SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended May 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 May 31, 1998, there were 164,428,778 shares of the Registrant's common
stock outstanding.
This document contains 19 pages
<PAGE>
This Amendment on Form 10-Q/A amends Part I, Items 1 and 2 and Part II, Items 1
and 6 of the Company's Quarterly Report on Form 10-Q previously filed for the
quarter ended May 31, 1998. This Quarterly Report on Form 10-Q/A is filed in
connection with the Company's restatement of its financial statements. Financial
statement information and related disclosures included in this amended filing
reflect, where appropriate, changes as a result of the restatements. All other
information contained in this Quarterly Report on Form 10-Q/A is as of the date
of the original filing.
INDEX
CABLETRON SYSTEMS, INC.
Page
----
Facing Page 1
Index 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - May 31, 1998 (unaudited) and
February 28, 1998 3
Consolidated Statements of Operations - Three months ended
May 31, 1998 and 1997 (unaudited) 4
Consolidated Statements of Cash Flows - Three months ended
May 31, 1998 and 1997 (unaudited) 5
Notes to Consolidated Financial Statements -
May 31, 1998 (unaudited) 6 - 9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10 - 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CABLETRON SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
(unaudited)
May 31, 1998 February 28, 1998
------------ -----------------
(Restated) (Restated)
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents .......................... $ 186,608 $ 207,078
Short-term investments ............................. 109,160 116,979
Accounts receivable, net ........................... 249,425 241,181
Inventories ........................................ 281,470 309,667
Deferred income taxes .............................. 30,226 81,161
Prepaid expenses and other assets .................. 91,511 89,396
---------- ----------
Total current assets .......................... 948,400 1,045,462
---------- ----------
Long-term investments ................................... 122,933 123,272
Long-term deferred income taxes ......................... 167,308 107,094
Property, plant and equipment, net ...................... 243,132 244,730
Intangible assets ....................................... 171,865 161,490
---------- ----------
Total assets ................................. $1,653,638 $1,682,048
========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ................................... $ 73,760 $ 79,969
Current portion of long-term obligation ............ 112,790 157,719
Accrued expenses ................................... 229,517 214,728
---------- ----------
Total current liabilities ..................... 416,067 452,416
Long-term obligation .................................... 132,500 132,500
Long-term deferred income taxes ......................... 9,102 12,057
---------- ----------
Total liabilities ....................................... 557,669 596,973
---------- ----------
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 164,429
and 158,267, respectively ........................ 1,644 1,583
Additional paid-in capital ......................... 464,887 300,834
Retained earnings .................................. 627,310 781,878
---------- ----------
1,093,841 1,084,295
Cumulative translation adjustment .................. 2,128 780
---------- ----------
Total stockholders' equity ................... 1,095,969 1,085,075
---------- ----------
Total liabilities and stockholders' equity ... $1,653,638 $1,682,048
========== ==========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
CABLETRON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
(unaudited)
Three Months Ended
May 31,
1998 1997
---- ----
(Restated) (Restated)
<S> <C> <C>
Net sales ......................................... $ 365,747 $ 362,688
Cost of sales ..................................... 216,112 159,561
--------- ---------
Gross profit ................................. 149,635 203,127
--------- ---------
Operating expenses:
Research and development ..................... 54,209 43,616
Selling, general and administrative .......... 106,786 80,915
Special charges .............................. 150,000 --
--------- ---------
Total operating expenses ................. 310,995 124,531
--------- ---------
Income (loss) from operations ............ (161,360) 78,596
Interest income ................................... 3,839 4,801
--------- ---------
Income (loss) before income taxes ........ (157,521) 83,397
Income tax expense (benefit) ...................... (2,952) 28,527
--------- ---------
Net income (loss) ................................. ($154,569) $ 54,870
========= =========
Net income (loss) per share - basic ............... ($ 0.95) $ 0.35
========= =========
Net income (loss) per share - diluted ............. ($ 0.95) $ 0.34
========= =========
Weighted average number of shares outstanding:
Basic ........................................ 163,394 156,857
========= =========
Diluted ...................................... 163,394 159,503
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
CABLETRON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
(unaudited)
Three Months Ended
May 31,
1998 1997
---- ----
(Restated) (Restated)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ................................................ ($154,569) $ 54,870
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating
activities:
Depreciation and amortization ................................ 23,246 17,912
Provision for losses on accounts receivable .................. 987 (185)
Deferred taxes ............................................... 8,117 (2,540)
Loss (gain) on disposal of property .......................... 399 (1,289)
Purchased research and development from acquisition .......... 150,000 --
Changes in assets and liabilities:
Accounts receivable ....................................... (9,898) (69,590)
Inventories ............................................... 28,095 (32,833)
Prepaid expenses and other assets ......................... 1,041 (6,470)
Accounts payable and accrued expenses ..................... (60,642) 25,014
Income taxes payable ...................................... (3,152) 22,234
--------- ---------
Net cash (used) provided by operating
activities .................................................. (16,376) 7,123
--------- ---------
Cash flows from investing activities:
Capital expenditures ............................................. (13,618) (26,595)
Cash received in business acquisition ............................ 317 --
Purchase of available-for-sale securities ........................ (24,528) (35,058)
Purchase of held-to-maturity securities .......................... (12,282) (27,228)
Maturities of marketable securities .............................. 44,982 28,630
--------- ---------
Net cash used in investing activities ......................... (5,129) (60,251)
--------- ---------
Cash flows from financing activity:
Proceeds from stock option exercise .............................. 972 11,611
--------- ---------
Net cash provided by financing activity ....................... 972 11,611
--------- ---------
Effect of exchange rate changes on cash ............................. 63 (169)
--------- ---------
Net decrease in cash and cash equivalents ........................... (20,470) (41,686)
Cash and cash equivalents, beginning of period ...................... 207,078 214,828
--------- ---------
Cash and cash equivalents, end of period ............................ $ 186,608 $ 173,142
========= =========
Cash paid during the period for:
Income taxes ..................................................... $ 2,131 $ 5,988
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
On June 3, 1999, and in conjunction with filing its Form 10-K for the year ended
February 28, 1999, the Company announced it had made revisions to the accounting
for certain prior acquisitions as set forth in its Form 10-K. These restatements
and reclassifications were made to address comments made by the Securities and
Exchange Commission ("SEC") in letters to the Company on accounting issues
related to the amount of purchase price allocated by the Company to in-process
research and development from certain acquisitions and to the timing of the
recognition and the classification of certain expenses included in special
charges. The purpose of this revised Form 10-Q is to reflect the impact of these
revisions on the previously reported quarterly results. Only those items
directly impacted by these revisions have been changed.
1.Basis of presentation
The accompanying unaudited consolidated 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, 1999.
Restatements and Reclassifications
The accompanying consolidated financial statements have been restated to reflect
the impact of adjustments made by the Company to reduce its previously reported
special charges associated with the acquisition of Yago Systems, Inc. ("Yago"),
during the quarter ended May 31, 1998, the Network Products Group of Digital
Equipment Corporation ("DNPG"), during the fourth quarter of the year ended
February 28, 1998, and ZeitNet, Inc. ("ZeitNet"), during the second quarter of
the year ended February 28, 1997. The Company has also reclassified certain
other expenses related to the DNPG acquisition and to three acquisitions
consummated during the year ended February 28, 1997 (ZeitNet, Network Express,
Inc. and Netlink, Inc.) from special charges to cost of sales and selling,
general and administrative expenses. The reclassifications had no effect on net
income (loss).
The Company has reduced special charges originally recorded in association with
the elimination of and phase out of superceded product lines based on the
acquisition of Yago by $10.0 million in the quarter ended May 31, 1998. These
charges will be reflected in cost of sales in future quarters, as the costs are
incurred. The Company has also reclassified $3.6 million of these special
charges to cost of sales in the quarter ended May 31, 1998 to reflect the costs
incurred in this quarter. The impact for the current quarter, was a decrease of
$13.6 million of special charges, of which $3.6 million was reclassified to cost
of sales and an increase of $3.9 million of tax expense.
The Company also reduced the amount of its charge for in-process research and
development, recorded in the fourth quarter in the year ended February 28, 1998,
in connection with the acquisition of DNPG, from $325.0 million to $199.3
million and, correspondingly, increased the amounts allocated to intangible
assets by $125.7 million. The $125.7 million increase to intangible assets was
allocated to customer relations ($97.0 million), goodwill ($14.1 million) and
developed technology ($14.6 million) and is being amortized by a non-cash charge
to income over a period of 5 - 10 years. The impact of this additional
amortization expense to the quarter ended May 31, 1998 was an increase of $4.3
million to selling, general and administrative expenses ("SG&A") and a
corresponding $1.7 million tax benefit.
The Company has also reduced the amount of its special charges recorded in the
fourth quarter of the year ended February 28, 1998 in connection with the
acquisition of DNPG by $33.2 million. The reduction of special charges related
to expenses recorded for contract employee benefits and contract compensation
write-offs of $12.5 million, software licenses and software tools costs of $7.0
million, professional fees and some facility costs reclassified to purchase
price of $3.2 million, customer warranty and stock rotation costs of $3.0
million and other integration costs reductions in estimates and classifications
of $7.5 million. To the extent that a portion of these costs were incurred in
the quarter ended May 31, 1998 the amounts are included in the restated results.
The amounts recorded resulted in an increase of $5.7 million to SG&A and an
increase of $3.0 million to cost of sales. A tax benefit of $3.0 million was
recorded as it related to these additional charges.
<PAGE>
The Company has also reduced the amount of its write down of inventory recorded
in the year ended February 28, 1997 related to the ZeitNet acquisition by $6.0
million and has recorded this charge, upon the disposal of this inventory, in
the quarter ended May 31, 1997.
The Company has reclassified certain expenses relating to its business
combinations from special charges to cost of sales and selling, general and
administrative expense. For the year ended February 28, 1998, $24.5 million
relating to the write down of Company inventory made redundant and discontinued
as a result of the acquisition of DNPG has been reclassified from special
charges to cost of sales. For the year ended February 28, 1997 the amounts
reclassified to cost of sales represented the write down of $20.3 million of
inventory that was duplicative and/or rendered obsolete as a result of the
acquisitions of ZeitNet, Network Express and Netlink. The amounts reclassified
to SG&A represented $3.4 million for customer warranty costs, $2.8 million for
contract termination, $1.5 million for stay bonuses and $7.3 million for other
costs that were attributable to the businesses acquired during the year ended
February 28, 1997. These reclassifications had no impact on the quarter ended
May 31, 1998.
The following is a summary of the effects of the restatements and
reclassifications on special charges and net income (loss) for the three months
ended May 31, 1998:
(in thousands)
Special charges, as originally reported $163,550
Reduction of special charges associated with
the acquisition of Yago (10,000)
Reclassification to cost of sales associated
the acquisition of Yago (3,550)
-------
Special charges, as restated $150,000
========
<TABLE>
<CAPTION>
Three Months Ended
May 31,
(in thousands, except per share amounts) 1998 1997
---- ----
<S> <C> <C>
Net income (loss), as originally reported $(152,300) $ 58,824
Reduction of special charges associated with
the acquisition of Yago, net of tax expense
of $3.9 million 6,110 ---
Increase in amortization charges, related to the
acquisition of DNPG, of intangible assets,
net of tax benefit of $1.7 million (2,628) ---
Recognition of integration costs, related to the
acquisition of DNPG, as incurred, net of tax
benefit of $2.0 million (3,774) ---
Recognition of stock rotation costs, related to
the acquisition of DNPG, net of tax benefit
of $1.0 million (1,977)
Recognition of inventory obsolescence, related
to the acquisition of ZeitNet, upon disposal of
inventory, net of tax benefit of $2.0 million --- (3,954)
------- -------
Net income (loss), as restated $(154,569) $54,870
========== =======
Net income (loss) per share - basic,
as originally reported ($0.93) $0.38
======= =====
Net income (loss) per share - diluted,
as originally reported ($0.93) $0.37
======= =====
Net income (loss) per share - basic,
as restated ($0.95) $0.35
======= =====
Net income (loss) per share - diluted,
as restated ($0.95) $0.34
======= =====
</TABLE>
<PAGE>
The effect of the restatement on the consolidated balance sheet as of May 31,
1998 is as follows:
<TABLE>
<CAPTION>
As Originally As
(in thousands) Reported Restated
------------- ----------
<S> <C> <C>
Inventories $ 271,470 $ 281,470
Deferred income taxes 77,988 30,226
Prepaid expenses and other assets 88,042 91,511
Total current assets 982,693 948,400
Intangible assets 51,551 171,865
Total assets 1,567,617 1,653,638
Accrued expenses 234,299 229,517
Total current liabilities 420,849 416,067
Total liabilities 565,435 557,669
Retained earnings 533,523 627,310
Total stockholders' equity 1,002,182 1,095,969
Total liabilities and stockholders' equity $1,567,617 $1,653,638
</TABLE>
2. 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 (loss), unrealized gains and losses from foreign
currency translation and unrealized gains and losses on available for sale
securities. Prior periods presented for comparative purposes have been formatted
to comply with the requirements of SFAS 130.
In June 1998, the FASB issued Financial Accounting Standard No. 133, "Accounting
for Derivative Instruments and Hedging Activities" (SFAS 133) which requires
companies to record derivative instruments on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting. SFAS 133 will be
effective for the Company's first quarter of fiscal year ending February 28,
2002. Management is currently evaluating the potential effects of this
pronouncement on its consolidated financial statements. However, management does
not expect the impact to be significant.
3. Inventories
Inventories consist of:
(in thousands)
May 31, February 28,
1998 1998
-------- ------------
Raw materials $ 57,241 $ 70,415
Work in process 10,165 24,521
Finished goods 214,064 214,731
-------- --------
Total inventories $281,470 $309,667
======== ========
<PAGE>
4. 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 Yago, not then owned by Cabletron. 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 approximately $165.7 million,
including direct costs of $2.6 million. This acquisition has been accounted for
under the purchase method of accounting. The cost represents 11.5 million shares
at $14.1875 per share, in addition to direct acquisition costs. Based on an
independent appraisal, approximately $150.0 million of the purchase price was
allocated to in-process research and development. Accordingly, Cabletron
recorded special charges of $150.0 million for this in-process research and
development, at the date of acquisition. The excess of cost over net assets
acquired was allocated to goodwill and other intangible assets. A total of $16.3
million was allocated to goodwill and other intangible assets and is being
amortized on a straight-line basis over a period of 5 - 10 years. Cabletron's
consolidated results of operations include the operating results of Yago from
the acquisition date.
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)
Per
Net Share
Period ended May 31, 1998 Income (Loss) Shares Amount
- ------------------------- ------------- ------ -------
Basic net loss per share ($154,569) 163,394 ($0.95)
Net additional common shares
upon exercise of common stock
options ---
-------
Diluted net loss per share ($154,569) 163,394 ($0.95)
======== ======= =====
Period ended May 31, 1997
Basic net income per share $54,870 156,857 $0.35
Net additional common shares
upon exercise of common stock
options 2,646
-------
Diluted net income per share $54,870 159,503 $0.34
======= ======= =====
At May 31, 1998, stock options outstanding were not included in the calculations
of diluted earnings (loss) per share because the effects were anti-dilutive.
6. Comprehensive Income (Loss)
The Company's total comprehensive income (loss) was as follows:
(in thousands)
Period ended
May 31, 1998 May 31, 1997
------------ ------------
Net income (loss) ($154,569) $54,870
Other comprehensive income:
Currency translation adjustment 1,348 (132)
---------- --------
Total comprehensive income (loss) ($153,221) $54,738
========== =======
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Cabletron Systems' worldwide net sales in the first quarter of fiscal 1999 (the
three month period ended May 31, 1998) were $365.7 million, a 1 percent increase
over net sales of $362.7 million for the first quarter of fiscal 1998. The
slight increase was primarily the result of sales of products from the 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 revenues in the first quarter of fiscal 1998. Sales of switched
products increased approximately $41.8 million, or 27%, to $197.5 million in the
first quarter of fiscal 1999 compared to $155.7 million in the first quarter of
fiscal 1998. This increase substantially offset a $53.7 million decrease in
sales of shared media products to $54.9 million in the first quarter of fiscal
1999 compared to $108.6 million in the same quarter of fiscal 1998, a decline of
approximately 50%. The increase in sales of switched products in the quarter was
driven primarily by increased sales of the SmartSwitch 6000 and sales of the DEC
MultiSwitch 900, which was acquired in the Company's acquisition of the DNPG and
thus did not contribute to sales in the first quarter of fiscal 1998. 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 $169.0 million or 46.2% of net sales in the first
quarter of fiscal 1999 as compared to $97.7 million or 27% of net sales for the
same period in fiscal 1998. The increase in international sales was largely a
result of sales by the DNPG, which has a large percentage of its sales in
European and Pacific Rim countries.
Gross profit as a percentage of net sales in the first quarter of fiscal 1999
decreased to 40.9% from 56.0% for the first 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) inventory expenses associated with
management's recent decision to narrow the Company's product offerings, and (ii)
sales of DNPG products which carry a lower margin than the Company's products.
Research and development expenses in the first quarter of fiscal 1999 increased
24.3% to $54.2 million from $43.6 million in the first quarter of fiscal 1998.
The increase in research and development spending reflected the additional
software and hardware engineers gained in the recent DNPG and associated costs
related to development of new products. Research and development spending as a
percentage of net sales increased to 14.8% from 12.0% in the first quarter of
fiscal 1998.
Selling, general and administrative ("SG&A") expenses in the first quarter of
fiscal 1999 increased 32.0% to $106.8 million from $80.9 million in the first
quarter of fiscal 1998. The increase in SG&A expenses was due predominately to
the increase in sales and technical personnel and costs in connection with the
DNPG acquisition. In comparison to the fourth quarter of fiscal 1998, SG&A
expense decreased by 4.6% or $5.2 million due to realignment of duplicate
functions.
In connection with the acquisition of Yago, the Company recorded a special
charge of $150.0 million for in-process research and development.
Net interest income in the first quarter of fiscal 1999 decreased $1.0 million
to $3.8 million, as compared to $4.8 million in the same quarter of fiscal 1998.
The decrease reflects lower cash balances due to cash spent in the acquisition
of DNPG.
Loss before income taxes was $157.5 million in the first quarter of fiscal 1999
compared to income before income taxes of $83.4 million in the first quarter of
fiscal 1998. The decrease in income before income taxes was due primarily to the
special charge of $150.0 million for the acquisition of Yago and, secondarily,
lower margins and higher expenses. Excluding the special charge, loss before
income taxes was $7.5 million in the quarter.
<PAGE>
Liquidity and Capital Resources
Cash, cash equivalents, marketable securities and long-term investments
decreased to $418.7 million at May 31, 1998 from $447.3 million at February 28,
1998. Net cash used by operating activities was $16.4 million in the quarter,
compared to net cash provided by operating activities of $7.1 million in the
first quarter of fiscal 1998. The decrease in cash and equivalents in the
quarter was primarily the result of cash used in operating activities in the
quarter. The Company's operating activities lost cash in the quarter primarily
because of Digital's use of products credits. In the Company's acquisition of
the DNPG, Digital acquired $302.5 million of product credits which Digital can
use, subject to annual limits and other conditions and in lieu of paying cash,
to purchase certain Cabletron products through February 7, 2000. The Company's
efforts to manage inventory levels and improve accounts receivable collections
slightly offset the effects of Digital's use of product credits on net cash
provided by operating activities in the quarter. The Company expects that net
cash provided by operating activities will not increase at the same rate of
growth as net sales through February 7, 2000 due to Digital's use of product
credits.
Net accounts receivable increased slightly by $8.2 million to $249.4 million at
May 31, 1998 from $241.2 million at February 28, 1998. Average day sales
outstanding were 61 days at May 31, 1998 compared to 78 days at February 28,
1998. The decrease in day 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 day sales outstanding
because the Company deems purchases paid in product credits to be collected
immediately.
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 May 31, 1998 were $281.5 million, or 117 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 May 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 increasing
reserves for inventory in connection with reducing the scope of the Company's
product offerings.
Capital expenditures for the first three months of fiscal 1999 were $13.6
million compared to $26.6 million for the same period of the preceding year.
Capital expenditures included approximately $8.3 million for equipment costs, of
which $5.4 million was for computer and computer related equipment, and $1.8
million represented upgrades to manufacturing.
Current liabilities at May 31, 1998 were $416.1 million compared to $452.4
million at the end of the prior fiscal year. This decrease was mainly due to the
use of product credits by Digital (which are recorded as a liability by the
Company) and the timing of disbursements.
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.
Yago Systems, Inc.
In connection with the acquisition of YAGO, the Company allocated $150.0 million
of the purchase price to in-process research and development projects. This
allocation represents the estimated fair value based on risk-adjusted cash flows
related to the incomplete products. At the date of acquisition, the development
of these projects had not yet reached technological feasibility and the research
and development ("R&D") in progress had no alternative future uses. Accordingly,
these costs were expensed as of the acquisition date.
The Company used independent third-party appraisers to assess and allocate
values to the in-process research and development. The value assigned to these
assets were determined by identifying significant research projects for which
technological feasibility had not been established, including development,
engineering and testing activities associated with the introduction of YAGO's
next-generation switching router family of products and technologies.
<PAGE>
At the time of its acquisition, YAGO was a development stage company that had
spent approximately $5.6 million on research and development focused on the
development of advanced gigabit switching technology. In fact, all of Yago's
efforts since the company's inception had been directed towards the introduction
of an advanced gigabit layer-2, layer-3, and layer-4 switching and router
product family. YAGO had no developed products or technology and had not
generated any revenues as of its acquisition date. At the time, YAGO was testing
the technology related to the MSR8000, its first product to be released, and was
developing its MSR16000/8600 family of products. These two primary development
efforts were made up of six significant research and development components,
which were ongoing at the acquisition date. These component efforts included
continued MSR8000 development and testing, research and development of the
MSR2000 (a desktop version of the MSR8000), development of the MSR8600,
development of Wide Area Network interfaces for its switching products, routing
software research and development, and device management software research and
development.
At the time of YAGO's acquisition, the Company believed that the MSR product
family of switching routers would set a new standard for performance and
functionality by delivering wire-speed layer-2, layer-3 and layer-4
functionality. Designed for the enterprise and ISP backbone markets, upon
completion of their development, the MSR products were intended to offer large
table capacity, a multi-gigabit non-blocking backplane, low latency and seamless
calling. YAGO also intended to develop its MSR products to be interoperable with
other standard-based routers and switches. As of the acquisition date,
management expected the development of the MSR product family would be the only
mechanism to fuel YAGO's revenue growth and profitability in the future. Despite
the incomplete state of YAGO's technology, the Company felt that the projected
size and growth of the market for the MSR product, YAGO's demonstrated promise
in the development of the MSR product family and the consideration paid by
Cabletron's competitors to acquire companies comparable to YAGO all warranted
the consideration paid by Cabletron for YAGO.
The nature of the efforts to develop the acquired in-process technology into
commercially viable products principally related to the completion of all
planning, designing, prototyping, high-volume verification, and testing
activities that were necessary to establish that the proposed technologies met
their design specifications including functional, technical, and economic
performance requirements. Anticipated completion dates for the projects in
progress were expected to occur over the next two years, the Company expected to
begin generating the economic benefits from the technologies in the second half
of 1998. Funding for such projects was expected to be obtained from internally
generated sources. Expenditures to complete the MSR technology were expected to
total approximately $10.0 million over the next two years. These estimates are
subject to change, given the uncertainties of the development process, and no
assurance can be given that deviations from these estimates will not occur.
The value assigned to purchased in-process technology was determined by
estimating the costs to develop the purchased in-process technology into
commercially viable products, estimating the resulting net cash flows from the
projects and discounting the net cash flows to their present value. The revenue
projection used to value the in-process research and development was based on
estimates of relevant market sizes and growth factors, expected trends in
technology and the nature and expected timing of new product introductions by
the Company and its competitors.
In the model used to value in-process research and development in the YAGO
acquisition, as of March 17, 1998, total revenues attributable to YAGO were
projected to exceed $900 million in 2002, assuming the successful completion and
market acceptance of the major R&D efforts. As of the valuation date, YAGO had
no existing products and accordingly all revenue growth in the first several
years were related to the in-process technologies. The estimated revenues for
the in-process were projected to peak in 2003 and then decline as other new
products and technologies were projected to enter the market.
Cost of sales was estimated based on YAGO's internally generated projections and
discussions with management regarding anticipated gross margin improvements. Due
to the market opportunities in the Gigabit Ethernet arena and YAGO's unique
product architecture substantial gross margins are expected through 2000.
Thereafter, gross margins are expected to gradually decline as competition
increases. Cost of sales was projected to average approximately 47.5 percent
through 2003. SG&A expenses (including depreciation), was projected to remain
constant as a percentage of sales at approximately 23 percent. R&D expenditures
were projected to decrease as a percentage of sales as the in-process projects
were completed. R&D expenditures were expected to peak in 1998 at 7.1 percent of
sales, decline, and then level out at 5.0 percent of sales in 2000 and
thereafter.
<PAGE>
The rates utilized to discount the net cash flows to their present value were
based on venture capital rates of return. Due to the nature of the forecast and
the risks associated with the projected growth, profitability and developmental
projects, discount rates of 45.0 to 50.0 percent were used for the business
enterprise and for the in-process R&D. The Company believes these rates were
appropriate because they were commensurate with YAGO's stage of development; the
uncertainties in the economic estimates described above; the inherent
uncertainty surrounding the successful development of the purchased in-process
technology; the useful life of such technology; the profitability levels of such
technology; and, the uncertainty of technological advances that are unknown at
this time.
The forecasts used by the Company in valuing in-process research and development
were based upon assumptions the Company believes to be reasonable but which are
inherently uncertain and unpredictable. No assurance can be given that the
underlying assumptions used to estimate expected project sales, development
costs or profitability, or the events associated with such projects, will
transpire as estimated. The Company's assumptions may be incomplete or
inaccurate, and unanticipated events and circumstances are likely to occur.
For these reasons, actual results may vary from the projected results.
Management expects to continue their support of these efforts and believes the
Company has a reasonable chance of successfully completing the R&D programs.
However, there is risk associated with the completion of the projects and there
is no assurance that any will meet with either technological or commercial
success. The Company believes as it did at the time of the YAGO acquisition,
that if YAGO does not successfully complete its outstanding in-process research
and development efforts, Cabletron's future operating results would be
materially adversely impacted and the value of the in-process research and
development might never be realized.
Network Products Group of Digital Equipment Corp.
In connection with the acquisition of NPG, the Company allocated $199.3 million
of the purchase price to in-process research and development projects. This
allocation represents the estimated fair value based on risk-adjusted cash flows
related to the incomplete products. At the date of acquisition, the development
of these projects had not yet reached technological feasibility and the research
and development ("R&D") in progress had no alternative future uses. Accordingly,
these costs were expensed as of the acquisition date.
The Company used independent third-party appraisers to assess and allocate
values to the in-process research and development. The value assigned to these
assets were determined by identifying significant research projects for which
technological feasibility had not been established, including development,
engineering and testing activities associated with the introduction of NPG's
next-generation switch, hub, adapter, and internetworking technologies.
The incomplete projects related to switch technology included, among other
efforts, the introduction of Fast Ethernet and OC-12 technology into
GIGAswitch/ATM and GIGAswitch/ FDDI technologies, development of Gigabit and
Fast Ethernet modules for the VNswitch 900 chassis, and the introduction of a
new GIGAswitch/Ethernet platform to provide Gigabit Ethernet technology. In the
internetworking area, the Company had several significant efforts on-going
related to network management software products, new wireless/remote access
offerings, and web gateway technology. The primary developmental efforts related
to the adapter family of products involved the introduction of new ATM and
Gigabit network interface cards. Finally, in the hub family, specific R&D
efforts included the introduction of ATM and Fast Ethernet modules for the
DEChub 900 and the development of advanced layer 3 switching support for the
100Mbps Hub Multiswitch.
The nature of the efforts to fully develop the acquired in-process technology
into commercially viable products, technologies, and services principally
related to the completion of all planning, designing, prototyping, high-volume
verification, and testing activities that were necessary to establish that the
proposed technologies met their design specifications including functional,
technical, and economic performance requirements. Anticipated completion dates
for the projects in progress were expected to occur over the next one and
one-half years, at which time the Company expected to begin generating economic
benefits from the technologies. Funding for such projects was expected to be
obtained from internally generated sources. As of February 7, 1998, expenditures
to complete these projects were expected to total approximately $61 million for
the remainder of calendar year 1998 and $10 million in calendar year 1999. These
estimates are subject to change, given the uncertainties of the development
process, and no assurance can be given that deviations from these estimates will
not occur.
<PAGE>
The value assigned to purchased in-process technology was determined by
estimating the costs to develop the purchased in-process technology into
commercially viable products, estimating the resulting net cash flows from the
projects and discounting the net cash flows to their present value. The revenue
projection used to value the in-process research and development was based on
estimates of relevant market sizes and growth factors, expected trends in
technology and the nature and expected timing of new product introductions by
the Company and its competitors. In the model used to value NPG's in-process
research and development, as of February 7, 1998, NPG' total revenues were
projected to exceed $1.1 billion in 2002, assuming the successful completion and
market acceptance of the major R&D programs. Estimated revenue from NPG's
existing technologies was expected to be $350 million in 1998, with a rapid
decline as existing processes and know-how approached obsolescence. The
estimated revenues for the in-process projects were estimated to peak in 2002
and then decline as other new products and technologies were expected to enter
the market.
In the model used to value NPG's in-process research and development, cost of
sales was estimated based on NPG's historical results and discussions with
management regarding anticipated gross margin improvements. A substantial gross
margin improvement was expected in 1999 due to a restructuring of NPG's cost
structure. Thereafter, gradual improvements were expected due to purchasing
power increases and general economies of scale. Cost of sales averaged
approximately 49.0 percent through 2003. Combined SG&A and R&D expenses were
expected to peak in 1998 at 44.6 percent of sales, decline, and level out at
approximately 35.8 percent of sales in 2001 and remain constant thereafter.
The rates utilized to discount the net cash flows to their present value were
based on cost of capital calculations. Due to the nature of the forecast and the
risks associated with the projected growth, profitability and developmental
projects, a discount rate of 15.0 percent was appropriate for the business
enterprise, 14.0 percent for the existing products and technology, and 30.0
percent for the in-process R&D. These discount rates were selected to reflect
NPG's corporate maturity; the uncertainties in the economic estimates described
above; the inherent uncertainty surrounding the successful development of the
purchased in-process technology; the useful life of such technology; the
profitability levels of such technology; and, the uncertainty of technological
advances that are unknown at this time.
The forecasts used by the Company in valuing in-process research and development
were based upon assumptions the Company believes to be reasonable but which are
inherently uncertain and unpredictable. No assurance can be given that the
underlying assumptions used to estimate expected project sales, development
costs or profitability, or the events associated with such projects, will
transpire as estimated. The Company's assumptions may be incomplete or
inaccurate, and unanticipated events and circumstances are likely to occur.
For these reasons, actual results may vary from the projected results.
Management expects to continue their support of these efforts and believes the
Company has a reasonable chance of successfully completing the R&D programs.
However, there has been and will continue to be risk associated with the
completion of the projects and there is no assurance that any will meet with
either technological or commercial success. The Company believes, as it did at
the time of the NPG acquisition, that if NPG did not successfully complete its
outstanding in-process research and development efforts, Cabletron's future
operating results could be materially impacted and the value of the in-process
research and development might never be realized.
<PAGE>
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 May 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 of 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 are 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.
YEAR 2000-COMPLIANCE
Historically, certain computer programs have been written using two digits
rather than four digits to define year. This could result in computers
recognizing a date using "00" as the year 1900 rather than the year 2000,
resulting in potential major system failures or miscalculations.
To address the above-mentioned Year 2000 issues and concerns, Cabletron has
established a "Year 2000 Task Force" to lead and coordinate all of its global
Year 2000 activities. This task force is accountable to provide the necessary
leadership, tools and knowledge required by all operating units to become Year
2000 compliant. The task force is currently testing all hardware, firmware and
software developed and sold by the Company for Year 2000 Compliance in
accordance with Cabletron's Year 2000 Policy Statement.
In addition, the Year 2000 Task Force is conducting a global assessment of
Cabletron's essential computer systems and is making reasonable efforts to
ensure that Cabletron's information technology infrastructure will not be
adversely affected by the turn of the century.
Currently, Cabletron has no reasonable estimate of the amount of out-of-pocket
costs which may be incurred to address Year 2000 issues for its products and
internal infrastructure. At this time, the company cannot reasonably estimate
the potential impact on its financial position and operations if key suppliers,
customers and other constituents do not become Year 2000-compliant on a timely
basis.
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
As previously disclosed in Cabletron's annual report on Form 10-K for fiscal
1998, a consolidated class action lawsuit purporting to state claims against
Cabletron and certain officers and directors of Cabletron was filed and
currently is pending in the United States District Court for the District of New
Hampshire. The complaint alleges that Cabletron and several of its officers and
directors disseminated materially false and misleading information about
Cabletron's operations and acted in violation of Section 10(b) and Rule 10b-5 of
the Exchange Act during the period between March 3, 1997 and December 2, 1997.
The complaint also alleges that certain of the Company's alleged accounting
practices resulted in the disclosure of materially misleading financial results
during the same period. More specifically, the complaint challenged the
Company's revenue recognition policies, accounting for product returns, and the
validity of certain sales. The Complaint does not specify the amount of damages
sought on behalf of the class. The legal costs incurred by Cabletron in
defending itself and its officers and directors against this litigation, whether
or not it prevails, could be substantial, and in the event that the plaintiffs
prevail, Cabletron could be required to pay substantial damages. This litigation
may be protracted and may result in a diversion of management and other
resources of Cabletron. The payment of substantial legal costs or damages, or
the diversion of management and other resources, could have a material adverse
effect on Cabletron's business, financial condition or results of operations.
Item 6. Exhibits and Reports on Form 8-K.
[a] There were no reports on Form 8-K filed during the quarter ended May 31,
1998.
[b] Exhibit 10.1 Employment agreement for John d'Auguste (filed with the
original Form 10-Q).
<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)
July 15, 1999 /s/ Piyush Patel
- ------------- ------------
Date Piyush Patel
Chairman, President, and
Chief Executive Officer
July 15, 1999 /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 ---
10.1 Employment agreement between the Company and
John d'Auguste dated April 1, 1998 ---
Exhibit 10.1 is on file with the SEC and not included in this document.
<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/A for
the period ending May 31, 1998, and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
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<NAME> CABLETRON SYSTEMS, INC.
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