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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10--K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-25996
TRANSWITCH CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 06-1236189
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
THREE ENTERPRISE DRIVE
SHELTON, CONNECTICUT 06484
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
TELEPHONE (203) 929-8810
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of Common Stock on February 28,
1998, as reported on the Nasdaq National Market, was approximately
$127,681,803 Shares of Common Stock held by each executive officer and
director and by each person who to the Company's knowledge owns 5% or more of
the outstanding voting stock have been excluded in that such persons may be
deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
COMMON STOCK, PAR VALUE $.001 PER SHARE, OUTSTANDING AT FEBRUARY 28, 1998:
13,283,117
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the following document are incorporated by reference in Part III of
this Form 10-K Report:
(1) Proxy Statement for Registrant's 1998 Annual Meeting of Shareholders--
Items 10, 11, 12 and 13.
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PART I
ITEM 1. BUSINESS
GENERAL
TranSwitch Corporation, a Delaware corporation established in April 1988
("TranSwitch" or the "Company"), designs, develops, markets and supports
highly integrated digital and mixed-signal semiconductor solutions for the
telecommunications and data communications markets. The Company's customers
are original equipment manufacturers (OEM's) who serve three communications
market segments: worldwide public network infrastructure, including cable
television (CATV), internet infrastructure and corporate wide area networks
(WAN).
TranSwitch's VLSI devices are compliant with asynchronous (called PDH in
Europe), synchronous optical network (SONET, SDH in Europe) and asynchronous
transfer mode (ATM) data and telecommunications transmission standards and are
designed to transparently integrate these standards. The Company's mixed-
signal and digital design capability, in conjunction with its
telecommunications systems expertise, enables the Company to determine and
implement optimal combinations of design elements for desired analog and
digital functionality. The Company believes that this approach allows its
customers to achieve faster time-to-market and to introduce systems that offer
greater functionality, improved performance, lower power dissipation and
greater reliability relative to competing discrete solutions, while reducing
system size and cost.
Statements in this Form 10-K which are not historical facts, so-called
"forward looking statements," are made pursuant to the safe harbor provisions
of Section 21 E of the Securities Exchange Act of 1934, as amended. Investors
are cautioned that all forward looking statements involve risks and
uncertainties, including those detailed in the Company's filings with the
Securities and Exchange Commission. See also "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations--Certain Factors
That May Affect Future Results."
PRODUCTS AND APPLICATIONS
TranSwitch supplies high-speed (broadband) VLSI devices to systems vendors
of public network equipment, such as multiplexers and DACS (Digital Access
Cross-connect Systems); ISP's (Internet Service Providers) and CATV systems
equipment; and local area networks (LAN) and WAN equipment, such as routers,
bridges and hubs. The Company's core competencies as a systems innovation
leader include an in-depth understanding of relevant asynchronous/PDH,
SONET/SDH and ATM standards and associated nuances, the ability to design
complex mixed-signal high-speed VLSI devices, and the capability to verify the
design against customers' requirements and standards' requirements through
analysis, simulation and certification.
The Company believes that its "chip-set" approach and broad product coverage
in all three product lines position it as a "one-stop source" for broadband
communications VLSI products. Systems vendors can mix and match TranSwitch's
VLSI devices to optimally configure a specific system. The Company's products
utilizing three technologies can be grouped synergistically, providing
seamless integration of asynchronous/PDH, SONET/SDH and ATM applications.
The prices for the Company's products typically range from $15 to $300
depending on volume, complexity and functionality.
Asynchronous/PDH Products
TranSwitch's asynchronous products provide high bandwidth connections and
can be used to configure transmission products for use in the public network,
to ease the management burden of public networks and to enable CPE (Customer
Premises Equipment) products like hubs and routers LANs and WANs to access the
public network for communication with similar products in other locations.
1
The Company's asynchronous VLSI products include devices that provide
physical interfaces for DS-series and E-series standards. This product line
also includes multiplexers, devices that combine multiple low speed lines to
form a higher speed line, and demultiplexers, which perform the reverse
function. In addition, the Company offers framers, devices that identify the
starting point of a defined bit stream, permitting a system to recognize other
bits.
SONET/SDH Products
In the SONET/SDH area, the Company offers devices that provide a direct
interface for fiber optic transmission in North America, Europe and the Far
East. The Company's "mappers" bridge the interconnection between SONET/SDH
equipment and asynchronous equipment, allowing DS-series and E-series
transmission lines to be connected with SONET/SDH lines. Asynchronous signals
can therefore be transported across the SONET/SDH network transparently.
TranSwitch's SONET/SDH products are used in Add/Drop multiplexers (ADM),
DACS and other telecommunications and data communications equipment. The
SONET/SDH products also have applications in CPE products such as routers and
LAN-switches, as well as in microwave transmission products. CATV vendors are
now using optical fiber technology based on SONET/SDH standards to upgrade
their infrastructure and provide new value-added services.
ATM Products
In the ATM area, TranSwitch offers devices that convert data communications
packets (such as those on LANs and WANs) into the cell format needed for
transmission on ATM networks, along with devices that provide ATM interfaces
to both asynchronous and SONET/SDH transmission links.
TECHNOLOGY
The Company believes that one of its core competencies is the
telecommunications and data communications knowledge and expertise of its key
executives and its engineering organization. The group possesses substantial
telecommunications and data communications design experience, as well as
extensive knowledge of relevant standards. A key aspect of "know-how" includes
not only a thorough understanding of the actual written standards promulgated,
but also an awareness of and appreciation for the nuances associated with
these standards necessary for assuring that device designs are fully
compliant. The Company's telecommunications and data communications experience
and participation in the standards development and promulgation process
provide it with significant advantages in designing semiconductor devices
meeting the evolving needs of its customers.
Complementing the Company's accumulated communications industry expertise is
its VLSI design competence. The Company's VLSI design staff has extensive
experience in designing analog and mixed-signal devices, which require a
sophisticated understanding of complex technology, as well as the specifics of
manufacturing processes and their resulting impact on device performance.
TranSwitch has also developed a large number of VLSI blocks that operate under
the demanding requirements of the telecommunications and data communications
industry. These blocks have been designed to be merged using standard
programming languages such as VHDL and M (a C-like language) to create new
devices that meet expanding customer requirements.
TranSwitch has also developed a proprietary toolset called the "Test Bench,"
which facilitates on-time development of products and ensures that products
meet customer and standards requirements. TranSwitch has also developed a
large library of reusable portable cells. In addition to standard logic
functions, the cell library consists of a large number of analog cells such as
clock-recovery functions, phase-locked-loops, and equalizers. The library also
includes key asynchronous, SONET/SDH and ATM functions. The Company is
investing significant resources in developing an architecture which allows
increased programmability. Programmability provides accelerated time-to-market
by decoupling hardware and software verification. In addition,
2
programmability permits standards upgrades and fixes to be effected more
easily. Further, customers can have the flexibility to tailor their products
to their specific requirements.
SALES AND MARKETING
TranSwitch's sales and marketing strategy is to focus on worldwide suppliers
of high-speed communications and communications-oriented equipment. These
customers are easily identifiable and include telecommunications, data
communications, CPE, computing, process control and defense equipment vendors.
The Company has established a direct sales force and a worldwide network of
independent distributors and sales representatives for marketing its products.
TranSwitch's direct sales force, technical support personnel and key
engineers work together in teams to support key customers. TranSwitch has
located technical support capabilities in key geographical locations,
including Europe and the Far East. These field sales engineers and independent
distributors and sales representatives support the Company's customers.
TranSwitch maintains a technical support team at the Company's headquarters as
a backup to the field sales engineers.
TranSwitch has established foreign distributors and sales representative
relationships in Australia, Benelux, Brazil, Canada, Finland, France, Germany,
Israel, Italy, Japan, Korea, People's Republic of China, Spain, Sweden,
Switzerland, Taiwan and the United Kingdom. The Company also sells its
products through a domestic distributor and a network of domestic sales
representatives. The Company has regional sales/technical support capabilities
in Boston, Ma., Sunnyvale, Ca., Morristown, N.J., Great Falls, Va., Brussels,
Belgium, and Taipei, Taiwan, as well as in its headquarters facility in
Shelton, Connecticut.
CUSTOMERS
Since shipping its first product in 1990, the Company has sold its products
and services to over 300 customers. The Company's customers include: public
network systems suppliers that incorporate the Company's products into
telecommunications systems; LAN and WAN equipment suppliers; ISP's;
communications test and performance measurement equipment suppliers; and
government, university and private laboratories that use the Company's
products in advanced public network and LAN/WAN developments.
In 1997, Insight Electronics, Inc. (a distributor selling to various end
users, none of which comprise more than 10% of the Company's total revenues)
and Tellabs Operations accounted for 41% and 16% of total revenues,
respectively. In 1996, ECI Telecom Ltd, Insight Electronics, Inc. and Tellabs
Operations, Inc. accounted for 22%, 16% and 14% of total revenues,
respectively. In 1995, Tellabs Operations, Inc. and Insight Electronics, Inc.
accounted for 17% and 16% of total revenues, respectively. No other customer
accounted for 10% or more of revenues during 1997, 1996, and 1995. Export
revenues represented 33%, 46%, and 38% of total revenues in 1997, 1996 and
1995, respectively. See "Note 12 of Notes to Consolidated Financial
Statements."
RESEARCH AND DEVELOPMENT
The Company believes that the continued introduction of new products in its
target markets is essential to its growth. As of December 31, 1997, the
Company had 56 full-time employees engaged in research and development
efforts. The Company currently anticipates only slight increases in its
research and development staffing in 1998. Expenditures for research and
development in 1997, 1996 and 1995 were approximately $9.2 million, $8.9
million and $6.5 million, respectively.
Currently, the Company's major development programs include new SONET/SDH
products, new ATM products and new Asynchronous/PDH products which are
targeted at end markets in the public network transmission structure, the
Internet infrastructure and the corporate wide area network (WAN).
3
PATENTS AND LICENSES
The Company has 24 patents issued and seven patent applications pending in
the U.S. Of the 24 issued patents, one is co-owned by ECI Telecom Ltd and one
is co-owned by Siemens Telecommunications Systems Ltd.. The Company has three
patents issued and 15 patent applications pending in Canada. The Company has
six patents issued in Taiwan, with one patent being co-owned by Siemens
Telecommunications Systems Ltd. The Company has three patents issued and four
patents pending in the People's Republic of China. The Company has 14 patent
applications pending in selected countries in the European Patent Office
(EPO), and one patent issued in France, Germany, and the U.K. In addition, the
Company has seven patent applications pending in Japan and four patents issued
in Israel. Further, the Company has two patent applications pending under the
Patent Cooperation Treaty (PCT) with the possibility of filing one PCT
application in the EPO, Canada, Japan and Israel and one PCT application in
Canada, the EPO and Japan. None of the Company's domestic and foreign patents
that have issued will expire in the near future. The Company's oldest patent
is not scheduled to expire for more than seven years. There can be no
assurance, however, that the claims allowed in any of the Company's existing
or future patents will provide competitive advantages for the Company's
products, will not be successfully challenged or circumvented by competitors
or that pending patent applications will ultimately issue as patents. Under
current law, patent applications in the United States are maintained in
secrecy until patents are issued and patent applications in foreign countries
are maintained in secrecy for a period after filing. The right to a patent in
the United States is attributable to the first to invent, not the first to
file a patent application. The Company cannot be sure that its product or
technologies do not infringe patents that may be granted in the future
pursuant to pending patent applications or that its products do not infringe
any patents or proprietary rights of third parties. In the event that any
relevant claims of third-party patents are upheld as valid and enforceable,
the Company could be prevented from selling its products or could be required
to obtain licenses from the owners of such patents or be required to redesign
its products to avoid infringement. There can be no assurance that such
licenses would be available or, if available, would be on terms acceptable to
the Company or that the Company would be successful in any attempts to
redesign its products or processes to avoid infringement. The Company's
failure to obtain these licenses or to redesign its products would have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company also has been granted registration of six trade or service marks
in the U.S., and it has eight more U.S. applications for trademarks awaiting
approval. The Company has also filed three trademark applications under the
European Trademark (ECT) procedure.
The Company's ability to compete depends upon its ability to protect its
proprietary information through various means, including ownership of patents,
copyrights, mask work registrations and trademarks. While no intellectual
property right of the Company has been invalidated or declared unenforceable,
there can be no assurance that such rights will be upheld in the future. The
Company believes that, in view of the rapid pace of technological change in
the semiconductor industry, the technical experience and creative skills of
its engineers and other personnel are the most important factors in
determining the Company's future technological success.
TranSwitch has entered into various license agreements for product or
technology exchange. The purpose of these licenses has, in general, been to
obtain second sources for standard products or to convey or receive rights to
certain proprietary or patented cores, cells or other technology. In March
1995, the Company entered into an agreement with StrataCom, Inc., whereby the
Company obtained the right to use intellectual property covered by two
StrataCom, Inc. patents. The Company entered into an OEM relationship with IBM
Corporation in 1994, whereby it was granted the right to purchase and resell
two ATM line interface products.
The Company sells its products into the telecommunications industry, an
industry whose products are subject to various standards which are agreed upon
by recognized industry standards committees. Where applicable, the Company
designs its product to be in conformity with these standards. The Company has
received and expects to continue to receive, in the normal course of business,
communications from third parties stating that if certain of TranSwitch's
products meet a particular standard, these products may infringe one or more
patents of that third party. After a review of the circumstances of each
communication, the Company in its discretion and upon the advice of counsel
has taken or may take in the future one of the following courses of
4
action; the Company may negotiate payment for a license under the patent or
patents that may be infringed, the Company may use its technology and/or
patents to negotiate a cross-license with the third party or the Company may
decline to obtain a license on the basis that it does not infringe the
claimant's patent or patents, or that such patents are not valid, or other
basis. There can be no assurance that licenses for any of these patents will
be available to the Company on reasonable terms, or that the Company would
prevail in any litigation seeking damages or expenses from the Company or to
enjoin the Company from selling its products on the basis of any of the
alleged infringements.
MANUFACTURING AND QUALITY
TranSwitch's manufacturing objective is to produce reliable, high quality
devices cost-competitively. To this end, the Company seeks to differentiate
itself by maximizing the reliability and quality of its products, achieving
on-time delivery of its products to its customers, minimizing capital and
other resource requirements by subcontracting capital-intensive manufacturing
and achieving a gross margin commensurate with the value of its products.
Effective June 25, 1997, the Company was registered by TUV Rheinland of
North America, Inc. as complying with the requirements of ISO-9001.
All of the Company's VLSI devices are manufactured by established
independent foundries. This approach permits the Company to focus on its
design strengths, minimize fixed costs and capital expenditures and access
diverse manufacturing technologies. Currently, the Company utilizes four
foundries to process its wafers: Texas Instruments Incorporated (TI), Symbios
Logic Inc. and LSI Logic Corporation in the U.S. and Taiwan Semiconductor
Manufacturing Company Limited (TSMC) in Taiwan. Foundries are required to have
qualified and reliable processes, high-frequency test capability, ISO-9002
qualification and quick turnaround prototyping. The selection of a foundry for
a specific device is based on availability of the required process technology
and the foundry's capability to support the particular set of tools used by
TranSwitch for that device. Currently, TI manufactures all of the Company's
BiCMOS devices. The Company entered into a foundry agreement with TI in
December 1995, pursuant to which the Company received access to TI's process
technology through 2000. The Company also has an agreement with TSMC that
guarantees the Company a minimum capacity level for four years, through 1999,
and in return the Company has agreed to purchase unutilized commitment below
an agreed minimum level. See also "Note 13 of Notes to Consolidated Financial
Statements."
There are certain significant risks associated with the Company's reliance
on outside foundries, including the lack of assured 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. In addition, the manufacture of
integrated circuits is a highly complex and technologically demanding process.
Although the Company has undertaken to diversify its sources of semiconductor
device supply and works closely with all its foundries to minimize the
likelihood of reduced manufacturing yields, the Company's foundries have from
time to time experienced 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 yields
have at times adversely affected the Company's operating results. There can be
no assurance that the Company's foundries will not experience lower than
expected manufacturing yields in the future, which could materially and
adversely affect the Company's business, financial condition and operating
results.
COMPETITION
The semiconductor industry is intensely competitive and is characterized by
price erosion, rapid technological change, shortage in fabrication capacity,
heightened international competition in many markets, and unforeseen
manufacturing yield problems. The telecommunications and data communications
industries, which are the primary target markets for TranSwitch, are also
becoming intensely competitive because of deregulation and heightened
international competition. This heightened competition is likely to result in
pricing
5
pressures on the Company's products, which could materially and adversely
affect the Company's business, financial condition and operating results.
TranSwitch believes that the principal bases of competition in the
semiconductor industry include product definition, product design, test
capabilities, reliability, functionality, time-to-market, reputation and
price. The Company believes that it competes favorably with respect to these
factors. TranSwitch also believes that its competitive strengths include the
distribution channels it has established, the Company's workforce of highly
experienced digital and mixed-signal circuit designers with strong systems
architecture skills, and its proprietary design and development tools,
including its proprietary simulations and testing software and its library of
analog and digital blocks and cells.
The ability of the Company to compete successfully in the rapidly evolving
area of high performance integrated circuit technology depends on factors both
within and outside its control, including success in designing and
subcontracting the manufacture of new products that implement new
technologies, protection of Company products by effective utilization of
intellectual property laws, product quality, reliability, price, efficiency of
production, the pace at which customers incorporate the Company's integrated
circuits into their products, success of competitors' products and general
economic conditions. Although the Company believes that it competes favorably
on the basis of functionality, reliability and price, there is no assurance
that the Company will be able to compete successfully in the future.
The Company's competition consists of suppliers of similar products from the
United States as well as other countries, including internal competition from
semiconductor divisions of vertically integrated companies like Lucent
Technologies, IBM Corporation, NEC Corporation and Siemens Corporation. New
entrants are also likely to attempt to obtain a share of the market for the
Company's current and future products. The Company's principal competitors in
the asynchronous/PDH and SONET/SDH areas are AMCC Corporation, Crystal
Semiconductor, Inc., Dallas Semiconductor Corp., EXAR Corporation, Integrated
Telecom Technology, Inc., Lucent Technologies, National Semiconductor
Corporation, PMC Sierra Corporation, Texas Instruments, Inc., Triquint
Semiconductor Inc., Vitesse Semiconductor Corp. and VLSI Technology. In
addition, there are a number of ASIC vendors, including AMI Industries, Inc.,
LSI Logic Corp., and SGS-Thompson Microelectronics, Inc. who compete with the
Company by supplying customer-specific products to OEMs. In the ATM area, the
Company's principal competitors include all the vendors mentioned above and
AMD Corporation, MMC Networks, Inc. and IDT. Numerous other domestic and
international vendors have announced plans to enter this market.
BACKLOG
As of December 31, 1997, the Company's backlog was $9.4 million, as compared
to $4.9 million as of December 31, 1996. Backlog represents firm orders
anticipated to be shipped within the next 12 months. The Company's business
and, to a large extent, that of the entire semiconductor industry is
characterized by short-term order and shipment schedules. Since orders
constituting the Company's current backlog are subject to changes in delivery
schedules or to cancellation at the option of the purchaser without
significant penalty, backlog is not necessarily an indication of future
revenue.
EMPLOYEES
As of December 31, 1997, the Company had 115 full time employees. The
Company's employees are not represented by any collective bargaining agreement
and the Company has never experienced a work stoppage. The Company believes
that its employee relationships are good.
ITEM 2. PROPERTIES
6
FACILITIES
The Company's headquarters are located in a suburban office park in Shelton,
Connecticut where it leases approximately 40,000 square feet in a four story
office building. Product development and all final inspection and shipping,
marketing and administration activities are located at this facility.
Approximately 80% of the existing space is fully utilized and the Company
believes its current space to be adequate to meet its needs for the next 12
months, although there can be no assurance that the space will be adequate or
that the Company will be able to obtain additional space on commercially
reasonable terms, if necessary. The lease is due to expire in November, 2007.
The Company also leases approximately 1,100 square feet in Research Triangle
Park, North Carolina where additional product development efforts take place.
In September, 1997 the Company leased approximately 3,200 square feet in
Stoneham, Massachusetts for product development and sales support. The Company
leases a 1,100 square foot sales and support facility in Sunnyvale,
California. The Company also maintains a small sales office in Brussels,
Belgium. In February 1996, the Company opened a new leased facility of 2,000
square feet in Taipei, Taiwan for product development and sales support.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
No matters were submitted to a vote of security holders during the three
months ended December 31, 1997.
7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been quoted on the Nasdaq National Market
tier of The Nasdaq Stock Market under the symbol "TXCC" since its initial
public offering on June 14, 1995. The following table sets forth, for the
periods indicated, the range of quarterly high and low bid information for the
Company's Common Stock as reported on the Nasdaq National Market:
HIGH BID LOW BID
-------- -------
1996
First Quarter............................................... $13.75 $ 7.88
Second Quarter.............................................. 21.63 12.44
Third Quarter............................................... 13.25 5.50
Fourth Quarter.............................................. 7.00 3.63
1997
First Quarter............................................... $ 7.63 $ 4.63
Second Quarter.............................................. 9.88 4.00
Third Quarter............................................... 12.38 8.25
Fourth Quarter.............................................. 14.25 6.82
On October 10, 1997, the Company issued 14,500 shares of Series A
Convertible Preferred Stock ("Series A Stock") to eleven accredited investors
in a private placement transaction exempt from registration under Rule 506 of
Regulation D under the Securities Act of 1933, as amended. The aggregate
consideration received by the Company for the Series A Stock was $14.5 million
in cash, or $1,000 per share. Each share of Series A Stock is convertible into
shares of Common Stock at any time at the option of the stockholder holding
such Series A Stock, subject to certain limitations, at the lesser of (i)
$10.58 per share and (ii) ninety percent (90%) of the average of the closing
bid price of the Company's Common Stock, as reported by the Nasdaq National
Market, for the ten (10) trading days immediately preceding the date written
notice of conversion is received by the Company; provided, however, that, in
no event shall the conversion price per share of Series A Stock be less than
$4.86 per share. Unless converted sooner at the option of the holders of
Series A Stock, all shares of Series A Stock will convert to Common Stock on
October 10, 2002 if, at that time, the Company's Registration Statement on
Form S-3 (Registration No. 333-40897) is in force and effect and the Company
is in compliance with the terms of the Series A Stock.
As of February 28, 1998, there were approximately 238 holders of record of
the Company's Common Stock and at least 3,000 beneficial holders, based on
information obtained from the Company's transfer agent.
The Company has never paid cash dividends on its Common Stock. The Company
currently intends to retain earnings, if any, for use in its business and does
not anticipate paying any cash dividend in the foreseeable future. In
addition, the Company's line of credit loan agreement prohibits the payment of
cash dividends without prior bank approval. Any future declaration and payment
of dividends will be subject to the discretion of the Company's Board of
Directors, will be subject to applicable law and will depend upon the
Company's results of operations, earnings, financial condition, contractual
limitations, cash requirements, future prospects and other factors deemed
relevant by the Company's Board of Directors.
8
ITEM 6. SELECTED FINANCIAL DATA
The following table includes selected consolidated financial data for each
of the five years ended December 31, 1997 which are derived from and more
fully described in the consolidated financial statements and notes included in
this report at Item 14.
Amounts presented in thousands, except per share data
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------ ------- -------
CONSOLIDATED STATEMENT OF OPERA-
TIONS DATA:
Total revenues.................... $27,084 19,650 17,466 12,101 12,018
Gross profit...................... 15,830 5,844 10,071 6,185 6,006
Net loss.......................... (1,873) (10,077) (1,773) (3,937) (1,094)
Basic loss per share (1)(2)(3).... $ (.15) ( .86) (.18) (.48)
Shares used in calculation of
basic loss per share............ 12,152 11,751 10,062 8,178
DECEMBER 31,
------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------ ------- -------
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short
term investments................. $21,618 12,688 17,250 3,352 6,702
Working capital................... 25,648 14,650 21,811 3,656 7,634
Total assets...................... 36,589 23,311 32,670 8,969 10,994
Note payable to bank.............. -- -- -- 1,191 128
Mandatorily redeemable convertible
preferred stock.................. -- -- -- 20,252 20,211
Stockholders' equity (deficit).... $30,161 17,299 26,706 (15,324) (11,445)
- --------
(1)See Note 1 of Note to Consolidated Financial Statements included in this
Report at Item 14.
(2) Gives effect to the mandatory conversion of all then outstanding Preferred
Stock into 7,009,742 shares of Common Stock on completion of the Company's
initial public offering in June, 1995. 1994 per share amount based on pro-
forma weighted average shares outstanding for 1994.
(3)Net loss per share amounts prior to 1994 are not meaningful.
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and the notes thereto included in this Report at Item 14.
OVERVIEW
TranSwitch Corporation commenced its operations in April, 1988. Since
incorporation, the Company has designed, sourced and marketed high-speed VLSI
devices for public and private network applications worldwide. The Company
shipped its first product in 1990 and has increased its volume of shipments
over the last eight years. The Company's product development efforts have been
focused on devices that meet the needs of public and private network
telecommunications and data communications equipment providers and are
compliant with established standards in these markets, including
asynchronous/PDH, SONET/SDH and the emerging ATM standards. The Company's
products are generally incorporated into original equipment manufacturer's
(OEM's) products at the design stage, which often requires significant
expenditures by the Company well in advance of substantial orders from the
customer.
The Company has not been profitable, on a yearly basis, since its inception.
As of December 31, 1997, the Company had an accumulated deficit of $30.0
million and there can be no assurance the Company will achieve profitability
in the future. The Company's operating results are subject to quarterly and
annual fluctuations as a result of a wide variety of factors that could
materially and adversely affect profitability, including but not limited to
competitive pressures on selling prices, availability and cost of
semiconductor foundry capacity and materials, fluctuations in yields, changes
in product mix, the Company's ability to introduce new products and
technologies on a timely basis, market acceptance of products of both the
Company and its customers, scheduling of orders by its customers, decisions by
customers to withhold or delay orders, fluctuations of inventory cycles in the
industry, foreign sales and currency fluctuations, the level of orders that
are received and can be shipped in a quarter and whether the Company's
customers buy through a distributor or directly from the Company. See "Certain
Factors that May Affect Future Results."
The Company recognizes product revenues upon shipment to customers. Sales to
certain distributors are made under distributor agreements which provide
certain price protection and return and allowance rights to the distributor.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Total Revenues. The Company derives its revenues principally from the sales
of its products. In 1997, the Company reported revenues of $27.1 million, an
increase of 38.0% over 1996. The increase was primarily in product revenues as
this was the Company's focus. The Company did not derive any revenue in 1997
attributable to product license and royalty fees. In December 1995, the
Company repurchased from Texas Instruments its license agreement (the "TI
License") which was the sole source of license and royalty fees in 1995. In
1996, the Company reported revenues of $19.7 million, an increase of 13.0%
over 1995. This increase was primarily due to the continued increase of
product revenues which grew to 97.9% of total revenues in 1996.
In 1997, Insight Electronics, Inc. (a distributor selling to various end
users, none of which comprise more than 10% of the Company's total revenues)
and Tellabs Operations, Inc. accounted for 41% and 16% of total revenues,
respectively. In 1996, ECI Telecom, Ltd., Insight Electronics, Inc. and
Tellabs Operations, Inc. accounted for 22%, 16% and 14% of total revenues,
respectively. In 1995, Tellabs Operations, Inc. and Insight Electronics, Inc.
accounted for 17% and 16% of total revenues, respectively. No other customer
accounted for more than 10.0% of the Company's total revenues during these
periods.
10
Foreign sales, primarily consisting of sales to customers in Europe, the
Middle East and the Far East, constituted 33%, 46% and 38% of total revenues
in 1997, 1996 and 1995, respectively. All sales are denominated in U.S.
dollars. The Company anticipates that international revenues will continue to
represent a significant portion of total revenues, particularly as the Company
opens direct sales offices in foreign countries. The Company maintains a sales
support office in Europe and one in the Far East. A significant portion of the
Company's total revenues may be subject to risks associated with foreign
sales, including 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, and potentially adverse tax consequences. In particular,
sales to Korea and other Pacific Rim countries may be impacted by the current
financial instability plaguing these nations. The currency fluctuations and
difficulty of obtaining loans from unstable banking and other financial
institutions in the Far East may cause the Company's customers in that region
to delay or reduce their orders.
Product revenues, net. In 1997, product revenues grew 40.1% to $26.9 million
from $19.2 million in 1996. This growth was driven by a broad strength across
all of the Company's product lines. In 1996, product revenues grew 16.8% to
$19.2 million from $16.5 million in 1995. This growth was primarily driven by
increased sales of SONET/SDH products. Revenues from ATM products as a portion
of total product revenues grew significantly both in absolute dollars and as a
percentage of total revenues during 1995 as systems manufacturers designed
products incorporating the new ATM standard and the Company introduced new ATM
VLSI devices.
Gross profit. Gross profit is derived from product sales. Cost of products
sold includes the costs of production of finished semiconductors produced by
third-party vendors, direct and indirect costs associated with procurement,
testing and other quality assurance procedures followed by the Company,
product royalty fees and the amortization of product licenses. Gross margin in
1997 increased to 58.4%. The increase was due to the lack of the TI License
expense recognized in 1996 and the growth in total volumes. Gross margin in
1996 decreased to 29.7% of total revenues from 57.6% in 1995 due primarily to
the write down of the TI License in the fourth quarter of 1996. The TI License
was written down to its net realizable value as the incremental revenue which
was originally forecast did not materialize.
In 1997, gross profit increased to $15.8 million, a function of the increase
in overall volume and the lack of the TI License expense recognized in 1996.
In 1996, product gross profit decreased to $5.8 million from $9.6 million in
1995, as the Company recognized $3.1 million of the cost of repurchasing the
TI License in cost of sales. In the fourth quarter of 1996, the Company
reviewed the drop in product revenue that occurred in the third and fourth
quarters and as a result determined that the originally forecasted revenues
were not going to materialize. Also in the cost of sales is the write down of
approximately $600 thousand of ATM product inventory which was primarily
related to those specific products for which there was a significant decline
in revenue the last two quarters of the year.
Research and development. In 1997, research and development expenditures
were $9.2 million, or 33.9% of total revenues, an increase of 3.3% over 1996.
In 1996, research and development expenditures were $8.9 million, or 45.3% of
total revenues, an increase of 34.0% over 1995. The increase was primarily
attributable to increases in staff and in non-recurring engineering charges
related to the introduction of new products during 1996. The Company believes
that the continued introduction of new products is essential to its
competitiveness and is committed to continued investment in research and
development. The Company believes that its research and development expenses
will increase in absolute dollars in the future as it continues to add
products to all of its product lines.
Marketing and sales. In 1997, marketing and sales expense increased 22.5% to
$6.7 million or 24.7% of total revenues compared to 1996. The increase is the
result of the increase in variable commissions on the increased volume as well
as an increase in staff in this area. In 1996, marketing and sales expense
increased 26.0% to $5.5 million or 27.8% of total revenues, from $4.3 million,
or 24.8% of total revenues in 1995. During 1995, the Company added new staff
in this area, opened a new sales office in Sunnyvale, California and Taipei,
Taiwan, and expanded its manufacturing representative coverage. The Company
anticipates that it will
11
continue to incur higher marketing and sales expenses in absolute dollars as
it expands its marketing and sales efforts.
General and administrative. In 1997, general and administrative expenses
increased 2.6% to $2.3 million over 1996 or 8.5% of total revenues. In 1996,
general and administrative expenses increased 51.4% to $2.2 million or 11.2%
of total revenues from $1.5 million or 8.0% of total revenues in 1995.
Included in the 1997 and 1996 expense is $225 thousand and $195 thousand,
respectively of non-cash expense related to the recognition of compensation
expense under SFAS No. 123 using a fair value approach to non-employee stock
option grants, and the remaining increase is attributed to the legal and
investor relations expenses required by the Company's being public for the
full year in 1996 versus 1995, in which the Company was a public company for
approximately six months.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations and met its capital requirements
since incorporation in 1988 primarily through cash generated from its
operations, private placements of preferred stock, and borrowings under a
working capital line of credit, and equipment financing line of credit from
Silicon Valley Bank. The Company completed an initial public offering by July
13, 1995 and raised a total of $24.0 million, including $3.1 million from the
exercise of an over-allotment option of 375,000 shares granted to the
Underwriters of the initial public offering. On October 10, 1997, the Company
received net proceeds of $13.7 million in cash in connection with a private
placement of its Series A Convertible Preferred Stock.
The Company's principal sources of liquidity as of December 31, 1997
consisted of $21.6 million in cash and short-term investments and $8.0 million
available under the Company's working capital line of credit and equipment
line of credit provided by Silicon Valley Bank. As of December 31, 1997 the
Company had no outstanding balance under these lines of credit. Pursuant to
the working capital and equipment financing agreements with Silicon Valley
Bank, the Company is restricted from further pledging its assets or granting
additional security interests in such assets.
In 1997, the Company used $2.0 million in cash for operating activities, the
result of a loss of $1.9 million, inclusive of non-cash charges of $1.8
million for depreciation and amortization, an increase of $2.9 million in
accounts receivable and inventory and a corresponding increase of $1.6 million
in accrued expenses. In 1996, the Company used $2.2 million in cash for
operating activities, the result of a loss of $10.1 million, offset by non-
cash charges of $2.2 million for depreciation and amortization, $3.1 million
write-down of the TI License, a decrease of $2.5 million in accounts
receivables and the remainder in other working capital items. In 1995 the
Company used $4.9 million of cash for operating activities to finance an
increase of $3.1 million in accounts receivable, a result of the growth in
total revenues, as well as a $1.4 million increase in inventories to support
the growth in shipments of products, while it sustained a loss of $1.8
million. The increase of $0.7 million in accounts payable was primarily due to
the increase in inventory.
In 1997, 1996 and 1995, the Company paid $0.7 million, $0.4 million and $2.1
million to Texas Instruments. The Company will make a minimum cash payment of
$1,250,000 to Texas Instruments in 1998 under the TI License, in addition to
incremental royalties based upon exceeding certain level of sales volume. The
Company anticipates that it will fund such payment from existing cash and
short term investments. See "Note 13 of Notes to Consolidated Financial
Statements." Capital expenditures, including purchases of computer equipment,
test equipment, furniture and fixtures and software, were $2.7 million in
1997, $1.9 million in 1996 and $1.3 million in 1995. In 1997, they were funded
from existing cash and short term investments. In 1996 and 1995, they were
funded from existing cash and by funds generated in the initial public
offering.
Net cash provided by financing activities consists primarily of proceeds
from the exercise of stock options and warrants of $0.7, $0.3 and $0.3 million
in 1997, 1996 and 1995, respectively, the gross proceeds from the issuance of
common stock for $24.0 million in 1995 and the gross proceeds from the
issuance of preferred stock of $14.5 million in 1997. In June 1995, the
Company repaid all outstanding notes payable of $1.2 million to Silicon Valley
Bank.
12
The Company believes that its existing cash resources and cash generated
from operations will fund necessary purchases of capital equipment and provide
adequate working capital through the end of 1998. However, there can be no
assurance that events in the future will not require the Company to seek
additional capital sooner or, if so required, that such capital will be
available on terms favorable or acceptable to the Company, if at all.
Inflation has not had a significant impact on the Company's operations.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by the Company, statements made by
its employees or information included in its filings with the Securities and
Exchange Commission (including this Form 10-K) may contain statements which
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. In particular, statements in "Item 1.
Business" relating to product introductions and the availability of third
party VLSI fabrication facilities, in "Item 2. Properties" concerning the
adequacy of the Company's current facility space, and in "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations"
relating to anticipated levels of contract revenues and license and royalty
fees, the anticipated level of foreign sales, anticipated increases in
research and development and sales and marketing expenses, and the
availability of capital for working capital and for the purchase of capital
equipment, may be forward-looking statements. The Company's 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 the Company's filings with the Securities
and Exchange Commission.
The Company's future results are subject to substantial risks and
uncertainties. The Company currently relies on four third-party VLSI
fabrication foundries to manufacture its products. There are significant risks
associated with this reliance on outside foundries, including the lack of
assured water 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,
among others. Also, the Company relies on certain intellectual property
protections to preserve its intellectual property rights. Any invalidation of
the Company's intellectual property rights or lengthy and expensive defense of
those rights could have a material adverse affect on the Company. The
development of new technologies, commercialization of those technologies into
products, and market acceptance and customer demand for those products are
critical to the Company's success. Successful product development and
introduction depend upon a number of factors, including accurate new product
definition, timely completion and introduction of new product designs,
availability of foundry capacity, achievement of manufacturing yields, market
acceptance of the Company's products and its customers' products, the ability
to continue to attract, retain and motivate key management and technical
personnel, such as experienced circuit designers and systems applications
engineers, and the ability to accurately specify and certify the conformance
of its products to applicable standards and to develop its products in
conformance with customer standards. The Company believes that factors
affecting its ability to achieve market acceptance of its products include
product performance, time to market, price and other factors. The
semiconductor industry is intensely competitive and is characterized by price
erosion, rapid technological change, shortage in fabrication capacity,
heightened international competition, and unforeseen manufacturing yield
problems. The telecommunications and data communications markets, which are
the Company's primary target markets, are also becoming intensely competitive.
Certain current and potential competitors of the Company are more established,
benefit from greater market recognition, and have substantially greater
financial, development, manufacturing and marketing resources than the
Company. Competitive pressures or other factors could result in significant
price erosion that could have a material adverse effect on the Company's
results of operations. The Company derives a significant
13
portion of its total revenues from foreign sales. Foreign sales are subject to
significant risks, including unexpected changes in legal and regulatory
requirements and policy changes affecting the Company's 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 the Company's
intellectual property and potentially adverse tax consequences. In particular,
sales to Korea and other Pacific Rim countries may be impacted by the current
financial instability plaguing these nations. The currency fluctuations and
difficulty of obtaining loans from unstable banking and other financial
institutions in the Far East may cause the Company's customers in that region
to delay or reduce their orders. Historically, a relatively small number of
customers have accounted for a significant portion of the Company's total
revenues. Loss of, or a decrease in orders from any one or more of the
Company's customers could have a material adverse effect on the Company's
results of operations.
The Company has created a committee to study the Year 2000 issue and take
actions to understand the nature and extent of work required to make its
products, systems and infrastructure Year 2000 compliant. The Company uses a
number of computer software programs and operating systems in its internal
operations, including applications in manufacturing, material planning,
product development, financial business systems and various administrative
functions. To the extent that these software applications contain source code
that is unable to appropriately interpret the upcoming year "2000", some level
of modification or possibly replacement of such source code or applications
will be necessary. The Company continues to evaluate the estimated costs
associated with these efforts based on actual experience. While these efforts
will involve some additional costs, the Company believes, based on available
information, that it will be able to manage its total Year 2000 transition
without material adverse effect on its business, financial condition or
operating results.
The Company's quarterly and annual operating results are affected by a wide
variety of factors that could materially adversely affect revenues and
profitability, including: competitive pressures on selling prices; the timing
and cancellation of customer orders; the timing and provision of pricing
protections and returns from certain distributors; availability of foundry
capacity and raw materials; fluctuations in yields; changes in product mix;
the Company's ability to introduce new products and technologies on a timely
basis; introduction of products and technologies by the Company's competitors;
market acceptance of the Company's and its customers' products; the level of
orders received that can be shipped in a quarter; the amount and timing of
recognition of non-recurring engineering revenue; the timing of investments in
research and development, including tooling expenses associated with product
development and pre-production; and whether the Company's customers buy
directly from the Company or from a distributor. Sudden shortages of raw
materials or production capacity constraints can lead producers to allocate
available supplies or capacity to customers with resources greater than those
of the Company, which could interrupt the Company's ability to meet its
production obligations. Historically, average selling prices in the
semiconductor industry have decreased over the life of a product, and as a
result, the average selling prices of the Company's products may be subject to
significant pricing pressures in the future. The Company's business is
characterized by short-term orders and shipment schedules, and customer orders
typically can be canceled or rescheduled without significant penalty to the
customer. Due to the absence of substantial noncancellable backlog, the
Company typically plans its production and inventory levels based on internal
forecasts of customer demand, which are highly unpredictable and can fluctuate
substantially. Because the Company is continuing to increase its operating
expenses for personnel and new product development and for inventory in
anticipation of increasing sales levels, operating results would be adversely
affected if increased sales are not achieved. In addition, the Company is
limited in its ability to reduce costs quickly in response to any revenue
shortfalls. From time to time, in response to anticipated long lead times to
obtain inventory and materials from its foundries, the Company may order in
advance of anticipated customer demand, which might result in excess inventory
levels if expected orders fail to materialize or other factors render the
customer's product less marketable. As a result of the foregoing and other
factors, the Company may experience material fluctuations in future operating
results on a quarterly or annual basis which could materially and adversely
affect its business, financial condition and operating results.
14
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is contained in the financial
statements and schedule set forth in Item 14 (a) of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There has been no change of accountants nor any disagreements with
accountants on any matter of accounting principles or practices or financial
statement disclosure required to be reported under this Item.
15
PART III
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 "Election of Directors," "Occupations
of Directors and Executive Officers," and "Compensation and Other Information
Concerning Directors and Officers" contained in the Company's 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, 1997.
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 Directors and Officers" contained in the Company's 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, 1997.
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 "Management and Principal
Stockholders" contained in the Company's 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, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
16
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Consolidated Financial Statements
For the following financial information included herein, see Index on page
F-1:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1997 and December 31, 1996
Consolidated Statements of Operations for each of the years in the three
year period ended December 31, 1997.
Consolidated Statements of Stockholders' Equity (Deficit) for each of the
years in the three year period ended December 31, 1997.
Consolidated Statements of Cash Flows for each of the years in the three
year period ended December 31, 1997.
Notes to Consolidated Financial Statements
2. Financial Statement Schedule
The following financial statement schedule is included herein:
Schedule II Valuation and Qualifying Accounts
All other schedules are not submitted because they are not applicable,
not required or because the information is included in the Consolidated
Financial Statements or Notes to Consolidated Financial Statements.
3. Exhibits
EXHIBIT
NUMBER DESCRIPTION
-------- -----------
3.2* Amended and Restated Certificate of Incorporation of the Company
3.3* By-laws, as amended and restated, of the Company
4.1* Specimen certificate representing the Common Stock
4.2* Fourth Amended and Restated Registration Rights Agreement
4.3+ Certificate of Designations, Preferences and Rights of Series A
Preferred Stock
4.4+ Form of Stock Purchase Agreement, dated October 10, 1997 among the
Company and the purchasers of Series A Convertible Preferred Stock
10.1* 1989 Stock Option Plan
10.2++ Second Amended and Restated 1995 Stock Plan
10.3* 1995 Employee Stock Purchase Plan
10.4* 1995 Non-Employee Director Stock Option Plan
10.5* Form of Incentive Stock Option Agreement for 1989 Stock Option Plan
10.6* Form of Non-Qualified Stock Option Agreement for 1989 Stock Option
Plan
10.7*** Form of Incentive Stock Option Agreement under the 1995 Stock Plan
of the Company
10.8*** Form of Non-Qualified Stock Option Agreement under the 1995 Stock
Plan of the Company
10.9*** 1995 Employee Stock Purchase Plan Enrollment/Authorization Form of
the Company
10.10*** Form of Non-Qualified Stock Option Agreement under the 1995 Non-
Employee Director Stock Option Plan of the Company
#10.11* Agreement with Texas Instruments Incorporated
10.12* Authorized Distributor Agreement with Insight Electronics, Inc.
10.13* Development Agreement with Connecticut Innovations, Incorporated
10.14** Lease Agreement, as amended, with Robert D. Scinto
10.15+++ Amended and Restated Promissory Note (Working Capital Line of
Credit) with Silicon Valley Bank
17
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.16+++ Amended and restated Promissory Note (Equipment Line of Credit)
with Silicon Valley Bank
10.17* Commitment Letter, as amended, from Silicon Valley Bank
10.18* Security Agreement with Silicon Valley Bank
10.19+++ Silicon Valley Bank Loan Modification Agreement
10.20* Development and License Agreement with Adaptive Corporation
10.21* OEM Agreement for Acquisition of IBM Products with International
Business Machines Corporation
#10.22* License Agreement with StrataCom, Inc.
#10.23**** Agreement with Texas Instruments Incorporated
#10.24**** Integrated Circuit Foundry Agreement with Texas Instruments
Incorporated
21.1** Subsidiary of the Company
23.1** Consent of KPMG Peat Marwick LLP
27.1** Financial Data Schedule
- --------
# Confidential treatment obtained as to certain portions.
* Previously filed as an exhibit to the Company's Registration Statement on
Form S-1 (File No. 33-91694) and incorporated herein by reference.
+ Previously filed as an exhibit to the Company's Registration Statement on
Form S-3 (File No. 333-40897) and incorporated herein by reference.
++ Previously filed as an exhibit to the Company's Form 10-K for the year
ended December 31, 1996 and incorporated herein by reference.
+++ Previously filed as an exhibit to the Company's Form 10-Q for the quarter
ended September 30, 1997 and incorporated herein by reference.
** Filed herewith.
*** Previously filed as an exhibit to the Company's Registration Statement on
Form S-8 (File No. 33-94324) and incorporated herein by reference.
**** Previously filed as an exhibit to the Company's Annual Report of Form 10-
K for the fiscal year ended December 31, 1995
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the fourth quarter
ended December 31, 1997. On February 13, 1998, the Company filed a Form 8-K
reporting its unaudited financial results for its fourth quarter and the
fiscal year ended December 31, 1997.
(c) Exhibits
The Company hereby files as exhibits to this Form 10-K, those exhibits
listed in Item 14 (a) (3) above.
(d) Financial Statement Schedule
The Company hereby files as a financial statement schedule to this Form 10-
K, the financial statement schedule listed in Item 14(a) (2) above.
18
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 27, 1998
TranSwitch Corporation
/s/ Dr. Santanu Das
By: _________________________________
Name: Dr. Santanu Das
Title: Chairman of the Board
President and Chief
Executive Officer
POWER OF ATTORNEY AND SIGNATURES
WE, THE UNDERSIGNED OFFICERS AND DIRECTORS OF TRANSWITCH CORPORATION, HEREBY
SEVERALLY CONSTITUTE AND APPOINT SANTANU DAS AND MICHAEL MCCOY, 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.
NAME AND SIGNATURE TITLE(S) DATE
------------------ -------- ----
/s/ Dr. Santanu Das Chairman of the Board, March 27, 1998
____________________________________ President, and Chief
DR. SANTANU DAS Executive Officer
(principal executive
officer)
/s/ Michael F. Stauff Senior Vice President, Chief March 27, 1998
____________________________________ Financial Officer and
MICHAEL F. STAUFF Treasurer (principal
financial and accounting
officer)
/s/ Dr. Steward S. Flaschen Director March 27, 1998
____________________________________
DR. STEWARD S. FLASCHEN
/s/ Dr. Charles Lee Director March 27, 1998
____________________________________
DR. CHARLES LEE
19
NAME AND SIGNATURE TITLE(S) DATE
------------------ -------- ----
/s/ Dr. Ljubomir Micic Director March 27, 1998
____________________________________
DR. LJUBOMIR MICIC
/s/ Dr. Albert E. Paladino Director March 27, 1998
____________________________________
DR. ALBERT E. PALADINO
/s/ Erik van der Kaay Director March 27, 1998
____________________________________
ERIK VAN DER KAAY
20
TRANSWITCH CORPORATION AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Auditors........................................... F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996............. F-3
Consolidated Statements of Operations for each of the years in the three-
year period ended
December 31, 1997....................................................... F-4
Consolidated Statements of Stockholders' Equity for each of the years in
the three-year period ended December 31, 1997........................... F-5
Consolidated Statements of Cash Flows for each of the years in the three-
year period ended December 31, 1997..................................... F-6
Notes to Consolidated Financial Statements............................... F-7
F-1
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
TranSwitch Corporation:
We have audited the accompanying consolidated balance sheets of TranSwitch
Corporation and subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of TranSwitch
Corporation and subsidiary as of December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the years in the three-
year period ended December 31, 1997, in conformity with generally accepted
accounting principles.
Stamford, Connecticut
February 4, 1998
F-2
TRANSWITCH CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31,
------------------
1997 1996
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................ $ 20,508 $ 3,911
Short-term investments................................... 1,110 8,777
Accounts receivable, less allowance for doubtful accounts
of $218 in 1997 and $140 in 1996........................ 4,528 2,893
Inventories, net......................................... 4,812 3,524
Prepaid expenses and other current assets................ 815 305
-------- --------
Total current assets................................... 31,773 19,410
Property and equipment, net................................ 3,816 2,647
Product licenses, net...................................... 1,000 1,254
-------- --------
Total assets........................................... $ 36,589 $ 23,311
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $ 1,350 $ 1,805
Accrued expenses......................................... 1,235 724
Accrued compensation..................................... 993 535
Warranty reserve......................................... 532 286
Sales allowance reserve.................................. 649 356
Royalty payable.......................................... 299 209
Product license fee payable, current portion............. 1,067 845
-------- --------
Total current liabilities.............................. 6,125 4,760
Product license fee payable, less current portion.......... 303 1,252
Commitments and contingencies (Note 13)
Stockholders' equity:
Convertible Preferred Stock $0.01 par value; authorized
15,000 shares; issued and outstanding 14,500 shares in
1997; none in 1996...................................... 14,357 --
Common Stock $.001 par value; authorized 25,000,000
shares; issued and outstanding 12,318,271 shares in
1997; 11,912,486 shares in 1996......................... 12 12
Additional paid-in capital............................... 45,753 45,375
Accumulated deficit...................................... (29,961) (28,088)
-------- --------
Total stockholders' equity............................. 30,161 17,299
-------- --------
Total liabilities and stockholders' equity............. $ 36,589 $ 23,311
======== ========
See accompanying notes to consolidated financial statements.
F-3
TRANSWITCH CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
--------------------------
1997 1996 1995
------- -------- -------
Revenues:
Product revenues, net............................ $26,930 $ 19,236 $16,464
Research and development contracts............... 154 414 877
License and royalty fees......................... -- -- 125
------- -------- -------
Total revenues................................. 27,084 19,650 17,466
------- -------- -------
Cost of revenues:
Cost of products sold............................ 11,254 10,615 6,913
Write-down of product license.................... -- 3,128 --
Cost of research and development contracts....... -- 63 482
------- -------- -------
Total cost of revenues......................... 11,254 13,806 7,395
------- -------- -------
Gross profit....................................... 15,830 5,844 10,071
------- -------- -------
Operating expenses:
Research and development......................... 9,194 8,928 6,660
Marketing and sales.............................. 6,681 5,454 4,329
General and administrative....................... 2,288 2,229 1,472
------- -------- -------
Total operating expenses....................... 18,163 16,611 12,461
------- -------- -------
Operating loss..................................... (2,333) (10,767) (2,390)
------- -------- -------
Interest income (expense):
Interest income.................................. 641 819 664
Interest expense................................. (181) (129) (47)
------- -------- -------
Interest income, net........................... 460 690 617
------- -------- -------
Net loss........................................... $(1,873) $(10,077) $(1,773)
======= ======== =======
Basic loss per share (Note 10)..................... $ (.15) $ (.86) $ (.18)
======= ======== =======
See accompanying notes to consolidated financial statements.
F-4
TRANSWITCH CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
COMMON STOCK
-----------------
CONVERTIBLE ADDITIONAL
PREFERRED PAID-IN ACCUMULATED
SHARES AMOUNT STOCK CAPITAL DEFICIT TOTAL
---------- ------ ----------- ---------- ----------- --------
Balance at December 31,
1994................... 1,071,992 $ 1 $ -- $ 913 $(16,238) $(15,324)
Shares of common stock
issued upon exercise of
stock options and
warrants............... 546,871 1 -- 288 -- 289
Common stock offered by
the company in initial
public offering........ 2,875,000 3 -- 23,169 -- 23,172
Conversion of preferred
stock to common stock.. 7,009,743 7 -- 20,235 -- 20,242
Compensation related to
issuance of stock op-
tions.................. -- -- -- 100 -- 100
Net loss................ -- -- -- -- (1,773) (1,773)
---------- ---- ------- ------- -------- --------
Balance at December 31,
1995................... 11,503,606 12 -- 44,705 (18,011) 26,706
Shares of common stock
issued upon exercise of
stock options and
warrants............... 408,880 -- -- 319 -- 319
Compensation related to
issuance of stock op-
tions.................. -- -- -- 351 -- 351
Net loss................ -- -- -- -- (10,077) (10,077)
---------- ---- ------- ------- -------- --------
Balance at December 31,
1996................... 11,912,486 12 -- 45,375 (28,088) 17,299
Shares of common stock
issued upon exercise of
stock options and
warrants............... 405,785 -- -- 699 -- 699
Issuance of convertible
preferred stock, net of
issuance costs......... -- -- 12,886 770 -- 13,656
Deemed dividend on
convertible preferred
stock.................. -- -- 1,471 (1,471) -- --
Compensation related to
issuance of stock op-
tions.................. -- -- -- 380 -- 380
Net loss................ -- -- -- -- (1,873) (1,873)
---------- ---- ------- ------- -------- --------
Balance at December 31,
1997................... 12,318,271 $ 12 $14,357 $45,753 $(29,961) $ 30,161
========== ==== ======= ======= ======== ========
See accompanying notes to consolidated financial statements.
F-5
TRANSWITCH CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
-------- --------- --------
Cash flows from operating activities:
Net loss...................................... $ (1,873) $ (10,077) $ (1,773)
-------- --------- --------
Adjustments required to reconcile net loss to
cash flows from operating activities:
Depreciation and amortization............... 1,807 2,195 802
Write-down of product license............... -- 3,128 --
Stock compensation expense.................. 380 351 100
Changes in assets and liabilities:
Decrease (increase) in accounts receiv-
able..................................... (1,635) 2,487 (3,084)
(Increase) in inventories................. (1,288) (753) (1,440)
Decrease (increase) in prepaids and other
current assets........................... (510) 194 (250)
Increase (decrease) in accounts payable... (455) (216) 742
Increase (decrease) in accrued expenses
and other liabilities.................... 1,598 516 13
-------- --------- --------
Total adjustments....................... (103) 7,902 (3,117)
-------- --------- --------
Net cash used in operating activities... (1,976) (2,175) (4,890)
-------- --------- --------
Cash flows from investing activities:
Purchase of product licenses.................. (3) (445) (2,176)
Proceeds from the sale of property and equip-
ment......................................... -- -- 3
Capital expenditures.......................... (2,719) (1,892) (1,309)
Purchases of short-term investments........... (8,615) (24,057) (5,620)
Proceeds from sale of short-term investments.. 16,282 18,900 2,000
-------- --------- --------
Net cash provided by (used in) investing
activities............................. 4,945 (7,494) (7,102)
-------- --------- --------
Cash flows from financing activities:
Payments on borrowings........................ -- -- (1,191)
Payments on product license obligations....... (727) (369)
Proceeds from the exercise of stock options
and warrants................................. 699 319 289
Proceeds from the issuance of common stock,
net.......................................... -- -- 23,172
Proceeds from the issuance of convertible
preferred stock, net of issuance costs....... 13,656 -- --
-------- --------- --------
Net cash provided by (used in) financing
activities............................. 13,628 (50) 22,270
-------- --------- --------
Increase (decrease) in cash and cash equiva-
lents.......................................... 16,597 (9,719) 10,278
Cash and cash equivalents at beginning of year.. 3,911 13,630 3,352
-------- --------- --------
Cash and cash equivalents at end of year........ $ 20,508 $ 3,911 $ 13,630
======== ========= ========
Supplemental disclosure of cash flows informa-
tion:
Cash paid for interest........................ $ 181 $ 129 $ 47
Supplemental schedule of non-cash financing ac-
tivities:
Obligations for purchase of product licenses.. $ -- $ 134 $ 2,399
See accompanying notes to consolidated financial statements.
F-6
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
TranSwitch Corporation (the "Company") was incorporated in Delaware on April
26, 1988. On January 28, 1994, the Company formed TranSwitch Europe N.V./S.A.,
a wholly-owned subsidiary located in Brussels, Belgium. The Company designs,
develops, markets and supports highly integrated digital and mixed-signal
semiconductor solutions for the telecommunications and data communications
markets.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary. All intercompany accounts and transactions
have been eliminated in consolidation.
Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year's presentation.
Cash Equivalents
Cash equivalents of $18,668 and $2,989 at December 31, 1997 and 1996,
respectively, consist of certificates of deposit, U.S. Treasury Bills,
commercial paper and U.S. Agency notes. For purposes of the statements of cash
flows, the Company considers all certificates of deposit, U.S. Treasury Bills,
commercial paper and U.S. Agency notes with original maturities of three
months or less to be cash equivalents.
Investment Securities
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
115 "Accounting for Certain Investments in Debt and Equity Securities." Under
SFAS No. 115, the Company's short-term investments were classified as
available-for-sale and were recorded at fair market value in the accompanying
balance sheet.
Inventories
Inventories are carried at the lower of cost (on a first-in, first-out
basis) or estimated net realizable value.
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation.
Depreciation of property and equipment is provided on the half-year convention
method based on the related assets estimated useful lives, ranging from three
to seven years. Depreciation of semiconductor tooling costs is provided on the
straight-line method using the lesser of three years or the life of the
related semiconductor it produces. Repairs and maintenance are charged to
operations as incurred.
Product Licenses
Product licenses are amortized over the lesser of the Company's estimated
product sales volume or the straight-line method over three to five years.
Subsequent to its acquisition, the Company continually evaluates whether
events and circumstances have occurred that indicate the remaining estimated
useful life of a product license may warrant revision or that the remaining
balance of a product license may not be recoverable. When factors indicate
that a product license should be evaluated for possible impairment, the
Company uses an estimate of the related product licenses' undiscounted future
cash flows over the remaining life of the asset in measuring whether the
product license is recoverable. Any impairment is measured against discounted
cash flows.
F-7
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Revenue Recognition
Sales of product are recognized upon shipment to distributors and original
equipment manufacturers. Sales to certain distributors are made under
distributor agreements which provide the distributor with certain price
protection and return and allowance rights. Revenues are reduced for estimated
price protection and returns based upon historical experience.
Revenues from development contracts are derived from agreements with third
parties. These agreements provide for payments to the Company for the
development of new products and reimbursement for expenses incurred based on
the achievement of certain milestones. Revenues are recognized as the related
costs are incurred over the term of the agreement. The Company primarily
retains exclusive ownership of technology developed in connection with the
design of semiconductors. Technology developed in connection with customized
computer boards generally transfers to third parties.
The Company recognizes royalties and license fees when its obligations under
the license and royalty agreements are fulfilled and when payment has been
received or is reasonably assured.
Concentration of Credit Risk
The Company sells its products to customers in the United States and
overseas. Credit evaluations are done on all new customers and periodically
evaluated for existing customers. The Company establishes an allowance for
doubtful accounts based upon factors surrounding the credit risk of specific
customers, historical trends and other information.
Product Warranties
The Company provides for expected costs that may be incurred under its
product warranties. Estimated warranty costs are accrued as products are sold
and charged to cost of revenues.
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 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 carryforwards. Deferred 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 tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
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
in-the-money stock options outstanding and full conversion of convertible
preferred stock into common stock at the beginning of the year or the date of
issuance, unless they are antidilutive.
Diluted loss per share is not presented as it is the same as basic loss per
share.
F-8
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Use of Estimates
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent liabilities to prepare these financial statements in conformity
with generally accepted accounting principles. Actual results could differ
from those estimates.
Accounting Changes
Effective December 1997, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 128--"Earnings per Share." SFAS No. 128
simplifies the calculation of earnings per share (EPS), replaces primary EPS
with basic EPS and replaces fully diluted EPS with diluted EPS.
Basic EPS is computed by dividing income available to common stockholders by
the weighted average number of common shares outstanding during the period.
The computation of diluted EPS is similar to the computation of basic EPS
except that it gives effect to all potentially dilutive instruments that were
outstanding during the period. In prior years, the Company has computed EPS
without consideration to potentially dilutive instruments due to the losses
incurred by the Company. Accordingly, the adoption of this standard has not
resulted in a change to the Company's previously reported EPS amounts.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," and No. 131, "Disclosures about Segments of
an Enterprise and Related Information." Commencing in 1998, SFAS No. 130 will
require companies to report comprehensive income, and SFAS No. 131 will
require companies to report segment performance as it is used internally to
evaluate segment performance. These statements provide for additional
disclosure requirements.
(2) SHORT-TERM INVESTMENTS
Short-term investments, classified as available-for-sale, consist of the
following at December 31, 1997 and 1996:
1997 1996
---------------------------- ----------------------------
AMORTIZED UNREALIZED FAIR AMORTIZED UNREALIZED FAIR
COST GAIN (LOSS) VALUE COST GAIN (LOSS) VALUE
--------- ----------- ------ --------- ----------- ------
Commercial paper and
corporate debt securi-
ties (average maturity
of 4 months in 1997 and
1996).................. $1,110 $ -- $1,110 $3,774 $ -- $3,774
Corporate bonds......... -- -- -- 1,004 -- 1,004
U.S. Treasury Bill...... -- -- -- 3,999 -- 3,999
------ ----- ------ ------ ----- ------
Total................. $1,110 $ -- $1,110 $8,777 $ -- $8,777
====== ===== ====== ====== ===== ======
Gross realized gains and losses on sales of securities in 1997 and 1996 were
immaterial.
(3) FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of our financial instruments at December 31, 1997
and 1996 follow:
1997 1996
---------------- ---------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ------- -------- ------
Cash and cash equivalents.................. $20,508 $20,508 $3,911 $3,911
Short-term investments..................... 1,110 1,110 8,777 8,777
Accounts receivable, net................... 4,528 4,528 2,893 2,893
F-9
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
The carrying amounts for cash and accounts receivables, net, approximate
fair value because of the short maturities of these instruments.
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and trade accounts
receivable. The Company places its cash primarily in market interest rate
accounts. The Company, by policy, limits the amount of credit exposure to any
one financial institution or commercial issuer.
(4) INVENTORIES
The components of inventories at December 31, 1997 and 1996 follow:
1997 19967
------ ------
Raw materials.................................................. $1,086 $ 600
Work in process................................................ 1,654 1,500
Finished goods................................................. 2,072 1,424
------ ------
Total........................................................ $4,812 $3,524
====== ======
(5) PROPERTY AND EQUIPMENT, NET
The components of property and equipment, net at December 31, 1997 and 1996
follow:
ESTIMATED USEFUL
LIVES 1997 1996
---------------- ------- -------
Purchased computer software............. 3 years $ 4,220 $ 2,756
Equipment............................... 3-7 years 3,171 2,356
Semiconductor tooling................... 3 years 879 771
Furniture............................... 3-7 years 967 351
Leasehold improvements.................. Lease term 186 158
Construction in progress................ 106 418
------- -------
9,529 6,810
Less accumulated depreciationand amorti-
zation................................. (5,713) (4,163)
======= =======
Property and equipment, net............. $ 3,816 $ 2,647
======= =======
(6) PRODUCT LICENSES, NET
Product licenses, net amounted to $1,000 and $1,254 at December 31, 1997 and
1996, respectively.
On December 15, 1995 the Company entered into a new agreement with Texas
Instruments (TI) in which it repurchased its license agreement for a total of
$4,875 representing an upfront payment of $2,125 in cash and the discounted
present value of future minimum payments. The Company recorded the repurchased
license (TI license) in its consolidated balance sheet under the caption
product licenses and is amortizing the asset over a five year period based
upon the estimated related incremental product sales. Interest expense is
being accrued over the three year minimum payment period.
In the fourth quarter of 1996, the TI License was written down to its net
realizable value as the forecasted incremental revenues attributable to the TI
license were significantly less than originally anticipated.
The Company purchased other product licenses during 1996 for $314 which are
being amortized over a three year period.
F-10
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Amortization of product licenses amounted to $257, $705 and $0 in 1997, 1996
and 1995, respectively.
(7) INCOME TAXES
The tax effect of temporary differences that give rise to deferred tax
assets and deferred tax liabilities at December 31, 1997 and 1996 are
presented below:
1997 1996
------- -------
Deferred tax assets:
Inventory obsolescence................................... $ 532 $ 497
Vacation accrual......................................... 137 79
Warranty reserve......................................... 221 119
Sales allowance reserve.................................. 270 148
Product license.......................................... -- 267
Net operating losses..................................... 12,244 10,637
Research and development credit.......................... 1,860 1,739
Other.................................................... 90 59
------- -------
Total gross deferred tax assets............................ 15,354 13,545
Less valuation allowance................................... (14,867) (13,384)
------- -------
Net deferred tax assets.................................... 487 161
Deferred tax liabilities:
Property and equipment................................... (487) (161)
------- -------
Total deferred taxes, net of valuation allowance....... $ -- $ --
======= =======
The net change in the total valuation allowance for the year ended December
31, 1997 was an increase of $1,483. Due to the Company's prior operating
losses, there is uncertainty surrounding whether the Company will ultimately
realize its deferred tax assets. Accordingly, these assets have been fully
reserved. Of the total valuation allowance of $14,867, subsequently recognized
tax benefits, if any, in the amount of $1,611 will be applied directly to
contributed capital.
The difference between the statutory federal income tax rate and the
Company's effective tax rate for the years ended December 31, 1997, 1996 and
1995 is principally due to net operating losses.
At December 31, 1997, the Company had available, for federal income tax
purposes, net operating loss carryforwards of approximately $29,440 and
research and development tax credit carryforwards of approximately $1,860
expiring in varying amounts from 2003 through 2012. Certain transactions
involving beneficial ownership of the Company 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 $24,000 of the Company's
net operating loss carryforward and $1,410 of the Company's research and
development tax credit carryforward are subject to these limitations.
(8) CONVERTIBLE PREFERRED STOCK
The Company has authorized 15,000 shares of preferred stock with a par value
of $.01. On October 10, 1997, the Company issued 14,500 shares of Series A
Convertible Preferred Stock (Series A Stock) for net proceeds, after issuance
costs, of $13,656. The Company allocated $1,614 of the net proceeds to
additional paid-in capital, representing the calculated value of a
preferential conversion feature on the date of issuance. This amount is being
accreted ratably to the Series A Stock as a deemed dividend through the
earliest conversion date.
F-11
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Each share of Series A Stock is convertible into shares of Common Stock at
any time at the option of the holder, subject to certain limitations, at the
lesser of (i) $10.58 per share or (ii) ninety percent (90%) of the average of
the closing bid price of the Company's Common Stock, as reported by the NASDAQ
National Market, for the ten (10) trading days immediately preceding the date
written notice of conversion is received by the Company. Unless converted
sooner at the option of the holders of the Series A Stock, all shares of
Series A Stock will convert to Common Stock on October 10, 2002. No Series A
Stock may be converted until the earlier of (i) January 8, 1998 or (ii) the
date upon which a registration statement filed with the Securities and
Exchange Commission to register additional common shares is declared
effective.
As of December 31, 1997, the Series A Stock was not yet eligible for
conversion into Common Stock.
(9) STOCKHOLDERS' EQUITY
Common Stock
On June 19, 1995 and July 13, 1995 the Company completed its initial public
offering of 2,500,000 shares of Common Stock and 375,000 shares of Common
Stock, respectively, all of which were sold by the Company. Concurrent with
consummation of the offering, all outstanding shares of Mandatorily Redeemable
Convertible Preferred Stock were converted into 7,009,743 shares of Common
Stock.
Stock-Based Compensation
1989 Stock Option Plan
Effective January 12, 1989, the Company adopted a Stock Option Plan. Under
the Plan, the Board of Directors (or an appointed committee) grants to all new
employees, and to certain key employees and consultants, incentive stock
options ("qualified" options) and non-qualified stock options to purchase
Common Stock. In 1993, the Company amended the Stock Option Plan, increasing
the total number of common shares reserved for issuance to 1,827,413.
The option price for incentive stock options shall not be less than 100% of
the fair market value (110% in the case of an employee owning more than 10% of
the combined voting power) on the date of grant; and the option price for non-
qualified stock options shall not be less than 85% of the fair market value on
the date of grant.
1995 Stock Plan
On April 11, 1995, the Company's Board of Directors adopted the 1995 Stock
Plan (the 1995 Plan) which was approved by the Company's stockholders on April
19, 1995. The 1995 Plan took effect upon the completion of the Initial Public
Offering. In 1996, the Company increased the total number of shares of Common
Stock authorized under the 1995 Stock Plan and amended and restated the 1995
Stock Plan (as amended and restated, "The 1995 Plan"). At December 31, 1997,
2,469,019 shares of the Company's Common Stock are reserved for issuance
pursuant to the grant to employees of incentive stock options and the grant of
non-qualified stock option, awards or direct purchases of the Company's Common
Stock to employees, consultants, directors and officers of the Company. The
terms of the options granted will be 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.
1995 Employee Stock Purchase Plan
On April 11, 1995, the Company's Board of Directors adopted the 1995
Employee Stock Purchase Plan (the "1995 Purchase Plan") which was approved by
the Company's stockholders on April 19, 1995. Under the
F-12
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
terms of the 1995 Purchase Plan, all employees of the Company, except five
percent or more stockholders, may contribute to the plan, up to 5% of their
annual compensation toward the purchase of the Company's Common Stock. The
Company has reserved 100,000 shares for issuance under the 1995 Purchase Plan.
The purchase price per share is the lesser of (a) 85% of the fair market value
of the Common Stock on the date of the grant of the option, as defined, or (b)
85% of the fair market value of the Common Stock on the date of exercise of
the option, as defined.
Non-Employee Director Stock Option Plan
The 1995 Non-Employee Director Stock Option Plan (the "Director Plan") was
adopted by the Board of Directors on April 11, 1995 and approved by the
Company's stockholders on April 19, 1995. The Director Plan provides for the
automatic grant of options to purchase shares of Common Stock to non-employee
directors of the Company on the anniversary date of each individual board
member joining the Board of Directors. Upon joining the Company's Board,
Directors are granted 12,500 shares, one-third of which vest immediately, one-
third after the first year, and the remaining one-third after the second year.
Annually thereafter, Directors are granted 7,500 shares which vest fully after
one year.
The Director Plan will be 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.
Stock Option Information
Information regarding the Company's stock options are set forth as follows:
NUMBER WEIGHTED AVERAGE
OF SHARES OPTION PRICE
--------- ----------------
Outstanding at December 31, 1994................. 1,190,912 $ 0.51
Granted........................................ 556,225 10.34
Exercised...................................... (390,055) 0.43
Canceled....................................... (50,373) 2.00
--------- ------
Outstanding at December 31, 1995................. 1,306,709 3.86
Granted........................................ 1,524,630 7.63
Exercised...................................... (296,954) 0.58
Canceled....................................... (778,968) 10.17
--------- ------
Outstanding at December 31, 1996................. 1,755,417 4.81
Granted........................................ 1,277,300 7.26
Exercised...................................... (382,584) 1.48
Canceled....................................... (592,117) 8.38
--------- ------
Outstanding at December 31, 1997................. 2,058,016 $ 5.72
========= ======
F-13
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Options outstanding and exercisable at December 31, 1997 are as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
--------------- ----------- ----------- -------- ----------- --------
$ 0.40 to $ 1.20 283,020 1.05 $ 0.73 248,928 $ 0.71
4.13 to 6.38 1,214,746 8.39 5.22 439,879 5.35
6.50 to 10.81 443,250 9.53 8.80 61,605 7.41
10.88 to 12.63 117,000 9.01 11.27 94,000 11.12
---------------- --------- ---- ------ ------- ------
$ 0.40 to $12.63 2,058,016 7.66 $ 5.72 844,412 $ 4.77
================ ========= ==== ====== ======= ======
Stock options expire five or ten years from the date of grant and are
generally exercisable ratably over four years from the date of grant.
In connection with stock options granted in January 1995 through March 31,
1995, the Company recorded deferred compensation expense of $618 for the
excess of the deemed value for accounting purposes of the Common Stock
issuable upon exercise of such stock options over the aggregate exercise price
of such options. The Company is recording compensation expense over the
applicable vesting periods (primarily four years). For the years ended
December 31, 1997, 1996 and 1995, the Company recorded compensation expense of
$155, $156 and $100, respectively, for these options.
The Company does not recognize compensation expense relating to employee
stock options because the exercise price of the option equals the fair value
of the stock on the date of grant. If the Company had determined the
compensation based on the fair value of the options on the date of grant in
accordance with SFAS No. 123, the pro forma net loss and loss per share would
be as follows:
1997 1996 1995
------- -------- -------
Net loss-as reported............................ $(1,873) $(10,077) $(1,773)
Net loss-pro forma.............................. (2,054) (12,599) (2,189)
Basic loss per share-as reported................ (0.15) (0.86) (0.18)
Basic loss per share-pro forma.................. (0.17) (1.07) (0.22)
The effects of applying SFAS No. 123 in this pro forma disclosure are not
necessarily indicative of future amounts because it does not take into
consideration pro forma compensation expense related to grants made prior to
1995. Diluted loss per share amounts are not presented as they are the same as
basic.
As reflected in the pro forma amounts in the preceding table, the average
fair value of each option granted in 1997, 1996 and 1995 was $6.73, $3.00 and
$4.70, respectively. The fair value of each option granted was estimated on
the date of grant using the modified Black-Scholes option pricing model based
on the following weighted average assumptions:
1997 1996 1995
---- ---- ----
Risk-free interest rate.................................... 5.7% 6.0% 5.5%
Expected life in years..................................... 4.0 6.0 6.0
Expected volatility........................................ 66.0% 52.0% 52.0%
Expected dividend yield.................................... -- -- --
F-14
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
For the years ended December 31, 1997 and 1996, the Company recognized
additional compensation expense of $225 and $195, respectively, as required by
SFAS No. 123 relating to stock options granted to non-employees.
Warrants
Warrants to purchase Common Stock and Preferred Stock have been granted to
the original investors in consideration of additional financing and loans, and
for services performed by various other parties. The warrants presented in the
table below are convertible into Common Stock and Preferred Stock at a rate of
one share of Common Stock and Preferred Stock for each warrant to purchase
Common Stock and Preferred Stock, respectively. During 1995, 58,396 shares of
Preferred Stock warrants were converted into 29,198 shares of Common Stock at
a rate of one share of Common Stock for each two shares of Preferred Stock and
13,488 shares of Preferred Stock warrants were canceled.
WARRANTS--COMMON STOCK WARRANTS--PREFERRED STOCK
------------------------------- ------------------------------
PRICE PER EXPIRATION PRICE PER EXPIRATION
NUMBER SHARE DATE NUMBER SHARE DATE
-------- --------- ----------- ------- ---------- ----------
Outstanding at December
31, 1994............... 215,409 $.06-1.00 12/96-11/98 71,884 $1.00-1.30 8/90-7/00
Exercised............. (122,964) -- 12/96-11/98 (58,396) $1.00-1.30 8/99-7/00
Canceled.............. -- -- -- (13,488) $1.00-1.30 8/99-7/00
-------- --------- ----------- ------- ---------- ---------
Outstanding at December
31, 1995............... 92,445 $.06-1.00 12/96-11/98 -- -- --
Exercised............. (82,011) -- 12/96-11/98 -- -- --
-------- --------- ----------- ------- ---------- ---------
Outstanding at December
31, 1996............... 10,434 $.40-1.00 12/96-11/98 -- -- --
Exercised............. (8,038) -- 12/96-11/98 -- -- --
-------- --------- ----------- ------- ---------- ---------
Outstanding at December
31, 1997............... 2,393 $.40-1.00 12/96-11/98 -- -- --
======== ========= =========== ======= ========== =========
(10) EARNINGS PER SHARE
The basic loss per share for the years ended December 31, 1997, 1996 and
1995 follows:
1997 1996 1995
------- -------- -------
Net loss........................................ $(1,873) $(10,077) $(1,773)
Average shares (in thousands)................... 12,152 11,751 10,062
Basic loss per share............................ $ (.15) $ (.86) $ (.18)
Diluted loss per share amounts are not presented as they are the same as
basic.
The weighted average shares of dilutive securities that would have been used
to calculate diluted EPS had their effect not been anti-dilutive are as
follows:
1997 1996 1995
--------- ------- -------
Options............................................ 634,867 281,460 541,490
Warrants........................................... 1,954 5,153 52,691
Convertible Preferred Stock 380,697 -- --
--------- ------- -------
Total............................................ 1,017,518 286,613 594,181
========= ======= =======
F-15
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(11) EMPLOYEE SAVINGS PLAN
On November 21, 1988, the Company established a 401(k) retirement savings
plan. All employees are entitled to contribute from 1% to 15% of their pre-tax
income, not exceeding the IRS maximum for income deferrals, to the Plan, and
may elect to invest their contributions in various established funds, which
include fixed income, growth and equity funds. In 1997, the maximum
contribution was 20% of pre-tax income subject to IRS limitations. The Company
began providing matching contributions in 1996 for 50 percent of the employees
deferred compensation up to a maximum of 6 percent. The Company's contribution
expense amounted to $188 and $156 for 1997 and 1996, respectively.
(12) CONCENTRATION OF SALES
The percentage of total revenues attributable to the Company's significant
customers for the years ended December 31, 1997, 1996 and 1995 follow:
1997 1996 995
---- ---- ---
Insight Electronics, Inc.*..................................... 41% 16% 16%
Tellabs Operations, Inc........................................ 16% 14% 17%
ECI Telecom, LTD............................................... ** 22% **
- --------
* Insight Electronics, Inc. is a distributor to various end-users, none of
which comprised more than 10% of the Company's total revenues.
** Revenues were less than 10% of the Company's total revenues in these
years.
Export revenues represented 33%, 46% and 38% of total revenues in 1997, 1996
and 1995, respectively.
Revenues from customers located outside the United States were as follows:
1997 1996 1995
------ ------ ------
Europe................................................ $3,902 $2,100 $3,084
Middle East........................................... 517 4,232 --
Far East.............................................. 2,885 1,976 1,798
Canada and other...................................... 1,721 592 1,626
------ ------ ------
Total................................................. $9,025 $8,900 $6,508
====== ====== ======
(13) COMMITMENTS AND CONTINGENCIES
Line of Credit
In June 1997, the Company entered into a new line of credit agreement with
Silicon Valley Bank whereby the Company has access up to $6,000 for working
capital purposes, bearing interest at prime + 3/4% due on July 10, 1998, and
$2,000 for equipment purchases, bearing interest at prime +1% due on May 31,
2002. The lines are secured by all corporate assets except intellectual
property of the Company.
The agreement contains certain financial restrictions and covenants which,
among other things, include provisions for maintaining a minimum amount of
cash, net worth and profitability.
At December 31, 1997, no amounts were outstanding under this agreement.
F-16
TRANSWITCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Development Agreements
From time to time, the Company has 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 the Company may use in the
manufacture of products, for which royalties are paid against actual sales of
these products. The Company recognized royalty expense of $1,110, $1,266 and
$829 in 1997, 1996 and 1995, respectively, under these agreements; these
amounts are included in cost of products sold in the consolidated statements
of operations.
Lease Agreements
Total rental expense under all operating lease agreements aggregated $745,
$446 and $586 during 1997, 1996 and 1995, respectively. Future minimum
operating lease commitments that have remaining, non-cancelable lease terms in
excess of one year at December 31, 1997 follow:
1998.............................................................. $ 548
1999.............................................................. 546
2000.............................................................. 466
2001.............................................................. 396
2002.............................................................. 393
Thereafter........................................................ 1,865
------
$4,214
======
Foundry Purchase Commitments
In April 1996, the Company entered into a foundry agreement with Taiwan
Semiconductor Manufacturing Co., Ltd. (TSMC) which includes future minimum
purchase commitments as follows:
1998................................................................ $476
1999................................................................ 128
----
$604
====
F-17
SCHEDULE II
TRANSWITCH CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
ADDITIONS
-------------------
BALANCE AT CHARGED TO CHARGES BALANCE
BEGINNING COSTS AND TO OTHER AT END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
----------- ---------- ---------- -------- ---------- ---------
Year ended December 31,
1997:
Deductions from asset
account:
Allowance for doubtful
accounts............. $ 140 100 -- (22) $ 218
Inventory valuation... 1,196 121 -- (39) 1,278
------ ----- --- ---- ------
$1,336 221 -- (61) $1,496
====== ===== === ==== ======
Year ended December 31,
1996:
Deductions from asset
account:
Allowance for doubtful
accounts............. $ 138 14 -- (12) $ 140
Inventory valuation... 295 1,261 -- (360) 1,196
------ ----- --- ---- ------
$ 433 1,275 -- (372) $1,336
====== ===== === ==== ======
Year ended December 31,
1995:
Deductions from asset
account:
Allowance for doubtful
accounts............. $ 36 110 -- (8) $ 138
Inventory valuation... 597 31 -- (333)(1) 295
------ ----- --- ---- ------
$ 633 141 -- (341) $ 433
====== ===== === ==== ======
- --------
(1) Includes a reversal of a reserve for inventory on hand which was built up
in anticipation of a major customer's order in 1994 which was no longer
required as products were shipped.