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 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 19
<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 August 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 - 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 (unaudited) 6 - 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10 - 16
PART II. OTHER MATTERS
Item 1. Legal Proceedings 17
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
Index to the Exhibits 19
<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
--------------- -----------------
(Restated) (Restated)
<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 ...................................................... 264,916 309,667
Deferred income taxes ............................................ 33,444 81,161
Prepaid expenses and other assets ................................ 102,575 89,396
---------- ----------
Total current assets ........................................ 920,988 1,045,462
---------- ----------
Long-term investments ................................................. 164,489 123,272
Long-term deferred income taxes ....................................... 167,295 107,094
Property, plant and equipment, net .................................... 238,954 244,730
Intangible assets ..................................................... 165,850 161,490
---------- ----------
Total assets ............................................... $1,657,576 $1,682,048
========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ................................................. $ 100,039 $ 79,969
Current portion of long-term obligation .......................... 216,766 157,719
Accrued expenses ................................................. 217,690 214,728
---------- ----------
Total current liabilities ................................... 534,495 452,416
---------- ----------
Long-term obligation .................................................. --- 132,500
Long-term deferred income taxes ....................................... 17,596 12,057
---------- ----------
Total liabilities ........................................... 552,091 596,973
---------- ----------
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
164,707 and 158,267, respectively .............................. 1,647 1,583
Additional paid-in capital ....................................... 467,290 300,834
Retained earnings ................................................ 633,704 781,878
---------- ----------
1,102,641 1,084,295
Accumulated other comprehensive income............................ 2,844 780
---------- ----------
Total stockholders' equity ................................. 1,105,485 1,085,075
---------- ----------
Total liabilities and stockholders' equity ................. $1,657,576 $1,682,048
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
<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
---- ---- ---- ----
(Restated) (Restated) (Restated)
<S> <C> <C> <C> <C>
Net sales .............................................. $370,591 $371,293 $736,338 $733,982
Cost of sales .......................................... 198,800 159,032 414,912 318,593
-------- -------- -------- --------
Gross profit ...................................... 171,791 212,261 321,426 415,389
-------- -------- -------- --------
Operating expenses:
Research and development .......................... 53,941 44,415 108,150 88,032
Selling, general and administrative ............... 112,819 85,412 219,605 166,327
Special charges.................................... -- -- 150,000 --
-------- -------- -------- --------
Total operating expenses ..................... 166,760 129,827 477,755 254,359
-------- -------- -------- --------
Income (loss) from operations ................ 5,031 82,434 (156,329) 161,030
Interest income ........................................ 4,081 4,819 7,920 9,620
-------- -------- -------- ---------
Income (loss) before income taxes ............ 9,112 87,253 (148,409) 170,650
Income tax expense (benefit)............................ 2,718 29,666 (234) 58,193
-------- -------- -------- --------
Net income (loss) ...................................... $ 6,394 $ 57,587 ($148,175) $112,457
======== ======== ======== ========
Net income (loss) per share - basic .................. $ 0.04 $ 0.37 ($ 0.90) $ 0.71
======== ======== ======== ========
Net income (loss) per share - diluted ................ $ 0.04 $ 0.36 ($ 0.90) $ 0.71
======== ======== ======== ========
Weighted average number of shares outstanding:
Basic 164,640 157,743 164,017 157,300
======== ======== ======== ========
Diluted 170,462 159,867 164,017 159,513
======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
CABLETRON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) (unaudited)
Six Months Ended
August 31,
1998 1997
---- ----
(Restated) (Restated)
Cash flows from operating activities:
Net income (loss) ............................... ($148,175) $ 112,457
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating
activities:
Depreciation and amortization ............... 44,557 34,845
Provision for losses on accounts receivable . 2,285 (1,202)
Deferred taxes .............................. (7,439) (10,255)
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 .............................. 44,244 (71,008)
Prepaid expenses and other assets ........ (14,728) (6,533)
Accounts payable and accrued expenses .... (52,397) 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
========= =========
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 revised.
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. Certain amounts in the consolidated
financial statements and notes thereto have been reclassified to conform to
current classifications. 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).
Based on a letter received from the SEC, prior to filing its original Form 10-Q
for the quarter ended August 31, 1998 on October 16, 1998, the Company
determined to reclassify $13.6 million of special charges to cost of sales,
recorded in its acquisition of Yago Systems, Inc. associated with the
elimination and phase out of superseded product lines, in the first quarter of
fiscal 1999. As a result, the Company's original Form 10-Q filed for the quarter
ended August 31, 1998, included the $13.6 million in cost of sales for the six
months ended August 31, 1998. Based on subsequent correspondence with the SEC,
the Company agreed to record this charge upon disposal of the inventory. The
Company identified that by August 31, 1998, only $7.4 million of the inventory
described above had been disposed of ($3.6 million in the first quarter and $3.8
million in the second quarter) resulting in $6.2 million to be disposed of in
future quarters. The impact for the quarter ended August 31, 1998 was an
increase to cost of sales of $3.8 million and increased tax benefit of $1.5
million, to reflect the amount of the disposals related to Yago inventory during
the quarter. The impact on the six months ended August 31, 1998 is a decrease to
cost of sales by $6.2 million and an increase to tax expense of $2.4 million.
The Company also reduced the amount of its charge for in-process research and
development, recorded in the fourth quarter of 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 August 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 impact on the six months ended August 31, 1998 was
increased SG&A of $8.6 million and increased tax benefit of $3.4 million.
<PAGE>
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 and six months ended August 31, 1998, the impact was reflected in
the results of the quarter and six months ended August 31, 1998, in the original
Form 10-Q.
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. This change had no impact on the financial
results of the quarter ended August 31, 1997, however, cost of sales and tax
benefit for the six months ended August 31, 1997 increased by $6.0 million and
$2.0 million, respectively.
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 selling, general and administrative expenses 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 three and six months ended August 31,
1998 and 1997.
The following is a summary of the effects of the restatements and
reclassifications on net income (loss):
<TABLE>
<CAPTION>
Three months ended Six Months Ended
August 31, August 31,
<S> <C> <C> <C> <C>
(in thousands, except per share data) 1998 1997 1998 1997
---- ---- ---- ----
Net income (loss), as originally reported $ 11,343 $ 57,587 $(146,707) $116,411
Decrease to cost of sales associated with the
acquisition of Yago for costs to be incurred
in future quarters, net of tax expense of
$2.4 million --- --- 3,788 ---
Increase in amortization charges, related to the
acquisition of DNPG, of intangible assets,
net of tax benefit of $1.7 million and
$3.4 million, respectively (2,628) --- (5,256) ---
Recognition of inventory obsolescence, upon
disposal of inventory, related to the
acquisition of Yago, net of tax benefit
of $1.5 million (2,321) --- --- ---
Recognition of inventory obsolescence, upon
disposal of inventory, related to the
acquisition of ZeitNet, net of tax benefit
of $2.0 million --- --- --- (3,954)
--------- -------- ---------- ---------
Net income (loss), as restated $ 6,394 $ 57,587 $(148,175) $112,457
========= ======== ========== =========
Net income (loss) per share - basic,
as originally reported $0.07 $0.37 ($0.89) $0.74
======= ===== ======= =====
Net income (loss) per share - diluted,
as originally reported $0.07 $0.36 ($0.89) $0.73
======= ===== ======= =====
Net income (loss) per share - basic,
as restated $0.04 $0.37 ($1.40) $0.84
======= ===== ======= =====
Net income (loss) per share - diluted,
as restated $0.04 $0.36 ($1.40) $0.83
======= ===== ======= =====
</TABLE>
<PAGE>
The effect of the restatement on the consolidated balance sheet as of August 31,
1998 is as follows:
<TABLE>
<CAPTION>
(in thousands) As Originally As
Reported Restated
------------- --------
<S> <C> <C>
Inventory $ 258,716 $ 264,916
Deferred income taxes 71,996 33,444
Prepaid expenses and other assets 109,295 102,575
Total current assets 960,060 920,988
Intangible assets 49,845 165,850
Total assets 1,569,136 1,657,576
Accrued expenses 220,559 217,690
Current liabilities 537,364 534,495
Long-term deferred income taxes --- 17,596
Total liabilities 537,364 552,091
Retained earnings 559,991 633,704
Total stockholders' equity 1,031,772 1,105,485
Total liabilities and stockholders' equity $1,569,136 $1,657,576
</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 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.
In June 1998, the FASB issued Financial Accounting Standard No. 133, "Accounting
for Derivative Instruments and Hedging Activities (SFAS 133)." This Statement
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, 2001. Management believes that this Statement will not have a
significant impact on the Company.
3. Inventories
Inventories consist of:
(in thousands) August 31, February 28,
1998 1998
--------- -----------
Raw materials $ 65,107 $ 70,415
Work in process 11,917 24,521
Finished goods 187,892 214,731
-------- --------
Total inventories $264,916 $309,667
======== ========
<PAGE>
4. 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>
Net income (loss) ......................... $ 6,394 $ 57,587 ($148,175) $112,457
======== ======== ========= ========
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 ....... $ 0.04 $ 0.37 ($ 0.90) $ 0.71
======== ======== ======== =======
Net income (loss) per share - diluted ..... $ 0.04 $ 0.36 ($ 0.90) $ 0.71
======== ======== ======== =======
</TABLE>
5. Comprehensive Income
The Company's total of comprehensive income (loss) was as follows:
(in thousands)
<TABLE>
<CAPTION>
Three months ended Six months ended
August 31, August 31,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) $ 6,394 $57,587 ($148,175) $112,457
Other comprehensive income:
Foreign currency translation
adjustment 716 94 2,064 (39)
-------- ------- ---------- --------
Total comprehensive income (loss) $ 7,110 $57,681 ($146,111) $112,418
======== ======= ========== ========
</TABLE>
6. 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 the estimated
fair value of net assets acquired 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.
<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 46.4% 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 32.1% to $112.8 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 $9.1 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 43.7 percent compared to 56.6 percent for the six months ended August
31, 1997.
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 $219.6
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 29.8 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 $148.4 million represented a decrease from income
before income taxes of $170.7 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 $264.9 million, or 120 days of inventory,
compared to $309.7 million, or 157 days of inventory at the end of the prior
fiscal year. Inventory turnover was 3.0 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 $534.5 million compared to $452.4
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.
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.
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.
<PAGE>
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.
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.
<PAGE>
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.
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.
<PAGE>
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.
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.
<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] Exhibit 11.1 Extracted Financial Data Schedule
[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)
July 20, 1999 /s/ Piyush Patel
- ------------- ---------------
Date Piyush Patel
Chairman, President, and
Chief Executive Officer
July 20, 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 ---
<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 August 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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