investments decreased
$5.6 million resulting in a net decrease to cash and short-term investments of
$2.3 million. Operating activities to support revenue growth required net cash
of $2.1 million. Cash requirements for increased inventory of $2.7 million, net
payments against liabilities of $3.3 million and a net loss of $1.5 million were
partially offset by depreciation and amortization of $4.0 million and the
proceeds from the sale of an investment of $1.0 million.
Cash flows from investing activities provided cash of $2.9 million. In
short-term investing activities, maturing investments exceeded purchases by $5.6
million. These proceeds were partially consumed by additions to plant and
equipment of $2.7 million. Financing activities consisted of sales of common
shares under various employee stock plans and provided cash of $2.5 million.
The Company maintains a $20.0 million line of credit with Fleet Bank which is
available until June 1, 1998. 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. Subsequent to the end of the third quarter of fiscal 1997,
the Company entered into a sale-leaseback arrangement with GE Capital Corp. for
certain computer and other electronic equipment which provided cash of
approximately $2.6 million. The operating leases contained in the arrangement,
which commenced on June 17, 1997, cover periods from two to four years. This
arrangement also provides an additional lease credit line of $4.0 million which
is available until December 31, 1997.
10
<PAGE> 11
Management believes that cash, short-term investments and the availability of
its lines 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 "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 "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.
11
<PAGE> 12
TELCO SYSTEMS, INC.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
- ------ ----------------------------------------------------------
Not Applicable
PART II. OTHER INFORMATION
- ---------------------------
Item 6. Exhibits and Reports filed on Form 8-K
- ------ --------------------------------------
(b) The Company filed no reports on Form 8-K during the fiscal
quarter for which this report is filed.
12
<PAGE> 13
TELCO SYSTEMS, INC.
SIGNATURE(S)
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
TELCO SYSTEMS, INC.
By: /s/ William J. Stuart
----------------------------------
William J. Stuart
Vice President and
Chief Financial Officer
Principal Accounting Officer
13
<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> MAY-25-1997
<EXCHANGE-RATE> 1
<CASH> 11,791
<SECURITIES> 978
<RECEIVABLES> 17,525
<ALLOWANCES> 642
<INVENTORY> 26,146
<CURRENT-ASSETS> 58,104
<PP&E> 47,940
<DEPRECIATION> 36,201
<TOTAL-ASSETS> 77,209
<CURRENT-LIABILITIES> 20,961
<BONDS> 0
0
0
<COMMON> 108
<OTHER-SE> 54,942
<TOTAL-LIABILITY-AND-EQUITY> 77,209
<SALES> 27,411
<TOTAL-REVENUES> 27,411
<CGS> 19,118
<TOTAL-COSTS> 31,428
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (4,017)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,017)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,017)
<EPS-PRIMARY> (0.37)
<EPS-DILUTED> (0.37)
</TABLE>
