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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 27, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 0-19360
VERILINK CORPORATION
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(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 94-2857548
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
145 BAYTECH DRIVE, SAN JOSE, CALIFORNIA 95134
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(Address of principal executive offices) (Zip Code)
408-945-1199
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The number of shares outstanding of the issuer's common stock as of November 4,
1998 was 13,925,867.
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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
Condensed Consolidated Statements of Operations for the 3
three months ended September 27, 1998 and September 28, 1997
Condensed Consolidated Balance Sheets at 4
September 27, 1998 and June 28, 1998
Condensed Consolidated Statements of Cash Flows for 5
the three months ended September 27, 1998 and September 28, 1997
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 9
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 19
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three months ended
September 27, September 28,
------------- -------------
1998 1997
-------- --------
<S> <C> <C>
Sales $ 17,078 $ 10,013
Cost of sales 8,308 5,008
-------- --------
Gross profit 8,770 5,005
-------- --------
Operating expenses:
Research and development 3,290 2,863
Selling, general and administrative 4,928 3,714
-------- --------
Total operating expenses 8,218 6,577
-------- --------
Income (loss) from operations 552 (1,572)
Interest and other income, net 559 574
-------- --------
Income (loss) before taxes 1,111 (998)
Provision for (benefit from) income taxes 389 (369)
-------- --------
Net income (loss) $ 722 $ (629)
======== ========
Net income (loss) per share - Basic $ 0.05 $ (0.05)
======== ========
Net income (loss) per share - Diluted $ 0.05 $ (0.05)
======== ========
Shares used in per share computations - Basic 13,908 13,655
======== ========
Shares used in per share computations - Diluted 14,244 13,655
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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VERILINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
September 27, June 28,
1998 1998
------------- --------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 12,741 $ 16,304
Short-term investments 29,145 26,111
Accounts receivable, net 7,752 5,992
Inventories 4,864 4,900
Deferred tax assets 1,532 1,532
Other current assets 257 342
-------- --------
Total current assets 56,291 55,181
Property and equipment, net 7,116 7,047
Deferred tax assets 436 436
Other assets 1,419 1,164
-------- --------
Total assets $ 65,262 $ 63,828
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,970 $ 2,527
Accrued expenses 7,516 6,747
Income taxes payable 1,117 744
-------- --------
Total liabilities 10,603 10,018
Stockholders' equity 54,659 53,810
-------- --------
Total liabilities and stockholders' equity $ 65,262 $ 63,828
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
<TABLE>
<CAPTION>
Three months ended
September 27, September 28,
------------- -------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 722 $ (629)
Adjustments to reconcile net income (loss) to net cash
Provided by (used in) operating activities:
Depreciation and amortization 471 537
Deferred compensation related to stock options 14 36
Changes in assets and liabilities:
Accounts receivable (1,760) 1,753
Inventories 36 (118)
Other assets (170) (278)
Accounts payable (557) 105
Accrued expenses 769 (645)
Income taxes payable 373 72
-------- --------
Net cash provided by (used in)
operating activities (102) 833
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (540) (673)
Purchases of short-term investments (3,034) (7,119)
Purchases of other assets -- (293)
-------- --------
Net cash used in investing activities (3,574) (8,085)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net 113 379
-------- --------
Net decrease in cash and cash equivalents (3,563) (6,873)
Cash and cash equivalents at beginning of period 16,304 36,596
-------- --------
Cash and cash equivalents at end of period $ 12,741 29,723
======== ========
Supplemental disclosures:
Cash paid (refund) for income taxes $ -- (455)
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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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 27, 1998 are not
necessarily indicative of results which may be achieved for the entire fiscal
year ending June 27, 1999. 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 28, 1998 as filed with the Securities and Exchange
Commission.
NOTE 2. Inventories (in thousands)
<TABLE>
<CAPTION>
September 27, June 28,
1998 1998
------------- --------
<S> <C> <C>
Raw materials $ 1,938 $ 2,313
Work in process 1,133 926
Finished goods 1,793 1,661
------- -------
$ 4,864 $ 4,900
======= =======
</TABLE>
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NOTE 3. Earnings Per Share
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128") during fiscal 1998. The statement simplifies
the standards for computing earnings per share (EPS) previously defined in
Accounting Principles Board Opinion No. 15, "Earnings Per Share" (APB 15) and
makes them comparable to international EPS standards. SFAS 128 requires
presentation of both Basic EPS and Diluted EPS on the face of the income
statement. Basic EPS, which replaces primary EPS, is computed by dividing net
income available to common stockholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period. Unlike the
computation of primary EPS, Basic EPS excludes the dilutive effect of stock
options. Diluted EPS replaces fully diluted EPS and gives effect to all dilutive
potential common shares outstanding during a period. In computing Diluted EPS,
the average price for the period is used in determining the number of shares
assumed to be purchased from exercise of stock options rather than the higher of
the average or ending price as used in the computation of fully diluted EPS.
Earnings per share for all periods presented have been restated to conform to
the SFAS 128 requirements.
The following is a reconciliation of the numerators and denominators of the
Basic and Diluted EPS computations for the periods presented below:
<TABLE>
<CAPTION>
(in thousands, except per share amounts)
----------------------------------------
Three Months Ended
----------------------
Sept 27 Sept 28
1998 1997
-------- --------
<S> <C> <C>
Net income (loss) [numerator] $ 722 $ (629)
======== ========
Shares Calculation [denominator]:
Weighted shares outstanding - Basic 13,908 13,655
Effect of Dilutive Securities:
Potential common stock
relating to stock options(a) 336 --
-------- --------
Weighted shares outstanding - Diluted 14,244 13,655
======== ========
Net income (loss) per share - Basic $ 0.05 (0.05)
======== ========
Net income (loss) per share - Diluted $ 0.05 (0.05)
======== ========
</TABLE>
(a) Potential common stock relating to stock options has been excluded for the
three month period ended September 28, 1997 since its inclusion would be
antidilutive.
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NOTE 4. Recent Accounting Pronouncements
In June, 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting
Comprehensive Income". SFAS 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 non-owner 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. No
comprehensive income information has been presented as the impact of the
disclosure required by SFAS 130 is immaterial to the financial statements of the
Company.
In June, 1997, the FASB issued Statement of Financial Accounting Standards
No. 131 ("SFAS 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 disclosures prescribed by SFAS 131
are effective for the fiscal year ending June 27, 1999 but are not required for
interim financial statements in 1999.
NOTE 5. Related Party Transactions
In September 1998, the Company began occupying an additional 16,000 square
feet of space at 161 Nortech Drive from Baytech Associates ("Baytech") in
accordance with an agreement currently under negotiation. Baytech is owned by
two stockholders who are Officers and Directors of the Company. The Company has
agreed to loan Baytech funds for leasehold improvements and rent obligations at
161 Nortech Drive in consideration of certain lease concessions made by Baytech
to the Company. The loan to Baytech will be evidenced by a promissory note
bearing interest at 8% and will be payable out of the net lease proceeds
received by Baytech from leasing the space not occupied by the Company.
In September 1998, the Company provided one if its officers with a loan
facility not to exceed $1,000,000 at an interest rate of 6% per annum. As of
November 4, 1998, $535,000 was borrowed against that facility. All loans made
pursuant to the facility are due on or before December 31, 1998.
In October 1998, the Company guaranteed $500,000 in borrowings made by one
of its officers by pledging as collateral $500,000 on deposit with the lending
institution (CivicBank of Commerce) and agreed to provide that officer with a
loan facility not to exceed $3,000,000, including the guaranty. All loans made
pursuant to this loan facility will be due on or before December 31, 1999. This
loan facility will be secured by a pledge of Verilink common stock having a fair
market value equal to at least twice the principal amount of the borrowings
under this loan facility.
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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
beliefs, expectations, intentions, hopes, plans and goals regarding the future
and statements regarding the Company's future capital requirements and Year 2000
assessment and remediation efforts. Actual results could differ from those
projected in any forward-looking statements for the reasons detailed below and
in the Sections entitled "Factors Affecting Future Results" and other sections
of this Report on Form 10-Q. The forward-looking statements included on this
Form 10-Q are based on information available to the Company as of 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 integrated access
products for telecommunications network service providers and corporate end
users. Verilink's integrated network access products are used by network service
providers such as inter-exchange and local exchange carriers, and providers of
Internet, personal communications and cellular services to provide seamless
connectivity and interconnect for multiple traffic types on wide area networks
("WANs"). 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, and frame relay services. Currently under development
is the Access System 3000 product which is expected to include an increase in
switching capacity, support for voice signals and broad-band multiplexing up to
T3 rates.
The Company is currently in the process of evaluating its information
technology infrastructure for year 2000 compliance. The Company believes that
its current product offerings are year 2000 compliant. See "Factors Affecting
Future Results."
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.
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 27, September 28,
------------- -------------
1998 1997
---- ----
<S> <C> <C>
Sales 100.0% 100.0%
Cost of sales 48.6% 50.0%
----- -----
Gross margin 51.4% 50.0%
----- -----
Operating expenses:
Research and development 19.3% 28.6%
Selling, general and administrative 28.9% 37.1%
----- -----
Total operating expenses 48.2% 65.7%
----- -----
Income (loss) from operations 3.2% (15.7%)
</TABLE>
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<TABLE>
<CAPTION>
Three months ended
September 27, September 28,
------------- -------------
1998 1997
---- ----
<S> <C> <C>
Interest and other income, net 3.3% 5.7%
----- -----
Income (loss) before taxes 6.5% (10.0%)
Provision for (benefit from) income taxes 2.3% (3.7%)
----- -----
Net income (loss) 4.2% (6.3%)
===== =====
</TABLE>
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Periods Ended September 27, 1998 and September 28, 1997
Sales. Net sales for the three months ended September 27, 1998 increased 70.6%
compared to the comparable period in the prior year, and decreased by 1.3%
compared to the fourth fiscal quarter of 1998. The increase from the
corresponding period in the prior year resulted primarily from higher demand for
the AS 2000 product line. Net sales to the Company's five largest customers
during the three months ended September 27, 1998 were approximately 75% of total
net sales as compared to approximately 53% during the related period ended
September 28, 1997. Net sales to the Company's wireless and carrier customers
accounted for 63% of sales during the three months ended September 27, 1998
compared to 43% during the comparable period in the prior year.
Gross Margin. Gross margin increased to 51.4% of net sales in the three
months ended September 27, 1998 from 50% of net sales during the comparable
period in the prior year primarily due to fixed manufacturing costs being spread
over increased revenue and reduced direct material costs.
Research and Development. Research and development expenditures increased
$0.4 million to $3.3 million during the three months ended September 27, 1998
compared to the comparable period in the prior year, and decreased as a
percentage of sales from 28.6% to 19.3%, reflecting increased engineering
material expenses at higher 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 1999 and will
vary over time as a percentage of sales.
Selling, general and administrative. Selling, general and administrative
expense increased $1.2 million during the three months ended September 27, 1998
compared to the corresponding period in the prior year, and decreased as a
percentage of sales from 37.1% to 28.9%. The increase in spending is primarily
due to an increase in headcount and selling expenses to support the increase in
sales. The Company expects selling, general and administrative expense to
increase in the future as a result of increased expenses associated with a
larger sales and marketing and support staff, as well as increased
administrative expenses for information technology costs necessary to support
expanded operations. The Company expects such expenses will vary over time as a
percentage of sales.
Interest and Other Income. Net interest and other income was relatively
unchanged during the three month period ended September 27, 1998 over the
comparable period in the prior year.
Provision for Income Taxes. The combined estimated Federal and State fiscal
1999 effective tax rate is 35%. Accordingly, the provision for income taxes of
$389,000 for the quarter ended September 27, 1998 reflects 35% of taxable
income.
LIQUIDITY AND CAPITAL RESOURCES
On September 27, 1998, the Company's principal sources of liquidity
included $41.9 million of cash and cash equivalents, and short-term investments.
During the three-month period ended September 27, 1998, the Company used
$102,000 for operating activities, down from the $833,000 generated for the
three-month period ended September 28, 1997. Accounts receivable were $1.8
million higher at September 27, 1998 than at June 28, 1998, reflecting
significantly higher sales levels in the third month of the current quarter.
Cash used in investing activities was $3.6 million for the three-month
period ended September 27, 1998, as compared to $8.1 million for the three-month
period ended September 28, 1997. The decrease is primarily a result of lower net
purchases of short-term investments. Verilink invested $540,000 in property and
equipment during the first three months of fiscal 1999, down slightly from the
corresponding prior year period. The Company estimates that total capital
expenditures for fiscal 1999 could approximate $5.0 million, which are
anticipated to be used for enterprise resource planning (ERP) software
applications and implementation, test equipment, design tools, and new
manufacturing capability, although no assurance can be given that additional
expenditures will not be needed. In mid-September, the
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Company began occupying an additional 16,000 square feet of office space. The
Company expects these facilities to be adequate through fiscal 1999.
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, the Company 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 continue to account for
a majority of the Company's sales. In the quarter ended September 27, 1998, MCI,
Nortel and Compuserve accounted for 33%, 21% and 10% of the Company's sales,
respectively, and sales to the Company's top five customers accounted for 75% of
the Company's sales. In fiscal 1998, Nortel, MCI, Qualcomm and CompuServe
accounted for 20%, 16%, 12% and 11% of the Company's sales, respectively, and
sales to the Company's top five customers accounted for 64% of the Company's
sales. In fiscal 1997, Nortel, MCI, Qualcomm and CompuServe accounted for 22%,
20%, 9% and 11% of the Company's sales, respectively, and the Company's top five
customers accounted for 67% of the Company's 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 sales. Other than Nortel,
MCI, Qualcomm and CompuServe, no customer accounted for more than 10% of the
Company's sales in fiscal years 1998, 1997, or 1996. 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. Certain customers of the Company have been or may be acquired by
other existing customers. The impact of such acquisitions on sales to such
customers is uncertain, but there can be no assurance that such acquisitions
will not result in a reduction in sales to those customers. In addition, such
acquisitions could result in further concentration of the Company's customers.
The Company has in the past experienced significant declines in sales it
believes were in part related to orders being delayed or cancelled as a result
of pending acquisitions relating to its customers. There can be no assurance
future merger and acquisition activity among the customers will not have a
similar adverse affect on the Company's sales and results of operations. 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 period to period. In some cases, major customers have
abruptly terminated purchases of the Company's products. 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" and "Fluctuations in Quarterly
Operating Results".
Fluctuations in Quarterly Operating Results. The Company's sales are
subject to quarterly and annual fluctuations due to a number of factors
resulting in more variability and less predictability in the Company's
quarter-to-quarter sales and operating results. For example, sales to MCI,
Nortel, Qualcomm and CompuServe have varied between quarters by as much as $4.0
million and were the major contributor to the variability of quarterly sales in
1998. 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.
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. The Company believes that recent period sales
have been adversely impacted by budgetary constraints caused by pending merger
discussions at
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some of its top 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
objectives, 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, and therefore continual improvement of manufacturing efficiencies and
introduction of new products and enhancements to existing products are required
to maintain gross margins. In response to customer demands or competitive
pressures, or to pursue new product or market opportunities, the Company may
take certain pricing or marketing actions, such as price reductions, volume
discounts, or provision of services at below-market rates. These actions could
materially and adversely affect the Company's operating results.
Operating results may also fluctuate due to factors such as the timing of
new product announcements and introductions by the Company, its major customers
or its competitors, delays in new product introductions by the Company, market
acceptance of new or enhanced versions of the Company's products, changes in the
product or customer mix of sales, changes in the level of operating expenses,
competitive pricing pressures, the gain or loss of significant customers,
increased research and development and sales and marketing expenses associated
with new product introductions, and general economic conditions. All of the
above factors are difficult for the Company to forecast, and these or other
factors can materially adversely affect the Company's business, financial
condition and results of operations for one quarter or a series of quarters. The
Company's expense levels are based in part on its expectations regarding future
sales and are fixed in the short term to a large extent. Therefore, the Company
may be unable to adjust spending in a timely manner to compensate for any
unexpected shortfall in sales. Any significant decline in demand relative to the
Company's expectations or any material delay of customer orders could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that the Company will be able
to sustain profitability on a quarterly or annual basis. In addition, 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".
The Company's products are covered by warranties and the Company is subject
to contractual commitments. If unexpected circumstances arise such that the
product does not perform as intended and the Company is not successful in
resolving product quality or performance issues, there could be an adverse
effect on the Company's business, financial condition and results of operations.
Also see "Year 2000 Compliance".
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.
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.
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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 both the Company's Access
System 2000 and the Access System 3000 product lines. The Access System 2000
product line represented approximately 86% of sales in fiscal 1998 and 80% of
sales in fiscal 1997. Market acceptance of both the Company's current and future
product lines 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 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
the Company can make them commercially available. The Company has in the past
experienced delays in the introduction of new products, product applications and
enhancements due to a variety of internal factors, such as reallocation of
priorities, difficulty in hiring sufficient qualified personnel and unforeseen
technical obstacles, as well as 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 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 and Marketing Organizations 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 and market 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 and marketing
personnel with the requisite experience and knowledge, or attract additional
qualified distributors. Availability of qualified sales and product marketing
personnel is limited, and competition for experienced personnel in the network
access and telecommunications equipment industries is intense. The failure to
timely expand the Company's sales force, expand its channels of distribution and
product marketing organization 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 or limited 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. See "Year 2000 Compliance".
Purchase orders from the Company's customers frequently require delivery
quickly after placement of the order. As 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 telecommunications network access 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 new entrants. The market for integrated access devices such as
the Company's Access System
14
<PAGE> 15
product line 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 and performance, support for multiple types of
communications services, network management, reliability, and quality of
customer support. There can be no assurance that the Company's current products
and future 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 and Larscom, Inc., a
subsidiary of Axel Johnson. In addition, the Company expects substantial
competition from companies in the computer networking market and other related
markets such as Newbridge Networks Corporation, Telco Systems, Inc., Visual
Networks Inc., and Adtran, 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 basic network termination products
is mature and 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, Digital Link, Kentrox, Paradyne and Larscom.
There can be no assurance that such companies or other competitors will not
introduce new products that provide greater functionality and/or at a lower
price than the Company's like products. In addition, advanced termination
products are emerging which represent both new market opportunities as well as a
threat to current products. Furthermore, basic line termination functions are
increasingly being integrated by competitors into other equipment such as
routers and switches, which include direct WAN interfaces in certain products,
eroding the addressable market for separate network termination products.
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 WAN 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, ISDN, Frame Relay, ATM
and IP. 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 delays 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".
Year 2000 Compliance. The year 2000 problem is widespread and complex. If
computer, information or telecommunication systems do not correctly recognize
date information when the year changes to 2000, there could be an adverse impact
on the Company's operations. The Company is evaluating its year 2000 risk as it
exists in four areas: Information Technology infrastructure, including reviewing
what actions are necessary to bring all software tools used internally to year
2000 compliance, information systems used by the Company's suppliers, potential
warranty and year 2000 claims from the Company's customers, and the potential
impact of reduced spending by customers or potential
15
<PAGE> 16
customers on telecommunication network solutions as a result of devoting a
substantial portion of their information system spending to resolve year 2000
compliance issues.
The Company is in the process of evaluating its information technology
infrastructure for year 2000 compliance, which include reviewing what actions
are required to make all software systems used internally year 2000 compliant.
The Company has purchased an enterprise resource planning (ERP) solution which
has been determined to be year 2000 compliant. The implementation of this ERP
solution will require a material investment by the Company in internal and
external resources. Significant delays by the Company in implementing this ERP
solution could have a material adverse impact on the business, operating results
and financial condition of the Company. It is the Company's intent for all
software systems and tools that are identified as non-compliant to be either
upgraded or replaced. For the non-compliant systems identified to date, the cost
to bring the systems to year 2000 compliance is not expected to be material to
the Company's operating results. However, if implementation of replacement
systems and tools is delayed, or if significant new non-compliance issues are
identified, the Company's results of operations, business and financial
condition could be materially affected.
The Company is in the process of contacting its key suppliers to determine
that the suppliers operations and the products and services they provide are
year 2000 compliant. In the event that any of the Company's key suppliers does
not successfully and timely achieve year 2000 compliance, the Company's
business, financial condition and results of operations could be adversely
affected.
All of the Company's products are currently being reviewed for compliance
to year 2000 guidelines. This process includes complete and thorough testing of
current products as well as inclusion of year 2000 requirements in
specifications for future product releases. Based on a preliminary review, the
Company believes its current product shipments are year 2000 compliant and that
neither performance nor functionality are affected by dates prior to, during,
and after the year 2000 and that the year 2000 is recognized as a leap year.
However, as all customer events cannot be anticipated, the Company may see an
increase in product warranty and other claims. In the event that any of the
Company's products ultimately are not year 2000 compliant, or there are customer
claims made against the Company, the Company's business, financial condition and
results of operations could be adversely affected.
The Company has not developed a contingency plan to address every potential
year 2000 non-compliance situation that may be present when the year changes to
2000. However, it is the Company's intention to formulate contingency plans in
those areas where year 2000 non-compliance could have an adverse effect on the
Company's business, financial condition and results of operation. See
"Enterprise Resource Planning".
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,
engineering and product marketing organizations. 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 personnel is quite
limited, and competition among companies for such personnel is intense. The
Company is currently attempting to hire a number of sales, product marketing and
engineering personnel and has experienced delays in filling such positions and
expects to experience continued difficulty in filling its needs for qualified
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 and introduction cycles or otherwise have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Need to Expand Sales and Marketing Organizations and Channels of
Distribution" and "Dependence on Key Personnel".
Risks Associated With Potential Acquisitions. An important element of the
Company's strategy is to review acquisition prospects that would compliment its
existing product offerings, augment its market coverage, enhance its
technological capabilities or offer growth opportunities. Future acquisitions by
the Company could result in potentially dilutive issuance of equity securities,
use of cash and/or the incurring of debt and the assumption of contingent
liabilities, any of which could have a material adverse effect on the Company's
business and operating results and/or the price of the Company's Common Stock.
Acquisitions entail numerous risks, including difficulties in the assimilation
of
16
<PAGE> 17
acquired operations, technologies and products, diversion of management's
attention from other business concerns, risks of entering markets in which the
Company has limited or no prior experience and potential loss of key employees
of acquired organizations. The Company's management has limited prior experience
in assimilating acquired organizations. No assurance can be given as to the
ability of the Company to successfully integrate any businesses, products,
technologies or personnel that might be acquired in the future, and the failure
of the Company to do so could have a material adverse effect on the Company's
business and operating results.
Enterprise Resource Planning. The Company is currently engaged in a major
project to upgrade its enterprise-wide database and information management
systems, based principally on software from Oracle. The Company anticipates the
project completion date to be in the third quarter of the current fiscal year.
However, there can be no assurance that the Company will not experience
significant disruption as a result of unexpected delays in the implementation
process, or that the Company will not complete the project within the planned
time frame or budget. Significant delays may have a material adverse impact on
the Company's business, financial condition and results of operations. See "Year
2000 Compliance".
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, performance monitoring services 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 to date
has had minimal direct sales to customers outside of North America. The Company
has little experience in Europe and Far East markets, but intends to expand
sales of its products outside of North America and to enter certain
international markets, which will require significant management attention and
financial resources. Conducting business outside of North America 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 related
patent is issued 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, could relate to the Company's
products. Software comprises
17
<PAGE> 18
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 be issued which relate to fundamental technologies
incorporated into the Company's products. The Company has received and may
receive in the future communications from third parties 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 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 independent contractors, 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. The Company has employment agreements
with Leigh S. Belden, the Company's President and Chief Executive Officer, and
Steven C. Taylor, the Company's Chief Technical Officer. The Company also is a
party to agreements with certain of its executive officers to help ensure the
officer's continual service to the Company in the event of a change-in-control.
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
18
<PAGE> 19
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
19
<PAGE> 20
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Index:
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibit
-------------- ----------------------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
(b) No reports on Form 8-K were filed during the quarter ended September
27, 1998.
20
<PAGE> 21
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 12, 1998 By: /s/ John C. Batty
----------------------------
John C. Batty,
Vice President, Finance and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
21
<PAGE> 22
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibit
- -------------- ----------------------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
22
<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 27, 1998 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-27-1999
<PERIOD-START> JUL-29-1998
<PERIOD-END> SEP-27-1998
<CASH> 12,741
<SECURITIES> 29,145
<RECEIVABLES> 7,814
<ALLOWANCES> 62
<INVENTORY> 4,864
<CURRENT-ASSETS> 56,291
<PP&E> 16,629
<DEPRECIATION> 9,513
<TOTAL-ASSETS> 65,262
<CURRENT-LIABILITIES> 10,603
<BONDS> 0
0
0
<COMMON> 139
<OTHER-SE> 54,520
<TOTAL-LIABILITY-AND-EQUITY> 65,262
<SALES> 17,078
<TOTAL-REVENUES> 17,078
<CGS> 8,308
<TOTAL-COSTS> 8,308
<OTHER-EXPENSES> 8,218
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,111
<INCOME-TAX> 389
<INCOME-CONTINUING> 722
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 722
<EPS-PRIMARY> 0.05
<EPS-DILUTED> 0.05
</TABLE>
