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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 28, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 0-19360
VERILINK CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 94-2857548
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
145 BAYTECH DRIVE, SAN JOSE, CALIFORNIA 95134
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(Address of principal executive offices) (Zip Code)
408-945-1199
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X . No .
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The number of shares outstanding of the issuer's common stock as of January 23,
1998 was 13,799,504.
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INDEX
VERILINK CORPORATION
FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE NO.
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Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the 3
three and six month periods ended December 28, 1997 and
December 29, 1996
Condensed Consolidated Balance Sheets as of 4
December 28, 1997 and June 29, 1997
Condensed Consolidated Statements of Cash Flows for 5
the six month periods ended December 28, 1997
and December 29, 1996
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 9
Financial Condition and Results of Operations
PART II. OTHER INFORMATION
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Item 4. Submission of Matters to a Vote of Security Holders 19
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share amounts)
(Unaudited)
Three months ended Six months ended
December 28, December 29, December 28, December 29,
------------ ------------ ------------ ------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
Net sales $ 9,518 $ 16,286 $ 19,531 $ 30,962
Cost of sales 4,879 7,791 9,888 14,913
------------ ------------ ------------ ------------
Gross profit 4,639 8,495 9,643 16,049
------------ ------------ ------------ ------------
Operating expenses:
Research and development 2,699 2,434 5,562 4,478
Selling, general and administrative 3,843 3,760 7,556 7,366
------------ ------------ ------------ ------------
Total operating expenses 6,542 6,194 13,118 11,844
------------ ------------ ------------ ------------
Income (loss) from operations (1,903) 2,301 (3,475) 4,205
Interest and other income, net 508 505 1,082 975
------------ ------------ ------------ ------------
Income (loss) before income taxes (1,395) 2,806 (2,393) 5,180
Provision for (benefit from) income taxes (520) 1,095 (889) 2,021
------------ ------------ ------------ ------------
Net income (loss) $ (875) $ 1,711 $ (1,504) $ 3,159
============ ============ ============ ============
Net income (loss) per share - Basic $ (0.06) $ 0.13 $ (0.11) $ 0.24
============ ============ ============ ============
Shares used in per share computations - Basic 13,686 13,192 13,660 13,168
============ ============ ============ ============
Net income (loss) per share - Diluted $ (0.06) $ 0.12 $ (0.11) $ 0.22
============ ============ ============ ============
Shares used in per share computations - Diluted 13,686 14,360 13,660 14,355
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements.
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VERILINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
December 28, June 29,
------------ ------------
1997 1997
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(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $25,242 $36,596
Short-term investments 13,169 2,454
Accounts receivable, net 5,846 8,462
Inventories 6,696 4,453
Deferred tax assets 1,840 957
Other current assets 190 215
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Total current assets 52,983 53,137
Property and equipment, net 6,663 6,607
Non-current deferred tax assets 616 616
Other assets 1,010 327
------- -------
Total assets $61,272 $60,687
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,425 $ 1,258
Accrued expenses 5,214 5,080
Income taxes payable 1,019 582
------- -------
Total current liabilities 8,658 6,920
Stockholders' equity 52,614 53,767
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Total liabilities and stockholders' equity $61,272 $60,687
======= =======
The accompanying notes are an integral part of these financial statements.
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VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Six Months Ended
December 28, December 29,
------------ ------------
1997 1996
------------ ------------
(unaudited)
Cash flows from operating activities:
Net income (loss) $ (1,504) $ 3,159
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,101 487
Deferred income taxes (883) -
Deferred compensation related to stock options 76 114
Accrued interest on notes receivable from stockholders (143) -
Changes in assets and liabilities:
Accounts receivable 2,616 441
Inventories (2,243) (744)
Other assets (658) 310
Accounts payable 1,167 813
Accrued expenses 134 1,105
Income taxes payable 437 42
------------ ------------
Net cash provided by operating activities 100 5,727
------------ ------------
Cash flows from investing activities:
Purchase of property and equipment (1,157) (3,146)
Purchase of short-term investments (14,167) (3,461)
Maturities of short-term investments 3,452 -
------------ ------------
Net cash used in investing activities (11,872) (6,607)
------------ ------------
Cash flows from financing activities:
Net proceeds from issuance of Common Stock 418 49
Repayment of notes receivable - 425
------------ ------------
Net cash provided by financing activities 418 474
------------ ------------
Net decrease in cash and cash equivalents (11,354) (406)
Cash and cash equivalents at beginning of period 36,596 40,542
------------ ------------
Cash and cash equivalents at end of period $ 25,242 $ 40,136
============ ============
Supplemental disclosures:
Cash paid (refund) for income taxes $ (455) $ 1,979
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. Interim Financial Statements
The accompanying unaudited interim condensed consolidated financial
statements of Verilink Corporation (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, these statements include all
adjustments, consisting of normal and recurring adjustments, considered
necessary for a fair presentation of the results for the periods presented. The
results of operations for the fiscal 1998 interim periods are not necessarily
indicative of results which may be achieved for the entire fiscal year ending
June 28, 1998. The unaudited interim condensed consolidated financial statements
should be read in conjunction with the financial statements and notes thereto
contained in the Company's Annual Report on Form 10-K for the fiscal year ended
June 29, 1997 as filed with the Securities and Exchange Commission.
NOTE 2. Inventories (in thousands)
December 28, June 29,
---------------- ---------------
1997 1997
---------------- ---------------
(unaudited)
Raw materials $ 3,083 $ 2,615
Work-in-process 1,286 883
Finished goods 2,327 955
---------------- ---------------
$ 6,696 $ 4,453
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NOTE 3. Earnings Per Share
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" (FAS 128) during the second quarter of 1998. The statement
simplifies the standards for computing earnings per share (EPS) previously
defined in Accounting Principles Board Opinion No. 15, "Earnings Per Share" (APB
15) and makes them comparable to international EPS standards. FAS 128 requires
presentation of both Basic EPS and Diluted EPS on the face of the income
statement. Basic EPS, which replaces primary EPS, is computed by dividing net
income available to common stockholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period. Unlike the
computation of primary EPS, Basic EPS excludes the dilutive effect of stock
options. Diluted EPS replaces fully diluted EPS and gives effect to all dilutive
potential common shares outstanding during a period. In computing Diluted EPS,
the average price for the period is used in determining the number of shares
assumed to be purchased from exercise of stock options rather than the higher of
the average or ending price as used in the computation of fully diluted EPS.
Earnings per share for all prior periods have been restated to conform to the
provisions of FAS 128.
Following is a reconciliation of the numerators and denominators of the
Basic and Diluted EPS computations for the periods presented below:
(in thousands, except per share amounts)
----------------------------------------------------------------------
Three Months Ended Six Months Ended
Dec.28, Dec. 29, Dec. 28, Dec. 29,
------------- ------------- ------------- -------------
1997 1996 1997 1996
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Net income (loss) [numerator] $ (875) $ 1,711 $ (1,504) $ 3,159
============= ============= ============= =============
Shares Calculation [denominator]:
Average shares outstanding -
basic 13,686 13,192 13,660 13,168
Effect of Dilutive Securities:
Potential common stock
relating to stock options(a) - 1,168 - 1,187
------------- ------------- ------------- -------------
Average shares outstanding -
diluted 13,686 14,360 13,660 14,355
============= ============= ============= =============
Net income (loss) per share -
basic $ (0.06) $ 0.13 $ (0.11) $ 0.24
============= ============= ============= =============
Net income (loss) per share -
diluted $ (0.06) $ 0.12 $ (0.11) $ 0.22
============= ============= ============= =============
(a) Potential common stock relating to stock options has been excluded for the
three and six month periods ended December 28, 1997 since its inclusion
would be antidilutive.
Options to purchase 1,762,184 shares of common stock at prices ranging
from $0.50 to $31.00 per share were outstanding at December 28, 1997 but were
not included in the computation of diluted EPS because inclusion of such options
would have been antidilutive.
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NOTE 4. Recent Accounting Pronouncements
In June 1997, the FASB issued Statement No. 130 ("FAS 130"),
"Reporting Comprehensive Income". FAS 130 establishes standards for reporting
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements. Comprehensive
income, as defined, includes all changes in equity (net assets) during a period
from nonowner sources. Examples of items to be included in comprehensive income,
which are excluded from net income, include foreign currency translation
adjustments and unrealized gain/loss on available-for-sale securities. The
disclosure prescribed by FAS 130 must be made beginning with fiscal 1999.
In June 1997, the FASB issued Statement No. 131 ("FAS 131"),
"Disclosures about Segments of an Enterprise and Related Information". This
statement establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. The Company has not yet determined the impact, if any, of adopting
this new standard. The disclosures prescribed by FAS 131 are effective for
fiscal 1999.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Forward-looking Statements.
This Report on Form 10-Q contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, including statements regarding the Company's
expectations, hopes, intentions, beliefs or strategies regarding the future.
Such forward-looking statements include, but are not limited to, the Company's
anticipated expense levels for research and development, and selling, general
and administrative operations; the amount of and specific uses of anticipated
capital expenditures; expectations regarding inventory balances, liquidity and
adequacy of cash resources; and adequacy of current facilities under the
sub-headings "Results of Operations" and "Liquidity and Capital Resources."
Actual results could differ materially from those projected in any
forward-looking statements for the reasons detailed below and in other sections
of this Report on Form 10-Q. All forward-looking statements included in this
Form 10-Q are based on information available to the Company on the date of this
Report on Form 10-Q, and the Company assumes no obligation to update the
forward-looking statements, or to update the reasons why actual results could
differ from those projected in the forward-looking statements. Investors should
also consult the risk factors listed from time to time in the Company's Reports
on Form 10-K and Annual Report to Stockholders.
RESULTS OF OPERATIONS
Overview
Verilink Corporation develops, manufactures and markets access products
for telecommunications network service providers and corporate end users.
Verilink designed the Access System 2000 with modular hardware and the Company's
software-based Advanced Programmable Architecture TM to enable its customers to
access increased network capacity and to adopt new communications services in a
cost-effective manner. The Access System 2000 provides integrated access to
narrowband transmission facilities including fractional or full T1/E1, and to
multiple T1/E1 facilities, up to broadband (T3) transmission speeds.
Verilink sells its products through a direct sales force and
non-exclusive resellers. Verilink's integrated network access products are used
by network service providers such as interexchange and local exchange carriers,
and providers of Internet, personal communications and cellular services. The
Company also sells single purpose network access devices for selected
applications. The Company's largest customers include MCI Communications Corp.,
CompuServe Corp., Northern Telecom, Inc. and QUALCOMM Incorporated.
The Company is currently in the process of evaluating its information
technology infrastructure for Year 2000 compliance. The Company believes that
its current product offerings are Year 2000 compliant. See "Factors Affecting
Future Results."
The Company believes that period-to-period comparisons of its financial
results are not necessarily meaningful and should not be relied upon as an
indication of future performance. In addition, the Company's results of
operations may fluctuate from period to period in the future.
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The following table presents the percentages of net sales represented by
certain line items from the Condensed Consolidated Statements of Operations for
the periods indicated.
Three Months Ended Six Months Ended
December 28, December 29, December 28, December 29,
---------------- --------------- ------------ ------------
1997 1996 1997 1996
---------------- --------------- ------------ ------------
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales 51.3 47.8 50.6 48.2
---------------- --------------- ------------ ------------
Gross margin 48.7 52.2 49.4 51.8
---------------- --------------- ------------ ------------
Operating expenses:
Research and development 28.4 14.9 28.5 14.5
Selling, general and
addministrative 40.3 23.1 38.7 23.8
---------------- --------------- ------------ ------------
Total operating expenses 68.7 38.0 67.2 38.3
---------------- --------------- ------------ ------------
Income (loss) from operations (20.0) 14.2 (17.8) 13.5
Interest and other income, net 5.3 3.0 5.5 3.2
---------------- --------------- ------------ ------------
Income (loss) before income taxes (14.7) 17.2 (12.3) 16.7
Provision for (benefit from) income
taxes (5.5) 6.7 (4.6) 6.5
---------------- --------------- ------------ ------------
Net income (loss) (9.2)% 10.5% (7.7)% 10.2%
---------------- --------------- ------------ ------------
Net Sales. Net sales for the three months ended December 28, 1997
decreased 4.9% from the preceding quarter and 41.6% from the fiscal quarter
ended December 29, 1996. Net sales for the first half of fiscal 1998 declined
36.9 % from the corresponding period of fiscal 1997. The decrease from the
preceding quarter resulted primarily from lower demand for products by the
Company's reseller and carrier customers, partially mitigated by improved sales
to the Company's wireless customers. The decrease in sales from the year earlier
quarter and the first half of fiscal 1997 resulted primarily from reduced sales
to both carrier and wireless customers. Sales to the Company's four largest
customers as a percentage of total sales were approximately 49% during both the
quarter ended December 28, 1997 and the preceding quarter and were approximately
65% of total sales during the quarter ended December 29, 1996. Sales to the
Company's four largest customers for the first six months of fiscal 1998
represented 49% of total sales compared to 63% for the corresponding period of
fiscal 1997.
Gross Margin. Gross margin decreased to 48.7% of total sales in the
three months ended December 28, 1997 from 50% of total sales during the
preceding quarter and from 52.2% of total sales during the fiscal quarter ended
December 29, 1996. For the first six months of fiscal 1998, gross margin was
49.4% compared to 51.8% for the corresponding period of fiscal 1997. The
decrease in gross margins from the previous quarter was principally due to
changes in product mix and period costs representing a higher percentage of
sales, partially mitigated by increased production volumes. The decrease in
gross margins from the year earlier quarter and from the first half of fiscal
1997 were due principally to lower sales volumes, increased manufacturing
overhead costs and reduced direct material costs.
Research and Development. Research and development (R&D) expenditures
decreased $0.2 million to $2.7 million (28.4% of net sales) in the quarter ended
December 28, 1997 from $2.9 million (28.6% of net sales ) during the preceding
quarter, and increased $0.3 million from $2.4 million (14.9% of net sales)
during the quarter ended December 29, 1996. For the first six months of fiscal
1998 R&D expenditures were $5.6 million (28.5% of net sales) compared to $4.5
million (14.5 % of net sales) during the same period of fiscal 1997. The
decrease in R&D expenditures from the previous quarter principally reflect
lowered contract development work during the December holiday period. In
comparing the quarter and six month periods ended December 28, 1997 to the
corresponding periods of fiscal 1997, the increases in both absolute dollar R&D
expenditures and R&D expenditures as a percentage of net
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sales reflected increased investment in new product development and lower sales
levels. The Company believes that a significant level of investment in product
development is required to remain competitive and, accordingly, anticipates that
research and development expense will continue to increase in amount during the
remainder of fiscal 1998 and will vary over time as a percentage of sales.
Selling, general and administrative. Selling, general and administrative
(SG&A) expense increased by $0.1 million to $3.8 million (40.3 % of net sales)
during the three months ended December 28, 1997 from $3.7 million (37.1% of net
sales) during the preceding quarter, and remained relatively unchanged in
absolute dollars at $3.8 million (23.1% of net sales) from the year earlier
quarter. The increase in SG&A spending from the preceding quarter was due
principally to increased marketing activities, while the percentage increase is
due primarily to lower sales. For the three month and six month periods ended
December 28, 1997, the Company held spending under tight control resulting in
only marginal increases in SG&A expenses as compared to the corresponding
periods of fiscal 1997. The increases in SG&A as a percentage of net sales was
due principally to lower sales. The Company expects SG&A expense to increase in
the future due to expenses associated with an increased sales force and related
increases in marketing and support staff as well as increased administrative
expenses related to legal and information technology costs necessary to support
expanded operations. The Company expects such expenses will vary over time as a
percentage of sales.
Interest and Other Income, Net. Interest and other income, net decreased
by approximately $0.1 million over the preceding quarter and was relatively
unchanged from the corresponding quarter of fiscal 1997. Interest and other
income, net increased approximately $0.1 million in the first six months of
fiscal 1998 compared to the first six months of fiscal 1997. The increase
between periods was primarily the result of higher yields on invested balances.
Provision for/Benefit from Income Taxes. The Company recorded a 37%
benefit from income taxes for the three month and six month periods ended
December 28, 1997 reflecting available net operating loss carry-back capacity
combined with expected tax credits in accordance with FAS 109. The provision for
income taxes for the three month and six month periods ended December 29, 1996
represented an estimated effective tax rate of 39%.
LIQUIDITY AND CAPITAL RESOURCES
At December 28, 1997, the Company's principal sources of liquidity included
$38.4 million of cash and cash equivalents, and short-term investments.
During the six-month period ended December 28, 1997, the Company generated
$0.1 million from operating activities, down from $5.7 million generated for the
six-month period ended December 29, 1996. Accounts receivable was $2.6 million
lower at December 28, 1997 when compared to June 29, 1997, reflecting lower
sales levels. Inventory increased $2.2 million reflecting product staging
requirements necessary to meet anticipated future product shipment requirements.
Accounts payable increased $1.2 million, reflecting increased procurement
activities.
Cash used for investing activities was $11.9 million for the six-month
period ended December 28, 1997, as compared to $6.6 million for the six-month
period ended December 29, 1996. The increase was primarily a result of greater
net purchases of short-term investments. The Company invested $1.2 million in
property and equipment during the first six months of fiscal 1998. The Company
estimates that total capital expenditures for fiscal 1998 could approximate $6.0
million, which are anticipated to be used for test equipment, design tools,
enterprise resource planning (ERP) software applications, and new manufacturing
capability. The Company expects its current facilities will be adequate through
fiscal 1998.
The Company's $2.0 million secured revolving line of credit expired in August
1997. There were no borrowings under the line of credit in 1997. While the
Company believes that its existing cash and cash equivalents, short-term
investments and anticipated cash flows from operations will satisfy the
Company's near-term cash needs, the Company continues to investigate the
possibility of generating financial resources through committed credit
agreements, technology or manufacturing partnerships, equipment financing, and
offerings of debt and equity securities.
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FACTORS AFFECTING FUTURE RESULTS
As described by the following factors, past financial performance should not
be considered to be a reliable indicator of future performance, and investors
should not use historical trends to anticipate results or trends in future
periods.
Customer Concentration. A small number of customers have accounted for a
majority of the Company's sales in each of the past several fiscal years. In
fiscal 1997, NORTEL, MCI, and CompuServe accounted for 22%, 20%, and 11% of the
Company's sales, respectively, and sales to the Company's top five customers
accounted for 67% of the Company's sales. In fiscal 1996, NORTEL, MCI, and
CompuServe accounted for 7%, 29% and 18% of the Company's sales, respectively,
and the Company's top five customers accounted for 64% of the Company's sales.
In fiscal 1995, MCI and CompuServe each accounted for 14% of the Company's sales
and the Company's top five customers accounted for 47% of sales. Other than
NORTEL, MCI and CompuServe, no customer accounted for more than 10% of the
Company's sales in fiscal years 1997, 1996, or 1995. There can be no assurance
that the Company's current customers will continue to place orders with the
Company, that orders by existing customers will continue at the levels of
previous periods, or that the Company will be able to obtain orders from new
customers. The Company's customers are typically not contractually obligated to
purchase any quantity of products in any particular period. Product sales to
major customers have varied widely from year to year. In some cases, major
customers have abruptly terminated purchases of the Company's products. For
example, sales of the Company's single purpose network access products to AT&T
Paradyne represented 24% of sales in fiscal 1993, but declined to 11% and 2% of
sales in fiscal 1994 and 1995, respectively, due to the decision by AT&T
Paradyne to focus its sales efforts on competing products developed within the
AT&T organization. In addition, sales to Stratacom, Inc. for provision of
network management capabilities in a system sold to another AT&T business unit
accounted for 9% of the Company's sales during fiscal 1995. Sales to Stratacom
ceased during the second half of fiscal 1995 due to the decision by such AT&T
business unit to internally provide such management functionality in its system.
Loss of, or a material reduction in orders by, one or more of the Company's
major customers would materially adversely affect the Company's business,
financial condition and results of operations. See "Competition."
Fluctuations in Quarterly Operating Results. The Company's sales are subject
to quarterly and annual fluctuations due to a number of factors. Most of the
Company's sales are in the form of large orders with short delivery times. The
Company's ability to affect and judge the timing of individual customer orders
is limited. The Company has experienced large fluctuations in sales from quarter
to quarter due to a wide variety of factors, such as delay, cancellation or
acceleration of customer projects, and other factors discussed below. The
Company's sales for a given quarter may depend to a significant degree upon
planned product shipments to a single customer, often related to specific
equipment deployment projects. The Company has experienced both acceleration and
slowdown in orders related to such projects, causing changes in the sales level
of a given quarter relative to both the preceding and subsequent quarters. Sales
to individual current customers have varied by as much as $2.0 million between
consecutive quarters.
Delays or lost sales can be caused by other factors beyond the Company's
control, including late deliveries by other vendors of components in a
customer's system, changes in implementation priorities, slower than anticipated
growth in demand for the services that the Company's products support and delays
in obtaining regulatory approvals for new services. Delays and lost sales have
occurred in the past and may occur in the future. Operating results in recent
periods have been adversely affected by delays in receipt of significant
purchase orders from customers. The Company believes that recent period sales
have been adversely impacted by budgetary constraints caused by pending merger
discussions at some of its top customers. In addition, the Company has in the
past experienced delays as a result of the need to modify its products to comply
with unique customer specifications. These and similar delays or lost sales
could materially adversely affect the Company's business, financial condition
and results of operations. See "Customer Concentration," and "Dependence on
Component Availability and Key Suppliers."
The Company's backlog at the beginning of each quarter typically is not
sufficient to achieve expected sales for that quarter. To achieve its sales
objective, the Company is dependent upon obtaining orders in a quarter for
shipment in that quarter. Furthermore, the Company's agreements with its
customers typically provide that they may change
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delivery schedules and cancel orders within specified timeframes, typically up
to 30 days prior to the scheduled shipment date, without significant penalty.
The Company's customers have in the past built, and may in the future build,
significant inventory in order to facilitate more rapid deployment of
anticipated major projects or for other reasons. Decisions by such customers to
reduce their inventory levels could lead to reductions in purchases from the
Company. These reductions, in turn, could cause fluctuations in the Company's
operating results and could have an adverse effect on the Company's business,
financial condition and results of operations in the periods in which the
inventory is reduced.
The Company's industry is characterized by declining prices of existing
products, therefore continual improvement of manufacturing efficiencies and
introduction of new products and enhancements to existing products are required
to maintain gross margins. In response to customer demands or competitive
pressures, or to pursue new product or market opportunities, the Company may
take certain pricing or marketing actions, such as price reductions, volume
discounts, or provision of services at below-market rates. These actions could
materially and adversely affect the Company's operating results.
Operating results may also fluctuate due to factors such as the timing of new
product announcements and introductions by the Company, its major customers or
its competitors, delays in new product introductions by the Company, market
acceptance of new or enhanced versions of the Company's products, changes in the
product or customer mix of sales, changes in the level of operating expenses,
competitive pricing pressures, the gain or loss of significant customers,
increased research and development and sales and marketing expenses associated
with new product introductions, and general economic conditions. All of the
above factors are difficult for the Company to forecast, and these or other
factors can materially adversely affect the Company's business, financial
condition and results of operations for one quarter or a series of quarters. The
Company's expense levels are based in part on its expectations regarding future
sales and are fixed in the short term to a large extent. Therefore, the Company
may be unable to adjust spending in a timely manner to compensate for any
unexpected shortfall in sales. Any significant decline in demand relative to the
Company's expectations or any material delay of customer orders could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that the Company will be able
to sustain profitability on a quarterly or annual basis. In addition, the
Company has had, and in some future quarter may have operating results below the
expectations of public market analysts and investors. In such event the price of
the Company's Common Stock would likely be materially and adversely affected.
See "Potential Volatility of Stock Price."
The Company's products are covered by warranties and the Company is subject
to contractual commitments. If unexpected circumstances arise such that the
product does not perform as intended and the Company is not successful in
resolving product quality or performance issues, there could be an adverse
effect on the Company's business, financial condition and results of operations.
Potential Volatility of Stock Price. The trading price of the Company's
Common Stock could be subject to wide fluctuations in response to quarter to
quarter variations in operating results, announcements of technological
innovations or new products by the Company or its competitors, developments with
respect to patents or proprietary rights, general conditions in the
telecommunication network access and equipment industries, changes in earnings
estimates by analysts, or other events or factors. In addition, the stock market
has experienced extreme price and volume fluctuations, which have particularly
affected the market prices of many technology companies and which have often
been unrelated to the operating performance of such companies. These
Company-specific factors or broad market fluctuations may materially adversely
affect the market price of the Company's Common Stock. The Company has
experienced significant fluctuations in its stock price and share trading volume
since its initial public offering in June 1996. There is no assurance that such
fluctuations will not continue.
Dependence on Recently Introduced Products and Products Under Development.
The Company's future results of operations are highly dependent on market
acceptance of existing and future applications for the Company's Access System
2000 product line. The Access System 2000 product line represented approximately
80% of sales in fiscal 1997 and 70% of sales in fiscal 1996. Increased market
acceptance of the Company's Access System 2000 products is dependent on a number
of factors, not all of which are in the Company's control, including the
continued growth in the use of bandwidth intensive applications, continued
deployment of new telecommunications services, market acceptance
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of integrated access devices in general, the availability and price of competing
products and technologies, and the success of the Company's sales efforts.
Failure of the Company's products to achieve increased market acceptance would
have a material adverse effect on the Company's business, financial condition
and results of operations. Failure to introduce new products in a timely manner
could cause companies to purchase products from competitors and have a material
adverse effect on the Company's business, financial condition and results of
operations. Due to a variety of factors, the Company may experience delays in
developing its planned products. New products may require additional development
work, enhancement, testing or further refinement before they can be made
commercially available by the Company. The Company has in the past experienced
delays in the introduction of Access System 2000 product applications and
enhancements due to a variety of internal factors, such as reallocation of
priorities, difficulty in hiring sufficient numbers of qualified personnel and
unforeseen technical obstacles, as well as to changes in customer requirements.
Although the Company does not believe that such delays have had a material
adverse effect on its customer relationships, such delays have deferred the
receipt of revenue from the products involved. If the Company's Access System
2000 products have performance, reliability or quality shortcomings, then the
Company may experience reduced orders, higher manufacturing costs, delays in
collecting accounts receivable and additional warranty and service expenses.
Need to Expand Sales Organization and Channels of Distribution. Currently the
Company sells its products to a small number of customers through a relatively
small sales force. The Company's strategy is to distribute its products to a
broader customer base, which will require the Company to significantly expand
its sales force and other channels of distribution. There can be no assurance
that the Company will be able to recruit, train, motivate and manage additional
qualified sales personnel with the requisite experience and knowledge, or
attract additional qualified distributors. Availability of qualified sales
personnel is limited, and competition for experienced sales personnel in the
network access and telecommunications equipment industries is intense. The
failure to timely expand the Company's sales force and expand its channels of
distribution could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Customer Concentration,"
"Management of Growth" and "Dependence on Key Personnel."
Dependence on Component Availability and Key Suppliers. On-time delivery of
the Company's products depends upon the availability of components and
subsystems used in its products. The Company depends in part upon suppliers to
manufacture, assemble and deliver components in a timely and satisfactory
manner. The Company obtains several components and licenses certain embedded
software from single sources. There can be no assurance that these suppliers
will continue to be able and willing to meet the Company's requirements for any
such components. The Company generally does not have any long-term contracts
with such suppliers, other than software vendors. Any significant interruption
in the supply of, or degradation in the quality of, any such item could have a
material adverse effect on the Company's results of operations. The Company has
no current plans to significantly expand its supplier base.
Purchase orders from the Company's customers frequently require delivery
quickly after placement of the order. Because the Company does not maintain
significant component inventories, delay in shipment by a supplier could lead to
lost sales. The Company uses internal forecasts to determine its general
materials and components requirements. Lead times for materials and components
may vary significantly, and depend on factors such as specific supplier
performance, contract terms and general market demand for components. If orders
vary from forecasts, the Company may experience excess or inadequate inventory
of certain materials and components. From time to time, the Company has
experienced shortages and allocations of certain components, resulting in delays
in fulfillment of customer orders. Such shortages and allocations could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Fluctuations in Quarterly Operating Results."
Competition. The market for network access and telecommunications equipment
is highly competitive, and the Company expects competition to increase in the
future. This market is subject to rapid technological change, regulatory
developments and emerging industry standards. The Company faces different
competitive environments for its Access System 2000 products than for its single
purpose network access products.
The market for integrated access devices such as the Company's Access System
2000 is newly emerging and is subject to rapid change. The Company believes that
the primary competitive factors in this market are the development and rapid
introduction of new product features, price/performance, support for multiple
types of communications
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services, network management, reliability and safety, and quality of customer
support. There can be no assurance that the Company's new products and products
under development will be able to compete successfully with respect to these or
other factors. The Company's principal competition to date for its current
Access System 2000 products has been from Digital Link Corporation, Kentrox, a
division of ADC Telecommunications (both in Kentrox's own products and products
supplied to Kentrox by Premisys Communications, Inc.), and Larscom, Inc. As the
Company develops new products for the Access System 2000 line, the Company
expects to increasingly compete with Premisys. The Company expects additional
competition from companies that are currently competitors in the market for the
Company's single purpose network access products, as such companies develop new
products. In addition, the Company expects competition from companies in the
computer networking market and other related markets such as Newbridge Networks
Corporation, Telco Systems, Inc. and Ascend Communications, Inc. To the extent
that current or potential competitors can expand their current offerings to
include products that have functionality similar to the Company's products and
planned products, the Company's business, financial condition and results of
operations could be materially adversely affected.
The Company believes that the market for its single purpose network access
products is mature. The Company believes that the principal competitive factors
in this market are price, installed base and quality of customer support. In
this market, the Company primarily competes with Adtran, Inc., Digital Link,
Kentrox and Larscom. There can be no assurance that such companies or other
competitors will not introduce new products at a lower price and/or that provide
greater functionality than the Company's single purpose network access products.
In addition, the Company anticipates that competitors and customers may develop
products that could be used for selected applications for which the Company's
products are currently provided. Successful, timely development of such products
could reduce the level of demand for the Company's products. The Company does
not expect to spend significant resources, if any, on research and development
of its single purpose network access products. There can be no assurance that
the Company's single purpose network access products will be competitive in the
future.
Many of the Company's current and potential competitors have substantially
greater technical, financial, manufacturing and marketing resources than the
Company. In addition, many of the Company's competitors have long-established
relationships with network service providers. There can be no assurance that the
Company will have the financial resources, technical expertise, manufacturing,
marketing, distribution and support capabilities to compete successfully in the
future.
Rapid Technological Change. The network access and telecommunications
equipment markets are characterized by rapidly changing technologies and
frequent new product introductions. The rapid development of new technologies
increases the risk that current or new competitors could develop products that
would reduce the competitiveness of the Company's products. The Company's
success will depend to a substantial degree upon its ability to respond to
changes in technology and customer requirements. This will require the timely
selection, development and marketing of new products and enhancements on a
cost-effective basis. The development of new, technologically advanced products
is a complex and uncertain process, requiring high levels of innovation. The
development of new products for the integrated access market requires competence
in the general areas of telephony, data networking, network management and
wireless telephony as well as specific technologies such as DSL, IP, ISDN and
ATM. Furthermore, the communications industry is characterized by the need to
design products which meet industry standards for safety, emissions and network
interconnection. With new and emerging technologies and service offerings from
network service providers, such standards are often changing or unavailable. As
a result, there is a potential for product development delay due to the need for
compliance with new or modified standards. The introduction of new and enhanced
products also requires that the Company manage transitions from older products
in order to minimize disruptions in customer orders, avoid excess inventory of
old products and ensure that adequate supplies of new products can be delivered
to meet customer orders. There can be no assurance that the Company will be
successful in developing, introducing or managing the transition to new or
enhanced products or that any such products will be responsive to technological
changes or will gain market acceptance. The Company's business, financial
condition and results of operations would be materially adversely affected if
the Company were to be unsuccessful, or to incur significant delays, in
developing and introducing such new products or enhancements. See "Dependence on
Recently Introduced Products and Products under Development."
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Year 2000 Compliance. The Company is currently in the process of evaluating
its information technology infrastructure for year 2000 compliance. The Company
does not currently have any information concerning the year 2000 compliance
status of its suppliers and customers. In the event that the Company or any of
the Company's significant suppliers or customers does not successfully and
timely achieve Year 2000 compliance, the Company's business, financial condition
and results of operation could be adversely affected. The Company believes that
its current product offerings are Year 2000 compliant.
Management of Growth. The Company has recently experienced and may continue
to experience growth in the number of its employees and the scope of its
operations. In particular, the Company intends to increase its sales, marketing
and support staff. These increases will result in increased responsibilities for
management. To manage potential future growth effectively, the Company must
improve its operational, financial and management information systems and must
hire, train, motivate and manage a growing number of employees. The future
success of the Company also will depend on its ability to increase its customer
support capability and to attract and retain qualified technical, sales,
marketing and management personnel, for whom competition is intense. In
particular, the current availability of qualified sales and engineering
personnel is quite limited, and competition among companies for such personnel
is intense. The Company is currently attempting to hire a number of sales and
engineering personnel and has experienced delays in filling such positions.
During strong business cycles, the Company expects to experience continued
difficulty in filling its needs for qualified sales, engineering and other
personnel. There can be no assurance that the Company will be able to
effectively achieve or manage any such growth, and failure to do so could delay
product development cycles or otherwise have a material adverse effect on the
Company's business, financial condition and results of operations. See "Need to
Expand Sales Organization and Channels of Distribution," and "Dependence on Key
Personnel."
Compliance with Regulations and Evolving Industry Standards. The market for
the Company's products is characterized by the need to meet a significant number
of communications regulations and standards, some of which are evolving as new
technologies are deployed. In the United States, the Company's products must
comply with various regulations defined by the Federal Communications Commission
and standards established by Underwriters Laboratories and Bell Communications
Research. For some public carrier services, installed equipment does not fully
comply with current industry standards, and this noncompliance must be addressed
in the design of the Company's products. Standards for new services such as
frame relay and ATM are still evolving. As these standards evolve, the Company
will be required to modify its products or develop and support new versions of
its products. The failure of the Company's products to comply, or delays in
compliance, with the various existing and evolving industry standards could
delay introduction of the Company's products, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Government regulatory policies are likely to continue to have a major impact
on the pricing of existing as well as new public network services and therefore
are expected to affect demand for such services and the telecommunications
products that support such services. Tariff rates, whether determined by network
service providers or in response to regulatory directives, may affect the cost
effectiveness of deploying communication services. Such policies also affect
demand for telecommunications equipment, including the Company's products.
Risks Associated With Entry into International Markets. The Company has had
minimal direct sales to international customers to date. The Company has little
experience in international markets, but intends to expand sales of its products
outside of the United States and to enter certain international markets, which
will require significant management attention and financial resources.
Conducting business outside of the United States is subject to certain risks,
including longer payment cycles, unexpected changes in regulatory requirements
and tariffs, difficulties in staffing and managing foreign operations, greater
difficulty in accounts receivable collection and potentially adverse tax
consequences. To the extent any Company sales are denominated in foreign
currency, the Company's sales and results of operations may also be directly
affected by fluctuations in foreign currency exchange rates. In order to sell
its products internationally, the Company must meet standards established by
telecommunications authorities in various countries, as well as recommendations
of the Consultative Committee on International Telegraph and Telephony. A delay
in obtaining, or the failure to obtain, certification of its products in
countries outside the United States could delay or preclude the Company's
marketing and sales efforts in such countries, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
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Risk of Third Party Claims of Infringement. The network access and
telecommunications equipment industries are characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert exclusive patent,
copyright, trademark and other intellectual property rights to technologies that
are important to the Company. The Company has not conducted a formal patent
search relating to the technology used in its products, due in part to the high
cost and limited benefits of a formal search. In addition, since patent
applications in the United States are not publicly disclosed until the patent
issues and foreign patent applications generally are not publicly disclosed for
at least a portion of the time that they are pending, applications may have been
filed which, if issued as patents, would relate to the Company's products.
Software comprises a substantial portion of the technology in the Company's
products. The scope of protection accorded to patents covering software-related
inventions is evolving and is subject to a degree of uncertainty which may
increase the risk and cost to the Company if the Company discovers third party
patents related to its software products or if such patents are asserted against
the Company in the future. Patents have been granted recently on fundamental
technologies in software, and patents may issue which relate to fundamental
technologies incorporated into the Company's products. The Company may receive
communications from third parties in the future asserting that the Company's
products infringe or may infringe the proprietary rights of third parties. In
its distribution agreements, the Company typically agrees to indemnify its
customers for any expenses or liabilities, generally without limitation,
resulting from claimed infringements of patents, trademarks or copyrights of
third parties. In the event of litigation to determine the validity of any
third-party claims, such litigation, whether or not determined in favor of the
Company, could result in significant expense to the Company and divert the
efforts of the Company's technical and management personnel from productive
tasks. In the event of an adverse ruling in such litigation, the Company might
be required to discontinue the use and sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses
from third parties. There can be no assurance that licenses from third parties
would be available on acceptable terms, if at all. In the event of a successful
claim against the Company and the failure of the Company to develop or license a
substitute technology, the Company's business, financial condition and results
of operations would be materially adversely affected.
Limited Protection of Intellectual Property. The Company relies upon a
combination of patent, trade secret, copyright and trademark laws and
contractual restrictions to establish and protect proprietary rights in its
products and technologies. The Company has been issued certain U.S. and Canadian
patents with respect to limited aspects of its single purpose network access
technology. The Company has not obtained significant patent protection for its
Access System 2000 technology. There can be no assurance that third parties have
not or will not develop equivalent technologies or products without infringing
the Company's patents or that the Company's patents would be held valid and
enforceable by a court having jurisdiction over a dispute involving such
patents. The Company has also entered into confidentiality and invention
assignment agreements with its employees, and enters into non-disclosure
agreements with its suppliers, distributors and appropriate customers so as to
limit access to and disclosure of its proprietary information. There can be no
assurance that these statutory and contractual arrangements will deter
misappropriation of the Company's technologies or discourage independent
third-party development of similar technologies. In the event such arrangements
are insufficient, the Company's business, financial condition and results of
operations could be materially adversely affected. The laws of certain foreign
countries in which the Company's products are or may be developed, manufactured
or sold may not protect the Company's products or intellectual property rights
to the same extent as do the laws of the United States and thus make the
possibility of misappropriation of the Company's technology and products more
likely.
Dependence on Key Personnel. The Company's future success will depend to a
large extent on the continued contributions of its executive officers and key
management, sales and technical personnel. The Company has employment agreements
with Leigh S. Belden, the Company's President and Chief Executive Officer, and
Steven C. Taylor, the Company's Chief Technical Officer. The Company also is a
party to agreements with certain of its executive officers to help ensure the
officer's continual services to the Company in the event of a change-in-control.
Each of the Company's executive officers, and key management, sales and
technical personnel would be difficult to replace. The loss of the services of
one or more of the Company's executive officers or key personnel, or the
inability to continue to attract qualified personnel could delay product
development cycles or otherwise have a material adverse effect on the Company's
business, financial condition and results of operations. See "Management of
Growth."
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Antitakeover Effects of Certain Charter Provisions. The Company's Board of
Directors has the authority to issue up to 1,000,000 shares of Preferred Stock
and to determine the price, rights, preferences and privileges of those shares
without any further vote or action by the stockholders. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any Preferred Stock that may be issued in the
future. The issuance of shares of Preferred Stock, while potentially providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire a majority of the outstanding voting stock of the
Company. The Company has no present intention to issue shares of Preferred
Stock. In addition, the Company is subject to the anti-takeover provisions of
Section 203 of the Delaware General Corporation Law, which will prohibit the
Company from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business
combination is approved in a prescribed manner. The application of Section 203
also could have the effect of delaying or preventing a change of control of the
Company. Furthermore, certain provisions of the Company's Amended and Restated
Certificate of Incorporation, including provisions that provide for the Board of
Directors to be divided into three classes to serve for staggered three-year
terms, may have the effect of delaying or preventing a change of control of the
Company, which could adversely affect the market price of the Company's Common
Stock.
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PART II. OTHER INFORMATION
--------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Stockholders of the Company was held on
November 13, 1997 (the "Annual Meeting"). The voting of holders of
record of 13,673,137 shares of the Company's Common Stock
outstanding at the close of business on September 19, 1997 was
solicited by proxy pursuant to Regulation 14A under the Securities
Exchange act of 1934.
(b) The following individual was elected as a Class I Director of the
Company at the Annual Meeting:
VOTES FOR VOTES WITHHOLDING AUTHORITY
David L. Lyon 11,537,807 51,129
(c) The appointment of Price Waterhouse LLP as the Company's independent
accountants for fiscal year 1998 was ratified. The stockholders'
vote on such appointment was 11,549,301 shares FOR; 8,451 shares
AGAINST; and 31,184 shares ABSTAINED from voting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Index:
Exhibit Number Description of Exhibit
-------------- ----------------------
10.17 Change of Control Severance Benefits Agreement -
Executive Officers*
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter ended December 28,
1997.
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* Management contract or compensatory plan or arrangements
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SIGNATURES
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERILINK CORPORATION
February 10 , 1998 By: /s/ John C. Batty
-------------------
John C. Batty,
Vice President, Finance and Chief
Financial Officer (Duly Authorized
Officer and Principal Financial Officer)
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Exhibit Index
Exhibit Number Description
- -------------- -----------
10.17 Change of Control Severance Benefits Agreement-
Executive Officers*
27.1 Financial Data Schedule
- ---------
* Management contract or compensating plan or arrangements