1
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 March 30, 2001
[ ] 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 0-28562
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VERILINK CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 94-2857548
(State of incorporation) (I.R.S. Employer
Identification No.)
950 EXPLORER BOULEVARD, HUNTSVILLE, ALABAMA 35806-2808
(Address of principal executive offices, including zip code)
(256) 327-2001
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X]. No [ ].
The number of shares outstanding of the issuer's common stock as of April 27,
2001 was 15,566,209.
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INDEX
VERILINK CORPORATION
FORM 10-Q
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements (unaudited):
Condensed Consolidated Statements of Operations for the 3
three months and nine months ended March 30, 2001
and March 31, 2000
Condensed Consolidated Balance Sheets as of 4
March 30, 2001 and June 30, 2000
Condensed Consolidated Statements of Cash Flows for the nine 5
months ended March 30, 2001 and March 31, 2000
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 9
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
PART II. OTHER INFORMATION
Item 2. Changes in Securities 21
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURE 21
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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 Nine Months Ended
------------------------ -------------------------
March 30, March 31, March 30, March 31,
2001 2000 2001 2000
--------- --------- --------- ---------
Net sales ........................................... $ 10,290 $17,822 $ 31,155 $ 48,857
Cost of sales ....................................... 6,305 8,569 17,391 25,380
-------- ------- -------- --------
Gross profit ...................................... 3,985 9,253 13,764 23,477
-------- ------- -------- --------
Operating expenses:
Research and development .......................... 3,461 1,743 16,551 7,078
Selling, general and administrative ............... 4,239 5,913 14,407 17,009
Restructuring and other non-recurring
charges ......................................... -- -- -- 8,300
-------- ------- -------- --------
Total operating expenses ...................... 7,700 7,656 30,958 32,387
-------- ------- -------- --------
Income (loss) from operations ....................... (3,715) 1,597 (17,194) (8,910)
Interest and other income, net ...................... 95 203 716 596
-------- ------- -------- --------
Income (loss) before provision for income taxes ..... (3,620) 1,800 (16,478) (8,314)
Provision for income taxes .......................... -- -- 6,311 --
-------- ------- -------- --------
Net income (loss) ................................... $ (3,620) $ 1,800 $(22,789) $ (8,314)
======== ======= ======== ========
Net income (loss) per share - Basic ................. $ (0.24) $ 0.13 $ (1.53) $ (0.59)
======== ======= ======== ========
Net income (loss) per share - Diluted ............... $ (0.24) $ 0.11 $ (1.53) $ (0.59)
======== ======= ======== ========
Shares used in per share computations - Basic ....... 15,312 14,301 14,915 14,074
======== ======= ======== ========
Shares used in per share computations - Diluted ..... 15,312 15,896 14,915 14,074
======== ======= ======== ========
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)
March 30,
2001 June 30,
(Unaudited) 2000
----------- --------
ASSETS
Current assets:
Cash and cash equivalents .................................. $ 10,603 $ 6,617
Restricted cash ............................................ 500 500
Short-term investments ..................................... 516 4,079
Accounts receivable, net ................................... 4,895 15,233
Inventories ................................................ 4,760 4,840
Notes receivable ........................................... 2,072 1,440
Other receivable ........................................... 223 515
Deferred tax assets ........................................ -- 2,638
Other current assets ....................................... 232 575
-------- --------
Total current assets ................................... 23,801 36,437
Property, plant and equipment, net ........................... 14,063 10,790
Restricted cash, long-term ................................... 500 500
Notes receivable, long-term .................................. 1,518 2,276
Goodwill and other intangible assets, net .................... 3,251 3,203
Deferred tax assets .......................................... -- 4,828
Other assets ................................................. 924 686
-------- --------
Total assets ........................................... $ 44,057 $ 58,720
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt .......................... $ 683 $ 600
Accounts payable ........................................... 1,577 3,601
Accrued expenses ........................................... 4,738 5,884
-------- --------
Total current liabilities .............................. 6,998 10,085
Long-term debt, less current portion above ................... 5,397 3,521
Other long-term liabilities .................................. 400 --
-------- --------
Total liabilities ...................................... 12,795 13,606
-------- --------
Stockholders' equity:
Common stock, $0.01 par value; 40,000,000 shares
authorized; 15,561,959 and 18,307,751 shares issued ...... 156 183
Additional paid-in capital ................................. 51,099 50,696
Treasury stock; 3,662,523 shares of common stock at cost ... -- (8,335)
Other stockholders' equity (deficit) ....................... (19,993) 2,570
-------- --------
Total stockholders' equity ............................. 31,262 45,114
-------- --------
Total liabilities and stockholders' equity ............. $ 44,057 $ 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)
Nine Months Ended
---------------------------
March 30, March 31,
2001 2000
--------- ---------
Cash flows from operating activities:
Net loss ............................................................. $(22,789) $(8,314)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization .................................... 2,591 2,983
Deferred income taxes ............................................ 6,311 --
Research and development expenses related to the Beacon Telco
warrants and bonus accrual ..................................... 8,735 --
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 ........... (216) (43)
Changes in assets and liabilities:
Accounts receivable ............................................ 10,338 (2,736)
Other receivable ............................................... 292 (2,135)
Inventories .................................................... 80 2,057
Other assets ................................................... 105 867
Accounts payable ............................................... (2,024) 462
Accrued expenses ............................................... (1,146) (768)
-------- -------
Net cash provided by (used in) operating activities .......... 2,277 (6,075)
-------- -------
Cash flows from investing activities:
Purchases of property, plant and equipment ........................... (5,132) (249)
Proceeds from sale of short-term investments ......................... 3,563 5,878
Decrease (increase) in goodwill ...................................... 375 (375)
Repayments of notes receivable, net of advances ...................... 302 --
-------- -------
Net cash provided by (used in) investing activities .......... (892) 5,254
-------- -------
Cash flows from financing activities:
Proceeds from long term debt, net of payments ........................ 1,959 --
Proceeds from issuance of common stock, net .......................... 375 3,093
Repurchase of common stock ........................................... -- (78)
Proceeds from repayment of notes receivable from stockholders ........ 309 167
Change in other comprehensive income ................................. (42) (4)
-------- -------
Net cash provided by financing activities .................... 2,601 3,178
-------- -------
Net increase in cash and cash equivalents .............................. 3,986 2,357
Cash and cash equivalents at beginning of period ....................... 6,617 6,880
-------- -------
Cash and cash equivalents at end of period ............................. $ 10,603 $ 9,237
======== =======
Supplemental disclosures:
Cash paid for interest ............................................... $ 302 $ --
======== =======
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 that 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 (deficit) in the accompanying
condensed consolidated balance sheets. For the three months ended March 30, 2001
and March 31, 2000, comprehensive income (loss) amounted to ($3,632,000) and
$1,796,000, respectively. For the nine months ended March 30, 2001 and March 31,
2000, comprehensive loss was ($22,831,000) and ($8,318,000), respectively.
NOTE 3. Restructuring and Other Non-recurring Charges
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):
March 30, June 30,
2001 2000
--------- --------
Raw materials $1,383 $1,517
Work in process 126 --
Finished goods 3,251 3,323
------ ------
$4,760 $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 nine months ended March 30, 2001 and March 31, 2000,
respectively:
(in thousands, except per share amounts)
--------------------------------------------------------------
Three Months Ended Nine Months Ended
----------------------------- ------------------------------
Mar. 30, 2001 Mar. 31, 2000 Mar. 30, 2001 Mar. 31, 2000
------------- ------------- ------------- -------------
Net income (loss) [numerator] $ (3,620) $ 1,800 $(22,789) $ (8,314)
======== ======= ======== ========
Shares calculation [denominator]:
Weighted shares outstanding - Basic 15,312 14,301 14,915 14,074
Effect of dilutive securities:
Potential common stock relating to
stock options and warrants (a) -- 1,595 -- --
-------- ------- -------- --------
Weighted shares outstanding - Diluted 15,312 15,896 14,915 14,074
======== ======= ======== ========
Net income (loss) per share - Basic $ (0.24) $ 0.13 $ (1.53) $ (0.59)
======== ======= ======== ========
Net income (loss) per share - Diluted $ (0.24) $ 0.11 $ (1.53) $ (0.59)
======== ======= ======== ========
(a) Options to purchase 4,050,068 shares of common stock at prices ranging
from $0.50 to $19.75 per share and stock warrants to purchase 1,500,000
shares at $4.75 were outstanding at March 30, 2001, but were not
included in the computation of diluted net income (loss) per share for
the three months and nine months ended March 30, 2001 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 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, common stock, or used as
payment toward the strike price at the time of exercise of the warrants). If the
price of the Company's common stock is less than $4.75 per share on the date the
second bonus payment is earned, this bonus will be reduced proportionately by
the amount the price is below $4.75 per share.
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 that was used in the exercise of the warrants as noted above. The
second bonus payment is being accrued and charged to research and development
expenses over the period of time the optical networking products are developed.
This bonus accrual is adjusted each quarter for changes, either increases or
decreases, in the closing market price of the Company's common stock when the
price is below $4.75 per share. For the third quarter of fiscal 2001, research
and development expenses include a $400,000 accrual for the second bonus payment
based upon the closing market price of the Company's common stock on March 30,
2001 of $1.5625 per share. This accrual is shown as other long-term liabilities
on the condensed consolidated balance sheet as of March 30, 2001.
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.
NOTE 10. Related Party Transactions
Amounts due from the Company's principal stockholder and director as
described in the paragraphs below require quarterly payments totaling $475,000
with the remaining balances due on March 31, 2002. During the third
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quarter of fiscal 2001, the $475,000 payment scheduled for March 31, 2001, plus
accrued interest thereon, was rescheduled to March 31, 2002.
In September 1993, the Company issued 1,600,000 shares of Common Stock
to a principal stockholder and director in exchange for a note totaling $800,000
with the issued shares of Common Stock collateralizing the note. Through
subsequent note modifications in February 1998 and September 1999, quarterly
payments of $115,000 on the $800,000 note, which bears interest at 5% per annum,
commenced in September 2000 with the balance due in March 2002. Principal and
interest outstanding under this note was $931,000 and $1,123,000 as of March 30,
2001 and June 30, 2000, respectively, and is included in other stockholders'
equity (deficit) on the condensed consolidated balance sheets. This note is
currently collateralized by 600,000 shares of Common Stock of the Company per
the note modification agreement entered into in September 1999.
In February 1999, the Company approved a loan facility of up to $3.0
million to the same principal stockholder and director in return for a note that
bears interest at 6% per annum with an original maturity date of March 1, 2000.
The September 1999 note modification agreement requires quarterly payments of
$360,000 on this note that commenced in September 2000 with the balance due in
March 2002. As of March 30, 2001 and June 30, 2000, $2,085,000 and $2,698,000,
respectively, of principal and interest were outstanding. This facility is
collateralized by an interest in Baytech Associates ("Baytech"). Baytech is
owned by two stockholders who held an aggregate of 32% of the Company's Common
Stock as of June 30, 2000, and who are also directors of the Company.
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 Nine Months Ended
----------------------- -----------------------
Mar. 30, Mar. 31, Mar. 30, Mar. 31,
2001 2000 2001 2000
-------- -------- -------- --------
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 61.3 48.1 55.8 51.9
----- ----- ----- -----
Gross profit 38.7 51.9 44.2 48.1
----- ----- ----- -----
Operating expenses:
Research and development 33.6 9.8 53.1 14.5
Selling, general and administrative 41.2 33.1 46.3 34.8
Restructuring and other non-recurring charges -- -- -- 17.0
----- ----- ----- -----
Total operating expenses 74.8 42.9 99.4 66.3
----- ----- ----- -----
Income (loss) from operations (36.1) 9.0 (55.2) (18.2)
Interest and other income, net .9 1.1 2.3 1.2
----- ----- ----- -----
Income (loss) before provision for income taxes (35.2) 10.1 (52.9) (17.0)
Provision for income taxes -- -- 20.2 --
----- ----- ----- -----
Net income (loss) (35.2)% 10.1% (73.1)% (17.0)%
===== ===== ===== =====
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Sales. Net sales decreased approximately 42% to $10.3 million for the
three months ended March 30, 2001 from $17.8 million in the comparable period of
the prior fiscal year. Net sales decreased 36% to $31.2 million for the nine
months ended March 30, 2001 from $48.9 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 $12.8 million in the three months ended March
31, 2000 to $5.7 million in the three months ended March 30, 2001 and decreased
from $31.9 million in the nine months ended March 31, 2000 to $18.4 million in
the nine months ended March 30, 2001. These decreases were primarily a result of
reduced spending by the large telecommunication infrastructure companies, which
we believe to be a result of both macro-economic and industry-wide factors,
including over-capacity in our customers' markets. In the short term, the
Company anticipates that reduced capital spending by our customers may continue
to affect sales, although forecasting is challenging in the current environment.
These companies have traditionally contributed more than half of the Company's
revenue base. Net sales to the Company's top five customers decreased
approximately 46% in the three months ended March 30, 2001 to $6.6 million from
$12.2 million in the three months ended March 31, 2000, and decreased 34% to
$19.9 million for the nine months ended March 30, 2001 from $30.2 million for
the nine months ended March 31, 2000. Net sales to all other customers declined
by approximately 34% and 40%, respectively, in the three- and nine-month periods
ended March 30, 2001 from the comparable periods in the prior fiscal year due in
part to the impact of the reorganization of the Company's sales force 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 presented.
Gross Margin. Gross margin decreased to 38.7% of net sales for the
three months ended March 30, 2001 as compared to 51.9% for the three months
ended March 31, 2000 and decreased to 44.2 % of net sales for the nine months
ended March 30, 2001 from 48.1% for the nine months ended March 31, 2000. These
decreases are attributable to several factors, including the mix of product
sales and a high level of unabsorbed manufacturing overhead and other costs
associated with the lower sales volume during the current year. In addition, a
one-time sale of excess inventory at reduced prices contributed to decreased
gross margin for the current quarter.
Research and Development. Research and development expenditures
increased 99% to $3.5 million for the three months ended March 30, 2001 from
$1.7 million for the three months ended March 31, 2000 and increased 134% to
$16.6 million for the nine months ended March 30, 2001 from $7.1 million for the
nine months ended March 31, 2000. As a percentage of sales, research and
development expenses increased from 9.8% for the three months ended March 31,
2000 to 33.6% for the three months ended March 30, 2001 and increased from 14.5%
for the nine months ended March 31, 2000 to 53.1% for the nine months ended
March 30, 2001. These increases were due primarily to the new optical networking
development project initiated in October 2000 that is discussed below, as well
as an increase in spending for WANsuite(TM) product development.
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 at an exercise
price of $4.75 per share. 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 agreements provide Beacon Telco
the opportunity to receive two bonus payments, totaling up to $10.7 million,
based in part on meeting certain milestones and the market price of the
Company's common stock.
The Company recorded a non-cash 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 of $3,562,500. The second bonus payment, of up to
$7.1 million, is being accrued and charged to research and development expenses
over the development period for
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the optical networking products. This bonus accrual is adjusted each quarter for
changes, either increases or decreases, in the closing market price of the
Company's common stock when the price is below $4.75 per share. Research and
development expenses for the three months ended March 30, 2001 included an
accrual of $400,000 for the second bonus payment based upon the closing market
price of the Company's common stock on March 30, 2001 of $1.5625 per share.
Research and development expenses are expected to increase above the
current quarter's expenses for the next five quarters in connection with the
development of optical networking products. See "Note 7 in the Notes to
Condensed Consolidated Financial Statements" 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 28% to $4.2 million for the three months ended
March 30, 2001 from $5.9 million for the three months ended March 31, 2000 and
decreased 15% to $14.4 million for the nine months ended March 30, 2001 from $17
million for the nine months ended March 31, 2000. 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 and third quarters of fiscal 2001, including a headcount
reduction in March 2001, and the benefits of the restructuring completed in the
second quarter of fiscal 2000. Selling, general and administrative expenses
increased as a percentage of sales from 33.2% for the three months ended March
31, 2000 to 41.2% for the three months ended March 30, 2001 and increased from
34.8% for the nine months ended March 31, 2000 to 46.2% for the nine months
ended March 30, 2001 due to the Company's lower sales levels. The Company
expects the dollar amount of selling, general and administrative expenses to
decrease in the future due to the headcount reductions in March 2001 and expects
that such expenses will vary over time as a percentage of sales.
Restructuring and Other Non-recurring Charges. During the second
quarter of fiscal 2000, the Company completed the consolidation of its
operations into its existing operations located in Huntsville, Alabama, and
outsourced its San Jose based manufacturing activities as announced in July
2000. The Company incurred pretax charges of $8.3 million in the nine-month
period ended March 31, 2000 for restructuring and other related non-recurring
activities. See "Note 3" in the "Notes to Condensed Consolidated Financial
Statements" for further details of the Company's restructuring and other
non-recurring charges.
Interest and Other Income, Net. Net interest and other income decreased
53% from $203,000 for the three months ended March 31, 2000 to $95,000 for the
three months ended March 30, 2001 due to the interest expense on the outstanding
debt associated with the acquisition of the new headquarters facility in June
2000. Net interest and other income increased 20% from $596,000 for the nine
months ended March 31, 2000 to $716,000 for the nine months ended March 30, 2001
as a result of higher interest-bearing assets and the higher market interest
rates during the first two quarters of fiscal 2001.
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 March
30, 2001. The Company did not record a tax benefit or provision for income taxes
in the three- or nine-month periods ended March 31, 2000.
LIQUIDITY AND CAPITAL RESOURCES
On March 30, 2001, the Company's principal sources of liquidity
included $11.1 million of cash and cash equivalents and short-term investments.
During the nine months ended March 30, 2001, cash flow provided by
operating activities was approximately $2.3 million compared to $6.1 million
used in operating activities during the nine months ended March 31, 2000. Net
cash provided by operating activities this quarter was due primarily to better
asset management, with accounts receivable decreasing $10.3 million from better
collection efforts and lower sales volume, offset by the cash loss from
operations of $5.2 million and the decrease in current liabilities of $3.1
million.
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Cash used in investing activities was approximately $900,000 for the
nine months ended March 30, 2001, as compared to approximately $5.3 million
provided for the nine months ended March 31, 2000. Capital expenditures of $5.1
million for the nine months ended March 30, 2001 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 $3.6 million in cash during the
first nine months of fiscal 2001. The renovation to the new headquarters
facility was completed during the quarter.
Cash provided by financing activities was $2.6 million for the nine
months ended March 30, 2001 compared to $3.2 million for the nine months ended
March 31, 2000. Proceeds of $2 million, net of payments, were provided during
the nine months ended March 30, 2001 from the loan agreements with Regions Bank
to borrow up to $6.5 million to finance the acquisition of the new headquarters
facility and improvements thereon.
As discussed in Note 10 - Related Party Transactions in the Notes to
Condensed Consolidated Financial Statements, the $475,000 payment due on March
31, 2001 from a principal stockholder and director was rescheduled to March
2002. Under the terms of the loan agreement with the principal stockholder,
payments of $475,000 are required each quarter with the final balance due in
March 2002.
The Company believes that its cash and investment balances, along with
anticipated cash flows from operations based upon our current operating forecast
and cost reduction programs, will be adequate to finance current operations,
anticipated investments, research and development expenses, and capital
expenditures for the next twelve months. The Company's future capital needs will
depend on the Company's ability to meet its current operating forecast, the
ability to successfully bring new products to market, and market demand for the
Company's products. The Company continues to investigate the possibility of
generating financial resources through committed credit agreements, technology
or manufacturing partnerships, joint ventures, equipment financing, and
offerings of debt and equity securities. To the extent that the Company obtains
additional financing, the terms of such financing may involve rights,
preferences or privileges senior to the Company's common stock and stockholders
may experience dilution.
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 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, all of whom are in the telecommunications
industry. 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. 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.
Through the first three quarters of fiscal
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2001, the Company's top five customers have not remained the same as in previous
years. 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. Substantial variations in
telecommunications infrastructure spending by the Company's current and target
customers, as well as by their customers, can cause material variations in the
Company's business, financial condition and results of operations. Reduced
telecommunications infrastructure spending in recent quarters has adversely
affected the Company's net sales and results of operations.
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. 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. In March 2001, the Company reduced the
size of its workforce as part of its cost reduction
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programs. This recent reduction may make it more difficult to attract and retain
qualified personnel. The Company is currently attempting to hire a number of
engineering personnel and has experienced some delays in filling such positions.
There can be no assurance that the Company will be able to effectively achieve
or manage any such growth, and failure to do so could delay product development
and introduction cycles or otherwise have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Dependence on Key Personnel".
Dependence on Component Availability and Key Suppliers. The Company
generally relies upon a contract manufacturer to buy component parts that are
incorporated into board assemblies used in its products. On-time delivery of the
Company's products depends upon the availability of components and subsystems
used in its products. Currently, the Company and third party sub-contractors
depend upon suppliers to manufacture, assemble and deliver components in a
timely and satisfactory manner. The Company has historically obtained several
components and licenses for certain embedded software from single or limited
sources. There can be no assurance that these suppliers will continue to be able
and willing to meet the Company's and third party sub-contractors' requirements
for any such components. The Company and third party sub-contractors generally
do not have any long-term contracts with such suppliers, other than software
vendors. Any significant interruption in the supply of, or degradation in the
quality of, any such item could have a material adverse effect on the Company's
results of operations. Any loss in a key supplier, increase in required lead
times, increase in prices of component parts, interruption in the supply of any
of these components, or the inability of the Company or its third party
sub-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 results of operations for the first three quarters of fiscal 2001.
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
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could materially adversely affect the Company's business, financial condition
and results of operations. See "Customer Concentration" and "Dependence on
Component Availability and Key Suppliers".
The Company's backlog at the beginning of each quarter typically is not
sufficient to achieve expected sales for that quarter. To achieve its sales
objectives, the Company is dependent upon obtaining orders in a quarter for
shipment in that quarter. Furthermore, the Company's agreements with its
customers typically provide that they may change delivery schedules and cancel
orders within specified timeframes, typically up to 30 days prior to the
scheduled shipment date, without significant penalty. The Company's customers
have in the past built, and may in the future build, significant inventory in
order to facilitate more rapid deployment of anticipated major projects or for
other reasons. Decisions by such customers to reduce their inventory levels
could lead to reductions in purchases from the Company. These reductions, in
turn, could cause fluctuations in the Company's operating results and could have
an adverse effect on the Company's business, financial condition, and results of
operations in the periods in which the inventory is reduced.
The Company's industry is characterized by declining prices of existing
products, and therefore continual improvement of manufacturing efficiencies and
introduction of new products and enhancements to existing products are required
to maintain gross margins. In response to customer demands or competitive
pressures, or to pursue new product or market opportunities, the Company may
take certain pricing or marketing actions, such as price reductions, volume
discounts, or provision of services at below-market rates. These actions could
materially and adversely affect the Company's operating results.
Operating results may also fluctuate due to 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 profitable 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.
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Potential Volatility of Stock Price. The trading price of the Company's
common stock could be subject to wide fluctuations in response to
quarter-to-quarter variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
developments with respect to patents or proprietary rights, general conditions
in the telecommunication network access and equipment industries, changes in
earnings estimates by analysts, or other events or factors. In addition, the
stock market has experienced extreme price and volume fluctuations, which have
particularly affected the market prices of many technology companies and which
have often been unrelated to the operating performance of such companies.
Company-specific factors or broad market fluctuations may materially adversely
affect the market price of the Company's common stock. The Company has
experienced significant fluctuations in its stock price and share trading volume
in the past and may continue to do so.
Dependence on Recently Introduced Products and New Product Development.
The Company's future results of operations are highly dependent on market
acceptance of existing and future applications for both the Company's AS2000
product line, and the WANsuite(TM) family of integrated access devices
introduced during the third quarter of fiscal 2000. The AS2000 product line
represented approximately 58% of net sales in fiscal 2000, 67% of net sales in
fiscal 1999 and 86% of net sales in fiscal 1998. Sales of WANsuite(TM) products
began during the last quarter 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
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agreed, the costs of licensing background or other intellectual property could
be substantial and may limit the ability of the Company to develop and market
the optical networking product on a profitable basis.
The success of the project may depend on the ability of the Company to
effectively utilize certain resources of the Photonics Center, which are to be
provided on an as-available basis at the discretion of the Trustees of Boston
University. If critical resources are not made available to the Company on a
timely basis, the project may be unsuccessful or may require significantly
higher costs than expected.
The Company's ongoing effort to develop and market an optical
networking product will require high levels of innovation and may not be
successful. Even if the Company does succeed in developing an optical networking
product, it may have difficulty marketing and selling the product. Moreover,
there can be no assurance that any product developed by the Company will gain
and hold market acceptance in the rapidly growing optical networking market that
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
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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 the third quarter of fiscal 2001, the
Company further refined its sales force reorganization that began in the first
fiscal quarter. These changes are intended to emphasize both a geographic and
product focus, and to better position the sales force for available sales
opportunities. Previously in July 2000, the Company had 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
the Company's recent efforts to return to a more geographic focus may continue
to be disruptive to the Company's sales in future quarters. 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. These changes
during this fiscal year 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
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providers or in response to regulatory directives, may affect the cost
effectiveness of deploying communication services. Such policies also affect
demand for telecommunications equipment, including the Company's products.
Risks Associated With Potential Acquisitions and Joint Ventures. An
important element of the Company's strategy is to review acquisition prospects
and joint venture opportunities that would compliment its existing product
offerings, augment its market coverage, enhance its technological capabilities
or offer growth opportunities. Transactions of this nature by the Company could
result in potentially dilutive issuance of equity securities, use of cash and/or
the incurring of debt and the assumption of contingent liabilities, any of which
could have a material adverse effect on the Company's business and operating
results and/or the price of the Company's common stock. Acquisitions entail
numerous risks, including difficulties in the assimilation of acquired
operations, technologies and products, diversion of management's attention from
other business concerns, risks of entering markets in which the Company has
limited or no prior experience and potential loss of key employees of acquired
organizations. Joint ventures entail risks such as potential conflicts of
interest and disputes among the participants, difficulties in 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
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might be required to discontinue the use and sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses
from third parties. There can be no assurance that licenses from third parties
would be available on acceptable terms, if at all. In the event of a successful
claim against the Company and the failure of the Company to develop or license a
substitute technology, the Company's business, financial condition, and results
of operations could be materially adversely affected.
Limited Protection of Intellectual Property. The Company relies upon a
combination of patent, trade secret, copyright, and trademark laws and
contractual restrictions to establish and protect proprietary rights in its
products and technologies. The Company has been issued certain U.S. and Canadian
patents with respect to limited aspects of its single purpose network access
technology. The Company has not obtained significant patent protection for its
Access System technology. There can be no assurance that third parties have not
or will not develop equivalent technologies or products without infringing the
Company's patents or that a court having jurisdiction over a dispute 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 March 30, 2001, the Company's investment portfolio consisted of
fixed income securities of $516,000. 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 March 30, 2001, 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 is subject to interest rate risks on its long-term debt. If
market interest rates were to increase immediately and uniformly by 10% from
levels as of March 30, 2001, the additional interest expense would not be
material. 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
As of February 9, 2001, Beacon Telco used a $3,562,500 bonus note
issued by the Company to pay the exercise price in connection with the exercise
of warrants for 749,900 shares of the Company's Common Stock. See Note 7 in the
Notes to Condensed Consolidated Financial Statements. The shares were issued
without registration under the Securities Act of 1933 pursuant to the exemption
provided by Section 3(a)(9) thereof.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Index:
Exhibit Number Description of Exhibit
-------------- ----------------------
10.57 Executive Deferred Compensation Plan adopted by Registrant for
certain of its executive employees and members of its Board of
Directors effective as of January 1, 2001
10.58 Separation Agreement between Registrant and Steven E. Turner dated
March 2, 2001
10.59 Separation Agreement between Registrant and Edward A. Etzel dated
March 1, 2001
(b) No reports on Form 8-K were filed during the quarter ended March 30,
2001.
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
May 9, 2001 By: /s/ Ronald G. Sibold
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Ronald G. Sibold,
Vice President and Chief Financial Officer (Duly
Authorized Officer and Principal Financial Officer)
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