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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 29, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 0-19360
VERILINK CORPORATION
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(Exact name of registrant as specified in its charter)
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
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(Address of principal executive offices) (Zip Code)
256-772-3770
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] . No [ ].
The number of shares outstanding of the issuer's common stock as of October 27,
2000 was 14,717,591.
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INDEX
VERILINK CORPORATION
FORM 10-Q
<TABLE>
<CAPTION>
Page No.
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited):
Condensed Consolidated Statements of Operations for the 3
three months ended September 29, 2000 and October 1, 1999
Condensed Consolidated Balance Sheets as of 4
September 29, 2000 and June 30, 2000
Condensed Consolidated Statements of Cash Flows for 5
the three months ended September 29, 2000 and October 1, 1999
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 2. Changes in Securities 21
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURE 21
</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
-------------------------
September 29, October 1,
2000 1999
-------- --------
<S> <C> <C>
Net sales ........................................ $ 11,829 $ 14,852
Cost of sales .................................... 5,382 8,697
-------- --------
Gross profit ................................ 6,447 6,155
-------- --------
Operating expenses:
Research and development .................... 2,106 3,165
Selling, general and administrative ......... 5,176 5,598
Restructuring and other non-recurring charges -- 6,900
-------- --------
Total operating expenses ................ 7,282 15,663
-------- --------
Loss from operations ............................. (835) (9,508)
Interest and other income, net ................... 310 171
-------- --------
Loss before provision for income taxes ........... (525) (9,337)
Provision for income taxes ....................... 6,311 --
-------- --------
Net loss ......................................... $ (6,836) $ (9,337)
======== ========
Net loss per share - Basic ....................... $ (0.46) $ (0.67)
======== ========
Net loss per share - Diluted ..................... $ (0.46) $ (0.67)
======== ========
Shares used in per share computations - Basic .... 14,715 13,949
======== ========
Shares used in per share computations - Diluted .. 14,715 13,949
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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VERILINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
September 29,
2000 June 30,
(Unaudited) 2000
----------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .............................. $ 9,289 $ 6,617
Restricted cash ........................................ 500 500
Short-term investments ................................. 2,200 4,079
Accounts receivable, net ............................... 10,774 15,233
Inventories ............................................ 7,268 4,840
Notes receivable ....................................... 1,419 1,440
Other receivable ....................................... 315 515
Deferred tax assets .................................... -- 2,638
Other current assets ................................... 520 575
-------- --------
Total current assets ............................... 32,285 36,437
Property, plant and equipment, net .......................... 10,908 10,790
Restricted cash, long-term .................................. 500 500
Notes receivable, long-term ................................. 2,098 2,276
Goodwill and other intangible assets, net ................... 4,130 3,203
Deferred tax assets ......................................... -- 4,828
Other assets ................................................ 663 686
-------- --------
Total assets ....................................... $ 50,584 $ 58,720
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ...................... $ 600 $ 600
Accounts payable ....................................... 2,703 3,601
Accrued expenses ....................................... 5,345 5,884
-------- --------
Total current liabilities .......................... 8,648 10,085
Long-term debt, less current portion above .................. 3,371 3,521
-------- --------
Total liabilities .................................. 12,019 13,606
-------- --------
Stockholders' equity:
Common stock, $0.01 par value; 40,000,000 shares
authorized; 18,380,114 and 18,307,751 shares issued .. 184 183
Additional paid-in capital ............................. 50,898 50,696
Treasury stock; 3,662,523 shares of common stock at cost (8,335) (8,335)
Other stockholders' equity ............................. (4,182) 2,570
-------- --------
Total stockholders' equity ......................... 38,565 45,114
-------- --------
Total liabilities and stockholders' equity ......... $ 50,584 $ 58,720
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
------------------------
September 29, October 1,
2000 1999
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss .......................................................... $(6,836) $(9,337)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization ................................... 842 1,144
Deferred income taxes ......................................... 6,311 --
Deferred compensation related to stock options ................ -- 49
Accrued interest on notes receivable from stockholders ........ (78) (15)
Changes in assets and liabilities:
Accounts receivable ...................................... 4,459 (2,135)
Other receivable ......................................... 200 --
Inventories .............................................. (2,428) (1,529)
Other assets ............................................. 78 638
Accounts payable ......................................... (898) (287)
Accrued expenses ......................................... (539) 6,805
------- -------
Net cash provided by (used in) operating activities .. 1,111 (4,667)
------- -------
Cash flows from investing activities:
Purchases of property, plant and equipment ........................ (732) (85)
Sale of short-term investments .................................... 1,879 3,434
Increase in restricted cash ....................................... -- (4)
Decrease in notes receivable ...................................... 261 --
------- -------
Net cash provided by investing activities ............ 1,408 3,345
------- -------
Cash flows from financing activities:
Long term debt payments ........................................... (150) --
Proceeds from issuance of common stock, net ....................... 203 348
Repurchase of common stock ........................................ -- (78)
Proceeds from repayment of notes receivable from stockholders ..... 115 55
Change in other comprehensive income .............................. (15) --
------- -------
Net cash provided by financing activities ............ 153 325
------- -------
Net increase (decrease) in cash and cash equivalents ................... 2,672 (997)
Cash and cash equivalents at beginning of period ....................... 6,617 6,365
------- -------
Cash and cash equivalents at end of period ............................. $ 9,289 $ 5,368
======= =======
Supplemental disclosures:
Cash paid for interest ............................................ $ 87 $ --
======= =======
Refund from income taxes .......................................... $ 23 $ 500
======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. 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 29,
2001. 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 30,
2000 as filed with the Securities and Exchange Commission.
NOTE 2. Comprehensive Income (Loss)
The Company records gains or losses on the Company's foreign currency
translation adjustments and unrealized gains or losses on the Company's
available-for-sale investments as accumulated other comprehensive income and
presents it in other stockholders' equity in the accompanying condensed
consolidated balance sheets. During the first quarter of fiscal 2001 and fiscal
2000, comprehensive loss amounted to $6,851,000 and $9,337,000, respectively.
NOTE 3. Restructuring Charge
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
charges (credits) of $6.9 million, $1.4 million, and ($0.3) million in the
first, second and fourth quarters of fiscal 2000, respectively, in connection
with the restructuring activities that included 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. As of September
29, 2000, all amounts accrued for the restructuring have been paid or charged
against the restructuring reserve.
NOTE 4. Inventories
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>
September 29, June 30,
2000 2000
------ ------
<S> <C> <C>
Raw materials $1,940 $1,517
Work in process 19 --
Finished goods 5,309 3,323
------ ------
$7,268 $4,840
====== ======
</TABLE>
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NOTE 5. 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. Following is a reconciliation of the numerators and denominators of the
basic and diluted net income (loss) per share for the three months ended
September 29, 2000 and October 1, 1999 (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three months ended
Sept. 29, Oct. 1,
2000 1999
-------- --------
<S> <C> <C>
Net income (loss) [numerator] $ (6,836) $ (9,337)
======== ========
Shares calculation [denominator]:
Weighted shares outstanding - Basic 14,715 13,949
Effect of dilutive securities:
Potential common stock relating to stock options (a) -- --
-------- --------
Weighted shares outstanding - Diluted 14,715 13,949
======== ========
Net loss per share - Basic $ (0.46) $ (0.67)
======== ========
Net loss per share - Diluted $ (0.46) $ (0.67)
======== ========
</TABLE>
(a) Options to purchase 4,002,256 and 2,686,247 shares of common stock at
prices ranging from $0.50 to $19.75 per share were outstanding at
September 29, 2000 and October 1, 1999, respectively, but were not
included in the computation of diluted net income (loss) per share
because inclusion of such options would have been antidilutive.
NOTE 6. Recently Issued Accounting Pronouncements
In June 1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 137, "Accounting for Derivative Instruments
and Hedging Activities Deferral of the Effective Date of FASB No. 133", which
deferred the effective date provisions of SFAS No. 133 for the Company until
fiscal 2001. 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.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements."
This pronouncement summarizes certain of the SEC staff's views on applying
generally accepted accounting principles to revenue recognition. The Company has
reviewed the requirements of SAB 101 and believes that its existing accounting
policies are in accordance with the guidance provided in the SAB.
NOTE 7. Subsequent Event
In October 2000, the Company announced agreements with Beacon Telco, L.P.
("Beacon Telco") and the Boston University Photonics Center to establish a
product development center at the Photonics Center to develop
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new optical networking products. As part of the agreements, the Company issued
Beacon Telco warrants for 2,249,900 shares of the Company's common stock
exercisable over time, subject to acceleration based upon meeting development
milestones and certain events, including the market price of the Company's
common stock. The issuance of these warrants will result in the dilution of the
Company's earnings per share of approximately 15% in future periods.
Additionally, the Company expects to record a charge to research and development
expenses in the second quarter of fiscal 2001 of approximately $11 million for
the warrants and other expenses related to the initial agreements. Management
expects that research and development expenses will significantly increase
during calendar 2001 in support of ongoing optical product development.
The Company is obligated to pay Beacon Telco a bonus payment of $3,562,500
on October 13, 2001 or upon termination of the agreements, if earlier. Beacon
Telco is also eligible to receive additional bonus payments based in part on
meeting certain milestones and the market price of the Company's common stock.
These bonus payments may be paid at the option of the Company in cash, common
stock or a five-year note (payable in either cash or common stock).
NOTE 8. Income Taxes
As discussed in the previous note, the Company entered into agreements
subsequent to the balance sheet date that will result in increased research and
development expenses for the next five or six quarters. With these increased
expenses, the Company expects to incur a net loss for the current fiscal year.
As a result of this subsequent event and the expected losses that will
arise therefrom, the Company established a full valuation allowance against its
deferred tax assets that exist at September 29, 2000. Management believes that
due to the net loss expected for the current fiscal year and the existing net
loss carryforwards from prior years, it is more likely than not that the
Company's $7,585,000 of deferred tax assets will not be realized.
The valuation allowance established at September 29, 2000 included
$1,155,000 related to the deferred tax assets of an acquired business for which
uncertainty now exists surrounding the realization of such assets. This amount
was recorded as an increase in costs in excess of net assets of the acquired
company (goodwill). The valuation allowance will be used to reduce goodwill in
the future when any portion of the related deferred tax assets is recognized.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information in this Item 2 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contains forward-looking
statements, including, without limitation, statements relating to the Company's
revenues, expenses, margins, liquidity and capital needs. Such forward-looking
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from those anticipated in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed elsewhere herein under the caption
"Factors Affecting Future Results."
RESULTS OF OPERATIONS
The following table presents the percentages of total sales represented by
certain line items from the Condensed Consolidated Statements of Operations for
the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
------------------------
September 29, October 1,
2000 1999
------ ------
<S> <C> <C>
Sales ............................................ 100.0 % 100.0 %
Cost of sales .................................... 45.5 58.6
------ ------
Gross margin ................................ 54.5 41.4
------ ------
Operating expenses:
Research and development .................... 17.8 21.3
Selling, general and administrative ......... 43.8 37.7
Restructuring and other non-recurring charges -- 46.4
------ ------
Total operating expenses ................ 61.6 105.4
------ ------
Loss from operations ............................. (7.1) (64.0)
Interest and other income, net ................... 2.6 1.1
------ ------
Loss before provision for income taxes ........... (4.5) (62.9)
Provision for income taxes ....................... 53.3 --
------ ------
Net loss ......................................... (57.8)% (62.9)%
====== ======
</TABLE>
Sales. Net sales for the three months ended September 29, 2000 decreased
approximately 20% to $11.8 million from $14.9 million in the comparable period
of the prior fiscal year. This decrease is primarily a result of a decline in
demand from the Company's enterprise access product customers, and to a lesser
extent, the carrier and carrier access customers. In particular, net sales to
the Company's enterprise access product customers in the first quarter of fiscal
2001 declined by approximately 33% to $4.3 million as compared to the same
period last year. Net sales to the Company's top five customers increased
approximately 15% to $8.3 million from $7.7 million in the first quarter of the
prior year, while net sales to all other customers declined by 58% during this
period due in part to the impact of the reorganization of the sales force from a
geographical focus to a market focus and the implementation of a two-tier
distribution channel. See "Factors Affecting Future Results -- Reorganization of
Sales Force." However, it should be noted that the top five customers did not
remain the same over the period.
Gross Margin. Gross margin increased to 54.5% of net sales for the three
months ended September 29, 2000 as compared to 41.4% for the three months ended
October 1, 1999. This increase is attributable to a number of factors, including
the product sales mix, the under-utilization of the San Jose manufacturing
facility and the high level of non-warranty repairs that carried a lower than
average gross margin in the first quarter of last year, and the benefit of the
outsourcing strategy implemented as part of the Company's restructuring plan
implemented during fiscal 2000. Under this strategy, the Company outsources
approximately two-thirds of product manufacturing in order to reduce the
negative impact of fixed manufacturing overhead costs in periods in which sales
volume declines.
Research and Development. Research and development expenditures for the
three months ended September 29, 2000 decreased approximately 33% to $2.1
million from $3.2 million in the comparable period of the prior fiscal
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year and decreased as a percentage of sales from 21.3% to 17.8%. The decrease in
absolute dollars and as a percentage of net sales is due to the decrease in
personnel, employment-related costs, and related support costs from the
completion of the Company's restructuring and consolidation in Huntsville,
Alabama. The Company continues to add resources in Huntsville to increase
research and development activities. In October 2000, the Company announced its
agreements with Beacon Telco and the Boston University Photonics Center that
will significantly increase research and development spending during the next
five to six quarters. See "Optical Networking Project and Related Warrants" and
"Factors Affecting Future Results - Optical Networking Product Development." The
Company believes that a significant level of investment in product development
is required to remain competitive and that such expenses will vary over time as
a percentage of net sales.
Selling, General and Administrative. Selling, general and administrative
expenses for the three months ended September 29, 2000 decreased 8% to $5.2
million from $5.6 million in the comparable period of the prior fiscal year and
increased as a percentage of sales from 37.7% to 43.8%. The decrease in absolute
dollars over the same period in the prior year is primarily due to the
completion of the restructuring and consolidation plan during fiscal 2000 while
the increase as a percentage of sales is due to lower sales levels. The Company
expects the dollar amount of selling, general and administrative expenses will
increase in the future and that such expenses will vary over time as a
percentage of sales.
Restructuring and Other Non-recurring Charges. During the first quarter of
fiscal 2000, the Company announced and began implementing its plans to
consolidate its operations into its existing operations located in Huntsville,
Alabama, and to outsource its San Jose based manufacturing activities. The
Company incurred a pretax charge of $6.9 million for restructuring and other
related non-recurring activities. See Note 3 in the Notes to Condensed
Consolidated Financial Statements for further details of the restructuring and
other non-recurring charges.
Interest and Other Income, Net. Net interest and other income was
approximately $310,000 for the three month period ended September 29, 2000 as
compared to $171,000 in the comparable period of the prior fiscal year. The
increase was a result of higher cash and cash equivalents, restricted cash and
short-term investments balances and higher market interest rates.
Provision for Income Taxes. As noted in the Notes to the Condensed
Consolidated Financial Statements, the Company recorded a full valuation
allowance established against its deferred tax assets as of September 29, 2000.
As a result, a net provision for income taxes of $6,311,000 was recorded in the
first quarter of fiscal 2001. The Company did not record a tax benefit or
provision for income taxes in the quarter ended October 1, 1999.
OPTICAL NETWORKING PROJECT AND RELATED WARRANTS
In October 2000, the Company announced agreements with Beacon Telco, L.P.
("Beacon Telco") and the Boston University Photonics Center to establish a
product development center at the Photonics Center to develop new optical
networking products. The goal of the project is to accelerate the development of
optics-based products to expand the Company's current product offerings and
market positioning, and to build in-house R&D expertise in optics technology to
support potential future development of a broad variety of optics-based
products. The arrangement provides the Company with access to the Photonics
Center's state-of-the-art optics laboratories and specialized technical
expertise, which, together with the Company's own engineering and strategic
marketing resources, may accelerate the development of new optics-based
products.
As part of the agreements, the Company issued Beacon Telco warrants to
purchase up to 2,249,900 shares of the Company's common stock (representing
approximately 15% of the current outstanding common stock of the Company) at an
exercise price of $4.75 per share, subject to customary anti-dilution
adjustments. The warrants become exercisable over time, subject to acceleration
based upon meeting development milestones and certain other events, including
the market price of the Company's common stock, and will expire on October 13,
2003. The Company has agreed to appoint one designee of Beacon Telco to the
Board of Directors of the Company. Until the earlier of October 13, 2005 or the
date that Beacon Telco beneficially owns less than 10% of Company's common
stock, including the common stock issuable upon exercise of its warrants, the
Company has agreed to recommend
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that stockholders elect the designee of Beacon Telco at each meeting of
stockholders at which the Beacon Designee is up for election, and Beacon Telco
has agreed to vote shares of Common Stock issued upon exercise of its warrants
in accordance with the recommendation of the Board of Directors of the Company.
In addition, Beacon Telco has agreed to certain "standstill" provisions and the
Company has agreed to register Beacon Telco's resale of the common stock
issuable upon exercise of the warrants under the Securities Act of 1933.
The Company expects to record a charge to research and development expenses
in the second quarter of fiscal 2001 of approximately $11 million for the
warrants and other expenses related to the initial agreements. The Company also
expects that research and development expenses will significantly increase
during calendar 2001 to support on-going optical networking product development.
The Company is obligated to pay Beacon Telco a bonus payment of $3,562,500
on October 13, 2001 or upon termination of the agreements if earlier. Beacon
Telco is also eligible to receive additional bonus payments based in part on
meeting certain milestones and the market price of the Company's common stock.
These bonus payments may be paid at the option of the Company in cash, common
stock or a five-year note (payable in either cash or common stock).
The foregoing description is qualified by reference to the definitive
documents, which are filed as exhibits hereto.
LIQUIDITY AND CAPITAL RESOURCES
On September 29, 2000, the Company's principal sources of liquidity included
$12.0 million of cash and cash equivalents, restricted cash, and short-term
investments.
During the three-month period ended September 29, 2000, the cash flow
provided by operating activities was approximately $1.1 million compared to $4.7
million used in operating activities during the three-month period ended October
1, 1999. Net cash provided by operating activities this quarter was primarily
due to the decrease in accounts receivable of $4.5 million offset by the
increase in inventories of $2.4 million. This increase in inventories was due to
a build-up of finished goods in anticipation of higher sales orders at the end
of the quarter that were not received as expected.
Cash provided by investing activities was approximately $1.4 million for the
three-month period ended September 29, 2000, as compared to approximately $3.3
million for the three-month period ended October 1, 1999. The funds provided by
investing activities are primarily a result of the maturity of short-term
investments being reinvested in cash and cash equivalents. Offsetting the
increase in funds provided by investing activities in the first quarter of
fiscal 2001 were purchases of property, plant and equipment of $732,000 that
included the costs associated with the Oracle implementation project completed
in July and the renovation of the new headquarters facility acquired by the
Company on June 30, 2000. The renovation to the facility is expected to total
approximately $3.2 million and is expected to be completed by January 2001.
Cash provided by financing activities was $153,000 for the three-month
period ended September 29, 2000, as compared to $325,000 for the three-month
period ended October 1, 1999. Proceeds from the exercise of stock options were
the primary source of cash from financing activities. In connection with the
acquisition of the new headquarters facility, the Company entered into a loan
agreement to borrow up to $6 million to finance the purchase price of the
property and make improvements thereon. The Company expects to use the remaining
$1.9 million available under the mortgage loan in the second and third fiscal
quarters of 2001 to fund the renovation to the facility described above.
The Company believes that its cash and investment balances, along with
anticipated cash flows from operations and the remaining funds available under
the multi-year mortgage will be adequate to finance current operations,
anticipated investments, research and development expenses, and capital
expenditures for at least the next twelve months. The Company continues to
investigate the possibility of generating financial resources through committed
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credit agreements, technology or manufacturing partnerships, equipment
financing, and offerings of debt and equity securities.
YEAR 2000 READINESS
The Company's products, computing, and communications infrastructure systems
have operated without year 2000 ("Y2K") related problems to date. The Company is
not aware that any of its major customers or third-party suppliers have
experienced significant Y2K related problems that would have a material impact
on the Company. The total cost to address Y2K was not material to the Company's
financial condition.
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; total budgeted capital
expenditures; expected research and development expenses; results and
anticipated benefits of the optical networking project; 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. 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.
Customer Concentration. A small number of customers continue to account for
a majority of the Company's sales. In fiscal 2000, net sales to Nortel,
WorldCom, and Ericsson accounted for 30%, 19%, and 3% of the Company's net
sales, respectively, and the Company's top five customers accounted for 61% of
the Company's net sales. In fiscal 1999, net sales to Nortel, WorldCom, and
Ericsson accounted for 17%, 27%, and 5% of the Company's net sales,
respectively, and net sales to the Company's top five customers accounted for
57% of the Company's net sales. Percentages of total revenue have been restated
for prior periods as if Ericsson's May 1999 acquisition of Qualcomm's
terrestrial Code Division Multiple Access (CDMA) wireless infrastructure
business had been in effect for all periods presented. Other than Nortel,
WorldCom, and Ericsson, no customer accounted for more than 10% of the Company's
net sales in fiscal years 2000, 1999, or 1998. 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 net sales to such customers is
uncertain, but there can be no assurance that such acquisitions will not result
in a reduction in net 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 net 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 that future merger and acquisition activity among the
Company's customers will not have a similar adverse affect on the Company's net
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
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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 Outside Contractors. In September 1999, the Company entered
into an agreement with a single outside contractor to outsource substantially
all of the manufacturing operations previously located in San Jose, including
its procurement, assembly, and system integration operations. The products
manufactured by the outside contractor located in California generated a
majority of the Company's revenues. There can be no assurance that this
contractor will continue to meet the Company's future requirements for
manufactured products, or that the contractor will not experience quality
problems in manufacturing the Company's products. The inability of the Company's
contractor 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 outside contractors could cause a delay in
the Company's ability to fulfill orders while the Company identifies a
replacement contractor. Because the establishment of new manufacturing
relationships involves numerous uncertainties, including those relating to
payment terms, cost of manufacturing, adequacy of manufacturing capacity,
quality control and timeliness of delivery, the Company is unable to predict
whether such relationships would be on terms that the Company regards as
satisfactory. Any significant disruption in the Company's relationships with its
manufacturing sources would 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 officers' continued
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. Several members of the senior management team
recently joined the Company and have had only a limited time to work together.
The loss of the services of one or more of the Company's executive officers or
key personnel, the inability of the management team to work effectively
together, 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.
Management of Growth. 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 may be limited and competition among
companies for such personnel is intense. The Company is currently attempting to
hire a number of engineering personnel and has experienced some delays in
filling such positions. 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. The Company
generally relies 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 and third party sub-contractors
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's 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-
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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."
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 Nortel, WorldCom, and
Ericsson have varied between quarters by as much as $4.0 million, and orders
delayed by these customers had a significant negative impact on the Company's
first quarter results of fiscal 2001 as well as the third and fourth quarter
results in fiscal 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 sales in prior periods have been adversely impacted by merger
activities by 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
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<PAGE> 15
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 a variety of factors,
particularly:
- 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;
- changes in the level of research and development 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 and 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 could 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. For example, during the fourth quarter of fiscal 1999, the Company
was notified by one of its major customers of an intermittent problem involving
one of the Company's products installed in the field. Although the Company
identified a firmware fix for this problem and negotiated an agreement with the
customer to share in the expense associated with the upgrade, this or similar
problems in the future could increase expenses or reduce product acceptance.
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
in the past and may continue to do so.
Dependence on Recently Introduced Products and New Product Development. The
Company's future results of operations are highly dependent on market acceptance
of existing and future applications for both the Company's AS2000 product line,
and the WANsuite(TM) family of integrated access devices introduced during the
third quarter of fiscal 2000. The AS2000 product line represented approximately
58% of net sales in fiscal 2000, 67% of net sales in fiscal 1999 and 86% of net
sales in fiscal 1998. Sales of WANsuite(TM) products began during the last
quarter
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<PAGE> 16
of fiscal 2000. 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. The market for the Company's products are
characterized by rapidly changing technology, evolving industry standards,
continuing improvements in telecommunication service offerings, and changing
demands of the Company's customer base. 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, and 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. See "Optical Networking Product Development."
Optical Networking Product Development. The Company's future results and
operations are highly dependent on the success of the Company's optical product
development project, the Company's cooperative research agreement with Beacon
(the "Cooperative Research Agreement"), and its related Premises Access and
Services Agreement with the Boston University Photonics Center (the "Facility
Access Agreement"). The Cooperative Research Agreement and the Facility Access
Agreement are hereinafter collectively referred to as the "Research Agreements".
The Company has committed to pay the expenses related to the Research
Agreements and therefore anticipates significant increases in research and
development expenses in addition to increases in the ongoing development and
marketing costs necessary to bring a potential optical networking product to
market. Either of these expenses may exceed the budget that the Company has
established and could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company has also agreed both
to license from Beacon Telco and/or the Boston University Photonics Center or
their affiliates, for additional license fees yet to be determined any
background intellectual property necessary to commercialize the optical
networking product and to certain limitations on the Company's ownership and use
of intellectual property generated in the course of the performance of the
Research Agreements. The parties may be unable to agree on the proper fees to be
charged for such license of background intellectual property necessary to
commercialize the optical networking product, or, if agreed, the costs of
licensing background or other intellectual property could be substantial and may
limit the ability of the Company to develop and market the optical networking
product on a profitable basis.
The success of the project may depend on the ability of the Company to
effectively utilize certain resources of the Photonics Center, which are to be
provided on an as-available basis at the discretion of the Trustees of Boston
University. If critical resources are not made available to the Company on a
timely basis, the project may be unsuccessful or may require significantly
higher costs than expected.
The Company's ongoing effort to develop and market an optical networking
product will require high levels of innovation and may not be successful. Even
if the Company does succeed in developing an optical networking product, it may
have difficulty marketing and selling the product. Moreover, there can be no
assurance that any product developed by the Company will gain and hold market
acceptance in the rapidly growing optical networking market which is
characterized by rapid innovation, numerous competing products and technologies,
as well as strong competition. Failure of the Company to develop an optical
networking product or to gain market acceptance for such a product would have a
material adverse effect on the Company's business, financial condition and
results of operations. Furthermore, the development of an optical networking
product may take longer or be less successful than anticipated, which, in either
event, could have a material adverse effect on the Company's business, financial
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<PAGE> 17
condition and results of operations. See "Rapid Technological Change,"
"Dependence on Recently Introduced Products and New Product Development" and
"Risks Associated with Potential Acquisitions and Joint Ventures."
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 and WANSuite(TM), and for enterprise devices such
as the PRISM, FrameStart(TM), and Lite product lines 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 AS2000 and
4000 products has been from Quick Eagle Networks (formerly Digital Link
Corporation), ADC Kentrox, a division of ADC Telecommunications, and Larscom,
Inc., a subsidiary of Axel Johnson. In addition, the Company experiences
substantial competition with its enterprise access and network termination
products from companies in the computer networking market and other related
markets. These competitors include Premisys Communications, Inc. (now a part of
Zhone Technologies), Newbridge Networks Corporation, Visual Networks, Adtran,
Inc., and Paradyne 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, but that the market for feature-enhanced network termination and
network access products continues to grow and expand, as more "capability" and
"intelligence" moves outward from the central office to the enterprise. The
Company believes that the principal competitive factors in this market are
price, feature sets, installed base, and quality of customer support. In this
market, the Company primarily competes with Adtran, Quick Eagle Networks, ADC
Kentrox, Paradyne, Visual Networks, 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, such as Cisco and Nortel Networks, into other equipment such as
routers and switches. These include direct WAN interfaces in certain products,
which may erode 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".
Reorganization of Sales Force. In July 2000, the Company restructured its
sales force from a sales force organized by geographical region to one focused
on sales to particular markets and through particular distribution channels.
This reorganization appeared to be disruptive in the first quarter of fiscal
2001 and may continue to be disruptive to the Company's sales in future quarters
and involves numerous uncertainties, including, but not limited to, the
increased costs to retrain the sales force in the methods and techniques needed
to effectively approach the different markets and distribution channels
available for the Company's products, the ability to retain current members of
the sales force, the effectiveness of the sales force in closing sales, and the
re-allocation of relationships that the sales force may have previously
developed with customers in the geographic regions. As a result, the Company
expects that the reorganization may continue to have a short-term negative
impact on the Company's sales and results of operations. The transition to a
market and distribution channel based sales force may take longer or be less
successful than anticipated, which, in either event, could have a material
adverse effect on the Company's business, financial condition, and results of
operations.
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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
Company may need to supplement its internal expertise and resources with
specialized expertise or intellectual property from third parties to develop new
products. 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
Digital Subscriber Lines (DSL), Integrated Services Digital Networks (ISDN),
Frame Relay, Asynchronous Transfer Mode (ATM), and Internet Protocols (IP).
Furthermore, the communications industry is characterized by the need to design
products that 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 New Product Development" and "Optical
Networking Product 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 Digital Subscriber Lines (DSL)
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 Potential Acquisitions and Joint Ventures. An
important element of the Company's strategy is to review acquisition prospects
and joint venture opportunities that would compliment its existing product
offerings, augment its market coverage, enhance its technological capabilities
or offer growth opportunities. Transactions of this nature 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. Joint ventures entail risks such as potential conflicts of
interest and disputes among the participants, difficulties in
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integrating technologies and personnel, and risks of entering new markets. The
Company's management has limited prior experience in assimilating such
transactions. 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 or to successfully develop any products or
technologies that might be contemplated by any future joint venture or similar
arrangement, and the failure of the Company to do so could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Optical Networking Product Development."
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 may receive 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 could 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 a court having jurisdiction over a dispute
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involving such patents would hold the Company's patents valid and enforceable.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
At September 29, 2000, the Company's investment portfolio consisted of fixed
income securities of $2.2 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 September 29, 2000, 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.
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PART II. OTHER INFORMATION
ITEM 2: CHANGES IN SECURITIES
On October 13, 2000, and in consideration of the execution of the agreements
described under "Optical Networking Project and Related Warrants" above, the
Company issued Beacon Telco warrants to purchase 2,249,900 shares of the
Company's common stock at an exercise price of $4.75 per share. The warrants
were issued in reliance on the exemption from registration provided by Section
4(2) of the Securities Act of 1933, as amended, for transactions by an issuer
not involving a public offering.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Index:
Exhibit Number Description of Exhibit
-------------- ----------------------
10.51 Second Amendment to the Verilink Corporation 1993 Amended and
Restated Stock Option Plan
10.52 Second Amendment to the Verilink Corporation 1996 Employee
Stock Purchase Plan
10.53 Cooperative Research Agreement between the Registrant and
Beacon Telco, L.P. dated October 13, 2000
10.54 Warrant and Stockholder's Agreement between the Registrant and
Beacon Telco, L.P. dated October 13, 2000
10.55 Premises License and Services Agreement between the
Registrant, Beacon Telco, L.P., and Trustees of Boston
University dated October 16, 2000
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter ended September
29, 2000.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERILINK CORPORATION
November 13, 2000 By: /s/ Ronald G. Sibold
----------------------------------------
Ronald G. Sibold,
Vice President and Chief Financial
Officer (Duly Authorized Officer and
Principal Financial Officer)
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