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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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ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 29, 2001
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.)
950 EXPLORER BOULEVARD, HUNTSVILLE, ALABAMA 35806-2808
(Address of principal executive offices)
(256) 327-2001
(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 August 31,
2001, as reported by the Nasdaq National Market was $23,813,811. 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 August 31, 2001, the registrant had outstanding 15,744,834 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 14, 2001 (the "Proxy Statement"), (Part III).
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PART I
ITEM 1. BUSINESS
OVERVIEW
Verilink Corporation (the "Company") develops, manufactures, and markets a
broad range of integrated access products and customer premises equipment
("CPE") for use by telecommunication network service providers and corporate end
users. The Company focuses on providing equipment that links service providers,
such as network service providers ("NSPs"), to their enterprise customers. The
Company's products enable connections at broadband access transmission speeds of
T1, NxT1, digital subscriber line ("DSL"), and various optical carrier speeds
(Fiber) with access services and protocols such as Internet ("IP"), Ethernet,
Frame Relay, and Asynchronous Transfer Mode ("ATM"). The Company's customers
include equipment integrators, service providers, and enterprise customers
consisting of wireline and wireless carriers, inter-exchange carriers ("IXCs"),
regional Bell operating companies ("RBOCs"), competitive local exchange carriers
("CLECs"), Internet service providers ("ISPs"), and local, state, and federal
government agencies. The Company was founded in San Jose, California in 1982 and
is a Delaware corporation.
During fiscal 2000 the Company consolidated its operations into its existing
operations located in Huntsville, Alabama in order to reduce expenses, and
thereby enable the Company to achieve profitability at lower revenue levels. The
San Jose based manufacturing operations were outsourced to a third party
electronics manufacturing services provider in September 1999. 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 established cost targets.
INDUSTRY BACKGROUND
Carriers, led by IXCs and RBOCs, have historically been the main consumers
of broadband, optical, and switching equipment. Capital spending by these
companies comprises the majority of telecommunications spending (94% for 2000
according to SG Cowen) and determines the overall direction of the industry.
Capital spending by carriers in calendar 2001 is expected to drop 17% to $94
billion from an all time high of $113 billion in calendar 2000, according to
data provided by SG Cowen. This decline in spending was the logical consequence
of the IXCs and RBOCs overbuilding their backbone networks in the last half of
1999 and throughout calendar 2000.
This high level of capital spending led to sharply higher valuations for
carriers and optical companies, a glut of bandwidth on the backbone networks,
and a lack of revenue from new customer services. As the industry refocuses on
business fundamentals and operating results, capital spending is expected to
grow more slowly to an anticipated $100 billion in calendar 2003. Accordingly,
carriers are expected to seek to improve broadband and optical equipment at the
network edge (the connection from the end-user to the high-speed backbone
network).
THE MARKET OPPORTUNITY
Industry Direction - High Bandwidth to the Network Edge
Verilink recognizes that the telecommunication industry is at a crossroads.
Emerging telecommunication applications and the convergence of voice, data, and
video are propelling the need for greater increased bandwidth capability at the
network edge where the end-user connects to the high-speed 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.
New technologies such as higher speed Ethernet have increased speed and
throughput to end users' Local Area Networks ("LANs"), and fiber technologies
such as Dense Wavelength Division Multiplexing ("DWDM") have tremendously
increased the supply of bandwidth on service provider backbones. The Company
expects high emerging market growth to be in access technologies that link
customers' new high speed LAN's to the massive network capacities generated by
DWDM.
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New services enabled by ATM and the emerging international DSL standard
(G.shdsl) over existing copper infrastructure are predicted to double annually
through calendar 2003 to address the immediate data capacity requirements. By
calendar 2003, approximately 16 million broadband access lines are expected to
be in service according to estimates from Dataquest market research. In addition
to copper based delivery, fiber-to-the-business is also expected to provide
enhanced service options that greatly increase bandwidth at economical price
points to customer premises. Industry analysts indicate that approximately 80%
of all businesses are within one mile of a fiber access point.
Company Growth - Wireline & Wireless
Based on the 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 ATM and IP based services. Applications such as electronic
commerce, web hosting, and storage area networks are expected to drive the need
for higher bandwidth services.
Demand by mobile workers and consumers for wireless communication services
has grown from 1999 through 2000 with significant continued growth through 2003
expected. This trend is enabled by the availability of new low cost digital
services and fueled by intense competition among service providers. Service
providers seeking delivery of new communication services in developing nations
are also increasingly choosing wireless technology as the most cost-effective
solution. The Company expects that future growth in the wireless 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.
The Verilink Solution - High-Bandwidth Access Technologies
Verilink's goal is to help service providers and their enterprise customers
maximize the current copper infrastructure by developing local access
technologies that rejuvenate existing copper installations by raising bandwidth
limits while improving management of critical network connections. Verilink is
also preparing for the movement to optical access technologies that will further
address the bandwidth and connectivity demands by pioneering new techniques to
carry optical networking to the network edge.
The Company combines expertise in broadband access technologies with
web-based application-level software to provide a cost effective, scalable,
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. The Company's
software-based approach results in next generation access devices with
flexibility that greatly improves network visibility for service providers and
their enterprise customers.
PRODUCTS
Verilink offers a portfolio of products appropriate for a wide range of
applications. The Company's products are both modular in design, such as the
Access System 2000 product family and the 1051 and 1024 chassis-based products,
as well as stand-alone devices, such as the WANsuite(R) product family, compact
Lite family of products, PRISM series of channel service/data service unit
devices, and FrameStart(TM) products.
WANsuite Product Family
The Company's WANsuite product family is a suite of software programmable
intelligent integrated access devices that target customer premise applications
for improving "last mile" or network edge broadband communications. The WANsuite
product family is powered by industry standard microprocessors that increase
processing power over traditional termination devices by a factor of 10 to 50
times, depending upon the application. The WANsuite platform supports
copper-based transmission services such as DDS, T1, E1, and G.shdsl, and
includes software support for ATM, Frame Relay, and IP service and application
monitoring and control. The WANsuite product line combines integral channel
service/data service units ("CSU/DSU"), routing, and network monitoring
capabilities. WANsuite products also utilize an embedded web server to provide
an innovative user interface that aligns with the Internet for ease-of-use by
NSPs. The increased flexibility of
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WANsuite products allows quick delivery of customer specific requirements. Some
key WANsuite features are IP Gateway, Network Probe, Intelligent APS, QMC,
SCADA, TCP/IP Server, and routing for IP, Frame Relay, and ATM applications.
Access System 2000
The Company's Access System 2000 ("AS2000(TM)") 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 that 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 gateway card has also
been added to the AS2000 for SCADA, IP Gateway, routing CSU, and DSU
applications.
Access System 4000
The Access System 4000 ("AS4000(TM)") 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.
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 the Company's customers to decrease initial equipment
deployment and ongoing operational costs, while optimizing network and bandwidth
efficiency and increasing equipment density to save space in network closets.
The PRISM 3030/3060 products are modular voice and data multiplexers, which
allow voice and data to be combined over a single T1 facility. The PRISM
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 is also available.
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"). The Company'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.
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 also sells its products and services to North American
enterprises primarily through indirect channels, which include distributors,
systems integrators, and value-added resellers. These include Interlink
Communication Systems, Anixter, Inc., Graybar Electronic Co. Inc., Integrated
Communications, Inc., Inter-Tel, Primary Telecommunications, Inc.,
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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.
In fiscal 2001, net sales to Nortel Networks accounted for 37% of the
Company's net sales, and the Company's top five customers accounted for 66% of
the Company's net sales. In fiscal 2000, net sales to Nortel and WorldCom
accounted for 30% and 19% of the Company's net sales, respectively, and net
sales to 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. Other than Nortel
Networks and WorldCom, no customer accounted for more than 10% of the Company's
net sales in fiscal 2001, 2000, or 1999. 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 "Item 7.
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 included the development of optical
network access products and emphasized enhancements of the existing WANsuite
intelligent integrated access product family. These enhancements to the WANsuite
product family included both advanced protocol development and customer
application inclusion. Other development activities included feature
enhancements and general product improvements to the AS2000 and AS3000 lines of
products. There was also development of some key low-end CSU/DSUs for the
indirect market. The Company's product development strategy has focused on the
development of modular software and hardware products that can be integrated and
adapted to the changing standards and requirements of the communications and
internetworking industries and on the development of low-cost CPE devices that
leverage advancements in hardware and software technology.
In October 2000, the Company entered into agreements with Beacon Telco, L.P.
and the Boston University Photonics Center to establish a product development
center at the Photonics Center to develop new optical network access products.
The arrangement provides the Company with access to the Photonics Center's
state-of-the-art optics laboratories and specialized technical expertise. In
October 2001, the Company suspended the optical network access project. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Subsequent Events and Liquidity".
During fiscal 2001, 2000, and 1999, total research and development
expenditures were $19,682,000, $8,950,000, and $13,391,000, respectively.
Research and development expenditures in fiscal 2001 related to the optical
network access product were $11,538,000. All research and development expenses
are charged to expense as incurred. See Note 7 to the
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Consolidated Financial Statements regarding the accounting treatment of warrants
and bonuses associated with the optical network access project.
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 continue its investment in research and
development in fiscal 2002 for product development of specific technologies,
such as monitoring and control applications software, IP, QoS, 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 "Item 7. Factors Affecting Future Results -- Dependence on
Recently Introduced Products and New Product Development".
MANUFACTURING AND QUALITY
The Company has an agreement with an electronics manufacturing services
provider to outsource substantially all of its procurement, assembly, and system
integration operations previously performed in San Jose. Under the terms of the
agreement, the Company maintains a bonded warehouse on the services provider's
premises and ships products directly to the Company's customers.
The Company's manufacturing operations located in Huntsville, Alabama
primarily support the manufacturing of the product line acquired as part of the
TxPort, Inc. acquisition, 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 facility completed its migration to ISO 9001:2000 certification in
July 2001. ISO 9001 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. In order to continually improve on a
quality management system to effectively and efficiently protect the integrity
of the products, software, and services that it offers its customers, the
Company has begun the implementation process of TL 9000. TL 9000 is a common set
of quality management system requirements and measurements built on currently
used industry standards, including ISO 9001:2000.
COMPETITION
The market for telecommunications network access equipment is characterized
as highly competitive with rapid price erosions on aging technologies. Even if
the number of competitors fades in the next year, consolidation into fewer,
larger competitors will likely fuel increased competition. This market is
subject to rapid technological change, regulatory developments, and new
entrants. The market for integrated access devices such as the Access System and
WANsuite product lines and for enterprise devices such as the PRISM and
FrameStart 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 products based on new technologies, high product value in price
versus performance comparisons, support for multiple types of communication
services, increased network monitoring and control, product reliability, and
quality of customer support. There can be no assurance that the Company's
current products and future products will be able to compete successfully with
respect to these or other factors.
The Company's principal competition for its current AS2000 and AS4000
products are Newbridge Networks Corporation, Tellabs, Telco Systems, ADC
Telecommunications, Inc., Adtran, Inc., and Paradyne Inc. Competition for its
WANsuite and FrameStart products are Visual Networks, Cisco Systems, Adtran,
Inc., and Paradyne Inc. Lastly, the Company's competition for enterprise access
and termination products are Adtran, Inc., Quick Eagle Networks, Kentrox
(recently acquired by Platinum Equity Holdings), General Data Corporation
("GDC"), and Paradyne Inc. 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. To the extent that current or
potential competitors can expand their current offerings to include products
that have functionality similar to the Company's
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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 and that margins are eroding, but the market for feature-enhanced
network termination and high bandwidth network access products may continue to
grow and expand, as more "capability" and "intelligence" moves outward from the
central office to the enterprise. The Company expects emerging broadband
standards and technologies like G.shdsl, ATM, and DWDM to start the next wave of
spending in this market as carriers and enterprises update services to the
network edge.
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
"Item 7. 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 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, enforceable, and infringed by such other technologies
or products. The Company also typically enters 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 on fundamental technologies in software, and patents may be issued which
relate to fundamental technologies incorporated into the Company's products. The
Company may receive communications from third parties 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, or to 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
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on acceptable terms, if at all. In the event of a successful claim against the
Company and the failure of the Company to develop or license a substitute
technology, the Company's business, financial condition, and results of
operations would be materially adversely affected. See "Item 7. Factors
Affecting Future Results -- Risk of Third Party Claims Infringement."
EMPLOYEES
As of June 29, 2001, the Company had 201 full-time employees worldwide, of
whom 66 were employed in engineering, 44 in sales, marketing and customer
service, 63 in manufacturing and 28 in general and administration. All of the
employees are located in the United States except two employees in Canada and
three employees in Mexico.
Management believes that the future success of the Company will depend in
part on its ability to attract and retain qualified employees, including
management, technical, and design personnel. Any lengthy delay in filling new
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, in part, upon its forecast of
customer demand and typically builds finished products in advance of or at the
time firm orders are received 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, and
manufacturing facility are located in a building owned by the Company containing
about 113,000 square feet on approximately 19 acres in Cummings Research Park
West in Huntsville, Alabama. The Company leases an additional 11,000 square feet
of warehouse space in Madison, Alabama.
In addition, the Company has five sales offices located in the United States
and Mexico, and an engineering office in Canada. 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
The Company is not currently involved in any legal actions expected to have
a material adverse effect on the financial conditions or results of operations
of the Company. From time to time, however, the Company may be subject to claims
and lawsuits arising in the normal course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders of the Company
during the fourth quarter ended June 29, 2001.
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 29,
2001.
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Mr. Graham G. Pattison, age 51, joined the Company in April 1999 as
President, Chief Executive Officer and Director. From May 1998 until joining the
Company, Mr. Pattison was Vice President and General Manager of new business
ventures at Motorola's new Internet and Networking Group ("Motorola ING"). From
June 1996 to May 1998, Mr. Pattison served as Vice President and General Manager
of Motorola's Network System Division. 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, Australia.
Mr. Michael L. Reiff, age 53, served the Company as Executive Vice President
and Chief Operating Officer from November 1999 to October 2001. From April 1999
until joining the Company, Mr. Reiff was Vice President of Internet and
Networking Solutions within Motorola 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 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 43, served the Company as Vice President and Chief
Financial Officer from June 2000 to October 2001. From January 1994 until
joining the Company, 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.
Mr. James B. Garner, age 34, joined the Company in November 1998 as Director
of Engineering of the Company's Huntsville business unit. In November 1999, he
transferred to the position of Director of Marketing for the Company and was
promoted to Vice President, Marketing in March 2000. From March 1998 until
joining the Company, 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 39, joined the Company in February 2000 as Vice
President, Operations. From July 1998 until joining the Company, 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 47, joined the Company in November 1998 as Controller
of the Company's Huntsville business unit. In September 1999, Mr. Smith was
promoted to the position of Vice President and Corporate Controller. From
February 1995 until joining the Company, 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 39, 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
the Company, 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.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock is traded on The Nasdaq National Market
("Nasdaq") under the symbol "VRLK". As of September 24, 2001, the Company had
121 shareholders of record and approximately 4,200 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 2001 -- QUARTER ENDED JUNE 29 MARCH 30 DECEMBER 29 SEPTEMBER 29
--------------------------- ------- -------- ----------- ------------
Market Price: High ................. $ 4.95 $ 3.94 $ 6.56 $13.25
Low .................. $ 1.41 $ 1.06 $ 1.75 $ 3.94
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
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 fiscal years 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 29, 2001 and June 30, 2000, and for each of the three years in the
period ended June 29, 2001, and the report of PricewaterhouseCoopers LLP
thereon, are included elsewhere in this report.
FINANCIAL INFORMATION BY YEAR
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND NUMBER OF EMPLOYEES)
FISCAL YEAR ENDED
------------------------------------------------------------
JUNE 29, JUNE 30, JUNE 27, JUNE 28, JUNE 29,
2001(1) 2000(2) 1999(3) 1998 1997
-------- -------- -------- -------- -------
RESULTS OF OPERATIONS DATA:
Net sales ....................................... $ 44,956 $ 67,661 $ 59,553 $ 50,915 $57,170
Gross profit .................................... 20,541 33,698 27,729 25,121 28,845
Income (loss) from operations ................... (17,183) (5,759) (14,901) (3,745) 4,832
Net income (loss) ............................... $(22,755) $ 25 $(13,666) $ (1,071) $ 4,194
Per share amounts:
Net income (loss):
Basic ....................................... $ (1.51) $ 0.00 $ (0.98) $ (0.08) $ 0.31
Diluted ..................................... $ (1.51) $ 0.00 $ (0.98) $ (0.08) $ 0.29
Number of weighted average shares outstanding:
Basic ....................................... 15,095 14,238 13,929 13,742 13,324
Diluted ..................................... 15,095 15,192 13,929 13,742 14,289
Cash dividends (4) ............................ -- -- -- -- --
Research and development as a percentage of sales 43.8% 13.2% 22.5% 24.5% 16.4%
BALANCE SHEET AND OTHER DATA:
Cash, cash equivalents and short-term investments $ 15,735 $ 10,696 $ 17,961 $ 42,415 $39,050
Working capital ................................. 16,251 26,352 25,960 45,163 46,217
Capital expenditures ............................ 5,304 7,333 2,586 2,752 6,471
Total assets .................................... 42,941 58,720 54,281 63,828 60,687
Long-term debt .................................. 5,210 3,521 -- -- --
Total stockholders' equity ...................... $ 29,600 $ 45,114 $ 40,139 $ 53,810 $53,767
Employees ....................................... 201 219 310 250 219
(1) Includes establishment of an income tax valuation allowance of $(13,381).
(2) Includes restructuring charges of $7,891 and reversal of the $3,424 income
tax valuation allowance established in 1999.
(3) Includes in-process research and development charge related to acquisition
of $3,330, restructuring charges of $3,200, and establishment of an income
tax valuation allowance of $(3,424).
(4) 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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12
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)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
----------------------------------------------------
(1)
FISCAL 2001 JUNE 29 MARCH 30 DECEMBER 29 SEPTEMBER 29
----------- ------- -------- ----------- ------------
Net sales ....................................... $ 13,801 $ 10,290 $ 9,036 $ 11,829
Gross profit .................................... 6,777 3,985 3,332 6,447
Income (loss) from operations ................... 11 (3,715) (12,644) (835)
Net income (loss) ............................... $ 34 $ (3,620) $(12,333) $ (6,836)
Per share amounts:
Net income (loss):
Basic ...................................... $ 0.00 $ (0.24) $ (0.84) $ (0.46)
Diluted .................................... $ 0.00 $ (0.24) $ (0.84) $ (0.46)
Number of weighted average shares outstanding:
Basic ...................................... 15,633 15,312 14,719 14,715
Diluted .................................... 16,094 15,312 14,719 14,715
THREE MONTHS ENDED
----------------------------------------------------
(2)
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 $ 1,800 $ (777) $ (9,337)
Per share amounts:
Net income (loss):
Basic ...................................... $ 0.57 $ 0.13 $ (0.06) $ (0.67)
Diluted .................................... $ 0.52 $ 0.11 $ (0.06) $ (0.67)
Number of weighted average shares outstanding:
Basic ...................................... 14,732 14,301 13,971 13,949
Diluted .................................... 16,083 15,896 13,971 13,949
(1) Provision for income taxes of $(6,311) includes establishment of income tax
valuation allowance.
(2) Includes $3,424 for reversal of income tax valuation allowance established
in fiscal 1999.
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13
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 2001 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.
Beginning with fiscal 2000, the Company's fiscal year is the 52- or 53-week
period ending on the Friday nearest to June 30. For fiscal 1999, the Company's
fiscal year was the 52-week period ending on the Sunday closest to June 30.
OVERVIEW
Verilink Corporation (the "Company") develops, manufactures, and markets a
broad range of integrated access products and customer premises equipment
("CPE") for use by telecommunication network service providers and corporate end
users. The Company focuses on providing equipment that links service providers,
such as network service providers ("NSPs"), to their enterprise customers. The
Company's products enable connections at broadband access transmission speeds of
T1, NxT1, digital subscriber line ("DSL"), and various optical carrier speeds
(Fiber) with access services and protocols such as Internet ("IP"), Ethernet,
Frame Relay, and Asynchronous Transfer Mode ("ATM"). The Company's customers
include equipment integrators, service providers, and enterprise customers
consisting of wireline and wireless carriers, inter-exchange carriers ("IXCs"),
regional Bell operating companies ("RBOCs"), competitive local exchange carriers
("CLECs"), Internet service providers ("ISPs"), and local, state, and federal
government agencies. The Company was founded in San Jose, California in 1982 and
is a Delaware corporation.
Verilink's AS2000 product line continued in fiscal 2001 to generate the
majority of sales. The Company 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 product family is a full line of access devices ranging from
CSU/DSUs to software programmable intelligent integrated access devices with
integrated routing and multi-tier reporting. The WANsuite product family is
powered by industry standard microprocessors that increase processing power over
traditional termination devices by a factor of 10 to 50 times, depending upon
the application. The Company also sells single purpose network access devices
for selected applications.
Through agreements entered into with Beacon Telco, L.P. and the Boston
University Photonics Center in fiscal 2001, the Company began development of
optical access broadband solutions that will allow service providers to provide
optical network access products to their enterprise customers. In October 2001,
the Company suspended the optical network access project.
During the second quarter of fiscal 1999, the Company acquired TxPort, Inc.,
a manufacturer of high-speed voice and data communications products, based in
Huntsville, Alabama. Accordingly, the results of operations of TxPort have been
included in the Company's results of operations beginning November 16, 1998, the
date of acquisition.
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 have and may continue to fluctuate from period-to-period in the
future.
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RESULTS OF OPERATIONS
SALES
FISCAL YEAR ENDED
------------------------------------
JUNE 29, JUNE 30, JUNE 27,
2001 2000 1999
-------- ------- -------
(THOUSANDS)
Net sales ........................... $ 44,956 $67,661 $59,553
Percentage change from preceding year (34)% 14% 17%
Net sales for fiscal 2001 decreased 34% to $44,956,000 from net sales of
$67,661,000 in fiscal 2000. This decrease in net sales resulted from a decrease
in sales volume to most of the Company's product markets. Carrier and carrier
access products net sales, primarily AS2000 products, decreased 35% to
$28,900,000 in fiscal 2001 from $44,823,000 in fiscal 2000 and Enterprise access
products decreased 30% to $16,056,000 in fiscal 2001 from $22,838,000 in fiscal
2000. These decreases were primarily a result of reduced spending by our large
telecommunication infrastructure customers, which we believe to be a result of
both economic and industry-wide factors, including over-capacity in our
customers' markets. In the short-term, the Company anticipates that reduced
capital spending by our customers may continue to affect sales, although
forecasting is challenging in the current environment. These large
infrastructure customers have traditionally contributed more than half of the
Company's revenue base. Net sales for 2000 increased 14% from 1999 to
$67,661,000. 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. Sales from the
TxPort products represented approximately 36%, 34%, and 20% of sales in fiscal
2001, 2000, and 1999, respectively. During fiscal 2001, shipments of the AS2000
product line accounted for approximately 61% of net sales compared to 58% during
2000 and 67% in 1999.
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 66%, 61%, and 57% of sales in fiscal 2001, 2000, and 1999,
respectively. The Company's largest customers in fiscal 2001 were Nortel
Networks, Ericsson, WorldCom, Interlink Communications Systems, and Verizon. 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, system integrators, value-added resellers, and
distributors. Sales to value-added resellers and distributors accounted for
approximately 26% of sales in fiscal 2001, as compared to approximately 24% in
2000 and 19% in 1999. 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
FISCAL YEAR ENDED
------------------------------------
JUNE 29, JUNE 30, JUNE 27,
2001 2000 1999
-------- ------- -------
(THOUSANDS)
Gross Profit ........................ $ 20,541 $33,698 $27,729
Percentage of Sales ................. 45.7% 49.8% 46.6%
Gross profit, as a percentage of sales, in fiscal 2001 was 45.7% as compared
to 49.8% in fiscal 2000 and 46.6% in fiscal 1999. The decrease in gross profit
margin in fiscal year 2001 was due to significantly lower sales volume and the
impact of unabsorbed manufacturing overhead. The increase in gross profit margin
in fiscal 2000 was a result of a number of factors, but was primarily
attributable to the impact of the restructuring and consolidation plan completed
during that year. However, fiscal 2000 gross margins were impacted negatively by
the mix of product sales, unabsorbed manufacturing overhead associated with the
San Jose facility before the restructuring, and 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. In future periods, the Company's gross profit
will vary depending upon a number
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15
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.
RESEARCH AND DEVELOPMENT
FISCAL YEAR ENDED
------------------------------------
JUNE 29, JUNE 30, JUNE 27,
2001 2000 1999
-------- ------- -------
(THOUSANDS)
Research and development ............ $ 19,682 $ 8,950 $13,391
Percentage of Sales ................. 43.8% 13.2% 22.5%
Research and development ("R&D") expenses increased to $19,682,000 or 43.8%
of sales in fiscal 2001 compared to $8,950,000 or 13.2% of sales in fiscal 2000.
This increase was due primarily to the new optical network access development
project initiated in October 2000 that is discussed below, as well as an
increase in spending for WANsuite product enhancements. The increase in R&D
expense in fiscal year 2001 as a percentage of sales compared to fiscal 2000 was
due to the increase in actual expenses on a lower sales volume. The expense
decrease in fiscal 2000 from fiscal 1999 was due primarily to the restructuring
and consolidation plan completed during fiscal 2000, and to refocusing R&D
resources to key product development activities such as WANsuite. The decrease
in R&D expenses in fiscal 2000 as a percentage of sales was due to the lower
spending at higher sales volumes.
In October 2000, the Company entered into agreements with Beacon Telco, L.P.
and the Boston University Photonics Center to establish a product development
center at the Photonics Center to develop new optical network access products.
As part of the agreements, the Company issued Beacon Telco warrants to purchase
up to 2,249,900 shares of the Company's Common Stock at an exercise price of
$4.75 per share. Beacon Telco exercised warrants for 749,000 shares in February
2001. The remaining warrants become exercisable over time, subject to
acceleration based upon meeting development milestones and certain other events,
including the market price of the Company's Common Stock exceeding a certain
price, and will expire on October 13, 2003. Based upon milestones achieved
during the fiscal year, warrants for 250,000 shares will become exercisable in
April 2002 subject to the acceleration clauses in the agreements. The agreements
provide Beacon Telco the opportunity to receive two bonus payments, totaling up
to $10,688,000, based in part on meeting certain milestones and the market price
of the Company's Common Stock. See "Subsequent Events and Liquidity" below.
The Company recorded a non-cash charge to research and development expenses
in fiscal 2001 of $8,335,000 for the warrants and the first bonus payment used
in the exercise of warrants for 749,900 shares. The second bonus, of up to
$7,125,000, is payable in full upon the completion of the final milestone in the
optical network access project, or if the agreements are terminated, a pro-rata
portion is payable based on the extent to which the milestones have been
completed. Additionally, the second bonus will be reduced if the price of the
Company's Common Stock is below $4.75 per share at the time the bonus payment is
made. The Company accrues the pro-rata portion of the second bonus related to a
milestone in the period that the milestone is achieved. This bonus accrual is
adjusted in subsequent periods for changes, either increases or decreases, in
the closing market price of the Company's Common Stock when the price is below
$4.75 per share. For fiscal 2001, research and development expenses include
$850,000 for the accrual of the pro-rata portion of the second bonus related to
the milestones achieved during the fiscal year and based upon the closing market
price of the Company's Common Stock on June 29, 2001 of $3.40 per share.
The Company considers product development expenditures to be important to
future sales, but expects research and development expenditures to decrease in
fiscal 2002, 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".
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SELLING, GENERAL AND ADMINISTRATIVE
FISCAL YEAR ENDED
------------------------------------
JUNE 29, JUNE 30, JUNE 27,
2001 2000 1999
-------- ------- -------
(THOUSANDS)
Selling, general and administrative ... $ 18,042 $22,616 $22,709
Percentage of Sales ................... 40.1% 33.4% 38.1%
The Company's selling, general and administrative ("SG&A") expenses
decreased to $18,042,000, or 40.1% of sales in fiscal 2001 from $22,616,000 or
33.4% of sales in fiscal 2000. The decrease in absolute dollars in fiscal year
2001 compared to fiscal 2000 was due to lower variable sales compensation on
lower sales volume, cost reduction programs implemented during the year that
included a headcount reduction in March 2001 and that eliminated or curtailed
substantially all discretionary spending, and the impact of the plan that
consolidated the Company in Huntsville completed during fiscal 2000. The
increase in SG&A as a percentage of sales in fiscal 2001 was due entirely to
lower sales volume. SG&A decreased slightly in fiscal 2000 to $22,616,000 from
$22,709,000 in fiscal 1999 due to several factors, including; (i) completion of
the consolidation plan in December 1999 with the closing of the facilities in
San Jose and the corresponding staff reductions, (ii) inclusion of SG&A expenses
due to the TxPort acquisition for 12 months in fiscal 2000 compared to 7 1/2
months in fiscal 1999, and (iii) depreciation and amortization related to our
Oracle ERP implementation for 12 months in fiscal 2000 compared to 3 months in
fiscal 1999. The decrease in SG&A spending in fiscal 2000 compared to fiscal
1999 as a percentage of sales is due to the slight decrease in dollar spending
at higher sales levels.
RESTRUCTURING CHARGES
During fiscal 2000, the Company announced and completed the consolidation of
its operations into its existing operations located in Huntsville, Alabama, and
outsourced its San Jose based manufacturing activities announced in July 1999.
The Company incurred a net restructuring charge during fiscal 2000 of
$8,041,000. See Note 2 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 2 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.
IN-PROCESS RESEARCH AND DEVELOPMENT CHARGE RELATED TO ACQUISITION
Effective November 16, 1998, the Company completed its acquisition of
TxPort, Inc. from Acme-Cleveland Corporation, by purchasing all the outstanding
shares of TxPort at a cost of $10,500,000. 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. The in-process research
and development of $3,300,000, which was expensed at the acquisition date,
represented the estimated current fair market value of the research and
development projects that had not reached technological feasibility and had no
alternative future uses at the date of the acquisition.
INTEREST AND OTHER INCOME, NET AND INTEREST EXPENSE
Interest and other income, net, declined to $974,000 in fiscal 2001 from
$1,075,000 and $1,235,000 in fiscal 2000 and 1999, respectively, as a result of
lower average invested cash and short-term investment balances, an increase in
early payment discounts from customers, and lower interest rates. With the
completion of renovations to the new headquarters facility in January 2001, the
Company began charging interest payments on long-term debt to interest expense
that totaled $235,000 during the last half of fiscal 2001.
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17
PROVISION FOR (BENEFIT FROM) INCOME TAXES
During fiscal 2001, the Company established a full valuation allowance
against its deferred tax assets due to the net operating loss carry forwards
from prior years and the operating losses incurred in the current fiscal year.
The operating losses in the current fiscal year, while not expected at the
beginning of the year, were driven by the development costs associated with the
optical network access project announced in October 2000, as well as the
downturn in the overall telecommunication market that the Company serves.
Therefore, the provision for income taxes of $6,311,000 established a full
valuation allowance at September 29, 2000 against the Company's deferred tax
assets.
In fiscal 2000 with a return to profitability during the last two quarters
of that fiscal year and the expectation of profits in fiscal 2001, the Company
reversed the deferred tax asset valuation allowance that had been established in
fiscal 1999 and recorded a net benefit from income taxes of $4,709,000. The
effective tax rate in fiscal 2000 without the impact of the change in the
deferred tax asset valuation allowance was a benefit of approximately (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 and other
intangible assets associated with the TxPort acquisition.
In fiscal 1999, the Company recorded no benefit from income taxes due to
operating losses and the uncertainty of realization of the Company's net
deferred tax assets that existed at that time.
LIQUIDITY AND CAPITAL RESOURCES
At June 29, 2001, the Company's principal source of liquidity included
$15,735,000 of unrestricted cash, cash equivalents, and short-term investments.
During fiscal 2001, the Company generated $6,534,000 of net cash from
operating activities, compared to net cash used in operating activities in
fiscal 2000 and 1999 of $7,358,000 and $7,185,000, respectively, due to better
working capital management in fiscal 2001. Accounts receivable decreased
$11,745,000 to $3,488,000 at June 29, 2001 from the prior year balance due to
the timing of shipments during the fourth quarter of each year and the early
payment discount plan utilized by our largest customer in fiscal 2001. Accounts
receivable increased $6,072,000 to $15,233,000 at June 30, 2000, over the
balance at June 27, 1999 due to more shipments being made towards the latter
part of the fourth quarter of fiscal 2000 and a slow down in payments from our
largest customer. Inventories decreased $1,439,000 to $3,401,000 at June 29,
2001 as a result of better control of inventory levels, and decreased $2,024,000
to $4,840,000 at June 30, 2000 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. In
fiscal 2001, accounts payable and accrued expenses decreased in total by
$2,901,000 due to the lower sales volume and cost reduction efforts implemented
during the year. During fiscal 2000, accounts payable and accrued expenses
decreased in total by $4,657,000 to $9,485,000 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.
Net cash used in investing activities of $793,000 in fiscal 2001 compares to
net cash provided by investing activities of $158,000 in fiscal 2000 and net
cash used in investing activities of $2,647,000 in fiscal 1999. The use of funds
in fiscal 2001 were due to capital expenditures of $5,304,000 for renovations to
the new headquarters facility, the completion of the Oracle implementation
project in July 2000, and other equipment purchases, offset by the maturity of
short term investments of $3,563,000. The increase in funds provided by
investing activities in fiscal 2000 is primarily a result of the maturity of
$7,517,000 in short-term investments reduced by $7,333,000 in purchases of
property, plant, and equipment that included the purchase of the new
headquarters facility for $6,350,000. The net cash used in investing activities
in fiscal 1999 resulted primarily from the maturity of $14,515,000 in short-term
investments offset by $10,500,000 of cash used for the acquisition of TxPort,
$2,586,000 for capital expenditures, and $3,561,000 in cash advanced to a
director.
Net cash provided by financing activities was $2,861,000 in fiscal 2001 and
$7,452,000 in fiscal 2000 compared to net cash used in financing activities of
$107,000 in fiscal 1999. Proceeds of $2,431,000, less payments of $645,000, from
loan agreements to borrow up to $6,500,000 to finance the acquisition of the
headquarters facility and improvements thereon and
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18
$808,000 from the issuance of Common Stock under employee stock plans were the
primary sources of cash in fiscal 2001 from financing activities. During fiscal
2000, proceeds of $4,121,000 from long-term debt used to finance the acquisition
of the new headquarters facility was the largest source of cash from financing
activities along with proceeds of $3,201,000 from the issuance of Common Stock
under employee stock plans. The use of cash in fiscal 1999 was primarily
attributable to the Company's repurchase of $937,000 of its Common Stock offset
by $795,000 of proceeds from the exercise of stock options and the employee
stock purchase plan.
As discussed in Note 10 - Related Party Transactions in the Notes to
Consolidated Financial Statements, as of March 2001, the remaining quarterly
payments of $475,000 on outstanding loans to a principal stockholder and
director were rescheduled to March 2002 and additional Common Stock delivered as
collateral for the loans. Under the terms of the loan agreement with the
principal stockholder, the outstanding balance is due in March 2002.
The Company believes that its cash and investment balances, along with
anticipated cash flows from operations based upon current operating plans and
the discretionary spending controls implemented during fiscal 2001 will be
adequate to finance current operations and capital expenditures for the next
fiscal year. The Company's future capital needs will depend on the Company's
ability to meet its current operating forecast, the ability to successfully
bring new products to market, market demand for the Company's products, and the
overall economic strength of our customers in the telecommunication sector. In
the event that results of operations do not substantially meet the Company's
current operating forecast, the Company may evaluate further cost containment,
reduce investments or delay R&D, which could adversely affect the Company's
ability to bring new products to market. The Company from time to time
investigates the possibility of generating financial resources through committed
credit agreements, technology or manufacturing partnerships, joint ventures,
equipment financing, and offerings of debt and equity securities. To the extent
that the Company obtains additional financing, the terms of such financing may
involve rights, preferences or privileges senior to the Company's Common Stock
and stockholders may experience dilution.
SUBSEQUENT EVENTS AND LIQUIDITY
The Company continues to operate in a difficult business environment as
general economic conditions in the United States and abroad have deteriorated
subsequent to year-end. The telecommunications sector continues to experience
weakness as the industry has delayed deployment of services and infrastructure.
The Company has taken actions designed to align its cost structure with current
market conditions. In October 2001, the Company announced cost reduction
measures, including company-wide staff reductions and the suspension of its
optical network access research and development project. The Company intends to
consolidate its assets related to the optical network access project at its
headquarters facility and to re-evaluate its optical position in the future.
Management believes that its cost reduction plan coupled with its current liquid
asset position will allow the Company to maintain adequate liquidity through
fiscal 2002. Management believes that its plans are attainable, but should the
Company experience even worse market conditions, certain other costs and
expenditures would be reduced to maintain adequate liquidity. The Company has
also announced the engagement of the investment banking firm of Morgan Keegan &
Co., Inc. to assist the Company in evaluating potential strategic alternatives.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations, which has an effective date of June 30, 2001 for all
business combinations initiated after this date. This statement supersedes APB
Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for
Preacquisition Contingencies of Purchased Enterprises. This statement requires
all business combinations within the scope of the Statement to be accounted for
using the purchase method of accounting. For business combinations completed
prior to June 30, 2001, the statement requires companies to recognize intangible
assets apart from goodwill and expand the disclosures about assets acquired and
liabilities assumed.
In June 2001, the Financial Accounting Standards Board issued SFAS No. 142,
Goodwill and Other Intangible Assets, which has an effective date starting with
fiscal years beginning after December 15, 2001. This statement, which supersedes
APB Opinion No. 17, Intangible Assets, addresses how intangible assets that are
acquired individually or with a group of other assets should be accounted for in
financial statements upon their acquisition. This statement also addresses how
goodwill and other intangible assets should be accounted for after they have
been initially recognized in the financial statements. Goodwill will cease to be
amortized upon the implementation of the statement and companies will test
goodwill at least annually for impairment.
In August 2001, the Financial Accounting Standards Board issued SFAS No.143,
Accounting for Asset Retirement Obligations ("ARO"), which has an effective date
for financial statements for fiscal years beginning after June 15, 2002. This
statement addresses the diversity in practice for recognizing asset retirement
obligations and requires that obligations associated with the retirement of a
tangible long-lived asset be recorded as a liability when those obligations are
incurred, with the amount of the liability initially measured at fair value.
Upon initially recognizing a liability for an ARO, an entity must capitalize the
cost by recognizing an increase in the carrying amount of the related long-lived
asset. Over time, the liability is accreted to its present value each period,
and the capitalized cost is depreciated over the useful life of the related
asset. Upon settlement of the liability, an entity either settles the obligation
for its recorded amount or incurs a gain or loss upon settlement.
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FACTORS AFFECTING FUTURE RESULTS
As described by the following factors, past financial performance should not
be considered to be a reliable indicator of future performance, and investors
should not use historical trends to anticipate results or trends in future
periods.
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 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 product features under development; selling, general and
administrative expenses; research and development expenditures; total budgeted
capital expenditures; and the adequacy of the Company's cash position for the
next fiscal year. These forward-looking statements involve risks and
uncertainties, and it is important to note that the Company's actual results
could differ materially from those in such forward-looking statements. Among the
factors that could cause actual results to differ materially are the factors
detailed below as well as the other factors set forth in Item 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 the
Company as of the date hereof, and the Company assumes no obligation to update
any forward-looking statement or risk factor. You should consult the risk
factors listed from time to time in the Company's Reports on 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 2001, net sales to Nortel Networks
accounted for 37% of the Company's net sales, and the Company's top five
customers accounted for 66% of the Company's net sales. In fiscal 2000, net
sales to Nortel and WorldCom accounted for 30% and 19% of the Company's net
sales, respectively, and net sales to 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. Other than Nortel Networks and WorldCom, no customer accounted for
more than 10% of the Company's net sales in fiscal years 2001, 2000, or 1999.
There can be no assurance that the Company's current customers will continue to
place orders with the Company, that orders by existing customers will continue
at the levels of previous periods, or that the Company will be able to obtain
orders from new customers. The current economic climate and conditions in the
telecommunication equipment industry are expected to result in reduced sales to
the Company's largest customers in the first quarter of fiscal 2002 as compared
to the fourth quarter of fiscal 2001.
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 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
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agreements with 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 difficult to replace. The loss of the services of one or more of the
Company's executive officers or key personnel, or the inability to continue to
attract qualified personnel would delay product development cycles or otherwise
would have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence on Key Suppliers and Component Availability. The Company has an
agreement with a single outside contractor to outsource substantially all of the
Company's manufacturing operations located in San Jose prior to November 1999,
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. 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 Company generally relies upon contract manufacturers 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.
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.
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 Networks and WorldCom
have varied between quarters by as much as $4.0 million, and order volatility by
these customers had a significant impact on the Company in fiscal 2001. Most of
the Company's sales are in the form of large orders with short delivery times.
The Company's ability to affect and judge the timing of individual customer
orders is limited. The Company has experienced large fluctuations in sales from
quarter-to-quarter due to a wide variety of factors, such as delay,
cancellation, or acceleration of customer projects, and other factors discussed
below. The Company's sales for a given quarter may depend to a significant
degree upon planned product
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shipments to a single customer, often related to specific equipment deployment
projects. The Company has experienced both acceleration and slowdown in orders
related to such projects, causing changes in the sales level of a given quarter
relative to both the preceding and subsequent quarters.
Delays or lost sales can be caused by other factors beyond the Company's
control, including late deliveries by the third party subcontractors the Company
is using to outsource its manufacturing operations as well as by other vendors
of components used in a customer's system, changes in implementation priorities,
slower than anticipated growth in demand for the services that the Company's
products support and delays in obtaining regulatory approvals for new services
and products. Delays and lost sales have occurred in the past and may occur in
the future. 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 Key Suppliers and Component Availability".
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
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successful in resolving product quality or performance issues, there could be an
adverse effect on the Company's business, financial condition, and results of
operations.
Potential Volatility of Stock Price. The trading price of the Company's
Common Stock could be subject to wide fluctuations in response to
quarter-to-quarter variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
developments with respect to patents or proprietary rights, general conditions
in the telecommunication network access and equipment industries, changes in
earnings estimates by analysts, or other events or factors. In addition, the
stock market has experienced extreme price and volume fluctuations, which have
particularly affected the market prices of many technology companies and which
have often been unrelated to the operating performance of such companies.
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 family of integrated access devices introduced during fiscal
2000. The AS2000 product line represented approximately 61% of net sales in
fiscal 2001, 58% of net sales in fiscal 2000, and 67% of net sales in fiscal
1999. Sales of WANsuite products that began during the last quarter of fiscal
2000 did not contribute significantly to net sales during fiscal 2001 as the
Company had anticipated.
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.
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Competition. The market for telecommunications network access equipment is
characterized as highly competitive with rapid price erosions on aging
technologies. Even if the number of competitors fades in the next year,
consolidation into fewer, larger competitors will likely fuel increased
competition. 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 and for enterprise devices such as
the PRISM and FrameStart 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 products based on new technologies, high product value
in price versus performance comparisons, support for multiple types of
communication services, increased network monitoring and control, product
reliability, and quality of customer support. There can be no assurance that the
Company's current products and future products will be able to compete
successfully with respect to these or other factors.
The Company's principal competition for its current AS2000 and AS4000
products are Newbridge Networks Corporation, Tellabs, Telco Systems, ADC
Telecommunications, Inc., Adtran, Inc., and Paradyne Inc. Competition for its
WANsuite and FrameStart products are Visual Networks, Cisco Systems, Adtran,
Inc., and Paradyne Inc. Lastly, competition for enterprise access and
termination products are Adtran, Inc., Quick Eagle Networks, Kentrox (recently
acquired by Platinum Equity Holdings), General Data Corporation ("GDC"), and
Paradyne Inc. 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. 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 and that margins are eroding, but the market for feature-enhanced
network termination and high bandwidth network access products may continue to
grow and expand, as more "capability" and "intelligence" moves outward from the
central office to the enterprise. The Company expects emerging broadband
standards and technologies like G.shdsl, ATM, and DWDM to start the next wave of
spending in this market as carriers and enterprises update services to the
network edge.
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".
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Reorganization of Sales Force. In fiscal 2001, the Company restructured its
sales force at the beginning of the year from a sales force organized by
geographical region to one focused on sales to particular markets and through
particular distribution channels. Midway through the year, the Company further
refined the sales force reorganization in order to emphasize both a geographic
focus and product focus, and to better position the sales force for available
sales opportunities. This reorganization appeared to be disruptive in the first
half of fiscal 2001 and the Company's efforts midway through the fiscal year to
return to a more geographic focus may continue to be disruptive to the Company's
sales in the future. As a result, the Company expects that the reorganization
may continue to have a short-term negative impact on the Company's sales and
results of operations. These changes during this fiscal year may take longer or
be less successful than anticipated, which, in either event, could have a
material adverse effect on the Company's business, financial condition, and
results of operations.
Rapid Technological Change. The network access and telecommunications
equipment markets are characterized by rapidly changing technologies and
frequent new product introductions. The rapid development of new technologies
increases the risk that current or new competitors could develop products that
would reduce the competitiveness of the Company's products. The Company's
success will depend to a substantial degree upon its ability to respond to
changes in technology and customer requirements. This will require the timely
selection, development, and marketing of new products and enhancements on a
cost-effective basis. The development of new, technologically advanced products
is a complex and uncertain process, requiring high levels of innovation. The
Company may need to supplement its internal expertise and resources with
specialized expertise or intellectual property from third parties to develop new
products. The development of new products for the WAN access market requires
competence in the general areas of telephony, data networking, network
management and wireless telephony as well as specific technologies such as DSL,
ISDN, Frame Relay, ATM, and 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 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 DSL are still evolving, such
as the new G.shdsl standard. 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 historical strategy has been to review
acquisition prospects and joint venture opportunities that would compliment its
existing product offerings, augment its
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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 parties asserting that the
Company's products infringe or may infringe the proprietary rights of third
parties. In its distribution agreements, the Company typically agrees to
indemnify its customers for any expenses or liabilities resulting from claimed
infringements of patents, trademarks or copyrights of third parties. In the
event of litigation to determine the validity of any third-party claims, such
litigation, whether or not determined in favor of the Company, could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel from productive tasks. In the event of an
adverse ruling in such litigation, the Company might be required to discontinue
the use and sale of infringing products, expend significant resources to develop
non-infringing technology or obtain licenses from third parties. There can be no
assurance that licenses from third parties would be available on acceptable
terms, if at all. In the event of a successful claim against the Company and the
failure of the Company to develop or license a substitute technology, the
Company's business, financial condition, and results of operations could be
materially adversely affected.
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Limited Protection of Intellectual Property. The Company relies upon a
combination of patent, trade secret, copyright, and trademark laws and
contractual restrictions to establish and protect proprietary rights in its
products and technologies. The Company has been issued certain U.S. and Canadian
patents with respect to limited aspects of its single purpose network access
technology. The Company has not obtained significant patent protection for its
Access System technology. There can be no assurance that third parties have not
or will not develop equivalent technologies or products without infringing the
Company's patents or that a court having jurisdiction over a dispute involving
such patents would hold the Company's patents valid, enforceable, and infringed.
The Company also typically enters into confidentiality and invention assignment
agreements with its employees and independent contractors, and non-disclosure
agreements with its suppliers, distributors and appropriate customers so as to
limit access to and disclosure of its proprietary information. There can be no
assurance that these statutory and contractual arrangements will deter
misappropriation of the Company's technologies or discourage independent
third-party development of similar technologies. In the event such arrangements
are insufficient, the Company's business, financial condition and results of
operations could be materially adversely affected. The laws of certain foreign
countries in which the Company's products are or may be developed, manufactured
or sold may not protect the Company's products or intellectual property rights
to the same extent as do the laws of the United States and thus, make the
possibility of misappropriation of the Company's technology and products more
likely.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At June 29, 2001, the Company's investment portfolio consisted of fixed
income securities of $516,000. These securities, like all fixed income
instruments, are subject to interest rate risk and will decline in value if
market interest rates increase. If market interest rates were to increase
immediately and uniformly by 10% from levels as of June 29, 2001, the decline in
the fair value of the portfolio would not be material. Additionally, the Company
has the ability to hold its fixed income investments until maturity and
therefore, the Company would not expect to recognize such an adverse impact in
income or cash flows. The Company invests cash balances in excess of operating
requirements in short-term securities, generally with maturities of 90 days or
less.
The Company is subject to interest rate risks on its long-term debt. If
market interest rates were to increase immediately and uniformly by 10% from
levels as of June 29, 2001, the additional interest expense would not be
material. The Company believes that the effect, if any, of reasonably possible
near-term changes in interest rates on the Company's financial position, results
of operations, and cash flows would not be material.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The chart entitled "Financial Information by Quarter (Unaudited)" contained
in Item 6 of Part II hereof is hereby incorporated by reference into this Item 8
of Part II of this form 10-K.
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