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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2000
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.)
127 JETPLEX CIRCLE, MADISON, ALABAMA 35758-8989
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(256) 772-3770
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 11, 2000, as reported by the Nasdaq National Market was $59,014,656.
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 11, 2000, the registrant had outstanding 14,716,791 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 15, 2000 (the "Proxy Statement"), (Part III).
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PART I
ITEM 1. BUSINESS
OVERVIEW
Verilink Corporation (the "Company") develops, manufactures, and markets
integrated access products and customer premises equipment ("CPE") for use by
telecommunication network service providers and corporate end users. The
Company's products enable network service providers to connect their enterprise
customers over broadband access services such as T1, Digital Subscriber Line
("DSL"), and Fiber. The Company's customers include equipment integrators,
service providers including wireline and wireless carriers, competitive local
exchange carriers (CLECs), Internet service providers (ISPs), and large
enterprise customers including local, state, and federal government agencies.
The Company was founded in 1982 and is a Delaware corporation.
CONSOLIDATION OF OPERATIONS
In July 1999 the Company announced its plans to substantially consolidate
its operations into its existing operations located outside Huntsville, Alabama.
The goal of this plan was to reduce expenses and enable the Company to achieve
profitability at lower revenue levels. The Company entered into an agreement in
September 1999 to outsource its San Jose based manufacturing operations to a
third party electronics manufacturing services provider. By December 1999, the
administrative and manufacturing facilities occupied by the Company in San Jose
were closed and the associated leases were terminated effective as of January 1,
2000. With the exception of the President, Graham Pattison, none of the
employees located in San Jose elected to transfer to Alabama. Therefore, the
Company recruited the necessary engineering, marketing, and administrative
personnel in Huntsville, which included the recruitment of several key
management executives. The consolidation of operations was successfully
completed ahead of schedule and within the cost targets established through the
restructuring reserves charged to results of operations during the first two
quarters of the fiscal year.
INDUSTRY BACKGROUND
The Link - The Last Mile Solution
In today's information economy, new classes of telecommunication service
providers are rapidly developing to take advantage of new broadband technologies
that provide high-speed access to significantly increased bandwidth in the core
backbone network. Business communication traffic from enterprise customers
continues to increase as data-centric applications provide new revenue
opportunities for NSPs and improved productivity for the enterprise.
Business-to-Business connectivity, E-commerce, packet-voice, and the critical
need to access information are key drivers of the growth in enterprise
communication traffic.
Higher-speed access will be critical in order to harness the power of
communications in the future. New technologies such as higher speed ethernet are
expected to add increased speed and throughput to local area enterprise
networks, and fiber technologies such as Dense Wavelength Division Multiplexer
(DWDM) are expected to tremendously increase the supply of bandwidth for public
and private telecommunication networks. However, LINKING service providers to
their enterprise customers with higher bandwidth demands creates a market need
for improved `last mile' access solutions that offer high-speed voice and data
integration with improved reliability and overall quality of service.
The Goal - High Speed Broadband Access with improved Quality of Service
A fundamental shift from a hierarchical network topology to a
shared-resource, packet-based, infrastructure requires a focus on application
monitoring and control to increase network visibility for next generation access
networks. The evolution from a telecommunication infrastructure designed for
hierarchical circuit switched voice to one centered on efficiently delivering an
increasing amount of packet switched data has resulted in a different approach
for data communications. More bandwidth and better quality of service are the
key requirements from network managers who are responsible for mission critical
business applications. As a result of this shift to shared-resource networks,
problems including latency (delay), data collisions (network congestion), and
lost packets have been introduced by the evolution from voice to data and packet
switching over the public infrastructure. In order for enterprise customers to
take advantage of the efficiencies and lower costs offered by packet-based
networks, they need assurance that the quality of service will allow them to
move mission
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critical applications from dedicated to shared-resource networks. To accomplish
this, service providers must offer guaranteed service level agreements to their
enterprise customers for availability and latency that parallel the dedicated
networks of the past. This requirement results in the need for improved network
visibility (the ability to monitor network performance and traffic patterns),
independent of network transport - T1, DSL or fiber, at the edge of the network
regardless if it is located at the customer premise or the service provider's
point of presence (POP).
The Verilink Solution - A Software Approach to Next Generation Access and
Control
Verilink combines expertise in broadband access technologies with web-based
application-level monitoring and control software to provide a cost effective,
scalable and highly functional integrated voice and data solution. In the past,
access devices were used to terminate circuits and did not have the processing
power needed to obtain higher-level statistics and provide the necessary service
level monitoring. By using industry standard microprocessors and programmable
gate arrays, features and functionality that were normally implemented in
hardware can be converted to software to provide more flexible end-to-end
solutions. Verilink's software-based approach results in next generation access
devices that add increasing levels of intelligence for monitoring and control,
greatly improving network visibility for service providers and their enterprise
customers.
THE MARKET OPPORTUNITY
Broadband communications continue to grow to meet increasing bandwidth needs...
At the end of calendar 1999, over four million high-speed copper lines
provided last mile solutions for businesses. By 2003, approximately 16 million
broadband lines are expected to be in service according to estimates from
Dataquest market research. DSL services for business, a key driver of growth in
broadband access, account for only a small percentage of the current market,
but are expected to experience rapid growth in the future. In addition to copper
based delivery, fiber-to-the-business (FTTB) is also expected to provide
enhanced service options that greatly increase bandwidth at economical price
points to the customer premise. Currently, 80% of all businesses are within one
mile of a fiber access point. Based on this significant market opportunity for
broadband business-to-business connectivity, Verilink expects that future growth
in the wireline market space will come from an increase in the number of
broadband subscribers and the continued growth of the Internet through
applications such as electronic commerce that drive the need for higher
bandwidth services.
Wireless communication continues to grow based on mobile Internet...
Demand by mobile workers and consumers for wireless communication services
has experienced significant growth over the past several years. This growth has
been enabled by the availability of new low cost digital services and fueled by
intense competition among service providers. In addition, service providers who
must deliver new communication services to developing nations are increasingly
looking to wireless technology as the most cost-effective solution. These two
growth drivers have given rise to a multi-billion dollar wireless communications
industry. The Company expects that future growth in this market will come from a
further increase in the number of subscribers, an increase in the total minutes
of use, the increased implementation of wireless local loop systems in
developing nations, and the emergence of broadband access in developed nations.
Wireless communication services provide untethered access between the user and
the service provider's Point-of-Presence (POP). From the POP, voice and data
traffic is then routed over specialized wireline transmission networks. In order
to provide the necessary capacity and geographic coverage to support
uninterrupted wireless access, multiple POP locations must be deployed and
interconnected. Telecom equipment specifically tailored to the rigorous demands
for reliability, scalability and network management will become critical to the
success of these large-scale deployments.
PRODUCTS
WANsuite(TM) Product Family
Verilink's WANsuite(TM) product family is a suite of software programmable
intelligent integrated access devices (I2ADs) that target customer premise
applications for improving "last mile" broadband communications. The
WANSuite(TM) product family is powered by industry standard microprocessors that
increase processing power over traditional termination devices by a factor of 10
to 50 times. The WANSuite(TM) platform supports copper-based transmission
services such as DDS, T1, E1,
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and DSL, and includes software support for frame relay and IP service and
application monitoring and control. The WANSuite(TM) product line combines
integral channel service/data service units (CSU/DSU) with network monitoring
capabilities, and utilizes an embedded web server to provide an innovative user
interface that aligns with the Internet for ease-of-use by network service
providers (NSPs).
Access System 2000(TM)
Verilink's Access System 2000(TM) ("AS2000") is a flexible network access
and management solution that provides cost-effective integrated access to a
broad range of network services. AS2000 products are installed at the
origination and termination points at which NSPs provide communications services
to their corporate customers. AS2000 systems provide transmission link
management, multiplexing, and inverse multiplexing functions for T1 (1.5 MBPS),
E1, multi-T1, multi-E1, and T3 (45 MBPS) access links. A key feature of the
AS2000 is its flexibility and adaptability made possible by a modular
architecture which allows customers to access new services or expanded network
capacity simply by configuring or changing circuit cards. In a single platform,
the AS2000 combines the functions of a T1 CSU/DSU, E1 NTU, inverse multiplexer,
cross-connect, T3 DSU, TDM, automatic protection switch, and a Simple Network
Management Protocol (SNMP) management agent. A WANSuite(TM) gateway card has
also been added to the AS2000 for central-site monitoring and control
applications with software support for providing Internet access.
Access System 4000(TM)
The Access System 4000(TM) ("AS4000") is an integrated access cross-connect
system that provides full non-blocking DACS capability, channel bank
functionality, and standard interfaces including T1, SDSL, HDSL, analog voice,
and T3. The AS4000 is targeted at carriers and enterprise networks that have
access requirements for voice and data applications over a wide array of WAN
circuit types. Numerous enhancements have been added to the AS4000 over the last
year to support routing, redundancy, and higher speed access.
PRISM 3030/3060 Integrated Access Multiplexer
The PRISM 3030/3060 family of intelligent channel banks enables customers to
combine voice and data requirements into a single, multi-functional access
device. This allows them to decrease initial equipment deployment and ongoing
operational costs, while optimizing network and bandwidth efficiency, and
increase equipment density to save space in network closets. The PRISM 3030 and
3060 products are modular voice and data multiplexers, which allow voice and
data to be combined over a single T1 facility. The 3030/3060 products are
deployed as managed voice channel banks, and support FXS, FXO, and E&M
functionality with advanced signaling feature support and integral diagnostic
capabilities. An OCU-DP feature option has been added over the last year.
CSU/DSU Circuit Management Products
Physical layer transmission standards form the foundation upon which all
advanced data services are based, including the Internet, frame relay service,
cell relay service, leased lines, and Integrated Services Digital Networks
(ISDN). Verilink's physical layer transmission devices convert standard data
interchange signals into formats appropriate for sending over carrier
facilities. Additionally, these devices provide physical layer performance
monitoring and diagnostic functions. Verilink transmission systems are produced
to carrier-grade standards of quality and are typically found deployed in the
mission-critical applications used by banks and other corporate enterprises.
Verilink offers a broad portfolio of products appropriate for a wide range
of applications in either modular systems, such as the 1051 and 1024
chassis-based products, or as stand-alone devices. Stand-alone devices include
the compact Lite family of products, and the PRISM 2000, 3000, and 4000 families
of channel service/data service unit devices. Introduced in fiscal 1999, the
FrameStart(TM) family of products enables network administrators to rapidly
deploy and test frame relay LAN-to-LAN or wide area networks at a fraction of
the cost of using full network probes.
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SALES, MARKETING, AND CUSTOMER SUPPORT
Sales and Marketing
The Company sells its products and services to network service providers and
wireless equipment manufacturers primarily through a direct sales force located
in major U.S. metropolitan areas. A direct sales effort, supported by sales
engineers who provide customers with pre- and post-sale technical 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 sells its products and services to North American enterprises
primarily through indirect channels, which include distributors, systems
integrators (SIs), and value-added resellers (VARs). These include Interlink
Communication Systems (ICS), Alltel Supply, Inc., Anixter Bro's, Inc., Graybar
Electronic Co. Inc., ICOM Inc., Inter-Tel, Kent Datacomm, RE/COM Group Inc., and
Sprint North Supply. With the addition of more intelligent integrated access
devices and CPE products, the Company believes that sales through indirect
channels will become increasingly more important.
The Company believes that entry into international markets for advanced
digital network products will be enabled through strategic relationships and
in-country distribution channels that reach both enterprise and NSP customers.
To date, the Company has had minimal direct sales to international customers. In
addition to the specific sales efforts directed at network service providers,
the Company's marketing activities include participating in industry trade shows
and conferences, distribution of sales and product literature, media relations,
advertising in trade journals, direct mail and ongoing communications with
customers and industry analysts. An office in Mexico City, Mexico was
established in May 2000 to focus on service providers in the Latin America
region.
In fiscal 2000, net sales to Nortel and WorldCom accounted for 30% and 19%
of the Company's net sales, respectively, and the Company's top five customers
accounted for 61% of the Company's net sales. In fiscal 1999, net sales to
Nortel and WorldCom accounted for 17% and 27% of the Company's net sales,
respectively, and net sales to the Company's top five customers accounted for
57% of the Company's net sales. In fiscal 1998, net sales to Nortel, WorldCom,
and Ericsson accounted for 20%, 31% and 12% of the Company's net sales,
respectively, and net sales to the Company's top five customers accounted for
64% of the Company's net sales. Percentages of total revenue have been restated
for prior periods as if the September 1998 merger of WorldCom and MCI, and
Ericsson's May 1999 acquisition of Qualcomm's terrestrial Code Division Multiple
Access (CDMA) wireless infrastructure business had been in effect for all
periods presented. Other than Nortel, WorldCom, and Ericsson, no customer
accounted for more than 10% of the Company's net sales in fiscal 2000, 1999, or
1998. 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. See "Factors Affecting Future Results
- - Customer Concentration."
Customer Service and Support
The Company maintains 24-hour, 7-day a week telephone support for all of its
customers. The Company provides for a fee direct installation and service of its
products utilizing its own resources or resources available under a Worldwide
Equipment Support agreement with Vital Network Services, Inc. The Company
provides product training and support to its customers dealing with the
installation, operation, and maintenance of the Company's products.
The Company also offers various levels of maintenance agreements to its
customers for a fee, which provide for on-site service in response to customer
reported difficulties.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts are focused on developing new
products, core technologies, and enhancements to existing products. During the
past year, product development activities have emphasized introduction and
enhancement of the WANsuite(TM) intelligent integrated access product family and
the expansion of features for the AS2000 product family. Other developments
included feature enhancements to the PRISM family of intelligent channel banks,
enhancements to existing CSU/DSUs, and the cost reduction and feature
enhancement of the lower-cost FrameStart(TM) and Lite families of CSU/DSUs. The
Company's product development strategy has focused on the development of modular
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software and hardware products that can be integrated and adapted to the
changing standards and requirements of the communications and internetworking
industries and on the development of low-cost CPE devices that leverage
advancements in hardware and software technology.
During fiscal 2000, 1999, and 1998, total research and development
expenditures were $9.0 million, $13.4 million, and $12.5 million, respectively.
All research and development expenses are charged to expense as incurred.
The markets for the Company's products are characterized by rapidly changing
technology, evolving industry standards, continuing improvements in
telecommunication service offerings, and changing demands of the Company's
customer base. The Company expects to increase its investment in research and
development significantly in fiscal 2001 for product development of specific
technologies, such as monitoring and control applications software, IP, QoS,
optical fiber network access and related technologies, xDSL, network management,
and other performance monitoring services, as well as to respond to market
demand and new service offerings from service providers. Research and
development activities may also include development of new products and markets
based on the Company's expertise in telecommunications network access
technologies. See "Factors Affecting Future Results -- Dependence on Recently
Introduced Products and New Product Development."
MANUFACTURING AND QUALITY
The Company entered into an agreement in September 1999 with an electronics
manufacturing services provider to outsource substantially all of its
procurement, assembly, and system integration operations previously performed in
San Jose. The transition was completed by the end of November 1999. Under the
terms of the agreement, the Company maintains a bonded warehouse on the services
provider's premises and ships products directly to its customers.
The Company's manufacturing operations located in Huntsville, Alabama
primarily support the manufacturing of the former TxPort, Inc. ("TxPort")
product line and 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
for the products at its Huntsville facility, with the exception of surface
mounted printed circuit board assembly. The Company's Huntsville facilities
completed their ISO 9001 certification in March 1999. 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. The Company obtained such
certification through an independent third party, with ongoing audits on a
semi-annual basis.
COMPETITION
The market for telecommunications network access equipment is highly
competitive, and the Company expects competition to increase in the future. This
market is subject to rapid technological change, regulatory developments, and
new entrants. The market for integrated access devices such as the Access System
product line and WANSuite(TM), and for enterprise devices such as the PRISM,
FrameStart(TM), and Lite product lines is subject to rapid change. The Company
believes that the primary competitive factors in this market are the development
and rapid introduction of new product features, price and performance, support
for multiple types of communications services, network management, reliability,
and quality of customer support. There can be no assurance that the Company's
current products and future products under development will be able to compete
successfully with respect to these or other factors. The Company's principal
competition to date for its current AS2000 and AS4000 products has been from
Quick Eagle Networks (formerly Digital Link Corporation), ADC Kentrox, a
division of ADC Telecommunications and Larscom, Inc., a subsidiary of Axel
Johnson. In addition, the Company experiences substantial competition with its
enterprise access and network termination products from companies in the
computer networking market and other related markets. These competitors include
Premisys Communications, Inc. (now a part of Zhone Technologies), Newbridge
Networks Corporation, Visual Networks, Adtran, Inc., and Paradyne Inc. To the
extent that current or potential competitors can expand their current offerings
to include products that have functionality similar to the Company's products
and planned products, the Company's business, financial condition and results of
operations could be materially adversely affected.
The Company believes that the market for basic network termination products
is mature, but that the market for feature-enhanced network termination and
network access products continues to grow and expand, as more "capability" and
"intelligence" moves outward from the central office to the enterprise. The
Company believes that the principal competitive
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factors in this market are price, feature sets, installed base, and quality of
customer support. In this market, the Company primarily competes with Adtran,
Quick Eagle Networks, ADC Kentrox, Paradyne, Visual Networks, and Larscom. There
can be no assurance that such companies or other competitors will not introduce
new products that provide greater functionality and/or at a lower price than the
Company's products. In addition, advanced termination products are emerging
which represent both new market opportunities as well as a threat to the
Company's current products. Furthermore, basic line termination functions are
increasingly being integrated by competitors, such as Cisco and Nortel Networks,
into other equipment such as routers and switches. These include direct WAN
interfaces in certain products, which may erode the addressable market for
separate network termination products.
Many of the Company's current and potential competitors have substantially
greater technical, financial, manufacturing and marketing resources than the
Company. In addition, many of the Company's competitors have long-established
relationships with NSPs. 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".
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company relies upon a combination of patent, trade secret, copyright,
and trademark laws as well as contractual restrictions to establish and protect
proprietary rights in its products and technologies. The Company has been issued
certain U.S., Canadian, and European patents with respect to limited aspects of
its network access technology. The Company has not yet obtained significant
patent protection for its Access System or WANsuite(TM) technologies. There can
be no assurance that third parties have not, or will not, develop equivalent
technologies or products without infringing the Company's patents or that a
court having jurisdiction over a dispute involving such patents would hold the
Company's patents valid and enforceable. The Company has also entered into
confidentiality and invention assignment agreements with its employees and
independent contractors, and enters into non-disclosure agreements with its
suppliers, distributors, and appropriate customers so as to limit access to and
disclosure of its proprietary information. There can be no assurance that these
statutory and contractual arrangements will deter misappropriation of the
Company's technologies or discourage independent third-party development of
similar technologies. In the event such arrangements are insufficient, the
Company's business, financial condition, and results of operations could be
materially adversely affected. The laws of certain foreign countries in which
the Company's products are or may be developed, manufactured, or sold may not
protect the Company's products or intellectual property rights to the same
extent as do the laws of the United States and thus, make the possibility of
misappropriation of the Company's technology and products more likely. See "Item
7. Management's Discussion and Analysis of Financial Conditions and Results of
Operations" and "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
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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 30, 2000, the Company had 219 full-time employees worldwide, of
whom 54 were employed in engineering, 66 in sales, marketing and customer
service, 70 in manufacturing and 29 in general and administration. All of the
employees are located in the United States except one employee in Canada and one
employee in Mexico.
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. The Company currently has several open
positions. Any lengthy delay in filling these positions could lead to delays in
the introduction of various products currently being developed, as well as the
research and development associated with potential new products. See "Item 7.
Management's Discussion and Analysis of Financial Conditions and Results of
Operations" and "Factors Affecting Future Results -- Dependence on Key
Personnel".
BACKLOG
The Company manufactures its products based upon its forecast of customer
demand and typically builds finished products in advance of receiving firm
orders from its customers. Orders for the Company's products are generally
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, engineering,
marketing, and manufacturing facilities are located in a three-building complex
in Madison, Alabama, in which the Company leases approximately 97,000 square
feet. The Company occupies these buildings under leases that expire on various
dates ranging from February 2001 through March 2002. On June 30, 2000, the
Company acquired a facility located in Cummings Research Park West in
Huntsville, Alabama containing about 110,000 square feet on approximately 19
acres. The Company will move its principal headquarters, including
administration, engineering, marketing and manufacturing, to this new facility
after remodeling and other renovations are completed in February 2001.
Approximately 11,000 square feet of warehouse space leased at the Madison
complex will be retained. The remaining leased space will be returned to the
landlord at the end of the various lease terms.
In connection with the consolidation of the Company's operations in
Huntsville, Alabama, the Company entered into a Termination of Lease agreement,
effective as of January 1, 2000, on its previous headquarters and manufacturing
facilities located in San Jose, California. The Company leased these buildings
from Baytech Associates, a partnership that is comprised of Leigh S. Belden and
Steven C. Taylor, Directors of the Company.
In addition, the Company has nine sales offices located in the U.S., Canada,
and Mexico. These properties are occupied under operating leases that expire on
various dates through the year 2003, with options to renew in most instances.
ITEM 3. LEGAL PROCEEDINGS
During fiscal 2000, the Company settled a legal claim arising from an
acquisition made by TxPort prior to the acquisition of TxPort by the Company.
The amount paid to settle this claim did not have a material effect on the
Company's financial position or results of operations.
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.
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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 ended June 30, 2000.
EXECUTIVE OFFICERS OF THE COMPANY
Set forth below is certain information concerning executive officers of the
Company. Unless otherwise indicated, the information set forth is as of June 30,
2000.
Mr. Graham G. Pattison, age 50, joined the Company in April 1999 as
President, Chief Executive Officer and Director. From May 1998 until joining
Verilink, Mr. Pattison was Vice President and General Manager of new business
ventures at Motorola's new Internet and Networking Group (ING). From June 1996
to May 1998, Mr. Pattison served as Vice President and General Manager of
Motorola's Network System Division (NSD). From November 1995 to June 1996, Mr.
Pattison served as Vice President of North American Distribution for Motorola.
From November 1994 to November 1995, Mr. Pattison served as Vice President of
International Distribution for Motorola. Mr. Pattison received a B.S. in
Electrical Engineering and a M.S. in Engineering Technology from Royal Melbourne
Institute of Technology (RMIT), Australia.
Mr. Michael L. Reiff, age 52, joined the Company in November 1999 as
Executive Vice President and Chief Operating Officer. From April 1999 until
joining Verilink, Mr. Reiff was Vice President of Internet and Networking
Solutions within Motorola's new Internet and Networking Group (ING). Prior to
April 1999, Mr. Reiff held several positions including General Manager of North
America Sales and Service for Motorola's Network System Division (NSD) and
Director of Worldwide Customer Service. From April 1994 to January 1997, Mr.
Reiff served as Managing Director of United Kingdom and Ireland for Motorola
ING. Mr. Reiff also held various positions within Motorola's Human Resources
including Director of Organization Development and International H.R. Mr. Reiff
received a B.A. in International Relations from Windham College
Mr. Ronald G. Sibold, age 42, joined the Company in June 2000 as Vice
President and Chief Financial Officer. From January 1994 until joining Verilink,
Mr. Sibold was Treasurer for SCI Systems, Inc., an electronics manufacturing
services company. From July 1993 to January 1994, Mr. Sibold was Assistant
Treasurer for SCI. From February 1989 to July 1993, Mr. Sibold served as vice
president and deputy manager, DG BANK Deutsche Genossenschaftsbank, Atlanta.
Prior to 1989, he held the following positions: assistant vice president,
Commerzbank AG, Frankfurt/Duesseldorf/Atlanta; assistant vice president,
National Australia Bank Ltd., Atlanta; and financial analyst, Wachovia
Corporation, Atlanta. Mr. Sibold received a B.A. in Government from the
University of Virginia, and a M.I.B.S. from the University of South Carolina in
Banking and Finance.
Dr. Edward A. Etzel, age 52, joined the company in April 2000 as Sr. Vice
President Worldwide Sales. From January 1998 until joining Verilink, Dr. Etzel
was Vice President of The Americas and Pacific Rim Sales and Service for
Intermec Technologies. From December 1997 to January 1998, Dr. Etzel served as
Vice President of North America Sales and Service, and from April 1996 to
December 1997, he held the position of Vice President of Indirect Sales at
Intermec Technologies, an automated data collection and mobile computing systems
company headquartered in Everett, Washington. Prior to April 1996, Etzel held
various senior management positions at Hewlett Packard; his last position prior
to joining Intermec Technologies was in the role of Americas Software Sales
Manager. Dr. Etzel received a B.S. in Computer Science from Miami University of
Ohio, a M.B.A. from Golden Gate University in San Francisco, and a Ph.D. from
Kennedy-Western University.
Mr. Steven E. Turner, age 42, joined the Company in November 1998 as Vice
President of the Company's Huntsville Strategic Business Unit. In November 1999,
he was promoted to the position of Vice President and Chief Technical Officer.
From August 1997 until joining Verilink, Mr. Turner served as Vice President of
Engineering and Technology for TxPort, Inc. From November 1995 to August 1997,
Mr. Turner was Vice President of Extended Range Products for Adtran, Inc. Prior
to joining Adtran, Mr. Turner served in various technical and management
capacities with Motorola's Transmission Products Division and Harris
Corporation. Mr. Turner received a B.S. in Electrical Engineering from Louisiana
Tech University and a M.S. in Electrical Engineering from the University of
Missouri.
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Mr. James B. Garner, age 33, joined the Company in November 1998 as Director
of Engineering of the Company's Huntsville Strategic Business Unit. In November
1999, he transferred to the position of Director of Marketing for Verilink and
was promoted to Vice President, Marketing in March 2000. From March 1998 until
joining Verilink, Mr. Garner served as Director of Engineering for TxPort, Inc.
From September 1988 to March 1998, Mr. Garner held various technical and
management positions within Motorola including Senior Marketing Manager for
Motorola's Transmission Products Division. Mr. Garner received a B.S. in
Electrical Engineering from the University of Alabama in Huntsville.
Mr. S. Todd Westbrook, age 38, joined the Company in February 2000 as Vice
President, Operations. From July 1998 until joining Verilink, Mr. Westbrook
served as the president of ZAE Research, Inc., a firm engaged in electronics
design. From April 1987 to July 1998, Mr. Westbrook held several positions at
Avex Electronics, Inc. including Vice President of North America Operations from
March 1996 to July 1998. Mr. Westbrook received a B.S. in Industrial Engineering
from Auburn University.
Mr. C. W. Smith, age 46, joined the Company in November 1998 as Controller
of the Company's Huntsville Strategic Business Unit. In September 1999, Mr.
Smith was promoted to the position of Vice President and Corporate Controller.
From February 1995 until joining Verilink, Mr. Smith served as Vice President,
Finance for TxPort, Inc. Mr. Smith received a B.S. in Accounting from the
University of Alabama.
Ms. Betsy D. Mosgrove, age 38, joined the Company in October 1999 as
Director of Human Resources. In July 2000, Ms. Mosgrove was promoted to the
position of Vice President, Human Resources. From February 1996 until joining
Verilink, Ms. Mosgrove served as Director of Human Resources for Avex
Electronics, Inc. Prior to February 1996, Ms. Mosgrove served in various
capacities in the human resources department at QMS, Inc., including Director of
Benefits, Affirmative Action & HRIS from December 1994 to February 1996. Ms.
Mosgrove received a B.S. in Business Administration from the University of
Alabama in Huntsville.
There are no family relationships among any of the directors or executive
officers of the Company.
All officers are elected annually by and serve at the pleasure of the Board
of Directors of the Company.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been traded on the Nasdaq National Market
(Nasdaq) under the symbol "VRLK" since the Company's initial public offering of
Common Stock in June 1996. Prior to the initial public offering, there was no
established trading market for the Company's Common Stock. As of September 11,
2000, the Company had 115 shareholders of record and approximately 5,300
beneficial owners of shares held in street name. The following table shows the
high and low sale prices per share for the Common Stock as reported by Nasdaq
for the periods indicated:
FISCAL 2000-- QUARTER ENDED JUNE 30 MARCH 31 DECEMBER 31 OCTOBER 1
- --------------------------- -------- -------- ----------- ---------
Market Price: High................. $ 14.13 $ 22.00 $ 5.44 $ 3.75
-------- -------- ------- -------
Low.................. $ 5.63 $ 4.00 $ 1.81 $ 2.00
FISCAL 1999-- QUARTER ENDED JUNE 27 MARCH 28 DECEMBER 27 SEPTEMBER 27
- --------------------------- -------- -------- ----------- ------------
Market Price: High................. $ 3.25 $ 2.63 $ 3.88 $ 4.63
Low.................. $ 3.06 $ 2.13 $ 3.63 $ 4.38
The Company has never declared or paid dividends on its capital stock and
does not intend to pay dividends in the foreseeable future.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data concerning the Company
for and as of the end of each of the years in the five year period ended June
30, 2000, are derived from the audited consolidated financial statements of the
Company. The selected financial data are qualified in their entirety by the more
detailed information and financial statements, including the notes thereto. The
financial statements of the Company as of June 30, 2000 and June 27, 1999, and
for each of the three years in the period ended June 30, 2000, and the report of
PricewaterhouseCoopers LLP thereon, are included elsewhere in this report.
FINANCIAL INFORMATION BY YEAR
(THOUSANDS, EXCEPT PER SHARE AMOUNTS AND NUMBER OF EMPLOYEES)
2000 1999 1998 1997 1996
-------- -------- -------- ------- -------
Net sales............................................... $ 67,661 $ 59,553 $ 50,915 $57,170 $41,608
Gross profit............................................ $ 33,698 $ 27,729 $ 25,121 $28,845 $21,453
Income (loss) from operations........................... $ (5,759)(1) $(14,901)(1) $ (3,745) $ 4,832 $ 3,232
Net income (loss)....................................... $ 25 (2) $(13,666)(2) $ (1,071) $ 4,194 $ 2,716
Net income (loss) per share-- basic..................... $ 0.00 $ (0.98) $ (0.08) $ 0.31 $ 0.27
Net income (loss) per share-- diluted................... $ 0.00 $ (0.98) $ (0.08) $ 0.29 $ 0.25
Shares used to compute net income (loss) per share--
basic................................................. 14,238 13,929 13,742 13,324 10,224
Shares used to compute net income (loss) per share--
diluted............................................... 15,192 13,929 13,742 14,289 10,804
Research and development as a percentage of sales....... 13.2% 22.5% 24.5% 16.4% 17.5%
Capital expenditures.................................... $ 7,333 $ 2,586 $ 2,752 $ 6,471 $ 958
Cash and cash equivalents, restricted
cash and short-term investments....................... $ 11,696 $ 18,476 $ 42,415 $39,050 $40,542
Working capital......................................... $ 26,352 $ 25,960 $ 45,163 $46,217 $45,015
Stockholders' equity.................................... $ 45,114 $ 40,139 $ 53,810 $53,767 $47,234
Total assets............................................ $ 58,720 $ 54,281 $ 63,828 $60,687 $55,218
Employees............................................... 219 310 250 219 182
(1) Includes restructuring charge of $7,891 in 2000 and in-process research and
development charge of $3,330 and restructuring charge of $3,200 in 1999.
(2) Includes income tax valuation allowance reversal of $3,424 in 2000 and
establishment of income tax valuation allowance of $(3,424) in 1999.
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SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table presents unaudited quarterly operating results for each
of the Company's last eight fiscal quarters. This information has been prepared
by the Company on a basis consistent with the Company's audited financial
statements and includes all adjustments, consisting of normal recurring
adjustments, that the Company considers necessary for a fair presentation of the
data.
FINANCIAL INFORMATION BY QUARTER (UNAUDITED)
(THOUSANDS, EXCEPT PER SHARE AMOUNTS)
3 MONTHS ENDED
--------------------------------------------------
FISCAL 2000 JUNE 30 MARCH 31 DECEMBER 31 OCTOBER 1
- ----------- -------- -------- ----------- ---------
Net sales..................................... $ 18,804 $ 17,822 $ 16,183 $ 14,852
Gross profit.................................. $ 10,221 $ 9,253 $ 8,069 $ 6,155
Income (loss) from operations................. $ 3,151 $ 1,597 $ (999) $ (9,508)
Net income (loss)............................. $ 8,339(1) $ 1,800 $ (777) $ (9,337)
Net income (loss) per share-- basic........... $ 0.57 $ 0.13 $ (0.06) $ (0.67)
Net income (loss) per share-- diluted......... $ 0.52 $ 0.11 $ (0.06) $ (0.67)
Shares used to compute net income (loss) per
share-- basic............................... 14,732 14,301 13,971 13,949
Shares used to compute net income (loss) per
share-- diluted............................. 16,083 15,896 13,971 13,949
3 MONTHS ENDED
---------------------------------------------------
FISCAL 1999 JUNE 27 MARCH 28 DECEMBER 27 SEPTEMBER 27
- ----------- -------- -------- ----------- ------------
Net sales..................................... $ 13,365 $ 12,003 $ 17,107 $ 17,078
Gross profit.................................. $ 5,694 $ 4,611 $ 8,654 $ 8,770
Income (loss) from operations................. $ (2,891) $ (8,925) $ (3,637) $ 552
Net income (loss)............................. $ (2,510) $ (8,650) $ (3,228) $ 722
Net income (loss) per share-- basic........... $ (0.18) $ (0.62) $ (0.23) $ 0.05
Net income (loss) per share-- diluted......... $ (0.18) $ (0.62) $ (0.23) $ 0.05
Shares used to compute net income (loss) per
share-- basic............................... 13,858 14,020 13,929 13,908
Shares used to compute net income (loss) per
share-- diluted............................. 13,858 14,020 13,929 14,244
(1) Includes income tax valuation allowance reversal of $3,424 in the quarter
ended June 30, 2000.
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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 ("MD&A") should be read in conjunction with the 2000 Consolidated
Financial Statements and Notes thereto.
This MD&A 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.
In November 1999, the Board of Directors approved the change in the
Company's fiscal year end from the Sunday nearest to June 30 to the Friday
nearest to June 30, beginning with fiscal year 2000. As a result, fiscal 2000
commenced on Monday, June 28, 1999 and ended on Friday, June 30, 2000.
Additionally, fiscal 2000 consisted of 53 weeks with a 14-week period for Q1 as
compared to 13 weeks for all other quarterly periods. Fiscal years 1999 and 1998
ended June 27 and June 28, respectively, and consisted of 52 weeks. References
to 2000, 1999, and 1998 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 and customer premises equipment ("CPE") for use by
telecommunication network service providers and corporate end users. The
Company's products enable network service providers to connect their enterprise
customers over broadband access services such as T1, DSL, and Fiber. The
Company's customers include equipment integrators, service providers including
wireline and wireless carriers, competitive local exchange carriers (CLECs),
Internet service providers (ISPs), and large enterprise customers including
local, state, and federal government agencies.
In fiscal 2000, the Company consolidated its operations into its existing
operations located in Huntsville, Alabama in order to reduce expenses and enable
the Company to achieve profitability at lower revenue levels. The San Jose
facilities were closed and the Company outsourced its San Jose-based
manufacturing operations to a third party electronics manufacturing services
provider.
During the second quarter of fiscal 1999, the Company acquired TxPort, a
manufacturer of high speed voice, and data communications products, based in
Huntsville, Alabama for $10,000,000 in cash, which was funded by the Company's
working capital. Accordingly, the results of operations of TxPort have been
included in the Company's results of operations commencing November 16, 1998,
the date of acquisition.
During 2000, Verilink's AS2000 product line continued to generate the
majority of sales. Verilink designed the AS2000 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 AS2000
provides integrated access to low speed services, fractional T1/E1 services, and
T1, E1, T3, and frame relay services.
The WANSuite(TM) product family is a suite of software programmable
intelligent integrated access devices (I2ADs) that target customer premise
applications for improving "last mile" broadband communications. The
WANSuite(TM) product family is powered by industry standard microprocessors that
increase processing power over traditional termination devices by a factor of 50
times. 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.
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RESULTS OF OPERATIONS
SALES
2000 1999 1998
------- ------- --------
(THOUSANDS)
Net sales ........................... $67,661 $59,553 $ 50,915
Percentage change from preceding year 14% 17% (11)%
Net sales for fiscal 2000 increased 14% to $67.7 million from net sales of
$59.6 million in 1999. The sales contribution of products acquired from TxPort
for a full twelve months in fiscal 2000 compared to 7 1/2 months in 1999
accounted for all this increase offset by lower sales to WorldCom in fiscal
2000. Net sales for 1999 increased 17% from 1998 net sales of $50.9 million. The
increase was primarily attributable to the sales contribution of products
acquired from the TxPort acquisition. Sales from the TxPort products represented
approximately 34% and 20% of sales in fiscal 2000 and 1999, respectively. Net
sales for 1998 were $50.9 million representing a decrease of 11% from 1997 sales
of $57.2 million. During fiscal 2000, shipments of the AS2000 product line
accounted for approximately 58% of net sales compared to 67% during 1999 and 86%
in 1998. The sales contribution of the WANSuite(TM) family of integrated access
devices was negligible in fiscal 2000 because customer testing cycles extended
beyond what had been anticipated.
The Company's business is characterized by a concentration of sales to a
limited number of key customers. Sales to the Company's top five customers
accounted for 61%, 57%, and 64% of sales in fiscal 2000, 1999, and 1998,
respectively. The Company's largest customers in fiscal 2000 were Nortel,
WorldCom, Bell Atlantic/NYNEX, Ameritech, and Ericsson (formerly Qualcomm). 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 through a
direct sales force and through a variety of resellers, including original
equipment manufacturers (OEMs), system integrators, value-added resellers
(VARs), and distributors. Sales to VARs and distributors accounted for
approximately 24% of sales in fiscal 2000, as compared to approximately 19% in
1999 and 10% in 1998. To date, sales outside of North America have not been
significant. However, the Company intends to expand the marketing of its
products to markets outside of North America.
GROSS PROFIT
2000 1999 1998
------- ------- --------
(THOUSANDS)
Gross Profit ........................ $33,698 $27,729 $ 25,121
Percentage of Sales ................. 49.8% 46.6% 49.3%
Gross profit, as a percentage of sales, in fiscal 2000 was 49.8% as compared
to 46.6% in 1999 and 49.3% in 1998. The increase in gross profit margin in
fiscal 2000 was a result of a number of factors, but was primarily attributable
to the benefits of the restructuring and consolidation plan completed during the
year. Fiscal 2000 gross margins were impacted negatively by under-utilization of
the San Jose facility before the restructuring, a high level of non-warranty
repairs during the first quarter of the fiscal year that carried a lower than
average gross margin, and the additional warranty costs associated with the
agreement the Company reached with a customer to share in the expense associated
with correcting a problem involving one of the Company's products installed in
the field. The decrease in gross profit margin in 1999 was primarily due to
significantly lower sales volume for the Company's then San Jose-based
operations, particularly in the second half of the year, in combination with the
relatively fixed cost of maintaining manufacturing operations in both California
and Alabama. This lower sales volume was accompanied by a reduction in unit
volumes of normally high unit volume products, and resulted in inefficiencies
associated with producing a high mix of products at lower volumes. In future
periods, the Company's gross profit will vary depending upon a number of
factors, including the cost of products manufactured at subcontract facilities,
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.
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RESEARCH AND DEVELOPMENT
2000 1999 1998
------- ------- --------
(THOUSANDS)
Research and development ............ $ 8,950 $13,391 $ 12,484
Percentage of Sales ................. 13.2% 22.5% 24.5%
Research and development (R&D) expenses decreased to $9 million or 13.2% of
sales in fiscal 2000 compared to $13.4 million or 22.5% of sales in fiscal 1999.
The expense decrease during fiscal 2000 was due primarily to the restructuring
and consolidation plan, and refocusing R&D resources to key product development
activities such as WANSuite(TM). The decrease in R&D expenses in fiscal 2000 as
a percentage of sales was due to the lower spending at higher sales volumes. The
R&D increase to $13.4 million or 22.5% of sales in 1999 from $12.5 million or
24.5% of sales in 1998 was due principally to the addition of expenses
associated with the TxPort development organization beginning in November 1998,
and to an increased rate of development on the AS3000 product line during the
first half of the fiscal year. Although R & D expenses increased in absolute
dollars, it decreased as a percentage of sales due to higher sales volume in
1999 as compared to 1998. The Company considers product development expenditures
to be critical to future sales and expects to significantly increase research
and development expenditures in 2001, 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. See "Factors Affecting Future Results -- Dependence on Recently
Introduced Products and Products Under Development".
SELLING, GENERAL AND ADMINISTRATIVE
2000 1999 1998
------- ------- --------
(THOUSANDS)
Selling, general and administrative . $22,616 $22,709 $ 16,382
Percentage of Sales ................. 33.4% 38.1% 32.2%
The Company's selling, general and administrative (SG&A) expenses decreased
to $22.6 million, or 33.4% of sales in fiscal 2000 from $22.7 million, or 38.1%
of sales in fiscal 1999. Several factors impact the comparability of these two
fiscal years such as: (i) completion of the restructuring and consolidation plan
in December 1999 with the closing of the facilities in San Jose and
corresponding staff reductions, (ii) inclusion of the expenses associated with
the TxPort acquisition for 12 months in fiscal 2000 compared to 7 1/2 months in
fiscal 1999, and (iii) depreciation and amortization from the ERP implementation
for 12 months in fiscal 2000 compared to 3 months in fiscal 1999 following the
April 1999 conversation date. Selling expenses increased, but at a lower rate
than the sales increase. Marketing expenses remained flat in fiscal 2000, but
included the cost from the use of an outside consultant to assist in
establishing a new strategic direction for the Company. General and
administrative expenses decreased with the reduction in the number of
administrative support personnel and the completion of the ERP implementation.
The decrease in SG&A spending as a percentage of sales is due to the slight
decrease in dollar spending at higher sales levels. The increase in SG&A dollars
spent in fiscal 1999 compared to 1998 was primarily the result of the addition
of expenses from the TxPort acquisition. Selling expenses increased as a result
of increased selling efforts and equipment demonstration costs. Marketing
expenses increased principally as a result of incremental costs associated with
the integration of sales collateral of TxPort into a single company, more
extensive trade show participation, and increases in other promotional
activities such as direct mail campaigns. General and Administrative expenses
also increased as a result of increases in staff associated with the acquisition
of TxPort and outside contract costs associated with the implementation of the
Company's ERP system. These expenses increased as a percentage of sales to 38.1%
in 1999 from 32.2% in 1998 due to increased dollar spending between periods. The
Company expects that general and administrative expenses will remain flat to
slightly increasing, but decrease as a percentage of sales. However, there can
be no assurance that the Company will be successful in its efforts to increase
sales and reduce SG&A as a percentage of sales. See "Factors Affecting Future
Results -- Restructuring Actions May Not Achieve Intended Results".
RESTRUCTURING CHARGES
In July 1999, the Company announced its plans to substantially consolidate
its San Jose operations into its existing operations located in Huntsville,
Alabama. The goal of this plan was to reduce expenses and enable the Company to
achieve
15
16
profitability at lower revenue levels. By the end of December 1999, the Company
had completed this consolidation of its operations. The Company incurred a net
restructuring charge during fiscal 2000 of $8,041,000. See Note 3 of "Notes to
Consolidated Financial Statements" for further details of this restructuring
charge. Approximately $6,522,000 of the restructuring charge was cash in nature
and paid out of the Company's working capital.
In March 1999, the Company announced and implemented a restructuring of the
business to streamline operations and eliminate redundant functions by
consolidating manufacturing operations, combining sales and marketing functions,
and restructuring research and development activities. Included as a part of the
restructuring activities was the retirement of the Company's two founders. The
Company incurred a restructuring charge of $3,200,000 in fiscal 1999 and a
credit of $150,000 was recorded in fiscal 2000. See Note 3 of "Notes to
Consolidated Financial Statements" for further details of the restructuring
charge. Approximately $2,930,000 of the restructuring charge was cash in nature
and paid out of the Company's working capital.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
Effective November 16, 1998, the Company completed its acquisition of
TxPort, Inc. ("TxPort") from Acme-Cleveland Corporation, by purchasing all the
outstanding shares of TxPort at a cost of $10,500,000. TxPort is a manufacturer
of high speed voice and data communications products.
The transaction was accounted for using the purchase method, and the
purchase price was allocated to the assets acquired, including core technology,
and liabilities assumed based on the estimated fair market values at the date of
acquisition.
At the time of the acquisition, the Company was involved in research and
development projects in relation to three areas, enhancement and augmentation of
the CSU product line, enhancement and augmentation of the CSU/DSU product line
and development of packet and frame aware CSU/DSU products along with a virtual
private network product. The in-process research and development of $3.3
million, which was expensed at the acquisition date, represented the estimated
current fair market value of the research and development projects which had not
reached technological feasibility and had no alternative future uses at the date
of acquisition. The value of in-process research and development was determined
by estimating the expected cash flows from the projects once commercially
viable, discounting the net cash flows back to their present value and then
applying a percentage of completion. The net cash flows from the identified
projects were based on management estimates of revenues, cost of sales, research
and development costs, selling, general and administrative costs, and income
taxes from the project. The research and development costs included in the model
reflect costs to sustain the project, but exclude costs to bring the in-process
project to technological feasibility. The estimated revenues were based on
management projections for the projects. Projected gross margins reflect recent
historical performance of other Company products and are in line with industry
expectations. The estimated selling, general and administrative costs, and
research and development costs were estimated excluding synergies expected from
the acquisition.
The discount rate used in discounting the net cash flows from in-process
research and development is 35%. This discount rate reflects the uncertainties
surrounding the successful development of the in-process research and
development, market acceptance of the technology, the useful life of such
technology, the profitability levels of such technology and the uncertainty of
technological advances that could potentially impact the estimates described
above.
The percent of completion for the three project areas was determined by
comparing both effort expected and research and development costs incurred as of
November 1998, to the remaining effort to be expended and research and
development costs to be incurred, based on management's estimates, to bring the
projects to technological feasibility. Based on these comparisons, management
estimated the three project areas to be approximately 55%, 35%, and 60% complete
as of the date of acquisition. The projects were substantially completed by June
1999. The effort and costs required to complete the projects approximated the
estimates made by management at the date of acquisition.
The results of the operations acquired have been included with those of the
Company from the date of acquisition. Intangible assets have been recorded and
are being amortized over estimated useful lives between three and ten years.
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INTEREST AND OTHER INCOME, NET
Interest and other income, net declined to $1.1 million in fiscal 2000 from
$1.2 million and $2.1 million in 1999 and 1998, respectively, as a result of
lower invested cash and short-term investment balances.
BENEFIT FROM INCOME TAXES
During fiscal 2000, the Company recorded a benefit from income taxes of
$4,709,000 that included the reversal of the deferred tax asset valuation
allowance established in fiscal 1999. The effective tax rate in fiscal 2000
without the impact of the change in the deferred tax asset valuation allowance
was about (31)%, compared to a combined federal and state statutory rate of
about 39%. The effective tax rate in fiscal 2000 without the impact of the
deferred tax asset valuation allowance is less than the combined federal and
state rates primarily due to the non-deductibility of the amortization of
goodwill associated with the TxPort acquisition.
In fiscal 1999, the Company recorded no benefit from income taxes due to
continued operating losses and the uncertainty of realization of the Company's
net deferred tax assets. In fiscal 1998, the Company recorded a benefit from
income taxes of $608,000, representing an effective tax rate of 36%.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2000, the Company's principal sources of liquidity included
$10.7 million of cash, cash equivalents, and short-term investments.
During fiscal 2000, the Company used $7.4 million of net cash in operating
activities; a $200,000 increase from the $7.2 million of net cash used in
operating activities in fiscal 1999. During fiscal 1998 the Company generated
$5.2 million in net cash from operating activities. Accounts receivable
increased $6.0 million to $15.2 million at June 30, 2000 from $9.2 million at
June 27, 1999 due to less linearity in shipments in the fourth quarter and a
slow down in payments from our largest customers. Accounts receivable increased
$3.2 million to $9.2 million at June 27, 1999 over the prior year balance. This
was due to the acquisition of TxPort, less linearity in shipments in the fourth
quarter of fiscal 1999 than in 1998, and a $1.3 million advance billing made to
a customer at its request. Inventories decreased $2 million to $4.8 million at
June 30, 2000 primarily due to raw materials and work in process inventories
transferred to the third party electronics manufacturing services provider in
October 1999 as part of the restructuring and consolidation plan. Inventories
increased $2.0 million to $6.9 million at June 27, 1999 from $4.9 million at
June 28, 1998. This increase was due to the acquisition of TxPort and lower
sales volume in the fourth quarter of 1999 than expected. During 2000, accrued
expenses decreased $5.4 million to $5.9 million due to lower salary and benefit
accruals associated with reduced headcount from the consolidation of operations,
payments charged against the warranty reserve for the agreement reached with a
customer to share in the cost of field upgrades, and one-time adjustments to
estimated accruals to customers and vendors. In 1999, total current liabilities
increased $4.1 million to $11.3 million due mainly to the liabilities assumed in
connection with the acquisition of TxPort.
Net cash provided by investing activities of $158,000 in fiscal 2000
compares to net cash used in investing activities of $2.6 million and $26.4
million in fiscal 1999 and 1998, respectively. The increase in funds provided by
investing activities in fiscal 2000 is primarily a result of the maturity of
$7.5 million in short-term investments offset by $7.3 million in purchases of
property, plant and equipment, including the new facility the Company acquired
on June 30, 2000 for $6.4 million. The net cash used in investing activities in
fiscal 1999 resulted primarily from the maturity of $14.5 in short-term
investments offset by $10.5 million in cash used for the acquisition of TxPort,
$2.6 million of capital equipment and $3.6 million of notes receivable from a
director. The net cash used in investing activities in 1998 was primarily the
result of greater purchases of short-term investments and purchases of property
and equipment. The Company estimates that total budgeted capital expenditures in
fiscal 2001 will approximate $4.8 million and will include expenditures to
remodel and upgrade the facility acquired on June 30, 2000 and for R&D and
manufacturing tools and equipment.
Net cash provided by financing activities was $7.5 million in fiscal 2000
compared to net cash used in financing activities of $107,000 in fiscal 1999 and
net cash provided by financing activities of $933,000 in 1998. Proceeds of $4.1
million from long-term debt used to finance the acquisition of the facility
purchased on June 30, 2000 was the largest source of cash from financing
activities during fiscal 2000 along with proceeds of $3.2 million from the
exercise of stock options and the Employee Stock Purchase Plan. The use of cash
in 1999 was primarily attributable to the Company's repurchase of $937,000
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of its Common Stock offset by $795,000 of proceeds from the exercise of stock
options and the Employee Stock Purchase Plan.
In February 1999, the Board of Directors authorized the Company's management
to systematically repurchase up to 1,000,000 shares of the Company's Common
Stock. The Company purchased 25,000 shares and 284,500 shares in fiscal 2000 and
1999 at a cost of $78,000 and $937,000, respectively, under this program. The
Company intends to cancel this repurchase program.
The Company believes that its cash and investment balances and anticipated
cash flows from operations will be adequate to finance current operations,
anticipated investments, and capital expenditures for at least the next twelve
months. However, the Company continues to investigate the possibility of
generating financial resources through committed credit agreements, technology,
or manufacturing partnerships, equipment financing, and offerings of debt and
equity securities.
YEAR 2000 READINESS
The Company's products, computing, and communications infrastructure systems
have operated without year 2000 ("Y2K") related problems to date. The Company is
not aware that any of its major customers or third-party suppliers has
experienced significant Y2K related problems that would have a material impact
on the Company. The total cost to address Y2K was not material to the Company's
financial condition.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 137, "Accounting for Derivative Instruments
and Hedging Activities Deferral of the Effective Date of FASB No. 133" which
deferred the effective date provisions of SFAS No. 133 for the Company until
fiscal year 2001. SFAS No. 133 establishes accounting and reporting standards
for derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. However, since the Company
currently does not hold any derivative instruments and does not engage in
hedging activities, the Company does not expect the adoption of SFAS No. 133 to
have a material impact on its results of operations, financial position or cash
flows.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements."
This pronouncement summarizes certain of the SEC staff's views on applying
generally accepted accounting principles to revenue recognition. The Company has
reviewed the requirements of SAB 101 and believes that its existing accounting
policies are in accordance with the guidance provided in the SAB.
FACTORS AFFECTING FUTURE RESULTS
As described by the following factors, past financial performance should not
be considered to be a reliable indicator of future performance, and investors
should not use historical trends to anticipate results or trends in future
periods.
This Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, including statements
using terminology such as "may," "will," "expects," "plans," "anticipates,"
"estimates," "potential," or "continue," or the negative thereof or other
comparable terminology regarding beliefs, plans, expectations or intentions
regarding the future. Forward-looking statements include statements in (i) Item
1 regarding the goals, intended benefits and continued success of the Company's
plans to substantially consolidate its operations and outsource its
manufacturing operations (the "Restructuring") particularly the goal of reducing
expenses; continued growth of the market for communications services; the
emergence of new communications carriers; the creation of new market
opportunities; the introduction of new telecommunications services; the growing
popularity and use of the Internet; the need for virtual private networking
capabilities becoming critical; the growth in the requirement for additional
bandwidth; the employment of new telecommunications equipment, technology and
facilities; the beneficiaries of the trend toward higher bandwidth; developing
nations increasingly looking to wireless technology; future growth in the
wireless communications industry, particularly in terms of number of
subscribers, minutes used, implementation of new systems and the emergence of
broadband access; research and development expenditures; and the growth of the
market for feature-enhanced network termination and access products; and (ii)
Item 7 regarding the goals and continued success of the Restructuring plan;
product features under development; selling, general and administrative
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expenses; research and development expenditures; total budgeted capital
expenditures; and the adequacy of the Company's cash position for the next
twelve months. These forward-looking statements involve risks and uncertainties,
and it is important to note that Verilink's actual results could differ
materially from those in such forward-looking statements. Among the factors that
could cause actual results to differ materially are the factors detailed below
as well as the other factors set forth in Item 1 and Item 7 hereof. All
forward-looking statements and risk factors included in this document are made
as of the date hereof, based on information available to Verilink as of the date
hereof, and Verilink assumes no obligation to update any forward-looking
statement or risk factor. You should consult the risk factors listed from time
to time in the Company's Reports on Form 10-Q and the Company's Annual Report to
Stockholders.
Customer Concentration. A small number of customers continue to account for
a majority of the Company's sales. In fiscal 2000, net sales to Nortel,
WorldCom, and Ericsson accounted for 30%, 19%, and 3% of the Company's net
sales, and the Company's top five customers accounted for 61% of the Company's
net sales. In fiscal 1999, net sales to Nortel, WorldCom, and Ericsson accounted
for 17%, 27%, and 5% of the Company's net sales, respectively, and net sales to
the Company's top five customers accounted for 57% of the Company's net sales.
In fiscal 1998, net sales to Nortel, WorldCom, and Ericsson accounted for 20%,
31%, and 12% of the Company's net sales, respectively, and net sales to the
Company's top five customers accounted for 64% of the Company's net sales.
Percentages of total revenue have been restated for prior periods as if the
September 1998 merger of WorldCom and MCI and Ericsson's May 1999 acquisition of
Qualcomm's terrestrial Code Division Multiple Access (CDMA) wireless
infrastructure business had been in effect for all periods presented. Other than
Nortel, WorldCom, and Ericsson, no customer accounted for more than 10% of the
Company's net sales in fiscal years 2000, 1999, or 1998. 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. Certain customers of the Company have been or may be acquired by
other existing customers. The impact of such acquisitions on net sales to such
customers is uncertain, but there can be no assurance that such acquisitions
will not result in a reduction in net sales to those customers. In addition,
such acquisitions could have in the past and could in the future, result in
further concentration of the Company's customers. The Company has in the past
experienced significant declines in net sales it believes were in part related
to orders being delayed or cancelled as a result of pending acquisitions
relating to its customers. There can be no assurance that future merger and
acquisition activity among the Company's customers will not have a similar
adverse affect on the Company's net sales and results of operations. The
Company's customers are typically not contractually obligated to purchase any
quantity of products in any particular period. Product sales to major customers
have varied widely from period to period. In some cases, major customers have
abruptly terminated purchases of the Company's products. Loss of, or a material
reduction in orders by, one or more of the Company's major customers would
materially adversely affect the Company's business, financial condition, and
results of operations. See "Competition" and "Fluctuations in Quarterly
Operating Results."
Dependence on Outside Contractors. In September 1999, the Company entered
into an agreement with a single outside contractor to outsource substantially
all of the manufacturing operations previously located in San Jose, including
its procurement, assembly, and system integration operations. The products
manufactured by the outside contractor located in California generated a
majority of the Company's revenues. There can be no assurance that this
contractor will continue to meet the Company's future requirements for
manufactured products, or that the contractor will not experience quality
problems in manufacturing the Company's products. The inability of the Company's
contractor to provide the Company with adequate supplies of high quality
products could have a material adverse effect on the Company's business,
financial condition, and results of operations.
The loss of any of the Company's outside contractors could cause a delay in
the Company's ability to fulfill orders while the Company identifies a
replacement contractor. Because the establishment of new manufacturing
relationships involves numerous uncertainties, including those relating to
payment terms, cost of manufacturing, adequacy of manufacturing capacity,
quality control and timeliness of delivery, the Company is unable to predict
whether such relationships would be on terms that the Company regards as
satisfactory. Any significant disruption in the Company's relationships with its
manufacturing sources would have a material adverse effect on the Company's
business, financial condition, and results of operations.
Dependence on Key Personnel. The Company's future success will depend to a
large extent on the continued contributions of its executive officers and key
management, sales, and technical personnel. The Company is a party to agreements
with certain of its executive officers to help ensure the officer's continual
service to the Company in the event of a change-in-control. Each of the
Company's executive officers, and key management, sales and technical personnel
would be
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difficult to replace. Several members of the senior management team recently
joined the Company and have had only a limited time to work together. The loss
of the services of one or more of the Company's executive officers or key
personnel, the inability of the management team to work effectively together, or
the inability to continue to attract qualified personnel would delay product
development cycles or otherwise would have a material adverse effect on the
Company's business, financial condition and results of operations.
Management of Growth. To manage potential future growth effectively, the
Company must improve its operational, financial and management information
systems and must hire, train, motivate and manage its employees. The future
success of the Company also will depend on its ability to increase its customer
support capability and to attract and retain qualified technical, marketing and
management personnel, for whom competition is intense. In particular, the
current availability of qualified personnel may be limited and competition among
companies for such personnel is intense. The Company is currently attempting to
hire a number of product marketing and engineering personnel and has experienced
some delays in filling such positions. There can be no assurance that the
Company will be able to effectively achieve or manage any such growth, and
failure to do so could delay product development and introduction cycles or
otherwise have a material adverse effect on the Company's business, financial
condition and results of operations. See "Dependence on Key Personnel."
Dependence on Component Availability and Key Suppliers. The Company
generally relies upon a contract manufacturer to buy component parts that are
incorporated into board assemblies used in its products. On-time delivery of the
Company's products depends upon the availability of components and subsystems
used in its products. Currently, the Company and third party sub-contractors
depend upon suppliers to manufacture, assemble and deliver components in a
timely and satisfactory manner. The Company has historically obtained several
components and licenses for certain embedded software from single or limited
sources. There can be no assurance that these suppliers will continue to be able
and willing to meet the Company and third party sub-contractors requirements for
any such components. The Company and third party sub-contractors generally do
not have any long-term contracts with such suppliers, other than software
vendors. Any significant interruption in the supply of, or degradation in the
quality of, any such item could have a material adverse effect on the Company's
results of operations. Any loss in a key supplier, increase in required lead
times, increase in prices of component parts, interruption in the supply of any
of these components, or the inability of the Company or its third party
sub-contractor to procure these components from alternative sources at
acceptable prices and within a reasonable time, could have a material adverse
effect upon the Company's business, financial condition and results of
operations.
Purchase orders from the Company's customers frequently require delivery
quickly after placement of the order. As the Company does not maintain
significant component inventories, delay in shipment by a supplier could lead to
lost sales. The Company uses internal forecasts to determine its general
materials and components requirements. Lead times for materials and components
may vary significantly, and depend on factors such as specific supplier
performance, contract terms, and general market demand for components. If orders
vary from forecasts, the Company may experience excess or inadequate inventory
of certain materials and components, and suppliers may demand longer lead times,
higher prices, or termination of contracts. From time to time, the Company has
experienced shortages and allocations of certain components, resulting in delays
in fulfillment of customer orders. Such shortages and allocations may occur in
the future, and could have a material adverse effect on the Company's business,
financial condition, and results of operations. See "Fluctuations in Quarterly
Operating Results."
Fluctuations in Quarterly Operating Results. The Company's sales are subject
to quarterly and annual fluctuations due to a number of factors resulting in
more variability and less predictability in the Company's quarter-to-quarter
sales and operating results. For example, sales to Nortel, WorldCom, and
Ericsson have varied between quarters by as much as $4.0 million, and orders
delayed by these customers had a significant negative impact on the Company's
third and fourth quarter results in fiscal 1999. Most of the Company's sales are
in the form of large orders with short delivery times. The Company's ability to
affect and judge the timing of individual customer orders is limited. The
Company has experienced large fluctuations in sales from quarter-to-quarter due
to a wide variety of factors, such as delay, cancellation or acceleration of
customer projects, and other factors discussed below. The Company's sales for a
given quarter may depend to a significant degree upon planned product shipments
to a single customer, often related to specific equipment deployment projects.
The Company has experienced both acceleration and slowdown in orders related to
such projects, causing changes in the sales level of a given quarter relative to
both the preceding and subsequent quarters.
Delays or lost sales can be caused by other factors beyond the Company's
control, including late deliveries by the third party subcontractors the Company
is using to outsource its manufacturing operations as well as by other vendors
of
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components used in a customer's system, changes in implementation priorities,
slower than anticipated growth in demand for the services that the Company's
products support and delays in obtaining regulatory approvals for new services
and products. Delays and lost sales have occurred in the past and may occur in
the future. Operating results in recent periods have been adversely affected by
delays in receipt of significant purchase orders from customers. The Company
believes that sales in prior periods have been adversely impacted by merger
activities by some of its top customers. In addition, the Company has in the
past experienced delays as a result of the need to modify its products to comply
with unique customer specifications. These and similar delays or lost sales
could materially adversely affect the Company's business, financial condition
and results of operations. See "Customer Concentration" and "Dependence on
Component Availability and Key Suppliers."
The Company's backlog at the beginning of each quarter typically is not
sufficient to achieve expected sales for that quarter. To achieve its sales
objectives, the Company is dependent upon obtaining orders in a quarter for
shipment in that quarter. Furthermore, the Company's agreements with its
customers typically provide that they may change delivery schedules and cancel
orders within specified timeframes, typically up to 30 days prior to the
scheduled shipment date, without significant penalty. The Company's customers
have in the past built, and may in the future build, significant inventory in
order to facilitate more rapid deployment of anticipated major projects or for
other reasons. Decisions by such customers to reduce their inventory levels
could lead to reductions in purchases from the Company. These reductions, in
turn, could cause fluctuations in the Company's operating results and could have
an adverse effect on the Company's business, financial condition, and results of
operations in the periods in which the inventory is reduced.
The Company's industry is characterized by declining prices of existing
products, and therefore continual improvement of manufacturing efficiencies and
introduction of new products and enhancements to existing products are required
to maintain gross margins. In response to customer demands or competitive
pressures, or to pursue new product or market opportunities, the Company may
take certain pricing or marketing actions, such as price reductions, volume
discounts, or provision of services at below-market rates. These actions could
materially and adversely affect the Company's operating results.
Operating results may also fluctuate due to a variety of factors,
particularly:
- delays in new product introductions by the Company;
- market acceptance of new or enhanced versions of the Company's
products;
- changes in the product or customer mix of sales;
- changes in the level of operating expenses;
- competitive pricing pressures;
- the gain or loss of significant customers;
- increased research and development and sales and marketing expenses
associated with new product introductions; and
- general economic conditions.
All of the above factors are difficult for the Company to forecast, and
these or other factors can materially and adversely affect the Company's
business, financial condition and results of operations for one quarter or a
series of quarters. The Company's expense levels are based in part on its
expectations regarding future sales and are fixed in the short term to a large
extent. Therefore, the Company may be unable to adjust spending in a timely
manner to compensate for any unexpected shortfall in sales. Any significant
decline in demand relative to the Company's expectations or any material delay
of customer orders could have a material adverse effect on the Company's
business, financial condition, and results of operations. There can be no
assurance that the Company will be able to sustain profitability on a quarterly
or annual basis. In addition, the Company has had, and in some future quarter
may have operating results below the expectations of public market analysts and
investors. In such event, the price of the Company's common stock would likely
be materially and adversely affected. See "Potential Volatility of Stock Price".
The Company's products are covered by warranties and the Company is subject
to contractual commitments concerning its products. If unexpected circumstances
arise such that the product does not perform as intended and the Company is not
successful in resolving product quality or performance issues, there could be an
adverse effect on the Company's business, financial condition, and results of
operations. For example, during the fourth quarter of fiscal 1999, the Company
was notified by one of its major customers of an intermittent problem involving
one of the Company's products installed in the field. Although the Company
identified a firmware fix for this problem and negotiated an agreement with the
customer to
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share in the expense associated with the upgrade, this or similar problems in
the future could increase expenses or reduce product acceptance.
Potential Volatility of Stock Price. The trading price of the Company's
common stock could be subject to wide fluctuations in response to
quarter-to-quarter variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
developments with respect to patents or proprietary rights, general conditions
in the telecommunication network access and equipment industries, changes in
earnings estimates by analysts, or other events or factors. In addition, the
stock market has experienced extreme price and volume fluctuations, which have
particularly affected the market prices of many technology companies and which
have often been unrelated to the operating performance of such companies.
Company-specific factors or broad market fluctuations may materially adversely
affect the market price of the Company's common stock. The Company has
experienced significant fluctuations in its stock price and share trading volume
in the past and may continue to do so.
Dependence on Recently Introduced Products and New Product Development. The
Company's future results of operations are highly dependent on market acceptance
of existing and future applications for both the Company's AS2000 product line,
and the WANsuite(TM) family of integrated access devices introduced during the
third quarter of fiscal 2000. The AS2000 product line represented approximately
58% of net sales in fiscal 2000, 67% of net sales in fiscal 1999, and 86% of net
sales in fiscal 1998. Sales of WANsuite(TM) products began during the last
quarter of fiscal 2000. Market acceptance of both the Company's current and
future product lines is dependent on a number of factors, not all of which are
in the Company's control, including the continued growth in the use of bandwidth
intensive applications, continued deployment of new telecommunications services,
market acceptance of integrated access devices in general, the availability and
price of competing products and technologies, and the success of the Company's
sales efforts. Failure of the Company's products to achieve market acceptance
would have a material adverse effect on the Company's business, financial
condition, and results of operations. The market for the Company's products are
characterized by rapidly changing technology, evolving industry standards,
continuing improvements in telecommunication service offerings, and changing
demands of the Company's customer base. Failure to introduce new products in a
timely manner could cause companies to purchase products from competitors and
have a material adverse effect on the Company's business, financial condition
and results of operations. Due to a variety of factors, the Company may
experience delays in developing its planned products. New products may require
additional development work, enhancement, and testing or further refinement
before the Company can make them commercially available. The Company has in the
past experienced delays in the introduction of new products, product
applications and enhancements due to a variety of internal factors, such as
reallocation of priorities, difficulty in hiring sufficient qualified personnel
and unforeseen technical obstacles, as well as changes in customer requirements.
Such delays have deferred the receipt of revenue from the products involved. If
the Company's products have performance, reliability or quality shortcomings,
then the Company may experience reduced orders, higher manufacturing costs,
delays in collecting accounts receivable and additional warranty and service
expenses.
Competition. The market for telecommunications network access equipment is
highly competitive, and the Company expects competition to increase in the
future. This market is subject to rapid technological change, regulatory
developments, and new entrants. The market for integrated access devices such as
the Access System product line and WANSuite(TM), and for enterprise devices such
as the PRISM, FrameStart(TM), and Lite product lines is subject to rapid change.
The Company believes that the primary competitive factors in this market are the
development and rapid introduction of new product features, price and
performance, support for multiple types of communications services, network
management, reliability, and quality of customer support. There can be no
assurance that the Company's current products and future products under
development will be able to compete successfully with respect to these or other
factors. The Company's principal competition to date for its current AS2000 and
4000 products has been from Quick Eagle Networks (formerly Digital Link
Corporation), ADC Kentrox, a division of ADC Telecommunications, and Larscom,
Inc., a subsidiary of Axel Johnson. In addition, the Company experiences
substantial competition with its enterprise access and network termination
products from companies in the computer networking market and other related
markets. These competitors include Premisys Communications, Inc. (now a part of
Zhone Technologies), Newbridge Networks Corporation, Visual Networks, Adtran,
Inc., and Paradyne Inc. To the extent that current or potential competitors can
expand their current offerings to include products that have functionality
similar to the Company's products and planned products, the Company's business,
financial condition and results of operations could be materially adversely
affected.
The Company believes that the market for basic network termination products
is mature, but that the market for feature-enhanced network termination and
network access products continues to grow and expand, as more "capability" and
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"intelligence" moves outward from the central office to the enterprise. The
Company believes that the principal competitive factors in this market are
price, feature sets, installed base, and quality of customer support. In this
market, the Company primarily competes with Adtran, Quick Eagle Networks, ADC
Kentrox, Paradyne, Visual Networks, and Larscom. There can be no assurance that
such companies or other competitors will not introduce new products that provide
greater functionality and/or at a lower price than the Company's like products.
In addition, advanced termination products are emerging which represent both new
market opportunities as well as a threat to the Company's current products.
Furthermore, basic line termination functions are increasingly being integrated
by competitors, such as Cisco and Nortel Networks, into other equipment such as
routers and switches. These include direct WAN interfaces in certain products,
which may erode the addressable market for separate network termination
products.
Many of the Company's current and potential competitors have substantially
greater technical, financial, manufacturing and marketing resources than the
Company. In addition, many of the Company's competitors have long-established
relationships with network service providers. There can be no assurance that the
Company will have the financial resources, technical expertise, manufacturing,
marketing, distribution and support capabilities to compete successfully in the
future. See "Factors Affecting Future Results -- Competition".
Reorganization of Sales Force. In July 2000, the Company restructured its
sales force from a sales force organized by geographical region to one focused
on sales to particular markets and through particular distribution channels.
This reorganization may be disruptive to our business and involves numerous
uncertainties, including, but not limited to, the increased costs to retrain the
sales force in the methods and techniques needed to effectively approach the
different markets and distribution channels available for the Company's
products, the ability to retain current members of the sales force, the
effectiveness of the sales force in closing sales, and the re-allocation of
relationships that the sales force may have previously developed with customers
in the geographic regions. As a result, the Company expects that the
reorganization may have a short-term impact on the Company's sales and results
of operations. The transition to a market and distribution channel based sales
force may take longer or be less successful than anticipated, which, in either
event, could have a material adverse effect on the Company's business, financial
condition, and results of operations.
Rapid Technological Change. The network access and telecommunications
equipment markets are characterized by rapidly changing technologies and
frequent new product introductions. The rapid development of new technologies
increases the risk that current or new competitors could develop products that
would reduce the competitiveness of the Company's products. The Company's
success will depend to a substantial degree upon its ability to respond to
changes in technology and customer requirements. This will require the timely
selection, development and marketing of new products and enhancements on a
cost-effective basis. The development of new, technologically advanced products
is a complex and uncertain process, requiring high levels of innovation. The
Company may need to supplement its internal expertise and resources with
specialized expertise or intellectual property from third parties to develop new
products. The development of new products for the WAN access market requires
competence in the general areas of telephony, data networking, network
management and wireless telephony as well as specific technologies such as
Digital Subscriber Lines (DSL), Integrated Services Digital Networks (ISDN),
Frame Relay, Asynchronous Transfer Mode (ATM), and Internet Protocols (IP).
Furthermore, the communications industry is characterized by the need to design
products that meet industry standards for safety, emissions, and network
interconnection. With new and emerging technologies and service offerings from
network service providers, such standards are often changing or unavailable. As
a result, there is a potential for product development delays due to the need
for compliance with new or modified standards. The introduction of new and
enhanced products also requires that the Company manage transitions from older
products in order to minimize disruptions in customer orders, avoid excess
inventory of old products, and ensure that adequate supplies of new products can
be delivered to meet customer orders. There can be no assurance that the Company
will be successful in developing, introducing or managing the transition to new
or enhanced products, or that any such products will be responsive to
technological changes or will gain market acceptance. The Company's business,
financial condition and results of operations would be materially adversely
affected if the Company were to be unsuccessful, or to incur significant delays
in developing and introducing such new products or enhancements. See "Dependence
on Recently Introduced Products and New Product Development."
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
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this noncompliance must be addressed in the design of the Company's products.
Standards for new services such as frame relay, performance monitoring services
and 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 Potential Acquisitions and Joint Ventures. An
important element of the Company's strategy is to review acquisition prospects
and joint venture opportunities that would compliment its existing product
offerings, augment its market coverage, enhance its technological capabilities
or offer growth opportunities. Transactions of this nature by the Company could
result in potentially dilutive issuance of equity securities, use of cash and/or
the incurring of debt and the assumption of contingent liabilities, any of which
could have a material adverse effect on the Company's business and operating
results and/or the price of the Company's common stock. Acquisitions entail
numerous risks, including difficulties in the assimilation of acquired
operations, technologies and products, diversion of management's attention from
other business concerns, risks of entering markets in which the Company has
limited or no prior experience and potential loss of key employees of acquired
organizations. Joint ventures entail risks such as potential conflicts of
interest and disputes among the participants, difficulties in integrating
technologies and personnel, and risks of entering new markets. The Company's
management has limited prior experience in assimilating such transactions. No
assurance can be given as to the ability of the Company to successfully
integrate any businesses, products, technologies or personnel that might be
acquired in the future or to successfully develop any products or technologies
that might be contemplated by any future joint venture or similar arrangement,
and the failure of the Company to do so could have a material adverse effect on
the Company's business, financial condition and results of operations.
Risks Associated With Entry into International Markets. The Company to date
has had minimal direct sales to customers outside of North America. The Company
has little experience in the European and Far Eastern markets, but intends to
expand sales of its products outside of North America and to enter certain
international markets, which will require significant management attention and
financial resources. Conducting business outside of North America is subject to
certain risks, including longer payment cycles, unexpected changes in regulatory
requirements and tariffs, difficulties in staffing and managing foreign
operations, greater difficulty in accounts receivable collection and potentially
adverse tax consequences. To the extent any Company sales are denominated in
foreign currency, the Company's sales and results of operations may also be
directly affected by fluctuations in foreign currency exchange rates. In order
to sell its products internationally, the Company must meet standards
established by telecommunications authorities in various countries, as well as
recommendations of the Consultative Committee on International Telegraph and
Telephony. A delay in obtaining, or the failure to obtain, certification of its
products in countries outside the United States could delay or preclude the
Company's marketing and sales efforts in such countries, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Risk of Third Party Claims of Infringement. The network access and
telecommunications equipment industries are characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert exclusive patent,
copyright, trademark, and other intellectual property rights to technologies
that are important to the Company. The Company has not conducted a formal patent
search relating to the technology used in its products, due in part to the high
cost and limited benefits of a formal search. In addition, since patent
applications in the United States are not publicly disclosed until the related
patent is issued and foreign patent applications generally are not publicly
disclosed for at least a portion of the time that they are pending, applications
may have been filed which, if issued as patents, could relate to the Company's
products. Software comprises a substantial portion of the technology in the
Company's products. The scope of protection accorded to patents covering
software-related inventions is evolving and is subject to a degree of
uncertainty which may increase the risk and cost to the Company if the Company
discovers third party patents related to its software products or if such
patents are asserted against the Company in the future. Patents have been
granted recently on fundamental technologies in software, and patents may be
issued which relate to fundamental technologies incorporated into the Company's
products. The Company may receive communications from third
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parties asserting that the Company's products infringe or may infringe the
proprietary rights of third parties. In its distribution agreements, the Company
typically agrees to indemnify its customers for any expenses or liabilities
resulting from claimed infringements of patents, trademarks or copyrights of
third parties. In the event of litigation to determine the validity of any
third-party claims, such litigation, whether or not determined in favor of the
Company, could result in significant expense to the Company and divert the
efforts of the Company's technical and management personnel from productive
tasks. In the event of an adverse ruling in such litigation, the Company might
be required to discontinue the use and sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses
from third parties. There can be no assurance that licenses from third parties
would be available on acceptable terms, if at all. In the event of a successful
claim against the Company and the failure of the Company to develop or license a
substitute technology, the Company's business, financial condition, and results
of operations could be materially adversely affected.
Limited Protection of Intellectual Property. The Company relies upon a
combination of patent, trade secret, copyright, and trademark laws and
contractual restrictions to establish and protect proprietary rights in its
products and technologies. The Company has been issued certain U.S. and Canadian
patents with respect to limited aspects of its single purpose network access
technology. The Company has not obtained significant patent protection for its
Access System technology. There can be no assurance that third parties have not
or will not develop equivalent technologies or products without infringing the
Company's patents or that a court having jurisdiction over a dispute involving
such patents would hold the Company's patents valid and enforceable. The Company
has also entered into confidentiality and invention assignment agreements with
its employees and independent contractors, and enters into non-disclosure
agreements with its suppliers, distributors and appropriate customers so as to
limit access to and disclosure