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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 March 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 0-19360
VERILINK CORPORATION
- --------------------------------------------------------------------------------
(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 May 9, 1997
was 13,489,905.
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INDEX
VERILINK CORPORATION
FORM 10-Q
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
- ------- --------------------- --------
<S> <C> <C>
Item 1. Financial Statements
Consolidated Condensed Statements of Income for the three 3
and nine months ended March 31, 1997 and 1996
Consolidated Condensed Balance Sheets at 4
March 31, 1997 and June 30, 1996
Consolidated Condensed Statements of Cash Flows for 5
the nine months ended March 31, 1997 and 1996
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of 8
Financial Condition and Results of Operations
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERILINK CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
------------------------ ------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales $13,760 $10,533 $44,722 $28,678
Cost of sales 6,943 5,106 21,856 14,070
----------- ----------- ----------- -----------
Gross profit 6,817 5,427 22,866 14,608
----------- ----------- ----------- -----------
Operating expenses:
Research and development 2,304 1,769 6,782 5,059
Selling, general and administrative 3,638 2,947 11,004 7,795
----------- ------------ ----------- -----------
Total operating expenses 5,942 4,716 17,786 12,854
----------- ----------- ----------- -----------
Income from operations 875 711 5,080 1,754
Interest and other income, net 543 10 1,518 65
----------- ----------- ----------- -----------
Income before income taxes 1,418 721 6,598 1,819
Provision for (benefit from) income taxes 553 (384) 2,574 55
----------- ----------- ----------- -----------
Net income $865 $1,105 $4,024 $1,764
=========== ============ =========== ===========
Net income per share $0.06 $0.10 $0.28 $0.16
=========== =========== =========== ===========
Shares used to compute net
income per share 14,312 11,496 14,341 11,115
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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VERILINK CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
March 31, June 30,
-------------- ------------
1997 1996
-------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $36,156 $40,542
Short-term investments 5,485 -
Accounts receivable, net 5,155 6,182
Inventories 6,513 4,952
Deferred tax assets 815 815
Other current assets 63 508
---------- ----------
Total current assets 54,187 52,999
Property and equipment, net 5,754 1,530
Deferred tax assets 613 613
Other assets 137 76
---------- ----------
Total assets $60,691 $55,218
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $1,645 $2,199
Accrued expenses 5,261 4,945
Income taxes payable 1,247 840
---------- ----------
Total current liabilities 8,153 7,984
Stockholders' equity 52,538 47,234
---------- ----------
Total liabilities and stockholders' equity $60,691 $55,218
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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VERILINK CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
March 31,
---------------------------
1997 1996
----------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $4,024 $1,764
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 881 579
Deferred income taxes - (1,064)
Compensation related to stock options 262 300
Changes in assets and liabilities:
Accounts receivable 1,027 (340)
Inventories (1,561) (754)
Other assets 384 (320)
Accounts payable (554) (125)
Accrued expenses 316 362
Income taxes payable 407 760
----------- ------------
Net cash provided by operating activities 5,186 1,162
----------- ------------
Cash flows from investing activities:
Purchase of property and equipment (5,105) (546)
Purchase of short-term investments (5,485) -
----------- ------------
Net cash used in investing activities (10,590) (546)
----------- ------------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net 592 104
Payments received on stockholders' notes receivable 426 -
Repurchase of Common Stock - (183)
Repayment of long-term debt - (128)
----------- ------------
Net cash provided by (used in) financing activities 1,018 (207)
----------- ------------
Net increase (decrease) in cash and cash equivalents (4,386) 409
Cash and cash equivalents at beginning of period 40,542 3,243
----------- ------------
Cash and cash equivalents at end of period $36,156 $3,652
=========== ============
Supplemental disclosures:
Cash paid for income taxes $2,167 $359
Common stock issued for notes receivable - $577
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. Interim Financial Statements
The accompanying unaudited interim consolidated condensed 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 and nine month periods ended March 31, 1997
are not necessarily indicative of results which may be achieved for the entire
fiscal year ending June 30, 1997. The unaudited consolidated condensed 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> March 31, June 30,
------------- -------------
1997 1996
------------- -------------
<S> <C> <C>
Raw materials $3,448 $2,999
Work-in-process 1,449 831
Finished goods 2,277 1,780
------------- -------------
7,174 5,610
Less inventory (661) (658)
reserves
------------- -------------
$6,513 $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 provide for annual minimum lease payments of
approximately $168,000 from 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 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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NOTE 4. Recent Accounting Pronouncement
In February 1997, the Financial Accounting Standards Board issued
Financial Accounting Standards No. 128 ("FAS 128"), "Earnings per Share". This
statement redefines earnings per share under generally accepted accounting
principles. Under the new standard, primary earnings per share is replaced by
basic earnings per share and fully diluted earnings per share is replaced by
diluted earnings per share. The Company is required to adopt the new standard in
the second quarter of fiscal 1998. The following table sets forth primary
earnings per share as reported and unaudited pro forma and diluted earnings per
share assuming FAS 128 had been applied during the periods presented:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
------------------------ ------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Primary earnings per share as reported $0.06 $0.10 $0.28 $0.16
Pro forma basic net income per share 0.06 0.10 0.30 0.17
Pro forma diluted net income per share 0.06 0.10 0.28 0.16
</TABLE>
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
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, but are not limited to, the Company's
anticipated expense levels for research and development, and selling, general
and administrative; anticipated capital expenditures; and expectations regarding
inventory balances, liquidity and adequacy of cash resources under the
sub-headings "Results of Operations" and "Liquidity and Capital Resources".
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 update the reasons why actual results could
differ from those projected in the forward-looking statements. Investors should
also consult the risk factors listed from time to time in the Company's Reports
on Form 10-K and Annual Report to Stockholders.
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
software 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.
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The following table presents the percentages of total sales represented
by certain line items from the Condensed Consolidated Statements of Income for
the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
------------------------ ------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 50.5% 48.5% 48.9% 49.1%
----------- ----------- ----------- -----------
Gross profit 49.5% 51.5% 51.1% 50.9%
----------- ----------- ----------- -----------
Operating expenses:
Research and development 16.7% 16.8% 15.2% 17.6%
Selling, general and administrative 26.4% 28.0% 24.6% 27.2%
----------- ----------- ----------- -----------
Total operating expenses 43.1% 44.8% 39.8% 44.8%
----------- ----------- ----------- -----------
Income from operations 6.4% 6.7% 11.3% 6.1%
Interest and other income, net 3.9% 0.1% 3.4% 0.2%
----------- ----------- ----------- -----------
Income before income taxes 10.3% 6.8% 14.7% 6.3%
Provision for (benefit from) income taxes 4.0% (3.7%) 5.7% 0.2%
----------- ----------- ----------- -----------
Net income 6.3% 10.5% 9.0% 6.1%
=========== =========== =========== ===========
</TABLE>
Periods Ended March 31, 1997 and 1996
Sales. Sales for the three and nine months ended March 31, 1997
represented increases of 31% and 56%, respectively, over sales of the comparable
prior year periods. The increases resulted primarily from increased unit
shipments of the Company's Access System 2000 product line which represented 80%
and 79% of total sales during the three and nine months ended March 31, 1997 as
compared with 69% and 65% of sales for the related periods ended March 31, 1996.
Sales to the Company's five largest customers during the three and nine months
ended March 31, 1997 were approximately 70% and 68% of total sales as compared
with approximately 63% and 58% during the related periods ended March 31, 1996.
Gross Profit. Gross profit increased in the three and nine months ended
March 31, 1997 from the comparable prior year periods, primarily due to an
increase in sales levels. Gross margin decreased to 49.5% of sales during the
quarter ended March 31, 1997 from 51.5% of sales during the respective prior
year quarter primarily due to increased material costs, as a percentage of
sales, as a result of changes in customer and product mix. Gross margin for the
nine months ended March 31, 1997 improved to 51.1% as compared to 50.9% for the
related nine month period in 1996. During the first nine months of fiscal 1997,
the Company experienced lower manufacturing costs, as a percentage of sales, as
a result of increased sales volume, offset by increased material costs, as a
percentage of sales, due to changes in customer and product mix.
Research and Development. Research and development expense increased
during the three and nine months ended March 31, 1997 as compared with the
corresponding prior year periods primarily due to salaries and other
personnel-related expenses resulting from increased staffing levels. Research
and development expense declined as a percentage of sales due to the increased
sales levels between the comparable 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 expense
will continue to increase in amount during the remainder of fiscal 1997 and will
vary over time as a percentage of sales.
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Selling, general and administrative. Selling, general and
administrative expense increased during the three and nine months ended March
31, 1997 as compared with the corresponding prior year periods primarily as a
result of increased personnel-related expenses, such as salaries and benefits,
in sales and marketing due to increased staff levels and also due to a higher
level of commission expense. 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, but expects such expenses will vary over time as a percentage of
sales.
Interest and Other Income. Net interest and other income increased
during the three and nine months ended March 31, 1997 as compared with the
corresponding prior year periods 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 for the
three and nine month periods ended March 31, 1997 represents a combined
estimated Federal and state effective tax rate of 39%. The three and nine
months ended March 31, 1996 included a tax benefit of $665,000 related to
previously expensed deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
The Company raised approximately $37 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 increase in cash provided by operations during the nine months
ended March 31, 1997 was primarily due to the Company's increased profitability.
Accounts receivable declined by approximately $1.0 million from June 1996
primarily due to the timing of shipments and collections during the quarter.
Inventory increased by approximately $1.6 million since June 1996 to meet
anticipated demand for the Company's products and due to the deferral of
expected shipments to certain of the Company's major customers during the
quarter ended March 31, 1997. The Company expects to reduce its inventory level
in the near term as the inventory related to such deferrals is shipped.
During the nine months ended March 31, 1997, the Company made capital
expenditures of approximately $5.1 million primarily for leasehold improvements
and computer and test equipment. The Company expects that capital expenditures
for the fiscal year ending June 30, 1997 will approximate $6.0 to $7.0 million.
At March 31, 1997, the Company had cash and cash equivalents of $36.1
million, short-term investments of $5.5 million and an unused line of credit of
$2,000,000. The Company believes that its existing cash and cash equivalents,
short-term investments, line of credit and anticipated cash flows from
operations will satisfy the Company's cash needs through at least the next
twelve months.
RISK FACTORS
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. Sales
to the top five customers during each of the three and nine month periods ended
March 31,1997 represented approximately 70% and 68%, respectively, of total
sales. 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
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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. 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 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 individual current customers have varied by as much as $2.0 million between
consecutive quarters.
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.
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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, the
Company has had and may, in some future quarter, have operating results 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."
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 has
experienced significant fluctuations in its stock price and share trading volume
since its initial public offering in June 1996. There is no assurance that such
fluctuations will not continue. These Company-specific factors or broad market
fluctuations may materially adversely affect the market price of the Company's
Common Stock.
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
80% of sales for the three and nine months ended March 31, 1997 and 70% of sales
in fiscal 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."
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,
which will require the Company to significantly expand its sales force. There
can be no assurance that the
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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. 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
13
<PAGE> 14
anticipates that competitors and customers may develop products that could be
used for selected applications for which the 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
14
<PAGE> 15
comply with current industry standards, and this noncompliance must be addressed
in the design of the Company's 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 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.
15
<PAGE> 16
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 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. Except for key man life insurance on and
employment agreements with Mr. Belden and Mr. Taylor, the Company does not
maintain key man life insurance on and has no employment agreements with any
other of such persons. 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 42% of the outstanding Common Stock.
Accordingly, these stockholders, if they were to act as a group, would
effectively 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.
16
<PAGE> 17
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Index:
Exhibit Number Description of Exhibit
-------------- ----------------------
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter ended March 31,
1997.
17
<PAGE> 18
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
May 14, 1997 By: /s/ JOHN C. BATTY
---------------------------------------------------
John C. Batty,
Vice President, Finance and Chief Financial Officer
(Duly Authorized Officer and Principal Financial
Officer)
18
<PAGE> 19
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
- ----------- -----------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-01-1996
<PERIOD-END> MAR-31-1997
<CASH> 36,156
<SECURITIES> 5,485
<RECEIVABLES> 5,155
<ALLOWANCES> 77
<INVENTORY> 6,513
<CURRENT-ASSETS> 54,187
<PP&E> 12,751
<DEPRECIATION> 6,997
<TOTAL-ASSETS> 60,691
<CURRENT-LIABILITIES> 8,153
<BONDS> 0
0
0
<COMMON> 135
<OTHER-SE> 52,403
<TOTAL-LIABILITY-AND-EQUITY> 60,691
<SALES> 44,722
<TOTAL-REVENUES> 44,722
<CGS> 21,856
<TOTAL-COSTS> 39,642
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 6,598
<INCOME-TAX> 2,574
<INCOME-CONTINUING> 4,024
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,024
<EPS-PRIMARY> .28
<EPS-DILUTED> .28
</TABLE>
