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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 28, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-28562
VERILINK CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 94-2857548
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
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145 BAYTECH DRIVE, SAN JOSE, CALIFORNIA
SAN JOSE, CALIFORNIA 95134
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(408) 945-1199
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing sale price of the Common Stock on September 18,
1998, as reported by the Nasdaq National Market was $44,604,158. Shares of
Common Stock held by each officer and director and by each person who owns 5% or
more of the outstanding Common Stock have been excluded from this computation in
that such persons may be deemed to be affiliates. This determination of
affiliate status is not a conclusive determination for other purposes.
As of September 18, 1998 the registrant had outstanding 13,913,340 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the following document are incorporated by reference in this Annual
Report on Form 10-K: the Proxy Statement for the Registrant's Annual Meeting of
Stockholders to be held November 23, 1998 (the "Proxy Statement"), (Part III).
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PART I
ITEM 1. BUSINESS
OVERVIEW
Verilink Corporation (the "Company") develops, manufactures and markets
integrated access products for use by telecommunications network service
providers ("NSPs") and corporate end users on wide area networks. Wide area
networks ("WANs") are comprised of information switching systems interconnected
by long-distance digital transmission links, and enable individuals, groups and
businesses to exchange information electronically. Verilink products provide
seamless connectivity and interconnect for multiple traffic types and implement
efficient transmission links between various network elements such as routers
and frame relay, ATM, and voice switches. Verilink access systems bring value to
digital transmission links by providing efficient use of bandwidth, support for
diverse applications, and management of networks in a space saving, high-density
platform. Corporate enterprises, and network service providers such as
interexchange and local exchange carriers, and providers of Internet, personal
communications and cellular services, use Verilink integrated access products.
INDUSTRY BACKGROUND
Three fundamental forces are driving growth in the market for
telecommunications equipment. First, corporate and end-user demand for data,
voice, and video communication services continues to grow rapidly worldwide.
Secondly, competition among telecommunication service providers is intensifying
due to continuing worldwide deregulation of the industry. And lastly, the
commercialization of new telecommunication technologies such as frame relay,
ATM, PCS, IP, and xDSL is enabling the introduction of new kinds of
telecommunication services at lower costs. These three forces have contributed
to the growing popularity of the Internet, the need for higher bandwidth, the
widespread adoption of wireless communication services, and the migration by
corporate enterprises to virtual private networks.
The Internet
The idea for the Internet was originally conceived by academic and
governmental organizations for use in such applications as E-mail and file
transfer. With the invention of the easy to use web browser and the availability
of low cost web servers the Internet has become a global and commercial
phenomenon. Today the Internet is the universal public data network -- it does
for data communication what the public telephone network does for voice
communication. Corporations use the Internet to provide access to information
resources and to connect on-line with prospects, customers, business partners,
and traveling employees. Consumers increasingly are using the Internet to access
information, perform routine banking and brokerage transactions, and to purchase
goods and services. As the application for the Internet expands to mainstream
business and consumer uses the need for Quality-of-Service ("QOS") controls,
security mechanisms, and other virtual private networking capabilities will
become critical.
Higher bandwidth
Bandwidth refers to the information carrying capacity of a channel, and is
a key factor for determining the amount, quality, and speed of a particular
service that a user has access to. As the number of users that make use of
corporate and public networks continues to increase, the requirement for
additional bandwidth will grow. In addition, as the use of more data intensive
applications such as multimedia and video conferencing gains popularity, the
total bandwidth requirements of networks will grow faster. In order to keep pace
with this rapid rate of expansion in the carrying capacity of the WAN, NSPs and
corporate enterprises are employing new telecommunications access equipment,
technology and transmission facilities. With ever-increasing demands for
bandwidth, both service providers and corporate end users need to manage their
communication services and budgets more efficiently and cost effectively.
Equipment vendors who differentiate themselves by providing the ability to
manage networks more efficiently and cost effectively will be beneficiaries of
this trend toward higher bandwidth.
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Wireless communication
Demand by mobile workers and consumers for wireless communication services
has been growing at double digit rates over the past several years. This growth
has been enabled by the availability of new low cost digital services and fueled
by intense competition among service providers. In addition, service providers
who must deliver new communication services to developing nations are
increasingly looking to wireless technology as the most cost-effective solution.
These two growth drivers have given rise to a multi-billion dollar wireless
communications industry. The Company expects that future growth will come from a
further increase in the number of subscribers, an increase in the total minutes
of use, increased implementation of wireless local loop systems in developing
nations, and by the emergence of broadband access markets in developed nations.
Wireless communication services provide un-tethered access between the user and
the service provider's Point-of-Presence ("POP") where voice and data traffic is
then routed over specialized wireline transmission networks. In order to provide
the necessary capacity and geographic coverage to support uninterrupted wireless
access, multiple POP locations must be deployed and interconnected. Telecom
equipment specifically tailored to the rigorous demands for reliability,
scalability and network management will become critical to the success of these
large-scale deployments.
Virtual private networks
Since the mid-1980's, corporations have relied on private data networks
that use dedicated digital circuits leased from communications carriers. In such
networks, the switching, multiplexing, alternate routing, management and other
functions are concentrated at the periphery of the network and are the
responsibility of the enterprise. Over the past several years the
commercialization of new technology has enabled new service offerings such as
Internet access, frame relay, and cell relay. These new capabilities combined
with increased competition among service providers, and cost driven corporate
downsizing, have spawned the creation of publicly shared networks. In these
public networks, a significant portion of the operational responsibility has
shifted to the network service provider at the center of the network. This shift
enables the enterprise to concentrate more on managing access to these services,
rather than on the specifics of the transmission facility or communications
protocol. The use by enterprises of public networks is becoming more attractive
as their use becomes more cost effective and the demand for information
transiting these public networks increase. While corporate enterprises find the
economics of public networks to be attractive, they must also have a high level
of confidence in network reliability and security in order to be comfortable
with transmitting vital corporate information over public transmission
facilities. These conflicting goals of achieving cost effectiveness and assuring
reliable and secure network performance have created the need for access
solutions that offer the benefits of the low cost of shared public services with
the control, quality and security of private networks. Access solutions that
resolve these competing goals are referred to as "virtual private networks"
(VPNs).
VERILINK STRATEGY
Verilink's objective is to become the leading provider of integrated
network access equipment for use by NSPs and large corporate customers. Key
elements of the Company's strategy include:
- Expand Relationships with Key Customers. The Company has developed close
relationships with MCI Communications Corp., CompuServe Corp., Nortel,
Inc. and Qualcomm, Inc., leaders in traditional or emerging
telecommunications markets. The Company believes that these relationships
have allowed it to gain an in-depth knowledge of several networking
technologies, which today are deployed in different markets. As its key
customers adopt new technologies to expand the range of services they
offer and enter new markets, the Company intends to leverage its
expertise in each of these technologies by selling additional types of
products to these customers.
- Expand Customer Base. The Company believes that a direct sales
organization that understands and can solve complex network access
problems is necessary to sell its products to NSPs and large
corporations. During fiscal 1998, the Company continued to invest in its
sales and support organization as well as in other distribution channels
in order to expand its customer base.
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- Offer Broad Array of Network Access Solutions. The Company's product
strategy is to offer multiple network access technologies on a single
integrated platform, as well as complimentary single-function access
devices. Verilink designed the modular and scalable architecture of the
Access System 2000 to provide a migration path to new network services,
enabling customers to provide additional services without entirely
replacing network access equipment. The Company is currently developing
the next generation Access System 3000 platform, and WANscope family of
frame relay performance monitoring probes.
- Focus on Emerging International Markets. The Company believes that the
markets for network access solutions in developing countries present
significant opportunities. The Company intends to address these
opportunities by partnering with NSPs and telecommunications equipment
providers active in these markets and by forming an international
distribution channel. To date the Company's Access System 2000 product
for E1 access has been selected by Avantel for deployment in Mexico, and
CompuServe and WorldCom for deployment in Europe.
- Provide Highly Reliable Products. The Company's customers operate in an
environment in which transmission reliability and availability are
increasingly mission critical factors. The Company has adopted a formal
total quality management process that integrates new product
specifications, development, manufacturing, repair and service, which is
intended to achieve high reliability of its products and services. The
Company has been ISO 9001 certified since 1993.
CURRENT PRODUCTS
Access System 2000
Verilink's Access System 2000 ("AS2000") is a flexible network access and
management solution that provides cost-effective integrated access to a broad
range of network services. Access System 2000 products are installed at the
origination and termination points at which NSPs provide communications services
to their corporate customers. AS2000 systems provide transmission link
management, multiplexing, and inverse multiplexing functions for T1 (1.5 Mbps),
E1, multi-T1, multi-E1, and T3 (45 Mbps) access links. A key feature of the
System 2000 is its flexibility and adaptability possible through a modular
architecture which allows customers to access new services or expanded network
capacity simply by configuring or changing out circuit cards. In a single
platform, the AS2000 combines the functions of a T1 CSU/DSU, E1 NTU, inverse
multiplexer, cross-connect, T3 DSU, TDM, automatic protection switch, and a
Simple Network Management Protocol (SNMP) management agent.
Inverse Multiplexer
Inverse multiplexing is a technology which transparently bonds multiple T1
lines into a single broadband transmission link suitable for use in Internet,
frame relay, and ATM applications. Its purpose is to bridge the price and speed
gap between T1 and T3. Since a typical T3 line costs about the same as 8 to 10
T1 lines, inverse multiplexing is particularly appropriate for bandwidth
requirements between 3 and 12 Mbps (2 to 8 T1s). Verilink products offer inverse
multiplexing capabilities.
Network Termination Units
Physical layer transmission standards form the foundation upon which all
advanced data services are based, including the Internet, frame relay service,
cell relay service, leased lines, and Integrated Services Digital Networks
(ISDN). Verilink's physical layer transmission devices convert standard data
interchange signals into formats appropriate for sending over carrier
facilities. Additionally, these devices provide physical layer performance
monitoring and diagnostic functions. Verilink transmission systems are produced
to carrier-grade standards of quality and are typically deployed for
mission-critical applications, such as banking. Verilink offers a portfolio of
products appropriate for a wide range of applications in either modular systems
or as stand-alone devices.
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Broadband T3 DSU
Verilink enables frame relay switches, routers, and other high-speed data
communications equipment to access broadband T3 transmission lines. Like the T1
and E1 products, the T3 DSU includes extensive physical layer performance and
diagnostic management tools. A single AS2000 system can support up to 13 T3
lines, or roughly 600 Mbps of throughput in a highly reliable, compact package.
PRODUCTS UNDER DEVELOPMENT
During fiscal 1998 the following products were under development. Although
these products were not yet generally available they were in various stages of
evaluation by potential customers and are scheduled for general availability
sometime in fiscal 1999. There can be no assurance that the company will be
successful in introducing these products or that customers will accept them. See
"Factors Affecting Future Results -- Dependence on Recently Introduced Products
and Products Under Development".
Node Manager
Verilink's element management system, Node Manager, provides centralized
fault and configuration management through an easy-to-use graphical interface.
To the extent that networking operating costs generally exceed capital costs
network element management capabilities minimize costs and simplify network
operation. Node Manager uses standard SNMP, and handles multiple simultaneous
users. It supports the Company's current Access System products and is expected
to support various future product releases. See "Factors Affecting Future
Results -- Dependence on Recently Introduced Products and Products Under
Development".
WANscope Frame Relay Performance Monitoring Probes
The WANscope family of access products is designed to be used in Customer
Premises Equipment (CPE) or Customer Located Equipment (CLE) applications.
WANscope products are being designed to feature the capability for NSPs or
corporate enterprises to constantly monitor and measure network performance for
frame relay service which is currently the predominant standard for enterprise
WAN backbones. Constant vigilance over network performance parameters such as
loss, delay, and throughput will enable service providers and service users to
enforce Service Level Agreements (SLAs), and to proactively manage network
capacity and congestion to avoid downtime and eliminate waste. See "Factors
Affecting Future Results -- Dependence on Recently Introduced Products and
Products Under Development".
Access System 3000
The AS3000 system is designed to build on the architecture of the
successful AS2000 platform. System enhancements to the AS2000 are expected to
include: a four-fold increase in switching capacity, support for voice signals,
broadband multiplexing up to T3 rates, new interfaces supporting the channelized
T3 (M13) format, and support for High-speed Digital Subscriber Line ("HDSL")
transmission. HDSL technology enables local exchange carriers to offer T1
services over standard copper lines without the use of repeaters thereby
reducing the cost of installation and maintenance as well as reducing
installation intervals. The AS3000 is targeted toward Competitive Local Exchange
Carriers (CLECs) who wish to offer customers integrated access to voice and data
network services as well as VPN services. See "Factors Affecting Future
Results -- Dependence on Recently Introduced Products and Products Under
Development".
Sales and Marketing
The Company has a four-pronged channel strategy. First, products for
advanced digital networks are offered to North American network service
providers (NSPs) primarily via its direct sales force. Second, products for
advanced digital networks are offered to North American enterprises primarily
through indirect channels, which include distributors, systems integrators
(SIs), and value-added resellers (VARs). Third, products for wireless
infrastructure are offered to global wireless operators primarily through OEM
relationships with major wireless equipment manufacturers. Fourth, entry into
international markets for advanced
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digital network products will be enabled through strategic relationships and
in-country distribution channels that reach both enterprise and NSP customers.
An important element of the Company's marketing strategy of targeting key
customer relationships is its direct sales efforts to NSPs. A direct sales
effort, supported by sales engineers who provide customers with pre- and
post-sale technical assistance, allows the Company to gain a more in-depth
knowledge of customers' network access requirements. The Company believes this
knowledge helps it to build long-term relationships and alliances with key
customers. The Company has fifteen sales offices located in major U.S.
metropolitan areas.
In addition to its direct sales force, the Company sells its products
through VARs and distributors such as Alltel Supply, Inc., Anixter Bro's, Inc.,
Graybar Electronic Co. Inc. and Kent Datacomm. Approximately 10% of the
Company's sales during fiscal 1998 were made to VARs and distributors. The
Company's VARs and distributors have sold primarily into enterprise networks.
Another important aspect to the Company's sales and marketing strategy is to
reach end users through either an NSP or SI who may bundle equipment with a
service offering, or may resell equipment to the enterprise. The Company
believes this is an important distribution model as enterprises look to
outsource wide-area networks and implement VPNs.
Verilink's strategy for reaching wireless service providers is to establish
OEM relationships with major infrastructure vendors who bundle Verilink products
when offering total network solutions. Examples of this include Qualcomm and
Nortel who accounted for 32% of Verilink's sales in 1998. Verilink plans to
extend this distribution strategy to other CDMA infrastructure providers, and to
extend wireless solutions into other communication standards such as TDMA, GSM
and 3G.
To date, the Company has had minimal direct sales to international
customers. The Company believes that the international market for network access
solutions will experience increased growth in the future. The Company's strategy
is to increase and diversify its international sales through corporate
relationships and by establishing international distributors. The Company's
Access System 2000 product has been designed to meet international
telecommunications standards. See "Factors Affecting Future Results -- Risks
Associated With Entry into International Markets".
CUSTOMER SERVICE AND SUPPORT
The Company maintains 24-hour, 7-day a week telephone support for all of
its customers. The Company provides direct installation and service of its
products utilizing its own resources or resources available under a Worldwide
Equipment Support agreement with Vital Network Services Inc.
The Company provides training to its customers relative to installation,
operation and maintenance of the Company's products.
The Company offers maintenance agreements to its customers which provide
that, in exchange for a fee, the Company will provide on-site service, within a
specified time, in response to any customer reported difficulties.
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 Access System
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
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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. 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, 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 the Company's 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. See "Factors Affecting Future Results -- Competition".
RESEARCH AND DEVELOPMENT
The Company's research and development efforts are focused on developing
new products, core technologies and enhancements to existing products. During
the past year, product development activities have emphasized expansion of
features for the Access System 2000 product family, the Access System
3000 -- the Company's next generation Integrated Access platform and development
of the Node Manager which provides element management capabilities. The
Company's product development strategy has focused on the development of modular
software and hardware products that can be integrated and adapted to the
changing standards and requirements of the communications and internetworking
industries.
During fiscal 1998, 1997 and 1996, total research and development
expenditures were $12.5 million, $9.4 million and $7.3 million, respectively.
All research and development expenses are charged to expense as incurred.
The Company expects that it will continue to expend significant resources
for product development of specific applications such as voice, DSL and other
performance monitoring services as well as to respond to market demand and new
service offerings from network service providers. See "Factors Affecting Future
Results -- Dependence on Recently Introduced Products and Products Under
Development".
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 future results 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. Further, the
communications industry is characterized by the need to design products which
meet industry standards for safety, emissions and network interconnection. With
new and emerging technologies and service offerings from network service
providers, such standards are often changing or unavailable. As a result, there
is a potential for product development delay due to the need for compliance with
new or modified standards. The introduction of new and enhanced products also
requires that the Company manage transitions from older products in order to
minimize disruptions in customer orders,
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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.
MANUFACTURING AND QUALITY
The Company's manufacturing operations consist primarily of material
requirements planning, materials procurement and final assembly, test and
quality control of subassemblies and systems. The Company performs virtually all
aspects of its manufacturing process at its San Jose facility, with the
exception of printed circuit board assembly. A local contract manufacturer
performs printed circuit board assembly with parts sourced by Verilink. This
control of the manufacturing process enables the Company to implement quality
control and continuous process improvement techniques and methods, including
failure mode analysis, statistical process control and the use of quality
improvement teams. In addition, the Company has extended these quality control
techniques to certain suppliers by teaching and assisting them to implement such
techniques as statistical process control and just-in-time parts delivery. The
Company has been ISO 9001 certified since 1993. ISO 9000 is an international
quality certification process, developed in the European Common Market and
adopted by the United States as the method by which companies can demonstrate
the functionality of their quality system. Verilink obtained such certification
through an independent third party, with ongoing audits on a semi-annual basis.
On-time delivery of the Company's products is dependent upon the
availability of quality components and subsystems used in its products. The
Company depends upon a subcontractor to assemble printed circuit boards used in
its products in a timely and satisfactory manner. The Company obtains several
components, and licenses certain embedded software, from single sources.
Although the Company believes that, in each case, either an alternative supplier
is available or the product can be redesigned to incorporate a different
component, significant interruption in the delivery of any such item could have
a material adverse effect on the Company's business, financial condition and
results of operations. In particular, the Company's orders 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. See "Factors Affecting Future Results -- Dependence on
Component Availability and Key Suppliers".
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
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. The Company is not currently
aware of any material past infringement on its technology by third parties.
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
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Company's technology and products more likely. See "Factors Affecting Future
Results -- Limited Protection of Intellectual Property".
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 all expenses or liabilities
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. See "Factors Affecting
Future Results -- Risk of Third Party Claims Infringement".
EMPLOYEES
As of June 28, 1998, the Company had approximately 250 employees worldwide,
of whom 74 were employed in engineering, 69 in sales, marketing and customer
service, 77 in manufacturing and 30 in general and administration. Management
believes that the future success of Verilink will depend in part on its ability
to attract and retain qualified employees, including management, technical, and
design personnel. In particular, the Company currently has numerous open
positions, specifically in the engineering area. Any lengthy delay in filling
these positions will lead to delays in the introduction of various products
currently being developed, as well as in the research and development associated
with potential new products. See "Factors Affecting Future Results -- Dependence
on Key Personnel" and "Factors Affecting Future Results -- Need to Expand Sales
and Marketing Organization and Channels of Distribution".
BACKLOG
The Company manufactures its products based upon its forecast of customer
demand and typically builds finished products in advance of receiving firm
orders from its customers. Orders for the Company's products are generally
placed by customers on an as-needed basis and the Company has typically been
able to ship these products within 30 days after the customer submits a firm
purchase order. Because of the possibility of customer changes in delivery
schedules or cancellation of orders, the Company's backlog as of any particular
date may not be indicative of sales in any future period.
9
<PAGE> 10
ITEM 2. PROPERTIES
The Company's headquarters and principal administrative and engineering
facility is located in a building containing approximately 55,000 square feet
located in San Jose, California. During 1997, the Company moved its
manufacturing operations into a new 24,000 square foot facility located nearby
its headquarters building in San Jose, California. The Company leases these
buildings through April 2001 and November 2001, respectively, from Baytech
Associates, a partnership which is comprised of Leigh S. Belden and Steven C.
Taylor, Directors of the Company. In September 1998, the Company began leasing
an additional 16,000 square feet of office space under a must-take provision of
the related lease and has guaranteed Baytech Associates' obligation on an
additional 30,000 square feet of office space.
In addition, the Company has fifteen sales offices located in the U.S. Ten
of these properties are occupied under operating leases that expire on various
dates through the year 2000, with options to renew in most instances.
The Company believes its current facilities are suitable for and adequate
to support its present level of operations and believes that leasing additional
space near these facilities can accommodate future growth. See Note 9 -- "Notes
to Consolidated Financial Statements".
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in any material legal actions. From
time to time, however, the Company may be subject to claims and lawsuits arising
in the normal course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders of the Company
during the fourth quarter ended June 28, 1998.
EXECUTIVE OFFICERS OF THE COMPANY
Information concerning executive officers of the Company is set forth
below:
Mr. Leigh S. Belden, age 49, co-founded the Company and has served as its
President, Chief Executive Officer and Director since its inception in December
1982. From 1980 to 1982, Mr. Belden was Vice President of Marketing for Cushman
Electronics, a manufacturer of telephone central office and two-way radio test
equipment. Previously, he held various international and domestic sales and
marketing management positions for California Microwave. Mr. Belden received a
B.S. in Electrical Engineering from the University of California at Berkeley and
an M.B.A. from Santa Clara University.
Mr. Steven C. Taylor, age 52, co-founded the Company and has served as its
Chief Technical Officer since its inception in December 1982. In addition, Mr.
Taylor served as Chairman of the Board of Directors from the Company's inception
until January 1996, at which time he became the Vice Chairman of the Board of
Directors. Previously, Mr. Taylor served as Chief Engineer of Digital Products
for Culbertson Industries and California Microwave. In 1980, Mr. Taylor formed
Telecommunications Consultants, Inc., a consulting firm engaged in the design
and support of digital and analog communications equipment.
Mr. John C. Batty, age 43, joined the Company in May 1997 as Vice
President, Finance and Chief Financial Officer. From December 1992 until joining
Verilink, Mr. Batty was Vice President and Treasurer for VLSI Technology, Inc.,
a semiconductor manufacturer. From April 1991 to December 1992, Mr. Batty was
Director Corporate Financial Planning for VLSI. Mr. Batty received a B.A. in
Economics from the University of New Hampshire, and an M.B.A. from the
University of Chicago.
Mr. Thomas A. Flak, age 32, joined the Company in July 1997 as Director,
Product Marketing. In August 1998, Mr. Flak was promoted to the position of Vice
President of Marketing. From October 1992 until joining Verilink, Mr. Flak
worked in various marketing management, sales and engineering positions with
Network Equipment Technologies, a telecommunications equipment manufacturer.
From June 1989 to
10
<PAGE> 11
October 1992, Mr. Flak was a systems engineer with Southwestern Bell Telephone
Company. Mr. Flak received a B.S. in Electrical Engineering from the University
of Missouri at Rolla and an M.S. in Information Networking from Carnegie-Mellon
University.
Mr. Robert F. Griffith, age 54, joined the Company in June 1996 as Vice
President of Sales. From February 1994 until joining Verilink, Mr. Griffith was
Vice President of Carrier Sales for Network Equipment Technologies, a
telecommunications equipment manufacturer. From November 1989 to February 1994,
Mr. Griffith was Director of Sales for Nortel, Inc. Mr. Griffith received a B.A.
in Business Administration from College of Notre Dame and an M.B.A. from
Pepperdine University.
Mr. Stephen G. Heinen, age 43, joined the Company in September 1998 as Vice
President, Engineering. From June 1987 until joining Verilink, Mr. Heinen held
various senior management positions within Northern Telecom (Nortel), including
Vice President of Planning and Strategy and Assistant Vice President of
Technology for the Meridian 1 Business Communications System, the leading
Private Branch Exchange (PBX) worldwide. Prior to 1987, Mr. Heinen was a member
of the scientific staff at Bell Northern Research, the research and development
subsidiary of Nortel. Mr. Heinen received a B.S. in Computer Science from the
University of California at Santa Barbara.
Ms. Andrea C. Potts, age 49, joined the Company in April 1997 as Vice
President, Human Resources. From June 1994 until joining Verilink, Ms. Potts was
Director, Human Resources, for the Western Region of Sony Electronics, Inc. From
June 1984 until January 1991, Ms. Potts was Manager of Human Resources for
Fujitsu Microelectronics, Inc., a semiconductor manufacturer. Ms. Potts received
a B.S. in Business Administration from San Jose State University.
Mr. Stephen M. Tennis, age 56, joined the Company in December 1997 as Vice
President, General Counsel. From March 1991 until joining Verilink, Mr. Tennis
was a partner in the Palo Alto office of Morrison & Foerster, LLP, an
international law firm. Prior to 1991, Mr. Tennis was a member of Ware &
Freidenrich, a Palo Alto law firm. Mr. Tennis received a B.A. in History from
Stanford University and an LLB from Stanford Law School.
Mr. Henry L. Tinker, age 67, joined the Company in May 1991 as Vice
President, Operations. From May 1990 until joining Verilink, Mr. Tinker served
as an Operations Consultant to the Company. From May 1984 to May 1990, Mr.
Tinker was Vice President of a business group of Cipher Data Products, a tape
drive manufacturer. Mr. Tinker received a B.S. in Business Administration from
the University of California at Los Angeles.
Other than Henry L. Tinker, who is the father-in-law of Leigh S. Belden,
there are no family relationships among any of the directors or executive
officers of the Company.
11
<PAGE> 12
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
<TABLE>
<CAPTION>
FISCAL 1998 -- QUARTER ENDED JUNE 28 MARCH 29 DECEMBER 28 SEPTEMBER 28
---------------------------- ------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Market Price: (1) High......................... $11.00 $11.00 $9.44 $13.00
Low........................ $ 6.38 $ 5.56 $5.56 $ 8.75
</TABLE>
<TABLE>
<CAPTION>
FISCAL 1997 -- QUARTER ENDED JUNE 29 MARCH 30 DECEMBER 29 SEPTEMBER 29
---------------------------- ------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Market Price: (1) High......................... $11.25 $33.25 $37.00 $30.00
Low........................ $ 5.50 $ 5.69 $24.50 $21.25
</TABLE>
- ---------------
(1) The Company's Common Stock is traded on the Nasdaq National Market under the
symbol VRLK. The market prices per share represent the highest and lowest
closing prices for Verilink's Common Stock on the Nasdaq national market
during each quarter. As of September 18, 1998, the Company had approximately
145 stockholders of record. The Company has never declared or paid dividends
on its capital stock and does not intend to pay dividends in the foreseeable
future.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
FINANCIAL INFORMATION BY YEAR (UNAUDITED)
(THOUSANDS, EXCEPT PER SHARE AMOUNTS AND NUMBER OF EMPLOYEES)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Net Sales................................ $50,915 $57,170 $41,608 $31,447 $36,533
Gross Profit............................. 25,121 28,845 21,453 14,755 17,647
Income (loss) from operations............ (3,745) 4,832 3,232 347 2,869
Net Income (loss)........................ (1,071) 4,194 2,716 448 2,263
Net Income (loss) per share -- basic..... $ (0.08) $ 0.31 $ 0.27 $ 0.05 $ 0.25
Net Income (loss) per share -- diluted... $ (0.08) $ 0.29 $ 0.25 $ 0.04 $ 0.25
Shares used to compute net income (loss)
per share -- basic..................... 13,742 13,324 10,224 9,519 9,186
Shares used to compute net income (loss)
per share -- diluted................... 13,742 14,289 10,804 9,961 9,186
Research and development as a percentage
of sales............................... 24.5% 16.4% 17.5% 21.0% 16.4%
Capital expenditures..................... $ 2,752 $ 6,471 $ 958 $ 782 $ 861
Cash and cash equivalents and short-term
investments............................ $42,415 $39,050 $40,542 $ 3,243 $ 6,161
Working capital.......................... $45,163 $46,217 $45,015 $ 5,695 $ 5,358
Stockholders' equity..................... $53,810 $53,767 $47,234 $ 7,433 $ 6,988
Total assets............................. $63,828 $60,687 $55,218 $12,617 $15,029
Employees................................ 250 219 182 152 147
</TABLE>
12
<PAGE> 13
FINANCIAL INFORMATION BY QUARTER (UNAUDITED)
(THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FISCAL 1998 JUNE 28 MARCH 29 DECEMBER 28 SEPTEMBER 28
----------- ------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Net Sales..................................... $17,303 $14,081 $ 9,518 $10,013
Gross Profit.................................. $ 8,758 $ 6,720 $ 4,639 $ 5,005
Income (loss) from operations................. $ 683 $ (953) $(1,903) $(1,572)
Net Income (loss)............................. $ 903 $ (470) $ (875) $ (629)
Net Income (loss) per share -- basic.......... $ 0.07 $ (0.03) $ (0.06) $ (0.05)
Net Income (loss) per share -- diluted........ $ 0.06 $ (0.03) $ (0.06) $ (0.05)
Shares used to compute net income (loss) per
share -- basic.............................. 13,818 13,805 13,690 13,655
Shares used to compute net income (loss) per
share -- diluted............................ 14,284 13,805 13,690 13,655
</TABLE>
<TABLE>
<CAPTION>
FISCAL 1997 JUNE 29 MARCH 30 DECEMBER 29 SEPTEMBER 29
----------- ------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Net Sales..................................... $12,448 $13,760 $16,286 $14,676
Gross Profit.................................. $ 5,979 $ 6,817 $ 8,495 $ 7,554
Income (loss) from operations................. $ (248) $ 875 $ 2,301 $ 1,904
Net Income.................................... $ 169 $ 865 $ 1,712 $ 1,448
Net Income per share -- basic................. $ 0.01 $ 0.06 $ 0.13 $ 0.11
Net Income per share -- diluted............... $ 0.01 $ 0.06 $ 0.12 $ 0.10
Shares used to compute net income per share --
basic....................................... 13,538 13,420 13,192 13,143
Shares used to compute net income per share --
diluted..................................... 14,127 14,310 14,399 14,319
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") should be read in conjunction with the 1998
Consolidated Financial Statements and Notes thereto.
This MD&A 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. Actual results could differ materially from those projected in the
forward-looking statements as a result of the risk factors set forth herein,
including those set forth in "Factors Affecting Future Results" below.
The Company's fiscal year ends on the Sunday nearest June 30. Fiscal years
1998, 1997, and 1996 ended June 28, June 29, and June 30, respectively, and
consisted of 52 weeks. References to 1998, 1997, and 1996 shall be to the
respective fiscal year unless otherwise stated or the context otherwise
requires.
OVERVIEW
Verilink Corporation (the "Company") develops, manufactures and markets
integrated access products for telecommunications network service providers
("NSPs") and corporate end users. 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 to provide seamless connectivity and interconnect for multiple traffic
types on wide area networks ("WANs").
During 1998, Verilink's Access System 2000 product line continued to
generate the majority of sales. 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. The Access
System 3000 product currently under development, is expected to include an
increase in switching capacity, support for voice signals and broadband
multiplexing up to T3 rates.
13
<PAGE> 14
The Company has other features under development that are intended to expand the
number of services the Access System products support. The Company also sells
single purpose network access devices for selected applications.
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.
RESULTS OF OPERATIONS
SALES
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(THOUSANDS)
<S> <C> <C> <C>
Net Sales............................................. $50,915 $57,170 $41,608
Percentage change from preceding year................. -11% 37% 32%
</TABLE>
Net sales for 1998 of $50.9 million represented a decrease of approximately
11% from 1997 net sales of $57.2 million. Net sales for 1997 increased
approximately 37% over 1996 net sales of $41.6 million. The decline in net sales
during 1998 was attributable primarily to a decline in shipments to the
Company's reseller and carrier customers partially off-set by improved shipments
to system integrators. The Company believes 1998 net sales were adversely
affected in part by pending merger and consolidation discussions among the
Company's key customers resulting in delayed purchases. During 1998, shipments
of the Access System 2000 product line in total accounted for approximately 86%
of net sales compared to 80% during 1997 and 70% in 1996, while shipments of the
Company's legacy products (CSU's and LIU's) have continued to decline. The
increase in 1997 net sales over 1996 net sales was primarily due to the increase
in unit shipments as a result of market acceptance of the Company's Access
System 2000 product line.
The Company's business is characterized by the concentration of sales to a
limited number of key customers. Sales to the Company's top five customers
accounted for 64%, 67% and 64% of sales in 1998, 1997, and 1996, respectively.
The Company's largest customers in fiscal 1998 were Nortel, MCI, Qualcomm,
CompuServe and Ameritech. See Note 1 -- "Notes to Consolidated Financial
Statements" and "Factors Affecting Future Results -- Customer Concentration".
The Company sells its products primarily in the United States through a
direct sales force and through a variety of resellers, including original
equipment manufacturers (OEMs), system integrators, value-added resellers (VARs)
and distributors. Sales to VARs and distributors accounted for approximately 10%
of sales in 1998 as compared to approximately 18% in 1997 and 14% in 1996. To
date, sales outside of North America have not been significant. The Company
intends to expand the marketing of its products, particularly to markets outside
of North America.
GROSS PROFIT
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(THOUSANDS)
<S> <C> <C> <C>
Gross Profit.......................................... $25,121 $28,845 $21,453
Percentage of Sales................................... 49.3% 50.5% 51.6%
</TABLE>
Gross profit as a percentage of sales in 1998 was 49.3% as compared to
50.5% in 1997 and 51.6% in 1996. The decrease in gross profit margin in 1998 was
primarily due to increased manufacturing overhead spending resulting from higher
labor and facility related costs at lower net sales levels. The increase in 1998
manufacturing overhead spending is offset in part by favorable direct material
costs. The decrease in gross profit margin in 1997 from 1996 was primarily the
result of higher fixed overhead costs associated with the addition of a new
manufacturing facility and lower sales volume during the second half of 1997. In
future periods, the Company's gross profit will vary depending upon a number of
factors, including the channels of distribution, the price of products sold,
discounting practices, the mix of products sold, price competition, increases in
material costs, and changes in other components of cost of sales. As the Company
introduces new
14
<PAGE> 15
products, it is possible that such products may have lower gross profit than
other established products in high volume production. Accordingly, gross profit
as a percentage of sales may vary.
RESEARCH AND DEVELOPMENT
<TABLE>
<CAPTION>
1998 1997 1996
------- ------ ------
(THOUSANDS)
<S> <C> <C> <C>
Research and development................................ $12,484 $9,373 $7,283
Percentage of Sales..................................... 24.5% 16.4% 17.5%
</TABLE>
Research and development expenses (R&D) increased to $12.5 million or 24.5%
of sales in 1998, compared to $9.4 million and $7.3 million or 16.4% and 17.5%
of sales for 1997 and 1996, respectively. The expense increase during 1998 is
due principally to the use of outside consultants and the addition of personnel
associated with product development activities. The increase in R&D expenses as
a percentage of sales is due to an increase in spending at reduced sales levels.
During 1998, the Company's new product development efforts focused on advanced
features for the Access System 2000 Platform, the Access System 3000 -- the
Company's next generation Integrated Access Platform and development of the Node
Manager developed to provide node element management capabilities for all Access
System 2000 and 3000 modules. The increase in R&D expenses during 1997 was due
principally to the addition of personnel, use of outside consultants,
depreciation of capital expenditures and prototype development, design and
testing. The Company considers product development expenditures to be critical
to future sales and expects to increase spending in absolute dollars, while such
expenditures as a percentage of sales may vary. There can be no assurance that
the Company's research and development efforts will result in commercially
successful new technology and products in the future, and those efforts may be
affected by other factors as noted below. See "Factors Affecting Future
Results -- Dependence on Recently Introduced Products and Products Under
Development".
SELLING, GENERAL AND ADMINISTRATIVE
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(THOUSANDS)
<S> <C> <C> <C>
Selling, general and administrative................... $16,382 $14,640 $10,938
Percentage of Sales................................... 32.2% 25.6% 26.3%
</TABLE>
The Company's selling, general and administrative expenses increased to
$16.4 million in 1998, compared to $14.6 million in 1997 and $10.9 million in
1996. The increase in dollars spent in 1998 was due to the increase in selling
and marketing activities and personnel related costs necessary to support the
Company's infrastructure. These expenses increased as a percentage of sales to
32.2% in 1998 from 25.6% in 1997 due to increased dollar spending between
periods at reduced net sales levels. The Company expects to increase sales and
marketing spending in fiscal 1999 as a part of its effort to increase and expand
the markets for its new and existing products. In addition, the Company expects
to increase administrative and information technology costs necessary to support
expanded operations. The Company expects that selling, general and
administrative expenses may over time vary as a percentage of sales.
INTEREST AND OTHER INCOME, NET
Interest and other income, net remained relatively unchanged between 1998
and 1997 at approximately $2.0 million compared to $147,000 in 1996. The
increase in interest income during 1997 is due primarily to the investment of
proceeds from the Company's initial public offering of its common stock,
completed in June 1996.
PROVISION FOR/BENEFIT FROM INCOME TAXES
During 1998, the Company recorded a benefit from income taxes of $608,000
representing an effective tax rate of 36%. This benefit reflects available net
operating loss carryback capacity. The provision for income taxes for 1997 was
$2.7 million, an effective tax rate of 39%, compared to an effective tax rate of
20% in 1996. The 1997 effective tax rate of 39% approximates the combined
federal and state statutory rates. The effective
15
<PAGE> 16
tax rate in 1996 was less than the combined federal and state statutory rates
primarily due to the recognition of previously reserved deferred tax assets
based on carryback capacity.
LIQUIDITY AND CAPITAL RESOURCES
At June 28, 1998, the Company's principal sources of liquidity included
$42.4 million of cash, cash equivalents, and short-term investments, an increase
of approximately $3.4 million from the June 29, 1997 balance of $39 million.
During 1998, the Company generated $5.2 million of net cash from operating
activities; a $1.5 million increase over the $3.7 million generated in 1997 and
a $3.5 million increase over the $1.7 million generated during 1996. Accounts
receivable was approximately $2.5 million lower at June 28, 1998, when compared
to June 29, 1997, reflecting an improvement in the linearity of shipments during
the fourth quarter of 1998. Accounts receivable remained constant in 1997 as
compared to 1996 at $2.3 million. Inventory levels increased approximately
$500,000 from 1997 reflecting product staging necessary to meet anticipated
future product shipment requirements. Inventory levels declined approximately
$500,000 in 1997 when compared to 1996 balances. In 1998, accounts payable and
accrued expenses increased $2.9 million, reflecting increased procurement
activities and accruals for outside consultants and service providers.
Net cash used for investing activities was $26.4 million in 1998 compared
to $8.9 million in 1997 and $1 million in 1996. The 1998 increase over 1997 and
1996 in cash used for net investing activities is primarily the result of
greater purchases of short-term investments. During 1998, Verilink invested
approximately $1 million in Information Technology tools and an Enterprise
Resource Planning (ERP) software application and approximately $800,000 in
engineering development and test tools. In 1997, the Company invested $6.5
million in property, and equipment compared to $1 million in 1996. The 1997
investments in property and equipment were primarily for computer and test
equipment and leasehold improvements for its new 24,000 square foot
manufacturing facility. The Company estimates that total budgeted capital
expenditures for 1999 will approximate $5 million and will include expenditures
for test equipment, design tools, and implementation of a new ERP software
application. See Note 8 -- "Notes to Consolidated Financial Statements".
Net cash provided from financing activities was $900,000 in 1998 compared
to $1.3 million in 1997 and $36.5 million in 1996. In 1997, the Company had a
secured $2.0 million revolving line of credit which expired on August 15, 1997.
There was no borrowing under the line of credit in 1998 or 1997. In June 1996
the Company raised $36.9 million through its initial public offering of common
stock. Prior to the offering, the primary source of financing for the Company
had been cash flow from operations.
The Company believes that its cash and investment balances and anticipated
cash flow from operations will be adequate to finance current operations,
anticipated investments and capital expenditures for at least the next twelve
months. However, 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.
The statements contained in this Annual Report that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of
1934, including statements regarding the Company's beliefs, expectations, hopes,
plans and goals regarding the future. Actual results could differ from those
projected in any forward-looking statements for the reasons detailed below and
in the other sections of this Annual Report on Form 10-K. The forward-looking
statements are made as of the date of this Annual Report on Form 10-K, 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. You should consult the risk factors listed
16
<PAGE> 17
from time to time in the Company's Reports on Forms 10-Q and 8-K and the
Company's Annual Report to Stockholders.
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 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 or worse 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 have been 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 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
17
<PAGE> 18
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.
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.
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
18
<PAGE> 19
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
19
<PAGE> 20
change, regulatory developments, and new entrants. The market for integrated
access devices such as the Company's Access System 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".
20
<PAGE> 21
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 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.
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
21
<PAGE> 22
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 issuances of equity securities,
use of cash and/or the incurrence 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 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.
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
22
<PAGE> 23
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 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".
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<PAGE> 24
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.
Business Interruption. The Company's corporate headquarters, including its
research and development operations and its manufacturing facilities, are
located in the Silicon Valley area of Northern California, a region known for
seismic activity. A significant natural disaster, such as an earthquake or a
flood, could have material adverse impact on the Company's financial results.
Effects of Recent Accounting Pronouncements. In June 1997, the Financial
Accounting Standards Board (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 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. The
disclosure prescribed by FAS 130 must be made beginning in 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The chart entitled "Financial Information by Quarter (Unaudited)" contained
in Item 6 of Part II hereof is hereby incorporated by reference into this Item 8
of Part II of this form 10-K.
24
<PAGE> 25
VERILINK CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Consolidated Financial Statements Included in Item 8:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of PricewaterhouseCoopers LLP, Independent
Accountants............................................... 26
Consolidated Balance Sheets as of June 28, 1998 and June 29,
1997...................................................... 27
Consolidated Statements of Operations for each of the three
years in the period ended June 28, 1998................... 28
Consolidated Statements of Cash Flows for each of the three
years in the period ended June 28, 1998................... 29
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended June 28, 1998......... 30
Notes to Consolidated Financial Statements.................. 31
Schedule for each of the three years in the period ended
June 28, 1998 included in Item 14(a):
II -- Valuation and Qualifying Accounts and Reserves........ 44
</TABLE>
Schedules other than those listed above have been omitted since the
required information is not present or not present in amounts sufficient to
require submission of the schedule, or because the information required is
included in the consolidated financial statements or the notes thereto.
25
<PAGE> 26
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Verilink Corporation
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Verilink Corporation and its subsidiary at June 28, 1998 and June
29, 1997, and the results of their operations and their cash flows for each of
the three years in the period ended June 28, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
--------------------------------------
PricewaterhouseCoopers LLP
San Jose, California
July 23, 1998
26
<PAGE> 27
VERILINK CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
JUNE 28, JUNE 29,
1998 1997
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $16,304 $36,596
Short-term investments.................................... 26,111 2,454
Accounts receivable, net of allowance of $62 and $76 for
1998 and 1997, respectively............................ 5,992 8,462
Inventories............................................... 4,900 4,453
Deferred tax assets....................................... 1,532 957
Other current assets...................................... 342 215
------- -------
Total current assets.............................. 55,181 53,137
Property and equipment, net................................. 7,047 6,607
Deferred tax assets......................................... 436 616
Other assets................................................ 1,164 327
------- -------
$63,828 $60,687
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 2,527 $ 1,258
Accrued expenses.......................................... 6,747 5,080
Income taxes payable...................................... 744 582
------- -------
Total liabilities................................. 10,018 6,920
------- -------
Commitments (Note 9)
Stockholders' equity:
Preferred Stock, $0.01 par value, 1,000,000 shares
authorized; no shares issued and outstanding........... -- --
Common Stock, $0.01 par value; 40,000,000 shares
authorized; 13,821,649 and 13,586,286 shares issued and
outstanding............................................ 138 136
Additional paid-in capital................................ 45,143 43,941
Notes receivable from stockholders........................ (1,260) (1,086)
Treasury stock; 3,352,710 shares of Common Stock at
cost................................................... (7,320) (7,320)
Deferred compensation related to stock options............ (266) (350)
Retained earnings......................................... 17,375 18,446
------- -------
Total stockholders' equity........................ 53,810 53,767
------- -------
$63,828 $60,687
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
27
<PAGE> 28
VERILINK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE YEARS ENDED JUNE 28,
-----------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Net sales................................................... $50,915 $57,170 $41,608
Cost of sales............................................... 25,794 28,325 20,155
------- ------- -------
Gross profit................................................ 25,121 28,845 21,453
------- ------- -------
Operating expenses:
Research and development.................................. 12,484 9,373 7,283
Selling, general and administrative....................... 16,382 14,640 10,938
------- ------- -------
Total operating expenses.................................... 28,866 24,013 18,221
------- ------- -------
Income (loss) from operations............................... (3,745) 4,832 3,232
Interest and other income, net.............................. 2,066 2,043 147
------- ------- -------
Income (loss) before income taxes........................... (1,679) 6,875 3,379
Provision for (benefit from) income taxes................... (608) 2,681 663
------- ------- -------
Net income (loss)........................................... $(1,071) $ 4,194 $ 2,716
======= ======= =======
Net income (loss) per share
Basic.................................................. $ (0.08) $ 0.31 $ 0.27
======= ======= =======
Diluted................................................ $ (0.08) $ 0.29 $ 0.25
======= ======= =======
Weighted average common shares:
Basic.................................................. 13,742 13,324 10,224
======= ======= =======
Diluted................................................ 13,742 14,289 10,804
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
28
<PAGE> 29
VERILINK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE YEARS ENDED JUNE 28,
-----------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... $(1,071) $ 4,194 $ 2,716
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization.......................... 2,312 1,394 846
Deferred income taxes.................................. (395) (145) (769)
Tax benefit from exercise of stock option.............. 271 897 57
Deferred compensation related to stock options......... 95 261 357
Accrued interest on notes receivable from
stockholders......................................... (174) (71) (18)
Changes in assets and liabilities:
Accounts receivable.................................. 2,470 (2,280) (2,269)
Inventories.......................................... (447) 499 (2,232)
Other assets......................................... (964) 42 80
Accounts payable..................................... 1,269 (941) 896
Accrued expenses..................................... 1,667 135 1,505
Income taxes payable................................. 162 (258) 571
------- ------- -------
Net cash provided by operating activities......... 5,195 3,727 1,740
------- ------- -------
Cash flows from investing activities:
Purchases of property and equipment....................... (2,752) (6,471) (958)
Sale (Purchase) of short-term investments................. (23,668) (2,454) --
------- ------- -------
Net cash used in investing activities............. (26,420) (8,925) (958)
------- ------- -------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net............... 933 797 36,872
Repurchase of Common Stock................................ -- -- (183)
Proceeds from repayments of notes receivable from
stockholders........................................... -- 455 --
Repayment of long-term debt............................... -- -- (172)
------- ------- -------
Net cash provided by financing activities......... 933 1,252 36,517
------- ------- -------
Net increase (decrease) in cash and cash equivalents........ (20,292) (3,946) 37,299
Cash and cash equivalents at beginning of year.............. 36,596 40,542 3,243
------- ------- -------
Cash and cash equivalents at end of year.................... $16,304 $36,596 $40,542
======= ======= =======
Supplemental disclosures:
Cash paid for income taxes................................ $ 92 $ 2,042 $ 805
Supplemental disclosure of noncash financing activities:
Common stock issued for notes receivable.................. $ -- $ 25 $ 577
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
29
<PAGE> 30
VERILINK CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
NOTES DEFERRED
COMMON STOCK ADDITIONAL RECEIVABLE COMPENSATION
------------------- PAID-IN FROM TREASURY RELATED TO RETAINED
SHARES AMOUNT CAPITAL STOCKHOLDERS STOCK STOCK OPTIONS EARNINGS TOTAL
---------- ------ ---------- ------------ -------- ------------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JULY 2, 1995...... 9,519,512 $ 95 $ 3,894 $ (850) $(7,320) $ -- $11,614 $ 7,433
Issuance of Common Stock in
initial public offering,
net........................ 2,555,000 25 36,742 -- -- -- -- 36,767
Issuance of Common Stock
under stock plans.......... 1,258,711 13 669 (577) -- -- -- 105
Repurchase and retirement of
shares of Common Stock..... (210,390) (2) (103) -- -- -- (78) (183)
Deferred compensation related
to stock options........... -- -- 1,173 -- -- (1,173) -- --
Amortization of deferred
compensation............... -- -- -- -- -- 357 -- 357
Accrued interest on notes
receivable from
stockholders............... -- -- -- (18) -- -- -- (18)
Tax benefit of stock
options.................... -- -- 57 -- -- -- -- 57
Net income................... -- -- -- -- -- -- 2,716 2,716
---------- ---- ------- ------- ------- ------- ------- -------
BALANCE AT JUNE 30, 1996..... 13,122,833 131 42,432 (1,445) (7,320) (816) 14,252 47,234
Issuance of Common Stock
under stock plans.......... 463,453 5 817 (25) -- -- -- 797
Amortization of deferred
compensation............... -- -- -- -- -- 261 -- 261
Reversal of deferred
compensation related to
forfeited stock options.... -- -- (205) -- -- 205 -- --
Accrued interest on notes
receivable from
stockholders............... -- -- -- (71) -- -- -- (71)
Repayment of notes receivable
from stockholders.......... -- -- -- 455 -- -- -- 455
Tax benefit of stock
options.................... -- -- 897 -- -- -- -- 897
Net income................... -- -- -- -- -- -- 4,194 4,194
---------- ---- ------- ------- ------- ------- ------- -------
BALANCE AT JUNE 29, 1997..... 13,586,286 136 43,941 (1,086) (7,320) (350) 18,446 53,767
Issuance of Common Stock
under stock plans.......... 235,363 2 931 -- -- -- -- 933
Amortization of deferred
compensation............... -- -- -- -- -- 84 -- 84
Accrued interest on notes
receivable from
stockholders............... -- -- -- (174) -- -- -- (174)
Tax benefit of stock
options.................... -- -- 271 -- -- -- -- 271
Net loss..................... -- -- -- -- -- -- (1,071) (1,071)
---------- ---- ------- ------- ------- ------- ------- -------
BALANCE AT JUNE 28, 1998..... 13,821,649 $138 $45,143 $(1,260) $(7,320) $ (266) $17,375 $53,810
========== ==== ======= ======= ======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
30
<PAGE> 31
VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED JUNE 28, 1998
NOTE 1 -- THE COMPANY AND A SUMMARY OF ITS SIGNIFICANT ACCOUNTING POLICIES:
THE COMPANY
Verilink Corporation (the "Company"), a Delaware Corporation, was
incorporated in 1982. The Company develops, manufactures and markets integrated
access products for telecommunications network service providers ("NSPs") and
corporate end users. The Company'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 to
provide seamless connectivity and interconnect for multiple traffic types on
wide area networks ("WANs").
CERTAIN EQUITY TRANSACTIONS
In April 1996, the Company's Board of Directors approved a two-for-one
stock split of the Company's Common Stock. All applicable share and per share
amounts of Common Stock have been retroactively adjusted to reflect the stock
split.
MANAGEMENT ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary in the United Kingdom. All significant
intercompany accounts and transactions have been eliminated.
The Company's fiscal year ends on the Sunday nearest June 30. Fiscal 1998,
1997 and 1996 ended June 28, June 29, and June 30 respectively, and consisted of
52 weeks. References to 1998, 1997, and 1996 shall be to the respective fiscal
year unless otherwise stated or the context otherwise requires.
FOREIGN CURRENCY
The functional currency of the Company's foreign subsidiary is the local
currency. The balance sheet accounts are translated into United States dollars
at the exchange rate prevailing at the balance sheet date. Revenues, costs and
expenses are translated into United States dollars at average rates for the
period. Gains and losses resulting from translation are accumulated as a
component of stockholders' equity and to date have not been material. Net gains
and losses resulting from foreign exchange transactions are included in the
consolidated statements of operations and were not significant during any of the
periods presented.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid instruments with a maturity of
three months or less when purchased to be cash equivalents.
31
<PAGE> 32
VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE YEARS ENDED JUNE 28, 1998
SHORT-TERM INVESTMENTS
The Company classifies its investment securities as available for sale.
Realized gains or losses are determined on the specific identification method
and are reflected in income. Net unrealized gains or losses are recorded
directly in stockholders' equity except those unrealized losses which are deemed
to be other than temporary which are reflected in the statements of operations.
No such losses were recorded during any of the periods presented.
INVENTORIES
Inventories are stated at the lower of cost, determined using the first-in,
first-out method, or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets,
generally two to five years. Leasehold improvements are amortized using the
straight-line method over the lesser of the estimated useful lives of the assets
or the remaining lease term.
REVENUE RECOGNITION
The Company generally recognizes a sale when the product has been shipped,
no material vendor or post-contract support obligations remain outstanding,
except as provided by a separate service agreement, and collection of the
resulting receivable is probable. The Company accrues related product return
reserves, warranty and royalty expenses at the time of sale. The Company extends
limited product return and price protection rights to certain distributors and
resellers. Such rights are generally limited to a certain percentage of sales
over a six-month period. The Company warrants products for a five year period.
The following table summarizes the percentage of total sales for customers
accounting for more than 10% of the Company's sales:
<TABLE>
<CAPTION>
THREE YEARS ENDED
JUNE 28,
--------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Nortel, Inc............................................. 20% 22% --
MCI Communications Corp................................. 16% 20% 29%
Qualcomm, Inc........................................... 12% -- --
CompuServe Corp......................................... 11% 11% 18%
</TABLE>
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of cash and cash equivalents,
short-term investments and accounts receivable. The Company limits the amount of
investment exposure to any one financial institution and financial instrument.
The Company's trade accounts receivables are derived from sales to customers
primarily in North America. The Company performs credit evaluations of its
customers' financial condition and, generally, requires no collateral from its
customers. The Company maintains reserves for potential credit losses based upon
the expected collectibility of the accounts receivable. Historically such losses
have been immaterial.
32
<PAGE> 33
VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE YEARS ENDED JUNE 28, 1998
The following table summarizes accounts receivable from customers
comprising 10% or more of the gross accounts receivable balance for the periods
indicated:
<TABLE>
<CAPTION>
JUNE 28, JUNE 29, JUNE 30,
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Nortel, Inc..................................... 26% 34% 17%
MCI Communications Corp......................... 26% 32% 50%
Qualcomm, Inc................................... 19% -- 16%
</TABLE>
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
SOFTWARE DEVELOPMENT COSTS
Software development costs are included in research and development and are
expensed as incurred. Statement of Financial Accounting Standards No. 86
requires the capitalization of certain software development costs incurred
subsequent to the date technological feasibility is established, which the
Company defines as the completion of a working model, and prior to the date the
product is generally available for sale. To date, the period between achieving
technological feasibility and the general availability of such software has been
short and software development costs qualifying for capitalization have been
insignificant. Accordingly, the Company has not capitalized any software
development costs.
INCOME TAXES
A deferred income tax liability or asset, net of valuation allowance, is
established for the expected future tax consequences resulting from the
differences between the financial reporting and income tax bases of the
Company's assets and liabilities and from tax credit carryforwards.
STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), as permitted
under the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123"). Under APB 25, if the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings per Share" ("SFAS 128") during the second quarter of fiscal 1998. SFAS
128 requires presentation of both basic and diluted earnings per share ("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 stock 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 stock price as
used in the computation of fully diluted EPS.
33
<PAGE> 34
VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE YEARS ENDED JUNE 28, 1998
Following is a reconciliation of the numerators and denominators of the
basic and diluted EPS for the years ended June 28, 1998, June 29, 1997 and June
30, 1996.
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Net income (loss) as reported................. $(1,071) $ 4,194 $ 2,716
======= ======= =======
Denominator used to compute basic earnings per
common share................................ 13,742 13,324 10,224
======= ======= =======
Shares issuable on exercise of options........ -- 965 580
------- ------- -------
Denominator used to compute diluted earnings
per common share............................ 13,742 14,289 10,804
------- ------- -------
Basic earnings (loss) per share............... $ (0.08) $ 0.31 $ 0.27
======= ======= =======
Diluted earnings (loss) per share............. $ (0.08) $ 0.29 $ 0.25
======= ======= =======
</TABLE>
Options to purchase 1,833,134 shares of Common Stock were outstanding at
June 28, 1998. As a result of a net loss incurred by the Company in 1998,
potential common shares attributable to stock options were antidilutive and were
excluded from the diluted net loss per share calculation.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the fiscal
1998 financial statement presentation.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement No. 130, "Reporting Comprehensive Income" ("FAS 130"). 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 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. The disclosure prescribed by FAS 130 must be made
beginning with fiscal 1999.
In June 1997, the FASB issued Statement No. 131, "Disclosures About
Segments of an Enterprise and Related Information" ("FAS 131"). 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.
NOTE 2 -- INITIAL PUBLIC OFFERING:
In June 1996, the Company completed an initial public offering and issued
2,555,000 shares of its Common Stock to the public at a price of $16.00 per
share. The Company realized proceeds of approximately $36.8 million, net of
underwriting discounts, commissions and other offering costs.
34
<PAGE> 35
VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE YEARS ENDED JUNE 28, 1998
NOTE 3 -- DETAILS OF BALANCE SHEET COMPONENTS:
<TABLE>
<CAPTION>
JUNE 28, JUNE 29,
1998 1997
-------- --------
<S> <C> <C>
Inventories:
Raw materials.......................................... $ 2,313 $ 2,615
Work-in-process........................................ 926 883
Finished goods......................................... 1,661 955
------- -------
$ 4,900 $ 4,453
======= =======
Property and equipment:
Furniture, fixtures and office equipment............... $ 7,734 $ 7,494
Machinery and equipment................................ 5,564 3,650
Leasehold improvements................................. 2,791 2,556
------- -------
16,089 13,700
Less: Accumulated depreciation and amortization........ (9,042) (7,093)
------- -------
$ 7,047 $ 6,607
======= =======
Accrued expenses:
Compensation and related benefits...................... $ 1,968 $ 2,142
Warranty............................................... 634 491
Other.................................................. 4,145 2,447
------- -------
$ 6,747 $ 5,080
======= =======
</TABLE>
NOTE 4 -- SHORT-TERM INVESTMENTS:
The Company's short-term investments consist primarily of municipal and
corporate bonds, and auction rate preferred stock.
NOTE 5 -- COMMON STOCK:
During fiscal 1996 and 1995, the Company repurchased and retired 210,390
and 9,602 shares of Common Stock, respectively, at prices ranging from $0.50 to
$2.17 per share.
In September 1993, the Company issued 1,600,000 shares of Common Stock to
one of its principal stockholders and 100,000 shares to one of its officers in
exchange for notes totaling $800,000 and $50,000, respectively. During fiscal
1997, the $50,000 note was repaid. The remaining $800,000 note bears interest at
5% per annum and is due in September 1999. The note is secured by 130,398 shares
of the Company's Common Stock.
During the period of November 1995 through February 1996, the Company made
loans totaling $577,000 to certain executives, employees and directors pursuant
to the Company's 1993 Stock Option Plan. During fiscal 1997, a total of $405,000
of such loans was repaid. The remaining loans outstanding are secured by 134,000
shares of the Company's Common Stock and other real and personal property, have
a five-year term and bear interest at 5% per annum. Principal plus accrued
interest is repayable at maturity.
35
<PAGE> 36
VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE YEARS ENDED JUNE 28, 1998
NOTE 6 -- INCOME TAXES:
The provision (benefit) for income taxes consists of the following (in
thousands):
<TABLE>
<CAPTION>
THREE YEARS ENDED JUNE 28,
----------------------------
1998 1997 1996
------ ------- -------
<S> <C> <C> <C>
Current:
Federal......................................... $(313) $2,528 $1,350
State........................................... 100 298 82
----- ------ ------
(213) 2,826 1,432
----- ------ ------
Deferred:
Federal......................................... (283) (200) (240)
State........................................... (112) 55 (529)
----- ------ ------
(395) (145) (769)
----- ------ ------
$(608) $2,681 $ 663
===== ====== ======
</TABLE>
The tax provision reconciles to the amount computed by multiplying income
before tax by the U.S. federal statutory rate of 34% as follows:
<TABLE>
<CAPTION>
THREE YEARS ENDED JUNE 28,
----------------------------
1998 1997 1996
------ ------- -------
<S> <C> <C> <C>
Provision at statutory rate....................... (34.0)% 34.0% 34.0%
State taxes, net of federal benefit............... 3.9 5.1 5.8
Change in valuation allowance..................... -- -- (30.8)
Credits........................................... (2.7) (2.6) --
Disallowance of research and development
credits......................................... -- -- 5.4
Other............................................. (3.4) 2.5 5.2
----- ------ ------
(36.2)% 39.0% 19.6%
===== ====== ======
</TABLE>
Deferred tax assets comprise the following (in thousands):
<TABLE>
<CAPTION>
JUNE 28, JUNE 29,
1998 1997
-------- --------
<S> <C> <C>
Credit carryforwards...................................... $ 222 $ 125
Inventory reserves........................................ 451 386
Warranty.................................................. 263 171
Other reserves and accruals............................... 417 230
Depreciation.............................................. 369 439
Other..................................................... 246 222
------ ------
Total deferred tax assets................................. 1,968 1,573
Valuation allowance....................................... -- --
------ ------
Net deferred tax assets................................... $1,968 $1,573
====== ======
</TABLE>
At June 28, 1998, the Company had credit carryforwards of $222,000
available to offset future income; such carryforwards expire in 2006.
36
<PAGE> 37
VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE YEARS ENDED JUNE 28, 1998
NOTE 7 -- EMPLOYEE BENEFIT PLANS:
The 1993 Stock Option Plan (the "1993 Plan") was approved by the Board of
Directors in March 1993. During fiscal 1996, the 1989 Directors Stock Option
Plan (the "1989 Plan") was terminated and all options outstanding and available
for grant under the 1989 Plan were incorporated into the 1993 Plan. As of June
28, 1998, a total of 4,050,000 shares of Common Stock had been reserved for
issuance under the 1993 Plan to eligible employees, officers, directors,
independent contractors and consultants upon the exercise of incentive stock
options ("ISOs") and nonqualified stock options ("NSOs"). Options granted under
the 1993 Plan are for periods not to exceed ten years and must be issued at
prices not less than 100% and 85% for ISOs and NSOs, respectively, of the fair
market value of the stock on the date of grant. Options granted under the 1993
Plan are exercisable immediately and generally vest over a four year period,
provided that the optionee remains continuously employed by the Company. Upon
cessation of employment for any reason, the Company has the option to repurchase
all unvested shares of Common Stock issued upon exercise of an option at a
repurchase price equal to the exercise price of such shares. Options granted to
stockholders who own greater than 10% of the outstanding stock are for periods
not to exceed five years and must be issued at prices not less than 110% of the
fair market value of the stock on the date of grant.
The following summarizes stock option activity under the Company's 1993
Plan:
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVERAGE
AVAILABLE OPTIONS EXERCISE
FOR GRANT OUTSTANDING PRICE
---------- ----------- --------
<S> <C> <C> <C>
BALANCE AT JULY 2, 1995...................... 1,111,354 1,676,984 $ 0.54
Approved................................... 500,000 --
Granted at market price.................... (563,800) 563,800 3.78
Granted below market price................. (493,800) 493,800 0.88
Exercised.................................. -- (1,258,711) 0.54
Canceled................................... 147,997 (147,997) 0.85
---------- ---------- ------
BALANCE AT JUNE 30, 1996..................... 701,751 1,327,876 2.00
Approved................................... 750,000 --
Granted at market price.................... (1,450,913) 1,450,913 17.01
Exercised.................................. -- (429,698) 0.67
Canceled................................... 777,415 (777,415) 20.68
---------- ---------- ------
BALANCE AT JUNE 29, 1997..................... 778,253 1,571,676 6.98
Granted at market price.................... (608,650) 608,650 7.39
Exercised.................................. -- (119,332) 1.44
Canceled................................... 227,860 (227,860) 7.12
---------- ---------- ------
BALANCE AT JUNE 28, 1998..................... 397,463 1,833,134 $ 7.46
========== ========== ======
</TABLE>
On June 11, 1997, the Company canceled options to purchase 346,000 shares
of Common Stock with exercise prices ranging from $16.13 to $36.13 previously
granted to employees, and reissued all such options at an exercise price of
$10.38, the fair market value of the stock on June 11, 1997. The reissued
options have a ten year term and vest over four years from the date of
reissuance.
37
<PAGE> 38
VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE YEARS ENDED JUNE 28, 1998
The following table summarizes information concerning outstanding and
vested stock options as of June 28, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS VESTED
----------------------------------------------- ------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE NUMBER VESTED EXERCISE PRICE
- --------------- ----------- ---------------- -------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
$0.50 - $ 0.88 333,168 7.04 $ 0.81 200,716 $ 0.78
$5.00 - $ 6.00 518,316 8.76 $ 5.75 145,140 $ 5.73
$6.06 - $ 6.75 220,200 9.49 $ 6.55 -- $ --
$6.88 - $10.38 661,450 8.92 $ 8.88 175,860 $ 9.03
$31.00 100,000 8.56 $31.00 45,833 $31.00
--------- ---- ------ ------- ------
$0.50 - $31.00 1,833,134 8.58 $ 7.46 567,549 $ 7.04
========= ==== ====== ======= ======
</TABLE>
1996 EMPLOYEE STOCK PURCHASE PLAN
In April 1996, the Company adopted an Employee Stock Purchase Plan (the
"Purchase Plan") under which 300,000 shares of Common Stock have been reserved
for issuance. The Purchase Plan permits eligible employees to purchase Common
Stock through periodic payroll deductions of up to 10% of their annual
compensation. The Purchase Plan provides for successive offering periods with a
maximum duration of 24 months. Each offering period is divided into consecutive
semi-annual purchase periods. The price at which Common Stock is purchased under
the Purchase Plan is equal to 85% of the fair market value of Common Stock on
the first day of the offering period, or the last day of the purchase period,
whichever is lower. During fiscal 1997 and 1998, a total of 33,755 and 116,031
shares of Common Stock were issued under the Purchase Plan at an average
purchase price of $12.65 and $6.39, respectively.
ESTIMATED FAIR VALUE AWARDS UNDER THE COMPANY'S STOCK PLANS
The weighted average estimated grant date fair value, as defined by SFAS
123, of options granted during fiscal 1996 at market price and below market
price under the Company's stock option plan was $1.82 and $2.49, respectively.
The weighted average estimated grant date fair value, as defined by SFAS 123, of
options granted during fiscal 1998 and fiscal 1997 at market price under the
Company's stock option plan were $3.17 and $6.17, respectively. The weighted
average estimated grant date fair value of Common Stock issued pursuant to the
Company's employee stock purchase plan during fiscal 1998, 1997 and 1996 was
$1.91, $3.89 and $4.88, respectively. The estimated grant date fair values
disclosed by the Company are calculated using the Black-Scholes model. The
Black-Scholes model, as well as other currently accepted option valuation
models, was developed to estimate the fair value of freely tradable, fully
transferable options without vesting restrictions, which significantly differ
from the Company's stock option awards. These models also require highly
subjective assumptions, including future stock price volatility and expected
time until exercise, which greatly affect the calculated grant date fair value.
38
<PAGE> 39
VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE YEARS ENDED JUNE 28, 1998
The following weighted average assumptions are included in the estimated
grant date fair value calculations for the Company's stock option and purchase
awards:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Stock option plan:
Expected dividend yield.............................. 0.0% 0.0% 0.0%
Expected stock price volatility...................... 70% 61% 61%
Risk free interest rate.............................. 5.58% 6.07% 5.69%
Expected life (years)................................ 2.32 2.55 2.55
Stock purchase plan:
Expected dividend yield.............................. 0.0% 0.0% 0.0%
Expected stock price volatility...................... 70% 61% 61%
Risk free interest rate.............................. 5.31% 5.36% 5.33%
Expected life (years)................................ 0.50 0.50 0.50
</TABLE>
PRO FORMA NET INCOME AND NET INCOME PER SHARE
Had the Company recorded compensation based on the estimated grant date
fair value, as defined by SFAS 123, for awards granted under its stock option
plan and stock purchase plan, the Company's net income (loss) and net earnings
(loss) per share would have been reduced to the pro forma amounts below for the
years ended June 28, 1998, June 29, 1997 and June 30, 1996 (in thousands, except
per share amounts):
<TABLE>
<CAPTION>
1998 1997 1996
------- ------ ------
<S> <C> <C> <C>
Net Income (loss) as reported................... $(1,071) $4,194 $2,716
Pro forma net income (loss)..................... $(2,753) $2,716 $2,529
Basic Earnings (loss) per share as reported..... $ (0.08) $ 0.31 $ 0.27
Diluted earnings (loss) per share as reported... $ (0.08) $ 0.29 $ 0.25
Pro forma basic earnings (loss) per share....... $ (0.20) $ 0.20 $ 0.25
Pro forma diluted earnings (loss) per share..... $ (0.20) $ 0.19 $ 0.24
</TABLE>
The pro forma effect on net income and net earnings per share is not
representative of the pro forma effect on net income in future years because it
does not take into consideration pro forma compensation expense related to
grants made prior to 1996.
The Company has recorded compensation expense for the difference between
the grant price and deemed fair market value of the Company's Common Stock for
options granted in January and February 1996. Such compensation expense was
$84,000, $261,000 and $357,000 for fiscal 1998, 1997 and 1996, respectively, and
will aggregate approximately $968,000 over the vesting period of four years.
Awards under the Company's profit sharing plan are based on achieving
targeted levels of profitability. The Company provided for awards of $35,000 and
$517,000 in fiscal 1998 and 1996 respectively. No expense under the plan was
incurred in fiscal 1997.
NOTE 8 -- RELATED PARTY TRANSACTIONS:
The Company leases its principal headquarters facility and its
manufacturing facility from Baytech Associates ("Baytech") under operating
leases which expire in April 2001 and November 2001, respectively. Baytech is
owned by two stockholders who hold an aggregate of 39% of the Company's Common
Stock and who are also officers and directors of the Company. Under terms of one
of the lease agreements with Baytech,
39
<PAGE> 40
VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
THREE YEARS ENDED JUNE 28, 1998
there is a "must take" provision of the lease requiring the Company to lease an
additional 16,000 square feet of office space commencing in September 1998. The
Company has guaranteed Baytech Associates' obligation on an additional 30,000
square feet of office space. During fiscal 1998, 1997 and 1996, rent expense
totaled $428,000, $428,000 and $826,000, respectively.
During fiscal 1997, the Company entered into an agreement with RISC
Communication Network Systems ("RC Network") which provides for the performance
of research and development services by RC Network on behalf of the Company. RC
Network is owned in part by Baytech Associates and one of the directors of the
Company. During fiscal 1998 and 1997, the Company paid $1,260,000 and $98,000,
respectively to RC Network for research and development services.
Included in other assets as of June 28, 1998 and June 29, 1997, are
advances of $502,000 and $402,000, respectively, due from certain officers of
the Company. These advances bear interest at varying rates up to 7.5%, with
various maturities to August 2002.
The Company paid approximately $240,000 for consulting services to two of
its outside directors during fiscal 1998 and approximately $110,000 and $120,000
for consulting services to an outside director during fiscal 1997 and 1996,
respectively.
NOTE 9 -- COMMITMENTS:
The Company leases its facilities under noncancelable operating lease
agreements, which expire through fiscal 2002. The Company's principal facility
lease (see Note 8) provides for lease payments based on the fair market value of
comparable facilities commencing in May 1999 through expiration of the lease in
April 2001. The future minimum lease payments set forth below assume that the
monthly lease payment for the Company's principal facility from May 1999 through
April 2001 will not vary significantly from the present monthly lease payment.
Future minimum lease payments under all noncancelable operating leases with
terms in excess of one year are as follows (in thousands):
<TABLE>
<S> <C>
Fiscal year,
1999................................................... $1,465
2000................................................... 1,530
2001................................................... 1,463
2002................................................... 429
------
Total minimum lease payments........................... $4,887
======
</TABLE>
Rent expense under all noncancelable operating leases totaled $873,000,
$797,000 and $906,000 for fiscal 1998, 1997 and 1996, respectively.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
40
<PAGE> 41
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors appearing under the caption "Election of
Directors" in the Proxy Statement is hereby incorporated by reference.
Information regarding executive officers is incorporated herein by
reference from Part I hereof under the heading "Executive Officers of the
Company" immediately following Item 4 in Part I hereof.
Information regarding compliance with Section 16(a) of the Securities Act
of 1934, as amended, is hereby incorporated by reference to the Company's Proxy
Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
Company's Proxy Statement.
41
<PAGE> 42
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
The financial statements (including the notes thereto) listed in the Index
to Consolidated Financial Statements and Financial Statement Schedule (set forth
in Item 8 of Part II of this Form 10-K) are filed within this Annual Report on
Form 10-K.
2. FINANCIAL STATEMENT SCHEDULE
The financial statement schedule listed in the Index to Consolidated
Financial Statements and Financial Statement Schedule (set forth in Item 8 of
Part II of this Form 10-K) is filed as part of this Annual Report on Form 10-K.
3. EXHIBITS
The exhibits listed under Item 14(c) hereof are filed as part of this
Annual Report on Form 10-K.
(b) REPORTS ON FORM 8-K
No reports on form 8-K were filed during the quarter ended June 28, 1998.
(c) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
3.1 Registrant's Amended and Restated Certificate of
Incorporation.(1)
3.2 Registrant's Amended and Restated Bylaws.(1)
4.1 Reference is made to Exhibits 3.1 and 3.2.
10.2 Form of Indemnification Agreement between the Registrant and
each of its executive officers and directors.(1)
10.3* Employment Agreement between the Registrant and Leigh S.
Belden dated as of April 16, 1986.(1)
10.4* Employment Agreement between the Registrant and Steven C.
Taylor dated as of April 16, 1986.(1)
10.7 Common Stock Purchase Agreement and Promissory Note between
the Registrant and Leigh S. Belden each dated as of
September 16, 1993.(1)
10.8 Promissory Notes of Timothy G. Conley in favor of the
Registrant dated as of November 16, 1995 and January 2,
1996.(1)
10.9 Promissory Note of James G. Regel in favor of the Registrant
dated as of January 1, 1996.(1)
10.11 Promissory Note of Howard Oringer in favor of the Registrant
dated as of January 2, 1996.(1)
10.12 Lease Agreement between the Registrant and Baytech
Associates, a California general partnership, dated February
27, 1986, and Memorandum of Lease Modification dated January
22, 1987.(1)
10.13+ Software License Agreement between the Registrant and
Integrated Systems, Inc. dated January 27, 1993, as
amended.(1)
10.14* Registrant's Amended and Restated 1993 Stock Option Plan,
including forms of agreements thereunder.(1)
10.15* Form of Registrant's 1996 Employee Stock Purchase Plan,
including forms of agreements thereunder.(1)
</TABLE>
42
<PAGE> 43
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
10.16* Promissory Note of Robert F. Griffith in favor of the
Registrant dated as of August 27, 1997.(2)
10.17* Change of Control Severance Benefits Agreements.(3)
10.18 Guarantee of lease obligation between the Registrant and
Baytech Associates, a California general partnership, dated
September 30, 1996.(4)
10.19 Amended Common Stock Purchase Agreement and Promissory Note
between the Registrant and Leigh S. Belden, dated as of
February 10, 1998.(4)
10.20 Promissory Note of Stephen M. Tennis in favor of the
Registrant dated June 30, 1994.(4)
10.21 Promissory Note of Stephen M. Tennis in favor of the
Registrant dated February 21, 1996.(4)
10.22 Promissory Note of Stephen M. Tennis in favor of the
Registrant dated May 23, 1996.(4)
10.23 Promissory Note of Stephen M. Tennis in favor of the
Registrant dated June 4, 1997.(4)
10.24 Loan facility dated September 1, 1998, provided by the
Registrant to Leigh S. Belden.(4)
23.1 Consent of PricewaterhouseCoopers LLP.(4)
27.1 Financial Data Schedule.(4)
</TABLE>
- ---------------
(1) Incorporated by reference to identically numbered Exhibit to the Company's
Registration Statement on Form S-1 (Commission File No. 333-4010), which
became effective on June 10, 1996.
(2) Incorporated by reference to identically numbered exhibit filed in response
to Item 14(a), "Exhibits," of Registrant's Report on Form 10-K for the
fiscal year ended June 29, 1997.
(3) Incorporated by reference to identically numbered exhibit filed in response
to Item 6(a), "Exhibits and Reports of Form 8-K," for the quarterly period
ended December 28, 1997.
(4) Filed herewith.
* Management contracts or compensatory plans or arrangements.
+ Confidential treatment granted as to portions of this exhibit.
(d) FINANCIAL STATEMENT SCHEDULES
See Item 14(a)(2) above.
43
<PAGE> 44
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS DEDUCTIONS BALANCE AT
BEGINNING CHARGED FROM END
OF YEAR TO INCOME RESERVES OF YEAR
---------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Inventory Reserves
Year ended June 28, 1998....................... $923 $165 $ -- $1,088
Year ended June 29, 1997....................... $658 $265 $ -- $ 923
Year ended June 30, 1996....................... $819 $ -- $(161) $ 658
</TABLE>
44
<PAGE> 45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
September 23, 1998 By: /s/ LEIGH S. BELDEN
------------------------------------
Leigh S. Belden
President, Chief Executive Officer
and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ LEIGH S. BELDEN President, Chief Executive September 23, 1998
- ----------------------------------------------------- Officer and Director
Leigh S. Belden (Principal Executive
Officer)
/s/ JOHN C. BATTY Vice President, Finance and September 23, 1998
- ----------------------------------------------------- Chief Financial Officer
John C. Batty (Principal Financial and
Accounting Officer)
/s/ HOWARD ORINGER Chairman of the Board of September 23, 1998
- ----------------------------------------------------- Directors
Howard Oringer
/s/ STEVEN C. TAYLOR Chief Technical Officer, September 23, 1998
- ----------------------------------------------------- Vice Chairman of the Board
Steven C. Taylor of Directors
/s/ DAVID L. LYON Director September 23, 1998
- -----------------------------------------------------
David L. Lyon
/s/ JOHN A. MCGUIRE Director September 23, 1998
- -----------------------------------------------------
John A. McGuire
</TABLE>
45
<PAGE> 46
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
3.1 Registrant's Amended and Restated Certificate of
Incorporation.(1)
3.2 Registrant's Amended and Restated Bylaws.(1)
4.1 Reference is made to Exhibits 3.1 and 3.2.
10.2 Form of Indemnification Agreement between the Registrant and
each of its executive officers and directors.(1)
10.3* Employment Agreement between the Registrant and Leigh S.
Belden dated as of April 16, 1986.(1)
10.4* Employment Agreement between the Registrant and Steven C.
Taylor dated as of April 16, 1986.(1)
10.7 Common Stock Purchase Agreement and Promissory Note between
the Registrant and Leigh S. Belden each dated as of
September 16, 1993.(1)
10.8 Promissory Notes of Timothy G. Conley in favor of the
Registrant dated as of November 16, 1995 and January 2,
1996.(1)
10.9 Promissory Note of James G. Regel in favor of the Registrant
dated as of January 1, 1996.(1)
10.11 Promissory Note of Howard Oringer in favor of the Registrant
dated as of January 2, 1996.(1)
10.12 Lease Agreement between the Registrant and Baytech
Associates, a California general partnership, dated February
27, 1986, and Memorandum of Lease Modification dated January
22, 1987.(1)
10.13+ Software License Agreement between the Registrant and
Integrated Systems, Inc. dated January 27, 1993, as
amended.(1)
10.14* Registrant's Amended and Restated 1993 Stock Option Plan,
including forms of agreements thereunder.(1)
10.15* Form of Registrant's 1996 Employee Stock Purchase Plan,
including forms of agreements thereunder.(1)
10.16* Promissory Note of Robert F. Griffith in favor of the
Registrant dated as of August 27, 1997.(2)
10.17* Change of Control Severance Benefits Agreements.(3)
10.18 Guarantee of lease obligation between the Registrant and
Baytech Associates, a California general partnership, dated
September 30, 1996.(4)
10.19 Amended Common Stock Purchase Agreement and Promissory Note
between the Registrant and Leigh S. Belden, dated as of
February 10, 1998.(4)
10.20 Promissory Note of Stephen M. Tennis in favor of the
Registrant dated June 30, 1994.(4)
10.21 Promissory Note of Stephen M. Tennis in favor of the
Registrant dated February 21, 1996.(4)
10.22 Promissory Note of Stephen M. Tennis in favor of the
Registrant dated May 23, 1996.(4)
10.23 Promissory Note of Stephen M. Tennis in favor of the
Registrant dated June 4, 1997.(4)
10.24 Loan facility dated September 1, 1998, provided by the
Registrant to Leigh S. Belden.(4)
23.1 Consent of PricewaterhouseCoopers LLP.(4)
27.1 Financial Data Schedule.(4)
</TABLE>
- ---------------
(1) Incorporated by reference to identically numbered Exhibit to the Company's
Registration Statement on Form S-1 (Commission File No. 333-4010), which
became effective on June 10, 1996.
(2) Incorporated by reference to identically numbered exhibit filed in response
to Item 14(a), "Exhibits," of Registrant's Report on Form 10-K for the
fiscal year ended June 29, 1997.
(3) Incorporated by reference to identically numbered exhibit filed in response
to Item 6(a), "Exhibits and Reports of Form 8-K," for the quarterly period
ended December 28, 1997.
(4) Filed herewith.
* Management contracts or compensatory plans or arrangements.
+ Confidential treatment granted as to portions of this exhibit.
<PAGE> 1
EXHIBIT 10.18
GUARANTY
For value received, Verilink Corporation, a Delaware corporation, hereby
guarantees the performance by Baytech Associates, a California general
partnership ("Baytech") of Baytech's obligations under the Lease between
Baytech and IDEC Corporation of 161 Nortech Parkway, San Jose, California,
dated September 30, 1996.
Dated: September 30, 1996 VERILINK CORPORATION
By: [SIG]
------------------------
Title: President
---------------------
<PAGE> 1
PROMISSORY NOTE
EXHIBIT 10.19
$800,000.00 February 10, 1998
San Jose, California
FOR VALUE RECEIVED, the undersigned hereby promises to pay to Verilink
Corporation ("Verilink"), at San Jose, California, the principal sum of Eight
Hundred Thousand Dollars ($800,000), plus interest thereon at a rate of five
percent (5%) per annum from September 16, 1993, payable at maturity. Principal
and accrued interest shall be paid in full on or before September 16, 1999.
This Promissory Note supersedes the Promissory Note in like amount executed by
the undersigned on September 16, 1993.
Upon the occurrence of any such of the following events, the undersigned
shall be deemed to be in default hereunder (a "Default"):
(a) commencement of any bankruptcy, insolvency arrangement,
reorganization or other debtor-relief proceedings by or against the
undersigned; or
(b) failure of the undersigned to pay principal hereunder when due.
Upon a default, Verilink may, at its election and without demand or notice
of any kind, which are hereby waived, declare the unpaid principal and accrued
interest due under this Promissory Note immediately due and payable, proceed to
collect the same, and exercise any and all other rights, powers and remedies
given it by this Promissory Note or by law.
The undersigned's obligations under this Promissory Note shall be secured
by a pledge by the undersigned of 130,398 shares of Verilink common stock held
by Leigh S. Belden and Deborah Tinker Belden, Trustees U/A Dated December 9,
1988. In the event of any default hereunder, Verilink's remedies shall be
limited to those of a secured party under the California Commercial Code;
provided, however, that this Promissory Note shall be recourse to the
undersigned only with respect to the pledged shares and the undersigned shall
have no personal liability under this Promissory Note.
In the event of any proceeding to enforce the undersigned's obligations
hereunder, the prevailing party shall be entitled to recover attorney's fees
and costs.
This Promissory Note shall be governed by the laws of the State of
California.
/s/ LEIGH S. BELDEN
----------------------------
Leigh S. Belden
<PAGE> 1
Exhibit 10.20
PROMISSORY NOTE
- --------------------------------------------------------------------------------
Borrower: Stephen M. Tennis Lender: Verilink Corporation
199 Hillside Avenue 145 Baytech Drive
Menlo Park, CA 94025 San Jose, CA 95134
- --------------------------------------------------------------------------------
Principal Amount: $50,000.00 Interest Rate: 7.5% Date of Note: June 30, 1994
FOR VALUE RECEIVED, Stephen M. Tennis ("Borrower") promises to pay Verilink
Corporation ("Verilink"), or order, in lawful money of the United States of
America, the principal amount of Fifty Thousand Dollars and No Cents
($50,000.00) or so much as may be outstanding, together with interest on the
unpaid outstanding principal balance from the above date until repayment of the
principal and interest.
Payment is due in full on demand of Verilink. In addition to payment of
principal, Borrower also agrees to pay interest on the aggregate unpaid
principal at a rate equal to Seven and One-Half Percent (7.5%) per annum.
Borrower may prepay all or any part of the amount due hereunder without penalty.
If any costs, expenses, and attorney's fees are paid or incurred, or adjudged
by a court in any action to enforce payment of this Note or any part of it,
then the prevailing party shall recover from the other party such costs,
expenses and attorney's fees.
Borrower waives presentment, demand, protest, notice of protest, notice of
dishonor, notice on nonpayment, any and all other notices and demands in
connection with the delivery, acceptance, performance, default or enforcement
of this Note.
This Note shall be deemed to be made under and shall be construed in accordance
with, and governed by, the laws of the State of California.
Borrower:
/s/ STEPHEN M. TENNIS
---------------------------------
Stephen M. Tennis
<PAGE> 1
Exhibit 10.21
PROMISSORY NOTE
$50,000.00 Dated 02/21/96
FOR VALUE RECEIVED, the undersigned hereby promises to pay to Verilink
Corporation ("Verilink") at San Jose, California, the sum of Fifty Thousand
Dollars ($50,000.00), plus interest thereon at the rate of five percent (5%)
per annum, payable at maturity. Principal and accrued interest shall be paid in
full on or before February 21, 2001.
Upon the occurrence of any such of the following events, the undersigned
shall be deemed to be in default hereunder (a "Default"):
(a) commencement of any bankruptcy, insolvency arrangement,
reorganization or other debtor-relief proceedings by or against the
undersigned; or
(b) failure of the undersigned to pay principal or interest hereunder
when due.
Upon a Default, Verilink may, at its election and without demand or notice
of any kind, which are hereby waived, declare the unpaid principal and accrued
interest due under this Promissory Note immediately due and payable, proceed to
collect the same, and exercise any and all other rights, powers and remedies
given it by this Promissory Note or by law.
In the event of any proceedings to enforce the undersigned's obligations
hereunder, the prevailing party shall be entitled to recover attorney's fees
and costs.
This Promissory Note shall be governed by the laws of the State of
California.
/s/ STEPHEN M. TENNIS
-----------------------------
Stephen M. Tennis
<PAGE> 1
Exhibit 10.22
PROMISSORY NOTE
$70,000.00 Dated: 05/23/96
FOR VALUE RECEIVED, the undersigned hereby promises to pay to Verilink
Corporation ("Verilink") at San Jose, California, the sum of Seventy Thousand
Dollars ($70,000.00), plus interest thereon at the rate of five percent (5%)
per annum, payable at maturity. Principal and accrued interest shall be paid in
full on or before May 23, 2001.
Upon the occurrence of any such of the following events, the undersigned
shall be deemed to be in default hereunder (a "Default"):
(a) commencement of any bankruptcy, insolvency arrangement,
reorganization or other debtor-relief proceedings by or against the undersigned;
or
(b) failure of the undersigned to pay principal or interest hereunder
when due.
Upon a Default, Verilink may, at its election and without demand or notice
of any kind, which are hereby waived, declare the unpaid principal and accrued
interest due under this Promissory Note immediately due and payable, proceed to
collect the same, and exercise any and all other rights, powers and remedies
given it by this Promissory Note or by law.
In the event of any proceedings to enforce the undersigned's obligations
hereunder, the prevailing party shall be entitled to recover attorney's fees
and costs.
This Promissory Note shall be governed by the laws of the State of
California.
[SIG]
---------------------------------
Stephen M. Tennis
<PAGE> 1
Exhibit 10.23
PROMISSORY NOTE
- -------------------------------------------------------------------------------
Borrower: Stephen M. Tennis Lender: Verilink Corporation
199 Hillside Avenue 145 Baytech Drive
Menlo Park, CA 94025 San Jose, CA 95134
- -------------------------------------------------------------------------------
Principal Amount: $20,000.00 Interest Rate: 6% Date of Note: June 4, 1997
FOR VALUE RECEIVED, Stephen M. Tennis ("Borrower") promises to pay to Verilink
Corporation ("Verilink"), or order, in lawful money of the United States of
America, the principal amount of Twenty Thousand Dollars and No Cents
($20,000.00) or so much as may be outstanding, together with interest on the
unpaid outstanding principal balance from the above date until repayment of the
principal and interest.
Payment is due in full on demand of Verilink. In addition to payment of
principal, Borrower also agrees to pay interest on the aggregate unpaid
principal at a rate equal to Six Percent (6%) per annum. Borrower may prepay
all or any part of the amount due hereunder without penalty.
If any costs, expenses and attorneys' fees are paid or incurred, or adjudged by
a court in any action to enforce payment of this Note or any part of it, the
prevailing party shall recover from the other party such costs, expenses and
attorneys' fees.
Borrower waives presentment, demand, protest, notice of protest, notice of
dishonor, notice on nonpayment, and any and all other notices and demands in
connection with the delivery, acceptance, performance, default or enforcement
of this Note.
This Note shall be deemed to be made under and shall be construed in accordance
with, and governed by, the laws of the State of California.
Borrower:
/s/ STEPHEN M. TENNIS
------------------------
Stephen M. Tennis
<PAGE> 1
EXHIBIT 10.24
PROMISSORY NOTE
Dated: September 1, 1998
FOR VALUE RECEIVED, the undersigned hereby promises to pay to Verilink
Corporation ("Verilink") at San Jose, California, the principal amounts of the
advances set forth on Schedule I, plus interest thereon at the rate of six
percent (6%) per annum, compounded monthly, commencing on the dates that the
advances were made to the undersigned, as set forth on Schedule I. Advances
hereunder shall not exceed the principal sum of $1,000,000.
All principal and accrued interest due under this note shall be paid on or
before December 31, 1998. Principal and interest are payable in lawful money of
the United States.
Each payment shall be credited first to the interest and the remainder to
principal, and interest shall thereupon cease upon principal so credited.
This Note may be prepaid at anytime, in whole or in part, without premium
or penalty.
If action should be instituted on this Note, the undersigned agrees to pay
the holder, in addition to such amounts owed pursuant to this Note, all costs
of collection, including a reasonable sum of attorneys' fees.
This Promissory Note shall be governed by the laws of the State of
California.
[SIG]
-----------------------------
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-05651) of Verilink Corporation of our report
dated July 23, 1998 appearing in this Form 10-K. We also consent to the
application of such report to the Financial Statement Schedule for the three
years ended June 28, 1998 listed under Item 14(a)2 of this Form 10-K when such
schedule is read in conjunction with the financial statements referred to in our
report. The audits referred to in such report also included this schedule.
PricewaterhouseCoopers LLP
San Jose, California
September 23, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS FINANCIAL SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FINANCIAL STATEMENTS CONTAINED IN THE FORM 10-K OF VERILINK CORPORATION FOR
THE FISCAL YEAR ENDED JUNE 28, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-28-1998
<PERIOD-START> JUN-30-1997
<PERIOD-END> JUN-28-1998
<CASH> 16,304
<SECURITIES> 26,111
<RECEIVABLES> 6,054
<ALLOWANCES> 62
<INVENTORY> 4,900
<CURRENT-ASSETS> 55,181
<PP&E> 16,089
<DEPRECIATION> 9,043
<TOTAL-ASSETS> 63,828
<CURRENT-LIABILITIES> 10,018
<BONDS> 0
0
0
<COMMON> 138
<OTHER-SE> 53,672
<TOTAL-LIABILITY-AND-EQUITY> 63,828
<SALES> 50,915
<TOTAL-REVENUES> 50,915
<CGS> 25,794
<TOTAL-COSTS> 25,794
<OTHER-EXPENSES> 28,866
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,679)
<INCOME-TAX> (608)
<INCOME-CONTINUING> (1,071)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,071)
<EPS-PRIMARY> (0.08)<F1>
<EPS-DILUTED> (0.08)
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT, PRIMARY MEANS BASIC.
</FN>
</TABLE>
