$1,084,000, partially offset by $239,000 of rent collected from the Sub-tenant of the facility assumed in Durham, North Carolina in connection with the Larscom acquisition. Restructuring charges were reduced in fiscal 2005 by $570,000 for the reduction in the restructuring accruals assumed in the Larscom acquisition for severance and related costs due to changes in the employment status of certain employees, and adjustments to the real estate restructuring accrual based on our review of the estimated remaining obligations.
In fiscal 2004, we began consolidation of certain manufacturing and administrative activities in Aurora, Colorado with our operations in Madison, Alabama. We recorded restructuring charges in fiscal 2004 of $390,000 in connection with these restructuring activities, which includes severance and other termination benefits. This restructuring resulted in a reduction in workforce of approximately 17 employees, or 10% of our total workforce. No payments or charges to the restructuring reserve were made during fiscal 2004. These consolidation activities were completed during the first quarter of fiscal 2005.
The in-process research and development expense of $316,000 for fiscal 2003 was a non-recurring charge for the acquisition costs of the 8000 series IAD product line attributable to in-process technologies.
Interest and other income, net, increased to $1,164,000 in fiscal 2005 from $927,000 in fiscal 2004 due to (i) the change in fair value of warrants issued in connection with the senior convertible notes of $543,000, (ii) offset by lower interest income on lower average investment balances during the period and (iii) a decrease of $121,000 in the income recognized on the forgiveness of the convertible promissory notes associated with the XEL acquisition. Rental income, net of expenses, was $551,000 and $542,000 in fiscal 2005 and 2004, respectively.
Interest and other income, net, increased to $927,000 in fiscal 2004 from $656,000 in fiscal 2003 due to net rental income related to property held for lease, earnest money forfeited by the potential buyer of the property held for lease in the amount of $75,000 and income of $229,000 from the forgiveness of a portion of convertible notes associated with the XEL acquisition, offset by lower interest income on lower average investment balances during the year and lower interest rates.
Interest expense increased to $1,133,000 in fiscal 2005 from $253,000 in fiscal 2004 as a result of (i) total interest charges related to the $10,000,000 in senior convertible notes issued on March 21, 2005 (ii) interest on the convertible notes issued in connection with the acquisition of XEL in February 2004, and (iii) interest paid on borrowings under the RBC line of credit from April 2004 through March 2005, which was repaid and terminated on March 21, 2005. Interest expense increased to $253,000 in fiscal 2004 from $181,000 in fiscal 2003 as a result of convertible notes issued in connection with the XEL acquisition and borrowings under our line of credit.
No tax provision or tax benefit was provided in fiscal 2005 due to the valuation allowance provided against the net change in deferred tax assets. We established a full valuation allowance in prior years against our deferred tax assets due to net operating losses. We have net operating loss carry forwards of approximately $74,071,000 as of July 1, 2005.
As of June 29, 2002, we adopted SFAS No. 142, ceased amortizing goodwill and completed our transitional impairment test of goodwill. As a result, we determined that our goodwill was impaired and recorded a charge of $1,233,000 in fiscal 2003. This charge is presented in the consolidated statement of operations as a cumulative effect of change in accounting principle, relating to goodwill.
Net Income (Loss)
Net loss for fiscal 2005 was $37,452,000 compared to net loss of $26,000 for fiscal 2004 as a result of the above factors, primarily due to impairment charges related to goodwill and intangible assets, the increase in operating expenses and the decline in gross profits. Net loss was (70.3)% of sales for fiscal 2005 and net loss for fiscal 2004 was an insignificant percentage of sales. Net loss of $26,000 for fiscal 2004 compares to net income for fiscal 2003 of $1,520,000, as a result of the above factors. Net income for fiscal 2003 was 5.4% of net sales.
Liquidity and Capital Resources
Our principal source of liquidity at July 1, 2005 included $3,504,000 of unrestricted cash and cash equivalents.
During fiscal 2005, we used $9,301,000 of net cash from operating activities, compared to net cash generated from operating activities in fiscal 2004 of $843,000 and net cash generated in operating activities in fiscal 2003 of $4,017,000. Accounts receivable, excluding accounts receivable acquired in the Larscom acquisition, decreased $459,000 to $10,068,000 at July 1, 2005. Accounts receivable, excluding accounts receivable acquired in the XEL acquisition, increased $2,083,000 to $7,881,000 at July 2, 2004, from the prior year balance due to additional sales revenue and the timing of shipments during the fourth quarter. Inventories, excluding the impact of inventory acquired in the Larscom acquisition, decreased $3,970,000 and totaled $5,256,000 at July 1, 2005 as a result of improved inventory management and inventory reserves provided during the year totaling $2,239,000. Inventories, excluding the impact of inventory acquired in the XEL acquisition, decreased $117,000 and totaled $6,010,000 at July 2, 2004. The change in accounts payable, accrued expenses and other non current liabilities used total cash of $9,018,000 in fiscal 2005 due to amounts paid for restructuring activities and the timing of payments to vendors, offset by an increase in accruals related to the increase in sales volume. The change in accounts payable and accrued expenses provided total cash of $731,000 in fiscal 2004 due to the timing of payments to vendors and increase in accruals related to the increase in sales volume.
Net cash generated in investing activities of $2,989,000 in fiscal 2005 compares to net cash used in investing activities of $8,266,000 and $1,045,000 in fiscal 2004 and 2003, respectively. The cash generated in fiscal 2005 was due to cash acquired at closing in connection with the Larscom acquisition of $4,273,000, offset by payments totaling $909,000 related to product line acquisitions and capital expenditures of $375,000. The cash used in fiscal 2004 was due to cash paid at closing in connection with the XEL acquisition of $7,612,000, payments totaling $1,395,000 related to product line acquisitions and capital expenditures of $600,000, reduced by the release of restricted cash of $1,000,000, the sale of short term investments of $101,000 and proceeds from the repayment of notes receivable of $240,000. The cash used in fiscal 2003 was due to payments totaling $1,200,000 related to a product line acquisition and capital expenditures of $602,000, reduced by the sale of short term investments of $497,000 and proceeds from the repayment of notes receivable of $260,000.
Net cash provided by financing activities was $6,381,000 in fiscal 2005 compared to net cash provided by financing activities of $2,375,000 in fiscal 2004 and cash used in financing activities on $94,000 in fiscal 2003. Repayments against bank borrowings and long-term debt of $3,980,000 and repurchase of common stock of $245,000 accounted for the primary use of funds in fiscal 2005, offset by the net proceeds from bank borrowings and long term debt of $10,378,000 and proceeds from the exercise of stock options of $228,000. Payments against bank borrowings and long-term debt of $731,000 accounted for the primary use of funds in fiscal 2004, offset by the proceeds from bank borrowings and long term debt under the bank line of credit of $2,046,000 and proceeds from the exercise of stock options of $1,060,000. Payments against bank borrowings and long-term debt of $724,000 and the purchase of common stock of $49,000 accounted for the primary use of funds in fiscal 2003, offset by the proceeds from the cash repayment of notes receivables from stockholder of $675,000.
Senior Convertible Notes
In March 2005, we entered into a securities purchase agreement for the private placement of up to $15,000,000 of senior convertible notes to six institutional investors. We issued an initial $10,000,000 of senior convertible notes, which can be converted into common stock at an initial price of $3.01 per share. The conversion price of the senior convertible notes will be subject to weighted average anti-dilution adjustments. The senior convertible notes may not be converted into more than 20% of the number of shares or voting power of our common stock outstanding as of the closing of the
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financing until such conversion or exercise has been approved by our stockholders. As of July 1, 2005, a total of $10,000,000 in face value of senior convertible notes was outstanding. These senior convertible notes are recorded in the consolidated balance sheet at July 1, 2005, at the discounted amount of $7,576,000. As provided in the securities purchase agreement, we used $3,500,000 of the proceeds from these senior convertible notes to repay and terminate the line of credit with RBC Centura Bank (“RBC”).
The senior convertible notes bear interest at a rate of six percent per annum and are repayable in ten quarterly installments beginning in July 2005, or earlier upon the occurrence of certain events. On July 11, 2005, we made the first quarterly installment of $1,000,000, which we elected to pay in cash. Payment of both principal and interest may be made in either cash or, provided that we have obtained stockholder approval to the extent necessary, by the delivery of shares of common stock at a price equal to the lower of (i) the conversion price of $3.01 or (ii) 90% of the weighted average sale price of our common stock for the fifteen consecutive trading days ending on the fourth trading day immediately preceding the applicable interest or installment payment date. Such issuance of common stock will not result in anti-dilution adjustments to the conversion price of the senior convertible notes. If by November 21, 2005, we have not obtained stockholder approval of the issuance of the senior convertible notes, the warrants and the shares of common stock to be issued thereunder and an increase in our authorized capital of at least 10,000,000 shares of common stock, we will be required to make at least 50% of interest and installment payments made after such date in cash. If, as of the end of each fiscal quarter during the period in which the senior convertible notes are outstanding, we fail to maintain certain minimum working capital requirements, the holders of the senior convertible notes may require us to make an additional installment payment under the senior convertible notes which shall be, at the option of each holder, such holder’s pro rata portion of one of the following: (1) the difference between (A) the unpaid principal, interest and any late charges then remaining under the senior convertible notes and (B) 60% of our working capital amount, as determined in accordance with the terms of the senior convertible notes, (2) $2,000,000 or (3) such lesser amount if reduced in accordance with the terms of the senior convertible notes. Substantially all of our assets are pledged as collateral for amounts outstanding under the senior convertible notes.
At July 1, 2005, “tested working capital”, as defined in the senior convertible notes, was $8,882,000. If we fail to maintain tested working capital of at least $8,000,000 at the end of each fiscal quarter in which amounts are outstanding under the senior convertible notes, the holders of the senior convertible notes may require us to make an additional special installment payment under these notes as described above.
Convertible Promissory Notes
In February 2004, we issued two convertible promissory notes totaling $10,480,000 in connection with our acquisition of XEL Communications, Inc. In May 2004, the holder of the $10,000,000 convertible promissory note converted $7,250,000 of the outstanding principal amount of the note into 1,361,758 shares of our common stock. These convertible promissory notes earn interest at a rate of 7% per annum and mature February 5, 2006. The holders may convert the note in whole or in increments of at least $1,000,000 into our common stock at a conversion price of $5.324 per share. As of July 1, 2005, the amount outstanding under the convertible promissory notes totaled $2,880,000.
Prior Line of Credit
As noted above, the line of credit with RBC was repaid and the loan and security agreement terminated on March 21, 2005 in connection with the issuance of the senior convertible notes. The interest on outstanding borrowings under this line was at a rate of 250 basis points over the 30-day London inter-bank offered rate.
Note Payable on Real Estate
The final balloon payment of approximately $3,039,000 is due on February 1, 2006 on a note secured by our facility leased to The Boeing Company (“Boeing”) located at 950 Explorer Boulevard in Huntsville, Alabama. We are working to amend the lease with Boeing to extend the lease term, among other things. We continue to seek a buyer for this facility and believe an extended lease term will increase the number of potential buyers and improve its salability. We may not, however, be able to finalize the lease amendment or complete a sale of the property on a timely basis on favorable terms to us, or at all.
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Liquidity Generally
In connection with our acquisition of the Miniplex product line, we purchased the seller’s Miniplex related inventories totaling approximately $2,100,000 on the earlier of the date used by us or December 31, 2004. The remaining purchase commitment of $586,000 is included in inventories and accounts payable on the consolidated balance sheet as of July 1, 2005.
As shown in our consolidated financial statements, we have incurred losses from operations over the last two fiscal years, and as of July 1, 2005, our current liabilities exceeded our current assets by $887,000. These factors raise substantial doubt about our ability to continue as a going concern. Management has instituted a cost reduction program that included a decrease in headcount and curtailment of other discretionary non-payroll costs. In addition, we have increased sales prices on certain products, obtained more favorable material costs for certain material components, and redesigned certain product lines to reduce manufacturing costs. We are also working to amend the lease terms of the facility at 950 Explorer Boulevard in Huntsville, Alabama in order to improve the salability of this facility; and to rationalize product lines, which could result in the potential sale and/or acquisition of product line(s). Management believes these factors will contribute toward achieving positive cash flow from operations.
On a quarterly basis, management will continue to evaluate revenue outlook and plans to adjust spending levels as necessary. We believe that our cash and cash equivalents, anticipated cash flow from operations and anticipated proceeds from the sale of the facility located at 950 Explorer Boulevard, Huntsville, Alabama will be sufficient to fund our operations through the next twelve months, although no such assurance can be given. However, if the facility is not sold or is sold for substantially less than the appraised value, we will need other sources of credit or financing in early calendar 2006 to repay amounts due in February 2006 under the convertible promissory notes and note payable on real estate and to provide working capital. If additional credit or other financing is not available as needed or on terms acceptable to us, we may seek to renegotiate certain of our contractual obligations.
The following table sets forth the annual payments we are required to make under contractual cash obligations and other commercial commitments for notes payable to bank, long-term debt, capital lease obligations, convertible notes, operating leases and for purchases of inventory and services, in thousands, at July 1, 2005.
| | Payment due by period | |
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Contractual Obligations | | Total | | Less than
1 year | | 1-3
Years | | 3-5
Years | | More than
5 Years | |
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Long-term debt: | | | | | | | | | | | | | | | | |
Senior convertible notes (1) | | $ | 7,576 | | $ | 2,470 | | $ | 5,106 | | $ | — | | $ | — | |
Convertible promissory notes (2) | | | 2,880 | | | 2,880 | | | — | | | — | | | — | |
Note payable on real estate | | | 3,319 | | | 3,319 | | | — | | | — | | | — | |
Capital lease obligations | | | 149 | | | 58 | | | 83 | | | 8 | | | — | |
Operating leases | | | 2,639 | | | 1,062 | | | 1,484 | | | 93 | | | — | |
Purchase commitments | | | 3,405 | | | 3,405 | | | — | | | — | | | — | |
Other long-term liabilities | | | 567 | | | 14 | | | 540 | | | 13 | | | — | |
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Total | | $ | 20,535 | | $ | 13,208 | | $ | 7,213 | | $ | 114 | | $ | — | |
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(1) Amounts shown net of discount, which totals $2,424,000 as of July 1, 2005. Gross payments due in less than one year and 1 – 3 years are $4,000,000 and $6,000,000, respectively. As noted in the narrative above, senior convertible notes can be converted by the holder into common stock at an initial price of $3.01 per share. We can elect to satisfy our payment obligations under the senior convertible notes through the issuance of common stock, instead of cash, subject to certain conditions described in the narrative above. |
(2) The holders may convert the note in whole or in increments of at least $1,000,000 into common stock of the Company at a conversion price of $5.324 per share. If the holders convert any portion of the promissory note, the holders must repay all interest received by them on the portion of the note converted before the Company will issue the common stock. These notes may be converted into common stock prior to the due date on February 5, 2006. |
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Acquisition
Larscom Incorporated.On July 28, 2004, we completed our acquisition of Larscom and issued approximately 5,948,652 shares of our common stock for all the outstanding stock of Larscom. Additionally, we assumed all outstanding stock options and warrants of Larscom. Larscom manufactures and markets high-speed network-access products for telecommunication service providers and corporate enterprise users. This acquisition reflects our strategy to pursue revenue growth, and brings a complementary customer base and product synergies.
The acquisition was recorded under the purchase method of accounting, and the purchase price was allocated based on the fair value of the assets acquired and liabilities assumed. The goodwill recorded as a result of the acquisition will not be amortized but will be included in our annual review of goodwill for impairment. A summary of the total purchase consideration is as follows:
Value of common stock issued | | $ | 26,043 | |
Value of options and warrants assumed | | | 516 | |
Direct merger costs | | | 1,300 | |
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Total purchase consideration | | $ | 27,859 | |
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Critical Accounting Policies
Our financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States of America. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Management bases our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods might be based upon amounts that differ from those estimates. The following represent what we believe are among the critical accounting policies most affected by significant management estimates and judgments:
Accounting for Acquisitions: We account for acquisitions as a purchase in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations. As such, we report all acquired tangible and intangible assets and liabilities at fair value. We recognize the fair value of the purchased intangible assets as operating expenses over the estimated useful life of each separate intangible asset. We recognize the fair value associated with any in-process technology as an operating expense in the period an acquisition is consummated. We value any employee stock options assumed as part of the acquisition using the Black-Scholes valuation model. The value of assumed vested options and the value of assumed unvested options in excess of the intrinsic value of such unvested options are included as part of the purchase price consideration. We report the intrinsic value of any unvested options as deferred compensation and record it as an operating expense over the remaining vesting period of the options. We value our stock issued as part of the consideration using the 5-day average price surrounding the date the acquisition was announced.
Impairment of Long-Lived Assets and Goodwill. We assess the impairment of long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable under the guidance prescribed by SFAS No.’s 144 and 142, respectively. Our long-lived assets include, but are not limited to, the property held for lease, furniture and equipment, software licenses, and goodwill and intangible assets related to acquisitions.
We assess the impairment of goodwill at least annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable under the guidance prescribed by SFAS No. 142. Due to circumstances that occurred during the first quarter of fiscal 2005, we completed a test for impairment of goodwill. These circumstances included the loss of product revenues from a significant customer, the low level of liquidity noted in the going concern opinion issued late in the quarter on our fiscal 2004 consolidated financial statements and the low market price of our common stock following the end of the first quarter. Based on this review, we determined that the carrying value of our goodwill was impaired and recorded an impairment charge related to goodwill of $19,984,000. The impairment charge was based on a projected discounted cash flow model using a discount rate commensurate with the risk inherent in our current business model. In connection with our annual review for impairment of goodwill completed as of July 1, 2005, we concluded that the carrying value of our goodwill was further impaired and recorded an additional impairment charge related to goodwill of $4,350,000.
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Prior to the first quarter of fiscal 2005, we utilized a fair value model that compared our carrying value of our equity to our market capitalization calculated by multiplying our outstanding shares by our current share price disregarding anomalies in share price that it deemed were temporary in nature. Due to the changes in facts and circumstances caused by the loss of product revenues from a significant customer, the significant volatility in our share price from the end of our 2004 fiscal year through the filing of our Quarterly Report on Form 10-Q for the first quarter of fiscal 2005, and our low level of liquidity, we evaluated the results of multiple fair value models and all available data points and concluded that the fair value calculated from a projected discounted cash flow model is a better indication of our fair value, as that term is contemplated in SFAS 142, Goodwill and Other Intangibles, than the market capitalization model used historically.
In fiscal 2005, we also recognized $2,150,000 in impairment losses on certain identified intangible assets (trade names and existing technology) acquired primarily in connection with the Larscom and XEL acquisitions. We stopped using the XEL trade name in fiscal 2005, which resulted in the impairment of this asset. Projected sales and margins of some of the acquired products have been lower than expected. As a result, projected future cash flows related to the existing technology intangible assets were determined to be less than the carrying values. The revised carrying values of these intangible assets were calculated using discounted estimated future cash flows. We also determined that the remaining useful life of the customer relations intangible asset acquired in the XEL acquisition should be reduced from thirteen and one-half years to ten years. The residual balance for this intangible asset, $4,603,000, will be amortized over the remaining ten years on a straight-line basis.
Inventories. We value inventory at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis. Inventory quantities on hand are reviewed on a quarterly basis and a provision for excess and obsolete inventory is recorded based primarily on our estimated forecast of product demand for the next twelve months. Management’s estimates of future product demand may prove to be inaccurate, in which case we may increase or decrease the provision required for excess and obsolete inventory in future periods. During fiscal 2005, we increased these inventory reserves and recorded a provision for excess and obsolete inventory of $2,239,000 based on our estimate of future sales. Inventory reserves totaled $8,633,000 and $3,316,000 as of July 1, 2005 and July 2, 2004, respectively.
Revenue Recognition. We recognize a sale when persuasive evidence of an arrangement exists, the product has been delivered or services have been performed, the price to the purchaser is fixed or determinable, and collection of the resulting receivable is reasonably assured. A reserve for future product returns is established at the time of the sale based on historical return rates and return policies, including stock rotation for sales to distributors that stock our products. The reserve for future product returns was $550,000 and $313,000 as of July 1, 2005 and July 2, 2004, respectively.
Warranty Provision. We record a warranty provision at the time of the sale based on our best estimate of the amounts necessary to settle future claims on products sold. During fiscal 2005, we reduced the warranty reserve by $800,000 based on recent actual experience reflecting a lower than expected return rate for products shipped in earlier years. While we believe that our warranty reserve is adequate and that the judgment applied is appropriate, actual product failure rates, material usage or other rework costs could differ from our estimates, which could result in revisions to our warranty liability, which totaled $1,290,000 and $1,192,000 as of July 1, 2005 and July 2, 2004, respectively.
Allowance for Doubtful Accounts. We estimate losses resulting from the inability of our customers to make payments for amounts billed. The collectability of outstanding invoices is continually assessed. Assumptions are made regarding the customer’s ability and intent to pay, and are based on historical trends, general economic conditions and current customer data. We recorded an increase in our allowance for doubtful accounts during fiscal 2005 totaling $382,000 due primarily to the bankruptcy of one of our customers. Should our actual experience with respect to collections further differ from these assessments, there could be additional adjustments to our allowance for doubtful accounts, which totaled $1,200,000 and $536,000 as of July 1, 2005 and July 2, 2004, respectively.
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Deferred Tax Assets. We have provided a full valuation reserve related to our deferred tax assets. In the future, if sufficient evidence of our ability to generate sufficient future taxable income in certain tax jurisdictions becomes apparent, we may be required to reduce our valuation allowances, resulting in income tax benefits in our consolidated statement of operations. Management evaluates the realizability of the deferred tax assets and assesses the need for the valuation allowance each reporting period. The valuation allowance related to our deferred tax assets was $59,803,000 and $16,783,000 as of July 1, 2005 and July 2, 2004, respectively.
Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. SFAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period costs. The provisions of SFAS 151 are effective for our fiscal 2006. We do not expect SFAS 151 to have a material impact on our financial position, results of operations, or cash flows.
In December 2004, the FASB finalized SFAS No. 123R Share-Based Payment, amending SFAS No. 123, effective beginning our first quarter of fiscal 2006. SFAS 123R requires us to expense stock options based on grant date fair value in our financial statements. Further, SFAS 123R requires additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. In March 2005, the U.S. Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin (“SAB”) No. 107, which expresses views of the SEC staff regarding the interaction between SFAS 123R and certain SEC rules and regulations, and provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. We are considering the guidance of this SAB in our adoption of SFAS 123R. The effect of expensing stock options on our results of operations using a Black-Scholes option-pricing model is presented in our consolidated financial statements in Note 1 under Stock Based Compensation. Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. We expect to utilize the prospective method which requires that compensation expense begin being recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R. We are evaluating the requirements of SFAS 123R and expect the adoption of SFAS 123R will have a material impact on our results of operations and earnings (loss) per share. We have not determined the effect of adopting SFAS 123R and we have not determined whether the adoption will result in amounts similar to the current pro-forma disclosures under SFAS 123.
In December 2004, FASB issued FASB Staff Position No. SFAS 109-a, Application of FAS 109 for the Tax Deduction Provided to U.S. Based Manufacturers by the American Job Creation Act of 2004, and FASB Staff Position No. SFAS 109-b, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. The American Jobs Creation Act of 2004 (“Act”) repeals export tax benefits, transitions in a new tax deduction for qualifying U.S. manufacturing activities and provides for the repatriation of earnings from foreign subsidiaries at reduced federal income tax rates. These two staff positions provide accounting and disclosure guidance related to the American Job Creation Act of 1004. The Act will have no effect on our fiscal 2005 tax liability; however, we are evaluating the impact on future years.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions. SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, Accounting for Nonmonetary Transactions, and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for periods beginning after June 15, 2005. We do not expect that adoption of SFAS 153 will have a material effect on our financial position, results of operations, or liquidity.
In March 2005, the FASB issued FASB Interpretation (“FIN”) No. 47, Accounting for Conditional Asset Retirement Obligations, which clarifies the term conditional asset retirement obligation as used in SFAS No. 143, Accounting for Asset Retirement Obligations, as a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the corporation. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005. Adoption is not expected to have a material impact on our financial position, results of operation or cash flows.
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In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which requires the direct effects of voluntary accounting principle changes to be retrospectively applied to prior periods’ financial statements. SFAS 154 does not change the transition provisions of any existing accounting pronouncements, but would apply in the unusual instance that a pronouncement does not include specific transition provisions. SFAS 154 maintains existing guidance with respect to accounting estimate changes and corrections of errors, and is effective for us beginning in fiscal year 2007. Adoption is not expected to have a material impact on our financial position, results of operation or cash flows.
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 Annual Report on Form 10-K 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”, “believe”, “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 in (i) Item 1 regarding the stabilization of the communications services market; stabilization of the telecommunication industry; growth of the Ethernet access market; consolidation of equipment manufacturers and service providers; the incremental investment in both equipment and infrastructure; the introduction of new telecommunications services; the growing popularity and use of the Internet; the need for virtual private networking capabilities; the requirement for better security, encryption, traffic prioritization and network management; the increase in bandwidth and addition of productivity-enhancing applications; the employment of new telecommunications equipment, technology and facilities; the beneficiaries of the trend toward higher bandwidth; the trend toward bundled service offerings; the creation of new revenue opportunities; under served markets increasingly looking to wireless and DSL technology; future growth in the wireless communications industry, particularly in terms of number of subscribers, minutes used, implementation of new systems and the emergence of broadband access; research and development expenditures; estimated increase in the demand for data services and the markets for our products; growth in VoIP and VoDSL; and integration of our manufacturing operations; and (ii) Item 7 regarding the extension of the lease agreement with Boeing and the sale of the facility at 950 Explorer Boulevard in Huntsville, Alabama; amortization of intangible assets; product features under development; selling, general and administrative expenses; research and development expenditures; total budgeted capital expenditures; decline in sales of legacy products; increase in foreign sales; the adequacy of our liquidity and capital resources for the next fiscal year and our ability to continue as a going concern; and the impact of recent accounting pronouncements. These forward-looking statements involve risks and uncertainties, and it is important to note that our 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 1 and Item 7 hereof. All forward-looking statements and risk factors included in this document are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward-looking statement or risk factor. You should consult the risk factors listed from time to time in our Reports on Form 10-Q and our Annual Report to Stockholders.
Our indebtedness and debt service obligations may adversely affect our cash flow.
Should we be unable to satisfy our interest and installment payment obligations under our senior convertible notes by the payment of shares of common stock, we will be required to pay those obligations in cash. If we are unable to generate sufficient cash to meet these obligations, we may have to restructure or severally limit our operations. Our indebtedness could have significant additional negative consequences, including, but not limited to: (i) requiring the dedication of a substantial portion of the our expected cash flow from operations to service the indebtedness, thereby reducing the amount of expected cash flow available for other purposes, including capital expenditures, (ii) increasing our vulnerability to general adverse economic and industry conditions, (iii) limiting our ability to obtain additional financing, (v) limiting our flexibility to plan for, or react to, changes in its business and the industry in which it competes, and (vi) placing us at a possible competitive disadvantage to competitors with less debt obligations and competitors that have better access to capital resources.
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Issuance of shares of common stock upon conversion or repayment of senior convertible notes, payment of interest, and exercise of warrants will dilute the ownership interest of existing stockholders and could adversely affect the market price of our common stock.
We may issue shares of common stock to the holders of our senior convertible notes (i) upon conversion of some or all of the senior secured convertible notes, (ii) in satisfaction of our installment obligations under the notes, in lieu of cash payments, (iii) in satisfaction of our interest obligations under the notes, in lieu of cash payments, and (iv) upon exercise of the warrants. Any of these issuances will dilute the ownership interests of existing stockholders. Any sales in the public market of this common stock could adversely affect prevailing market prices of the common stock. In addition, the existence of these notes and warrants may encourage short selling by market participants.
The senior convertible notes provide that upon the occurrence of various events of default and change of control transactions, the holders would be entitled to require us to redeem the notes for cash, which could leave us with little or no working capital for operations or capital expenditures.
The senior convertible notes allow the holders to require redemption of the notes upon the occurrence of various events of default, such as the termination of trading of our common stock on The Nasdaq National Market, or specified change of control transactions. In such a situation, we may be required to redeem all or part of the notes, including any accrued interest and penalties, within 5 business days after receipt of a demand for such redemption. Some of the events of default include matters over which we may have some, little or no control. If an event of default or a change of control occurs, we may be unable to pay the full redemption price in cash. Even if we were able to pay the redemption price in cash, any such redemption could leave us with little or no working capital for our business. We have not established a sinking fund for payment of our obligations under the notes, nor do we anticipate doing so.
If we cannot obtain the required stockholder approval to issue common stock in satisfaction of our interest and installment obligations under the senior convertible notes, we must satisfy at least 50% of these obligations in cash.
After November 21, 2005, stockholder approval will be required for us to make certain interest and installment payments under the senior convertible notes with shares of common stock. In the event that stockholder approval is not obtained by this date, we will be required to make at least 50% of such interest and installment payments in cash. Any such payments could leave us with insufficient working capital for our business.
The senior convertible notes are secured by substantially all of our assets.
The investors in our private placement received a security interest in and a lien on substantially all of our assets, including our existing and future accounts receivable, cash, general intangibles (including intellectual property) and equipment. As a result of this security interest and lien, if we fail to meet our payment or other obligations under the notes, the investors would be entitled to foreclose on and liquidate substantially all of our assets. Under those circumstances, we may not have sufficient funds to service our day-to-day operational needs. Any foreclosure by the investors in the private placement would have a material adverse effect on our financial condition.
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If tested working capital falls below certain defined levels, we may be required to make additional payments to the holders of the senior convertible notes.
We may be required to make additional payments under the senior convertible notes if, as of the end of each fiscal quarter during the period in which the senior convertible notes are outstanding, we fail to maintain certain minimum working capital requirements. In that event, we must provide notice of the working capital deficiency to the noteholders on the date of our quarterly results announcement. For a period of seven business days after our notice to the noteholders, each holder may provide us a notice requiring us to pay such holder’s pro rata portion of one of the following: (1) the difference between (A) the unpaid principal, interest and any late charges then remaining under the senior convertible notes and (B) 60% of our working capital amount, as determined in accordance with the terms of the senior convertible notes, (2) $2,000,000 or (3) such lesser amount if reduced in accordance with the terms of the senior convertible notes. Our payment of these additional amounts may be in cash and/or common stock pursuant to similar terms as the payment of regular installment amounts. Any requirement that we make any such payments in cash could leave us with insufficient working capital for our business.
Liquidity in general and need for additional financing.
We may need other sources of financing or credit to repay amounts due in February 2006 under the convertible promissory notes and note payable on real estate and to provide working capital. With respect to the convertible promissory notes, the amount outstanding totaled $2,880,000 as of July 1, 2005. With respect to the note payable on real estate, a final balloon payment of approximately $3,039,000 is due on February 1, 2006. To the extent our results of operations do not substantially meet our operating plan, or the facility located at 950 Explorer Boulevard, Huntsville, Alabama is not sold or is sold substantially below its appraised value, or additional working capital is needed to support growth, credit or other financing may be needed in greater amounts or earlier than otherwise. If additional funds are raised through the issuance of equity securities, the percentage of equity ownership of our existing stockholders will be reduced. If additional funds are raised through the issuance of debt securities, we may incur significant interest charges, and these securities would have rights, preferences and privileges senior to holders of common stock. The terms of these securities could also impose restrictions on our operations. Additional credit or other financing may not be available when needed or on terms favorable to us or at all.
Our independent registered public accounting firm’s report includes a “going concern” explanatory paragraph.
Our independent registered public accounting firm has included in its report on our consolidated financial statements for the fiscal year ended July 1, 2005, a going concern explanatory paragraph, which refers to our working capital deficiency, operating loss and negative cash flow from operations that raise substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our ability to continue as a going concern is dependent upon our ability to maintain adequate financing and achieve a level of revenues and cash flow adequate to support our capital and operating requirements. If we do not effectively manage our working capital or achieve targeted cost savings as contemplated in management’s operating plan, we may need to implement additional cost containment measures, seek additional financing, and/or seek to renegotiate our contractual obligations. This uncertainty may cause our stock price to fall and impair our ability to raise additional capital, if necessary. This uncertainty may create a concern among our current and future customers and vendors as to whether we will be able to fulfill our contractual obligations. As a result, current and future customers may determine not to do business with us, or only do so on less favorable terms, which would cause our revenues to decline. Employee concern about the future of the business and their continued prospects for employment may cause them to seek employment elsewhere, depriving us of the human capital we need to be successful.
Evolving regulation of corporate governance and public disclosure may result in additional expenses and continuing uncertainty.
Changing laws, regulations and standard relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market rules are creating uncertainty for public companies. We continually evaluate and monitor developments with respect to new and proposed rules and cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs. These new or changed laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices.
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We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we have invested resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and we may be harmed.
When we adopt SFAS 123R related to the accounting for employee stock option and employee stock purchase plans using a fair-value method, our results from operations and earnings per share will be reduced significantly.
The Financial Accounting Standards Board issued SFAS No. 123R “Share-Based Payment” in December 2004. SFAS 123R requires companies to measure all stock-based compensation awards using a fair-value method and record such expense in their consolidated financial statements. SFAS 123R is effective beginning our first quarter of fiscal 2006. We are assessing the impact of SFAS 123R on our stock-based compensation programs; however, we expect to record significant stock-based compensation expense that will reduce our net income (loss) and earnings per share. When we are required to treat all stock-based compensation as an expense, we may change both our cash and stock-based compensation practices.
We are dependent on continued market acceptance of legacy products, acquired products, recently introduced products and new product development.
Our future results of operations are dependent on market acceptance of existing and future applications for our existing products, products that we have acquired and new products in development. In prior fiscal years, the majority of sales were provided by our legacy products, primarily the AS2000 product line. The Miniplex product line acquired from Terayon Communication Systems, Inc. (“Terayon”) can also be classified as a legacy product. We experienced a significant decline of legacy sales in fiscal 2005 compared to fiscal 2004 and we expect sales to further decline in the future.
Market acceptance of our products is dependent on a number of factors, not all of which are in our control, including the continued growth in the use of bandwidth intensive applications, continued deployment of new telecommunications services such as VoIP, market acceptance of integrated access devices and packetized voice systems in general, the availability and price of competing products and technologies, and the success of our sales and marketing efforts. Failure of our products to achieve market acceptance or our failure to introduce new products in a timely manner could cause companies to purchase products from competitors and reduce our net sales, which may cause our stock price to decline.
New products may require additional development work, enhancement and testing or further refinement before we can make them commercially available. We have 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 our products have performance, reliability or quality shortcomings, we may experience reduced orders, higher manufacturing costs, delays in collecting accounts receivable and additional warranty and service expenses.
We expect revenues from sales of some of our current products to decline over time as a result of decreased demand and pricing pressure. Therefore, our future operating results are highly dependent on market acceptance of recently-introduced products and products that may be introduced in the future. There can be no assurance that such products will achieve widespread market acceptance, and, in fact, some other products we or Larscom introduced in recent years have failed to meet our sales expectations. The industry-wide telecommunications equipment downturn caused sales of new products to be well below expectations. We have, in the past, experienced delays and changes in course in the development of new products and the enhancement of existing products, and such delays and changes in course may occur in the future. Our inability to develop and introduce new products or product versions in a timely manner, due to resource constraints or technological or other reasons, or to achieve timely and widespread market awareness and acceptance of our new products or releases, would have a material adverse effect on our net sales and the market share of our products.
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We currently have limited resources to invest in the development and marketing of new products. If we do not substantially meet our operating plan, we may need to implement further cost reductions that could adversely affect our ability to develop and market new products.
There are risks associated with our acquisitions, potential acquisitions and joint ventures.
An important element of our strategy is to seek acquisition prospects and joint venture opportunities that we believe will complement our existing product offerings, augment our market coverage and customer base, enhance our technological capabilities or offer revenue and profit growth opportunities. We acquired all of the outstanding stock of Larscom on July 28, 2004, for approximately 5,948,652 shares of our common stock. We acquired all of the outstanding stock of XEL Communications, Inc. (“XEL”) on February 5, 2004, for approximately $17,650,000, consisting of $7,650,000 in cash and a $10,000,000 convertible promissory note. In July 2003, we acquired the Miniplex product line from Terayon for up to $982,000, plus the assumption of service and warranty obligations for the Miniplex product line, and purchased Terayon’s Miniplex related inventories totaling approximately $2,100,000 on the earlier of the date used or December 31, 2004. As of July 1, 2005, we owe Terayon $586,000 for Miniplex related inventories. In January 2003, we acquired the net assets used in and directly relating to Polycom, Inc.’s line of NetEngine integrated access devices for up to $3,000,000, plus the assumption of service and warranty obligations for existing NetEngine customers as of the closing of the acquisition. Further transactions of this nature could result in potentially dilutive issuance of equity securities, use of cash and/or the incurring of debt and the assumption of contingent liabilities.
Acquisitions entail numerous costs, challenges and risks, including difficulties in the assimilation of acquired operations, technologies, personnel and products and the retention of existing customers and strategic partners, diversion of management’s attention from other business concerns, risks of entering markets in which we have limited or no prior experience and potential loss of key employees of acquired organizations. Other risks include the potential strain on the combined companies’ financial and managerial controls and reporting systems and procedures, greater than anticipated costs and expenses related to restructuring, including employee severance or relocation costs and costs related to vacating leased facilities, and potential unknown liabilities associated with the acquired entities. Joint ventures entail risks such as potential conflicts of interest and disputes among the participants, difficulties in integrating technologies and personnel, and risks of entering new markets. No assurance can be given as to our ability to successfully integrate the businesses, products, technologies or personnel acquired in past acquisitions or those of other entities that may 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. A failure to fully integrate our past acquisitions or to integrate future potential acquisitions could result in our failure to achieve our costs savings and revenue growth objectives associated with acquisitions, or recover costs associated with these acquisitions, which could reduce our ability to achieve profitability and cause the price of our common stock to decline.
Our results and performance are dependent on a limited customer base.
A small number of customers have historically accounted for a majority of our sales, as well as the historical sales of XEL and Larscom. We expect a majority of future sales to continue to be from a small number of customers. While we are trying to diversify our customer base through the acquisitions of product lines and companies that have relationships with other customers, there can be no assurance that our strategy will be successful, and we may continue to experience quarter to quarter fluctuations based on the unpredictable ordering patterns of a limited customer base. There can be no assurance that our current customers will continue to place orders with us, that orders by existing customers will continue at the levels of previous periods, or that we will be able to obtain orders from new customers. The economic climate and conditions in the telecommunication equipment industry relative to growth and equipment spending are expected to remain unpredictable in fiscal 2006 and beyond.
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Sales for a given quarter generally depend on orders received from, and product shipments to, a limited number of customers. Sales to individual large customers are often related to the customer’s specific equipment deployment projects, the timing of which are subject to change on limited notice, in addition to changes in our customers’ business conditions and the effect of competitors’ product offerings. We have in the past experienced both increases and decreases in orders related to such projects, causing changes in the sales level of a given quarter relative to both the preceding and subsequent quarters. Since most of our sales are in the form of large orders with short delivery times to a limited number of customers, our ability to predict revenues will continue to be limited. In addition, announcements by us or our competitors of new products and technologies could cause customers to defer, limit or stop purchases of our products. In the event that we lose one or more of our large customers, anticipated orders from major customers fail to materialize, or delivery schedules are deferred or canceled as a result of the above described factors, or other unanticipated factors, our business and operating results would be materially adversely affected.
As a result of the downturn in the telecommunications industry, many of our customers have experienced financial difficulties and have reduced their expenditures on capital equipment. The continued financial difficulties or failure of any of our major customers would have a material adverse effect on our business and operating results.
We are dependent on key personnel.
Our future success will depend to a large extent on the continued contributions of our executive officers and key management, sales, and technical personnel. We are a party to agreements with our executive officers to help ensure the officer’s continual service in the event of a change-in-control. Each of our executive officers, and key management, sales and technical personnel would be difficult to replace. We implemented significant cost and staff reductions in recent years, which may make it more difficult to attract and retain key personnel. The loss of the services of one or more of our executive officers or key personnel, or the inability to attract qualified personnel, could delay product development cycles or otherwise could have a material adverse effect on our business, financial condition and results of operations.
We are dependent on key suppliers and the availability of components.
We generally rely upon contract manufacturers to buy finished goods for certain product families and component parts that are incorporated into board assemblies used in our products. On-time delivery of our products depends upon the availability of components and subsystems used in our products. Currently, our third party sub-contractors and we depend upon suppliers to manufacture, assemble and deliver components in a timely and satisfactory manner. We have historically obtained several components and licenses for certain embedded software from single or limited sources. Our third party sub-contractors and we generally do not have any long-term contracts with such suppliers, other than software vendors. Additionally, we rely on original equipment manufacturers to produce some of our product lines. There can be no assurance that these suppliers will continue to be able and willing to meet our third party subcontractors’ and our requirements for any such components. Any significant interruption in the supply of or degradation in the quality of any such item would reduce our ability to fulfill customer orders, which could result in the loss of our existing customers or our inability to attract new customers. Additionally, 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 us or our third party sub-contractor to procure these components from alternative sources at acceptable prices and within a reasonable time, could also delay our ability to fulfill customer orders.
The loss of any of our outside contractors could cause a delay in our ability to fulfill orders while we identify 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, we are unable to predict whether such relationships would be on terms that we would regard as satisfactory. Any significant disruption in our relationships with our manufacturing sources would have a material adverse effect on our business, financial condition and results of operations.
Purchase orders from our customers frequently require delivery quickly after placement of the order. As we do not maintain significant component inventories, delay in shipment by a supplier could lead to lost sales. We use internal forecasts to manage our 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, we 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, we have 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 result in lost sales or our inability to attract new customers.
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Our operating results are subject to significant quarter to quarter fluctuations.
Historically, our sales are subject to quarterly and annual fluctuations. Our ability to anticipate the timing of individual customer orders is limited. Large quarterly fluctuations in sales are due to a wide variety of factors, such as delay, cancellation or acceleration of customer projects, and other factors discussed below. Our sales for a given quarter may depend to a significant degree upon planned product shipments to a single customer, often related to specific equipment or service deployment projects. We have 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 our control, including late deliveries by the third party subcontractors we are using to outsource our manufacturing operations (as well as by other vendors of components used in a our products), changes in our customers’ implementation priorities, slower than anticipated growth in demand for the services that our 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. We believe that sales in the past have been adversely impacted by merger activities by some of our top customers. In addition, we have experienced delays as a result of the need to modify our products to comply with unique customer specifications. These and similar delays or lost sales could materially adversely affect our revenues and cause our stock price to decline.
Our backlog at the beginning of each quarter typically is not sufficient to achieve expected sales for that quarter. To achieve our sales objectives, we are dependent upon obtaining orders in a quarter for shipment in that quarter. Furthermore, our agreements with certain of our 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. Our 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 in certain periods. These reductions, in turn, could cause fluctuations in our operating results and could have an adverse effect on our business, financial condition and results of operations in the periods in which the inventory is reduced.
| Operating results may also fluctuate due to a variety of factors, particularly: |
| | |
| • | delays in new product introductions; |
| • | market acceptance of new or enhanced versions of our products; |
| • | changes in the product or customer mix of sales; |
| • | changes in the level of operating expenses; |
| • | competitive offerings and pricing actions; |
| • | the gain or loss of significant customers; |
| • | increased research and development and sales and marketing expenses associated with new product introductions; |
| • | long sales cycles for our products; and |
| • | general economic conditions. |
All of the above factors are difficult for us to forecast, and these or other factors can materially and adversely affect our business, financial condition and results of operations for one quarter or a series of quarters. Our expense levels are based in part on our expectations regarding future sales and are fixed in the short term to a certain extent. Therefore, we 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 our expectations or any material delay of customer orders could have a material adverse effect on our business, financial condition and results of operations. There can be no assurance that we will be able to achieve profitability on a quarterly or annual basis. In addition, we have had in the past, and may have in the future, quarterly operating results below the expectations of public market analysts and investors. In such event, the price of our common stock would likely be materially and adversely affected.
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Our stock price has and may continue to be subject to large fluctuations.
The trading price of our common stock has been and may continue to be subject to wide fluctuations in response to quarter-to-quarter variations in operating results, announcements of technological innovations or new products by us or our 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 stock prices of many technology companies and which have often been unrelated to the operating performance of such companies. Specific factors applicable to us or broad market fluctuations may materially adversely affect the market price of our common stock.
The telecommunications equipment market is highly competitive with intense price pressure.
The market for telecommunications network access equipment addressed by our IAD product families: 8000 Series, NetEngine Series, eLink, WANsuite and Shark is highly competitive, with intensive equipment price pressure. This market is subject to rapid technological change, wide-ranging regulatory requirements and the entrance of low cost competitors. The market for cellular wireless access addressed by our new NetPath2000 wireless access platform is also a highly competitive segment where we expect increasing price pressures. The market for our PRISM and Miniplex product lines, which are based on older technology, has declined over the long term, and we expect it to experience further decline.
Industry consolidation could lead to competition with fewer, but stronger competitors. In addition, advanced termination products are emerging, which represent both new market opportunities, as well as a threat to our current products. Furthermore, basic line termination functions are increasingly being integrated by competitors, such as Cisco Systems, Lucent Technologies, Inc. and Nortel Networks, into other equipment such as routers and switches. To the extent that current or potential competitors can expand their current offerings to include products that have functionality similar to our products and planned products, the sales and market share for our products may decline.
In addition, our products compete primarily with Adtran, Inc., Cisco Systems, RAD, Telco Systems, ADC, Charles Industries, General Datacomm, GoDigital Networks, Fujitsu, Lucent Technologies, Quick Eagle Networks and Zhone. As a result of our acquisition of Larscom, we compete to a lesser extent with other telecommunications equipment companies. Cisco Systems, Lucent Technologies and Alcatel are three of the largest communications equipment companies in the world. Many of our current and potential competitors have substantially greater technical, financial, manufacturing, distribution and marketing resources than us. In addition, many of our competitors have long-established relationships with network service providers. There can be no assurance that we will have the financial resources, technical expertise, manufacturing, marketing, distribution and support capabilities to compete successfully in the future.
The telecommunications equipment market was in an extended downturn and recovery may be delayed.
The downturn in the United States economy and the rapid and severe downturn for the domestic telecommunications industry, beginning in late 2000, negatively affected demand for our products. In addition to the deteriorating domestic economic environment, the worldwide telecommunications market also experienced reduced demand. This decreased demand has led to unpredictable and revised order forecasts from some of our customers. The unfavorable financial positions of many of our customers resulting from the prolonged downturn in the telecommunications industry may delay any recovery in orders for our products relative to a general recovery in the United States and global economies, and any such recovery may not occur at all.
The telecommunications equipment market is subject to rapid technological change.
The telecommunications equipment markets associated with wireline and wireless network access 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 our products. Our success will depend to a substantial degree upon our ability to respond to changes in technology and customer requirements. We may not be able to achieve 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
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uncertain process, requiring high levels of innovation. We may need to supplement our internal expertise and resources with specialized expertise or intellectual property from third parties to develop new products, which may not be available to us on favorable terms or at all. 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, IP, VPN, Ethernet, GPRS, CDMA, Edge and UMTS. There can be no assurance that we will continue to develop the necessary competence in these areas.
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 we 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. In the past, some of our newly-introduced products have not met our sales expectations. There can be no assurance that we 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.
As a result of the Larscom acquisition, our business could be materially and adversely affected by shifts in the use of technology common throughout the industry today. Three shifts affecting Larscom’s products and industry are: the integration of CSU/DSU technology into routers and switches, a move from T1/E1 services to more Ethernet-based services (10/100/100BT) and the increase in demand for more managed, customer-premise-based services. The failure to accommodate these shifts in technology could impact sales of our products and have a material adverse affect on our business and operating results.
The telecommunications equipment market requires regulatory compliance and compliance with evolving standards.
The market for our 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 of America, our 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 our products. Standards for new services such as Voice over IP and Voice over DSL have evolved rapidly, such as the emergence of G.SHDSL and ADSL 2+ standards and the new Sessions Initiated Protocol (SIP) required for Voice over IP signaling. As standards continue to evolve, we will be required to modify our products or develop and support new versions of our products. The failure of our products to comply, or delays in compliance, with the various existing and evolving industry standards could delay introduction of our products, which could cause our stock price to decline.
There are risks associated with our continuing entry into international markets.
We had limited experience in the international markets until our acquisition of the IAD products from Polycom in January 2003, after which we began expanding sales of our products outside of North America and entered certain international markets. 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 of our sales are denominated in foreign currency, our sales and results of operations may also be directly affected by fluctuations in foreign currency exchange rates. In order to sell our products internationally, we 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 our products in countries outside the United States could delay or preclude our marketing and sales efforts in such countries, which could cause the sales of our products to fall short of expectations and result in a decline in our stock price.
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The telecommunications equipment market is subject to 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 us. We have not conducted a formal patent search relating to the technology used in our products, due in part to the high cost and limited benefits of a formal search. In addition, since patent applications in the United States of America 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 our products. Software comprises a substantial portion of the technology in our 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 us if we discover third party patents related to our software products or if such patents are asserted against us 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 our products.
We may receive communications from third parties asserting that our products infringe or may infringe the proprietary rights of third parties. In our distribution agreements, we typically agree to indemnify our 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 our favor, could result in significant expense to us and divert the efforts of our technical and management personnel from productive tasks. In the event of an adverse ruling in such litigation, we 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 us and the failure of us to develop or license a substitute technology, our business, financial condition and results of operations could be materially adversely affected.
There are limitations on our ability to protect our intellectual property.
We rely upon a combination of patent, trade secret, copyright, and trademark laws and contractual restrictions to establish and protect proprietary rights in our products and technologies. We have been issued certain U.S. and Canadian patents with respect to limited aspects of our single purpose network access technology. We have not obtained significant patent protection for our Access System or WANsuite technologies. There can be no assurance that third parties have not or will not develop equivalent technologies or products without infringing our patents or that a court having jurisdiction over a dispute involving such patents would hold our patents valid, enforceable and infringed. We also typically enter into confidentiality and invention assignment agreements with our employees and independent contractors, and non-disclosure agreements with our suppliers, distributors and appropriate customers so as to limit access to and disclosure of our proprietary information. There can be no assurance that these statutory and contractual arrangements will deter misappropriation of our technologies or discourage independent third-party development of similar technologies. In the event such arrangements are insufficient, our business, financial condition and results of operations could be materially adversely affected. The laws of certain foreign countries in which our products are or may be developed, manufactured or sold may not protect our 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 our technology and products more likely.
We have not conducted a formal patent search relating to the technology used in our products.
From time to time, third parties may assert exclusive patent, copyright, trademark and other intellectual property rights to technologies that are important to us. Since patent applications in the United States are not publicly disclosed immediately, applications that we do not know about may have been filed by our competitors, which could relate to our products. The scope of protection accorded to patents covering software-related inventions is evolving and is subject to uncertainty, which may increase the risk and cost to us if we discover third-party patents related to our software products or if such patents are asserted against us in the future. In the event of litigation to determine the validity of any third-party claims, such litigation, whether or not determined in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel. In the event of an adverse ruling in such litigation, we may be required to pay damages, discontinue the use and sale of infringing products, and 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. A successful claim against us and our failure to develop or license a substitute technology could have an adverse impact on our business and operating results and cause our stock price to decline.
-36-
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
At July 1, 2005, we did not have any market risk related to an investment portfolio. We invest cash balances in excess of operating requirements in short-term securities with maturities of 90 days or less.
We are subject to interest rate risks on our note payable on real estate. If market interest rates were to increase immediately and uniformly by 10% from levels as of July 1, 2005, the additional interest expense would not be material. We believe that the effect, if any, of reasonably possible near-term changes in interest rates on our financial position, results of operations and cash flows would not be material.
Item 8. Financial Statements and Supplementary Data
The chart entitled “Financial Information by Quarter (Unaudited)” contained in Item 6 of Part II hereof is hereby incorporated by reference into this Item 8 of Part II of this form 10-K.
VERILINK CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Consolidated Financial Statements Included in Item 8:
| Page |
|
|
Report of Independent Registered Public Accounting Firms | 38 |
Consolidated Balance Sheets as of July 1, 2005 and July 2, 2004 | 40 |
Consolidated Statements of Operations and Comprehensive Income (Loss) for each of the three fiscal years in the period ended July 1, 2005 | 41 |
Consolidated Statements of Cash Flows for each of the three fiscal years in the period ended July 1, 2005 | 42 |
Consolidated Statements of Stockholders’ Equity for each of the three fiscal years in the period ended July 1, 2005 | 43 |
Notes to Consolidated Financial Statements | 44 |
Schedule for each of the three fiscal years in the period ended July 1, 2005 included in Item 14(a): | |
Schedule II — Valuation and Qualifying Accounts and Reserves | 70 |
Schedules other than those listed above have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.
-37-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Verilink Corporation
Centennial, Colorado
We have audited the consolidated balance sheet of Verilink Corporation and Subsidiaries as of July 1, 2005 and the related consolidated statements of operations and comprehensive loss, changes in stockholders’ equity and cash flows for the year then ended. We have also audited the financial statement schedule II for the year ended July 1, 2005 as listed in the accompanying index. These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Verilink Corporation and Subsidiaries as of July 1, 2005, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule II for the year ended July 1, 2005, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has a working capital deficiency and has generated an operating loss and negative cash flow from operations which raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Ehrhardt Keefe Steiner & Hottman PC |
|
September 21, 2005 |
Denver, Colorado |
-38-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Verilink Corporation
In our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Verilink Corporation and its subsidiaries at July 2, 2004, and the results of their operations and their cash flows for each of the two years in the period ended July 2, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has uncertain revenue streams and a low level of liquidity that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
As explained in Notes 1 and 7 to the consolidated financial statements, the Company adopted SFAS No. 142, Goodwill and Intangible Assets, effective June 29, 2002.
PricewaterhouseCoopers LLP
Birmingham, Alabama
October 1, 2004
-39-
VERILINK CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
| | July 1,
2005 | | July 2,
2004 | |
| |
|
| |
|
| |
ASSETS | | | | | | | |
Current assets: | | | | | | | |
Cash and cash equivalents | | $ | 3,504 | | $ | 3,448 | |
Restricted cash | | | 333 | | | — | |
Accounts receivable, net of allowance for doubtful accounts of $1,200 and $536, respectively | | | 10,068 | | | 7,881 | |
Inventories, net | | | 5,256 | | | 6,010 | |
Other current assets | | | 744 | | | 941 | |
| |
|
| |
|
| |
Total current assets | | | 19,905 | | | 18,280 | |
Property held for lease, net | | | 6,076 | | | 6,269 | |
Property, plant and equipment, net | | | 1,697 | | | 1,381 | |
Goodwill, net | | | 1,114 | | | 9,887 | |
Other intangible assets, net | | | 13,253 | | | 9,182 | |
Other assets | | | 283 | | | 1,139 | |
| |
|
| |
|
| |
| | $ | 42,328 | | $ | 46,138 | |
| |
|
| |
|
| |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | |
Current liabilities: | | | | | | | |
Note payable to bank | | $ | — | | $ | 2,046 | |
Current portion of long-term debt and capital lease obligations | | | 8,727 | | | 487 | |
Accounts payable | | | 4,944 | | | 6,229 | |
Accrued salaries and wages | | | 1,804 | | | 1,474 | |
Accrued liabilities | | | 2,843 | | | 2,127 | |
Deferred revenues | | | 945 | | | 799 | |
Warranty reserve | | | 1,290 | | | 1,192 | |
Accrued purchase consideration | | | 239 | | | 1,148 | |
| |
|
| |
|
| |
Total current liabilities | | | 20,792 | | | 15,502 | |
Long-term debt and capital lease obligations, less current portion | | | 5,197 | | | 6,262 | |
Other long-term liabilities | | | 567 | | | — | |
| |
|
| |
|
| |
Total liabilities | | | 26,556 | | | 21,764 | |
| |
|
| |
|
| |
Commitments and contingencies (Note 18) | | | | | | | |
Stockholders’ equity: | | | | | | | |
Preferred stock, $0.01 par value, 1,000 shares authorized; no shares issued and outstanding | | | — | | | — | |
Common stock, $0.01 par value; 40,000 shares authorized; 23,082 and 16,777 shares issued and outstanding in 2005 and 2004, respectively | | | 231 | | | 168 | |
Additional paid-in capital | | | 87,812 | | | 59,532 | |
Deferred compensation | | | — | | | (520 | ) |
Accumulated other comprehensive loss | | | (52 | ) | | (39 | ) |
Accumulated deficit | | | (72,219 | ) | | (34,767 | ) |
| |
|
| |
|
| |
Total stockholders’ equity | | | 15,772 | | | 24,374 | |
| |
|
| |
|
| |
| | $ | 42,328 | | $ | 46,138 | |
| |
|
| |
|
| |
The accompanying notes are an integral part of these consolidated financial statements.
-40-
VERILINK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except per share amounts)
| | Fiscal Year Ended | |
| |
| |
| | July 1,
2005 | | July 2,
2004 | | June 27,
2003 | |
| |
|
| |
|
| |
|
| |
Product sales | | $ | 42,195 | | $ | 42,419 | | $ | 26,894 | |
Service sales | | | 11,097 | | | 3,764 | | | 1,210 | |
| |
|
| |
|
| |
|
| |
Net sales | | | 53,292 | | | 46,183 | | | 28,104 | |
| |
|
| |
|
| |
|
| |
Product cost of sales | | | 30,873 | | | 24,506 | | | 13,360 | |
Service cost of sales | | | 5,103 | | | 1,960 | | | 579 | |
| |
|
| |
|
| |
|
| |
Cost of sales | | | 35,976 | | | 26,466 | | | 13,939 | |
| |
|
| |
|
| |
|
| |
Gross profit | | | 17,316 | | | 19,717 | | | 14,165 | |
| |
|
| |
|
| |
|
| |
Operating expenses: | | | | | | | | | | |
Research and development | | | 7,454 | | | 6,876 | | | 3,985 | |
Selling, general and administrative | | | 18,040 | | | 12,124 | | | 7,102 | |
Amortization of intangible assets | | | 2,546 | | | 1,027 | | | 484 | |
Restructuring charges | | | 275 | | | 390 | | | — | |
Impairment charges related to goodwill | | | 24,334 | | | — | | | — | |
Impairment charge related to other intangible assets | | | 2,150 | | | — | | | — | |
In-process research and development | | | — | | | — | | | 316 | |
| |
|
| |
|
| |
|
| |
Total operating expenses | | | 54,799 | | | 20,417 | | | 11,887 | |
| |
|
| |
|
| |
|
| |
Income (loss) from operations | | | (37,483 | ) | | (700 | ) | | 2,278 | |
Interest and other income, net | | | 1,164 | | | 927 | | | 656 | |
Interest expense | | | (1,133 | ) | | (253 | ) | | (181 | ) |
| |
|
| |
|
| |
|
| |
Income (loss) before provision for income taxes | | | (37,452 | ) | | (26 | ) | | 2,753 | |
Provision for income taxes | | | — | | | — | | | — | |
| |
|
| |
|
| |
|
| |
Net income (loss) before cumulative change in accounting principle, relating to goodwill | | | (37,452 | ) | | (26 | ) | | 2,753 | |
Cumulative effect of change in accounting principle, relating to goodwill | | | — | | | — | | | (1,233 | ) |
| |
|
| |
|
| |
|
| |
Net income (loss) | | $ | (37,452 | ) | $ | (26 | ) | $ | 1,520 | |
| |
|
| |
|
| |
|
| |
Net income (loss) per share, basic and diluted: | | | | | | | | | | |
Net income (loss) before cumulative change in accounting principle, relating to goodwill | | $ | (1.68 | ) | $ | (0.00 | ) | $ | 0.18 | |
Cumulative effect of change in accounting principle, relating to goodwill | | | — | | | — | | | (0.08 | ) |
| |
|
| |
|
| |
|
| |
Net income (loss) | | $ | (1.68 | ) | $ | (0.00 | ) | $ | 0.10 | |
| |
|
| |
|
| |
|
| |
Weighted average shares outstanding: | | | | | | | | | | |
Basic | | | 22,316 | | | 15,170 | | | 14,871 | |
| |
|
| |
|
| |
|
| |
Diluted | | | 22,316 | | | 15,170 | | | 15,294 | |
| |
|
| |
|
| |
|
| |
Consolidated Statements of Comprehensive Income (Loss): | | | | | | | | | | |
Net income (loss) | | $ | (37,452 | ) | $ | (26 | ) | $ | 1,520 | |
Foreign currency translation adjustments | | | (12 | ) | | (7 | ) | | (2 | ) |
Unrealized loss on marketable equity securities | | | — | | | — | | | (5 | ) |
| |
|
| |
|
| |
|
| |
Comprehensive income (loss) | | $ | (37,464 | ) | $ | (33 | ) | $ | 1,513 | |
| |
|
| |
|
| |
|
| |
The accompanying notes are an integral part of these consolidated financial statements.
-41-
VERILINK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| | Fiscal Year Ended | |
| |
| |
| | July 1,
2005 | | July 2,
2004 | | June 27,
2003 | |
| |
|
| |
|
| |
|
| |
Cash flows from operating activities: | | | | | | | | | | |
Net income (loss) | | $ | (37,452 | ) | $ | (26 | ) | $ | 1,520 | |
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | | | | | |
Depreciation and amortization | | | 4,487 | | | 2,023 | | | 1,341 | |
Expense related to stock awards | | | 186 | | | 1,000 | | | — | |
Amortization of deferred compensation | | | 507 | | | 516 | | | — | |
Forgiveness of convertible notes | | | (121 | ) | | — | | | — | |
In process research and development | | | — | | | — | | | 316 | |
Impairment charges | | | 26,484 | | | — | | | — | |
Change in fair value of warrants liability | | | (543 | ) | | — | | | — | |
Loss on disposal of property, plant & equipment | | | 38 | | | 13 | | | — | |
Accrued interest on notes receivable from stockholders, net | | | — | | | (293 | ) | | (422 | ) |
Cumulative effect of change in accounting principle, relating to goodwill | | | — | | | — | | | 1,233 | |
Changes in assets and liabilities: | | | | | | | | | | |
Accounts receivable | | | 459 | | | (2,083 | ) | | 424 | |
Inventories | | | 3,970 | | | 117 | | | (1,050 | ) |
Other assets | | | 1,702 | | | (1,155 | ) | | (130 | ) |
Accounts payable | | | (3,436 | ) | | (163 | ) | | 113 | |
Accrued expenses | | | (5,138 | ) | | 894 | | | 672 | |
Other non-current liabilities | | | (444 | ) | | — | | | — | |
| |
|
| |
|
| |
|
| |
Net cash provided by (used in) operating activities | | | (9,301 | ) | | 843 | | | 4,017 | |
| |
|
| |
|
| |
|
| |
Cash flows from investing activities: | | | | | | | | | | |
Purchases of property, plant and equipment | | | (375 | ) | | (600 | ) | | (602 | ) |
Decrease in restricted cash | | | — | | | 1,000 | | | — | |
Sale of short-term investments | | | — | | | 101 | | | 497 | |
Payments related to product line acquisitions | | | (909 | ) | | (1,395 | ) | | (1,200 | ) |
Cash acquired in acquisition of Larscom Incorporated, net of transaction costs | | | 4,273 | | | — | | | — | |
Acquisition of XEL Communications, Inc., net of cash acquired | | | — | | | (7,612 | ) | | — | |
Proceeds from the repayment of notes receivable | | | — | | | 240 | | | 260 | |
| |
|
| |
|
| |
|
| |
Net cash provided by (used in) investing activities | | | 2,989 | | | (8,266 | ) | | (1,045 | ) |
| |
|
| |
|
| |
|
| |
Cash flows from financing activities: | | | | | | | | | | |
Proceeds from bank borrowings and long-term debt | | | 11,455 | | | 2,046 | | | — | |
Debt issuance costs | | | (1,077 | ) | | — | | | — | |
Repayment of bank borrowings and long-term debt | | | (3,980 | ) | | (731 | ) | | (724 | ) |
Proceeds from issuance of common stock under stock plans | | | 228 | | | 1,060 | | | 4 | |
Repurchase of common stock | | | (245 | ) | | — | | | (49 | ) |
Proceeds from repayment of notes receivable from stockholder | | | — | | | — | | | 675 | |
| |
|
| |
|
| |
|
| |
Net cash provided by (used in) financing activities | | | 6,381 | | | 2,375 | | | (94 | ) |
| |
|
| |
|
| |
|
| |
Change in other comprehensive loss | | | (13 | ) | | (7 | ) | | (5 | ) |
| |
|
| |
|
| |
|
| |
Net increase (decrease) in cash and cash equivalents | | | 56 | | | (5,055 | ) | | 2,873 | |
Cash and cash equivalents at beginning of year | | | 3,448 | | | 8,503 | | | 5,630 | |
| |
|
| |
|
| |
|
| |
Cash and cash equivalents at end of year | | $ | 3,504 | | $ | 3,448 | | $ | 8,503 | |
| |
|
| |
|
| |
|
| |
Supplemental disclosures: | | | | | | | | | | |
Cash paid for interest | | $ | 454 | | $ | 254 | | $ | 181 | |
Cash paid for income taxes | | $ | — | | $ | 89 | | $ | 17 | |
Non-cash investing activities: | | | | | | | | | | |
Acquisition of Larscom Incorporated for stock and stock options assumed | | $ | 26,840 | | $ | — | | $ | — | |
Purchase of property, plant and equipment through capital lease obligations | | $ | 173 | | $ | — | | $ | — | |
Warrants issued with senior convertible notes | | $ | 1,870 | | $ | — | | $ | — | |
Convertible notes issued in acquisition of XEL Communications, Inc. | | $ | — | | $ | 10,480 | | | — | |
Common stock issued in connection with note conversion | | $ | — | | $ | 7,250 | | | — | |
Non-cash financing activities: | | | | | | | | | | |
Repayment of notes receivable from stockholder with common stock | | $ | — | | $ | 2,428 | | $ | 341 | |
The accompanying notes are an integral part of these consolidated financial statements.
-42-
VERILINK CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
| | | Common Stock | | Additional
Paid-in
Capital | | Deferred
Compensation | | Notes
Receivable
from
Stockholder | | Accumulated
Other
Comprehensive
Loss | | Retained
Earnings
(Deficit) | | Total | |
|
|
|
| Shares | | Amount |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Balance at June 28, 2002 | | | 14,997 | | $ | 150 | | $ | 51,483 | | $ | — | | $ | (3,230 | ) | $ | (25 | ) | $ | (36,261 | ) | $ | 12,117 | |
Issuance of common stock under stock plans | | | 14 | | | — | | | 4 | | | — | | | — | | | — | | | — | | | 4 | |
Purchase and retirement of treasury stock | | | (340 | ) | | (3 | ) | | (387 | ) | | — | | | — | | | — | | | — | | | (390 | ) |
Accrued interest on notes receivable from stockholder | | | — | | | — | | | — | | | — | | | (161 | ) | | — | | | — | | | (161 | ) |
Repayment of notes receivable from stockholder | | | — | | | — | | | — | | | — | | | 1,016 | | | — | | | — | | | 1,016 | |
Unrealized loss on marketable equity securities | | | — | | | — | | | — | | | — | | | — | | | (5 | ) | | — | | | (5 | ) |
Foreign currency translation adjustment | | | — | | | — | | | — | | | — | | | — | | | (2 | ) | | — | | | (2 | ) |
Net income | | | — | | | — | | | — | | | — | | | — | | | | | | 1,520 | | | 1,520 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Balance at June 27, 2003 | | | 14,671 | | | 147 | | | 51,100 | | | — | | | (2,375 | ) | | (32 | ) | | (34,741 | ) | | 14,099 | |
Issuance of common stock under stock plans | | | 751 | | | 8 | | | 1,646 | | | (200 | ) | | — | | | — | | | — | | | 1,454 | |
Issuance of common stock not under a stock plan | | | 338 | | | 3 | | | 1,797 | | | (800 | ) | | — | | | — | | | — | | | 1,000 | |
Retirement of treasury stock received in payment of stockholder notes | | | (343 | ) | | (3 | ) | | (2,284 | ) | | — | | | 2,287 | | | — | | | — | | | — | |
Shares issued on note conversion | | | 1,362 | | | 13 | | | 7,237 | | | — | | | — | | | — | | | — | | | 7,250 | |
Amortization of deferred compensation | | | — | | | — | | | 43 | | | 473 | | | — | | | — | | | — | | | 516 | |
Forfeiture of restricted stock awards | | | (2 | ) | | — | | | (7 | ) | | 7 | | | — | | | — | | | — | | | — | |
Accrued interest on notes receivable from stockholders | | | — | | | — | | | — | | | — | | | (53 | ) | | — | | | — | | | (53 | ) |
Repayment of notes receivable from stockholder | | | — | | | — | | | — | | | — | | | 141 | | | — | | | — | | | 141 | |
Foreign currency translation adjustment | | | — | | | — | | | — | | | — | | | — | | | (7 | ) | | — | | | (7 | ) |
Net loss | | | — | | | — | | | — | | | — | | | — | | | — | | | (26 | ) | | (26 | ) |
| |
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Balance at July 2, 2004 | | | 16,777 | | | 168 | | | 59,532 | | | (520 | ) | | — | | | (39 | ) | | (34,767 | ) | | 24,374 | |
Issuance of common stock under stock plans | | | 365 | | | 4 | | | 412 | | | — | | | — | | | — | | | — | | | 416 | |
Shares issued in acquisition of Larscom Incorporated | | | 6,040 | | | 60 | | | 26,781 | | | — | | | — | | | — | | | — | | | 26,841 | |
Purchase and retirement of treasury stock | | | (97 | ) | | (1 | ) | | (246 | ) | | — | | | — | | | — | | | — | | | (247 | ) |
Reclassification of warrants liability | | | — | | | — | | | 1,326 | | | — | | | — | | | — | | | — | | | 1,326 | |
Amortization of deferred compensation | | | — | | | — | | | 23 | | | 504 | | | — | | | — | | | — | | | 527 | |
Forfeiture of restricted stock awards | | | (3 | ) | | — | | | (16 | ) | | 16 | | | — | | | — | | | — | | | — | |
Foreign currency translation adjustment | | | — | | | — | | | — | | | — | | | — | | | (13 | ) | | — | | | (13 | ) |
Net loss | | | — | | | — | | | — | | | — | | | — | | | — | | | (37,452 | ) | | (37,452 | ) |
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Balance at July 1, 2005 | | | 23,082 | | $ | 231 | | $ | 87,812 | | $ | — | | $ | — | | $ | (52 | ) | $ | (72,219 | ) | $ | 15,772 | |
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The accompanying notes are an integral part of these consolidated financial statements.
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VERILINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 — The Company and a Summary of Significant Accounting Policies
The Company
Verilink Corporation, a Delaware Corporation, was incorporated in 1982. We develop, manufacture, and market integrated access devices, Optical Ethernet access products, wireless access devices, and bandwidth aggregation solutions for network service providers, enterprise customers, and original equipment manufacturer (“OEM”) partners. Our integrated network access and customer premises/located equipment products are used by network service providers such as interexchange and local exchange carriers, and providers of Internet, personal communications, and cellular services to provide seamless connectivity and interconnect for multiple traffic types on wide area networks.
The accompanying financial statements have been prepared on a going concern basis which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business and do not reflect adjustments that might result if we were not to continue as a going concern. The auditor’s report on our financial statements as of July 1, 2005 contains an explanatory paragraph, which refers to our working capital deficiency, operating loss and negative cash flow from operations which raise substantial doubt about our ability to continue as a going concern. The auditor’s report on the our financial statements as of July 2, 2004 contains an explanatory paragraph, which refers to uncertain revenue streams and a low level of liquidity and notes that these matters raise substantial doubt about the our ability to continue as a going concern.
As shown in the accompanying consolidated financial statements, we have incurred losses from operations over the last two fiscal years, and as of July 1, 2005, our current liabilities exceeded our current assets by $887,000. These factors raise substantial doubt about our ability to continue as a going concern. Management has instituted a cost reduction program that included a decrease in headcount and curtailment of other discretionary non-payroll costs. In addition, we have increased sales prices on certain products, obtained more favorable material costs for certain material components, and redesigned certain product lines to reduce manufacturing costs. We are also working to amend the lease terms of the facility at 950 Explorer Boulevard in Huntsville, Alabama to improve its salability; and to rationalize product lines, which could result in the potential sale and/or acquisition of product line(s). Management believes these factors will contribute toward achieving positive cash flow from operations.
On a quarterly basis, management will continue to evaluate revenue outlook and plans to adjust spending levels as necessary. We believe that our cash and cash equivalents and anticipated cash flow from operations will be sufficient to fund our operations and contractual obligations through fiscal 2006 based on our current operating plan, although no such assurance can be given. If we do not substantially meet our current operating plan, then we may implement additional cost containment measures, or may need to seek additional financing or seek to renegotiate our contractual obligations. While we do not believe we will need to seek additional financing in the near term, the sale of additional equity or debt securities could result in additional dilution to our stockholders. Arrangements for additional financing or renegotiation of contractual obligations may not be available on terms acceptable to us, if at all.
Basis of presentation
The consolidated financial statements include our accounts and our wholly owned subsidiaries in the United States of America, Canada, Mexico and Great Britain. All significant intercompany accounts and transactions have been eliminated in consolidation.
Our fiscal year is the 52- or 53-week period ending on the Friday nearest to June 30.
Management estimates and assumptions
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
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Foreign currency
The functional currency of our foreign subsidiaries is the local currency. The balance sheet accounts of foreign subsidiaries are translated into United States dollars at the exchange rate prevailing at the balance sheet date. Revenues, costs and expenses are translated into United States dollars at average rates for the period. Gains and losses resulting from translation are accumulated as a component of stockholders’ equity and to date have not been material. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations and were not significant during any of the periods presented.
Cash and cash equivalents
We consider all highly liquid instruments with a maturity of three months or less when purchased to be cash equivalents.
Short-term investments
We consider highly liquid instruments with a maturity greater than three months when purchased, and our investment securities classified as available for sale to be short-term investments. Realized gains or losses are determined on the specific identification method and are reflected in income. Net unrealized gains or losses are recorded directly in stockholders’ equity except those unrealized losses that are deemed to be other than temporary which are reflected in the statements of operations. No such losses were recorded during any of the periods presented.
Accounts receivable
Accounts receivable from customers are stated net of an allowance for doubtful accounts. We estimate losses resulting from the inability of our customers to make payments for amounts billed. The collectability of outstanding invoices is continually assessed. Assumptions made regarding the customer’s ability and intent to pay are based on historical trends, general economic conditions and current customer data.
Inventories
Inventories are stated at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis.
Fair value of financial instruments
The carrying amounts of cash, cash equivalents, short-term investments and other current assets and liabilities such as accounts receivable, accounts payable, and accrued expenses, as presented in the financial statements, approximate fair value based on the short-term nature of these instruments. The fair value of note payable to bank and long-term debt is determined based on the borrowing rates currently available to us for loans with similar terms and maturities.
Property held for lease
Property held for lease is carried at cost, less accumulated depreciation, which is computed using the straight-line method over the estimated useful lives of the assets, which are 25 years for the building and generally five years for the other assets. Rental income from this property is recorded on a monthly basis in accordance with the lease terms. Initial direct costs are deferred and matched against rental income over the initial term of the lease (see Note 6).
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Property, plant and equipment
Property, plant and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which are two to five years for furniture, fixtures and office equipment, and five years for machinery and equipment. Leasehold improvements are amortized using the straight-line method over the lesser of the estimated useful lives of the assets or the remaining lease term. Depreciation expense was $1,419,000, $997,000 and $857,000 for fiscal 2005, 2004 and 2003, respectively. Maintenance and repairs are charged to operations as incurred. Upon sale, retirement or other disposition of these assets, the cost and related accumulated depreciation are removed from the respective accounts. We perform reviews of estimated future cash flows expected to result from the use of property, plant and equipment to determine the impairment of such assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Long-lived assets
We review long-lived assets for impairment under the guidance prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. We recognize impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying values. An impairment loss would be recognized in the amount by which the recorded value of the asset exceeds the fair value of the asset, measured by the quoted market price of an asset or an estimate based on the best information available in the circumstances. There were no such losses recognized during fiscal 2005, 2004 or 2003.
Goodwill
We record goodwill when the cost of an acquired entity exceeds the net amounts assigned to identifiable assets acquired and liabilities assumed. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we conduct a formal impairment test of goodwill on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value below its carrying value. There were no such losses recognized during fiscal 2004 or 2003. During fiscal 2005, we recorded impairment charges related to goodwill of $24,334,000 (See Note 7).
Other intangible assets
Other intangible assets are amortized on a straight-line basis over the estimated economic lives, which range from three to eleven years. Other intangible assets are reviewed for impairment on an undiscounted cash flow basis, whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. There were no such losses recognized during fiscal 2004 or 2003. During fiscal 2005, we recorded impairment charges related to other intangible assets of $2,150,000 (See Note 8).
Liability for warranty returns
We generally warrant our products for a five-year period, except for certain product families which provide a warranty period of one year, three years or as required by contract. We accrue for warranty returns at cost to repair or replace products. The liability for warranty returns totaled $1,290,000 and $1,192,000 at July 1, 2005 and July 2, 2004, respectively (see Note 10).
Revenue recognition
We recognize a sale when persuasive evidence of an arrangement exists, the product has been delivered or services have been performed, the price to the purchaser is fixed or determinable, and collection of the resulting receivable is reasonably assured. Revenue from separately priced extended warranty and service programs is deferred and recognized over the respective service or extended warranty period when we are the obligor. We accrue related product return reserves and warranty costs at the time of the sale.
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The following table summarizes the percentage of total sales for customers accounting for more than 10% of our sales:
| | | | | | | | | | |
| | Fiscal Year Ended | |
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| | July 1,
2005 | | July 2,
2004 | | June 27,
2003 | |
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Verizon. | | | 42 | % | | 28 | % | | — | |
Nortel Networks | | | — | | | 30 | % | | 51 | % |
Interlink Communication Systems, Inc. | | | — | | | — | | | 11 | % |
Concentrations of credit risk
Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments and accounts receivable. We limit the amount of investment exposure to any one financial institution and financial instrument. Our trade accounts receivables are derived from sales to customers primarily in North America, Europe and Australia. We perform credit evaluations of our customers’ financial condition and require no collateral from our customers. We maintain reserves for potential credit losses based upon the expected collectibility of the accounts receivable.
The following table summarizes accounts receivable from customers comprising 10% or more of our gross accounts receivable balance as of the dates indicated:
| | July 1,
2005 | | July 2,
2004 | | June 27,
2003 | |
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Verizon | | | 29 | % | | 29 | % | | — | |
Lucent Technologies | | | 12 | % | | 18 | % | | — | |
Nortel Networks | | | — | | | 15 | % | | 61 | % |
Research and development costs
Research and development costs are expensed as incurred. Software development costs are included in research and development and are expensed as incurred. SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, requires the capitalization of certain software development costs incurred subsequent to the date technological feasibility is established, which we define as the completion of a working model, and prior to the date the product is generally available for sale. To date, the period between achieving technological feasibility and the general availability of such software has been short and software development costs qualifying for capitalization have been insignificant. Accordingly, we have not capitalized any software development costs. During fiscal 2005, 2004 and 2003, total research and development expenditures were $7,454,000, $6,876,000 and $3,985,000, respectively.
Income taxes
We use the liability method of accounting for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Under this method, a deferred income tax liability or asset, net of valuation allowance, is recognized for the estimated future tax effects attributable to temporary differences between the financial statement basis and the tax basis of assets and liabilities as well as tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period of the change. We file a consolidated federal income tax return. Consolidated federal income taxes are allocated to appropriate subsidiaries using the separate return method.
Stock-based compensation
We account for stock-based awards to employees using the intrinsic value method in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, no compensation expense has been recognized for options granted with an exercise price equal to market value at the date of grant or in connection with the employee stock purchase plan.
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Had we recorded compensation based on the estimated grant date fair value, as defined by SFAS No. 123, Accounting for Stock-Based Compensation, for awards granted under our stock option plan, our net income (loss) and earnings (loss) per share would have been reduced to the pro forma amounts below for the years ended July 1, 2005, July 2, 2004 and June 27, 2003, respectively (in thousands, except per share amounts):
| | | 2005 | | | 2004 | | | 2003 | |
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Net income (loss), as reported | | $ | (37,452 | ) | $ | (26 | ) | $ | 1,520 | |
Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects and valuation allowance | | | 480 | | | 1,571 | | | — | |
Deduct: Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects and valuation allowance | | | (2,687 | ) | | (3,111 | ) | | (200 | ) |
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Pro forma net income (loss) | | $ | (39,659 | ) | $ | (1,566 | ) | $ | 1,320 | |
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Earnings (loss) per share: | | | | | | | | | | |
Basic, as reported | | $ | (1.68 | ) | $ | (0.00 | ) | $ | 0.10 | |
Basic, pro forma | | $ | (1.78 | ) | $ | (0.10 | ) | $ | 0.09 | |
Diluted, as reported | | $ | (1.68 | ) | $ | (0.00 | ) | $ | 0.10 | |
Diluted, pro forma | | $ | (1.78 | ) | $ | (0.10 | ) | $ | 0.09 | |
We recorded deferred compensation of $43,000 in fiscal 2004 in connection with the grant of stock options to certain employees in California, which were issued at less than fair market value as of the date of grant and also provided a limited cash award payable upon the exercise of the underlying stock option award. During fiscal 2005 and 2004, we recognized total compensation expense of $3,000 and $60,000, respectively, related to these options. At July 1, 2005, all deferred compensation related to these awards has been charged to expense.
In connection with the acquisition of XEL Communications, Inc. (“XEL”) in fiscal 2004, we issued 187,826 shares of common stock to certain employees and recorded a charge to compensation expense in the amount of $1 million. We also issued 187,826 shares of restricted common stock to certain employees and recorded deferred compensation of $1,000,000, which will be charged to expense over the three year vesting period. On February 17, 2005, we accelerated the vesting of the restricted stock awards outstanding as of that date and the remaining deferred compensation was charged to expense. During fiscal 2005 and 2004, we recognized total compensation expense of $476,000 and $501,000, respectively, related to these awards.
The pro forma amounts reflected in the table above are not representative of the effects on reported net income (loss) in future years because, in general, the options granted typically do not vest for several years and additional awards are made each year. The fair value of each option grant is estimated on the grant date using the Black-Scholes option-pricing model using the weighted-average assumptions shown in the table below. The weighted average estimated grant date fair value, as defined by SFAS No. 123, of options granted during fiscal 2005, 2004 and 2003 under our stock option plan was $1.73, $3.46 and $0.86, respectively.
| | | 2005 | | | 2004 | | | 2003 | |
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Expected dividend yield | | | 0.0 | % | | 0.0 | % | | 0.0 | % |
Expected stock price volatility | | | 139 | % | | 148 | % | | 156 | % |
Risk free interest rate | | | 3.09 | % | | 2.41 | % | | 1.99 | % |
Expected life (years) | | | 3.07 | | | 3.47 | | | 2.67 | |
Earnings (loss) per share
Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share gives effect to all dilutive potential common shares outstanding during a period. In computing diluted earnings (loss) per share, the average price of our common stock for the period is used in determining the number of shares assumed to be purchased from exercise of stock options and stock warrants under the treasury method. The following table sets forth the computation of basic and diluted earnings (loss) per share for each of the past three fiscal years (in thousands, except per share amounts):
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| | Fiscal Year Ended | |
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| | July 1,
2005 | | July 2,
2004 | | June 27,
2003 | |
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Net income (loss) | | $ | (37,452 | ) | $ | (26 | ) | $ | 1,520 | |
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Weighted average shares outstanding: | | | | | | | | | | |
Basic | | | 22,316 | | | 15,170 | | | 14,871 | |
Effect of potential common stock from the exercise of stock options and warrants | | | — | | | — | | | 423 | |
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Diluted | | | 22,316 | | | 15,170 | | | 15,294 | |
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Basic earnings (loss) per share | | $ | (1.68 | ) | $ | 0.00 | | $ | 0.10 | |
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Diluted earnings (loss) per share | | $ | (1.68 | ) | $ | 0.00 | | $ | 0.10 | |
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Weighted average option shares and warrants excluded from the computation of diluted earnings (loss) per share because their effect is anti-dilutive | | | 5,931 | | | 3,754 | | | 2,163 | |
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Restricted common stock outstanding issued to employees as of July 2, 2004 totaling 186,416 shares was excluded from the computation of basic earnings (loss) per share since the shares had not vested and remained subject to forfeiture at that date.
Potential common shares from conversion of the senior convertible notes and convertible promissory notes totaling 3,863,207 shares were not included in the computation of diluted earnings (loss) per share because the inclusion of such shares would have been antidilutive.
Comprehensive income (loss)
Comprehensive income (loss) consists of net income (loss), unrealized gains/losses on available-for-sale securities, and gains or losses on our foreign currency translation adjustments, and is presented in the Consolidated Statement of Operations and Comprehensive Income (Loss).
Interest and other income, net
Interest and other income includes income from interest, rental property held for lease, net of expenses, forgiveness of convertible note, change in the fair value of warrants liability and other miscellaneous income and expenses.
Reclassifications
Certain prior year amounts have been reclassified to conform to the fiscal 2005 financial statement presentation. These reclassifications had no effect on previously reported net income (loss), cash flows from operations or total stockholders’ equity.
Recently issued accounting pronouncements
In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. SFAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period costs. The provisions of SFAS 151 are effective for our fiscal 2006. We do not expect SFAS 151 to have a material impact on our financial position, results of operations, or cash flows.
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In December 2004, the FASB finalized SFAS No. 123R Share-Based Payment, amending SFAS No. 123, effective beginning our first quarter of fiscal 2006. SFAS 123R requires us to expense stock options based on grant date fair value in our financial statements. Further, the SFAS 123R requires additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. In March 2005, the U.S. Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin (“SAB”) No. 107, which expresses views of the SEC staff regarding the interaction between SFAS 123R and certain SEC rules and regulations, and provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. We are considering the guidance of this SAB in our adoption of SFAS 123R. The effect of expensing stock options on our results of operations using a Black-Scholes option-pricing model is presented in our consolidated financial statements in Note 1 under Stock Based Compensation. Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. We expect to utilize the prospective method which requires that compensation expense begin being recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R. We are evaluating the requirements of SFAS 123R and expect the adoption of SFAS 123R will have a material impact on our results of operations and earnings (loss) per share. We have not determined the effect of adopting SFAS 123R and we have not determined whether the adoption will result in amounts similar to the current pro-forma disclosures under SFAS 123.
In December 2004, FASB issued FASB Staff Position No. SFAS 109-a, Application of FAS 109 for the Tax Deduction Provided to U.S. Based Manufacturers by the American Job Creation Act of 2004, and FASB Staff Position No. SFAS 109-b, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. The American Jobs Creation Act of 2004 (“Act”) repeals export tax benefits, transitions in a new tax deduction for qualifying U.S. manufacturing activities and provides for the repatriation of earnings from foreign subsidiaries at reduced federal income tax rates. These two staff positions provide accounting and disclosure guidance related to the American Job Creation Act of 1004. The Act will have no effect on our fiscal 2005 tax liability; however, we are evaluating the impact on future years.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions. SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, Accounting for Nonmonetary Transactions, and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for periods beginning after June 15, 2005. We do not expect that adoption of SFAS 153 will have a material effect on our financial position, results of operations, or liquidity.
In March 2005, the FASB issued FASB Interpretation (“FIN”) No. 47, Accounting for Conditional Asset Retirement Obligations, which clarifies the term conditional asset retirement obligation as used in SFAS No. 143, Accounting for Asset Retirement Obligations, as a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the corporation. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005. Adoption is not expected to have a material impact on our financial position, results of operation or cash flows.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which requires the direct effects of voluntary accounting principle changes to be retrospectively applied to prior periods’ financial statements. SFAS 154 does not change the transition provisions of any existing accounting pronouncements, but would apply in the unusual instance that a pronouncement does not include specific transition provisions. SFAS 154 maintains existing guidance with respect to accounting estimate changes and corrections of errors, and is effective for us beginning in fiscal year 2007. Adoption is not expected to have a material impact on our financial position, results of operation or cash flows.
Note 2 — Acquisition of Larscom Incorporated
On July 28, 2004, we completed our acquisition of Larscom Incorporated (“Larscom”) and issued approximately 5,948,652 shares of our common stock for all the outstanding stock of Larscom. We also assumed all outstanding stock options and warrants of Larscom. Larscom manufactures and markets high-speed network-access products for telecommunication service providers and corporate enterprise users. This acquisition reflects our strategy to pursue revenue growth, and brings a complementary customer base and product synergies. The results for fiscal 2005 include the results of Larscom since July 29, 2004, the first date after the closing of the acquisition.
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The acquisition was recorded under the purchase method of accounting, and the purchase price was allocated based on the fair value of the assets acquired and liabilities assumed. The goodwill recorded as a result of the acquisition will not be amortized but will be included in our review of goodwill for impairment. The total purchase price of $27,859,000 consisted of (a) approximately 5,948,652 shares of our common stock issued upon consummation and valued at approximately $26,043,000, using a fair value per share of $4.378, (b) approximately $516,000 of consideration for options and warrants to purchase approximately 983,306 equivalent shares of our common stock assumed as part of the acquisition, and (c) direct transaction costs of approximately $1,300,000, including 91,028 shares of our common stock valued at $281,000. The fair value of our common stock issued was determined using the five-trading-day average price surrounding the date the acquisition was announced (April 29, 2004). The fair value of options and warrants assumed in the transaction was determined using the Black-Scholes option-pricing model and the following assumptions: (i) options assumed that are expected to terminate within one year following the date of closing – expected life of 0.57 years, risk-free interest rate of 1.20%, expected volatility of 85.37% and no expected dividend yield, (ii) all other options assumed – expected life of 3.06 years, risk-free interest rate of 2.99%, expected volatility of 143.10% and no expected dividend yield, and (iii) warrants assumed – remaining contractual life of 0.26 years, risk-free interest rate of 1.20% and expected volatility of 85.37%. A summary of the total purchase consideration is as follows (in thousands):
Value of common stock issued | | $ | 26,043 | |
Value of options and warrants assumed | | | 516 | |
Direct transaction costs | | | 1,300 | |
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Total purchase consideration | | $ | 27,859 | |
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The purchase consideration was allocated to the estimated fair values of the assets acquired and liabilities assumed. Based upon management’s estimate of fair value, which was based upon an independent valuation, the purchase price allocation is as follows (in thousands, except years):
| | Purchase Price
Allocation | | Amortization
Life | |
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Tangible assets | | $ | 13,163 | | | various | |
Goodwill | | | 15,561 | | | — | |
Developed technology | | | 4,566 | | | 4 – 6 years | |
Customer relationships | | | 3,278 | | | 10 years | |
Trademarks | | | 924 | | | 6 years | |
Liabilities assumed | | | (9,633 | ) | | — | |
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Total purchase price allocation | | $ | 27,859 | | | | |
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The acquisition was funded through the issuance of common stock and available cash.
Pro Forma Financial Information – The following unaudited pro forma summary combines our results as if the acquisition of Larscom had occurred on June 28, 2003. Certain adjustments have been made to reflect the impact of the purchase transaction. These pro forma results have been prepared for comparative purposes only and are not indicative of what would have occurred had the acquisition been made at the beginning of the respective periods, or of the results which may occur in the future (in thousands, except per share amounts).
| | Fiscal Year Ended | |
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| | | July 1,
2005 | | | July 2,
2004 | |
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Net sales | | $ | 54,745 | | $ | 82,425 | |
Net loss | | $ | (40,314 | ) | $ | (11,063 | ) |
Earnings (loss) per share, basic | | $ | (1.77 | ) | $ | (0.52 | ) |
Earnings (loss) per share, diluted | | $ | (1.77 | ) | $ | (0.52 | ) |
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Note 3 — Restructuring Charges
In March 2004, we announced plans to consolidate certain manufacturing and administrative activities in Aurora, Colorado with our operations in Madison, Alabama. We recorded pretax restructuring charges totaling $26,000 and $390,000 in fiscal 2005 and 2004, respectively, in the consolidated statement of operations in connection with these restructuring activities which include severance and other termination benefits. This restructuring resulted in a reduction in workforce of approximately 17 employees, or 10% of our total workforce. We completed these consolidation activities during the first quarter of fiscal 2005.
In September 2004, we announced plans to consolidate our engineering functions into our Madison, Alabama and Newark, California facilities. As a result of this resource alignment, we closed our Santa Barbara, California office and transitioned the engineering located in Aurora, Colorado to the appropriate facility in either Madison, Alabama or Newark, California. We substantially completed the engineering consolidation during the second quarter of fiscal 2005. As part of this engineering consolidation plan, we reduced our workforce by approximately 5% and recorded restructuring charges totaling $624,000 in fiscal 2005, including $576,000 for one-time termination benefits for departing personnel and $48,000 for other costs associated with office and resource re-alignment. This restructuring activity was completed in the third quarter of fiscal 2005.
In connection with our acquisition of Larscom on July 28, 2004, we assumed restructuring accruals totaling $2,811,000 recorded as restructuring charges by Larscom in periods prior to the acquisition date, which included the following items explained in more detail below: (i) real estate lease related to the closure of the Larscom facility in Durham, North Carolina, (ii) real estate lease related to the abandonment of the former Larscom headquarters in Milpitas, California, and (iii) charges related to the planned reduction in work force of certain Larscom positions in connection with our acquisition of Larscom.
Larscom closed its facility in Durham, North Carolina in 2001, but remained financially responsible for the existing lease and recorded the remaining lease payments as a restructuring charge. Larscom entered into a sublease agreement for the entire 27,000 square foot facility with a start-up company (“Sub-tenant”) that had a commencement date of February 15, 2002. Due to the uncertainty of the receipt of income under the sublease, restructuring expenses are reduced as the sublease income is received. As of July 28, 2004, the balance in the restructuring accrual totaled $1,299,000. We made monthly payments during fiscal 2005 totaling $324,000 which reduced the accrual. Sublease payments received during fiscal 2005, including amounts drawn under the letter of credit provided by the Sub-tenant, totaling $238,000 were recorded as a reduction in restructuring charges in the consolidated statement of operations. The Sub-tenant is currently in default under the sublease agreement and is working to obtain additional sources of financing. We expect the remaining lease obligation will be paid out by January 2007. An adjustment totaling $200,000 was recorded in fiscal 2005 to reduce the amount of the accrual to the estimated remaining amounts to be paid. No additional restructuring costs are expected to be incurred related to this lease.
During 2003, Larscom abandoned its former headquarters in Milpitas, California. As of July 28, 2004, the balance in the accrual related to this abandonment totaled $42,000, which relates to estimated final payment of costs for the lease that expired in August 2004. After further review, no additional payments were required and the balance in this accrual was credited to restructuring charges in the consolidated statement of operations.
In connection with the Larscom acquisition, we announced plans to eliminate redundant positions and to consolidate certain manufacturing and administrative positions in Newark, California with our operations in Madison, Alabama. We assumed a liability totaling $1,470,000 for employment termination costs as of the acquisition date recorded in accordance with EITF 95-3. We recorded additional restructuring charges in fiscal 2005 totaling approximately $434,000 related to additional employment termination costs. We completed these consolidation activities during the second quarter of fiscal 2005. This restructuring reserve assumed in the Larscom acquisition was reduced a total of $329,000 in fiscal 2005 due to changes in the employment status of certain employees and other adjustments.
-52-
The following table provides details of the activity and remaining balances for restructuring charges as of July 1, 2005 (in thousands):
| | Total
Charges | | Real Estate
and Other
Costs | | Employee
Termination
Costs | |
| |
|
| |
|
| |
|
| |
XEL Consolidation: | | | | | | | | | | |
Balance as of July 2, 2004 | | $ | 390 | | $ | — | | $ | 390 | |
Restructuring charge in fiscal 2005 | | | 26 | | | — | | | 26 | |
Payments made in cash | | | (416 | ) | | — | | | (416 | ) |
| |
|
| |
|
| |
|
| |
Balance as of July 1, 2005 | | $ | — | | $ | — | | $ | — | |
| |
|
| |
|
| |
|
| |
Engineering Consolidation: | | | | | | | | | | |
Balance as of July 2, 2004 | | $ | — | | $ | — | | $ | — | |
Restructuring charge in fiscal 2005 | | | 624 | | | 48 | | | 576 | |
Payments made in cash | | | (624 | ) | | (48 | ) | | (576 | ) |
| |
|
| |
|
| |
|
| |
Balance as of July 1, 2005 | | $ | — | | $ | — | | $ | — | |
| |
|
| |
|
| |
|
| |
2001 Restructuring (Larscom): | | | | | | | | | | |
Balance as of July 2, 2004 | | $ | — | | $ | — | | $ | — | |
Assumed as of July 28, 2004 | | | 1,299 | | | 1,299 | | | — | |
Payments made in cash | | | (324 | ) | | (324 | ) | | — | |
Adjustment to restructuring charge | | | (200 | ) | | (200 | ) | | — | |
| |
|
| |
|
| |
|
| |
Balance as of July 1, 2005 | | $ | 775 | | $ | 775 | | $ | — | |
| |
|
| |
|
| |
|
| |
2003 Restructuring (Larscom): | | | | | | | | | | |
Balance as of July 2, 2004 | | $ | — | | $ | — | | $ | — | |
Assumed as of July 28, 2004 | | | 42 | | | 42 | | | — | |
Adjustment to restructuring charge | | | (42 | ) | | (42 | ) | | — | |
| |
|
| |
|
| |
|
| |
Balance as of July 1, 2005 | | $ | — | | $ | — | | $ | — | |
| |
|
| |
|
| |
|
| |
Larscom Consolidation: | | | | | | | | | | |
Balance as of July 2, 2004 | | $ | — | | $ | — | | $ | — | |
Established as of July 28, 2004 | | | 1,470 | | | — | | | 1,470 | |
Restructuring charge in fiscal 2005 | | | 434 | | | — | | | 434 | |
Payments made in cash | | | (1,574 | ) | | | | | (1,574 | ) |
Adjustment to restructuring charge | | | (329 | ) | | — | | | (329 | ) |
| |
|
| |
|
| |
|
| |
Balance as of July 1, 2005 | | $ | 1 | | $ | — | | $ | 1 | |
| |
|
| |
|
| |
|
| |
Note 4 — Restricted Cash and Short-Term Investments
As of July 1, 2005, restricted cash of $333,000 consists of a deposit with our bank for an irrevocable letter of credit for a like amount that is used as collateral for the lease on the Newark, California facility.
-53-
Note 5 — Balance Sheet Components
| | July 1,
2005 | | July 2,
2004 | |
| |
|
| |
|
| |
| | (in thousands) | |
Inventories: | | | | | | | |
Raw materials | | $ | 8,792 | | $ | 5,828 | |
Work-in-process | | | 93 | | | 140 | |
Finished goods | | | 4,418 | | | 2,254 | |
Miniplex inventory purchase commitment | | | 586 | | | 1,104 | |
| |
|
| |
|
| |
| | | 13,889 | | | 9,326 | |
Less: Inventory reserves | | | (8,633 | ) | | (3,316 | ) |
| |
|
| |
|
| |
Inventories, net | | $ | 5,256 | | $ | 6,010 | |
| |
|
| |
|
| |
Property, plant and equipment: | | | | | | | |
Furniture, fixtures and office equipment | | $ | 6,258 | | $ | 6,558 | |
Machinery and equipment | | | 5,216 | | | 4,384 | |
Leasehold improvements | | | 431 | | | 207 | |
Projects in progress | | | — | | | 15 | |
| |
|
| |
|
| |
| | | 11,905 | | | 11,164 | |
Less: Accumulated depreciation | | | (10,208 | ) | | (9,783 | ) |
| |
|
| |
|
| |
Property, plant and equipment, net | | $ | 1,697 | | $ | 1,381 | |
| |
|
| |
|
| |
Note 6 — Property Held for Lease
We own a facility in Huntsville, Alabama located at 950 Explorer Boulevard. In August 2002, we entered into an agreement with The Boeing Company (“Boeing”) to lease this facility through November 2007. The lease provides an option for Boeing to extend the lease term for five additional two-year periods. Rental income for the fiscal years ended July 1, 2005 and July 2, 2004 totaled $795,000 and $785,000, respectively.
Property held for lease consists of the following at July 1, 2005 and July 2, 2004 (in thousands):
| | July 2,
2004 | | July 2,
2004 | |
| |
|
| |
|
| |
Land | | $ | 1,400 | | $ | 1,400 | |
Building and improvements | | | 5,462 | | | 5,462 | |
Machinery and equipment | | | 44 | | | 44 | |
| |
|
| |
|
| |
| | | 6,906 | | | 6,906 | |
Less: Accumulated depreciation | | | (830 | ) | | (637 | ) |
| |
|
| |
|
| |
Property held for lease, net | | $ | 6,076 | | $ | 6,269 | |
| |
|
| |
|
| |
Future minimum rental income on this operating lease over the non-cancelable period as of July 1, 2005 is as follows (in thousands):
Fiscal years ending June: | | | | |
2006 | | $ | 900 | |
2007 | | | 900 | |
2008 | | | 375 | |
| |
|
| |
| | $ | 2,175 | |
| |
|
| |
-54-
Note 7 —Goodwill
The changes in the carrying amount of goodwill for the years ended July 1, 2005 and July 2, 2004, are as follows (in thousands):
| | Fiscal Year Ended | |
| |
| |
| | July 1,
2005 | | July 2,
2004 | |
| |
|
| |
|
| |
Balance as of beginning of fiscal year | | $ | 9,887 | | $ | — | |
Goodwill acquired during the fiscal year | | | 15,561 | | | 9,887 | |
Impairment losses | | | (24,334 | ) | | — | |
| |
|
| |
|
| |
Balance as of end of fiscal year | | $ | 1,114 | | $ | 9,887 | |
| |
|
| |
|
| |
During fiscal 2005, we completed an interim test for impairment of goodwill due to triggering events that occurred during the first quarter that we believed would more likely than not, reduce the fair value of goodwill below our carrying value. These triggering events were (a) the loss of product revenues from a significant customer, (b) the low level of liquidity noted in an explanatory paragraph included in the independent registered public accounting firm’s report on our fiscal 2004 consolidated financial statements which were filed in our Form 10-K on October 1, 2004, and (c) the low market price of our common stock following the end of the first quarter. Based on the initial impairment assessment, we determined that the fair value of our reporting unit was less than our carrying value after considering a combination of quoted market prices and discounted cash flows. In order to determine the amount of the goodwill impairment, we prepared a purchase price allocation using a discounted cash flow model utilizing the assistance of a third party valuation specialist. The projected discounted cash flow model was prepared using a discount rate commensurate with the risk inherent in our current business model. As a result, we recorded an impairment charge related to goodwill in the first quarter of fiscal 2005 totaling $19,984,000.
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we completed our annual impairment test of goodwill as of July 1, 2005. We again prepared a purchase price allocation using a discounted cash flow model with a discount rate commensurate with the risk inherent in our current business model. The test concluded that the fair value of our reporting unit was less than our carrying value. As a result, we recorded an impairment charge related to goodwill in the fourth quarter of fiscal 2005 totaling $4,350,000.
Prior to the first quarter of fiscal 2005, our annual impairment assessment considered the carrying value of our equity to our market capitalization calculated by multiplying our outstanding shares by our current share price, disregarding anomalies in share price that we deemed were temporary in nature. Due to the changes in facts and circumstances caused by the loss of product revenues from Nortel Networks (our largest customer in fiscal 2004), the significant volatility in our share price from the end of our 2004 fiscal year through the filing of our Quarterly Report on Form 10-Q for the first quarter of fiscal 2005, and our low level of liquidity, we considered both quoted market prices and discounted cash flows as fair value models and concluded that a projected discounted cash flow model is a better indicator of our fair value, as that term is contemplated in SFAS No. 142 than the market capitalization model used historically.
With the adoption of SFAS No. 142 in fiscal 2003, we completed a transitional impairment test of all goodwill and intangible assets as of June 29, 2002. The test concluded that goodwill was impaired. A transitional impairment loss of $1,233,000 was recorded in fiscal 2003 as a cumulative change in accounting principle in the consolidated statement of operations.
Note 8 –Other Intangible Assets
Acquired other intangible assets subject to amortization are as follows (in thousands):
| | July 1, 2005 | | July 2, 2004 | |
| |
| |
| |
| | Gross
Carrying
Costs | | Accumulated
Amortization | | Gross
Carrying
Costs | | Accumulated
Amortization | |
| |
|
| |
|
| |
|
| |
|
| |
Customer relations | | $ | 11,834 | | $ | 3,158 | | $ | 8,556 | | $ | 2,117 | |
Developed technology | | | 6,362 | | | 2,242 | | | 2,390 | | | 1,105 | |
Trademarks | | | 917 | | | 460 | | | 1,549 | | | 91 | |
| |
|
| |
|
| |
|
| |
|
| |
| | $ | 19,113 | | $ | 5,860 | | $ | 12,495 | | $ | 3,313 | |
| |
|
| |
|
| |
|
| |
|
| |
-55-
Amortization expense relating to other intangible assets was $2,546,000, $1,026,000 and $484,000 for fiscal 2005, 2004 and 2003, respectively. The approximate future annual amortization for other intangible assets is as follows (in thousands):
Fiscal years ending June: | | | | |
2006 | | $ | 2,256 | |
2007 | | $ | 2,180 | |
2008 | | $ | 1,959 | |
2009 | | $ | 1,608 | |
2010 | | $ | 1,464 | |
Thereafter | | $ | 3,786 | |
In fiscal 2005, we also recognized $2,150,000 in impairment losses on certain identified intangible assets (trade names and existing technology) acquired primarily in connection with the Larscom and XEL acquisitions. We stopped using the XEL trade name in fiscal 2005, which resulted in the impairment of this asset. Projected sales and margins of some of the acquired products have been lower than expected. As a result, projected future cash flows related to the existing technology intangible assets were determined to be less than the carrying values. The revised carrying values of these intangible assets were calculated using discounted estimated future cash flows. We also determined that the remaining useful life of the customer relations intangible asset acquired in the XEL acquisition should be reduced from thirteen and one-half years to ten years. The residual balance for this intangible asset, $4,603,000, will be amortized over the remaining ten years on a straight-line basis.
Note 9 — Transfer of Financial Assets
During fiscal 2003, we transferred and assigned certain pre-bankruptcy accounts receivable due from WorldCom, Inc. (“WorldCom”) to third parties subject to recourse under certain conditions, which would require us to repurchase the WorldCom receivables from the purchasers plus interest at seven percent. The amount received under these agreements of $164,000 was recorded as a secured borrowing and included in accrued expenses in the consolidated balance sheets in prior fiscal years. During fiscal 2005, the conditions that would require repurchase lapsed, and the amount received was recorded as a credit to bad debt expense in the consolidated statement of operations.
Note 10 — Warranty Liability
We generally warrant our products for a five-year period, except for certain product families which provide a warranty period of one year, three years or as required by contract. A reconciliation of the changes in warranty liability for the fiscal years ended July 1, 2005 and July 2, 2004, respectively, is as follows (in thousands):
| | Fiscal Year Ended | |
| |
| |
| | July 1,
2005 | | July 2,
2004 | |
| |
|
| |
|
| |
Balance as of beginning of fiscal year | | $ | 1,192 | | $ | 1,374 | |
Additions: | | | | | | | |
Accruals for product warranties issued during the period | | | 305 | | | 212 | |
Assumed in acquisition | | | 1,018 | | | 60 | |
Change in estimate adjustment | | | (800 | ) | | (200 | ) |
Less settlements charged against the liability | | | (425 | ) | | (254 | ) |
| |
|
| |
|
| |
Balance as of end of fiscal year | | $ | 1,290 | | $ | 1,192 | |
| |
|
| |
|
| |
Note 11 — Note Payable to Bank
In connection with the issuance of the senior convertible notes discussed in Note 12 below, the amount outstanding under the revolving line of credit with RBC totaling $3,500,000 was repaid and the loan and security agreement terminated as of March 21, 2005. The interest on outstanding borrowings was at a rate of 250 basis points over the 30-day London inter-bank offered rate. All of our assets, other than the property subject to lease and restricted cash, were pledged as collateral securing amounts outstanding under this line.
-56-
Note 12 — Long-Term Debt
Long-term debt and capital lease obligations consist of the following (in thousands):
| | July 1,
2005 | | July 2,
2004 | |
| |
|
| |
|
| |
Senior convertible notes, 6% coupon rate, payable in $1,000,000 quarterly payments beginning in July 2005 (or sooner under certain circumstances), net of unamortized discount of $2,424 | | $ | 7,576 | | $ | — | |
Note payable on real estate | | | 3,319 | | | 3,723 | |
Convertible promissory notes | | | 2,880 | | | 3,001 | |
Capital lease obligations | | | 149 | | | 25 | |
| |
|
| |
|
| |
| | | 13,924 | | | 6,749 | |
Less: Current portion of long-term debt and lease obligations | | | (8,727 | ) | | (487 | ) |
| |
|
| |
|
| |
Long-term debt | | $ | 5,197 | | $ | 6,262 | |
| |
|
| |
|
| |
Senior Convertible Notes
In March 2005, we entered into a securities purchase agreement for the private placement of up to $15,000,000 of senior convertible notes to six institutional investors. We issued an initial $10,000,000 of senior convertible notes, which can be converted into common stock at an initial price of $3.01 per share. The conversion price of the senior convertible notes will be subject to weighted average anti-dilution adjustments. The senior convertible notes may not be converted into more than 20% of the number of shares or voting power of our common stock outstanding as of the closing of the financing until such conversion or exercise has been approved by our stockholders. We recorded initial discounts of (i) $1,870,000 from the allocation of the proceeds to the debt and warrants in accordance with Accounting Principles Board Opinion No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants, and (ii) $1,077,000 related to debt issuance costs. As of July 1, 2005, a total of $10,000,000 in face value of senior convertible notes was outstanding. These senior convertible notes are recorded in the consolidated balance sheet at July 1, 2005, at the discounted amount of $7,576,000. We are recording the difference between the face value and discounted amount as additional interest expense over the estimated life of the senior convertible notes. In connection with this transaction, we also issued warrants to purchase shares of our common stock as described in Note 14 – Stock Warrants.
The senior convertible notes bear interest at a rate of six percent per annum and are repayable in ten quarterly installments beginning in July 2005, or earlier upon the occurrence of certain events. Payment of both principal and interest may be made in either cash or, provided that we have obtained stockholder approval to the extent necessary, by the delivery of shares of common stock at a price equal to the lower of (i) the conversion price of $3.01 or (ii) 90% of the weighted average sale price of our common stock for the fifteen consecutive trading days ending on the fourth trading day immediately preceding the applicable interest or installment payment date. Such issuance of common stock will not result in anti-dilution adjustments to the conversion price of the senior convertible notes. If by November 21, 2005, we have not obtained stockholder approval of the issuance of the senior convertible notes, the warrants and the shares of common stock to be issued thereunder and an increase in our authorized capital of at least 10,000,000 shares of common stock, we will be required to make at least 50% of interest and installment payments made after such date in cash. If, as of the end of each fiscal quarter during the period in which the senior convertible notes are outstanding, we fail to maintain certain minimum working capital requirements, as defined in the notes, the holders of the senior convertible notes may require us to make an additional installment payment under the senior convertible notes which shall be, at the option of each holder, such holder’s pro rata portion of one of the following: (1) the difference between (A) the unpaid principal, interest and any late charges then remaining under the senior convertible notes and (B) 60% of our working capital amount, as determined in accordance with the terms of the senior convertible notes, (2) $2,000,000 or (3) such lesser amount if reduced in accordance with the terms of the senior convertible notes. Substantially all of our assets are pledged as collateral for amounts outstanding under the senior convertible notes.
-57-
Note Payable on Real Estate
In connection with our June 2000 acquisition of a facility in Huntsville, Alabama located at 950 Explorer Boulevard, we entered into a loan agreement with Regions Bank to borrow up to $6,000,000 to finance the purchase of the property and to make improvements thereon. In December 2000, we entered into a second agreement with Regions Bank to borrow an additional $500,000 to finance further improvements to the facility. The land and building are provided as collateral for amounts outstanding under these agreements. In June 2004, the outstanding balances under the two loan agreements were combined under one note, which requires a monthly payment of $50,000. The interest is at a rate of 225 basis points over the 30 day London inter-bank offered rate, which was 5.34% at July 1, 2005. As of July 1, 2005, the amount outstanding under this note totaled $3,319,000. The final balloon payment of approximately $3,039,000 is due on February 1, 2006.
Convertible Promissory Notes
We issued two convertible promissory notes in February 2004 totaling $10,480,000 in connection with our acquisition of XEL Communications, Inc. In May 2004, the holder of the $10,000,000 convertible promissory note converted $7,250,000 of the outstanding principal amount of the note into 1,361,758 shares of our common stock. These convertible promissory notes earn interest at a rate of 7% per annum and mature February 5, 2006. The holders may convert the note in whole or in increments of at least $1,000,000 into our common stock at a conversion price of $5.324 per share. If the holders convert any portion of the convertible promissory notes, the holders must repay all interest received by them on the portion of the convertible promissory note converted before we will issue the common stock. Interest expense will be reduced by the amount of interest repaid by the holders in the period the convertible promissory note is converted into common stock. Under the terms of the $10,000,000 convertible promissory note, the note was reduced by $350,000 for payment of retention bonuses in February 2005 to certain XEL employees pursuant to retention agreements between us and the employees. As the retention bonuses were accrued and charged to compensation expense, the carrying value of the convertible promissory note was reduced and other income from the loan reduction was recorded, which totaled $121,000 and $229,000 in fiscal 2005 and 2004, respectively.
Capital Lease Obligations
Long-term debt at July 1, 2005 also includes three capital lease obligations totaling $149,000, which currently require monthly payments totaling $6,309, including interest at rates ranging from 10% to 13.6%. These leases terminate on various dates between March 2006 and February 2010.
Long-term debt and capital lease obligations are payable as follows (in thousands):
Fiscal year, | | | | |
| | | | |
2006 | | $ | 8,727 | |
2007 | | | 3,235 | |
2008 | | | 1,944 | |
2009 | | | 10 | |
2010 | | | 8 | |
| |
|
| |
Total | | $ | 13,924 | |
| |
|
| |
-58-
Note 13 — Income Taxes
The provision for (benefit from) income taxes consists of the following (in thousands):
| | Fiscal Year Ended | |
| |
| |
| | July 1,
2005 | | July 2,
2004 | | June 27,
2003 | |
| |
|
| |
|
| |
|
| |
Current: | | | | | | | | | | |
Federal | | $ | — | | $ | — | | $ | — | |
State | | | — | | | — | | | — | |
| |
|
| |
|
| |
|
| |
| | | — | | | — | | | — | |
| |
|
| |
|
| |
|
| |
Deferred: | | | | | | | | | | |
Federal | | | (12,677 | ) | | (238 | ) | | 991 | |
State | | | (2,381 | ) | | (54 | ) | | 195 | |
Change in valuation allowance | | | 15,058 | | | 292 | | | (1,186 | ) |
| |
|
| |
|
| |
|
| |
| | $ | — | | $ | — | | $ | — | |
| |
|
| |
|
| |
|
| |
The provision for (benefit from) federal income taxes differs from the amount computed by applying the statutory rate of 34% to taxable income as follows (in thousands):
| | Fiscal Year Ended | |
| |
| |
| | July 1,
2005 | | July 2,
2004 | | June 27,
2003 | |
| |
|
| |
|
| |
|
| |
Expected federal income tax provision (benefit) | | $ | (12,734 | ) | $ | (9 | ) | $ | 936 | |
State taxes, net of federal benefit | | | (2,381 | ) | | (54 | ) | | 195 | |
Change in valuation allowance | | | 15,058 | | | (24 | ) | | (1,186 | ) |
Amortization of goodwill | | | — | | | 42 | | | 103 | |
Other | | | 57 | | | 45 | | | (48 | ) |
| |
|
| |
|
| |
|
| |
| | $ | — | | $ | — | | $ | — | |
| |
|
| |
|
| |
|
| |
The components of the net deferred income tax assets and liabilities at July 1, 2005 and July 2, 2004, are as follows (in thousands):
| | | July 1,
2005 | | | July 2,
2004 | |
| |
|
| |
|
| |
Net operating loss | | $ | 29,300 | | $ | 12,224 | |
Intangible assets | | | 17,716 | | | 299 | |
Credit carry forwards | | | 3,857 | | | 59 | |
Inventory reserves | | | 3,518 | | | 1,078 | |
Property, plant and equipment | | | 1,342 | | | 611 | |
Other reserves and accruals | | | 1,337 | | | 650 | |
Inventory overhead allocation under UNICAP | | | 766 | | | 499 | |
Warranty provisions | | | 409 | | | 345 | |
Impairment of long-lived assets | | | — | | | 306 | |
Deferred revenue | | | 385 | | | 326 | |
Other | | | 1,173 | | | 386 | |
| |
|
| |
|
| |
Total deferred tax assets | | | 59,803 | | | 16,783 | |
Valuation allowance | | | (59,803 | ) | | (16,783 | ) |
| |
|
| |
|
| |
Net deferred tax assets | | $ | — | | $ | — | |
| |
|
| |
|
| |
At July 1, 2005, the valuation allowance increased by $27,962,000 for deferred tax assets acquired in the Larscom acquisition for which uncertainty exists surrounding the realization of such assets. The valuation allowance will first be used to reduce goodwill and other intangible assets when any portion of the related deferred tax asset is recognized.
-59-
At July 1, 2005, we had net operating loss carry forwards of approximately $74,071,000 for federal income tax purposes, which will begin to expire in the year 2016, and $60,980,000 for state income tax purposes, which begin to expire in 2006. We also had credit carry forwards of $3,803,000 available to offset future income, which expire in 2006 through 2021.
The Tax Reform Act of 1996 limits the use of net operating losses in certain situations where changes occur in the stock ownership of a company. The availability and timing of net operating losses carried forward to offset the taxable income may be limited due to the occurrence of certain events, including change of ownership.
Note 14 — Capitalization
Preferred Stock
We have 1,000,000 shares of $0.01 par value preferred stock authorized, of which 40,000 shares have been reserved for issuance in connection with a preferred stock rights plan. The right entitles the holder to purchase from us one one-thousandth of a share of Series A Junior Participating Preferred Stock at a price of $22.00. The rights were distributed at the rate of one right for each share of common stock as a non-taxable dividend and will expire December 2011. The rights will be exercisable only in the event that a person or group acquires 20% or more of our outstanding common stock.
Treasury Stock
We recorded 97,218 shares received as treasury stock with a value of $247,000 related to shares withheld in payment of required tax withholdings on stock awards that vested during fiscal 2005. The employees elected to reduce the shares received in payment of the required tax withholdings, which we remitted to the taxing authorities. The shares received were retired during fiscal 2005.
We retired 2,912 shares and 1,409 shares of our common stock during fiscal 2005 and 2004, respectively, forfeited upon termination of employees with restricted stock awards.
We received 343,034 shares of our common stock in November 2003 from our President and Chief Executive Officer in repayment of the outstanding amount owed to us (see Note 17). These shares were recorded by us as treasury stock and retired in December 2003.
During fiscal 2003, our Board of Directors approved a program to repurchase up to $1,000,000 of our common stock. The program allowed us to repurchase shares on the open market based on market conditions, availability of cash consistent with our operating plan, and in accordance with the requirements of the Securities and Exchange Commission. Under this program, we re-purchased 50,000 shares of our common stock during the fiscal year ended June 27, 2003 at a total cost of $49,000.
Also during fiscal 2003, we received 289,824 shares of our common stock from our President and Chief Executive Officer in repayment of outstanding amounts owed to us (see Note 17). These shares were recorded by us as treasury stock. In June 2003, these shares and the 50,000 shares acquired in the stock re-purchase program were retired.
Stock Warrants
On March 21, 2005, we issued warrants in connection with the issuance of the $10,000,000 senior convertible notes to purchase up to 830,563 shares of our common at a price per share of $3.41. These warrants have a term of five years and are exercisable beginning September 21, 2005.
In accordance with EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, the warrants were originally valued at fair value on the date of issuance and were included as a liability. The fair value of the warrants was determined using the Black-Scholes option-pricing model and the following assumptions: expected life of 5 years, risk-free interest rate of 4.18%, expected volatility of 133.01% and no
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expected dividend yield. As a liability, we recorded other income of $544,000 related to the change in fair value from the date of issuance of these warrants to April 18, 2005, the effective date of the registration statement for the underlying shares. The change in fair value recorded as other income is included as a component of Interest and other income, net, in our consolidated statement of operations. On the effective date of the registration statement, the warrants liability totaling $1,326,000 was reclassified to additional paid in capital in the consolidated balance sheet.
Note 15 — Employee Benefit Plans
2004 Stock Incentive Plan
A total of 2,300,000 shares of common stock are reserved for issuance under the 2004 Stock Incentive Plan (the “2004 Plan”) to eligible employees, officers, directors, and other service providers upon the exercise of equity based incentives, including incentive stock options (“ISOs”), NSOs, stock appreciation rights, stock awards and other stock incentives. In addition, the number of shares of common stock for issuance under the 2004 Plan will automatically increase by the lesser of (a) 1,000,000 or (b) the result of 1,800,000 minus the maximum number of shares available for issuance under the 2004 Plan immediately prior to the calculation of the annual adjustment. These automatic annual increases will be made as of the last day of our fiscal year until the expiration of its term. Therefore, on July 1, 2005, shares under the 2004 Plan increased by 1,000,000 shares. The number of shares of our common stock reserved will be reduced only by the number of shares actually issued to participants in the 2004 Plan. The 2004 Plan was approved by stockholders at a meeting on July 28, 2004. Options granted under the 2004 Plan must be for option periods not to exceed ten years at prices not less than 100% and 85% for ISOs and NSOs, respectively, of the fair market value of the stock on the date of grant. Options granted under the 2004 Plan to employees typically provide for the immediate exercise of the option with a four-year vesting period, provided that the optionee remains continuously employed by us. Upon cessation of employment for any reason, we have the option to repurchase all unvested shares of common stock issued upon exercise of an option at a repurchase price equal to the exercise price of such shares. A total of 1,047,994 of the options outstanding as of July 1, 2005 in the table below were issued under the 2004 Plan.
2004 New Hire Stock Incentive Plan
A total of 500,000 shares of common stock are reserved for issuance under the 2004 New Hire Stock Incentive Plan (the “New Hire Plan”) to eligible newly hired employees, officers, directors and other service providers upon the exercise of equity based incentives, including nonqualified stock options (“NSOs”), stock appreciation rights, stock awards and other stock incentives. The number of shares of our common stock reserved will be reduced only by the number of shares actually issued to participants in the New Hire Plan. The New Hire Plan was adopted by our Board of Directors on December 6, 2004. The term and exercise price for options granted under the New Hire Plan are determined by the administrative committee on the date of grant. Options granted under the New Hire Plan to employees typically provide for the immediate exercise of the option with a four-year vesting period, provided that the optionee remains continuously employed by us. Upon cessation of employment for any reason, we have the option to repurchase all unvested shares of common stock issued upon exercise of an option at a repurchase price equal to the exercise price of such shares. A total of 314,266 of the options outstanding as of July 1, 2005 in the table below were issued under the New Hire Plan.
2002 Stock Incentive Plan
A total of 2,500,000 shares of common stock are reserved for issuance under the 2002 Stock Incentive Plan (the “2002 Plan”) to eligible employees, officers, directors, and other service providers upon the exercise of equity based incentives, including ISOs, NSOs, stock appreciation rights, stock awards and other stock incentives. Options granted under the 2002 Plan to employees generally vest over a four-year period, provided that the optionee remains continuously employed by us. ISOs granted under the 2002 Plan must be issued at prices not less than 100% of the fair market value of the stock on the date of grant and with terms not exceeding ten years. ISOs granted to stockholders who own greater than 10% of the outstanding stock must be issued at prices not less than 110% of the fair market value of the stock on the date of grant and with terms not exceeding five years. A total of 1,907,081 of the options outstanding as of July 1, 2005 in the table below were issued under the 2002 Plan.
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1993 Amended and Restated Stock Option Plan
The 2002 Plan replaced our 1993 Amended and Restated Stock Option Plan (the “1993 Plan”) with respect to shares available for future grant. A total of 1,825,864 of the options outstanding as of July 1, 2005 in the table below were issued under the 1993 Plan. Options granted under the 1993 Plan were for periods not to exceed ten years and were issued at prices not less than 100% and 85% for ISOs and NSOs, respectively, of the fair market value of the stock on the date of grant. Options granted under the 1993 Plan to employees are generally exercisable immediately and the shares issued upon exercise generally vest over a four-year period, provided that the optionee remains continuously employed by us. Upon cessation of employment for any reason, we have the option to repurchase all unvested shares of common stock issued upon exercise of an option at a repurchase price equal to the exercise price of such shares. A total of 1,825,864 of the options outstanding as of July 1, 2005 in the table below were issued under the 1993 Plan.
Stock Options Assumed
In connection with our acquisition of Larscom in July 2004, we assumed all the outstanding options under the Larscom stock incentive plans, including ISOs and NSOs, to purchase approximately 665,172 shares of our common stock. These options were 100% vested as of the date assumed. A total of 508,049 of the options outstanding as of July 1, 2005 in the table below were assumed in the Larscom acquisition.
The following table summarizes stock option activity under our stock option plans described above and the options assumed in the Larscom acquisition:
| | Shares
Available
for Grant | | Options
Outstanding | | Weighted
Average
Exercise
Price | |
| |
|
| |
|
| |
|
| |
Balance at June 28, 2002 | | | 1,832,625 | | | 4,265,723 | | $ | 2.57 | |
Approved (2002 Plan) | | | 2,500,000 | | | — | | | — | |
Share reserve released (1993 Plan) | | | (3,347,454 | ) | | — | | | — | |
Granted | | | (580,500 | ) | | 580,500 | | | 1.12 | |
Exercised | | | — | | | (13,815 | ) | | 0.31 | |
Canceled | | | 1,615,829 | | | (1,615,829 | ) | | 3.56 | |
| |
|
| |
|
| |
|
| |
Balance at June 27, 2003 | | | 2,020,500 | | | 3,216,579 | | | 1.82 | |
Approved (2004 Plan) | | | 1,300,000 | | | — | | | — | |
Plan shares expired | | | (104,584 | ) | | — | | | — | |
Granted | | | (1,697,250 | ) | | 1,697,250 | | | 4.20 | |
Stock awards | | | (133,196 | ) | | — | | | 4.31 | |
Exercised | | | — | | | (617,743 | ) | | 1.72 | |
Canceled | | | 340,126 | | | (340,126 | ) | | 4.02 | |
| |
|
| |
|
| |
|
| |
Balance at July 2, 2004 | | | 1,725,596 | | | 3,955,960 | | | 2.67 | |
Assumed in Larscom acquisition | | | — | | | 665,172 | | | 9.25 | |
Approved (New Hire Plan) | | | 500,000 | | | — | | | — | |
Shares added at year-end (2004 Plan) | | | 1,000,000 | | | — | | | — | |
Plan shares expired | | | (203,835 | ) | | — | | | — | |
Granted | | | (2,440,352 | ) | | 2,440,352 | | | 2.21 | |
Stock awards | | | (141,196 | ) | | — | | | 1.49 | |
Exercised | | | — | | | (227,745 | ) | | 1.01 | |
Canceled | | | 1,230,485 | | | (1,230,485 | ) | | 4.19 | |
| |
|
| |
|
| |
|
| |
Balance at July 1, 2005 | | | 1,670,698 | | | 5,603,254 | | $ | 2.98 | |
| |
|
| |
|
| |
|
| |
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The following table summarizes information concerning outstanding and exercisable stock options as of July 1, 2005:
| | Options Outstanding | | Options Exercisable | |
| |
| |
| |
Range of
Exercise Prices | | Number
Outstanding | | Weighted
Average
Remaining
Contractual Life | | Weighted
Average
Exercise
Price | | Number
Exercisable | | Weighted
Average
Exercise
Price | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
$ 0.22 — $ 0.69 | | | 1,001,945 | | | 6.59 | | $ | 0.60 | | | 854,752 | | $ | 0.60 | |
$ 0.70 — $ 1.19 | | | 1,163,012 | | | 6.35 | | | 1.14 | | | 816,423 | | | 1.14 | |
$ 1.20 — $ 2.88 | | | 949,684 | | | 6.78 | | | 2.27 | | | 647,161 | | | 2.14 | |
$ 2.89 — $ 3.51 | | | 1,071,906 | | | 8.99 | | | 3.16 | | | 805,863 | | | 3.15 | |
$ 3.52 — $ 5.04 | | | 935,325 | | | 8.19 | | | 4.23 | | | 469,640 | | | 4.45 | |
$ 5.05 — $ 146.74 | | | 481,382 | | | 5.51 | | | 10.96 | | | 419,964 | | | 11.77 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
$ 0.22 — $ 146.74 | | | 5,603,254 | | | 7.21 | | $ | 2.98 | | | 4,023,803 | | $ | 3.09 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Profit Sharing Plan
Awards under our discretionary profit sharing plan are based on achieving targeted levels of profitability. We provided for awards of $48,000 and $72,000 in fiscal 2004 and 2003, respectively. No expense was incurred under the plan in fiscal 2005.
Note 16 — Retirement Plans
We have retirement plans that provide certain employment benefits to eligible employees and qualify as deferred arrangements under Section 401(k) of the Internal Revenue Code of 1986, as amended. Employees are 100% vested in their contributions to these plans, and we may match their contributions in varying amounts at our discretion. An employee’s interest in our contributions becomes 100% vested at the date participation in our retirement plan commences. Charges to results of operations for our contributions to these plans totaled $60,000, $152,000 and $84,000 in fiscal 2005, 2004 and 2003, respectively.
Note 17 — Related Party Transactions
During fiscal 2004, our President and Chief Executive Officer (“President”) repaid the outstanding note due to us totaling $2,428,000. The repayments were made as follows: (i) in September 2003, the net after tax portion of the fiscal 2003 discretionary bonus provided to the President, totaling approximately $141,000, was applied against the outstanding note, and (ii) in November 2003, the remaining principal balance of this note plus accrued interest, totaling $2,287,000, was paid by the delivery of 343,034 shares of common stock to us as contemplated by the loan documentation.
During fiscal 2003, we approved providing our President with additional relocation benefits of approximately $300,000 in connection with the sale of his California residence. In November 2002, the President made a cash payment of $675,000 against another outstanding note to us due in March 2003. The remaining balance of this note, which totaled $341,000, was paid prior to its March 2003 due date by the surrender of 289,824 shares of our common stock in accordance with the terms of the note. This note was paid in full during fiscal 2003 with total payments of $1,016,000.
Note 18 — Commitments and Contingencies
We lease various sales offices, warehouse space and equipment under operating leases that expire on various dates from June 2006 through May 2010.
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Future minimum lease payments under all non-cancelable operating leases with initial terms in excess of one year are as follows (in thousands):
Fiscal year, | | Operating
Leases | |
| |
|
| |
2006 | | $ | 1,062 | |
2007 | | | 743 | |
2008 | | | 591 | |
2009 | | | 150 | |
2010 | | | 93 | |
| |
|
| |
Total minimum lease payments | | $ | 2,639 | |
| |
|
| |
Rent expense under all non-cancelable operating leases totaled $993,000, $669,000 and $264,000 for fiscal 2005, 2004, and 2003, respectively.
As of July 1, 2005, we had approximately $3,405,000 of outstanding purchase commitments for inventory and inventory components.
We are not currently involved in any legal actions expected to have a material adverse effect on the financial conditions or our results of operations. From time to time, however, we may be subject to claims and lawsuits arising in the normal course of business.
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Item 9. Changes In and Disagreements With Accountants on Accounting And Financial Disclosure
Not Applicable.
Item 9A. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) for the company. Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures as of the end of the period covered by this annual report, have concluded that our disclosure controls and procedures are effective.
(b) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting identified in management’s evaluation that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information regarding directors appearing under the caption “Election of Directors” in the Proxy Statement is hereby incorporated by reference.
Information regarding executive officers is incorporated herein by reference from Part I hereof under the heading “Executive Officers of the Company” immediately following Item 4 in Part I hereof.
Information regarding compliance with Section 16(a) of the Securities Act of 1934, as amended, is hereby incorporated by reference to our Proxy Statement.
Verilink’s Code of Ethics, as adopted by the Audit Committee of the Board of Directors, is filed as exhibit 14.1 to our Annual Report on Form 10-K for the year ended July 2, 2004.
Item 11. Executive Compensation
The information required by this item is incorporated by reference to our Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is incorporated by reference to our Proxy Statement.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated by reference to our Proxy Statement.
Item 14. Principal Accountant Fees and Services
Information regarding principal accountant fees and services appearing under the caption “Ratification of Appointment of Independent Accountants” in the Proxy Statement is hereby incorporated by reference.
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PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) 1. Financial Statements
The financial statements (including the notes thereto) listed in the Index to Consolidated Financial Statements and Financial Statement Schedule (set forth in Item 8 of Part II of this Form 10-K) are filed within this Annual Report on Form 10-K.
2. Financial Statement Schedule
The financial statement schedule listed in the Index to Consolidated Financial Statements and Financial Statement Schedule (set forth in Item 8 of Part II of this Form 10-K) is filed as part of this Annual Report on Form 10-K.
3. Exhibits
The exhibits listed under Item 15(b) hereof are filed as part of this Annual Report on Form 10-K.
(b) Exhibits
Exhibit
Number | | | Description |
| |
|
|
2.1 | | – | Stock Purchase Agreement by and between the Registrant and The Kennedy Company, dated as of February 5, 2004 (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K dated as of February 20, 2004) |
| | | |
2.2 | | – | Agreement and Plan of Merger by and between the Registrant, SRI Acquisition Corp. and Larscom Incorporated, dated as of April 28, 2004 (incorporated by reference to Annex A to the Joint Proxy Statement/Prospectus, dated June 24, 2004, forming a part of Verilink’s Registration Statement on Form S-4 (File No. 333-116472)) |
| | | |
3.1 | | – | Registrant’s Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to our Registration Statement on Form S-1, effective June 10, 1996, Commission File No. 333-4010) |
| | | |
3.2 | | – | Registrant’s Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to our Registration Statement on Form S-1, effective June 10, 1996, Commission File No. 333-4010) |
| | | |
4.1 | | – | Reference is made to Exhibits 3.1 and 3.2 |
| | | |
4.2 | | – | Rights Agreement dated as of November 29, 2001 by and between the Registrant and EquiServe Trust Company, N.A. (incorporated by reference to Exhibit 1 to our Registration Statement on Form 8-A, effective December 6, 2001) |
| | | |
4.2A | | – | Rights Agent Appointment and Amendment No. 1 to Rights Agreement dated as of May 30, 2002 by and between the Registrant and American Stock Transfer and Trust Company (incorporated by reference to Exhibit 4.2A to our Annual Report on Form 10-K for the fiscal year ended June 28, 2002) |
| | | |
4.2B | | – | Amendment No. 2 to the Rights Agreement dated as of April 28, 2004 by and between the Registrant and American Stock Transfer & Trust Company (incorporated by reference to Exhibit 4.1 to our Current Report on Form 8-K dated as of April 30, 2004) |
| | | |
4.2C | | – | Amendment No. 3 to the Rights Agreement dated as of March 20, 2005 by and between the Registrant and American Stock Transfer & Trust Company (incorporated by reference to Exhibit 4.2C to our Current Report on Form 8-K dated as of April 19, 2005) |
| | | |
4.3 | | – | Certificate of Designations of Series A Junior Participating Preferred Stock (incorporated by reference to Exhibit 2 to our Registration Statement on Form 8-A, effective December 6, 2001) |
| | | |
4.4 | | – | Form of Right Certificate (incorporated by reference to Exhibit 3 to our Registration Statement on Form 8-A, effective December 6, 2001) |
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Exhibit
Number | | | Description |
| |
|
|
4.5 | | – | Summary of Rights to Purchase Preferred Shares (incorporated by reference to Exhibit 4 to our Registration Statement on Form 8-A, effective December 6, 2001) |
| | | |
4.6 | | – | Form of Senior Secured Convertible Note (incorporated by reference to Exhibit 4.6 to our Current Report on Form 8-K dated as of April 19, 2005) |
| | | |
4.7 | | – | Form of Senior Secured Convertible Note issuable upon the exercise of the Additional Investment Rights (incorporated by reference to Exhibit 4.7 to our Current Report on Form 8-K dated as of April 19, 2005) |
| | | |
4.8 | | – | Pledge and Security Agreement dated as of March 20, 2005 by and among the Company, Larscom Incorporated, Verilink Europe Limited and Portside Growth & Opportunity Fund, as collateral agent (incorporated by reference to Exhibit 4.8 to our Current Report on Form 8-K dated as of April 19, 2005) |
| | | |
4.9 | | – | Guaranty dated as of March 20, 2005 by and among the Company, Larscom Incorporated, Verilink Europe Limited and Portside Growth & Opportunity Fund, as collateral agent (incorporated by reference to Exhibit 4.9 to our Current Report on Form 8-K dated as of April 19, 2005) |
| | | |
10.1* | | – | Registrant’s 2004 Stock Incentive Plan (incorporated by reference to Annex E to the Joint Proxy Statement/Prospectus, dated June 24, 2004, forming a part of Verilink’s Registration Statement on Form S-4 (Commission File No. 333-116472)) |
| | | |
10.1A* | | – | Form of Option Award Agreement for officers of the Registrant |
| | | |
10.1B* | | – | Form of Option Award Agreement for directors of the Registrant |
| | | |
10.2* | | – | Registrant’s 2002 Stock Incentive Plan (incorporated by reference to our definitive Proxy Statement, filed October 16, 2002) |
| | | |
10.2A* | | – | Form of Option Award Agreement for officers of the Registrant |
| | | |
10.2B* | | – | Form of Option Award Agreement for directors of the Registrant |
| | | |
10.3* | | – | Registrant’s Amended and Restated 1993 Stock Option Plan (incorporated by reference to our definitive Proxy Statement, filed October 14, 1999) |
| | | |
10.3A* | | – | First Amendment to the Verilink Corporation Amended and Restated 1993 Stock Option Plan (incorporated by reference to Exhibit 10.51 to our Annual Report on Form 10-K for the fiscal year ended June 30, 2000) |
| | | |
10.3B* | | – | Second Amendment to the Verilink Corporation 1993 Amended and Restated Stock Option Plan (incorporated by reference to Exhibit 10.51 to our Quarterly Report on Form 10-Q for the quarterly period ended September 29, 2000) |
| | | |
10.4 | | – | Form of Registrant’s 1996 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.15 to our Registration Statement on Form S-1, effective June 10, 1996) |
| | | |
10.4A | | – | First Amendment to the Verilink Corporation 1996 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.50 to our Annual Report on Form 10-K for the fiscal year ended June 30, 2000) |
| | | |
10.4B | | – | Second Amendment to the Verilink Corporation 1996 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.52 to our Quarterly Report on Form 10-Q for the quarterly period ended September 29, 2000) |
| | | |
10.5 | | – | Form of Registration Rights Agreement, dated as of July 28, 2004, by and between the Registrant and the stockholders listed on the signature pages thereto (incorporated by reference to Exhibit 10.2 to Verilink’s Registration Statement on Form S-4, Commission File No. 333-116472, filed with the SEC on June 14, 2004) |
| | | |
10.6 | | – | Convertible Promissory Note issued to The Kennedy Company on February 5, 2004 (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed February 20, 2004) |
| | | |
10.7* | | – | Form of Indemnification Agreement between the Registrant and each of our executive officers and directors (incorporated by reference to Exhibit 10.2 to our Registration Statement on Form S-1, effective June 10, 1996, Commission File No. 333-4010) |
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Exhibit
Number | | | Description |
| |
|
|
10.8* | | – | Form of Change of Control Agreement with executive officers other than CEO (incorporated by reference to Exhibit 10.6 to the Joint Proxy Statement/Prospectus, dated June 24, 2004, forming a part of Verilink’s Registration Statement on Form S-4 (File No. 333-116472)) |
| | | |
10.9* | | – | Employment Agreement between the Registrant and Leigh S. Belden dated January 8, 2002 (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K, dated as of January 18, 2002) |
| | | |
10.9A* | | – | Change of Control Severance Benefits Agreement between the Registrant and Leigh S. Belden dated September 2, 2003 (incorporated by reference to Exhibit 10.7A to our Annual Report on Form 10-K for the fiscal year ended June 27, 2003) |
| | | |
10.10* | | – | Verilink Corporation 2004 New Hire Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on December 10, 2004) |
| | | |
10.10A* | | – | Form of Option Award Agreement under the 2004 New Hire Stock Incentive Plan (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed on December 10, 2004) |
| | | |
10.11 | | – | Lease Agreement between Registrant and Industrial Properties of the South for 127 Jetplex Circle, Suites A&B, Madison, Alabama, dated April 16, 2002 (incorporated by reference to Exhibit 10.18 to our Annual Report on Form 10-K for the fiscal year ended June 28, 2002) |
| | | |
10.11A | | – | Addendum No. 1 to Lease Agreement between Registrant and Industrial Properties of the South for 127 Jetplex Circle, Suites A&B, Madison, Alabama, dated June 19, 2002 (incorporated by reference to Exhibit 10.18A to our Annual Report on Form 10-K for the fiscal year ended June 28, 2002) |
| | | |
10.12 | | – | Triple Net Lease Agreement between Registrant and The Boeing Company for 950 Explorer Boulevard, Huntsville, Alabama, dated August 2, 2002 (incorporated by reference to Exhibit 10.19 to our Annual Report on Form 10-K for the fiscal year ended June 28, 2002) |
| | | |
10.13 | | – | Lease Agreement between Registrant (as successor to Larscom Incorporated) and Metropolitan Life Insurance Company, dated October 23, 2003 (incorporated by reference to Exhibit 10.16 to Larscom’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003) |
| | | |
10.14 | | – | Lease Agreement between Registrant (as successor to Larscom Incorporated), Technology IX, LLC, and Keystone Corporation, (incorporated by reference to Exhibit 10.7 to Larscom’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000) |
| | | |
10.15 | | – | Sublease Agreement between Registrant (as successor to Larscom Incorporated) and Silicon Wireless Corporation (incorporated by reference to Exhibit 10.8 to Larscom’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001) |
| | | |
10.16 | | – | Securities Purchase Agreement dated as of March 20, 2005 by and among the Company and the investors identified on the Schedule of Buyers attached thereto (incorporated by reference to Exhibit 4.19 to our Current Report on Form 8-K dated as of April 19, 2005) |
| | | |
10.17 | | – | Form of Warrant to Purchase Common Stock (incorporated by reference to Exhibit 4.20 to our Current Report on Form 8-K dated as of April 19, 2005) |
| | | |
10.18 | | – | Form of Additional Investment Right (incorporated by reference to Exhibit 4.21 to our Current Report on Form 8-K dated as of April 19, 2005) |
| | | |
10.19 | | – | Registration Rights Agreement dated as of March 20, 2005 by and among the Company and the Buyers set forth in the signature pages thereto (incorporated by reference to Exhibit 4.22 to our Current Report on Form 8-K dated as of April 19, 2005) |
| | | |
10.20 | | – | Voting Agreement dated as of March 20, 2005 between the Registrant and each of Leigh S. Belden and Beltech, Inc. (incorporated by reference to Exhibit 4.23 to our Current Report on Form 8-K dated as of April 19, 2005) |
| | | |
14.1 | | – | Registrant’s Code of Ethics (incorporated by reference to Exhibit 14.1 to our Annual Report on Form 10-K for the fiscal year ended July 2, 2004) |
| | | |
23.1† | | – | Consent of Ehrhardt Keefe Steiner & Hottman PC |
| | | |
23.2† | | – | Consent of PricewaterhouseCoopers LLP |
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Exhibit
Number | | | Description |
| |
|
|
31.1† | | – | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934 |
| | | |
31.2† | | – | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934 |
| | | |
32.1† | | – | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | | |
|
* Identifies Exhibit that consists of or includes a management contract or compensatory plan or arrangement. |
† Filed herewith. |
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VERILINK CORPORATION
SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(in thousands)
| | | | | | | | | | | | | | | | |
| | Balance at
Beginning
of Year | | Assumed in
Acquisition | | Additions
Charged to
Income | | Deductions
from
Reserves | | Balance at
End
of Year | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Inventory Reserves: | | | | | | | | | | | | | | | | |
Year ended July 1, 2005 | | $ | 3,316 | | $ | 5,934 | | $ | 2,239 | | $ | (2,856 | ) | $ | 8,633 | |
Year ended July 2, 2004 | | $ | 2,708 | | $ | 844 | | $ | 458 | | $ | (694 | ) | $ | 3,316 | |
Year ended June 27, 2003 | | $ | 3,210 | | $ | — | | $ | 286 | | $ | (788 | ) | $ | 2,708 | |
Allowance for Doubtful Accounts: | | | | | | | | | | | | | | | | |
Year ended July 1, 2005 | | $ | 536 | | $ | 1,304 | | $ | 387 | | $ | (1,027 | ) | $ | 1,200 | |
Year ended July 2, 2004 | | $ | 532 | | $ | 24 | | $ | — | | $ | (20 | ) | $ | 536 | |
Year ended June 27, 2003 | | $ | 560 | | $ | — | | $ | (16 | ) | $ | (12 | ) | $ | 532 | |
Allowances for Notes Receivable: | | | | | | | | | | | | | | | | |
Year ended July 1, 2005 | | $ | 66 | | $ | — | | $ | (23 | ) | $ | — | | $ | 43 | |
Year ended July 2, 2004 | | $ | 421 | | $ | — | | $ | 2 | | $ | (357 | ) | $ | 66 | |
Year ended June 27, 2003 | | $ | 840 | | $ | — | | $ | (260 | ) | $ | (159 | ) | $ | 421 | |
Warranty Liability: | | | | | | | | | | | | | | | | |
Year ended July 1, 2005 | | $ | 1,192 | | $ | 1,018 | | $ | (495 | ) | $ | (425 | ) | $ | 1,290 | |
Year ended July 2, 2004 | | $ | 1,374 | | $ | 60 | | $ | 12 | | $ | (254 | ) | $ | 1,192 | |
Year ended June 27, 2003 | | $ | 920 | | $ | 286 | | $ | 282 | | $ | (114 | ) | $ | 1,374 | |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on our behalf by the undersigned, thereunto duly authorized.
| Verilink Corporation |
| | |
| | |
September 27, 2005 | By: | /s/ LEIGH S. BELDEN |
| |
|
| | Leigh S. Belden |
| | President, Chief Executive Officer and Director |
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature | | Title | | Date |
| |
| |
|
| | | | |
/s/ LEIGH S. BELDEN | | President, Chief Executive Officer and Director | | September 27, 2005 |
| | (Principal Executive Officer) | | |
Leigh S. Belden | | | | |
| | | | |
| | | | |
/s/ TIMOTHY R. ANDERSON | | Vice President and Chief Financial Officer | | September 27, 2005 |
| | (Principal Financial and Accounting Officer) | | |
Timothy R. Anderson | | | | |
| | | | |
| | | | |
/s/ HOWARD ORINGER | | Chairman of the Board of Directors | | September 27, 2005 |
| | | | |
Howard Oringer | | | | |
| | | | |
| | | | |
/s/ STEVEN C. TAYLOR | | Vice Chairman of the Board of Directors | | September 27, 2005 |
| | | | |
Steven C. Taylor | | | | |
| | | | |
| | | | |
/s/ JOHN E. MAJOR | | Director | | September 27, 2005 |
| | | | |
John E. Major | | | | |
| | | | |
| | | | |
/s/ JOHN A. MCGUIRE | | Director | | September 27, 2005 |
| | | | |
John A. McGuire | | | | |
| | | | |
| | | | |
/s/ DESMOND P. WILSON III | | Director | | September 27, 2005 |
| | | | |
Desmond P. Wilson III | | | | |
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