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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 29, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-28562
VERILINK CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-2857548
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
145 BAYTECH DRIVE, SAN JOSE, CALIFORNIA
SAN JOSE, CALIFORNIA 95134
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(408) 945-1199
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing sale price of the Common Stock on September
19, 1997, as reported by the Nasdaq National Market was $67,096,642. Shares of
Common Stock held by each officer and director and by each person who owns 5% or
more of the outstanding Common Stock have been excluded from this computation in
that such persons may be deemed to be affiliates. This determination of
affiliate status is not a conclusive determination for other purposes.
As of September 19, 1997 the registrant had outstanding 13,673,137 shares
of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the following document are incorporated by reference in this
Annual Report on Form 10-K: the Proxy Statement for the Registrant's Annual
Meeting of Stockholders to be held November 13, 1997 (the "Proxy Statement"),
(Part III).
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PART I
ITEM 1. BUSINESS
INTRODUCTION
Verilink Corporation develops, manufactures and markets access products for
telecommunications network service providers and corporate end users. Verilink
designed the Access System 2000 with modular hardware and the Company's
software-based Advanced Programmable Architecture(TM) to enable its customers to
access increased network capacity and to adopt new communications services in a
cost-effective manner. The Access System 2000 provides integrated access to
narrowband transmission facilities including fractional or full T1/E1, and to
multiple T1/E1 facilities, up to broadband (T3) transmission speeds. The AS2000
enables carriers to seamlessly connect their service networks to support the
full range of these transmission rates. The AS2000 may be deployed to support a
broad range of services including ISDN, Frame Relay, and Internet Protocol (IP).
Verilink's integrated network access products are used in corporate networks and
by network service providers such as interexchange and local exchange carriers,
and providers of Internet, personal communications and cellular services. The
Company also sells single purpose network access devices for selected
applications. The Company's largest customers include NORTEL, MCI Communications
Corp., CompuServe Corp., and QUALCOMM Incorporated.
INDUSTRY BACKGROUND
Corporate and consumer demand for data, voice and video transmission
services is expanding worldwide, creating a need for both increased bandwidth
and new communication services. At the same time, the competitive landscape
faced by providers of high bandwidth transmission capacity is evolving rapidly
due to developments including the migration of corporations from private
networks to public networks, the proliferation of the Internet, the continuing
deregulation of the telecommunications industry and the introduction of new
services. In response to these developments, network service providers ("NSPs"),
including interexchange and local exchange carriers, and providers of Internet,
personal communications and cellular services, are offering a variety of new
communications services, each of which traditionally required a separate single
purpose network access device. The limitations of single purpose network access
devices in high-density deployment have created the need for flexible integrated
network access equipment that will allow NSPs to provide corporate users access
to a variety of communications services in a cost-effective manner.
Demand for Increased Bandwidth
Businesses increasingly depend on the flow of data, voice and video traffic
through their communication networks, driving demand for additional bandwidth.
Corporate employees increasingly travel, telecommute and work in geographically
dispersed teams, creating a need for remote connections to corporate local area
networks ("LANs"). Corporations are also deploying wide area networks ("WANs")
to connect LANs located in local and remote locations. In addition, the type of
information transmitted over networks increasingly requires high transmission
rates. For example, video conferencing and multimedia applications require
substantially more bandwidth than needed for traditional data file transfers.
This continued growth in demand for bandwidth has caused corporations to seek
network access solutions from NSPs and equipment suppliers that accommodate both
current and future bandwidth requirements.
Migration from Private to Public Networks
Since the mid-1980s, corporations have relied on private data networks
using dedicated digital circuits leased from communications carriers.
Corporations now increasingly use public network services offered by NSPs as an
alternative to the high cost of corporate private networks. These public network
services allow users to access end-to-end digital circuits on an as-needed
basis. This migration resulted from cost-effective and reliable new
communication services offered by NSPs, the trend to outsource non-core
corporate functions, and the growth in the cost and complexity of maintaining
private networks. In order to provide
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competitive service to these corporations, NSPs need flexible network access
equipment that facilitates cost-effective provision of a variety of
communications services.
Growth of Corporate Use of the Internet
The Internet was originally used by academic and governmental organizations
for applications such as e-mail and file transfer. Increasingly, corporations
and individuals are using the Internet for more bandwidth-intensive applications
that use sound, images and video, and to provide interconnectivity within the
enterprise. Internet users now face transmission delays as backbone capacity
lags the growth in the number of users and as use of high-bandwidth applications
increases. In response to this transmission bottleneck, NSPs are upgrading the
Internet's communications backbone, which may encourage corporations to continue
increasing activity on the Internet.
Deregulation and Increased Competition
The market for providing communication services to larger organizations has
become increasingly competitive since the 1984 divestiture of AT&T. This
environment has led to the development and introduction of new services by a
broader range of NSPs, including long distance companies (such as AT&T, MCI and
Sprint), local exchange carriers (such as regional Bell operating companies
("RBOCs") and GTE) and competitive access providers (such as MFS Communications
Company, Inc. and Teleport Communications Group, Inc.). The deregulation
effected by the Telecommunications Act of 1996 is expected to further increase
competition among NSPs, as long distance and local exchange carriers enter each
others' business and new entrants emerge, including cable TV operators, wireless
carriers, Competitive Local Exchange Carriers ("CLECs"), and Internet/on-line
service providers. To compete successfully, this growing group of NSPs must
offer customers access to new services at a low cost and with high reliability.
Wide Range of New Communications Services and Technologies
Over the past several years, NSPs have introduced a variety of new,
high-bandwidth switched services as alternatives to historical dedicated leased
line services. For example, ISDN service allows users to exchange data, voice
and video on a "dial-up" basis. In the United States, ISDN service is currently
offered by NSPs at transmission rates from 64 Kbps to 1.544 Mbps. Furthermore,
NSPs have introduced packet and cell-based switching services such as frame
relay and ATM. Frame relay is a data service which provides corporate users with
dedicated access to the NSP's frame relay network at transmission speeds of 56
Kbps to 45 Mbps ("T3"). ATM provides high speed transmission and low latency
which allows effective transmission of data, voice and video traffic, in a
single, shared network.
Wireless telecommunications services are becoming more widespread due to
advances in technology, regulatory encouragement and increased demand. The
Company expects that personal communication services ("PCS"), digital cellular
and other emerging services will make wireless service cheaper, easier to use
and more compatible with existing information delivery systems.
LIMITATIONS OF SINGLE PURPOSE NETWORK ACCESS SOLUTIONS
Traditionally, a dedicated single purpose access device has been deployed
for each type of network communications service. For example, one device is used
for Frame Relay service and another entirely separate device is used to provide
voice service. The use of single purpose devices to access the expanding variety
of communications services has become increasingly costly and inefficient for
several reasons:
- Limited Ability to Accommodate Emerging Technologies and Services. As new
technologies and services such as ATM or Digital Subscriber Line ("DSL")
are deployed, the need to have a flexible and cost-effective migration
path to such technologies is critical, as few companies can afford to
replace large portions of their network access equipment. Single purpose
network access devices typically cannot provide such a migration path.
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- Limited Ability to Accommodate Multiple Services. The migration of
network users from dedicated private to switched public networks has
placed NSPs in the position of having to be "everything to everyone"
because NSPs must offer network access compatible with the various
communications services chosen by their customers. Expenditures for
numerous single purpose access devices that each support a single service
offering can be an inefficient use of NSP's financial resources.
- Limited Scalability. The rapid expansion of networks has increased demand
for upgraded network access which is difficult to meet efficiently by
simply purchasing more non-scalable single purpose network access
devices. Furthermore, growing bandwidth requirements often necessitate
the adoption of new and faster technologies, thereby requiring additional
outlays for new access equipment.
- Difficulty of Maintenance and Support. Use of numerous single purpose
network access devices built to different standards and requiring
separate management systems can complicate operating procedures and
result in multiple potential failure points. The increasing importance of
network applications to end users has resulted in new focus on the
importance of investing in network access equipment that is reliable and
easy to manage, repair and upgrade.
THE VERILINK SOLUTION
Verilink's Access System 2000 is a flexible network access and management
solution that provides cost-effective integrated access to a broad range of
network services. The Access System 2000 uses a modular hardware architecture
and the Company's software-based Advanced Programmable Architecture ("APA") to
provide a scalable, adaptable platform for a flexible network migration path to
new communications services. In addition, the Access System 2000 was designed to
simplify network management and to provide reliable service. The benefits of the
Access System 2000 include:
- Flexible Access to Multiple Services. The integrated Access System 2000
is designed to allow NSPs to rely on a single, flexible equipment
platform that they can adapt to meet the current and emerging service
needs of multiple customers. The Access System 2000 currently enables
NSPs to support data transmission over fractional T1/E1, T1/E1, multiple
T1/E1, and T3 for access to services such as private lines, ISDN, ATM,
frame relay and Internet Protocol ("IP") in an integrated platform.
Verilink expects to offer voice and DSL functionality on the Access
System 2000 platform during fiscal 1998. As these service needs change,
the Access System 2000's modular hardware architecture and APA allows
NSPs to use the same platform to provide access to multiple services.
- Migration Path to New Technologies and Services. The Access System 2000
architecture was designed to allow NSPs and corporate customers to add
new technologies and services incrementally. The Access System 2000
allows the customer access to increased network capacity or access to
additional service offerings by adding circuit cards. The end-user can
also vary certain system features simply by downloading new software.
- Scalable Growth. The Access System 2000's scalable design enables it to
be expanded to meet customer demands for access to increased network
capacity by adding additional circuit cards often at lower incremental
cost, compared to the cost of buying, installing and maintaining multiple
new dedicated single-purpose access devices.
- Ease of Network Management. The Access System 2000 can also be monitored
remotely using the Company's proprietary management system, the Access
Manager 2000, or using industry standard simple network management
protocol ("SNMP") tools. The Company's APA technology allows the product
to be configured, upgraded and serviced remotely.
- Reliable Performance. Verilink's Access System 2000 is designed to be
highly reliable, and its ability to provide access to multiple services
from one integrated device lowers the number of potential failure points.
In addition, the Company believes its product reliability is enhanced by
its commitment to high quality standards and its formal program of total
quality management. See "-- Manufacturing and Quality."
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VERILINK STRATEGY
The Company's objective is to become the leading provider of integrated
network access equipment for use by NSPs and large corporate customers. Key
elements of the Company's strategy include:
- Expand Relationships with Key Customers. The Company has developed close
relationships with MCI, CompuServe, NORTEL and QUALCOMM, leaders in
traditional or emerging telecommunications markets. The Company believes
that these relationships have allowed it to gain an in-depth knowledge of
several networking technologies, which today are deployed in different
markets. As its key customers adopt new technologies to expand the range
of services they offer and enter new markets, the Company intends to
leverage its expertise in each of these technologies by selling
additional types of products to these customers.
- Expand Customer Base. The Company believes that a direct sales
organization that understands and can solve complex network access
problems is necessary to sell its products to NSPs and large
corporations. During fiscal 1997, the Company invested significantly to
enlarge this sales and support organization. The Company intends to
continue to invest in this sales and support organization as well as in
other distribution channels in order to expand its customer base.
- Offer Broad Array of Network Access Solutions. The Company's product
strategy is to offer multiple network access technologies on a single
integrated platform, as well as complimentary single-function access
devices. Verilink designed the modular and scalable architecture of the
Access System 2000 to provide a migration path to new network services,
enabling customers to provide additional services without entirely
replacing network access equipment. The Company is currently developing
voice, M1-3 multiplexing and DSL applications for the Access System 2000
product line.
- Focus on Emerging International Markets. The Company believes that the
markets for network access solutions in developing countries present
significant opportunities. The Company intends to address these
opportunities by partnering with NSPs and telecommunications equipment
providers active in these markets and by forming an international
distribution channel. To date the Company's Access System 2000 product
for E1 access has been selected by Avantel for deployment in Mexico, by
CompuServe and Concert for deployment in Europe.
- Provide Highly Reliable Products. The Company's customers operate in an
environment in which transmission reliability and availability are
increasingly mission critical factors. The Company has adopted a formal
total quality management process that integrates new product
specifications, development, manufacturing, repair and service, which is
intended to achieve high reliability of its products and services. The
Company has been ISO 9001 certified since 1993.
PRODUCTS
Access System 2000
Verilink's Access System 2000 is a flexible network access and management
solution that provides cost-effective integrated access to a broad range of
network services. Access System 2000 products are designed for installation at
the origination and termination points at which NSPs provide communications
services to their corporate customers. A key element of the flexibility and
adaptability of the Access System 2000 is its modular architecture which allows
customers to access new services or expanded network capacity by installing new
circuit cards. In addition, its Advanced Programmable Architecture allows
certain functions of
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the Access System 2000's hardware to be configured through software downloads.
The table below summarizes the Access System 2000 product line:
VERILINK ACCESS SYSTEM 2000 PRODUCT LINE
APPLICATION DESCRIPTION AND GENERAL FEATURES
- ----------------------- ------------------------------------------------------------
CSU Accesses T1 lines for PBX, multiplexer and D4 channel banks
Provides ESF performance monitoring capabilities
Supports TDM applications
DSU/CSU Integrated DSU/CSU to connect standard serial ports such as
V.35 to T1 and fractional T1 facilities
Supports data applications at low speeds and at multiples of
56 Kbps/64 Kbps rates
T1/E1 Multiplexing Aggregates multiple lower speed data ports onto a single
T1/E1 line
Supports V.35, RS449, E1A530 and other interfaces and
provides drop-and-insert capability
Subrate Multiplexing Aggregates up to five RS-232 subrate data channels into a
single DSO. Supports DS0A/DS0B formats.
Supports synchronous/asynchronous modes from 300 bps to 19.2
Kbps
DACS Supports 13 T1/E1 lines
Non-blocking 0-1 cross connect
Inverse Multiplexing Provides bit-based inverse multiplexing for high-speed data
Supports up to eight T1/E1s
DS3 Provides DS3 access for high-speed data applications
Supports a single or dual port High-Speed Serial Interface
Automatic Protection Provides T1 transmission facility protection switching
Switching User-defined protection groups
Automatic or manual switching
ISDN Provides ISDN-PRI access for bandwidth on demand protection
switching.
ATM* Provides ATM WAN access for data applications
Supports T1/E1 and T3/E3 and NxT1/E1
Internetworking functions for frame relay to ATM
M13* Supports channelized access to DS3 or Fractional DS3
transmission.
HDSL* Supports 8 HDSL modems supporting 4 T1 lines
Analog Voice* FXO, FXS, and 2 and 4 wire E&M for legacy analog voice
applications.
- ---------------
* Currently under development. See "Factors Affecting Future
Results -- Dependence on Recently Introduced Products and Products Under
Development."
The Access System 2000 is accessed and controlled by the Access Manager
2000, a full-network monitoring system. The Access Manager 2000 facilitates
remote configuration of node equipment and provides integral performance
monitoring, diagnostics, test and maintenance capabilities for the entire
network. Software downloads for product upgrades and modifications can be
implemented remotely using the Access Manager 2000 or SNMP tools.
Access System 2000 Applications
NSPs use the Access System 2000 in a number of applications. The following
are brief descriptions of some of the uses of the Access System 2000:
Interexchange Carrier Frame Relay Network. In an interexchange carrier
("IXC") frame relay network, the Access System 2000 is located at the IXC's
point of presence and is used to terminate T1, fractional T1, mulitiple T1 or T3
circuits from frame relay subscribers. In this application, the Access System
2000 is used to concentrate frame relay traffic from multiple users, providing
more efficient use of
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network ports on the carrier's frame relay switches or nodal processors. As a
result, the carrier can achieve increased circuit utilization and decreased
transmission costs.
Internet Service Provider Network. In an Internet service provider ("ISP")
network, the Access System 2000 is located at the ISP's network access point and
provides access to high-speed transmission between the ISP's regional centers
and its network operation center. The Access System 2000 provides high-bandwidth
connections between router serial ports and transmission systems such as T3 and
multiple T1/E1 circuits. The Access System 2000 provides physical transmission
management, bandwidth sharing, and inverse multiplexing functions.
Personal Communications Service Network. In a new personal communication
service ("PCS") network based on Code Division Multiple Access (CDMA), the
Access System 2000 is being used to provide wireline access and termination. The
Access System 2000, with its integrated access technology, is designed to be
used by the service provider to connect to carrier-provided services, while
providing channel grooming, performance monitoring and drop-and-insert functions
at their mobile switching sites.
Other Products and Services
Dedicated single purpose access devices are designed to support a specific
type of network communications service. For example, one device may be used to
support a Frame Relay service while another entirely separate device may be used
to support voice service. Low cost single purpose devices can be a good choice
for remote sites with limited application requirements and where customers
prefer an end-to-end solution from a single equipment vendor. In response to
this need, Verilink offers the following other products and services:
ConnecT DSU/CSU Products. The Company's ConnecT DSU/CSU line of products
integrates the capabilities of T1 data service units ("DSUs") and channel
service units ("CSUs"). They are designed to provide economical solutions for
connecting LANs and geographically separated digital devices, including video
teleconferencing equipment, mainframe computers, computer aided design and
manufacturing (CAD/CAM) workstations and imaging systems. Verilink's ConnecT
DSU/CSU products include the ConnecT1, a dual-port device with integrated
DSU/CSU functions that allow users to interconnect digital applications
operating at data rates from 56Kbps to T1, via the carrier network, and the
ConnecT FT1, a costeffective, single-port device that provides access to T1 and
fractional T1 services.
Extended Superframe ("ESF") Products. The Company's ESF CSU products
interface data terminal equipment to a network facility and offer the full
benefit of ESF performance measurement. The ESF CSU products can be controlled
and monitored locally or remotely and are offered in a variety of
configurations, ranging from a single T1 circuit to a multiline shelf
accommodating up to 10 ESF CSUs.
C-Series Products. The Company's C-Series line of products are
ultra-compact integrated CSU/DSUs that support digital voice and data services
over T1/E1 or fractional T1/E1, and data only applications over 56K/64K digital
access lines. They come equipped with fully embedded SNMP management to provide
an interface to industry-standard management platforms. They are designed to
provide low cost point-to-point service in small offices or satellite locations.
Services. The Company offers its customers the option of purchasing
extended services in addition to those provided under its standard product
warranty. These extended services include product upgrades, software and on-site
hardware maintenance and installation services, extended telephone support,
on-site training and advanced equipment exchange.
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CUSTOMERS
The market for the Company's products is comprised of NSPs and large
corporations with private networks. The following table sets forth a
representative list of Verilink's NSP and corporate end user customers, and its
resellers, in these markets.
Alamo Rent A Car N.E.T
Alltel Supply Nynex
Ameritech Pacific Bell
Anixter QUALCOMM
Bell South Rockwell International
Compuserve Source
EDS Southwestern Bell
First Data Corp. Sungard
Graybar The Travelers Group
MCI Worldcom
NORTEL
The Company's products are sold to a limited number of customers. See "Factors
Affecting Future Results -- Customer Concentration."
SALES AND MARKETING
The Company sells its products primarily to NSPs and their large corporate
end user customers through a direct sales force and through a number of
non-exclusive resellers, including OEMs, VARs and distributors. The Company has
focused its marketing strategy on leveraging existing, and developing new, key
customer relationships in specific telecommunications market segments, including
the WAN and remote LAN access, Internet access, and wireless access segments.
An important element of the Company's marketing strategy of targeting key
customer relationships is its direct sales efforts to such customers.
Approximately 82% of the Company's sales during fiscal 1997 were derived through
direct sales to such customers. A direct sales effort, supported by sales
engineers who provide customers with pre- and post-sale technical and strategic
assistance, allows the Company to gain a more in-depth knowledge of customers'
network access requirements. The Company believes this knowledge helps it to
build long-term relationships and alliances with key customers. The Company
increased the size of its direct sales and support organization in fiscal 1997,
and intends to expand further its direct sales and support organization in
fiscal 1998. The Company has eleven offices located in major U.S. metropolitan
areas.
Verilink's service and support program includes: a five-year product
warranty; formal customer training programs; on-site installation and
maintenance; free telephone support; complete repair, refurbishment and upgrade
services with a committed ten-day turnaround; and local applications engineering
support.
In addition to its direct sales, the Company sells its products through
VARs and distributors such as Alltel Supply, Anixter, Graybar and Kent
Electronics. Approximately 18% of the Company's sales during fiscal 1997 were
made to VARs and distributors. The Company's VARs and distributors have
primarily sold the Company's single purpose network access products.
To date, the Company has had minimal direct sales to international
customers. The Company believes that the international market for network access
solutions will experience increasing growth in the future. The Company's
strategy is to increase and diversify its international sales through corporate
relationships and by establishing international distributors. The Company's
Access System 2000 product has been designed to meet international
telecommunications standards. See "Factors Affecting Future Results -- Risks
Associated With Entry into International Markets."
COMPETITION
The market for network access and telecommunications equipment is highly
competitive, and the Company expects competition to increase in the future. This
market is subject to rapid technological change,
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regulatory developments and emerging industry standards. The Company faces
different competitive environments for its Access System 2000 products than for
its single purpose network access products.
The market for integrated access devices such as the Company's Access
System 2000 is newly emerging and is subject to rapid change. The Company
believes that the primary competitive factors in this market are the development
and rapid introduction of new product features, price/performance, support for
multiple types of communications services, network management, reliability and
safety, and quality of customer support. There can be no assurance that the
Company's products and products under development will be able to compete
successfully with respect to these or other factors. The Company's principal
competition to date for its current Access System 2000 products has been from
Digital Link Corporation, Kentrox, a division of ADC Telecommunications (both in
Kentrox's own products and products supplied by Premisys Communications, Inc.)
and Larscom, Inc., a subsidiary of Axel Johnson. To the extent that the Company
develops new products for the Access System 2000 line, the Company expects to
increasingly compete with Premisys. The Company expects additional competition
from companies that are currently competitors in the markets for the Company's
single purpose network access products, as such companies develop new products.
In addition, the Company expects substantial competition from companies in the
computer networking market and other related markets such as Newbridge Networks
Corporation, Telco Systems, Inc., and Ascend Communications, Inc. To the extent
that current or potential competitors can expand their current offerings to
include products that have functionality similar to the Company's products and
planned products, the Company's business, financial condition and results of
operations could be materially adversely affected.
The Company believes that the market for its single purpose network access
products is mature. The Company believes that the principal competitive factors
in this market are price, installed base and quality of customer support. In
this market, the Company primarily competes with Adtran, Inc., Digital Link,
Kentrox and Larscom. There can be no assurance that such companies or other
competitors will not introduce new products that provide greater functionality
and/or at a lower price than the Company's single purpose network access
products. In addition, the Company anticipates that competitors and customers
may develop products that could be used for selected applications for which the
Company's products are currently provided. Successful, timely development of
such products could reduce the level of demand for the Company's products. There
can be no assurance that the Company's single purpose network access products
will be competitive in the future. AT&T Paradyne Corporation, a company that had
been a major customer in fiscal 1993, developed a product for use in
applications addressed by one of the Company's single purpose network access
products and subsequently substantially reduced orders for the Company's
products.
Many of the Company's current and potential competitors have substantially
greater technical, financial, manufacturing and marketing resources than the
Company. In addition, many of the Company's competitors have long-established
relationships with network service providers. There can be no assurance that the
Company will have the financial resources, technical expertise, manufacturing,
marketing, distribution and support capabilities to compete successfully in the
future. See "Factors Affecting Future Results -- Competition."
RESEARCH AND DEVELOPMENT
The Company's research and development efforts are focused on developing
new products, core technologies and enhancements to existing products. For the
past several years, product development activities have emphasized expansion of
features and functionality for the Access System 2000 product family. The
Company's product development strategy has focused on the development of modular
software and hardware products that can be integrated and adapted to the
changing standards and requirements of the communications and internetworking
industries.
During fiscal 1997, 1996 and 1995, total research and development
expenditures were $9.4 million, $7.3 million and $6.6 million, respectively. All
research and development expenses are charged to expense as incurred.
The Company expects that it will continue to expend significant resources
for product development of specific applications such as voice and DSL as well
as to respond to market demand and new service offerings
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from network service providers. See "Factors Affecting Future
Results -- Dependence on Recently Introduced Products and Products Under
Development."
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 future results will
depend to a substantial degree upon its ability to respond to changes in
technology and customer requirements. This will require the timely selection,
development and marketing of new products and enhancements on a cost-effective
basis. The development of new, technologically advanced products is a complex
and uncertain process, requiring high levels of innovation. The development of
new products for the integrated access market requires competence in the general
areas of telephony, data networking, network management and wireless telephony
as well as specific technologies such as DSL, IP, ISDN, and ATM. Further, the
communications industry is characterized by the need to design products which
meet industry standards for safety, emissions and network interconnection. With
new and emerging technologies and service offerings from network service
providers, such standards are often changing or unavailable. As a result, there
is a potential for product development delay due to the need for compliance with
new or modified standards. The introduction of new and enhanced products also
requires that the Company manage transitions from older products in order to
minimize disruptions in customer orders, avoid excess inventory of old products
and ensure that adequate supplies of new products can be delivered to meet
customer orders. There can be no assurance that the Company will be successful
in developing, introducing or managing the transition to new or enhanced
products or that any such products will be responsive to technological changes
or will gain market acceptance. The Company's business, financial condition and
results of operations would be materially adversely affected if the Company were
to be unsuccessful, or to incur significant delays, in developing and
introducing such new products or enhancements.
MANUFACTURING AND QUALITY
The Company's manufacturing operations consist primarily of material
requirements planning, materials procurement and final assembly, test and
quality control of subassemblies and systems. The Company performs virtually all
aspects of its manufacturing process at its San Jose facility, with the
exception of printed circuit board assembly. A local contract manufacturer
performs printed circuit board assembly with parts sourced by Verilink. This
control of the manufacturing process enables the Company to implement quality
control and continuous process improvement techniques and methods, including
failure mode analysis, statistical process control and the use of quality
improvement teams. In addition, the Company has extended these quality control
techniques to certain suppliers by teaching and assisting them to implement such
techniques as statistical process control and just-in-time parts delivery. The
Company has been ISO 9001 certified since 1993. ISO 9000 is an international
quality certification process, developed in the European Common Market and
adopted by the United States as the method by which companies can demonstrate
the functionality of their quality system. Verilink obtained such certification
through an independent third party, with ongoing audits on a semi-annual basis.
On-time delivery of the Company's products is dependent upon the
availability of quality components and subsystems used in its products. The
Company depends upon a subcontractor to assemble printed circuit boards used in
its products in a timely and satisfactory manner. The Company obtains several
components, and licenses certain embedded software, from single sources.
Although the Company believes that, in each case, either an alternative supplier
is available or the product can be redesigned to incorporate a different
component, significant interruption in the delivery of any such item could have
a material adverse effect on the Company's business, financial condition and
results of operations. In particular, the Company's orders frequently require
delivery quickly after placement of the order. Because the Company does not
maintain significant component inventories, delay in shipment by a supplier
could lead to lost sales. See "Factors Affecting Future Results -- Dependence on
Component Availability and Key Suppliers."
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INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company relies upon a combination of patent, trade secret, copyright
and trademark laws and contractual restrictions to establish and protect
proprietary rights in its products and technologies. The Company has been issued
certain U.S. and Canadian patents with respect to limited aspects of its single
purpose network access technology. The Company has not obtained significant
patent protection for its Access System 2000 technology. The Company is not
currently aware of any material past infringement on its technology by third
parties. There can be no assurance that third parties have not or will not
develop equivalent technologies or products without infringing the Company's
patents or that the Company's patents would be held valid and enforceable by a
court having jurisdiction over a dispute involving such patents. The Company has
also entered into confidentiality and invention assignment agreements with its
employees, and enters into non-disclosure agreements with its suppliers,
distributors and appropriate customers so as to limit access to and disclosure
of its proprietary information. There can be no assurance that these statutory
and contractual arrangements will deter misappropriation of the Company's
technologies or discourage independent third-party development of similar
technologies. In the event such arrangements are insufficient, the Company's
business, financial condition and results of operations could be materially
adversely affected. The laws of certain foreign countries in which the Company's
products are or may be developed, manufactured or sold may not protect the
Company's products or intellectual property rights to the same extent as do the
laws of the United States and thus make the possibility of misappropriation of
the Company's technology and products more likely. See "Factors Affecting Future
Results -- Limited Protection of Intellectual Property."
The network access and telecommunications equipment industries are
characterized by the existence of a large number of patents and frequent
litigation based on allegations of patent infringement. From time to time, third
parties may assert exclusive patent, copyright, trademark and other intellectual
property rights to technologies that are important to the Company. The Company
has not conducted a formal patent search relating to the technology used in its
products, due in part to the high cost and limited benefits of a formal search.
In addition, since patent applications in the United States are not publicly
disclosed until the patent issues and foreign patent applications generally are
not publicly disclosed for at least a portion of the time that they are pending,
applications may have been filed which, if issued as patents, would relate to
the Company's products. Software comprises a substantial portion of the
technology in the Company's products. The scope of protection accorded to
patents covering software-related inventions is evolving and is subject to a
degree of uncertainty which may increase the risk and cost to the Company if the
Company discovers third party patents related to its software products or if
such patents are asserted against the Company in the future. Patents have been
granted recently on fundamental technologies in software, and patents may issue
which relate to fundamental technologies incorporated into the Company's
products. The Company may receive communications from third parties in the
future asserting that the Company's products infringe or may infringe the
proprietary rights of third parties. In its distribution agreements, the Company
typically agrees to indemnify its customers for all 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 would be materially adversely affected. See "Factors Affecting
Future Results -- Risk of Third Party Claims Infringement."
EMPLOYEES
As of June 29, 1997, the Company had approximately 219 employees worldwide.
Management believes that the future success of Verilink will depend in part on
its ability to attract and retain qualified employees, including management,
technical, and design personnel. In particular, the Company currently has
numerous
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open positions, specifically in the engineering arena. Any lengthy delays in
filling these positions will lead to delays in the introduction of various
products currently being developed, a well as the research and development
associated with potential new products. See "Factors Affecting Future
Results -- Dependence on Key Personnel," and "Factors Affecting Future
Results -- Need to Expand Sales Organization and Channels of Distribution."
BACKLOG
Orders for the Company's products are usually placed by customers on an
as-needed basis and the Company has typically been able to ship these products
within 30 days after the customer submits a firm purchase order. Because of the
possibility of customer changes in delivery schedules or cancellation of orders,
the Company's backlog as of any particular date may not be indicative of sales
in any future period.
ITEM 2. PROPERTIES
The Company's headquarters and principal administrative and engineering
facility is located in a building containing approximately 55,000 square feet
located in San Jose, California. During 1997, the Company moved its
manufacturing operations into a new 24,000 square foot facility located nearby
its headquarters building in San Jose, California. The Company leases these
buildings through April 2001 and November 2001, respectively, from a partnership
which is comprised of Leigh S. Belden and Steven C. Taylor. Under the terms of
the leases the Company must lease an additional 45,800 square feet no later than
December 1, 1998. The Company believes these leases were made on terms that are
no less favorable to the Company than would have been obtained from unaffiliated
third parties.
In addition, the Company has eleven sales offices located in the U.S These
properties are occupied under operating leases that expire on various dates
through 2002 with options to renew in most instances.
The Company believes its current facilities are suitable for and adequate
to support its present level of operations and believes that future growth can
be accommodated by leasing additional space near these facilities.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in any material legal actions. From
time to time, however, the Company may be subject to claims and lawsuits arising
in the normal course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders of the Company
during the fourth quarter of fiscal 1997, which ended June 29, 1997.
EXECUTIVE OFFICERS OF THE COMPANY
Information concerning executive officers of the Company is set forth
below:
Mr. Leigh S. Belden, age 48, co-founded the Company and has served as its
President, Chief Executive Officer and Director since its inception in December
1982. From 1980 to 1982, Mr. Belden was Vice President of Marketing for Cushman
Electronics, a manufacturer of telephone central office and two-way radio test
equipment. Previously, he held various international and domestic sales and
marketing management positions for California Microwave. Mr. Belden received a
B.S. in Electrical Engineering from the University of California at Berkeley and
an M.B.A. from Santa Clara University.
Mr. Steven C. Taylor, age 51, co-founded the Company and has served as its
Chief Technical Officer since its inception in December 1982. In addition, Mr.
Taylor served as Chairman of the Board of Directors from the Company's inception
until January 1996, at which time he became the Vice Chairman of the Board of
Directors. Previously, Mr. Taylor served as Chief Engineer of Digital Products
for Culbertson Industries
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and California Microwave. In 1980, Mr. Taylor formed Telecommunications
Consultants, Inc., a consulting firm engaged in the design and support of
digital and analog communications equipment.
Mr. John C. Batty, age 42, joined the Company in May 1997 as Vice
President, Finance and Chief Financial Officer. From December 1992 until joining
Verilink, Mr. Batty was Vice President and Treasurer for VLSI Technology, Inc.,
a semiconductor manufacturer. From April 1991 to December 1992, Mr. Batty was
Director Corporate Financial Planning for VLSI. Mr. Batty received a B.A. in
Economics from the University of New Hampshire, and an M.B.A. from the
University of Chicago.
Mr. Robert F. Griffith, age 53, joined the Company in June 1996 as Vice
President of Sales. From February 1994 until joining Verilink, Mr. Griffith was
Vice President of Sales of Network Equipment Technologies, a telecommunications
equipment manufacturer. From November 1989 to February 1994, Mr. Griffith was
Director of Sales for NORTEL, Inc Mr. Griffith received a B.A. in Business
Administration and an M.B.A. from Pepperdine University.
Mr. Michael Harmon, age 38, joined the Company in May 1997 as Vice
President, Engineering. From March 1996 until joining Verilink, Mr. Harmon was
Director, Wave Engineering for Madge Networks Inc., a telecommunications and LAN
equipment manufacturer. From July 1987 to February 1996 Mr. Harmon was Vice
President of Engineering and Director of Development at Teleos Communications,
Inc., a telecommunications equipment manufacturer. Mr. Harmon received a M.S. in
Electrical Engineering from the California Institute of Technology.
Ms. Andrea Potts, age 48, joined the Company in April 1997 as Vice
President, Human Resources. From June 1994 until joining Verilink, Ms. Potts was
Director, Human Resources, for the Western Region of Sony Electronics, Inc. From
June 1984 until January 1991, Ms. Potts was Manager of Human Resources for
Fujitsu Microelectronics, Inc., a semiconductor manufacturer. Ms. Potts received
a B.S. in Business Administration from San Jose State University.
Mr. Henry L. Tinker, age 65, joined the Company in May 1991 as Vice
President, Operations. From May 1990 until joining Verilink, Mr. Tinker served
as an Operations Consultant to the Company. From May 1984 to May 1990, Mr.
Tinker was Vice President of a business group of Cipher Data Products, a tape
drive manufacturer. Mr. Tinker received a B.S. in Business Administration from
the University of California at Los Angeles.
Other than Henry L. Tinker, who is the father-in-law of Leigh S. Belden,
there are no family relationships among any of the directors or executive
officers of the Company.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
FISCAL 1997 -- QUARTER ENDED JUNE 29 MARCH 30 DECEMBER 29 SEPTEMBER 29
- --------------------------------------------------- ---------- -------- ----------- ------------
Market Price:(1) High.............................. $11.25 $33.25 $ 37.00 $30.00
Low............................. $ 5.50 $ 5.69 $ 24.50 $21.25
FISCAL 1996 -- QUARTER ENDED JUNE 30(2) MARCH 31 DECEMBER 31 OCTOBER 1
- --------------------------------------------------- ---------- -------- ----------- ------------
Market Price:(1) High.............................. $26.25 -- -- --
Low............................. $18.50 -- -- --
- ---------------
(1) The Company's Common Stock is traded on the Nasdaq National Market under the
symbol VRLK. The market prices per share represent the highest and lowest
closing prices for Verilink's Common Stock on the Nasdaq national market
during each quarter. As of September 19, 1997 the Company had approximately
224 stockholders of record. The Company has never declared or paid dividends
on its capital stock and does not intend to pay dividends in the foreseeable
future.
(2) Beginning June 10, 1996.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
FINANCIAL INFORMATION BY YEAR (UNAUDITED)
(THOUSANDS, EXCEPT PER SHARE AMOUNTS AND NUMBER OF EMPLOYEES)
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
Sales.................................... $57,170 $41,608 $31,447 $36,533 $28,007
Gross Profit............................. 28,845 21,453 14,755 17,647 11,887
Income (loss) from operations............ 4,832 3,232 347 2,869 (955)
Net Income (loss)........................ 4,194 2,716 448 2,263 (1,390)
Net Income per share..................... $ 0.29 $ 0.24 $ 0.04 $ 0.23 $ (0.16)
Shares used to compute net income per
share.................................. 14,293 11,367 10,676 9,900 8,579
Research and development as a percentage
of sales............................... 16.4% 17.5% 21.0% 16.4% 19.6%
Capital expenditures..................... $ 6,471 $ 958 $ 782 861 491
Cash and cash equivalents and short-term
investments............................ $39,050 $40,542 $ 3,243 $ 6,161 $ 931
Working capital.......................... $46,217 $45,015 $ 5,695 $ 5,358 $ 3,082
Stockholders' equity..................... $53,767 $47,234 $ 7,433 $ 6,988 $ 4,737
Total assets............................. $60,687 $55,218 $12,617 $15,029 $10,891
Employees................................ 219 182 152 147 132
FINANCIAL INFORMATION BY QUARTER (UNAUDITED)
(THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FISCAL 1997 JUNE 29 MARCH 30 DECEMBER 29 SEPTEMBER 29
------- -------- ----------- ------------
Sales......................................... $12,448 $13,760 $16,286 $ 14,676
Gross Profit.................................. $ 5,979 $ 6,817 $ 8,495 $ 7,554
Income (loss) from operations................. $ (248) $ 875 $ 2,301 $ 1,904
Net Income.................................... $ 169 $ 865 $ 1,712 $ 1,448
Net Income per share.......................... $ 0.01 $ 0.06 $ 0.12 $ 0.10
Shares used to compute net income per share... 14,150 14,312 14,360 14,350
FISCAL 1996 JUNE 30 MARCH 31 DECEMBER 31 OCTOBER 1
------- -------- ----------- ------------
Sales......................................... $12,931 $10,533 $ 8,640 $ 9,505
Gross Profit.................................. $ 6,567 $ 5,427 $ 4,284 $ 4,897
Income from operations........................ $ 1,479 $ 711 $ 293 $ 750
Net Income.................................... $ 952 $ 1,105 $ 196 $ 463
Net Income per share.......................... $ 0.08 $ 0.10 $ 0.02 $ 0.04
Shares used to compute net income per share... 12,122 11,496 11,011 10,837
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MDA") should be read in conjunction with the 1997
Consolidated Financial Statements and Notes thereto.
This MDA contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Actual results could differ materially from those projected in the
forward-looking statements as a result of the risk factors set forth herein,
including those set forth in "Factors Affecting Future Results" below.
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The Company's fiscal year ends on the Sunday nearest June 30. Fiscal years
1997, 1996, and 1995 ended June 29, June 30, and July 2 respectively, and
consisted of 52 weeks. References to 1997, 1996, and 1995 shall be to the
respective fiscal year unless otherwise stated or the context otherwise
requires.
OVERVIEW
Verilink Corporation (the "Company") develops, manufactures and markets
integrated access products for telecommunications network service providers
("NSPs") and corporate end users. Verilink's integrated network access products
are used by network service providers such as interexchange and local exchange
carriers, and providers of Internet, personal communications and cellular
services to provide seamless connectivity and interconnect for multiple traffic
types on wide area networks ("WANs").
Verilink's Access System 2000 product line continued to be well received in
the marketplace and generated the majority of 1997 sales. Verilink designed the
Access System 2000 with modular hardware and software to enable its customers to
access increased network capacity and to adopt new communications services in a
cost-effective manner. The Access System 2000 provides integrated access to low
speed services, fractional T1/E1 services, and T1, E1, T3, and frame relay
services. The Company has other products under development that are intended to
expand the number of services the Access System 2000 platform supports. The
Company also sells single purpose network access devices for selected
applications.
The Company believes that period-to-period comparisons of its financial
results are not necessarily meaningful and should not be relied upon as an
indication of future performance. In addition, the Company's results of
operations may fluctuate from period to period in the future.
RESULTS OF OPERATIONS
SALES
(THOUSANDS) 1997 1996 1995
------- ------- -------
Sales......................................................... $57,170 $41,608 $31,447
Percentage change from preceding year......................... 37% 32% -14%
Sales for 1997 increased 37% to $57.2 million as compared to $41.6 million
in 1996, which increased 32% from $31.4 million in 1995. The growth in sales
during 1997 and 1996 was attributable primarily to an increase in unit shipments
as a result of market acceptance of the Company's Access System 2000 product
line. The increase in unit shipments for the Access System 2000 product line was
primarily attributable to the growth in the business targeted at wireless
communications service applications which accounted for approximately 31% of
sales in 1997 as compared to 13% and 4% in 1996 and 1995 respectively. The
Access System 2000 product line in total accounted for approximately 80% of
sales in 1997 as compared to approximately 70% in 1996 and approximately 53% in
1995.
The Company's business is characterized by the concentration of sales to a
limited number of customers. Sales to the Company's top five customers accounted
for 67%, 64% and 47% of sales in 1997, 1996, and 1995, respectively. The
Company's largest customers include NORTEL, Inc., MCI Communications Corp.,
CompuServe Corp., and QUALCOMM Incorporated. See Note 1 of "Notes to
Consolidated Financial Statements," and "Factors Affecting Future
Results -- Customer Concentration."
The Company sells its products primarily in the United States to NSPs
through a direct sales force and through a variety of resellers, including
original equipment manufacturers (OEMs), value added resellers (VARs) and
distributors. Sales to VARs and distributors accounted for approximately 18% of
sales in 1997 as compared to approximately 14% in 1996, and 24% in 1995. To
date, international sales have not been significant. The Company intends to
expand the marketing of its products generally and particularly to markets
outside the United States.
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GROSS PROFIT
(THOUSANDS) 1997 1996 1995
------- ------- -------
Gross Profit.................................................. $28,845 $21,453 $14,755
Percentage of Sales........................................... 50.5% 51.6% 46.9%
Gross profit as a percentage of sales in 1997 was 50.5% as compared to
51.6% in 1996. The decrease in gross profit margin was primarily the result of
higher fixed overhead costs associated with the addition of a new manufacturing
facility in 1997, and lower sales volume in the second half of the year. Gross
profit as a percentage of sales in 1996 increased to 51.6% from 46.9% in 1995
due to manufacturing efficiencies attributable to higher volume production and
lower component costs. In future periods, the Company's gross profit will vary
depending upon a number of factors, including the channels of distribution, the
price of products sold, discounting practices, the mix of products sold, price
competition, increases in material costs, and changes in other components of
cost of sales. As the Company introduces new products, it is possible that such
products may have lower gross profit than other established products in high
volume production. Accordingly, gross profit as a percentage of sales may vary.
RESEARCH AND DEVELOPMENT
(THOUSANDS) 1997 1996 1995
------ ------ ------
Research and development......................................... $9,373 $7,283 $6,619
Percentage of Sales.............................................. 16.4% 17.5% 21.0%
Research and development expenses increased to $9.4 million or 16.4% of
sales in 1997, compared to $7.3 million and $6.6 million or 17.5% and 21.0% of
sales for 1996 and 1995, respectively. The expense increase was due principally
to the addition of personnel, use of outside consultants, depreciation of
capital expenditures and prototype development, design, and testing. The Company
considers product development expenditures to be critical to future sales and
expects to increase spending in absolute dollars, while such expenditures as a
percentage of sales may vary. There can be no assurance that the Company's
research and development efforts will result in commercially successful new
technology and products in the future, and those efforts may be affected by
other factors as noted below.
SELLING, GENERAL AND ADMINISTRATIVE
(THOUSANDS) 1997 1996 1995
------- ------- -------
Selling, general, and administrative.......................... $14,640 $10,938 $ 7,789
Percentage of Sales........................................... 25.6% 26.3% 24.8%
The Company's selling, general and administrative expenses increased to
$14.6 million in 1997 compared to $10.9 million in 1996 and $7.8 million in
1995. The increase in dollars spent was due to the addition of personnel, the
expansion of domestic sales offices, and incentive compensation, including
commissions associated with sales growth. These expenses decreased as a
percentage of sales to 25.6% in 1997 from 26.3% in 1996 primarily due to
increased sales. The Company expects to increase sales and marketing spending in
fiscal 1998 as a part of its effort to increase international sales and expand
the markets for its products. In addition, the Company expects to increase
administrative, legal, and information technology costs necessary to support
expanded operations. The Company expects that selling, general, and
administrative expenses may vary as a percentage of sales.
INTEREST AND OTHER INCOME, NET
Interest income increased to $2.0 million in 1997 compared to $147,000 in
1996 and $141,000 in 1995. The increase in interest income during 1997 is due
primarily to the investment of proceeds from the Company's initial public
offering of its common stock, completed in June 1996.
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PROVISION FOR INCOME TAXES
The provision for income taxes for 1997 was $2.7 million, an effective tax
rate of 39%, compared to an effective tax rate of 20% and 8.2% for 1996 and 1995
respectively. The 1997 effective tax rate of 39% approximates the combined
federal and state statutory rates. The effective tax rate in 1996 was less than
the combined federal and state statutory rates primarily due to the recognition
of previously reserved deferred tax assets based on carryback capacity and, to a
lesser extent, expectations of future income in 1997. The provision for income
taxes of $40,000 in fiscal 1995 represented minimum state income and franchise
taxes.
LIQUIDITY AND CAPITAL RESOURCES
On June 29, 1997, the Company's principal sources of liquidity included
$39.1 million of cash and cash equivalents, and short-term investments. The
Company had a secured $2.0 million revolving line of credit which expired on
August 15, 1997. There was no borrowing under the line of credit in 1997. The
Company is currently investigating the possibility of establishing a new
unsecured credit facility on more favorable terms. There can be no assurance
that the Company will be able to establish such facility on more favorable
terms, or at all.
During 1997, the Company generated $2.8 million of net cash from operating
activities, a 68% increase over the $1.7 million generated in 1996. During 1995,
net cash used in operating activities was $2.0 million, primarily due to the
payment of accrued compensation expense. Accounts receivable remained constant
in 1997 as compared to 1996 at $2.3 million while increasing from 1995 levels of
$1.4 million. Inventory levels declined $499,000 from 1996 reflecting the
shipment of product that had accumulated in anticipation of higher sales in
early 1997. Accounts payable decreased by $941,000 in 1997 reflecting lower
year-end volume with outside subcontractors and suppliers.
Net cash used for investing activities was $8.9 million in 1997, as
compared to $958,000 and $782,000 in 1996 and 1995 respectively. Verilink
invested $6.5 million in property, and equipment during 1997 compared to
$958,000 in 1996 and $782,000 in 1995. The 1997 investments in property and
equipment were primarily for leasehold improvements for its new 24,000 square
foot manufacturing facility, and computer and test equipment. The Company
estimates that total budgeted capital expenditures for 1998 will approximate
$6.0 million and will include expenditures for test equipment, design tools, and
new manufacturing capability. The Company expects current facilities will be
adequate through 1998.
Net cash provided from financing activities was $2.1 million in 1997
compared to $36.6 million in 1996 . The Company raised $36.9 million through its
initial public offering of common stock in June 1996. Prior to the offering, the
primary source of financing for the Company had been cash flow from operations.
In addition, the Company had used proceeds from the private sale of equity
securities and bank borrowings to support its operations, acquire capital
equipment and finance inventory and accounts receivable growth.
The Company believes that its cash and investment balances and anticipated
cash flow from operations, will be adequate to finance current operations,
anticipated investments and capital expenditures for at least the next twelve
months. However, there can be no assurance that future events will not require
the Company to seek additional capital sooner, or if so required, that adequate
capital will be available on terms acceptable to the Company, or at all.
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.
Forward-looking Statements. This Report on Form 10-K contains
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such
forward-looking statements include the Company's plans to introduce Voice and
DSL functionality on the Access System 2000 platform and the timing of such
introduction, the Company's expectation that the percentage of its sales
represented by Access System 2000 products will increase, and the Company's
plans
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to develop new products, expand its sales force, expand its customer base and
enter international markets, and the Company's plans to increase levels of
spending on research and development and capital equipment. Such forward-looking
statements also include the Company's expectations concerning factors affecting
the markets for its products, such as demand for increased bandwidth, the
migration from private to public networks, growth in the corporate use of the
Internet, deregulation and increased competition, the introduction of a wide
range of new communication services and technologies (including the potential
deployment of ATM and DSL and product and service developments) and growth in
the international market for network access solutions. Actual results could
differ from those projected in any forward-looking statements for the reasons
detailed below and in the other sections of this Annual Report on Form 10-K. The
forward-looking statements are made as of the date of this Annual Report on Form
10-K, and the Company assumes no obligation to update the forward-looking
statements, or to update the reasons why actual results could differ from those
projected in the forward-looking statements. You should consult the risk factors
listed from time to time in the Company's Reports on Form 10-Q, 8-K, 10-K and
Annual Report to Stockholders.
Customer Concentration. A small number of customers have accounted for a
majority of the Company's sales in each of the past several fiscal years. In
fiscal 1997, NORTEL, MCI, and CompuServe accounted for 22%, 20%, and 11% of the
Company's sales, respectively, and sales to the Company's top five customers
accounted for 67% of the Company's sales. In fiscal 1996, NORTEL, MCI, and
CompuServe accounted for 7%, 29% and 18% of the Company's sales, respectively,
and the Company's top five customers accounted for 64% of the Company's sales.
In fiscal 1995, MCI and CompuServe each accounted for 14% of the Company's sales
and the Company's top five customers accounted for 47% of sales. Other than
NORTEL, MCI and CompuServe, no customer accounted for more than 10% of the
Company's revenue in fiscal 1997, fiscal 1996, or fiscal 1995. There can be no
assurance that the Company's current customers will continue to place orders
with the Company, that orders by existing customers will continue at the levels
of previous periods, or that the Company will be able to obtain orders from new
customers. The Company's customers are typically not contractually obligated to
purchase any quantity of products in any particular period. Product sales to
major customers have varied widely from year to year. In some cases, major
customers have abruptly terminated purchases of the Company's products. For
example, sales of the Company's single purpose network access products to AT&T
Paradyne represented 24% of sales in fiscal 1993, but declined to 11% and 2% of
sales in fiscal 1994 and 1995, respectively, due to the decision by AT&T
Paradyne to focus its sales efforts on competing products developed within the
AT&T organization. In addition, sales to Stratacom, Inc. for provision of
network management capabilities in a system sold to another AT&T business unit
accounted for 9% of the Company's sales during fiscal 1995. Sales to Stratacom
ceased during the second half of fiscal 1995 due to the decision by such AT&T
business unit to internally provide such management functionality in its system.
Loss of, or a material reduction in orders by, one or more of the Company's
major customers would materially adversely affect the Company's business,
financial condition and results of operations. See "Competition."
Fluctuations in Quarterly Operating Results. The Company's sales are
subject to quarterly and annual fluctuations due to a number of factors. Most of
the Company's sales are in the form of large orders with short delivery times.
The Company's ability to affect and judge the timing of individual customer
orders is limited. The Company has experienced large fluctuations in sales from
quarter to quarter due to a wide variety of factors, such as delay, cancellation
or acceleration of customer projects, and other factors discussed below. The
Company's sales for a given quarter may depend to a significant degree upon
planned product shipments to a single customer, often related to specific
equipment deployment projects. The Company has experienced both acceleration and
slowdown in orders related to such projects, causing changes in the sales level
of a given quarter relative to both the preceding and subsequent quarters. Sales
to individual current customers have varied by as much as $2.0 million between
consecutive quarters.
Delays or lost sales can be caused by other factors beyond the Company's
control, including late deliveries by other vendors of components in a
customer's system, changes in implementation priorities, slower than anticipated
growth in demand for the services that the Company's products support and delays
in obtaining regulatory approvals for new services. Delays and lost sales have
occurred in the past and may occur in the future. Operating results in recent
periods have been adversely affected by delays in receipt of significant
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purchase orders from customers. In addition, the Company has in the past
experienced delays as a result of the need to modify its products to comply with
unique customer specifications. These and similar delays or lost sales could
materially adversely affect the Company's business, financial condition and
results of operations. See "Customer Concentration," and "Dependence on
Component Availability and Key Suppliers."
The Company's backlog at the beginning of each quarter typically is not
sufficient to achieve expected sales for that quarter. To achieve its sales
objective, the Company is dependent upon obtaining orders in a quarter for
shipment in that quarter. Furthermore, the Company's agreements with its
customers typically provide that they may change delivery schedules and cancel
orders within specified timeframes, typically up to 30 days prior to the
scheduled shipment date, without significant penalty. The Company's customers
have in the past built, and may in the future build, significant inventory in
order to facilitate more rapid deployment of anticipated major projects or for
other reasons. Decisions by such customers to reduce their inventory levels
could lead to reductions in purchases from the Company. These reductions, in
turn, could cause fluctuations in the Company's operating results and could have
an adverse effect on the Company's business, financial condition and results of
operations in the periods in which the inventory is reduced.
The Company's industry is characterized by declining prices of existing
products, therefore continual improvement of manufacturing efficiencies and
introduction of new products and enhancements to existing products are required
to maintain gross margins. In response to customer demands or competitive
pressures, or to pursue new product or market opportunities, the Company may
take certain pricing or marketing actions, such as price reductions, volume
discounts, or provision of services at below-market rates. These actions could
materially and adversely affect the Company's operating results.
Operating results may also fluctuate due to factors such as the timing of
new product announcements and introductions by the Company, its major customers
or its competitors, delays in new product introductions by the Company, market
acceptance of new or enhanced versions of the Company's products, changes in the
product or customer mix of sales, changes in the level of operating expenses,
competitive pricing pressures, the gain or loss of significant customers,
increased research and development and sales and marketing expenses associated
with new product introductions, and general economic conditions. All of the
above factors are difficult for the Company to forecast, and these or other
factors can materially adversely affect the Company's business, financial
condition and results of operations for one quarter or a series of quarters. The
Company's expense levels are based in part on its expectations regarding future
sales and are fixed in the short term to a large extent. Therefore, the Company
may be unable to adjust spending in a timely manner to compensate for any
unexpected shortfall in sales. Any significant decline in demand relative to the
Company's expectations or any material delay of customer orders could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that the Company will be able
to sustain profitability on a quarterly or annual basis. In addition, the
Company has had, and in some future quarter may have operating results below the
expectations of public market analysts and investors. In such event the price of
the Company's Common Stock would likely be materially and adversely affected.
See "Potential Volatility of Stock Price."
Potential Volatility of Stock Price. The trading price of the Company's
Common Stock could be subject to wide fluctuations in response to quarter to
quarter variations in operating results, announcements of technological
innovations or new products by the Company or its competitors, developments with
respect to patents or proprietary rights, general conditions in the
telecommunication network access and equipment industries, changes in earnings
estimates by analysts, or other events or factors. In addition, the stock market
has experienced extreme price and volume fluctuations, which have particularly
affected the market prices of many technology companies and which have often
been unrelated to the operating performance of such companies. These
Company-specific factors or broad market fluctuations may materially adversely
affect the market price of the Company's Common Stock. The Company has
experienced significant fluctuations in its stock price and share trading volume
since its initial public offering in June 1996. There is no assurance that such
fluctuations will not continue.
Dependence on Recently Introduced Products and Products Under
Development. The Company's future results of operations are highly dependent on
market acceptance of existing and future applications for the
18
20
Company's Access System 2000 product line. The Access System 2000 product line
represented approximately 80% of sales in fiscal 1997 and 70% of sales in fiscal
1996. Increased market acceptance of the Company's Access System 2000 products
is dependent on a number of factors, not all of which are in the Company's
control, including the continued growth in the use of bandwidth intensive
applications, continued deployment of new telecommunications services, market
acceptance of integrated access devices in general, the availability and price
of competing products and technologies, and the success of the Company's sales
efforts. Failure of the Company's products to achieve increased market
acceptance would have a material adverse effect on the Company's business,
financial condition and results of operations. Failure to introduce new products
in a timely manner could cause companies to purchase products from competitors
and have a material adverse effect on the Company's business, financial
condition and results of operations. Due to a variety of factors, the Company
may experience delays in developing its planned products. New products may
require additional development work, enhancement, testing or further refinement
before they can be made commercially available by the Company. The Company has
in the past experienced delays in the introduction of Access System 2000 product
applications and enhancements due to a variety of internal factors, such as
reallocation of priorities, difficulty in hiring sufficient numbers of qualified
personnel and unforeseen technical obstacles, as well as to changes in customer
requirements. Although the Company does not believe that such delays have had a
material adverse effect on its customer relationships, such delays have deferred
the receipt of revenue from the products involved. If the Company's Access
System 2000 products have performance, reliability or quality shortcomings, then
the Company may experience reduced orders, higher manufacturing costs, delays in
collecting accounts receivable and additional warranty and service expenses.
Need to Expand Sales Organization and Channels of Distribution. Currently
the Company sells its products to a small number of customers through a
relatively small sales force. The Company's strategy is to distribute its
products to a broader customer base, which will require the Company to
significantly expand its sales force and other channels of distribution. There
can be no assurance that the Company will be able to recruit, train, motivate
and manage additional qualified sales personnel with the requisite experience
and knowledge, or attract additional qualified distributors. Availability of
qualified sales personnel is limited, and competition for experienced sales
personnel in the network access and telecommunications equipment industries is
intense. The failure to timely expand the Company's sales force and expand its
channels of distribution could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Customer
Concentration," "Management of Growth" and "Dependence on Key Personnel."
Dependence on Component Availability and Key Suppliers. On-time delivery of
the Company's products depends upon the availability of components and
subsystems used in its products. The Company depends in part upon suppliers to
manufacture, assemble and deliver components in a timely and satisfactory
manner. The Company obtains several components and licenses certain embedded
software from single sources. There can be no assurance that these suppliers
will continue to be able and willing to meet the Company's requirements for any
such components. The Company generally does not have any long-term contracts
with such suppliers, other than software vendors. Any significant interruption
in the supply of, or degradation in the quality of, any such item could have a
material adverse effect on the Company's results of operations. The Company has
no current plans to significantly expand its supplier base.
Purchase orders from the Company's customers frequently require delivery
quickly after placement of the order. Because the Company does not maintain
significant component inventories, delay in shipment by a supplier could lead to
lost sales. The Company uses internal forecasts to determine its general
materials and components requirements. Lead times for materials and components
may vary significantly, and depend on factors such as specific supplier
performance, contract terms and general market demand for components. If orders
vary from forecasts, the Company may experience excess or inadequate inventory
of certain materials and components. From time to time, the Company has
experienced shortages and allocations of certain components, resulting in delays
in fulfillment of customer orders. Such shortages and allocations could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Fluctuations in Quarterly Operating Results."
Competition. The market for network access and telecommunications equipment
is highly competitive, and the Company expects competition to increase in the
future. This market is subject to rapid technological
19
21
change, regulatory developments and emerging industry standards. The Company
faces different competitive environments for its Access System 2000 products
than for its single purpose network access products.
The market for integrated access devices such as the Company's Access
System 2000 is newly emerging and is subject to rapid change. The Company
believes that the primary competitive factors in this market are the development
and rapid introduction of new product features, price/performance, support for
multiple types of communications services, network management, reliability and
safety, and quality of customer support. There can be no assurance that the
Company's new products and products under development will be able to compete
successfully with respect to these or other factors. The Company's principal
competition to date for its current Access System 2000 products has been from
Digital Link Corporation, Kentrox, a division of ADC Telecommunications (both in
Kentrox's own products and products supplied to Kentrox by Premisys
Communications, Inc.), and Larscom, Inc. As the Company develops new products
for the Access System 2000 line, the Company expects to increasingly compete
with Premisys. The Company expects additional competition from companies that
are currently competitors in the market for the Company's single purpose network
access products, as such companies develop new products. In addition, the
Company expects competition from companies in the computer networking market and
other related markets such as Newbridge Networks Corporation, Telco Systems,
Inc. and Ascend Communications, Inc. To the extent that current or potential
competitors can expand their current offerings to include products that have
functionality similar to the Company's products and planned products, the
Company's business, financial condition and results of operations could be
materially adversely affected.
The Company believes that the market for its single purpose network access
products is mature. The Company believes that the principal competitive factors
in this market are price, installed base and quality of customer support. In
this market, the Company primarily competes with Adtran, Inc., Digital Link,
Kentrox and Larscom. There can be no assurance that such companies or other
competitors will not introduce new products at a lower price and/or that provide
greater functionality than the Company's single purpose network access products.
In addition, the Company anticipates that competitors and customers may develop
products that could be used for selected applications for which the Company's
products are currently provided. Successful, timely development of such products
could reduce the level of demand for the Company's products. The Company does
not expect to spend significant resources, if any, on research and development
of its single purpose network access products. There can be no assurance that
the Company's single purpose network access products will be competitive in the
future.
Many of the Company's current and potential competitors have substantially
greater technical, financial, manufacturing and marketing resources than the
Company. In addition, many of the Company's competitors have long-established
relationships with network service providers. There can be no assurance that the
Company will have the financial resources, technical expertise, manufacturing,
marketing, distribution and support capabilities to compete successfully in the
future.
Rapid Technological Change. The network access and telecommunications
equipment markets are characterized by rapidly changing technologies and
frequent new product introductions. The rapid development of new technologies
increases the risk that current or new competitors could develop products that
would reduce the competitiveness of the Company's products. The Company's
success will depend to a substantial degree upon its ability to respond to
changes in technology and customer requirements. This will require the timely
selection, development and marketing of new products and enhancements on a
cost-effective basis. The development of new, technologically advanced products
is a complex and uncertain process, requiring high levels of innovation. The
development of new products for the integrated access market requires competence
in the general areas of telephony, data networking, network management and
wireless telephony as well as specific technologies such as DSL, IP, ISDN and
ATM. Furthermore, the communications industry is characterized by the need to
design products which meet industry standards for safety, emissions and network
interconnection. With new and emerging technologies and service offerings from
network service providers, such standards are often changing or unavailable. As
a result, there is a potential for product development delay due to the need for
compliance with new or modified standards. The introduction of new and enhanced
products also requires that the Company manage transitions from older products
in order to minimize disruptions in customer orders, avoid excess inventory of
old products and ensure that adequate supplies of
20
22
new products can be delivered to meet customer orders. There can be no assurance
that the Company will be successful in developing, introducing or managing the
transition to new or enhanced products or that any such products will be
responsive to technological changes or will gain market acceptance. The
Company's business, financial condition and results of operations would be
materially adversely affected if the Company were to be unsuccessful, or to
incur significant delays, in developing and introducing such new products or
enhancements. See "Dependence on Recently Introduced Products and Products under
Development."
Management of Growth. The Company has recently experienced and may continue
to experience growth in the number of its employees and the scope of its
operations. In particular, the Company intends to increase its sales, marketing
and support staff. These increases will result in increased responsibilities for
management. To manage potential future growth effectively, the Company must
improve its operational, financial and management information systems and must
hire, train, motivate and manage a growing number of employees. The future
success of the Company also will depend on its ability to increase its customer
support capability and to attract and retain qualified technical, sales,
marketing and management personnel, for whom competition is intense. In
particular, the current availability of qualified sales and engineering
personnel is quite limited, and competition among companies for such personnel
is intense. The Company is currently attempting to hire a number of sales and
engineering personnel and has experienced delays in filling such positions.
During strong business cycles, the Company expects to experience continued
difficulty in filling its needs for qualified sales, engineering and other
personnel. There can be no assurance that the Company will be able to
effectively achieve or manage any such growth, and failure to do so could delay
product development cycles or otherwise have a material adverse effect on the
Company's business, financial condition and results of operations. See "Need to
Expand Sales Organization and Channels of Distribution," "Dependence on Key
Personnel."
Compliance with Regulations and Evolving Industry Standards. The market for
the Company's products is characterized by the need to meet a significant number
of communications regulations and standards, some of which are evolving as new
technologies are deployed. In the United States, the Company's products must
comply with various regulations defined by the Federal Communications Commission
and standards established by Underwriters Laboratories and Bell Communications
Research. For some public carrier services, installed equipment does not fully
comply with current industry standards, and this noncompliance must be addressed
in the design of the Company's products. Standards for new services such as
frame relay and ATM are still evolving. As these standards evolve, the Company
will be required to modify its products or develop and support new versions of
its products. The failure of the Company's products to comply, or delays in
compliance, with the various existing and evolving industry standards could
delay introduction of the Company's products, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Government regulatory policies are likely to continue to have a major
impact on the pricing of existing as well as new public network services and
therefore are expected to affect demand for such services and the
telecommunications products that support such services. Tariff rates, whether
determined by network service providers or in response to regulatory directives,
may affect the cost effectiveness of deploying communication services. Such
policies also affect demand for telecommunications equipment, including the
Company's products.
Risks Associated With Entry into International Markets. The Company has had
minimal direct sales to international customers to date. The Company has little
experience in international markets, but intends to expand sales of its products
outside of the United States and to enter certain international markets, which
will require significant management attention and financial resources.
Conducting business outside of the United States is subject to certain risks,
including longer payment cycles, unexpected changes in regulatory requirements
and tariffs, difficulties in staffing and managing foreign operations, greater
difficulty in accounts receivable collection and potentially adverse tax
consequences. To the extent any Company sales are denominated in foreign
currency, the Company's sales and results of operations may also be directly
affected by fluctuations in foreign currency exchange rates. In order to sell
its products internationally, the Company must meet standards established by
telecommunications authorities in various countries, as well as recommendations
of the Consultative Committee on International Telegraph and Telephony. A delay
in obtaining, or the
21
23
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 patent
issues and foreign patent applications generally are not publicly disclosed for
at least a portion of the time that they are pending, applications may have been
filed which, if issued as patents, would relate to the Company's products.
Software comprises a substantial portion of the technology in the Company's
products. The scope of protection accorded to patents covering software-related
inventions is evolving and is subject to a degree of uncertainty which may
increase the risk and cost to the Company if the Company discovers third party
patents related to its software products or if such patents are asserted against
the Company in the future. Patents have been granted recently on fundamental
technologies in software, and patents may issue which relate to fundamental
technologies incorporated into the Company's products. The Company may receive
communications from third parties in the future asserting that the Company's
products infringe or may infringe the proprietary rights of third parties. In
its distribution agreements, the Company typically agrees to indemnify its
customers for any expenses or liabilities, generally without limitation,
resulting from claimed infringements of patents, trademarks or copyrights of
third parties. In the event of litigation to determine the validity of any
third-party claims, such litigation, whether or not determined in favor of the
Company, could result in significant expense to the Company and divert the
efforts of the Company's technical and management personnel from productive
tasks. In the event of an adverse ruling in such litigation, the Company might
be required to discontinue the use and sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses
from third parties. There can be no assurance that licenses from third parties
would be available on acceptable terms, if at all. In the event of a successful
claim against the Company and the failure of the Company to develop or license a
substitute technology, the Company's business, financial condition and results
of operations would be materially adversely affected.
Limited Protection of Intellectual Property. The Company relies upon a
combination of patent, trade secret, copyright and trademark laws and
contractual restrictions to establish and protect proprietary rights in its
products and technologies. The Company has been issued certain U.S. and Canadian
patents with respect to limited aspects of its single purpose network access
technology. The Company has not obtained significant patent protection for its
Access System 2000 technology. There can be no assurance that third parties have
not or will not develop equivalent technologies or products without infringing
the Company's patents or that the Company's patents would be held valid and
enforceable by a court having jurisdiction over a dispute involving such
patents. The Company has also entered into confidentiality and invention
assignment agreements with its employees, and enters into non-disclosure
agreements with its suppliers, distributors and appropriate customers so as to
limit access to and disclosure of its proprietary information. There can be no
assurance that these statutory and contractual arrangements will deter
misappropriation of the Company's technologies or discourage independent
third-party development of similar technologies. In the event such arrangements
are insufficient, the Company's business, financial condition and results of
operations could be materially adversely affected. The laws of certain foreign
countries in which the Company's products are or may be developed, manufactured
or sold may not protect the Company's products or intellectual property rights
to the same extent as do the laws of the United States and thus make the
possibility of misappropriation of the Company's technology and products more
likely.
Dependence on Key Personnel. The Company's future success will depend to a
large extent on the continued contributions of its executive officers and key
management, sales and technical personnel, including Leigh S. Belden, the
Company's President and Chief Executive Officer, and Steven C. Taylor, the
Company's Chief Technical Officer. Except for employment agreements with Mr.
Belden and Mr. Taylor, the Company
22
24
does not have employment agreements with any other of such persons. Each of the
Company's executive officers, and key management, sales and technical personnel
would be difficult to replace. The loss of the services of one or more of the
Company's executive officers or key personnel, or the inability to continue to
attract qualified personnel could delay product development cycles or otherwise
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Management of Growth."
Control of the Company; Antitakeover Effects of Certain Charter
Provisions. The current officers, directors and holders of five percent or more
of the Company's Common Stock own approximately 36% of the outstanding Common
Stock. Accordingly, these stockholders, if they were to act as a group, would
effectively be able to elect all of the Company's directors, increase the
authorized capital and otherwise control the policies of the Company. The
Company's Board of Directors has the authority to issue up to 1,000,000 shares
of Preferred Stock and to determine the price, rights, preferences and
privileges of those shares without any further vote or action by the
stockholders. The rights of the holders of Common Stock will be subject to, and
may be adversely affected by, the rights of the holders of any Preferred Stock
that may be issued in the future. The issuance of shares of Preferred Stock,
while potentially providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could have the effect of making it
more difficult for a third party to acquire a majority of the outstanding voting
stock of the Company. The Company has no present intention to issue shares of
Preferred Stock. In addition, the Company is subject to the anti-takeover
provisions of Section 203 of the Delaware General Corporation Law, which will
prohibit the Company from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. The application of
Section 203 also could have the effect of delaying or preventing a change of
control of the Company. Furthermore, certain provisions of the Company's Amended
and Restated Certificate of Incorporation, including provisions that provide for
the Board of Directors to be divided into three classes to serve for staggered
three-year terms, may have the effect of delaying or preventing a change of
control of the Company, which could adversely affect the market price of the
Company's Common Stock.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The chart entitled "Financial Information by Quarter (Unaudited)" contained
in Item 5 of Part II hereof is hereby incorporated by reference into this Item 8
of Part II of this form 10-K.
23
25
VERILINK CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Consolidated Financial Statements Included in Item 8:
PAGE
----
Report of Price Waterhouse LLP, Independent Accountants............................... 25
Consolidated Balance Sheets as of June 29, 1997 and June 30, 1996..................... 26
Consolidated Statements of Operations for each of the three years in the period ended
June 29, 1997....................................................................... 27
Consolidated Statements of Cash Flows for each of the three years in the period ended
June 29, 1997....................................................................... 28
Consolidated Statements of Stockholders' Equity for each of the three years in the
period ended June 29, 1997.......................................................... 29
Notes to Consolidated Financial Statements............................................ 30
Schedule for each of the three years in the period ended June 29, 1997 included in
Item 14(a):
II -- Valuation and Qualifying Accounts and Reserves................................ 44
Schedules other than those listed above have been omitted since the
required information is not present or not present in amounts sufficient to
require submission of the schedule, or because the information required is
included in the consolidated financial statements or the notes thereto.
24
26
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Verilink Corporation
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Verilink Corporation and its subsidiary at June 29, 1997 and June
30, 1996, and the results of their operations and their cash flows for each of
the three years in the period ended June 29, 1997, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PRICE WATERHOUSE LLP
--------------------------------------
PRICE WATERHOUSE LLP
San Jose, California
July 23, 1997
25
27
VERILINK CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
JUNE 29, JUNE 30,
1997 1996
-------- --------
Current assets:
Cash and cash equivalents.............................................. $ 36,596 $ 40,542
Short-term investments................................................. 2,454 --
Accounts receivable, net of allowance of $76 at each date.............. 8,462 6,182
Inventories............................................................ 4,453 4,952
Deferred tax assets.................................................... 957 815
Other current assets................................................... 215 508
------- -------
Total current assets........................................... 53,137 52,999
Property and equipment, net.............................................. 6,607 1,530
Deferred tax assets...................................................... 616 613
Other assets............................................................. 327 76
------- -------
$ 60,687 $ 55,218
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................................... $ 1,258 $ 2,199
Accrued expenses....................................................... 5,080 4,945
Income taxes payable................................................... 582 840
------- -------
Total liabilities.............................................. 6,920 7,984
Commitments (Note 10)
Stockholders' equity:
Preferred Stock, $0.01 par value, 1,000,000 shares authorized; no
shares issued and outstanding....................................... -- --
Common Stock, $0.01 par value; 40,000,000 shares authorized; 13,586,286
and 13,122,833 shares issued and outstanding........................ 136 131
Additional paid-in capital............................................. 43,941 42,432
Notes receivable from stockholders..................................... (1,086) (1,445)
Treasury stock; 3,352,710 shares of Common Stock at cost at each
date................................................................ (7,320) (7,320)
Deferred compensation related to stock options......................... (350) (816)
Retained earnings...................................................... 18,446 14,252
------- -------
Total stockholders' equity..................................... 53,767 47,234
------- -------
$ 60,687 $ 55,218
======= =======
The accompanying notes are an integral part of this consolidated financial
statements.
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28
VERILINK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE YEARS ENDED JUNE 29, 1997
-------------------------------
1997 1996 1995
------- ------- -------
Sales......................................................... $57,170 $41,608 $31,447
Cost of sales................................................. 28,325 20,155 16,692
------- ------- -------
Gross profit.................................................. 28,845 21,453 14,755
------- ------- -------
Operating expenses:
Research and development.................................... 9,373 7,283 6,619
Selling, general and administrative......................... 14,640 10,938 7,789
------- ------- -------
Total operating expenses...................................... 24,013 18,221 14,408
------- ------- -------
Income from operations........................................ 4,832 3,232 347
Interest and other income, net................................ 2,043 147 141
------- ------- -------
Income before income taxes.................................... 6,875 3,379 488
Provision for income taxes.................................... 2,681 663 40
------- ------- -------
Net income.................................................... $ 4,194 $ 2,716 $ 448
======= ======= =======
Net income per share.......................................... $ 0.29 $ 0.24 $ 0.04
======= ======= =======
Shares used to compute net income per share................... 14,293 11,367 10,676
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
27
29
VERILINK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
THREE YEARS ENDED JUNE 29,
1997
---------------------------
1997 1996 1995
------- ------- -------
Cash flows from operating activities:
Net income...................................................... $ 4,194 $ 2,716 $ 448
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization................................ 1,394 846 977
Deferred income taxes........................................ (145) (769) --
Deferred compensation related to stock options............... 261 357 --
Accrued interest on notes receivable from stockholders....... (71) (18) --
Changes in assets and liabilities:
Accounts receivable........................................ (2,280) (2,269) (1,381)
Inventories................................................ 499 (2,232) 409
Other assets............................................... 42 80 271
Accounts payable........................................... (941) 896 (236)
Accrued expenses........................................... 135 1,505 (2,645)
Income taxes payable....................................... (258)