-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, O4AjXvcxqM62B/WtDeK5z1I5tqMVX5T5SEo/IB/GMRNMz9mmMRIQ09btUJu33wSm JcaB+ReGSq4mxI6KhkYrlw== 0000950172-99-000593.txt : 19990520 0000950172-99-000593.hdr.sgml : 19990520 ACCESSION NUMBER: 0000950172-99-000593 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19990519 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ASCEND COMMUNICATIONS INC CENTRAL INDEX KEY: 0000921146 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER COMMUNICATIONS EQUIPMENT [3576] IRS NUMBER: 943092033 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-23774 FILM NUMBER: 99630726 BUSINESS ADDRESS: STREET 1: 1701 HARBOR BAY PKWY CITY: ALAMEDA STATE: CA ZIP: 94502 BUSINESS PHONE: 5107696001 MAIL ADDRESS: STREET 1: ONE ASCEND PLAZA STREET 2: 1701 HARBOR BAY PARKWAY CITY: ALAMEDA STATE: CA ZIP: 94502 10-K/A 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A AMENDMENT NO. 2 (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO ________ Commission File Number: 000-23774 ASCEND COMMUNICATIONS, INC. (Exact name of registrant as specified in its charter) Delaware 94-3092033 - ------------------------------------- -------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1701 Harbor Bay Parkway, Alameda, CA 94502 - ------------------------------------------------------------------------------ (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (510) 769-6001 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 Par Value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of December 31, 1997 the approximate aggregate market value of voting stock held by non-affiliates of the Registrant was $4,320,434,003 (based upon the closing price for shares of the Registrant's Common Stock as reported by the Nasdaq National Market on that date). Shares of Common Stock held by each officer, director and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. The determination of affiliate status is not necessarily a conclusive determination for other purposes. As of February 28, 1998, 191,906,397 shares of the Registrant's Common Stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the proxy statement for the annual stockholders meeting to be held on May 21, 1998 are incorporated by reference into Part III of this Report on Form 10-K. PORTIONS AMENDED The Registrant hereby amends and restates Items 3 and 7 of this Report on Form 10-K, and Footnotes 8 and 9 to the Registrant's Consolidated Financial Statements set forth in this Report on Form 10-K, in each case as set forth below. ITEM 3. LEGAL PROCEEDINGS The Company and various of its current and former officers and directors are parties to a number of related lawsuits which purport to be class actions filed on behalf of all persons who purchased or acquired the Company's stock (excluding the defendants and parties related to them) for the period November 5, 1996 to September 30, 1997. The lawsuits, which are substantially identical, allege that the defendants violated the federal securities laws by engaging in a scheme to artificially inflate and maintain the Company's stock price by disseminating materially false and misleading information concerning its business and earnings and the development, efficiency, introduction and deployment of its digital modems based on 56K-bps technology. All of these actions are in the early stages of proceedings and the Company is currently investigating the allegations. Based on its current information, the Company believes the suits to be without merit and intends to defend itself and its officers and directors vigorously. Although it is reasonably possible the Company may incur a loss upon the conclusion of these claims, an estimate of any loss or range of loss cannot be made. No provision for any liability that may result upon adjudication has been made in the Company's consolidated financial statements. In the opinion of management, resolution of this matter is not expected to have a material adverse effect on the financial position of the Company. However, depending on the amount and timing, an unfavorable resolution of this matter could materially affect the Company's future results or cash flows in a particular period. In connection with these legal proceedings, the Company expects to incur substantial legal and other expenses. Shareholder suits of this kind are highly complex and can extend for a protracted period of time, which can substantially increase the cost of such litigation and divert the attention of the Company's management. On April 16, 1997, a civil action was filed against Sahara, its three founders and ten employees of Sahara by General Datacomm Industries, Inc. in the Superior Court for the State of Connecticut. The complaint alleges several causes of action, including: breach of contract; tortious interference with contractual relations; misappropriation of trade secrets; unfair competition and violation of the Connecticut Unfair Trade Practices Act. The plaintiff seeks relief of unspecified monetary damages, costs and injunctive relief. The Company has not yet engaged in substantive discovery and the ultimate outcome of this matter cannot yet be determined. The Company plans to vigorously defend this lawsuit. No provision for any liability that may result from the action has been recognized in the consolidated financial statements. In the opinion of management, resolution of this litigation is not expected to have a material adverse effect on the financial position of the Company. However, depending on the amount and timing, an unfavorable resolution of this matter could materially affect the Company's future results or cash flows in a particular period. On April 18, 1997, the Company received a claim and request for royalties alleging patent infringement on four separate patents. Subsequently, the claim and request for royalties was amended to include four additional patents. The Company is currently investigating the claims of such infringement and thus the ultimate outcome of this claim cannot yet be determined. Although it is reasonably possible the Company may incur a loss upon the conclusion of these claims, an estimate of any loss or range of loss cannot be made. No provision for any liability that may result from the claim has been recognized in the consolidated financial statements. In the opinion of management, resolution of this matter is not expected to have a material adverse effect on the financial position of the Company. However, depending on the amount and timing, an unfavorable resolution of this matter could materially affect the Company's future results or cash flows in a particular period. The Company is a party as a defendant in various other lawsuits, contractual disputes and other legal claims arising in the ordinary course of business, the results of which are not presently determinable. Although it is reasonably possible the Company may incur a loss upon the conclusion of these claims, an estimate of any loss or range of loss cannot be made. No provision for any liability that may result from these claims has been recognized in the consolidated financial statements. However, in the opinion of management, after consultation with legal counsel, the amount of losses that might be sustained, if any, from these lawsuits would not materially affect the Company's financial position. However, depending on the amount and timing, an unfavorable resolution of some or all of these matters could materially affect the Company's future results of operations or cash flows in a particular period. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Ascend Communications, Inc. (the "Company") develops, manufactures and sells wide area networking solutions for telecommunications carriers, Internet service providers and corporate customers worldwide that enable them to build: (i) Internet access systems consisting of point-of-presence termination ("POP") equipment for Internet service providers ("ISPs") and remote site Internet access equipment for Internet subscribers; (ii) telecommunications carrier and ISP backbone networks utilizing high speed Frame Relay, Asynchronous Transfer Mode ("ATM") and Internet Protocol ("IP") switches for application; (iii) extensions and enhancements to corporate backbone networks that facilitate access to these networks by remote offices, telecommuters and mobile computer users; and (iv) videoconferencing and multimedia access facilities. The Company's products support existing digital and analog networks. The Company acquired four companies in the year ended December 31, 1997. In February 1997, the Company purchased InterCon Systems Corporation ("InterCon"), a leading developer of remote access client software products for both corporate and ISP markets. On April 1, 1997, the Company acquired Whitetree, Inc. ("Whitetree"), a developer and manufacturer of high speed ATM switching products. On June 30, 1997, the Company acquired Cascade Communications Corp. ("Cascade"), a leading developer and manufacturer of carrier class Frame Relay, ATM and IP switching products. In January 1997, Cascade acquired Sahara Networks, Inc. ("Sahara"), a privately held developer of scaleable high-speed broadband access products (See Note 8 to the Financial Statements). Results of Operations The following table sets forth for the periods indicated the percentage of net sales represented by certain line items from the Company's consolidated statements of operations:
YEAR ENDED DECEMBER 31, ------------------------------------ 1997 1996 1995 ---------- ---------- ------- Net sales................................... 100 % 100 % 100 Cost of sales............................... 35 35 35 ------- ------ ------ Gross profit............................. 65 65 65 Operating expenses: Research and development................. 14 10 13 Sales and marketing...................... 21 18 20 General and administrative............... 3 3 6 Purchased research and development....... 20 - - Costs of mergers......................... 13 2 - ------- ------ ------ Total operating expenses.............. 71 33 39 ------- ------ ------ Operating income (loss)..................... (6) 32 26 Interest income............................. 2 2 3 ------- ------ ------ Income (loss) before income taxes........... (4) 34 29 Provision for income taxes.................. 7 13 11 ------- ------ ------ Net income (loss)........................... (11) % 21 % 18% ======= ====== ======
Years Ended December 31, 1997, 1996 and 1995 Net Sales. Net sales for 1997 increased 31% to $1.167 billion as compared to $890.3 million in 1996, which increased 210% from $287.4 million in 1995. International sales (sales outside of North America) increased to $362.3 million in 1997 as compared to $313.3 million in 1996 and to $65.5 million in 1995 and accounted for 31%, 35% and 23% of net sales in 1997, 1996 and 1995, respectively. Substantially all of the increase in sales in each period was attributable to increases in unit shipments of the Company's products. In the aggregate, average selling prices and gross margins for the Company's products were relatively constant for each period. Decreases in average selling prices for products of the Enterprise Access business unit were offset by increases in average selling prices for products of the Access Switching business unit, due primarily to the release of the higher priced MAX TNT product during the fourth quarter of 1996. The following table provides a breakdown of net sales by business unit as a percentage of total Company net sales for 1997, 1996 and 1995, respectively: YEAR ENDED DECEMBER 31, ----------------------- BUSINESS UNIT 1997 1996 1995 - ---------------------------- ------ ------ ------- Access Switching............ 52% 48% 28% Core Systems................ 35 36 46 Enterprise Access........... 9 13 22 Other....................... 4 3 4 --- --- --- Total Company............ 100% 100% 100% === === === Access Switching - The Access Switching business unit offers of the MAX family of products. MAX products accounted for 52%, 48% and 28% of total Company net sales for 1997, 1996 and 1995, respectively. The increase in unit shipments of MAX products was primarily attributable to the growth in business from ISPs and increased demand for corporate remote networking applications. Core Systems - The Core Systems business unit offers of the B-STDX family of Frame Relay switches, the CBX500 family of ATM switches and the GRF family of Internet Protocol ("IP") switches. Core Systems products accounted for 35%, 36% and 46% of total Company net sales for 1997, 1996 and 1995, respectively. The decline in Core Systems sales as a percent of net sales was primarily attributable to the increase in the sales of the MAX family of products. Enterprise Access - The Enterprise Access business unit offers the Pipeline family remote access equipment as well as the Multiband MAX family of inverse multiplexing equipment. Enterprise Access products accounted for 9%, 13% and 22% of total Company net sales for 1997, 1996 and 1995, respectively. The decline of Enterprise Access net sales as a percent of total Company net sales was primarily attributable to the increase in the sales of the MAX family of products and price reductions of the Pipeline products due to increased competition. Gross Margin. Gross margin was 65% for 1997, 1996 and 1995. In the past, gross margins have been affected by the mix of products sold and the mix of distribution channels used by the Company. In the future, the Company's gross margin may be affected by several factors, including the mix of products sold, the price of products sold, the introduction of new products with lower gross margins, the distribution channels used, price competition, increases in material costs and changes in other components of cost of sales. Research and Development. Research and development expenses increased to $156.0 million in 1997 compared to $93.7 million in 1996 and $36.1 million in 1995. These increases were primarily due to the addition of engineering personnel, payments for consulting services in connection with developing and enhancing the Company's existing and new products and payments for consulting services related to filing applications and product testing required to obtain governmental approvals to resell the Company's products outside of North America. In 1997, research and development expenses increased in part through the addition of engineering personnel as a result of the Company's mergers and acquisitions. Research and development expenses as a percent of net sales increased to 14% in 1997 from 10% in 1996 which decreased from 13% in 1995. The Company expects that spending for research and development will increase in absolute dollars in 1998 but may continue to vary as a percentage of net sales. Sales and Marketing. Sales and marketing expenses were $249.1 million, $156.3 million and $56.0 million for 1997, 1996 and 1995, respectively. These increases in expenses were primarily due to the addition of sales, marketing and technical support personnel and related commissions; expenditures for demonstration and loaner equipment used by customers; and expenses associated with opening additional sales offices in North America, Europe and Asia and the Pacific Basin. For 1997, approximately 35%, 20% and 45% of the total increase in sales and marketing expenses were attributable to each of the factors listed above, respectively. For 1996, approximately 65%, 10% and 25% of the total increase in sales and marketing expenses were attributable to each of the factors listed above, respectively. The growth in sales, marketing and technical support personnel was primarily due to the need to manage the activities of an increased number of value-added resellers, distributors, and end-user customers and to the introduction of several new products. Sales and marketing expenses as a percent of net sales increased to 21% in 1997 from 18% in 1996 which decreased from 20% in 1995. The Company expects that sales and marketing expenses will increase in absolute dollars in 1998 and may continue to vary as a percentage of net sales. General and Administrative. General and administrative expenses increased to $35.3 million in 1997 as compared to $29.9 million in 1996 and $16.1 million in 1995. These increases were primarily due to the addition of finance and administrative personnel, bonus compensation paid to the Company's employees, increased costs for insurance and contract personnel associated with information systems service and support, and increased costs associated with being a public company. General and administrative expenses as a percent of net sales were 3% in 1997 and 1996 as compared to 6% in 1995. The Company expects that spending for general and administrative activities will increase in absolute dollars in 1998 and may continue to vary as a percentage of net sales. Purchased Research and Development. Purchased research and development costs were $231.1 million for 1997. These costs were for the purchase of technology and related assets associated with the acquisitions of InterCon and Sahara during the first quarter of 1997. These acquisitions provide technology and expertise that the Company is using to enhance and expand the breadth of its offerings to end-user markets. Sahara was a developer of scaleable high speed broadband access products based in Wallingford, Connecticut. Sahara was founded in August 1995, and as of the valuation date of January 1997 had no commercially available products. Sahara was focused on developing broadband access solutions to support a wide variety of service types and interfaces, removing the requirement for multiple non-integrated switching and transmission elements. Communications providers are currently facing a diverse set of network technologies. Leased lines use time division multiplexing. Frame relay is based on frame switching, ATM uses cell relay, and the Internet typically employs routers. There is no single technology that supports all of the services in a provider's portfolio. Sahara management is convinced that broadband access solutions are needed to support a wide variety of service types and interfaces. Sahara's technology was intended to develop a cost effective access system that is designed specifically for broadband networking, is scaleable to meet growing demand and meets the highest levels of reliability. Sahara's management plans to embed broadband access technology in three products: the SA-100 Broadband Service Unit, the SA-600 Broadband Service Concentrator and the SA- 1200 Service Access Multiplexer (collectively referred to as the "SA family of products"). These three products will use interchangeable hardware and software components. In management's opinion, the SA family of products will have the power and scaleablility to address the needs of a range of requirements. The design of the products is intended to allow the ability to easily customize and upgrade the system to meet the needs of this high growth market. Sahara has had no product revenues over its existence and was a development stage enterprise at the date of acquisition. A fair value of $213.0 million was assigned to the Broadband Access technology. At the time of the valuation, management anticipated costs of approximately $4.2 million to complete the technology with completion and achievement of technological feasibility anticipated in the second calendar quarter of 1997, facilitating product release dates for the SA family of products during the second and third quarters of 1997. Material risks affecting timely completion and commercialization included successful integration of hardware and software designs, successful product testing, and achievement of operating performance requirements of regional Bell operating companies whom management expected to be significant customers of the Broadband Access Technology products. In addition, the revenue projections were based on assumptions for the total market for Broadband Access products, which is a relatively new market. To the extent that the market demand for Broadband Access products is lower than anticipated, the revenue assumptions for the products based on the Broadband Access technology will be affected, irrespective of the success of the Company's development efforts. As of the date of this filing, management continues to believe that the overall market for Broadband Access products will be a significant growth market. However, the adoption of Broadband Access Technology by the Company's customers has not occurred as rapidly as originally anticipated. In addition, the Company's development efforts have encountered certain delays. As a result, the first product based on the Broadband Access Technology was not released until the fourth quarter of 1997, and significant revenues from the products developed from the Broadband Access Technology are not expected until 1999. Cost of Mergers. For the year ended December 31, 1997, the Company charged to operations one-time merger costs of approximately $150.3 million. These costs principally related to the acquisitions of Cascade and Whitetree and consist primarily of merger transaction costs and accruals for redundant assets, redundant products, fees relating to the cancellation of certain obligations and employee severance packages. The total charge included $54.1 million relating to merger transaction costs and $96.2 million of integration expenses. Included in merger transaction costs are the following amounts: (1) $48.9 million for investment banking, legal and accounting costs, (2) $2.3 million of printing and distribution costs, and (3) $2.9 million for other miscellaneous costs. Included in integration expenses are the following amounts: (1) $7.2 million for severance and outplacement costs for employees involved in duplicate functions, including manufacturing and logistics, sales and marketing, and finance and administration, (2) $67.4 million for assets relating to duplicate product lines, and (3) $21.6 million relating to the cancellation of redundant facility leases and other contracts and obligations. In conjunction with the acquisitions of Cascade and Whitetree, certain duplicate functions were eliminated over transition periods ranging from two months to one year. These functions consisted primarily of employees involved in general corporate functions, including finance, human resources, information technology, sales and corporate marketing. In addition, manufacturing positions relating to discontinued products were also eliminated. The discontinued product lines consisted of the Arris family of remote access concentrator products acquired from Cascade, and the entire product line of Whitetree ATM switches. These product lines were eliminated and related and certain other redundant assets were immediately abandoned upon the closing of the mergers, as the Arris family of products was redundant with the Ascend MAX TNT product, and management believed that the market opportunity addressed by the Whitetree products was limited. Termination benefits actually paid to 267 employees through December 31, 1997 were $6.7 million, with the remaining balance expected to be paid during the first quarter of 1998. Facilities that were eliminated in conjunction with acquisitions of Cascade and Whitetree included the corporate headquarters facility for Cascade in Westford, Massachusetts, a previously planned facility expansion for the broadband access division of Cascade, and various duplicate sales and service offices, including those in McClean, Virginia; Schaumburg, Illinois; Dallas, Texas; White Plains, New York; and Redwood City, California. The $67.4 million charge for assets relating to redundant assets and duplicate product lines consists of the following major components: (1) $29.0 million related to fixed assets, evaluation inventory and internal systems, (2) $13.0 million for inventory relating to discontinued products, (3) $12.9 million to reserve accounts receivable relating to discontinued products, (4) $10.0 million for warranty obligations relating to discontinued products and other merger related product issues, and (5) $2.5 million for other valuation reserves. The $21.6 million reserved for the cancellation of redundant facility leases and other contracts consists of the following major components: (1) $13.6 million for purchase commitments related to discontinued products, (2) $6.4 million for redundant facilities, and (3) $1.6 million for other non-cancellable commitments. The following summarizes merger related accrual activity for the year ended December 31, 1997 (in thousands):
CASH EXPENDITURES NON-CASH ACTIVITY ------------------------------------------ ----------------- CANCELLATION OF FACILITY ASSETS MERGER SEVERANCE LEASES AND ASSOCIATED TRANSACTION AND OTHER WITH DUPLICATE COSTS OUT-PLACEMENT CONTRACTS PRODUCT LINES TOTAL ----------- ------------- ------------ ---------------- ----- 6/30/97 Balance $ 54,148 $ 7,200 $ 21,558 $ 67,365 $150,271 Cash Payments (48,073) (6,712) (6,180) - (60,965) Asset Writeoffs - - - (56,992) (56,992) 12/31/97 --------- -------- -------- --------- -------- Balance $ 6,075 $ 488 $ 15,378 $ 10,373 $ 32,314 ========= ======== ======== ========= ========
The remaining portion of the merger related accruals at December 31, 1997 was approximately $32.3 million. Total expected cash expenditures for the mergers were estimated to be approximately $82.9 million, of which approximately $61.0 million was disbursed prior to December 31, 1997. Termination benefits paid to 267 employees through December 31, 1997 were $6.7 million, with the remaining balance expected to be paid during the first quarter of 1998. For the year ended December 31, 1996, the Company charged to operations one-time merger costs of approximately $13.9 million. These costs principally related to the acquisitions of NetStar, Inc. and StonyBrook Services, Inc. during 1996 and consisted primarily of investment banking fees, professional fees and other direct costs associated with the acquisitions. Interest Income. Interest income increased to $23.0 million in 1997 compared to $17.2 million in 1996 and $8.4 million in 1995. The increase in interest income during 1997 and 1996 is due primarily to the investment of proceeds from the Company's public offering of its common stock which was completed in August 1995, proceeds from the exercise of stock options and issuance of common stock in connection with the Company's employee and outside director stock plans and cash from operations. Provision for Income Taxes. The provision for income taxes for 1997 was $79.4 million compared to $118.1 million for 1996 and $32.8 million in 1995. The Company's tax expense for 1997 was impacted by non-deductible costs associated with the acquisitions of Cascade and Whitetree and approximately $213.1 million of non-deductible purchased research and development costs associated with the acquisition of Sahara. Exclusive of the effects of these non-deductible one-time charges, the Company's effective tax rate for 1997 was 37.3%, which approximates the effective statutory federal and state income tax rates adjusted for the impact of tax exempt interest and the benefits associated with the Company's Foreign Sales Corporation. Exclusive of the effects of non-deductible one-time charges, the Company's effective tax rate was 38.2% for both 1996 and 1995. Liquidity and Capital Resources At December 31, 1997, the Company's principal sources of liquidity included $576.6 million of cash and cash equivalents, short-term investments and investments and an unsecured $25.0 million revolving line of credit which expires in June 1999. There were no borrowings or amounts outstanding under the line of credit as of December 31, 1997. The decrease in cash and cash equivalents of $71.6 million for 1997 was principally due to $246.0 million of cash used in investing activities, offset by $109.3 million of cash provided by financing activities and $65.1 million of cash provided by operations. The net cash provided by operating activities for 1997 was primarily due to net loss, adjusted for the effects of purchased research and development, costs of mergers and depreciation, offset by decreases in accounts payable and accrued liabilities and by increases in accounts receivable and inventories. Net cash used in investing activities of $246.0 million for 1997 related primarily to net purchases of investments of $127.0 million and expenditures for furniture, fixtures and equipment of $105.3 million. Financing activities provided $109.3 million for 1997, primarily due to $109.1 million of proceeds from, and tax benefits related to, stock options and issuance of common stock in connection with the Company's employee and outside director stock plans. At December 31, 1997, the Company had $745.9 million in working capital. The Company currently has no significant capital commitments other than commitments under facilities and operating leases. The Company believes that its available sources of funds and anticipated cash flow from operations will be adequate to finance current operations, anticipated investments and capital expenditures for at least the next twelve months. Factors that May Affect Future Results The Company's quarterly and annual operating results are affected by a wide variety of risks and uncertainties as discussed in the Company's Registration Statement on Form S-4/A (No. 333-25287) filed on April 22, 1997 in connection with the acquisition of Cascade. This Report on Form 10-K should be read in conjunction with such Form S-4, particularly the section entitled "Risk Factors". These risks and uncertainties include but are not limited to competition, the mix of products sold, the mix of distribution channels employed, the Company's success in developing, introducing and shipping new products, the Company's ability to attract and retain key employees, the Company's success in integrating acquired operations, the Company's dependence on single or limited source suppliers for certain components used in its products, price reductions for the Company's products, risks inherent in international sales, changes in the levels of inventory held by third-party resellers, the timing of orders from and shipments to customers, seasonality and general economic conditions. In particular, a substantial portion of the Company's sales of MAX and Pipeline products is related to the Internet industry. In North America, the Company sells a substantial percentage of its products, particularly its MAX products, to ISPs. Additionally, a substantial portion of the Company's sales of core systems products is related to the telecommunications carrier industry. In North America, the Company sells a substantial percentage of the core systems products to public carriers. There can be no assurance that these industries and their infrastructure will continue to develop or that acceptance of the Company's products by these industries will be sustained. The Company believes competition in the Internet and public carrier industry will increase significantly in the future and could adversely affect the Company's business, results of operations and financial condition. The Company has concluded the acquisition of four companies in 1997 and five companies in 1996. Achieving the anticipated benefits of these acquisitions or any other acquisitions the Company may undertake will depend in part upon whether the integration of the acquired companies' products and technologies, research and development activities, and sales, marketing and administrative organizations is accomplished in an efficient and effective manner, and there can be no assurance that this will occur. Moreover, the integration process may temporarily divert management attention from the day-to-day business of the Company. Failure to successfully accomplish the integration of the acquired companies could have a material adverse effect on the Company's business, financial condition and/or results of operations. The Company expects that its gross margins could be adversely affected in future periods by price changes as a result of increased competition. In addition, increased sales of Pipeline products as a percentage of net sales may adversely affect the Company's gross margins in future periods as these products have lower gross margins than the Company's other products. In addition, the Company's use of third parties to distribute its products to other value-added resellers may adversely affect the Company's gross margins. The Company expects that international sales will continue to account for a significant portion of the Company's net sales in future periods. International sales are subject to certain inherent risks, including unexpected changes in regulatory requirements and tariffs, difficulties in staffing and managing foreign operations, longer payment cycles, problems in collecting accounts receivable and potentially adverse tax consequences. The Company depends on third party resellers for a substantial portion of its international sales. Certain of these third party resellers also act as resellers for competitors of the Company that can devote greater effort and resources to marketing competitive products. The loss of certain of these third party resellers could have a material adverse effect on the Company's business and results of operations. Although the Company's sales are denominated in U.S. dollars, fluctuations in currency exchange rates could cause the Company's products to become relatively more expensive to customers in a particular country, leading to a reduction in sales and profitability in that country. Furthermore, future international activity may result in foreign currency denominated sales, and, in such event, gains and losses on the conversion to U.S. dollars of accounts receivable and accounts payable arising from international operations may contribute to fluctuations in the Company's results of operations. In addition, sales in Europe and certain other parts of the world typically are adversely affected in the third quarter of each calendar year as many customers reduce their business activities during the summer months. These seasonal factors may have an adverse effect on the Company's business, results of operations and financial condition. The Company typically operates with a relatively small backlog. As a result, quarterly sales and operating results generally depend on the volume of, timing of and ability to fulfill orders received within the quarter, which are difficult to forecast. In the Company's most recent quarters, the sequential sales growth slowed from prior levels, and a disproportionate share of the sales occurred in the last month of the quarter. These occurrences are extremely difficult to predict and may happen in the future. The Company's ability to meet financial expectations could be hampered if the nonlinear sales pattern continues in future periods. Accordingly, the cancellation or delay of even a small percentage of customer purchases could adversely affect the Company's results of operations in the quarter. A significant portion of the Company's net sales in prior periods has been derived from relatively large sales to a limited number of customers, and therefore the failure of the Company to secure expected large sales may have a material adverse impact on results of operations. A significant portion of the Company's expense levels is relatively fixed in advance based in large part on the Company's forecasts of future sales. If sales are below expectations in any given quarter, the adverse impact of the shortfall on the Company's operating results may be magnified by the Company's inability to adjust spending to compensate for the shortfall. The market for the Company's products is characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and short product life cycles. The introduction of new products requires the Company to manage the transition from older products in order to minimize disruption in customer ordering patterns, avoid excessive levels of older product inventories and ensure that adequate supplies of new products can be delivered to meet customer demand. Furthermore, products such as those offered by the Company may contain undetected or unresolved hardware problems or software errors when they are first introduced or as new versions are released. There can be no assurance that, despite extensive testing by the Company, hardware problems or software errors will not be found in new products after commencement of commercial shipments, resulting in delay in or loss of market acceptance. Future delays in the introduction or shipment of new or enhanced products, the inability of such products to gain market acceptance or problems associated with new product transitions could adversely affect the Company's business, results of operations and financial condition. Many computer systems were not designed to handle any dates beyond the Year 1999, and therefore computer hardware and software will need to be modified prior to the Year 2000 in order to remain functional. The Company is concerned that many enterprises will be devoting a substantial portion of their information systems spending to resolving this upcoming Year 2000 problem. This may result in spending being diverted from networking solutions over the next three years. Additionally, the Company will have to devote resources to providing the Year 2000 solution for its own products. The Year 2000 issue could lower demand for the Company's products while increasing the Company's costs. These combining factors could have a material adverse impact on the Company's financial results. The Company believes the majority of its major systems are currently Year 2000 compliant, and costs to transition the Company's remaining systems to Year 2000 compliance are not anticipated to be material. There can be no assurance that systems operated by third parties that interfere with or contain the Company's products will timely achieve Year 2000 compliance. Any failure of these third parties' systems to timely achieve Year 2000 compliance could have a material adverse effect on the Company's business, financial condition and results of operations. The Company mainly competes in four segments of the data networking market : (i) wide area network ("WAN") and Internet access, (ii) WAN and Internet backbone switching, (iii) remote LAN access and Internet subscriber access, and (iv) videoconferencing and multimedia access. The Company competes in one or more of these market segments with Cisco Systems, Inc., 3Com Corporation, Bay Networks, Inc., Newbridge Networks, Inc., Shiva Corporation, Northern Telecom, Inc., and many others. Some of these competitors have substantially greater financial, marketing and technical resources than the Company. The Company expects additional competition from existing competitors and from a number of other companies, some of which may have substantially greater financial, marketing and technical resources than the Company, that may enter the Company's existing and future markets. Increased competition could result in price reductions, reduced profit margins and loss of market share, each of which would adversely affect the Company's business, results of operations and financial condition. The Company's sales are, to a significant degree, made through telecommunications carriers, value-added resellers ("VARs") and distributors. Accordingly, the Company is dependent on the continued viability and financial stability of these companies. While the Company has contractual relationships with many telecommunications carriers, VARs and distributors, these agreements do not require these companies to purchase the Company's products and can be terminated by these companies at any time. There can be no assurance that any of the telecommunications carriers, VARs or distributors will continue to market the Company's products. The telecommunications carrier customers, to the extent they are resellers, VARs and distributors, generally offer products of several different companies, including products that are competitive with the Company's products. Accordingly, there is a risk that these companies may give higher priority to products of other suppliers, thus reducing their efforts to sell the Company's products. Any special distribution arrangement and product pricing arrangement that the Company may implement in one or more distribution channels for strategic purposes could adversely affect gross profit margins. The Company's success depends to a significant degree upon the continuing contributions of its key management, sales, marketing and product development personnel. The Company does not have employment contracts with its key personnel and does not maintain any key person life insurance policies. The loss of key personnel could adversely affect the Company. The Company is currently experiencing rapid growth and expansion, which has placed, and will continue to place, a significant strain on its administrative, operational and financial resources and increased demands on its systems and controls. This growth has resulted in a continuing increase in the level of responsibility for both existing and new management personnel. The Company anticipates that its continued growth will require it to recruit and hire a substantial number of new engineering, sales, marketing and managerial personnel. There can be no assurance that the Company will be successful at hiring or retaining these personnel. The Company's ability to manage its growth successfully will also require the Company to continue to expand and improve its operational, management and financial systems and controls and to expand its manufacturing capacity. If the Company's management is unable to manage growth effectively, the Company's business, results of operations and financial condition may be materially and adversely affected. The Company relies on a combination of patents, copyright, and trade secret laws and non-disclosure agreements to protect its proprietary technology. The Company is currently involved in patent disputes the results of which are not presently determinable. Such disputes could result in significant expenses to the Company and divert the efforts of the Company's technical management personnel. Although the Company generally uses standard parts and components for its products, certain components, including certain key microprocessors and integrated circuits, are presently available only from a single source or from limited sources. The Company has no supply commitments from its vendors and generally purchases components on a purchase order basis as opposed to entering into long term procurement agreements with vendors. The Company has generally been able to obtain adequate supplies of components in a timely manner from current vendors or, when necessary to meet production needs, from alternate vendors. The Company believes that, in most cases, alternate vendors can be identified if current vendors are unable to fulfill needs. However, delays or failure to identify alternate vendors, if required, or a reduction or interruption in supply, or a significant increase in the price of components could adversely affect the Company's revenues and financial results and could impact customer relations. The Company's common stock has experienced significant price volatility, and such volatility may occur in the future, particularly as a result of quarter-to-quarter variations in the actual or anticipated financial results of the Company or other companies in the networking industry, announcements by the Company or competitors regarding new product introductions or other developments affecting the Company and/or changes in financial estimates by public market analysts. In addition, the market has experienced extreme price and volume fluctuations that have affected the market price of many technology companies' stocks and that have been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of the Company's common stock. Recent periods of volatility in the market price of a Company's securities resulted in securities class action litigation against the Company and various officers and directors. In consideration of these factors, there can be no assurance that the Company will be able to sustain growth in revenues or profitability, particularly on a period-to-period basis. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 8. Business Combinations On June 30, 1997, the Company acquired Cascade, a developer and manufacturer of wide area network switches, in a transaction that was accounted for as a pooling of interests. The Company issued approximately 66.3 million shares of its common stock to Cascade stockholders in exchange for all outstanding Cascade shares. Outstanding options to purchase Cascade common stock were converted to options to purchase approximately 8.5 million shares of Ascend common stock. The historical consolidated financial results of Ascend for prior periods have been restated to include the financial position and results of operations of Cascade. The following table shows the historical results of Ascend and Cascade for the periods prior to the consummation of the merger of the two entities: Three Months Ended March 31, Year Ended December 31, --------- ------------------------ Revenue: 1997 1996 1995 --------- -------- -------- Ascend.................. $ 202,412 $549,297 $152,604 Cascade................. 90,328 340,976 134,834 --------- -------- -------- Total................. $ 292,740 $890,273 $287,438 ========= ======== ======== - --------------------------------------------------------------------- Net Income (loss): Ascend.................. $ 35,093 $113,111 $ 27,535 Cascade................. (198,334) 70,779 25,410 --------- -------- -------- Total................. $(163,241) $183,890 $ 52,945 ========= ======== ======== In February 1997, the Company acquired all of the outstanding stock of InterCon Systems Corporation, a developer of remote access client software products for both corporate and ISP markets, in a transaction that was accounted for as a purchase. The purchase price consisted of a cash payment of $12.0 million, the assumption of approximately $9.0 million of liabilities and transaction costs of approximately $600,000. The total purchase price of $21.6 million was allocated to the net assets acquired based upon their estimated fair market value. The estimated fair value of tangible net assets acquired was $600,000. In addition, $18.0 million of the purchase price was allocated to purchased research and development that had not reached technological feasibility and that had no alternative future use, and $3.0 million was allocated to purchased software. On April 1, 1997, the Company acquired Whitetree, Inc. ("Whitetree"), a developer and manufacturer of high speed ATM switching products, in a transaction that was accounted for as a pooling of interests. The Company issued approximately 1.3 million shares of its common stock to Whitetree shareholders in exchange for all outstanding Whitetree shares. In addition, the Company assumed all outstanding Whitetree stock options to purchase approximately 99,000 shares of the Company's stock. The results of operations of Whitetree, which have not been material in relation to those of the Company, are included in the consolidated results of operations for periods subsequent to the acquisition. The Company's historical consolidated financial statements prior to the combination have not been restated to reflect the financial results of Whitetree as these results were not material to the Company. In conjunction with the acquisitions of Cascade and Whitetree, the Company recorded one-time merger costs of approximately $150.3 million. The total charge included $54.1 million relating to merger transaction costs and $96.2 million of integration expenses. Included in integration expenses are the following amounts: (1) $7.2 million for severance and outplacement costs for approximately 275 employees involved in duplicate functions, including manufacturing and logistics, sales and marketing, and finance and administration, (2) $67.4 million for redundant assets and assets relating to duplicate product lines, and (3) $21.6 million relating to the cancellation of redundant facility leases and other contracts and obligations. In conjunction with the acquisitions of Cascade and Whitetree, certain duplicate functions were eliminated over transition periods ranging from two months to one year. These functions consisted primarily of employees involved in general corporate functions, including finance, human resources, information technology, sales and corporate marketing. In addition, manufacturing positions relating to discontinued products were also eliminated. The discontinued product lines consisted of the Arris family of remote access concentrator products acquired from Cascade, and the entire product line of Whitetree ATM switches. These product lines were eliminated and related and certain other redundant assets were immediately abandoned upon the closing of the mergers, as the Arris family of products was redundant with the Ascend MAX TNT product, and management believed that the market opportunity addressed by the Whitetree products was limited. Termination benefits actually paid to 267 employees through December 31, 1997 were $6.7 million, with the remaining balance expected to be paid during the first quarter of 1998. Facilities that were eliminated in conjunction with acquisitions of Cascade and Whitetree included the corporate headquarters facility for Cascade in Westford, Massachusetts, a previously planned facility expansion for the broadband access division of Cascade, and various duplicate sales and service offices, including those in McClean, Virginia; Schaumburg, Illinois; Dallas, Texas; White Plains, New York; and Redwood City, California. On January 28, 1997, Cascade completed its acquisition of Sahara Networks, Inc. ("Sahara"), a privately held developer of scaleable high-speed broadband access products, in a transaction that was accounted for as a purchase. Cascade issued approximately 3.4 million shares of Cascade common stock (or 2.4 million equivalent shares of the Company's common stock after exchange ratio) in exchange for all the outstanding shares of Sahara. In addition, Cascade assumed all outstanding Sahara stock options to purchase approximately 400,000 shares of Cascade common stock. The acquisition was accounted for under the purchase method of accounting. Accordingly, the purchase price of approximately $219.0 million was allocated to the net assets acquired based upon their estimated fair market value. The purchase price includes $22.2 million for the fair market value of the Sahara options assumed by Cascade. The fair value of the stock options was determined using the Black-Scholes model. The estimated fair value of the tangible net assets acquired was approximately $6.0 million. In addition, approximately $213.0 million of the purchase price was allocated to in-process research and development that had not reached technological feasibility and that had no alternative future use. Management is primarily responsible for estimating the fair value of the purchased in-process research and development ("IPRD") obtained through the acquisition of Sahara. At the date of acquisition, Sahara was a development stage enterprise that had never introduced a product to market or had any existing products that it was selling to customers. The Broadband Access Technology acquired from Sahara was being developed to provide communications providers with an enhanced access platform for a diverse set of networking technologies. The Broadband Access Technology was valued based on the income forecast method, which requires a projection of revenues and expenses specifically attributable to the intangible assets. The discounted cash flow technique was then applied to the potential income streams after making necessary adjustments with respect to such factors as the wasting nature of the acquired intangible assets, the allowance for a fair return on the net tangible and other intangible assets employed, and consideration of development cost and risk. The adjustments were made to separate the value of the specific intangible asset being valued from the portion of the purchase price that already has been allocated to the net tangible and other intangible assets employed. Significant assumptions that affected valuation of the Broadband Access Technology of Sahara included revenue and cost of completion assumptions as well as the timing of the product release. In addition, the selection of an appropriate risk adjusted discount rate was a significant assumption used in the valuation analysis. Since Sahara had no revenues prior to the acquisition, the assumptions used in the valuation for pricing, margins and expense levels were consistent with Cascade's historical experience with similar types of products. The revenue for the product categories based on the Broadband Access Technology was a key variable to the analysis. Cascade management estimated the revenue from the Broadband Access Technology in quarterly revenue projections over the expected economic life of the technology once completed. These projections reflected management's anticipated release dates in the second and third calendar quarters of 1997 for the SA- 100, SA-600 and SA-1200 product categories, all of which are expected to be based on the Broadband Access Technology. Material net cash inflows from the Broadband Access Technology were projected to commence in the first quarter of 1998. The costs of completion assumptions were based on cost analyses provided by senior management responsible for development of the Broadband Access Technology. Given the uncertainty of the development milestones, the actual costs to complete could have been significantly higher or lower than estimated depending on the relative success of the development team in addressing the outstanding technological issues of the technology. The expected timing of the product release directly affects the timing of the revenue projections. Any miscalculation of the product release date could affect the revenue projections. In addition, the revenue projections were based on assumptions for the total market for Broadband Access products, which is a relatively new market. To the extent that the market demand for Broadband Access products is lower than anticipated, the revenue assumptions for the products based on the Broadband Access technology will be affected, irrespective of the success of the Company's development efforts. In estimating an appropriate discount rate for valuing IPRD, management considered several factors. Among the factors considered were the cost of capital for the target company, and the risk associated with the IPRD project. Considering these factors, management selected a discount rate of 25% which it believes to be consistent with the risks of the IPRD. The Broadband Access Technology had not reached technological feasibility at the time of the acquisition. Furthermore, management concluded that no technologies were acquired which may have an alternative use other than their original design purposes. At the time of acquisition, Sahara had not completed its first product, and had no revenue to date. The projected development cost remaining for the Broadband Access Technology project, at the time of the acquisition, to reach technological feasibility was approximately $4.2 million. The continued development of Broadband Access Technology following the acquisition was dependent upon the successful and timely completion of various developmental milestones. In August 1996, the Company acquired NetStar, a developer and manufacturer of high performance, high speed IP network routers, in a transaction that was accounted for as a pooling of interests. The Company issued approximately 3.9 million shares of its common stock to NetStar shareholders in exchange for all outstanding NetStar shares. The Company`s historical consolidated financial statements for prior periods have been restated to reflect the financial position and results of operations of NetStar. 9. Litigation The Company and various of its current and former officers and directors are parties to a number of related lawsuits which purport to be class actions filed on behalf of all persons who purchased or acquired the Company's stock (excluding the defendants and parties related to them) for the period November 5, 1996 to September 30, 1997. The lawsuits, which are substantially identical, allege that the defendants violated the federal securities laws by engaging in a scheme to artificially inflate and maintain the Company's stock price by disseminating materially false and misleading information concerning its business and earnings and the development, efficiency, introduction and deployment of its digital modems based on 56K-bps technology. All of these actions are in the early stages of proceedings and the Company is currently investigating the allegations. Based on its current information, the Company believes the suits to be without merit and intends to defend itself and its officers and directors vigorously. Although it is reasonably possible the Company may incur a loss upon the conclusion of these claims, an estimate of any loss or range of loss cannot be made. No provision for any liability that may result upon adjudication has been made in the Company's consolidated financial statements. In the opinion of management, resolution of this matter is not expected to have a material adverse effect on the financial position of the Company. However, depending on the amount and timing, an unfavorable resolution of this matter could materially affect the Company's future results or cash flows in a particular period. In connection with these legal proceedings, the Company expects to incur substantial legal and other expenses. Shareholder suits of this kind are highly complex and can extend for a protracted period of time, which can substantially increase the cost of such litigation and divert the attention of the Company's management. On April 16, 1997, a civil action was filed against Sahara, its three founders and ten employees of Sahara by General Datacomm Industries, Inc. in the Superior Court for the State of Connecticut. The complaint alleges several causes of action, including: breach of contract; tortious interference with contractual relations; misappropriation of trade secrets; unfair competition and violation of the Connecticut Unfair Trade Practices Act. The plaintiff seeks relief of unspecified monetary damages, costs and injunctive relief. The Company has not yet engaged in substantive discovery and the ultimate outcome of this matter cannot yet be determined. The Company plans to vigorously defend this lawsuit. No provision for any liability that may result from the action has been recognized in the consolidated financial statements. In the opinion of management, resolution of this litigation is not expected to have a material adverse effect on the financial position of the Company. However, depending on the amount and timing, an unfavorable resolution of this matter could materially affect the Company's future results or cash flows in a particular period. On April 18, 1997, the Company received a claim and request for royalties alleging patent infringement on four separate patents. Subsequently, the claim and request for royalties was amended to include four additional patents. The Company is currently investigating the claims of such infringement and thus the ultimate outcome of this claim cannot yet be determined. Although it is reasonably possible the Company may incur a loss upon the conclusion of these claims, an estimate of any loss or range of loss cannot be made. No provision for any liability that may result from the claim has been recognized in the consolidated financial statements. In the opinion of management, resolution of this matter is not expected to have a material adverse effect on the financial position of the Company. However, depending on the amount and timing, an unfavorable resolution of this matter could materially affect the Company's future results or cash flows in a particular period. The Company is a party as a defendant in various other lawsuits, contractual disputes and other legal claims arising in the ordinary course of business, the results of which are not presently determinable. Although it is reasonably possible the Company may incur a loss upon the conclusion of these claims, an estimate of any loss or range of loss cannot be made. No provision for any liability that may result from these claims has been recognized in the consolidated financial statements. However, in the opinion of management, after consultation with legal counsel, the amount of losses that might be sustained, if any, from these lawsuits would not materially affect the Company's financial position. However, depending on the amount and timing, an unfavorable resolution of some or all of these matters could materially affect the Company's future results of operations or cash flows in a particular period. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ASCEND COMMUNICATIONS, INC. DATE May 19, 1999 by /s/ Mory Ejabat -------------- --------------------------------------- Mory Ejabat, President, Chief Executive Officer and Director -----END PRIVACY-ENHANCED MESSAGE-----