-----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, HNyXZ+Nj0pgsrjJ9N9tOTBkUd3UMoeCpKrCw47q3CQJamNCiYr7xR2G9SjAZMgbv cg9rixqKMRSdYqG9ViTQpQ== 0000927016-98-001193.txt : 19980330 0000927016-98-001193.hdr.sgml : 19980330 ACCESSION NUMBER: 0000927016-98-001193 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971227 FILED AS OF DATE: 19980326 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: EXCEL SWITCHING CORP CENTRAL INDEX KEY: 0001036261 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATIONS EQUIPMENT, NEC [3669] IRS NUMBER: 042992806 STATE OF INCORPORATION: MA FISCAL YEAR END: 1227 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 333-35791 FILM NUMBER: 98574863 BUSINESS ADDRESS: STREET 1: 255 INDEPENDENCE DR CITY: HYANNIS STATE: MA ZIP: 02601 BUSINESS PHONE: 5088623000 MAIL ADDRESS: STREET 1: 255 INDEPENDENCE DR CITY: HYANNIS STATE: MA ZIP: 02601 FORMER COMPANY: FORMER CONFORMED NAME: EXCEL INC DATE OF NAME CHANGE: 19970325 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 27, 1997 [_] 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 0-23263 EXCEL SWITCHING CORPORATION --------------------------- (Exact name of registrant as specified in its charter) Massachusetts 04-2992806 ------------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 255 Independence Drive ---------------------- HYANNIS, MASSACHUSETTS 02601 ---------------------------- (Address of principal executive offices) (Zip code) (508) 862-3000 -------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 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. [_] The aggregate market value of the Registrant's Common Stock, $.01 par value, held by non-affiliates of the Registrant as of March 6, 1998 was $629,092,888 based on the price of $19.25 on that date as reported on the Nasdaq National Market. As of March 6, 1998, 32,720,200 shares of the Registrant's Common Stock, $.01 par value, were issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE (1) Specified portions of the Company's Proxy Statement, which is expected to be filed within 120 days after the end of the Company's fiscal year, are incorporated by reference into Part III (Items 10, 11, 12 and 13) of this Report. 1 PART I ITEM 1. BUSINESS Information contained in this Report contains forward-looking statements such as statements of the Company's plans, objectives, expectations and intentions, that can be identified by the use of forward-looking terminology, such as "may", "will", "expect", "anticipate", "believe", "plan", "intend", "could", "estimates", "is being" or "goal" or other variations of these terms or comparable terminology. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. The cautionary statements made in this Report should be read as being applicable to all forward-looking statements whenever they appear in this Report. Factors that could cause or contribute to such differences include those discussed in the risk factors set forth in Item 7 below (the "Risk Factors") as well as those discussed elsewhere herein. Excel Switching Corporation ("Excel" or the "Company") is a leading provider of open switching platforms for telecommunications networks worldwide. The Company develops, manufactures, markets and supports a family of open, programmable, carrier-class switches that address the complex enhanced services and wireless and wireline infrastructure needs of network providers. Excel's products offer network providers the flexibility to address multiple market applications and the scalability to deploy a variety of system capacities. The Company's programmable switching platforms enable network providers to deliver improved networking functionality at a lower cost than purchasing, upgrading or reprogramming traditional, closed, central office switches. The Company's products are currently deployed in telecommunications networks in almost 60 countries throughout the world. Excel offers a family of programmable switching platforms that are designed with distributed architecture and open software to maximize performance and provide multiple levels of programmability and redundancy. Excel's open switching platforms integrate with a wide variety of host computer systems, operating systems and application development environments. The Company's product family scales from approximately 100 to 30,720 ports. Using Excel's patented Programmable Protocol Language ("PPL"), application developers can customize the switching software to their unique requirements, allowing them to introduce new services and applications rapidly. As customer requirements evolve, the Excel platform can be upgraded without requiring extensive and complex programming changes to the underlying software. The Company sells to a variety of customers in the worldwide telecommunications market. Excel's customers integrate the Company's open, programmable switching platforms with their product offerings to address a variety of market applications for network providers, ranging from enhanced services such as voice messaging, one number services and prepaid debit cards, to wireless and wireline infrastructure services such as tandem switching, mobile switching centers and intelligent base station controllers. INDUSTRY BACKGROUND Global deregulation and technological advances have led to significant change in the worldwide telecommunications market. Increased telecommunications service demand coupled with the advent of new carriers are creating an intensely competitive environment for network providers. In the United States, competition exists among the Regional Bell Operating Companies ("RBOCs"), Interexchange Carriers ("IXCs"), Local Exchange Carriers ("LECs"), Competitive Local Exchange Carriers ("CLECs"), wireless carriers and cable television broadcasters. Internationally, established network providers ("PTTs") are facing competition from emerging alternative wireless and wireline carriers. Increasing competitive pressures in the United States and internationally are forcing network providers to lower infrastructure costs, increase network flexibility and offer new and enhanced services. These challenges require network providers to deploy new services rapidly and cost-effectively, while protecting their existing infrastructure investment. Functionality of the core telecommunications switching infrastructure has not developed as quickly as network providers demand. Traditional telecommunications switches are designed for specific uses, and as a result, are time-consuming and expensive to modify for new applications. These traditional, closed switches do not provide the scalability, flexibility or cost-effectiveness to address the requirements of enhanced services or wireless and wireline 2 infrastructure. In addition, traditional switches are not compatible among vendors nor are they easily adaptable to different international network signaling requirements. Enhanced Services The evolving telecommunications environment is increasingly forcing network providers to differentiate their offerings. As network providers strive to capture or maintain market share and stimulate usage, they must offer as standard features many enhanced services that were once offered as premium applications. Enhanced services include such diverse telephony applications as voice messaging, one number services, paging, e-mail, fax messaging, unified messaging, voice recognition dialing, prepaid debit cards and conference bridging. Once deployed, enhanced services enable network providers to increase revenues through subscription fees and greater network utilization. Open, programmable switches address an emerging market for enhanced services as application developers, OEMs and systems integrators increasingly are able to develop applications that were once controlled by closed switch vendors. Systems designed by traditional switch vendors are not easily modified for enhanced services. Using open, programmable switching platforms, network providers are able to implement applications cost-effectively today that can scale as customer demand increases over time, while protecting their existing investment in legacy switches. Wireless Infrastructure Deregulation, increased consumer demand, increased competition for subscribers and price/performance improvements in service have led to rapid growth in the wireless infrastructure market. The wireless infrastructure market includes traditional cellular systems, emerging personal communication services ("PCS"), wireless local loop and mobile satellite systems. Wireless infrastructure equipment for these markets needs to address both high and low mobility wireless networks and accommodate analog and emerging digital standards such as CDMA, GSM and PCS-1900. Network providers are seeking solutions that will allow them to meet today's market demands cost-effectively while scaling to meet future requirements. Network providers also are seeking an alternative to the expensive and traditional infrastructure of the telephone network to address the local loop. As widespread replacement or installation of copper wireline remains prohibitively expensive, the market for wireless systems to provide basic telephone service has emerged. Open, programmable switches provide the speed, scalability and cost- effectiveness that wireless network providers are seeking. Programmable switches enable wireless network providers to prototype, test and deploy new wireless services in a rapid timeframe. Open, programmable switches can scale incrementally as the wireless subscriber base expands or demands more services, allowing wireless network providers to make cost-effective initial infrastructure investments. In addition, open, programmable switches enable wireless network providers to add enhanced services to their networks using the same infrastructure platform. Wireline Infrastructure Traditional switching technology has not kept pace with the new applications and service requirements generated by the rapid growth and competitive changes within the global telecommunications markets. New entrants, such as CLECs, long distance resellers and emerging international network providers, do not wish to invest in or incur the high operating costs of traditional, inflexible, single- purpose switching equipment. Many of these new network providers must initially compete with incumbent RBOCs, LECs, IXCs and PTTs for subscribers based upon lower prices and improved services. In addition, many existing network providers are expanding into new markets, such as the RBOCs entering the long distance market and the IXCs entering the local exchange market. To compete in these new markets, incumbent providers must add cost-effective switches to their current networking infrastructure. Using open, programmable switching platforms, network providers can build flexible, cost-effective wireline infrastructures which can be adapted to their specific service requirements. With open, programmable switching platforms, network providers can scale their networks as they add subscribers and implement new and enhanced services 3 using the same infrastructure. Open, programmable switches have recently been implemented in tandem switching, one-plus dialing, international call-back services and international gateway. Initial Programmable Switching Products Several companies market switching products aimed at addressing the limitations of traditional, closed switches. However, the initial switching products designed to address this opportunity have not satisfied the requirements of network providers. Initial products positioned as open, programmable switches have been configurable, but have lacked the programmability, openness, flexibility and scalability needed to address a wide range of enhanced services and wireless and wireline infrastructure requirements. The Company believes that network providers are demanding telecommunications switches that are truly open and programmable, thereby enabling them rapidly and cost-effectively to meet their enhanced services and infrastructure requirements. THE EXCEL SOLUTION Excel has developed open, programmable switching platforms that allow network providers to offer cost-effective, scalable and flexible enhanced services and wireless and wireline communications with a time-to-market advantage over conventional switching platforms. The Company's integrated hardware and software solutions are designed to offer the following benefits: Open Programmability. The Company's product architecture is designed to be open at multiple software programming levels, including the protocol, call control, digital signal processing, resource provisioning and application levels. Using these programmability features, network providers can rapidly integrate applications with non-standard and international protocol variations and offer customized services to their end-users. Excel's switching platforms offer complete programmability, rather than configurability, from the host computer. They are designed to be truly open, allowing customers to control their own applications, and to have the capability to modify any function of the software within the platform at any level, time or geographic location. Rapid Time-to-Market. The Company's products are designed to allow application developers to offer network providers new services more quickly than with conventional switching platforms. Excel's open programmability facilitates rapid deployment of these services in domestic and international markets by integrating rapidly with various signaling protocols and global network standards. Flexibility. The Company's switching platforms can be programmed by a customer to be used for a wide-range of enhanced services and wireless and wireline infrastructure applications. Scalability. The distributed and modular nature of Excel's switching platforms allows network providers to expand their networks easily as the subscriber base increases. Excel's switching platforms can scale from 512 to 2,048 ports within the individual chassis and total system capacity can be expanded to 30,720 ports through the use of Excel's patented fiber optic expansion network, EXNET. In addition, network providers can migrate across the Company's product family without undertaking expensive and time consuming modifications to the host platform. Distributed Architecture. The Company's products are designed with distributed architecture utilizing its patented Selective Space Switching technology and a fiber optic expansion network. These designs increase reliability and allow linear growth in performance as resources are added. Cost-Effective. Excel's products offer increased capacity, performance and functionality for a lower initial investment and reduced operational costs than traditional, closed switches. Redundancy and Reliability. The Company's carrier-class products are designed to meet the high redundancy and reliability requirements demanded by network providers. The redundant features of the Company's products ensure that critical applications remain operational. 4 PRODUCTS AND TECHNOLOGY Excel's products and technology are contained within the framework of Open Network Expansion Architecture ("ONE Architecture ") which was introduced in February 1998. ONE Architecture is Excel's concept that its switching solutions provide an open, scalable and cost-effective solution for the telecommunication needs of network providers. ONE Architecture encompasses the existing family of switching products and related software technologies described below. PRODUCTS The Company offers a family of open, programmable switching products for application developers, OEMs and systems integrators. The Company's product family consists of four switching products: the LNX, a 2,048 port switching platform; the CSN, a 1,024 port switching platform; the PCX, a 512 port switching platform; and the EXS, a 30,720 port switching system. All of the Company's products can be used in a wide range of enhanced services and wireless and wireline infrastructure applications. All of Excel's products share a common software architecture, allowing any specific application to run on any platform, and are designed with multiple levels of redundancy. The LNX and CSN switching platforms share a set of common card components which include network interface line cards such as T1, E1 and J1 interfaces, and service resource cards such as multi-function Digital Signal Processors, Primary Rate ISDN, SS7 and DASS2. Excel's network interface line cards provide direct connectivity to, and ease of integration with, a variety of international signaling protocols. The service resource cards provide customers with a range of common channel signaling and switching applications, offering network providers the ability to control their applications and the flexibility to expand to other services or signaling protocols as needed. Multiple cards can be installed on a single chassis to manage various signaling and call control capabilities or to provide fault tolerant configurations. In addition, the Company offers network interface line cards and service resource cards separately to allow customers to upgrade previously deployed switching platforms. EXCEL PRODUCT FAMILY LNX The LNX is a 2,048 port, non-blocking, open, programmable switching platform which provides high performance and fault tolerance in a small chassis. With all modules supporting redundant configurations, the LNX is designed for central office environments requiring a high level of reliability and ease of maintainability. The LNX can operate as a stand-alone switch or as a node in Excel's patented EXS switching system, currently supporting scalability up to 30,720 non-blocking ports. The LNX consists of the 2,048 port matrix card residing in a 20-slot chassis, a host interface and a fully configurable combination of network interface line and service resource cards. All LNX cards can be replaced while the system is operating ("hot-swappable"), providing ease of maintenance and upgrading without interruption of service. The predecessor to the LNX, the XLDX, is a 1,536 port programmable platform first installed in a central office environment in 1988. XLDX systems are still supported by the Company for customers with an XLDX installed base. CSN The CSN is a 1,024 port, non-blocking, open, programmable switching platform that provides the same features and scalability as the LNX but in a more compact chassis. The CSN utilizes the same common elements of network line interfaces, service resources, common channel signaling packet engines and host interfaces as the LNX, with the same reliability features such as hot-swappability and full redundancy. The CSN is well suited for wireless applications where space constraints dictate the need for carrier-class switching within a compact chassis. 5 PCX The PCX is a PC-based, 512 port, non-blocking, open, programmable switching platform that supports the same programmable features and shares the same hardware and software architecture as the LNX and CSN platforms. The PCX is designed for the customer premises equipment marketplace to provide a total solution in a small chassis, addressing the needs of midrange switching applications. With its PC-based platform, the PCX can support an internal host processor as well as internal voice processing resources. The PCX enables application developers to combine Excel's programmable switching features with industry-standard voice processing technology for a single, stand-alone solution. EXS The EXS is an open, non-blocking system comprised of LNX and CSN programmable switching platforms distributed across EXNET, the Company's fiber optic expansion network. The current EXNET network can support up to 30,720 ports, encompassing any combination of LNXs and CSNs. The patented EXS architecture is designed to allow further expansion beyond the current 30,720 ports. Parallel EXNET fiber networks can also be used to create fully redundant systems to ensure maximum availability and fault tolerance. Because each EXS node is a self-contained LNX or CSN switching platform, processing power can scale linearly as the system is expanded. Individual LNX or CSN nodes can be isolated and serviced without the entire system being brought out-of-service, providing ease of maintenance. Since each node can operate and process calls independently, total system reliability and availability is increased. TECHNOLOGY Selective Space Switching Technology A unique aspect of Excel's distributed architecture is its patented Selective Space Switching technology which allows the platform's internal bus to switch traffic between any input or output port, DSP, packet engine resource or EXNET Controller without losing critical port capacity. Unlike traditional switches, with Selective Space Switching technology, available port capacity is not compromised as additional modules are added. When resource modules are added, the platform's switching capacity increases, and its full non-blocking switch port capacity is retained. Open Software Technology Unlike traditional, proprietary switches, Excel's programmable platforms share a common, open, software architecture designed to be programmable by third parties. The open programmability of Excel's switching platforms is based on its Application Programming Interface ("API") and its patented Programmable Protocol Language ("PPL"). The API is a message-based protocol designed for communication between the programmable switching platform and the application software located on a host computer. Excel's open API allows the application software to access call processing control, configuration, maintenance and alarm reporting functions within the switch at a level that is not currently available in competitive products. Excel's API is compatible across the Company's product family. Excel's PPL is a patented technology that provides an easy and convenient mechanism for developers and operators to implement modifications at multiple programming levels without having to write complex software code. Protocols are developed and modified using a graphical user interface development environment, requiring the user to have only limited software programming experience. With PPL, support personnel can easily effect detailed changes to the switching software on site without using expensive equipment or requiring additional technical personnel. These benefits provide increased software maintainability while reducing development costs and eliminating customized work for Excel and its customers. Using its PPL technology, Excel is continually working with its customers to provide additional domestic and international network interfaces. 6 CUSTOMERS During 1997 the Company sold its products to over 130 customers engaged in a variety of segments of the telecommunications industry. The Company's customers include application developers, OEMs and systems integrators. Approximately 40.6%, 36.7% and 26.0% of the Company's revenues in 1995, 1996 and 1997, respectively, were derived from sales to Comverse Network Systems (formerly Boston Technology, Inc.), approximately 10.2% of the Company's revenues in 1997 were derived from sales to QUALCOMM Incorporated and approximately 11.4% of the Company's revenues in 1995 were derived from sales to Ericsson Messaging Systems Inc. The primary end-users of the Company's products are public network providers, including RBOCs, IXCs, LECs, CLECs, wireless carriers and PTTs. The Company's products also are used by a number of large corporations to satisfy specific telecommunications requirements. CUSTOMER SERVICE, SUPPORT AND TRAINING The Company believes that the responsiveness and expertise of its customer service personnel is essential to developing and maintaining long-term relationships with its customers which require uninterrupted operation of the Company's products. The Company provides pre- and post-sales engineering services and has a technical assistance center which provides support and service by telephone. The Company offers a variety of engineering services such as customer application design review, protocol development, product training, performance testing and field support. The Company has a fully-equipped training facility and provides a wide range of training courses to its customers, both on and off site. The Company also has a fully-equipped applications lab with call traffic load capabilities where customers can test and verify new applications or enhancements to existing applications. The Company's technical assistance center provides telephone support and service on a 24-hour, seven-day-a-week basis. To ensure that the Company is providing quality support services, the Company has instituted a formal customer satisfaction program which involves senior management review and regularly scheduled customer support surveys. In addition, Company personnel meet regularly with customers to discuss product quality and customer satisfaction. The Company provides a product warranty on its hardware products which generally covers a period of 14 months from shipment. This warranty coverage includes technical assistance, as well as product repair or product replacement, depending upon the circumstances of the warranty claim. Although the Company charges fees for certain support and services, to date, revenues from such fees have been immaterial. SALES AND MARKETING The Company sells its products primarily to application developers, OEMs and systems integrators which incorporate the Company's products into their service and product offerings. The Company's principal marketing activities are to identify customers which could benefit from the Company's products, identify new markets for the Company's products and increase sales to existing customers. The sale of the Company's products is a multi-step and interdisciplinary process which can typically range from 12 to 24 months or more from initial customer contact to large-scale commercialization of a customer's application or service based on the Company's products. The initial evaluation stage, typically three to six months, is primarily the role of the Company's sales and marketing personnel, and members of the Company's senior management, and involves educating potential customers on the functionality and benefits derived from using the Company's products. The next stage, which can involve members of both the Company's customer support and research and development organizations, involves providing the customer with the required training and technical support to integrate the Company's products into a new application or service. This stage of the sales process is generally the longest and is dependent upon an application or service provider's own internal application or service development program. The Company sells to its customers through its own sales force, from its headquarters, as well as from sales offices in California, Georgia, Illinois, Massachusetts, New York, Ohio and Texas. The Company recently hired a sales 7 representative in Japan to focus on the Far East market. The Company is currently negotiating with an individual in Belgium to act as a sales representative focusing on the European market. The Company currently has no other offices outside the United States, but is exploring the establishment of foreign sales offices within the next 12 months in Europe and Asia. To date, the Company has no firm commitments to establish such international sales offices and there can be no assurance that the Company will actually open any foreign offices. In addition, the Company maintains an inside sales group, located at its headquarters, which is responsible for platform configuration and price quotations, order administration and telephone sales activities. In order to create awareness, market demand and sales opportunities, the Company engages in a number of marketing activities which include exhibiting products and customer applications at industry trade shows, advertising in selected publications aimed at targeted markets, public relations activities with trade and business press, publication of technical articles and the distribution of sales literature, technical specifications and documentation. RESEARCH AND PRODUCT DEVELOPMENT Management believes that the Company's success will depend on its ability to develop and introduce in a timely fashion new products and enhancements to its existing products. The Company has in the past made, and intends to continue to make, significant investments in product and technological development. Extensive product development input is obtained through customers and the Company's monitoring of end-user needs and changes in the marketplace. The Company is focusing its development efforts on providing enhanced functionality to its products including increased port capacity and performance, the development of additional related software applications and tools and the improvement of third-party application integration. The software applications under development are being designed to enable customers to shorten their application development cycle thereby improving time-to-market and reducing initial investment in research and development. There can be no assurance that the Company will not experience difficulties that could delay or prevent the successful development, introduction or marketing of such new products and enhancements, or that its new products and enhancements will adequately meet the requirements of the marketplace and achieve market acceptance. Announcements of currently planned or other new product offerings by the Company or its competitors may cause customers to defer or cancel the purchase of existing Company products. The Company's inability to develop on a timely basis new products or enhancements to existing products, or the failure of such new products or enhancements to achieve market acceptance, could have a material adverse effect on the Company's business, financial condition and results of operations. The development of new, technologically advanced products is a complex and uncertain process requiring the accurate anticipation of technological and market trends. The introduction of new or enhanced products also 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 anticipated customer demand. There can be no assurance that the Company will successfully develop, introduce or manage the transition to new products. Furthermore, products such as those offered by the Company may contain undetected or unresolved errors when they are first introduced or as new versions are released. There can be no assurance that despite extensive testing by the Company, errors will not be found in new products or upgrades after commencement of commercial shipments, resulting in delays in or loss of market acceptance and sales, diversion of development resources, injury to the Company's reputation or increased service and warranty costs, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. See Item 7. "Risk Factors--Risk of New Product Introductions" and "Risk Factors--Rapid Technological Change." The Company's engineering, research and development expenditures totaled approximately $8.1 million, $11.1 million and $13.3 million in 1995, 1996 and 1997, respectively. The Company performs its research and product development activities at its principal offices in Hyannis, Massachusetts. The Company has achieved International Standard Organization (ISO) 9001 registration for quality assurance in design production, installation and service. 8 MANUFACTURING The Company's manufacturing operations consist primarily of materials planning and procurement, final assembly, testing and quality control. The Company uses several independent manufacturers to provide certain printed circuit boards, chassis and subassemblies. The Company's manufacturing process enables it to configure its products to meet a wide variety of individual customer requirements. The Company plans to strengthen manufacturing capability both in its existing facilities and through expansion of activities with independent manufacturers. Future growth of the Company will require extension of existing internal and external manufacturing resources, hiring of additional technical personnel, improved coordination of supplier relationships with the Company's inventory ordering and management practices, and expansion of information systems to accommodate planned growth across these areas. See Item 7. "Risk Factors--Management of Growth and Hiring of Additional Personnel." Although the Company generally uses standard parts and components for its products, many critical components are purchased from sole or single source vendors for which alternative sources may not be currently available. Some of these components are available from only one supplier, for which there is no substitute at this time. If supply of these components should cease, the Company would be required to redesign its products. Although the Company works closely with some well-established vendors, 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. To date, the Company has generally been able to obtain adequate supplies in a timely matter from its primary 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 an alternate vendor, if required, or a reduction or interruption in supply, or a significant increase in the price of components would materially and adversely affect the Company's business, financial condition and results of operations and could impact customer relationships. See Item 7. "Risk Factors--Dependence on Single and Sole Source Suppliers." COMPETITION The markets in which the Company competes are characterized by intense competition, with a large number of suppliers providing different types of products to different segments of the markets. The Company currently competes principally on the basis of: (i) the breadth of its products' features and benefits; (ii) the flexibility, scalability, quality, ease of use, reliability and cost effectiveness of its products; and (iii) the Company's reputation and the depth of its expertise, customer service and support. While the Company believes that it currently competes favorably overall with respect to these factors, there can be no assurance that the Company will be able to continue to do so. The Company competes or may compete directly or indirectly with the following categories of companies: (i) other manufacturers of programmable switches such as Summa Four, Inc., Redcom Laboratories, Inc. and Harris Corporation; (ii) large, well-established switch and telecommunications equipment manufacturers such as Alcatel Alsthom Compagnie Generale d'Electricite SA, DSC Communications Corporation, Lucent Technologies Inc., Northern Telecom Limited, Siemens AG and Telefonaktiebolaget LM Ericsson; and (iii) to a lesser degree, systems integrators and application developers whose switches are based on PC card-level products manufactured by companies such as Aculab Inc., Dialogic Corporation and Natural MicroSystems Corporation. In addition, several smaller companies have begun recently to manufacture programmable switching platforms. Due to the rapidly evolving markets in which the Company competes, additional competitors with significant market presence and financial resources, including large telecommunications equipment manufacturers and computer hardware and software companies, may enter those markets, thereby further intensifying competition. Additionally, there can be no assurance that one or more of the Company's application developers will not begin to develop or market products in competition with the Company. Many of the Company's current and potential competitors have significantly greater financial, selling and marketing, technical, manufacturing and other resources than the Company. As a result, these competitors may be able to devote greater resources to the development, promotion, sale and support of their products than the Company. The Company, however, does not believe any of its competitors are currently dominant in its industry segment. Some of the Company's competitors currently offer financing alternatives to their customers, a service that the Company does not provide at this time. The Company has no current intention to offer such financing alternatives to its customers in the 9 foreseeable future. Moreover, these companies may introduce additional products that are competitive with those of the Company or enter into strategic relationships to offer complete solutions which the Company does not currently offer. There can be no assurance that the Company's products would compete effectively with such products. The Company believes that its open, programmable switching platform, with the Company's patented Selective Space Switching technology and Programmable Protocol Language, offers its customers a competitive advantage for flexible, scaleable and cost-effective switching capabilities. Although the Company believes these technological features represent advantages over its competitors, maintaining these advantages will require continued investment by the Company in research and development, selling and marketing and customer service and support. In addition, as the Company enters new markets, distribution channels, technical requirements and levels and bases of competition may be different than those in the Company's current markets. There can be no assurance that the Company will be able to compete successfully against either current or potential competitors in the future. See Item 7. "Risk Factors--Highly Competitive Market." INTELLECTUAL PROPERTY The Company relies upon a combination of patent, copyright and trademark and trade secret laws as well as confidentiality procedures and contractual restrictions to establish and protect its proprietary rights. The Company has also entered into confidentiality and invention assignment agreements with its employees and consultants and enters into non-disclosure agreements with its suppliers, distributors and customers so as to limit access to and disclosure of its proprietary information. There can be no assurance such measures will be adequate to deter and prevent misappropriation of the Company's technologies or independent third-party development of similar technologies. The laws of certain foreign countries in which the Company's products are or may be developed, manufactured or sold may not protect the Company's products or intellectual property rights to the same extent as do the laws of the United States and thus make the possibility of piracy of the Company's technology and products more likely. As of December 27, 1997, a total of nine U.S. patents and one foreign patent have been issued to the Company. The Company has a total of 11 U.S. patent applications and 64 international and foreign national patent applications pending. The U.S. issued patents cover various aspects of: (i) the architecture and division of call processing responsibility in the Company's PCX product; (ii) the design and internal construction of a rack-mountable chassis used with the Company's PCX product; (iii) the architecture of certain communications resource and I/O cards which may be used in conjunction with any of the Company's family of programmable switching platforms relating to the Company's Selective Space Switching technology; (iv) the PPL software which may be used, in conjunction with any of the Company's family of programmable switching platforms, to create or modify applications or communications protocols; (v) a line card redundancy arrangement for use in conjunction with the Company's LNX and CSN products; and (vi) the architecture of the Company's fiber optic expansion network, EXNET. The U.S. patents will expire at various times between the years 2008 and 2014. The Company also has thirteen U.S. trademark applications pending. The telecommunications industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies that are important to the Company. Although the Company has from time to time received communications from third parties asserting that the Company's products infringe or may infringe proprietary rights of third parties, the Company believes that none of such claims, if determined adversely to the Company, would have a material adverse effect on the Company's business, financial condition or results of operations. In its distribution agreements, the Company agrees to indemnify its customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties. In certain limited instances, the amount of such indemnities may be greater than the revenues the Company may have received from the customer. In the event of litigation to determine the validity of any third-party claims, such litigation, whether or not determined in favor of the Company, could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel. In the event of an adverse ruling in such litigation, the Company might be required to discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses from third parties. There can be no assurance that licenses from third parties would be available on reasonable commercial terms, if at all. In the event of a successful claim against the Company and the failure of the Company to develop or license a substitute technology, the Company's business, financial 10 condition and results of operations would be materially adversely affected. The Company changed its name from Excel Inc. to Excel Switching Corporation in September 1997. Searches performed on the term Excel have revealed several registrations and numerous uses of that term, and terms substantially similar to it, alone and in combination with other terms and designs. Accordingly, there can be no assurance that third parties will not assert trademark infringement claims relating to the name Excel Switching Corporation in the future. See Item 7. "Risk Factors--Dependence on Proprietary Rights." EMPLOYEES As of December 27, 1997, the Company employed 270 persons, including 98 in engineering, research and development, 69 in selling, marketing and customer service and support, 59 in manufacturing and 44 in finance, administration and management information systems. None of the Company's employees are represented by collective bargaining arrangements, and the Company believes that its relations with its employees are good. The Company expects to hire additional engineering, sales and marketing personnel over the next 12 to 18 months to accommodate planned domestic and international expansion. The hiring of additional personnel will place additional demands on management's ability to assimilate, direct and supervise a growing work force. There can be no assurance that the Company will be successful in assimilating this growth in personnel. See Item 7. "Risk Factors--Management of Growth and Hiring of Additional Personnel." The Company's success depends to a significant degree upon the continuing contributions of its key management, sales, engineering, customer support and product development personnel. The loss of any of the key management or technical personnel could have a material adverse effect on the Company. The Company believes that its future success will depend in large part upon its ability to attract and retain highly-skilled managerial, sales, customer support and product development personnel. The Company has at times experienced and continues to experience difficulty in recruiting qualified personnel. Competition for qualified personnel in the Company's industry is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. Failure to attract and retain key personnel could have a material adverse effect on the Company's business, financial condition and results of operations. See Item 7. "Risk Factors--Dependence on Key Personnel" and "Risk Factors--Management of Growth and Hiring of Additional Personnel." ITEM 2. PROPERTIES The Company's headquarters total approximately 98,250 square feet and are located in four buildings in Hyannis, Massachusetts. Two of the buildings, totaling approximately 55,500 square feet, are owned by the Company and house the engineering, sales, marketing and administrative functions of the Company. The third building, approximately 25,750 square feet, is leased by the Company and houses the manufacturing and manufacturing support functions of the Company. The lease expires in July 2000, but contains an option for an additional five- year term. An option to purchase this building may be exercised at any time after August 1998. The Company intends to exercise this option and, accordingly, has recorded this lease as a capital transaction. The fourth building, approximately 17,000 square feet, is leased by the Company until March 31, 1998 as temporary office space for research and development activities until construction of the new building described below is completed. Management Company is currently negotiating with the owner of the building to become a tenant at will through May 1998. There can be no assurance that such an agreement will be reached nor at terms acceptable to the Company. During 1997 the Company purchased additional property and initiated construction of a building, expected to be completed in 1998, which will add approximately 46,000 square feet of space for engineering activities. In January 1998, the Company entered into a Purchase and Sale Agreement to purchase approximately 108,000 square feet of additional land and also executed an agreement providing Excel with an option to purchase up to an additional 274,000 square feet of land. This option does not expire until January 2000 subject to an annual, non-refundable payment. The Company also leases sales offices in San Jose and Sand Diego, California; Atlanta, Georgia, Rolling Meadows, Illinois; Newton, Massachusetts; White Plains, New York; Cleveland, Ohio; and Grapevine, Texas. The Company intends to expand the capabilities and size of these offices and open additional offices, both domestically and internationally, as needs arise. 11 Although the Company anticipates that it will not require additional manufacturing space for at least the next 12 months, the Company's business, financial condition and results of operations could be materially adversely affected if it does not expand manufacturing capacity as required. The Company believes that its current facilities and planned expansions are adequate to meet its needs through the next 12 months. However, due to the limited supply of suitable additional or alternative office and manufacturing space in the Hyannis, Massachusetts area, there can be no assurance that the Company will not be required in the future to invest heavily in the renovation of space in the Hyannis vicinity or in relocating the Company's headquarters. See Item 7. "Risk Factors--Management of Growth and Hiring of Additional Personnel" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information - The Company's Common Stock is quoted on the Nasdaq National Market under the symbol "XLSW". The following table sets forth the quarterly high and low sales prices per share of Common Stock since the Company's initial public offering on November 4, 1997, as reported by the Nasdaq National Market.
Fiscal Year Ended December 27, 1997 High Low - ----------------------------------- ------ ------ First Quarter N/A N/A Second Quarter N/A N/A Third Quarter N/A N/A Fourth Quarter (from November 4, 1997) 27 7/8 14 1/4
Number of Holders - As of March 23, 1998, there were approximately 98 holders of record of the Company's Common Stock, including multiple beneficial holders at depositories, banks and brokers listed as a single holder in the street name of each respective depository, bank or broker. The Company believes there are over 400 beneficial owners of its Common Stock. Dividend Policy - The Company does not expect to pay cash dividends on its Common Stock in the foreseeable future. The Company currently intends to retain all of its future earnings, if any, for use in the operation of the business. In addition, the Company's credit facility restricts the Company's payment of cash dividends. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Recent Sales of Unregistered Securities - The following information is furnished with regard to all securities issued by the Registrant within fiscal 1997 which were not registered under the Securities Act. On December 2, 1997 options to purchase a total of 2,000 shares of Common Stock granted to employees of the Company under the Registrant's Stock Option Program were exercised at an exercise price of $1.00 per share, for an aggregate purchase price of $2,000.00. On December 4, 1997 options to purchase a total of 400 shares of Common Stock granted to employees of the Company under the Registrant's Stock Option Program were exercised at an exercise price of $1.00 per share, for an aggregate purchase price of $400.00. 12 The securities issued in such transactions were not registered under the Securities Act, as amended, in reliance upon exemptions from registration set forth in Section 3(b) and 4(2) of the Securities Act, relating to sales by an issuer not involving any public offering. None of the foregoing transactions, either individually or in the aggregate, involved a public offering. Use of Proceeds of Initial Public Offering - On November 4, 1997 the Securities and Exchange Commission declared effective the Company's Registration Statement on Form S-1, Commission file number 333-35791, relating to the initial public offering of the Company's Common Stock, $.01 par value. The offering commenced on November 4, 1997 and all shares covered by the Registration Statement were sold. The managing underwriters for the offering were Morgan Stanley & Co. Incorporated, Hambrecht & Quist LLC and NationsBanc Montgomery Securities LLC. The following sets forth certain information regarding the offering and the Company's application of the net proceeds therefrom through December 27, 1997. Number of shares registered 5,175,000 Number of shares sold by the Company 4,500,000 Number of shares sold by the selling stockholder 675,000 Aggregate price of the offering amount registered and sold by the Company $94,500,000 Offering Expenses: Underwriting discounts and commissions 6,615,000 Finder's fees - Expenses paid to or for underwriters - Other expenses 779,000 ----------- Total expenses 7,394,000 ----------- Net offering proceeds to the Company $87,106,000 =========== Aggregate price of the offering amount registered and sold by selling $14,175,000 stockholder Offering expenses: Underwriting discounts and commissions 992,250 Finder's fees - Expenses paid to underwriters - Other expenses - ----------- Total expenses 992,250 ----------- Net offering proceeds to the selling stockholder $13,182,750 ===========
No such expenses were paid directly or indirectly to directors, officers, general partners of the Company or their associates, to persons owning ten percent or more of any class of equity of the Company or to affiliates of the Company. To date, the Company has not utilized any of the net proceeds from the IPO. The Company has invested all such net proceeds in investment grade, interest- bearing securities. 13 ITEM 6. SELECTED FINANCIAL DATA The following table contains certain selected consolidated financial data of the Company and is qualified in its entirety by the more detailed Consolidated Financial Statements included herein. This data should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations" and the Consolidated Financial Statements appearing elsewhere herein.
FISCAL YEAR ------------------------------------------------------------------ 1993 1994 1995 1996 1997 ---------- ---------- ---------- ---------- ---------- (in thousands, except per share data) CONSOLIDATED STATEMENTS OF INCOME DATA: Revenues $10,033 $20,723 $36,161 $62,050 $88,727 Cost of revenues....................................... 2,945 7,074 12,100 24,312 26,631 ------- ------- ------- ------- ------- Gross profit........................................ 7,088 13,649 24,061 37,738 62,096 ------- ------- ------- ------- ------- Operating expenses:.................................... Engineering, research and development............... 1,862 3,301 8,117 11,121 13,260 Selling and marketing............................... 140 362 2,923 6,621 11,486 General and administrative.......................... 2,194 2,903 4,238 6,426 7,949 ------- ------- ------- ------- ------- Total operating expenses......................... 4,196 6,566 15,278 24,168 32,695 ------- ------- ------- ------- ------- Income from operations........................... 2,892 7,083 8,783 13,570 29,401 Other income (expense)................................. (681) (4) 38 (384) 1,392 ------- ------- ------- ------- ------- Income before provision for income taxes......... 2,211 7,079 8,821 13,186 30,793 Provision for income taxes............................. 815 2,889 3,410 5,285 12,177 ------- ------- ------- ------- ------- Net income............................................. $ 1,396 $ 4,190 $ 5,411 $ 7,901 $18,616 ======= ======= ======= ======= ======= Basic earnings per share............................... $.05 $.15 $.19 $.28 $.65 ======= ======= ======= ======= ======= Diluted earnings per share............................. $.05 $.13 $.17 $.24 $.54 ======= ======= ======= ======= ======= Basic weighted average shares outstanding.............. 27,946 27,946 27,962 28,090 28,756 Diluted weighted average shares outstanding............ 30,864 31,341 31,822 32,697 34,361
Dec. 31, Dec. 31, Dec. 31, Dec. 28, Dec. 27, 1993 1994 1995 1996 1997 -------- -------- -------- -------- -------- (in thousands) Consolidated Balance Sheet Data: Working capital................................. $2,323 $5,906 $10,238 $14,960 $116,374 Total assets.................................... 5,483 9,973 22,683 34,772 149,694 Long-term obligations, less current maturities.. - - 3,537 3,837 108 Total stockholders' equity...................... 2,255 6,471 12,125 20,086 125,915
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with "Item 1. Business", "Item 6. Selected Financial Data", the Company's Consolidated Financial Statements and Notes thereto and the information described under the caption "Risk Factors" below. 14 OVERVIEW Excel Switching Corporation ("Excel" or the "Company") has been profitable since it was founded in 1988 and has financed its operations principally through cash generated from operations. The Company has experienced significant revenue growth resulting, in part, from the increasing acceptance of programmable switching as a means of addressing the enhanced services and wireless and wireline infrastructure needs of network providers. The Company designed and shipped its first programmable switching product, the XLDX, during the fourth quarter of 1988, to Comverse Network Systems (formerly Boston Technology, Inc.) ("Comverse"). Excel subsequently expanded its product offering to include a family of open, programmable switching platforms. The LNX and PCX switching platforms were introduced in 1991 and have been subsequently enhanced. The Company introduced the EXS switching system in 1995 and the CSN switching platform in 1996. Through December 27, 1997, the Company's revenues have been derived from sales to application developers, OEMs and systems integrators. During the early years of the Company's operations, revenues from Comverse represented substantially all of the Company's annual revenues. The Company has continued to establish customer relationships with other application developers, OEMs and systems integrators, penetrate new markets, and improve the capacity, functionality and features of its family of products. Currently, Excel sells its products to over 130 customers engaged in a variety of segments of the global telecommunications industry. During 1997, Comverse represented approximately 26.0% of the Company's revenues. The Company's products are sold through its direct sales force primarily to application developers, OEMs and systems integrators which incorporate the Company's products into their service and product offerings. The Company sells each of its switching platforms with a varying combination of network interface line cards and service resource cards that are specified by customer and application requirements. The Company also sells additional network interface line cards and service resource cards that allow customers to expand capacity and functionality and provide for redundancy of their installed systems. Revenues from product sales are recognized upon shipment, at which time the Company provides an estimate of anticipated post sale support, warranty costs and sales returns. The increase in the reserve for sales returns can be attributed to the volume increase in sales, the timing and significance of new product introductions and the increased complexity of the uses of the Company's equipment. In addition, the Company estimates reserves to adjust for the realizability of accounts receivable and inventory. While the Company believes its estimates for post sale support, warranty costs, sales returns and the realizability of accounts receivable and inventory are adequate, actual results could differ from those estimates. Revenues from sales of software development tools and services such as technical support, training and product maintenance have not been significant to date. The Company has not capitalized any software development costs and all research and development costs have been expensed as incurred. The Company's profitability is influenced by a number of factors, including pricing, cost of materials, product and technological advancements from research and development efforts and the expansion of its operations. The Company anticipates the addition of personnel and related infrastructure as it seeks to increase revenues, and to meet other strategic goals such as developing new products and technologies, broadening strategic partnerships with, and incorporating new applications for, its customers, entering new markets and expanding internationally. The Company anticipates that engineering, research and development expenses will increase in absolute dollars, and may increase as a percentage of revenues, as the Company pursues engineering efforts to provide enhanced functionality to its products, increase port capacity and develop additional software features. 15 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage of revenues represented by certain items reflected in the Company's Consolidated Statements of Income:
Fiscal Year ------------------------------------------------------------ 1995 1996 1997 ---------- ---------- ---------- Revenues.................................................... 100.0% 100.0% 100.0% Cost of revenues............................................ 33.5 39.2 30.0 ----- ----- ----- Gross profit............................................. 66.5 60.8 70.0 ----- ----- ----- Operating Expenses:......................................... Engineering, research and development.................... 22.4 17.9 14.9 Selling and marketing.................................... 8.1 10.7 13.0 General and administrative............................... 11.7 10.3 9.0 ----- ----- ----- Total operating expenses.................................... 42.2 38.9 36.9 ----- ----- ----- Income from operations...................................... 24.3 21.9 33.1 Other income (expense)...................................... .1 (.6) 1.6 ----- ----- ----- Income before provision for income taxes.................... 24.4 21.3 34.7 Provision for income taxes.................................. 9.4 8.5 13.7 ----- ----- ----- Net income.................................................. 15.0% 12.8% 21.0% ===== ===== =====
FISCAL YEAR ENDED DECEMBER 27, 1997 COMPARED TO FISCAL YEAR ENDED DECEMBER 28, 1996 Revenues. The Company's revenues consist of sales, primarily in the United States, of its open, programmable switching platforms and related network interface line cards and service resource cards. Revenues increased 43.0% from $62.1 million in 1996 to $88.7 million for 1997. The increase resulted, in part, from the Company's continuing efforts to enhance the scalability, performance, capacity and functionality of its products through the modification and introduction of features and products. The increase in revenues also resulted from the introduction of new or expanded offerings by existing customers incorporating the Company's products, the expansion of customers' existing markets and the introduction of new applications by new and existing customers. In addition, revenues increased due to increased market penetration resulting from the efforts of the Company's expanded selling and marketing organizations. Revenues from the Company's five largest customers represented approximately 57.1% and 50.9% of the Company's revenues for 1996 and 1997, respectively. Comverse represented approximately 36.7% and 26.0% of the Company's revenues for these same periods, respectively. Additionally, 10.2% of the Company's revenues in 1997 were derived from QUALCOMM Incorporated. Although the Company's largest customers have varied from period to period, the Company believes that revenues derived from current and potential large customers will continue to represent a significant proportion of revenues, and that its results of operations in any given period will continue to depend to a significant extent upon sales to a limited number of customers. There can be no assurance that the Company's principal customers will continue to purchase product at current levels, if at all. Gross Profit. Cost of revenues consists primarily of the cost of purchased components and subassemblies, contract manufacturing costs, labor and overhead relating to material procurement, final assembly, testing and quality control, and warranty and post sale support costs. Cost of revenues increased 9.5% from $24.3 million in 1996 to $26.6 million for 1997. Gross margin increased from 60.8% in 1996 to 70.0% in 1997. The increase in gross margin was primarily attributable to lower component prices, changes in product mix and increased manufacturing efficiencies as the Company increased its production volume in 1997. In addition, gross margins for 1996 were negatively impacted by the introduction of the EXS switching system and related technology which resulted in valuation adjustments of certain existing inventory components. Engineering, Research and Development. Engineering, research and development costs consist primarily of compensation and related costs of engineering and development personnel, materials and supplies consumed in prototype development, related facility costs and depreciation of engineering and test equipment. All research and 16 development costs, including software development costs, have been expensed as incurred. Engineering, research and development costs increased 19.2% from $11.1 million in 1996 to $13.3 million for 1997. As a percentage of revenues, these costs were 17.9% and 14.9%, respectively, in such periods. The increase in engineering, research and development costs in absolute dollars was primarily attributable to an increase in engineering and research personnel partially offset by decreases in the consumption of prototype supplies and materials. Engineering and research personnel increased from 68 employees at the end of 1996 to 98 employees at the end of 1997. Selling and Marketing. Selling and marketing costs consist primarily of compensation and related costs for sales, marketing and customer support personnel, travel and advertising, trade show and other promotional activities. Selling and marketing costs increased 73.5% from $6.6 million in 1996 to $11.5 million for 1997. As a percentage of revenues, these costs were 10.7% and 13.0%, respectively, in such periods. The increase in selling and marketing costs in absolute dollars was primarily attributable to an increase in sales, marketing and customer support personnel and an increase in trade show and promotional activities during 1997. Sales, marketing and customer support personnel increased from 51 employees at the end of 1996 to 69 employees at the end of 1997. General and Administrative. General and administrative costs include compensation and related costs of management, finance, management information systems and administrative personnel, professional services, costs to implement and maintain manufacturing and management information systems and other general corporate expenses. General and administrative costs increased 23.7% from $6.4 million in 1996 to $7.9 million for 1997. As a percentage of revenues, these costs were 10.3% and 9.0%, respectively, in such periods. The increase in general and administrative costs in absolute dollars was primarily attributable to an increase in general and administrative personnel from 35 employees at the end of 1996 to 44 employees at the end of 1997. Other Income (Expense). Other income (expense), which primarily includes interest income and interest expense, increased from ($384,000) in 1996 to $1.4 million in 1997. This increase was primarily attributable to an increase in interest income derived from larger balances of invested cash and securities. Provision for Income Taxes. The Company's effective rate for Federal and state income taxes was 40.1% and 39.5% for 1996 and 1997, respectively. The decrease in effective rates is primarily attributable to a decrease in the effective state income tax rate and the utilization of certain tax credits. FISCAL YEAR ENDED DECEMBER 28, 1996 COMPARED TO FISCAL YEAR ENDED DECEMBER 31, 1995 Revenues. Revenues increased from $36.2 million in 1995 to $62.1 million in 1996. The increase resulted, in part, from the Company's continuing efforts to enhance the scalability, performance, capacity and functionality of its products through the modification and introduction of features and products, including the introduction of the EXS switching system in 1995 and the CSN switching platform in 1996. The increase in revenues also resulted from the introduction of new or expanded offerings by existing customers incorporating the Company's products, the introduction of new applications by new and existing customers and the expansion of the Company's selling and marketing efforts. Revenues from the Company's five largest customers represented approximately 70.1% and 57.1% of the Company's revenues for 1995 and 1996, respectively. During 1995 and 1996, Comverse represented approximately 40.6% and 36.7%, respectively, of the Company's revenues. Additionally, 11.4% of the Company's revenues in 1995 were derived from sales to Ericsson Messaging Systems Inc. Gross Profit. Cost of revenues increased from $12.1 million in 1995 to $24.3 million in 1996. The gross margin decreased from 66.5% in 1995 to 60.8% in 1996. The decrease in gross margin in 1996 resulted primarily from the introduction of the EXS switching system and related technology, which resulted in valuation adjustments of certain existing inventory components. Increased warranty and related support costs also contributed to the decline in gross margin. In addition, gross margin was negatively impacted by the Company's relocation of its manufacturing operations in November 1995, the subsequent expansion of this facility in 1996 and increased compensation and related costs associated with the Company's efforts to strengthen its manufacturing infrastructure. 17 Engineering, Research and Development. Engineering, research and development costs increased from $8.1 million in 1995 to $11.1 million in 1996. As a percentage of revenues, engineering, research and development expenses were 22.4% and 17.9% for 1995 and 1996, respectively. The increases in engineering, research and development costs in absolute dollars were primarily attributable to continuing efforts to expand the Company's research and development infrastructure. Engineering, research and development personnel increased from 38 employees at the end of 1995 and to 68 employees at the end of 1996. Increases also resulted from the timing and amount of the consumption of materials used for prototypes in the development process. The Company's relocation in 1995 to a larger facility and capital investments made in 1995 and 1996 in engineering and test equipment resulted in increased occupancy costs and depreciation expenses for both years. Selling and Marketing. Selling and marketing costs increased from $2.9 million in 1995 to $6.6 million in 1996. As a percentage of revenues, these costs were 8.1% and 10.7% for 1995 and 1996, respectively. The increase in selling and marketing costs reflects the expansion of the Company's sales, marketing and customer support personnel from 28 employees at the end of 1995 and to 51 employees at the end of 1996. During 1995 and 1996, the Company's expanded efforts to market and promote its products through trade shows, advertising, public relations and other promotional activities also resulted in increased selling and marketing costs. The Company's relocation in 1995 and the opening of four sales offices in 1996 resulted in increased occupancy costs in 1995 and 1996. General and Administrative. General and administrative costs increased from $4.2 million in 1995 to $6.4 million in 1996. As a percentage of revenues, these costs were 11.7% and 10.3% for 1995 and 1996, respectively. The increase in general and administrative costs in absolute dollars resulted primarily from an increase in general and administrative personnel from 21 employees at the end of 1995 to 35 employees at the end of 1996. The Company's efforts to expand and strengthen the administrative infrastructure included the additions of a Chief Financial Officer, Chief Operating Officer and other personnel in the areas of finance, human resources and purchasing. During 1996, the Company made significant investments in its manufacturing and management information systems, including the implementation of its enterprise resource planning system. The Company's relocation to larger facilities in 1995 resulted in increased occupancy and depreciation costs in 1995 and 1996. Other Income (Expense). Other income (expense) was $38,000 and ($384,000) for 1995 and 1996, respectively. Provision for Income Taxes. The Company's effective rate for Federal and state income taxes was 38.7% and 40.1% for 1995 and 1996, respectively. LIQUIDITY AND CAPITAL RESOURCES Since inception, Excel has funded its operations primarily through cash provided by operations. In November 1997, the Company received total net proceeds of approximately $87.1 million from the initial public offering of its common stock. See Item 5. "Market for Registrant's Common Equity and Related Stockholder Matters". At December 27, 1997, the Company's principal sources of liquidity consisted of cash, cash equivalents and marketable securities of approximately $114.9 million, working capital of approximately $116.4 million and $15.0 million of funds available under a bank line of credit. During 1995, 1996 and 1997, cash provided by operating activities totaled $1.2 million, $7.3 million and $27.2 million, respectively. The increase in 1996 was primarily attributable to increases in net income, accrued expenses and accrued income taxes, partially offset by an increase in deferred income taxes and a decrease in accounts payable. The increase in 1997 was primarily attributable to an increase in profitability, accounts payable and accrued expenses. The Company's investing activities consumed $4.1 million, $4.1 million and $70.4 million in 1995, 1996 and 1997, respectively. During 1997, net purchases of marketable securities consumed approximately $67.0 million. The remaining expenditures primarily reflect the acquisition, renovation and expansion of the Company's facilities and the purchase of capital equipment. 18 During 1995, the Company purchased and renovated two buildings and related land for approximately $3.2 million. These acquisitions and renovations were financed, in part, by the proceeds from a $2.6 million secured loan from a bank. This loan was paid in full in January 1998. In 1995, the Company entered into a building lease which requires monthly payments of approximately $13,000 through July 2000. The lease can be extended through July 2005 and includes a purchase option exercisable, beginning in August 1998, for $875,000. The Company intends to exercise this option as early as possible, and accordingly, has reflected this lease as a capital transaction. On June 30, 1997, the Company purchased property to be used for the construction of an additional building. The purchase price of $575,000 and the estimated construction costs were to be financed, in part, by a $2.1 million Real Estate Promissory Note with a bank, of which $460,000 was advanced to the Company during 1997. Borrowings under this note bore interest at prime plus .25% and were secured by the property and certain other assets. Monthly payments of interest began in July 1997. In January 1998, the Company paid in full all outstanding balances under this note. During 1997, the Company began construction of a 46,000 square foot building to be used for engineering and research activities. Construction is expected to be completed by the end of the second quarter of 1998 at an estimated cost of approximately $3.7 million. In January 1998, the Company executed a Purchase and Sale Agreement to purchase approximately 108,000 square feet of additional land for approximately $324,000 and also completed an agreement providing Excel with an option to purchase up to an additional 274,000 square feet of land at a total cost of approximately $821,000. This option does not expire until January 2000 subject to an annual, non-refundable payment of approximately $71,000. The total costs of the facility and land acquisition will be funded by existing cash resources. The Company's unsecured line of credit arrangement with a bank provides up to $15.0 million in credit availability. Borrowings under this agreement bear interest, at the Company's discretion, at either the bank's base rate or the Eurodollar rate plus 2.5%. The agreement requires the Company to comply with certain financial covenants, including a liabilities to tangible net worth ratio, a current assets to current liabilities ratio and a minimum profitability covenant. The agreement also restricts the Company's ability to pay cash dividends. The Company was in compliance with these covenants as of December 27, 1997. There were no amounts outstanding under this line of credit at December 28, 1996 or December 27, 1997. The Company does not have any other significant capital commitments and believes that available funds and cash generated from operations, will be sufficient to meet the Company's working capital requirements for at least the foreseeable future. The Company plans to finance its long-term capital needs with available funds, together with available borrowings and cash flow from operations. To the extent that such funds are insufficient to finance the Company's activities, the Company may have to raise working capital through the issuance of additional equity or debt securities. There can be no assurance that additional financing will be available on acceptable terms. Year 2000 Compliance: Management has initiated a Company-wide program to assess the impact of the Year 2000 issue on the Company's computer systems and applications as well as the Company's product offerings. Management believes that a majority of the Company's product offerings are currently Year 2000 compliant and that its primary internal information systems used to support its operations are compatible with the Year 2000. However, the Company utilizes other third party equipment, telecommunication products and other third party software applications which may or may not be Year 2000 compliant. Although the Company is currently taking steps to address the impact, if any, of the Year 2000 issue surrounding such third party products, failure of any critical third- party products to operate properly in the Year 2000 may have a material adverse effect on results of operations or require the Company to incur unanticipated expenses to remedy any problems. In addition, as the Company purchases many critical components from single or sole source suppliers, failure of any such vendor to adequately address issues relating to the Year 2000 problem may have a material adverse effect on the Company's business, financial condition and results of operations. RECENT ACCOUNTING ANNOUNCEMENT On February 10, 1998, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 98 (SAB 98). This bulletin revises the SEC's guidance for calculating earnings per share with respect to equity securities 19 issued prior to an initial public offering and is effective for fiscal years ending after December 15, 1997. The prior years' earnings per share have been retroactively restated to reflect the adoption of SAB 98. As a result of this restatement, the Company's previously reported diluted earnings per share has been increased by $.01 in each of the fiscal years 1993, 1995 and 1996 to $.05, $.07 and $.24, respectively. RISK FACTORS This Report contains statements which may be "forward-looking" statements and are subject to risks and uncertainties that could cause actual results to differ significantly from expectations. In particular, statements contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" which are not historical facts, including, but not limited to, statements regarding the anticipated adequacy of cash resources to meet the Company's working capital requirements, statements regarding the intention to exercise a purchase option on an existing building lease and statements regarding the anticipated proportion of revenues to be derived from a limited number of customers, may constitute forward looking statements. Factors that could cause or contribute to such differences include those discussed below, as well as those discussed elsewhere in this Report. Fluctuations in Results of Operations. The Company's results of operations have varied significantly in the past and may vary significantly in the future, on a quarterly and annual basis, as a result of a variety of factors, many of which are outside the Company's control. These factors include, without limitation: (i) the timing and size of orders which are received and can be shipped in any particular period; (ii) the commercial success of the Company's products; (iii) delays in the introduction of products or product enhancements by the Company and the Company's ability to introduce new products and technologies on a timely basis; (iv) the financial stability of the Company's major customers; (v) the timing of new product introductions or announcements by the Company or its competitors; (vi) the availability of adequate supplies of key components and assemblies and the adequacy of third-party manufacturing capabilities; (vii) the seasonality of the placement of customer orders; (viii) the timing and nature of selling and marketing expenses such as tradeshows and advertising campaigns; (ix) the timing of development expenditures and personnel changes; (x) the publication of opinions about the Company and its products, or its competitors or their products, by industry analysts; (xi) customer order deferrals in anticipation of product enhancements or new product offerings by the Company or its competitors; and (xii) customer cancellation of orders and the gain or loss of significant customers, including those due to industry combinations. Moreover, any downturn in general economic conditions could precipitate significant reductions in corporate spending for telecommunications infrastructure, which could result in delays or cancellations of orders for the Company's products. The Company's expense levels are relatively fixed and are based, in significant part, on expectations of future revenues. Consequently, if revenue levels are below expectations, expense levels could be disproportionately high as a percentage of revenues, and the Company's business, financial condition and results of operations would be materially adversely affected. The Company has historically operated with little backlog because its products are generally shipped within 60 days of acceptance of an order by the Company. As a result, revenues in any quarter are substantially dependent on orders booked and shipped in that quarter and on sales by the Company's customers to end users. See "--Concentration of Customers" and "Business-- Customers." The Company has experienced significant fluctuations in revenues, expenses and results from operations from quarter to quarter, and such fluctuations are likely to continue. The Company typically receives more product orders and generates greater revenues in the fourth quarter. During the last several years, revenues in the first quarter have typically been lower than those recorded in the preceding fourth quarter. The Company believes that this concentration of order placements in specific quarterly periods is due to customer's' buying patterns and budgeting cycles. A significant portion of the Company's revenues have been generated from a limited number of customers and it is difficult to predict the timing of future orders and shipments to these and other customers. The Company anticipates that its results of operations in any given period will continue to depend to a significant extent upon sales to a small number of customers. See "--Concentration of Customers" and "Business--Customers." The Company also believes that the purchase of its products generally involves a significant commitment of a customer's capital resources. Therefore, any downturn in any customer's business could have a material adverse effect on the Company's revenues, business, financial condition and quarterly results of operations. In addition, the Company historically has recognized a large portion of its revenues from sales booked and shipped in the last month of a quarter such that the magnitude of quarterly fluctuations may not become evident until late in, or at the end of, a particular 20 quarter. Because a number of the Company's individual orders are for significant amounts, the failure to ship a significant order in a particular quarter could materially adversely affect revenues and results of operations for such quarter. To the extent that significant sales occur earlier than expected, results of operations for subsequent quarters may be materially adversely affected. Due to these and other factors, the Company's quarterly revenues, expenses and results of operations could vary significantly in the future, and period-to-period comparisons should not be relied upon as indications of future performance. There can be no assurance that the Company will be able to increase its revenues in future periods or be able to sustain its level of revenues or its rate of revenue growth on a quarterly or annual basis. See "--Length of Sales Cycle" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Due to all of the foregoing factors, it is possible that in some future quarter, the Company's results of operations will be below the expectations of public market analysts and investors. In such event, the market price of the Company's Common Stock would likely be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Dependence on Relationships with Application Developers, OEMs and Systems Integrators. The Company sells substantially all of its products to, and maintains strategic relationships with, application developers, original equipment manufacturers ("OEMs") and systems integrators which incorporate the Company's products into their service and product offerings. As a result, sales of the Company's products are dependent upon the continued market acceptance of the service and product offerings of the Company's customers. Although the Company maintains contractual relationships with a substantial number of its customers, such contracts do not provide for minimum purchase requirements, nor do they contain provisions requiring the exclusive purchase of the Company's products. The development of an application or service for the telecommunications market can involve a substantial amount of time and expense. The delay or failure of a customer's application development program incorporating the Company's products could delay or prevent expected sales of the Company's products. The inability or cessation of customers to integrate the Company's products into their service and product offerings, product development delays by application developers and other customers, lack of market acceptance of the service and product offerings of the Company's customers or a customer's decision to market products manufactured by a competitor of the Company, or the manufacture of such products themselves, would have a material adverse effect on the Company's business, financial condition and results of operations. Additionally, selling through indirect channels may limit the Company's information concerning the volume of products sold by the Company's customers to end users and the Company's contact with its end users. As a result, the Company's ability to forecast revenues accurately (notwithstanding the forecasts of its customers), evaluate end-user satisfaction and recognize emerging end- user requirements may be hindered. See "Business--Sales and Marketing." Length of Sales Cycle. The time between the date of initial contact with a potential customer and large-scale commercialization of a new customer application or system based on the Company's products is often lengthy, typically ranging from 12 to 24 months or more, and is subject to delays over which the Company has little or no control, including customers' budgetary constraints, customers' internal acceptance reviews, the success and continued internal support of customers' own development efforts, and the possibility of cancellation of projects by customers. Although the Company attempts to develop its products with the goal of shortening the time to market of its customers' products, the timing of the commercialization of a new customer application or service based on the Company's products is primarily dependent on the success and timing of a customer's own internal development program. Delays can also be caused by late deliveries by other vendors, changes in implementation priorities and slower than anticipated growth in demand for the services that the Company's products support. A delay in, or cancellation of, the sale of the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations and cause the Company's results of operations to vary significantly from quarter to quarter. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Concentration of Customers. Approximately 40.6%, 36.7% and 26.0% of the Company's revenues in 1995, 1996 and 1997, respectively, were derived from sales to Comverse Network Systems (formerly Boston Technology, Inc.), approximately 10.2% of the Company's revenues in 1997 were derived from sales to QUALCOMM Incorporated and approximately 11.4% of the Company's revenues in 1995 were derived from sales to Ericsson Messaging Systems, Inc. 21 In 1995, 1996 and 1997, the Company's five largest customers accounted for approximately 70.1%, 57.1% and 50.9%, respectively, of the Company's revenues. Although the Company's largest customers have varied from period to period, the Company anticipates that its results of operations in any given period will continue to depend to a significant extent upon sales to a small number of customers. None of the Company's customers has entered into a long-term supply agreement requiring any of them to purchase a minimum amount of product from the Company. There can be no assurance that the Company's principal customers will continue to purchase product from the Company at current levels, if at all, or that the Company will be able to replace such purchases with sales to other customers. In January 1998, Boston Technology, Inc. merged with Comverse Technologies, Inc. In September 1997, Octel Communications Corporation, one of the Company's five largest customers in 1996 and 1997, was acquired by Lucent Technologies Inc. The Company cannot estimate the potential impact on its business of these two recent transactions. The loss of one or more major customers could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business-- Customers." Evolving Market For Telecommunications Services. The Company's future success will depend on continued growth in the market for telecommunications services. The global telecommunications marketplace is evolving and it is difficult to predict its potential size or future growth rate. There can be no assurance that deregulation and continued improvements and expansions of infrastructure will continue to cause this market to grow or that increased regulation will not present barriers to the sales of existing or future products. There can also be no assurance that telecommunications applications and infrastructure needs will not emerge for which the Company's products are not designed. If this market fails to grow or grows more slowly or in a different direction than the Company currently anticipates, the Company's business, financial condition and results of operations could be materially adversely affected. See "Business--Industry Background." Concentrated Product Family. The Company currently derives substantially all of its revenues from its family of open, programmable switching platforms and expects that this concentration will continue in the foreseeable future. As a result, any decrease in the overall level of sales of, or the prices for, open, programmable switching platforms due to product enhancements, introductions or announcements by the Company's competitors, a decline in the demand for open, programmable switches, product obsolescence, price competition, technological change or any other reason could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risk of New Product Introductions. The Company intends to continue to invest in product and technology development, including increasing port capacity and performance, the development of additional related software applications and tools, the improvement of third-party application integration, and the continued provision of updated product features and enhancements. There can be no assurance that the Company will not experience difficulties that could delay or prevent the successful development, introduction or marketing of such new products and enhancements, or that its new products and enhancements will adequately meet the requirements of the marketplace and achieve market acceptance. Announcements of currently planned or other new product offerings by the Company or its competitors may cause customers to defer or cancel the purchase of existing Company products. The Company's inability to develop on a timely basis new products or enhancements to existing products, or the failure of such new products or enhancements to achieve market acceptance, could have a material adverse effect on the Company's business, financial condition and results of operations. See "--Rapid Technological Change," "Business--Products and Technology" and "Business--Research and Product Development." The development of new, technologically advanced products is a complex and uncertain process requiring the accurate anticipation of technological and market trends. The introduction of new or enhanced products also 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 anticipated customer demand. There can be no assurance that the Company will successfully develop, introduce or manage the transition to new products. Furthermore, products such as those offered by the Company may contain undetected or unresolved errors when they are first introduced or as new versions are released. There can be no assurance that despite extensive testing by the Company, errors will not be found in new products or upgrades after commencement of commercial shipments, resulting in delays in or loss of market acceptance and sales, diversion of 22 development resources, injury to the Company's reputation or increased service and warranty costs, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Research and Product Development." Rapid Technological Change. The telecommunications equipment market is subject to rapid technological change, evolving industry standards and frequent new product introductions and enhancements that may render existing products obsolete. As a result, the Company's position in this market could erode rapidly due to unforeseen changes in product features and functions of competing products. The Company's growth and future results of operations will depend in part on its ability to respond to these changes by enhancing its existing products and developing and introducing, on a timely and cost-effective basis, new products and features to meet or exceed technological advances in the marketplace. The failure of the Company to respond to rapidly changing technologies could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Industry Background" and "Business--Research and Product Development." Management of Growth and Hiring of Additional Personnel. The Company has experienced growth in revenues and expansion of its operations which have placed significant demands on the Company's management, engineering staff and facilities. The Company has recently hired additional engineering, marketing, accounting and finance personnel, including its Vice President of Research and Development within the last 12 months. The Company is also implementing additional financial and management procedures which the Company believes will address increasing demands on resources. However, the Company believes that further improvements in management and operational controls are needed, and will continue to be needed, to manage any future growth. Continued growth will also require the Company to hire more engineering, selling and marketing and administrative personnel, expand customer support capabilities, expand management information systems and improve its inventory management practices. The Company has at times experienced, and continues to experience, difficulty in recruiting qualified personnel. Recruiting qualified personnel is an intensely competitive and time-consuming process. There can be no assurance that the Company will be able to attract and retain the necessary personnel to accomplish its growth strategies or that it will not experience constraints that will adversely affect its ability to satisfy customer demand in a timely fashion or to support satisfactorily its customers and operations. If the Company's management is unable to manage growth effectively, the Company's business, financial condition and results of operations could be materially adversely affected. See "Business--Employees." While the Company believes its current and planned facilities are adequate to meet its needs through the next 12 months, future growth may require the Company to obtain additional or alternative facilities. Due to the limited supply of suitable additional or alternative office and manufacturing space in the Cape Cod, Massachusetts area, there can be no assurance that such space can be leased or acquired without substantial required renovations. Relocation of any segment of the Company's operations may disrupt business and have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the local permitting and variance procedures for the renovation of buildings or new construction in the Cape Cod area is more onerous than found in metropolitan areas. Accordingly, there can be no assurance that the Company will not be required in the future to devote significant resources to the permitting and renovation of additional facilities or in relocating some or all of the Company's facilities. See "Item 2--Properties." Dependence on Key Personnel. The Company's success depends to a significant degree upon the continued contributions of its President, Chief Executive Officer and principal stockholder, Robert P. Madonna, and its key management, engineering, selling and marketing and manufacturing personnel, many of whom would be difficult to replace. The Company does not have employment contracts with its key personnel. The loss of the services of any key personnel, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel, particularly software engineers, could have a material adverse effect on the Company's business, financial condition and results of operations. Highly Competitive Market. The market for telecommunications products is highly competitive and subject to rapid technological change. The Company competes or may compete directly or indirectly with the following categories of companies: (i) other manufacturers of programmable switches such as Summa Four, Inc., Redcom Laboratories, Inc. and Harris Corporation; (ii) large, well- established switch and telecommunications equipment manufacturers such as 23 Alcatel Alsthom Compagnie Generale d'Electricite SA, DSC Communications Corporation, Lucent Technologies Inc., Northern Telecom Limited, Siemens AG and Telefonaktiebolaget LM Ericsson; and (iii) to a lesser degree, systems integrators and application developers whose switches are based on PC card-level products manufactured by companies such as Aculab Inc., Dialogic Corporation and Natural MicroSystems Corporation. In addition, several smaller companies have begun to manufacture programmable switching platforms. Due to the rapidly evolving markets in which the Company competes, additional competitors with significant market presence and financial resources, including large telecommunications equipment manufacturers and computer hardware and software companies, may enter those markets, thereby further intensifying competition. Additionally, there can be no assurance that one or more of the Company's application developers will not begin to develop or market products in competition with the Company. Increased competition could result in price reductions and loss of market share which would materially adversely affect the Company's business, financial condition and results of operations. Many of the Company's current and potential competitors have significantly greater financial, selling and marketing, technical, manufacturing and other resources than the Company. Some of the Company's competitors currently offer financing alternatives to their customers, a service that the Company does not provide. Moreover, the Company's competitors may also foresee the course of market developments more accurately than the Company. Although the Company believes it has certain technological and other advantages over its competitors, realizing and maintaining such advantages will require a continued high level of investment by the Company in research and product development, marketing and customer service and support. There can be no assurance that the Company will have sufficient resources to continue to make such investments or that the Company will be able to make the technological advances necessary to compete successfully with its existing competitors or with new competitors. See "Business--Competition." Dependence on Single and Sole Source Suppliers. The Company purchases many critical components from single or sole source vendors. The inability to develop alternative sources for these components or to obtain sufficient quantities of these components could result in delays or reductions in product shipments which could materially adversely affect the Company's business, financial condition and results of operations. In the event of a reduction or interruption of supply, a significant amount of time, in some cases as much as three to four months, could be required before the Company would begin receiving adequate supplies from such alternative suppliers. Further, in such event, the Company's business, financial condition and results of operations would be materially adversely affected. In addition, the manufacture of certain of these single or sole source components is extremely complex, and the Company's reliance on the suppliers of these components exposes the Company to potential production difficulties and quality variations, which could negatively impact cost and timely delivery of the Company's products. Certain components are available from only one supplier, for which there is no substitute at this time. If supply of these components should cease, the Company would be required to redesign its products. No assurance can be given that supply problems will not occur or, if such problems do occur, that satisfactory solutions would be available. The Company does not have long-term contracts with its suppliers and there can be no assurance that these suppliers will continue to be able to produce these components or to meet the Company's requirements. Any significant interruption in the supply, or degradation in the quality, of any such component could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Manufacturing." Although the Company generally requires its customers to submit quarterly forecasts of their needs, the Company's customers frequently require rapid delivery after placement of a purchase order. Because the Company does not maintain significant component inventories, a delay in shipment by a supplier could lead to lost sales. Lead times for materials and components may vary significantly and depend on factors such as specific supplier performance, contract terms and general market demand for components. If orders vary from forecasts, the Company may experience excess or inadequate inventory of certain materials and components. While the Company has not experienced shortages and allocations of these components to date, any shortages in the future, including those occasioned by increased sales, could result in delays in fulfillment of customer orders. Such delays, shortages and allocations could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Manufacturing." Dependence on Third-Party Manufacturers. The Company relies on a limited number of independent manufacturers, some of which are small, privately-held companies, to provide certain components and assemblies made to the Company's specifications. These manufacturers substantially complete production of the Company's products, which are then shipped to the Company for final assembly and quality control. In the event that any of the Company's subcontractors were to experience financial, operational, production or quality assurance difficulties or a catastrophic 24 event that resulted in a reduction or interruption in supply to the Company, the Company's business, financial condition and results of operations would be materially adversely affected until the Company was able to establish sufficient manufacturing capabilities from alternative sources. There can be no assurance that alternative manufacturing sources will be able to meet the Company's future requirements or that existing or alternative sources will continue to be available to the Company at favorable prices. See "Business--Manufacturing." Compliance with Regulations and Evolving Industry Standards. The market for the Company's products is characterized by the need to meet a significant number of communications regulations and standards, some of which are evolving as new technologies are deployed. In the United States, the Company's products must comply with various regulations including those promulgated by the Federal Communications Commission and standards established by Underwriters Laboratories and Bell Communications Research. Furthermore, there are regulations and standards imposed by various foreign countries where the Company's products are installed. The failure of the Company's products to comply, or delays in compliance, with the various existing and evolving industry regulations and standards could delay the introduction of the Company's products. Moreover, the enactment by federal, state or foreign governments of new laws or regulations, changes in the interpretation of existing laws or regulations or a reversal of the trend toward deregulation in the telecommunications industry could materially adversely affect the Company's customers, and thereby materially adversely affect the Company's business, financial condition and results of operations. See "Business--Industry Background." Dependence on Proprietary Rights. The Company's success and its ability to compete is dependent, in part, upon its proprietary rights. The Company relies primarily on a combination of patent, copyright, trademark and trade secret laws, as well as confidentiality procedures and contractual restrictions to establish and protect its proprietary rights. There can be no assurance that such measures will be adequate to protect the Company's proprietary rights. Further, the Company may be subject to additional risks as it enters into transactions in countries where intellectual property laws are not well developed or are difficult to enforce. Legal protections of the Company's proprietary rights may be ineffective in such countries. Litigation to defend and enforce the Company's intellectual property rights could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and results of operations, regardless of the final outcome of such litigation. Despite the Company's efforts to safeguard and maintain its proprietary rights both in the United States and abroad, there can be no assurance that the Company will be successful in doing so or that the steps taken by the Company in this regard will be adequate to deter misappropriation or independent third-party development of the Company's technology or to prevent an unauthorized third party from copying or otherwise obtaining and using the Company's products or technology. There also can be no assurance that others will not independently develop similar technologies or duplicate any technology developed by the Company. Any such events could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has entered into agreements with a small number of its customers requiring the Company to deposit its source code and, on occasion, manufacturing blueprints, tooling diagrams and production specifications, in escrow with a third party. These escrow agreements typically provide that these customers have a non-exclusive right to use such code and other materials in the event that there is a bankruptcy proceeding by or against the Company, if the Company ceases to conduct business or if the Company defaults on its support obligations. The use of such agreements may increase the likelihood of misappropriation by third parties. As the number of entrants to the Company's markets increases and the functionality of the Company's products increases and overlaps with the products of other companies, the Company may become subject to claims of infringement or misappropriation of the intellectual property rights of others. In its distribution agreements, the Company agrees to indemnify its customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties. In certain limited instances, the amount of such indemnities may be greater than the revenues the Company may have received from the customer. There can be no assurance that third parties will not assert infringement or misappropriation claims against the Company in the future with respect to current or future products. Any claims or litigation, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require the Company to enter into royalty or licensing arrangements. Such royalty or licensing arrangements, if required, may not be available on terms acceptable to the Company, if at all, which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the 25 Company changed its name from Excel Inc. to Excel Switching Corporation in September 1997. Searches performed on the term Excel have revealed several registrations and numerous uses of that term, and terms substantially similar to it, alone and in combination with other terms and designs. Accordingly, there can be no assurance that third parties will not assert trademark infringement claims relating to the name Excel in the future. See "Business--Intellectual Property." Risks Associated with International Sales. In 1996 and 1997, sales to customers located outside of the United States accounted for less than 4% and 8%, respectively, of the Company's revenues in each such period. However, the Company sells its products to application developers, OEMs and systems integrators located within the United States which market products and services based on the Company's products worldwide. The Company intends to expand its operations outside the United States and enter additional international markets, which will require significant management attention and financial resources. International sales are subject to a variety of risks, including difficulties in establishing and managing international distribution channels, in servicing and supporting products sold outside the United States and in translating products and related materials into foreign languages. International operations are also subject to difficulties in collecting accounts receivable, staffing and managing personnel and enforcing intellectual property rights. Other factors that can adversely affect international operations include fluctuations in the value of foreign currencies and currency exchange rates, changes in import/export duties and quotas, introduction of tariff or non-tariff barriers and economic or political changes in international markets. Any inability to obtain foreign regulatory approvals on a timely basis could have a material adverse effect on the Company's business, financial condition and results of operations. If the Company's international sales increase, its revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower levels of sales which typically occur during the summer months in Europe and other parts of the world. There can be no assurance that these factors will not have a material adverse effect on the Company's future international sales and, consequently, on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations". Risks Relating to Potential Acquisitions. The Company may, from time to time, pursue the acquisition of other companies, assets, products and technologies although the Company has no present commitments or agreements with respect to any such acquisitions. Acquisitions involve a number of operating risks that could materially adversely affect the Company's results of operations, including the diversion of management's attention to assimilate the operations, products and personnel of the acquired companies, the amortization of acquired intangible assets, and the potential loss of key employees of the acquired companies. Furthermore, acquisitions may involve businesses in which the Company lacks experience. Because management has limited experience in acquisitions and the Company has no experience in integrating acquired companies or technologies into its operations, there can be no assurance that the Company will be able to manage one or more acquisitions successfully, or that the Company will be able to integrate the operations, products or personnel gained through any such acquisitions without a material adverse effect on the Company's business, financial condition and results of operations. Control by Principal Stockholder. Robert P. Madonna, the Company's President, Chief Executive Officer, Chairman of the Board and principal stockholder, beneficially owns approximately 83.6% of the outstanding shares of Common Stock of the Company. As a result, Mr. Madonna has the ability to elect the Company's directors and to determine the outcome of corporate actions requiring stockholder approval, irrespective of how other stockholders of the Company may vote. This concentration of ownership may have the effect of delaying or preventing a change in control of the Company which may be favored by a majority of the remaining stockholders, or cause a change of control not favored by the Company's other stockholders. Shares Eligible for Future Sale. Sales of substantial amounts of shares of the Company's Common Stock 180 days after the Company's initial public offering on November 4, 1997 could adversely affect the market price of the Common Stock. Upon expiration of lock-up agreements with the Underwriters on May 4, 1998, approximately 27,918,400 additional shares of Common Stock will be available for sale in the public market, subject to the provisions of Rule 144 under the Securities Act. At December 27, 1997, approximately 7,179,990 shares of Common Stock were issued or issuable pursuant to vested options under the Company's stock plans, of which approximately 107,700 shares are not subject to lock-up agreements with the Underwriters and were eligible for sale in the public market in accordance with Rule 701 under the Securities Act beginning February 4, 1998. The Company intends to file one or more registration statements on Form S-8 under the Securities Act on or about May 4, 1998 to register up to 11,275,840 shares of Common Stock subject to outstanding stock options granted pursuant to the Company's Stock Option Program as of 26 December 27, 1997, of which options to purchase 7,149,990 shares of Common Stock were vested as of December 27, 1997 and 3,625,000 shares of Common Stock issuable pursuant to the Company's 1997 stock plans. Such registration statements are expected to become effective upon filing. At such time, approximately 7,327,050 shares of Common Stock issuable upon the exercise of options granted as of December 27, 1997 and covered by these registration statements will be vested and eligible for sale in the public market upon the exercise of underlying options to the extent not previously sold pursuant to Rule 701. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements and Supplementary Data of the Company are listed under Part IV, Item 14, in this Report. 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 information required by this Item 10 is hereby incorporated by reference to the information under the headings "Elections of Directors" and "Executive Officers" in the Company's definitive proxy statement to be filed by the Company within 120 days after the close of its fiscal year ended December 27, 1997. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item 11 is hereby incorporated by reference to the information under the heading "Executive Compensation" and "Options and Stock Plans" in the Company's definitive proxy statement to be filed by the Company within 120 days after the close of its fiscal year ended December 27, 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item 12 is hereby incorporated by reference to the information under the heading "Security Ownership of Certain Beneficial Owners and Management" in the definitive proxy statement to be filed by the Company within 120 days after the close of its fiscal year ended December 27, 1997. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item 13 is hereby incorporated by reference to the information under the heading "Certain Transactions", if any, in the Company's definitive proxy statement to be filed by the Company within 120 days after the close of its fiscal year ended December 27, 1997. 27 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report: Page ---- (1) Financial Statements Report of Independent Public Accountants F-1 Consolidated Balance Sheets as of December 28, 1996 and December 27, 1997 F-2 Consolidated Statements of Income for the Fiscal Years 1995, 1996 and 1997 F-3 Consolidated Statements of Stockholders' Equity for the Fiscal Years 1995, 1996 and 1997 F-4 Consolidated Statements of Cash Flows for the Fiscal Years 1995, 1996 and 1997 F-5 Notes to Consolidated Financial Statements F-6 (2) Financial Statement Schedule Report of Independent Public Accountants Valuation and qualifying accounts Schedule II (3) Listing of Exhibits
28
EXHIBIT NO. REFERENCE 3.1 Restated Articles of Organization of the Company. A** 3.2 Restated By-laws of the Company. A** 4.1 Specimen certificate representing the Common Stock. A** 10.1 1997 Stock Option Plan. A** 10.2 1997 Non-Employee Director Stock Option Plan. A** 10.3 1997 Employee Stock Purchase Plan. A** 10.4 Form of Stock Option Agreement of the Company used under Stock Option Program. A** 10.5 Lease dated as of July 27, 1995 between the Company and Independence Park, Inc., A** as amended 10.6 Purchase and Resale Agreement dated as of May 27, 1994 between the Company and A** Boston Technology, Inc. 10.7 Credit Agreement and Promissory Note dated as of December 21, 1995 between the Filed Company and The First National Bank of Boston, as amended. herewith 10.8 Mortgage and Security Agreement and Real Estate Promissory Note dated April 21, A** 1995 between the Company and Cape Cod Bank and Trust Company. 10.9 Loan Agreement, Real Estate Promissory Note and Security Agreement dated as of A** June 30, 1997 between the Company and Cape Cod Bank and Trust Company. 21.1 Subsidiaries of the Company Filed herewith 27 Financial Data Schedule Filed herewith
- -------------------------- A Incorporated by reference to the Company's registration statement on Form S-1 (Registration No. 333-35791). The number set forth herein is the number of the Exhibit in said registration statement. ** In accordance with Rule 12b-32 under the Securities Exchange Act of 1934, as amended, reference is made to the documents previously filed with the Securities and Exchange Commission, which documents are hereby incorporated by reference. (b) REPORTS ON FORM 8-K ------------------- The Company did not file any current reports on Form 8-K during the quarter ended December 27, 1997. 29 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. EXCEL SWITCHING CORPORATION Dated: March 25, 1998 By: /s/ Robert P. Madonna ---------------------- Robert P. Madonna President, Chief Executive Officer & Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
Signature Title Date /s/ Robert P. Madonna Director, President, Chief Executive Officer and March 25, 1998 - ---------------------- Chairman of the Board (Principal Executive Officer) Robert P. Madonna /s/ Stephen S. Galliker Vice President, Finance and Administration March 25, 1998 - ------------------------ and Chief Financial Officer (Principal Financial Stephen S. Galliker and Accounting Officer) /s/ Christopher Stavros Director, Vice President, General Counsel March 25, 1998 - ---------------------- and Clerk Christopher Stavros /s/ Edward L. Breslow Director March 25, 1998 - --------------------- Edward L. Breslow /s/ John Loughlin Director March 25, 1998 - ----------------- John Loughlin
30 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Excel Switching Corporation: We have audited the accompanying consolidated balance sheets of Excel Switching Corporation (a Massachusetts corporation formerly known as Excel Inc.) and subsidiaries as of December 28, 1996 and December 27, 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 27, 1997. 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 audits. 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 provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Excel Switching Corporation and subsidiaries as of December 28, 1996 and December 27, 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 27, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Boston, Massachusetts January 21, 1998 F-1 EXCEL SWITCHING CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data) ASSETS December 28, December 27, 1996 1997 CURRENT ASSETS: Cash and cash equivalents $ 4,069 $ 47,968 Marketable securities - 66,929 Accounts receivable, net of reserves of $979 and $1,350 in 1996 and 1997, respectively 10,329 12,843 Inventories 7,358 4,740 Prepaid taxes - 122 Deferred tax asset 3,761 5,626 Other current assets 292 1,298 --------- ---------- Total current assets 25,809 139,526 --------- ---------- PROPERTY AND EQUIPMENT: Test equipment 3,400 4,015 Buildings 3,925 3,991 Office equipment, furniture and fixtures 1,836 3,460 Land 576 576 Building improvements 493 523 Assets under capital lease 489 489 Construction in progress (Note 7) - 1,129 --------- ---------- 10,719 14,183 Less--Accumulated depreciation and amortization 1,756 4,015 ---------- ----------- 8,963 10,168 --------- ---------- $ 34,772 $ 149,694 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term obligations $ 499 $ 4,213 Accounts payable 1,896 4,177 Accrued expenses 5,807 11,156 Accrued income taxes 2,647 3,606 --------- --------- Total current liabilities 10,849 23,152 --------- --------- DEFERRED INCOME TAXES - 519 --------- --------- LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 3,837 108 --------- --------- COMMITMENTS (Note 7) STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value- Authorized--10,000,000 shares; no shares issued and outstanding - - Common stock, $.01 par value- Authorized--100,000,000 shares Issued and outstanding--28,089,600 and 32,592,000 shares at December 28, 1996 281 326 and December 27, 1997, respectively Additional paid-in capital 647 88,134 Deferred compensation (192) (491) Unrealized loss on investments - (20) Retained earnings 19,350 37,966 --------- --------- Total stockholders' equity 20,086 125,915 --------- --------- $ 34,772 $ 149,694 ========= ========= The accompanying notes are an integral part of these consolidated financial statements. F-2 EXCEL SWITCHING CORPORATION CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data)
-------------------Year Ended-------------------- December 31, December 28, December 27, 1995 1996 1997 REVENUES $ 36,161 $ 62,050 $ 88,727 COST OF REVENUES 12,100 24,312 26,631 ---------- ---------- ---------- Gross profit 24,061 37,738 62,096 ---------- ---------- ---------- OPERATING EXPENSES: Engineering, research and development 8,117 11,121 13,260 Selling and marketing 2,923 6,621 11,486 General and administrative 4,238 6,426 7,949 ---------- ---------- ---------- Total operating expenses 15,278 24,168 32,695 ---------- ---------- ---------- Income from operations 8,783 13,570 29,401 OTHER INCOME (EXPENSE): Interest income and other expense, net 110 111 1,764 Interest expense (72) (495) (372) ---------- ---------- ---------- Total other income (expense) 38 (384) 1,392 ---------- ---------- ---------- Income before provision for income taxes 8,821 13,186 30,793 PROVISION FOR INCOME TAXES 3,410 5,285 12,177 ---------- ---------- ---------- NET INCOME $ 5,411 $ 7,901 $ 18,616 ========== ========== ========== BASIC EARNINGS PER SHARE $ .19 $ .28 $ .65 ========== ========== ========== DILUTED EARNINGS PER SHARE $ .17 $ .24 $ .54 ========== ========== ========== BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 27,962 28,090 28,756 ========== ========== ========== DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 31,822 32,697 34,361 ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. F-3 EXCEL SWITCHING CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except share data)
Common Stock Additional Deferred Unrealized Retained Number of $.01 Par Paid-in Compensation Loss on Earnings Total Shares Value Capital Investments BALANCE, DECEMBER 31, 1994 27,945,600 $ 280 $ 251 $ (99) $ -- $ 6,039 $ 6,471 Compensation expense associated with the grant of -- -- 432 (189) -- -- 243 stock options Forfeiture of stock options with deferred -- -- (16) 16 -- -- -- compensation Exercise of stock options 144,000 1 -- -- -- (1) -- Net income -- -- -- -- -- 5,411 5,411 ---------- ----- -------- ------ ----- -------- --------- BALANCE, DECEMBER 31, 1995 28,089,600 281 667 (272) -- 11,449 12,125 Compensation expense associated with the grant of -- -- -- 73 -- -- 73 stock options Forfeiture of stock options with deferred -- -- (20) 7 -- -- (13) compensation Net income -- -- -- -- -- 7,901 7,901 ---------- ----- -------- ------ ----- -------- --------- BALANCE, DECEMBER 28, 1996 28,089,600 281 647 (192) -- 19,350 20,086 Compensation expense associated with the grant of -- -- 424 (299) -- -- 125 stock options Exercise of stock options 2,400 -- 2 -- -- -- 2 Proceeds of initial public offering of common 4,500,000 45 87,061 -- -- -- 87,106 stock, net of approximately $7,394,000 in issuance costs Unrealized loss on investments -- -- -- -- (20) -- (20) Net income -- -- -- -- -- 18,616 18,616 ---------- ----- -------- ------ ----- -------- --------- BALANCE, DECEMBER 27, 1997 32,592,000 $ 326 $ 88,134 $ (491) $ (20) $ 37,966 $ 125,915 ========== ===== ======== ====== ===== ======== =========
The accompanying notes are an integral part of these consolidated financial statements. F-4 EXCEL SWITCHING CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
-------------------Year Ended--------------------- December 31, December 28, December 27, 1995 1996 1997 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,411 $ 7,901 $ 18,616 Adjustments to reconcile net income to net cash provided by operating activities- Depreciation and amortization 560 1,166 2,259 Loss on disposal of property and equipment 95 - - Unrealized loss on investments - - 20 Deferred income taxes (487) (3,417) (1,346) Compensation expense associated with the grant of stock 243 60 125 options, net of forfeitures Changes in assets and liabilities- Accounts receivable (3,928) (2,020) (2,514) Inventories (3,760) (409) 2,618 Prepaid taxes (401) 401 (122) Other current assets (123) (132) (1,006) Accounts payable 2,419 (2,473) 2,281 Accrued expenses 1,198 3,877 5,349 Accrued income taxes (55) 2,350 959 --------- --------- --------- Net cash provided by operating activities 1,172 7,304 27,239 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (4,096) (4,601) (3,464) Proceeds from sale of property and equipment - 548 - Purchases of marketable securities, net - - (66,969) --------- --------- --------- Net cash used in investing activities (4,096) (4,053) (70,433) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of long-term obligations 2,740 649 460 Payments on long-term obligations (53) (601) (475) Proceeds from sale of common stock - - 87,106 Proceeds from the exercise of stock options - - 2 --------- --------- --------- Net cash provided by financing activities 2,687 48 87,093 --------- --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (237) 3,299 43,899 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,007 770 4,069 --------- --------- --------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 770 $ 4,069 $ 47,968 ========= ========= ========= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for- Interest $ 119 $ 490 $ 377 ========= ========= ========= Taxes $ 4,353 $ 5,951 $ 13,271 ========= ========= ========= SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES: Acquisition of property and equipment under capital lease $ 1,112 $ 489 $ - obligations ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. F-5 EXCEL SWITCHING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 27, 1997 (1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES Excel Switching Corporation (the Company), formerly known as Excel Inc., was incorporated in Massachusetts in January 1988 and is a leading provider of open switching platforms for telecommunications networks worldwide. The Company develops, manufactures, markets and supports a family of open, programmable, carrier-class switches that address the complex enhanced services and wireless and wireline infrastructure needs of network providers. The Company sells to a variety of customers in the worldwide telecommunications market, including applications developers, original equipment manufacturers (OEMs) and system integrators. The accompanying consolidated financial statements reflect the application of certain accounting policies as described below and elsewhere in these notes to consolidated financial statements. (a) Principles of Consolidation These consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions have been eliminated. (b) Change in Fiscal Year-End During 1996, the Company elected to change its fiscal year-end from December 31 to the last Saturday in December. In the accompanying consolidated financial statements, 1995 refers to the year ended December 31, 1995; 1996 refers to the year ended December 28, 1996; and 1997 refers to the year ended December 27, 1997. (c) Management 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. The market for telecommunications equipment in which the company operates can be characterized as rapidly changing due to several factors including technological advancements, the introduction of new products and services by the Company and its competitors, and the increasing demands placed on equipment in worldwide telecommunications networks. Significant assets and liabilities with reported amounts based on estimates include accounts receivable, inventory and accrued expenses for post sale support costs, warranty costs and sales returns. While the Company believes its estimates are adequate, actual results could differ from those estimates. F-6 EXCEL SWITCHING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 27, 1997 (Continued) (d) Revenue Recognition Revenue from product sales is recognized at the time of shipment to the customer at which time transfer of ownership occurs. The Company provides for anticipated product returns, post sale support and warranty costs at the time of product shipment. (e) Sources of Supply and Third-Party Manufacturing Relationships Certain components used in the manufacture of the Company's products are currently available only from single- or sole-source suppliers. In addition, the Company relies on a limited number of third parties to manufacture certain other components and subassemblies. Shortages resulting from a change in arrangements with these suppliers and manufacturers could cause delays in manufacturing and product shipments and possible deferral or cancellation of customer orders. (f) Cash, Cash Equivalents and Marketable Securities The Company accounts for investments in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under this standard, investments for which the Company has the positive intent and ability to hold to maturity are reported at amortized cost, which approximates fair market value, and are classified as held-to-maturity. The Company did not classify any investments as held-to-maturity at December 28, 1996 or December 27, 1997. Investments purchased to be held for indefinite periods of time and not intended at the time of purchase to be held-to-maturity are classified as available-for-sale and reported at fair market value. Unrealized losses on available-for-sale securities at December 27, 1997 were approximately $20,000. The investments that the Company has deemed available-for-sale include certificates of deposit, commercial paper, bankers' acceptances and corporate, state municipality and U.S. government debt securities. Cash equivalents are highly liquid investments with original maturities of three months or less. Marketable securities are highly liquid investment grade securities with original maturities of greater than three months. To date, the Company has not recorded any realized gains or losses. F-7 EXCEL SWITCHING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 27, 1997 (Continued) Cash, cash equivalents and marketable securities consist of the following (in thousands): 1996 1997 Cash and cash equivalents- Cash $ 4,016 $ 1,655 Time deposits 53 1,459 Money markets - 9,791 Commercial paper - 32,071 Bankers' acceptance - 2,992 ------- -------- Total cash and cash equivalents $ 4,069 $ 47,968 ======= ======== Marketable securities- Time deposits $ - $ 2,004 U.S. government and agency debt securities - 31,090 Municipality debt securities - 2,000 Commercial paper - 4,900 Corporate debt securities - 26,935 ------- -------- Total marketable securities $ - $ 66,929 ======= ======== The following table summarizes the remaining maturity of the Company's investments in debt securities as of December 27, 1997 (in thousands): One year or less $ 83,343 One to five years 14,647 Variable maturity 2,000 -------- $ 99,990 ======== (g) Inventories Inventories are valued at the lower of cost (first-in, first-out) or market. Work-in-process and finished goods consist of materials, labor and manufacturing overhead. Inventories at December 28, 1996 and December 27, 1997 consist of the following (in thousands): 1996 1997 Raw materials $ 3,585 $ 396 Work-in-process 2,988 3,713 Finished goods 785 631 ------- ------- $ 7,358 $ 4,740 ======= ======= F-8 EXCEL SWITCHING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 27, 1997 (Continued) (h) Depreciation and Amortization The Company provides for depreciation and amortization using both straight-line and accelerated methods by charges to operations in amounts that allocate the cost of the assets over their estimated useful lives as follows: Estimated Description Useful Lives Test equipment 2-5 years Buildings 40 years Office equipment, furniture and fixtures 2-7 years Building improvements 7-40 years Assets under capital lease 3 years (i) Research and Development and Software Development Costs Research and development costs have been charged to operations as incurred. Capitalization of computer software costs begin upon the establishment of technological feasibility. Because the Company believes its current process for developing software is essentially completed concurrently with the establishment of technological feasibility, no costs have been capitalized to date. (j) Concentrations of Credit Risk Financial instruments that subject the Company to significant concentrations of credit risk consist primarily of cash, cash equivalents, marketable securities and trade accounts receivable. The Company's investments are in financial instruments of high quality. Concentration of credit risk with respect to accounts receivable is limited to customers to whom the Company makes significant sales. One significant customer accounted for approximately 34% and 15% of accounts receivable at December 28, 1996 and December 27, 1997, respectively. Another significant customer accounted for approximately 18% of accounts receivable at December 27, 1997 (see Note 9). To control credit risk, the Company performs regular credit evaluations of its customers' financial condition and maintains allowances for potential credit losses. (k) Fair Value of Financial Instruments The carrying amounts of the Company's cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to the short-term nature of these instruments. The carrying amounts of debt issued pursuant to agreements with banks approximate fair value since the interest rates on these instruments fluctuate with market interest rates. F-9 EXCEL SWITCHING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 27, 1997 (Continued) (l) Earnings per Share In March 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 128, Earnings per Share. This statement established standards for computing and presenting earnings per share and applies to entities with publicly traded common stock or potential common stock. This statement is effective for fiscal years ending after December 15, 1997. In February 1998, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 98. This bulletin revises the SEC's guidance for calculating earnings per share with respect to equity security issuances before an initial public offering (IPO) and is effective for fiscal years ending after December 15, 1997. The prior years' earnings per share have been retroactively restated to reflect the adoption of SFAS No. 128 and SAB No. 98. Basic earnings per share was determined by dividing net income by the weighted average common shares outstanding during the period. Diluted earnings per share was determined by dividing net income by diluted weighted average shares outstanding. Diluted weighted average shares reflects the dilutive effect, if any, of both common equivalent shares and nominal issuances. Common equivalent shares include common stock options to the extent their effect is dilutive, based on the treasury stock method. Nominal issuances arise when a registrant issues common stock, options or warrants to purchase common stock or other potentially dilutive instruments for nominal consideration, as defined by SAB No. 98, in the periods preceding an IPO. During the period preceding the Company's IPO, the Company did not have any nominal issuances. The calculations of basic and diluted weighted average shares outstanding are as follows (in thousands): 1995 1996 1997 Basic weighted average common shares outstanding 27,962 28,090 28,756 Weighted average common equivalent shares 3,860 4,607 5,605 ------ ------ ------ Diluted weighted average shares outstanding 31,822 32,697 34,361 ====== ====== ====== (m) New Accounting Standards In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 requires disclosure of all components of comprehensive income on an annual and interim basis. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. F-10 EXCEL SWITCHING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 27, 1997 (Continued) In July 1997, the FASB issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS No. 131, requires certain financial and supplementary information to be disclosed on an annual and interim basis for each reportable segment of an enterprise. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. Unless impracticable, companies would be required to disclose similar prior period information upon adoption. (2) LONG-TERM OBLIGATIONS Long-term obligations consist of the following at December 28, 1996 and December 27, 1997 (in thousands): 1996 1997 Mortgage and Security Agreement $ 2,485 $ 2,386 Real Estate Promissory Note - 460 Promissory note payable to a bank 435 272 Capital lease obligation--building 997 926 Capital lease obligation--equipment 419 277 ------- ------- 4,336 4,321 Less--Current maturities 499 4,213 ------- ------- $ 3,837 $ 108 ======= ======= In January 1998, the Company repaid all outstanding obligations under the Mortgage and Security Agreement, promissory note payable and the Real Estate Promissory Note. Accordingly, all outstanding balances as of December 27, 1997 have been reflected as current liabilities in the accompanying December 27, 1997 consolidated balance sheet. On April 21, 1995, the Company entered into a $2,600,000 Mortgage and Security Agreement with a bank to finance the purchase of two buildings and related land. The agreement required monthly principal and interest payments through April 2010. Interest accrued at prime (8.5% at December 27, 1997) plus .75%. The mortgage was collateralized by the two buildings and related land, which have a carrying value of approximately $3,100,000 at December 27, 1997. The Company was subject to certain restrictive covenants under this agreement. F-11 EXCEL SWITCHING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 27, 1997 (Continued) In June 1997, the Company purchased property to be used for the construction of an additional building. The purchase price of $575,000 and the construction costs were to be financed, in part, by a $2,100,000 Real Estate Promissory Note with a bank. In connection with the purchase, the bank advanced $460,000 under this note. Borrowings under this note bore interest at prime (8.5% at December 27, 1997) plus .25% and were secured by the property and a certificate of deposit in the amount of $385,000. During 1996, the Company entered into a promissory note with a bank for $489,000, the proceeds of which were used to fund building improvements and to retire a previous promissory note with the same bank in the original amount of $300,000. Borrowings under this note required monthly principal payments plus interest at prime (8.5% at December 27, 1997) plus 1% through August 1999. In 1995, the Company entered into a building lease that requires monthly payments of approximately $13,000 through July 2000. This lease includes a purchase option exercisable beginning in August 1998 for $875,000. Management intends to exercise this option and, accordingly, has recorded this lease as a capital lease obligation. The present value of the remaining lease payments and the purchase price have been recognized as the capital lease obligation using an effective rate of 8.3%. During 1996, the Company entered into an agreement with a leasing company, which provided for the sale and leaseback of certain equipment that had a net book value of approximately $474,000. Proceeds to the Company in connection with this sale were approximately $548,000. The resulting gain has been deferred and is being recognized ratably over the lease term. Under the terms of the agreement, the Company is required to make thirty- six monthly installments of approximately $16,000. The present value of the lease payments has been recognized as a capital lease obligation using an effective rate of 9%. Assuming the Company exercises its purchase option in 1998 with respect to the 1995 building lease, future maturities of the remaining capital lease obligations are as follows (in thousands): 1998 $ 1,167 1999 112 ------- 1,279 Less--Amount representing interest 76 Total long-term obligations $ 1,203 ======= F-12 EXCEL SWITCHING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 27, 1997 (Continued) (3) LINE-OF-CREDIT ARRANGEMENT In December 1997, the Company's unsecured line-of-credit arrangement with a bank was amended to provide up to $15,000,000 in financing. Borrowings under this line bear interest at either the bank's base rate (8.5% at December 27, 1997) or the Eurodollar rate (5.7% at December 27, 1997) plus 1.75%. The Company is required to maintain certain restrictive covenants under this agreement. This agreement expires June 30, 1999. There were no borrowings outstanding under this agreement at December 28, 1996 or December 27, 1997. (4) INCOME TAXES The Company provides for income taxes under SFAS No. 109, Accounting for Income Taxes. Under SFAS No. 109, a deferred tax asset or liability is determined based on the difference between the financial statement and tax bases of assets and liabilities, as measured by the enacted tax rates expected to be in effect when the differences reverse. The components of the provision for income taxes are as follows (in thousands): 1995 1996 1997 Current- Federal $ 3,054 $ 6,731 $11,249 State 843 1,971 2,274 ------- ------- ------- 3,897 8,702 13,523 ------- ------- ------- Deferred (prepaid)- Federal (363) (2,904) (1,036) State (124) (513) (310) ------- ------- ------- (487) (3,417) (1,346) ------- ------- ------- Total provision $ 3,410 $ 5,285 $12,177 ======= ======= ======= A reconciliation of the federal statutory rate to the Company's effective tax rate is as follows: 1995 1996 1997 Income tax provision at federal statutory rate 34% 34% 35% Increase (decrease) in tax resulting from- State tax provision, net of federal benefit 6 6 5 Research and development tax credits (1) - (2) Other - - 2 ---- ---- ---- Effective tax rate 39% 40% 40% ==== ==== ==== F-13 EXCEL SWITCHING CORPORATION Notes To Consolidated Financial Statements December 27, 1997 (Continued) The approximate income tax effect of each type of temporary difference composing the net deferred tax asset at December 28, 1996 and December 27, 1997 is as follows (in thousands): 1996 1997 Difference in inventory accounting method $ (275) $ (778) Nondeductible reserves 1,427 2,185 Nondeductible accruals 2,674 3,736 Depreciation and amortization 137 - Other temporary differences (202) (36) -------- -------- Net deferred tax asset $ 3,761 $ 5,107 ======== ======== (5) STOCKHOLDERS' EQUITY (a) Initial Public Offering In November 1997, the Company completed an IPO of 4,500,000 shares of common stock at a per share price of $21. The Company received proceeds of approximately $87.1 million, net of underwriting discounts and commissions and offering expenses of approximately $7.4 million. (b) Common Stock On September 16, 1997, the Company restated its Articles of Organization to provide for authorized common stock of 100,000,000 shares, with a $.01 par value, 85,000,000 of which were designated as voting shares and 15,000,000 of which were designated as nonvoting shares. The accompanying consolidated financial statements have been retroactively restated for this change. Upon the effective date of the Registration Statement relating to the Company's IPO of common stock, all authorized and outstanding shares of nonvoting common stock were automatically converted, on a one-for-one basis, into shares of voting common stock. At December 27, 1997, there were 14,840,840 shares of common stock reserved for future issuance under the Company's stock option plans. (c) Preferred Stock In September 1997, the Board of Directors and sole voting stockholder authorized 10,000,000 shares of $.01 par value preferred stock. The Board of Directors has the authority to issue such shares in one or more series and to fix the relative rights and preferences without further vote or action by the stockholders. Currently, the Board of Directors has no plans to issue any shares of preferred stock. F-14 EXCEL SWITCHING CORPORATION Notes to Consolidated Financial Statements (Continued) (d) Stock Splits On September 19, 1996, the Company declared a three-for-one split of the shares of common stock. On September 16, 1997, the Company declared a two-for-one split of the shares of common stock. All share and per share amounts for all periods presented have been adjusted to reflect these splits. (6) STOCK OPTION PLANS (a) Stock Option Program The Company has granted nonqualified stock options to purchase shares of its common stock at exercise prices generally determined to be at fair market value by the Company's Board of Directors on the date of grant. Options are generally exercisable within 10 years of the original date of grant and vest over a period of up to five years from the date of grant. In some instances, options have been granted at exercise prices below the fair market value on the date of grant. The difference, if any, between the fair market value of shares of the Company's nonvoting common stock, as determined by the Company's Board of Directors, and the exercise price of the option is recognized as compensation expense over the vesting term. During 1995, 1996 and 1997, the Company recognized net compensation expense of approximately $243,000, $60,000 and $125,000, respectively. In November 1997, this program was terminated. There are 11,215,840 options outstanding under this program as of December 27, 1997. (b) 1997 Stock Option Plan In September 1997, the Company's Board of Directors and sole voting stockholder adopted the 1997 Stock Option Plan (1997 Plan). Under the terms of the 1997 Plan, incentive and nonqualified stock options may be granted to employees and consultants to purchase an aggregate of 3,000,000 shares of common stock. Subsequent to December 27, 1997, approximately 108,900 options were been granted under the 1997 Plan. F-15 EXCEL SWITCHING CORPORATION Notes to Consolidated Financial Statements December 27, 1997 (Continued) (c) Director Option Plan The Company's Non-Employee Director Stock Option Plan (Director Option Plan) was adopted by the Board of Directors and sole voting stockholder in September 1997. The Director Option Plan provides for the grant of options to purchase an aggregate 225,000 shares of common stock to nonemployee directors of the Company. Each such director will be granted an option to purchase 30,000 shares upon election to the Board of Directors. In addition, each such director will be automatically granted an option to purchase 15,000 shares in each of the two years following the date such person becomes a director. These options will vest 1/3 on grant date, 1/3 one year from grant date and 1/3 two years from grant date. In November of 1997, three nonemployee directors were elected and each received 30,000 options at an exercise price of $21 per share. (d) 1997 Employee Stock Purchase Plan In September 1997, the Company's Board of Directors and sole voting stockholder approved the 1997 Employee Stock Purchase Plan, pursuant to which a maximum of 400,000 shares of common stock may be issued to participating employees in semiannual grants at a price equal to 85% of fair market value, as defined. No shares have been issued under this plan. (e) Stock Option Activity Stock option activity under all plans for the three years in the period ended December 27, 1997 is as follows: Number of Weighted Shares Average Exercise Price Outstanding, December 31, 1994 6,639,840 $ 0.025 Granted 1,491,000 0.333 Exercised (144,000) 0.002 Forfeited (96,000) 0.002 ----------- ------- Outstanding, December 31, 1995 7,890,840 0.084 Granted 1,997,500 4.250 Forfeited (30,000) 0.333 ----------- ------- Outstanding, December 28, 1996 9,858,340 0.927 Granted 1,574,100 9.471 Exercised (2,400) 1.000 Forfeited (124,200) 4.035 ----------- ------- Outstanding, December 27, 1997 11,305,840 $ 2.083 =========== ======= F-16 EXCEL SWITCHING CORPORATION Notes to Consolidated Financial Statements December 27, 1997 (Continued) The following table summarizes information about stock options outstanding at December 27, 1997:
Range of exercise prices Number Weighted Number Weighted Outstanding Average Exercisable Average Remaining Exercise Contractual Price Life $ 0.002 5,469,840 6.1 5,355,840 $ 0.002 0.167 930,000 6.9 687,600 0.167 0.333 1,455,600 7.7 829,800 0.333 1.00- 2.33 321,600 8.5 60,000 2.333 4.50- 6.00 2,222,300 8.9 216,750 4.777 7.00-10.50 391,300 9.3 - - 11.50-15.50 417,800 9.7 - - 18.00-21.00 97,400 9.9 30,000 21.000 ----------- --------- -------- 11,305,840 7,179,990 $ 0.307 =========== ========= ======== Exercisable, December 28, 1996 6,356,940 $ 0.046 ========= ======== Exercisable, December 31, 1995 5,840,040 $ 0.029 ========= ========
(f) Fair Value of Stock Options In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 requires the measurement of the fair value of stock options to be included in the statement of income or disclosed in the notes to financial statements. The Company has determined that it will continue to account for stock-based compensation for employees under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and elect the disclosure-only alternative under SFAS No. 123. Had compensation cost for the Company's option plans been determined based on the fair value at the grant dates, as prescribed in SFAS No. 123, the Company's net income would have been as follows: 1995 1996 1997 Net income (in thousands)- As reported $ 5,411 $ 7,901 $ 18,616 Pro forma 5,317 7,456 16,712 Diluted earnings per share- As reported $ .17 $ .24 $ .54 Pro forma .17 .23 .49 F-17 EXCEL SWITCHING CORPORATION Notes to Consolidated Financial Statements December 27, 1997 (Continued) The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants during the applicable period: 1995 1996 1997 Dividend yield - - - Volatility 56.6% 56.6% 56.6% Risk-free interest rate 6.0%-6.5% 5.9%-6.8% 5.0%-6.6% Expected option term 7.5 years 7.5 years 5.0 years Weighted average fair value per share of options granted $.97 $5.64 $5.28 (7) COMMITMENTS The Company leases certain equipment and office facilities under noncancelable operating leases, which expire at various dates through November 2001. Future minimum lease payments required under these leases at December 27, 1997 are approximately as follows (in thousands): Fiscal Year Amount 1998 $ 925 1999 600 2000 229 2001 125 -------- $ 1,879 ======== Total rent expense under these agreements for 1995, 1996 and 1997 was approximately $193,000, $1,062,000 and $1,172,000, respectively. During 1997, the Company began construction of a new office and research facility. As of December 31, 1997, the Company had incurred approximately $1.1 million of acquisition and construction costs, which are classified as construction in progress in the accompanying consolidated balance sheets. The Company estimates total facility costs to be approximately $3,700,000. F-18 EXCEL SWITCHING CORPORATION Notes To Consolidated Financial Statements December 27, 1997 (Continued) (8) EMPLOYEE BENEFIT PLAN The Company has a qualified 401(k) retirement savings plan covering all employees. Under this plan, participants may elect to defer a portion of their compensation, subject to certain limitations. In addition, the Company, at the discretion of the Board of Directors, may make profit sharing contributions into the plan. For fiscal years 1995, 1996 and 1997, the Company made contributions of approximately $209,000, $534,000 and $898,000, respectively. (9) SIGNIFICANT CUSTOMERS Sales to significant customers as a percentage of the Company's total revenues were as follows: 1995 1996 1997 Significant customer A 41% 37% 26% Significant customer B - - 10 Significant customer C 11 - - (10) ACCRUED EXPENSES Accrued expenses at December 28, 1996 and December 27, 1997 consist of the following (in thousands): 1996 1997 Accrued sales returns $ 1,243 $ 4,397 Accrued payroll and benefits 1,322 2,297 Accrued post-sales support and warranty 1,225 1,690 Accrued marketing 352 1,166 Accrued professional fees 624 737 Accrued other 1,041 869 ---------- ---------- $ 5,807 $ 11,156 ========== ========== F-19 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Excel Switching Corporation: We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Excel Switching Corporation and subsidiaries included in this Form 10-K and have issued our report thereon dated January 21, 1998. Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in Item 14(a)(2) is the responsibility of the Company's management and is presented for the purpose of complying with Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states, in all material respects, the financial data required to be set forth therein, in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP Boston, Massachusetts January 21, 1998 SCHEDULE II EXCEL SWITCHING CORPORATION VALUATION AND QUALIFYING ACCOUNTS Allowance for Balance Charged Doubtful Beginning to Cost Deductions Balance End of Accounts of Period or Expense (Write-offs) Period ------------- --------- ---------- ------------ -------------- 1995 266,000 387,000 0 653,000 1996 653,000 497,000 (171,000) 979,000 1997 979,000 555,000 (184,000) 1,350,000 EX-10.7 2 CREDIT AGREEMENT EXHIBIT 10.7 EXCEL, INC. CREDIT AGREEMENT Dated as of December 21, 1995 THIS CREDIT AGREEMENT is made as of December 21, 1995, by and between EXCEL INC. (the "Company"), a Massachusetts corporation having its chief executive office at 255 Independence Drive, Hyannis, Massachusetts and THE FIRST NATIONAL BANK OF BOSTON (the "Bank"), a national banking association having its head office at 100 Federal Street, Boston, Massachusetts 02110. SECTION I --------- DEFINITIONS ----------- 1.1. Definitions. ----------- All capitalized terms used in this Agreement or in the Note or in any certificate, report or other document made or delivered pursuant to this Agreement (unless otherwise defined therein) shall have the meanings assigned to them below: Adjusted Eurodollar Rate. Applicable to any Interest Period, shall mean a ------------------------ rate per annum determined pursuant to the following formula: AER = [ IOR ]* --- [1.00-RP] AER = Adjusted Eurodollar Rate IOR = Interbank Offered Rate RP = Reserve Percentage *The amount in brackets shall be rounded upwards, if necessary, to the next higher 1/100 of 1%. Where: "Interbank Offered Rate" applicable to any Eurodollar Loan for any Interest Period means the rate of interest determined by the Bank to be the prevailing rate per annum at which deposits in U.S. dollars are offered to the Bank by first-class banks in the interbank Eurodollar market in which it regularly participates on or about 10:00 a.m. (Boston time) two Business Days before the first day of such Interest Period in an amount approximately equal to the principal amount of the Eurodollar Loan to which such Interest Period is to apply for a period of time approximately equal to such Interest Period. -2- "Reserve Percentage" applicable to any Interest Period means the rate (expressed as a decimal) applicable to the Bank during such Interest Period under regulations issued from time to time by the Board of Governors of the Federal Reserve System for determining the maximum reserve requirement (including, without limitation, any basic, supplemental, emergency or marginal reserve requirement) of the Bank with respect to "Eurocurrency liabilities" as that term is defined under such regulations. The Adjusted Eurodollar Rate shall be adjusted automatically as of the effective date of any change in the Reserve Percentage. Affected Loans. See Section 2.7(a). -------------- Agreement. This Agreement, as the same may be supplemented or amended from --------- time to time. Bank. See Preamble. ---- Base Rate. The greater of (i) the rate of interest announced from time to --------- time by the Bank at its head office at 100 Federal Street, Boston, Massachusetts 02110 as its Base Rate, and (ii) the Federal Funds Effective Rate plus 1/2 of 1% per annum (rounded upwards, if necessary, to the next 1/8 of 1%). Base Rate Loan. Any Loan bearing interest determined with reference to the -------------- Base Rate. Borrowing Base. An amount equal to the lesser of (a) the Commitment Amount -------------- or (b) 75% of the net outstanding amount of Base Accounts. "Base Accounts" means accounts receivable of the Company as ------------- to which the Company has furnished to the Bank the information required by this Agreement and shall not include (a) accounts payable by subsidiaries, affiliates and employees of the Company, (b) accounts payable by debtors not located in the United States, unless otherwise approved in writing by the Bank or (c) accounts evidenced by promissory notes. The "net outstanding amount of Base Accounts" means the net --------------------------------------- amount of Base Accounts outstanding after eliminating from the aggregate amount of outstanding Base Accounts (i) such accounts that are more than 90 days past the date of the original invoice date or more than 60 days past the due date, whichever is earlier, and (ii) all other accounts of any account debtor with 25% or more of its accounts that are more than 90 days past the date of the original invoice date or more than 60 days past due as aforesaid; and deducting from the aggregate face amount of the remaining Base Accounts all payments, adjustments and credits applicable thereto and all amounts due thereon considered by the Bank difficult to collect or uncollectible by reason of return, rejection, repossession, loss or damage of or to the merchandise giving rise thereto, a merchandise or other dispute, -3- insolvency of the account debtor, or any other reason, all as determined by the Bank in its discretion, which determination shall be final and binding upon the Company. Business Day. (i) For all purposes other than as covered by clause (ii) ------------ below, any day other than a Saturday, Sunday or legal holiday on which banks in Boston, Massachusetts are open for the conduct of a substantial part of their commercial banking business; and (ii) with respect to all notices and determinations in connection with, and payments of principal and interest on, Eurodollar Loans, any day that is a Business Day described in clause (i) and that is also a day for trading by and between banks in U.S. Dollar deposits in the interbank Eurodollar market. Code. The Internal Revenue Code of 1986 and the rules and regulations ---- thereunder, collectively, as the same may from time to time be supplemented or amended and remain in effect. Commitment Amount. $5,000,000.00 or any lesser amount, including zero, ----------------- resulting from a termination or reduction of such amount in accordance with Section 7.2. Company. See Preamble. ------- Computation Rate. See Section 2.11. ---------------- Consolidated Current Liabilities. At any date as of which the amount -------------------------------- thereof shall be determined, all amounts that should, in accordance with generally accepted accounting principles, be included as current liabilities on the consolidated balance sheet of the Company and its Subsidiaries as at such date, plus, to the extent not already included therein, all Loans made under this Agreement, and all Indebtedness that is payable upon demand or within one year from the date of determination thereof unless such Indebtedness is renewable or extendable at the option of the Company or any Subsidiary to a date more than one year from the date of determination. Consolidated Tangible Net Worth. At any date as of which the amount ------------------------------- thereof shall be determined, the consolidated total assets of the Company and its Subsidiaries minus (i) the sum of any amounts attributable to (a) goodwill, ----- (b) intangible items such as unamortized debt discount and expense, patents, trade and service marks and names, copyrights, capitalized software development costs, and research and development expenses except prepaid expenses, (c) all reserves not already deducted from assets, (d) any writeup in the book value of assets resulting from any revaluation thereof subsequent to the date of the financial statements referred to in Section 4.6 and (e) the value of any minority interests in Subsidiaries and (ii) Consolidated Total Liabilities. --- Consolidated Total Liabilities. At any date as of which the amount thereof ------------------------------ shall be determined, all obligations that should, in accordance with generally accepted accounting principles, be classified as liabilities on the consolidated balance sheet of the Company and its Subsidiaries, including in any event all Indebtedness. -4- Controlled Group. All trades or businesses (whether or not incorporated) ---------------- under common control that, together with the Company, are treated as a single employer under Section 414(b) or 414(c) of the Code or Section 4001 of ERISA. Default. An Event of Default or event or condition that, but for the ------- requirement that time elapse or notice be given, or both, would constitute an Event of Default. Encumbrances. See Section 6.5. ------------ ERISA. The Employee Retirement Income Security Act of 1974 and the rules ----- and regulations thereunder, collectively, as the same may from time to time be supplemented or amended and remain in effect. Eurodollar Loan. Any Loan bearing interest at a rate determined with --------------- reference to the Adjusted Eurodollar Rate. Event of Default. Any event described in Section 7.1. ---------------- Federal Funds Effective Rate. For any day, a fluctuating interest rate per ---------------------------- annum equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day that is a Business Day, the average of the quotations for such day on such transactions received by the Bank from three Federal funds brokers of recognized standing selected by the Bank. Guarantees. As applied to the Company and its Subsidiaries, all ---------- guarantees, endorsements or other contingent or surety obligations with respect to obligations of others whether or not reflected on the consolidated balance sheet of the Company and its Subsidiaries, including any obligation to furnish funds, directly or indirectly (whether by virtue of partnership arrangements, by agreement to keep-well or otherwise), through the purchase of goods, supplies or services, or by way of stock purchase, capital contribution, advance or loan, or to enter into a contract for any of the foregoing, for the purpose of payment of obligations of any other person or entity. Indebtedness. As applied to the Company and its Subsidiaries, (i) all ------------ obligations for borrowed money or other extensions of credit, whether or not secured, absolute or contingent, including, without limitation, unmatured reimbursement obligations in respect of letters of credit or guarantees issued for the account of or on behalf of the Company and its Subsidiaries; (ii) all obligations representing the deferred purchase price of property, other than accounts payable arising in the ordinary course of business; (iii) all obligations evidenced by bonds, notes, debentures or other similar instruments; (iv) all obligations secured by any mortgage, pledge, security interest or other lien on property owned or acquired by the Company or any of its Subsidiaries whether or not the obligations secured thereby shall have been assumed; (v) that portion of all obligations arising under capital leases that is required to be capitalized on the consolidated balance sheet of the Company and its Subsidiaries; (vi) all Guarantees; and (vii) all -5- obligations that are immediately due and payable out of the proceeds of or production from property now or hereafter owned or acquired by the Company or any of its Subsidiaries. Interest Period. --------------- (a) With respect to each Eurodollar Loan, the period commencing on the date of such Eurodollar Loan and ending one, two, three or six months thereafter, as the Company may elect the applicable Notice of Borrowing; (b) with respect to each Base Rate Loan, the period commencing on the date of such Base Rate Loan; provided that: -------- (i) any Interest Period (other than an Interest Period determined pursuant to clause (iii) below) that would otherwise end on a day that is not a Business Day shall be extended to the next succeeding Business Day unless, in the case of Eurodollar Loans, such Business Day falls in the next calendar month, in which case such Interest Period shall end on the immediately preceding Business Day; (ii) any Interest Period applicable to a Eurodollar Loan that begins on the last Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall, subject to clause (iii) below, end on the last Business Day of a calendar month; (iii) any Interest Period during the Revolving Credit Period that would otherwise end after the Revolving Credit Termination Date shall end on the Revolving Credit Termination Date; and (iv) notwithstanding clauses (iii) and (iv) above, no Interest Period applicable to a Eurodollar Loan shall have a duration of less than one month, and if any Interest Period applicable to such Loans would be for a shorter period, such Interest Period shall not be available hereunder. Investment. As applied to the Company and its Subsidiaries, the purchase ---------- or acquisition of any share of capital stock, partnership interest, evidence of indebtedness or other equity security of any other person or entity, any loan, advance or extension of credit to, or contribution to the capital of, any other person or entity, any real estate held for sale or investment, any commodities futures contracts held other than in connection with bona fide hedging transactions, any other investment in any other person or entity, and the making of any commitment or acquisition of any option to make an Investment. Loan. A loan made to the Company by the Bank pursuant to Section 11 of ---- this Agreement, and "Loans" means all of such loans, collectively. -6- Note. A promissory note of the Company, substantially in the form of ---- Exhibit A hereto, evidencing the obligation of the Company to the Bank to repay the Loans. Notice of Borrowing. See Section 2.2. ------------------- Obligations. Any and all obligations of the Company to the Bank of every ----------- kind and description, direct or indirect, absolute or contingent, primary or secondary, due or to become due, now existing or hereafter arising, regardless of how they arise or by what agreement or instrument, if any, and including obligations to perform acts and refrain from taking action as well as obligations to pay money. PBGC. The Pension Benefit Guaranty Corporation or any entity succeeding to ---- any or all of its functions under ERISA. Permitted Encumbrances. See Section 6.5. ---------------------- Plan. At any time, an employee pension or other benefit plan that is ---- subject to Title IV of ERISA or subject to the minimum funding standards under Section 412 of the Code. Qualified Investments. As applied to the Company and its Subsidiaries, --------------------- investments in (i) notes, bonds or other obligations of the United States of America or any agency thereof that as to principal and interest constitute direct obligations of or are guaranteed by the United States of America; (ii) certificates of deposit or other deposit instruments or accounts of banks or trust companies organized under the laws of the United States or any state thereof that have capital and surplus of at least $100,000,000, (iii) commercial paper that is rated not less than prime-one or A-1 or their equivalents by Moody's Investors Service, Inc. or Standard & Poor's Corporation, respectively, or their successors, and (iv) any repurchase agreement secured by any one or more of the foregoing. Revolving Credit Period. The period beginning on the date of this ----------------------- Agreement and extending through and including the Revolving Credit Termination Date or such earlier date on which the commitment to make Loans is terminated or the Commitment Amount is reduced to zero in accordance with the terms hereof. Revolving Credit Termination Date. December 15,1997. --------------------------------- Subsidiary. Any corporation, association, joint stock company, business ---------- trust or other similar organization of which 50% or more of the ordinary voting power for the election of a majority of the members of the board of directors or other governing body of such entity is held or controlled by the Company or a Subsidiary of the Company; or any other such organization the management of which is directly or indirectly controlled by the Company or a Subsidiary of the Company through the exercise of voting power or otherwise; or any joint venture, whether incorporated or not, in which the Company has a 50% ownership interest. 1.2. Accounting Terms. All terms of an accounting character shall have the ---------------- meanings assigned thereto by generally accepted accounting principles applied on a basis consistent with -7- the financial statements referred to in Section 4.6 of this Agreement, modified to the extent, but only to the extent, that such meanings are specifically modified herein. SECTION 11 ---------- DESCRIPTION OF CREDIT --------------------- 2.1. The Loans. During the Revolving Credit Period, and subject to the --------- terms and conditions hereof, the Bank will make Loans to the Company, from time to time until the close of business on the Revolving Credit Termination Date, in such sums as the Company may request, provided that the aggregate principal -------- amount of all Loans at any one time outstanding hereunder shall not exceed the Borrowing Base. The Company may borrow, repay pursuant to Section 2.8 and reborrow, from the date of this Agreement until the Revolving Credit Termination Date, the full amount of the Borrowing Base or any lesser sum that is at least $100,000.00 and an integral multiple of $100,000.00. Any Loan not repaid by the Revolving Credit Termination Date shall be due and payable on the Revolving Credit Termination Date. 2.2. Notice and Manner of Borrowing of Loans. (a) Whenever the Company --------------------------------------- desires to obtain a Loan hereunder, the Company shall notify the Bank (which notice shall be irrevocable) by telephone received no later than 2:00 p.m. Boston time on the day on which the requested Loan is to be made as a Base Rate Loan, and received no later than 10:00 a.m. Boston time on the date two Business Days before the day on which the requested Loan is to be made as a Eurodollar Loan. Such notice shall specify (i) the effective date and amount of each Loan, subject to the limitations set forth in Section 2.1, (ii) the interest rate option to be applicable thereto, and (iii) with respect to any requested Eurodollar Loans, the duration of the applicable Interest Period (subject to the provisions of the definition of Interest Period and Section 2.5). If requested by the Bank, such notification (a "Notice of Borrowing") shall be immediately followed by a written confirmation thereof, provided that if such written -------- confirmation differs in any material respect from the action taken by the Bank, the records of the Bank shall control absent manifest error. Prior to the end of the Interest Period applicable to any Eurodollar Loan, the Borrower shall deliver a Notice of Borrowing in accordance with this Section 2.2 which shall specify the interest rate option and duration of the applicable Interest Period to rollover such Eurodollar Loan. Failure to deliver such Notice of Borrowing shall be deemed to be an election of the Base Rate. (b) Subject to the terms and conditions hereof, the Bank shall make each Loan on the effective date specified therefor by crediting the amount of such Loan to the Company's demand deposit account with the Bank; provided that if -------- such Loan is to be made on a day on which the Company is to repay all or any part of an outstanding Loan, the Bank shall apply the proceeds of such new Loan to make such repayment and only an amount equal to the difference (if any) between the amount being borrowed and the amount being repaid shall be made available by the Bank to the Company. 2.3. Facility Fee. The Company shall pay to the Bank during the Revolving ------------ Credit Period an annual facility fee equal to $9,500.00. The facility fee shall be payable quarterly in advance, on the first day of January, April, July and October of each year beginning January 1, -8- 1996. A prorated amount for the period from the date hereof to December 31, 1995 shall be payable at the closing. 2.4. The Note. (a) The Loans shall be evidenced by a single Note, payable -------- to the order of the Bank and having a final maturity of December 15, 1997. The Note shall be dated on or before the date of the first Loan and shall have the blanks, if any, therein appropriately completed. (b) The Bank shall, and is hereby irrevocably authorized by the Company to, enter on the schedule forming a part of the Note or otherwise in its records appropriate notations evidencing the date and the amount of each Loan, the interest rate applicable thereto and the date and amount of each payment of principal made by the Company with respect thereto; and in the absence of manifest error, such notations shall constitute conclusive evidence thereof. The Bank is hereby irrevocably authorized by the Company to attach to and make a part of the Note a continuation of any such schedule as and when required. No failure on the part of the Bank to make any notation as provided in this subsection (b) shall in any way affect any Loan or the rights or obligations of the Bank or the Company with respect thereto. 2.5. Duration of Interest Periods. Subject to the provisions of the ---------------------------- definition of Interest Period, the duration of the Interest Period for each Eurodollar Loan shall be as specified in the applicable Notice of Borrowing. Notwithstanding the foregoing, the Company may not select an Interest Period that would end, but for the provisions of the definition of Interest Period, after the final maturity hereof. 2.6. Interest Rates and Payments of Interest. (a) Each Base Rate Loan --------------------------------------- shall bear interest on the outstanding principal amount thereof at a rate per annum equal to the Base Rate, which rate shall change contemporaneously with any change in the Base Rate. Such interest shall be payable on the last day of each month commencing December 31, 1995, and when such Base Rate Loan is due (whether at maturity, by reason of acceleration or otherwise). (b) Each Eurodollar Loan shall bear interest on the outstanding principal amount thereof, for the Interest Period applicable thereto, at a rate per annum equal to the Adjusted Eurodollar Rate plus two and one half percent (2.5%). Such interest shall be payable for such Interest Period on the last day thereof and when such Eurodollar Loan is due (whether at maturity, by reason of acceleration or otherwise) and, if such Interest Period is longer than three months, at intervals of three months after the first day thereof. 2.7. Changed Circumstances. --------------------- (a) In the event that: (i) on any date on which the Adjusted Eurodollar Rate would otherwise be set the Bank shall have determined in good faith (which determination shall be final and conclusive) that, by reason of changes affecting the interbank Eurodollar market, adequate and reasonable means do not exist for ascertaining the Interbank Offered Rate, or -9- (ii) at any time the Bank shall have determined in good faith (which determination shall be final and conclusive) that: (A) the making of a Eurodollar Loan has been made impracticable or unlawful by (1) the occurrence of a contingency that materially and adversely affects the interbank Eurodollar market or (2) compliance by the Bank in good faith with any applicable law or governmental regulation, guideline or order or interpretation or change thereof by any governmental authority charged with the interpretation or administration thereof or with any request or directive of any such governmental authority (whether or not having the force of law); or (B) the Adjusted Eurodollar Rate shall no longer represent the effective cost to the Bank for U.S. dollar deposits in the interbank market for deposits in which it regularly participates; then, and in any such event, the Bank shall forthwith so notify the Company thereof. Until the Bank notifies the Company that the circumstances giving rise to such notice no longer apply, the obligation of the Bank to allow selection by the Company of the type of Loan affected by the contingencies described in this Section 2.7(a) (herein called "Affected Loans") shall be suspended. If at the -------------- time the Bank so notifies the Company, the Company has previously given the Bank a Notice of Borrowing with respect to one or more Affected Loans but such Loans have not yet gone into effect, such notification shall be deemed to be void and the Company may borrow Loans of a nonaffected type by giving a substitute Notice of Borrowing pursuant to Section 2.2 hereof. Upon such date as shall be specified in such notice (which shall not be earlier than the date such notice is given) the Company shall, with respect to the outstanding Affected Loans, prepay the same, together with interest thereon and any amounts required to be paid pursuant to Section 2.11, and may borrow a Loan of another type in accordance with Section 2.1 hereof by giving a Notice of Borrowing pursuant to Section 2.2 hereof. (b) In case any law, regulation, treaty or official directive or the interpretation or application thereof by any court or by any governmental authority charged with the administration thereof or the compliance with any guideline or request of any central bank or other governmental authority (whether or not having the force of law): (i) subjects the Bank to any tax with respect to payments of principal or interest or any other amounts payable hereunder by the Company or otherwise with respect to the transactions contemplated hereby (except for taxes on the overall net income of the Bank imposed by the United States of America or any political subdivision thereof), or (ii) imposes, modifies or deems applicable any deposit insurance, reserve, special deposit or similar requirement against assets held by, or deposits in or for the account of, or loans by, the Bank (other than such requirements as are already included in the determination of the Adjusted Eurodollar Rate), or -10- (iii) imposes upon the Bank any other condition with respect to its performance under this Agreement, and the result of any of the foregoing is to increase the cost to the Bank, reduce the income receivable by the Bank or impose any expense upon the Bank with respect to any Loans, the Bank shall notify the Company thereof. The Company agrees to pay to the Bank the amount of such increase in cost reduction in income or additional expense as and when such cost, reduction or expense is incurred or determined, upon presentation by the Bank of a statement in the amount and setting forth the Bank's calculation thereof, which statement shall be deemed true and correct absent manifest error. (c) If the Bank shall have determined that (i) the adoption of or change in any law, rule, regulation or guideline, directive or request regarding capital requirements for banks or bank holding companies (whether or not having the force of law), or any change in the interpretation or application thereof by any governmental authority, central bank or comparable authority charged with the interpretation or administration thereof, or (ii) compliance by the Bank with any of the foregoing, imposes on or increases a requirement of the Bank to allocate capital resources to the Bank's commitment to make Loans hereunder that has or would have the effect of reducing the return on the Bank's capital as a consequence of its commitment to make Loans hereunder to a level below that which the Bank could have achieved (taking into consideration the Bank's then existing policies with respect to capital adequacy and assuming the full utilization of the Bank's capital) but for such adoption, change or compliance by any amount deemed by the Bank to be material, then the Bank shall notify the Company thereof. The Company agrees to pay to the Bank the amount of such reduction of capital as and when such reduction is determined, upon presentation by the Bank of a statement in the amount and setting forth the Bank's calculation thereof, which statement shall be deemed true and correct absent manifest error. In determining such amount, the Bank may use any reasonable averaging and attribution methods. 2.8. Payments and Prepayments of the Loans. (a) Each Loan shall mature, ------------------------------------- and the principal amount thereof shall be due and payable, on the Revolving Credit Termination Date. Eurodollar Loans may not be prepaid. Base Rate Loans may be prepaid at any time, without premium or penalty. Interest accrued on the amounts so paid shall be paid in accordance with Section 2.6. No prepayment of the Loans during the Revolving Credit Period shall affect the Commitment Amount or impair the Company's right to borrow as set forth in Section 2.1. (b) If at any time the aggregate principal amount of outstanding Loans shall exceed the Borrowing Base, the Company shall repay such principal amount (together with accrued interest thereon) of the outstanding Loans, if any, as may be necessary so that after such repayment the aggregate outstanding principal amount of the Loans does not exceed the amount of the Borrowing Base. 2.9. Method of Payment. All payments and prepayments of principal and all ----------------- payments of interest shall be made by the Company to the Bank at 100 Federal Street, Boston, Massachusetts in immediately available funds, on or before 2:00 p.m. (Boston time) on the due -11- date thereof, free and clear of, and without any deduction or withholding for, any taxes or other payments. The Bank may, and the Company hereby authorizes the Bank to, debit the amount of any payment not made by such time to the demand deposit account of the Company with the Bank, followed promptly by notice to the Company of such action taken. 2.10. Overdue Payments. (a) Overdue principal (whether at maturity, by ---------------- reason of acceleration or otherwise) and, to the extent permitted by applicable law, overdue interest and fees or any other amounts payable hereunder or under the Note shall bear interest from and including the due date thereof until paid, compounded daily and payable on demand, at a rate per annum equal to (i) if such due date occurs prior to the end of an Interest Period for Eurodollar Loans, 2% above the interest rate applicable to such Loan for such Interest Period until the expiration of such Interest Period, and thereafter, 2% above the Base Rate; and (ii) in all other cases, 2% above the rate then applicable to Base Rate Loans, which interest shall be compounded daily and payable on demand. (b) If a payment of principal or interest hereunder is not made within 10 days of its due date, the Company will also pay, on demand, a late payment charge equal to 5% of the amount of such payment. Nothing in the preceding sentence shall affect the Bank's rights to exercise any of its rights or remedies, including those provided in Section 7.2, if an Event of Default has occurred. 2.11. Payments Not at End of Interest Period. If the Company for any -------------------------------------- reason makes any payment of principal with respect to any Eurodollar Loan on any day other than the last day of the Interest Period applicable to such Eurodollar Loan, or fails to borrow a Eurodollar Loan after giving a Notice of Borrowing pursuant to Section 2.2, the Company shall pay to the Bank an amount computed pursuant to the following formula: L = (R - T) x P x D --------------- 360 L = amount payable to the Bank R = interest rate on such Loan T = effective interest rate per annum at which any readily marketable bond or other obligation of the United States, selected at the Bank's sole discretion, maturing on or near the last day of the Interest Period of such Loan and in approximately the same amount as such Loan can be purchased by the Bank on the day of such payment of principal or failure to borrow P = the amount of principal prepaid or the amount of the requested Loan D = the number of days remaining in the Interest Period as of the date of such payment or the number of days of the requested Interest Period The Company shall pay such amount upon presentation by the Bank of a statement setting forth the amount and the Bank's calculation thereof pursuant hereto, which statement shall be deemed true and correct absent manifest error. 2.12. Computation of Interest and Fees. Interest and all fees payable -------------------------------- hereunder shall be computed daily on the basis of a year of 360 days and paid for the actual number of days for -12- which due. If the due date for any payment of principal is extended by operation of law, interest shall be payable for such extended time. If any payment required by this Agreement becomes due on a day that is not a Business Day such payment may be made on the next succeeding Business Day (subject to clause (i) of the definition of Interest Period), and such extension shall be included in computing interest in connection with such payment. SECTION III ----------- CONDITIONS OF LOANS ------------------- 3.1. Conditions Precedent to Initial Loan. The obligation of the Bank to ------------------------------------ make its initial Loan is subject to the condition precedent that the Bank shall have received, in form and substance satisfactory to the Bank and its counsel, the following: (a) this Agreement and the Note, duly executed by the Company; (b) a certificate of the Clerk or an Assistant Clerk of the Company with respect to resolutions of the Board of Directors authorizing the execution and delivery of this Agreement and the Note and identifying the officer(s) authorized to execute, deliver and take all other actions required under this Agreement, and providing specimen signatures of such officers; (c) the certificate of incorporation of the Company and all amendments and supplements thereto, filed in the office of the Secretary of The Commonwealth of Massachusetts, certified by said Secretary of The Commonwealth as being a true and correct copy thereof; (d) the Bylaws and articles of incorporation of the Company and all amendments and supplements thereto, certified by the Clerk or an Assistant Clerk as being a true and correct copy thereof; (e) a certificate of the Secretary of The Commonwealth of Massachusetts, as to legal existence and good standing in such state and listing all documents on file in the office of said Secretary of State; (f) an opinion addressed to it from Christopher Stavros, counsel to the Company, substantially in the form of Exhibit G hereto; and --------- (g) such other documents, and completion of such other matters, as counsel for the Bank may deem necessary or appropriate. 3.2. Conditions Precedent to all Loans. The obligation of the Bank to make --------------------------------- each Loan, including the initial Loan, is further subject to the following conditions: (a) timely receipt by the Bank of the Notice of Borrowing as provided in Section 2.2; (b) the representations and warranties contained in Section IV shall be true and accurate in all material respects on and as of the date of such Notice of Borrowing and on the effective date of each Loan as though made at and as of each such date (except to the extent that -13- such representations and warranties expressly relate to an earlier date), and no Default shall have occurred and be continuing, or would result from such Loan; (c) the resolutions referred to in Section 3.1(b) shall remain in full force and effect; and (d) no change shall have occurred in any law or regulation or interpretation thereof that, in the opinion of counsel for the Bank, would make it illegal or against the policy of any governmental agency or authority for the Bank to make Loans hereunder. The making of each Loan shall be deemed to be a representation and warranty by the Company on the date of such Loan as to the accuracy of the facts referred to in subsection (b) of this Section 3.2. SECTION IV ---------- REPRESENTATIONS AND WARRANTIES ------------------------------ In order to induce the Bank to enter into this Agreement and to make Loans hereunder, the Company represents and warrants to the Bank that: 4.1. Organization and Qualification. Each of the Company and its ------------------------------ Subsidiaries (a) is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation, (b) has all requisite corporate power to own its property and conduct its business as now conducted and as presently contemplated and (c) is duly qualified and in good standing as a foreign corporation and is duly authorized to do business in each jurisdiction where the nature of its properties or business requires such qualification. 4.2. Corporate Authority. The execution, delivery and performance of this ------------------- Agreement and the Note and the transactions contemplated hereby are within the corporate power and authority of the Company and have been authorized by all necessary corporate proceedings, and do not and will not (a) require any consent or approval of the stockholders of the Company, (b) contravene any provision of the charter documents or bylaws of the Company or any law, rule or regulation applicable to the Company, (c) contravene any provision of, or constitute an event of default or event that, but for the requirement that time elapse or notice be given, or both, would constitute an event of default under, any other agreement, instrument, order or undertaking binding on the Company, or (d) result in or require the imposition of any Encumbrance on any of the properties, assets or rights of the Company. 4.3. Valid Obligations. This Agreement and the Note and all of their ----------------- respective terms and provisions are the legal, valid and binding obligations of the Company, enforceable in accordance with their respective terms except as limited by bankruptcy, insolvency, reorganization, moratorium or other laws affecting the enforcement of creditors' rights generally, and except as the remedy of specific performance or of injunctive relief is subject to the discretion of the court before which any proceeding therefor may be brought. -14- 4.4. Consents or Approvals. The execution, delivery and performance of --------------------- this Agreement and the Note and the transactions contemplated herein do not require any approval or consent of, or filing or registration with, any governmental or other agency or authority, or any other party. 4.5. Title to Properties; Absence of Encumbrances. Each of the Company -------------------------------------------- and its Subsidiaries has good and marketable title to all of the properties, assets and rights of every name and nature now purported to be owned by it, including, without limitation, such properties, assets and rights as are reflected in the financial statements referred to in Section 4.6 (except such properties, assets or rights as have been disposed of in the ordinary course of business since the date thereof), free from all Encumbrances except Permitted Encumbrances or those Encumbrances disclosed in Exhibit B hereto, and, except as --------- so disclosed, free from all defects of title that might materially adversely affect such properties, assets or rights, taken as a whole. 4.6. Financial Statements. The Company has furnished the Bank its -------------------- consolidated balance sheet as of December 31, 1994 and its consolidated statements of income, changes in stockholders' equity and cash flow for the fiscal year then ended, and related footnotes, audited and certified by Arthur Andersen & Co. The Company has also furnished the Bank its consolidated balance sheet as of September 22, 1995 and its consolidated statements of income, changes in stockholders' equity and cash flow for the period then ended, certified by the principal financial officer of the Company but subject, however, to normal, recurring year-end adjustments that shall not in the aggregate be material in amount. All such financial statements were prepared in accordance with generally accepted accounting principles applied on a consistent basis throughout the periods specified and present fairly the financial position of the Company and its Subsidiaries as of such dates and the results of the operations of the Company and its Subsidiaries for such periods. There are no liabilities, contingent or otherwise, not disclosed in such financial statements that involve a material amount. 4.7. Changes. Since the date of the financial statements referred to in ------- Section 4.6, there have been no changes in the assets, liabilities, financial condition, business or prospects of the Company or any of its Subsidiaries other than changes in the ordinary course of business, the effect of which has not, in the aggregate, been materially adverse. 4.8. Defaults. As of the date of this Agreement, no Default exists. -------- 4.9. Taxes. The Company and each Subsidiary have filed all federal, ----- state and other tax returns required to be filed, and all taxes, assessments and other governmental charges due from the Company and each Subsidiary have been fully paid. The Company and each Subsidiary have established on their books reserves adequate for the payment of all federal, state and other tax liabilities. 4.10. Litigation. Except as set forth on Exhibit C hereto, there is no ---------- --------- litigation, arbitration, proceeding or investigation pending, or, to the knowledge of the Company's or any Subsidiary's officers, threatened, against the Company or any Subsidiary that, if adversely determined, would result in a material judgment not fully covered by insurance or could result in a forfeiture of all or any substantial part of the property of the Company or its Subsidiaries, or -15- would otherwise have a material adverse effect on the assets, business or prospects of the Company or any Subsidiary. 4.11. Use of Proceeds. No portion of any Loan is to be used for the --------------- "purpose of purchasing or carrying" any "margin stock" as such terms are used in Regulations U and X of the Board of Governors of the Federal Reserve System, 12 C.F.R. 221 and 224, as amended; and following the application of the proceeds of each Loan, the value of all "margin stock" of the Company will not exceed 25% of the value of the total assets of the Company that are subject to the restrictions set forth in Section 6.5 and 6.6. 4.12. Subsidiaries. As of the date of this Agreement, all the ------------ Subsidiaries of the Company are listed on Exhibit D hereto. The Company or a --------- Subsidiary of the Company is the owner, free and clear of all liens and encumbrances, of all of the issued and outstanding stock of each Subsidiary. All shares of such stock have been validly issued and are fully paid and nonassessable, and no rights to subscribe to any additional shares have been granted, and no options, warrants or similar rights are outstanding. 4.13. Investment Company Act. Neither the Company nor any of its ---------------------- Subsidiaries is subject to regulation under the Investment Company Act of 1940, as amended. 4.14 Compliance with ERISA. The Company and each member of the --------------------- Controlled Group have fulfilled their obligations under the minimum funding standards of ERISA and the Code with respect to each Plan and are in compliance in all material respects with the applicable provisions of ERISA and the Code, and have not incurred any liability to the PBGC or a Plan under Title IV of ERISA; and no "Prohibited transaction" or "reportable event" (as such terms are defined in ERISA) has occurred with respect to any Plan. 4.15. Environmental Matters. The Company and each of its Subsidiaries --------------------- are in material compliance with all Federal, state and local environmental laws and ordinances with respect to the conduct of their business or business operations and have no knowledge or notice of any material violation of any environmental protection law, regulation or order. SECTION V --------- AFFIRMATIVE COVENANTS --------------------- So long as the Bank has any commitment to lend hereunder or any Loan or other Obligation remains outstanding, the Company covenants as follows: 5.1. Financial Statements and other Reporting Requirements. The Company ----------------------------------------------------- shall furnish to the Bank: (a) as soon as available to the Company, but in any event within 90 days after the end of each of its fiscal years, a consolidated and consolidating balance sheet as of the end of each such year, and a related consolidated and consolidating statement of income, changes in stockholders' equity and cash flow for such year, audited and certified by Arthur Andersen & Co. -16- (or other independent certified public accountants acceptable to the Bank) in the case of such consolidated statements, and certified by the chief financial officer in the case of such consolidating statements; and, concurrently with such financial statements, a copy of said certified public accountants' management report; (b) as soon as available to the Company, but in any event within 30 days after the end of each month, (i) a consolidated and consolidating balance sheet as of the end of each such fiscal quarter, and a related consolidated and consolidating statement of income for the period then ended, certified by the principal financial officer of the Company but subject, however, to normal, recurring yearend adjustments that shall not in the aggregate be material in amount and (ii) a borrowing base report substantially in the form of Exhibit E; ---------- (c) as soon as available to the Company, but in any event within 30 days after the end of each of its fiscal quarters, a report in substantially the form of Exhibit F hereto signed on behalf of the Company by its chief financial --------- officer; (d) promptly after the receipt thereof by the Company, copies of any reports submitted to the Company by independent public accountants in connection with any interim review of the accounts of the Company made by such accountants; (e) promptly alter the same are available, copies of all proxy statements, financial statements and reports as the Company may file with the Securities and Exchange Commission or any governmental authority at any time having jurisdiction over the Company or its Subsidiaries; (f) if and when the Company gives or is required to give notice to the PBGC of any "Reportable Event" (as defined in Section 4043 of ERISA) with respect to any Plan that might constitute grounds for a termination of such Plan under Title IV of ERISA, or knows that any member of the Controlled Group or the plan administrator of any Plan has given or is required to give notice of any such Reportable Event, a copy of the notice of such Reportable Event given or required to be given to the PBGC; (g) immediately upon becoming aware of the existence of any condition or event that constitutes a Default, written notice thereof specifying the nature and duration thereof and the action being or proposed to be taken with respect thereto; (h) promptly upon becoming aware of any investigative proceedings by a governmental agency or authority commenced or threatened against the Company or any of its Subsidiaries regarding any environmental hazard or condition or any spill, release, discharge or disposal of any substance defined or designated by any environmental statute, rule or regulation of any governmental entity now in effect and applicable to such property, as hazardous or toxic material, hazardous or toxic substance or any similar term, written notice thereof and the action being or proposed to be taken with respect thereto; (i) promptly upon becoming aware of any litigation or of any other investigative proceedings by a governmental agency or authority commenced or threatened against the -17- Company or any of its Subsidiaries of which it has notice, the outcome of which would or might have a materially adverse effect on the assets, business or prospects of the Company or the Company and its Subsidiaries on a consolidated basis, written notice thereof and the action being or proposed to be taken with respect thereto; and (j) from time to time, such other financial data and information about the Company or its Subsidiaries as the Bank may reasonably request. 5.2. Conduct of Business. Each of the Company and its Subsidiaries ------------------- shall: (a) duly observe and comply in all material respects with all applicable laws and valid requirements of any governmental authorities relative to its corporate existence, rights and franchises, to the conduct of its business and to its property and assets, and shall maintain and keep in full force and effect all licenses and permits necessary in any material respect to the proper conduct of its business; (b) maintain its corporate existence; and (c) remain engaged substantially in the design and manufacture of telecommunication platforms, and related software, devices, and services. 5.3. Maintenance and Insurance. Each of the Company and its Subsidiaries ------------------------- shall maintain its properties in good repair, working order and condition as required for the normal conduct of its business. Each of the Company and its Subsidiaries shall at all times maintain liability and casualty insurance with financially sound and reputable insurers in such amounts as the officers of the Company in the exercise of their reasonable judgment deem to be adequate. In the event of failure to provide and maintain insurance as herein provided, the Bank may, at its option, provide such insurance and charge the amount thereof to the account of the Company or any of its Subsidiaries with the Bank. 5.4. Taxes. The Company shall pay or cause to be paid all taxes, ----- assessments or governmental charges on or against it or any of its Subsidiaries or its or their properties on or prior to the time when they become due. 5.5. Inspection by the Bank. The Company shall permit the Bank or its ---------------------- designees, at any reasonable time, and upon reasonable notice (or if a Default shall have occurred and is continuing, at any time and without prior notice), to (i) visit and inspect the properties of the Company and its Subsidiaries, (ii) examine and make copies of and take abstracts from the books and records of the Company and its Subsidiaries, and (iii) discuss the affairs, finances and accounts of the Company and its Subsidiaries with their appropriate officers, employees and accountants. In handling such information the Bank shall exercise the same degree of care that it exercises with respect to its own proprietary information of the same types to maintain the confidentiality of any nonpublic information thereby received or received pursuant to subsections 5.1(a), (b), or (c) except that disclosure of such information may be made (i) to the subsidiaries or affiliates of the Bank in connection with their present or prospective business relations with the Company, (ii) to prospective transferees or purchasers of an interest in the Loans, (iii) as -18- required by law, regulation, rule or order, subpoena, judicial order or similar order and (iv) as may be required in connection with the examination, audit or similar investigation of the Bank. 5.6. Maintenance of Books and Records. Each of the Company and its -------------------------------- Subsidiaries shall keep adequate books and records of account, in which true and complete entries will be made reflecting all of its business and financial transactions, and such entries will be made in accordance with generally accepted accounting principles consistently applied and applicable law. 5.7. Consolidated Tangible Net Worth. The Company shall at all times ------------------------------- maintain Consolidated Tangible Net Worth of at least (i) $5,000,000.00. Any consolidated losses shall not reduce the amount of Consolidated Tangible Net Worth required to be maintained pursuant to this Section 5.7. 5.8. Consolidated Total Liabilities to Consolidated Tangible Net Worth ----------------------------------------------------------------- Ratio. The Company shall at all times maintain a ratio of Consolidated Total - ----- Liabilities to Consolidated Tangible Net Worth of not greater than 1.25 to 1.00. 5.9. Cash Flow Coverage. The Company shall at all times maintain ------------------ consolidated Cash Flow Coverage of not less than 2.0 to 1.00. As used in this Section 5.9, "Cash Flow Coverage" shall mean, at any date as of which the amount ------------------ thereof shall be determined and for the period specified, the quotient obtained by dividing the total of: (i) consolidated earnings before income taxes for -------- such period, excluding any nonrecurring or extraordinary items, plus (ii) ---- consolidated depreciation and amortization expenses for such period, plus (iii) ---- consolidated interest expense (including imputed interest on capital lease obligations) (collectively, "Interest Expense") minus (iv) capital expenditures ---------------- ----- minus cash taxes minus dividends and distributions; by the total of (i) Interest - ----- ----- -- Expense for such period plus (ii) current maturities of long-term Indebtedness ---- for such period. 5.10. Profitability. The Company shall earn consolidated pretax income of ------------- at least $1,000,000.00 in every fiscal quarter. 5.11. Cleanup Provision. The Company shall reduce its outstanding loan ----------------- balance once each period to a maximum of $500,000 and once each period to $300,000, each for 30 consecutive days in the 12 month periods ending December 31, 1996 and December 31, 1997, respectively. 5.12. Further Assurances. At any time and from time to time the Company ------------------ shall, and shall cause each of its Subsidiaries to, execute and deliver such further instruments and take such further action as may reasonably be requested by the Bank to effect the purposes of this Agreement and the Note. SECTION VI ---------- NEGATIVE COVENANTS ------------------ -19- So long as the Bank has any commitment to lend hereunder or any Loan or other Obligation remains outstanding, the Company covenants as follows: 6.1. Indebtedness. Neither the Company nor any of its Subsidiaries shall ------------ create, incur, assume, guarantee or be or remain liable with respect to any Indebtedness other than the following: (a) Indebtedness of the Company or any of its Subsidiaries to the Bank or any of its affiliates; (b) Indebtedness existing as of the date of this Agreement and disclosed on Exhibit B hereto or in the financial statements referred to in Section 4.6; and - --------- (c) other Indebtedness of the Company in an aggregate outstanding principal amount not exceeding $300,000.00 annually. 6.2. Contingent Liabilities. Neither the Company nor any of its ---------------------- Subsidiaries shall create, incur, assume, guarantee or remain liable with respect to any Guarantees other than in favor of the Bank or its affiliates, without the prior written consent of the Bank. 6.3. Leases. Neither the Company nor any of its Subsidiaries shall ------ during any fiscal year enter into any leases of real or personal property as lessee, except for capital leases or leases providing for payments in any one fiscal year (whether or not such payments are termed rent) that in the aggregate do not increase the aggregate annual lease payments of the Company and its Subsidiaries in excess of $100,000.00 over such payments required to be made during the immediately preceding fiscal year. 6.4. Sale and Leaseback. Neither the Company nor any of its Subsidiaries ------------------ shall enter into any arrangement, directly or indirectly, whereby it shall sell or transfer any property owned by it in order to lease such property or lease other property that the Company or any such Subsidiary intends to use for substantially the same purpose as the property being sold or transferred. 6.5. Encumbrances. Neither the Company nor any of its Subsidiaries shall ------------ create, incur, assume or suffer to exist any mortgage, pledge, security interest, lien or other charge or encumbrance, including the lien or retained security title of a conditional vendor upon or with respect to any of its property or assets including, without limitation, on any of its accounts receivable or inventory ("Encumbrances"), or assign or otherwise convey any ------------ right to receive income, including the sale or discount of accounts receivable with or without recourse, except the following ("Permitted Encumbrances"): ---------------------- (a) Encumbrances in favor of the Bank or any of its affiliates; and (b) Encumbrances existing as of the date of this Agreement and disclosed in Exhibit B hereto; - --------- -20- 6.6. Merger; Consolidation; Sale or Lease of Assets. Neither the Company ---------------------------------------------- nor any of its Subsidiaries shall sell, lease or otherwise dispose of assets or properties (valued at the lower of cost or market), other than sales of inventory in the ordinary course of business, in the aggregate in excess of $500,000 in any fiscal year; or liquidate, merge or consolidate into or with any other person or entity, provided that any Subsidiary of the Company may merge or -------- consolidate into or with (i) the Company if no Default has occurred and is continuing or would result from such merger and if the Company is the surviving company, or (ii) any other wholly-owned Subsidiary of the Company. 6.7. Change in Control. Robert Madonna, his spouse or issue shall own at ----------------- least 51% of the Equity Securities of the Company, but in any case Robert Madonna shall not own less than 51% of the voting stock. For purposes hereof "Equity Securities" shall mean (a) all common stock, preferred stock, participations, shares, partnership interests, or other equity interests in and of the Company (regardless of how designated and whether or not voting or non- voting) and (b) all warrants, options, and other rights to acquire any of the foregoing. 6.8. Equity Distributions. The Company shall not pay any dividends on -------------------- any class of its capital stock or make any other distribution or payment on account of or in redemption, retirement or purchase of such capital stock which result in an Event of Default under Sections 5.7, 5.8, 5.9 or 5.10, or violates any other provision of this Agreement. 6.9. Investments. Neither the Company nor any of its Subsidiaries shall ----------- make or maintain any Investments other than (i) existing Investments in Subsidiaries and (ii) Qualified Investments. 6.10. ERISA. Neither the Company nor any member of the Controlled ----- Group shall permit any Plan maintained by it to (i) engage in any "prohibited transaction" (as defined in Section 4975 of the Code, (ii) incur any "accumulated funding deficiency" (as defined in Section 302 of ERISA) whether or not waived, or (iii) terminate any Plan in a manner that could result in the imposition of a lien or encumbrance on the assets of the Company or any of its Subsidiaries pursuant to Section 4068 of ERISA. SECTION VII ----------- DEFAULTS -------- 7.1. Events of Default. There shall be an Event of Default hereunder if ----------------- any of the following events occurs: (a) the Company shall fail to pay when due (i) any amount of principal of any Loans, (ii) any amount of interest thereon or (iii) any fees or expenses payable hereunder or under the Note within 10 days following notice; or (b) The Company shall fail to perform any term, covenant or agreement contained in Sections 5.1(g), 5.5, 5.7 through 5.11 or 6.1 through 6.10; or -21- (c) the Company shall fail to perform any covenant contained in Sections 5.1(f, 5.1(h) or 5.2, and such failure shall continue for 30 days; or (d) the Company shall fail to perform any term, covenant or agreement (other than in respect of subsections 7.1(a) through (c) hereof) contained in this Agreement and such default shall continue for 30 days after notice thereof has been sent to the Company by the Bank; or (e) any representation or warranty of the Company made in this Agreement or in the Note or any other documents or agreements executed in connection with the transactions contemplated by this Agreement or in any certificate delivered hereunder shall prove to have been false in any material respect upon the date when made or deemed to have been made; or (f) there shall occur any material adverse change in the assets, liabilities, financial condition, business or prospects of the Company or the Company and its Subsidiaries, taken as a whole, as determined by the Bank acting good faith; or (g) the Company or any of its Subsidiaries shall fail to pay at maturity, or within any applicable period of grace, any obligation or obligations which in the aggregate exceed $10,000 for borrowed monies or advances, or for the use of real or personal property, or fail to observe or perform any term, covenant or agreement evidencing or securing such obligations for borrowed monies or advances, or relating to such use of real or personal property, the result of which failure is to permit the holder or holders of such Indebtedness to cause such Indebtedness to become due prior to its stated maturity upon delivery of required notice, if any; or (h) the Company or any of its Subsidiaries shall (i) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee, liquidator or similar official of itself or of all or a substantial part of its property, (ii) be generally not paying its debts as such debts become due, (iii) make a general assignment for the benefit of its creditors, (iv) commence a voluntary case under the Federal Bankruptcy Code (as now or hereafter in effect), (v) take any action or commence any case or proceeding under any law relating to bankruptcy, insolvency, reorganization, winding-up or composition or adjustment of debts, or any other law providing for the relief of debtors, (vi) fail to contest within 30 days or in an appropriate manner, or acquiesce in writing to, any petition filed against it in an involuntary case under the Federal Bankruptcy Code or other law, (vii) take any action under the laws of its jurisdiction of incorporation or organization similar to any of the foregoing; or (i) a proceeding or case shall be commenced, without the application or consent of the Company or any of its Subsidiaries in any court of competent jurisdiction, seeking (i) the liquidation, reorganization, dissolution, winding up, or composition or readjustment of its debts, (ii) the appointment of a trustee, receiver, custodian, liquidator or the like of it or of all or any substantial part of its assets, or (iii) similar relief in respect of it, under any law relating to bankruptcy, insolvency, reorganization, winding-up or composition or adjustment of debts or any other law providing for the relief of debtors, and such proceeding or case shall continue undismissed, or unstayed and in effect, for a period of 30 days; or an order for relief shall be entered in an involuntary case under the Federal Bankruptcy Code, against the Company or such Subsidiary; or action under the laws of the jurisdiction of incorporation or organization of the -22- Company or any of its Subsidiaries similar to any of the foregoing shall be taken with respect to the Company or such Subsidiary and shall continue unstayed and in effect for any period of 30 days; or (j) a judgment or order for the payment of money shall be entered against the Company or any of its Subsidiaries by any court, or a warrant of attachment or execution or similar process shall be issued or levied against property of the Company or such Subsidiary, and such judgment, order, warrant or process shall continue undischarged or unstayed for 30 days; or (k) the Company or any member of the Controlled Group shall fail to pay when due any amount or amounts that it shall have become liable to pay to the PBGC or to a Plan under Title IV of ERISA; or notice of intent to terminate a Plan or Plans shall be filed under Title IV of ERISA by the Company, any member of the Controlled Group, any plan administrator or any combination of the foregoing; or the PBGC shall institute proceedings under Title IV of ERISA to terminate or to cause a trustee to be appointed to administer any such Plan or Plans or a proceeding shall be instituted by a fiduciary of any such Plan or Plans against the Company and such proceedings shall not have been dismissed within 30 days thereafter; or a condition shall exist by reason of which the PBGC would be entitled to obtain a decree adjudicating that any; or 7.2. Remedies. Upon the occurrence of an Event of Default described in -------- subsections 7.1(h) and (i), immediately and automatically, and upon the occurrence of any other Event of Default, at any time thereafter while such Event of Default is continuing, at the Bank's option and upon the Bank's declaration: (a) the Bank's commitment to make any further Loans hereunder shall terminate; (b) the unpaid principal amount of the Loans together with accrued interest and all other Obligations shall become immediately due and payable without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived; and (c) the Bank may exercise any and all rights it has under this Agreement, the Note or any other documents or agreements executed in connection herewith, or at law or in equity, and proceed to protect and enforce the Bank's rights by any action at law, in equity or other appropriate proceeding. SECTION VIII ------------ MISCELLANEOUS ------------- 8.1. Notices. Unless otherwise specified herein, all notices hereunder ------- to any party hereto shall be in writing and shall be deemed to have been given when delivered by hand, when properly deposited in the mails postage prepaid, when sent by electronic facsimile transmission, or when delivered to the overnight courier, addressed to such party at its address indicated below: If to the Company, at -23- EXCEL INC. 255 Independence Drive Hyannis, MA 02601 Attention: Nathan Apatow If to the Bank, at The First National Bank of Boston 100 Federal Street Boston, Massachusetts 02110 Attention: Bradford Egan MA Corp. Cape Cod or at any other address specified by such party in writing. 8.2. Expenses. The Company shall, on demand, pay or reimburse the Bank -------- for all expenses (including attorneys' fees of outside counsel or allocation costs of in-house counsel incurred or paid by the Bank in connection with the preparation, negotiation and closing of this Agreement and the Note (whether or not the transactions contemplated hereby shall be consummated) or in connection with the administration or amendment of this Agreement or the Note (whether or not the transactions contemplated hereby shall be consummated) and with the enforcement of any Obligation or exercise of any right of the Bank hereunder or under the Note. 8.3. Set-Off. Regardless of the adequacy of any collateral or other ------- means of obtaining repayment of the Obligations, any deposits, balances or other sums credited by or due from the head office of the Bank or any of its branch offices to the Company may, at any time and from time to time after the occurrence of an Event of Default hereunder, without notice to the Company or compliance with any other condition precedent now or hereafter imposed by statute, rule of law, or otherwise (all of which are hereby expressly waived) be set off, appropriated, and applied by the Bank against any and all obligations of the Company to the Bank or any of its affiliates in such manner as the head office of the Bank or any of its branch offices in their sole discretion may determine, and the Company hereby grants the Bank a continuing security interest in such deposits, balances or other sums for the payment and performance of all such obligations. 8.4. Term of Agreement. This Agreement shall continue in force and ----------------- effect so long as the Bank has any commitment to make Loans hereunder or any Loan or any Obligation shall be outstanding. 8.5. No Waivers. No failure or delay by the Bank in exercising any ---------- right, power or privilege hereunder or under the Note or under any other documents or agreements executed in connection herewith shall operate as a waiver thereof; nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies herein and in the Note provided are cumulative and not exclusive of any rights or remedies otherwise provided by agreement or law. -24- 8.6. Massachusetts Law. This Agreement and the Note shall be deemed to ----------------- be contracts made under seal and shall be construed in accordance with and governed by the laws of The Commonwealth of Massachusetts (without giving effect to any conflicts of law provisions contained therein). 8.7. Amendments. Neither this Agreement nor the Note nor any provision ---------- hereof or thereof may be amended, waived, discharged or terminated except by a written instrument signed by the Bank and, in the case of amendments, by the Company. 8.8. Binding Effect of Agreement. This Agreement shall be binding upon --------------------------- and inure to the benefit of the Company and the Bank and their respective successors and assigns; provided that the Company may not assign or transfer its -------- rights or obligations hereunder. The Bank may sell, transfer or grant participations in the Note without the prior written consent of the Company, and the Company agrees that any transferee or participant shall be entitled to the benefits of Sections 2.7, 2.11, 5.5 and 8.3 to the same extent as if such transferee or participant were the Bank hereunder; provided that notwithstanding any such transfer or participation, the Company may, for all purposes of this Agreement, treat the Bank as the person entitled to exercise all rights hereunder and under the Note and to receive all payments with respect thereto. 8.9. Counterparts. This Agreement may be signed in any number of ------------ counterparts with the same effect as if the signatures hereto and thereto were upon the same instrument. 8.10. Partial Invalidity. The invalidity or unenforceability of any one ------------------ or more phrases, clauses or sections of this Agreement shall not affect the validity or enforceability of the remaining portions of it. 8.11. Captions. The captions and headings of the various sections and -------- subsections of this Agreement are provided for convenience only and shall not be construed to modify the meaning of such sections or subsections. 8.12. Termination. The Company shall have the right to terminate this ----------- Agreement upon sixty (60) days written notice, without prejudice to any rights of the Bank set forth in this Agreement and only to the extent that there is no loan Obligation outstanding at the time of termination. 8.13. WAIVER OF JURY TRIAL. EXCEPT AS PROHIBITED BY LAW, NEITHER THE -------------------- COMPANY NOR THE BANK, NOR ANY OF THEIR ASSIGNEES OR SUCCESSORS, SHALL (A) SEEK A JURY TRIAL IN ANY LAWSUIT, PROCEEDING, COUNTERCLAIM OR ANY OTHER LITIGATION PROCEDURE BASED UPON OR ARISING OUT OF THIS AGREEMENT OR ANY RELATED DOCUMENT OR AGREEMENT, OR THE DEALINGS OR THE RELATIONSHIP BETWEEN OR AMONG ANY OF THEM, OR (B) SEEK TO CONSOLIDATE ANY SUCH ACTION, IN WHICH A JURY TRIAL HAS BEEN WAIVED, WITH ANY OTHER ACTION IN WHICH A JURY TRIAL CAN NOT BE OR HAS NOT BEEN WAIVED. THE PROVISIONS OF THIS SECTION HAVE BEEN FULLY DISCUSSED BY THE PARTIES HERETO, AND THE PROVISIONS HEREOF SHALL BE SUBJECT TO NO EXCEPTIONS. NO PARTY HERETO HAS IN ANY WAY AGREED -25- WITH OR REPRESENTED TO ANY OTHER PARTY THAT THE PROVISIONS OF THIS SECTION 8.12 WILL NOT BE FULLY ENFORCED IN ALL INSTANCES. 8.14. Entire Agreement. This Agreement, the Note and the documents and ---------------- agreements executed in connection herewith constitute the final agreement of the parties hereto and supersede any prior agreement or understanding, written or oral, with respect to the matters contained herein and therein. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their duly authorized officers as of the day and year first above written. EXCEL INC. By /s/ Robert P. Madonna ---------------------------------- Title: President THE FIRST NATIONAL BANK OF BOSTON By /s/ Bradford P. Egan ---------------------------------- Title: Vice President EXCEL INC. PROMISSORY NOTE $5,000,000.00 December 21, 1995 Boston, Massachusetts For value received, the undersigned hereby promises to pay to The First National Bank of Boston (the "Bank"), or order, at the head office of the Bank at 100 Federal Street, Boston, Massachusetts 02110, the principal amount of Five Million Dollars ($5,000,000.00) or such lesser amount as shall equal the aggregate unpaid principal amount of all Loans (as defined in the Agreement referred to below) made by the Bank to the undersigned pursuant to the Agreement, in lawful money of the United States and in immediately available funds, in the amounts and on the dates provided on the schedule attached hereto and to pay interest on the unpaid principal amount hereof, at said office, in like money and funds, for the period commencing on the date hereof until paid in full, at the rates per annum and on the dates provided on such schedule. Overdue payments of principal (whether at stated maturity, by acceleration or otherwise), and, to the extent permitted by law, overdue interest, shall bear interest, compounded monthly and payable on demand in immediately available funds, at a rate per annum equal to two percent (2%) above greater of (i) the rate in effect with respect to such principal prior to its maturity and (ii) the rate then applicable to Base Rate Loans under the Agreement. This Note is issued pursuant to, and entitled to the benefits of, and is subject to, the provisions of a certain Credit Agreement dated as of December 21, 1995 by and between the undersigned and the Bank (herein, as the same may from time to time be amended or extended, referred to as the "Agreement"), but neither this reference to the Agreement nor any provision thereof shall affect or impair the absolute and unconditional obligation of the undersigned maker of this Note to pay the principal of and interest on this Note as herein provided. As provided in the Agreement, this Note is subject to mandatory prepayment in certain circumstances. In case an Event of Default (as defined in the Agreement) shall occur, the aggregate unpaid principal of plus accrued interest on this Note shall become or may be declared to be due and payable in the manner and with the effect provided in the Agreement. The undersigned may at its option prepay all or any part of the principal of this Note before maturity upon the terms provided in the Agreement. The undersigned maker hereby waives presentment, demand, notice of dishonor, protest and all other demands and notices in connection with the delivery, acceptance, performance and enforcement of this Note. This instrument shall have the effect of an instrument executed under seal and shall be governed by and construed in accordance with the laws of The Commonwealth of Massachusetts (without giving effect to any conflicts of laws provisions contained therein). EXCEL INC. By: /s/ Robert P. Madonna ------------------------------- Title: President AMENDMENT TO CREDIT AGREEMENT AND PROMISSORY NOTE This Amendment to Credit Agreement and Promissory Note (the "Amendment") is made as of May 24, 1996 and amends the Credit Agreement dated as of December 21, 1995 (as amended, the "Agreement"), between EXCEL, INC. (the "Company"), and THE FIRST NATIONAL BANK OF BOSTON, a national banking association (the "Bank") and the Promissory Note dated as of December 21, 1995 executed by the Company in favor of the Bank (as amended, the "Note"). Capitalized terms which are used in this Amendment and are defined in the Agreement, shall have the meanings given to them in the Agreement unless they are otherwise defined in this Amendment. WHEREAS, the Bank has made available to the Company a certain $5,000,000 credit facility as described in the Agreement and evidenced by the Note; and WHEREAS, the Company and the Bank have agreed to increase the credit facility to $10,000,000; NOW, THEREFORE, the Bank and the Company agree as follows: I. AMENDMENTS TO THE AGREEMENT 1. Section 1.1. of the Agreement is hereby amended by deleting "$5,000,000.00" from the definition of "Commitment Amount" set forth ----------------- and substituting "$10,000,000.00" therefor. 2. Section 2.3 of the Agreement is hereby amended by deleting it in its entirety and replacing it with the following: "2.3 Facility Fee. The Company shall pay to the Bank during the ------------ Revolving Credit Period an annual fee equal to (i) $9,500.00 from the date of this Agreement until June 30, 1996 and $25,000.00 thereafter. The facility fee shall be payable quarterly in advance, on the first day of January, April, July and October of each year. The Company shall pay $2,375.00 on each of January 1, 1996, and April 1, 1996 and $6,250.00 each quarter in advance thereafter commencing on July 1, 1996. A prorated amount for the period from the date of the Agreement to December 31, 1995 shall be payable at the closing." II. AMENDMENT TO THE NOTE The Note is hereby amended by deleting "$5,000,000.00" and "Five Million Dollars ($5,000,000.00)" from the first page thereof and substituting "$10,000,000.00" and "Ten Million Dollars $10,000,000.00)", respectively, therefor. III. MISCELLANEOUS AGREEMENTS 1. Continuing Effect of the Agreement. This Amendment shall not ---------------------------------- constitute an amendment of any provision of the Agreement or the Note not expressly referred to herein and shall not be construed as a consent to any action on the part of the Company that would require a waiver or consent of the Bank except as expressly stated herein. The provisions of the Agreement and the Note that are not expressly amended or modified hereby are and shall remain in full force and effect, and are hereby ratified and confirmed, including without limitation, the negative pledge on assets of the Company as set forth in Section 6.5 of the Agreement. 2. Representations and Warranties. The Company hereby represents and ------------------------------ warrants to the bank that the representations and warranties set forth in the Agreement and the Note as amended by this Amendment are true and correct on and as of the date hereof as if made on and as of the date hereof, and that no Event of Default exists on and as of the date hereof. 3. Fees, Costs, Expenses and Taxes. The Company also agrees to pay on ------------------------------- demand all costs and expenses of the Bank in connection with the preparation, execution and delivery of this Amendment and the other instruments and documents to be delivered hereunder, including the fees and allocation costs of its in-house counsel. 4. Effectiveness of Amendment. This Amendment shall be effective as of -------------------------- the date hereof upon receipt by the Bank of (a) this Amendment duly executed and delivered by the Company and the Bank and (b) such other documents and certificates as the bank or its counsel may have requested. 5. Governing Law. The Amendment shall be deemed to be a contract under ------------- seal and for all purposes shall be governed by and construed and enforced in accordance with the laws of The Commonwealth of Massachusetts. 6. Counterparts. The Amendment may be executed in any number of ------------ counterparts and by the different parties hereto on separate counterparts, each of which, when so executed, shall be deemed an original, but all such counterparts shall constitute but one and the same instrument. The Amendment shall be firmly attached to the Note by stapling or other permanent means of attachment and shall constitute an integral part of the Note from and after the date first above written. IN WITNESS WHEREOF, the parties have caused this Amendment to be executed and delivered by their duly authorized officers as of the date first above written. EXCEL. INC. By: /s/ Robert P. Madonna -------------------------------- Title: President THE FIRST NATIONAL BANK OF BOSTON By: /s/ Bradford P. Egan -------------------------------- Title: Vice President as of March 20, 1997 Excel, Inc. 255 Independence Park Hyannis, MA 02601 Attention: Mr. Robert Madonna RE: Line of Credit -------------- Gentlemen: The First National Bank of Boston (the "Bank") has made a certain revolving line of credit (the "Line") available to Excel, Inc. (the "Borrower") pursuant to a certain credit agreement dated December 21, 1995 (as amended, the "Agreement"). All obligations with respect to the Line are evidenced by a certain Promissory Note in the principal amount of $5,000,000 dated as of December 21, 1995, amended and increased to $10,000,000 (as amended, the "Note"). The Borrower has requested, and the Bank has agreed to amend the Borrowing Base definition and waive and amend certain covenants as set forth in the Agreement. Now, therefore, for good and valuable consideration, the receipt of which is hereby acknowledged, the Borrower and the Bank hereby agree as follows: 1. The Borrowing Base as defined in the Agreement is hereby amended to include 50% of the Net Security Value of Base Inventory net of the obsolescence reserve. "Net Security Value of Base Inventory" shall mean the net value of Base Inventory, calculated at the lesser of fair market value or cost determined on the "first in, first out" basis, after subtracting the value of any Base Inventory which is damaged or detective and after taking into account charges and liens, other than those of the Bank, of all kinds against the Base Inventory, changes in the market value thereof, and transportation, processing and other handling charges affecting the value thereof, all as determined by the Bank in its discretion, which determination shall be final and binding upon the Borrowers. "Base Inventory" shall mean inventory consisting of raw materials as to which a Borrower has acquired title, and is otherwise in compliance with Section 6.5 Encumbrance, and the Borrowers have furnished to the Bank ----------- information as required by Section 5.1(b) hereof. Inventory immediately loses the status of Base Inventory if and when a Borrower sells it, otherwise passes title thereto or consumes it. 2. Section 5.1(a) of the Agreement requires that audited fiscal year end statements be submitted to the Bank within 90 days of the Borrower's fiscal year end. The Borrower has made it known to the Bank that the statement will not be available within that set period of time for fiscal 1996. The Borrower has requested a waiver of the covenant default. Based on the representations made by the Borrower, the Bank hereby waives the covenant default referenced above for the year ended December 31, 1996 and resets the time period to 180 days from the Borrower's fiscal year end. Thereafter, the time period for said covenant will again be 90 days from fiscal year end. -2- 3. Section 6.3 of the Agreement requires that the Borrower or any of its subsidiaries not enter into any leases of real or personal property as lessee which increase the aggregate annual lease payments over $100,000 from the prior fiscal year. The Borrower has made it known to the Bank that the Borrower entered into new leases requiring annual aggregate lease payments of $225,000 in the fiscal year ended December 31, 1996, $125,000 in excess of the permitted amount. The Bank hereby waives the covenant default referenced above for the year ended December 31, 1996 based on the representations made by the Borrower and resets the covenant amending the annual limitation to $300,000 (from the previously agreed $100,000) for future periods. 4. Section 6.4 of the Agreement restricts the Borrower from entering into sale or leaseback transactions. The Borrower has made it known to the Bank that the Borrower did enter into a $560,000 sale/leaseback transaction in the fiscal year ended December 31, 1996. The Bank hereby waives the covenant default referenced above for the year ended December 31, 1996, based on the representations made by the Borrower and resets the covenant for the periods thereafter. These waivers shall not constitute a waiver of any provision of the Agreement other than Section 5.1(a), 6.3, and 6.4 and shall not be construed as a consent to any action on the part of the Borrower that would require a waiver or consent of the Bank except as expressly stated herein. All of the provisions of the Agreement are and shall remain in full force and effect and are hereby ratified and confirmed. Sincerely, THE FIRST NATIONAL BANK OF BOSTON By: /s/ Bradford P. Egan -------------------------------- Its: Vice President --------------------------- Acknowledged: Excel, Inc. By: /s/ Nathan C. Apatow ------------------------ Its: Treasurer -3- Exhibit MONTHLY BORROWING BASE CERTIFICATE Company ____________________________ 1. Accounts Receivable @ ___________ (date) $_____________ a. Less Accounts over 60 days $_____________ b. Less Accounts due to Cross Aging Rule (25%) $_____________ c. Less Affiliate Receivables $_____________ d. Less Foreign Receivables $_____________ e. Less Other Ineligibles $_____________ 2. Eligible Accounts Receivable $_____________ 3. Advance Rate (75%) $_____________ 4. Accounts Receivable Availability $_____________ 5. Raw Material Inventory $_____________ 6. Advance Rate (50%) $_____________ 7. Net Obsolescence Reserve $_____________ 8. Inventory Availability $_____________ 9. Total AIR and Inventory Availability $_____________ 10. Less Outstanding Loan Balance (maximum $10,000,000) $_____________ 12. Net Availability (Overadvance) $_____________ The undersigned, and the individual signing this certificate on behalf of the undersigned, certify that the information contained herein is true, correct, and complete as of the date set forth above. By: ______________________________ (Authorized Official) Date: ____________________________ Exhibit A --------- EXCEL, INC. PROMISSORY NOTE December 21, 1995 $5,000,000.00 Boston, Massachusetts For value received, the undersigned hereby promises to pay to The First National Bank of Boston (the "Bank"), or order, at the head office of the Bank at 100 Federal Street, Boston, Massachusetts 02110, the principal amount of Five Million Dollars ($5,000,000.00) or such lesser amount as shall equal the aggregate unpaid principal amount of all Loans (as defined in the Agreement referred to below) made by the Bank to the undersigned pursuant to the Agreement, in lawful money of the United States and in immediately available funds, in the amounts and on the dates provided on the schedule attached hereto and to pay interest on the unpaid principal amount hereof, at said office, in like money and funds, for the period commencing on the date hereof until paid in full, at the rates per annum and on the dates provided on such schedule. Overdue payments of principal (whether at stated maturity, by acceleration or otherwise), and, to the extent permitted by law, overdue interest, shall bear interest, compounded monthly and payable on demand in immediately available funds, at a rate per annum equal to two percent (2%) above greater of (i) the rate in effect with respect to such principal prior to its maturity and (ii) the rate then applicable to Base Rate Loans under the Agreement. This Note is issued pursuant to, and entitled to the benefits of, and is subject to, the provisions of a certain Credit Agreement dated as of December 21, 1995 by and between the undersigned and the Bank (herein, as the same may from time to time be amended or extended, referred to as the "Agreement"), but neither this reference to the Agreement nor any, provision thereof shall affect or impair the absolute and unconditional obligation of the undersigned maker of this Note to pay the principal of and interest on this Note as herein provided. As provided in the Agreement, this Note is subject to mandatory prepayment in certain circumstances. In case an Event of Default (as defined in the Agreement) shall occur, the aggregate unpaid principal of plus accrued interest on this Note shall become or may be declared to be due and payable in the manner and with the effect provided in the Agreement. The undersigned may at its option prepay all or any part of the principal of this Note before maturity upon the terms provided in the Agreement. The undersigned maker hereby waives presentment, demand, notice of dishonor, protest and all other demands and notices in connection with the delivery, acceptance, performance and enforcement of this Note. -2- This instrument shall have the effect of an instrument executed under seal and shall be governed by and construed in accordance with the laws of The Commonwealth of Massachusetts (without giving effect to any conflicts of laws provisions contained therein). EXCEL INC. By: -------------------------------- Title: -3- SCHEDULE I TO PROMISSORY NOTE
Type of Loan Amount of Eurodollar Interest Interest Notation Date Loan or Base Loan Rate Rate* Period Amount Paid Made By
* For Base Rate Loans, insert "Base Rate" ** For Eurodollar Loans -4- EXHIBIT B List of Indebtedness and Encumbrances 1. $2.6 Million First Mortgage on corporate headquarters building #60 and #70 at 255 Independence Drive , Hyannis, MA. Seven year note, twenty year amortization provided by Cape Cod Bank & Trust. 2. $300 Thousand Term Note secured by equipment and provided by Cape Cod Bank & Trust. -5- EXHIBIT C List of litigation. Arbitration, or Investigations Pending Litigation: Melissa Lima v Excel Inc., et al (Employment Litigation, discrimination in hiring) U.S. District Court Mass. 95-10330-PBS) Arbitration: None Investigations: None -6- EXHIBIT D List of Subsidiaries NONE -7- Exhibit E MONTHLY BORROWING BASE CERTIFICATE Company ____________________ 1. Account Receivable @ _________________(date) $________________ a. Less Accounts over 60 days $________________ b. Less Accounts due to Cross Aging Rule (25%) $________________ c. Less Affiliate Receivables $________________ d. Less Foreign Receivables $________________ e. Less Other Ineligibles $________________ 2. Eligible Accounts Receivable $________________ 3. Advance Rate (75%) X 4. Accounts Receivable Availability $________________ 5. Less Outstanding Loan Balance (Maximum $5,000,000) $________________ 6. Net Availability or (Overadvance) $________________ The undersigned, and the individual signing this certificate on behalf of the undersigned, certify that the information contained herein is true, correct and complete as of the date(s) set forth above. By:____________________________ Authorized Official Date:__________________________ -8- EXHIBIT F --------- REPORT OF CHIEF FINANCIAL OFFICER --------------------------------- EXCEL, INC. (the "Company) HEREBY CERTIFIES that: This Report is furnished pursuant to the Credit Agreement dated as of December 8, 1995 by and between the Company and The First National Bank of Boston (the "Agreement"). Unless otherwise defined herein, the terms used in this Report have the meanings given to them in the Agreement. As required by the Agreement, financial statements of the Company for the quarter ended ______________ (the "Financial Statements') prepared in accordance with generally accepted account principals consistently applied accompany this Report. The Financial Statements present fairly the financial position of the Company as the date thereof and the results of the operations of the Company for the period covered thereby (subject only to normal recurring year-end adjustments). The figures set forth in Schedule I for determining compliance by the Company with the financial covenants contained in the Agreement are true and complete as of the date thereof. The activities of the Company during the period covered by the Financial Statements have been reviewed by the Chief Financial Officer or by employees or agents under his immediate supervision. Based on such review, to the best knowledge and belief of the Chief Financial Officer, and as of the date of this Report, no Default has occurred.* WITNESS my hand this ___ day of __________, 199__. EXCEL, INC. By: -------------------------------- Title: ----------------------------- *If a Default has occurred, this paragraph is to be modified with an appropriate statement as to the nature thereof, the period of existence thereof and what action the Company has taken, is taking, or proposes to take with respect thereto. -9- SCHEDULE I TO REPORT OF CHIEF FINANCIAL OFFICER Schedule of Compliance as of ___________ with provisions of Section 5.7, 5.8, 5.9, and 5.10 of the Credit Agreement dated as of December 8, 1995 (the "Agreement") between Excel, Inc. and the First National Bank of Boston. 1. Consolidated Tangible Net Worth (Section 5.7) --------------------------------------------- (i) Total Assets $________________ (ii) Excluded Items (if any) $________________ (iii) Total Liabilities $________________ (iv) Tangible Net Worth $________________ [(I) minus the sum of (ii) and (iii)] ----- (v) Minimum Tangible Net Worth permitted by Agreement $________________ 2. Ratio of Total Liabilities to Tangible Net Worth (Section 58) ------------------------------------------------------------- (i) Total Liabilities $________________ (ii) Tangible Net Worth $________________ (iii) Ratio of (I) to (ii) ________________ 3. Cash Flow Coverage (Section 5.9) -------------------------------- (i) Earnings before interest and income taxes $________________ [excluding non-recurring or extraordinary items] (ii) Depreciation and Amortization $________________ (iii) Capital Expenditures $________________ (iv) Cash Taxes Paid $________________ (v) Dividends and Distributions $________________ -10- (vi) Total Operating Cash Flow (I) plus (ii) minus (iii) minus (iv) minus (v) $________________ (vii) Interest Expense $________________ (viii) Principal on Debt and Capital Leases paid $________________ (ix) Total Debt Service (vii) plus (viii) $________________ (x) Cash Flow Coverage Ratio (vi) divided by (ix) ________________ (xi) Cash Flow Ratio Required by Agreement ________________ 4. Profitability (Section 5. 10) ----------------------------- (i) Fiscal Quarter Pre-Tax Income Required by Agreement $________________ -11- EXHIBIT G --------- FORM OF OPINION OF COUNSEL TO THE COMPANY ------------------------ The First National Bank of Boston 100 Federal Street Boston, Massachusetts 02110 RE: Revolving Credit Agreement dated as of ______________ by and between The First National Bank of Boston (the "Bank") and [NAME OF COMPANY] (the "Company") Ladies/Gentlemen: We have acted as counsel to ___________ (the "Company") in connection with the preparation, execution and delivery of the Revolving Credit and Term Loan Agreement, dated as of __________ (the "Agreement") between The First National Bank of Boston (the "Bank") and the Company pursuant to which the Company has executed and delivered to the Bank its Note in the principal amount of $_________. All terms defined in the Agreement shall have the same meanings herein. We have examined executed counterparts of the Agreement and the Note and originals, or copies, the authenticity of which has been established to our satisfaction, of such other documents, corporate records, agreements and instruments and certificates of public officials and officers of the Company as we have deemed necessary as the basis for the opinions herein expressed. As to the questions of fact material to such opinions we have, when relevant facts were not independently established, relied upon certifications by officers of the Company. Based on the foregoing and having regard for legal considerations as we have deemed relevant, it is our opinion that: 1. The Company is a corporation duly organized, validly existing and in good standing under the laws of the [State/Commonwealth of ___________], has all requisite corporate power to own its property and conduct its business as now conducted and is duly qualified and in good standing as a foreign corporation and duly authorized to do business in each jurisdiction wherein the nature of its properties or business requires such qualification, except where the failure to be so qualified would not have a material adverse effect on its business, financial condition, assets or properties taken as a whole. 2. The execution and delivery of the Agreement and the Note and performance by the Company of its obligations thereunder and of the transactions contemplated thereby are within the corporate power and authority of the Company, and have been authorized by proper -12- corporate proceedings and do not contravene any provision of law of the United States or its political subdivisions or the [Certificate of Incorporation/Articles of Organization] or ByLaws of the Company, or, to the best of our knowledge, contravene any provision of, or constitute an event of default or event which, with the lapse of time or the giving of notice, or both, would constitute an event of default under, any other agreement, instrument or undertaking binding on the Company. 3. The Agreement and the Note have been duly executed and delivered by the Company. The Agreement and the Note and all of the terms and provisions thereof are the legal, valid and binding obligations of the Company, enforceable in accordance with their respective terms except as limited by bankruptcy, insolvency, reorganization, moratorium or other laws affecting enforcement of creditors' rights generally, and except as the remedy of specific performance or of injunctive relief is subject to the discretion of the court before which any proceeding therefor may be brought. 4. The execution, delivery and performance of the Agreement and the Note and the transactions contemplated thereby do not require any approval or consent of, or filing or registration with, any governmental or other agency or authority, or any other party. 5. Except as set forth on Exhibit D to the Agreement, there is no --------- litigation, proceeding or investigation pending, or, to the best of our knowledge after due inquiry, threatened, against the Company or any Subsidiary which, if adversely determined, would result in a material judgment not substantially covered by insurance or would otherwise have a material adverse effect on the assets, business or prospects of the Company or any Subsidiary. 6. Each Subsidiary of the Company is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation, has all requisite corporate power to own its property and conduct its businesses as now conducted and is duly qualified and in good standing as a foreign corporation and is duly authorized to do business in each jurisdiction where the nature of its properties or businesses requires such qualification, except where the failure to be so qualified would not have a material adverse effect on its business, financial condition, assets or properties taken as a whole. 7. As of the date of the Agreement, all the Subsidiaries of the Company are listed on Exhibit E thereto. The Company is the record holder of all of the --------- issued and outstanding stock of each of its Subsidiaries. All shares of such stock have been validly issued and are fully paid and nonassessable, and no rights to subscribe to any additional shares have been granted, and no options, warrants or similar rights are outstanding. 8. Neither the Company nor any Subsidiary is subject to regulation under the Investment Company Act of 1940, as amended. 9. All state and local recording, franchise, stamp, documentary and other taxes and governmental charges and assessments required to be paid in connection with the execution, -13- delivery, filing or recordation of, or as a condition to the enforcement of, the Agreement and the Note and any of the transactions contemplated thereby, have been duly paid. Very truly yours, EXCEL SWITCHING CORPORATION (f/k/a Excel, Inc.) 255 Independence Drive Hyannis, Massachusetts 02601 Dated as of: December 19, 1997 BankBoston, N.A., (f/k/a The First National Bank of Boston) 100 Federal Street Boston, Massachusetts 02110 Re: Amendment No. 1 to Loan Agreement --------------------------------- Ladies and Gentlemen: We refer to the Loan Agreement, dated as of December 21, 1995 (as amended, the "Agreement"), between Excel Switching Corporation (f/k/a Excel, Inc.), a Massachusetts corporation (the "Borrower"), and BankBoston, N.A. (f/k/a The First National Bank of Boston), a national banking association (the "Lender"). Terms used in this letter of agreement (this "Amendment") which are not defined herein, but which are defined in the Agreement, shall have the same respective meanings herein as therein. We have advised you that, effective September 16, 1997, we have changed the legal name of the corporation from Excel, Inc. to Excel Switching Corporation. In addition, we have requested you to make certain amendments to the Agreement. You have advised us that you are prepared and would be pleased to make the amendments so requested by us on the condition that we join with you in this Amendment. Accordingly, in consideration of these premises, the promises, mutual covenants and agreements contained in this Amendment, and fully intending to be legally bound by this Amendment, we hereby agree with you as follows: ARTICLE I --------- AMENDMENTS TO AGREEMENT ----------------------- Effective December 19, 1997, the Agreement is amended as follows: (a) The definition of "Borrowing Base" in Section 1.1 of the Agreement (and including the definitions of "Base Accounts" and "net outstanding amount of Base Accounts" contained therein) is deleted in its entirety. -2- (b) The definition of "Commitment Amount" in Section 1.1 of the Agreement is amended to read in its entirety as follows: "Commitment Amount. $15,000,000 or any lesser amount, including zero ----------------- resulting from a termination or reduction of such amount in accordance with Section 7.2." (c) Section 1.1 is amended by inserting, immediately following the definition of "Computation Rate" contained therein, the following new definition: "Consolidated Current Assets. At any date as of which the amount --------------------------- thereof shall be determined, all amounts that should, in accordance with generally accepted accounting principles, be included as current assets on the consolidated balance sheet of the Company and its Subsidiaries at such date." (d) The definition of "Revolving Credit Termination Date" in Section 1.1 of the Agreement is amended to read in its entirety as follows: "Revolving Credit Termination Date: June 30, 1999". (e) Section 2.1 of the Agreement is amended by deleting each reference to "Borrowing Base" contained therein, and by inserting in place thereof the following: "Commitment Amount". (f) Section 2.4(a) of the Agreement is amended by deleting the reference to "December 15, 1997" contained therein, and by inserting in place thereof the following: "June 30, 1999". (g) Section 2.6(b) of the Agreement is amended by deleting the reference to "two and one half percent (2.5%)" contained therein, and by inserting in place thereof the following: "one and three-quarters percent (1.75%)". (h) Section 5.1(b) of the Agreement is amended by deleting the reference to the borrowing base report and Exhibit E contained in clause (ii) thereof. --------- (i) Section 5.7 of the Agreement is amended to read in its entirety as follows: "[Intentionally Omitted.]" (j) Section 5.8 of the Agreement is amended by deleting the reference to "1.25" contained therein, and by inserting in place thereof the following: "1.00". -3- (k) Section 5.9 of the Agreement is amended to read in its entirety as follows: "5.9 Consolidated Current Assets to Consolidated Current Liabilities --------------------------------------------------------------- Ratio. The Company shall at all times maintain a ratio of ----- Consolidated Current Assets to Consolidated Current Liabilities of at least 2.00 to 1.00, tested quarterly." (l) Section 7.1(b) of the Agreement is amended to read in its entirety as follows: "(b) The Company shall fail to perform any term, covenant or agreement contained in Sections 5.1(g), 5.5, 5.8 through 5.11, inclusive, or 6.1 through 6.10, inclusive; or". (m) Each reference in the Agreement, the Note and the other documents and agreements executed in connection therewith to (i) "Excel, Inc." shall be deemed to be a reference to "Excel Switching Corporation" and (ii) "The First National Bank of Boston" shall be deemed to be a reference to "BankBoston, N.A." (n) Section 2.3 of the Agreement is amended to read in its entirety as follows: "2.3 Facility Fee. The Company shall pay to the Bank during the ------------ Revolving Credit Period an annual facility fee, payable quarterly in advance on the first Business Day of each quarter, equal to 1/4% per annum of the Commitment Amount then in effect." ARTICLE II ---------- AMENDMENT TO NOTE ----------------- Effective December 19, 1997, the Note is amended by deleting each reference to "$10,000,000" or "Ten Million Dollars ($10,000,000) contained therein and by inserting a reference to "$15,000,000" or "Fifteen Million Dollars ($15,000,000)", respectively, in place thereof. In addition, the Schedule attached to the Note is amended by inserting a maturity date of June 30, 1999. ARTICLE III ----------- REPRESENTATIONS AND WARRANTIES ------------------------------ The Borrower represents and warrants to you as follows: (a) Representations in Agreement. Each of the representations and ---------------------------- warranties made by the Borrower to you in the Agreement was true, correct and complete when made and is true, correct and complete on and as of the date hereof with the same full force and effect as if each of such representations and warranties had been made by the Borrower on the date hereof and in this Amendment. -4- (b) No Defaults or Events of Default. No default or Event of Default -------------------------------- exists on the date of this Amendment (after giving effect to all of the arrangements and transactions contemplated by this Amendment). (c) Binding Effect of Documents. This Amendment has been duly executed and --------------------------- delivered to you by the Borrower and is in full force and effect as of the date hereof, and the agreements and obligations of the Borrower contained herein constitute legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with its terms. The Borrower has delivered to you with this Amendment duly executed board resolutions authorizing the incurrence of the additional indebtedness evidenced hereby and the other terms and conditions of this Amendment. ARTICLE IV ---------- MISCELLANEOUS ------------- This Amendment may be executed in any number of counterparts, each of which when executed and delivered shall be deemed an original, but all of which together shall constitute one instrument. In making proof of this Amendment, it shall not be necessary to produce or account for more than one counterpart thereof signed by each of the parties hereto. Except to the extent specifically amended and supplemented hereby, all of the terms, conditions and the provisions of the Agreement, the Note and each of the other documents and agreements executed in connection therewith shall remain unmodified, and the Agreement, the Note and each of the other documents, as amended and supplemented by this Amendment, are confirmed as being in full force and effect. If you are in agreement with the foregoing, please sign the form of acceptance on the enclosed counterpart of this Amendment and return such counterpart to the undersigned, whereupon this Amendment, as so accepted by you, shall become a binding agreement between you and the undersigned. Very truly yours, EXCEL SWITCHING CORPORATION (f/k/a EXCEL, INC.) By: /s/ Stephen S. Galliker ------------------------------ Title: Vice President -5- The foregoing Amendment is hereby accepted by the undersigned as of December 19, 1997 BANKBOSTON, N.A., (f/k/a THE FIRST NATIONAL BANK OF BOSTON) By: /s/ Bradford P. Egan ---------------------------- Title: Vice President EX-21.1 3 SUBSIDIARIES OF THE COMPANY EXHIBIT 21.1 EXCEL SWITCHING CORPORATION SUBSIDIARIES OF THE COMPANY 1. Excel Securities Corp. a Massachusetts Corporation Excel Switching Corporation ownership 100% EX-27 4 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-27-1997 DEC-29-1996 DEC-27-1997 47,968 66,929 12,843 1,350 4,740 139,526 14,183 4,015 149,694 23,152 0 0 0 326 125,589 149,694 88,727 88,727 26,631 32,695 0 0 (1,392) 30,793 12,177 18,616 0 0 0 18,616 .65 .54
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