Item 1. Business.
The following description of our business should be read in conjunction with the information included elsewhere in this document. The description contains certain forward-looking statements that involve risks and uncertainties. When used in this document, the word "intend", "believe", "estimate", "plan", and "expect" and similar expressions as they relate to us are included to identify forward-looking statements. Our actual results could differ materially from the results discussed in the forward-looking statements as a result of certain risk factors set forth elsewhere in this document. See also, "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Certain Factors That May Affect Future Results."
General
We are a Delaware corporation incorporated on April 26, 1988, that designs, develops, markets and supports highly integrated digital and mixed-signal (analog and digital) semiconductor system-on-a-chip solutions for use in building emerging networks for telecommunications and data communications applications. Our very large-scale integrated (VLSI) semiconductor devices provide core functionality for communications network equipment. Our programmable VLSI solutions can be tailored by network equipment manufacturers to provide high levels of functionality for broadband communication networks and to implement value-added features, thus differentiating our products from competitive offerings. Our programmable VLSI solutions also accommodate new customer application requirements and protocol changes throughout the networking equipment life cycle. Our VLSI devices are compliant with Asynchronous/Plesiochronous Digital Hierarchy (Asynchronous/PDH), Synchronous Optical Network/Synchronous Digital Hierarchy (SONET/SDH) and Asynchronous Transfer Mode/Internet Protocol (ATM/IP) standards. We also offer products that combine multi-protocol capabilities on a single chip that can be programmed for multi-service applications. Our mixed-signal and digital design capability, in conjunction with our communications systems expertise, enables us to determine and implement optimal combinations of design elements for enhanced functionality. We believe that this approach permits our customers to achieve faster time-to-market and to introduce systems that offer greater functionality, improved performance, lower power dissipation, reduced system size and cost and greater reliability relative to discrete solutions.
Our principal customers are Original Equipment Manufacturers (OEMs) that serve three market segments:
o the worldwide public network infrastructure that supports voice and data communications;
o the Internet infrastructure that supports the World Wide Web and other data services; and
o corporate Wide Area Networks (WANs) that support voice and data information exchange within medium-sized and large enterprises.
We have sold our VLSI devices to more than 400 customers worldwide. We sell our products through a worldwide direct sales force and a worldwide network of independent distributors and sales representatives.
Products and Applications
We supply high-speed, broadband VLSI semiconductor devices to network systems OEMs that serve three market segments: the worldwide public network infrastructure that supports both voice and data communications, the Internet infrastructure that supports the World Wide Web and other data services and corporate WANs. As a system-on-a-chip innovation leader, our core competencies include:
o an in-depth understanding of SONET/SDH, Asynchronous/PDH and ATM/IP standards;
o the ability to design complex mixed-signal high-speed VLSI devices; and
o the capability to verify the design against our customers' requirements and industry standards through analysis, simulation, emulation, verification and certification.
Our three product lines consist of (a) SONET/SDH, (b) Asynchronous/PDH and (c) ATM/IP VLSI semiconductor devices. We believe that our chip-set approach and broad product coverage in all three product lines position us as a "one-stop source" for broadband communications VLSI products. Network equipment OEMs can mix and match our VLSI devices to optimally configure their specific systems. Our product lines can be combined to provide a cost-effective communication systems solution with increased functional integration and features while providing seamless integration of SONET/SDH, Asynchronous/PDH and ATM/IP for broadband network applications. In 2001, the prices for our products typically ranged from approximately $10 to $200 per device, depending on technology, volume, complexity and functionality.
During the last few years, we extended our product family to provide seamless integration of Asynchronous/PDH, SONET/SDH and ATM/IP protocols on a single chip. The mix and match of protocols in these products enables our telecommunications and data communications OEMs to develop multi-service systems for access and transport applications.
SONET/SDH Products
In the SONET/SDH area, we offer devices that provide a direct interface for fiber optic transmission in North America, Europe and Asia. Our mappers, which bridge the interconnections between SONET/SDH equipment and asynchronous equipment, allow DS-series and E-series transmission lines to be connected with SONET/SDH lines. These mappers transparently transport Asynchronous/PDH signals across the SONET/SDH network.
Our current SONET/SDH products are used to build access equipment, add/drop multiplexers, digital cross connects and other telecommunication and data communications equipment. This equipment is configured for use in both domestic and international fiber-based public networks. Our SONET/SDH products have applications in Customer Premise Equipment (CPE), such as routers and hubs and in central offices, adding integrated fiber optic transmission capability to telephone switches.
Asynchronous/PDH Products
Our Asynchronous/PDH products provide high-bandwidth connections and are used to configure transmission equipment for use in the public network. This equipment is used to increase the capacity of the copper-based public network. Our Asynchronous/PDH VLSI products also enable CPE, such as hubs and routers used in WANs and Local Area Networks (LANs), to access the public network for voice and data communications with similar products in other locations.
Our Asynchronous/PDH products provide high levels of integration, as well as cost, power and performance benefits relative to discrete and competing integrated circuit solutions. Our Asynchronous/PDH VLSI products include devices that provide solutions for DS-0 through DS-3 and E-1 through E-3 transmission lines. This product line includes line interfaces, multiplexers, which combine multiple low-speed lines to form a higher speed line, as well as demultiplexers, which perform the reverse function. In addition, we offer framers, which are devices that identify the starting points of defined bit streams and enable systems to recognize the remaining bits.
ATM/IP Products
Our ATM/IP family of products targets the core elements of ATM/IP-based multi-service access multiplexer systems. Our CellBus(R) is a system architecture for implementing ATM/IP access multiplexers and ATM/IP switching systems. The first two products incorporating our CellBus Technology were the CUBIT and CUBIT-Pro VLSI devices. Our CellBus Technology provides single-chip ATM/IP switching capability in access equipment. These products have been designed into many network system OEMs' solutions since late 1995, establishing CellBus as a significant technology in the global broadband network access market. Our ATM/IP products also include VLSI semiconductor devices for line interfacing and service adaptation functions.
Technology
We believe that one of our core competencies is our personnels' knowledge of the telecommunications and data communications landscape. Specifically, our systems engineering personnel group possess substantial
telecommunications and data communications design experience, as well as extensive knowledge of these relevant standards. This includes not only a thorough understanding of the actual written standards, but also an awareness of and appreciation for the nuances associated with these standards necessary for assuring that device designs are fully compliant. To date, we have been very successful in delivering VLSI devices that are standards compliant as we have insignificant warranty claims.
Complementing our communications industry expertise is our VLSI design competence. Our VLSI design personnel have extensive experience in designing high-speed digital and mixed-signal devices for communications applications. These designs require a sophisticated understanding of complex technology, as well as the specifics of the deep submicron manufacturing processes and their resulting impact on device performance. We have developed a large number of VLSI blocks and intellectual property (IP) cores that operate under the demanding requirements of the telecommunications and data communications industries. These blocks and IP cores have been designed using standard VLSI-oriented programming languages such as Visic Hardware Descriptive Language (VHDL) and Verilog and verified with standard verification tools.
We have developed proprietary tool sets, called "Test Benches", that facilitate on-time development of VLSI products and help assure that our products meet customer and standards requirements. These Test Benches consist of behavioral models of all applicable functions in a high level design environment and also include test signal generators and analyzers such as models of SONET/SDH signals. Systems engineers use Test Benches to test new architectural concepts, while VLSI designers use Test Benches to ensure that the device conforms to product specifications.
We have invested significant resources in developing a multi-million gate system-on-a-chip architecture, with a high level of software functionality for our programmable products. Besides our ASPEN family, we have our PHAST (Programmable High Performance ATM/PPP (Point-to-Point Protocol)/TDM (Time Division Multiplexing) SONET/SDH Terminator) series of products that target simultaneous mapping and transport of ATM/PPP and TDM services over fiber optic networks. In addition, we have introduced the first product in a family of devices to provide complete channeled services for Access Networks. The T3BwP VLSI device supports both data and management planes with an on-chip Reduced Instruction Set Computing (RISC) processor supporting full standards based management and performance monitoring.
We have enhanced our internal chip layout through the acquisition of experienced personnel through standard hiring practices and enhanced our design for test capability through the acquisition of Horizon Semiconductors, Inc., both of which have resulted in significant improvements in silicon efficiency and time-to-market. Our system-on-a-chip definition, architecture, verification expertise and design methodology ensure that hardware and software architectural trade-offs yield desired performance from our VLSI solutions. The system-on-a-chip performance, simulation, emulation, verification and stress testing, using Test Benches and test equipment, provides customers with wire speed services.
Marketing and Sales
Our marketing strategy focuses on key customer relationships to promote early adoption of our VLSI devices in the products of market-leading communications equipment OEMs. Through our customer sponsorship program, OEMs collaborate on product specifications and applications while participating in product testing in parallel with our own certification process. This approach accelerates our customers' time-to-market delivery while enabling us to achieve early design wins for our products and derive non-recurring engineering expense support and volume forecasts for specific products from these sponsors.
Our sales strategy focuses on worldwide suppliers of high-speed communications and communications-oriented equipment. These customers include telecommunications, data communications, Internet, customer premise, computing, process control and defense equipment vendors. In addition, we target emerging technology leaders in the communications equipment market that are developing next generation solutions for the telecommunications and data communications markets. We identify and address sales opportunities through our worldwide direct sales force and our worldwide network of independent distributors and sales representatives.
Our worldwide direct sales force, technical support personnel and key engineers work together in teams to support our customers. We have technical support capabilities located in key geographical locations throughout the world as well as a technical support team at our headquarters as a backup to the field applications engineers.
We have established foreign distributors and sales representative relationships in Australia, Benelux, Brazil, Canada, China, France, Germany, Great Britain, Israel, Italy, Japan, Korea, Spain, Sweden, Switzerland and Taiwan. We also sell our products through domestic distributors and a network of domestic sales representatives. We have
regional sales and technical support capabilities in Boston, Massachusetts; Chicago, Illinois; San Jose, California; Morristown, New Jersey; Raleigh/Durham, North Carolina; Dallas, Texas; Ottawa, Ontario; Stockholm, Sweden; Paris, France; Rome, Italy; Berkshire, England; Hilversum, Netherlands; Brussels, Belgium; Tel Aviv, Israel; New Delhi, India; Singapore, Singapore; and Taipei, Taiwan, as well as at our headquarters facility in Shelton, Connecticut.
Customers
We have sold our products and services to over 400 customers since shipping our first product in 1990. Our customers include public network systems OEMs that incorporate our products into telecommunications systems, WAN and LAN equipment OEMs, Internet-oriented OEMs, communications test and performance measurement equipment OEMs and government, university and private laboratories that use our products in advanced public network and WAN and LAN developments.
Foreign net revenues, consisting primarily of shipments to customers in Europe and Asia, constituted 69%, 46% and 32% of net revenues in the years 2001, 2000 and 1999, respectively. Refer also to note 6 of our financial statements of our consolidated financial statements for additional detail about geographic sales.
We sell our products through a worldwide direct sales force and through a worldwide network of distributors and sales representatives. The following tables set forth the percentage of net revenues attributable to all of our major distributors as well as the significant customers that had total purchases (either direct or through distributors) of greater than 10% of net revenues for the three years ended December 31, 2001:
(1) The end customers of the shipments to Insight Electronics, Inc. include Redback Networks, Inc. in 2001, Lucent Technologies, Inc. in 2001, 2000 and 1999, a portion of Tellabs, Inc. purchases in 2000 and a portion of Nortel Networks Corporation's purchases in 1999.
(2) The primary end customer of the shipments to Weone Corporation was Samsung Corporation in 2001.
(3) A portion of the shipments to Siemens AG were distributed through Unique Memec.
(4) The end customers of the shipments to Arrow Electronics, Inc. include Tellabs, Inc. in 1999 and 2000 as well as Nortel Networks Corporation in 1999.
(5) Shipments to Lucent Technologies, Inc. also includes those made to Ascend Communications, which was acquired by Lucent Technologies, Inc. during 1999.
* Revenues were less than 10% of our net revenues in these years.
A limited number of customers have accounted for a substantial portion of our net revenues. Shipments in 2001, 2000 and 1999 to our top five customers, including sales to distributors, accounted for approximately 64%, 66% and 72% respectively, of our net revenues. We expect that a limited number of customers may account for a substantial portion of the net revenues for the foreseeable future.
Research and Development
We believe that the continued introduction of new products in our target markets is essential to our growth. As of December 31, 2001, we had 291 full-time employees engaged in research and development efforts. We have added 98 employees to our research and development staff since December 31, 2000. We employ designers who have the necessary engineering and systems qualifications and are experienced in software, mixed-signal, high-speed digital, telecommunications and data communications technologies. See Item 2
Item 2. Properties.
Our headquarters are located in a suburban office park in Shelton, Connecticut. We have additional sales offices and design centers located throughout the world. The following is a summary of our offices and locations for which we have lease commitments of greater than one year:
Notes
Refer to note 13 of our consolidated financial statements for additional disclosures regarding our commitments under lease obligations. Also, refer to note 11 of our consolidated financial statements regarding our restructuring charges during fiscal 2001 as we have recorded charges during the year for future rent payments relating to excess office space.
(1) Of the space being leased in Shelton, Connecticut, approximately 114,000 feet is considered excess for which we have taken a restructuring charge for in 2001. A portion of this space is currently being sublet.
(2) We have exited the facility in Stoneham, Massachusetts effective December 31, 2001 and have transitioned the staff and business functions to our Bedford, Massachusetts facility.
Item 3.
Item 3. Legal Proceedings
We are not party to any material litigation proceedings.
Item 4.
Item 4. Submission of Matters to a Vote of Security-Holders.
We did not submit any matters to a vote of our security-holders during the three months ended December 31, 2001.
PART II
Item 5.
Item 5. Market for Registrants' Common Equity and Related Stockholder Matters
Our common stock is traded on the Nasdaq National Market under the symbol "TXCC". The following table sets forth, for the periods indicated, the range of high and low closing prices for our common stock on the Nasdaq National Market. The prices set forth below reflect a 3-for-2 stock split in the form of a dividend effected on June 8, 1999, a 3-for-2 stock split in the form of a dividend effected on January 11, 2000, and 2-for-1 stock split in the form of a dividend effected on August 10, 2000.
High Low ---- --- Year Ended December 31, 2000: First Quarter..................................... $67.25 $19.21 Second Quarter.................................... $48.75 $22.56 Third Quarter..................................... $67.86 $33.19 Fourth Quarter.................................... $74.69 $24.50
Year Ended December 31, 2001: First Quarter..................................... $55.75 $12.00 Second Quarter.................................... $20.35 $6.69 Third Quarter..................................... $10.75 $2.80 Fourth Quarter.................................... $6.38 $2.15
As of March 15, 2002 there were approximately 557 holders of record and approximately 41,000 beneficial shareholders of our common stock.
We have never paid cash dividends on our common stock. We currently intend to retain earnings for use in our business and do not anticipate paying any cash dividend in the foreseeable future. Any future declaration and payment of dividends will be subject to the discretion of our Board of Directors, will be subject to applicable law and will depend upon our results of operations, earnings, financial condition, contractual limitations, cash requirements, future prospects and any other factors deemed relevant by our Board of Directors.
Item 6.
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing in Item 7
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. When used in this report, the words, "intend", "anticipate", "believe", "estimate", "plan" and "expect" and similar expressions as they relate to us are included to identify forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Certain Factors That May Affect Future Results" and elsewhere in this report. You should read this discussion in conjunction with the consolidated financial statements and the notes thereto included in this report.
Significant Accounting Policies and Use of Estimates
Our financial statements and related disclosures, which are prepared to conform with accounting principles generally accepted in the United States of America, require us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the period reported. We are also required to disclose amounts of contingent assets and liabilities at the date of the financial statements. Our actual results in future periods could differ from those estimates. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.
We consider the most significant estimates in our consolidated financial statements to be those surrounding: (1) revenues, cost of revenues and gross profit; (2) reserves for excess inventories; (3) valuation of deferred tax assets; (4) valuation and impairment of goodwill, other intangibles and long-lived assets; and (5) estimated restructuring reserves. The accounting policies, basis for these estimates and potential impact to our consolidated financial statements, should any of these estimates change, are further described as follows:
Revenues, Cost of Revenues and Gross Profit. Net revenues are comprised of product shipments, principally to domestic and international telecommunications and data communications OEMs and to distributors. Net revenues from product sales are recognized at the time of product shipment when the following criteria are met: (1) title and risk of loss transfers to the customer; (2) the selling price is fixed or determinable; and (3) collectibility is reasonably assured. Agreements with certain distributors provide price protection and return and allowance rights. With respect to revenues to our distributors the: (1) prices are fixed at the date of shipment from our facilities; (2) payment is not contractually or otherwise excused until the product is resold; (3) we do not have any obligations for future performance relating to the resale of the product; and (4) the amount of future returns, allowances, refunds and costs to be incurred can be reasonably estimated and are accrued at the time of shipment.
At the time of shipment, we record a liability against our gross revenues for price protection, sales allowances and potential returns. This liability is established based on historical experience, contractually agreed to provisions and future shipment forecasts. As of December 31, 2001, we had established liabilities totaling $2.3 million for future returns, price protection and allowances related to sales which were recorded during fiscal 2001. Should our actual experience differ from our estimated liabilities, there could be adjustments (either favorable or unfavorable) to our net revenues, cost of sales and gross margins.
We warranty our products for up to one year from the date of shipment. A liability is recorded for estimated claims to be incurred under product warranties and is based primarily on historical experience. Estimated warranty expense is recorded as cost of revenues when products are shipped. As of December 31, 2001, we had a warranty liability established in the amount of $0.2 million, which is included in accrued expenses on the consolidated balance sheet. Should future warranty claims differ from our estimated current liability, there could be adjustments (either favorable or unfavorable) to our cost of sales. Any adjustments to cost of sales could also impact future gross margins.
Reserves for Excess Inventories. We periodically review our inventory levels to determine if inventory is stated at the lower of cost or our net realizable value. Due to the severe downturn in the telecommunications and data communications industry, we evaluated our inventory position based on known backlog of orders, projected sales and marketing forecasts, shipment activity and inventory held at our significant distributors. As a result of current
and anticipated business conditions, as well as lower than anticipated demand, we recorded a provision for excess inventories during the year ended December 31, 2001 of approximately $39.2 million. We currently do not anticipate the excess inventories subject to this provision will be used at a later date based upon our current demand forecast. Should our future demand exceed the estimates that we used in reserving for excess inventories, then we will recognize a favorable impact to cost of sales and gross margin. Should demand fall below our current expectations, then we may establish additional inventory reserves which will result in a negative impact to cost of sales and gross margins. Any future changes to our inventory reserves for excess inventories will be disclosed in the notes of our consolidated financial statements.
Valuation of Deferred Tax Assets. Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. To the extent that it is more likely than not that we will not be able to utilize deferred income tax assets in the future, then a valuation allowance is established. At December 31, 2001, we had deferred income tax assets, net of valuation allowances of $68.6 million. We estimate that we will generate operating income in future periods and will be able to use our deferred income tax assets before they expire to offset future income tax liabilities. Should our actual results differ from our current forecasts then we may need to establish an additional valuation allowance, thereby reducing future income tax benefits and reducing future net income or increase in future net loss.
Valuation and Impairment of Goodwill, Other Intangibles and Long-Lived Assets. We review long-lived assets, goodwill and certain identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When factors indicate that an intangible or long-lived asset should be evaluated for possible impairment, an estimate of the related asset's undiscounted future cash flows over the remaining life of the asset will be made to measure whether the carrying value is recoverable. Any impairment is measured based upon the excess of the carrying value of the asset over its estimated fair value which is generally based on an estimate of future discounted cash flows. A significant amount of management judgment is used in estimating future discounted cash flows. At December 31, 2001 we had goodwill, other intangibles and long-lived assets on our consolidated balance sheet totaling $88.2 million. Should our business or market conditions vary from our current expectations, then we may not be able to realize the carrying value of these assets and will record an impairment charge at that time.
Estimated Restructuring Reserves. As mentioned below and in note 11 of our consolidated financial statements, we recorded restructuring charges totaling $32.5 million during fiscal 2001. At December 31, 2001 the restructuring liabilities that remain totaled $29.9 million on our consolidated balance sheets. Of this amount, $3.0 million is related to employee termination benefits that we expect to pay in early 2002. The remaining $26.9 is related to estimated future payments, primarily for rent and related operating expenses, due over the next fifteen years. Certain assumptions went into this estimate including future maintenance costs, price escalation and sublease income derived from these facilities. Should we negotiate additional subleases or reach a settlement with our landlords to be released from our existing obligations, then we could realize a favorable benefit to our results of future operations. Should future lease, maintenance or other costs related to these facilities exceed our estimates, then we could incur additional expense in future periods.
Overview
We commenced operations in April 1988. Since incorporation, we have designed, sourced and marketed high-speed VLSI semiconductor devices for public and private network applications worldwide. We shipped our first product in 1990. We have focused our product development efforts on devices that meet the needs of public and private network telecommunications and data communications equipment providers that serve the worldwide public network, Internet and corporate wide area network markets. Our devices are compliant with established standards in these markets, including SONET/SDH, Asynchronous/PDH and ATM/IP. We also offer products that combine multi-protocol capabilities on a single chip that can be programmed for multi-service applications. Our mixed-signal and digital design capability, in conjunction with our communications systems expertise, enables us to determine
and implement optimal combinations of design elements for enhanced functionality. We believe that this approach permits our customers to achieve faster time-to-market and to introduce systems that offer greater functionality, improved performance, lower power dissipation, reduced system size and cost and greater reliability relative to discrete solutions.
Our principal customers are OEMs that serve three market segments:
. the worldwide public network infrastructure that supports voice and data communications;
. the Internet infrastructure that supports the World Wide Web and other data services; and
. corporate WANs that support voice and data information exchange within medium-sized and large enterprises.
We have sold our VLSI devices to more than 400 customers worldwide. We sell our products through a worldwide direct sales force and a worldwide network of independent distributors and sales representatives.
We conduct our business in foreign markets with approximately 69% of our net sales in fiscal 2001 coming from overseas. The countries that account for the majority of this percentage include Germany, China, United Kingdom, Korea and Israel.
We work with network equipment OEMs during their system design phase with the goal of having our products designed into the OEMs' products. Our sales cycle often extends beyond one year because of the long lead times between an OEM's design to the start of volume shipments. We incur product research and development expenses well before the generation of substantial net revenues from product shipments to OEMs. A significant portion of our net revenues have been, and are anticipated to be, shipped into foreign markets. Substantially all of our foreign net revenues are currently denominated in U.S. dollars. Our cost of revenues consists primarily of the purchase cost of finished VLSI devices produced by third-party semiconductor manufacturers. We intend to continue to outsource all of our VLSI device fabrication requirements.
Our operating results are subject to quarterly and annual fluctuations as a result of several factors that could materially and adversely affect profitability, as discussed below in "CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS".
Results of Operations
The results of operations which follow should be read in conjunction with our significant accounting policies and estimates summarized above as well as our consolidated financial statements and notes thereof contained in Item 8 of this report.
The following table sets forth certain consolidated statements of operations data as a percentage of net revenues for the periods indicated.
COMPARISON OF FISCAL YEARS 2001 AND 2000
Net Revenues. The following table summarizes our revenue mix by product line for the three years ended December 31, 2001:
Years ended December 31, -------------------------------- 2001 2000 1999 ---- ---- ---- SONET/SDH 56% 59% 57% Asynchronous/PDH 13% 18% 29% ATM/IP 31% 23% 14% --- --- --- Total 100% 100% 100%
Net revenues for the year ended December 31, 2001 decreased by $96.4 million, or 62%, over fiscal 2000. The decrease in absolute dollars was distributed across all three of our product lines. The decrease in SONET/SDH was not as significant as the decrease in Asynchronous/PDH and ATM/IP product lines. These decreases were primarily related to a decline in volumes shipped over prior comparable periods. We believe that the significant decline in revenues is part of an industry wide condition where end-users of our products (telecommunications and data communications OEMs) found themselves with too much inventory during a time of declining demand and depressed market conditions. As a result, the product mix percentage mentioned above is not consistent with historical trends. Given the lack of visibility in the current market, we cannot predict when, and to the extent that, historical product mix percentages will return. Our customer base during the year ended December 31, 2001 has remained relatively constant compared to the prior year, although our customers are ordering substantially less product due to market conditions.
International net revenues represented approximately 69% of net revenues for fiscal 2001, compared with approximately 46% in fiscal 2000. The increase in the percentage of international net revenues to total net revenues during fiscal 2001 is due to the fact that the telecommunication and data communications markets have experienced a more significant decline in the United States than in international markets.
Gross Profit. Gross profit for the year ended December 31, 2001 decreased by $110.7 million, or 102%, over the prior year. The decrease of gross profit dollars and the percentage of net revenues is the result of lower net revenues for the comparable period, shift in product mix and the provision for excess inventories of $39.2 million which was recorded in 2001. Our gross profit, excluding the excess inventory provision, was $37.4 million, or a 64% gross margin, for fiscal 2001 compared to $108.9 million, or 70% gross margin, for fiscal 2000. The decrease in gross margin percentage is due to a change in product mix sold during 2001 over the previous year.
Research and Development. Research and development expenses for the year ended December 31, 2001 increased by $25.1 million, or 104%, over the prior year from $24.2 million to $49.3 million. This increase in absolute dollars is the result of acquisitions during 2001 and continued investment in personnel, depreciation, software and related tools to develop next generation telecommunication and data communication products. As a percentage of net revenues, our research and development costs increased as we continued investing in the design and development of future products notwithstanding the fact that current product shipments have declined due to industry conditions. We have monitored our sales volumes and expense run rates closely and, as a result, took two restructuring actions in 2001 which we expect will reduce research and development costs. We currently believe that the level of personnel and other fixed costs in the research and development area is appropriate based on our expectation of sales growth from new products in future periods. We will continue to closely monitor both our costs and our growth expectations in future periods and will take actions as market conditions dictate. There can be no assurances that future acquisitions, market conditions or unforeseen events will not cause our expenses to rise in future periods.
Marketing and Sales. Marketing and sales expenses for the year ended December 31, 2001 increased by $1.7 million, or 8%, over the prior year from $20.5 million to $22.2 million. This increase includes increased provisions for doubtful customer accounts by approximately $1.0 million during the fiscal year 2001 as we specifically identified customer collection risks that exist in light of the current general economic weakness in the communication semiconductor industry. We also added sales and marketing personnel and infrastructure during fiscal 2001. We have monitored our sales volumes and expense run rates closely and, as a result, took two restructuring actions in 2001 which we expect will reduce sales and marketing costs in the future. We currently believe that the level of personnel and other fixed costs in the sales and marketing area is appropriate based on our expectation of sales growth from new products in future periods. We will continue to closely monitor both our costs and our growth expectations in future periods and will take actions as market conditions dictate. There can be no assurances that future acquisitions, market conditions or unforeseen events will not cause our expenses to rise in future periods.
General and Administrative. General and administrative expenses for the year ended December 31, 2001 increased by $3.4 million, or 60%, over the prior year from $5.6 million to $9.0 million. The increase in absolute dollars was the result of acquisitions, and increases in personnel, legal and professional fees and our continued infrastructure investment in the general and administrative area. As a percentage of net revenues, our general and administrative costs increased since the fixed components of these costs do not fluctuate with net revenues which decreased during fiscal 2001. We have monitored our sales volumes and expense run rates closely and, as a result, took two restructuring actions in 2001 which we expect will reduce general and administrative costs in the future. We currently believe that the level of personnel and other fixed costs in the general and administrative area is appropriate based on our expectation of sales growth from new products in future periods. We will continue to closely monitor both our costs and our growth expectations in future periods and will take actions as market conditions dictate. There can be no assurances that future acquisitions, market conditions or unforeseen events will not cause our expenses to rise in future periods.
Amortization of Goodwill and Purchased Intangible Assets. Amortization of goodwill and purchased intangible assets for the year ended December 31, 2001 increased by, $2.1 million or 545%, over the prior year. This expense is related to business combinations of Alacrity, ADV Engineering and Horizon Semiconductors
accounted for as purchases in August 2000, January 2001 and February 2001, respectively. For the comparable period of the prior year the only amortization was that of Alacrity acquired in August 2000. The increase as a percentage of net revenues for the year ended December 31, 2001, compared to fiscal 2000, is due to the increase of goodwill and purchased intangibles during fiscal 2001 and the decline in net revenues compared to the prior year.
We adopted the recently issued accounting pronouncements SFAS 141, Accounting for Business Combinations, and adopted SFAS 142, Accounting for Intangibles, effective January 1, 2002, at which time all future amortization of goodwill will cease. We will be required to review goodwill and purchased intangibles for impairment, at a minimum, annually.
Purchased In-Process Research and Development. During the year ended December 31, 2001, we recorded a charge for in-process research and development (IPR&D) of $22.0 million related to our purchase of Onex in September 2001. During the year ended December 31, 2000 we recorded a charge for in-process research and development of $2.8 million related to our purchase of Alacrity Communications in August 2000.
We determined the fair value of the existing products as well as the technology that was currently under development using the income approach. Under the income approach, expected future after-tax cash flows from each of the projects under development for the companies acquired (Onex and Alacrity) are estimated and discounted to their net present value at an appropriate risk- adjusted rate of return. Revenues were estimated based on relevant market size and growth factors, expected industry trends, individual product sales cycles and the estimated life of each product's underlying technology. Estimated operating expenses, income taxes and charges for the use of contributory assets were deducted from estimated revenues to determine estimated after-tax cash flows for each project. These projected future cash flows were further adjusted for the value contributed by any core technology and development efforts expected to be completed post acquisition.
These forecasted cash flows were then discounted based on rates derived from our weighted average cost of capital, weighted average return on assets and venture capital rates of return adjusted upward to reflect additional risks inherent in the development life cycle. The risk adjusted discount rates used involved consideration of the characteristics and applications of each product, the inherent uncertainties in achieving technological feasibility, anticipated levels of market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets. After considering these factors, we determined the risk adjusted discount rates for the Onex and Alacrity product portfolios to be 30%.
We believe that the pricing model used for the product portfolios related to these acquisitions is representative within the telecommunications and data communications industries and that the estimated IPR&D amounts determined represent fair value and do not exceed the amounts that a third party would pay for these projects. When we acquire companies we do not expect to achieve a material amount of expense reductions or synergies as a result of integrating the acquired in-process technology. Therefore, the valuation assumptions do not include anticipated cost savings.
The in-process technology acquired from Onex consisted of two projects: Switch Processor (SP) and Switch Element (SE). The technology acquired from Alacrity was 6400 cell-bus switching technology. A description of the IPR&D projects acquired are set forth below:
The SP technology consists of highly integrated and programmable silicon that can combine any and all combinations of SONET/SDH transmission and native support for TDM, ATM and packet processing on a single chip. Significant features under development of the SP technology include the fact that SP is a 17 million-gate device. The portion of in-process research and development allocated to this project was $14.1 million. It was estimated that the SP project was approximately 60% complete and the remaining costs to complete the project were $4.9 million. This project is expected to be completed in April 2002. The risks associated with the development of SP product are technical completion, timing, cost, and market risks. Technical completion must bear the risk that the technology's backend layout is appropriate. Timing risk of developing the SP is significant due to the unpredictable nature of technical issues with such technology. Although a market exists for this type of product, producing the SP product cost-effectively and gaining general market acceptance has yet to be proven and presents risk to the success of the SP product.
The SE technology consists of a 30 gigabits per second (Gbps) (12 port OC-48) switch technology capable of switching TDM, ATM or variable length packet traffic. Significant features under development of the SE technology include frequency and phase synchronization. The portion of in-process research and development allocated to this project was $7.9 million. It was estimated that the SE technology was approximately 75% complete and the remaining costs to complete the project were $2.7 million. The initial development of this project was completed in December 2001 and is being tested at year end. The risks associated with the development of SE product are technical completion, timing, cost, and market risks. Technical completion for the initial prototype lots centers on the reliability of certain IBM technology. Although a market for the SE product exists, producing the SE product cost-effectively and gaining general market acceptance has yet to be proven and presents risk to the success of the product.
The 6400 cell-bus switch technology utilizes unidirectional, time-slotted, looped bus and multiple switch interfaces. The cell-bus switch simultaneously supports prioritized asynchronous and isochronous cell access. Significant features of this technology include efficiency, prioritized cell access, fairness, minimal latency for real time traffic, capacity, simplicity and scalability. At the date of acquisition we estimated that Alacrity technology was 75% complete and the costs to complete the project to be $2.6 million. This technology was completed in June 2001.
The above estimates were determined by comparing the time and costs spent to date and the complexity of the technologies achieved to date to the total costs, time and complexities that were expected to be expended to bring the technologies to completion.
Restructuring Charges, Asset Impairments and Merger Costs. During fiscal 2001 we announced restructuring plans on July 16, 2001 (the "July Plan") and November 15, 2001 (the "November Plan") due to current and anticipated business conditions. These plans resulted in 77 positions being eliminated in North America and the closing of four locations. The July Plan restructuring charges consisted of employee termination benefits of approximately $1.3 million related solely to a workforce reduction of 30 positions throughout the Company. These employees were terminated during the third quarter of 2001 and were provided severance and related benefits. The November Plan restructuring charges consisted of employee termination benefits of approximately $1.9 million related to a workforce reduction of 47 positions throughout all functional areas of the Company. These employees were terminated during the fourth quarter of 2001 and were provided severance and related benefits. The November Plan also consisted of the closing of facilities in four locations. We are obligated for certain lease commitments for the facilities which we have exited through fiscal 2017. We have secured and are in the process of negotiating sub-lease commitments with interested parties on a portion of the excess space over the next several years. For the space for which we do not have sub-lease commitments in place as of December 31, 2001, we have taken a charge of $28.6 million, which represents the remaining rent and operating cost obligations related to these excess facilities net of future expected sublease income. Excess furniture, leasehold improvements and equipment of $0.6 million was written off in conjunction with these facility closures.
During fiscal 2001, we also reduced the asset carrying value of a technology product license and certain tooling by approximately $1.7 million as a result of an impairment analysis performed pursuant to Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be disposed of." Refer to note 11 of our consolidated financial statements for additional detail on the restructuring plans and asset impairment charges.
During the fiscal year ended December 31, 2000, we expensed merger costs of $1.2 million related to the EASICS NV transaction completed in May 2000. There were no such comparable costs for the year ended December 31, 2001.
Interest Income (Expense). Interest income, net of interest expense, for year ended December 31, 2001 decreased 69% from the prior year. Our 4 1/2% Convertible Notes due 2005 were issued in September of 2000, thus we recorded less than four months of interest expense associated with these notes for the year ended December 31, 2000. These notes were outstanding during the entire year ended December 31, 2001 which resulted in an additional eight and a half months interest expense partially offset by lower convertible note balances compared to the same period in the prior year. During fiscal 2001, we have experienced declining interest income due to lower cash
balances and lower interest rates. At December 31, 2001 and 2000, the effective interest rate on our interest-bearing securities was approximately 3.52%, and 5.60%, respectively.
During the year ended December 31, 2001, we repurchased $145.9 million, face value, of our convertible notes. These purchases were made with our existing cash, cash equivalents, and short-term investments. Subsequent to year-end, in February 2002, we announced a tender offer to repurchase up to $200 million face value of our outstanding notes. This tender offer was completed in March 2002. Refer also to note 17 of our consolidated financial statements.
Income Tax Expense (Benefit). Our effective tax rate, before extraordinary items, for the year ended December 31, 2001 is a benefit of 28.1%, compared to an effective income tax rate expense of approximately 38.9% for the year ended December 31, 2000. Excluding the write-off of purchased in-process research and development, for which there is no income tax benefit, the effective income tax benefit would have been 33.7% for the year ended December 31, 2001. The income tax benefit for the year ended December 31, 2001 differed from statutory rates primarily due to the non tax deductible write-off of purchased in-process research and development of $22.0 million and a valuation allowance of $3.2 million taken against certain tax credits which we expect will expire unutilized. The following table summarizes the differences between the U.S. federal statutory rate and our effective tax rate on continuing operations for financial statement purposes for the years ended December 31, 2001 and 2000:
Years ended December 31, ------------------------ 2001 2000 ---- ---- U.S. federal statutory tax rate ............ (35.0)% 35.0% State taxes ................................ (1.8) 3.4 In-process research and development ........ 5.6 1.6 Foreign sales corporation benefit .......... -- (1.9) Change in beginning valuation allowance .... 2.4 -- Permanent differences and other ............ 0.7 0.8 ------------------ Effective income tax rate .................. (28.1)% 38.9% ==================
In addition to the tax benefit recorded during the year ended December 31, 2001, we recorded income tax expense of $13.2 million on the extraordinary gain from the repurchase of a portion of the 4 1/2% Convertible Notes due 2005.
We continue to periodically review the realizability of deferred income tax assets considering all positive and negative evidence available to us which includes, among other factors, our specific historical operating results, changes in our future expectations of revenues and its impact on future profitability. To the extent that we believe that it is more likely than not that some or all of our deferred income tax assets will not be realized, we will establish or adjust established valuation allowances. Such a valuation allowance adjustment may impact our effective tax rate. We recorded a valuation allowance in 2001 as noted above.
Extraordinary Gain from Repurchase of 4 1/2% Convertible Notes due 2005. In April 2001, we announced a repurchase program for our 4 1/2% Convertible Notes due 2005. During the year ended December 31, 2001, we have repurchased $145.9 million face value of our outstanding convertible notes for $106.1 million, including a write-off of deferred financing fees of $4.4 million, realizing a pre-tax gain of $35.3 million. Net of income taxes, this extraordinary gain was $22.1 million for the year ended December 31 2001. The timing and amount of any additional repurchases will depend on many factors, including, but not limited to, the prevailing market price of the convertible notes and overall market conditions. We intend to fund additional repurchases of the convertible notes, if any, from available cash, cash equivalents and short-term investments. Subsequent to year-end, in February 2002, we announced a tender offer to repurchase up to $200 million face value of our outstanding convertible notes. This tender offer was completed in March 2002. Refer to the subsequent events paragraph in this section as well as note 17 to our consolidated financial statements.
COMPARISON OF FISCAL 2000 AND 1999
Net Revenues. In fiscal 2000, we reported net revenues of $155.1 million, an increase of 110.9% over fiscal 1999. The increase was driven by the strength in our SONET/SDH and ATM/IP product lines. Foreign net revenues, consisting primarily of shipments to customers in Europe, the Middle East and the Far East, constituted 46% and 32% of net revenues in fiscal 2000 and 1999, respectively.
Gross Profit. Gross margin for fiscal 2000 increased to 70.2% from 65.7% for fiscal 1999. The increase in gross margin in fiscal 2000 was primarily a result of the continued reduction in the costs of our products, achieved by meeting higher volume milestones established by our foundries.
During fiscal 2000, gross profit increased to $108.9 million from $48.3 million in 1999. This increase was a function of the continued increase in overall volume and the improvement in the gross margin on certain product lines.
Research and Development. In fiscal 2000, research and development expenses were $24.2 million, or 15.6% of net revenues, an increase of 66.5% over 1999 expenditures. The increase was primarily attributable to increases in staff and in engineering charges related to the introduction of new products during fiscal 2000. We believe that the continued introduction of new products is essential to our competitiveness, and we are committed to continuing our investment in research and development.
Marketing and Sales. In fiscal 2000, marketing and sales expenses increased 69.6% over 1999, to $20.5 million, which represented 13.2% of net revenues. The increase was the result of the increase in variable cost of commissions on the increased net revenues and additional staff during fiscal 2000.
General and Administrative. In fiscal 2000, general and administrative expenses increased 45.8% over 1999 to $5.6 million, or 3.6% of net revenues. The increase in overall expenses was the result of our continued investment in the general and administrative area.
Amortization of Goodwill and Purchased In-Process Research and Development. We recorded $0.4 million of amortization of goodwill and purchased intangible assets and a $2.8 million charge to operations for purchased in-process research and development both related to the acquisition of Alacrity Communications Inc., completed in August 2000. The expense for purchased IPR&D was determined in that the underlying project did not reach technological feasibility, had no alternative future use and successful development was uncertain. This project was 75% completed at the date of acquisition. It is anticipated that net cash inflows for this project will commence in 2002, however, there can be no assurance. To date there have been no shipments of this product and development efforts are continuing as planned. If the development of this project is unsuccessful, our sales and profitability may be adversely affected in future periods. Commercial results are also subject to certain market events and risks, which are beyond our control.
Merger Costs. During fiscal 2000, we incurred $1.2 million in transaction costs related to the combination with Easics NV completed in May 2000.
Income Taxes. For fiscal 2000, our effective tax rate was 38.9%. During the third quarter of 1999, we concluded that it is more likely than not that substantially all of our net deferred tax assets would be realized. Accordingly, we reversed our valuation allowance for net deferred tax assets, which contributed to the resulting net tax benefit of $2.8 million for fiscal 1999. This resulted in a 1999 effective tax rate benefit of (12.5%).
Liquidity and Capital Resources
Cash Inflows and Outflows
During fiscal 2001, the net decrease in cash and cash equivalents was $137.3 million compared to a net increase of $451.9 million during fiscal 2000. Details of our cash inflows and outflows are as follows:
Operating Activities: During fiscal 2001, we recorded a net loss of $77.5 million and had a net decrease of $14.4 million in working capital. These uses of cash were offset by non-cash items of $15.2 million and restructuring liabilities of $29.9 million, resulting in $46.8 million in cash used in operating activities.
The more significant changes in our cash flows from operations were:
. accounts receivable, net of allowances, decreased by $24.9 million, or 87.6%, in fiscal 2001 due to the decline in customer shipments;
. inventories declined by $6.7 million, or 45%, in fiscal 2001 due to lower sales volumes because of industry conditions. In fiscal 2001, we recorded charges of $39.2 million for excess inventories; and
. the restructuring liabilities consist of approximately $1.3 million in employee termination benefits to be paid in early 2002 and $28.6 million in rent and operating cost payments due for excess facilities over the next fifteen years.
Investing Activities: In fiscal 2001, we invested approximately $11.5 million in capital equipment and product licenses. We also invested $9.0 million to acquire minority (less than 20%) ownership in non-publicly traded companies and $12.7 million (net of cash acquired) to acquire Onex. These investments were offset by net proceeds from held-to-maturity investments of $44.8 million.
Financing Activities: In fiscal 2001, we used $102.1 million in financing activities, which consisted primarily of $106.2 million used to repurchase our 4 1/2% Convertible Notes due 2005 and $4.2 million used to repurchase our common stock, offset by proceeds from the exercise of stock options of $8.3 million.
Effect of Exchange Rates and Inflation: Exchange rates and inflation have not had a significant impact on our operations.
Cash, Cash Equivalents and Investments
We have financed our operations and have met our capital requirements since incorporation in 1988 primarily through private and public issuances of equity securities, convertible notes, bank borrowings and cash generated from operations. Our principal sources of liquidity as of December 31, 2001 consisted of $370.3 million in cash and cash equivalents, $39.3 million in short-term investments and $26.6 million in long-term investments for a total cash and investment balance of $436.2 million. Cash and cash equivalents are cash or instruments with maturities of less than 90 days, short-term investments have maturities of greater then 90 days but less than one year and long-term investments have maturities of greater than one year. Our cash investments consist of U.S. Treasury Bills, corporate debt, taxable municipal securities, money market instruments, overnight repurchase investments and commercial paper.
We believe that our existing cash, cash equivalents and investments will be sufficient to fund operating losses, capital expenditures and provide adequate working capital at least through December 31, 2002. However, there can be no assurance that events in the future will not require us to seek additional capital and, if so required, that capital will be available on terms favorable or acceptable us, if at all.
Commitments
We had a line of credit agreement in place with Silicon Valley Bank, which expired in July of 2001. Since we did not have an outstanding balance on this obligation and had sufficient cash and investments to fund operations as well as its investment and financing requirements through the end of fiscal 2002, we did not renew this line of credit and, thus were released from all obligations, restrictions and financial covenants thereof.
We have outstanding operating lease commitments of approximately $46.6 million payable over the next fifteen years. Some of these commitments are for space which was not being utilized and, as a result, we recorded a restructuring charge of $28.6 during fiscal 2001 for excess facilities. We are in the process of trying to sublease some of this excess space, however, it is unlikely that any sublease income generated will offset the entire future commitment. We currently believe that we can fund these lease commitments in the future, however, there can be no assurances that we will not be required to seek additional capital or provide additional guarantees or collateral on these obligations.
We have existing commitments to make future interest payments on our existing 4 1/2% Convertible Notes due 2005. As of December 31, 2001, we had $4.1 million in accrued interest payable on our consolidated balance sheet. In March 2002, we repurchased $199.9 million of our outstanding 4 1/2% Convertible Notes due 2005. Over the remaining life of the outstanding notes, we expect to accrue and pay approximately $20.9 million in interest to the holders. Refer to the subsequent event disclosure below and note 17 of our consolidated financial statements regarding our tender offer.
A summary of our significant future commitments (which reflects the impact of the tender of the 4 1/2% Convertible Notes due 2005 discussed in the subsequent events paragraph below) and their payments by fiscal year is summarized as follows (in thousands):
Related Party Transactions
On a limited basis, we conduct certain related party transactions with the companies in which we have less than 20% ownership interest. During 2001, these transactions consisted primarily of design work that was performed for us, for which we paid approximately $0.8 million. In addition to TranSwitch, certain directors and officers of TranSwitch currently have, or have had, investments in these companies on the same terms that were available to TranSwitch. As a result of their investment in Onex, certain directors and officers received cash and shares of our common stock in exchange for their shares of Onex when this acquisition was completed in fiscal 2001.
We do not have any obligation to participate in future rounds of financing in the companies which we have less then 20% ownership interest in, although we do have a right of first refusal to purchase additional securities offered by the above companies. We do not have any commitments to acquire or merge with any of the companies that we have investments in. Additionally, we do not have a right of first refusal to acquire these companies. Our rights are consistent with the rights of all shareholders in the class of stock that we have purchased.
In fiscal 2001, we also invested in GTV Capital, L.P., which is a partnership in the business of making, supervising and disposing of capital investments in equity or equity-related securities in companies engaged in high-technology industries. The partnership focuses on seed and early-stage investments in communication infrastructure technology companies including wireless and optical systems technology, storage and related semiconductor technology, and media convergence technology. We have a 48% ownership interest in this partnership and we account for it under the equity method.
Subsequent Events
On January 24, 2002, ADV achieved certain milestones that had been set in its purchase agreement. As a result, we paid $5.0 million in cash that was recorded as additional goodwill on the consolidated balance sheets.
In January 2002, we pledged $1.4 million in available cash and cash equivalents as collateral for a stand-by letter of credit that guarantees certain long-term property lease obligations.
On February 11, 2002, our Board of Directors approved a tender offer to purchase up to $200 million (the "Offer Amount") aggregate principal amount of our outstanding 4 1/2% Convertible Notes due 2005 at a price not greater than $700 nor less than $650 per $1,000 principal amount, plus accrued and unpaid interest thereon to, but not including, the date of the purchase. This tender offer expired at midnight on March 11, 2002 and we repurchased $199.9 million face value of our convertible notes at the price of $700 per $1,000 principal amount for a cash payment of $139.9 million. Net of taxes, deferred financing costs and transaction fees, we expect this transaction to result in an extraordinary gain of approximately $32.5 million which will be recorded in the first quarter of 2002. Upon completion of the tender offer, the remaining outstanding balance of our 4 1/2% Convertible Notes due 2005 is $114.1 million.
Recent Accounting Pronouncements
In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations" (SFAS 141). SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS 141 also specifies certain criteria that must be met in order for intangible assets acquired in a purchase method business combination to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. We adopted the provisions of SFAS 141 as of July 1, 2001.
In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142) which is effective for TranSwitch's fiscal year beginning January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions, upon adoption, for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. Upon adoption of SFAS 142, we will cease to amortize approximately $54.5 million of goodwill and assembled workforce intangible assets. We had recorded approximately $2.5 million of amortization on these amounts during 2001 and would have recorded approximately $2.6 million of amortization during 2002. In lieu of amortization we will be required to perform an impairment review of our goodwill balance upon the initial adoption of SFAS 142. We expect to complete the initial review during the second quarter of 2002. We do not expect to record an impairment charge upon completion of the initial review, however, there can be no assurance that at the time the review is completed a material impairment loss will not be recorded. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle.
In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 supercedes SFAS 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". SFAS 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30 (APB 30), Reporting Results of Operations-Reporting the Effects of Disposal of a Division of a Business. SFAS 144 develops one accounting model for long-lived assets that are to be disposed of by sale and requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 is effective for TranSwitch's fiscal year beginning January 1, 2002. We do not expect the adoption of this standard to have a material impact on our financial position, results of operations, or liquidity.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133), and in June 2000 it issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities, an Amendment of FASB Statement No. 133" (SFAS No. 138). SFAS No. 133, as amended by SFAS No. 138, requires companies to recognize all derivatives as assets or liabilities measured at their fair value. Gains or losses resulting from changes in the value of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. The adoption of SFAS No. 133 as of January 1, 2001, had no material impact on our financial position, results of operations or liquidity.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by us, statements made by our employees or information included in our filings with the Securities and Exchange Commission (including this Form 10-K) may contain statements that are not historical facts, so-called "forward-looking statements," which involve risks and uncertainties. Such forward-looking statements are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended. These statements can be identified by the use of forward-looking terminology such as "may", "should", "could", "will", "expect", "anticipate", "estimate", "continue", "believe" or the negative of these terms or other similar words. These statements discuss future expectations, contain projections of results of operations or of financial condition or state other forward-looking information. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this Form 10-K.
Our actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below. Each of these factors, and others, are discussed from time to time in our filings with the Securities and Exchange Commission.
Our operating results may fluctuate because of a number of factors, many of which are beyond our control. If our operating results are below the expectations of public market analysts or investors, then the market price of our common stock could decline. Some of the factors that affect our quarterly and annual results, but which are difficult to control or predict are:
We recently experienced a significant decline in net revenues.
Our net revenues declined substantially during the twelve months ended December 31, 2001, to $58.7 million from $155.1 million during the twelve months ended December 31, 2000. Due to declining current economic conditions and slowdowns in purchases of VLSI semiconductor devices, it has become increasingly difficult for us to predict the purchasing activities of our customers and we expect that our net revenues will fluctuate substantially in the future.
We expect that our operating results will fluctuate in the future due to reduced demand in our markets.
Our business is characterized by short-term orders and shipment schedules, and customer orders typically can be cancelled or rescheduled without significant penalty to our customers. Because we do not have substantial non-cancelable backlog, we typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. Future fluctuations to our operating results may also be caused by a number of factors, many of which are beyond our control.
In response to anticipated long lead times to obtain inventory and materials from our foundries, we may order in advance of anticipated customer demand, which might result in excess inventory levels if the expected orders fail to materialize. As a result, we cannot predict the timing and amount of shipments to our customers, and any significant downturn in customer demand for our products would reduce our quarterly and our annual operating results. During 2001, these conditions occurred and as a result, we recorded a provision for excess inventories of an aggregate of $39.2 million during fiscal 2001.
Historically, average selling prices in the communication semiconductor industry have decreased over the life of a product, and, as a result, the average selling prices of our products may decrease in the future. Decreases in the price of our products would adversely affect our operating results.
In the past, we have incurred significant new product and process development costs because our policy is to expense these costs, including tooling and pre-production expenses, at the time that they are incurred. We may continue to incur these types of expenses in the future. These additional expenses will have a material and adverse effect on our earnings in future periods. The occurrence of any of the above mentioned risk factors could have a material adverse effect on our business and financial results.
Sudden shortages of raw materials or production capacity constraints can lead producers to allocate available supplies or capacity to larger customers than us, which could interrupt our ability to meet our production obligations.
We are using our available cash each quarter to fund our operating activities.
During the fourth quarter of fiscal 2001, we used $25.9 million of our available cash, cash equivalents and investments to fund our operating, investing and financing activities. We anticipate that we will use a similar amount of our available cash, cash equivalents and investments to fund our operating, investing and financing activities in the first quarter of fiscal 2002. We believe that we will continue to use our available cash, cash equivalents and investments in the future although we believe that we have sufficient cash for our needs to last through December 31, 2002. We will continue to experience losses and to use our cash, cash equivalents and investments if we do not receive sufficient product orders and our costs are not controlled.
We may have to further restructure our business.
On July 16, 2001, we announced a restructuring plan as a result of current and anticipated business conditions. We incurred a restructuring charge of approximately $1.3 million, which was solely related to a workforce reduction of thirty positions throughout our company. We terminated these employees during the third quarter of 2001 and provided severance and related benefits. On November 15, 2001, we announced further restructuring and incurred an additional restructuring charge of $31.2 million related to a workforce reduction of 47 positions throughout our company and the related consolidation of several of our leased facilities. We terminated these employees during the fourth quarter of 2001 and provided severance and related benefits. We cannot be sure that these measures will be sufficient to offset lower net revenues, and if they are not, our earnings will be adversely affected.
We anticipate that shipments of our products to relatively few customers will continue to account for a significant portion of our net revenues.
Historically, a relatively small number of customers have accounted for a significant portion of our net revenues in any particular period. For the year ended December 31, 2001, shipments to our top five customers, including sales to distributors, accounted for approximately 64% of our net revenues. We expect that a limited number of customers may account for a substantial portion of our net revenues for the foreseeable future.
Some of the following may reduce our net revenues:
. reduction, delay or cancellation of orders from one or more of our significant customers;
. development by one or more of our significant customers of other sources of supply for current or future products;
. loss of one or more of our current customers or a disruption in our sales and distribution channels; and
. failure of one or more of our significant customers to make timely payment of our invoices.
We cannot be certain that our current customers will continue to place orders with us, that orders by existing customers will return to the levels of previous periods or that we will be able to obtain orders from new customers. We have no long-term volume purchase commitments from any of our significant customers. The following table sets forth our significant distributors (who have accounted for at least 10% of our net revenues during fiscal 2001) and customers (who accounted for at least 10% of our net revenues during 2001 either directly or through distributors during fiscal 2001):
Significant Distributors: Major Customers: -------------------------------------------------------------------------- Insight Electronics, Inc. Lucent Technologies, Inc. Unique Memec Nortel Networks Corporation Weone Corporation Samsung Corporation Siemens AG Redback Networks, Inc.
Our international business operations expose us to a variety of business risks.
Foreign markets are a significant part of our net revenues. In the year ended December 31, 2001, foreign shipments accounted for 69% of our net revenues. We expect foreign markets to continue to account for a significant percentage of our net revenues. A significant portion of our net revenues will, therefore, be subject to risks associated with foreign markets, including the following:
. unexpected changes in legal and regulatory requirements and policy changes affecting the telecommunications and data communications markets;
. changes in tariffs;
. exchange rates and other barriers;
. political and economic instability;
. difficulties in accounts receivable collection;
. difficulties in managing distributors and representatives;
. difficulties in staffing and managing foreign operations;
. difficulties in protecting our intellectual property overseas;
. seasonality of customer buying patterns; and
. potentially adverse tax consequences.
Although substantially all of our net revenues to date have been denominated in U.S. dollars, the value of the U.S. dollar in relation to foreign currencies also may reduce our net revenues to foreign customers. To the extent that we expand our international operations or change our pricing practices to denominate prices in foreign currencies, we will expose our margins to increased risks of currency fluctuations. We have assessed the risks related to foreign exchange fluctuations, and have determined at this time that any such risk is not material.
We must successfully transition to new process technologies to remain competitive.
Our future success depends upon our ability to do the following:
. to develop products that utilize new process technologies;
. to introduce new process technologies to the marketplace ahead of competitors; and
. to have new process technologies selected to be designed into products of leading systems manufacturers.
Semiconductor design and process methodologies are subject to rapid technological change and require large expenditures for research and development. We currently manufacture our products using 0.8, 0.5, 0.35 and 0.25 micron complementary metal oxide semiconductor (CMOS) processes and a 1.0 micron bipolar CMOS (BiCMOS) process. We continuously evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies. We are migrating to a 0.18 micron CMOS process, and we anticipate that we will need to migrate to smaller CMOS processes in the future. Other companies in the industry have experienced difficulty in transitioning to new manufacturing processes and, consequently, have suffered reduced yields or delays in product
deliveries. We believe that transitioning our products to smaller geometry process technologies will be important for us to remain competitive, and we cannot be certain that we can make such a transition successfully, if at all, without delay or inefficiencies.
Our success depends on the timely development of new products, and we face risks of product development delays.
Our success depends upon our ability to develop new VLSI devices and software for existing and new markets. The development of these new devices and software is highly complex, and from time to time we have experienced delays in completing the development of new products. Successful product development and introduction depends on a number of factors, including the following:
. accurate new product definition;
. timely completion and introduction of new product designs;
. availability of foundry capacity;
. achievement of manufacturing yields; and
. market acceptance of our products and our customers' products.
Our success also depends upon our ability to do the following:
. build products to applicable standards;
. develop products that meet customer requirements;
. adjust to changing market conditions as quickly and cost-effectively as necessary to compete successfully;
. introduce new products that achieve market acceptance; and
. develop reliable software to meet our customers' application needs in a timely fashion.
In addition, we cannot ensure that the systems manufactured by our customers will be introduced in a timely manner or that such systems will achieve market acceptance.
Our net revenues depend on the success of our customers' products.
Our customers generally incorporate our new products into their products or systems at the design stage. However, customer decisions to use our products (design wins), which can often require significant expenditures by us without any assurance of success, often precede the generation of volume sales, if any, by a year or more. In addition, even after we achieve a design win, a customer may require further design changes. Implementing these design changes can require significant expenditures of time and expense by us in the development and pre-production process. Moreover, the value of any design win largely will depend upon the commercial success of the customer's product and on the extent to which the design of the customer's systems accommodates components manufactured by our competitors. We cannot ensure that we will continue to achieve design wins in customer products that achieve market acceptance.
We sell a range of products that each have a different profit margin. Our net revenues will be adversely affected if most of our shipments are of products with low profit margins.
We currently sell more than 50 products. Some of our products have a high profit margin while others do not. If our customers decide to buy more of our products with low profit margins and fewer of our products with high profit margins, our net revenues could be adversely affected. We plan our mix of products based on our internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially.
Our success depends on the rate of growth of the global communications infrastructure.
We derive virtually all of our net revenues from products for telecommunications and data communications applications. These markets are characterized by the following:
. susceptibility to seasonality of customer buying patterns;
. general business cycles;
. intense competition;
. rapid technological change; and
. short product life cycles.
In addition, although the telecommunications and data communications equipment markets have grown rapidly in the last few years, we are currently experiencing a significant slowdown in these markets. We anticipate that these markets will not grow at the same historical rates in the near future.
Our products must successfully include industry standards to remain competitive.
Products for telecommunications and data communications applications are based on industry standards, which are continually evolving. Our future success will depend, in part, upon our ability to successfully develop and introduce new products based on emerging industry standards, which could render our existing products unmarketable or obsolete. If the telecommunications or data communications markets evolve to new standards, we cannot be certain that we will be able to design and manufacture new products successfully that address the needs of our customers or that such new products will meet with substantial market acceptance.
We face intense competition in the communication semiconductor market.
The communication semiconductor industry is intensely competitive and is characterized by the following:
. rapid technological change;
. general business cycles;
. shortage in fabrication capacity;
. price erosion;
. unforeseen manufacturing yield problems; and
. heightened international competition in many markets.
These factors are likely to result in pricing pressures on our products, thus potentially affecting our operating results.
Our ability to compete successfully in the rapidly evolving area of high-performance integrated circuit technology depends on factors both within and outside our control, including:
. success in designing and subcontracting the manufacture of new products that implement new technologies;
. protection of our products by effective use of intellectual property laws;
. product quality;
. reliability;
. price;
. efficiency of production;
. the pace at which customers incorporate our products into their products;
. success of competitors' products; and
. general economic conditions.
The telecommunications and data communications industries, which are our primary target markets, have become intensely competitive because of deregulation and heightened international competition.
The cyclical nature of the communication semiconductor industry affects our business and we are currently experiencing a significant downturn.
We provide semiconductor devices to the telecommunications and data communications markets. The semiconductor industry is highly cyclical and currently is experiencing a significant contraction of the market. These downturns are characterized by:
. diminished product demand;
. accelerated erosion of average selling prices; and
. production over-capacity.
We may experience substantial fluctuations in future operating results due to general semiconductor industry conditions, overall economic conditions, seasonality of customers' buying patterns and other factors. We are currently experiencing a significant slowdown in the communication semiconductor industry.
We rely on outside fabrication facilities, and our business could be hurt if our relationships with our foundry suppliers are damaged.
We do not own or operate a VLSI circuit fabrication facility. Seven foundries currently supply us with most of our semiconductor device requirements. While we have had good relations with these foundries, we cannot be certain that we will be able to renew or maintain contracts with them or negotiate new contracts to replace those that expire. In addition, we cannot be certain that renewed or new contracts will contain terms as favorable as our current terms. There are other significant risks associated with our reliance on outside foundries, including the following:
. the lack of assured semiconductor wafer supply and control over delivery schedules;
. the unavailability of, or delays in obtaining access to, key process technologies; and
. limited control over quality assurance, manufacturing yields and production costs.
Reliance on third-party fabrication facilities limits our control of the manufacturing process.
Manufacturing integrated circuits is a highly complex and technology-intensive process. Although we try to diversify our sources of semiconductor device supply and work closely with our foundries to minimize the likelihood of reduced manufacturing yields, our foundries occasionally experience lower than anticipated manufacturing yields, particularly in connection with the introduction of new products and the installation and start-up of new process technologies. Such reduced manufacturing yields have at times reduced our operating results. A manufacturing disruption at one or more of our outside foundries, including as a result of natural occurrences, could impact production for an extended period of time.
Our dependence on a small number of fabrication facilities exposes us to risks of interruptions in deliveries of semiconductor devices.
We purchase semiconductor devices from outside foundries pursuant to purchase orders, and we do not have a guaranteed level of production capacity at any of our foundries. We provide the foundries with rolling forecasts of our production requirements. However, the ability of each foundry to provide wafers to us is limited by the foundry's available capacity. Therefore, our foundry suppliers could choose to prioritize capacity for other customers or reduce or eliminate deliveries to us on short notice. Accordingly, we cannot be certain that our foundries will allocate sufficient capacity to satisfy our requirements.
We have been, and expect in the future to be, particularly dependent upon a limited number of foundries for our VLSI device requirements. In particular, as of the date of this Form 10-K, a single foundry manufactures all of our BiCMOS devices. As a result, we expect that we could experience substantial delays or interruptions in the shipment of our products due to the following:
. sudden demand for an increased amount of semiconductor devices or sudden reduction or elimination of any existing source or sources of semiconductor devices;
. time required to qualify alternative manufacturing sources for existing or new products could be substantial; and
. failure to find alternative manufacturing sources to produce VLSI devices with acceptable manufacturing yields.
Our failure to protect our proprietary rights, or the costs of protecting these rights, may harm our ability to compete.
Our success depends in part on our ability to obtain patents and licenses and to preserve other intellectual property rights covering our products and development and testing tools. To that end, we have obtained certain domestic and foreign patents and intend to continue to seek patents on our inventions when appropriate. The process of seeking patent protection can be time consuming and expensive. We cannot ensure the following:
. that patents will be issued from currently pending or future applications;
. that our existing patents or any new patents will be sufficient in scope or strength to provide meaningful protection or any commercial advantage to us;
. that foreign intellectual property laws will protect our foreign intellectual property rights; and
. that others will not independently develop similar products, duplicate our products or design around any patents issued to us.
Intellectual property rights are uncertain and involve complex legal and factual questions. We may be unknowingly infringing on the proprietary rights of others and may be liable for that infringement, which could result in significant liability for us. For example, we are not aware of any third-party intellectual property rights that would prevent our use and sale of our products, although we have received correspondence from others alleging infringement. If we do infringe the proprietary rights of others, we could be forced to either seek a license to intellectual property rights of others or alter our products so that they no longer infringe the proprietary rights of others. A license could be very expensive to obtain or may not be available at all. Similarly, changing our products or processes to avoid infringing the rights of others may be costly or impractical.
We are responsible for any patent litigation costs. If we were to become involved in a dispute regarding intellectual property, whether ours or that of another company, we may have to participate in legal proceedings in the United States Patent and Trademark Office or in the United States or foreign courts to determine one or more of patent validity, patent infringement, patent ownership or inventorship. These types of proceedings may be costly and time consuming for us, even if we eventually prevail. If we do not prevail, we might be forced to pay significant damages, obtain a license, if available, or stop making a certain product.
We also rely on trade secrets, proprietary know-how and confidentiality provisions in agreements with employees and consultants to protect our intellectual property. Other parties may not comply with the terms of their agreements with us, and we may not be able to adequately enforce our rights against these people.
We may engage in acquisitions that may harm our operating results, dilute our stockholders and cause us to incur debt or assume contingent liabilities.
We may pursue acquisitions that could provide new technologies, skills, products or service offerings. Future acquisitions by us may involve the following:
. use of significant amounts of cash;
. potentially dilutive issuances of equity securities; and
. incurrence of debt or amortization expenses related to intangible assets with definitive lives.
In addition, acquisitions involve numerous other risks, including:
. diversion of management's attention from other business concerns;
. risks of entering markets in which we have no or limited prior experience; and
. unanticipated expenses and operational disruptions while acquiring and integrating new acquisitions.
From time to time, we have engaged in discussions with third parties concerning potential acquisitions of product lines, technologies and businesses. However, we currently have no commitments or agreements with respect to any such acquisition. If such an acquisition does occur, we cannot be certain that our business, operating results and financial condition will not be materially adversely affected or that we will realize the anticipated benefits of the acquisition.
We have made, and may continue to make, investments in development stage companies which may not produce any returns for us in the future.
We have made investments of less then 20% in early stage venture-backed, start-up companies that develop technologies that are complementary to our product roadmap. The following table summarizes the investments we have made and their related technologies during the three years ended December 31, 2001.
The total investments in these companies is approximately $12.1 million and is recorded on the cost basis on our consolidated balance sheet. These investments involve all the risks normally associated with investments in development stage companies. As such, there can be no assurance that we will receive a favorable return on these or any future venture backed investments that we may make. Additionally, our original investment may become impaired if these companies do not succeed in their business plans. Any impairment of these investments could negatively impact our future operating results.
The loss of key management could affect our ability to run our business.
Our success depends largely upon the continued service of our executive officers, including Dr. Santanu Das, President, Chief Executive Officer and Chairman of the Board of Directors, and other key management and technical personnel and on our ability to continue to attract, retain and motivate other qualified personnel. The competition for such employees is intense.
We continue to have substantial indebtedness after the completion of our tender offer for some of our notes.
In the third quarter of 2000, we sold in a private placement $460 million of 4 1/2% Convertible Notes due 2005. As a result, we incurred $460 million of additional indebtedness, substantially increasing our ratio of debt to total capitalization. In April 2001, we adopted a repurchase program for our notes through which we repurchased some of the convertible notes from time to time at varying prices. During fiscal 2001, we repurchased $145.9 million of our 4 1/2% Convertible Notes due 2005. We did not repurchase any 4 1/2% Convertible Notes due 2005 during the three months ended December 31, 2001. Subsequent to year end, in February 2002, we announced a tender offer to buy back up to $200 million face value of the outstanding 4 1/2% Convertible Notes due 2005 at an aggregate purchase
price of approximately $140 million. This tender offer was completed in March 2002 with approximately $199.9 million of face value notes being tendered. Subsequent to the tender offer, we will continue to have approximately $114.1 million in face value of indebtedness outstanding. Subject to compliance with federal securities laws, we may continue to repurchase our 4 1/2% Convertible Notes due 2005 after the consummation of the tender offer. We funded repurchases of the notes in the tender offer and will fund any additional repurchases of the convertible notes, if any, made after the tender offer, from available cash, cash equivalents and short-term investments.
We may incur substantial additional indebtedness in the future. The level of our indebtedness, among other things, could:
. make it difficult for us to make payments on the notes outstanding after consummation of the tender offer;
. make it difficult for us to obtain any necessary future financing for working capital, capital expenditures, debt service requirements or other purposes;
. limit our flexibility in planning for, or reacting to changes in, our business; and
. make us more vulnerable in the event of a downturn in our business.
There can be no assurance that we will be able to meet our debt service obligations, including our obligations under the convertible notes.
We may not be able to satisfy a change in control offer.
The indenture governing the 4 1/2% Convertible Notes due 2005 contains provisions that apply to a change in our control. If someone triggers a change in control as defined in the indenture, we must offer to purchase the 4 1/2% Convertible Notes due 2005 with cash. If we have to make that offer, we cannot be sure that we will have enough funds to pay for all the 4 1/2% Convertible Notes due 2005 that the holders could tender.
We may not be able to pay our debt and other obligations.
If our cash flow is inadequate to meet our obligations, we could face substantial liquidity problems. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments on the 4 1/2% Convertible Notes due 2005 or our other obligations, we would be in default under the terms thereof, which would permit the holders of the notes to accelerate the maturity of the 4 1/2% Convertible Notes due 2005 and also could cause defaults under future indebtedness we may incur. Any such default could have a material adverse effect on our business, prospects, financial condition and operating results. In addition, we cannot assure you that we would be able to repay amounts due in respect of the 4 1/2% Convertible Notes due 2005 if payment of the notes were to be accelerated following the occurrence of an event of default as defined in the indenture. In April 2001, we adopted a repurchase program for our 4 1/2% Convertible Notes due 2005 through which we repurchased some of the convertible notes from time to time at varying prices. During fiscal 2001, we repurchased $145.9 million of our 4 1/2% Convertible Notes due 2005. We did not repurchase any 4 1/2% Convertible Notes due 2005 during the three months ended December 31, 2001. Subsequent to year-end, in February 2002, we announced a tender offer to buy back up to $200 million face value of the outstanding convertible notes at an aggregate purchase price of approximately $140 million. This tender offer was completed in March 2002 with approximately $199.9 million of face value notes being tendered. Subsequent to the tender offer, we will continue to have approximately $114.1 million in face value of indebtedness outstanding. Subject to compliance with federal securities laws, we may continue to repurchase 4 1/2% Convertible Notes due 2005 after the consummation of the tender offer. We funded repurchases of the notes in the tender offer and will fund any additional repurchases of the notes, if any, made after the tender offer, from available cash, cash equivalents and short-term investments.
Our stock price is volatile.
The market for securities for communication semiconductor companies, including TranSwitch, has been highly volatile. The market sale price of our common stock has fluctuated between a low of $0.80 and a high of $74.69 during the period from June 19, 1995 to December 31, 2001. The closing price was $2.87 on February 28, 2002. It is likely that the price of our common stock will continue to fluctuate widely in the future. In September 2001, we adopted a repurchase program for up to 10% of our common stock. During the third quarter of 2001, we repurchased approximately one million shares of our common stock. We may continue to purchase some of our shares from time to time on the open market. Factors affecting the trading price of our common stock include:
. responses to quarter-to-quarter variations in operating results;
. announcements of technological innovations or new products by us or our competitors;
. current market conditions in the telecommunications and data communications equipment markets (we are currently experiencing a significant downturn); and
. changes in earnings estimates by analysts.
We could be subject to class action litigation due to stock price volatility, which if it occurs, will distract our management and could result in substantial costs or large judgments against us.
In the past, securities and class action litigation has often been brought against companies following periods of volatility in the market prices of their securities. We may be the target of similar litigation in the future. Securities litigation could result in substantial costs and divert our management's attention and resources, which could cause serious harm to our business, operating results and financial condition or dilution to our stockholders.
Provisions of our certificate of incorporation, by-laws, stockholder rights plan and Delaware law may discourage take over offers and may limit the price investors would be willing to pay for our common stock.
Delaware corporate law contains, and our certificate of incorporation and by-laws and shareholder rights plan contain, certain provisions that could have the effect of delaying, deferring or preventing a change in control of TranSwitch even if a change of control would be beneficial to our stockholders. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. Certain of these provisions:
. authorize the issuance of "blank check" preferred stock (preferred stock which our Board of Directors can create and issue without prior stockholder approval) with rights senior to those of common stock;
. prohibit stockholder action by written consent;
. establish advance notice requirements for submitting nominations for election to the Board of Directors and for proposing matters that can be acted upon by stockholders at a meeting; and
. dilute stockholders who acquire more than 15% of our common stock.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risk. We have investments in money market accounts, government securities and commercial paper that earns interest income that is a function of the market rates. As a result we do have exposure to changes in interest rates. For example, if interest rates were to decrease by one percentage point from their current levels, our potential interest income, assuming a constant cash balance, for calendar year 2002 would decrease by approximately $4.3 million. We do, however, expect our cash balance to decline during fiscal 2002.
Foreign Currency Exchange Risk. All of our sales and the majority of our expenses to date have been denominated in U.S. dollars, and, as a result, we have relatively little exposure to foreign currency exchange risk. We do not currently enter into any significant forward exchange contracts to hedge exposures denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. However, in the event our exposure to foreign currency risk increases, we may choose to hedge those exposures in the future.
Fair Value of Financial Instruments. As of December 31, 2001, our long-term debt consisted of convertible notes with interest at a fixed rate of 4 1/2%. Consequently, we do not have significant cash flow exposure on our long-term debt. However, the fair value of the convertible notes is subject to significant fluctuation due to changes in market interest rates and their convertibility into shares of our common stock. The fair market value of the convertible notes was approximately $178.5 million and $400 million at December 31, 2001 and 2000, respectively. Changes in interest rates affect the fair value of our convertible notes.
Item 8.
Item 8. Financial Statements and Supplementary Data.
TRANSWITCH CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Independent Auditors' Report
The Board of Directors and Shareholders TranSwitch Corporation:
We have audited the consolidated financial statements of TranSwitch Corporation and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 TranSwitch Corporation and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, effective July 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and certain provisions of SFAS No. 142, "Goodwill and Other Intangible Assets," as required for goodwill and intangible assets resulting from business combinations consummated after June 30, 2001.
/s/ KPMG LLP
Stamford, Connecticut January 17, 2002, except for note 17, which is as of March 11, 2002
TRANSWITCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
See accompanying notes to consolidated financial statements.
TRANSWITCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
TRANSWITCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS) (in thousands, except share data)
See accompanying notes to consolidated financial statements.
TRANSWITCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
See accompanying notes to consolidated financial statements.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Tabular dollars in thousands, except share and per share amounts)
Note 1. Summary of Significant Accounting Policies
Description of Business
TranSwitch Corporation ("TranSwitch" or the "Company") was incorporated in Delaware on April 26, 1988 and is headquartered in Shelton, Connecticut. The Company and its subsidiaries (collectively, "TranSwitch" or the "Company") design, develop, market and support highly integrated digital and mixed-signal semiconductor devices for the telecommunications and data communications markets.
Principles of Consolidation
The consolidated financial statements include the accounts of TranSwitch Corporation and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the period reported. Actual results could differ from those estimates. Estimates are used in accounting for, among other things, allowances for uncollectable receivables, inventory obsolescence, product warranty, depreciation and amortization, taxes, and contingencies. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.
Cash, Cash Equivalents and Investments in Marketable Securities
All highly liquid investments with an original maturity of three months or less are considered cash equivalents. Cash equivalents were approximately $370.2 and $470.7 million for the fiscal years ended December 31, 2001 and 2000, respectively. Cash equivalents consist of overnight bank repurchase agreements, certificates of deposit, U.S. Treasury Bills, commercial paper and U.S. Agency Notes. The majority of the Company's cash and cash equivalents are maintained with three major financial institutions. The cash, cash equivalents and investment balances at institutions may, at times, be above the Federal Deposit Insurance Corporation insured limit of $0.1 million per account.
Short and long-term investments are comprised of marketable securities, primarily U.S. Treasury Bills, commercial paper, and corporate debt securities. Investments with remaining maturities greater then ninety days, but less than one year, as of the date of the balance sheet are considered short-term. Long-term investments consist of the same mix of securities with maturity dates greater than one year from the balance sheet date. At December 31, 2001 and 2000, all of the Company's marketable securities are classified as held-to-maturity. Held-to-maturity securities are those securities in which the Company has the ability and intent to hold the securities to maturity. These investments are recorded at amortized cost.
Fair Value of Financial Instruments
The carrying amounts for cash and cash equivalents, short-term investments, accounts receivable, and accounts payable approximate fair value because of their short maturities. The fair values of long-term investments and the 4 1/2% Convertible Notes due 2005 are determined using quoted market prices for those securities or similar financial instruments. The fair value of the outstanding 4 1/2% Convertible Notes due 2005 was approximately $178.5 and $400.0 million at December 31, 2001 and 2000, respectively. The fair value of the Company's long-term investments are disclosed in note 3 to the consolidated financial statements.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Inventories
Inventories are carried at the lower of cost (on a weighted-average cost basis) or estimated net realizable value.
Product Licenses
Product licenses are amortized using the greater of: (1) the amount computed using the ratio of a product's current gross revenues to the product's total of current and estimated future gross revenues; or (2) or the straight-line method over the estimated useful life of the asset, generally three to five years, not to exceed the term of the license. The Company capitalized $2.0 million, $0.5 million and $1.0 million for the years ended December 31, 2001, 2000 and 1999, respectively, in connection with the acquisition of selected technologies. Amortization of product licenses amounted to $0.3, $0.4 and $0.5 million for the years ended December 31, 2001, 2000 and 1999, respectively. Product licenses, net, are included in other assets on the consolidated balance sheets. During fiscal 2001, the Company recorded an impairment charge related to a product license, refer to note 11.
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization of property and equipment is calculated using the half-year convention method over the asset's estimated useful lives, ranging from three to seven years. Any gain or loss resulting from sale or retirement is included in the consolidated statement of operations. Repairs and maintenance are expensed as incurred while renewals and betterments are capitalized. Costs incurred for assets being constructed or installed but not yet placed in service at the balance sheet date are recorded as construction in progress.
Goodwill and Purchased Intangible Assets
Goodwill and purchased intangible assets are carried at cost less accumulated amortization, and are being amortized over the estimated economic lives of the respective assets, generally five to ten years. Accumulated amortization for goodwill and purchased intangible assets amounted to $2.9 million and $0.4 million for the years ended December 31, 2001 and 2000. Refer also to "Recent Accounting Pronouncements" below as well as note 2 "Business Combinations" for additional disclosure.
Deferred Financing Costs
Deferred financing costs on our 4 1/2% Convertible Notes due 2005 are amortized using the interest method over the term of the related notes. The Company had deferred financing costs, net of $8.1 and $15.2 million at December 31, 2001 and 2000, respectively. Amortization, included in the consolidated statement of operations as a component of interest expense, was $2.7 million and $1.1 million for the years ended December 31, 2001 and 2000, respectively. During the year ended December 31, 2001, the Company recognized a gain related to the early extinguishment of convertible notes which were reduced by the write-off of $4.5 million in associated deferred financing costs. Refer to note 10 for additional details on our 4 1/2% convertible notes due 2005.
Impairment of Intangibles and Long-Lived Assets
The Company reviews long-lived assets, goodwill and certain identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When factors indicate that an intangible or long-lived asset should be evaluated for possible impairment, an estimate of the related asset's undiscounted future cash flows over the remaining life of the asset will be made to determine whether the carrying value is recoverable. Any impairment is measured based upon the excess of the carrying value of the asset over its estimated fair value which is generally based on an estimate of future discounted cash flows.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Investments in Non-Publicly Traded Companies
The Company has certain minority investments in the convertible preferred stock of several non-publicly traded companies in which it has less than 20 percent of the voting rights and does not exercise significant influence. These investments are carried at cost and are reviewed periodically for impairment. The appropriate reductions in carrying values are recorded when and if necessary. During the three years ended December 31, 2001, the Company did not record any impairment charges on these investments.
Revenue Recognition
Net revenues are comprised of product shipments, principally to domestic and international telecommunications and data communications OEMs and to distributors. Net revenues from product sales are recognized at the time of product shipment when the following criteria are met: (1) title and risk of loss transfers to the customer; (2) the selling price is fixed or determinable; and (3) collectibility is reasonably assured.
Agreements with certain distributors provide price protection and return and allowance rights. With respect to the sales to distributors the: (1) prices are fixed at the date of shipment from the Company's facilities; (2) payment is not contractually or otherwise excused until the product is resold; (3) Company does not have any obligations for future performance relating to the resale of the product; and (4) amount of future returns, allowances, refunds and costs to be incurred can and are reasonably estimated and accrued at the time of shipment.
Concentrations of Credit Risk
Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents, marketable securities, and accounts receivable.
Cash, cash equivalents, and marketable securities are maintained in investment grade financial instruments with high-quality financial institutions, thereby reducing credit risk concentrations. In addition, the Company limits the amount of credit exposure to any one financial institution and any one type of investment.
At December 31, 2001, over 90% of accounts receivable were due from four major customers. The majority of the Company's sales are to customers in the telecommunications and data communications industries. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company does establish an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.
Product Warranties
TranSwitch provides warranties on its products for up to one year from the date of sale. A liability is recorded for estimated costs to be incurred under product warranties, which is based primarily on historical experience. Estimated warranty expense is recorded as cost of revenues as products are sold.
Research and Development Costs
Research and development costs are expensed as incurred.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
includes the enactment date. To the extent that it is more likely than not that the Company will not be able to utilize deferred income tax assets in the future, a valuation allowance is established.
Stock-Based Compensation
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," the Company accounts for employee stock-based compensation in accordance with Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees", and FASB Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions Involving Stock-Based Compensation, an interpretation of APB Opinion No. 25" and related interpretations in accounting for its stock-based compensation plans. Stock-based compensation related to non-employees is based on the fair value of the related stock or options in accordance with SFAS No. 123 and its interpretations. Expense associated with stock-based compensation is amortized over the vesting period of each individual award.
Earnings Per Share
Basic earnings per share are based upon the weighted average common shares outstanding during the period. Diluted earnings per share assume exercise of all outstanding "in-the-money" stock options and the conversion of the 4 1/2% Convertible Notes due 2005 into common stock at the beginning of the period or the date of issuance, if later, unless they are anti-dilutive.
Foreign Currency Translation
All foreign subsidiaries use their local currency as their functional currency. Therefore, assets and liabilities of foreign subsidiaries are translated at exchange rates in effect at the balance sheet date and revenue and expense accounts are translated at average exchange rates during the year. The resulting translation adjustments are recorded in accumulated other comprehensive income (loss). Gains and losses related to monetary assets and liabilities denominated in a currency different than a subsidiary's functional currency are included in the consolidated statements of operations.
Reclassifications
Certain reclassifications have been made in the 2000 balance sheet to conform to the 2001 presentation.
Recent Accounting Pronouncements
In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS 141 also specifies certain criteria that must be met in order for intangible assets acquired in a purchase method business combination to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. The Company adopted the provisions of SFAS 141 as of July 1, 2001. Accordingly, for the acquisition of Onex, the Company recorded $40.6 million in goodwill which is not being amortized. Refer also to note 2 of these consolidated financial statements.
In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") which is effective for TranSwitch's fiscal year beginning January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions, upon adoption, for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. Upon adoption of SFAS 142, the Company will cease to amortize approximately $54.5 million of goodwill and assembled workforce intangible assets. The Company had recorded approximately $2.5 million of amortization on these amounts during 2001 and would have recorded approximately $2.6 million of amortization during 2002. In lieu of
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
amortization, the Company will be required to perform an impairment review of its goodwill balance upon the initial adoption of SFAS 142. The Company expects to complete the initial review during the second quarter of 2002. The Company does not expect to record an impairment charge upon completion of the initial review, however there can be no assurance that at the time the review is completed a material impairment loss will not be recorded. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle.
In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 supercedes SFAS 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". SFAS 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30 (APB 30), Reporting Results of Operations -Reporting the Effects of Disposal of a Division of a Business. SFAS 144 develops one accounting model for long-lived assets that are to be disposed of by sale and requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 is effective for TranSwitch's fiscal year beginning January 1, 2002. The Company does not expect the adoption of this standard to have a material impact on its financial statements.
Note 2. Business Combinations
During the years ended December 31, 2001 and 2000, the Company completed five acquisitions. All acquisitions during 2001 and 2000 were accounted for under the purchase method of accounting for business combinations, with the exception of EASICS NV which was accounted for as a pooling of interests during 2000. The consolidated financial statements include the operating results of each business from the date of acquisition, except EASICS NV where historical balances are reflected. All significant intercompany balances and transactions have been eliminated.
FISCAL 2001
A summary of purchase transactions completed during fiscal 2001 is outlined as follows:
Onex Communications Corporation
On September 21, 2001 the Company acquired Onex, which develops System Silicon Solutions for multi-service platforms. This acquisition was a strategic investment aimed at enhancing the Company's product offering with higher speed solutions. As a result of this acquisition, the Company issued 5,481,504 shares of its common stock and assumed 523,543 common stock options. The common stock issued was valued at the closing price of $8.80 per share as listed on the Nasdaq National Market on the date that the definitive merger agreement was signed (August 17, 2001) as the number of common shares to be issued were fixed on that date. This equates to a total fair value of $52.8 million in common stock. The Company also paid $20.0 million in
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
cash. The Company incurred transaction fees of approximately $3.5 million in conjunction with this purchase, which were substantially paid as December 31, 2001. This purchase, combined with a previous investment of $5.1 million accounted for under the cost method, brings the Company's total purchase price of Onex to $81.4 million.
Purchased In-Process Research and Development
The $22.0 million allocated to IPR&D was determined through independent valuations using established valuation techniques in our industry. The value allocated to IPR&D was based upon the forecasted operating after-tax cash flows from the technology acquired, giving effect to the stage of completion at the acquisition date. Future cash flows were adjusted for the value contributed by any core technology and development efforts expected to be completed post acquisition. These forecasted cash flows were then discounted at rates commensurate with the risks involved in completing the acquired technologies taking into consideration the characteristics and applications of each product, the inherent uncertainties in achieving technological feasibility, anticipated levels of market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets. After considering these factors, the risk adjusted discount rates for the Onex products were determined to be 30%. Acquired technology that had not yet reached technological feasibility and for which no alternative future uses existed was expensed upon acquisition. The in-process technology acquired from Onex consisted of two projects: Switch Processor (SP) and Switch Element (SE). These projects are further described as follows:
The SP technology consists of highly integrated and programmable silicon that can combine any and all combinations of SONET/SDH transmission and native support for TDM, ATM and packet processing on a single chip. Significant features under development of the SP technology include the fact that SP is a 17 million gate device. The portion of in-process research and development allocated to this project was $14.1 million. It was estimated that the SP project was approximately 60% complete and the remaining costs to complete the project were $4.9 million. This project is expected to be completed in April 2002. The risks associated with the development of SP product are technical completion, timing, cost, and market risks. Technical completion must bear the risk that the technology's back-end layout is appropriate. Timing risk of developing the SP is significant due to the unpredictable nature of technical issues with such technology. Although a market exists for this type of product, producing the SP product cost-effectively and gaining general market acceptance has yet to be proven and presents risk to the success of the SP product.
The SE technology consists of a 30 Gbps (12 port OC-48) switch technology capable of switching TDM, ATM or variable length packet traffic. Significant features under development of the SE technology include frequency and phase synchronization. The portion of in-process research and development allocated to this project was $7.9 million. It was estimated that the SE technology was approximately 75% complete and the remaining costs to complete the project were $2.7 million. The initial development of this project was completed in December 2001 and was in the process of being tested at year end. The risks associated with the development of SE product are technical completion, timing, cost, and market risks. Technical completion for the initial prototype lots centers on the reliability of IBM's Unilink technology. Although a market for the SE product exists, producing the SE product cost-effectively and gaining general market acceptance has yet to be proven and presents risk to the success of the product.
Goodwill
The excess purchase price, including the Company's original investment in Onex, over the fair value of the net identifiable assets and liabilities acquired of $40.6 million has been recorded as goodwill. In accordance with SFAS 141 and SFAS 142, the Company is not amortizing this asset as the transaction was completed after June 30, 2001, but will perform a periodic evaluation for impairment.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Patents
Patents of $1.6 million acquired were determined to have an estimated useful life of 10 years and are being amortized, on a straight-line basis, over this period.
Proforma Financial Information
The following unaudited proforma financial information presents the combined results of operations of TranSwitch and Onex as if the acquisition had occurred on January 1, 2000. This presentation gives effect to certain adjustments including: the write-off of acquired in-process research and development, amortization of the acquired patents, additional depreciation expense and related income tax effects. The proforma financial information does not necessarily reflect the results of operations that would have occurred had TranSwitch and Onex constituted a single entity during such periods.
Horizon Semiconductors, Inc.
On February 6, 2001, the Company acquired all of the outstanding stock of Horizon Semiconductors, Inc. (Horizon) for 43,507 shares of common stock valued at approximately $1.7 million, and $0.5 million of cash paid to Horizon stockholders. The common stock issued was valued at the average closing price of $38.47 per share as listed on the Nasdaq National Market for the twenty trading days immediately preceding the two trading days prior to the closing date in accordance with the purchase agreement. The total purchase price of approximately $2.3 million includes direct costs of the acquisition totaling approximately $0.2 million. Horizon is a specialized design company for test and diagnostics engineering and was acquired for the strategic value of its products and processes to TranSwitch.
Goodwill of $2.1 million is being amortized on a straight-line basis over 5 years, and the assembled workforce of $0.2 million is being amortized on a straight-line basis over 3 years. As described in note 1, upon full adoption of SFAS 142 as of January 1, 2002 the Company will no longer amortize goodwill but perform periodic evaluations of impairment. In addition, assembled workforce is not an intangible asset under SFAS 142 and will be combined with goodwill. Pro forma results of operations for Horizon have not been presented because the effects of this acquisition were not material to the financial statements either individually or combined with other acquisitions.
ADV Engineering S.A.
On January 18, 2001, the Company acquired all of the outstanding stock of ADV Engineering S.A. (ADV) for 129,971 shares of common stock valued, in the aggregate, at approximately $5.6 million. The common stock issued was valued at the average closing price of $42.85 per share as listed on the Nasdaq National Market for the thirty trading days immediately preceding the two trading days prior to the closing date in accordance with the purchase agreement. The total purchase price of approximately $6.2 million includes direct
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
costs of the acquisition totaling approximately $0.6 million. In addition, if ADV achieved certain milestones, the Company was obligated to pay out an additional $5 million in cash or stock in January 2002. Subsequent to year end, the milestones were achieved and the Company paid $5 million in cash on January 24, 2002; which we recorded as goodwill (refer to subsequent events, note 17 for additional detail). ADV is a fabless semiconductor company and was acquired for the strategic value of its products and processes to TranSwitch.
Goodwill of $4.9 million is being amortized on a straight-line basis over 5 years, and the assembled workforce of $0.5 million was being amortized on a straight-line basis over 3 years. As described in note 1, the Company will adopt SFAS 142 as of January 1, 2002 at which time it will no longer amortize goodwill but perform periodic evaluations of impairment. In addition, assembled workforce is not an intangible asset under SFAS No. 141 and will be combined with goodwill. Pro forma results of operations for ADV have not been presented because the effects of this acquisition were not material to the financial statements either individually or combined with other acquisitions.
FISCAL YEAR 2000
EASICS NV
In May 2000, the Company completed a combination with EASICS NV, a Belgian communications semiconductor design service provider, in which Easics NV became a wholly-owned subsidiary of TranSwitch. The Company issued 505,382 shares of common stock in exchange for all of the outstanding stock of EASICS NV. The transaction was accounted for as a pooling-of-interests and, accordingly, the historical consolidated financial statements were restated to include the financial position, results of operations, and cash flows of EASICS NV for all periods presented. During the year ended December 31, 2000, merger-related transaction costs of $1.2 million were recorded and included under merger costs in the Consolidated Statements of Operations. There were no significant adjustments required to the accounting policies of EASICS NV.
Alacrity Communications, Inc.
On August 1, 2000, the Company acquired all of the outstanding stock of Alacrity for 266,836 shares of common stock, which includes the conversion of stock options to purchase 5,756 shares of common stock, valued, in the aggregate, at approximately $10.7 million. The total purchase price of approximately $11.3 million also includes professional fees and other direct costs of the acquisition totaling $0.6 million. Alacrity specializes in the development and marketing of high-capacity VLSI switching devices for telecommunications and data communications applications. The allocation of purchase price among tangible and intangible assets acquired and liabilities assumed are as follows:
Tangible assets ....................... $ 359 Intangible assets: Goodwill .............................. 8,477 Assembled workforce ................... 350 In-process research and development ... 2,800 Liabilities ........................... (697) -------- Total purchase price .................. $ 11,289 ========
The amount allocated to in-process research and development of $2.8 million was expensed upon acquisition, as it was determined that the underlying project had not reached technological feasibility, had no alternative future use and successful development was uncertain. The charge for IPR&D was based on a methodology that focused on the present value of after-tax cash flows attributable to the in-process project combined with the consideration of the stage of completion of the individual research and development project at the date of acquisition.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
The significant assumptions used in determining the valuation of the IPR&D are as follows:
o Net cash inflows are anticipated to commence in 2002;
o Risk adjusted discount rate applied to cash flows of 30%; and
o No anticipated material changes from historical pricing margin and expense levels.
To date, there have been no shipments related to this product or changes in development that would require an adjustment to the valuation.
Note 3. Investments in Marketable Securities and Investments in Non-Publicly Traded Companies
Investments in Marketable Securities
The following table summarizes investments in securities classified as cash and cash equivalents, short-term and long-term investments at December 31, 2001 and 2000:
Marketable debt securities had scheduled maturities of less than three and four years for the years ended December 31, 2001 and 2000 respectively.
During the year ended December 31, 2001, the Company sold certain held-to-maturity securities prior to their maturity date due to a decline in credit quality of the underlying issuers. The total amortized cost of the securities sold prior to maturity was approximately $5.4 million and the Company recognized a loss of approximately $0.1 million on these sales. This loss is netted against interest income on the Company's consolidated statements of operations. There were no early sales of held -to- maturity securities during the year ended December 31, 2000.
Investments in Non-Publicly Traded Companies
The Company has purchased shares of convertible preferred stock of certain privately held companies. The Company's direct and indirect (which include certain board members and employees) voting interest is less than 20% of the total ownership of each of these companies as of December 31, 2001, and the Company does not exercise significant influence over the management of these companies as defined by APB Opinion No. 18 "The
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Equity Method of Accounting for Investments in Common Stock," and other relevant literature. During 2001, the Company has also purchased an interest of approximately 48% in GTV Capital, L.P., a venture capital limited partnership. This investment has been accounted for under the equity method. The Company has recorded 48% of the limited partnership's losses from its date of investment through December 31, 2001 which have been insignificant. Excluding GTV Capital, L.P., all investments in non-publicly traded companies are carried at cost.
The following table summarizes the Company's investments in non publicly-traded companies at December 31, 2001 and 2000:
December 31, Investee company: 2001 2000 ------------------- TeraOp (USA) Inc. ......................................... $ 4,000 $ -- OptiX Networks, Inc. ...................................... 3,658 2,554 Accordion Networks, Inc. .................................. 1,500 -- Intellectual Capital for Integrated Circuits, Inc. ........ 1,385 831 Onex Communications Corporation(1) ........................ -- 5,095 GTV Capital, L.P. ......................................... 1,186 150 Systems On Silicon, Inc. .................................. 409 -- ------------------- Total minority investments .. $12,138 $8,630 ===================
(1) The Company acquired Onex Communications Corporation during fiscal 2001, refer to note 2.
From time to time, the Company will conduct business transactions with the companies listed above. During fiscal 2001, the Company contracted IC4IC, Inc. to perform approximately $0.8 million in design services.
Note 4. Inventories
The components of inventories at December 31, 2001 and 2000 are as follows:
December 31, 2001 2000 ------------------- Raw material ...................... $3,961 $ 1,414 Work-in-process ................... 1,031 4,130 Finished goods .................... 3,235 9,354 ------------------- Total inventories .... $8,227 $14,898 ===================
As a result of current and anticipated business conditions, as well as lower than anticipated demand, the Company recorded a provision for excess inventories of approximately $39.2 million during the year ended December 31, 2001. This provision was calculated in accordance with the Company's accounting policy. The effect of this inventory provision was to write inventory down to a new cost basis. There has been no subsequent disposal of inventory previously written-down reflected in the consolidated statement of operations.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Note 5. Property and Equipment, Net
The components of property and equipment, net at December 31, 2001 and 2000 are as follows:
- ---------- * Shorter of estimated useful life or lease term.
Depreciation expense was $6.1, $4.6 and $3.5 million for the years ended December 31, 2001, 2000 and 1999, respectively.
Note 6. Segment Information and Major Customers
Under SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," the Company uses the "management" approach to reporting segments. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS No. 131 also requires disclosures about products and services, geographic areas, and major customers. Under SFAS No. 131, there is one business segment: communication semiconductor products.
Products and Services
TranSwitch's products are VLSI semiconductor devices that provide core functionality of communications network equipment. The integration of various technologies and standards in these devices result in a homogeneous product line for management and measurement purposes.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Enterprise-wide Information
Enterprise-wide information provided on geographic net revenues is based on the customer's ordering location. Long-lived asset information is based on the physical location of the assets. The following tables present net revenues and long-lived assets information for geographic areas:
Information about Major Customers
The Company ships its products to both distributors and directly to end customers. The following tables set forth the percentage of net revenues attributable to all of the Company's major distributors as well as the significant customers that had total purchases (either direct or through distributors) of greater than 10% of net revenues for the three years ended December 31, 2001:
- ------------ (1) The end customers of the shipments to Insight Electronics, Inc. include Redback Networks, Inc. in 2001, Lucent in 2001, 2000 and 1999, a portion of Tellabs, Inc. purchases in 2000 and a portion of Nortel Networks Corporation's purchases in 1999. (2) The primary end customer of the shipments to Weone Corporation was Samsung Corporation in 2001.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
(3) A portion of the shipments to Siemens AG were distributed through Unique Memec. (4) The end customers of the shipments to Arrow Electronics, Inc. include Tellabs, Inc. in 1999 and 2000 as well as Nortel Networks Corporation in 1999. (5) Shipments to Lucent Technologies, Inc. also includes those made to Ascend Communications, which was acquired by Lucent Technologies, Inc. during 1999.
* Revenues were less than 10% of our net revenues in these years.
Note 7. Income Taxes
The components of income (loss) before income taxes and extraordinary gain for the three years ended December 31, 2001 are as follows:
The provision (benefit) for income taxes is comprised of the following:
Years ended December 31, 2001 2000 1999 ------------------------------------- Federal income taxes: Current ..................... $ -- $19,638 $ 1,581 Deferred .................... (36,906) 1,184 (4,682) State income taxes: Current ..................... -- 3,210 434 Deferred .................... (2,395) 90 (263) Foreign income taxes: Current ..................... 451 261 216 Deferred .................... -- -- (98) ------------------------------------- Income tax expense (benefit) ...... $(38,850) $24,383 $(2,812) =====================================
In addition, there was income tax expense of $13.2 million related to the extraordinary gain from the repurchase of the 4 1/2% Convertible Notes due 2005.
The following table summarizes the differences between the U.S. federal statutory rate and the Company's effective tax rate for financial statement purposes for the three years ended December 31, 2001:
Years ended December 31, 2001 2000 1999 -------------------------------- U.S. federal statutory tax rate ...... (35.0)% 35.0% 35.0% State taxes .......................... (1.8) 3.4 0.8 In-process research and development .. 5.6 1.6 -- Foreign sales corporation benefit .... -- (1.9) -- Change in valuation allowance ........ 2.4 -- (48.2) Permanent differences and other ...... 0.7 0.8 (0.1) -------------------------------- Effective income tax rate ............ (28.1)% 38.9% (12.5)% ================================
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
The tax effect of temporary differences that give rise to deferred income tax assets and deferred income tax liabilities at December 31, 2001 and 2000 are presented below:
The valuation allowance of $12.3 million relates to state tax net operating losses and federal and state research and development and other credits which management believes it more likely than not will expire unutilized. Subsequently recognized income tax benefits, if any, in the amount of $3.8 million will be applied directly to additional paid-in capital and $0.6 million will be applied to reduce goodwill. Of the total deferred income tax assets at December 31, 2001, $3.0 million is recorded as current and $65.5 million is recorded as non-current.
At December 31, 2001, the Company had available, for federal income tax purposes, net operating loss ("NOL") carryforwards of approximately $126.2 million and research and development tax credit carryforwards of approximately $7.2 million expiring in varying amounts from 2003 through 2021. For state income tax purposes, the Company had available NOL carryforwards of approximately $45.6 million and state tax credit carryforwards of $5.3 million expiring in varying amounts from 2002 to 2021.
Certain transactions involving the Company's beneficial ownership have occurred which resulted in a stock ownership change for purposes of Section 382 of the Internal Revenue Code of 1986, as amended. Consequently, approximately $21.9 million of the NOL carryforwards and $1.4 million of research and development tax credit carryforwards are subject to these limitations. However, the Company believes it is more likely than not that the NOL carryforwards will be utilized.
Note 8. Stockholders' Equity
Stockholders' Rights Plan
On October 1, 2001, the Board of Directors enacted a stockholder rights plan and declared a dividend of one preferred share purchase right for each outstanding share of TranSwitch common stock outstanding at the close of business on October 1, 2001 to the stockholders of record on that date. Each stockholder of record as of October 1, 2001 received a summary of the rights and any new stock certificates issued after the record date contain a legend describing the rights. Each preferred share purchase right entitles the registered holder to purchase from us one one-thousandth of a share of Series A Junior Participating Preferred Stock, par value $0.001 per share, of the Company, at a price of $50.00 per one one-thousandth of a Preferred Share, subject to adjustment, upon the occurrence of certain triggering events, including the purchase of 15% or more of the Company's outstanding common stock by a third party. Until a triggering event occurs, the common stockholders have no right to purchase shares under the stockholder rights plan. If the right to purchase the preferred stock is triggered, the common stockholders will have the ability to purchase sufficient stock to significantly dilute the 15% or greater holder.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Stock Buyback
On September 17, 2001, the Company announced it had adopted a plan to buy back up to 10% of the then outstanding shares of its common stock, based on the price and general market conditions over the next twelve months. The purpose for this stock buy back plan was to stabilize the price of the Company's common stock following the events of September 11, 2001. During the year ended December 31, 2001, TranSwitch repurchased 1,010,000 shares at an average price of $4.13 per share for approximately $4.2 million. Accordingly, this transaction has been reflected on the Company's consolidated balance sheets and consolidated statements of cash flows. The stock repurchases were made with the Company's available cash and cash equivalents.
Authorized Shares
In connection with the May 2000 annual shareholders' meeting, the shareholders approved an increase to the authorized number of shares of common stock from 100,000,000 to 300,000,000 shares.
Stock Splits
In June 1999 and January 2000, the Company effected three-for-two splits, and in August 2000, the Company effected a two-for-one split of its common stock paid in the form of a stock dividend. All share and per share data for all periods presented have been adjusted to reflect these stock splits.
Follow-on Common Stock Offering
On February 9, 1999 and March 16, 1999, the Company completed a follow-on public offering of 8,797,500 shares of its common stock for net proceeds, after issuance costs, of $68.2 million.
Note 9. Employee Benefit Plans
Employee Stock Purchase Plan
To provide employees with an opportunity to purchase common stock through payroll deductions, the Company established the 1995 Employee Stock Purchase Plan (the "Purchase Plan"), under which 450,000 shares of common stock have been reserved for issuance. Under the Purchase Plan, eligible employees may purchase a limited number of shares of common stock at 85% of the fair market value at either the date of enrollment or the date of purchase, whichever is less. Under the Purchase Plan, 75,585, 10,340 and 25,305 shares were issued in 2001, 2000, and 1999, respectively. At December 31, 2001, 62,542 shares remained available for future issuance.
Stock Option Plans
The Company has three stock options plans: the 1995 Stock Plan, as amended (the "1995 Plan"); the 1995 Non-Employee Director Stock Option Plan (the "Director Plan"); and the 2000 Stock Option Plan (the "2000 Plan").
With respect to the 1995 Plan, in connection with the May 2000 annual shareholders meeting, the shareholders approved an increase to the maximum number of shares reserved and authorized for issuance to 31,400,000 shares of TranSwitch common stock, pursuant to the grant to employees of incentive stock options and the grant of non-qualified stock options, stock awards or opportunities to make direct purchases of common stock to employees, consultants, directors and executive officers. The terms of the options granted are subject to the provisions of the 1995 Plan as determined by the Compensation Committee of the Board of Directors. The 1995 Plan will terminate ten years after its adoption unless earlier terminated by the Board of Directors. As of December 31, 2001, 7,026,102 shares were available for grant under the 1995 Plan.
The 2000 Plan, adopted by the Board of Directors on July 14, 2000 and amended on December 21, 2001, provides for the grant of non-qualified options to purchase shares of common stock, up to an aggregate of 10,000,000 shares, to employees and consultants. No member of the Board of Directors or executive officers as
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
appointed by the Board of Directors shall be eligible for grants of options under the 2000 Plan. The terms of the options granted are subject to the provisions of the 2000 Plan as determined by the Compensation Committee of the Board of Directors. Each non-qualified stock option shall either be fully exercisable on the date of grant or shall become exercisable thereafter in such installments as the Board of Directors may specify. The 2000 Plan will terminate ten years after its adoption. No option granted under the 2000 Plan may be exercised after the expiration of seven years from the date of grant. The exercise price of options under the 2000 Plan must be equal to the fair market value of the Common Stock on the date of grant. Options granted under the 2000 Plan are generally nontransferable. As of December 31, 2001, 2,878,419 shares were available for grant under the 2000 Plan.
The Director Plan provides for the automatic grant of options to purchase shares of common stock, up to an aggregate of 1,575,000 shares, to non-employee directors on the anniversary date of each individual board member joining the Board of Directors. Upon joining the Board of Directors, each director is granted an option to purchase 37,500 shares, one-third of which vest immediately, one-third after the first year, and the remaining one-third after the second year. Annually thereafter, each director is granted an option to purchase 28,800 shares, which vest fully after one year.
The Director Plan is administered by the Compensation Committee of the Board of Directors. No option granted under the Director Plan may be exercised after the expiration of five years from the date of grant. The exercise price of options under the Director Plan must be equal to the fair market value of the common stock on the date of grant. Options granted under the Director Plan are generally nontransferable. As of December 31, 2001, 9,899 shares were available for grant under the Director Plan.
Information regarding stock options is set forth as follows:
Number Weighted average of options exercise price outstanding per share -------------------------------- Outstanding at December 31, 1998 ... 12,909,430 $ 2.65 Granted ...................... 5,470,116 11.54 Exercised .................... (3,643,948) 1.83 Canceled ..................... (915,526) 4.54 -------------------------------- Outstanding at December 31, 1999 ... 13,820,072 $ 8.76 Granted and assumed .......... 6,442,610 33.55 Exercised .................... (4,173,771) 5.04 Canceled ..................... (255,034) 13.64 -------------------------------- Outstanding at December 31, 2000 ... 15,833,877 $ 25.45 Granted and assumed .......... 9,582,662 14.35 Exercised .................... (1,701,777) 4.68 Canceled ..................... (2,169,907) 22.03 -------------------------------- Outstanding at December 31, 2001 ... 21,544,855 $ 16.61 ================================
The Company has, in connection with the acquisitions of various companies, assumed the stock option plans of each acquired company, and the related options are included in the preceding table.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Options outstanding and exercisable at December 31, 2001 are as follows:
Stock options generally expire five, seven or ten years from the date of grant and generally vest ratably over four years from the date of grant and exercisable thereafter.
As part of our November 2001 Restructuring Plan (see note 11), which resulted in a wage freeze and salary reductions throughout the Company, the Board of Directors approved a special option grant for most employees where options have a two year vesting schedule beginning in January 2002. These grants, which occurred in November 2001, were for approximately 2 million shares and are included in the $4.02 to $5.00 range above.
Stock-Based Compensation Fair Value Disclosures
As permitted by SFAS 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the Company applies APB 25 and related interpretations in accounting for stock-based awards. Under APB 25, no compensation expense is recognized in the financial statements for employee stock options because the exercise price of the option equals the market price of the underlying stock on the date of grant.
The Company is required under SFAS 123 to disclose pro forma information regarding option grants made to employees based on specified valuation techniques that produce estimated compensation charges. Pro forma information under SFAS 123 is as follows:
Years ended December 31, 2001 2000 1999 ------------------------------------- Net income (loss): As reported ................ $ (77,464) $38,355 $25,334 Pro forma .................. $(137,185) $(4,113) $13,254 Basic earnings (loss) per share: As reported ................ $ (0.89) $ 0.47 $ 0.33 Pro forma .................. $ (1.58) $ (0.05) $ 0.17 Diluted earnings (loss) per share: As reported ................ $ (0.89) $ 0.44 $ 0.31 Pro forma .................. $ (1.58) $ (0.05) $ 0.16
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing with the following assumptions:
2001 2000 1999 ------------------------------- Risk-free interest rate .... 4.7% 5.1% 6.7% Expected life in years ..... 2.9 3.0 3.2 Expected volatility ........ 97.6% 85.8% 73.0% Expected dividend yield .... -- -- --
The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected volatility of the stock price. Because the Company's stock-based awards have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards to employees.
The weighted average fair value of stock options granted, calculated using the Black-Scholes option-pricing model, is $11.86, $19.03 and $6.16 for the three years ended December 31, 2001.
As required by SFAS 123, the Company recognized compensation expense related to stock options granted to non-employees of $.09 million, $.06 million, and $.06 million for each of the three years ended December 31, 2001, respectively.
Employee 401(k) Plan
TranSwitch sponsors a 401(k) plan known as the TranSwitch Corporation 401(k) Retirement Plan (the "Plan"). The Plan provides tax-deferred salary deductions for eligible employees. Employees may contribute from 1% to 20% of their annual compensation to the Plan, limited to an annual maximum amount as set periodically by the Internal Revenue Service. The Company provides matching contributions equal to 50% of the employees' deferred compensation, up to a maximum of 6% of the employee's annual compensation. All matching contributions vest immediately. The contribution expense related to the Plan amounted to $0.6 million, $0.4 million and $0.3 million for each of the three years ended December 31, 2001, respectively.
Note 10. 4 1/2% Convertible Notes due 2005 and Extraordinary Gain
In September 2000, the Company issued $460 million of 4 1/2% Convertible Notes due September 12, 2005, and received proceeds of $444 million, net of debt issuance costs. The notes are convertible, at the option of the holder, at any time on or prior to maturity, into shares of common stock at a conversion price of $61.9225 per share.
The notes are unsecured and unsubordinated obligations and rank on a parity in right of payment with all existing and future unsecured and unsubordinated indebtedness.
The Company may redeem the notes, in whole or in part, at any time on or prior to September 12, 2003 at a redemption price equal to 100 percent of the principal amount of notes to be redeemed plus accrued and unpaid interest, if any, to the date of redemption if the closing price of the Company's common stock has exceeded 150 percent of the conversion price then in effect for at least 20 trading days within a period of 30 consecutive trading days ("Provisional Redemption").
Upon any Provisional Redemption, the Company will make an additional payment with respect to the notes called for redemption in an amount equal to $135 per $1,000 principal amount of notes, less the amount of any interest actually paid on the notes before the provisional redemption date. These additional payments are made, at each holder's option, either in cash or common stock or a combination of both.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
During the second and third quarters of 2001, the Company repurchased some of its outstanding 4 1/2% Convertible Notes due September 12, 2005. The gain on these repurchases, net of deferred financing fees and income taxes, has been recorded as an extraordinary gain in the consolidated statement of operations. Details of the repurchase and resulting gain on these notes for the year ended December 31, 2001 are as follows:
Year ended December 31, 2001 ----------------- 4 1/2% Convertible Notes due 2005 repurchased at par ... $ 145,950 Write-off of related deferred financing fees ........... (4,480) Purchase price of 4 1/2% Convertible Notes due 2005 .... (106,163) --------- Gain on repurchase of notes 35,307
Income taxes on gain on repurchase of notes ............ (13,214) --------- Extraordinary gain ..................................... $ 22,093 =========
The Company has funded the repurchases of the 4 1/2% Convertible Notes due 2005 from available cash, cash equivalents and short-term investments. Refer also to note 17 - subsequent events regarding additional repurchases of these notes.
Note 11. Restructuring and Asset Impairment Charges
The Company announced restructuring plans on July 16, 2001 (the "July Plan") and November 15, 2001 (the "November Plan") due to current and anticipated business conditions. These plans resulted in the elimination of seventy-seven positions in North America and the closing of four office buildings in Canada, Massachusetts and Connecticut. A summary and explanation of the restructuring charges and outstanding liabilities are as follows:
July November Plan Plan Total -------------------------------- Restructuring Charges: Employee termination benefits ............... $1,292 $ 1,944 $ 3,236 Costs to exit facilities .................... -- 29,256 29,256 -------------------------------- Total Restructuring charges ... $1,292 $31,200 $32,492 ================================
Restructuring Liabilities:
Current ..................................... $ -- $ 2,999 $ 2,999 Long-term ................................... -- 26,925 26,925 -------------------------------- Total Restructuring Liabilities ... $ -- $29,924 $29,924 ================================
The July Plan consisted of employee termination benefits of approximately $1.3 million related solely to a workforce reduction of thirty positions in North America and across all functional areas of the Company. These employees were terminated during the third quarter of 2001 and provided severance and related benefits. As of December 31, 2001, all obligations under the July Plan have been paid.
The November Plan consisted of employee termination benefits of approximately $1.9 million related to a workforce reduction of forty-seven positions in North America and across all functional areas of the Company. These employees were terminated during the fourth quarter of 2001 and provided severance and related benefits. As of December 31, 2001, the Company has made cash payments totaling approximately $0.6 million which have been charged against the restructuring liabilities. The remaining $1.3 million in employee termination obligations under this plan is included in current restructuring liabilities on the consolidated balance sheet and is expected to be paid out during the first quarter of 2002.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
The November Plan also included the closing of two facilities in Shelton, Connecticut, one facility in Stoneham, Massachusetts and one facility in Montreal, Canada. The Company is obligated through fiscal 2017 for certain lease commitments for the facilities that were exited. The Company has secured and is in the process of negotiating sub-lease commitments with interested parties on a portion of the excess space over the next several years. The space for which there are no sub-lease commitments in place as of December 31, 2001, the Company has taken a charge of $28.6 million which represents the remaining future minimum lease payments and operating cost obligations related to these excess facilities net of future expected sublease income. Of this outstanding rent obligation, approximately $1.7 million is included in current restructuring liabilities on the consolidated balance sheets and $26.9 million is included in restructuring liabilities - long term on the consolidated balance sheets.
Excess furniture, leasehold improvements and equipment of $0.6 million was written off in conjunction with these facility closures.
During the year ended December 31, 2001, the Company also reduced the asset carrying value of a technology product license and certain tooling by approximately $1.7 million as a result of an impairment analysis performed pursuant to SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
Note 12. Earnings (Loss) Per Share
Basic earnings (loss) per share for the three years ended December 31, 2001 are as follows:
Years ended December 31, 2001 2000 1999 ----------------------------------- Net (loss) income ....................... $(77,464) $38,355 $25,334 =================================== Weighted average shares (in thousands) .. 86,904 81,681 76,676 Basic earnings per share ................ $ (0.89) $ 0.47 $ 0.33 ===================================
Diluted earnings per share for the years ended December 31, 2001, 2000, and 1999 are as follows:
(1) As the Company recorded a loss in fiscal year 2001, the assumed exercise of dilutive securities (4.3 million shares of in-the-money stock options) was not considered as they would have been anti-dilutive.
(2) For purposes of calculating the dilutive earnings (loss) per share for the year ended December 31, 2000, the assumed conversion of 4 1/2% Convertible Notes due 2005 is not taken into consideration as its effect is anti-dilutive. For the purposes of calculating diluted earnings per share had the 4 1/2% Convertible Notes due 2005 been converted, approximately $6.2 and $3.8 million of interest expense (after tax) would have been added to net income during the years ended December 31, 2001 and 2000, respectively. Also, 5,072,000 and 2,476,000 additional shares of common stock would have been assumed outstanding for the years ended December 31, 2001 and 2000, respectively.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Note 13. Commitments and Contingencies
Line of Credit
The Company had a line of credit agreement in place with Silicon Valley Bank that expired in July 2001. As the Company did not have an outstanding balance on this obligation and had sufficient cash and investments to fund operations as well as its investment and financing requirements for at least through the end of fiscal 2002, it did not renew this line of credit and was released from all its obligations, restrictions and financial covenants.
Development Agreements
From time to time, TranSwitch and its subsidiaries have entered into agreements with third parties for the development and/or licensing of products for its manufacture and sale, or the licensing of technology that may be used in the manufacture of products, for which royalties are paid based upon actual sales of these products. The Company recognized royalty expense of $0.3, $0.2 and $0.6 million in the three years ended December 31, 2001, respectively. These amounts are included in cost of revenues in the consolidated statements of operations.
Lease Agreements
The Company leases buildings and equipment at its headquarters in Shelton, Connecticut as well as at its subsidiaries worldwide. Total rental costs expensed under all operating lease agreements was $2.1, $1.3 and $1.2 million in the years ended December 31, 2001, 2000, and 1999, respectively.
Future minimum operating lease commitments, including contractually obligated building operating commitments, that have remaining, non-cancelable lease terms in excess of one year at December 31, 2001 are as follows:
2002.................................. $ 4,378 2003.................................. 4,911 2004.................................. 4,534 2005.................................. 3,797 2006.................................. 3,523 Thereafter............................ 25,449 ------- $46,592 =======
During the fiscal year ended December 31, 2001, the Company recorded a restructuring charge for the rent and operating cost commitments on excess facilities in the amount of $28.6 million (see note 11).
Note 14. Supplemental Cash Flow Information
The following represents supplemental cash flow information:
The following represents a supplemental schedule of non-cash investing and financing activities:
The Company includes capital lease obligations as part of accrued expenses on the consolidated balance sheets.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Note 15. Quarterly Information (Unaudited)
The following tables contain selected unaudited consolidated statement of operations data for each quarter of fiscal years 2001 and 2000. The Company believes that the following information reflects all normal recurring adjustments necessary for a fair presentation of the information for the periods presented. The operating results for any quarter are not necessarily indicative of results to be expected for any future period.
- -------- (1) The sum of quarterly per share amounts may not equal per share amounts reported for year-to-date periods. This is due to changes in the number of weighted average shares outstanding and the effects of rounding for each period.
Note 16. Fourth Quarter Results
In the fourth quarter of fiscal 2001, the Company announced a restructuring plan as well as a number of other charges which impacted its operating results. These charges, which are further described throughout these footnotes, included: (1) the write-down of approximately $14.5 million of excess inventory based on the Company's assessment of demand for current products, (2) the impact of approximately $31.2 million of restructuring costs of which approximately $1.8 million was related to the November 2001 workforce reduction and the remainder relating to the consolidation of four TranSwitch locations including future lease commitments, (3) a one-time non-cash charge of approximately $1.1 million to reflect the impairment of certain software, tools and licenses and (4) a non-cash charge of approximately $4.2 million (after tax) related to the valuation allowance for deferred income taxes and other income tax adjustments. Refer also to note 15 which summarizes of the Company's quarterly information.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Tabular dollars in thousands, except share and per share amounts)
Note 17. Subsequent Events
A. On January 24, 2002, ADV achieved certain milestones that had been set in its purchase agreement. As a result, TranSwitch paid $5.0 million in cash that was recorded as additional goodwill on the consolidated balance sheets.
B. On January 24, 2002, the Company pledged $1.4 million in available cash and cash equivalents as collateral for a stand-by letter of credit that guarantees certain long-term property lease obligations.
C. On February 11, 2002, the Company's Board of Directors approved a tender offer to purchase up to $200 million (the Offer Amount) aggregate principal amount of the Company's outstanding 4 1/2% Convertible Notes due 2005 at a price not greater than $700 nor less than $650 per $1,000 principal amount, plus accrued and unpaid interest thereon to, but not including, the date of the purchase. This tender offer expired at midnight on March 11, 2002 and the Company repurchased $199.9 million face value of the outstanding notes at the price of $700 per $1,000 principal amount for a cash payment of $139.9 million. Net of taxes, deferred financing costs and transaction fees, the Company expects that this transaction to result in an extraordinary gain of approximately $32.5 million which will be recorded in the first quarter of 2002. Upon completion of the tender offer, the remaining outstanding balance of the 4 1/2% Convertible Notes due 2005 is $114.1 million.
Schedule II TranSwitch Corporation Valuation and Qualifying Accounts (in thousands)
- ---------- (1) During fiscal 2001, the Company recorded a permanent charge to its inventory position for inventories which were determined to be excess. Refer to note 4 of the consolidated financial statements.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
The information required by this Item is incorporated herein by reference to the information in the sections entitled Proposal No. 1 "Election of Directors" and "Compensation and Other Information Concerning Named Executive Officers" contained in our definitive proxy statement to be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year ended December 31, 2001.
Item 11.
Item 11. Executive Compensation.
The information required by this Item is incorporated herein by reference to the information in the section entitled "Compensation and Other Information Concerning Named Executive Officers" contained in our definitive proxy statement to be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year ended December 31, 2001.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this Item is incorporated herein by reference to the information in the section entitled "Security Ownership of Certain Beneficial Owners and Management" contained in our definitive proxy statement to be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year ended December 31, 2001.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The information required by this Item is incorporated herein by reference to the information in the sections entitled "Compensation Committee Interlocks and Insider Participation" and "Certain Transactions" contained in our definitive proxy statement to be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year ended December 31, 2001.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) (1) and (2) Consolidated Financial Statements and Financial Statement Schedule
See "Index to Consolidated Financial Statements and Supplementary Data" at Item 8 to this Annual Report on Form 10-K. All other schedules are not submitted because they are either not applicable, not required or because the information is included in the Consolidated Financial Statements and Financial Statement Schedule.
(a) (3) Exhibits
2.1 Agreement and Plan of Reorganization, dated as of August 16, 2001, by and among TranSwitch, Opal Acquisition Corporation, Onex Communications Corporation and the other parties thereto (previously filed as Exhibit 2.1 to TranSwitch's registration statement on Form S-3 (File No. 333-70508) and incorporated by reference herein).
2.2 Escrow Agreement, dated as of September 21, 2001, by and among TranSwitch, the Onex stockholders and State Street Bank and Trust Company, N.A., as escrow agent (previously filed as Exhibit 2.2 to TranSwitch's registration statement on Form S-3 (File No. 333-70508) and incorporated by reference herein).
2.3 Form of Investment Agreement, dated as of September 21, 2001, by and among TranSwitch Corporation and the Onex stockholders (previously filed as Exhibit 2.4 to TranSwitch's registration statement on Form S-3 (File No. 333-70508) and incorporated by reference herein).
2.4 Form of Voting Agreement, dated as of September 21, 2001, by and among TranSwitch Corporation and the Onex stockholders (previously filed as Exhibit 2.5 to TranSwitch's registration statement on Form S-3 (File No. 333-70508) and incorporated by reference herein).
2.5 Share Purchase Agreement, dated January 18, 2001, by and among TranSwitch, Inc., and the ADV Stockholders (filed as Exhibit 2.1 to the TranSwitch registration statement on Form S-3 (File No. 333-54368) and incorporated herein by reference).
2.6 Escrow Agreement, dated January 18, 2001, by and among TranSwitch, the ADV Stockholders and the other parties thereto (filed as Exhibit 2.2 to the TranSwitch registration statement on Form S-3 (File No. 333-54368) and incorporated herein by reference).
2.7 Warranty Agreement, dated January 18, 2001, by and among TranSwitch III Inc., Robert Bousquet, and Patricia Baert (filed as Exhibit 2.3 to the TranSwitch registration statement on Form S-3 (File No. 333-54368) and incorporated herein by reference).
2.8 Guaranty, dated January 18, 2001, by and among TranSwitch and the ADV stockholders (filed as Exhibit 2.4 to the TranSwitch registration statement on Form S-3 (File No. 333-54368) and incorporated herein by reference).
2.9 Agreement and Plan of Reorganization, dated as of February 6, 2001, by and among TranSwitch Corporation, Sea Level Acquisition Corporation, Horizon Semiconductors, Inc., and certain Horizon Stockholders (filed as Exhibit 2.1 to the TranSwitch registration statement on Form S-3 (File No. 333-56740) and incorporated herein by reference).
2.10 Escrow Agreement, dated as of February 6, 2001, by and among TranSwitch Corporation and the Horizon Stockholders (filed as Exhibit 2.2 to the TranSwitch registration statement on Form S-3 (File No. 333-56740) and incorporated herein by reference).
3.1 Amended and Restated Articles of Incorporation of TranSwitch, as amended to date (previously filed as Exhibit 3.1 to TranSwitch's quarterly report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference).
3.2 By-Laws, as amended and restated, of the Company (filed herewith).
4.1 Amended and Restated Articles of Incorporation of TranSwitch, as amended to date (previously filed as Exhibit 3.1 to TranSwitch's quarterly report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference).
4.2 Specimen certificate representing the common stock of TranSwitch (previously filed as Exhibit 4.1 to TranSwitch's quarterly report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference).
4.3 2000 Stock Option Plan of TranSwitch Corporation (previously filed as Exhibit 4.2 to TranSwitch's registration statement on Form S-8 and incorporated by reference herein).
4.3 Registration Rights Agreement, dated September 21, 2001, by and among TranSwitch and the Onex stockholders (previously filed as Exhibit 2.3 to TranSwitch's registration statement on Form S-3 (File No. 333-70508) and incorporated by reference herein).
4.4 Form of Non-Qualified Stock Option Agreement under the 2000 Stock Option Plan (previously filed as Exhibit 4.3 to TranSwitch's registration statement on Form S-8 and incorporated by reference herein).
4.5 Rights Agreement, dated as of October 1, 2001, between TranSwitch Corporation and Equiserve Trust Company, N.A., which includes the form of Rights Certificate and the Summary of Rights to Purchase Preferred Shares (previously filed as Exhibit 1 to TranSwitch's registration statement No. 0-25996 on Form 8-A filed on October 2, 2001 and incorporated by reference herein).
4.6 1999 Stock Incentive Plan of Onex Communications Corporation (previously filed as Exhibit 4.2 to TranSwitch's registration statement on Form S-8 (File No. 333-70344) and incorporated by reference herein).
4.7 Form of Incentive Stock Option Agreement under the 1999 Stock Incentive Plan of Onex Communications Corporation (previously filed as Exhibit 4.3 to TranSwitch's registration statement on Form S-8 (File No. 333-70344) and incorporated by reference herein).
4.7 1995 Stock Plan of Alacrity Communications, Inc. (previously filed as Exhibit 4.2 of the TranSwitch's Registration Statement on Form S-8 (File No. 333-44032) and incorporated herein by reference).
4.8 Registration Rights Agreement, dated as of January 18, 2001, by and among TranSwitch and the ADV Stockholders (filed as Exhibit 4.1 to the TranSwitch registration statement on Form S-3 (File No. 333-54368) and incorporated herein by reference).
4.8 Form of Stock Option Agreement under the 1995 Stock Plan of Alacrity Communications, Inc. (previously filed as Exhibit 4.3 to the TranSwitch's Registration Statement on Form S-8 (File No. 333-44032) and incorporated herein by reference).
4.9 Registration Rights Agreement, dated as of February 6, 2001, by and among TranSwitch and the Horizon Stockholders (filed as Exhibit 4.1 to the TranSwitch registration statement on Form S-3 (File No. 333-56740) and incorporated herein by reference).
10.1 Third Amended and Restated 1995 Stock Option Plan as amended (previously filed as an exhibit to the TranSwitch's Definitive Proxy Statement on Schedule 14A dated April 26, 1999 and incorporated herein by reference).
10.2 1995 Employee Stock Purchase Plan (previously filed as an exhibit to the TranSwitch's Registration Statement on Form S-1 (File No. 33-91694) and incorporated herein by reference).
10.3 1995 Non-Employee Director Stock Option Plan, as amended (previously filed as an exhibit to the TranSwitch's Definitive Proxy Statement on Schedule 14A dated April 26, 1999 and incorporated herein by reference).
10.4 Form of Incentive Stock Option Agreement under the 1995 Stock Plan of the Company (previously filed as an exhibit to the TranSwitch's Registration Statement on Form S-8 (File No. 33-94324) and incorporated herein by reference).
10.5 Form of Non-Qualified Stock Option Agreement under the 1995 Stock Plan of the Company (previously filed as an exhibit to the TranSwitch's Registration Statement on Form S-8 (File No. 33-94324) and incorporated herein by reference).
10.6 1995 Employee Stock Purchase Plan Enrollment/Authorization Form of the Company (filed herewith).
10.7 Form of Non-Qualified Stock Option Agreement under the 1995 Non-Employee Director Stock Option Plan of the Company (previously filed as an exhibit to the TranSwitch's Registration Statement on Form S-8 (File No. 33-94324) and incorporated herein by reference).
10.8 Lease Agreement, as amended, with Robert D. Scinto (previously filed as an exhibit to the TranSwitch's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 and incorporated herein by reference).
21.1 Subsidiaries of the Company (filed herewith).
23.1 Consent of KPMG LLP (filed herewith).
- ---------- # Confidential treatment obtained as to certain portions.
(b) Reports on Form 8-K.
We filed with the Securities and Exchange Commission on October 2, 2001, a Current Report on Form 8-K for the September 17, 2001 event reporting the public dissemination of a press release announcing that the Company's board of directors approved a stock repurchase program for up to 10% of the Company's outstanding shares.
The Company filed with the Securities and Exchange Commission on October 2, 2001, a Current Report on Form 8-K for the September 24, 2001 event reporting the public dissemination of a press release announcing that we completed our previously announced acquisition of Onex Communications Corporation for $20 million in cash and approximately 6 million shares of TranSwitch common stock. This transaction closed on September 21, 2001.
We filed with the Securities and Exchange Commission on November 21, 2001, a Current Report on Form 8-K for the November 16, 2001 event reporting the public dissemination of a press release announcing that we had reduced our workforce by approximately 10 percent of the 460 people that we employ worldwide and that we had been named in a lawsuit filed by The Lemelson Medical, Education & Research Foundation, Limited Partnership.
(c) Exhibits
We hereby file as exhibits to this Form 10-K, those exhibits listed in Item 14 (a) (3) above.
(d) Financial Statement Schedule
TranSwitch files as a financial statement schedule to this Form 10-K, the financial statement schedule listed in Item 8 and 14(a) (2) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
March 22, 2002
TRANSWITCH CORPORATION
By: /s/ Dr. Santanu Das ------------------------------------------- Dr. Santanu Das Chairman of the Board, President and Chief Executive Officer
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned named executive officers and directors of TranSwitch Corporation, hereby severally constitute and appoint Dr. Santanu Das and Mr. Peter J. Tallian, and each of them singly, our true and lawful attorneys, with full power to them and each of them singly, to sign for us in our names in the capacities indicated below, all amendments to this report, and generally to do all things in our names and on our behalf in such capacities to enable TranSwitch Corporation to comply with the provisions of the Securities Exchange Act of 1934, as amended and all requirements of the Securities and Exchange Commission.
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.