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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
[ ] 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 0-19360
VERILINK CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 94-2857548
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
145 BAYTECH DRIVE, SAN JOSE, CALIFORNIA 95134
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(Address of principal executive offices) (Zip Code)
408-945-1199
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
----- -----
The number of shares outstanding of the issuer's common stock as of November
12, 1996 was 13,165,614.
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INDEX
VERILINK CORPORATION
FORM 10-Q
<TABLE>
<S> <C> <C>
PART I. FINANCIAL INFORMATION PAGE NO.
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Item 1. Financial Statements
Condensed Consolidated Balance Sheets at 3
September 30, 1996 and June 30, 1996
Condensed Consolidated Statements of Income for the three months 4
ended September 30, 1996 and 1995
Condensed Consolidated Statements of Cash Flows for 5
the three months ended September 30, 1996 and 1995
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 7
Financial Condition and Results of Operations
PART II. OTHER INFORMATION
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Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURES 17
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</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERILINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
September 30, June 30,
------------ -----------
1996 1996
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(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $34,577 $40,542
Short-term investments 7,871 -
Accounts receivable, net 5,575 6,182
Inventories 5,684 4,952
Deferred tax assets 815 815
Other current assets 350 508
Total current assets 54,872 52,999
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Property and equipment, net 1,975 1,530
Deferred tax assets 613 613
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Other assets 133 76
Total assets $57,593 $55,218
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $2,178 $2,199
Accrued expenses 5,006 4,945
Income taxes payable 1,657 840
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Total current liabilities 8,841 7,984
Stockholders' equity 48,752 47,234
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Total liabilities and stockholders' equity $57,593 $55,218
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</TABLE>
The accompanying notes are an integral part of these financial statements.
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VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
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1996 1995
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<S> <C> <C>
Sales $14,676 $9,505
Cost of sales 7,122 4,608
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Gross profit 7,554 4,897
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Operating expenses:
Research and development 2,044 1,608
Selling, general and 3,606 2,539
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Total operating expenses 5,650 4,147
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Income from operations 1,904 750
Interest and other income, net 470 22
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Income before income taxes 2,374 772
Provision for income taxes 926 309
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Net income $1,448 $463
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Net income per share $0.10 $0.04
======= =======
Shares used to compute net
income per share 14,350 10,837
</TABLE> ======= =======
The accompanying notes are an integral part of these financial statements.
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VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
----------------------
1996 1995
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<S> <C> <C>
Cash flows from operating activities:
Net income $1,448 $463
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 238 209
Deferred compensation related to stock options 57 --
Changes in assets and liabilities:
Accounts receivable 607 14
Inventories (732) (745)
Other assets 101 (159)
Accounts payable (21) (186)
Accrued expenses 61 44
Income taxes payable 817 526
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Net cash provided by
operating activities 2,576 166
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Cash flows from investing activities:
Purchase of property and equipment (675) (98)
Purchase of short-term investments (7,871) --
------ ------
Net cash used in investing activities (8,546) (98)
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Cash flows from financing activities:
Proceeds from issuance of Common Stock, net 5 --
Repurchase of Common Stock -- (15)
Repayment of long-term debt -- (42)
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Net cash provided by (used in) financing activities 5 (57)
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Net increase (decrease) in cash and cash equivalents (5,965) 11
Cash and cash equivalents at beginning of period 40,542 3,243
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Cash and cash equivalents at end of period $34,577 $3,254
======= ======
Supplemental disclosures:
Cash paid (refund) for income taxes 109 (217)
</TABLE>
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. Interim Financial Statements
The accompanying unaudited interim consolidated financial statements
of Verilink Corporation (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, these statements include all adjustments,
consisting of normal and recurring adjustments, considered necessary for a fair
presentation of the results for the periods presented. The results of
operations for the three month period ended September 30, 1996 are not
necessarily indicative of results which may be achieved for the entire fiscal
year ending June 30, 1997. The unaudited consolidated interim financial
statements should be read in conjunction with the financial statements and
notes thereto contained in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 1996 as filed with the Securities and Exchange
Commission.
NOTE 2. Inventories (in thousands)
<TABLE>
<CAPTION>
September 30, June 30,
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1996 1996
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<S> <C> <C>
Raw materials $2,856 $2,999
Work-in-process 1,265 831
Finished goods 2,220 1,780
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6,341 5,610
Less inventory reserves (657) (658)
------ ------
$5,684 $4,952
====== ======
</TABLE>
NOTE 3. Lease Commitments
The Company leases its principal facility from Baytech Associates
(Baytech) under an operating lease which expires in April 2001. Baytech is
owned by the Company's two principal stockholders who are officers and
directors of the Company. In September 1996, the Company entered into a new
lease agreement (Agreement) with Baytech to sublease additional operating
facilities under terms and conditions reflecting prevailing market conditions
at that time. The principal terms of the Agreement result in future annual
minimum lease payments of approximately $168,000 beginning December 1996
through November 2001 and additional annual payments of $367,000 beginning
between September 1997 and December 1998, depending on the timing of additional
space utilization. As a part of the Agreement, the Company has agreed to
assume performance responsibility under the primary lease agreement between
Baytech and its lessor in the event Baytech is unable to do so.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
General
Verilink Corporation develops, manufactures and markets integrated
access products for telecommunications network service providers and corporate
end users. Verilink designed the Access System 2000 with modular hardware and
the Company's software-based Advanced Programmable Architecture(TM) to enable
its customers to access increased network capacity and to adopt new
communications services in a cost-effective manner. The Access System 2000
provides integrated access to low speed services, fractional T1/E1 services,
and T1, E1, T3, frame relay and SMDS services, with ATM and ISDN products under
development.
Verilink sells its products through a direct sales force and
non-exclusive resellers. Verilink's integrated network access products are used
by network service providers such as interexchange and local exchange carriers,
and providers of Internet, personal communications and cellular services. The
Company also sells single purpose network access devices for selected
applications. The Company's largest customers include MCI Communications Corp.,
CompuServe Corp., Northern Telecom, Inc. and QUALCOMM Incorporated.
The Company believes that period-to-period comparisons of its
financial results are not necessarily meaningful and should not be relied upon
as an indication of future performance. In addition, the Company's results of
operations may fluctuate from period to period in the future.
Quarter Ended September 30, 1996 compared with Quarter Ended September 30, 1995
Sales. Sales increased by 54% to $14,676,000 in the quarter ended
September 30, 1996 from $9,505,000 in the quarter ended September 30, 1995.
The increase in total sales resulted primarily from increased sales of the
Company's Access System 2000 product line which increased to $11,199,000 or 76%
of total sales in the quarter ended September 30, 1996. This compares with
$6,458,000 or 68% of total sales in the quarter ended September 30, 1995.
Sales to the Company's five largest customers during the quarter ended
September 30, 1996 were $9,616,000 or 65% of total sales as compared with sales
of $5,714,000 or 60% of total sales for the five largest customers during the
quarter ended September 30, 1995.
Gross Profit. Gross profit increased to $7,554,000 in the quarter
ended September 30, 1996 from $4,897,000 in the prior year quarter primarily
due to an increase in sales levels. As a percentage of sales, gross profit
remained constant at 51.5% in each quarter. Although the Company experienced
an improvement in the percentage related to manufacturing costs in the quarter
ended September 30, 1996 as compared with the prior year quarter, the benefit
was offset by increased material costs due to changes in product mix.
Research and Development. Research and development expense was
$2,044,000 or 13.9% of sales in the quarter ended September 30, 1996 as
compared with $1,608,000 or 16.9% of sales in the corresponding prior year
quarter. The increased expense of $436,000 between quarters was primarily
related to salaries and other personnel-related expenses due to an increased
staffing level. Research and development expense declined as a percentage of
sales due to the increased sales levels between the comparable quarterly
periods. The Company believes that a significant level of investment in
product development is required to remain competitive and, accordingly,
anticipates that research and development will continue to increase in amount
during the remainder of fiscal 1997.
Selling, general and administrative. Selling, general and
administrative expense was $3,606,000 or 24.6% of sales in the quarter ended
September 30, 1996 as compared with $2,539,000 or 26.7% of sales in the same
quarter a year ago. The increase in expense levels between periods was
primarily attributable to personnel-related expenses such as salaries and
benefits in the sales and marketing functions due to increased staff levels and
also due to a higher
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level of commission expense due to increased sales. The Company expects
selling, general and administrative expense to increase in the future due to
expenses associated with an increased sales force and related increases in
marketing and support staff as well as increased administrative expenses
related to public company reporting requirements.
Interest and Other Income. Net interest and other income increased to
$470,000 in the quarter ended September 30, 1996 from $22,000 in the comparable
prior year quarter primarily as a result of the interest earned on the net
proceeds from the Company's initial public offering which was completed in June
1996.
Provision for Income Taxes. The provision for income taxes of
$926,000 for the quarter ended September 30, 1996 represents a combined
estimated Federal and state effective tax rate of 39%, a rate which
approximates the statutory tax rate. The tax provision of $309,000 for the
quarter ended September 30, 1995 represented an estimated effective tax rate of
40%.
LIQUIDITY AND CAPITAL RESOURCES
The Company raised $36.8 million through its initial public offering
of common stock in June 1996. Prior to the offering, the primary source of
financing for the Company had been cash flow from operations. In addition, the
Company had used proceeds from the private sale of equity securities and bank
borrowings to support its operations, acquire capital equipment and finance
inventory and accounts receivable growth.
The Company generated $2,576,000 of cash from operations during the
quarter ended September 30, 1996 primarily due to increased profitability.
Accounts receivable declined by $607,000 from June 1996 primarily due to the
timing of shipments and collections during the quarter. The Company expects
receivable balances to increase in the future due to expected sales growth and
possible changes in the timing of shipments and collections. Inventory
increased by $732,000 to meet demand for the Company's products and the Company
believes that such balances are likely to further increase to support
anticipated future demand. Income taxes payable increased by $817,000
primarily due to estimated taxes on earnings during the quarter not yet due and
payable.
Investment activities during the quarter ended September 30, 1996
included the purchase of short-term investments of $7,871,000. These
investments are placed in highly rated commercial paper and tax-free municipal
securities. The Company expects to significantly increase capital
expenditures, to approximately $6.0 to $7.0 million, during the fiscal year
ending June 30, 1997 primarily for leasehold improvements and computer and test
equipment. Investment activities during the quarter ended September 30, 1996
included capital expenditures of $675,000 for such items.
At June 30, 1996, the Company had cash and cash equivalents of
$34,577,000, short-term investments of $7,871,000 and an unused line of credit
of $2,000,000. The Company believes that its existing cash, cash equivalents
and short-term investments, along with anticipated funds from operations, will
satisfy the Company's cash needs through at least the next twelve months.
RISK FACTORS
Forward-looking Statements. This Report on Form 10-Q contains
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including
statements regarding the Company's expectations, hopes, intentions, beliefs or
strategies regarding the future. Such forward-looking statements include the
Company's expected sales growth, anticipated expense levels for research and
development, selling, general and administrative, and capital expenditures, and
the Company's expectations regarding receivables, inventory balances, liquidity
and anticipated cash needs under the heading "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Actual results
could differ materially from those projected in any forward-looking statements
for the reasons detailed below and in other sections of this Report on Form
10-Q. All forward-looking statements included in this Form 10-Q are based on
information available to the Company on the date of this Report on Form 10-Q,
and the Company assumes no obligation to update the forward-looking statements,
or to
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update the reasons why actual results could differ from those projected in the
forward-looking statements. You should also consult the risk factors listed from
time to time in the Company's Reports on Form 10-Q, 8-K, 10-K and Annual Report
to Stockholders.
Dependence on Recently Introduced Products and Products Under
Development. The Company's future results of operations are highly dependent
on market acceptance of existing and future applications for the Company's
Access System 2000 product line. The Access System 2000 product line
represented approximately 70% of sales in fiscal year 1996. Increased market
acceptance of the Company's Access System 2000 products is dependent on a
number of factors, not all of which are in the Company's control, including the
continued growth in the use of bandwidth intensive applications, continued
deployment of new telecommunications services, market acceptance of integrated
access devices in general, the availability and price of competing products and
technologies, and the success of the Company's sales efforts. Failure of the
Company's products to achieve increased market acceptance would have a material
adverse effect on the Company's business, financial condition and results of
operations. Failure to introduce new products in a timely manner could cause
companies to purchase products from competitors and have a material adverse
effect on the Company's business, financial condition and results of
operations. Due to a variety of factors, the Company may experience delays in
developing its planned products. New products may require additional
development work, enhancement, testing or further refinement before they can be
made commercially available by the Company. The Company has in the past
experienced delays in the introduction of Access System 2000 product
applications and enhancements due to a variety of internal factors, such as
reallocation of priorities, difficulty in hiring sufficient numbers of
qualified personnel and unforeseen technical obstacles, as well as to changes
in customer requirements. Although the Company does not believe that such
delays have had a material adverse effect on its customer relationships, such
delays have deferred the receipt of revenue from the products involved. If the
Company's Access System 2000 products have performance, reliability or quality
shortcomings, then the Company may experience reduced orders, higher
manufacturing costs, delays in collecting accounts receivable and additional
warranty and service expenses. See "-- Need to Expand Sales Organization."
Customer Concentration. A small number of customers have accounted
for a majority of the Company's sales in each of the past several fiscal years.
In fiscal 1996, MCI and CompuServe accounted for 29% and 18% of the Company's
sales, respectively, and the Company's top five customers accounted for 64% of
the Company's sales. In fiscal 1995, MCI and CompuServe each accounted for 14%
of the Company's sales and the Company's top five customers accounted for 47%
of sales. In fiscal 1994, MCI accounted for 20% of the Company's sales, and the
Company's top five customers accounted for 46% of sales. Other than MCI and
CompuServe, no customer accounted for more than 10% of the Company's revenue in
fiscal 1996 or fiscal 1995. There can be no assurance that the Company's
current customers will continue to place orders with the Company, that orders
by existing customers will continue at the levels of previous periods, or that
the Company will be able to obtain orders from new customers. The Company's
customers are typically not contractually obligated to purchase any quantity of
products in any particular period. Product sales to major customers have
varied widely from year to year. In some cases, major customers have abruptly
terminated purchases of the Company's products. For example, sales of the
Company's single purpose network access products to AT&T Paradyne represented
24% of sales in fiscal 1993, but declined to 11% and 2% of sales in fiscal 1994
and 1995, respectively, due to the decision by AT&T Paradyne to focus its sales
efforts on competing products developed within the AT&T organization. In
addition, sales to Stratacom, Inc. for provision of network management
capabilities in a system sold to another AT&T business unit accounted for 9% of
the Company's sales during fiscal 1995. Sales to Stratacom ceased during the
second half of fiscal 1995 due to the decision by such AT&T business unit to
internally provide such management functionality in its system. Loss of, or a
material reduction in orders by, one or more of the Company's major customers
would materially adversely affect the Company's business, financial condition
and results of operations. See "-- Competition."
Fluctuations in Quarterly Operating Results. The Company's sales are
subject to quarterly and annual fluctuations due to a number of factors. Most
of the Company's sales are in the form of large orders with short delivery
times. The Company's ability to affect and judge the timing of individual
customer orders is limited. Recently, the Company has experienced large
fluctuations in sales from quarter to quarter due to a wide variety of factors,
such as delay, cancellation or acceleration of customer projects, and other
factors discussed below. The Company's sales for a given
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quarter may depend to a significant degree upon planned product shipments to a
single customer, often related to specific equipment deployment projects. The
Company has experienced both acceleration and slowdown in orders related to
such projects, causing changes in the sales level of a given quarter relative
to both the preceding and subsequent quarters. Sales to MCI and CompuServe, the
Company's two largest current customers, have varied by as much as $1.0 million
and $700,000, respectively, between consecutive quarters, and sales to other
current customers have also varied by as much as $1.0 million from quarter to
quarter.
Delays or lost sales can be caused by other factors beyond the
Company's control, including late deliveries by other vendors of components in
a customer's system, changes in implementation priorities, slower than
anticipated growth in demand for the services that the Company's products
support and delays in obtaining regulatory approvals for new services. Delays
and lost sales have occurred in the past and may occur in the future. Operating
results in recent periods have been adversely affected by delays in receipt of
significant purchase orders from customers. In addition, the Company has in the
past experienced delays as a result of the need to modify its products to
comply with unique customer specifications. These and similar delays or lost
sales could materially adversely affect the Company's business, financial
condition and results of operations. See "-- Customer Concentration," and "--
Dependence on Component Availability and Key Suppliers."
The Company's backlog at the beginning of each quarter typically is
not sufficient to achieve expected sales for that quarter. To achieve its sales
objective, the Company is dependent upon obtaining orders in a quarter for
shipment in that quarter. Furthermore, the Company's agreements with its
customers typically provide that they may change delivery schedules and cancel
orders within specified timeframes, typically up to 30 days prior to the
scheduled shipment date, without significant penalty. The Company's customers
have in the past built, and may in the future build, significant inventory in
order to facilitate more rapid deployment of anticipated major projects or for
other reasons. Decisions by such customers to reduce their inventory levels
could lead to reductions in purchases from the Company. These reductions, in
turn, could cause fluctuations in the Company's operating results and could
have an adverse effect on the Company's business, financial condition and
results of operations in the periods in which the inventory is reduced.
The Company's industry is characterized by declining prices of
existing products, therefore continual improvement of manufacturing
efficiencies and introduction of new products and enhancements to existing
products are required to maintain gross margins. In response to customer
demands or competitive pressures, or to pursue new product or market
opportunities, the Company may take certain pricing or marketing actions, such
as price reductions, volume discounts, or provision of services at below-market
rates. These actions could materially and adversely affect the Company's
operating results.
Operating results may also fluctuate due to factors such as the timing
of new product announcements and introductions by the Company, its major
customers or its competitors, delays in new product introductions by the
Company, market acceptance of new or enhanced versions of the Company's
products, changes in the product or customer mix of sales, changes in the level
of operating expenses, competitive pricing pressures, the gain or loss of
significant customers, increased research and development and sales and
marketing expenses associated with new product introductions, and general
economic conditions. All of the above factors are difficult for the Company to
forecast, and these or other factors can materially adversely affect the
Company's business, financial condition and results of operations for one
quarter or a series of quarters. The Company's expense levels are based in part
on its expectations regarding future sales and are fixed in the short term to a
large extent. Therefore, the Company may be unable to adjust spending in a
timely manner to compensate for any unexpected shortfall in sales. Any
significant decline in demand relative to the Company's expectations or any
material delay of customer orders could have a material adverse effect on the
Company's business, financial condition and results of operations. There can be
no assurance that the Company will be able to sustain profitability on a
quarterly or annual basis. In addition, it is possible that in some future
quarter, the Company's operating results may be below the expectations of
public market analysts and investors. In such event the price of the Company's
Common Stock would likely be materially and adversely affected. See "--
Potential Volatility of Stock Price."
Need to Expand Sales Organization. Currently the Company sells its
products to a small number of customers through a relatively small sales force.
The Company's strategy is to distribute its products to a broader customer
base,
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which will require the Company to significantly expand its sales force. There
can be no assurance that the Company will be able to recruit, train, motivate
and manage additional qualified sales personnel with the requisite experience
and knowledge. Availability of qualified sales personnel is limited, and
competition for experienced sales personnel in the network access and
telecommunications equipment industries is intense. The failure to timely
expand the Company's sales force could have a material adverse effect on the
Company's business, financial condition and results of operations. See "--
Customer Concentration," "-- Management of Growth" and "-- Dependence on Key
Personnel."
Dependence on Component Availability and Key Suppliers. On-time
delivery of the Company's products depends upon the availability of components
and subsystems used in its products. The Company depends in part upon suppliers
to manufacture, assemble and deliver components in a timely and satisfactory
manner. The Company obtains several components and licenses certain embedded
software from single sources. There can be no assurance that these suppliers
will continue to be able and willing to meet the Company's requirements for any
such components. The Company generally does not have any long-term contracts
with such suppliers, other than software vendors. Any significant interruption
in the supply of, or degradation in the quality of, any such item could have a
material adverse effect on the Company's results of operations. The Company has
no current plans to significantly expand its supplier base.
Purchase orders from the Company's customers frequently require
delivery quickly after placement of the order. Because the Company does not
maintain significant component inventories, delay in shipment by a supplier
could lead to lost sales. The Company uses internal forecasts to determine its
general materials and components requirements. Lead times for materials and
components may vary significantly, and depend on factors such as specific
supplier performance, contract terms and general market demand for components.
If orders vary from forecasts, the Company may experience excess or inadequate
inventory of certain materials and components. From time to time, the Company
has experienced shortages and allocations of certain components, resulting in
delays in fulfillment of customer orders. Such shortages and allocations could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "-- Fluctuations in Quarterly Operating
Results."
Competition. The market for network access and telecommunications
equipment is highly competitive, and the Company expects competition to
increase in the future. This market is subject to rapid technological change,
regulatory developments and emerging industry standards. The Company faces
different competitive environments for its Access System 2000 products than for
its single purpose network access products.
The market for integrated access devices such as the Company's Access
System 2000 is newly emerging and is subject to rapid change. The Company
believes that the primary competitive factors in this market are the
development and rapid introduction of new product features, price/performance,
support for multiple types of communications services, network management,
reliability and safety, and quality of customer support. There can be no
assurance that the Company's new products and products under development will
be able to compete successfully with respect to these or other factors. The
Company's principal competition to date for its current Access System 2000
products has been from Digital Link Corporation, Kentrox, a division of ADC
Telecommunications (both in Kentrox's own products and products supplied to
Kentrox by Premisys Communications, Inc.), and Larscom, Inc., a subsidiary of
Axel Johnson. As the Company develops new products for the Access System 2000
line, the Company expects to increasingly compete with Premisys. The Company
expects additional competition from companies that are currently competitors in
the market for the Company's single purpose network access products, as such
companies develop new products. In addition, the Company expects competition
from companies in the computer networking market and other related markets such
as Newbridge Networks Corporation and Ascend Communications, Inc. To the
extent that current or potential competitors can expand their current offerings
to include products that have functionality similar to the Company's products
and planned products, the Company's business, financial condition and results
of operations could be materially adversely affected.
The Company believes that the market for its single purpose network
access products is mature. The Company believes that the principal competitive
factors in this market are price, installed base and quality of customer
support. In this market, the Company primarily competes with Adtran, Inc.,
Digital Link, Kentrox and Larscom. There can be no assurance that such
companies or other competitors will not introduce new products at a lower price
and/or that provide greater functionality than the Company's single purpose
network access products. In addition, the Company anticipates that competitors
and customers may develop products that could be used for selected applications
for which the
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Company's products are currently provided. Successful, timely development of
such products could reduce the level of demand for the Company's products. The
Company does not expect to spend significant resources, if any, on research and
development of its single purpose network access products. There can be no
assurance that the Company's single purpose network access products will be
competitive in the future.
Many of the Company's current and potential competitors have
substantially greater technical, financial, manufacturing and marketing
resources than the Company. In addition, many of the Company's competitors have
long-established relationships with network service providers. There can be no
assurance that the Company will have the financial resources, technical
expertise, manufacturing, marketing, distribution and support capabilities to
compete successfully in the future.
Rapid Technological Change. The network access and telecommunications
equipment markets are characterized by rapidly changing technologies and
frequent new product introductions. The rapid development of new technologies
increases the risk that current or new competitors could develop products that
would reduce the competitiveness of the Company's products. The Company's
success will depend to a substantial degree upon its ability to respond to
changes in technology and customer requirements. This will require the timely
selection, development and marketing of new products and enhancements on a
cost-effective basis. The development of new, technologically advanced products
is a complex and uncertain process, requiring high levels of innovation. The
development of new products for the integrated access market requires
competence in the general areas of telephony, data networking, network
management and wireless telephony as well as specific technologies such as
SMDS, ATM and ISDN. Further, the communications industry is characterized by
the need to design products which meet industry standards for safety, emissions
and network interconnection. With new and emerging technologies and service
offerings from network service providers, such standards are often changing or
unavailable. As a result, there is a potential for product development delay
due to the need for compliance with new or modified standards. The introduction
of new and enhanced products also requires that the Company manage transitions
from older products in order to minimize disruptions in customer orders, avoid
excess inventory of old products and ensure that adequate supplies of new
products can be delivered to meet customer orders. There can be no assurance
that the Company will be successful in developing, introducing or managing the
transition to new or enhanced products or that any such products will be
responsive to technological changes or will gain market acceptance. The
Company's business, financial condition and results of operations would be
materially adversely affected if the Company were to be unsuccessful, or to
incur significant delays, in developing and introducing such new products or
enhancements. See "-- Dependence on Recently Introduced Products and Products
under Development."
Management of Growth. The Company has recently experienced and may
continue to experience growth in the number of its employees and the scope of
its operations. In particular, the Company intends to increase its sales,
marketing and support staff. These increases will result in increased
responsibilities for management. To manage potential future growth effectively,
the Company must improve its operational, financial and management information
systems and must hire, train, motivate and manage a growing number of
employees. The future success of the Company also will depend on its ability to
increase its customer support capability and to attract and retain qualified
technical, sales, marketing and management personnel, for whom competition is
intense. In particular, the current availability of qualified sales and
engineering personnel is quite limited, and competition among companies for
such personnel is intense. The Company is currently attempting to hire a number
of sales and engineering personnel and has experienced delays in filling such
positions. During strong business cycles, the Company expects to experience
continued difficulty in filling its needs for qualified sales, engineering and
other personnel. There can be no assurance that the Company will be able to
effectively achieve or manage any such growth, and failure to do so could delay
product development cycles or otherwise have a material adverse effect on the
Company's business, financial condition and results of operations. See "-- Need
to Expand Sales Organization," "-- Dependence on Key Personnel."
Compliance with Regulations and Evolving Industry Standards. The
market for the Company's products is characterized by the need to meet a
significant number of communications regulations and standards, some of which
are evolving as new technologies are deployed. In the United States, the
Company's products must comply with various regulations defined by the Federal
Communications Commission and standards established by Underwriters
Laboratories and Bell Communications Research. For some public carrier
services, installed equipment does not fully comply with current industry
standards, and this noncompliance must be addressed in the design of the
Company's
12
<PAGE> 13
products. Standards for new services such as frame relay and ATM are still
evolving. As these standards evolve, the Company will be required to modify its
products or develop and support new versions of its products. The failure of
the Company's products to comply, or delays in compliance, with the various
existing and evolving industry standards could delay introduction of the
Company's products, which could have a material adverse effect on the Company's
business, financial condition and results of operations.
Government regulatory policies are likely to continue to have a major
impact on the pricing of existing as well as new public network services and
therefore are expected to affect demand for such services and the
telecommunications products that support such services. Tariff rates, whether
determined by network service providers or in response to regulatory
directives, may affect the cost effectiveness of deploying communication
services. Such policies also affect demand for telecommunications equipment,
including the Company's products.
Risks Associated With Entry into International Markets. The Company
has had minimal direct sales to international customers to date. The Company
has little experience in international markets, but intends to expand the sales
of its products outside of the United States and to enter certain international
markets, which will require significant management attention and financial
resources. Conducting business outside of the United States is subject to
certain risks, including longer payment cycles, unexpected changes in
regulatory requirements and tariffs, difficulties in staffing and managing
foreign operations, greater difficulty in accounts receivable collection and
potentially adverse tax consequences. To the extent any Company sales are
denominated in foreign currency, the Company's sales and results of operations
may also be directly affected by fluctuations in foreign currency exchange
rates. In order to sell its products internationally, the Company must meet
standards established by telecommunications authorities in various countries,
as well as recommendations of the Consultative Committee on International
Telegraph and Telephony. A delay in obtaining, or the failure to obtain,
certification of its products in countries outside the United States could
delay or preclude the Company's marketing and sales efforts in such countries,
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
Risk of Third Party Claims of Infringement. The network access and
telecommunications equipment industries are characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert exclusive patent,
copyright, trademark and other intellectual property rights to technologies
that are important to the Company. The Company has not conducted a formal
patent search relating to the technology used in its products, due in part to
the high cost and limited benefits of a formal search. In addition, since
patent applications in the United States are not publicly disclosed until the
patent issues and foreign patent applications generally are not publicly
disclosed for at least a portion of the time that they are pending,
applications may have been filed which, if issued as patents, would relate to
the Company's products. Software comprises a substantial portion of the
technology in the Company's products. The scope of protection accorded to
patents covering software-related inventions is evolving and is subject to a
degree of uncertainty which may increase the risk and cost to the Company if
the Company discovers third party patents related to its software products or
if such patents are asserted against the Company in the future. Patents have
been granted recently on fundamental technologies in software, and patents may
issue which relate to fundamental technologies incorporated into the Company's
products. The Company may receive communications from third parties in the
future asserting that the Company's products infringe or may infringe the
proprietary rights of third parties. In its distribution agreements, the
Company typically agrees to indemnify its customers for any expenses or
liabilities, generally without limitation, resulting from claimed infringements
of patents, trademarks or copyrights of third parties. In the event of
litigation to determine the validity of any third-party claims, such
litigation, whether or not determined in favor of the Company, could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel from productive tasks. In the event of an
adverse ruling in such litigation, the Company might be required to discontinue
the use and sale of infringing products, expend significant resources to
develop non-infringing technology or obtain licenses from third parties. There
can be no assurance that licenses from third parties would be available on
acceptable terms, if at all. In the event of a successful claim against the
Company and the failure of the Company to develop or license a substitute
technology, the Company's business, financial condition and results of
operations would be materially adversely affected.
Limited Protection of Intellectual Property. The Company relies upon
a combination of patent, trade secret, copyright and trademark laws and
contractual restrictions to establish and protect proprietary rights in its
products and
13
<PAGE> 14
technologies. The Company has been issued certain U.S. and Canadian patents
with respect to limited aspects of its single purpose network access
technology. The Company has not obtained significant patent protection for its
Access System 2000 technology. There can be no assurance that third parties
have not or will not develop equivalent technologies or products without
infringing the Company's patents or that the Company's patents would be held
valid and enforceable by a court having jurisdiction over a dispute involving
such patents. The Company has also entered into confidentiality and invention
assignment agreements with its employees, and enters into non-disclosure
agreements with its suppliers, distributors and appropriate customers so as to
limit access to and disclosure of its proprietary information. There can be no
assurance that these statutory and contractual arrangements will deter
misappropriation of the Company's technologies or discourage independent
third-party development of similar technologies. In the event such arrangements
are insufficient, the Company's business, financial condition and results of
operations could be materially adversely affected. The laws of certain foreign
countries in which the Company's products are or may be developed, manufactured
or sold may not protect the Company's products or intellectual property rights
to the same extent as do the laws of the United States and thus make the
possibility of misappropriation of the Company's technology and products more
likely.
Dependence on Key Personnel. The Company's future success will depend
to a large extent on the continued contributions of its executive officers and
key management, sales and technical personnel, including Leigh S. Belden, the
Company's President and Chief Executive Officer, and Steven C. Taylor, the
Company's Chief Technical Officer. The Company does not maintain key man life
insurance on any of such persons and none of such persons has an employment
agreement with the Company, except for insurance on and contracts with Mr.
Belden and Mr. Taylor. Each of the Company's executive officers, and key
management, sales and technical personnel would be difficult to replace. The
loss of the services of one or more of the Company's executive officers or key
personnel, or the inability to continue to attract qualified personnel could
delay product development cycles or otherwise have a material adverse effect on
the Company's business, financial condition and results of operations. See "--
Management of Growth."
Control of the Company; Antitakeover Effects of Certain Charter
Provisions. The current officers, directors and holders of five percent or
more of the Company's Common Stock own approximately 43% of the outstanding
Common Stock. Accordingly, these stockholders, if they were to act as a group,
would be able to elect all of the Company's directors, increase the authorized
capital and otherwise control the policies of the Company. The Company's Board
of Directors has the authority to issue up to 1,000,000 shares of Preferred
Stock and to determine the price, rights, preferences and privileges of those
shares without any further vote or action by the stockholders. The rights of
the holders of Common Stock will be subject to, and may be adversely affected
by, the rights of the holders of any Preferred Stock that may be issued in the
future. The issuance of shares of Preferred Stock, while potentially providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire a majority of the outstanding voting stock of the
Company. The Company has no present intention to issue shares of Preferred
Stock. In addition, the Company is subject to the anti-takeover provisions of
Section 203 of the Delaware General Corporation Law, which will prohibit the
Company from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business
combination is approved in a prescribed manner. The application of Section 203
also could have the effect of delaying or preventing a change of control of the
Company. Furthermore, certain provisions of the Company's Amended and Restated
Certificate of Incorporation, including provisions that provide for the Board
of Directors to be divided into three classes to serve for staggered three-year
terms, may have the effect of delaying or preventing a change of control of the
Company, which could adversely affect the market price of the Company's Common
Stock.
Potential Volatility of Stock Price. The trading price of the
Company's Common Stock could be subject to wide fluctuations in response to
quarter to quarter variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
developments with respect to patents or proprietary rights, general conditions
in the telecommunication network access and equipment industries, changes in
earnings estimates by analysts, or other events or factors. In addition, the
stock market has experienced extreme price and volume fluctuations, which have
particularly affected the market prices of many technology companies and which
have often been unrelated to the operating performance of such companies. The
Company's sales or operating results in future quarters may be below the
expectations of public market securities analysts and investors. In such event,
the
14
<PAGE> 15
price of the Company's Common Stock would likely decline, perhaps
substantially. These Company-specific factors or broad market fluctuations may
materially adversely affect the market price of the Company's Common Stock.
Shares Eligible for Future Sale. Sales of substantial amounts of
Common Stock in the public market after the date of this Report on Form 10-Q
could adversely affect the prevailing market price of the Common Stock. As of
November 12, 1996, there were 13,165,614 shares of Common Stock outstanding.
Beginning 180 days after June 10, 1996, approximately 2,671,758 shares, which
are "restricted" shares ("Restricted Shares") under the Securities Act of 1933,
as amended (the "Securities Act"), will first become eligible for sale in the
public market pursuant to Rules 144 and 701 promulgated under the Securities
Act, as a result of the expiration of certain lock-up agreements with the
Company's underwriters, or due to a combination of the foregoing. Of the
Restricted Shares that will first become eligible for sale in the public market
approximately 180 days after June 10, 1996, approximately 848,000 shares will
be subject to certain volume limitations and other resale restrictions pursuant
to Rule 144. Beginning 270 days after June 10, 1996, approximately 4,812,838
additional shares will become eligible for sale subject to the provisions of
Rule 144 upon the expiration of agreements not to sell such shares entered into
between the Company's underwriters and such stockholders. In addition, options
to purchase an additional approximately 318,014 shares will be vested and
exercisable, and the shares issuable upon exercise thereof eligible for sale
180 days following June 10, 1996, upon expiration of certain lock-up
agreements. In addition, the Commission has proposed revisions to Rule 144 and
Rule 144(k), the effect of which would be to shorten the holding period under
Rule 144 from two years to one year and to shorten the holding period under
Rule 144(k) from three years to two years. If enacted, these proposed revisions
would increase, potentially substantially, the number of shares that would be
available for sale in the public market 180 days after June 10, 1996. Any
shares subject to lock-up agreements may be released at any time without notice
by Hambrecht & Quist LLC.
The Company has filed a registration statement on Form S-8 registering
approximately 1,524,498 shares of Common Stock reserved for issuance under its
Amended and Restated 1993 Stock Option Plan and 300,000 shares of Common Stock
reserved for issuance under its Employee Stock Purchase Plan. Shares of Common
Stock issued pursuant to these plans will be available for sale in the public
market, subject to expiration of the lock-up agreement with the Company's
underwriters and to Rule 144 volume limitations applicable to affiliates.
15
<PAGE> 16
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None.
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERILINK CORPORATION
November 13, 1996 By: /s/ Timothy G. Conley
----------------------------------------
Timothy G. Conley,
Vice President, Finance and Chief
Financial Officer (Duly Authorized
Officer and Principal Financial Officer)
17
<PAGE> 18
VERILINK CORPORATION
INDEX TO EXHIBITS
Exhibit Description
- ------- -----------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<CASH> 34,577
<SECURITIES> 7,871
<RECEIVABLES> 5,575
<ALLOWANCES> 77
<INVENTORY> 5,684
<CURRENT-ASSETS> 54,872
<PP&E> 8,381
<DEPRECIATION> 6,406
<TOTAL-ASSETS> 57,593
<CURRENT-LIABILITIES> 8,841
<BONDS> 0
0
0
<COMMON> 131
<OTHER-SE> 7,698
<TOTAL-LIABILITY-AND-EQUITY> 57,593
<SALES> 14,676
<TOTAL-REVENUES> 14,676
<CGS> 7,122
<TOTAL-COSTS> 7,122
<OTHER-EXPENSES> 5,650
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 470
<INCOME-PRETAX> 2,374
<INCOME-TAX> 926
<INCOME-CONTINUING> 1,448
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,448
<EPS-PRIMARY> .10
<EPS-DILUTED> .10
</TABLE>
