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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 29, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-19360
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VERILINK CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 94-2857548
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(State of incorporation) (I.R.S. Employer
Identification No.)
950 EXPLORER BOULEVARD, HUNTSVILLE, ALABAMA 35806
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(Address of principal executive offices, including zip code)
(256) 327-2001
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(Registrant's telephone number, including area code)
127 JETPLEX CIRCLE, MADISON, ALABAMA 35758
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(Former Address)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ].
The number of shares outstanding of the issuer's common stock as of January 26,
2001 was 14,811,371.
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INDEX
VERILINK CORPORATION
FORM 10-Q
PART I. FINANCIAL INFORMATION Page No.
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Item 1. Financial Statements (unaudited):
Condensed Consolidated Statements of Operations for the 3
three months and six months ended December 29, 2000
and December 31, 1999
Condensed Consolidated Balance Sheets as of 4
December 29, 2000 and June 30, 2000
Condensed Consolidated Statements of Cash Flows for 5
the six months ended December 29, 2000 and December 31, 1999
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 9
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
PART II. OTHER INFORMATION
- -------- -----------------
Item 2. Changes in Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURE 22
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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 29, December 31, December 29, December 31,
2000 1999 2000 1999
-------------- --------------- -------------- ---------------
Net sales............................................. $ 9,036 $ 16,183 $ 20,865 $ 31,035
Cost of sales......................................... 5,704 8,114 11,086 16,811
-------- -------- -------- --------
Gross profit...................................... 3,332 8,069 9,779 14,224
-------- -------- -------- --------
Operating expenses:
Research and development.......................... 10,984 2,170 13,090 5,335
Selling, general and administrative............... 4,992 5,498 10,168 11,096
Restructuring and other non-recurring
charges.......................................... -- 1,400 -- 8,300
-------- -------- -------- --------
Total operating expenses....................... 15,976 9,068 23,258 24,731
-------- -------- -------- --------
Loss from operations.................................. (12,644) (999) (13,479) (10,507)
Interest and other income, net........................ 311 222 621 393
-------- -------- -------- --------
Loss before provision for income taxes................ (12,333) (777) (12,858) (10,114)
Provision for income taxes............................ -- -- 6,311 --
-------- -------- -------- --------
Net loss.............................................. $(12,333) $ (777) $(19,169) $(10,114)
======== ======== ======== ========
Net loss per share - Basic............................ $ (0.84) $ (0.06) $ (1.30) $ (0.72)
======== ======== ======== ========
Net loss per share - Diluted.......................... $ (0.84) $ (0.06) $ (1.30) $ (0.72)
======== ======== ======== ========
Shares used in per share computations - Basic......... 14,719 13,971 14,717 13,960
======== ======== ======== ========
Shares used in per share computations - Diluted....... 14,719 13,971 14,717 13,960
======== ======== ======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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VERILINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 29,
2000 June 30,
(Unaudited) 2000
--------------- -------------
ASSETS
Current assets:
Cash and cash equivalents.................................................. $ 11,156 $ 6,617
Restricted cash............................................................ 500 500
Short-term investments..................................................... 2,200 4,079
Accounts receivable, net................................................... 5,564 15,233
Inventories................................................................ 6,404 4,840
Notes receivable........................................................... 1,423 1,440
Other receivable........................................................... 417 515
Deferred tax assets........................................................ -- 2,638
Other current assets....................................................... 333 575
-------- --------
Total current assets.................................................... 27,997 36,437
Property, plant and equipment, net............................................. 13,373 10,790
Restricted cash, long-term..................................................... 500 500
Notes receivable, long-term.................................................... 2,091 2,276
Goodwill and other intangible assets, net...................................... 3,503 3,203
Deferred tax assets............................................................ -- 4,828
Other assets................................................................... 902 686
-------- --------
Total assets............................................................ $ 48,366 $ 58,720
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt.......................................... $ 600 $ 600
Accounts payable........................................................... 2,708 3,601
Accrued expenses........................................................... 4,788 5,884
-------- --------
Total current liabilities............................................... 8,096 10,085
Long-term debt, less current portion above..................................... 5,558 3,521
-------- --------
Total liabilities....................................................... 13,654 13,606
-------- --------
Stockholders' equity:
Common stock, $0.01 par value; 40,000,000 shares
authorized; 14,719,258 and 18,307,751 shares issued...................... 147 183
Additional paid-in capital................................................. 50,942 50,696
Treasury stock; 3,662,523 shares of common stock at cost................... -- (8,335)
Other stockholders' equity................................................. (16,377) 2,570
-------- --------
Total stockholders' equity.............................................. 34,712 45,114
-------- --------
Total liabilities and stockholders' equity.............................. $ 48,366 $ 58,720
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Six Months Ended
--------------------------------------
December 29, December 31,
2000 1999
------------- --------------
Cash flows from operating activities:
Net loss........................................................................ $(19,169) $(10,114)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization................................................ 1,707 2,150
Deferred income taxes........................................................ 6,311 --
Research and development expenses related to warrants........................ 8,335 --
Deferred compensation related to stock options............................... -- 91
Net book value of assets charged against restructuring reserve............... -- 1,461
Accrued interest on notes receivable from stockholders....................... (149) (31)
Changes in assets and liabilities:
Accounts receivable....................................................... 9,669 (3,114)
Other receivable.......................................................... 98 (3,558)
Inventories............................................................... (1,564) 3,377
Other assets.............................................................. 26 807
Accounts payable.......................................................... (893) 866
Accrued expenses.......................................................... (1,096) 1,204
-------- --------
Net cash provided by (used in) operating activities................... 3,275 (6,861)
-------- --------
Cash flows from investing activities:
Purchases of property, plant and equipment...................................... (3,810) (182)
Proceeds from sale of short-term investments.................................... 1,879 8,017
Decrease (increase) in goodwill................................................. 375 (375)
Repayments of notes receivable, net of advances................................. 322 --
-------- --------
Net cash provided by (used in) investing activities................... (1,234) 7,460
-------- --------
Cash flows from financing activities:
Proceeds from long term debt, net of payments................................... 2,037 --
Proceeds from issuance of common stock, net..................................... 210 382
Repurchase of common stock...................................................... -- (78)
Proceeds from repayment of notes receivable from stockholders................... 281 55
Change in other comprehensive income............................................ (30) --
-------- --------
Net cash provided by financing activities............................. 2,498 359
-------- --------
Net increase in cash and cash equivalents........................................... 4,539 958
Cash and cash equivalents at beginning of period.................................... 6,617 6,880
-------- --------
Cash and cash equivalents at end of period.......................................... $ 11,156 $ 7,838
======== ========
Supplemental disclosures:
Cash paid for interest.......................................................... $ 189 $ --
======== ========
Refund from income taxes........................................................ $ 23 $ 500
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. Basis of Presentation
The accompanying unaudited interim condensed consolidated financial
statements of Verilink Corporation (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, these statements include all
adjustments, consisting of normal and recurring adjustments, considered
necessary for a fair presentation of the results for the periods presented. The
results of operations for the periods presented are not necessarily indicative
of results which may be achieved for the entire fiscal year ending June 29,
2001. The unaudited interim condensed consolidated financial statements should
be read in conjunction with the financial statements and notes thereto contained
in the Company's Annual Report on Form 10-K for the fiscal year ended June 30,
2000 as filed with the Securities and Exchange Commission.
NOTE 2. Comprehensive Income (Loss)
The Company records gains or losses on the Company's foreign currency
translation adjustments and unrealized gains or losses on the Company's
available-for-sale investments as accumulated other comprehensive income and
presents it in other stockholders' equity in the accompanying condensed
consolidated balance sheets. For the three months ended December 29, 2000 and
December 31, 1999, comprehensive loss amounted to $12,348,000 and $777,000,
respectively. For the six months ended December 29, 2000 and December 31, 1999,
comprehensive loss was $19,199,000 and $10,114,000, respectively.
NOTE 3. Restructuring Charge
During the first quarter of fiscal 2000, the Company announced its
plans to consolidate its San Jose operations with its facilities in Huntsville,
Alabama, and outsource its San Jose-based manufacturing operations. The Company
recorded charges (credits) of $6.9 million, $1.4 million, and ($0.3) million in
the first, second and fourth quarters of fiscal 2000, respectively, in
connection with the restructuring activities that included 1) severance and
other termination benefits for the approximately 135 San Jose-based employees
who were involuntarily terminated, 2) the termination of certain facility
leases, 3) the write-down of certain impaired assets and 4) the pro-rata portion
of the non-recurring retention bonuses offered to the involuntarily terminated
employees to support the transition from California to Alabama. All amounts
accrued for the restructuring have been paid or charged against the
restructuring reserve.
NOTE 4. Inventories
Inventories are stated at the lower of cost, determined using the
first-in, first-out method, or market. Inventories consisted of the following
(in thousands):
December 29, June 30,
2000 2000
------------ ---------
Raw materials $1,642 $1,517
Work in process 213 --
Finished goods 4,549 3,323
------ ------
$6,404 $4,840
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NOTE 5. Earnings Per Share
Basic net income (loss) per share is computed by dividing net income
(loss) available to common stockholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period. Diluted net
income (loss) per share gives effect to all dilutive potential common shares
outstanding during a period. In computing diluted net income (loss) per share,
the average price of the Company's Common Stock for the period is used in
determining the number of shares assumed to be purchased from the exercise of
stock options under the treasury stock method. Following is a reconciliation of
the numerators and denominators of the basic and diluted net income (loss) per
share for the three and six months ended December 29, 2000 and December 31,
1999, respectively:
(in thousands, except per share amounts)
-------------------------------------------------------------------
Three Months Ended Six Months Ended
--------------------------------- -----------------------------
Dec. 29, 2000 Dec. 31, 1999 Dec. 29, 2000 Dec. 31, 1999
-------------- --------------- ------------- -------------
Net loss [numerator] $ (12,333) $ (777) $ (19,169) $(10,114)
========== ========== ========== ========
Shares calculation [denominator]:
Weighted shares outstanding - Basic 14,719 13,971 14,717 13,960
Effect of dilutive securities:
Potential common stock relating to
stock options and warrants (a) -- -- -- --
---------- ---------- ---------- --------
Weighted shares outstanding - Diluted 14,719 13,971 14,717 13,960
========== ========== ========== ========
Net loss per share - Basic $ (0.84) $ (0.06) $ (1.30) $ (0.72)
========== ========== ========== ========
Net loss per share - Diluted $ (0.84) $ (0.06) $ (1.30) $ (0.72)
========== ========== ========== ========
(a) Options to purchase 4,282,431 and 3,453,964 shares of common stock at
prices ranging from $0.50 to $19.75 per share were outstanding at
December 29, 2000 and December 31, 1999, respectively, and stock
warrants to purchase 2,249,900 shares at $4.75 were outstanding at
December 29, 2000, but were not included in the computation of diluted
net loss per share because inclusion of such options would have been
antidilutive.
NOTE 6. Recently Issued Accounting Pronouncements
In June 1999, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 137, "Accounting for Derivative
Instruments and Hedging Activities Deferral of the Effective Date of FASB No.
133", which deferred the effective date provisions of SFAS No. 133 for the
Company until fiscal 2001. SFAS 133 establishes new standards of accounting and
reporting for derivative instruments and hedging activities. SFAS 133 requires
that all derivatives be recognized at fair value in the statement of financial
position, and that the corresponding gains or losses be reported either in the
statement of operations or as a component of other comprehensive income,
depending on the type of hedging relationship that exists. The Company currently
does not hold derivative instruments or engage in hedging activities.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements".
This pronouncement summarizes certain of the SEC staff's views on applying
generally accepted accounting principles to revenue recognition. The Company has
reviewed the requirements of SAB 101 and believes that its existing accounting
policies are in accordance with the guidance provided in the SAB.
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NOTE 7. Stock Warrants and Related Agreements
In October 2000, the Company entered into agreements with Beacon Telco,
L.P. ("Beacon Telco") and the Boston University Photonics Center to establish a
product development center at the Photonics Center to develop new optical
networking products. As part of the agreements, the Company issued Beacon Telco
warrants for 2,249,900 shares of the Company's common stock at an exercise price
of $4.75 per share that will become exercisable at various dates, and will
expire on October 13, 2003. The exercise dates of the warrants may be
accelerated based upon meeting development milestones and certain other events,
including the market price of the Company's common stock exceeding a certain
price. The issuance of these warrants dilutes the Company's earnings per share
by approximately 15%.
The agreements provide Beacon Telco the opportunity to receive two
bonus payments based in part on meeting certain milestones and the market price
of the Company's common stock. The first bonus payment of $3,562,500 was earned
on October 13, 2000 and paid on February 9, 2001 in the form of a note that
Beacon Telco used in conjunction with the exercise of warrants for 749,900
shares of the Company's common stock. The second bonus payment of up to $7.1
million, if earned, may be paid at the option of the Company in cash, common
stock, or a five-year note (payable in either cash or common stock).
The Company recorded a charge to research and development expenses in
the second quarter of fiscal 2001 of $8.3 million for the warrants and the first
bonus payment to be used in the exercise of the warrants. The second bonus
payment will be charged to research and development expenses in future periods
as the optical networking products are developed to achieve the related
milestones. Management expects research and development expenses, excluding the
$8.3 million charge for the warrants and bonus, to increase significantly during
calendar 2001 in support of ongoing optical product development at the Photonics
Center.
NOTE 8. Treasury Stock
In November 2000, the Company retired all 3,662,523 shares of its
treasury stock by charging the original cost against common stock and additional
paid in capital.
NOTE 9. Income Taxes
As a result of losses currently expected to arise from the increased
research and development expenses for the optical networking products, the
Company established a full valuation allowance against its deferred tax assets
at September 29, 2000. Management believes that due to the net loss expected for
the current fiscal year and the existing net loss carryforwards from prior
years, it is more likely than not that the Company's deferred tax assets will
not be realized.
The valuation allowance includes $1,155,000 related to the deferred tax
assets of an acquired business for which uncertainty now exists surrounding the
realization of such assets. This amount was recorded as an increase in costs in
excess of net assets of the acquired company (goodwill). The valuation allowance
will be used to reduce goodwill in the future when any portion of the related
deferred tax assets is recognized.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information in this Item 2 - "Management's Discussion and Analysis
of Financial Condition and Results of Operations" contains forward-looking
statements, including, without limitation, statements relating to the Company's
revenues, expenses, margins, liquidity and capital needs. Such forward-looking
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from those anticipated in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed elsewhere herein under the caption
"Factors Affecting Future Results".
RESULTS OF OPERATIONS
The following table presents the percentages of total sales represented
by certain line items from the Condensed Consolidated Statements of Operations
for the periods indicated.
Three Months Ended Six Months Ended
------------------------- -------------------------
Dec. 29, Dec. 31, Dec. 29, Dec. 31,
2000 1999 2000 1999
--------- --------- --------- ----------
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 63.1 50.1 53.1 54.2
------ ------ ------ ------
Gross margin 36.9 49.9 46.9 45.8
------ ------ ------ ------
Operating expenses:
Research and development 121.6 13.4 62.8 17.2
Selling, general and administrative 55.2 34.0 48.7 35.8
Restructuring and other non-recurring charges -- 8.7 -- 26.7
------ ------ ------ ------
Total operating expenses 176.8 56.1 111.5 79.7
------ ------ ------
Loss from operations (139.9) (6.2) (64.6) (33.9)
Interest and other income, net 3.4 1.4 3.0 1.3
------ ------ ------ ------
Loss before provision for income taxes (136.5) (4.8) (61.6) (32.6)
Provision for income taxes -- -- 30.2 --
------ ------ ------ ------
Net loss (136.5)% (4.8)% (91.9)% (32.6)%
====== ====== ====== ======
Sales. Net sales decreased approximately 44% to $9 million for the
three months ended December 29, 2000 from $16.2 million in the comparable period
of the prior fiscal year. Net sales decreased 33% to $20.9 million for the six
months ended December 29, 2000 from $31 million during the comparable period in
the prior year. The decrease in net sales resulted from a decrease in sales
volume to most of the Company's product markets. Carrier and carrier access
products net sales decreased from $10.6 million in the three months ended
December 31, 1999 to $5.2 million in the three months ended December 29, 2000
and decreased from $19.1 million in the six months ended December 31, 1999 to
$12.7 million in the six months ended December 29, 2000. These decreases were
primarily a result of reduced spending by the large telecommunication
infrastructure companies that have traditionally contributed to more than half
of the Company's revenue base. Net sales to the Company's top five customers
decreased approximately 52% in the three months ended December 29, 2000 to $5
million from $10.3 million in the three months ended December 31, 1999, and
decreased 26% to $13.3 million for the six months ended December 29, 2000 from
$18 million for the six months ended December 31, 1999. Net sales to all other
customers declined by approximately 31% and 58%, respectively, in the three- and
six-month periods ended December 29, 2000 from the comparable periods in the
prior fiscal year due in part to the impact of the reorganization of the sales
force from a geographical focus to a market focus and the implementation of a
two-tier distribution channel. See "Factors Affecting Future Results --
Reorganization of Sales Force". The Company's top five customers did not remain
the same over the periods.
Gross Margin. Gross margin decreased to 36.9% of net sales for the
three months ended December 29, 2000 as compared to 49.9% for the three months
ended December 31, 1999. This decrease is attributable to a number of factors,
including the product sales mix, a high level of unabsorbed manufacturing
overhead and other costs
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associated with the lower sales volume this year, and additional excess
inventory reserves provided against certain product lines. Gross margin improved
to 46.9 % of net sales for the six months ended December 29, 2000 from 45.8% for
the six months ended December 31, 1999, again due to a number of factors
including, higher gross margins in the first quarter of fiscal 2001 due to that
quarter's product sales mix, the duplication of costs in both San Jose and
Huntsville in fiscal 2000 prior to the Company's move to Huntsville in December
1999, a high level of warranty expense in the first two quarters of fiscal 2000,
and a high level of non-warranty repairs that carry a lower than average gross
margin in the first quarter of fiscal 2000.
Research and Development. Research and development expenditures
increased 406% to $11 million for the three months ended December 29, 2000 from
$2.2 million for the three months ended December 31, 1999 and increased 145% to
$13.1 million for the six months ended December 29, 2000 from $5.3 million for
the six months ended December 31, 1999. As a percentage of sales, research and
development expenses increased from 13.4% for the three months ended December
31, 1999 to 121.6% for the three months ended December 29, 2000 and increased
from 17.2% for the six months ended December 31, 1999 to 62.8% for the six
months ended December 29, 2000. These increases were due to the agreements
announced in October 2000 with Beacon Telco and the Boston University Photonics
Center to establish a product development center to develop new optical
networking products. In connection with these agreements, the Company recorded a
non-cash charge to research and development expenses for $8.3 million in the
second quarter of fiscal 2001. Research and development expenses, excluding the
$8.3 million charge for the warrants and bonus, are expected to increase during
the next five to six quarters in connection with the development of optical
networking products. See "Optical Networking Project and Related Warrants" and
"Factors Affecting Future Results - Optical Networking Product Development". The
Company believes that a significant level of investment in product development
is required to remain competitive and that such expenses will vary over time as
a percentage of net sales.
Selling, General and Administrative. Selling, general and
administrative expenses decreased 9% to $5 million for the three months ended
December 29, 2000 from $5.5 million for the three months ended December 31, 1999
and decreased 8% to $10.2 million for the six months ended December 29, 2000
from $11.1 million for the six months ended December 31, 1999. The decrease in
absolute dollars over the same periods in the prior year is due to a decrease in
variable selling expenses on the lower sales volume, cost reduction programs
implemented during the second quarter of fiscal 2001, and to the completion of
the restructuring and consolidation plan during fiscal 2000. Selling, general
and administrative expenses increased as a percentage of sales from 34.0% for
the three months ended December 31, 1999 to 55.2% for the three months ended
December 29, 2000 and increased from 35.8% for the six months ended December 31,
1999 to 48.7% for the six months ended December 29, 2000 due to the lower sales
levels. The Company expects the dollar amount of selling, general and
administrative expenses will remain flat to slightly increasing in the future
and that such expenses will vary over time as a percentage of sales.
Restructuring and Other Non-recurring Charges. During the first quarter
of fiscal 2000, the Company announced and began implementing its plans to
consolidate its operations into its existing operations located in Huntsville,
Alabama, and to outsource its San Jose based manufacturing activities. The
Company incurred pretax charges of $1.4 million and $8.3 million, respectively,
in the three- and six-month periods ended December 31, 1999 for restructuring
and other related non-recurring activities. See Note 3 in the Notes to Condensed
Consolidated Financial Statements for further details of the restructuring and
other non-recurring charges.
Interest and Other Income, Net. Net interest and other income increased
40% from $222,000 for the three months ended December 31, 1999 to $311,000 for
the three months ended December 29, 2000 and increased 58% from $393,000 for the
six months ended December 31, 1999 to $621,000 for the six months ended December
29, 2000. These increases are a result of higher cash and cash equivalents,
restricted cash and short-term investment balances and higher market interest
rates.
Provision for Income Taxes. With the full valuation allowance established
against its deferred tax assets at September 29, 2000, the Company did not
record a tax benefit for income taxes for the three months ended December 29,
2000. The Company did not record a tax benefit or provision for income taxes in
the three- and six-month periods ended December 31, 1999.
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OPTICAL NETWORKING PROJECT AND RELATED WARRANTS
In October 2000, the Company entered into agreements with Beacon Telco,
L.P. ("Beacon Telco") and the Boston University Photonics Center to establish a
product development center at the Photonics Center to develop new optical
networking products. The goal of this project is to accelerate the development
of optics-based products to expand the Company's current product offerings and
market positioning, and to build in-house R&D expertise in optics technology to
support potential future development of a broad variety of optics-based
products. The arrangement provides the Company with access to the Photonics
Center's state-of-the-art optics laboratories and specialized technical
expertise, which, together with the Company's own engineering and strategic
marketing resources, may accelerate the development of new optics-based
products.
As part of the agreements, the Company issued Beacon Telco warrants to
purchase up to 2,249,900 shares of the Company's common stock (representing
approximately 15% of the current outstanding common stock of the Company) at an
exercise price of $4.75 per share, subject to customary anti-dilution
adjustments. The warrants become exercisable over time, subject to acceleration
based upon meeting development milestones and certain other events, including
the market price of the Company's common stock exceeding a certain price, and
will expire on October 13, 2003. The Company has agreed to appoint one designee
of Beacon Telco to the Board of Directors of the Company. Until the earlier of
October 13, 2005 or the date that Beacon Telco beneficially owns less than 10%
of Company's common stock, including the common stock issuable upon exercise of
its warrants, the Company has agreed to recommend that its stockholders elect
the designee of Beacon Telco at each meeting of stockholders at which the Beacon
Designee is up for election. Beacon Telco has agreed to vote shares of Common
Stock issued upon exercise of its warrants in accordance with the recommendation
of the Board of Directors of the Company. In addition, Beacon Telco has agreed
to certain "standstill" provisions and the Company has agreed to register Beacon
Telco's resale of the common stock issuable upon exercise of the warrants under
the Securities Act of 1933.
The agreements provide Beacon Telco the opportunity to receive two
bonus payments based in part on meeting certain milestones and the market price
of the Company's common stock. The first bonus payment of $3,562,500 was earned
on October 13, 2000 and paid on February 9, 2001 in the form of a note that
Beacon Telco used in conjunction with the exercise of warrants for 749,900
shares of the Company's common stock. The second bonus payment of up to $7.1
million, if earned, may be paid at the option of the Company in cash, common
stock, or a five-year non-interest bearing note (payable in either cash or
common stock).
The Company recorded a charge to research and development expenses in
the second quarter of fiscal 2001 of $8.3 million for the warrants and the first
bonus payment to be used in the exercise of the warrants. The second bonus
payment will be charged to research and development expenses in future periods
as the optical networking products are developed to achieve the related
milestones. Management expects research and development expenses, excluding the
$8.3 million charge for the warrants and bonus, to increase significantly during
calendar 2001 in support of ongoing optical product development at the Photonics
Center.
The foregoing description is qualified by reference to the definitive
documents that were filed as exhibits to Form 10-Q for the quarterly period
ended September 29, 2000 filed on November 13, 2000.
LIQUIDITY AND CAPITAL RESOURCES
On December 29, 2000, the Company's principal sources of liquidity
included $13.9 million of cash and cash equivalents, restricted cash, and
short-term investments.
During the six months ended December 29, 2000, cash flow provided by
operating activities was approximately $3.3 million compared to $6.9 million
used in operating activities during the six months ended December 31, 1999. Net
cash provided by operating activities this quarter was due primarily to better
asset management, with accounts receivable decreasing $9.7 million from better
collection efforts and lower sales volume, offset by the cash loss from
operations of $2.8 million, the increase in inventories of $1.6 million, and the
decrease in current liabilities of $2 million. Overall, the reduced sales volume
impacted the changes in accounts receivable, inventories, and current
liabilities during this six-month period.
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Cash used in investing activities was approximately $1.2 million for
the six months ended December 29, 2000, as compared to approximately $7.5
million provided for the six months ended December 31, 1999. Capital
expenditures of $3.8 million for the six months ended December 29, 2000 were
used primarily for renovation to the new headquarters facility acquired by the
Company on June 30, 2000 and completion of the Oracle implementation project in
July 2000. The maturity of short-term investments provided $1.9 million in cash
during the first six months of fiscal 2001. The Company is committed to spend
approximately $1.1 million to complete the renovation of the new headquarters
facility, with an expected completion date in February 2001.
Cash provided by financing activities was $2.5 million for the six
months ended December 29, 2000 compared to $359,000 for the six months ended
December 31, 1999. Proceeds of $2 million were provided during the six months
ended December 29, 2000 from the loan agreement, as amended during the second
quarter of fiscal 2001. Under the terms of the amended loan agreement, the
Company can borrow up to $6.5 million to finance the purchase of the new
headquarters property and make improvements thereon. As of December 29, 2000,
the Company had approximately $42,000 of borrowings that are available under
this loan agreement.
The Company believes that its cash and investment balances, along with
anticipated cash flows from operations according to our current operating
forecast, and the remaining funds available under the multi-year mortgage will
be adequate to finance current operations, anticipated investments, research and
development expenses, and capital expenditures for at least the next twelve
months. The Company continues to investigate the possibility of generating
financial resources through committed credit agreements, technology or
manufacturing partnerships, equipment financing, and offerings of debt and
equity securities.
FACTORS AFFECTING FUTURE RESULTS
As described by the following factors, past financial performance
should not be considered to be a reliable indicator of future performance, and
investors should not use historical trends to anticipate results or trends in
future periods.
This Report on Form 10-Q contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, including statements
using terminology such as "may", "will", "expects", "plans", "anticipates",
"estimates", "potential", or "continue", or the negative thereof or other
comparable terminology regarding beliefs, plans, expectations or intentions
regarding the future. Forward-looking statements include statements regarding
the Company's consolidation of its operations and outsourcing of its
manufacturing operations (the "Restructuring"); the goals, intended benefits and
success of the Restructuring, particularly the goal of reducing expenses;
expected changes in selling, general and administrative expenses; total budgeted
capital expenditures; expected research and development expenses; results and
anticipated benefits of the optical networking project; and the adequacy of the
Company's cash position for the near-term. These forward-looking statements
involve risks and uncertainties, and it is important to note that the Company's
actual results could differ materially from those in such forward-looking
statements. Among the factors that could cause actual results to differ
materially are the factors detailed below as well as the other factors set forth
in Item 2 hereof. All forward-looking statements and risk factors included in
this document are made as of the date hereof, based on information available to
the Company as of the date hereof, and the Company assumes no obligation to
update any forward-looking statement or risk factor. You should consult the risk
factors listed from time to time in the Company's Reports on Forms 10-Q and
10-K.
Customer Concentration. A small number of customers continue to account
for a majority of the Company's sales. In fiscal 2000, net sales to Nortel,
WorldCom, and Ericsson accounted for 30%, 19%, and 3% of the Company's net
sales, respectively, and the Company's top five customers accounted for 61% of
the Company's net sales. In fiscal 1999, net sales to Nortel, WorldCom, and
Ericsson accounted for 17%, 27%, and 5% of the Company's net sales,
respectively, and net sales to the Company's top five customers accounted for
57% of the Company's net sales. Percentages of total revenue have been restated
for prior periods as if Ericsson's May 1999 acquisition of Qualcomm's
terrestrial Code Division Multiple Access (CDMA) wireless infrastructure
business had been in effect for all periods presented. Other than Nortel,
WorldCom, and Ericsson, no customer accounted for more than 10% of the Company's
net sales in fiscal years 2000 or 1999. There can be no assurance that the
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Company's current customers will continue to place orders with the Company, that
orders by existing customers will continue at the levels of previous periods, or
that the Company will be able to obtain orders from new customers. Certain
customers of the Company have been or may be acquired by other existing
customers. The impact of such acquisitions on net sales to such customers is
uncertain, but there can be no assurance that such acquisitions will not result
in a reduction in net sales to those customers. In addition, such acquisitions
could have in the past, and could in the future, result in further concentration
of the Company's customers. The Company has in the past experienced significant
declines in net sales it believes were in part related to orders being delayed
or cancelled as a result of pending acquisitions relating to its customers.
There can be no assurance that future merger and acquisition activity among the
Company's customers will not have a similar adverse affect on the Company's net
sales and results of operations. The Company's customers are typically not
contractually obligated to purchase any quantity of products in any particular
period. Product sales to major customers have varied widely from period to
period. In some cases, major customers have abruptly terminated purchases of the
Company's products. Loss of, or a material reduction in orders by, one or more
of the Company's major customers would materially adversely affect the Company's
business, financial condition, and results of operations. See "Competition" and
"Fluctuations in Quarterly Operating Results".
Dependence on Outside Contractors. In September 1999, the Company
entered into an agreement with a single outside contractor to outsource
substantially all of the manufacturing operations previously located in San
Jose, including its procurement, assembly, and system integration operations.
The products manufactured by the outside contractor located in California
generated a majority of the Company's revenues. There can be no assurance that
this contractor will continue to meet the Company's future requirements for
manufactured products, or that the contractor will not experience quality
problems in manufacturing the Company's products. The inability of the Company's
contractor to provide the Company with adequate supplies of high quality
products could have a material adverse effect on the Company's business,
financial condition, and results of operations.
The loss of any of the Company's outside contractors could cause a
delay in the Company's ability to fulfill orders while the Company identifies a
replacement contractor. Because the establishment of new manufacturing
relationships involves numerous uncertainties, including those relating to
payment terms, cost of manufacturing, adequacy of manufacturing capacity,
quality control and timeliness of delivery, the Company is unable to predict
whether such relationships would be on terms that the Company regards as
satisfactory. Any significant disruption in the Company's relationships with its
manufacturing sources would have a material adverse effect on the Company's
business, financial condition, and results of operations.
Dependence on Key Personnel. The Company's future success will depend
to a large extent on the continued contributions of its executive officers and
key management, sales, and technical personnel. The Company is a party to
agreements with certain of its executive officers to help ensure the officers'
continued service to the Company in the event of a change-in-control. Each of
the Company's executive officers, and key management, sales and technical
personnel would be difficult to replace. Several members of the senior
management team recently joined the Company and have had only a limited time to
work together. The loss of the services of one or more of the Company's
executive officers or key personnel, the inability of the management team to
work effectively together, or the inability to continue to attract qualified
personnel would delay product development cycles or otherwise would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Management of Growth. To manage potential future growth effectively,
the Company must improve its operational, financial and management information
systems and must hire, train, motivate and manage its employees. The future
success of the Company also will depend on its ability to increase its customer
support capability and to attract and retain qualified technical, marketing and
management personnel, for whom competition is intense. In particular, the
current availability of qualified personnel may be limited and competition among
companies for such personnel is intense. The Company is currently attempting to
hire a number of engineering personnel and has experienced some delays in
filling such positions. There can be no assurance that the Company will be able
to effectively achieve or manage any such growth, and failure to do so could
delay product development and introduction cycles or otherwise have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Dependence on Key Personnel".
Dependence on Component Availability and Key Suppliers. The Company
generally relies upon a contract manufacturer to buy component parts that are
incorporated into board assemblies used in its products. On-time
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delivery of the Company's products depends upon the availability of components
and subsystems used in its products. Currently, the Company and third party
sub-contractors depend upon suppliers to manufacture, assemble and deliver
components in a timely and satisfactory manner. The Company has historically
obtained several components and licenses for certain embedded software from
single or limited sources. There can be no assurance that these suppliers will
continue to be able and willing to meet the Company's and third party
sub-contractors' requirements for any such components. The Company and third
party sub-contractors generally do not have any long-term contracts with such
suppliers, other than software vendors. Any significant interruption in the
supply of, or degradation in the quality of, any such item could have a material
adverse effect on the Company's results of operations. Any loss in a key
supplier, increase in required lead times, increase in prices of component
parts, interruption in the supply of any of these components, or the inability
of the Company or its third party sub-contractor to procure these components
from alternative sources at acceptable prices and within a reasonable time,
could have a material adverse effect upon the Company's business, financial
condition and results of operations.
Purchase orders from the Company's customers frequently require
delivery quickly after placement of the order. As the Company does not maintain
significant component inventories, delay in shipment by a supplier could lead to
lost sales. The Company uses internal forecasts to determine its general
materials and components requirements. Lead times for materials and components
may vary significantly, and depend on factors such as specific supplier
performance, contract terms, and general market demand for components. If orders
vary from forecasts, the Company may experience excess or inadequate inventory
of certain materials and components, and suppliers may demand longer lead times,
higher prices, or termination of contracts. From time to time, the Company has
experienced shortages and allocations of certain components, resulting in delays
in fulfillment of customer orders. Such shortages and allocations may occur in
the future, and could have a material adverse effect on the Company's business,
financial condition, and results of operations. See "Fluctuations in Quarterly
Operating Results".
Fluctuations in Quarterly Operating Results. The Company's sales are
subject to quarterly and annual fluctuations due to a number of factors
resulting in more variability and less predictability in the Company's
quarter-to-quarter sales and operating results. For example, sales to Nortel,
WorldCom, and Ericsson have varied between quarters by as much as $4.0 million,
and orders delayed by these customers had a significant negative impact on the
Company's first and second quarter results of fiscal 2001 as well as the third
and fourth quarter results in fiscal 1999. Most of the Company's sales are in
the form of large orders with short delivery times. The Company's ability to
affect and judge the timing of individual customer orders is limited. The
Company has experienced large fluctuations in sales from quarter-to-quarter due
to a wide variety of factors, such as delay, cancellation or acceleration of
customer projects, and other factors discussed below. The Company's sales for a
given quarter may depend to a significant degree upon planned product shipments
to a single customer, often related to specific equipment deployment projects.
The Company has experienced both acceleration and slowdown in orders related to
such projects, causing changes in the sales level of a given quarter relative to
both the preceding and subsequent quarters.
Delays or lost sales can be caused by other factors beyond the
Company's control, including late deliveries by the third party subcontractors
the Company is using to outsource its manufacturing operations as well as by
other vendors of components used in a customer's system, changes in
implementation priorities, slower than anticipated growth in demand for the
services that the Company's products support and delays in obtaining regulatory
approvals for new services and products. Delays and lost sales have occurred in
the past and may occur in the future. Operating results in recent periods have
been adversely affected by delays in receipt of significant purchase orders from
customers. The Company believes that sales in prior periods have been adversely
impacted by merger activities by some of its top customers. In addition, the
Company has in the past experienced delays as a result of the need to modify its
products to comply with unique customer specifications. These and similar delays
or lost sales could materially adversely affect the Company's business,
financial condition and results of operations. See "Customer Concentration" and
"Dependence on Component Availability and Key Suppliers".
The Company's backlog at the beginning of each quarter typically is not
sufficient to achieve expected sales for that quarter. To achieve its sales
objectives, the Company is dependent upon obtaining orders in a quarter for
shipment in that quarter. Furthermore, the Company's agreements with its
customers typically provide that they may change delivery schedules and cancel
orders within specified timeframes, typically up to 30 days prior to the
scheduled shipment date, without significant penalty. The Company's customers
have in the past built, and may in
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the future build, significant inventory in order to facilitate more rapid
deployment of anticipated major projects or for other reasons. Decisions by such
customers to reduce their inventory levels could lead to reductions in purchases
from the Company. These reductions, in turn, could cause fluctuations in the
Company's operating results and could have an adverse effect on the Company's
business, financial condition, and results of operations in the periods in which
the inventory is reduced.
The Company's industry is characterized by declining prices of existing
products, and therefore continual improvement of manufacturing efficiencies and
introduction of new products and enhancements to existing products are required
to maintain gross margins. In response to customer demands or competitive
pressures, or to pursue new product or market opportunities, the Company may
take certain pricing or marketing actions, such as price reductions, volume
discounts, or provision of services at below-market rates. These actions could
materially and adversely affect the Company's operating results.
Operating results may also fluctuate due to a variety of factors,
particularly:
- delays in new product introductions by the Company;
- market acceptance of new or enhanced versions of the Company's
products;
- changes in the product or customer mix of sales;
- changes in the level of operating expenses;
- changes in the level of research and development expenses;
- competitive pricing pressures;
- the gain or loss of significant customers;
- increased research and development and sales and marketing
expenses associated with new product introductions; and
- general economic conditions.
All of the above factors are difficult for the Company to forecast, and
these or other factors can materially and adversely affect the Company's
business, financial condition and results of operations for one quarter or a
series of quarters. The Company's expense levels are based in part on its
expectations regarding future sales and are fixed in the short term to a large
extent. Therefore, the Company may be unable to adjust spending in a timely
manner to compensate for any unexpected shortfall in sales. Any significant
decline in demand relative to the Company's expectations or any material delay
of customer orders could have a material adverse effect on the Company's
business, financial condition, and results of operations. There can be no
assurance that the Company will be able to sustain profitability on a quarterly
or annual basis. In addition, the Company has had, and in some future quarter
may have operating results below the expectations of public market analysts and
investors. In such event, the price of the Company's common stock could likely
be materially and adversely affected. See "Potential Volatility of Stock Price".
The Company's products are covered by warranties and the Company is
subject to contractual commitments concerning its products. If unexpected
circumstances arise such that the product does not perform as intended and the
Company is not successful in resolving product quality or performance issues,
there could be an adverse effect on the Company's business, financial condition,
and results of operations. For example, during the fourth quarter of fiscal
1999, the Company was notified by one of its major customers of an intermittent
problem involving one of the Company's products installed in the field. Although
the Company identified a firmware fix for this problem and negotiated an
agreement with the customer to share in the expense associated with the upgrade,
this or similar problems in the future could increase expenses or reduce product
acceptance.
Potential Volatility of Stock Price. The trading price of the Company's
common stock could be subject to wide fluctuations in response to
quarter-to-quarter variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
developments with respect to patents or proprietary rights, general conditions
in the telecommunication network access and equipment industries, changes in
earnings estimates by analysts, or other events or factors. In addition, the
stock market has experienced extreme price and volume fluctuations, which have
particularly affected the market prices of many technology companies and which
have often been unrelated to the operating performance of such companies.
Company-specific factors or broad
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market fluctuations may materially adversely affect the market price of the
Company's common stock. The Company has experienced significant fluctuations in
its stock price and share trading volume in the past and may continue to do so.
Dependence on Recently Introduced Products and New Product Development.
The Company's future results of operations are highly dependent on market
acceptance of existing and future applications for both the Company's AS2000
product line, and the WANsuite(TM) family of integrated access devices
introduced during the third quarter of fiscal 2000. The AS2000 product line
represented approximately 58% of net sales in fiscal 2000, 67% of net sales in
fiscal 1999 and 86% of net sales in fiscal 1998. Sales of WANsuite(TM) products
began during the last quarter of fiscal 2000. Market acceptance of both the
Company's current and future product lines is dependent on a number of factors,
not all of which are in the Company's control, including the continued growth in
the use of bandwidth intensive applications, continued deployment of new
telecommunications services, market acceptance of integrated access devices in
general, the availability and price of competing products and technologies, and
the success of the Company's sales efforts. Failure of the Company's products to
achieve market acceptance would have a material adverse effect on the Company's
business, financial condition, and results of operations. The market for the
Company's products are characterized by rapidly changing technology, evolving
industry standards, continuing improvements in telecommunication service
offerings, and changing demands of the Company's customer base. Failure to
introduce new products in a timely manner could cause companies to purchase
products from competitors and have a material adverse effect on the Company's
business, financial condition and results of operations. Due to a variety of
factors, the Company may experience delays in developing its planned products.
New products may require additional development work, enhancement, and testing
or further refinement before the Company can make them commercially available.
The Company has in the past experienced delays in the introduction of new
products, product applications and enhancements due to a variety of internal
factors, such as reallocation of priorities, difficulty in hiring sufficient
qualified personnel and unforeseen technical obstacles, as well as changes in
customer requirements. Such delays have deferred the receipt of revenue from the
products involved. If the Company's products have performance, reliability or
quality shortcomings, then the Company may experience reduced orders, higher
manufacturing costs, delays in collecting accounts receivable and additional
warranty and service expenses. See "Optical Networking Product Development".
Optical Networking Product Development. The Company's future results
and operations are highly dependent on the success of the Company's optical
product development project, the Company's cooperative research agreement with
Beacon Telco (the "Cooperative Research Agreement"), and its related Premises
Access and Services Agreement with the Boston University Photonics Center (the
"Facility Access Agreement"). The Cooperative Research Agreement and the
Facility Access Agreement are hereinafter collectively referred to as the
"Research Agreements".
The Company has committed to pay the expenses related to the Research
Agreements and therefore anticipates significant increases in research and
development expenses in addition to increases in the ongoing development and
marketing costs necessary to bring a potential optical networking product to
market. Either of these expenses may exceed the budget that the Company has
established and could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company has also agreed both
to license from Beacon Telco and/or the Boston University Photonics Center or
their affiliates, for additional license fees yet to be determined any
background intellectual property necessary to commercialize the optical
networking product and to certain limitations on the Company's ownership and use
of intellectual property generated in the course of the performance of the
Research Agreements. The parties may be unable to agree on the proper fees to be
charged for such license of background intellectual property necessary to
commercialize the optical networking product, or, if agreed, the costs of
licensing background or other intellectual property could be substantial and may
limit the ability of the Company to develop and market the optical networking
product on a profitable basis.
The success of the project may depend on the ability of the Company to
effectively utilize certain resources of the Photonics Center, which are to be
provided on an as-available basis at the discretion of the Trustees of Boston
University. If critical resources are not made available to the Company on a
timely basis, the project may be unsuccessful or may require significantly
higher costs than expected.
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The Company's ongoing effort to develop and market an optical
networking product will require high levels of innovation and may not be
successful. Even if the Company does succeed in developing an optical networking
product, it may have difficulty marketing and selling the product. Moreover,
there can be no assurance that any product developed by the Company will gain
and hold market acceptance in the rapidly growing optical networking market
which is characterized by rapid innovation, numerous competing products and
technologies, as well as strong competition. Failure of the Company to develop
an optical networking product or to gain market acceptance for such a product
would have a material adverse effect on the Company's business, financial
condition and results of operations. Furthermore, the development of an optical
networking product may take longer or be less successful than anticipated,
which, in either event, could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Rapid
Technological Change", "Dependence on Recently Introduced Products and New
Product Development", and "Risks Associated with Potential Acquisitions and
Joint Ventures".
Competition. The market for telecommunications network access equipment
is highly competitive, and the Company expects competition to increase in the
future. This market is subject to rapid technological change, regulatory
developments, and new entrants. The market for integrated access devices such as
the Access System product line and WANSuite(TM), and for enterprise devices such
as the PRISM, FrameStart(TM), and Lite product lines is subject to rapid change.
The Company believes that the primary competitive factors in this market are the
development and rapid introduction of new product features, price and
performance, support for multiple types of communications services, network
management, reliability, and quality of customer support. There can be no
assurance that the Company's current products and future products under
development will be able to compete successfully with respect to these or other
factors. The Company's principal competition to date for its current AS2000 and
AS4000 products has been from Quick Eagle Networks (formerly Digital Link
Corporation), ADC Kentrox, a division of ADC Telecommunications, and Larscom,
Inc., a subsidiary of Axel Johnson. In addition, the Company experiences
substantial competition with its enterprise access and network termination
products from companies in the computer networking market and other related
markets. These competitors include Premisys Communications, Inc. (now a part of
Zhone Technologies), Newbridge Networks Corporation, Visual Networks, Adtran,
Inc., and Paradyne Inc. To the extent that current or potential competitors can
expand their current offerings to include products that have functionality
similar to the Company's products and planned products, the Company's business,
financial condition and results of operations could be materially adversely
affected.
The Company believes that the market for basic network termination
products is mature, but that the market for feature-enhanced network termination
and network access products continues to grow and expand, as more "capability"
and "intelligence" moves outward from the central office to the enterprise. The
Company believes that the principal competitive factors in this market are
price, feature sets, installed base, and quality of customer support. In this
market, the Company primarily competes with Adtran, Quick Eagle Networks, ADC
Kentrox, Paradyne, Visual Networks, and Larscom. There can be no assurance that
such companies or other competitors will not introduce new products that provide
greater functionality and/or at a lower price than the Company's like products.
In addition, advanced termination products are emerging which represent both new
market opportunities as well as a threat to the Company's current products.
Furthermore, basic line termination functions are increasingly being integrated
by competitors, such as Cisco and Nortel Networks, into other equipment such as
routers and switches. These include direct WAN interfaces in certain products,
which may erode the addressable market for separate network termination
products.
Many of the Company's current and potential competitors have
substantially greater technical, financial, manufacturing and marketing
resources than the Company. In addition, many of the Company's competitors have
long-established relationships with network service providers. There can be no
assurance that the Company will have the financial resources, technical
expertise, manufacturing, marketing, distribution and support capabilities to
compete successfully in the future. See "Competition".
Reorganization of Sales Force. In July 2000, the Company restructured
its sales force from a sales force organized by geographical region to one
focused on sales to particular markets and through particular distribution
channels. This reorganization appeared to be disruptive in the first half of
fiscal 2001 and may continue to be disruptive to the Company's sales in future
quarters and involves numerous uncertainties, including, but not limited to, the
increased costs to retrain the sales force in the methods and techniques needed
to effectively approach the different markets and distribution channels
available for the Company's products, the ability to retain current
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members of the sales force, the effectiveness of the sales force in closing
sales, and the re-allocation of relationships that the sales force may have
previously developed with customers in the geographic regions. As a result, the
Company expects that the reorganization may continue to have a short-term
negative impact on the Company's sales and results of operations. The transition
to a market and distribution channel based sales force may take longer or be
less successful than anticipated, which, in either event, could have a material
adverse effect on the Company's business, financial condition, and results of
operations.
Rapid Technological Change. The network access and telecommunications
equipment markets are characterized by rapidly changing technologies and
frequent new product introductions. The rapid development of new technologies
increases the risk that current or new competitors could develop products that
would reduce the competitiveness of the Company's products. The Company's
success will depend to a substantial degree upon its ability to respond to
changes in technology and customer requirements. This will require the timely
selection, development and marketing of new products and enhancements on a
cost-effective basis. The development of new, technologically advanced products
is a complex and uncertain process, requiring high levels of innovation. The
Company may need to supplement its internal expertise and resources with
specialized expertise or intellectual property from third parties to develop new
products. The development of new products for the WAN access market requires
competence in the general areas of telephony, data networking, network
management and wireless telephony as well as specific technologies such as
Digital Subscriber Lines (DSL), Integrated Services Digital Networks (ISDN),
Frame Relay, Asynchronous Transfer Mode (ATM), and Internet Protocols (IP).
Furthermore, the communications industry is characterized by the need to design
products that meet industry standards for safety, emissions, and network
interconnection. With new and emerging technologies and service offerings from
network service providers, such standards are often changing or unavailable. As
a result, there is a potential for product development delays due to the need
for compliance with new or modified standards. The introduction of new and
enhanced products also requires that the Company manage transitions from older
products in order to minimize disruptions in customer orders, avoid excess
inventory of old products, and ensure that adequate supplies of new products can
be delivered to meet customer orders. There can be no assurance that the Company
will be successful in developing, introducing or managing the transition to new
or enhanced products, or that any such products will be responsive to
technological changes or will gain market acceptance. The Company's business,
financial condition and results of operations would be materially adversely
affected if the Company were to be unsuccessful, or to incur significant delays
in developing and introducing such new products or enhancements. See "Dependence
on Recently Introduced Products and New Product Development" and "Optical
Networking Product Development".
Compliance with Regulations and Evolving Industry Standards. The market
for the Company's products is characterized by the need to meet a significant
number of communications regulations and standards, some of which are evolving
as new technologies are deployed. In the United States, the Company's products
must comply with various regulations defined by the Federal Communications
Commission and standards established by Underwriters Laboratories and Bell
Communications Research. For some public carrier services, installed equipment
does not fully comply with current industry standards, and this noncompliance
must be addressed in the design of the Company's products. Standards for new
services such as frame relay, performance monitoring services and Digital
Subscriber Lines (DSL) are still evolving. As these standards evolve, the
Company will be required to modify its products or develop and support new
versions of its products. The failure of the Company's products to comply, or
delays in compliance, with the various existing and evolving industry standards
could delay introduction of the Company's products, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Government regulatory policies are likely to continue to have a major
impact on the pricing of existing as well as new public network services and
therefore are expected to affect demand for such services and the
telecommunications products that support such services. Tariff rates, whether
determined by network service providers or in response to regulatory directives,
may affect the cost effectiveness of deploying communication services. Such
policies also affect demand for telecommunications equipment, including the
Company's products.
Risks Associated With Potential Acquisitions and Joint Ventures. An
important element of the Company's strategy is to review acquisition prospects
and joint venture opportunities that would compliment its existing product
offerings, augment its market coverage, enhance its technological capabilities
or offer growth opportunities. Transactions of this nature by the Company could
result in potentially dilutive issuance of equity securities, use of
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cash and/or the incurring of debt and the assumption of contingent liabilities,
any of which could have a material adverse effect on the Company's business and
operating results and/or the price of the Company's common stock. Acquisitions
entail numerous risks, including difficulties in the assimilation of acquired
operations, technologies and products, diversion of management's attention from
other business concerns, risks of entering markets in which the Company has
limited or no prior experience and potential loss of key employees of acquired
organizations. Joint ventures entail risks such as potential conflicts of
interest and disputes among the participants, difficulties in integrating
technologies and personnel, and risks of entering new markets. The Company's
management has limited prior experience in assimilating such transactions. No
assurance can be given as to the ability of the Company to successfully
integrate any businesses, products, technologies or personnel that might be
acquired in the future or to successfully develop any products or technologies
that might be contemplated by any future joint venture or similar arrangement,
and the failure of the Company to do so could have a material adverse effect on
the Company's business, financial condition and results of operations. See
"Optical Networking Product Development".
Risks Associated With Entry into International Markets. The Company to
date has had minimal direct sales to customers outside of North America. The
Company has little experience in the European and Far Eastern markets, but
intends to expand sales of its products outside of North America and to enter
certain international markets, which will require significant management
attention and financial resources. Conducting business outside of North America
is subject to certain risks, including longer payment cycles, unexpected changes
in regulatory requirements and tariffs, difficulties in staffing and managing
foreign operations, greater difficulty in accounts receivable collection and
potentially adverse tax consequences. To the extent any Company sales are
denominated in foreign currency, the Company's sales and results of operations
may also be directly affected by fluctuations in foreign currency exchange
rates. In order to sell its products internationally, the Company must meet
standards established by telecommunications authorities in various countries, as
well as recommendations of the Consultative Committee on International Telegraph
and Telephony. A delay in obtaining, or the failure to obtain, certification of
its products in countries outside the United States could delay or preclude the
Company's marketing and sales efforts in such countries, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Risk of Third Party Claims of Infringement. The network access and
telecommunications equipment industries are characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert exclusive patent,
copyright, trademark, and other intellectual property rights to technologies
that are important to the Company. The Company has not conducted a formal patent
search relating to the technology used in its products, due in part to the high
cost and limited benefits of a formal search. In addition, since patent
applications in the United States are not publicly disclosed until the related
patent is issued and foreign patent applications generally are not publicly
disclosed for at least a portion of the time that they are pending, applications
may have been filed which, if issued as patents, could relate to the Company's
products. Software comprises a substantial portion of the technology in the
Company's products. The scope of protection accorded to patents covering
software-related inventions is evolving and is subject to a degree of
uncertainty which may increase the risk and cost to the Company if the Company
discovers third party patents related to its software products or if such
patents are asserted against the Company in the future. Patents have been
granted recently on fundamental technologies in software, and patents may be
issued which relate to fundamental technologies incorporated into the Company's
products. The Company may receive communications from third parties asserting
that the Company's products infringe or may infringe the proprietary rights of
third parties. In its distribution agreements, the Company typically agrees to
indemnify its customers for any expenses or liabilities resulting from claimed
infringements of patents, trademarks or copyrights of third parties. In the
event of litigation to determine the validity of any third-party claims, such
litigation, whether or not determined in favor of the Company, could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel from productive tasks. In the event of an
adverse ruling in such litigation, the Company might be required to discontinue
the use and sale of infringing products, expend significant resources to develop
non-infringing technology or obtain licenses from third parties. There can be no
assurance that licenses from third parties would be available on acceptable
terms, if at all. In the event of a successful claim against the Company and the
failure of the Company to develop or license a substitute technology, the
Company's business, financial condition, and results of operations could be
materially adversely affected.
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Limited Protection of Intellectual Property. The Company relies upon a
combination of patent, trade secret, copyright, and trademark laws and
contractual restrictions to establish and protect proprietary rights in its
products and technologies. The Company has been issued certain U.S. and Canadian
patents with respect to limited aspects of its single purpose network access
technology. The Company has not obtained significant patent protection for its
Access System technology. There can be no assurance that third parties have not
or will not develop equivalent technologies or products without infringing the
Company's patents or that a court having jurisdiction over a dispute involving
such patents would hold the Company's patents valid and enforceable. The Company
has also entered into confidentiality and invention assignment agreements with
its employees and independent contractors, and enters into non-disclosure
agreements with its suppliers, distributors and appropriate customers so as to
limit access to and disclosure of its proprietary information. There can be no
assurance that these statutory and contractual arrangements will deter
misappropriation of the Company's technologies or discourage independent
third-party development of similar technologies. In the event such arrangements
are insufficient, the Company's business, financial condition and results of
operations could be materially adversely affected. The laws of certain foreign
countries in which the Company's products are or may be developed, manufactured
or sold may not protect the Company's products or intellectual property rights
to the same extent as do the laws of the United States and thus, make the
possibility of misappropriation of the Company's technology and products more
likely.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
At December 29, 2000, the Company's investment portfolio consisted of
fixed income securities of $2.2 million. These securities, like all fixed income
instruments, are subject to interest rate risk and will decline in value if
market interest rates increase. If market interest rates were to increase
immediately and uniformly by 10% from levels as of December 29, 2000, the
decline in the fair value of the portfolio would not be material. Additionally,
the Company has the ability to hold its fixed income investments until maturity
and therefore, the Company would not expect to recognize such an adverse impact
in income or cash flows. The Company invests cash balances in excess of
operating requirements in short-term securities, generally with maturities of 90
days or less. The Company believes that the effect, if any, of reasonably
possible near-term changes in interest rates on the Company's financial
position, results of operations and cash flows would not be material.
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PART II. OTHER INFORMATION
ITEM 2: CHANGES IN SECURITIES
On October 13, 2000, and in consideration of the execution of the
agreements described under "Optical Networking Project and Related Warrants"
above, the Company issued Beacon Telco warrants to purchase 2,249,900 shares of
the Company's common stock at an exercise price of $4.75 per share. The warrants
were issued in reliance on the exemption from registration provided by Section
4(2) of the Securities Act of 1933, as amended, for transactions by an issuer
not involving a public offering.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Stockholders of the Company was held on November
15, 2000 (the "Annual Meeting"). The voting of holders of record of
14,717,591 shares of the Company's Common Stock outstanding at the
close of business on October 2, 2000 was solicited by proxy pursuant to
Regulation 14A under the Securities Exchange Act of 1934, as amended.
(b) The following individuals were elected as Class I Directors of the
Company at the Annual Meeting:
VOTES
WITHHOLDING
CLASS I DIRECTOR VOTES FOR AUTHORITY
------------------ ----------- -------------
Graham G. Pattison 11,768,947 868,534
John E. Major 11,757,808 879,673
The following Directors' terms of office as Director continued after
the meeting: Leigh S. Belden, John A. McGuire, Howard Oringer, and
Steven C. Taylor.
(c) The amendments to the Company's Amended and Restated 1993 Stock Option
Plan to increase the number of shares available for issuance thereunder
from 6,050,000 to 8,800,000 shares of common stock were ratified. The
stockholders' vote was 5,833,977 shares FOR; 1,503,746 shares AGAINST;
31,187 shares ABSTAINED from voting; and 5,268,571 shares NO VOTE.
(d) The amendments to the Company's 1996 Employee Stock Purchase Plan to
increase the number of shares available for issuance thereunder from
500,000 to 750,000 shares of common stock were ratified. The
stockholders' vote was 7,176,299 shares FOR; 158,241 shares AGAINST;
31,868 shares ABSTAINED from voting; and 5,271,073 shares NO VOTE.
(e) The appointment of PricewaterhouseCoopers LLP as the Company's
independent certified public accountants for fiscal year 2001 was
ratified. The stockholders' vote on such appointment was 12,566,651
shares FOR; 21,450 shares AGAINST; 46,878 shares ABSTAINED from voting;
and 2,502 shares NO VOTE.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Index:
Exhibit Number Description of Exhibit
-------------- ----------------------
10.56 Lease Cancellation Agreement and Business Terms of
Lease Cancellation Agreement between Registrant and
Industrial Properties of the South dated January 19,
2001
(b) No reports on Form 8-K were filed during the quarter ended
December 29, 2000.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERILINK CORPORATION
February 12, 2000 By: /s/ Ronald G. Sibold
------------------------------------------
Ronald G. Sibold,
Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal
Financial Officer)
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