-----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, KLgxzee+Dz5Z7Me/9hcM761/iogU7/sK5U9Ex5v+CqZsRiAAjcDkxpMWPfhPgFh7 sYx8FetwKuCIrJVpRdYcJw== 0000950134-98-006960.txt : 19980817 0000950134-98-006960.hdr.sgml : 19980817 ACCESSION NUMBER: 0000950134-98-006960 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: DSC COMMUNICATIONS CORP CENTRAL INDEX KEY: 0000316004 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 541025763 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-10018 FILM NUMBER: 98688543 BUSINESS ADDRESS: STREET 1: 1000 COIT RD CITY: PLANO STATE: TX ZIP: 75075 BUSINESS PHONE: 9725193000 MAIL ADDRESS: STREET 1: 1000 COIT ROAD CITY: PLANO STATE: TX ZIP: 75075-5813 FORMER COMPANY: FORMER CONFORMED NAME: DIGITAL SWITCH CORP DATE OF NAME CHANGE: 19850425 10-Q 1 FORM 10-Q FOR QUARTER ENDED JUNE 30, 1998 1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to __________ Commission File Number: 0-10018 --------- DSC COMMUNICATIONS CORPORATION -------------------------------- (Exact name of registrant as specified in its charter) Delaware 54-1025763 - -------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1000 Coit Road, Plano, Texas 75075 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (972) 519-3000 -------------------------------------------------------- (Registrant's telephone number, including area code) 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 ---- ---- APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes No ---- ---- APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. Number of Shares Outstanding Title of Each Class as of July 31, 1998 - -------------------------------- ----------------------------------- Common Stock, $0.01 Par Value 119,098,418 2 Item 1. Financial Statements. DSC COMMUNICATIONS CORPORATION AND SUBSIDIARIES Condensed Consolidated Balance Sheets (In thousands)
June 30, December 31, 1998 1997 ------------------ ------------------- (Unaudited) Assets - ------------------------------------------------------------------------------ CURRENT ASSETS Cash and cash equivalents .............................................. $ 158,940 $ 277,200 Marketable securities .................................................. 328,121 340,642 Receivables ............................................................ 392,740 436,093 Inventories ............................................................ 390,338 374,247 Deferred income taxes .................................................. 100,032 79,879 Other current assets ................................................... 132,252 86,969 ----------- ----------- Total current assets .............................................. 1,502,423 1,595,030 ----------- ----------- PROPERTY AND EQUIPMENT, at cost .......................................... 921,032 870,943 Less accumulated depreciation and amortization ...................................................... (454,918) (427,333) ----------- ----------- 466,114 443,610 ----------- ----------- CAPITALIZED SOFTWARE DEVELOPMENT COSTS ................................... 82,692 72,341 COST IN EXCESS OF NET ASSETS OF BUSINESSES ACQUIRED, NET ............................................... 154,379 159,594 OTHER .................................................................... 157,738 168,940 ----------- ----------- Total assets .................................................. $ 2,363,346 $ 2,439,515 =========== =========== Liabilities and Shareholders' Equity - ------------------------------------------------------------------------------ CURRENT LIABILITIES Accounts payable ....................................................... $ 107,085 $ 110,135 Accrued liabilities .................................................... 312,234 301,044 Income taxes payable ................................................... 259 28,536 Current portion of long-term debt ...................................... 32,590 32,602 ----------- ----------- Total current liabilities ......................................... 452,168 472,317 ----------- ----------- LONG-TERM DEBT, net of current portion ................................... 598,154 629,206 NONCURRENT INCOME TAXES AND OTHER LIABILITIES ................................................... 124,070 122,172 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Common stock, $0.01 par value, issued - 123,944 in 1998 and 122,377 in 1997; outstanding - 118,955 in 1998 and 117,388 in 1997 ....................................................... 1,239 1,231 Additional capital ..................................................... 765,630 755,963 Unrealized gains on securities, net of income taxes ................................................... 375 194 Accumulated translation adjustment ..................................... 567 2,494 Retained earnings ...................................................... 464,254 499,049 ----------- ----------- 1,232,065 1,258,931 Treasury stock, at cost, 4,989 shares .................................. (43,111) (43,111) ----------- ----------- Total shareholders' equity .......................................... 1,188,954 1,215,820 ----------- ----------- Total liabilities and shareholders' equity ........................................ $ 2,363,346 $ 2,439,515 =========== ===========
See the accompanying Notes to Condensed Consolidated Financial Statements. Page 2 of 17 3 DSC COMMUNICATIONS CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Operations (In thousands, except per share data) (Unaudited)
Three Months Ended Six Months Ended June 30, June 30, --------------------------- ---------------------------- 1998 1997 1998 1997 --------- --------- --------- --------- Revenue ..................................... $ 388,446 $ 382,883 $ 703,284 $ 729,086 Cost of revenue ............................. 268,023 226,327 491,847 433,255 --------- --------- --------- --------- Gross profit .............................. 120,423 156,556 211,437 295,831 --------- --------- --------- --------- Operating costs and expenses: Research and product development .......... 66,616 59,545 135,869 114,326 Selling, general and administrative ....... 62,719 57,335 122,119 115,386 Other operating costs ..................... 3,493 2,462 7,126 4,934 --------- --------- --------- --------- Total operating costs and expenses ...... 132,828 119,342 265,114 234,646 --------- --------- --------- --------- Operating income (loss) ................... (12,405) 37,214 (53,677) 61,185 Interest income ............................. 7,702 4,513 16,031 9,551 Interest expense ............................ (12,647) (4,988) (26,701) (10,812) Other income (expense), net ................. 9,904 30,708 9,117 33,910 --------- --------- --------- --------- Income (loss) before income taxes ....... (7,446) 67,447 (55,230) 93,834 Income tax expense (benefit) ................ (2,755) 25,630 (20,435) 35,657 ========= ========= ========= ========= Net income (loss) ....................... $ (4,691) $ 41,817 $ (34,795) $ 58,177 ========= ========= ========= ========= Basic income (loss) per share ............... $ (0.04) $ 0.36 $ (0.29) $ 0.50 ========= ========= ========= ========= Diluted income (loss) per share ............. $ (0.04) $ 0.35 $ (0.29) $ 0.49 ========= ========= ========= ========= Average shares used in per share computation: Basic ................................... 118,350 117,124 118,276 117,072 Diluted ................................. 118,350 119,301 118,276 119,188
See the accompanying Notes to Condensed Consolidated Financial Statements. Page 3 of 17 4 DSC COMMUNICATIONS CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (In thousands) (Unaudited)
Six Months Ended June 30, --------------------------------------- 1998 1997 ---------------- ----------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) .................................. $ (34,795) $ 58,177 Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: Depreciation and amortization .................. 52,997 48,609 Amortization of capitalized software development costs ........................... 16,765 12,276 Deferred income taxes .......................... (20,435) 5,699 Gain from sales of stock received from 1996 litigation settlement .................. -- (35,494) Decrease in current and long-term receivables ...... 47,975 13,861 Increase in inventories ............................ (8,407) (28,547) Increase (decrease) in income taxes payable ........ (28,277) 19,956 Other, including changes in other assets, current payables and other liabilities ... (29,406) (29,936) --------- --------- NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES ....................... (3,583) 64,601 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment ................ (67,731) (77,850) Purchases of marketable securities ................. (521,730) (122,244) Proceeds from sales and maturities of marketable securities ....................................... 535,961 152,447 Proceeds from sales of stock received from 1996 litigation settlement ....................... -- 35,494 Additions to capitalized software development costs ................................ (26,916) (22,507) Other .............................................. (8,862) (11,535) --------- --------- NET CASH USED FOR INVESTING ACTIVITIES ....................... (89,278) (46,195) --------- ---------
(Continued) Page 4 of 17 5 DSC COMMUNICATIONS CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Continued) (In thousands) (Unaudited)
Six Months Ended June 30, ------------------------------- 1998 1997 ------------ ------------- CASH FLOWS FROM FINANCING ACTIVITIES Payments on long-term borrowings ................. (30,312) (29,443) Proceeds from the sale of common stock under stock plans ............................. 4,499 1,041 Other ............................................ 547 4,018 --------- --------- NET CASH USED FOR FINANCING ACTIVITIES ..................... (25,266) (24,384) --------- --------- EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS ..................... (133) (767) NET DECREASE IN CASH AND CASH EQUIVALENTS .............................. (118,260) (6,745) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ... 277,200 155,101 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD ......... $ 158,940 $ 148,356 ========= ========= SUPPLEMENTAL CASH FLOW INFORMATION: Interest paid .................................... $ 22,954 $ 9,618 ========= ========= Income taxes paid ................................ $ 33,658 $ 10,934 ========= =========
See the accompanying Notes to Condensed Consolidated Financial Statements. Page 5 of 17 6 DSC COMMUNICATIONS CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements June 30, 1998 and 1997 and December 31, 1997 (Unaudited) BASIS OF PRESENTATION The accompanying unaudited Condensed Consolidated Financial Statements reflect, in the opinion of management, all adjustments necessary to present fairly the Company's financial position, results of operations and cash flows. Such adjustments are of a recurring nature unless otherwise disclosed herein. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to rules and regulations promulgated by the Securities and Exchange Commission. However, the Company believes that the disclosures contained herein are adequate to make the information presented not misleading. Quarterly consolidated financial results may not be indicative of annual consolidated financial results. The Company has not paid or declared a cash dividend on its common stock since its organization. Certain prior year's financial statement information has been reclassified to conform with the current year financial statement presentation. These unaudited financial statements should be read in conjunction with the audited financial statements and accompanying notes included in the Company's 1997 Annual Report to Shareholders for the year ended December 31, 1997. The Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" in the first quarter of 1998. This standard requires disclosure of comprehensive income, defined as net income plus nonowner changes in shareholders' equity, such as accumulated translation adjustments and unrealized gains (losses) on certain marketable securities. For the three months ended June 30, 1998 and 1997, total comprehensive income (loss) amounted to ($4.7) million and $28.8 million, respectively. Total comprehensive income (loss) amounted to ($36.5) million and $51.8 million for the six months ended June 30, 1998 and 1997, respectively. The primary difference between comprehensive income and net income for the three months ended June 30, 1997 is related to a decrease in unrealized appreciation due to the sale of an investment in common stock received from a litigation settlement. PENDING MERGER On June 3, 1998, Alcatel Alsthom ("Alcatel") and the Company signed a definitive agreement under which Alcatel will acquire the Company in a stock-for-stock transaction. Under the terms of the agreement all outstanding shares of the Company's stock will be exchanged at a ratio of 0.815 of an Alcatel ADS for each outstanding DSC share. Based on the closing price of Alcatel's ADS on June 3, 1998, the total value of the acquisition is approximately $4.4 billion. The transaction will be accounted for under the purchase method of accounting. The transaction is expected to close in the third quarter of 1998 subject to various terms and conditions including the approval of Company shareholders and regulatory agencies. The Company's shareholders have been asked to vote on the proposed merger at a Special Meeting to be held on August 27, 1998. Page 6 of 17 7 INVENTORIES Inventories consisted of the following (in thousands):
June 30, December 31, 1998 1997 ------------ ------------ Raw Materials................................................. $ 92,246 $ 88,796 Work in Process............................................... 20,677 17,840 Finished Goods................................................ 277,415 267,611 ------------ ----------- $ 390,338 $ 374,247 ============ ============
CREDIT AGREEMENTS AND LONG-TERM DEBT The Company has an unsecured $160.0 million revolving credit facility with several banks which expires in May 2001. This facility provides for borrowings and issuances of letters of credit in various currencies. The maximum borrowings available under the facility are reduced by the value of outstanding letters of credit issued by the banks on behalf of the Company. The letters of credit issued by the banks under this agreement at June 30, 1998 totaled $2.2 million. This facility contains various financial covenants and there have been no borrowings under this agreement. Two of the Company's foreign subsidiaries also have credit agreements providing for borrowings of up to $18.3 million with local banks. The Company's senior debt agreements contain various financial covenants, including among other things, minimum net worth, maintenance of certain fixed charge ratios and maximum allowable indebtedness to net worth. In 1998, the Company and its senior lenders agreed to amendments to the senior loan agreements modifying certain of these financial covenants. As a result, the Company is in compliance with all of the provisions of its senior loan agreements. In addition, the variable interest rate on certain senior borrowings (approximately $79.7 million outstanding at June 30, 1998) was increased from a maximum of 0.69% above Danish index rates to 0.80% above the index rate and maturities of $31.0 million of these borrowings were reduced from 2011 to 2001. The Company also agreed to increase the interest rate on other senior borrowings (approximately $140.6 million outstanding at June 30, 1998) from 9.0% to 9.6%. Should the Company's credit rating be downgraded, the Company has also agreed to pay the lenders (i) $2.5 million in cash if the merger (see "Pending Merger") is consummated, or (ii) warrants to purchase the Company's common stock with an equivalent value of $2.5 million should the merger not be consummated. The warrants, if issued, would be exercisable by the lenders for up to ten years at the fair market value of the Company's common stock at the date of issuance. OTHER INCOME (EXPENSE), NET Included in Other income (expense), net for the second quarter of 1998 was a pre-tax gain of $10.0 million from the sale of the Company's remaining investment in Airspan Communications Corporation ("Airspan"). Other income (expense), net in the first and second quarters of 1997 included pre-tax gains of approximately $4.0 million and $31.5 million, respectively, from sales of common stock received from a settlement of litigation in 1996. INCOME TAXES The Company provided an income tax benefit of $20.4 million for the first half of 1998 at the estimated annual effective income tax rate of 37%. The income tax benefit and related increase in the deferred tax asset were recorded based on the Company's operating history as well as a current assessment that the Company will generate taxable earnings in the future. Page 7 of 17 8 The Company's income taxes include federal, foreign and state (including Puerto Rico) income taxes. The effective income tax rate is based upon estimates for the full year for a number of variables including, among other things, forecasted income in the United States and foreign jurisdictions. The effective tax rate could change as estimates of these and other variables are finalized at the end of the year. INCOME (LOSS) PER SHARE The following table sets forth the computation of basic and diluted income (loss) per share (in thousands, except per share data):
Three Months Ended Six Months Ended June 30, June 30, ------------------------------ ----------------------------- 1998 1997 1998 1997 -------------- -------------- ------------- ------------- Numerator: Net income (loss) ................ $ (4,691) $ 41,817 $ (34,795) $ 58,177 Denominator for basic income (loss) per share: Weighted average shares outstanding .................... 118,350 117,124 118,276 117,072 Effect of dilutive securities: Stock options and awards ......... -- 2,177 -- 2,116 --------- --------- --------- --------- Denominator for diluted income (loss) per share ................. 118,350 119,301 118,276 119,188 Basic income (loss) per share ....... $ (0.04) $ 0.36 $ (0.29) $ 0.50 ========= ========= ========= ========= Diluted income (loss) per share ..... $ (0.04) $ 0.35 $ (0.29) $ 0.49 ========= ========= ========= =========
For both the three and six months ended June 30, 1998, the number of stock options and awards excluded from the computation of income (loss) per share because of their antidilutive effect was 12.2 million shares, compared to 4.3 million shares for the same periods in 1997. In addition, approximately 8.0 million shares of common stock issuable upon conversion of the 7% convertible notes were excluded from the calculation of income (loss) per share for the three and six months ended June 30, 1998 due to their antidilutive effect. COMMITMENTS AND CONTINGENCIES Contingent Liabilities The Company has guarantees of $69.1 million outstanding at June 30, 1998 supporting bid and performance bonds to customers and others, of which $2.2 million were collateralized by letters of credit issued under the Company's credit facility. Additionally, in the past, the Company has sold customer receivables and leases under agreements which contain recourse provisions. The Company could be obligated to repurchase a portion of the sales-type and operating lease receivables which were previously sold on a partial recourse basis, the terms of which allow the Company to limit its risk of loss to approximately $7.5 million at June 30, 1998. The Company believes it has adequate reserves for any ultimate losses associated with these contingencies. At June 30, 1998, the Company had forward foreign exchange contracts of $54.1 million outstanding. Page 8 of 17 9 Litigation In August, 1996, the Company filed suit against Samsung Information Systems America, Inc., Samsung Electronics Co., Ltd. and James L. Bunch and later added additional defendants Leo Putchinski, Kevin Gallagher, Jim Olivier, Nancy Korman, Martin Wu, David Fox, Bhushan Gupta and Michael Bray (collectively the "Defendants"). The suit arises out of research and development that the Company was and is doing on a next-generation switching system. Many of the Defendants to this suit were long-term employees of the Company and were involved in the research and development of the Company's next-generation switching system. In the summer and early fall of 1996, Samsung hired each of these individuals and placed them into similar positions researching and developing Samsung's next-generation switching system. The Company alleges claims for breach of contract, theft of trade secrets, unfair competition and tortious interference with contract and prospective contractual relations. Based on these claims, the Company is seeking damages in an amount that is not yet specified. The Company is also seeking an injunction against the Defendants to prevent them from using the Company's trade secrets. The Company obtained a temporary restraining order against Defendant Bunch on August 14, 1996. On December 31, 1996, the Defendants filed a counterclaim against the Company, alleging a variety of causes of action, including a claim for declaratory judgment, wrongful injunction, tortious interference with actual and prospective contractual relations, misappropriation of trade secrets, unfair competition, exclusion from telephony switch market, civil conspiracy, fraud and negligent misrepresentation, breach of fiduciary or confidential relationship, defamation and intentional infliction of emotional distress. These allegations arise primarily out of the filing and prosecution of the Company's suit against the Defendants. The Company believes that it has valid and substantial claims against the Defendants and valid defenses to the Defendants' counterclaims. On October 8, 1996, the Company filed suit against Pulse Communications, Inc. ("Pulsecom") alleging contributory copyright infringement and misappropriation of trade secrets relating to the manufacture and sale of a POTS line card advertised as compatible with the Company's Litespan-2000 system. The Company sought damages and an injunction barring further infringement of the Company's intellectual property rights by Pulsecom and its agents. Pulsecom filed a counterclaim alleging that the Universal Voice Grade line card manufactured by the Company for the Litespan-2000 system infringes U. S. Patent No. 5,263,081 assigned to Pulsecom. The Company's claims against Pulsecom were dismissed by the trial court on June 10, 1997. Pulsecom's claims against the Company were dismissed August 29, 1997. Both parties have filed appeals. Based on the facts known at this time, the Company believes it has a valid defense to Pulsecom's claim and that the ultimate outcome of the dispute will not have a material adverse effect on the Company's consolidated financial position. On May 25, 1994, the Company filed suit against DGI Technologies, Inc. ("DGI"), a Texas corporation, in the United States District Court for the Northern District of Texas, Dallas Division. The Company alleged that DGI misappropriated the Company's trade secrets regarding digital trunk interface cards and microprocessor cards. The Company sought damages for DGI's prior actions and permanent injunctive relief. DGI brought counterclaims for alleged violations of federal antitrust statutes, tortious interference, industrial espionage, misappropriation of trade secrets, trespass, conversion and unfair competition. DGI's antitrust counterclaims were based upon allegations that the Company's claims constituted "sham" litigation, that the Company's statements to customers about the impact of their use of DGI products on the Company's warranties were unlawful attempts to exclude competition, and that Page 9 of 17 10 the Company unlawfully tied the sale of its microprocessors to the sale of other products. The balance of DGI's counterclaim was based upon certain investigative procedures employed by the Company in connection with this controversy. DGI asked the court to award unspecified actual damages, treble damages under antitrust statutes, punitive damages, injunctive relief and attorneys' fees, and sought declaratory relief that DGI's sales of microprocessors did not violate any proprietary rights of the Company or any applicable law. The case was tried in January 1997 and the jury returned a verdict. The Court entered a final judgment on November 18, 1997. The judgment enjoined DGI from selling its microprocessor cards and included a net monetary judgment of $0.3 million in the Company's favor. Both parties have filed appeals to the Fifth Circuit Court of Appeals. On December 22, 1997, Catherine Millet, the Company's former Vice President of advanced planning in the Access Products Division and her new employer, Advanced Fibre Communications, Inc. ("AFC"), sued the Company in Roseville, California State Court for declaratory judgment against the Company. Millet is attempting to keep the Company from enforcing rights in its trade secrets and intellectual property which Millet will inevitably be required to use in her new position with AFC. Ms. Millet is performing the identical job function in advanced product planning that she performed for the Company in regard to the same line of products. The Company had previously sued AFC for theft of trade secrets in U. S. District Court. That case was resolved at trial. On January 22, 1998, the Company filed patent infringement action against AFC, in federal court, Texarkana, Texas. On May 28, 1998, AFC filed a counterclaim against the Company alleging Sherman Act violation, unfair competition, interference with business advantage, breach of contract, fraud, and negligent misrepresentation. While no specific amount of damages is stated by AFC, treble and punitive damages are also requested. On July 2, 1998, Charles Grimes, a shareholder of the Company, filed a complaint in Delaware State Court against the Company and all of its current directors. Styled as a class action, it alleges corporate waste. The complaint does not seek to enjoin or interfere with the merger. The Company believes that the allegation is wholly without merit, and it intends to pursue several valid defenses. The Company is also party to other routine legal proceedings incidental to its business. The Company does not believe the ultimate resolution of these matters will have a material adverse effect on its consolidated financial position. Page 10 of 17 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. "SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 Except for the historical information contained herein, the matters discussed or incorporated by reference in this Quarterly Report on Form 10-Q herein, including the matters relating to future performance, are forward-looking statements that are dependent upon a number of risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. These risks and uncertainties include, but are not limited to, those described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other risks indicated from time to time in the Company's filings with the Securities and Exchange Commission. Pending Merger On June 3, 1998, Alcatel and the Company signed a definitive agreement under which Alcatel will acquire the Company in a stock-for-stock transaction. Under the terms of the agreement all outstanding shares of the Company's stock will be exchanged at a ratio of 0.815 of an Alcatel ADS for each outstanding DSC share. Based on the closing price of Alcatel's ADS on June 3, 1998, the total value of the acquisition is approximately $4.4 billion. The transaction will be accounted for under the purchase method of accounting. The transaction is expected to close in the third quarter of 1998 subject to various terms and conditions including the approval of Company shareholders and regulatory agencies. The Company's shareholders have been asked to vote on the proposed merger at a Special Meeting to be held on August 27, 1998. Results of Operations For the three months ended June 30, 1998, the Company reported revenue of $388.4 million and a net loss of $4.7 million, or $0.04 per diluted share, compared to revenue of $382.9 million and net income of $41.8 million, or $0.35 per diluted share, for the three months ended June 30, 1997. Net income for the second quarter of 1998 included a pre-tax gain of $10.0 million (after-tax gain of $6.3 million or $0.05 per diluted share) from the sale of Company's remaining investment in Airspan Communications Corporation. Second quarter 1997 net income included a pre-tax gain of approximately $31.5 million (after-tax gain of $19.5 million or $0.16 per diluted share) from the sale of stock received from a 1996 litigation settlement. Excluding the effects of these special gains, the net loss for the three months ended June 30, 1998 was $11.0 million, or $0.09 per diluted share, compared to net income of $22.3 million, or $0.19 per diluted share, for the same period in 1997. For the six months ended June 30, 1998, the Company reported revenue of $703.3 million and a net loss of $34.8 million, or $0.29 per diluted share compared to revenue of $729.1 million and net income of $58.2 million, or $0.49 per diluted share for the same period in 1997. Excluding the effects of special gains, the net loss for the first half of 1998 was $41.1 million, or $0.35 per diluted share, compared to net income of $36.2 million, or $0.31 per diluted share, for the six months ended June 30, 1997. Although revenue levels for the 1998 and 1997 second quarters remained comparable, revenue of access and transmission products increased, while switch product deliveries declined. The lower level of switch product revenue was due to a number of factors, including the reduction in deliveries of wireless switch platforms, delayed purchasing decisions by certain long-distance customers involved in merger and restructuring activities, and delayed customer orders from a key Japanese customer. Page 11 of 17 12 Gross profit as a percentage of revenue was 31% and 30% for the three and six months ended June 30, 1998, respectively, compared to 41% for the same periods in 1997. The gross profit percentage for the second quarter of 1998 was negatively impacted by a higher volume of access and transmission products which have traditionally produced lower margins than switching products. The Company's gross profit percentage and operating performance could vary significantly from period to period in the future due to changes in the relative mix of product deliveries, as was experienced in the first half of 1998, software content and the impact of sales price changes. The Company's European transmission business and newly acquired cellular infrastructure business continued to incur operating losses in the first half of 1998. The ultimate profitability of these businesses is dependent upon successful market acceptance and deployment of these products. Research and product development expenses were $66.6 million, or 17% of revenue, in the second quarter of 1998, compared to $59.5 million, or 16% of revenue, for the same period in 1997. For the first half of 1998, research and development expenses were $135.9 million, or 19% of revenue, compared to $114.3 million, or 16% of revenue for the same period in 1997. The Company continues to make a substantial investment in research and development to maintain the Company's ongoing development of new products and enhancements to existing products across all strategic product areas, including the cellular infrastructure business acquired in December 1997. Selling, general and administrative expenses totaled $62.7 million and $122.1 million for the three and six months ended June 30, 1998, respectively, compared to $57.3 million and $115.4 million, respectively, for the same periods in 1997. As a percentage of revenue, selling, general and administrative expense was 16% and 17% for the three and six months ended June 30, 1998, compared to 15% and 16% for the same periods in 1997. The Company's active pursuit of claims related to its intellectual property rights have resulted in increased legal expenses which may continue at a high level as this litigation progresses. See "Litigation" under "Commitments and Contingencies" in Notes to Condensed Consolidated Financial Statements for further discussion. Interest income and interest expense were at higher levels in the first half of 1998 compared to the 1997 first half primarily as a result of the convertible debt offering in August 1997. Included in Other income (expense), net for the second quarter of 1998 was a pre-tax gain of $10.0 million related to the sale of the Company's remaining investment in Airspan. For the first and second quarters of 1997, Other income (expense), net included pre-tax gains of $4.0 million and $31.5 million, respectively, resulting from the sales of stock received as part of a litigation settlement in 1996. See "Other Income (Expense), Net" in Notes to Condensed Consolidated Financial Statements for further discussion. See "Income Taxes" in Notes to Condensed Consolidated Financial Statements for information on the Company's income taxes during 1998. Financial Condition and Liquidity The Company's cash and cash equivalents at June 30, 1998 were $158.9 million compared to $277.2 million at December 31, 1997, and marketable securities were $328.1 million at June 30, 1998 compared to $340.6 million at December 31, 1997. Cash of $3.6 million was used in operating activities. Cash usage resulted primarily from the Company's net loss and a significant U.S. income tax payment, substantially offset by a reduction in receivables. In order to reduce the risk of collection associated with the Company's receivables, among other things, the Company has historically sold both current and long-term Page 12 of 17 13 receivables primarily without recourse. The net proceeds collected from the receivable sales in the first six months of 1998 were $96.7 million. The Company may from time to time continue to sell receivables in the future. Investing activities during the six months ended June 30, 1998 included additions to property and equipment of $67.7 million. The Company anticipates that capital expenditures for 1998 could be in the range of $140 million to $160 million. This amount includes capital additions related to a new customer service facility on the Plano campus, which is expected to be completed in the third quarter of 1998. However, the timing and extent of any future capital expenditures is dependent upon future business growth. The Company received proceeds of approximately $35.5 million in the first half of 1997 from the sales of common stock received as part of a litigation settlement in 1996. In April 1998, the Company made a scheduled annual principal payment of $28.1 million on the $225.0 million loan entered into during 1995. As discussed in "Credit Agreements and Long-Term Debt" in Notes to Condensed Consolidated Financial Statements, the Company has an unsecured $160.0 million revolving credit agreement. There have been no borrowings under this credit facility. Outstanding letters of credit, which totaled $2.2 million at June 30, 1998, reduce the amount of available borrowings. Two of the Company's foreign subsidiaries also have credit agreements providing for borrowings of up to $18.3 million with local banks. As discussed in "Credit Agreements and Long-Term Debt" in Notes to Condensed Consolidated Financial Statements, in 1998, certain financial covenants in the Company's senior loan agreements were modified and, as a result, the Company continues to be in compliance with the provisions of its senior loan agreements. The Company believes it will remain in compliance with the provisions of its loan agreements for the foreseeable future. However, should the Company's operating results continue to deteriorate in the future, additional amendments or waivers to these agreements could become necessary. Additionally, the Company agreed to repay a senior lender $31.0 million of senior notes previously due in 2011 in 2001. As a result, total long-term debt maturities in 2001 have increased from $53.2 million to $84.2 million. See "Credit Agreements and Long-Term Debt" in Notes to Condensed Consolidated Financial Statements for further discussion. The Company is party to certain litigation, as disclosed in "Litigation" under "Commitments and Contingencies" in Notes to Condensed Consolidated Financial Statements, the outcome of which the Company believes will not have a material adverse effect on its consolidated financial position. The Company believes that its existing cash and short-term investments and available credit facilities will be adequate to support the Company's financial resource needs, including working capital requirements, capital expenditures, operating lease obligations and debt payments. In order to remain competitive in the future, the Company believes that it will become increasingly necessary to offer financing alternatives to both domestic and international customers. To the extent such financing becomes significant or other business requirements arise, additional financing could become necessary. Risks and Uncertainties The Company has taken action to understand the nature and extent of the work required to make its products, systems and infrastructure Year 2000 compliant. A Year 2000 project team has been appointed to bring its products, systems and infrastructure into compliance. The Company is currently evaluating responses Page 13 of 17 14 from and addressing issues with significant vendors to determine the extent to which the Company's systems and infrastructure are vulnerable to those third parties which fail to remedy their own Year 2000 issues. The Company anticipates its systems and infrastructure will be compliant by the end of 1998 or early 1999. The Company will develop contingency plans for those critical suppliers the Company deems to be at risk of not being compliant. Relative to the Company's products, Year 2000 compliant releases are generally available for the majority of the Company's products, and for the remainder of the products, a Year 2000 compliant release will be available by the end of 1998. While the Company does not believe the Year 2000 issue will pose significant operational problems, if the Year 2000 compliance modifications are not made, or completed timely, the Year 2000 issue could have a material adverse impact on the Company's business. The Year 2000 compliance activities will be performed as a part of the Company's normal sustaining activity and will not result in significant incremental costs to the Company. It is estimated that the total Year 2000 costs, including costs previously incurred and future costs, will be in the range of $15 million to $20 million. The estimated cost and date on which the Company believes it will be Year 2000 compliant are based on management's best estimates, yet there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. The Company's future operating results may be affected by a number of factors, including, but not limited to, the introduction and market acceptance of new products on a timely basis; mix of products sold; the impact of sales price changes; the timing and ultimate receipt of orders from certain customers which continue to constitute a large portion of the Company's revenue; the successful enhancement of existing products; manufacturing lead times; significant fluctuations in foreign currency exchange rates; the successful integration of strategic acquisitions; effects of consolidation among the Company's customer base; the success of underlying technologies in which the Company has chosen to target certain of its products; the successful completion of certain multi-year projects which include requirements to develop new technologies including hardware, software and installation of infrastructure systems; effects of customer purchasing budgets, which have historically resulted in weaker demand for the Company's products in the first half of the year; and changes in general worldwide economic conditions, any of which could have an adverse impact on operating results. The industry in which the Company operates requires substantial investment in product development, capital and, at times, inventory prior to customer acceptance of new products or enhancements to existing products. One of the keys to the Company's overall success has been anticipating the appropriate timing of such activities. Delays in product completion and/or slower than expected market acceptance of certain newer products have in the past negatively impacted the Company's operating performance and also, in certain cases, resulted in adjustments to carrying values of assets. Future operating performance could be impacted should timing of further product development and/or market acceptance be delayed. Recent Accounting Pronouncements In June 1998, the FASB issued SFAS No. 133 - Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). SFAS 133 establishes standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS 133 is effective for all fiscal years beginning after June 15, 1999. Earlier application of SFAS 133 is encouraged but should not be applied retroactively to financial statements of prior periods. The Company is currently evaluating the requirements and impact of SFAS 133. Page 14 of 17 15 Item 6. Exhibits and Reports on Form 8-K. A. Exhibits. 10.1 Agreement and Plan of Merger among the Company, Alcatel, and Net Acquisition, Inc., dated June 3, 1998 (filed as an exhibit to the Company's Current Report on 8-K, dated June 5, 1998, and incorporated herein by reference). 27.1 Financial Data Schedule - June 30, 1998 (for EDGAR filing purposes only). 27.2 Restated Financial Data Schedule - June 30, 1997 (for EDGAR filing purposes only). B. Reports on Form 8-K. Form 8-K, dated June 5, 1998 Item 5. Other Events - Joint press release of Alcatel Alsthom and DSC Communications Corporation announcing merger Item 7. Financial Statements and Exhibits - Press Release and Agreement and Plan of Merger between DSC Communications Corporation, Alcatel Alsthom and Net Acquisition, Inc. Page 15 of 17 16 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DSC COMMUNICATIONS CORPORATION Dated: August 14, 1998 By: /s/ KENNETH R. VINES ---------------------------------------- Kenneth R. Vines Vice President, Finance, duly authorized officer and principal accounting officer Page 16 of 17 17 EXHIBIT INDEX EXHIBIT DESCRIPTION - -------- ------------ 10.1 Agreement and Plan of Merger (Incorporated by Reference) 27.1 Financial Data Schedule 27.2 Restated Financial Data Schedule Page 17 of 17 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 6-MOS DEC-31-1998 JAN-01-1998 JUN-30-1998 158,940 328,121 392,740 0 390,338 1,502,423 921,032 454,918 2,363,346 452,168 598,154 0 0 1,239 1,187,715 2,363,346 703,284 703,284 491,847 491,847 142,995 0 26,701 (55,230) (20,435) (34,795) 0 0 0 (34,795) (0.29) (0.29)
EX-27.2 3 RESTATED FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-1997 JAN-01-1997 JUN-30-1997 148,356 148,781 389,733 0 369,137 1,183,178 824,199 396,658 1,950,571 441,033 235,028 0 0 1,224 1,202,382 1,950,571 729,086 729,086 433,255 433,255 119,260 0 10,812 93,834 35,657 35,657 0 0 0 58,177 .50 .49
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