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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 1, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 0-19360
VERILINK CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 94-2857548
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 JETPLEX CIRCLE, MADISON, ALABAMA 35758
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
256-772-3770
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X]. No [ ].
The number of shares outstanding of the issuer's common stock as of October 28,
1999 was 14,022,317.
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INDEX
VERILINK CORPORATION
FORM 10-Q
<TABLE>
<CAPTION>
<S> <C> <C>
PART I. FINANCIAL INFORMATION PAGE NO.
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the 3
three months ended October 1, 1999 and September 27, 1998
Condensed Consolidated Balance Sheets as of 4
October 1, 1999 and June 27, 1999
Condensed Consolidated Statements of Cash Flows for 5
the three months ended October 1, 1999 and September 27, 1998
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 9
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURES 22
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------
October 1, September 27,
1999 1998
---------- -------------
<S> <C> <C>
Net sales $ 14,852 $ 17,078
Cost of sales 8,697 8,308
-------- --------
Gross profit 6,155 8,770
Operating expenses:
Research and development 3,165 3,290
Selling, general and administrative 5,598 4,928
Restructuring and other non-recurring charge 6,900 --
-------- --------
Total operating expenses 15,663 8,218
Income (loss) from operations (9,508) 552
Interest and other income, net 171 559
-------- --------
Income (loss) before provision for income taxes (9,337) 1,111
Provision for income taxes -- 389
-------- --------
Net income (loss) $ (9,337) $ 722
======== ========
Net income (loss) per share - Basic $ (0.67) $ 0.05
======== ========
Net income (loss) per share - Diluted $ (0.67) $ 0.05
======== ========
Shares used in per share computations - Basic 13,998 13,908
======== ========
Shares used in per share computations - Diluted 13,998 14,244
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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VERILINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, unaudited)
<TABLE>
<CAPTION>
October 1, June 27,
1999 1999
----------- --------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 5,368 $ 6,365
Restricted cash 519 515
Short-term investments 8,162 11,596
Accounts receivable, net 11,296 9,161
Inventories 8,393 6,864
Notes receivable 1,396 3,561
Other current assets 1,587 2,040
-------- --------
Total current assets 36,721 40,102
Property and equipment, net 6,908 7,706
Notes receivable, long term 2,211 --
Goodwill and other intangible assets, net 5,076 5,337
Other assets 905 1,136
-------- --------
Total assets $ 51,821 $ 54,281
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,531 $ 2,818
Accrued expenses 18,129 11,324
-------- --------
Total liabilities 20,660 14,142
Stockholders' equity 31,161 40,139
-------- --------
Total liabilities and stockholders' equity $ 51,821 $ 54,281
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
<TABLE>
<CAPTION>
Three Months Ended
October 1, September 27,
1999 1998
---------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (9,337) $ 722
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,144 471
Deferred compensation related to stock options 49 14
Accrued interest on notes receivable from stockholders (15) --
Changes in assets and liabilities:
Accounts receivable (2,135) (1,760)
Inventories (1,529) 36
Other assets 638 (170)
Accounts payable (287) (557)
Accrued expenses 6,805 769
Income tax payable -- 373
-------- --------
Net cash used in operating activities (4,667) (102)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (85) (540)
Sale (purchase) of short-term investments 3,434 (3,034)
-------- --------
Net cash provided by (used in) investing activities 3,349 (3,574)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 348 113
Repurchase of common stock (78) --
Proceeds from repayment of notes receivable from stockholders 55 --
-------- --------
Net cash provided by financing activities 325 113
-------- --------
Net decrease in cash and cash equivalents (993) (3,563)
Cash and cash equivalents and restricted cash at beginning of period 6,880 16,304
-------- --------
Cash and cash equivalents and restricted cash at end of period $ 5,887 $ 12,741
======== ========
Supplemental disclosures:
Refund from income taxes $ 500 $ --
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. Basis of Presentation
The accompanying unaudited interim condensed consolidated financial
statements of Verilink Corporation (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, these statements include all
adjustments, consisting of normal and recurring adjustments, considered
necessary for a fair presentation of the results for the periods presented. The
results of operations for the periods presented are not necessarily indicative
of results which may be achieved for the entire fiscal year ending June 30,
2000. The unaudited interim condensed consolidated financial statements should
be read in conjunction with the financial statements and notes thereto contained
in the Company's Annual Report on Form 10-K for the fiscal year ended June 27,
1999 as filed with the Securities and Exchange Commission.
In November 1999, the Board of Directors approved the change in the
Company's fiscal year end from the Sunday nearest to June 30 to the Friday
nearest to June 30, beginning with fiscal year 2000. As a result, fiscal 2000
commenced on Monday, June 28, 1999 and will end on Friday, June 30, 2000. Each
quarter beginning in fiscal 2000 will also end on a Friday. Additionally, fiscal
2000 consists of 53 weeks resulting in a 14 week period for Q1 as compared to 13
weeks for all prior quarter periods.
NOTE 2. Restructuring Charge
During the third quarter of fiscal 1999, the Company announced and began
implementing its plans to streamline operations and eliminate redundant
functions by consolidating manufacturing, combining sales and marketing
functions, and restructuring research and development activities. The action
resulted in a pretax restructuring charge of $3.2 million. The following table
represents the restructuring activity from June 27, 1999 to October 1, 1999:
<TABLE>
<CAPTION>
Restructuring Reserve
(in thousands, unaudited)
Reduction in
Workforce Other Costs Total
------------- ----------- --------
<S> <C> <C> <C>
Balance at June 27, 1999 $ 345 $ 2 $ 347
Payment of non-salary benefits (a) (139) -- (139)
Reserve on employee loan (b) -- (2) (2)
-------- -------- --------
Balance at October 1, 1999 $ 206 $ -- $ 206
======== ======== ========
</TABLE>
(a) cash; (b) non-cash
During the first quarter of fiscal 2000, the Company announced its plans to
consolidate its San Jose operations with its facilities in Huntsville, Alabama,
and outsource its San Jose-based manufacturing operations. The Company recorded
a $6.9 million charge in connection with the restructuring activities which
include 1) severance and other termination benefits for the approximately 135
San Jose-based employees who were involuntarily terminated, 2) the termination
of certain facility leases, 3) the write-down of certain impaired assets and 4)
the pro-rata portion of the non-recurring retention bonuses offered to the
involuntarily terminated employees to support the transition from California to
Alabama. No payments or charges to the restructuring reserve were made during
the current quarter.
<TABLE>
<CAPTION>
Restructuring Reserve
(in thousands, unaudited)
Lease Write-down of
Terminations Impaired Retention
Severance(a) (a) Asset(b) Bonuses(a) Total
------------ ------------- -------------- ---------- -------
<S> <C> <C> <C> <C> <C>
Balance at October 1, 1999 $ 2,262 $ 1,442 $ 1,696 $ 1,500 $ 6,900
============= ============ ============== ========= ========
</TABLE>
(a) cash; (b) non-cash
The severance reserve includes severance, related medical benefits and
other termination benefits.
The balance of the restructuring accrual is included in accrued expenses on
the condensed consolidated balance sheets.
NOTE 3. Inventories
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Inventories are stated at the lower of cost, determined using the first-in,
first-out method, or market. Inventories consisted of the following (in
thousands):
<TABLE>
<CAPTION>
October 1, June 27,
1999 1999
---------- --------
<S> <C> <C>
Raw materials $ 4,214 $ 3,453
Work in process 784 1,309
Finished goods 3,395 2,102
-------- --------
$ 8,393 $ 6,864
======== ========
</TABLE>
NOTE 4. Earnings Per Share
Basic net income (loss) per share is computed by dividing net income (loss)
available to common stockholders (numerator) by the weighted average number of
common shares outstanding (denominator) during the period. Diluted net income
(loss) per share gives effect to all dilutive potential common shares
outstanding during a period. In computing diluted net income (loss) per share,
the average price of the Company's Common Stock for the period is used in
determining the number of shares assumed to be purchased from exercise of stock
options.
<TABLE>
<CAPTION>
(in thousands, except
per share amount)
Three months ended
Oct. 1, Sept. 27,
1999 1998
-------- ---------
<S> <C> <C>
Net income (loss) [numerator] $ (9,337) $ 722
======== ========
Shares calculation [denominator]:
Weighted shares outstanding - Basic 13,998 13,908
Effect of dilutive securities:
Potential common stock relating to stock options (a) -- 336
-------- --------
Weighted diluted shares outstanding - Diluted 13,998 14,244
======== ========
Net income (loss) per share - Basic $ (0.67) $ 0.05
======== ========
Net income (loss) per share - Diluted $ (0.67) $ 0.05
======== ========
</TABLE>
(a) Options to purchase 2,686,247 shares of common stock at prices ranging from
$0.50 to $10.38 per share were outstanding at October 1, 1999 but were not
included in the computation of diluted net income (loss) per share because
inclusion of such options would have been antidilutive.
NOTE 5. Recently issued accounting pronouncements
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use ("SOP 98-1"). SOP 98-1
provides guidance over accounting for computer software developed or obtained
for internal use including the requirement to capitalize specified costs and
amortization of such costs over the estimated useful life of the software. SOP
98-1 was effective for the Company's current fiscal year. The adoption of this
standard did not have a material impact on the Company's results of operations,
financial position or cash flows.
7
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In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities," which will be effective for fiscal years
beginning after June 15, 2000. SFAS 133 establishes new standards of accounting
and reporting for derivative instruments and hedging activities. SFAS 133
requires that all derivatives be recognized at fair value in the statement of
financial position, and that the corresponding gains or losses be reported
either in the statement of operations or as a component of comprehensive income,
depending on the type of hedging relationship that exists. The Company currently
does not hold derivative instruments or engage in hedging activities.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
During the second quarter of fiscal 1999, the Company acquired TxPort,
Inc., a manufacturer of high speed voice and data communications products, based
in Huntsville, Alabama for $10,000,000 in cash, paid out of the Company's
working capital. Accordingly, the results of operations of TxPort, Inc.
commencing from November 16, 1998, the date of acquisition, are consolidated in
the Company's operating results for fiscal 1999 and fiscal 2000.
The following table presents the percentages of total sales represented
by certain line items from the Condensed Consolidated Statements of Operations
for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
October 1, September 27,
1999 1998
---------- -------------
<S> <C> <C>
Sales 100.0% 100.0%
Cost of sales 58.6 48.6
------ ------
Gross margin 41.4 51.4
Operating expenses:
Research and development 21.3 19.3
Selling, general and administrative 37.7 28.9
Restructuring and other non-recurring charges 46.4 --
------ ------
Total operating expenses 105.4 48.2
------ ------
Income (loss) from operations (64.0) 3.2
Interest and other income, net 1.1 3.3
------ ------
Income (loss) before income taxes (62.9) 6.5
Provision for (benefit from) income taxes -- 2.3
------ ------
Net income (loss) (62.9)% 4.2%
====== ======
</TABLE>
8
<PAGE> 9
Sales. Net sales for the three months ended October 1, 1999 decreased
approximately 13% to $14.9 million from $17.1 million in the comparable period
of the prior fiscal year. This decrease is a result of a decline in demand by
the Company's carrier, carrier access, and wireless business customers, offset
in part by an increase in demand by the Company's enterprise access product
customers. In particular, net sales to the Company's wireless customers in the
first quarter of fiscal 2000 declined by approximately 39% to $3.0 million as
compared to the same period last year. Net sales to the Company's top customer
MCI Worldcom also declined by approximately 58% to $3.1 million in the first
quarter of fiscal 2000 due to lower demand. Offsetting these declines, in part,
was an increase in demand for the Company's enterprise access products which was
principally the result of the contribution of products acquired in the
acquisition of TxPort, Inc. in November of 1998.
Gross Margin. Gross margin decreased to 41.4% of net sales for the three
months ended October 1, 1999 as compared to 51.4% for the three months ended
September 27, 1998. The decrease in gross margin in the first quarter of fiscal
2000 is primarily due to under-utilization of the San Jose based manufacturing
facility, a high level of non-warranty repairs which carry a lower than average
gross margin, and an increase in excess inventory reserves associated with
product rationalization decisions. In addition, during the fourth quarter of
fiscal 1999, the Company was notified by one of its major customers of an
intermittent problem involving one of its products that is installed in the
field. The Company is currently negotiating with its customer to share in the
expense associated with correcting this problem and began providing for this
expected expense in the fourth quarter of fiscal 1999 and first quarter of
fiscal 2000. Failure of the Company to negotiate a reasonable cost sharing
agreement could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Factors Affecting Future
Results -- Fluctuations in Quarterly Operating Results".
Research and Development. Research and development expenditures for the
three months ended October 1, 1999 decreased approximately 4% to $3.2 million
from $3.3 million in the comparable period of the prior fiscal year and
increased as a percentage of sales from 19.3 % to 21.3%. The increase as a
percentage of net sales for the three-month period comparison is a result of
comparable expenses spread over a lower sales volume. The Company believes that
a significant level of investment in product development is required to remain
competitive and such expenses will vary over time as a percentage of sales.
Selling, general and administrative. Selling, general and administrative
expenses for the three months ended October 1, 1999 increased 14% to $5.6
million from $4.9 million in the comparable period of the prior fiscal year and
increased as a percentage of sales from 28.9% to 37.7%. These increases in
spending over the corresponding period in the prior year are primarily due to an
increase in expenses that resulted from the acquisition of TxPort, Inc. and the
associated redundancy of facility-related and other overhead expenses. The
Company expects selling, general and administrative expense to decrease in the
future as a result of the Company's restructuring activities and consolidation
of its headquarters operations to Huntsville, Alabama. The Company expects such
expenses will vary over time as a percentage of sales.
Restructuring and other non-recurring charge. The Company announced and
began implementing during the first quarter of fiscal 2000, its plans to
consolidate its operations into its existing operations located in Huntsville,
Alabama, and to outsource its San Jose based manufacturing activity. The Company
incurred a pretax charge of $6.9 million for restructuring and other related
non-recurring activities. See Note 2 in the Notes to Condensed Consolidated
Financial Statements for further details of the restructuring and other
non-recurring charge and the restructuring reserve activity during the current
quarter. A charge of approximately $1.5 million for the balance of transition
related activities including that portion of retention bonuses related to the
second quarter effort is expected to be incurred in the second quarter of fiscal
2000.
Interest and Other Income. Net interest and other income was approximately
$171,000 for the three month period ended October 1, 1999 as compared to
$559,000 in the comparable period of the prior fiscal year. The decrease was a
result of lower cash and cash equivalents, restricted cash and short-term
investments balances.
Provision for Income Taxes. Based on the estimated taxable income for
fiscal 2000, the Company did not record a tax benefit or provision for income
taxes for the quarter ended October 1, 1999. The provision for income taxes for
the quarter ended September 27, 1998 reflected 35% of taxable income.
9
<PAGE> 10
LIQUIDITY AND CAPITAL RESOURCES
On October 1, 1999, the Company's principal sources of liquidity included
$14.0 million of cash and cash equivalents, restricted cash, and short-term
investments.
During the three-month period ended October 1, 1999, the Company used
approximately $4.7 million for operating activities, compared to the $102,000
used during the three-month period ended September 27, 1998. Net cash used in
operating activities was primarily due to the loss of $9.3 million incurred
through the three months ended October 1, 1999, and increases in working capital
that were associated with preparations to outsource the Company's San Jose based
manufacturing operations to a subcontract manufacturer.
Cash provided by investing activities was approximately $3.3 million for
the three-month period ended October 1, 1999, as compared to approximately $3.6
million used in investing activities for the three-month period ended September
27, 1998. The increase in funds provided by investing activities is primarily a
result of the maturity of short-term investments being reinvested in cash and
cash equivalents.
Cash provided by financing activities was approximately $325,000 for the
three-month period ended October 1, 1999, as compared to approximately $113,000
provided for the three-month period ended September 27, 1998. The increase in
funds provided by financing activities of $212,000 is primarily due to the
exercise of stock options by departing employees and by participation by
employees in the employee stock participation plan.
While the Company believes that its existing cash and cash equivalents,
short-term investments and anticipated cash flows from operations will satisfy
the Company's near-term cash needs, the Company continues to investigate the
possibility of generating financial resources through committed credit
agreements, technology or manufacturing partnerships, equipment financing, and
offerings of debt and equity securities. To the extent that the Company needs
additional public or private financing, no assurance can be given that
additional financing will be available or that, if available, it will be
available on terms favorable to the Company or its stockholders. If additional
capital is needed and adequate funds are not available to satisfy the Company's
capital requirements, the Company would be required to significantly limit its
operations, which would have a material adverse effect on the Company's
business, financial condition and results of operation. In the event the Company
raises additional equity financing, further dilution to the Company's
stockholders will result.
YEAR 2000 READINESS
The year 2000 presents concerns, which are 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 has evaluated and continues to evaluate
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 evaluated its information technology infrastructure for year
2000 compliance, which included reviewing what actions were required to make all
software systems used internally year 2000 compliant. The Company purchased and
implemented an enterprise resource planning solution (ERP) which has been
determined to be year 2000 compliant. 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 adversely affected.
The Company contacted its key suppliers to determine that the suppliers
operations and the products and services they provide are year 2000 compliant.
Responses have generally indicated substantial remediation, or documented plans
10
<PAGE> 11
to remediate the year 2000 issue. Some have given written certification of
internal and product compliance. Substantially all key suppliers have indicated
compliance of their product or service. 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 were reviewed for compliance to year 2000
guidelines. This process included a complete and thorough testing of current
products as well as inclusion of year 2000 requirements in specifications for
future product releases. Based on this 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.
Costs. The total cost to address the Year 2000 issue has not been and is
not expected to be material to the Company's financial condition. The Company is
using both internal and external resources to reprogram, or replace, and test
its software for Year 2000 modifications. The Company does not separately track
internal costs incurred on the Year 2000 Project, which principally includes
payroll and related costs for Information Management employees that are being
expensed as incurred. These costs will be funded through operating cash flows.
Risks. The Company believes, based on currently available information, that
it will be able to properly manage its total Year 2000 exposure. There can be no
assurance, however, that the Company will be successful in its efforts, or that
the computer systems of other companies on which the Company relies will be able
to be modified in a timely manner. Additionally, there can be no assurance that
a failure to modify such systems by another company, or modifications that are
incompatible with the Company's systems, would not have a material adverse
effect on the Company's business, financial condition, or results of operations.
Contingency Plans. The Company has formulated contingency plans in those
areas where year 2000 non-compliance could have a material adverse effect on the
Company's business, financial condition and results of operations. However, 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.
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.
This Report on Form 10-Q contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, including statements
using terminology such as "may," "will," "expects," "plans," "anticipates,"
"estimates," "potential," or "continue," or the negative thereof or other
comparable terminology regarding beliefs, plans, expectations or intentions
regarding the future. Forward-looking statements include statements regarding
the Company's consolidation of its operations and outsourcing its manufacturing
operations (the "Restructuring"); the goals, intended benefits and success of
the Restructuring, particularly the goal of reducing expenses; the expected
decrease in selling, general and administrative expenses; evaluation and
resolution of the Year 2000 problems; expenses associated with the Year 2000
problem; total budgeted capital expenditures; and the adequacy of the Company's
cash position for the near-term. These forward-looking statements involve risks
and uncertainties, and it is important to note that the Company's actual results
could differ materially from those in such forward-looking statements. Among the
factors that could cause actual results to differ materially are the factors
detailed below as well as the other factors set forth in Item 2 hereof,
particularly those related to the year 2000 problem and the Company's cash
needs. All forward-looking statements and risk factors included in this document
are made as of the date hereof, based on information available to the Company as
of the date hereof, and the Company assumes no obligation to update any
forward-looking statement or risk factor. You should consult the risk factors
listed from time to time in the Company's Reports on Forms 10-Q and 10-K.
11
<PAGE> 12
Restructuring Actions May Not Achieve Intended Results. The Company
announced in July 1999 its plans to substantially consolidate its operations in
Huntsville, Alabama in order to strengthen its business and improve its results
from operations. These actions are intended to streamline the Company's
operations, reduce operating costs, and enable the Company to achieve
profitability at lower revenue levels. Delay or difficulty in implementing these
actions or market factors could reduce the anticipated benefit of these actions.
The Company's revenues, operating results, and financial condition, could be
adversely affected by the Company's ability to manage effectively the transition
to Huntsville, to continually improve new product development processes, and to
outsource a substantial portion of its manufacturing activities. In particular,
there is a risk that the company may be unable to efficiently manage its
operations due to the currently expected departure of all members of its senior
management team, except Graham Pattison, President and CEO, and Steve Turner,
Vice President, Huntsville Business Unit, and the inherent complexities included
in managing operations in both Alabama and California. See "Dependence on Key
Personnel". Moreover, the Company's outsourcing of a substantial portion of its
manufacturing activities exposes it to a number of risks including reduced
control over manufacturing and delivery schedules, quality control and costs.
The failure by the Company to overcome these risks and achieve the intended
results from its restructuring actions would have a significant adverse affect
on the Company's business and results of operations, particularly in light of
the Company's recent disappointing operating results.
Customer Concentration. A small number of customers continue to account for
a majority of the Company's sales. In September 1998, MCI and WorldCom completed
their merger and now operate under the same name MCIWorldCom. Percentages of
total revenue have been restated for fiscal 1999 and prior years as if the
merger had been in effect for all periods presented. Similarly, in May, 1999,
Ericsson completed its acquisition of Qualcomm's terrestrial Code Division
Multiple Access (CDMA) wireless infrastructure business. Percentages of total
revenue for Ericsson have been restated for fiscal 1999 and prior years as if
the acquisition had been in effect for all periods presented. In fiscal 1999,
sales to MCIWorldCom, Nortel, and Ericsson accounted for 27%, 17%, and 5% of the
Company's sales respectively and sales to the Company's top five customers
accounted for 57% of the Company's sales. In fiscal 1998, sales to MCIWorldCom,
Nortel, and Ericsson accounted for 31%, 20%, and 12% 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, MCIWorldCom, Nortel and Ericsson accounted
for 33%, 22%, and 9% of the Company's sales, respectively, and the Company's top
five customers accounted for 67% of the Company's sales. Other than MCIWorldCom,
Nortel, and Ericsson, no customer accounted for more than 10% of the Company's
sales in fiscal years 1999, 1998, or 1997. 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
have in the past and could in the future, result in further concentration of the
Company's customers. The Company has in the past experienced significant
declines in sales it believes were in part related to orders being delayed or
cancelled as a result of pending acquisitions relating to its customers. There
can be no assurance future merger and acquisition activity among the customers
will not have a similar adverse affect on the Company's sales and results of
operations. The Company's customers are typically not contractually obligated to
purchase any quantity of products in any particular period. Product sales to
major customers have varied widely from period to period. In some cases, major
customers have abruptly terminated purchases of the Company's products. Loss of,
or a material reduction in orders by, one or more of the Company's major
customers would materially adversely affect the Company's business, financial
condition and results of operations. See "Competition" and "Fluctuations in
Quarterly Operating Results".
Dependence on Contract Manufacturers. The Company entered into arrangements
with a single contract manufacturer to outsource substantially all of the
Company's San Jose-based manufacturing operations, including its procurement,
assembly, and system integration operations. During 1999, a majority of the
Company's revenues were generated by products manufactured by its operations
located in California. There can be no assurance that this contract manufacturer
will be able to meet the Company's future requirements for manufactured
products, or that such independent contractor will not experience quality
problems in manufacturing the Company's products. The inability of the Company's
contract manufacturer to provide the Company with adequate supplies of high
quality products could have a material adverse effect on the Company's business,
financial condition, and results of operations. The loss of any of the Company's
contract manufacturers could cause a delay in the Company's ability to fulfill
orders while the
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Company identifies a replacement manufacturer. Such an event could have a
material adverse effect on the Company's business, financial condition, and
results of operations.
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 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. As a result of the Company's plans to consolidate
its operations in Huntsville, Alabama, the Company believes that the only
existing executive officers who will continue employment with the Company after
the transition will be Graham Pattison, President and CEO, and Steve Turner,
Vice President of the Huntsville Business Unit. If the Company cannot fill these
positions with either existing personnel from Huntsville or with new personnel,
it may be unable to effectively manage its operations and its business,
financial condition and results of operations will suffer. The loss of the
services of one or more of the Company's remaining executive officers or key
personnel, or the inability to continue to attract qualified personnel would
delay product development cycles or otherwise would have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Management of Growth".
Management of Growth. The Company has recently experienced growth in the
scope of its operations as a result of its recent acquisition. To manage
potential future growth effectively, the Company must improve its operational,
financial and management information systems and must hire, train, motivate and
manage its 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, marketing and management personnel, for whom competition is
intense. In particular, the current availability of qualified personnel is quite
limited, a number of personnel have left the employ of the Company, and
competition among companies for such personnel is intense. The Company is
currently attempting to hire a number of executive management, product marketing
and engineering personnel and has experienced delays in filling such positions
and expects to experience continued difficulty in filling its needs for
qualified personnel. There can be no assurance that the Company will be able to
effectively achieve or manage any such growth, and failure to do so could delay
product development and introduction cycles or otherwise have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Dependence on Key Personnel".
Dependence on Component Availability and Key Suppliers. Under the
outsourcing plan, the Company will generally rely upon a contract manufacturer
to buy component parts that are incorporated into board assemblies used in its
products. On-time delivery of the Company's products depends upon the
availability of components and subsystems used in its products. Currently, the
Company depends upon and in the future, third party sub-contractors will depend
upon suppliers to manufacture, assemble and deliver components in a timely and
satisfactory manner. The Company has historically obtained several components
and licenses for 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 and third party sub-contractors requirements for any such
components. The Company and third party sub-contractors generally do 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. Any loss in a key supplier, increase in required lead times,
increase in prices of component parts, interruption in the supply of any of
these components, or the inability of the Company or its third party
sub-contractor to procure these components from alternative sources at
acceptable prices and within a reasonable time, could have a material adverse
effect upon the Company's business, financial condition and results of
operations.
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, and suppliers may demand longer lead times,
higher prices, or termination of contracts. 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 may occur in
the future, and could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Fluctuations in Quarterly
Operating Results".
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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
MCIWorldCom, Nortel, and Ericsson have varied between quarters by as much as
$4.0 million and delayed orders by these customers substantially negatively
impacted the Company's third and fourth quarter results in 1999. 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 the third party subcontractors the Company
is using to outsource its manufacturing operations as well as by other vendors
of components used 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
and products. 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 merger
activities 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 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 ability of
the Company to effectively execute the Restructuring and achieve the intended
benefits of the Restructuring particularly the ability to reduce expenses while
maintaining effective operations, 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
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<PAGE> 15
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 concerning its products. 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. In particular, during the fourth quarter of fiscal 1999, the Company
was notified by one of its major customers of an intermittent problem involving
one of its products that is installed in the field. The Company believes it has
identified a firmware fix for this problem and is in the process of retrofitting
the affected equipment. The Company is currently negotiating an agreement where
by it will share in the expense associated with this upgrade with the customer.
Failure of the Company to negotiate a reasonable cost sharing agreement could
have a material adverse effect on the Company's business, financial condition
and results of operations.
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 67% of sales in fiscal 1999, 86% of sales
in fiscal 1998 and 80% of sales in fiscal 1997. Market acceptance of both the
Company's current and future product lines is dependent on a number of factors,
not all of which are in the Company's control, including the continued growth in
the use of bandwidth intensive applications, continued deployment of new
telecommunications services, market acceptance of integrated access devices in
general, the availability and price of competing products and technologies, and
the success of the Company's sales efforts. Failure of the Company's products to
achieve market acceptance would have a material adverse effect on the Company's
business, financial condition and results of operations. Failure to introduce
new products in a timely manner could cause companies to purchase products from
competitors and have a material adverse effect on the Company's business,
financial condition and results of operations. Due to a variety of factors, the
Company may experience delays in developing its planned products. New products
may require additional development work, enhancement, testing or further
refinement before the Company can make them commercially available. The Company
has in the past experienced delays in the introduction of new products, product
applications and enhancements due to a variety of internal factors, such as
reallocation of priorities, difficulty in hiring sufficient qualified personnel
and unforeseen technical obstacles, as well as changes in customer requirements.
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.
Risks Associated with the Acquisition of TxPort. In addition to risks
described below under "Risks Associated With Potential Acquisitions," the
Company faces significant risks associated with its acquisition of TxPort and
related Restructuring. There can be no assurance that the Company will realize
the desired benefits of this acquisition or Restructuring. In order to
successfully integrate TxPort, the Company must, among other things, continue to
attract and retain key personnel, integrate the acquired products and technology
from engineering, sales and marketing perspectives, and consolidate functions
and facilities. Difficulties encountered in the integration may have a material
adverse effect on the Company's business, financial condition and results of
operations.
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The Company applied the purchase method of accounting in connection with
its acquisition of TxPort, resulting in a charge to be taken in each of the next
three to ten years for the amortization of intangible assets.
Risks Associated with Year 2000. There can be no assurances that the
Company's current products do not contain undetected errors or defects
associated with year 2000 date functions that may result in material costs or
liabilities to the Company. In addition, there can be no assurances that the
Company's current products do not contain undetected errors or defects
associated with year 2000 date functions that may result in material costs to
the Company. Moreover, the Company's products directly and indirectly interact
with a large number of other hardware and software systems could contain defects
associated with the year 2000 date. The Company is unable to predict to what
extent its business may be affected if its software or the systems that operate
in conjunction with its products experience a material year 2000 related
failure. Any year 2000 defect in the Company's products or the software and
hardware systems with which the Company's products operate could expose the
Company to litigation that could have a material adverse impact on the Company.
The risks of such litigation may be particularly acute due to the
mission-critical applications for which the Company's products are used. Some
commentators have stated that a significant amount of litigation will arise out
of year 2000 compliance issues, and the Company is aware of a growing number of
lawsuits against other software vendors. Because of the unprecedented nature of
such litigation, it is uncertain whether or to what extent the Company may be
affected by it.
The Company could also experience serious unanticipated negative
consequences caused by undetected year 2000 defects in its internal systems,
including third party software and hardware products. Internal systems are
primarily composed of third-party software and third-party hardware which
contain embedded software and the Company's own software products. For example,
the Company could experience a (i) corruption of data contained in the Company's
internal information systems or a (ii) failure of hardware, software, or other
information technology systems, causing an interruption or failure of normal
business operations. Any such events could have a material adverse impact on the
Company. In addition, the Company could experience serious unanticipated
negative consequences caused by the failure of services or products provided by
third parties that are critical to the continued day-to-day operations of the
Company, such as electrical power, telecommunications services, and shipping
services (particularly outside of countries such as the United States where year
2000 remediation has progressed the furthest), which consequences could have a
material adverse effect on the Company's business operations.
In addition, a widely-predicted freeze in deployment of new communications
systems by large corporations in the second half of calendar year 1999 related
to remediation of the Y2K problem could result in an unusual fluctuation of
orders, in which an unusually large number of orders are received in the first
half of calendar 2000, followed by an unusual decrease in orders in subsequent
quarters.
Enterprise Resource Planning (ERP). The Company went live in March 1999
with an upgrade to its enterprise-wide database and information management
systems, based principally on software from Oracle. This change in systems and
processes was substantial, and involved significant outside contract resources
to implement. Due to the relative immaturity of this system implementation and
the need to move it to Huntsville, Alabama, problems with the system, due to
software or configuration problems, or lack of trained personnel could cause
delays in order processing, shipments of products, and in the accumulation and
analysis of financial data. There can be no assurance that these problems, if
they occur, will not have an adverse effect on the Company's business, financial
condition, and results from operations.
Competition. The market for telecommunications network access equipment is
highly competitive, and the Company expects competition to increase in the
future. This market is subject to rapid technological change, regulatory
developments, and new entrants. The market for integrated access devices such as
the Company's Access System 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., a division of World Access, Inc., Visual Networks Inc., and Adtran, Inc.
To the extent that current or potential competitors can
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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, such as Cisco and Nortel Networks,
into other equipment such as routers and switches. These 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".
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
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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 Potential Acquisitions. An important element of the
Company's strategy is to review acquisition prospects that would compliment its
existing product offerings, augment its market coverage, enhance its
technological capabilities or offer growth opportunities. Future acquisitions by
the Company could result in potentially dilutive issuance of equity securities,
use of cash and/or the incurring of debt and the assumption of contingent
liabilities, any of which could have a material adverse effect on the Company's
business and operating results and/or the price of the Company's common stock.
Acquisitions entail numerous risks, including difficulties in the assimilation
of 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.
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 the European and Far Eastern markets, but intends to
expand sales of its products outside of North America and to enter certain
international markets, which will require significant management attention and
financial resources. Conducting business outside of North America is subject to
certain risks, including longer payment cycles, unexpected changes in regulatory
requirements and tariffs, difficulties in staffing and managing foreign
operations, greater difficulty in accounts receivable collection and potentially
adverse tax consequences. To the extent any Company sales are denominated in
foreign currency, the Company's sales and results of operations may also be
directly affected by fluctuations in foreign currency exchange rates. In order
to sell its products internationally, the Company must meet standards
established by telecommunications authorities in various countries, as well as
recommendations of the Consultative Committee on International Telegraph and
Telephony. A delay in obtaining, or the failure to obtain, certification of its
products in countries outside the United States could delay or preclude the
Company's marketing and sales efforts in such countries, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Risk of Third Party Claims of Infringement. The network access and
telecommunications equipment industries are characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert exclusive patent,
copyright, trademark and other intellectual property rights to technologies that
are important to the Company. The Company has not conducted a formal patent
search relating to the technology used in its products, due in part to the high
cost and limited benefits of a formal search. In addition, since patent
applications in the United States are not publicly disclosed until the related
patent is issued and foreign patent applications generally are not publicly
disclosed for at least a portion of the time that they are pending, applications
may have been filed which, if issued as patents, could relate to the Company's
products. Software comprises 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 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.
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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.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
At October 1, 1999, the Company's investment portfolio consisted of fixed
income securities of $8.7 million. These securities, like all fixed income
instruments, are subject to interest rate risk and will decline in value if
market interest rates increase. If market interest rates were to increase
immediately and uniformly by 10% from levels as of October 1, 1999, the decline
in the fair value of the portfolio would not be material. Additionally, the
Company has the ability to hold its fixed income investments until maturity and
therefore, the Company would not expect to recognize such an adverse impact in
income or cash flows. The Company invests cash balances in excess of operating
requirements in short-term securities, generally with maturities of 90 days or
less. The Company believes that the effect, if any, of reasonably possible
near-term changes in interest rates on the Company's financial position, results
of operations and cash flows would not be material.
19
<PAGE> 20
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Index:
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibit
-------------- ----------------------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
(b) No reports on Form 8-K were filed during the quarter ended October
1, 1999.
20
<PAGE> 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERILINK CORPORATION
November 5, 1999 By: /s/ JOHN C. BATTY
--------------------------------
John C. Batty,
Vice President, Finance and Chief
Financial Officer (Duly Authorized
Officer and Principal Financial
Officer)
21
<PAGE> 22
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibit
-------------- ----------------------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS FINANCIAL SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FINANCIAL STATEMENTS CONTAINED IN THE FORM 10-Q OF VERILINK CORPORATION FOR
THE FIRST FISCAL QUARTER ENDED OCTOBER 1, 1999 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-28-1999
<PERIOD-END> OCT-01-1999
<CASH> 5,887
<SECURITIES> 8,162
<RECEIVABLES> 11,500
<ALLOWANCES> 204
<INVENTORY> 8,393
<CURRENT-ASSETS> 36,721
<PP&E> 19,601
<DEPRECIATION> 12,693
<TOTAL-ASSETS> 51,821
<CURRENT-LIABILITIES> 20,660
<BONDS> 0
0
0
<COMMON> 144
<OTHER-SE> 31,017
<TOTAL-LIABILITY-AND-EQUITY> 51,821
<SALES> 14,852
<TOTAL-REVENUES> 14,852
<CGS> 8,697
<TOTAL-COSTS> 8,697
<OTHER-EXPENSES> 15,663
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (9,337)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,337)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,337)
<EPS-BASIC> (0.67)
<EPS-DILUTED> (0.67)
</TABLE>
