UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 2
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
Commission File Number: 000-23774
ASCEND COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3092033
- ------------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1701 Harbor Bay Parkway, Alameda, CA 94502
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (510) 769-6001
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 Par Value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of December 31, 1997 the approximate aggregate market value of voting
stock held by non-affiliates of the Registrant was $4,320,434,003 (based
upon the closing price for shares of the Registrant's Common Stock as
reported by the Nasdaq National Market on that date). Shares of Common
Stock held by each officer, director and holder of 5% or more of the
outstanding Common Stock have been excluded in that such persons may be
deemed to be affiliates. The determination of affiliate status is not
necessarily a conclusive determination for other purposes.
As of February 28, 1998, 191,906,397 shares of the Registrant's Common
Stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual stockholders meeting to be
held on May 21, 1998 are incorporated by reference into Part III of this
Report on Form 10-K.
PORTIONS AMENDED
The Registrant hereby amends and restates Items 3 and 7 of this Report on
Form 10-K, and Footnotes 8 and 9 to the Registrant's Consolidated Financial
Statements set forth in this Report on Form 10-K, in each case as set forth
below.
ITEM 3. LEGAL PROCEEDINGS
The Company and various of its current and former officers and
directors are parties to a number of related lawsuits which purport to be
class actions filed on behalf of all persons who purchased or acquired the
Company's stock (excluding the defendants and parties related to them) for
the period November 5, 1996 to September 30, 1997. The lawsuits, which are
substantially identical, allege that the defendants violated the federal
securities laws by engaging in a scheme to artificially inflate and
maintain the Company's stock price by disseminating materially false and
misleading information concerning its business and earnings and the
development, efficiency, introduction and deployment of its digital modems
based on 56K-bps technology.
All of these actions are in the early stages of proceedings and the
Company is currently investigating the allegations. Based on its current
information, the Company believes the suits to be without merit and intends
to defend itself and its officers and directors vigorously. Although it is
reasonably possible the Company may incur a loss upon the conclusion of
these claims, an estimate of any loss or range of loss cannot be made. No
provision for any liability that may result upon adjudication has been made
in the Company's consolidated financial statements. In the opinion of
management, resolution of this matter is not expected to have a material
adverse effect on the financial position of the Company. However, depending
on the amount and timing, an unfavorable resolution of this matter could
materially affect the Company's future results or cash flows in a
particular period. In connection with these legal proceedings, the Company
expects to incur substantial legal and other expenses. Shareholder suits of
this kind are highly complex and can extend for a protracted period of
time, which can substantially increase the cost of such litigation and
divert the attention of the Company's management.
On April 16, 1997, a civil action was filed against Sahara, its three
founders and ten employees of Sahara by General Datacomm Industries, Inc.
in the Superior Court for the State of Connecticut. The complaint alleges
several causes of action, including: breach of contract; tortious
interference with contractual relations; misappropriation of trade secrets;
unfair competition and violation of the Connecticut Unfair Trade Practices
Act. The plaintiff seeks relief of unspecified monetary damages, costs and
injunctive relief. The Company has not yet engaged in substantive discovery
and the ultimate outcome of this matter cannot yet be determined. The
Company plans to vigorously defend this lawsuit. No provision for any
liability that may result from the action has been recognized in the
consolidated financial statements. In the opinion of management, resolution
of this litigation is not expected to have a material adverse effect on the
financial position of the Company. However, depending on the amount and
timing, an unfavorable resolution of this matter could materially affect
the Company's future results or cash flows in a particular period.
On April 18, 1997, the Company received a claim and request for
royalties alleging patent infringement on four separate patents.
Subsequently, the claim and request for royalties was amended to include
four additional patents. The Company is currently investigating the claims
of such infringement and thus the ultimate outcome of this claim cannot yet
be determined. Although it is reasonably possible the Company may incur a
loss upon the conclusion of these claims, an estimate of any loss or range
of loss cannot be made. No provision for any liability that may result from
the claim has been recognized in the consolidated financial statements. In
the opinion of management, resolution of this matter is not expected to
have a material adverse effect on the financial position of the Company.
However, depending on the amount and timing, an unfavorable resolution of
this matter could materially affect the Company's future results or cash
flows in a particular period.
The Company is a party as a defendant in various other lawsuits,
contractual disputes and other legal claims arising in the ordinary course
of business, the results of which are not presently determinable. Although
it is reasonably possible the Company may incur a loss upon the conclusion
of these claims, an estimate of any loss or range of loss cannot be made.
No provision for any liability that may result from these claims has been
recognized in the consolidated financial statements. However, in the
opinion of management, after consultation with legal counsel, the amount of
losses that might be sustained, if any, from these lawsuits would not
materially affect the Company's financial position. However, depending on
the amount and timing, an unfavorable resolution of some or all of these
matters could materially affect the Company's future results of operations
or cash flows in a particular period.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Ascend Communications, Inc. (the "Company") develops, manufactures
and sells wide area networking solutions for telecommunications carriers,
Internet service providers and corporate customers worldwide that enable
them to build: (i) Internet access systems consisting of point-of-presence
termination ("POP") equipment for Internet service providers ("ISPs") and
remote site Internet access equipment for Internet subscribers; (ii)
telecommunications carrier and ISP backbone networks utilizing high speed
Frame Relay, Asynchronous Transfer Mode ("ATM") and Internet Protocol
("IP") switches for application; (iii) extensions and enhancements to
corporate backbone networks that facilitate access to these networks by
remote offices, telecommuters and mobile computer users; and (iv)
videoconferencing and multimedia access facilities. The Company's products
support existing digital and analog networks.
The Company acquired four companies in the year ended December 31,
1997. In February 1997, the Company purchased InterCon Systems Corporation
("InterCon"), a leading developer of remote access client software products
for both corporate and ISP markets. On April 1, 1997, the Company acquired
Whitetree, Inc. ("Whitetree"), a developer and manufacturer of high speed
ATM switching products. On June 30, 1997, the Company acquired Cascade
Communications Corp. ("Cascade"), a leading developer and manufacturer of
carrier class Frame Relay, ATM and IP switching products. In January 1997,
Cascade acquired Sahara Networks, Inc. ("Sahara"), a privately held
developer of scaleable high-speed broadband access products (See Note 8 to
the Financial Statements).
Results of Operations
The following table sets forth for the periods indicated the
percentage of net sales represented by certain line items from the
Company's consolidated statements of operations:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- -------
<S> <C> <C> <C>
Net sales................................... 100 % 100 % 100
Cost of sales............................... 35 35 35
------- ------ ------
Gross profit............................. 65 65 65
Operating expenses:
Research and development................. 14 10 13
Sales and marketing...................... 21 18 20
General and administrative............... 3 3 6
Purchased research and development....... 20 - -
Costs of mergers......................... 13 2 -
------- ------ ------
Total operating expenses.............. 71 33 39
------- ------ ------
Operating income (loss)..................... (6) 32 26
Interest income............................. 2 2 3
------- ------ ------
Income (loss) before income taxes........... (4) 34 29
Provision for income taxes.................. 7 13 11
------- ------ ------
Net income (loss)........................... (11) % 21 % 18%
======= ====== ======
</TABLE>
Years Ended December 31, 1997, 1996 and 1995
Net Sales. Net sales for 1997 increased 31% to $1.167 billion as
compared to $890.3 million in 1996, which increased 210% from $287.4
million in 1995. International sales (sales outside of North America)
increased to $362.3 million in 1997 as compared to $313.3 million in 1996
and to $65.5 million in 1995 and accounted for 31%, 35% and 23% of net
sales in 1997, 1996 and 1995, respectively. Substantially all of the
increase in sales in each period was attributable to increases in unit
shipments of the Company's products. In the aggregate, average selling
prices and gross margins for the Company's products were relatively
constant for each period. Decreases in average selling prices for products
of the Enterprise Access business unit were offset by increases in average
selling prices for products of the Access Switching business unit, due
primarily to the release of the higher priced MAX TNT product during the
fourth quarter of 1996.
The following table provides a breakdown of net sales by business
unit as a percentage of total Company net sales for 1997, 1996 and 1995,
respectively:
YEAR ENDED DECEMBER 31,
-----------------------
BUSINESS UNIT 1997 1996 1995
- ---------------------------- ------ ------ -------
Access Switching............ 52% 48% 28%
Core Systems................ 35 36 46
Enterprise Access........... 9 13 22
Other....................... 4 3 4
--- --- ---
Total Company............ 100% 100% 100%
=== === ===
Access Switching - The Access Switching business unit offers of the
MAX family of products. MAX products accounted for 52%, 48% and 28% of
total Company net sales for 1997, 1996 and 1995, respectively. The increase
in unit shipments of MAX products was primarily attributable to the growth
in business from ISPs and increased demand for corporate remote networking
applications.
Core Systems - The Core Systems business unit offers of the B-STDX
family of Frame Relay switches, the CBX500 family of ATM switches and the
GRF family of Internet Protocol ("IP") switches. Core Systems products
accounted for 35%, 36% and 46% of total Company net sales for 1997, 1996
and 1995, respectively. The decline in Core Systems sales as a percent of
net sales was primarily attributable to the increase in the sales of the
MAX family of products.
Enterprise Access - The Enterprise Access business unit offers the
Pipeline family remote access equipment as well as the Multiband MAX family
of inverse multiplexing equipment. Enterprise Access products accounted for
9%, 13% and 22% of total Company net sales for 1997, 1996 and 1995,
respectively. The decline of Enterprise Access net sales as a percent of
total Company net sales was primarily attributable to the increase in the
sales of the MAX family of products and price reductions of the Pipeline
products due to increased competition.
Gross Margin. Gross margin was 65% for 1997, 1996 and 1995. In the
past, gross margins have been affected by the mix of products sold and the
mix of distribution channels used by the Company. In the future, the
Company's gross margin may be affected by several factors, including the
mix of products sold, the price of products sold, the introduction of new
products with lower gross margins, the distribution channels used, price
competition, increases in material costs and changes in other components of
cost of sales.
Research and Development. Research and development expenses increased
to $156.0 million in 1997 compared to $93.7 million in 1996 and $36.1
million in 1995. These increases were primarily due to the addition of
engineering personnel, payments for consulting services in connection with
developing and enhancing the Company's existing and new products and
payments for consulting services related to filing applications and product
testing required to obtain governmental approvals to resell the Company's
products outside of North America. In 1997, research and development
expenses increased in part through the addition of engineering personnel as
a result of the Company's mergers and acquisitions. Research and
development expenses as a percent of net sales increased to 14% in 1997
from 10% in 1996 which decreased from 13% in 1995. The Company expects that
spending for research and development will increase in absolute dollars in
1998 but may continue to vary as a percentage of net sales.
Sales and Marketing. Sales and marketing expenses were $249.1
million, $156.3 million and $56.0 million for 1997, 1996 and 1995,
respectively. These increases in expenses were primarily due to the
addition of sales, marketing and technical support personnel and related
commissions; expenditures for demonstration and loaner equipment used by
customers; and expenses associated with opening additional sales offices in
North America, Europe and Asia and the Pacific Basin. For 1997,
approximately 35%, 20% and 45% of the total increase in sales and marketing
expenses were attributable to each of the factors listed above,
respectively. For 1996, approximately 65%, 10% and 25% of the total
increase in sales and marketing expenses were attributable to each of the
factors listed above, respectively. The growth in sales, marketing and
technical support personnel was primarily due to the need to manage the
activities of an increased number of value-added resellers, distributors,
and end-user customers and to the introduction of several new products.
Sales and marketing expenses as a percent of net sales increased to 21% in
1997 from 18% in 1996 which decreased from 20% in 1995. The Company expects
that sales and marketing expenses will increase in absolute dollars in 1998
and may continue to vary as a percentage of net sales.
General and Administrative. General and administrative expenses
increased to $35.3 million in 1997 as compared to $29.9 million in 1996 and
$16.1 million in 1995. These increases were primarily due to the addition
of finance and administrative personnel, bonus compensation paid to the
Company's employees, increased costs for insurance and contract personnel
associated with information systems service and support, and increased
costs associated with being a public company. General and administrative
expenses as a percent of net sales were 3% in 1997 and 1996 as compared to
6% in 1995. The Company expects that spending for general and
administrative activities will increase in absolute dollars in 1998 and may
continue to vary as a percentage of net sales.
Purchased Research and Development. Purchased research and
development costs were $231.1 million for 1997. These costs were for the
purchase of technology and related assets associated with the acquisitions
of InterCon and Sahara during the first quarter of 1997. These acquisitions
provide technology and expertise that the Company is using to enhance and
expand the breadth of its offerings to end-user markets.
Sahara was a developer of scaleable high speed broadband access
products based in Wallingford, Connecticut. Sahara was founded in August
1995, and as of the valuation date of January 1997 had no commercially
available products. Sahara was focused on developing broadband access
solutions to support a wide variety of service types and interfaces,
removing the requirement for multiple non-integrated switching and
transmission elements.
Communications providers are currently facing a diverse set of
network technologies. Leased lines use time division multiplexing. Frame
relay is based on frame switching, ATM uses cell relay, and the Internet
typically employs routers. There is no single technology that supports all
of the services in a provider's portfolio. Sahara management is convinced
that broadband access solutions are needed to support a wide variety of
service types and interfaces. Sahara's technology was intended to develop a
cost effective access system that is designed specifically for broadband
networking, is scaleable to meet growing demand and meets the highest
levels of reliability.
Sahara's management plans to embed broadband access technology in
three products: the SA-100 Broadband Service Unit, the SA-600 Broadband
Service Concentrator and the SA- 1200 Service Access Multiplexer
(collectively referred to as the "SA family of products"). These three
products will use interchangeable hardware and software components. In
management's opinion, the SA family of products will have the power and
scaleablility to address the needs of a range of requirements. The design
of the products is intended to allow the ability to easily customize and
upgrade the system to meet the needs of this high growth market. Sahara has
had no product revenues over its existence and was a development stage
enterprise at the date of acquisition.
A fair value of $213.0 million was assigned to the Broadband Access
technology. At the time of the valuation, management anticipated costs of
approximately $4.2 million to complete the technology with completion and
achievement of technological feasibility anticipated in the second calendar
quarter of 1997, facilitating product release dates for the SA family of
products during the second and third quarters of 1997. Material risks
affecting timely completion and commercialization included successful
integration of hardware and software designs, successful product testing,
and achievement of operating performance requirements of regional Bell
operating companies whom management expected to be significant customers of
the Broadband Access Technology products. In addition, the revenue
projections were based on assumptions for the total market for Broadband
Access products, which is a relatively new market. To the extent that the
market demand for Broadband Access products is lower than anticipated, the
revenue assumptions for the products based on the Broadband Access
technology will be affected, irrespective of the success of the Company's
development efforts.
As of the date of this filing, management continues to believe that
the overall market for Broadband Access products will be a significant
growth market. However, the adoption of Broadband Access Technology by the
Company's customers has not occurred as rapidly as originally anticipated.
In addition, the Company's development efforts have encountered certain
delays. As a result, the first product based on the Broadband Access
Technology was not released until the fourth quarter of 1997, and
significant revenues from the products developed from the Broadband Access
Technology are not expected until 1999.
Cost of Mergers. For the year ended December 31, 1997, the Company
charged to operations one-time merger costs of approximately $150.3
million. These costs principally related to the acquisitions of Cascade and
Whitetree and consist primarily of merger transaction costs and accruals
for redundant assets, redundant products, fees relating to the cancellation
of certain obligations and employee severance packages. The total charge
included $54.1 million relating to merger transaction costs and $96.2
million of integration expenses. Included in merger transaction costs are
the following amounts: (1) $48.9 million for investment banking, legal and
accounting costs, (2) $2.3 million of printing and distribution costs, and
(3) $2.9 million for other miscellaneous costs. Included in integration
expenses are the following amounts: (1) $7.2 million for severance and
outplacement costs for employees involved in duplicate functions, including
manufacturing and logistics, sales and marketing, and finance and
administration, (2) $67.4 million for assets relating to duplicate product
lines, and (3) $21.6 million relating to the cancellation of redundant
facility leases and other contracts and obligations. In conjunction with
the acquisitions of Cascade and Whitetree, certain duplicate functions were
eliminated over transition periods ranging from two months to one year.
These functions consisted primarily of employees involved in general
corporate functions, including finance, human resources, information
technology, sales and corporate marketing. In addition, manufacturing
positions relating to discontinued products were also eliminated. The
discontinued product lines consisted of the Arris family of remote access
concentrator products acquired from Cascade, and the entire product line of
Whitetree ATM switches. These product lines were eliminated and related and
certain other redundant assets were immediately abandoned upon the closing
of the mergers, as the Arris family of products was redundant with the
Ascend MAX TNT product, and management believed that the market opportunity
addressed by the Whitetree products was limited. Termination benefits
actually paid to 267 employees through December 31, 1997 were $6.7 million,
with the remaining balance expected to be paid during the first quarter of
1998.
Facilities that were eliminated in conjunction with acquisitions of
Cascade and Whitetree included the corporate headquarters facility for
Cascade in Westford, Massachusetts, a previously planned facility expansion
for the broadband access division of Cascade, and various duplicate sales
and service offices, including those in McClean, Virginia; Schaumburg,
Illinois; Dallas, Texas; White Plains, New York; and Redwood City,
California.
The $67.4 million charge for assets relating to redundant assets and
duplicate product lines consists of the following major components: (1)
$29.0 million related to fixed assets, evaluation inventory and internal
systems, (2) $13.0 million for inventory relating to discontinued products,
(3) $12.9 million to reserve accounts receivable relating to discontinued
products, (4) $10.0 million for warranty obligations relating to
discontinued products and other merger related product issues, and (5) $2.5
million for other valuation reserves. The $21.6 million reserved for the
cancellation of redundant facility leases and other contracts consists of
the following major components: (1) $13.6 million for purchase commitments
related to discontinued products, (2) $6.4 million for redundant
facilities, and (3) $1.6 million for other non-cancellable commitments.
The following summarizes merger related accrual activity for the year
ended December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
CASH EXPENDITURES NON-CASH ACTIVITY
------------------------------------------ -----------------
CANCELLATION
OF FACILITY ASSETS
MERGER SEVERANCE LEASES AND ASSOCIATED
TRANSACTION AND OTHER WITH DUPLICATE
COSTS OUT-PLACEMENT CONTRACTS PRODUCT LINES TOTAL
----------- ------------- ------------ ---------------- -----
<S> <C> <C> <C> <C> <C>
6/30/97 Balance $ 54,148 $ 7,200 $ 21,558 $ 67,365 $150,271
Cash Payments (48,073) (6,712) (6,180) - (60,965)
Asset Writeoffs - - - (56,992) (56,992)
12/31/97
--------- -------- -------- --------- --------
Balance $ 6,075 $ 488 $ 15,378 $ 10,373 $ 32,314
========= ======== ======== ========= ========
</TABLE>
The remaining portion of the merger related accruals at December 31,
1997 was approximately $32.3 million. Total expected cash expenditures for
the mergers were estimated to be approximately $82.9 million, of which
approximately $61.0 million was disbursed prior to December 31, 1997.
Termination benefits paid to 267 employees through December 31, 1997 were
$6.7 million, with the remaining balance expected to be paid during the
first quarter of 1998.
For the year ended December 31, 1996, the Company charged to
operations one-time merger costs of approximately $13.9 million. These
costs principally related to the acquisitions of NetStar, Inc. and
StonyBrook Services, Inc. during 1996 and consisted primarily of investment
banking fees, professional fees and other direct costs associated with the
acquisitions.
Interest Income. Interest income increased to $23.0 million in 1997
compared to $17.2 million in 1996 and $8.4 million in 1995. The increase in
interest income during 1997 and 1996 is due primarily to the investment of
proceeds from the Company's public offering of its common stock which was
completed in August 1995, proceeds from the exercise of stock options and
issuance of common stock in connection with the Company's employee and
outside director stock plans and cash from operations.
Provision for Income Taxes. The provision for income taxes for 1997
was $79.4 million compared to $118.1 million for 1996 and $32.8 million in
1995. The Company's tax expense for 1997 was impacted by non-deductible
costs associated with the acquisitions of Cascade and Whitetree and
approximately $213.1 million of non-deductible purchased research and
development costs associated with the acquisition of Sahara. Exclusive of
the effects of these non-deductible one-time charges, the Company's
effective tax rate for 1997 was 37.3%, which approximates the effective
statutory federal and state income tax rates adjusted for the impact of tax
exempt interest and the benefits associated with the Company's Foreign
Sales Corporation. Exclusive of the effects of non-deductible one-time
charges, the Company's effective tax rate was 38.2% for both 1996 and 1995.
Liquidity and Capital Resources
At December 31, 1997, the Company's principal sources of liquidity
included $576.6 million of cash and cash equivalents, short-term
investments and investments and an unsecured $25.0 million revolving line
of credit which expires in June 1999. There were no borrowings or amounts
outstanding under the line of credit as of December 31, 1997. The decrease
in cash and cash equivalents of $71.6 million for 1997 was principally due
to $246.0 million of cash used in investing activities, offset by $109.3
million of cash provided by financing activities and $65.1 million of cash
provided by operations. The net cash provided by operating activities for
1997 was primarily due to net loss, adjusted for the effects of purchased
research and development, costs of mergers and depreciation, offset by
decreases in accounts payable and accrued liabilities and by increases in
accounts receivable and inventories.
Net cash used in investing activities of $246.0 million for 1997
related primarily to net purchases of investments of $127.0 million and
expenditures for furniture, fixtures and equipment of $105.3 million.
Financing activities provided $109.3 million for 1997, primarily due to
$109.1 million of proceeds from, and tax benefits related to, stock options
and issuance of common stock in connection with the Company's employee and
outside director stock plans.
At December 31, 1997, the Company had $745.9 million in working
capital. The Company currently has no significant capital commitments other
than commitments under facilities and operating leases. The Company
believes that its available sources of funds and anticipated cash flow from
operations will be adequate to finance current operations, anticipated
investments and capital expenditures for at least the next twelve months.
Factors that May Affect Future Results
The Company's quarterly and annual operating results are affected by
a wide variety of risks and uncertainties as discussed in the Company's
Registration Statement on Form S-4/A (No. 333-25287) filed on April 22,
1997 in connection with the acquisition of Cascade. This Report on Form
10-K should be read in conjunction with such Form S-4, particularly the
section entitled "Risk Factors". These risks and uncertainties include but
are not limited to competition, the mix of products sold, the mix of
distribution channels employed, the Company's success in developing,
introducing and shipping new products, the Company's ability to attract and
retain key employees, the Company's success in integrating acquired
operations, the Company's dependence on single or limited source suppliers
for certain components used in its products, price reductions for the
Company's products, risks inherent in international sales, changes in the
levels of inventory held by third-party resellers, the timing of orders
from and shipments to customers, seasonality and general economic
conditions.
In particular, a substantial portion of the Company's sales of MAX
and Pipeline products is related to the Internet industry. In North
America, the Company sells a substantial percentage of its products,
particularly its MAX products, to ISPs. Additionally, a substantial portion
of the Company's sales of core systems products is related to the
telecommunications carrier industry. In North America, the Company sells a
substantial percentage of the core systems products to public carriers.
There can be no assurance that these industries and their infrastructure
will continue to develop or that acceptance of the Company's products by
these industries will be sustained. The Company believes competition in the
Internet and public carrier industry will increase significantly in the
future and could adversely affect the Company's business, results of
operations and financial condition.
The Company has concluded the acquisition of four companies in 1997
and five companies in 1996. Achieving the anticipated benefits of these
acquisitions or any other acquisitions the Company may undertake will
depend in part upon whether the integration of the acquired companies'
products and technologies, research and development activities, and sales,
marketing and administrative organizations is accomplished in an efficient
and effective manner, and there can be no assurance that this will occur.
Moreover, the integration process may temporarily divert management
attention from the day-to-day business of the Company. Failure to
successfully accomplish the integration of the acquired companies could
have a material adverse effect on the Company's business, financial
condition and/or results of operations.
The Company expects that its gross margins could be adversely
affected in future periods by price changes as a result of increased
competition. In addition, increased sales of Pipeline products as a
percentage of net sales may adversely affect the Company's gross margins in
future periods as these products have lower gross margins than the
Company's other products. In addition, the Company's use of third parties
to distribute its products to other value-added resellers may adversely
affect the Company's gross margins.
The Company expects that international sales will continue to account
for a significant portion of the Company's net sales in future periods.
International sales are subject to certain inherent risks, including
unexpected changes in regulatory requirements and tariffs, difficulties in
staffing and managing foreign operations, longer payment cycles, problems
in collecting accounts receivable and potentially adverse tax consequences.
The Company depends on third party resellers for a substantial portion of
its international sales. Certain of these third party resellers also act as
resellers for competitors of the Company that can devote greater effort and
resources to marketing competitive products. The loss of certain of these
third party resellers could have a material adverse effect on the Company's
business and results of operations. Although the Company's sales are
denominated in U.S. dollars, fluctuations in currency exchange rates could
cause the Company's products to become relatively more expensive to
customers in a particular country, leading to a reduction in sales and
profitability in that country. Furthermore, future international activity
may result in foreign currency denominated sales, and, in such event, gains
and losses on the conversion to U.S. dollars of accounts receivable and
accounts payable arising from international operations may contribute to
fluctuations in the Company's results of operations. In addition, sales in
Europe and certain other parts of the world typically are adversely
affected in the third quarter of each calendar year as many customers
reduce their business activities during the summer months. These seasonal
factors may have an adverse effect on the Company's business, results of
operations and financial condition.
The Company typically operates with a relatively small backlog. As a
result, quarterly sales and operating results generally depend on the
volume of, timing of and ability to fulfill orders received within the
quarter, which are difficult to forecast. In the Company's most recent
quarters, the sequential sales growth slowed from prior levels, and a
disproportionate share of the sales occurred in the last month of the
quarter. These occurrences are extremely difficult to predict and may
happen in the future. The Company's ability to meet financial expectations
could be hampered if the nonlinear sales pattern continues in future
periods. Accordingly, the cancellation or delay of even a small percentage
of customer purchases could adversely affect the Company's results of
operations in the quarter. A significant portion of the Company's net sales
in prior periods has been derived from relatively large sales to a limited
number of customers, and therefore the failure of the Company to secure
expected large sales may have a material adverse impact on results of
operations. A significant portion of the Company's expense levels is
relatively fixed in advance based in large part on the Company's forecasts
of future sales. If sales are below expectations in any given quarter, the
adverse impact of the shortfall on the Company's operating results may be
magnified by the Company's inability to adjust spending to compensate for
the shortfall.
The market for the Company's products is characterized by rapidly
changing technologies, evolving industry standards, frequent new product
introductions and short product life cycles. The introduction of new
products requires the Company to manage the transition from older products
in order to minimize disruption in customer ordering patterns, avoid
excessive levels of older product inventories and ensure that adequate
supplies of new products can be delivered to meet customer demand.
Furthermore, products such as those offered by the Company may contain
undetected or unresolved hardware problems or software errors when they are
first introduced or as new versions are released. There can be no assurance
that, despite extensive testing by the Company, hardware problems or
software errors will not be found in new products after commencement of
commercial shipments, resulting in delay in or loss of market acceptance.
Future delays in the introduction or shipment of new or enhanced products,
the inability of such products to gain market acceptance or problems
associated with new product transitions could adversely affect the
Company's business, results of operations and financial condition.
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. This may result in spending being diverted from networking
solutions over the next three years. Additionally, the Company will have to
devote resources to providing the Year 2000 solution for its own products.
The Year 2000 issue could lower demand for the Company's products while
increasing the Company's costs. These combining factors could have a
material adverse impact on the Company's financial results.
The Company believes the majority of its major systems are currently
Year 2000 compliant, and costs to transition the Company's remaining
systems to Year 2000 compliance are not anticipated to be material. There
can be no assurance that systems operated by third parties that interfere
with or contain the Company's products will timely achieve Year 2000
compliance. Any failure of these third parties' systems to timely achieve
Year 2000 compliance could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company mainly competes in four segments of the data networking
market : (i) wide area network ("WAN") and Internet access, (ii) WAN and
Internet backbone switching, (iii) remote LAN access and Internet
subscriber access, and (iv) videoconferencing and multimedia access. The
Company competes in one or more of these market segments with Cisco
Systems, Inc., 3Com Corporation, Bay Networks, Inc., Newbridge Networks,
Inc., Shiva Corporation, Northern Telecom, Inc., and many others. Some of
these competitors have substantially greater financial, marketing and
technical resources than the Company. The Company expects additional
competition from existing competitors and from a number of other companies,
some of which may have substantially greater financial, marketing and
technical resources than the Company, that may enter the Company's existing
and future markets. Increased competition could result in price reductions,
reduced profit margins and loss of market share, each of which would
adversely affect the Company's business, results of operations and
financial condition.
The Company's sales are, to a significant degree, made through
telecommunications carriers, value-added resellers ("VARs") and
distributors. Accordingly, the Company is dependent on the continued
viability and financial stability of these companies. While the Company has
contractual relationships with many telecommunications carriers, VARs and
distributors, these agreements do not require these companies to purchase
the Company's products and can be terminated by these companies at any
time. There can be no assurance that any of the telecommunications
carriers, VARs or distributors will continue to market the Company's
products. The telecommunications carrier customers, to the extent they are
resellers, VARs and distributors, generally offer products of several
different companies, including products that are competitive with the
Company's products. Accordingly, there is a risk that these companies may
give higher priority to products of other suppliers, thus reducing their
efforts to sell the Company's products. Any special distribution
arrangement and product pricing arrangement that the Company may implement
in one or more distribution channels for strategic purposes could adversely
affect gross profit margins.
The Company's success depends to a significant degree upon the
continuing contributions of its key management, sales, marketing and
product development personnel. The Company does not have employment
contracts with its key personnel and does not maintain any key person life
insurance policies. The loss of key personnel could adversely affect the
Company.
The Company is currently experiencing rapid growth and expansion,
which has placed, and will continue to place, a significant strain on its
administrative, operational and financial resources and increased demands
on its systems and controls. This growth has resulted in a continuing
increase in the level of responsibility for both existing and new
management personnel. The Company anticipates that its continued growth
will require it to recruit and hire a substantial number of new
engineering, sales, marketing and managerial personnel. There can be no
assurance that the Company will be successful at hiring or retaining these
personnel. The Company's ability to manage its growth successfully will
also require the Company to continue to expand and improve its operational,
management and financial systems and controls and to expand its
manufacturing capacity. If the Company's management is unable to manage
growth effectively, the Company's business, results of operations and
financial condition may be materially and adversely affected.
The Company relies on a combination of patents, copyright, and trade
secret laws and non-disclosure agreements to protect its proprietary
technology. The Company is currently involved in patent disputes the
results of which are not presently determinable. Such disputes could result
in significant expenses to the Company and divert the efforts of the
Company's technical management personnel.
Although the Company generally uses standard parts and components for
its products, certain components, including certain key microprocessors and
integrated circuits, are presently available only from a single source or
from limited sources. The Company has no supply commitments from its
vendors and generally purchases components on a purchase order basis as
opposed to entering into long term procurement agreements with vendors. The
Company has generally been able to obtain adequate supplies of components
in a timely manner from current vendors or, when necessary to meet
production needs, from alternate vendors. The Company believes that, in
most cases, alternate vendors can be identified if current vendors are
unable to fulfill needs. However, delays or failure to identify alternate
vendors, if required, or a reduction or interruption in supply, or a
significant increase in the price of components could adversely affect the
Company's revenues and financial results and could impact customer
relations.
The Company's common stock has experienced significant price
volatility, and such volatility may occur in the future, particularly as a
result of quarter-to-quarter variations in the actual or anticipated
financial results of the Company or other companies in the networking
industry, announcements by the Company or competitors regarding new product
introductions or other developments affecting the Company and/or changes in
financial estimates by public market analysts. In addition, the market has
experienced extreme price and volume fluctuations that have affected the
market price of many technology companies' stocks and that have been
unrelated or disproportionate to the operating performance of these
companies. These broad market fluctuations may adversely affect the market
price of the Company's common stock. Recent periods of volatility in the
market price of a Company's securities resulted in securities class action
litigation against the Company and various officers and directors.
In consideration of these factors, there can be no assurance that the
Company will be able to sustain growth in revenues or profitability,
particularly on a period-to-period basis.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
8. Business Combinations
On June 30, 1997, the Company acquired Cascade, a developer and
manufacturer of wide area network switches, in a transaction that was
accounted for as a pooling of interests. The Company issued approximately
66.3 million shares of its common stock to Cascade stockholders in exchange
for all outstanding Cascade shares. Outstanding options to purchase Cascade
common stock were converted to options to purchase approximately 8.5
million shares of Ascend common stock. The historical consolidated
financial results of Ascend for prior periods have been restated to include
the financial position and results of operations of Cascade. The following
table shows the historical results of Ascend and Cascade for the periods
prior to the consummation of the merger of the two entities:
Three Months
Ended
March 31, Year Ended December 31,
--------- ------------------------
Revenue: 1997 1996 1995
--------- -------- --------
Ascend.................. $ 202,412 $549,297 $152,604
Cascade................. 90,328 340,976 134,834
--------- -------- --------
Total................. $ 292,740 $890,273 $287,438
========= ======== ========
- ---------------------------------------------------------------------
Net Income (loss):
Ascend.................. $ 35,093 $113,111 $ 27,535
Cascade................. (198,334) 70,779 25,410
--------- -------- --------
Total................. $(163,241) $183,890 $ 52,945
========= ======== ========
In February 1997, the Company acquired all of the outstanding stock
of InterCon Systems Corporation, a developer of remote access client
software products for both corporate and ISP markets, in a transaction that
was accounted for as a purchase. The purchase price consisted of a cash
payment of $12.0 million, the assumption of approximately $9.0 million of
liabilities and transaction costs of approximately $600,000. The total
purchase price of $21.6 million was allocated to the net assets acquired
based upon their estimated fair market value. The estimated fair value of
tangible net assets acquired was $600,000. In addition, $18.0 million of
the purchase price was allocated to purchased research and development that
had not reached technological feasibility and that had no alternative
future use, and $3.0 million was allocated to purchased software.
On April 1, 1997, the Company acquired Whitetree, Inc. ("Whitetree"),
a developer and manufacturer of high speed ATM switching products, in a
transaction that was accounted for as a pooling of interests. The Company
issued approximately 1.3 million shares of its common stock to Whitetree
shareholders in exchange for all outstanding Whitetree shares. In addition,
the Company assumed all outstanding Whitetree stock options to purchase
approximately 99,000 shares of the Company's stock. The results of
operations of Whitetree, which have not been material in relation to those
of the Company, are included in the consolidated results of operations for
periods subsequent to the acquisition. The Company's historical
consolidated financial statements prior to the combination have not been
restated to reflect the financial results of Whitetree as these results
were not material to the Company.
In conjunction with the acquisitions of Cascade and Whitetree, the
Company recorded one-time merger costs of approximately $150.3 million. The
total charge included $54.1 million relating to merger transaction costs
and $96.2 million of integration expenses. Included in integration expenses
are the following amounts: (1) $7.2 million for severance and outplacement
costs for approximately 275 employees involved in duplicate functions,
including manufacturing and logistics, sales and marketing, and finance and
administration, (2) $67.4 million for redundant assets and assets relating
to duplicate product lines, and (3) $21.6 million relating to the
cancellation of redundant facility leases and other contracts and
obligations.
In conjunction with the acquisitions of Cascade and Whitetree,
certain duplicate functions were eliminated over transition periods ranging
from two months to one year. These functions consisted primarily of
employees involved in general corporate functions, including finance, human
resources, information technology, sales and corporate marketing. In
addition, manufacturing positions relating to discontinued products were
also eliminated. The discontinued product lines consisted of the Arris
family of remote access concentrator products acquired from Cascade, and
the entire product line of Whitetree ATM switches. These product lines were
eliminated and related and certain other redundant assets were immediately
abandoned upon the closing of the mergers, as the Arris family of products
was redundant with the Ascend MAX TNT product, and management believed that
the market opportunity addressed by the Whitetree products was limited.
Termination benefits actually paid to 267 employees through December 31,
1997 were $6.7 million, with the remaining balance expected to be paid
during the first quarter of 1998.
Facilities that were eliminated in conjunction with acquisitions of
Cascade and Whitetree included the corporate headquarters facility for
Cascade in Westford, Massachusetts, a previously planned facility expansion
for the broadband access division of Cascade, and various duplicate sales
and service offices, including those in McClean, Virginia; Schaumburg,
Illinois; Dallas, Texas; White Plains, New York; and Redwood City,
California.
On January 28, 1997, Cascade completed its acquisition of Sahara
Networks, Inc. ("Sahara"), a privately held developer of scaleable
high-speed broadband access products, in a transaction that was accounted
for as a purchase. Cascade issued approximately 3.4 million shares of
Cascade common stock (or 2.4 million equivalent shares of the Company's
common stock after exchange ratio) in exchange for all the outstanding
shares of Sahara. In addition, Cascade assumed all outstanding Sahara stock
options to purchase approximately 400,000 shares of Cascade common stock.
The acquisition was accounted for under the purchase method of accounting.
Accordingly, the purchase price of approximately $219.0 million was
allocated to the net assets acquired based upon their estimated fair market
value. The purchase price includes $22.2 million for the fair market value
of the Sahara options assumed by Cascade. The fair value of the stock
options was determined using the Black-Scholes model. The estimated fair
value of the tangible net assets acquired was approximately $6.0 million.
In addition, approximately $213.0 million of the purchase price was
allocated to in-process research and development that had not reached
technological feasibility and that had no alternative future use.
Management is primarily responsible for estimating the fair value of
the purchased in-process research and development ("IPRD") obtained through
the acquisition of Sahara. At the date of acquisition, Sahara was a
development stage enterprise that had never introduced a product to market
or had any existing products that it was selling to customers. The
Broadband Access Technology acquired from Sahara was being developed to
provide communications providers with an enhanced access platform for a
diverse set of networking technologies. The Broadband Access Technology was
valued based on the income forecast method, which requires a projection of
revenues and expenses specifically attributable to the intangible assets.
The discounted cash flow technique was then applied to the potential income
streams after making necessary adjustments with respect to such factors as
the wasting nature of the acquired intangible assets, the allowance for a
fair return on the net tangible and other intangible assets employed, and
consideration of development cost and risk. The adjustments were made to
separate the value of the specific intangible asset being valued from the
portion of the purchase price that already has been allocated to the net
tangible and other intangible assets employed.
Significant assumptions that affected valuation of the Broadband
Access Technology of Sahara included revenue and cost of completion
assumptions as well as the timing of the product release. In addition, the
selection of an appropriate risk adjusted discount rate was a significant
assumption used in the valuation analysis. Since Sahara had no revenues
prior to the acquisition, the assumptions used in the valuation for
pricing, margins and expense levels were consistent with Cascade's
historical experience with similar types of products.
The revenue for the product categories based on the Broadband Access
Technology was a key variable to the analysis. Cascade management estimated
the revenue from the Broadband Access Technology in quarterly revenue
projections over the expected economic life of the technology once
completed. These projections reflected management's anticipated release
dates in the second and third calendar quarters of 1997 for the SA- 100,
SA-600 and SA-1200 product categories, all of which are expected to be
based on the Broadband Access Technology. Material net cash inflows from
the Broadband Access Technology were projected to commence in the first
quarter of 1998.
The costs of completion assumptions were based on cost analyses
provided by senior management responsible for development of the Broadband
Access Technology. Given the uncertainty of the development milestones, the
actual costs to complete could have been significantly higher or lower than
estimated depending on the relative success of the development team in
addressing the outstanding technological issues of the technology. The
expected timing of the product release directly affects the timing of the
revenue projections. Any miscalculation of the product release date could
affect the revenue projections. In addition, the revenue projections were
based on assumptions for the total market for Broadband Access products,
which is a relatively new market. To the extent that the market demand for
Broadband Access products is lower than anticipated, the revenue
assumptions for the products based on the Broadband Access technology will
be affected, irrespective of the success of the Company's development
efforts.
In estimating an appropriate discount rate for valuing IPRD,
management considered several factors. Among the factors considered were
the cost of capital for the target company, and the risk associated with
the IPRD project. Considering these factors, management selected a discount
rate of 25% which it believes to be consistent with the risks of the IPRD.
The Broadband Access Technology had not reached technological
feasibility at the time of the acquisition. Furthermore, management
concluded that no technologies were acquired which may have an alternative
use other than their original design purposes. At the time of acquisition,
Sahara had not completed its first product, and had no revenue to
date.
The projected development cost remaining for the Broadband Access
Technology project, at the time of the acquisition, to reach technological
feasibility was approximately $4.2 million. The continued development of
Broadband Access Technology following the acquisition was dependent upon
the successful and timely completion of various developmental milestones.
In August 1996, the Company acquired NetStar, a developer and
manufacturer of high performance, high speed IP network routers, in a
transaction that was accounted for as a pooling of interests. The Company
issued approximately 3.9 million shares of its common stock to NetStar
shareholders in exchange for all outstanding NetStar shares. The Company`s
historical consolidated financial statements for prior periods have been
restated to reflect the financial position and results of operations of
NetStar.
9. Litigation
The Company and various of its current and former officers and
directors are parties to a number of related lawsuits which purport to be
class actions filed on behalf of all persons who purchased or acquired the
Company's stock (excluding the defendants and parties related to them) for
the period November 5, 1996 to September 30, 1997. The lawsuits, which are
substantially identical, allege that the defendants violated the federal
securities laws by engaging in a scheme to artificially inflate and
maintain the Company's stock price by disseminating materially false and
misleading information concerning its business and earnings and the
development, efficiency, introduction and deployment of its digital modems
based on 56K-bps technology.
All of these actions are in the early stages of proceedings and the
Company is currently investigating the allegations. Based on its current
information, the Company believes the suits to be without merit and intends
to defend itself and its officers and directors vigorously. Although it is
reasonably possible the Company may incur a loss upon the conclusion of
these claims, an estimate of any loss or range of loss cannot be made. No
provision for any liability that may result upon adjudication has been made
in the Company's consolidated financial statements. In the opinion of
management, resolution of this matter is not expected to have a material
adverse effect on the financial position of the Company. However, depending
on the amount and timing, an unfavorable resolution of this matter could
materially affect the Company's future results or cash flows in a
particular period. In connection with these legal proceedings, the Company
expects to incur substantial legal and other expenses. Shareholder suits of
this kind are highly complex and can extend for a protracted period of
time, which can substantially increase the cost of such litigation and
divert the attention of the Company's management.
On April 16, 1997, a civil action was filed against Sahara, its three
founders and ten employees of Sahara by General Datacomm Industries, Inc.
in the Superior Court for the State of Connecticut. The complaint alleges
several causes of action, including: breach of contract; tortious
interference with contractual relations; misappropriation of trade secrets;
unfair competition and violation of the Connecticut Unfair Trade Practices
Act. The plaintiff seeks relief of unspecified monetary damages, costs and
injunctive relief. The Company has not yet engaged in substantive discovery
and the ultimate outcome of this matter cannot yet be determined. The
Company plans to vigorously defend this lawsuit. No provision for any
liability that may result from the action has been recognized in the
consolidated financial statements. In the opinion of management, resolution
of this litigation is not expected to have a material adverse effect on the
financial position of the Company. However, depending on the amount and
timing, an unfavorable resolution of this matter could materially affect
the Company's future results or cash flows in a particular period.
On April 18, 1997, the Company received a claim and request for
royalties alleging patent infringement on four separate patents.
Subsequently, the claim and request for royalties was amended to include
four additional patents. The Company is currently investigating the claims
of such infringement and thus the ultimate outcome of this claim cannot yet
be determined. Although it is reasonably possible the Company may incur a
loss upon the conclusion of these claims, an estimate of any loss or range
of loss cannot be made. No provision for any liability that may result from
the claim has been recognized in the consolidated financial statements. In
the opinion of management, resolution of this matter is not expected to
have a material adverse effect on the financial position of the Company.
However, depending on the amount and timing, an unfavorable resolution of
this matter could materially affect the Company's future results or cash
flows in a particular period.
The Company is a party as a defendant in various other lawsuits,
contractual disputes and other legal claims arising in the ordinary course
of business, the results of which are not presently determinable. Although
it is reasonably possible the Company may incur a loss upon the conclusion
of these claims, an estimate of any loss or range of loss cannot be made.
No provision for any liability that may result from these claims has been
recognized in the consolidated financial statements. However, in the
opinion of management, after consultation with legal counsel, the amount of
losses that might be sustained, if any, from these lawsuits would not
materially affect the Company's financial position. However, depending on
the amount and timing, an unfavorable resolution of some or all of these
matters could materially affect the Company's future results of operations
or cash flows in a particular period.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
ASCEND COMMUNICATIONS, INC.
DATE May 19, 1999 by /s/ Mory Ejabat
-------------- ---------------------------------------
Mory Ejabat, President, Chief Executive
Officer and Director
