<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
November 9, 1998
(November 4, 1998)
----------------------------------------------------
Date of report (Date of earliest event reported)
Telco Systems, Inc.
----------------------------------------------------
(Exact Name of Registrant as Specified in Charter)
Delaware 0-12622 94-2178777
-------------------- -------------------- -----------------
(State or Other Juris- (Commission File No.) (IRS Employer
diction of Incorporation) Identification No.)
68 Nahatan Street
Norwood, Massachusetts 02062
-----------------------------------------------------
(Address of Principal Executive Offices and Zip Code)
(781) 551-0300
----------------------------------------------------
(Registrant's telephone number, including area code)
<PAGE> 2
ITEM 5. OTHER EVENTS
This Current Report on Form 8-K/A amends the Company's Current Report on
Form 8-K dated November 4, 1998 to replace the audited historical financial
statements filed therein with the following definitive audited historical
financial statements of the Company, a copy of which is attached as an exhibit
hereto and incorporated by reference herein: Consolidated Balance Sheets as of
August 30, 1998 and August 31, 1997 and the related Consolidated Statements of
Operations, Shareholders' Equity and Cash Flows for each of the three years
ended August 30, 1998.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(c) Exhibits
Exhibit 23.1 Consent of Independent Auditors
Exhibit 99.1 Definitive Consolidated Financial Statements and Schedule
of the Company as of August 30, 1998 and 1997 and for
each of the three years in the period ended August 30,
1998 and report of independent auditors
2
<PAGE> 3
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned's duly authorized signatory.
Dated: November 9, 1998
TELCO SYSTEMS, INC.
By: /s/ William J. Stuart
-------------------------------------------------
Name: William J. Stuart
Title: Vice President and Chief Financial Officer
3
<PAGE> 1
EXHIBIT 23.1
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); the Telco Systems, Inc. 1990 Stock
Option Plan (Form S-8 Nos. 33-42751, 333-00959 and 333-57581) and acquisition of
Jupiter Technology, Inc. (Form S-3 No. 333-46877) of our report dated November
4, 1998, with respect to the consolidated financial statements and schedule of
Telco Systems, Inc. for the year ended August 30, 1998 included in the Current
Report of Telco Systems, Inc. Form 8-K dated November 4, 1998, as amended by
Form 8-K/A dated November 9, 1998, both filed with the Securities and Exchange
Commission.
/s/ERNST & YOUNG LLP
Boston, Massachusetts
November 5, 1998
<PAGE> 1
Exhibit 99.1
================================================================================
<TABLE>
<CAPTION>
Index to Definitive Consolidated Financial Statements and Schedules Page
- ------------------------------------------------------------------- ----
<S> <C>
Report of Ernst & Young LLP Independent Auditors 2
Consolidated Statements of Operations 3
Consolidated Balance Sheets 4
Consolidated Statements of Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Consolidated Financial Statement Schedules: 17
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).
</TABLE>
<PAGE> 2
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 30, 1998 and August 31, 1997, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended August 30, 1998. Our audits also
included the accompanying financial statement schedule. 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 30, 1998, and August 31, 1997,
and the consolidated results of its operations and its cash flows for each of
the three years in the period ended August 30, 1998, 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.
/s/ERNST & YOUNG LLP
Boston, Massachusetts
November 4, 1998
2
<PAGE> 3
CONSOLIDATED STATEMENTS OF OPERATIONS Telco Systems, Inc.
<TABLE>
<CAPTION>
Three years ended August 30, 1998 1998 1997 1996
- -----------------------------------------------------------------------------------------------
(In thousands except per share amounts)
<S> <C> <C> <C>
Net sales............................................ $ 113,230 $ 117,843 $ 93,954
Costs and expenses
Cost of products sold................................ 71,194 74,985 57,285
Research and development............................. 15,485 15,355 17,991
Sales, marketing and administration.................. 24,300 29,652 30,408
Purchased research and development................... 5,135 -- --
Restructuring costs.................................. -- -- 4,209
Gain on investment................................... -- (1,070) --
Amortization of intangible assets.................... 795 669 752
Interest income...................................... (728) (670) (1,146)
--------- -------- ---------
116,181 118,921 109,499
--------- -------- ---------
Pretax loss.......................................... (2,951) (1,078) (15,545)
Income tax provision................................. 300 -- --
--------- -------- ---------
Net loss............................................. $ (3,251) $ (1,078) $ (15,545)
========= ======== =========
Shares used in computing net loss per share ......... 10,966 10,701 10,357
Net loss per share, basic and diluted................ $ (.30) $ (.10) $ (1.50)
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
CONSOLIDATED BALANCE SHEETS TELCO SYSTEMS, INC.
<TABLE>
<CAPTION>
August 30, 1998 and August 31, 1997 1998 1997
- ---------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C>
Assets
Current assets:
Cash and equivalents............................................ $ 18,743 $ 5,406
Marketable securities........................................... 2,244 7,302
Accounts receivable, less allowance for
doubtful accounts of $665 in 1998 ($895 in 1997)............ 24,336 19,663
Inventories, net................................................ 12,016 28,370
Other current assets............................................ 3,756 985
-------- --------
Total current assets....................................... 61,095 61,726
Plant and equipment, at cost......................................... 45,904 46,401
Less accumulated depreciation................................... 37,579 36,712
-------- --------
Net plant and equipment.................................... 8,325 9,689
Intangible and other assets, less accumulated
amortization of $11,063 in 1998 ($11,651 in 1997)................... 8,403 7,184
-------- --------
Total assets.................................................... $ 77,823 $ 78,599
======== ========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable................................................ $ 7,368 $ 7,292
Payroll and related liabilities................................. 2,727 3,492
Other accrued liabilities....................................... 11,317 10,528
-------- --------
Total current liabilities.................................. 21,412 21,312
Restructuring and other long-term liabilities........................ 911 1,531
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: 11,115 at August 30, 1998;
(10,805 at August 31, 1997) .................................... 111 108
Capital in excess of par value.................................. 79,556 76,602
Accumulated deficit............................................. (24,137) (20,886)
Unearned compensation - restricted stock........................ (30) (68)
-------- --------
Total shareholders' equity..................................... 55,500 55,756
-------- --------
Total liabilities and shareholders' equity...................... $ 77,823 $ 78,599
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY TELCO SYSTEMS, INC.
<TABLE>
<CAPTION>
Three years ended August 30, 1998
- ---------------------------------------------------------------------------------------------------------------------------
Common Stock Paid-in Unearned Accumulated
Shares Amount Capital Compensation Deficit Total
------ ------ ------- ------------ ----------- -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
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
Net loss for year....................... (3,251) (3,251)
Issuance of common stock:
Employee stock purchase plan............ 43 444 444
Exercise of stock options............... 159 2 1,521 1,523
Restricted stock, net................... 6 59 (59) --
Shares issued for acquisition............. 102 1 999 1,000
Amortization of unearned
compensation.......................... (69) 97 28
------ ------ ------- ----- --------- --------
BALANCE, AUGUST 30, 1998 11,115 $ 111 $79,556 $ (30) $ (24,137) $ 55,500
====== ====== ======= ===== ========= ========
</TABLE>
See accompanying notes to consolidated financial statements
5
<PAGE> 6
CONSOLIDATED STATEMENTS OF CASH FLOWS TELCO SYSTEMS, INC.
<TABLE>
<CAPTION>
Three years ended August 30, 1998 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C>
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
Cash Flows from Operating Activities
Net loss..................................................... $(3,251) $(1,078) $(15,545)
Depreciation and amortization................................ 4,743 5,094 5,324
Write-off of purchased research and development.............. 5,135 -- --
Restructuring costs.......................................... -- -- 4,209
Amortization of unearned compensation........................ 28 26 88
Change in assets and liabilities
Accounts receivable, net..................................... (4,623) (1,638) (7,978)
Refundable income taxes...................................... -- 702 549
Inventories, net............................................. 16,354 (4,875) (6,074)
Other current assets......................................... (2,771) (175) 1,775
Other assets................................................. (2) 1,000 25
Accounts payable and other current liabilities............... 357 (1,512) 9,585
Restructuring liabilities.................................... (1,242) (2,192) (1,845)
Long-term liabilities........................................ (533) 536 113
------- ------- -------
Net cash provided by (used in) operating activities ............ 14,195 (4,112) (9,774)
Cash Flows from Investing Activities
Additions to plant and equipment, net ....................... (2,547) (3,634) (6,336)
Purchase of assets of Jupiter Technology, Inc................ (4,336) -- --
Investment in Synaptyx Corporation........................... (1,000) -- --
Proceeds from sale-lease back................................ -- 2,601 --
Purchase of marketable securities............................ (3,694) (11,674) (24,350)
Maturities of marketable securities.......................... 8,752 10,953 28,664
------- ------- -------
Net cash used in investing activities........................ (2,825) (1,754) (2,022)
Cash Flows from Financing Activities
Proceeds and related tax benefits from sale of common
shares under employee stock plans.......................... 1,967 2,811 2,049
------- ------- -------
Net cash provided by financing activities.................... 1,967 2,811 2,049
------- ------- -------
Increase(decrease) in cash and equivalents...................... 13,337 (3,055) (9,747)
Cash and equivalents at beginning of year....................... 5,406 8,461 18,208
------- ------- -------
Cash and equivalents at end of year............................. $18,743 $ 5,406 $ 8,461
======= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash Paid During the Year
Income taxes................................................ $ 149 $ -- $ 89
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Shares issued for assets of Jupiter Technology, Inc............. $ 1,000 $ -- $ --
Liabilities assumed relating to Jupiter Technology, Inc......... $ 898 $ -- $ --
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 7
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 52 weeks in fiscal 1998 and fiscal 1996 and
53 weeks in fiscal 1997. 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 6).
NEW ACCOUNTING STANDARDS 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 does not believe the adoption of SFAS 130 will have a
material impact on the Company's financial results or financial condition. 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.
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 days 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.
7
<PAGE> 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 1 (continued)
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>
1998 1997
---- ----
(in thousands)
<S> <C> <C>
Raw material............................... $2,655 $12,803
Work-in-process............................ 2,397 5,605
Finished goods ............................ 6,964 9,962
------- -------
$12,016 $28,370
======= =======
</TABLE>
In January 1998, the Company entered into an agreement to subcontract the
manufacture of certain products. The agreement commits the Company to annual
purchases of $25 million for the three years ending March 2001. Included in
Other Current Assets at August 30, 1998 is $2.1 million of advances to the
subcontractor.
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>
1998 1997
---- ----
(in thousands)
<S> <C> <C>
Machinery and equipment.................... $33,799 $33,313
Furniture and leasehold improvements....... 12,105 13,088
------- -------
$45,904 $46,401
======= =======
</TABLE>
INTANGIBLE AND OTHER ASSETS Intangible assets arising in connection with
business acquisitions were $7,450,000 and $7,122,000 at August 31, 1998 and
August 31, 1997, respectively. They are amortized over lives ranging from five
to twenty-five years using the straight-line method, with an average remaining
life of 8.4 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.
EARNINGS (LOSS) PER SHARE In February 1997, the Financial Accounting Standards
Board issued Statement No. 128, "Earnings Per Share" (FAS 128), which the
Company adopted in the second quarter of fiscal 1998. The Company has restated
all prior period per share amounts to comply with the requirements of FAS 128.
Under the new requirements, primary and fully diluted earnings per share were
replaced by basic and diluted earnings per share. Basic earnings per share is
calculated by dividing net income or loss by the weighted average number of
common shares outstanding during the
8
<PAGE> 9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
periods. Diluted earnings per share is calculated by dividing net income or loss
by the sum of the weighted average number of common shares outstanding plus all
additional common shares that would have been outstanding if potentially
dilutive common shares had been issued. Potentially dilutive common shares were
excluded from the diluted calculation for those periods in which the Company
reported a net loss. See Note 9 for a description of the Company's stock plans.
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 41% of sales
in fiscal 1998, 39% of sales in fiscal 1997, and 37% of sales in fiscal 1996.
RBOC sales include sales to one RBOC of 36% of sales in fiscal 1998, 33% of
sales in fiscal 1997, and 31% of sales in fiscal 1996. In fiscal 1998, two
additional customers each represented 12% of sales. 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.
On June 4, 1998, the Company entered into a definitive agreement to
merge with a merger subsidiary of World Access, Inc. The transaction is subject
to stockholder and regulatory approval and is expected to be accounted for as a
purchase. The merger agreement, which was amended as of October 27, 1998,
provides that all shares of the Company's common stock will be converted into
shares of World Access common stock based on the average daily closing price of
World Access common stock as reported on the Nasdaq National Market System for a
predefined period prior to the effective time of the merger (the "Closing
Price"). If the Closing Price is more than $36.00, then each share of the
Company's common stock will be converted into 0.4722 shares of World Access
common stock. If the Closing Price is less than $29.00, then each share of the
Company's common stock will be converted into 0.5862 shares of World Access
common stock, provided that the nominal value of the consideration to be
received will be no less than $12.00 per share. If the Closing Price is between
$29.00 and $36.00, then the ratio will be the quotient of $17.00 divided by the
Closing Price (consideration value based upon the average of the high and low
trading prices of the World Access Common Stock on the day of the merger).
During fiscal 1998, the Company recorded sales of $1,442,000 to World Access.
NOTE 3 INCOME TAXES
The components of the provision (benefit) for income taxes were as
follows:
<TABLE>
<CAPTION>
Fiscal Year
-----------
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Federal:
Current ....................................... $ 877 $ -- $(1,105)
Deferred ...................................... (650) 1,105
----- -------
227 --
State:
Current ....................................... 73
----- ----- -------
$ 300 $ -- $ --
===== ===== =======
</TABLE>
9
<PAGE> 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 3 (continued)
The provision (benefit) for income taxes differs from the amount computed using
the statutory rate as follows:
<TABLE>
<CAPTION>
Fiscal Year
-----------
1998 1997 1996
----------------------------------
(In thousands)
<S> <C> <C> <C>
Federal income taxes at statutory rate...................... $ (1,105) $ (366) $ (5,285)
Losses and deductions producing no current tax benefit...... 2,675 123 5,024
Benefit of loss carryforward................................ (855)
Amortization of goodwill.................................... 227 243 247
Tax credits ................................................ (727)
State income taxes, net of federal tax benefits............. 48
Other....................................................... 37 14
-------- ------ -------
Income tax provision ....................................... $ 300 $ -- $ --
======== ====== =======
</TABLE>
The components of deferred tax assets and liabilities at fiscal year end are as
follows:
<TABLE>
<CAPTION>
1998 1997
----------------------
(In thousands)
<S> <C> <C>
DEFERRED TAX ASSETS
Inventory and other reserves ......................... $ 10,693 $ 8,049
Tax credit carryforward................................ 3,392 4,019
Capitalized research and development expenditures ..... 2,946 1,138
Restructuring costs.................................... 1,713 1,863
Net operating loss carryforward........................ 920
Other ................................................. 65 97
-------- --------
18,809 16,086
Valuation reserve ..................................... (17,222) (15,009)
-------- --------
Total deferred tax assets............................. 1,587 1,077
-------- --------
DEFERRED TAX LIABILITIES
Accelerated tax deduction ............................. 1,323 1,261
Acquisition costs...................................... 246 267
Tax depreciation....................................... (558) (373)
Other ................................................. (74) (78)
-------- --------
Total deferred tax liabilities ....................... 937 1,077
-------- --------
Net deferred tax assets................................ $ 650 $ --
======== ========
</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. In fiscal 1998 the valuation reserve increased by
$2,213,000 due primarily to the purchased research and development charge
related to the Jupiter acquisition (see Note 8) which was capitalized for
income tax purposes. This net increase also reflected the recognition of
$650,000 of net deferred tax assets, included in Other Current Assets,
attributable to 1998 current income tax liabilities available to benefit future
income tax losses, if any.
10
<PAGE> 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
The Company had unused research and development and investment tax
credit carryforwards of $3,400,000 at August 30, 1998, which expire from fiscal
years 1999 through 2013.
NOTE 4 ACCRUED LIABILITIES
Accrued liabilities at fiscal year end were as follows:
<TABLE>
<CAPTION>
1998 1997
------------------------
(In thousands)
<S> <C> <C>
Accrued income taxes....................... $ 1,507 $ 919
Restructuring costs........................ 1,513 2,485
Warranty and rework ....................... 1,903 2,027
All other accrued liabilities.............. 6,394 5,097
------- -------
$11,317 $10,528
======= =======
</TABLE>
NOTE 5 LINE OF CREDIT
The Company maintains a $20 million secured line of credit with Fleet
Bank which is available until December 31, 1998. At August 30, 1998, $351,100
was reserved to support various guarantees relating to European Community
customs and duties in effect at that date. The Company had no borrowings against
the credit line at August 30, 1998.
NOTE 6 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.
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 30, 1998 are set forth in the
following table. Amounts relating to excess facilities included herein have been
accrued as discussed in Note 7:
11
<PAGE> 12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 6 (continued)
<TABLE>
<CAPTION>
Gross Lease Sub-lease Net Lease
Fiscal Year Payments income Payments
- ----------- -------- ------ --------
(In thousands)
<S> <C> <C> <C>
1999............................. $ 2,931 $ 509 $2,422
2000............................. 2,166 509 1,657
2001............................. 2,089 412 1,677
2002............................. 1,704 69 1,635
2003............................. 1,704 1,704
Beyond........................... 710 -- 710
------- ------ ------
$11,304 $1,499 $9,805
======= ====== ======
</TABLE>
Rent expense under operating leases was $2.7 million in fiscal 1998,
$3.1 million in fiscal 1997, and $2.9 million in fiscal 1996.
NOTE 7 RESTRUCTURING COSTS
During fiscal 1996, the Company's management approved a plan to restructure
its operations and recognized the following charges (in thousands):
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
========
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 relocation plan was
accomplished within original cost estimates. At August 30, 1998, the remaining
fiscal 1993 and 1996 restructuring reserves for excess facility costs aggregated
$1.5 million.
NOTE 8 ACQUISITIONS
On January 26, 1998, the Company acquired substantially all of the
assets of Jupiter Technology, Inc., a privately held company engaged in the
development of ATM and frame relay access equipment. The transaction was
accounted for using the purchase method at a cost of $6.2 million, including
issuance of 101,636 shares of common stock. The purchase price included $5.1
million which represented the value of in-process technology that had not yet
reached technological feasibility and had no alternative use. This amount was
expensed during fiscal 1998. In addition, the purchase price included $1.1
million of goodwill, which will be amortized over five years.
In August 1998, the Company acquired a minority equity interest of
Synaptyx Corporation, a privately held communications network hardware company,
for $1 million with an option to acquire 100% equity ownership. The $1 million
investment is accounted for under the cost method and included in Intangible and
Other Assets at August 30, 1998. In October 1998, the Company exercised its
option and acquired the remaining ownership for $9 million of equity securities
of the Company. The Synaptyx Acquisition Agreement provides for the Company to
issue an additional $4 million of common stock to be paid upon achievement of
certain revenue goals. The acquisition will be accounted for as a purchase.
12
<PAGE> 13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
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 exercisable ratably over a 48 month period,
commencing six months from the date of grant, and expire after ten years. At
August 30, 1998, 1,551,423 shares of common stock were reserved for issuance
under the Plans.
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 30, 1998, no shares carried restrictions.
On February 11, 1998, 6,000 restricted shares of the Company's common
stock were 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 30, 1998, all 6,000
shares carried restrictions. Restrictions on shares expire ratably on the
anniversary date of the award over the two-year period following the date of
grant.
A summary of the activity in the stock option plans for fiscal 1998,
1997, and 1996 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 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
Authorized under 1990 Plan................... 250,000
Grants....................................... (477,180) 477,180 $ 10.00 - $18.25
Exercised.................................... (165,353) $ 2.25 - $13.88
Canceled..................................... 173,290 (173,290) $ 3.38 - $17.13
Expired...................................... (13,010) -- $ --
-------- --------- ----------------
Balance at August 30, 1998........................ 296,900 1,254,523 $ 3.75 - $19.00
</TABLE>
13
<PAGE> 14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 9 (continued)
At August 30, 1998, August 31, 1997, and August 25, 1996, there were 664,907
shares, 464,589 shares, and 464,767 shares exercisable, respectively.
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. During fiscal 1998, an additional 100,000 shares were
authorized under the Plan. There were 58,534 shares issuable under the
Plan for fiscal 1998 of which 36,969 were outstanding at August 30, 1998. For
fiscal 1997 and 1996 38,947 shares and 56,010 shares, respectively,
were issued under the Plan. At August 30, 1998, 115,707 shares of common
stock were reserved for issuance under the Plan.
In October 1995, the Financial Accounting Standards Board issued
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.
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
1998 1997 1996 1998 1997 1996
<S> <C> <C> <C> <C> <C> <C>
Weighted Average fair value of shares $7.37 $8.36 $10.54 $3.23 $6.00 $4.16
Shares Granted 477,180 902,831 631,305 58,534 38,947 56,010
Assumptions:
Risk-free interest rate 5.25% 5.9% 6.0% 4.9% 5.0% 5.0%
Expected volatility 71% 146.2% 144.4% 68% 88.0% 87.2%
Expected life of grants: 5.4 years 5.5 years 5.5 years .5 years .5 years .5 years
Dividend yield None None None None None None
</TABLE>
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>
1998 1997 1996
<S> <C> <C> <C>
Net loss:
As reported $ (3,251) $(1,078) $ (15,545)
Pro forma $ (6,143) $(4,380) $ (16,787)
Net loss per share:
As reported $ (.30) $ (.10) $ (1.50)
Pro forma $ (.56) $ (.41) $ (1.62)
</TABLE>
14
<PAGE> 15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TELCO SYSTEMS, INC.
NOTE 9 (continued)
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.
Outstanding and Exercisable by
Price Range
As of August 30, 1998
<TABLE>
<CAPTION>
Shares Outstanding Shares Exercisable
------------------ -------------------
Weighted
Average Weighted
Number Remaining Weighted Average Average
Range of Outstanding Contractual Exercise Number Exercisable Exercise
Exercise Prices at 8/30/98 Life Price at 8/30/98 Price
- --------------- ------------ ---- ----- ------------ -----
<S> <C> <C> <C> <C> <C>
STOCK OPTION PLAN
$ 3.75 - $9.50 123,124 6.68 $8.82 93,641 $8.62
$ 9.63 - $9.63 279,266 8.11 $9.63 144,582 $9.63
$9.88 - $11.38 377,851 7.78 $10.64 207,710 $10.82
$11.75 - $13.25 348,246 8.33 $12.91 137,961 $13.00
$13.88 - $19.00 126,036 7.25 $16.59 81,013 $16.18
--------------- --------- ---- ------ ------- ------
$ 3.75 - $19.00 1,254,523 7.84 $11.45 664,907 $11.35
=============== ========== ==== ====== ======= ======
STOCK PURCHASE PLAN
$8.18 36,969 -- $8.18 36,969 $8.18
===== ====== ==== ===== ====== =====
</TABLE>
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 $391,000 in fiscal 1998,
$468,000 in fiscal 1997, and $547,000 in fiscal 1996.
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
15
<PAGE> 16
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.
On June 4, 1998, the Plan was amended to allow for the merger with
World Access, Inc. without the Rights becoming exercisable.
16
<PAGE> 17
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Years Ended August 30, 1998
---------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Allowance for Doubtful Accounts:
Balance at beginning of period........... $895 $676 $649
Charges to costs and expenses............ 200 292 102
Deductions............................... (430) (73) (75)
---- ---- ----
Balance at end of period................. $665 $895 $676
==== ==== ====
</TABLE>
17
