SECURITIES AND EXCHANGE COMMISSION
Washington , D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended August 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-10228
CABLETRON SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-2797263 (State or
other jurisdiction of (I.R.S. Employer
incorporation or organization) identification no.)
35 Industrial Way, Rochester, New Hampshire 03867
(Address of principal executive offices and Zip Code)
Registrant's telephone number, including area code: (603) 332-9400
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 -
As of August 31, 1998 there were 164,706,515 shares of the Registrant's common
stock outstanding.
This document contains 20 pages
Exhibit index on page 20
<PAGE>
INDEX
CABLETRON SYSTEMS, INC.
Page
Facing Page 1
Index 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - August 31, 1998 (unaudited) and
February 28, 1998 3
Consolidated Statements of Operations - Three and six months
ended August 31, 1998 and 1997 (unaudited) 4
Consolidated Statements of Cash Flows - Six months ended
August 31, 1998 and 1997 (unaudited) 5
Notes to Consolidated Financial Statements - August 31, 1998 6 - 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9 - 16
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 16
PART II. OTHER MATTERS
Item 4. Submission of Matters to a Vote of Security Holders. 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
Index to the Exhibits 20
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CABLETRON SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
(unaudited)
August 31, 1998 February 28, 1998
--------------- -----------------
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents ........................................ $ 164,633 $ 207,078
Short-term investments ........................................... 94,886 116,979
Accounts receivable, net ......................................... 260,534 241,181
Inventories ...................................................... 258,716 309,667
Deferred income taxes ............................................ 71,996 81,161
Prepaid expenses and other assets ................................ 109,295 78,084
---------- ----------
Total current assets ........................................ 960,060 1,034,150
---------- ----------
Long-term investments ................................................. 164,489 123,272
Long-term deferred income taxes ....................................... 155,788 167,308
Property, plant and equipment, net .................................... 238,954 244,730
Intangible assets ..................................................... 49.845 36,867
---------- ----------
Total assets ............................................... $1,569,136 $1,606,327
========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ................................................. $ 100,039 $ 79,969
Current portion of long-term obligation .......................... 216,766 157,719
Accrued expenses ................................................. 220,559 235,062
---------- ----------
Total current liabilities ................................... 537,364 472,750
Long-term obligation .................................................. --- 132,500
Long-term deferred income taxes ....................................... --- 12,057
---------- ----------
Total liabilities ........................................... 537,364 617,307
---------- ----------
Stockholders' equity:
Preferred stock, $1.00 par value. Authorized
2,000 shares; none issued ...................................... --- ---
Common stock $0.01 par value. Authorized
240,000 shares; issued and outstanding
164,707 and 158,267, respectively .............................. 1,647 1,583
Additional paid-in capital ....................................... 467,290 300,834
Retained earnings ................................................ 559,991 685,823
---------- ----------
1,028,928 988,240
Accumulated other comprehensive income............................ 2,844 780
---------- ----------
Total stockholders' equity ................................. 1,031,772 989,020
---------- ----------
Total liabilities and stockholders' equity ................. $1,569,136 $1,606,327
========== ==========
</TABLE>
<PAGE>
CABLETRON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
(unaudited)
Three Months Ended Six Months Ended
August 31, August 31,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales .............................................. $370,591 $371,293 $736,338 $733,982
Cost of sales .......................................... 195,000 159,032 421,112 312,593
-------- -------- -------- --------
Gross profit ...................................... 175,591 212,261 315,226 421,389
-------- -------- -------- --------
Operating expenses:
Research and development .......................... 53,941 44,415 108,149 88,032
Selling, general and administrative ............... 108,511 85,412 210,988 166,327
Special charges.................................... -- -- 150,000 --
-------- -------- -------- --------
Total operating expenses ..................... 162,452 129,827 469,137 254,359
-------- -------- -------- --------
Income (loss) from operations ................ 13,139 82,434 (153,911) 167,030
Interest income ........................................ 4,081 4,819 7,920 9,621
-------- -------- -------- ---------
Income (loss) before income taxes ............ 17,220 87,253 (145,991) 176,651
Income tax expense ..................................... 5,877 29,666 716 60,240
-------- -------- -------- --------
Net income (loss) ...................................... $ 11,343 $ 57,587 ($146,707) $116,411
======== ======== ======== ========
Net income (loss) per share - basic .................. $ 0.07 $ 0.37 ($ 0.89) $ 0.74
======== ======== ======== ========
Weighted average number of shares outstanding - basic . 164,640 157,743 164,017 157,300
======== ======== ======== ========
Net income (loss) per share - diluted ................ $ 0.07 $ 0.36 ($ 0.89) $ 0.73
======== ======== ======== ========
Weighted average number of shares outstanding - diluted 170,462 159,867 164,017 159,513
======== ======== ======== ========
</TABLE>
<PAGE>
CABLETRON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars) (unaudited)
Six Months Ended
August 31,
1998 1997
---- ----
Cash flows from operating activities:
Net income (loss) ............................... ($146,707) $ 116,411
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating
activities:
Depreciation and amortization ............... 40,248 34,876
Provision for losses on accounts receivable . 2,285 (1,202)
Deferred taxes .............................. (9,179) (8,209)
Loss (gain) on disposal of property 698 (489)
Purchased research and development from
acquisition ................................. 150,000 --
Changes in assets and liabilities:
Accounts receivable ...................... (20,938) (74,938)
Inventories .............................. 50,444 (77,008)
Prepaid expenses and other assets ........ (21,129) (6,564)
Accounts payable and accrued expenses .... (47,615) 29,491
Income taxes payable ..................... (1,292) (8,918)
-------- -------
Net cash (used in) provided by operating
activities ................................. (3,185) 3,450
Cash flows from investing activities:
Capital expenditures ............................ (24,110) (46,517)
Cash received in business acquisition ........... 317 --
Purchases of available-for-sale securities ...... (59,830) (72,884)
Purchases of held-to-maturity securities......... (57,928) (27,228)
Maturities of marketable securities.............. 98,653 105,340
-------- --------
Net cash used in investing activities ........ (42,898) (41,289)
--------- --------
Cash flows from financing activities:
Proceeds from stock option exercise.............. 1,254 13,215
Common stock issued to employee stock
purchase plan................................ 2,124 3,311
-------- --------
Net cash provided by financing activities .... 3,378 16,526
-------- --------
Effect of exchange rate changes on cash............. 260 408
--------- ---------
Net decrease in cash and cash equivalents .......... (42,445) (20,905)
Cash and cash equivalents, beginning of period ..... 207,078 214,828
--------- ---------
Cash and cash equivalents, end of period ........... $ 164,633 $ 193,923
========= =========
Cash paid during the period for:
Income taxes .................................... $ 8,366 $ 40,151
========= =========
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of presentation
The accompanying unaudited financial statements have been prepared in accordance
with the instructions to Form 10-Q and Article 2 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the opinion
of management, all adjustments consisting of normal recurring accruals necessary
for a fair presentation of the results of operations for the interim periods
presented have been reflected herein. The results of operations for the interim
periods are not necessarily indicative of the results to be expected for the
entire year. The accompanying financial statements should be read in conjunction
with the consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended February 28, 1998.
2. Acquisition related charges
The Company has received a letter from the staff of the Securities and Exchange
Commission (the "Staff") commenting on the Company's Form 10-K for the year
ended February 28, 1998 and its Form 10-Q for the quarter ended May 31, 1998.
For a more complete description of the Staff's letter and its potential
ramifications for the Company see "Item 5. Other Information" later in this
report. Upon receiving advice from its auditors and other professionals in
reviewing the Forms 10-K and 10-Q and formulating a response to the Staff, the
Company has determined to reduce the $57.7 million in special charges the
Company recorded in the fourth quarter of fiscal 1998 in connection with its
acquisition of the DNPG by approximately $33.2 million. As a result of this
reduction, (i) the Company's loss from operations for the first quarter of
fiscal 1999 has been increased by approximately $8.7 million of acquisition
related expenses from the amount previously disclosed (including as disclosed in
the Company's Form 10-Q for such quarter) and (ii) the Company's income from
operations for the second quarter of fiscal 1999 has been decreased by
approximately $5.0 million of acquisition related expenses from the amount
disclosed in a press release dated September 21, 1998. As a consequence, loss
per share for the first quarter has been increased by approximately $0.04 to
($0.97) and earnings per share for the second quarter has been reduced by
approximately $0.02 to $0.07. In addition, the Company has determined to
reclassify $13.6 million of special charges recorded in its acquisition of Yago
Systems, Inc. associated with the elimination and phase out of superceded
product lines to cost of sales in the first quarter of fiscal 1999. The
adjustments described above have been fully incorporated into the financial
statements contained in this report, excluding the Company's February 28, 1998
balance sheet which does not reflect these adjustments. The Company intends,
after reaching a final resolution with the Staff, to amend its Form 10-K for
fiscal 1998 (including the balance sheet contained in this report), its Form
10-Q for the first quarter of fiscal 1998 and possibly this report to reflect
the adjustments related to special charges described above and any additional
adjustments required by the Staff.
<PAGE>
Total DNPG acquisition related charges reported in the year
ended February 28, 1998 (in millions) $57.7
Less reductions:
Contract employee benefits and contract
compensation write-offs (12.5)
Professional fees and some facility costs
reclassified to assumed liabilities (5.0)
Other integration costs reductions in
estimates and classifications (15.7)
-----
Total merger related costs as revised, consisting
of elimination and phase out of overlapping
products $24.5
=====
3. New Accounting Standards
Effective March 1, 1998, the Company adopted Financial Accounting Standards
Board Statement No. 130, "Reporting Comprehensive Income" ("SFAS 130") which
establishes standards for reporting and display of comprehensive income and its
components in a full set of financial statements. For the Company, comprehensive
income includes net income and unrealized gains and losses from foreign currency
translation.
In June 1997, the Financial Accounting Standards Board issued Statement 131
(SFAS 131), "Disclosures about Segments of an Enterprise and Related
Information," which establishes standards for the way that public business
enterprises report selected information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. This Statement
becomes effective for the Company in its fiscal year ending February 28, 1999.
The Company is in the process of determining the impact of SFAS 131 on its
footnote disclosures.
4. Inventories
Inventories consist of:
August 31, February 28,
1998 1998
---- ----
Raw materials $ 65,107 $105,099
Work in process 11,917 34,247
Finished goods 181,692 170,321
-------- --------
Total inventories $258,716 $309,667
======== ========
<PAGE>
5. EPS Reconciliation
The reconciliation of the numerators and denominators of the basic and diluted
income (loss) per common share computations for the Company's reported net
income (loss) is as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three months ended Six months ended
August 31, August 31,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic net income (loss) ................... $ 11,343 $ 57,587 ($146,707) $116,411
======== ======== ========= ========
Weighted average shares outstanding - basic 164,640 157,743 164,017 157,300
Contingent shares per acquisition
agreement .............................. 5,500 -- -- --
Net additional common shares upon
exercise of common stock options ....... 322 2,124 -- 2,213
-------- -------- -------- -------
Weighted average shares outstanding -
diluted ................................ 170,462 159,867 164,017 159,513
======== ======== ======== =======
Net income (loss) per share - basic ....... $ 0.07 $ 0.37 ($ 0.89) $ 0.74
======== ======== ======== =======
Net income (loss) per share - diluted ..... $ 0.07 $ 0.36 ($ 0.89) $ 0.73
======== ======== ======== =======
</TABLE>
6. Comprehensive Income
The Company's total of comprehensive income (loss) was as follows:
(in thousands)
For the six month period ended
August 31, 1998 August 31, 1997
--------------- ---------------
Net income (loss) ($146,707) $116,411
Other comprehensive income:
Foreign currency translation
adjustment 2,064 (39)
-------- --------
Total comprehensive income (loss) ($144,643) $116,372
======== ========
7. Business Combination
On March 17, 1998 Cabletron acquired Yago Systems, Inc. ("Yago"), a privately
held manufacturer of wire speed routing and layer-4 switching products and
solutions. Under the terms of the merger agreement, Cabletron issued 6.0 million
shares of Cabletron common stock to the shareholders of Yago in exchange for all
of the outstanding shares of stock of Yago not then owned by Cabletron. In
addition, Cabletron assumed Yago stock options for approximately 2.1 million
shares of Cabletron common stock. Prior to the closing of the acquisition,
Cabletron held approximately twenty-five percent of Yago's capital stock,
calculated on a fully-diluted basis. Cabletron also agreed, pursuant to the
terms of the merger agreement, to issue up to 5.5 million shares of Cabletron
common stock to the former shareholders of Yago in the event the shares
originally issued in the transaction do not attain a market value of $35 per
share eighteen months after the closing of the transaction.
Cabletron recorded the cost of the acquisition at $165.7 million. This
represents 11.5 million shares at $14.1875 per share for a total of $163.1
million, in addition to direct acquisition costs of $2.6 million. In connection
with the acquisition, Cabletron recorded special charges of $150.0 million for
in-process research and development costs. Previously, the Company had recorded
an additional $13.6 million in special charges. The Company has reclassifed this
amount into its cost of sales in the six month consolidated statements of
operations contained in this report. Cabletron's consolidated results of
operations include the operating results of Yago from the acquisition date.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Cabletron Systems' worldwide net sales in the second quarter of fiscal 1999 (the
three month period ended August 31, 1998) were $370.6 million, a decrease of
less than one percent, compared to net sales of $371.3 million for the second
quarter of fiscal 1998. The slight decrease in net sales for the second quarter
of fiscal 1999 was primarily a result of the continued weakening of sales of
shared media products. The decrease in sales of shared media products was
partially offset by the sales of products from Digital Network Products Group
("DNPG"), a division the Company acquired from Digital Equipment Corporation
("Digital") on February 7, 1998 and which did not contribute to the revenues in
the second quarter of fiscal 1998. Sales of switched products increased
approximately $25.6 million, or 14.4%, to $203.8 million in the second quarter
of fiscal 1999 compared to $178.2 million in the second quarter of fiscal 1998.
Sales of shared media products decreased $40.9 million to $51.9 million in the
second quarter of fiscal 1999 compared to $92.8 million in the same quarter of
fiscal 1998, a decline of approximately 44.1%. The increase in sales of switched
products in the quarter was driven primarily by increased sales of the
SmartSwitch 6000 and the SmartSwitch Router. These sales were partially offset
by decreased sales of some older switched products. The decrease in sales of
shared media products was a result of declining unit shipments and lower prices
per product for the MMAC and components for the MMAC. The Company expects sales
of its shared media products to continue to decrease this fiscal year as
customers continue to migrate from shared media products to switched products.
International sales were $136.2 million or 36.8% of net sales in the second
quarter of fiscal 1999 as compared to $108.8 million or 29.3% of net sales for
the same period in fiscal 1998. The increase in international sales was largely
a result of sales by DNPG, which has a large percentage of its sales in the
European and Pacific Rim countries.
Gross profit as a percentage of net sales in the second quarter of fiscal 1999
decreased to 47.4% from 57.2% for the second quarter of fiscal 1998. The
decrease was primarily due to pricing pressures on the Company's products,
especially in foreign markets which traditionally carry a higher margin than
products sold in the United States. Other secondary factors causing a decrease
in the Company's gross profit margin in the quarter were (i) sales of DNPG
products which carry a lower margin than the Company's historic products, and
(ii) an increase in the percentage of sales to distributors and resellers which
require higher discounts than sales directly to end users.
Research and development expenses in the second quarter of fiscal 1999 increased
21.4% to $53.9 million from $44.4 million in the second quarter of fiscal 1998.
The increase in research and development spending reflected the additional
software and hardware engineers acquired as a result of acquisitions and
associated costs related to development of new products. Research and
development spending as a percentage of net sales increased to 14.6% from 12.0%
in the second quarter of fiscal 1998.
Selling, general and administrative ("SG&A") expenses in the second quarter of
fiscal 1999 increased 27.0% to $108.5 million from $85.4 million in the second
quarter of fiscal 1998. The increase in SG&A expenses was due predominately to
the increase in sales and technical personnel and incentive payments to
employees added through the recent acquisitions by the Company.
Net interest income in the second quarter of fiscal 1999 decreased $0.7 million
to $4.1 million, as compared to $4.8 million in the same quarter of fiscal 1998.
The decrease reflects lower cash balances due to cash expended for the
acquisition of DNPG.
<PAGE>
Income before income taxes was $17.2 million in the second quarter of fiscal
1999 compared to income before income taxes of $87.3 million in the second
quarter of fiscal 1998. The decrease in income before income taxes was due
primarily to lower margins and higher expenses.
Results of the Six Months ended August 31. 1998 vs Six Months ended August 31,
1997
Cabletron Systems' worldwide net sales of $736.3 million for the six months
ended August 31, 1998 represented a less than one percent increase over net
sales of $734.0 million reported for the same period of the preceding year.
International sales as a percentage of total net sales increased to 41.5 percent
from 28.1 percent for the same period of the preceding year.
Gross profit as a percentage of net sales for the six months ended August 31,
1998 was 42.8 percent compared to 57.4 percent for the six months ended August
31, 1997. The gross profit was 44.7 percent excluding the $13.6 million of
superceded product inventory charges related to the Yago acquisition.
Research and development costs increased to $108.1 million compared to $88.0
million for the same period of the preceding fiscal year. As a percentage of net
sales, spending for research and development increased to 14.7 percent from 12.0
percent. The higher spending for research and development reflected increased
numbers of software and hardware engineers hired and acquired as a result of
acquisitions and associated costs related to development of new products.
Spending for selling, general and administrative expenses increased to $211.0
million compared to $166.3 million for the same period of the preceding year. As
a percentage of net sales, spending for selling, general and administration
increased to 28.7 percent from 22.7 percent for the same period of the preceding
year. The increase in spending was the result of an increase in sales and
technical personnel and incentive payments to employees added through the recent
acquisitions by the Company.
Interest income was $7.9 million compared to $9.6 million in the same period
last year. The decrease reflects lower cash balances due to cash expended for
acquisitions.
Loss before income taxes of $146.0 million represented a decrease from income
before income taxes of $176.7 million for the same period a year ago. The
decrease was due largely to one-time acquisition expenses for Yago Systems. For
the six months ended August 31, 1998 the actual tax rate differs from the
expected tax rate due to the non-deductibility of the in-process research and
development charge of $150.0 million taken in connection with Company's
acquisition of Yago Systems.
Liquidity and Capital Resources
Cash, cash equivalents, marketable securities and long-term investments
decreased to $424.0 million at August 31, 1998 from $447.3 million at February
28, 1998. Net cash used in operating activities was $3.2 million in the six
month period ended August 31, 1998, compared to net cash provided by operating
activities of $3.5 million in the comparable period of fiscal 1998. The primary
reason operating activities used cash during the period was due to the use of
product credits by Digital. In the Company's acquisition of the DNPG, Digital
received product credits which Digital can use until February 7, 2000 to
purchase products from the Company. No cash is exchanged when Digital purchases
products using product credits; instead Digital's remaining product credits are
reduced by the amount of the purchase. The effect of Digital's use of product
credits on net cash provided by operating activities in this period was
partially offset by the Company's reduction of inventories due to improved
inventory controls.
Net accounts receivable increased by $19.3 million to $260.5 million at August
31, 1998 from $241.2 million at February 28, 1998. Average days sales
outstanding were 63 days at August 31, 1998 compared to 78 days at February 28,
1998. The decrease in days sales outstanding was due primarily to the use of
product credits by Digital and, secondarily, to the increased collection efforts
of the Company. Digital's use of product credits reduces days sales outstanding
because the Company deems purchases paid in product credits to be collected
immediately.
<PAGE>
The Company has historically maintained higher levels of inventory than its
competitors in the LAN industry in order to implement its policy of shipping
most orders requiring immediate delivery within 24 to 48 hours. Worldwide
inventories at August 31, 1998 were $258.7 million, or 119 days of inventory,
compared to $309.7 million, or 157 days of inventory at the end of the prior
fiscal year. Inventory turnover was 3.1 turns at August 31, 1998, compared to
2.3 turns at February 28, 1998. Inventories decreased and inventory turnover
increased due both to improved inventory control performance and increased
reserves for inventory in connection with reducing the scope of the Company's
product offerings.
Capital expenditures for the first six months of fiscal 1999 were $24.1 million
compared to $46.5 million for the same period of the preceding year. Capital
expenditures included approximately $16.3 million for equipment costs, of which
$13.7 million was for computer and computer related equipment, and $1.4 million
represented upgrades to manufacturing equipment.
Current liabilities at August 31, 1998 were $537.4 million compared to $472.8
million at the end of the prior fiscal year. This increase was mainly due to
product credits (which are recorded as a liability by the Company) issued to
Digital previously recorded as a long-term liability becoming a current
liability. This was offset partially by Digital's use of the product credits.
In the opinion of management, internally generated funds from operations and
existing cash, cash equivalents and short-term investments will prove adequate
to support the Company's working capital and capital expenditure requirements
for the next twelve months.
Year 2000-compliance. Many computer systems were not designed to handle any
dates beyond the year 1999 and, therefore, computer hardware and software will
need to be modified prior to the year 2000 in order to remain functional. The
Company is concerned that many enterprises will be devoting a substantial
portion of their information systems spending to resolving this upcoming Year
2000 problem. As is true for most companies, the Year 2000 computer issue
creates a risk for Cabletron Systems. If systems do not correctly recognize date
information when the year changes to 2000, there could be an adverse impact on
the Company's operations. The risk for Cabletron Systems exists in four areas:
systems used by the Company to run its business, systems used by the Company's
suppliers, potential warranty or other claims from Cabletron Systems' customers,
and the potential reduced spending by other companies on networking solutions as
a result of significant information systems spending on Year 2000 remediation.
The Company is currently evaluating its exposure in all of these areas.
Cabletron Systems is in the process of conducting a comprehensive inventory and
evaluation of its systems, equipment and facilities. Cabletron Systems has a
number of projects underway to replace or upgrade systems, equipment and
facilities that are known to be Year 2000 non-compliant. The Company has not
identified alternative remediation plans if upgrade or replacement is not
feasible. The Company will consider the need for such remediation plans as it
continues to assess the Year 2000 risk. For the Year 2000 non-compliance issues
identified to date, the cost of upgrade or remediation is not expected to be
material to the Company's operating results. The Company expects to conclude its
estimates of cost by the end of the calendar year. If implementation of
replacement systems is delayed, or if significant new non-compliance issues are
identified, the Company's results of operations or financial condition could be
materially adversely affected.
Cabletron Systems is also in the process of contacting its critical suppliers to
determine that the suppliers' operations and the products and services they
provide are Year 2000 compliant. Where practicable, Cabletron Systems will
attempt to mitigate its risks with respect to the failure of suppliers to be
Year 2000 ready. In the event that suppliers are not Year 2000 compliant, the
Company will seek alternative sources of supplies. However, such failures remain
a possibility and could have an adverse impact on the Company's results of
operations or financial condition. Additionally, litigation may arise from
situations in which the Company has minimum purchase commitment contracts with
suppliers that are not Year 2000 compliant.
<PAGE>
The Company believes its current products are Year 2000 compliant; however,
since all customer situations cannot be anticipated, particularly those
involving third party products, Cabletron Systems may see an increase in
warranty and other claims as a result of the Year 2000 transition. In addition,
litigation regarding Year 2000 compliance issues is expected to escalate. For
these reasons, the impact of customer claims could have a material adverse
impact on the Company's results of operations or financial condition.
Year 2000 compliance is an issue for virtually all businesses whose computer
systems and applications may require significant hardware and software upgrades
or modifications. Companies owning and operating such systems may plan to devote
a substantial portion of their information systems' spending to fund such
upgrades and modifications and divert spending away from networking solutions.
Such changes in customer spending patterns could have a material adverse impact
on the Company's sales, operating results, or financial condition.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
FOREIGN EXCHANGE RISK MANAGEMENT
As the Company's international sales grow as a percentage of total sales,
exposure to volatility in exchange rates could have a material impact on the
Company's financial results.
The Company uses foreign currency forward and option contracts to manage the
risk of exchange fluctuations. The Company uses these derivative instruments to
reduce its exchange risk by essentially creating offsetting market exposures.
The instruments are not held for trading or speculative purposes.
Based on the Company's overall currency rate exposure at August 31, 1998
including derivative and other foreign currency sensitive instruments, a
near-term change in currency rates based on historic currency rate movements,
would not materially affect the consolidated financial position, results of
operations, or cash flows of the Company.
The success of the hedging program depends on forecasts of transaction activity
in various currencies. To the extent that these forecasts are over or
understated during periods of currency volatility, the Company could experience
unanticipated currency gains or losses.
INTEREST RATE RISK
The Company maintains an investment portfolio consisting of debt securities of
various issuers, types and maturities. The securities that are classified as
held to maturity are recorded on the balance sheet at amortized cost. A portion
of the investments is classified as available for sale. These instruments are
not held for purposes of trading. The securities are recorded at amortized cost
which approximates market value. Unrealized gains or losses associated with
these securities are not material. Due to the average maturity and conservative
nature of the investment portfolio, a sudden change in interest rates would not
have a material effect on the value of the portfolio.
<PAGE>
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its annual meeting on July 9, 1998. The following matters were
voted upon at the meeting with the accompanying results:
1. Election of Directors:
Number of Number of Votes
Votes For Withheld Authority
Craig R. Benson 133,221,484 4,066,365
Paul R. Duncan 133,198,542 4,089,307
As a result of such vote the directors of the Company remain Craig R. Benson,
Paul R. Duncan, Michael D. Myerow and Donald F. McGuinness.
2. Approval of the Company's 1998 Equity Incentive Plan:
Number of votes for: 107,251,838
Number of votes against: 29,425,010
Number of abstentions: 604,701
Number of broker nonvotes: 6,300
Item 5. Other Information.
The Company has received a letter from the staff of the Securities and Exchange
Commission (the "Staff") commenting on the Company's Form 10-K for the year
ended February 28, 1998 and its Form 10-Q for the quarter ended May 31, 1998.
The Staff proposes that the Company amend its Forms 10-K and 10-Q to reflect the
Staff's comments. The Staff's comments focus primarily on accounting issues
related to the Company's acquisition of the DNPG, Yago Systems, Inc., and
certain earlier acquisitions, including principally the amount of the purchase
price in the DNPG and Yago acquisitions allocated by the Company to in-process
research and development, as well as the extent of the disclosure related to
such allocations, and to special charges the Company recorded in connection with
these acquisitions. The Company believes that the comments by the Staff are
similar to those made to a number of public companies, particularly in the
technology industry, that have reported acquisitions in the recent past. The
accounting for acquisitions reflected in the Forms 10-K and 10-Q is, the Company
believes, consistent with industry practice and was based upon consultation with
its auditors and, with respect to in-process research and development, with an
independent third party appraiser.
Upon receiving further advice from its auditors and other professionals in
reviewing the Forms 10-K and 10-Q and formulating a response to the Staff, the
Company has determined to reduce the $57.7 million in special charges the
Company recorded in the fourth quarter of fiscal 1998 in connection with its
acquisition of the DNPG by approximately $33.2 million. The amount being reduced
is comprised primarily of (i) approximately $13 million related to the buy-out
of certain Digital benefits and employee starting bonuses which amount will be
amortized over the six quarters following the closing of the acquisition, (ii)
approximately $3 million of professional fees which will be allocated to the
purchase price and (iii) approximately $16 million of other estimated
acquisition related obligations, which estimates have subsequently been reduced.
As a result, (i) the Company's loss from operations for the first quarter of
<PAGE>
fiscal 1999 has been increased by approximately $8.7 million of acquisition
related expenses from the amount previously disclosed (including as disclosed in
the Company's Form 10-Q for such quarter) and (ii) the Company's income from
operations for the second quarter of fiscal 1999 has been decreased by
approximately $5.0 million of acquisition related expenses from the amount
disclosed in a press release dated September 21, 1998. As a consequence, loss
per share for the first quarter of fiscal 1999 has been increased by
approximately $0.04 to ($0.97) and earnings per share for the second quarter has
been reduced by approximately $0.02 to $0.07. The adjustments described in this
paragraph have been fully incorporated into the financial statements contained
in this report, excluding the Company's February 28, 1998 balance sheet which
does not incorporate these adjustments. The Company expects that this
reallocation of acquisition related expenses will have the effect of increasing
operating expenses between $2 and $4 million in each of its next three quarters
(beginning with the current third fiscal quarter). In addition, the Company has
determined to reclassify $13.6 million of special charges associated with the
elimination and phase out of superceded product lines recorded in its
acquisition of Yago Systems, Inc. into its cost of sales for the first quarter
of fiscal 1999. This reclassification will not effect future financial results.
The Company has not yet submitted its response to the Staff. The Staff may seek
additional adjustments of special charges related to the DNPG or other
acquisitions. Together with the adjustments reflected in this report, any such
additional adjustments may have a material adverse impact upon the Company's
operating expenses and earnings in future periods. In addition, the Staff may
seek reductions in the amount of the purchase prices allocated to in-process
research and development in the DNPG and Yago Systems, Inc. acquisitions. The
Company allocated $325.0 million of the DNPG purchase price and $150.0 million
of the Yago purchase price to in-process research and development. In the event
that the Company is required to reduce the charges for in-process research and
development, those amounts will be reallocated to goodwill, which would be
amortized against earnings on a straight line basis over eight years. Any such
reallocation may have a material adverse impact upon the Company's operating
expenses and earnings in future periods. The Company intends, after reaching a
final resolution with the Staff, to amend its Form 10-K for fiscal 1998
(including the balance sheet contained in this report), its Form 10-Q for the
first quarter of fiscal 1998 and possibly this report to reflect the adjustments
related to special charges described above and any additional adjustments
required by the Staff and to add additional textual disclosure concerning these
special charges, the in-process research and development allocations and certain
other matters.
Item 6. Exhibits and Reports on Form 8-K
(a) There were no exhibits filed during the quarter ended August 31, 1998.
(b) Cabletron filed the following report on Form 8-K during the quarter ending
August 31, 1998: Current report on Form 8-K dated July 29, 1998. Such report
disclosed the resignation of Mr. Donald B. Reed from the Board of Directors.
<PAGE>
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 thereunto duly authorized.
CABLETRON SYSTEMS, INC.
(Registrant)
October 16, 1998 /s/ Craig R. Benson
Date Craig R. Benson
Chairman, President,
Chief Executive Officer and
Treasurer
October 16, 1998 /s/ David J. Kirkpatrick
Date David J. Kirkpatrick
Corporate Executive Vice President
of Finance and
Chief Financial Officer
<PAGE>
EXHIBIT INDEX
Exhibit
Page
No. Exhibit
No.
11.1 Included in notes to consolidated financial statements ---
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet, consolidated statement of operations and the
consolidated statement of cash flows included in the Company's Form 10-Q for
the period ending August 31, 1998, and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<CIK> 0000846909
<NAME> CABLETRON SYSTEMS, INC.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> FEB-28-1999
<PERIOD-START> MAR-01-1998
<PERIOD-END> AUG-31-1998
<EXCHANGE-RATE> 1.00
<CASH> 164,633
<SECURITIES> 94,886
<RECEIVABLES> 283,859
<ALLOWANCES> 23,325
<INVENTORY> 258,716
<CURRENT-ASSETS> 960,060
<PP&E> 488,021
<DEPRECIATION> 249,067
<TOTAL-ASSETS> 1,569,136
<CURRENT-LIABILITIES> 537,364
<BONDS> 0
0
0
<COMMON> 1,647
<OTHER-SE> 1,031,772
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<SALES> 736,338
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<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (145,991)
<INCOME-TAX> 716
<INCOME-CONTINUING> (146,707)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (146,707)
<EPS-PRIMARY> (0.89)
<EPS-DILUTED> (0.89)
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