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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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
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(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, 1998 the approximate aggregate market value of voting stock
held by non-affiliates of the Registrant was $11,672,400,250 (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, 1999, 222,250,267 shares of the Registrant's common stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Not applicable.
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ASCEND COMMUNICATIONS, INC.
FORM 10-K
TABLE OF CONTENTS
<TABLE>
<S> <C> <C> <C>
Part I:
ITEM 1. Business 3
ITEM 2. Properties 10
ITEM 3. Legal Proceedings 10
ITEM 4. Submission of Matters to a Vote of Security Holders 12
Part II:
ITEM 5. Market for the Registrant's Common Equity 13
and Related Stockholder Matters
ITEM 6. Selected Financial Data 14
ITEM 7. Management's Discussion and Analysis of Financial 15
Condition and Results of Operations
ITEM 7A. Quantitative and Qualitative Disclosures About 25
Market Risk
ITEM 8. Financial Statements and Supplementary Data 27
ITEM 9. Changes in and Disagreements with Accountants on 49
Accounting and Financial Disclosure
Part III:
ITEM 10. Directors and Executive Officers of the Registrant 49
ITEM 11. Executive Compensation 53
ITEM 12. Security Ownership of Certain Beneficial Owners 57
and Management
ITEM 13. Certain Relationships and Related Transactions 59
Part IV:
ITEM 14. Exhibits, Financial Statement Schedules, and 60
Reports on Form 8-K
Signatures 64
</TABLE>
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This report on Form 10-K contains forward-looking statements which reflect the
current views of the Company with respect to future events that will have an
effect on its future financial performance. These statements include the words
"expects", "believes", "anticipates", and similar expressions. These forward-
looking statements are subject to various risks and uncertainties, including
without limitation those referred to under "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Factors Which May Affect
Future Results" and elsewhere herein, that could cause actual future results to
differ materially from historical results or those currently anticipated.
Readers are cautioned not to place undue reliance on these forward-looking
statements.
PART I
ITEM 1. BUSINESS
Ascend Communications, Inc. ("Ascend" or the "Company") develops, manufactures
and sells wide area networking solutions for telecommunications carriers,
Internet service providers ("ISPs") and corporate customers worldwide which
enable them to build: (i) Internet access systems consisting of point-of-
presence termination ("POP") equipment for 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; (iii) extensions and enhancements
to corporate backbone networks that facilitate access by remote offices,
telecommuters and mobile computer users; (iv) non-stop computing platforms and
Intelligent Networking ("IN") solutions for enhanced voice services in telephony
networks; and (v) videoconferencing and multimedia access solutions. The
Company's products support existing digital and analog networks.
In January 1999, the Company entered into an Agreement and Plan of Merger (the
"Merger Agreement") with Lucent Technologies Inc. ("Lucent"), pursuant to which
each outstanding share of Ascend common stock will be exchanged for 0.825 shares
of Lucent common stock, and each outstanding option or warrant to purchase
Ascend common stock will be converted into an option or warrant to purchase a
number of shares of Lucent common stock equal to the number of shares of Ascend
common stock subject to each option multiplied by the exchange ratio. The
merger is expected to be accounted for as a pooling of interests, is subject to
stockholder approval and standard regulatory approvals and is expected to close
during the second quarter of 1999.
In February 1999, Lucent announced a two-for-one stock split, payable on April
1, 1999, to shareholders of record as of March 5, 1999. Under the terms of the
Merger Agreement the exchange ratio will be adjusted for the effect of this
stock split and any similar changes in the capitalization of Lucent.
Wide Area Networking
The continuing growth in the need for individuals, groups and businesses to
exchange information electronically has given rise to the multi-billion dollar
wide area networking ("WAN") industry. Wide area networking solutions involve
the use of public carrier telecommunications networks as a medium to accomplish
electronic information exchange. Ascend provides products for use in the
following three layers of a typical WAN system infrastructure:
The Edge Layer
The edge layer is an end-user's first point of connection to the WAN. A
typical edge layer device is a home or branch office router, which connects one
or more computers to the WAN via a dial-up or dedicated network connection. In
this market, competitors differentiate themselves based on price, ease of
installation and management, security and enhanced user-friendly features.
The Access Layer
The access layer is the first point of connection within the public carrier
network where many edge layer connections are terminated and consolidated for
transport over the public backbone network. A
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common access layer device is an access concentrator, which terminates a high
volume and wide variety of dial-up and dedicated WAN connections. Products in
this market are differentiated based on the variety of access services
supported, port density, price per port, operational support system ("OSS"),
and management platform.
The Core Layer
The Core Layer represents the public carrier's and internet service provider's
backbone network, which takes the data traffic that is handed off from the
access concentrators and carries it from one point of the network to another at
very high speeds. A typical core layer device is a backbone switch, that uses
either IP, Frame Relay or ATM protocols to move network traffic quickly and
efficiently over the backbone. In this market, the products are differentiated
by aggregate capacity, reliability, scalability, performance, OSS and network
management.
Ascend's Strategy
Ascend's strategy is to provide data networking solutions for next generation
public networks through a broad set of products spanning these three layers of a
typical WAN infrastructure. The Company's product families incorporate
scaleable, modular software and hardware architectures that facilitate rapid,
flexible customer deployments. The Company provides integrated firewall and
encryption security software for several of its products. Ascend products can
be managed from a central location using either Ascend's proprietary remote
management protocols or the industry standards-based Simple Network Management
Protocol ("SNMP").
Products
Ascend has developed various products to address these three layers of the
typical WAN infrastructure as follows:
The Access Layer
The MAX family of integrated access switches is a broad product offering which
provides bandwidth on demand for WAN, Internet access and multimedia access over
carrier analog and digital access facilities. Most MAX products support a
modular card and backplane architecture that allows users to configure each unit
according to the specific application and bandwidth requirements. Products in
the MAX product family range from the low-end MAX 200+, which would commonly be
used in small company or branch offices, to the high-end MAX TNT, used by the
largest carriers and ISPs worldwide. The Max family of products are multi-
service platforms supporting a wide variety of access services such as Digital
Subscriber Line ("DSL") technology, Integrated Services Digital Network
("ISDN"), analog, Frame Relay and digital private lines. These products also
combine the dial access capability, router functionality, security features and
network management, all on a single integrated platform.
The high-end MAX TNT is a carrier-class product due to its high density,
reliability, and high-capacity architecture. Specific high-speed interfaces
supported by the MAX TNT include channelized and unchannelized T3, various types
of DSL technology and other types of access services, including 56 kbps modem
technology, ISDN, and Frame Relay. The MAX TNT is also Network Equipment
Building System ("NEBS") compliant, a key carrier requirement, and supports a
common OSS to simplify operational management.
Working in conjunction with the MAX TNT is the Ascend SS7 Signaling Gateway
("ASG"), a fault tolerant computing platform used in service provider networks
for internet call diversion applications. The ASG provides a seamless migration
of data traffic from the public switched telephone network ("PSTN") onto the
public data network for efficient and cost-effective transport of IP traffic.
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The Core Layer
To meet the backbone requirements of large carrier and ISP networks, Ascend
has developed a broad set of routing, switching and Intelligent Networking
("IN") solutions: the GRF family of IP routers, the B-STDX family of
Multiservice Frame Relay switches, the SA family of broadband access products,
the Multiservice CBX 500 ATM Switch and GX 550 core ATM switch, and the family
of IN solutions. Incorporating switched backplane architecture, distributed
processing and modular design to bring redundancy, flexibility and scalability,
these products use IP, Frame Relay and ATM switching technologies to improve the
speed, performance and reliability of carrier backbone networks. In the
aggregate, these products support a high number of connections ranging in speed
from 64 kbps to OC-48 (2,488 Mbps).
The B-STDX family of products provide scalable, multi-service support for
interworking among Frame Relay, ATM, and IP broadband packet networks. The CBX
500 product is a high-speed, multi-service ATM switch, supporting ATM, Frame
Relay and IP access on a highly scalable, highly reliable carrier-class
platform. The GX 550 product is a high-speed ATM core switch that provides 25
Gbps of capacity. The SA family of products is designed to provide cost points
that make ATM-based services viable for even small branch offices, providing
carriers a cost-effective solution to deliver native ATM services to their
customers. The GRF product family has an innovative architecture, combining
Layer-3 switching with intelligent IP forwarding media cards to deliver scalable
performance. The family of IN solutions support enhanced voice services,
including 800 number calling and local number portability, for use in routing
voice calls in the public telecommunications network. These solutions are
supported on non-stop computing platforms for high reliability and availability
of service.
The Edge Layer
The Pipeline family of routers is designed for the home or branch office to
link one or more computers to the wide area network. These routers connect from
an Ethernet local area network ("LAN") via one or more ports, to the WAN via one
or more ports ranging in speed from ISDN to T1/PRI. The Pipeline family of
products is easy to install and manage using a JAVA configuration utility, and
provides robust security solutions using virtual private networking ("VPN"),
tunneling, and an integrated firewall technology. These products also provide
user-friendly enhancements such as IP address translation, support for automatic
backup, and dynamic bandwidth on demand.
The Multiband family and Multiband Max family of products use inverse
multiplexing technology to provide dynamic bandwidth on demand for
videoconferencing operations, data backup and overflow, and other applications
with fluctuating bandwidth needs. These products use Ascend Inverse
Multiplexing ("AIM") to optimize the dial-up bandwidth process, and conform with
industry standards such as the Bandwidth ON Demand Interoperability Group
("BONDING"). The Multiband family and Multiband Max family of products scale
from 128 kbs speed to 3 Mbps on a single connection, and the Multiband Max
family is scalable enough to upgrade to remote access capabilities, offering
true multi-service flexibility.
Network Management and Security
The Navis family and SecureConnect family of network management and security
products provide comprehensive network management and security across the
Company's broad product offerings. The Navis network management family provides
comprehensive operations control for Ascend access and switch devices, using the
latest client/server and web technologies to ease operator use. The Navis
family consists of NavisCore, NavisXtend and NavisAccess, which are applications
that deliver management features such as discovery and mapping, configuration
management, performance measurement and fault monitoring. These features
provide customized information about the network ranging from the "big picture"
view to the smallest details.
The SecureConnect family of security products works hand-in-hand with the Max
and Pipeline family of products to bring affordable network security to both
central sites and branch offices. The SecureConnnect family includes the Secure
Access Firewall, an integrated firewall product offering, the
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Secure Control Manager, a configuration and management utility, and
NavisRadius, a product offering that supports user authentication, billing and
accounting.
Sales and Marketing
The Company's sales and marketing objective is to ensure that subscribers to
network services and users of applications equipment requiring such services are
aware of the capabilities and benefits of the Company's products. To accomplish
this objective, the Company has developed and maintains marketing and sales
relationships with major telecommunications carriers, ISPs, VARs, distributors,
and applications equipment manufacturers who, in turn, market and sell the
Company's products to end-user customers. The Company's sales force also sells
products directly to end-user customers.
The primary role of the Company's sales force is to: (i) provide support to
telecommunications carriers, ISPs, VARs, distributors, and applications
equipment manufacturers; (ii) assist telecommunications carriers, ISPs and end-
user customers in addressing complex network and Internet access problems; (iii)
differentiate the features and capabilities of the Company's products from
competitive offerings; and (iv) continually monitor and understand
telecommunications carriers', ISPs' and end-user customers' evolving needs for
network services.
The Company also has several marketing programs to support the sale and
distribution of its products. The objective of these programs is to inform
telecommunications carriers, ISPs, VARs, distributors, applications equipment
manufacturers and end-user customers about the capabilities and benefits
available with the use of the Company's remote networking equipment. The
programs include participation in industry trade shows and technical
conferences, design and presentation of technology seminars, publication of
customer newsletters and technical and educational articles for the trade press
and other industry journals and frequent communications with the installed base
of end-user customers regarding evolving applications for the Company's
products.
Telecommunications Carriers
The Company's products are sold and serviced by major telecommunications
carriers around the world. Sales to telecommunications carriers are subject to
the Company's standard terms and conditions of sale. Certain of the
telecommunications carriers are entitled to periodically exchange unsold
inventory for other products offered by the Company, subject to a maximum
exchange limit and subject to a minimum restocking requirement for returned
inventory.
Internet Service Providers
The Company's products are sold through its direct, value-added reseller and
distributor channels to ISPs. The Company has relationships with many major ISPs
worldwide, including UUNET. Sales to UUNET (including its parent company MCI
Worldcom) accounted for 13% and 17% of net sales in 1998 and 1997, respectively.
Value-Added Resellers and Distributors
In North America, the Company employs a two-tier reseller channel strategy.
As part of this strategy, the Company maintains contractual relationships with
and sells its products to VARs and end users around the world through three
multinational distributors. In addition, the Company has entered into non-
exclusive agreements with premier VARs to sell and service the Company's
products. The terms of the agreements generally are for periods not in excess
of twelve months, subject to annual renewals and earlier termination by either
party with prior notice. VARs and distributors are entitled to periodically
return unsold inventory to the Company. Returns are subject to a maximum limit
and may be subject to a minimum restocking requirement.
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Applications Equipment Manufacturers
The Company's products are also sold and serviced by several applications
equipment manufacturers, under which the Company provides its certain of its
products for resale. Some of these applications equipment manufacturers may, at
any time, cancel orders for product delivery which it has placed with the
Company, subject to the payment of specified minimum amounts. In addition, the
Company has entered into agreements with applications equipment manufacturers
and integrators of videoconferencing equipment, under which these companies are
authorized to resell the Company's products using their own identification
label. These videoconferencing applications equipment manufacturers are not
obligated to purchase minimum volumes of product and may cancel orders placed
with the Company at any time prior to scheduled shipment.
Worldwide Sales and Marketing Organization
The Company's worldwide sales and marketing organization supports North
American and International sales across all business units. In North America,
the Company has sales offices located in major metropolitan areas including:
Atlanta, Boston, Chicago, Cincinnati, Cleveland, Columbus, Durham, Dallas,
Denver, Hartford, Houston, Indianapolis, Kansas City, Los Angeles, Minneapolis,
New York, Orlando, Phoenix, Portland, Providence, San Francisco, Seattle, St.
Louis, Tampa, Toronto, Vancouver and Washington D.C. International sales have
been principally export sales and currently are made through telecommunications
carriers, ISPs, VARs and distributors servicing approximately 50 countries,
including Japan, Germany, United Kingdom, France, Sweden, Belgium, Italy, Spain,
Hong Kong, Australia, Singapore, Korea, Taiwan, India and China. The carriers,
VARs and distributors generally provide system installation, technical
assistance and support to end-user customers within their area of
responsibility. Generally, international telecommunications carriers, VARs and
distributors have non-exclusive rights to sell and market the Company's products
within their respective countries. International sales accounted for
approximately 29%, 31% and 35% of net sales in 1998, 1997 and 1996 respectively.
International sales are made primarily in United States dollars and are subject
to government controls and other risks associated with international business
activities.
Technical Assistance and Support
A high level of continuing technical assistance and support is important to
the Company's objective of developing long-term relationships with customers.
The majority of these technical assistance and support activities are related to
installations and network configuration issues and are primarily provided by
third parties distributing the Company's products. The Company supports its
sales personnel and customers by providing telephone support and remote access
to customer installations through the Company's Technical Assistance Centers in
Alameda and San Jose, California, Phoenix, Arizona, Westford and Marlboro,
Massachusetts, Sophia Antipolis, France, Melbourne, Australia and Tokyo, Japan.
Remote access is accomplished either through a digital dial-up network
connection directly to a customer's installation or through a modem connection
to the control port of the customer's system. The connection allows the
Company's technical support personnel to remotely analyze and correct
installation and configuration problems. The Company also offers on-site
installation and technical assistance for fixed fees, which to date have not
been significant.
The Company's products have standard hardware warranties of up to 12 months
and standard software warranties of up to 90 days. The Company has a variety of
comprehensive and flexible hardware and software maintenance and support
programs available for products no longer under warranty, with services ranging
from time and materials remote service support to 24-hour on-site support,
depending on the end-user customer preference. The Company also offers various
training courses for its third party resellers and end-user customers.
Research and Development
The Company believes that its future success depends in part on its ability
to continue to enhance its existing products and to develop new products that
maintain technological competitiveness. The Company
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also believes its product development activities should be directed to solving
the practical needs of its customers. The Company monitors changing customer
needs and works closely with users of network access products, including
telecommunications carriers, ISPs, applications equipment manufacturers, VARs
and distributors, end-user customers and market research organizations to
monitor changes in the marketplace. The Company intends to remain dedicated to
industry standards and to continue to support emerging wide area networking
protocol standards and carrier services.
The Company's software and hardware architecture is modular in design,
facilitating a relatively short product design and development cycle and
reducing the time to market for new products and features. The Company has
utilized this architectural design to develop and introduce numerous product
models and enhancements since the introduction of its first products in 1991.
The Company intends to continue to utilize this architectural design to develop
and introduce additional products and enhancements in the future. The Company
and its major customers test new products prior to their general commercial
availability. The Company conducts both internal testing and beta testing with
selected customers.
The Company has expanded its research and development expertise by acquiring
key technologies and core competencies through mergers with and acquisitions of
public and private companies in the networking industry. In October 1998, the
Company purchased Stratus Computer, Inc. ("Stratus"), a manufacturer of fault-
tolerant computer systems, and announced its intention to divest the non-
telecommunications business units of Stratus prior to the consummation of the
acquisition. In June 1997, the Company acquired Cascade Communications Corp.
("Cascade"), a developer and manufacturer of wide area network switches. In
April 1997, the Company acquired Whitetree, Inc. ("Whitetree"), a developer and
manufacturer of high-speed ATM switching products. In February 1997, the
Company purchased InterCon Systems Corporation ("InterCon"), a developer of
remote access client software products. In January 1997, Cascade acquired
Sahara Networks, Inc. ("Sahara"), a privately held developer of scaleable high-
speed broadband access products.
The Company is currently undertaking development efforts for all of its
product families with emphasis on increasing reliability and availability, cost-
reduction engineering to stay price-competitive and to reduce the overall
network operating costs to end users, increasing scalability driven by the
increasing size of networks and increasing functionality such as support for
VPNs, for new routing protocols, and for higher speed interfaces. Schedules for
high technology products are inherently difficult to predict, and there can be
no assurance that the Company will achieve its scheduled first customer shipment
dates. Also, there can be no assurance that the Company's product development
efforts will result in commercially successful products, or that the Company's
products will not be rendered obsolete by changing technology or new product
announcements by other companies.
The Company's research and development expenditures were $216.2 million,
$156.0 million and $93.7 million in 1998, 1997 and 1996, respectively. Research
and development expenditures are expensed as incurred. At December 31, 1998,
approximately 1,320 full-time employees were engaged in research and
development.
Competition
The market for WAN products is highly competitive and subject to rapid
technological change. The Company expects competition to continue and increase
in the future. The Company's primary competitors are Cisco Systems, Inc.
("Cisco"), 3Com Corporation ("3Com"), Newbridge Networks, Inc. ("Newbridge") and
Northern Telecom, Ltd. ("Nortel"). Cisco, 3Com and Nortel have substantially
greater financial and marketing resources than the Company. Competitive factors
in the WAN market include core technology, breadth of product features,
scalability of products, product quality and functionality, pricing, marketing
and distribution resources, international certifications and technical service
and support. The Company believes it presently competes favorably with respect
to each of these factors and is positioned to respond to anticipated competitive
actions.
The Company expects additional competition from existing competitors and from
a number of other companies that may enter the Company's existing and future
markets. The additional competition could
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adversely affect the Company's business, results of operations and financial
condition. Some of the Company's current and potential competitors have
substantially greater financial, marketing and technical resources than the
Company.
Manufacturing and Quality
The Company has received the International Standard Organization ("ISO") 9002
certification for quality. The Company's manufacturing operations consist
primarily of materials planning and procurement, final assembly, burn-in, final
system testing and quality control. The Company designs all of the hardware sub-
assemblies for its products and uses the services of contract manufacturers to
build these sub-assemblies and certain of its products to the Company's
specifications. The Company presently uses a variety of independent third party
contract assembly companies to perform printed circuit board assembly and in-
circuit testing. The Company installs its proprietary software into the
electronically erasable programmable read only memory ("EEPROM") of its systems
in order to configure products to meet customer needs and to maintain quality
control and system security. The manufacturing process enables the Company to
configure its products in combinations to meet a wide variety of individual
customer requirements. The Company uses automated testing equipment and burn-in
procedures, as well as comprehensive inspection, testing and statistical process
control testing by technicians, to assure the quality and reliability of its
products.
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 has increased its manufacturing capacity as required by adding
additional facilities and personnel and will continue to increase its
manufacturing capacity as needed. The Company's financial results could be
adversely affected if it encounters delays or for any other reason does not
expand manufacturing capacity as required.
Proprietary Rights
The Company's success and ability to compete is dependent in part upon its
proprietary technology, although the Company believes that its success is more
dependent upon its technical expertise than its proprietary rights. The Company
relies on a combination of patent, copyright and trade secret laws and non-
disclosure agreements to protect its proprietary technology. The Company
generally enters into confidentiality or license agreements with its employees,
distributors, customers and potential customers and limits access to its
software, documentation and other proprietary information. There can be no
assurance that the steps taken by the Company in this regard will be adequate to
prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. In addition, the laws of some foreign
countries do not protect the Company's proprietary rights to the same extent as
do the laws of the United States. The Company is also subject to the risk of
adverse claims and litigation alleging infringement of the intellectual property
rights of others. From time to time the Company has received claims of
infringement of other parties' proprietary rights. There can be no assurance
that third parties will not assert infringement claims in the future with
respect to the Company's current or future products or that any such claims will
not require the Company to enter into license arrangements or result in
protracted and costly litigation, regardless of the merits of such claims. No
assurance can be given that any necessary licenses will be available or that, if
available, such licenses can be obtained on commercially reasonable terms.
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Employees
As of December 31, 1998, the Company employed approximately 3,060 persons,
including 1,240 in sales and marketing, 290 in manufacturing, 1,320 in
engineering and 210 in finance and administration. Of these, approximately 410
were employed outside of North America. None of the Company's employees are
represented by a labor union. The Company has experienced no work stoppages and
believes its relationship with its employees is good. 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
typically does not have employment contracts with its key personnel and does not
maintain any key person life insurance policies. The loss of key management or
technical 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.
ITEM 2. PROPERTIES
The Company's principal administrative, engineering, manufacturing, marketing
and sales facilities total approximately 375,000 square feet and are located in
seven buildings in Alameda, California. The Company occupies its current
facilities under leases which expire at various dates through March 2003. In
addition, the Company leases sales offices and development centers in major
metropolitan areas including Atlanta, Boston, Chicago, Cincinnati, Cleveland,
Columbus, Durham, Dallas, Denver, Hartford, Houston, Indianapolis, Kansas City,
Los Angeles, Minneapolis, New York, Orlando, Phoenix, Portland, Providence, Salt
Lake City, San Francisco, Seattle, St. Louis, Tampa, Toronto, Vancouver and
Washington D.C. The Company expects that it will require additional facilities
over the next few years.
ITEM 3. LEGAL PROCEEDINGS
On January 13, 1999, four purported class action complaints challenging the
proposed merger between Ascend and Lucent were filed in the Delaware Court of
Chancery by individuals who claim to be stockholders of Ascend. The complaints
name the Company, its directors and certain former directors of Cascade
Communications Corp. as defendants. One of the complaints also names Lucent as
a defendant. The complaints allege, among other things, that the defendants
have resolved to wrongfully allow Lucent to obtain the assets of Ascend at a
bargain price, that the defendants have breached their fiduciary duties to the
class, that action by the defendants will prevent Ascend's stockholders from
receiving a fair price for their shares, that Ascend's directors failed to make
an informed decision in recommending Lucent's offer, and that the terms of the
proposed merger fail to include appropriate mechanisms to protect Ascend's
stockholders against a decline in the price of Lucent's or Ascend's stock. The
complaint naming Lucent alleges that it aided and abetted the breaches of
fiduciary duty by the other defendants. The plaintiffs seek, among other
things, (i) a declaration that the proposed transaction is unfair, unjust and
inequitable; (ii) preliminary and permanent injunctive relief against the
consummation or closing of the proposed transaction; (iii) rescission of the
transaction in the event it is consummated; (iv) damages, (v) allowance for
plaintiffs' attorneys' fees and expenses; and, (vi) other relief as the Court
may deem just and proper.
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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
the named defendants 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 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 financial position, future results of
operations or cash flows in a particular period.
The Company and various of its current and former officers and directors are
defendants in a number of consolidated class action lawsuits pending in the
United Stated District Courts for the Central District of California, which have
been 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 ("federal securities actions"). In
addition, the Company and one of its officers are defendants in a securities
action filed in the Superior Court of Alameda County, California ("state
securities action"). The state securities action purports to be brought in
behalf of all purchasers of the Company's stock between July 15, 1997 and
September 29, 1997 (excluding the defendants and parties related to them). The
lawsuits allege that the defendants violated the federal or state 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.
On August 17, 1998, the Court certified the federal securities actions as a
class action and appointed four plaintiffs to serve as class representatives.
On September 4, 1998, plaintiffs filed a second Amended and Consolidated
Complaint. On February 2, 1999, the Court issued an Order granting the motion
to dismiss and allowing plaintiffs to file an amended complaint. The state
securities action has been stayed pending resolution of the motion to dismiss in
the federal securities action.
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 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 financial position, future
results of operations 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.
In April 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.
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 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.
11
<PAGE>
The Company is a party as a defendant in various other lawsuits, contractual
disputes and other legal claims, the results of which are not presently
determinable. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders of Ascend during the
fourth quarter of 1998.
12
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's common stock trades on the Nasdaq National Market tier of The
Nasdaq Stock Market under the symbol ASND. As of February 28, 1999, there were
approximately 3,340 stockholders of record. The following table sets forth for
the period indicated, the high and low closing prices for Ascend's common stock
as reported by the Nasdaq National Market.
<TABLE>
<CAPTION>
1998 1997
--------------------------- ----------------------------
High Low High Low
------------ ------------ ------------- -----------
<S> <C> <C> <C> <C>
Fourth quarter ended December 31, $ 69.63 $ 33.94 $ 35.69 $ 22.00
Third quarter ended September 30, 55.06 32.63 56.75 30.00
Second quarter ended June 30, 51.81 36.13 60.00 36.13
First quarter ended March 31, 38.75 24.38 80.25 40.12
</TABLE>
The Company has not paid cash dividends on its common stock to date. The
Company currently intends to retain earnings, if any, for use in its business,
and does not anticipate paying cash dividends to its stockholders in the near
future.
The Company believes factors such as quarter-to-quarter variances in financial
results and announcements of new products and new orders by the Company or its
competitors could cause the market price of the Company's common stock to
fluctuate substantially. In addition, the stock prices for many high technology
companies typically experience extreme price fluctuations, which often are not
related to changes in the operating performance of the specific companies. Broad
market fluctuations as well as general economic conditions such as a
recessionary period or high interest rates may adversely affect the market price
of the Company's common stock.
13
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended December 31,
Consolidated Statements of ----------------------------------------------------------------------------------
Operations Data: 1998 1997 1996 1995 1994
-------------- -------------- -------------- -------------- --------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Net sales $ 1,478,682 $ 1,167,352 $ 890,273 $ 287,438 $ 89,715
Cost of sales 543,971 413,570 311,745 101,859 32,500
-------------- -------------- -------------- -------------- --------------
Gross profit 934,711 753,782 578,528 185,579 57,215
Operating expenses:
Research and development 216,235 155,996 93,669 36,083 13,523
Sales and marketing 302,045 249,129 156,286 56,034 21,956
General and administrative 78,864 35,267 29,855 16,084 6,268
Purchased in-process research and
development 266,953 231,100 - - -
Costs of mergers (18,279) 150,271 13,900 - -
-------------- -------------- -------------- -------------- --------------
Total operating expenses 845,818 821,763 293,710 108,201 41,747
-------------- -------------- -------------- -------------- --------------
Operating income (loss) 88,893 (67,981) 284,818 77,378 15,468
Interest income 28,102 23,029 17,186 8,360 1,750
-------------- -------------- -------------- -------------- --------------
Income (loss) before income taxes 116,995 (44,952) 302,004 85,738 17,218
Provision for income taxes 136,649 79,422 118,114 32,793 1,402
-------------- -------------- -------------- -------------- --------------
Net income (loss) $ (19,654) $(124,374) $ 183,890 $ 52,945 $ 15,816
============== ============== ============== ============== ==============
Net income (loss) per share - diluted $ (0.10) $ (0.66) $ 0.94 $ 0.30 $ 0.11
============== ============== ============== ============== ==============
Number of shares used in per share
calculation - diluted 199,291 189,129 196,246 175,216 148,516
============== ============== ============== ============== ==============
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------------
Consolidated Balance Sheet Data: 1998 1997 1996 1995 1994
-------------- -------------- -------------- -------------- --------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Working capital $ 1,050,785 $ 745,949 $ 652,447 $ 331,937 $ 92,415
Total assets 2,531,478 1,137,894 922,127 481,873 126,620
Total stockholders' equity 2,094,144 969,256 767,233 411,293 103,154
</TABLE>
14
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Ascend develops, manufactures and sells wide area networking solutions for
telecommunications carriers, ISPs and corporate customers worldwide which enable
them to build: (i) Internet access systems consisting of POP equipment for ISPs
and remote site Internet access equipment for Internet subscribers; (ii)
telecommunications carrier and ISP backbone networks utilizing high speed Frame
Relay, ATM and IP switches; (iii) extensions and enhancements to corporate
backbone networks that facilitate access by remote offices, telecommuters and
mobile computer users; (iv) non-stop computing platforms and Intelligent
Networking ("IN") solutions for enhanced voice services in telephony networks;
and (v) videoconferencing and multimedia access solutions. The Company's
products support existing digital and analog networks.
In January 1999, the Company entered into an Agreement and Plan of Merger (the
"Merger Agreement") with Lucent, pursuant to which each outstanding share of
Ascend common stock will be exchanged for 0.825 shares of Lucent common stock,
and each outstanding option or warrant to purchase Ascend common stock will be
converted into an option or warrant to purchase Lucent common stock (adjusted
for the exchange ratio). The merger is expected to be accounted for as a
pooling of interests, is subject to standard regulatory approvals and is
expected to close during the second quarter of 1999.
In February 1999, Lucent announced a two-for-one stock split, payable on April
1, 1999 to shareholders of record as of March 5, 1999. Under the terms of the
Merger Agreement the exchange ratio will be adjusted for the effect of this
stock split and any similar changes in the capitalization of Lucent.
In October 1998, the Company purchased Stratus, a manufacturer of fault-
tolerant computer systems, and announced its intention to divest the non-
telecommunications business units of Stratus prior to the consummation of the
acquisition. In June 1997, the Company acquired Cascade, a developer and
manufacturer of wide area network switches. In April 1997, the Company acquired
Whitetree, a developer and manufacturer of high-speed ATM switching products.
In February 1997, the Company purchased InterCon, a developer of remote access
client software products. In January 1997, Cascade acquired Sahara, a privately
held developer of scaleable high-speed broadband access products.
15
<PAGE>
Results of Operations
The following table summarizes the percentage of net sales represented by
certain line items from the Company's consolidated statements of operations:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------
1998 1997 1996
------------- -------------- --------------
<S> <C> <C> <C>
Net sales................................................ 100 % 100 % 100 %
Cost of sales............................................ 37 35 35
----------- ------------ ------------
Gross profit........................................... 63 65 65
Operating expenses:
Research and development............................... 15 14 10
Sales and marketing.................................... 20 21 18
General and administrative............................. 5 3 3
Purchased in-process research and development.......... 18 20 -
Costs of mergers....................................... (1) 13 2
----------- ------------ ------------
Total operating expenses............................ 57 71 33
----------- ------------ ------------
Operating income (loss) ................................. 6 (6) 32
Interest income, net..................................... 2 2 2
----------- ------------ ------------
Income (loss) before income taxes........................ 8 (4) 34
Provision for income taxes............................... 9 7 13
----------- ------------ ------------
Net income (loss)........................................ (1) % (11) % 21 %
=========== ============ ============
</TABLE>
Years Ended December 31, 1998, 1997 and 1996
Net Sales. Net sales for 1998 increased 27% to $1.479 billion as compared to
$1.167 billion in 1997, which increased 31% from $890.3 million in 1996.
International sales (sales outside of North America) increased to $427.5 million
in 1998 as compared to $362.3 million in 1997 and to $313.3 million in 1996 and
accounted for 29%, 31% and 35% of net sales in 1998, 1997 and 1996,
respectively. Substantially all of the increase in sales in each period was
attributable to increases in unit shipments of the Company's products.
The following table provides a breakdown of net sales by business unit as a
percentage of total Company net sales for 1998, 1997 and 1996, respectively:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------
Business Unit 1998 1997 1996
- --------------------------------------- ------------- ------------- -------------
<S> <C> <C> <C>
Core Systems........................... 47 % 35 % 36 %
Access Switching....................... 41 52 48
Enterprise Access...................... 7 9 13
Other.................................. 5 4 3
------------- ------------- -------------
Total Company..................... 100 % 100 % 100 %
============= ============= =============
</TABLE>
Core Systems - The Core Systems business unit consists of the B-STDX family of
Frame Relay switches, the CBX500 and GX 550 ATM switches, the SA family of
broadband access products, the Carrier Signaling Group of products acquired from
Stratus and the GRF family of IP switches. Core Systems products accounted for
47%, 35% and 36% of total Company net sales for 1998, 1997 and 1996,
16
<PAGE>
respectively. The increase in Core Systems sales as a percentage of net sales
in 1998 was primarily attributable to significant growth in sales of ATM
switches. Incremental revenues from the acquisition of Stratus also contributed
to the increase, to a lesser extent. The decline in Core Systems revenues as a
percent of net sales in 1997 was primarily attributable to the increase in sales
of the MAX family of Access Switching products.
Access Switching - The Access Switching business unit consists of the MAX
family of products, which accounted for 41%, 52% and 48% of total Company net
sales for 1998, 1997 and 1996, respectively. Access Switching revenues were
relatively flat year-over-year from 1997 to 1998, but declined as a percentage
of total sales due to the increase in total revenues. The increase in Access
Switching revenues as percent of net sales in 1997 was primarily attributable to
increased shipments of MAX products, due to increased demand for corporate
remote networking applications.
Enterprise Access - The Enterprise Access business unit consists of the
Pipeline family of remote access equipment as well as the Multiband MAX family
of inverse multiplexing equipment. Enterprise Access products accounted for 7%,
9% and 13% of total Company net sales for 1998, 1997 and 1996, respectively.
Enterprise Access revenues were relatively flat year-over-year from 1997 to
1998, but declined as a percentage of total sales due to the increase in total
revenues. The decline in Enterprise revenues as a percent of net sales in 1996
was primarily attributable to price reductions of the Pipeline family of
products due to increased competition.
Gross Margin. Gross margin was 63% for 1998 and 65% for both 1997 and 1996.
The decrease in gross margin in 1998 was primarily due to decreases in the
average selling prices of the Company's products. To a lesser extent, the
acquisition of Stratus contributed to the decrease in gross margin, as gross
margins for products sold by Stratus were lower than the Company's gross
margins. 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
$216.2 million in 1998 as compared to $156.0 million in 1997 and $93.7 million
in 1996. These increases were primarily due to the addition of engineering
personnel, expenses related to the development and enhancement of the Company's
existing and new products, expenses related to applications and product testing
required to enter new markets, addition of development laboratory equipment, and
material costs associated with new product prototypes. In addition, research
and development expenses have 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 15% in
1998 from 14% in 1997 and 10% in 1996. The Company expects that spending for
research and development will increase in absolute dollars in 1999 but may
continue to vary as a percentage of net sales.
Sales and Marketing. Sales and marketing expenses increased to $302.0
million in 1998 compared to $249.1 million in 1997 and $156.3 million in 1996.
These increases were primarily due to the addition of sales, marketing and
technical support personnel and related commissions, and expenses associated
with opening additional sales offices in North America, Europe and Asia and the
Pacific Basin. Approximately 50% of the total increase in sales and marketing
expenses in 1998 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 increasing number
of customers and products. Sales and marketing expenses as a percent of net
sales decreased slightly to 20% in 1998 from 21% in 1997, which increased from
18% in 1996. The Company expects that sales and marketing expenses will increase
in absolute dollars in 1999 but may continue to vary as a percentage of net
sales.
General and Administrative. General and administrative expenses increased to
$78.9 million in 1998 as compared to $35.3 million in 1997 and $29.9 million in
1996. The increase in 1998 was partially due to the effect of special charges
totaling $27.5 million related to the settlement of a patent issue, the
settlement of an outstanding receivable from a contract manufacturer and the
establishment of reserves against certain customers afforded working capital
loans. In addition, the increases in absolute dollars in both years were
17
<PAGE>
due to the addition of finance and administrative personnel, bonus
compensation paid to the Company's employees, and increased costs for
insurance and contract personnel associated with information systems service
and support. General and administrative expenses as a percent of net sales
were 5% in 1998 compared to 3% in both 1997 and 1996. Excluding the effect of
the special charges discussed above, general and administrative expenses were
3% of net sales in 1998. The Company expects that spending for general and
administrative activities will increase in absolute dollars in 1999 but may
continue to vary as a percentage of net sales.
Purchased In-Process Research and Development. Purchased in-process research
and development costs were $267.0 million for 1998 and $231.1 million for 1997.
These costs were related to the acquisition of Stratus during the fourth quarter
of 1998, and 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 product offerings to end-user
markets.
In connection with the acquisition of Stratus, purchased in-process research
and development totaling $267.0 million was written off as a non-recurring
charge at the date of acquisition because the purchased in-process research and
development had not yet reached technological feasibility and had no future
alternative use. A total of $133.5 million was allocated to existing technology
($130.0 million) and the assembled work force ($3.5 million), with these amounts
being amortized over periods of ten years and three years, respectively.
The purchased in-process research and development acquired in 1998 is expected
to facilitate the development of products which will enable carriers and network
service providers to more effectively integrate their existing voice and data
networks. As a result, the Company expects to be able to target markets that
have historically been served by traditional telecommunications equipment
suppliers. The Company is using the purchased in-process research and
development to create new products that will become part of the Core Systems
business unit product suite, with anticipated product release dates throughout
1999 and 2000. Although the Company expects that the purchased in-process
research and development will be successfully developed, there can be no
assurance that commercial viability of these products will be achieved.
The nature of the efforts required to develop the purchased in-process
research and development into commercially viable products principally relates
to the completion of all planning, designing, prototyping, verification and
testing activities that are necessary to establish whether the product will be
able to meet its design specifications, including functions, features and
technical performance requirements. The estimated cost to develop the in-
process research and development was approximately $48 million, the majority of
which is expected to be incurred in 1999.
The value of the purchased in-process research and development from the
Stratus acquisition was determined by estimating the projected net cash flows
related to such products, including costs to complete the development of the
technology and the future revenues to be earned upon commercialization of the
products. These cash flows were discounted back to their net present value. The
resulting projected net cash flows from such projects were based on management's
estimates of revenues and operating profits related to such projects. These
estimates were based on several assumptions, including those summarized below.
If these projects to develop commercial products based on the purchased in-
process research and development are not successfully completed, the Company's
operating results may be adversely affected in future periods.
Revenues and operating profit attributable to the in-process research and
development were estimated to total $5.1 billion and $2.3 billion, respectively,
over an eleven-year projection period. The resulting projected net cash flows
were discounted to their present value using a discount rate of 35%, which was
calculated based on the weighted average cost of capital, adjusted for the
technology risk associated with the purchased in-process research and
development, which was considered to be significant due to the rapid pace of
technological change in the telecommunications industry. The resulting
valuation of $370.8
18
<PAGE>
million was subsequently reduced to $267.0 million due to the pro-rata
allocation of the excess of the estimated fair value of the net assets
acquired over the purchase price.
For projected cash flows attributable to existing technology, a discount rate
of 30% was used, which reflects the weighted average cost of capital, adjusted
for the technology risk associated with these technologies.
The primary purchased in-process research and development in 1997 was the
Broadband access technology acquired through the January 1997 acquisition of
Sahara by Cascade, which was subsequently acquired by the Company. In
connection with the acquisition of Sahara, purchased in-process research and
development totaling $213.0 million was written off as a non-recurring charge at
the date of acquisition because the purchased technology had not yet reached
technological feasibility and had no future alternative use. At the acquisition
date, Sahara had no revenues or commercially available products. The Company's
revenues attributable to the Broadband access technology were not significant in
either 1998 or 1997.
Costs of Mergers. In 1998, the Company reversed accrued merger costs of $18.3
million, which related to the estimated costs charged to operations in 1997 of
approximately $150.3 million. These costs principally related to the
acquisition of Cascade and consisted primarily of investment banking fees,
professional fees, reserves for redundant assets, redundant products and
employee severance packages. In 1996, the Company charged to operations merger
costs of approximately $13.9 million. These costs principally related to the
acquisition of NetStar, Inc. and consisted primarily of investment banking fees,
professional fees and other direct costs associated with the merger. There were
no remaining merger related accruals at September 30, 1998.
In conjunction with the acquisition of Stratus in the fourth quarter of 1998,
the Company recorded, as part of the purchase price, accrued merger costs of
$49.3 million, which consist of $7.6 million of merger transaction costs and
$41.7 million of integration expenses. Integration expenses consist of $2.4
million for severance and outplacement costs, $34.8 million for costs associated
with the divestiture of the non-telecommunications business units, and $4.5
million of other merger related costs. At December 31, 1998, the accrued merger
costs for Stratus were $49.3 million, with such costs expected to be paid during
the first three quarters of 1999.
Interest Income. Interest income increased to $28.1 million in 1998 compared
to $23.0 million in 1997 and $17.2 million in 1996. The increase in interest
income during 1998 and 1997 was primarily due to increases in cash and
investments balances, which were primarily attributable to cash generated from
operations, and proceeds received from the exercise of stock options.
Provision for Income Taxes. The provision for income taxes for 1998 was $136.6
million compared to $79.4 million for 1997 and $118.1 million in 1996. The
Company's tax expense for 1998 and 1997 was impacted by non-deductible costs
associated with the Company's business combinations. Excluding the effects of
these non-deductible charges, the Company's effective tax rate was 35.6% for
1998 and 37.3% for 1997, which approximates the effective statutory federal and
state income tax rates adjusted for the impact of tax exempt interest, the
benefits associated with the Company's Foreign Sales Corporation and the
utilization of various tax credits. The decrease in the Company's effective tax
rate from 1997 to 1998 was primarily attributable to the utilization of various
tax credits. Excluding the effects of non-deductible one-time charges, the
Company's effective tax rate was 38.2% for 1996.
Liquidity and Capital Resources
At December 31, 1998, the Company's principal sources of liquidity included
cash and cash equivalents, short-term investments and investments totaling
$1.137 billion 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, 1998. The increase in cash and cash
equivalents of $201.8 million for 1998 was attributable to $281.9 million of
cash provided by operations and $203.8 million of
19
<PAGE>
cash provided by financing activities, offset by $283.9 million of cash used
in investing activities. The net cash provided by operating activities for
1998 was primarily due to the net loss, adjusted for the effects of purchased
research and development and depreciation and amortization, offset by changes
in working capital assets.
Net cash used in investing activities of $283.9 million for 1998 related
primarily to net purchases of investments of $362.9 million and expenditures for
property and equipment of $157.5 million, offset by cash acquired in conjunction
with the acquisition of Stratus of $269.4 million. Financing activities
provided $203.8 million in 1998, due to proceeds from the exercise of stock
options and issuance of common stock in connection with the Company's stock
option and stock purchase plans.
At December 31, 1998, the Company had $1.051 billion 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 which may affect future results
The Company's quarterly and annual operating results are affected by a wide
variety of risks and uncertainties as discussed below and in the Company's
Registration Statement on Form S-4/A (No. 333-62281) filed on September 9, 1998
in connection with the acquisition of Stratus. This Report on Form 10-K should
be read in conjunction with such Form S-4/A, particularly the section entitled
"Risk Factors".
Merger Agreement with Lucent
On January 12, 1999, the Company and Lucent executed a definitive merger
agreement pursuant to which Dasher Merger Inc., a Delaware corporation and a
wholly owned subsidiary of Lucent, will merge, subject to certain conditions,
with and into the Company and the Company will become a wholly owned subsidiary
of Lucent. Under the terms of the merger, each outstanding share of common
stock of the Company will be exchanged for 0.825 shares of common stock of
Lucent, subject to adjustment for changes in Lucent's capitalization, including
the two-for-one stock split announced by Lucent in February 1999. The
announcement of the merger could have an impact on the ability of the Company to
market its products and services to its customers, possibly causing operating
results to vary from those expected. The merger is subject to approval by the
Company's stockholders and various regulatory agencies, including the Department
of Justice, and there can be no assurance that the merger will be successfully
completed. In the event that the merger is not successfully completed, the
Company's results of operations and common stock price could be materially
adversely affected.
If the merger is successfully completed, holders of the Company's common stock
will become holders of Lucent common stock. Lucent's business is different from
that of the Company, and Lucent's results of operations, as well as the price of
Lucent common stock, may be affected by factors different than those affecting
the Company's results of operations and the price of the Company's common stock.
For a discussion of Lucent's business and certain factors to consider in
connection with such business, see Lucent's Annual Report on Form 10-K for the
fiscal year ended September 30, 1998.
Dependence on the Internet Access and Telecommunications Markets
A substantial portion of the Company's sales of its 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 its core systems
products is related to the telecommunications carrier industry. In North
America, the Company sells a substantial percentage of its 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
20
<PAGE>
Internet and public carrier industry will increase significantly in the future
and could have a material adverse effect on the Company's business, results of
operations or financial condition.
Integration of Acquisitions
The Company concluded the acquisition of one company in 1998 and four
companies in 1997. 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. 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 acquired
companies could have a material adverse effect on the Company's business,
financial condition or results of operations.
International Sales
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, political and economic instability,
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, financial condition or results of operations. Although substantially
all of 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 a material
adverse effect on the Company's business, results of operations and financial
condition.
Fluctuations in Quarterly Operating Results
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, all of which are
difficult to forecast. In the Company's most recent quarters, the sequential
sales growth has fluctuated significantly, 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 materially 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 expenses are 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 sales
shortfall on the Company's operating results may be magnified by the Company's
inability to adjust spending to compensate for the shortfall.
21
<PAGE>
Rapidly Changing Technologies
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 have a material adverse effect on
the Company's business, results of operations or financial condition.
Competition
The Company mainly competes in four segments of the data networking market:
(i) 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, 3Com, Newbridge, Nortel 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 have a material adverse effect on the Company's business,
results of operations and financial condition.
The Company expects that its gross margins could be adversely affected in
future periods by price changes resulting from increased competition. In
addition, increased sales of Pipeline products as a percentage of net sales may
materially adversely affect the Company's gross margins in future periods as
these products have lower gross margins than the Company's other products.
Reliance on Third Party Telecommunications Carriers, Value-Added Resellers and
Distributors
The Company's use of third parties to distribute its products to VARs may
adversely affect the Company's gross margins. The Company's sales are, to a
significant degree, made through telecommunications carriers, 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 or product pricing arrangement that the Company may implement in one
or more distribution channels for strategic purposes could materially adversely
affect gross profit margins.
22
<PAGE>
Dependence on Key Personnel
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 typically 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 materially adversely affect the Company.
Management of Growth
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.
Proprietary Rights
The Company relies on a combination of patents, copyright, and trade secret
laws and non-disclosure agreements to protect its proprietary technology.
However, there can be no assurance that any of the Company's proprietary
technology rights will not be challenged, invalidated or circumvented, or that
any such rights will provide significant competitive advantage. From time to
time, the Company receives notices from third parties regarding patent or
copyright claims. Any such claims, with or without merit, could be time
consuming to defend, result in costly litigation, divert management's attention
and resources and cause the Company to incur significant expenses. 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.
Dependence on Contract Manufacturers and Single-Source Suppliers
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 materially adversely affect the Company's revenues and financial results
and could impact customer relations.
Ascend Year 2000 Readiness Disclosure
The Year 2000 computer issue creates a risk for Ascend and therefore the
Company makes the following Year 2000 readiness disclosure. If computer systems
do not correctly recognize date information when the year changes to 2000, there
could be a materially adverse impact on the Company's operations. The risk for
the Company 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 the Company's 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 and expects to complete such evaluation no later
than June 30, 1999.
23
<PAGE>
Internal Systems. The Company has almost completed a comprehensive assessment
and evaluation of its systems, equipment and facilities. The Company has a
number of projects underway to test and replace or upgrade systems, equipment
and facilities that are known to be Year 2000 non-compliant. The Company
expects Year 2000 internal testing to be complete by June 1999. 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. 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.
Suppliers. The Company is also in the process of contacting its critical
suppliers to determine whether the suppliers' operations and the products and
services they provide are Year 2000 compliant. The Company's process for
assessing such compliance includes obtaining supplier certifications, supplier
follow-up meetings and external testing, if required. Supplier certifications,
supplier follow-up meetings and external testing, if required, are expected to
be completed by June 1999. 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 a materially 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.
Warranty. On the basis of product designs and quality assurance tests, the
Company believes the majority of its current products are Year 2000 compliant;
however, some of the products sold by the Company in the past may not be Year
2000 compliant. The Company currently identifies the products that are
certified as Y2K compliant through its Year 2000 readiness disclosure to
customers, and for other products, does not have any obligation to upgrade these
products. However, the Company's products are sometimes bundled or marketed
with, or used by customers with, third party products which may not always be
Year 2000 compliant. For these reasons, the Company may experience an increase
in warranty and other claims as a result of the Year 2000 transition and such
claims could have a material adverse impact on the Company's results of
operations or financial condition. In addition, in the event that a significant
number of the Company's customers experience Year 2000-related problems, whether
or not due to the Company's products, demand for technical support and
assistance may increase substantially. In such case, the Company's costs for
providing technical support may rise and the quality of such technical support
or the Company's ability to manage incoming requests may be impaired.
Sales Impact. Year 2000 compliance is an issue for almost 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 customers' spending patterns could have a material
adverse impact on the Company's sales, operating results or financial condition.
General. In order to evaluate the risks outlined above and to implement Year
2000 compliance solutions, Ascend has established a company wide team coupled
with outside consultants. The internal Ascend Year 2000 compliance team
consists of representatives from various functional areas, including risk
management, finance, engineering, purchasing, and legal. The external Year 2000
compliance team includes various national Year 2000 compliance consultants. The
team has established an overall Year 2000 compliance goal, incremental
milestones and meets regularly to assess progress on its milestones.
Currently, the Company is establishing contingency plans to address the impact
to the Company in the event its suppliers, products and internal systems are not
Year 2000 compliant.
Costs incurred to date on the Company's Year 2000 compliance project are
approximately $11.5 million. Total costs of the project and compliance are
estimated to be $20.0 million to $24.0 million and
24
<PAGE>
should be substantially incurred by June 30, 1999. However, there can be no
assurance that these costs will not be greater than anticipated, or that
corrective actions undertaken will be completed before any Year 2000
compliance problems occur.
The Company's Year 2000 compliance criteria comply with the requirements
established by the US Government as stated in The Final GSA - Year 2000
Compliance.
Volatility of Stock Price
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 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 materially adversely affect the
market price of the Company's common stock. Recent periods of volatility in the
market price of the Company's securities resulted in securities class action
litigation against the Company and various officers and directors. Such
litigation could result in substantial costs and a diversion of management's
attention and resources, which would have a material adverse effect on the
operating results and financial condition of the Company.
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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is experiencing a greater proportion of its sales activity through
its partners in two-tier distribution channels. Such partners tend to have
access to more limited financial resources than other resellers and end-user
customers and therefore represent potential sources of increased credit risk.
Additionally, the Company is experiencing increased demands for customer
financing and leasing solutions. The Company also continues to monitor
increased credit exposures because of the weakened financial conditions in Asia
and South America and the impact that such conditions may have on the worldwide
economy. Although the Company has not experienced significant losses due to
customer default to date, such losses, if incurred, may have a material adverse
impact on the Company's business, operating results, and financial position.
The Company maintains investment portfolio holdings of various issuers, types,
and maturities. These securities are generally classified as available for
sale. The Company also has certain real estate lease commitments with payments
tied to short-term interest rates. At any time, a sharp rise in interest rates
could have a material adverse impact on the fair value of the Company's
investment portfolio while increasing the costs associated with its lease
commitments. Conversely, declines in interest rates could have a material
impact on interest earnings for the Company's investment portfolio. The Company
does not currently hedge these interest rate exposures.
The following table presents the hypothetical changes in fair values in the
financial instruments held by the Company at December 31, 1998 that are
sensitive to changes in interest rates. These instruments are not leveraged and
are held for purposes other than trading. The modeling technique used measures
the change in fair values arising from selected potential changes in interest
rates. Market changes reflect immediate hypothetical parallel shifts in the
yield curve of plus or minus 50 basis points ("BPS"), 100BPS, and 150BPS over a
twelve-month time horizon. Beginning fair values represent the market principal
plus accrued interest and dividends for investments at December 31, 1998, which
consist entirely of obligations of states and political subdivisions. Ending
fair values comprise the market principal plus accrued interest, dividends, and
reinvestment income at a twelve-month time horizon. This table estimates the
fair value of the portfolio at a twelve-month time horizon (in thousands):
25
<PAGE>
<TABLE>
<CAPTION>
Valuation of securities No change Valuation of securities
given an interest rate in interest given an interest rate
decrease of X basis points rates increase of X basis points
-------------------------- ----------- --------------------------
<S> <C> <C> <C> <C> <C> <C>
(150 BPS) (100 BPS) (50 BPS) 50 BPS 100 BPS 150 BPS
- --------- --------- -------- ------ ------- -------
$708,723 $703,999 $699,293 $694,717 $690,092 $685,534 $680,958
</TABLE>
A 50BPS move in the Federal Funds Rate has occurred in 9 of the last 10 years;
a 100BPS move in the Federal Funds Rate has occurred in 6 of the last 10 years;
and a 150BPS move in the Federal Funds Rate has occurred in 3 of the last 10
years. The Company also is exposed to interest rate risk associated with a
lease on its facilities whose payments are tied to the London Interbank Offered
Rate (LIBOR), and has evaluated the hypothetical change in lease obligations
held at December 31, 1998 due to changes in the LIBOR rate. Market changes
reflected immediate hypothetical parallel shifts in the LIBOR curve of plus or
minus 50BPS, 100BPS, and 150BPS over a twelve-month period. The results of this
analysis were not material to the Company's financial results.
The Company also maintains investments in various privately held companies
totaling $37.0 million at December 31, 1998, and may acquire additional
investments in the future. The carrying value of these investments is subject
to potential declines in value, depending on the financial performance of the
privately held companies in which the investments are maintained. Although the
Company believes that the investments are fairly valued at cost at December 31,
1998, there can be no assurance that unanticipated declines in value will not
occur, the results of which could have a material adverse effect on the
Company's financial position and results of operations.
Prior to the acquisition of Stratus in the fourth quarter of 1998,
substantially all of the Company's sales were denominated in US dollars. With
the acquisition of Stratus, nondollar-denominated sales have increased to some
extent. Accordingly, the Company has entered into forward foreign exchange
contracts to offset the impact of currency fluctuations on certain nonfunctional
currency assets and liabilities, primarily denominated in certain European,
Japanese, Asian, and Australian currencies. The forward currency contracts
generally have original maturities of one to three months, with none having a
maturity greater than one year in length. The total notional values of forward
contracts purchased and forward contracts sold were not material at December 31,
1998, and management does not expect gains or losses on these contracts to have
a material impact on the Company's financial position and results of operations.
As a global concern, the Company faces exposure to adverse movements in
foreign currency exchange rates. These exposures may change over time as
business practices evolve and could have a material adverse impact on the
Company's financial results. Currently, the Company's primary exposures relate
to nondollar-denominated sales in Europe, Japan, the rest of Asia, and Australia
and nondollar-denominated operating expenses in Europe and Asia. The
introduction of the Euro as a common currency for members of the European
Monetary Union has not had a material effect on the Company. At the present
time, the Company hedges only those currency exposures associated with certain
known assets and liabilities, denominated in nonfunctional currencies, and does
not hedge anticipated foreign currency cash flows. The hedging activity of the
Company is intended to offset the impact of currency fluctuations on certain
nonfunctional currency assets and liabilities. The success of this activity
depends upon estimation of balances denominated in various currencies, primarily
certain European, Japanese and Australian currencies. To the extent that these
estimates are over- or understated during periods of currency volatility, the
Company could experience unanticipated currency gains or losses.
26
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ASCEND COMMUNICATIONS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Ernst & Young LLP, Independent Auditors 28
Report of Independent Accountants 29
Report of Independent Accountants 30
Consolidated Balance Sheets at December 31, 1998 and 1997 31
Consolidated Statements of Operations for the
years ended December 31, 1998, 1997 and 1996 32
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1998, 1997 and 1996 33
Consolidated Statements of Cash Flows for the
years ended December 31, 1998, 1997 and 1996 34
Notes to Consolidated Financial Statements 35
27
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Ascend Communications, Inc.
We have audited the accompanying consolidated balance sheets of Ascend
Communications, Inc. as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1998. Our audits also
included the financial statement schedule listed in the Index at Item 14. These
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. In
June 1997, the Company merged with Cascade Communications Corp. ("Cascade") in a
transaction which was accounted for as a pooling of interests. We did not audit
the financial statements of Cascade for the year ended December 31, 1996, which
statements reflect total revenues constituting 38% of the related 1996
consolidated financial statement totals. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to data included for Cascade, is based solely on the report of the other
auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Ascend Communications,
Inc. at December 31, 1998 and 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
Also, in our opinion, the financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.
ERNST & YOUNG LLP
Walnut Creek, California
January 22, 1999
28
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Cascade Communications Corp.:
We have audited the accompanying consolidated statements of income, cash flows
and stockholders' equity (none of which are presented herein) of Cascade
Communications Corp. for the year ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above of Cascade
Communications Corp. present fairly, in all material respects, the consolidated
results of operations and cash flows for the year ended December 31, 1996 in
conformity with generally accepted accounting principles.
PricewaterhouseCoopers LLP
Boston, Massachusetts
January 22, 1997,
except for Note M as to which
the date is March 30, 1997
29
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Cascade Communications Corp.:
Our report on the consolidated financial statements of Cascade Communications
Corp. (none of which are presented herein) is included in this Annual Report on
Form 10-K of Ascend Communications, Inc. In connection with our audit of such
financial statements, we have also audited the related financial statement
schedule included in the 1996 Annual Report on Form 10-K of Cascade
Communications Corp. (not separately presented herein).
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
PricewaterhouseCoopers LLP
Boston, Massachusetts
January 22, 1997
30
<PAGE>
ASCEND COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31,
-----------------------------------
1998 1997
-------------- ---------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................. $ 442,625 $ 240,817
Short-term investments.................................................... 237,330 234,610
Accounts receivable, less allowance for uncollectible accounts of
$24,467 and $11,300 at December 31, 1998 and 1997, respectively....... 390,103 234,183
Inventories............................................................... 197,896 99,637
Deferred income taxes..................................................... 151,782 85,057
Other current assets...................................................... 57,335 20,283
-------------- ---------------
Total current assets............................................... 1,477,071 914,587
Investments.................................................................... 457,387 97,212
Property and equipment, net.................................................... 282,260 114,351
Other assets................................................................... 314,760 11,744
-------------- ---------------
Total assets....................................................... $2,531,478 $1,137,894
============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................................... $ 113,060 $ 54,414
Accrued compensation and related liabilities.............................. 72,896 25,315
Other accrued liabilities................................................. 240,330 88,909
-------------- ---------------
Total current liabilities.......................................... 426,286 168,638
Deferred income taxes.......................................................... 11,048 -
Commitments and contingencies (Notes 7 and 8)
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares - 2,000
No shares issued or outstanding.................................... - -
Common stock, $.001 par value:
Authorized shares - 400,000
220,499 shares issued and outstanding (191,216 - 1997)............. 220 191
Additional paid-in capital................................................ 2,022,968 878,455
Retained earnings......................................................... 70,956 90,610
-------------- ---------------
Total stockholders' equity......................................... 2,094,144 969,256
-------------- ---------------
Total liabilities and stockholders' equity......................... $2,531,478 $1,137,894
============== ===============
</TABLE>
See accompanying notes
31
<PAGE>
ASCEND COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------
1998 1997 1996
--------------- -------------- ---------------
<S> <C> <C> <C>
Net sales..................................................... $1,478,682 $1,167,352 $ 890,273
Cost of sales................................................. 543,971 413,570 311,745
--------------- -------------- ---------------
Gross profit............................................. 934,711 753,782 578,528
Operating expenses:
Research and development................................. 216,235 155,996 93,669
Sales and marketing...................................... 302,045 249,129 156,286
General and administrative............................... 78,864 35,267 29,855
Purchased in-process research and development............ 266,953 231,100 -
Costs of mergers......................................... (18,279) 150,271 13,900
--------------- -------------- ---------------
Total operating expenses............................. 845,818 821,763 293,710
--------------- -------------- ---------------
Operating income (loss) ...................................... 88,893 (67,981) 284,818
Interest income............................................... 28,102 23,029 17,186
--------------- -------------- ---------------
Income (loss) before income taxes............................. 116,995 (44,952) 302,004
Provision for income taxes.................................... 136,649 79,422 118,114
--------------- -------------- ---------------
Net income (loss)............................................. $ (19,654) $ (124,374) $ 183,890
=============== ============== ===============
Net income (loss) per share - diluted......................... $ (0.10) $ (0.66) $ 0.94
=============== ============== ===============
Number of shares used in per share
calculation - diluted.................................... 199,291 189,129 196,246
=============== ============== ===============
Net income (loss) per share - basic........................... $ (0.10) $ (0.66) $ 1.03
=============== ============== ===============
Number of shares used in per share
calculation - basic...................................... 199,291 189,129 178,630
=============== ============== ===============
</TABLE>
See accompanying notes
32
<PAGE>
ASCEND COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Common Stock Additional
------------------------ Paid-in Retained
Shares Amount Capital Earnings Total
------------ ---------- -------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995............ 171,858 $ 172 $ 359,985 $ 51,137 $ 411,294
Tax benefit related to
stock options...................... - - 104,823 - 104,823
Effect of poolings...................... 3,129 3 12,122 (1,491) 10,634
Exercise of warrants, Netstar........... 399 - 7,904 - 7,904
Issuance of common stock
under employee stock option
and stock purchase plans........... 6,695 7 42,373 - 42,380
Issuance of common stock................ 444 - 6,308 - 6,308
Net income.............................. - - - 183,890 183,890
------------ ---------- -------------- ------------- --------------
Balance at December 31, 1996............ 182,525 182 533,515 233,536 767,233
Tax benefit related to
stock options...................... - - 59,294 - 59,294
Effect of poolings...................... 1,350 1 22,510 (18,552) 3,959
Purchase of Sahara...................... 2,386 3 213,097 - 213,100
Issuance of common stock
under employee stock option
and stock purchase plans........... 4,955 5 50,039 - 50,044
Net loss................................ - - - (124,374) (124,374)
------------ ---------- -------------- ------------- --------------
Balance at December 31, 1997............ 191,216 191 878,455 90,610 969,256
Tax benefit related to
stock options...................... - - 100,434 - 100,434
Purchase of Stratus..................... 18,134 18 836,362 - 836,380
Issuance of common stock
under employee stock option
and stock purchase plans........... 11,149 11 207,717 - 207,728
Net loss ............................... - - - (19,654) (19,654)
------------ ---------- -------------- ------------- --------------
Balance at December 31, 1998............ 220,499 $ 220 $ 2,022,968 $ 70,956 $2,094,144
============ ========== ============== ============= ==============
</TABLE>
See accompanying notes
33
<PAGE>
ASCEND COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------
1998 1997 1996
-------------- -------------- -------------
<S> <C> <C> <C>
Net income (loss)............................................. $ (19,654) $ (124,374) $ 183,890
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization.......................... 73,276 45,733 22,463
Purchased in-process research and development.......... 266,953 231,100 -
Costs of mergers....................................... (18,279) 150,271 13,900
Deferred income taxes.................................. (56,844) (29,778) (27,529)
Tax benefit related to stock options................... 100,434 59,294 104,823
Compensation related to stock options.................. 3,941 434 -
Changes in operating assets and liabilities:
Accounts receivable................................ (118,626) (58,418) (133,946)
Inventories........................................ (38,470) (42,797) (37,331)
Other current assets............................... (32,576) 6,337 (20,869)
Other assets....................................... (3,258) (2,905) (2,366)
Accounts payable and other accrued liabilities..... 77,471 (105,951) 76,901
Accrued compensation and related liabilities....... 47,581 (4,111) 1,839
-------------- -------------- -------------
Net cash provided by operating activities...... 281,949 124,835 181,775
-------------- -------------- -------------
Investing activities:
Purchases of investments............................... (1,048,751) (483,122) (268,631)
Maturities and sales of investments.................... 685,856 356,172 211,237
Investments in privately held companies................ (33,000) - (4,000)
Purchases of property and equipment, net............... (157,471) (105,343) (72,121)
Effect of business combinations........................ 269,438 (13,704) 9,169
-------------- -------------- -------------
Net cash used in investing activities.......... (283,928) (245,997) (124,346)
-------------- -------------- -------------
Financing activities:
Proceeds from issuance of common stock, net............ 203,787 49,610 54,524
Repayment of notes payable............................. - - (2,108)
-------------- -------------- -------------
Net cash provided by financing activities...... 203,787 49,610 52,416
-------------- -------------- -------------
Net increase (decrease) in cash and cash equivalents.......... 201,808 (71,552) 109,845
Cash and cash equivalents, beginning of year.................. 240,817 312,369 202,524
-------------- -------------- -------------
Cash and cash equivalents, end of year........................ $ 442,625 $ 240,817 $ 312,369
============== ============== =============
Supplemental disclosure of cash flow information:
Income tax payments.................................... $ 60,078 $ 45,395 $ 54,270
============== ============== =============
Supplemental schedule of noncash investing and financing
activities information:
Issuance of common stock for acquisitions.............. $ 836,380 $ 213,100 $ -
============== ============== =============
Exercise of warrants in exchange for retirement of
notes payable...................................... $ - $ - $ 2,068
============== ============== =============
</TABLE>
See accompanying notes
34
<PAGE>
ASCEND COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company
Ascend Communications, Inc. ("Ascend" or the "Company") develops,
manufactures and sells wide area networking solutions for telecommunications
carriers, Internet service providers and corporate customers worldwide which
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;
(iii) extensions and enhancements to corporate backbone networks that facilitate
access by remote offices, telecommuters and mobile computer users; (iv) non-stop
computing platforms and Intelligent Networking ("IN") solutions for enhanced
voice services in telephony networks; and (v) videoconferencing and multimedia
access solutions. The Company's products support existing digital and analog
networks.
In January 1999, the Company entered into an Agreement and Plan of Merger (the
"Merger Agreement") with Lucent Technologies Inc. ("Lucent"), pursuant to which
each outstanding share of Ascend common stock will be exchanged for 0.825 shares
of Lucent common stock, and each outstanding option or warrant to purchase
Ascend common stock will be converted into an option or warrant to purchase
Lucent common stock (adjusted for the exchange ratio). The merger is subject to
approval by the Company's stockholders and various regulatory agencies,
including the Department of Justice, and there can be no assurance that the
merger will be successfully completed. In the event that the merger is not
successfully completed, the Company's results of operations and common stock
price could be materially adversely affected.
2. Accounting Policies
Basis of Presentation -- The consolidated financial statements include the
accounts of Ascend and its subsidiaries. All significant intercompany
transactions and balances have been eliminated.
Cash and Cash Equivalents -- Cash and cash equivalents consist of demand
deposits and commercial paper in highly liquid short-term instruments with
original maturities of three months or less from the date of purchase and are
stated at cost, which approximates fair value. Substantially all of the
Company's cash and cash equivalents are maintained by seven major financial
institutions.
Investments -- The Company maintains its investments with various high quality
financial institutions, consistent with its investment policy objectives to
preserve principal and maintain liquidity. Management determines the
appropriate classification of debt securities at the time of purchase and re-
evaluates such designation as of each balance sheet date. At December 31, 1998
and 1997, the Company's investments were all classified as available-for-sale.
Available-for-sale securities are carried at acquired costs which approximate
fair value, determined using quoted market prices for these securities or
similar financial instruments. Unrealized gains and losses, net of tax, are
recorded in stockholders' equity until disposition. Unrealized gains and losses
were not material for 1998, 1997 and 1996. Realized gains and losses and
declines in value judged to be other than temporary on available-for-sale debt
and equity securities are included in interest and other income.
Accounts Receivable -- The Company sells and distributes a substantial
percentage of its products to ISPs, VARs and distributors, and local and long-
distance telecommunications carriers throughout North America, Europe, Asia and
the Pacific Basin. Accounts receivable are principally from these customers.
The Company conducts ongoing credit evaluations of its customers and maintains
an allowance for doubtful accounts. The Company does not require collateral and
has historically not experienced significant losses on trade receivables.
35
<PAGE>
Inventories -- Inventories are stated at the lower of cost (determined by the
first-in, first-out method) or market. The Company provides for obsolete
inventories in the period when obsolescence is determined to have occurred.
Property and Equipment -- Property and equipment are recorded at cost.
Depreciation is provided using the straight-line method over estimated useful
lives of three to four years, except for buildings and related improvements,
which are depreciated using the straight-line method over periods ranging from
fifteen to thirty-nine years.
Intangible Assets -- Intangible assets are included in other assets and are
carried at cost less accumulated amortization. Amortization of these intangible
assets is provided on the straight-line basis over the respective useful lives,
which range from three to ten years. Purchased in-process research and
development without alternative future use is expensed when acquired.
Management periodically reviews the carrying amounts of the Company's intangible
assets for indications of impairment.
Revenue Recognition -- The Company recognizes revenue from product sales upon
shipment provided that no significant customer and post-contract support
obligations remain and collection of the related receivable is deemed probable.
The Company defers recognition of revenue on initial shipments of certain new
products until such products have been tested in the marketplace. The Company
provides for potential product returns and estimated warranty costs in the
period of the sale.
Key Suppliers -- The Company is dependent on single or limited source
suppliers for certain components used in its products. The Company has
generally been able to obtain adequate supplies of these components. In
addition, the Company believes that there are alternative suppliers for the
components used in its products. However, an extended interruption in the
supply of the components currently obtained from single or limited source
suppliers could adversely affect the Company's business and results of
operations.
Stock-Based Compensation -- The Company accounts for stock-based awards to
employees under the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB
25") and has adopted the disclosure-only alternative of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation ("FAS
123").
Income Taxes -- The Company accounts for income taxes using the liability
method, in which deferred tax assets and liabilities are determined based on the
differences between financial reporting and income tax basis of assets and
liabilities. Deferred tax assets and liabilities are calculated using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse. The realization of deferred tax assets is based on
historical tax positions and expectations of future taxable income.
Segment Reporting -- In 1998, the Company adopted FAS 131, Disclosures about
Segments of an Enterprise and Related Information. FAS 131 established new
reporting requirements for public companies based on the management approach to
segment reporting. In addition, FAS 131 also established new reporting
requirements for disclosures about products and services, geographical areas,
and major customers. Note 9 to the consolidated financial statements contains a
summary of the disclosures required by FAS 131.
Recent Accounting Pronouncements -- In June 1998, the Financial Accounting
Standards Board issued FAS 133, Accounting for Derivative Instruments and
Hedging Activities. FAS 133, which will be adopted by the Company in 2000,
requires all derivative financial instruments to be recorded on the balance
sheet at fair value, and also establishes new requirements for accounting for
various types of hedging activity. The adoption of FAS 133 is not expected to
have a material impact on the Company's consolidated financial position, results
of operations or cash flows.
Net Income (Loss) Per Share -- Basic net income (loss) per share is calculated
using the weighted average shares of common stock outstanding during the period.
Diluted net income (loss) per share is calculated using the weighted average
shares of common stock outstanding, plus the dilutive effect of stock
36
<PAGE>
options and warrants, calculated using the treasury stock method. For 1998 and
1997, the common stock equivalent effect of stock options and warrants (11.4
million and 10.6 million shares, respectively) has been excluded from the
calculation of diluted net loss per share, as their effect would otherwise be
anti-dilutive.
Use of Estimates -- The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Reclassifications -- Certain prior year balances have been reclassified to
conform to the current year presentation.
3. Business Combinations
Pooling of Interests Combinations
- ---------------------------------
Business combinations which were accounted for as pooling of interests are
summarized as follows (in millions):
<TABLE>
<CAPTION>
Cascade Whitetree Netstar
------- --------- -------
<S> <C> <C> <C>
Acquisition date .......................................... June 1997 April 1997 August 1996
Shares of common stock issued.............................. 66.3 1.3 3.9
Stock options and warrants assumed......................... 8.5 0.1 0.7
</TABLE>
Cascade Communications Corp. ("Cascade") was a developer and manufacturer of
wide area network switches. Whitetree, Inc. ("Whitetree") was a developer and
manufacturer of high-speed ATM switching products. NetStar, Inc. ("NetStar")
was a developer and manufacturer of high performance, high-speed IP network
routers. The Company's historical financial results were restated for each
pooling of interest business combination, except in the case of Whitetree, where
the results of the acquired entity were not material to the Company's
consolidated results.
37
<PAGE>
Purchase Combinations
- ---------------------
Business combinations which were accounted for as a purchase are summarized as
follows (in millions):
<TABLE>
<CAPTION>
Stratus InterCon Sahara
------- -------- ------
<S> <C> <C> <C>
Acquisition date.......................................... October 1998 February 1997 January 1997
Purchase price ........................................... $ 916.7 $ 21.6 $ 219.0
Consideration
Shares of common stock issued........................... 18.1 - 2.4
Fair value of common stock issued....................... $ 808.7 $ - $ 196.8
Fair value of common stock options assumed.............. $ 27.7 $ - $ 22.2
Cash paid............................................... $ - $ 12.0 $ -
Liabilities assumed..................................... $ 80.3 $ 9.6 $ -
Allocation of purchase price
Net tangible assets..................................... $ 400.2 $ 0.6 $ 6.0
Assets held for sale.................................... $ 116.0 $ - $ -
Purchased in-process research and development........... $ 267.0 $ 18.0 $ 213.0
Existing technology..................................... $ 130.0 $ 3.0 $ -
Assembled work force.................................... $ 3.5 $ - $ -
Amortization period - existing technology (years)....... 10 3 -
Amortization period - assembled work force (years)...... 3 - -
</TABLE>
Stratus Computer, Inc. ("Stratus") was a manufacturer of fault-tolerant
computer systems. InterCon Systems Corporation ("InterCon") was a developer of
remote access client software products. Sahara Networks, Inc. ("Sahara") was a
privately held developer of scaleable high-speed broadband access products.
Sahara was acquired by Cascade, which was subsequently acquired by the Company.
For business combinations accounted for as a purchase, the Company's
consolidated financial statements include the operating results from the date of
acquisition. The amounts allocated to purchased in-process research and
development were determined using the discounted cash flow method and were
expensed upon acquisition because technological feasibility had not been
established and no future alternative uses existed.
Prior to the consummation of the acquisition of Stratus, the Company announced
its intention to divest the non-telecommunication business units of Stratus,
which consist of the Enterprise computer business unit, two business units
comprised of financial and enterprise software (TCAM and S2), and a software
joint venture interest (Astria). Accordingly, these business units were
recorded at their estimated fair value upon acquisition and are classified as
assets held for sale at December 31, 1998. Operating losses totaling $16.0
million related to these business units were excluded from the Company's
consolidated results of operations and treated as a reduction in the carrying
value of the assets held for sale. In January and February 1999, the Company
entered into definitive agreements to divest each of these business units, for a
combined total of approximately $165 million. The following summary of the
unaudited pro forma combined results of Ascend and Stratus (as if the
acquisition had occurred on January 1, 1997) excludes the results of operations
for the acquired business units held for sale (thousands, except per share
data):
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1998 1997
----------------- ----------------
(unaudited) (unaudited)
<S> <C> <C>
Net sales................................. $ 1,647,075 $ 1,470,152
Operating income (loss)................... 74,684 (45,556)
Net loss.................................. (20,337) (102,637)
Net loss per share - basic and diluted.... (0.10) (0.50)
</TABLE>
38
<PAGE>
Included in the liabilities assumed are $49.3 million of accrued merger costs,
which consist of $7.6 million of merger transaction costs and $41.7 million of
integration expenses. Integration expenses consist of $2.4 million for
severance and outplacement costs, $34.8 million for costs associated with the
divestiture of the non-telecommunications business units, and $4.5 million of
other merger related costs.
The purchase price allocation for the Stratus acquisition is tentative and will
be adjusted based on certain factors, including the value received for the
business units held for sale. Accordingly, the purchase price allocation will
be adjusted during the first or second quarter of 1999.
4. Balance Sheet Details (in thousands)
Investments consist of:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------
1998 1997
--------------- ---------------
<S> <C> <C>
States and political subdivisions................................... $ 694,717 $ 277,251
Corporate securities................................................ - 32,185
U.S. government .................................................... - 22,386
--------------- ---------------
$ 694,717 $ 331,822
=============== ===============
</TABLE>
Contractual maturity of investments:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------
1998 1997
--------------- ---------------
<S> <C> <C>
Less than one year................................................. $ 237,330 $ 234,610
One year to five years............................................. 450,287 73,612
Five years to ten years............................................ 7,100 23,600
--------------- ---------------
$ 694,717 $ 331,822
=============== ===============
</TABLE>
Inventories consist of:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------
1998 1997
--------------- ---------------
<S> <C> <C>
Finished goods.................................................... $ 66,199 $ 18,053
Products in process............................................... 59,285 15,579
Raw materials and supplies........................................ 72,412 66,005
--------------- ---------------
$ 197,896 $ 99,637
=============== ===============
</TABLE>
39
<PAGE>
Property and equipment consist of:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------
1998 1997
--------------- ---------------
<S> <C> <C>
Land and buildings................................................... $ 60,158 $ -
Computer equipment................................................... 223,637 87,640
Laboratory equipment................................................. 165,654 47,779
Furniture and fixtures............................................... 79,169 38,009
--------------- ---------------
528,618 173,428
Less accumulated depreciation........................................ (246,358) (59,077)
--------------- ---------------
$282,260 $114,351
=============== ===============
</TABLE>
Other assets consist of:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------
1998 1997
--------------- ---------------
<S> <C> <C>
Intangible assets - Stratus acquisition,
net of accumulated amortization of $2,284 ......................... $ 131,257 $ -
Assets held for sale - Stratus acquisition........................... 116,013 -
Investments in privately held companies.............................. 37,000 4,000
Other assets ........................................................ 30,490 7,744
--------------- ---------------
$ 314,760 $ 11,744
=============== ===============
</TABLE>
Other accrued liabilities consist of:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------
1998 1997
--------------- ---------------
<S> <C> <C>
Income taxes payable................................................. $ 82,885 $ 9,432
Accrued merger costs - Stratus acquisition........................... 49,234 -
Other accrued liabilities............................................ 77,364 57,421
Customer deposits.................................................... 30,847 22,056
--------------- ---------------
$ 240,330 $ 88,909
=============== ===============
</TABLE>
5. Income Taxes
The following is a geographical breakdown of consolidated income (loss) before
income taxes (including intercompany revenue and expenses) by income tax
jurisdiction (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------
1998 1997 1996
--------------- --------------- --------------
<S> <C> <C> <C>
United States............................................ $ 101,934 $ (50,392) $ 299,355
Foreign.................................................. 15,061 5,440 2,649
--------------- --------------- --------------
$ 116,995 $ (44,952) $ 302,004
=============== =============== ==============
</TABLE>
40
<PAGE>
Significant components of the provision for income taxes are as follows (in
thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Current:
Federal..................................................... $ 164,008 $ 89,899 $ 121,975
State....................................................... 24,601 17,338 22,728
Foreign..................................................... 4,884 1,963 940
------------- ------------- -------------
Total current...................................................... 193,493 109,200 145,643
Deferred:
Federal..................................................... (49,584) (25,381) (23,985)
State....................................................... (7,260) (4,397) (3,544)
------------- ------------- -------------
Total deferred..................................................... (56,844) (29,778) (27,529)
------------- ------------- -------------
Total provision for income taxes................................... $ 136,649 $ 79,422 $ 118,114
============= ============= =============
</TABLE>
A reconciliation of income taxes at the statutory federal income tax rate to
the provision for income taxes included in the accompanying statements of
operations is as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
US federal taxes at statutory rate............................... $ 40,948 $ (15,733) $ 105,701
State taxes, net of federal benefit.............................. 17,254 12,941 16,545
Tax-exempt interest.............................................. (7,589) (4,552) (3,168)
Foreign Sales Corporation........................................ (2,454) (3,465) (5,304)
Non-deductible purchased research and development................ 93,434 74,585 -
Non-deductible merger expenses................................... - 15,682 2,625
Research and development tax credits............................. (5,250) (1,316) -
Other............................................................ 306 1,280 1,715
------------ ------------ ------------
Total provision for income taxes................................. $ 136,649 $ 79,422 $ 118,114
============ ============ ============
Effective tax rate, excluding acquisition related
non-deductible charges......................................... 35.6% 37.3% 38.2%
============ ============ ============
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's net deferred tax assets are as follows (in thousands):
41
<PAGE>
<TABLE>
<CAPTION>
December 31,
--------------------------------------
1998 1997
------------- -------------
<S> <C> <C>
Deferred tax assets:
Allowance for uncollectible accounts............................ $ 15,557 $ 11,147
Reserve for warranties and inventories.......................... 38,243 33,992
Deferred revenue and customer deposits.......................... 45,770 8,736
Net operating loss and tax credit carryovers
of acquired companies....................................... 28,487 12,799
Accrued liabilities............................................. 30,356 6,934
Other........................................................... 4,006 11,449
------------- -------------
Total deferred tax assets............................................ 162,419 85,057
Deferred tax liability - non-amortizable intangibles................. (11,048) -
------------- -------------
Total net deferred tax assets........................................ $ 151,371 $ 85,057
============= =============
Recorded as:
Current deferred tax assets..................................... $ 151,782 $ 85,057
Non-current deferred tax assets................................. 10,637 -
Non-current deferred tax liabilities............................ (11,048) -
------------- -------------
Total net deferred tax assets....................................... $ 151,371 $ 85,057
============= =============
</TABLE>
The Company has federal net operating loss carryforwards attributable to
acquired subsidiaries of approximately $31.8 million which will expire in
various amounts beginning in 2007. The Company also has tax credit
carryforwards attributable to acquired subsidiaries of approximately $15.5
million which will expire in various amounts beginning in 2005.
As of December 31, 1998, taxes are not provided on approximately $311 million
of unremitted earnings of certain subsidiaries outside the United States. Such
earnings are considered to be permanently invested in operations outside the
United States. If these earnings are remitted in the form of dividends or
otherwise, the Company will potentially be subject to both U.S. income taxes and
foreign withholding taxes less an adjustment for applicable foreign tax credits.
It is not practical to estimate the amount of taxes payable on these foreign
earnings.
6. Stockholders' Equity
Preferred Stock -- The Company's Board of Directors has the authority to issue
up to 2,000,000 shares of preferred stock in one or more series and to fix the
rights, preferences, privileges and restrictions of ownership. At December 31,
1998 and 1997, there were no outstanding shares of preferred stock.
Employee Stock Purchase Plan -- The Company has an Employee Stock Purchase
Plan under which eligible employees may purchase common stock at a price equal
to 85% of the lower of the fair market value of the common stock at the
beginning or end of each six-month offering period. Participation is limited to
10% of an employee's compensation (not to exceed amounts allowed by the Internal
Revenue Code). A total of 2,800,000 shares of common stock have been reserved
for issuance under this plan. During 1998, 1997 and 1996, 335,212, 96,242 and
86,870 shares of common stock were issued under this plan, respectively.
Stock Option Plans -- The Company has various stock option plans, including
those assumed from companies acquired, under which a total of approximately
75,000,000 shares of common stock were originally reserved for issuance to
employees, officers, directors and consultants of the Company. Options
typically vest ratably over four years from the date of grant. In the event
option holders cease to be
42
<PAGE>
employed by the Company, all unvested options are forfeited and typically all
vested options may be exercised within a 30-day period after termination. As
of December 31, 1998, options to purchase approximately 2,894,336 shares of
common stock were available for grant under these plans.
Stock options under these plans are typically granted at not less than the
fair market value of common stock on the date of grant. All options expire no
later than ten years from the date of grant, except options granted to 10%
stockholders, which have a maximum term of five years.
In October and November 1997, the Board of Directors approved stock option
repricing programs pursuant to which all employees of the Company (excluding
certain executive officers) could elect to exchange or amend their then
outstanding employee stock options for new employee stock options having
exercise prices of $34.94 per share and $24.44 per share, respectively (equal to
the then fair market values), with exercise generally prohibited until January
19, 1998 and February 27, 1998, respectively. A total of 13,962,994 and
15,513,687 options with exercise prices ranging from $35.125 to $113.04 per
share and $24.75 to $104.46 per share, respectively, were exchanged or amended
under these programs.
Outside Directors Stock Option Plan -- In March 1994, the Board of Directors
approved an Outside Directors Stock Option Plan under which directors of the
Company who are not officers or employees of the Company may receive
nonstatutory options to purchase shares of common stock of the Company. A total
of 2,400,000 shares of common stock have been reserved for issuance under this
plan. Options granted under this plan expire no later than ten years from the
date of grant. As of December 31, 1998, options to purchase 399,000 shares were
available for grant under this plan.
1996 Restricted Stock Plan -- In October 1996, the Board of Directors approved
a Restricted Stock Plan under which employees and consultants who are not
existing officers or directors of the Company may receive common stock. A total
of 250,000 shares of common stock have been reserved for issuance under this
plan. Options granted under this plan expire no later than five years from the
date of grant. As of December 31, 1998, options to purchase 65,000 shares of
common stock were available for grant under this plan. The Company recorded
$3,941,000 and $434,000 of compensation expense related to this plan during 1998
and 1997, respectively.
Pro Forma Disclosure of the Effect of Stock-Based Compensation -- The
following table summarizes pro forma net income (loss) and net income (loss) per
share, as if the Company had elected to recognize compensation cost based on the
fair value of the options granted at grant date as prescribed by FAS 123:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Pro forma net income (loss).................................. $ (127,388) $ (275,758) $ 118,136
Pro forma net income (loss) per share - diluted.............. $ (0.64) $ (1.46) $ 0.60
Pro forma net income (loss) per share - basic................ $ (0.64) $ (1.46) $ 0.66
</TABLE>
The pro forma effect on net income (loss) and net income (loss) per share is
not expected to be indicative of the pro forma effects in future years. The fair
value of each option grant is estimated on the date of grant using the Black-
Scholes option valuation model with the following assumptions:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Expected volatility........................................... 0.61 0.66 0.61
Risk-free interest rate....................................... 5.01% 6.24% 6.20%
Expected life of options in years............................. 2.9 3.5 3.5
Expected dividend yield....................................... 0.00% 0.00% 0.00%
</TABLE>
43
<PAGE>
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in these subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not provide a reliable single measure of the
fair value of its stock options. The following table summarizes activity under
all of the Company's stock option plans from December 31, 1995 through December
31, 1998.
<TABLE>
<CAPTION>
Weighted
Average
Number of Exercise
Options Price
---------------- -------------
<S> <C> <C>
Balance at December 31, 1995................................................ 25,191,385 $ 11.66
Granted and assumed.................................................... 10,353,380 58.52
Exercised.............................................................. (6,528,853) 5.71
Canceled............................................................... (456,636) 30.85
----------------
Balance at December 31, 1996................................................ 28,559,276 29.76
Granted and assumed.................................................... 44,654,323 33.33
Exercised.............................................................. (4,775,087) 8.80
Canceled............................................................... (35,994,523) 42.53
----------------
Balance at December 31, 1997................................................ 32,443,989 23.60
Granted and assumed.................................................... 24,151,775 42.40
Exercised.............................................................. (10,813,788) 18.07
Canceled............................................................... (6,620,828) 38.47
----------------
Balance at December 31, 1998................................................ 39,161,148 $ 34.21
================
Outstanding options exercisable at December 31, 1998........................ 36,836,434 $ 34.46
================
Options available for grant at December 31, 1998............................ 3,358,336
================
</TABLE>
The weighted average fair value (using the Black-Scholes option valuation
model) of options granted during 1998, 1997 and 1996 is $18.73, $33.42 and
$29.06, respectively. The following table summarizes information concerning
currently outstanding and exercisable options:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------- ------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- ----------------------------- ---------------- ------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
$ 0.01 - $ 23.63 6,081,821 6.38 $ 13.29 5,460,911 $ 13.69
23.63 - 24.44 9,863,324 7.96 24.44 9,203,443 24.44
24.44 - 41.38 6,133,950 8.87 32.87 5,778,969 32.93
41.38 - 45.50 5,701,733 9.60 43.33 5,539,619 43.27
45.50 - 48.00 7,521,226 9.63 47.58 7,461,347 47.58
48.00 - 89.46 3,859,094 9.13 54.67 3,392,145 54.31
---------------- --------------
39,161,148 36,836,434
================ ==============
</TABLE>
44
<PAGE>
Reserved for Future Issuance -- As of December 31, 1998, the Company has
reserved the following shares of its common stock for future issuance:
<TABLE>
<S> <C>
Stock option plans........................................................................... 42,519,484
Employee Stock Purchase Plan................................................................. 2,020,996
----------------
Total shares reserved........................................................................ 44,540,480
================
</TABLE>
6. Retirement Plan
In July 1993, the Company established a retirement savings plan, which has
been qualified under Section 401(k) of the Internal Revenue Code, covering
substantially all employees who meet certain minimum eligibility requirements.
Company contributions to the plan were $4.1 million in 1998 and $2.5 million in
1997 (no contributions were made in 1996). Eligible employees can contribute
amounts to the plan via payroll withholdings, subject to certain limitations.
7. Commitments
Leases -- The Company leases facilities under noncancelable operating leases.
Rent expense on these operating leases was approximately $14.3 million, $9.2
million and $6.4 million for 1998, 1997 and 1996, respectively.
Future minimum payments under noncancelable operating leases with initial
terms of one year or more consist of the following at December 31, 1998 (in
thousands):
<TABLE>
<S> <C>
1999........................................................................... $ 20,332
2000........................................................................... 16,283
2001........................................................................... 13,410
2002........................................................................... 10,763
2003........................................................................... 9,219
2004 and beyond................................................................ 19,567
------------
Total minimum lease payments................................................... $ 89,574
============
</TABLE>
In March 1996, the Company entered into an agreement to lease its corporate
facilities located in Alameda, California; the agreement was subsequently
amended in March 1998. Certain buildings currently being used for the Company's
headquarters have been constructed on the land. The lessor has funded
approximately $42.5 million for the land and construction of the buildings. The
lease has an initial term of three years and an option to renew for two years,
subject to the lessor's consent. The rent obligation for the lease commenced in
December 1996, and was amended in March 1998. At any time during the term of
the lease, the Company may purchase the land and buildings. If the Company does
not exercise its purchase option at the end of the lease or if the Company does
not maintain certain financial and other covenants, the Company has guaranteed a
residual value relating to the land and buildings of approximately $38.2
million.
Line of Credit -- The Company has a bank line of credit for $25.0 million
which expires in June 1999. Interest is computed at the bank's prime rate or
0.5% over LIBOR, at the option of the Company. The line of credit requires the
Company to maintain certain financial ratios, minimum net worth and
profitability on a quarterly basis. There were no borrowings under the line of
credit agreement during 1998 or 1997.
45
<PAGE>
8. Litigation
On January 13, 1999, four purported class action complaints challenging the
proposed merger between Ascend and Lucent were filed in the Delaware Court of
Chancery by individuals who claim to be stockholders of Ascend. The complaints
name the Company, its directors and certain former directors of Cascade
Communications Corp. as defendants. One of the complaints also names Lucent as
a defendant. The complaints allege, among other things, that the defendants
have resolved to wrongfully allow Lucent to obtain the assets of Ascend at a
bargain price, that the defendants have breached their fiduciary duties to the
class, that action by the defendants will prevent Ascend's stockholders from
receiving a fair price for their shares, that Ascend's directors failed to make
an informed decision in recommending Lucent's offer, and that the terms of the
proposed merger fail to include appropriate mechanisms to protect Ascend's
stockholders against a decline in the price of Lucent's or Ascend's stock. The
complaint naming Lucent alleges that it aided and abetted the breaches of
fiduciary duty by the other defendants. The plaintiffs seek, among other
things, (i) a declaration that the proposed transaction is unfair, unjust and
inequitable; (ii) preliminary and permanent injunctive relief against the
consummation or closing of the proposed transaction; (iii) rescission of the
transaction in the event it is consummated; (iv) damages, (v) allowance for
plaintiffs' attorneys' fees and expenses; and, (vi) other relief as the Court
may deem just and proper.
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
the named defendants 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 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 financial position, future results of
operations or cash flows in a particular period.
The Company and various of its current and former officers and directors are
defendants in a number of consolidated class action lawsuits pending in the
United Stated District Courts for the Central District of California, which have
been 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 ("federal securities actions"). In
addition, the Company and one of its officers are defendants in a securities
action filed in the Superior Court of Alameda County, California ("state
securities action"). The state securities action purports to be brought in
behalf of all purchasers of the Company's stock between July 15, 1997 and
September 29, 1997 (excluding the defendants and parties related to them). The
lawsuits allege that the defendants violated the federal or state 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.
On August 17, 1998, the Court certified the federal securities actions as a
class action and appointed four plaintiffs to serve as class representatives.
On September 4, 1998, plaintiffs filed a second Amended and Consolidated
Complaint. On February 2, 1999, the Court issued an Order granting the motion
to dismiss and allowing plaintiffs to file an amended complaint. The state
securities action has been stayed pending resolution of the motion to dismiss in
the federal securities action.
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 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 financial position, future
results of operations or cash flows in a particular period. In connection with
these
46
<PAGE>
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.
In April 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.
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 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.
The Company is a party as a defendant in various other lawsuits, contractual
disputes and other legal claims, the results of which are not presently
determinable. 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.
9. Segment and Geographical Information
Segment Disclosures -- The Company operates in one business segment, which is
the global communications networking industry. For management purposes, the
Company is divided into three primary business units, Core Systems, Access
Switching and Enterprise Access. Revenues attributable to each business unit
are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------
1998 1997 1996
-------------- -------------- -------------
<S> <C> <C> <C>
Core Systems.............................. $ 688,889 $ 410,144 $320,498
Access Switching.......................... 603,523 605,906 427,331
Enterprise Access......................... 103,135 100,291 115,735
Other..................................... 83,135 51,011 26,709
-------------- -------------- -------------
$1,478,682 $1,167,352 $890,273
============== ============== =============
</TABLE>
For financial reporting purposes, the Core Systems and Access Switching
business units (which total approximately 87%, 87% and 84% of total revenues in
1998, 1997 and 1996, respectively) are combined into a single industry segment,
because the nature of the products and services, the production processes, types
of customers, distribution method and gross margins for these business units are
similar.
Major Customers and Revenues by Geographic Area -- One customer accounted for
13% and 17% of net sales in 1998 and 1997, respectively. No customer accounted
for more than 10% of net sales in 1996. Net sales were derived from customers
based in the following geographic areas (in thousands):
47
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------
1998 1997 1996
-------------- --------------- ---------------
<S> <C> <C> <C>
North America.................................. $1,051,160 $ 805,012 $ 576,996
Europe......................................... 184,128 157,960 129,126
Asia and Pacific Basin......................... 212,184 189,675 170,747
Latin and South America........................ 31,210 14,705 13,404
-------------- --------------- ---------------
$1,478,682 $1,167,352 $ 890,273
============== =============== ===============
</TABLE>
Substantially all of the Company's identifiable assets at December 31, 1998
and 1997 were attributable to North American operations.
10. Quarterly Information (unaudited)
The following table presents unaudited quarterly operating results for each of
the Company's eight quarters in the two-year period ended December 31, 1998 (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
Quarter Ended
----------------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
-------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
1998
Net sales........................................ $ 305,114 $ 327,355 $ 370,346 $ 475,867
Gross profit..................................... 195,304 210,236 236,902 292,269
Operating income (loss).......................... 76,933 86,352 96,168 (170,560)
Net income (loss)................................ 52,372 59,085 66,076 (197,187)
Net income (loss) per share - diluted............ 0.26 0.29 0.32 (0.92)
Net income (loss) per share - basic.............. 0.27 0.30 0.33 (0.92)
1997
Net sales........................................ $ 292,740 $ 311,693 $ 270,372 $ 292,547
Gross profit..................................... 190,353 203,016 173,191 187,222
Operating income (loss).......................... (137,745) (56,807) 57,511 69,060
Net income (loss)................................ (163,241) (48,837) 40,128 47,576
Net income (loss) per share - diluted............ (0.88) (0.26) 0.20 0.24
Net income (loss) per share - basic.............. (0.88) (0.26) 0.21 0.25
</TABLE>
In the quarter ended December 31, 1998, the Company recorded a charge for
purchased in-process research and development of $267.0 million. In the quarter
ended September 30, 1998, the Company reduced a merger accrual by $18.3 million.
In the quarter ended June 30, 1997, the Company recorded a charge for costs of
mergers of $150.3 million. In the quarter ended March 31, 1997, the Company
recorded a charge for purchased in-process research and development of $231.1
million.
48
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's directors are as follows:
<TABLE>
<CAPTION>
Name Position with the Company Age Director Since
- ---------------------------- ------------------------------------------------------ ------- ----------------------
<S> <C> <C> <C>
Mory Ejabat Director, President and Chief Executive Officer 48 1994
Betsy S. Atkins Director 42 1989
Robert K. Dahl Director 58 1995
Roger L. Evans Director 53 1989
Reed E. Hundt Director 51 1998
C. Richard Kramlich Director 63 1990
James P. Lally Director 54 1989
Martin L. Schoffstall Director 38 1996
</TABLE>
The Company's executive officers are as follows:
<TABLE>
<CAPTION>
Name Position with the Company Age Employed Since
- ---------------------------- ------------------------------------------------------ ------- ----------------------
<S> <C> <C> <C>
Michael F.G. Ashby Executive Vice President, Chief Financial Officer and 50 1997
Secretary
Roger Boyce Vice President and General Manager, Enterprise 44 1996
Networking Business Unit
Ken W. Fehrnstrom Vice President, Business Development 38 1997
James R. Hindmarch Senior Vice President, Global Operations 55 1998
Michael E. Hendren Executive Vice President, Worldwide Sales 52 1994
Robert N. Machlin Vice President, Marketing 41 1997
Bruce I. Sachs Executive Vice President and General Manager, Carrier 39 1998
Signaling and Management
Curtis N. Sanford Executive Vice President and General Manager, 40 1990
Access Switching Business Unit
Jeannette A. Symons Executive Vice President, Advanced Products and Chief 36 1989
Technical Officer
Scott D. Thompson Executive Vice President, Global Integration Services 42 1998
Donald P. Zerio Vice President and Corporate Controller 38 1998
</TABLE>
There are no family relationships among any directors or executive officers of
the Company.
Directors and Executive Officers Professional Experience
Mory Ejabat has served as President and Chief Executive Officer and as a
director of the Company since June 1995. Prior to that, Mr. Ejabat served as
the Company's President and Chief Operating Officer and as a Director from March
1994 to June 1995, as Executive Vice President from December 1992 to March 1994
and as Vice President, Operations from January 1990 to December 1992. Mr.
Ejabat has also served in various management capacities, including Vice
President for Wide Area Communications
49
<PAGE>
Products and Vice President of Development and Operations for Micom Systems,
Inc., a data communications equipment manufacturer.
Betsy S. Atkins has served as a director of the Company since August 1989.
Ms. Atkins has been a private investor and professional board member since 1993.
Prior to that, Ms. Atkins was President and Chief Executive Officer of Nellson
Candies, Inc. from 1990 to 1993. From August 1989 to January 1990, Ms. Atkins
was Vice President of Marketing and Sales for the Company. From 1987 to 1989,
Ms. Atkins served Vice President of Marketing for Unisys Corporation, a computer
manufacturer. Ms. Atkins also serves as Chairperson of the Board of Directors of
Amplitude Software Corp. and as a member of the respective Boards of Directors
of Secure Computing Corporation and Olympia Steel, Inc.
Robert K. Dahl has served as a director of the Company since July 1995. Mr.
Dahl served as the Company's Executive Vice President, Planning from October
1997 to January 1998 and as Vice President of Finance and Chief Financial
Officer from January 1994 to October 1997. Prior to joining the Company, Mr.
Dahl was a private investor and a principal in Dahl-De Vivo Management Co., a
private investment firm. Mr. Dahl also serves on the respective Boards of
Directors of the Bank of Alameda, Spear Technologies, Northpoint Communications,
Inc., Conducent Technologies, Inc., APAC Communications, Inc., Object Switch,
Inc., Momentum Business Applications, Inc. and Jovial Test Equipment, Inc.
Roger L. Evans has served as a director of the Company since April 1989. He
has been a General Partner of Greylock Limited Partnership since 1991.
Reed E. Hundt has served as a director of the Company since July 1998. Mr.
Hundt has served as a Senior Advisor at McKinsey & Company, a consulting
company, since November 1998. Mr. Hundt has been a principal at Charles Ross
Partners, LLC, a law firm, since November 1997. Prior to that time, Mr. Hundt
served as Chairman of the Federal Communications Commission from November 1993
to November 1997. Mr. Hundt also serves on the respective Boards of Directors
of Allegiance Telecom, Inc., Northpoint Communications, Inc. and Novell, Inc.
C. Richard Kramlich has served as a director of the Company since February
1990. Mr. Kramlich has been a general partner of New Enterprise Associates, a
venture capital firm, since June 1978. Mr. Kramlich also serves on the
respective Boards of Directors of Chalone, Inc., Macromedia, Inc., Silicon
Graphics, Inc. and Lumisys Incorporated.
James P. Lally has served as a director of the Company since April 1989. Mr.
Lally has been a general partner at Kleiner Perkins Caufield & Byers, a venture
capital firm, since September 1981. Mr. Lally also serves on the respective
Boards of Directors of NeoMagic Corporation and Vivid Semiconductor, Inc.
Martin L. Schoffstall has served as a director of the Company since June 1996.
Mr. Schoffstall is a founder of TimeSink Communications, Inc., an Internet
communications and advertising company, and has served as its President and
Chairman of the Board of Directors since its inception in April 1996. Mr.
Schoffstall is a co-founder of PSINet Inc. ("PSINet"), an Internet access and
service provider, and served as PSINet's Senior Vice President from February
1995 to April 1996, as director and Chief Technical Officer of PSINet from its
inception in 1988 to April 1996 and as Vice President and Treasurer of PSINet
from 1988 to February 1995. Mr. Schoffstall also serves on the respective Boards
of Directors of Go2Net, Inc., Conducent Technologies, Inc. and ICSA.
Michael F.G. Ashby joined the Company in October 1997 as Executive Vice
President and Chief Financial Officer. Prior to joining the Company, Mr. Ashby
was Vice President and Chief Financial Officer at Pacific Telesis from September
1995 to October 1997. Mr. Ashby served as Chief Financial Officer from
September 1992 to August 1995 and President and Chief Executive Officer from
January 1995 to August 1995 of Network Systems Corporation in Minneapolis.
Prior to that time, Mr. Ashby served as Chief Financial Officer of Teradata
Corporation in Los Angeles from 1988 to August 1992.
50
<PAGE>
Roger Boyce has served as the Company's Vice President and General Manager,
Enterprise Networking Business Unit since January 1996. Prior to joining the
Company, Mr. Boyce served in various management positions at AT&T from July 1985
to December 1995.
Ken W. Fehrnstrom has served as the Company's Vice President, Business
Development since April 1998. Prior to that time, Mr. Fehrnstrom served as Vice
President of Sales Operations from January 1997 to April 1998. Prior to joining
the Company, Mr. Fehrnstrom served in various executive management positions
including Worldwide Sales Operations, Business Development and Marketing for
Cisco Systems, Inc. from April 1991 to January 1997. Mr. Fehrnstrom has also
served in various capacities at Network Equipment Technologies, Inc., Ungerman-
Bass, Inc., Telco Systems, Inc. and GTE Corporation.
Michael E. Hendren has served as the Company's Executive Vice President,
Worldwide Sales since August 1998. Prior to that time, Mr. Hendren served
Senior Vice President, North American Sales and Service from December 1995 to
August 1998 and as Vice President, North American Sales from May 1994 to
December 1995. From January 1990 to April 1994, Mr. Hendren served in various
management positions, including Vice President of Sales for ACC Corp., a
communications equipment manufacturer.
James R. Hindmarch has served as the Company's Senior Vice President, Global
Operations since August 1998. Prior to joining the Company, Mr. Hindmarch
served as Senior Vice President, Operations at CIDCO Incorporated from August
1997 to August 1998 and as Senior Vice President, Operations at Power Computing
Corporation from January 1997 to August 1997. Prior to that time, Mr. Hindmarch
served as Senior Vice President, Operations at Plantronics, Inc. from August
1994 to January 1997. Mr. Hindmarch has also served in various capacities at
SuperMac Technology, Inc. and Dell Computer Corporation.
Robert N. Machlin has served as Vice President of Marketing of the Company
since June 1997. Prior to that time, Mr. Machlin served as Vice President of
Marketing of Cascade Communications Corp. from October 1994 to June 1997. Mr.
Machlin served as an independent consultant to manufacturers of networking
equipment from December 1993 to September 1994. Mr. Machlin served as Vice
President of Marketing at Coral Network Corporation from October 1992 to
November 1993 and as Vice President of Marketing at Amnet, Inc., a manufacturer
of wide area network switches, from December 1988 to October 1992.
Bruce I. Sachs has served as the Company's Executive Vice President and
General Manager, Carrier Signaling and Management since October 1998. Prior to
that, Mr. Sachs served as Chief Executive Officer of Stratus Computer, Inc. from
August 1993 to December 1995 and again from May 1997 to October 1998. Mr. Sachs
served as Executive Vice President and General Manager of the Internet/Telecom
Business Unit of Bay Networks, Inc. from December 1995 to May 1997.
Curtis N. Sanford has served as Executive Vice President and General Manager
of the Access Switching Business Unit of the Company since August 1998. Prior
to that time, Mr. Sanford served as the Company's Senior Vice President,
International Sales and General Manager of International Operations from
December 1995 to August 1998, as Vice President of International Sales from May
1994 to December 1995, as Vice President Worldwide Marketing and International
Sales from January 1993 to May 1994 and Vice President, International from
January 1990 to January 1993. From June 1980 to December 1989, Mr. Sanford
served in various positions, including Director, Far East Operations for BBN
Communications Corporation, a data communications equipment manufacturer.
Jeanette A. Symons is co-founder of the Company and has served as Executive
Vice President of Advanced Products and Chief Technical Officer since June 1995.
Prior to that time, Ms. Symons served as Vice President of Engineering for the
Company from January 1994 to June 1995 and served in various other management
positions with the Company from 1989 to 1993. Ms. Symons served as a software
engineer from October 1983 to December 1988 for Hayes Microcomputer, where she
developed and managed its ISDN program.
Scott D. Thompson has served as Executive Vice President, Global Integration
Services since June 1998. Prior to joining the Company, Mr. Thompson served as
Vice President, Global Service and
51
<PAGE>
Solutions at Compaq Computer Corporation from June 1997 to June 1998. Prior to
that time, Mr. Thompson served as President and General Manager, Asia Pacific at
Tandem Computers Incorporated for 17 years.
Donald P. Zerio joined the Company in November 1998 as Vice President and
Corporate Controller. Prior to joining the Company, Mr. Zerio served as the
International Controller for Linear Technology Corporation from January 1997 to
November 1998. From November 1992 to October 1996, Mr. Zerio served in various
management positions for Conner Peripherals, Inc., most recently as the
Assistant Corporate Controller. Mr. Zerio was a certified public accountant
with Price Waterhouse from 1984 to 1992.
Board of Directors' Meetings and Committees
During 1998, the Board of Directors held eleven meetings. No incumbent
director serving on the Board of Directors in 1998 attended fewer than 75% of
such meetings of the Board of Directors and the Committees on which he or she
serves. The Company has an Audit Committee and a Compensation Committee.
The Audit Committee's function is to review with the Company's independent
auditors and management the annual financial statements and independent
auditors' opinion, review the scope and results of the examination of the
Company's financial statements by the independent auditors, approve all
professional services and related fees performed by the independent auditors,
recommend the retention of the independent auditors to the Board of Directors,
subject to ratification by the stockholders, and periodically review the
Company's accounting policies and internal accounting and financial controls.
Effective May 1998, the members of the Audit Committee are Messrs. Dahl and
Lally. During 1998, the Audit Committee held three meetings.
The Compensation Committee's function is to review and establish salary levels
for executive officers and certain other management employees and to grant stock
options. The members of the Compensation Committee are Ms. Atkins and Mr.
Kramlich. During 1998, the Compensation Committee held three meetings.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act of 1934, as amended, requires the Company's
directors, executive officers and holders of more than 10% of the Company's
outstanding shares of common stock (collectively, "Reporting Persons") to file
with the Securities and Exchange Commission (the "Commission") initial reports
of ownership and reports of changes in ownership of common stock of the Company.
Such persons are required by regulations of the Commission to furnish the
Company with copies of all such filings. Based on its review of the copies of
such filings received by it with respect to the fiscal year ended December 31,
1998 and written representations from certain Reporting Persons, the Company
believes that all Reporting Persons complied with all Section 16(a) filing
requirements in the fiscal year ended December 31, 1998, with the following
exception: Roger Evans, Director, filed a late Form 5 in February 1999,
reporting a transaction occurring in 1998.
52
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
Executive Compensation Summary
The following table sets forth summary information concerning the annual and
long-term compensation paid or earned for services rendered to the Company
during the years ended December 31, 1998, 1997 and 1996 to the Company's Chief
Executive Officer and each of the four most highly compensated executive
officers of the Company in the year ended December 31, 1998 (the "Named
Executive Officers").
Summary Compensation Table (1)
<TABLE>
<CAPTION>
Compensation
------------------------------------------------------- Long Term
Annual Compensation Compensation
------------------------------------------------------- Awards
Name and Principal Position Year Salary ($) Bonus ($) Options (#)
- ------------------------------------ ------------- ------------------- ---------------- ---------------------
(2) (3)
<S> <C> <C> <C> <C>
Mory Ejabat 1998 525,732 525,000 300,000
President and Chief 1997 426,464 238,000 300,000
Executive Officer 1996 327,928 487,500 400,000
Michael E. Hendren 1998 464,846 -- 150,000
Executive Vice President, 1997 357,216 -- 75,000
Worldwide Sales 1996 325,227 -- 150,000
Michael F.G. Ashby 1998 325,000 325,000 150,000
Executive Vice President and 1997 50,000 125,480 200,000
Chief Financial Officer 1996 -- -- --
Jeanette A. Symons 1998 275,000 395,000 150,000
Executive Vice President, 1997 250,000 120,000 225,000
Advanced Products and 1996 200,000 300,000 300,000
Chief Technical Officer
Scott D. Thompson 1998 233,333 313,000 210,000
Executive Vice President, 1997 -- -- --
Global Integration Services 1996 -- -- --
</TABLE>
(1) Excludes perquisites and other personal benefits, if any, the aggregate
annual amount of which for each officer was less than the lesser of
$50,000 or 10% of the total of annual salary and bonus reported.
(2) Bonuses are reported in the year earned, even if actually paid in a
subsequent year.
(3) Stock option grants made in 1996 to Mr. Ejabat, Mr. Hendren, and Ms.
Symons were canceled effective April 1997, without replacement.
53
<PAGE>
Option Grants in 1998
- ---------------------
The following table provides the specified information concerning grants of
options to purchase the Company's common stock made during 1998 to the Company's
Named Executive Officers. No stock appreciation rights were granted in 1998.
<TABLE>
<CAPTION> Potential Realizable
Number of % of Total Value of Assumed Annual
Securities Options Rates of Stock
Underlying Granted to Price Appreciation
Options Employees Exercise For Option Term (4)
Granted in Fiscal Price Expiration -----------------------------------
Name (#) Year ($/Share) Date 0% ($) 5% ($) 10% ($)
- ---------------------------- ------------ ------------ ---------- ------------ --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Mory Ejabat 300,000 (1) 1.40% 46.50 11/03/08 -- 8,773,080 22,232,707
Michael E. Hendren 150,000 (1) 0.70% 46.50 11/03/08 -- 4,386,540 11,116,354
Michael F.G. Ashby 150,000 (1) 0.70% 46.50 11/03/08 -- 4,386,540 11,116,354
Jeanette A. Symons 150,000 (1) 0.70% 46.50 11/03/08 -- 4,386,540 11,116,354
Scott D. Thompson 150,000 (2) 0.70% 42.50 05/01/08 -- 4,009,203 10,160,108
10,000 (3) 0.05% 1.00 05/01/03 415,000 532,420 674,467
50,000 (1) 0.23% 46.50 11/03/08 -- 1,462,180 3,705,451
</TABLE>
(1) Represents options granted to the Named Executive Offic above under the
Company's 1998 Stock Incentive Plan. The options vest as to 1/36th of the
subject shares upon completion of each full month of continuous employment
following the date of grant, upon the completion of one continuous year of
employment with the Company.
(2) Represents options granted to the Named Executive Officer above under the
Company's 1989 Stock Option Plan. Options generally vest, in the case of
new employees, as to 1/4th of the subject shares on the first anniversary
of the employee's hire date, and an additional 1/48th of the subject shares
upon completion of each succeeding full month of continuous employment with
the Company thereafter. Subsequent options granted to an employee
typically vest as to 1/48th of the subject shares upon completion of each
full month of continuous employment following the date of grant.
(3) Represents options granted to the Named Executive Officer above under the
Company's 1996 Restricted Stock Option Plan. The market price on the date
of grant was $42.50. The option vests as to 1/4th of the subject shares
per quarter upon the completion of continuous employment following the date
of grant.
(4) Potential gains are net of the exercise price but before taxes associated
with the exercise. Amounts represent hypothetical gains that could be
achieved for the respective options if exercised at the end of the option
term. The assumed 0%, 5% and 10% rates of stock price appreciation are
provided in accordance with the rules of the Commission and do not
represent the Company's estimate or projection of the future common stock
price. Actual gains, if any, on stock option exercises are dependent on
the future financial performance of the Company, overall market conditions
and the option holder's continued employment through the vesting period.
Option Exercises and Fiscal Year-End Values
The following table sets forth information with respect to options to purchase
the Company's common stock granted to the Company's Named Executive Officers
under the Company's 1989 Stock Option Plan, including: (i) the number of shares
of common stock purchased upon exercise of options in the fiscal year ending
December 31, 1998; (ii) the net value realized upon such exercise; (iii) the
number of unexercised options outstanding at December 31, 1998; and (iv) the
value of such unexercised options at December 31, 1998. No stock appreciation
rights were exercised or outstanding in 1998.
54
<PAGE>
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Shares Value Options at FY-End at FY-End ($)(3)
Acquired on Realized ---------------------------------- -----------------------------------
Name Exercise (#) ($)(1) Exercisable (2) Unexercisable Exercisable Unexercisable
- ---------------------- ---------------- ---------- --------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Mory Ejabat 350,000 14,217,813 1,123,843 0 41,654,106 0
Michael E. Hendren 208,541 8,411,318 296,250 0 7,330,308 0
Michael F.G. Ashby 30,000 896,250 320,000 0 9,591,875 0
Jeanette A. Symons 180,000 8,593,806 790,093 0 35,120,285 0
Scott D. Thompson 0 0 205,000 5,000 4,773,750 323,750
</TABLE>
(1) Amounts disclosed in this column do not reflect amounts actually received
by the Named Executive Officers, but are calculated based on the difference
between the fair market value of the Company's common stock on the date of
exercise and the exercise price of the options. Named Executive Officers
will receive cash only if and when they sell the common stock issued upon
exercise of the options and the amount of cash received by such individuals
is dependent on the price of the Company's common stock at the time of such
sale.
(2) Options granted under the Company's 1989 Stock Option Plan and 1998 Stock
Incentive Plan generally are exercisable immediately subject to a
repurchase right in favor of the Company which lapses as the option vests
as described in Footnotes 1 and 2 to the table entitled "Option Grants in
1998."
(3) Value is based on the difference between the option exercise price and the
fair market value at December 31, 1998, the last day during the year for
which market prices are available ($65.75 per share as quoted on the Nasdaq
National Market), multiplied by the number of shares underlying the option.
Employment Contracts and Termination and Change of Control Arrangements
Certain options granted under the Company's 1989 Stock Option Plan and the
1998 Stock Incentive Plan contain provisions pursuant to which the unvested
portions of outstanding options become immediately exercisable and fully vested
upon a merger of the Company in which the Company's stockholders do not retain,
directly or indirectly, at least a majority of the beneficial interest in the
voting stock of the Company or its successor, if the successor corporation fails
to assume the outstanding options or substitute options for the successor
corporation's stock to replace the outstanding options. The outstanding options
will terminate to the extent they are not exercised as of the consummation of
the merger, or assumed or substituted for by the successor corporation. Certain
outstanding options granted to officers and other key employees under the 1998
Stock Incentive Plan will be accelerated upon a transfer of control such that
the individual shall be entitled to an additional twelve months of vesting.
In March 1998, the Board of Directors approved certain benefits for officers
and other key employees upon a change in control of the Company in which the
Company's stockholders do not retain, directly or indirectly, greater than 55%
of the beneficial interest in the voting stock of the Company or its successor,
or there is a change of a majority of the incumbent members of the Board of
Directors of the Company or its successor. Certain outstanding options granted
to officers and other key employees will receive 12 months advancement of
vesting and, under certain circumstances, the individual may receive severance
payments for up to 18 months at the individual's current annual salary and bonus
plus certain adjustments for excess parachute excise taxes.
55
<PAGE>
Compensation Committee Interlocks and Insider Participation
During 1998, the Compensation Committee was comprised of two outside directors
of the Board of Directors, Ms. Atkins and Mr. Kramlich. No member of the
Compensation Committee was at any time during the past fiscal year an officer or
employee of the Company or any of its subsidiaries.
No executive officer of the Company served as a member of the Compensation
Committee (or other Board committee performing equivalent functions or, in the
absence of any such committee, the entire Board of Directors ) of another
entity, where an executive officer of such other entity served as a director of
the Company. In addition, no executive officer of the Company served on the
Board of Directors of another entity, one of whose executive officers served as
a member of the Compensation Committee of the Company.
Compensation of Directors
As compensation for serving on the Board of Directors, the Company pays each
non-employee director $2,000 for each meeting that they attend of the Board of
Directors. Non-employee directors are reimbursed for reasonable travel expenses
incurred for the Board of Director meetings they attend. Pursuant to the
Company's 1994 Outside Directors Stock Option Plan (the "Directors Option
Plan"), all non-employee directors of the Company are automatically granted non-
qualified stock options to purchase shares of the Company's common stock upon
their initial appointment to the Board of Directors (each, an "Initial Grant")
and then thereafter on an annual basis (each a "Subsequent Grant"). Effective
May 21, 1998, the Initial Grant is for an option to purchase 75,000 shares and
the Subsequent Grant is for an option to purchase 25,000 shares. Such options
generally become vested and exercisable in equal annual installments over a
four-year period beginning on the date of grant. The exercise price per share
of all options granted under the Directors Option Plan is equal to the fair
market value of the Company's common stock on the date of grant, and such
options expire on the date which is ten years from the date of option grant.
Options to purchase 75,000 shares at an exercise price of $48.25 per share,
150,000 shares at an exercise price of $45.4375 per share and 192,000 shares at
an exercise price of $30.0625 per share were granted in 1998.
56
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information, as of January 31, 1999,
with respect to beneficial ownership of the Company's common stock by: (i) each
person who, to the knowledge of the Company, beneficially owned more than 5% of
the shares of common stock outstanding as of such date; (ii) each director;
(iii) each executive officer identified in the Summary Compensation Table, and
(iv) all directors and executive officers as a group.
<TABLE>
<CAPTION>
Amount and
Nature of Percentage of Common
Name and Address of Beneficial Owner Ownership (1) Stock Outstanding (2)
- -------------------------------------------------------------- -------------------- ----------------------------------
<S> <C> <C>
5% Stockholders
FMR Corp. 22,016,980 (3) 9.93%
82 Devonshire Street
Boston, Massachusetts 02109
Putnam Investments, Inc. 19,824,703 (4) 8.94%
One Post Office Square
Boston, Massachusetts 02109
Directors and Executive Officers
Betsy S. Atkins 96,000 (5) *
Robert K. Dahl 81,979 (6) *
Roger L. Evans 1,067,044 (7) *
Reed E. Hundt -- *
C. Richard Kramlich 313,082 (8) *
James P. Lally 298,434 (9) *
Martin L. Schoffstall 110,037 (10) *
Mory Ejabat 1,123,843 (11) *
Michael E. Hendren 299,985 (12) *
Michael F.G. Ashby 323,200 (13) *
Jeanette A. Symons 900,757 (14) *
Scott D. Thompson 207,781 (15) *
Directors and executive officers as a group 6,384,858 (16) 2.81%
(19 persons)
</TABLE>
* Less than 1% of the total number of outstanding shares of common stock.
(1) Except as otherwise noted, each person or entity named in the table has sole
voting and investment power with respect to the shares.
(2) The number of shares of common stock deemed outstanding on January 31, 1999
includes (i) 221,651,763 shares of common stock outstanding on such date
and (ii) all options that are currently exercisable or will become
exercisable within 60 days of January 31, 1999 by the person or group in
question.
(3) Represents (i) 20,114,680 shares held by various investment companies
advised by Fidelity Management & Research Company, an investment advisor
registered under Section 203 of the Investment Advisers Act of 1940, as
amended, (the "Advisers Act"), and a subsidiary of FMR Corp.; (ii) 43,300
shares held by Fidelity American Special Situation Trust, a unit trust
advised by Fidelity International Limited ("FIL"), a non-U.S. investment
advisor, some of the shares of which are owned by shareholders of FMR Corp.,
but which is otherwise independent of FMR Corp.; (iii) 1,668,300 shares held
by certain institutional accounts advised by Fidelity Management Trust
Company, a bank as defined in Section3(a)(b) of the Securities Exchange Act
of 1934, as
57
<PAGE>
amended, and a subsidiary of FMR Corp.; and (iv) an additional 190,700
shares held by certain non-U.S. investment companies and institutional
accounts advised by FIL. Members of the Edward C. Johnson 3d family and
trusts for their benefit own approximately 49% of the voting power of FMR
Corp. and are parties to a shareholders' voting agreement regarding FMR
Corp. A partnership controlled by Edward C. Johnson 3d and members of his
family owns approximately 39.89% of the voting power of FIL. Information
stated above is based solely on a Schedule 13G filed with the Securities
and Exchange Commission on January 7, 1999.
(4) Represents (i) 16,330,474 shares held by various registered investment
companies advised by Putnam Investment Management, Inc. an investment
advisor registered under Section 203 of the Advisers Act and a subsidiary of
Putnam Investment, Inc. ("Putnam"); and (ii) 3,494,229 shares held by
certain institutional accounts advised by The Putnam Advisory Company, Inc.,
an investment adviser registered under Advisers Act and a subsidiary of
Putnam. Putnam is a subsidiary of Marsh & McLennan Companies, Inc. ("M&MC).
M&MC does not have dispository power or voting power over any of the shares
reported herein. Information stated above is based solely on a Schedule 13G
filed with the Securities and Exchange Commission on February 4, 1999.
(5) Consists of 96,000 shares of common stock issuable pursuant to stock options
that are currently exercisable or will become exercisable within 60 days of
January 31, 1999.
(6) Includes 48,000 shares of common stock issuable pursuant to stock options
that are currently exercisable or will become exercisable within 60 days of
January 31, 1999.
(7) Includes 80,238 shares of common stock held by Greylock Equity Limited
Partnership. Mr. Evans is a general partner of Greylock Equity GP Limited
Partnership, the general partner of Greylock Equity Limited Partnership. As
such Mr. Evans is entitled to an indeterminate number of these shares, but
disclaims beneficial ownership of the balance of the shares. Also includes
535 shares in the name of the Evans Children's Trust and 264,000 shares of
common stock issuable pursuant to stock options that are currently
exercisable or will become exercisable within 60 days of January 31, 1999.
(8) Includes 204,033 shares of common stock issuable pursuant to stock options
that are currently exercisable or will become exercisable within 60 days of
January 31, 1999.
(9) Includes 264,000 shares of common stock issuable pursuant to stock options
that are currently exercisable or will become exercisable within 60 days of
January 31, 1999.
(10) Includes 1,600 shares of common stock held in an irrevocable charitable
trust in which a family member of Mr. Schofstall is a trustee and Mr.
Schofstall is the beneficiary. Also includes 108,000 shares of common
stock issuable pursuant to stock options that are currently exercisable or
will become exercisable within 60 days of January 31, 1999.
(11) Consists of 1,123,843 shares of common stock issuable pursuant to stock
options that are currently exercisable or will become exercisable within 60
days of January 31, 1999.
(12) Includes 296,250 shares of common stock issuable pursuant to stock options
that are currently exercisable or will become exercisable within 60 days of
January 31, 1999.
(13) Includes 320,000 shares of common stock issuable pursuant to stock options
that are currently exercisable or will become exercisable within 60 days of
January 31, 1999.
(14) Includes 790,093 shares of common stock issuable pursuant to stock options
that are currently exercisable or will become exercisable within 60 days of
January 31, 1999.
58
<PAGE>
(15) Includes 207,500 shares of common stock issuable pursuant to stock options
that are currently exercisable or will become exercisable within 60 days of
January 31, 1999.
(16) Includes 5,153,826 shares of common stock issuable pursuant to stock
options that are currently exercisable or will become exercisable within 60
days of January 31, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain Relationships and Related Transactions
During 1994, the Company accepted full-recourse notes, bearing interest at
5.4% per annum, from certain executive officers and key employees in payment of
the exercise price for options granted in January 1994. The Company waived an
aggregate of approximately $30,000, $26,000 and $14,000 of interest which had
accrued on these notes during 1996, 1997 and 1998 respectively. The Company
received notes with principal amounts of $105,000 and $60,000 from Mr. Ejabat
and Ms. Symons, respectively. At December 31, 1998, the outstanding balances
due from Mr. Ejabat and Ms. Symons were $51,250 and $60,000, respectively.
In 1998, the Company entered into a consulting agreement with Charles Ross
Partners, LLC to perform various consulting services regarding the
telecommunications regulatory environment and policy. Mr. Reed Hundt, a
director of the Company is a principal of Charles Ross Partners, LLC. As of
December 31, 1998, the Company paid Charles Ross Partners, LLC a total of
$51,507 for services performed in 1998.
To date, the Company has made no loans to officers, directors, principal
stockholders or other affiliates except (i) advances of reimburseable expenses
and (ii) as described above. All such transactions, including loans, are
subject to approval by a majority of the Company's independent and disinterested
directors.
59
<PAGE>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K
Financial Statements
The financial statements filed as part of this report are listed on the Index
to Consolidated Financial Statements on Page 27.
Financial Statement Schedules
The following consolidated financial statement schedule of Ascend
Communications, Inc. is filed as part of this Report and should be read in
conjunction with the consolidated financial statements of Ascend Communications,
Inc.
Schedule Page
- -------- ----
II Valuation and Qualifying Accounts 65
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
Reports on Form 8-K:
On October 15, 1998, the Company filed a Report on Form 8-K announcing that
the Company had received clearance from both the United States and Foreign Anti-
Trust Regulators for its proposed merger with Stratus.
On October 23, 1998, the Company filed a Report on Form 8-K announcing that on
October 19, 1998, the Company completed its merger with Stratus. On November 3,
1998, the Company filed on Form 8-K/A an amendment to the Form 8-K previously
filed on October 23, 1998 for required financial statement disclosures.
On January 15, 1999, the Company filed a Report on Form 8-K announcing that on
January 12, 1999, the Company had entered into an agreement and plan of merger
and related stock option agreement with Lucent.
60
<PAGE>
Exhibits:
No. Description
---- --------------------------------------------------------
(15) 2.1 Agreement and Plan of Merger, dated as of
January 12, 1999, by and among
Lucent Technologies Inc., Dasher Merger Inc. and
Ascend Communications,
Inc.
(15) 2.2 Stock Option Agreement, dated as of January 12, 1999, by and
between Ascend Communications, Inc. and Lucent Technologies
Inc.
(4) 3.1 Certificate of Incorporation.
(1) 3.2 By-Laws.
(1) 10.1 First Amended and Restated 1989 Stock Option agreements used
thereunder. Plan and forms of stock option
(1) 10.2 Ascend Communications, Inc. 1994 Employee Stock Purchase
Plan.
(1) 10.3 Ascend Communications, Inc. 1994 Outside Directors Stock
Option Plan.
(1) 10.5 Lease dated August 8, 1991, by and between the Registrant
and Harbor Bay Isle Associates, the First Addendum thereto,
dated August 8, 1991, and the Second Addendum thereto, dated
February 25, 1994.
(1) 10.8 Form of Indemnity Agreement for directors and officers.
(2) 10.10 Lease Agreement, Lease Rider and Second Lease Rider, dated
May 17, 1995 by and between the Registrant and Resurgence
Properties, Inc.
(3) 10.12 Lease agreement dated March 27, 1996, by and between the
Registrant and Sumitomo Bank Leasing and Financing, Inc.
(5) 10.13 Ascend Communications, Inc. 1996 Restricted Stock Plan.
(6) 10.14 Cascade Communications Corp. Amended and Restated 1991 Stock
Plan.
(7) 10.15 Cascade Communications Corp. 1994 Employee Stock Purchase
Plan.
(7) 10.16 Cascade Communications Corp. 1994 Non-Employee Director
Stock Plan.
(7)(8)(9) 10.18 Lease dated July 27, 1993 between Glenborough Corporation
and the Registrant; as amended by the first amendment
thereto
(10) 10.19 Lease dated November 14, 1996 between the Registrant and
Nashoba View Associated, LLC.
(11) 10.20 Loan Agreement and related agreements, dated November 30,
1995, by and between the Registrant and Wells Fargo Bank
of California, as amended by the first amendment thereto,
dated October 15, 1997.
61
<PAGE>
No. Description
----- --------------------------------------------------------
(12) 10.21 Lease agreement dated March 20, 1998, by and between the
Registrant and Sumitomo Bank Leasing and Financing, Inc.
(12) 10.22 Form of Change in Control Agreement for CEO and Executive
Vice Presidents
(12) 10.23 Form of Change in Control Agreement for Vice Presidents
(13) 10.24 Ascend Communications, Inc. 1998 Stock Incentive Plan
(14) 10.25 Ascend Communications, Inc. 1998 Supplemental Stock
Incentive Plan
21.1 Subsidiaries of Ascend Communications, Inc.
23.1 Consent of Ernst & Young LLP, Independent Auditors
23.2 Consent of Independent Accountants
24.1 Power of attorney (see signature page)
27.0 Financial Data Schedule.
(1) Incorporated by reference from the Company's Registration Statement (File
No. 33-77146), effective May 12, 1994.
(2) Incorporated by reference from the Company's Form 10-Q for the quarter
ended June 30, 1995.
(3) Incorporated by reference from the Company's Form 10-Q for the quarter
ended March 31, 1996.
(4) Incorporated by reference from the Company's Form 10-Q for the quarter
ended June 30, 1996.
(5) Incorporated by reference from the Company's Form 10-K for the year ended
December 31, 1996.
(6) Incorporated by reference from Cascade Communications Corp.'s
Registration Statement on Form S-8 (File No. 33-93152) filed with the
Securities and Exchange Commission (the "Commission") on June 6, 1995.
(7) Incorporated by reference from Cascade Communications Corp.'s Registration
Statement on Form S-1 (File No. 33-79330) filed with the Commission on
May 26, 1994, as amended, which Registration Statement became effective
on July 28, 1994.
(8) Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to Cascade Communications Corp.'s Form 10-K filed for the
fiscal year ended December 31, 1994 on March 29, 1995.
(9) Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to Cascade Communications Corp.'s Form 10-K filed for the
fiscal year ended December 31, 1995 on March 1, 1996.
62
<PAGE>
(10) Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to Cascade Communications Corp.'s Form 10-K filed for the
fiscal year ended December 31, 1996 on March 14, 1997.
(11) Incorporated by reference from the Company's Form 10-K for the year ended
December 31, 1997.
(12) Incorporated by reference from the Company's Form 10-Q for the quarter
ended March 31, 1998.
(13) Incorporated by reference from the Company's Registration Statement on Form
S-8 (File No. 333-54029) filed with the Commission on June 1, 1998.
(14) Incorporated by reference from the Company's Registration Statement on Form
S-8 (File No. 333-65467) filed with the Commission on October 8, 1998.
(15) Incorporated by reference to the Company's Form 8-K filed with the
Commission on January 15, 1999.
63
<PAGE>
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 March 30, 1999 by /S/ Mory Ejabat
-------------- ----------------------------------------
Mory Ejabat, President, Chief Executive
Officer and Director
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Mory Ejabat and Michael F.G. Ashby, jointly and
severally, his attorney in fact, each with the full power of substitution, for
such person, in any and all capacities, to sign any and all amendments
(including post-effective amendments) to this report on Form 10-K, and to file
the same, with all exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission, hereby ratifying and confirming all
that each of said attorneys-in-fact and agents, or his substitute or
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
on Form 10-K has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Date March 30, 1999 by /S/ Mory Ejabat
-------------- ------------------------------------------------
Mory Ejabat, President, Chief Executive
Officer and Director
Date March 30, 1999 by /S/ Michael F.G. Ashby
-------------- ------------------------------------------------
Michael F.G. Ashby, Executive Vice President,
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)
Date March 30, 1999 by /S/ Betsy S. Atkins
-------------- ------------------------------------------------
Director
Date March 30, 1999 by /S/ Robert K. Dahl
-------------- ------------------------------------------------
Robert K. Dahl, Director
Date March 30, 1999 by /S/ Reed E. Hundt
-------------- ------------------------------------------------
Reed E. Hundt, Director
Date March 30, 1999 by /S/ C. Richard Kramlich
-------------- ------------------------------------------------
C. Richard Kramlich, Director
Date March 30, 1999 by /S/ James P. Lally
-------------- ------------------------------------------------
James P. Lally, Director
Date March 30, 1999 by /S/ Martin L. Schoffstall
-------------- ------------------------------------------------
Martin L. Schoffstall, Director
64
<PAGE>
Financial Statement Schedules
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ALLOWANCE FOR DOUBTFUL ACCOUNTS
<TABLE>
<CAPTION>
Balance of Charged to Balance at
Beginning Costs and End of
Description of Period Expenses Deductions Period
- ----------------------------- ------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Year ended December 31, 1998: $ 11,300 $ 16,810 $ (3,643) $ 24,467
============ ========== =========== ===========
Year ended December 31, 1997: $ 2,632 $ 9,300 $ (632) $ 11,300
============ ========== =========== ===========
Year ended December 31, 1996: $ 1,202 $ 1,435 $ (5) $ 2,632
============ ========== =========== ===========
</TABLE>
65
<PAGE>
EXHIBIT 21.1
ASCEND COMMUNICATIONS, INC.
SUBSIDIARIES OF ASCEND COMMUNICATIONS, INC.
(a) Ascend Foreign Sales Corporation
(b) Ascend Credit Corporation
(c) Ascend Communications Europe Limited (United Kingdom)
(d) Ascend Communications France SARL
(e) Ascend Communications Premea SARL
(f) Ascend Communications Japan KK
(g) Ascend Australia Pty. Limited (Australia)
(h) Ascend Communications GmbH (Germany)
(i) Ascend Communications (HK) Limited (Hong Kong)
(j) Ascend Communications Canada Ltd.
(k) Ascend Communications Pte. Ltd. (Singapore)
(l) Ascend Communications Benelux (Belgium)
(m) Ascend Communications Nordic AB (Sweden)
(n) Ascend Communications SRL (Italy)
(o) Ascend Communications M.E., Inc.
(p) NetStar International, Ltd.
(q) StonyBrook Services Inc.
(r) Whitetree, Inc.
(s) InterCon Systems Corporation
(t) Sahara Networks, Inc.
(u) Cascade Communications Corp.
(v) Cascade Communications Securities Corporation
(w) Cascade Communications Asia Corporation
(x) Cascade Communications HC Corporation
<PAGE>
(y) Arris Networks, Inc.
(z) Cascade Export, Inc.
(aa) Cascade Communications Limited (United Kingdom)
(ab) Cascade Communications, LTDA (Brazil)
(ac) Cascade Communications (Canada) Corp.
(ad) Cascade Communications France SARL
(ae) Stratus Computer, Inc. ("Stratus")
(af) Stratus Computer Limited (Ireland)
<PAGE>
EXHIBIT 23.1
ASCEND COMMUNICATIONS, INC.
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8) pertaining to the First Amended and Restated 1989 Stock Option Plan
and 1994 Outside Directors Stock Option Plan; 1994 Employee Stock Purchase Plan;
Individual Option Agreements Issued by Morning Star Technologies, Inc. and
Assumed by Ascend Communications, Inc.; 401(k) Savings Plan; 1996 Restricted
Stock Plan; 1989 Stock Option Plan and Individual Option Agreements Issued by
NetStar, Inc. and Assumed by Ascend Communications, Inc.; Options Granted under
the Whitetree, Inc. 1993 Incentive Stock Plan, Cascade Communications Corp.
Amended and Restated 1991 Stock Plan, Cascade Communications Corp. 1994 Non-
Employee Director Stock Option Plan, Arris Networks, Inc. 1995 Stock Option Plan
and Sahara Networks, Inc. 1995 Stock Plan and Assumed by Ascend Communications,
Inc.; 1998 Stock Incentive Plan; 1996 Restricted Stock Plan and 1994 Outside
Directors Stock Option Plan; 1998 Supplemental Stock Incentive Plan; Options
Granted under the Stratus Computer, Inc. 1983 Stock Option Plan, as Amended,
Non-Qualified Common Stock Option Plan and 1997 Non-Qualified Common Stock
Option Plan and Assumed by Ascend Communications, Inc.; and First Amended and
Restated 1989 Stock Option Plan/ (1) / and in the Registration Statements (Form
S-3) No. 333- 13377, No. 333-11091, No. 333-21751, and No. 333-32781 and in the
related Prospectuses, of Ascend Communications, Inc. of our report dated January
22, 1999, with respect to the consolidated financial statements and financial
statement schedule of Ascend Communications, Inc. included in this Annual Report
(Form 10-K) for the year ended December 31, 1998.
Walnut Creek, California ERNST & YOUNG LLP
March 26, 1999
<PAGE>
EXHIBIT 23.2
ASCEND COMMUNICATIONS, INC.
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements
on Form S-8 (File Nos. 33-82550, 33-94886, 333-00442, 333-03686, 333-10879, 333-
15697, 333-30823, 333-54029, 333-55675, 333-65467, 333-65917) and on Form S-3
(File Nos. 333-13377, 333-11091, 333-21751 and 333-32781) of Ascend
Communications, Inc. of our report dated January 22, 1997, except for note M as
to which the date is March 30, 1997, on our audit of the consolidated financial
statements and our report dated January 22, 1997 on our audit of the
consolidated financial statement schedule of Cascade Communications Corp. for
the year ended December 31, 1996, which reports are included in this Annual
Report on Form 10-K of Ascend Communications, Inc.
Boston, Massachusetts PricewaterhouseCoopers LLP
March 26, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF ASCEND COMMUNICATIONS, INC. FOR THE YEAR
ENDED DECEMBER 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000921146
<NAME> ASCEND COMMUNICATIONS, INC.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLAR
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 442,625
<SECURITIES> 237,330
<RECEIVABLES> 414,570
<ALLOWANCES> 24,467
<INVENTORY> 197,896
<CURRENT-ASSETS> 1,477,071
<PP&E> 528,618
<DEPRECIATION> 246,358
<TOTAL-ASSETS> 2,531,478
<CURRENT-LIABILITIES> 426,286
<BONDS> 0
0
0
<COMMON> 220
<OTHER-SE> 2,093,924
<TOTAL-LIABILITY-AND-EQUITY> 2,531,478
<SALES> 1,478,682
<TOTAL-REVENUES> 1,478,682
<CGS> 543,971
<TOTAL-COSTS> 543,971
<OTHER-EXPENSES> 845,818
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (28,102)
<INCOME-PRETAX> 116,995
<INCOME-TAX> 136,649
<INCOME-CONTINUING> (19,654)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (19,654)
<EPS-PRIMARY> (0.10)
<EPS-DILUTED> (0.10)
</TABLE>
