<PAGE> 1
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 28, 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
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
145 BAYTECH DRIVE, SAN JOSE, CALIFORNIA 95134
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
408-945-1199
- --------------------------------------------------------------------------------
(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 7,
1997 was 13,681,254.
1
<PAGE> 2
INDEX
VERILINK CORPORATION
FORM 10-Q
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
- ------- --------------------- --------
<S> <C> <C>
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the 3
three months ended September 28, 1997 and September 29, 1996
Condensed Consolidated Balance Sheets at 4
September 28, 1997 and June 29, 1997
Condensed Consolidated Statements of Cash Flows for 5
the three months ended September 28, 1997 and September 29, 1996
Notes to Condensed Consolidated 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>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousand except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three months ended
September 28, September 29,
1997 1996
------------ ------------
<S> <C> <C>
Net sales $ 10,013 $ 14,676
Cost of sales 5,008 7,122
------------ ------------
Gross profit 5,005 7,554
------------ ------------
Operating expenses:
Research and development 2,863 2,044
Selling, general and administrative 3,714 3,606
------------ ------------
Total operating expenses 6,577 5,650
------------ ------------
Income (loss) from operations (1,572) 1,904
Interest and other income, net 574 470
------------ ------------
Income (loss) before income taxes (998) 2,374
Provision for (benefit from) income taxes (369) 926
------------ ------------
Net income (loss) $ (629) $ 1,448
============ ============
Net income (loss) per share $ (0.05) $ 0.10
============ ============
Weighted average common and common
equivalent shares outstanding 13,634 14,350
============ ============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
3
<PAGE> 4
VERILINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
( in thousands, unaudited )
<TABLE>
<CAPTION>
September 28, June 29,
1997 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 29,723 $ 36,596
Short-term investments 9,573 2,454
Accounts receivable, net 6,709 8,462
Inventories 4,571 4,453
Deferred tax assets 957 957
Other current assets 393 215
------------ ------------
Total current assets 51,926 53,137
Property and equipment, net 6,743 6,607
Non-current deferred tax assets 616 616
Other assets 720 327
------------ ------------
Total assets $ 60,005 $ 60,687
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,363 $ 1,258
Accrued expenses 4,435 5,080
Income taxes payable 654 582
------------ ------------
Total current liabilities 6,452 6,920
Stockholders' equity 53,553 53,767
------------ ------------
Total liabilities and stockholders' equity $ 60,005 $ 60,687
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 5
VERILINK
CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
<TABLE>
<CAPTION>
Three Months Ended
September 28, September 29,
1997 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) (629) 1,448
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 537 238
Deferred compensation related to stock options 36 57
Changes in assets and liabilities:
Accounts receivable 1,753 607
Inventories (118) (732)
Other assets (278) 101
Accounts payable 105 (21)
Accrued expenses (645) 61
Income taxes payable 72 817
------------- -------------
Net cash provided by operating activities 833 2,576
------------- -------------
Cash flows from investing activities:
Purchase of property and equipment (673) (675)
Purchase of short-term investments (7,119) (7,871)
Purchase of other assets (293) -
------------- -------------
Net cash used in investing activities (8,085) (8,546)
------------- -------------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net 379 5
Net decrease in cash and cash equivalents (6,873) (5,965)
Cash and cash equivalents at beginning of period 36,596 40,542
------------- -------------
Cash and cash equivalents at end of period 29,723 34,577
============= =============
Supplemental disclosures:
Cash paid (refund) for income taxes (455) 109
</TABLE>
5
<PAGE> 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. Interim Financial Statements
The accompanying unaudited interim condensed 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 months ended September 28, 1997 are not
necessarily indicative of results which may be achieved for the entire fiscal
year ending June 28, 1998. The unaudited interim condensed consolidated
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 29, 1997 as filed with the Securities and Exchange
Commission.
NOTE 2. Inventories (in thousands)
<TABLE>
<CAPTION>
September 28, June 29,
1997 1997
------------- -------------
<S> <C> <C>
Raw materials $ 3,220 $ 3,228
Work-in-process 703 973
Finished goods 1,485 1,175
------------- -------------
5,408 5,376
Less inventory reserves (837) (923)
------------- -------------
$ 4,571 $ 4,453
============= =============
</TABLE>
6
<PAGE> 7
NOTE 3. Recent Accounting Pronouncement
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of 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 net income (loss) per share as reported and unaudited
pro forma basic and diluted net income (loss) per share assuming FAS 128 had
been applied during the periods presented:
<TABLE>
<CAPTION>
September 28, September 29,
1997 1996
------------- -------------
<S> <C> <C>
Net income (loss) per share as reported $ (0.05) $ 0.10
Pro forma basic net income (loss) per share (0.05) 0.11
Pro forma diluted net income (loss) per share (0.05) 0.10
</TABLE>
In June 1997, the FASB issued Statement No. 130 ("FAS 130"), "Reporting
Comprehensive Income". FAS 130 establishes standards for reporting comprehensive
income and its components in a financial statement that is displayed with the
same prominence as other financial statements. Comprehensive income, as defined,
includes all changes in equity (net assets) during a period from nonowner
sources. Examples of items to be included in comprehensive income, which are
excluded from net income, include foreign currency translation adjustments and
unrealized gain/loss on available-for-sale securities. The disclosure prescribed
by FAS 130 must be made beginning with fiscal 1999.
In June 1997, the FASB issued Statement No. 131 ("FAS 131"),
"Disclosures about Segments of an Enterprise and Related Information". This
statement establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. The Company has not yet determined the impact, if any, of adopting
this new standard. The disclosures prescribed by FAS 131 are effective for
fiscal 1999.
7
<PAGE> 8
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 operations; 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
Overview
Verilink Corporation develops, manufactures and markets 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
narrowband transmission facilities including fractional or full T1/E1, and to
multiple T1/E1 facilities, up to broadband (T3) transmission speeds.
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.
8
<PAGE> 9
The following table presents the percentages of total sales represented
by certain line items from the Condensed Consolidated Statements of Operations
for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
------------------------------
September 28, September 29,
1997 1996
------------- -------------
<S> <C> <C>
Sales 100.0% 100.0%
Cost of sales 50.0% 48.5%
------------- -------------
Gross margin 50.0% 51.5%
------------- -------------
Operating expenses:
Research and development 28.6% 13.9%
Selling, general and administrative 37.1% 24.6%
------------- -------------
Total operating expenses 65.7% 38.5%
------------- -------------
Income (loss) from operations (15.7)% 13.0%
Interest and other income, net 5.7 % 3.2%
------------- -------------
Income (loss) before income taxes (10.0)% 16.2%
Provision for (benefit from) income taxes (3.7)% 6.3%
------------- -------------
Net income (loss) (6.3)% 9.9%
------------- -------------
</TABLE>
Periods Ended September 28, 1997 and September 29, 1996
Sales. Sales for the three months ended September 28, 1997 decreased
31.8% from the comparable prior year period and decreased 19.6% from the fourth
fiscal quarter of 1997. The decreases from the corresponding prior year period
and prior quarter resulted primarily from lower demand for products used in
wireless applications. Sales to the Company's five largest customers during the
three months ended September 28, 1997 were approximately 46% of total sales as
compared to approximately 65% during the related period ended September 29,
1996.
Gross Margin. Gross margin decreased to 50% of total sales in the three
months ended September 28, 1997 from 51% of total sales during the comparable
prior year quarter primarily due to lower sales volumes.
Research and Development. Research and development expenditures
increased $0.8 million to $2.9 million in the three months ended September 28,
1997 over the corresponding prior year period, and increased as a percentage of
sales from 13.9% to 28.6%, reflecting increased investment in new product
development and lower sales levels. 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 1998 and will vary
over time as a percentage of sales.
Selling, general and administrative. Selling, general and administrative
expense increased by $0.1 million in the three months ended September 28, 1997
over the corresponding prior year period, and increased as a percentage of sales
from 24.6% to 37.1%. The increase in spending is due primarily to increased
selling activities, while the increase in percent is due primarily to lower
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 legal and information technology costs
necessary to support expanded operations. The Company expects such expenses will
vary over time as a percentage of sales.
9
<PAGE> 10
Interest and Other Income. Net interest and other income increased by
$0.1 million in the three months ended September 28, 1997 over the corresponding
prior year period primarily as a result of higher yields on invested balances.
Provision for Income Taxes. The benefit from income taxes for the three
month period ended September 28, 1997 reflects available carryback capacity
combined with expected R&D tax credits in accordance with FAS 109. The combined
estimated Federal and State effective tax rate for fiscal 1998 is 37%. The
provision for income taxes of $926,000 for the quarter ended September 29, 1996
represented an estimated effective tax rate of 39%.
LIQUIDITY AND CAPITAL RESOURCES
On September 28, 1997, the Company's principal sources of liquidity
included $39.3 million of cash and cash equivalents, and short-term investments.
During the three-month period ended September 28, 1997, the Company
generated $833,000 from operating activities, down from the $2.6 million
generated for the three-month period ended September 29, 1996. Accounts
receivable were $1.8 million lower at September 28, 1997 than at June 29, 1997,
reflecting lower sales levels and the collection of the prior quarter's
shipments.
Cash used for investing activities was $8.1 million for the three-month
period ended September 28, 1997, as compared to $8.5 million for the three-month
period ended September 29, 1996. The decrease is primarily a result of lower net
purchases of short-term investments. Verilink invested $673,000 in property and
equipment during the first three months of fiscal 1998 which was approximately
the same as the corresponding prior year period. The Company estimates that
total capital expenditures for fiscal 1998 could approximate $6.0 million, which
are anticipated to be used for test equipment, design tools, enterprise resource
planning (ERP) software applications, and new manufacturing capability. The
Company expects its current facilities will be adequate through 1998.
The Company's $2.0 million secured revolving line of credit expired on August
15, 1997. There was no borrowing under the line of credit in 1997. While the
Company believes that its existing cash and cash equivalents, short-term
investments and anticipated cash flows from operations will satisfy the
Company's near-term cash needs, Verilink continues to investigate the
possibility of generating financial resources through committed credit
agreements, technology or manufacturing partnerships, equipment financing and
offerings of debt and equity securities.
FACTORS AFFECTING FUTURE RESULTS
As described by the following factors, past financial performance should
not be considered to be a reliable indicator of future performance, and
investors should not use historical trends to anticipate results or trends in
future periods.
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 1997, NORTEL, MCI, and CompuServe accounted for 22%, 20%, and 11% of the
Company's sales, respectively, and sales to the Company's top five customers
accounted for 67% of the Company's sales. In fiscal 1996, NORTEL, MCI, and
CompuServe accounted for 7%, 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. Other than
NORTEL, MCI and CompuServe, no customer accounted for more than 10% of the
Company's revenue in fiscal 1997, 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
10
<PAGE> 11
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.
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
11
<PAGE> 12
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 in some future quarter may 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. These
Company-specific factors or broad market fluctuations may materially adversely
affect the market price of the Company's Common Stock. The Company 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.
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 in fiscal 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.
Need to Expand Sales Organization and Channels of Distribution.
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 and other channels of distribution. 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, or attract additional qualified distributors. 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 and expand its
channels of distribution could have a material adverse effect on the Company's
business, financial
12
<PAGE> 13
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, Telco Systems,
Inc. 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 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.
13
<PAGE> 14
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 DSL, IP, ISDN and
ATM. Furthermore, 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 and Channels of Distribution," and "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 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
14
<PAGE> 15
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.
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
15
<PAGE> 16
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 employment agreements with Mr.
Belden and Mr. Taylor, the Company does not have 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."
Antitakeover Effects of Certain Charter Provisions. 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 September 28,
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
November 13, 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
INDEX TO EXHIBITS
-----------------
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS FINANCIAL SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FINANCIAL STATEMENTS CONTAINED IN THE FORM 10-Q OF VERILINK CORPORATION FOR
THE FIRST FISCAL QUARTER ENDED SEPTEMBER 28, 1997 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-29-1997
<PERIOD-START> JUN-30-1997
<PERIOD-END> SEP-28-1997
<CASH> 29,723
<SECURITIES> 9,573
<RECEIVABLES> 6,785
<ALLOWANCES> 76
<INVENTORY> 4,571
<CURRENT-ASSETS> 51,926
<PP&E> 14,010
<DEPRECIATION> 7,267
<TOTAL-ASSETS> 60,005
<CURRENT-LIABILITIES> 6,452
<BONDS> 0
0
0
<COMMON> 137
<OTHER-SE> 53,416
<TOTAL-LIABILITY-AND-EQUITY> 60,005
<SALES> 10,013
<TOTAL-REVENUES> 10,013
<CGS> 5,008
<TOTAL-COSTS> 5,008
<OTHER-EXPENSES> 6,577
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (998)
<INCOME-TAX> (369)
<INCOME-CONTINUING> (629)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (629)
<EPS-PRIMARY> (0.05)
<EPS-DILUTED> (0.05)
</TABLE>
